104-1 Income Tax Fundamentals: Inclusions and Exclusions from Income

Question 1

Basic federal income tax formula (as implemented on IRS Form 1040)

Answer 1

Income
- exclusions from gross income
= gross income
- deductions from adjusted gross income (AGI)
= AGI
- the greater of total itemized deductions or standard deduction
OR
taxable income
x Taxpayer filing status to calculate tax
\+ any other taxes
- allowable credits
= taxpayer’s tax liability

Question 2

IRS Form 1040EZ

Answer 2

The most user-friendly of all 3 income tax forms and may be used if a # of requirements apply:
A) taxpayer income is derived solely from wages, salaries, or tips
B) taxable income is < $100k annually
C) no adjustments to income are claimed

Question 3

IRS Form 1040A

Answer 3

Used where the taxpayer does not meet all of the requirements to file IRS Form 1040EZ and if:

A) the only adjustments to taxpayer income are for deductible contributions to an IRA and the student loan interest deduction
B) deductions are not itemized
C) only certain tax credits are claimed

Question 4

5 types of filing statuses

Answer 4

1) Single (S)
2) Married filing jointly (MFJ)
3) Married filing separately (MFS)
4) Head of household (HH)
5) Qualifying widow(er) w/ dependent child [aka Surviving Spouse (SS)]

Question 5

Filing status: Single (S)

Answer 5

Umarried, legally separated, or divorced individual who does not qualify for any other filing status

Question 6

Filing status: Married filing jointly (MFJ)

Answer 6

Usually advantageous for married persons to file a joint return because the combined amount of tax is usually lower

Question 7

Filing status: Married filing separately (MFS)

Answer 7

Each spouse reports only his own income and applicable deductions and credits

May be used when couple is going through a divorce proceeding or merely do not want to assume the joint and several liability of MFJ status

Question 8

Filing status: Head of household (HH)

Answer 8

Unmarried individuals who maintain a household for a qualifying child or relative under the tax law (usually a dependent child or dependent parent)

Rates somewhere between MFJ and single filing status

Question 9

Filing status: Qualifying widow(er) w/ dependent child [aka surviving spouse (SS)]

Answer 9

Taxpayer w/ a dependent child and whose spouse has died within the last three years may use this filing status

Question 10

Gross income

Answer 10

Defined as all income from whatever source derived except for those items specifically excluded by the Tax Code

Question 11

Inclusions

Answer 11

Items that are included in an individual’s gross income

Question 12

FICA (Federal Insurance Contributions Act) payroll tax

Answer 12

Consists of 2 separate taxes:

1) OASDI (Old Age, Survivors, and Disability Insurance, aka social security)
2) Medicare tax

Question 13

Schedule C Income

Answer 13

If reported on the cash flow statement of any taxpayer, you know the individual is self-employed

Question 14

Taxation of social security

Answer 14

Retirement beneficiaries of significant total incomes may be required to include up to 85% of their Social Security benefits as income

For single taxpayers w/ income of $25k or less and married taxpayers w/ provisional income of $34k or less, none of the income is taxable

Question 15

When income is taxed and NOT physically received

Answer 15

1) imputed interest rule

2) constructive receipt income doctrine

Question 16

Imputed interest rule

Answer 16

Occurs in instances when a lender has engaged in a below-market-IR loan transaction, when the lender may be required to impute (report) interest income even without actually receiving this interest

Question 17

Imputed interest rules generally apply to the following types of below-market loans

Answer 17

1. Gift loans
2. Compensation-related loans
3. Tax-avoidance loans

Question 18

Constructive receipt income tax rule or doctrine

Answer 18

Applies when there is no substantial limitation or restriction on a taxpayer’s right to bring the funds under personal control

(E.g. check is ready to be picked up at the desk and person waits until next tax year to pick up)

Question 19

Windfall taxation

E.g. lottery

Answer 19

The winner of a lottery who is given the option of receiving either a lump sum or an annuity must include the full value of the annuity in income immediately, even if she takes the proceeds over time

Exception: qualified prize option

Question 20

Structured settlement

Answer 20

A method of compensating a victim for injuries arising, in most cases, as a result of a personal injury lawsuit

May be taken as an annuity or a lump sum

Prior to 1982, could only be taken as a lump sum

Question 21

Compensatory damages

Answer 21

If the damages arising out of the personal injury lawsuit are considered only to make the injured party whole

Tax free unless it’s payment for discrimination

Question 22

Punitive damages

Answer 22

Damages arising out of a personal injury lawsuit, intended to punish the offender

Generally taxable

Question 23

Exclusions

Answer 23

Usually break down into several categories:

• items categorized by love, affection, or assistance
• items that are a return of capital
• items that, per Tax Codec make the taxpayer “whole” again
• items that are socially desirable or a matter of legislative grace
• items or benefits provided by an employer

Question 24

Fringe Benefits

Answer 24

Part of the compensation package given to an employee that is not salary but consists of valuable consideration

Either nontaxable in full or at least in part

Taxation may result on fringe benefits when they discriminate

Question 25

Accident and Health Plans fringe benefits

Answer 25

Premiums paid by the employer for accident, health, and disability income insurance plans (group plans) are deductible by the employer and generally excludable from the employee’s income

Question 26

Meals And Lodging Fringe Benefits

Answer 26

Meals furnished by the employer on its business premises and for its convenience to employees are not taxable

Question 27

Athletic Facility Provided to Employees fringe benefits

Answer 27

The value of an athletic facility or gym provided by the employer on its premises, if solely for the use of the employee and the employee’s dependents, is nontaxable to the employee

Question 28

Group Term Life Insurance Fringe Benefits

Answer 28

An employee can exclude the premiums paid by the employer on the first $50k of group term life insurance coverage

If the plan is discriminatory, key employees lose the $50k coverage exclusion

Question 29

Education assistance fringe benefits

Answer 29

Undergraduate and graduate education assistance is excluded from an employee’s income in any 1 year, up to a max of $5,250

Question 30

Employer-provided child and dependent care services fringe benefits

Answer 30

An employee can exclude up to $5k annually in child care expenses paid by an employer to enable the employee to work

Question 31

Employer-provided auto (Company car)

Answer 31

The business use of such auto is excludable without limit from the employee’s income

Question 32

Adjusted gross income (AGI)

Answer 32

Gross income - deductions = AGI

a taxpayer who does not itemize deductions is still entitled to any of these adjustments to gross income

Question 33

Capital Loss Carryover

Answer 33

Capital losses may offset capital gains without limit

If capital losses exceed capital gains, they may offset ordinary income up to $3,000

The excess may be carried forward to future tax years

Question 34

Self-Employed Health Insurance Deductions

Answer 34

Self-employer taxpayers (sole proprietors and partners), as well as taxpayers who are more than 2% shareholders of an S corporation, can take a 100% deduction for amounts paid for health insurance coverage for themselves, their spouses, and eligible dependents

Question 35

Student Loan Interest Deduction

Answer 35

Interest paid on qualified higher educational loans is generally deductible to reach AGI

Max allowable deduction = $2,500

This is subject to phaseout

Question 36

Above-the-line deductions

Answer 36

These are allowable regardless of whether the taxpayer claims itemized deductions

These include deductible contributions to IRA’s

These are subtracted from gross income in determining adjusted gross income

Question 37

Gross Income

Answer 37

All income is included in gross income, unless the Internal Revenue Code specifically excludes that income from taxation

Question 38

Form 990

Answer 38

Tax filing for charitable organizations

Question 39

Form 1040 Schedule C

Answer 39

Used to report the income from a sole proprietorship