12 Gross Income

Question 1

Describe the principal residence–use test.

Answer 1

The residence is used by taxpayer as a principal residence for at least two of the preceding five years.

Question 2

Describe the principal residence–ownership test.

Answer 2

The taxpayer must have owned the residence for at least two of the preceding five years. For marital exclusion, both must have used the residence, but only one had to own it.

Question 3

What is the gain on the sale of residence exclusion rule?

Answer 3

A taxpayer may exclude gains up to $250,000 ($500,000 joint return) on the sale of residence.

Question 4

What are the requirements for the $250,000 exclusion on sale of a residence rule?

Answer 4

Frequency test
Ownership test
Use test

Question 5

Describe the principal residence–frequency test.

Answer 5

The exclusion is available no more frequently than every two years; there are limited exceptions.

Question 6

Define “capital assets” and list the two most common categories of capital assets.

Answer 6

Capital assets are assets other than inventory, accounts receivable, notes receivable, assets used in a trade or business, and creative works (in the hands of the creator).
The two most common categories of capital assets are assets used in one’s personal life and investments.

Question 7

Define “Section 1231 assets.”

Answer 7

Realty and depreciable property used in a trade or business owned more than one year.

Question 8

Define “long-term holding period.”

Answer 8

More than one year

Question 9

For corporate tax purposes, what is and what is not considered to be a capital asset?

Answer 9

Capital assets—investment property (not used in a business), such as ownership of stocks and bonds
Noncapital assets—property used in a trade or business, such as inventory, machinery, buildings, and receivables

Question 10

What differences exist between how an individual handles a net capital loss and how a corporation handles a net capital loss?

Answer 10

In connection with net capital losses:
1. Individuals can deduct (against ordinary income) up to $3,000 per year ($1,500 for Married-Filing-Separately taxpayers). Any remaining amount can be carried forward indefinitely.
2. Corporations do not get a capital loss deduction (against ordinary income). However, they can carry net capital losses back for up to three years and forward for up to five years to reduce capital gains. If not fully used up after five years, the remaining capital loss is lost forever. In carrying back or carrying forward capital losses, apply current year losses first. In carrying back or carrying forward capital losses, the capital losses automatically become short-term, regardless of what they originally were.

Question 11

A taxpayer has the following:
$3,000 short-term capital gain
$7,000 short-term capital loss
$9,000 long-term capital gain
$10,000 long-term capital loss
What is the overall tax effect?

Answer 11

1. All short-term transactions are netted first, followed by a netting of all long-term transactions. The net short-term loss is $4,000 ($3,000 gain minus $7,000 loss), and the net long-term loss is $1,000 ($9,000 gain minus $10,000 loss).
2. If both net figures have the same sign (both are gains or both are losses), no further netting is done.
3. Both short-term and long-term transactions are losses here. The short-term losses are deducted (against ordinary income) first but only up to a total deduction of $3,000 ($1,500 for Married-Filing-Separately taxpayers). Because the short-term loss was $4,000, the taxpayer can deduct only $3,000 short-term loss with the remaining ($1,000 short-term and $1,000 long-term) losses carried over indefinitely. This assumes the taxpayer filing status was not Married Filing Separately, in which case the capital loss deduction is limited to $1,500 per year (not $3,000 per year).

Question 12

What is the maximum tax rate for gain attributable to depreciation claimed on real estate for an individual?

Answer 12

25% for straight-line depreciation recapture

Question 13

When can interest on Series EE savings bonds be excluded?

Answer 13

When the taxpayer incurs higher education expenses in year bonds are cashed in.
The exclusion is available only for bonds that are issued to individuals who are at least 24 years old.

Question 14

What type of interest can be excluded from income?

Answer 14

Interest on state or local governmental obligations is excluded.

Question 15

What is the tax treatment of alimony for a divorce finalized after 2018?

Answer 15

For divorces finalized after 2018:
Alimony is not taxed to the recipient.
Alimony is not allowed as a “for adjusted gross income” deduction to the payor.

Question 16

What requirements must be met for a payment to qualify as alimony?

Answer 16

The payment:
Must be in cash or via expense payment.
Must be contingent on the recipient still being alive.
Must be required by a written agreement or decree.
Must not be identified as nonalimony.

Question 17

What is the tax treatment of child support?

Answer 17

It is never taxable to the recipient.
There is no deduction for the payor.

Question 18

Describe the personal injury exclusion rule.

Answer 18

Compensatory damages for physical injuries or sickness only are excluded from income.

Question 19

What is the treatment of life insurance proceeds?

Answer 19

Proceeds of life insurance received due to the death of the insured are excluded from income.

Question 20

What is the tax treatment of gifts?

Answer 20

Gifts are excluded from income.
Income accrued up to the date of the gift is taxable to the donor; after the date of the gift, it is taxable to the donee.

Question 21

Are prizes and awards subject to taxation?

Answer 21

Yes, generally they are taxed.

Question 22

Are scholarships taxable?

Answer 22

Generally scholarships are excluded up to the amount of tuition and expenses.
No services can be required.

Question 23

How does one determine the amount of property dividend that should be included in income?

Answer 23

Value received to extent paid from earnings and profits

Question 24

What is the tax treatment of proportionate stock dividends and splits?

Answer 24

They are not taxable events.
The taxpayer must adjust basis per share.
The option to receive cash instead triggers dividend income to all recipients.

Question 25

Under what circumstances are health insurance proceeds excluded from income?

Answer 25

Health insurance proceeds are excluded from income if:
The taxpayer paid the premiums.
The employer paid the premiums and reimbursement is for qualified medical expenses.

Question 26

What are common types of fringe benefits that can be excluded from an employee’s income?

Answer 26

Meals and lodging for convenience of the employer
Working condition expenses
De minimis fringes
No-additional-cost fringes
Employee discounts
Employee gifts (under $25)
Safety/achievement awards

Question 27

What is the working condition benefit?

Answer 27

It is a benefit provided by the employer that would be deductible if the employee had instead paid the expense, excluded from income if reimbursed by the employer.

Question 28

A taxpayer generally can exclude the value of an employee discount that an employer provides an employee from the employee’s wages, up to what limits?

Answer 28

20% of the value of services
Average gross profit percentage for goods

Question 29

What is the tax treatment of contributions of salary to “qualified” pension plans?

Answer 29

The contributions are tax deferred until distributions are made from the pension.

Question 30

What insurance premiums paid for employees are excludible from the employee’s income?

Answer 30

Group term life insurance up to $50,000 of coverage
Health insurance premiums
Disability insurance premiums

Question 31

What types of worldwide income must U.S. taxpayers include in the tax return?

Answer 31

U.S. taxpayers must include income earned from anywhere in the world on their federal income tax return.

Question 32

A taxpayer has the following:
$10,000 short-term capital gain.
$8,000 short-term capital loss.
$9,000 long-term capital gain.
$13,000 long-term capital loss.
What is the overall tax effect?

Answer 32

All short-term transactions are netted first, followed by a netting of all long-term transactions. The net short-term gain is $2,000 ($10,000 gain minus $8,000 loss), and the net long-term loss is $4,000 ($9,000 gain minus $13,000 loss).
Because one of these is a gain and one is a loss, they are netted together to create a single $2,000 net loss, which is long-term because the long-term loss was larger than the short-term gain.

Question 33

List the requirements for deducting losses for worthless assets.

Answer 33

The asset must be totally worthless.
It is treated as sold for no consideration on the last day of the taxable year.

Question 34

List the requirements for deducting non-business bad debts.

Answer 34

The debts must be bona fide loans.
They are deductible as short-term capital losses in the year they are completely worthless.
Partial worthlessness is not deductible.

Question 35

What deductions are allowed for illegal drug businesses?

Answer 35

Only the cost of goods sold is allowed as a deduction.

Question 36

List the requirements for business expense deductions.

Answer 36

The expenses must:
Have bona fide profit motive.
Be ordinary and necessary.
Be reasonable in amount.

Question 37

Are tips always included in an individual taxpayer’s gross income?

Answer 37

Tips are included in an individual’s gross income whether reported to the employer or not. Tips reported by the employee to the employer are included in taxable wages.

Question 38

Most fringe benefits cannot discriminate against non-highly compensated employees. The discrimination rules do not apply to which fringe benefits?

Answer 38

• Health insurance premiums (as long as plan is not self-insured)
• Working condition fringe benefits
• Transportation and parking fringe benefits
• Lodging on the employer’s premises

Question 39

What is a guaranteed payment from a partnership to a partner?

Answer 39

Guaranteed payments are based on a separate contractual relationship between a partner and a partnership without regard to the partnership’s income. They are usually made in exchange for services or for the use of capital and are taxable as ordinary income to the recipient partner.

Question 40

What is an annuity?

Answer 40

An annuity is a contract between an individual and an insurance or investment company in which the individual pays a lump sum of money today to receive regular, fixed payments in the future. Earnings (usually interest) from an annuity accumulate on a tax-deferred (postponed) basis. How the annuity is funded (with pre-tax or post tax dollars) determines the tax treatment of the distributions.

Question 41

If an annuity is purchased with pre-tax dollars, what is the tax consequence of the distribution from the annuity?

Answer 41

Distributions are fully taxable.

Question 42

What is the tax consequence of receiving an inheritance?

Answer 42

The receipt of an inheritance is nontaxable.

Question 43

True or False: An individual taxpayer must always include their Social Security benefits in their gross income.

Answer 43

False. Taxpayers may be required to include up to 85% of their benefits in gross income unless their modified AGI is under a certain threshold.

Question 44

What is income in respect of a decedent?

Answer 44

Income in respect of a decedent (IRC) refers to income the decedent had earned or had a right to receive during their lifetime, that wasn’t properly includible in their final income tax return (eg, rent, wages, dividends).
IRD is excluded from the decedent’s final income tax return and taxed to the taxpayer, typically the estate or the beneficiary, who actually or constructively collects the IRD.