12.01 Gross Income

Question 1

What does gross income include?

Answer 1

U.S. tax law specifies that gross income includes realized income from whatever source derived unless exempted by statute.

Question 2

When is income realized?

Answer 2

Income is realized when:
1. A taxpayer engages in a transaction (including exchange of services) with another party, and
2. The transactions results in a measurable change in property rights between parties.

Question 3

What are some examples of what is included in taxable wages?

Answer 3

Salaries and wages, including overtime and premium pay
Vacation, sick, and holiday pay and PTO
Bonuses, commissions, prizes, and awards
Tips reported by the employee to the employer
Business expense reimbursements made under a nonaccountable plan
Taxable employee and employer contributions to an HSA
Noncash payments, such as taxable fringe benefits

Question 4

Define a fringe benefit.

Answer 4

A fringe benefit is nonmonetary compensation for services performed. Unless excluded by law, employees recognize compensation or ordinary income on all benefits received.

Question 5

What are examples of taxable fringe benefits?

Answer 5

Gym memberships; automobile allowance on a personal car; use of a corporate jet; moving expense reimbursements; personal expenses paid by the employer; anything else not specifically excluded by law; parking reimbursements in excess of the exclusion amount.

Question 6

What are examples of fringe benefits excluded from income?

Answer 6

Accident and health benefits; achievements awards; adoption assistance; athletic facilities on business premises; de minimis benefits; dependent care assistance; employee discounts; employee stock options; group-term life insurance; HSA; lodging on business premises; meals provided for employer convenience; no additional cost services; retirement planning; tuition reduction.

Question 7

What are the discrimination rules regarding fringe benefits?

Answer 7

Most fringe benefits cannot discriminate against non-highly compensated employees. That is, the benefit cannot be extended to only those who are highly compensated.

Question 8

What happens if a fringe benefit is discriminatory?

Answer 8

If a benefit is discriminatory, then the highly compensated employees are taxed at the FMV of the benefit received.

Question 9

What fringe benefits are excluded from the discrimination rules?

Answer 9

Health insurance premiums; Working condition fringe benefits; Transportation and parking fringe benefits; Lodging on the employer’s premises.

Question 10

What is a flexible spending account?

Answer 10

A flexible spending account is a benefit that allows employees to set aside a portion of pre-tax salary to pay for qualified medical, dependent care, or adoption expenses. One drawback is that any funds not used by the end of the tax year are forfeited.

Question 11

Define interest income.

Answer 11

Interest income is investment income on financial instruments that accrues over time. In general, all interest income is taxable unless a specific exception exists.

Question 12

What are the rules regarding interest income earned on bonds?

Answer 12

State and local municipal bonds interest is not taxable. All other government interest is taxable (e.g. federal bonds, T-bills).

Question 13

When is the interest income earned on Series EE or Series I savings bonds excluded from income?

Answer 13

Exempt if used for higher education for self, spouse, or dependent. Applied to tuition and qualifying fees, but expenses for room and board do not qualify.

Question 14

Where is interest income reported?

Answer 14

Schedule B

Question 15

Where are dividends reported?

Answer 15

Schedule B

Question 16

What is a dividend?

Answer 16

A distribution of cash or property from a corporation.

Question 17

What are the two categories of dividends?

Answer 17

Ordinary and qualified.

Question 18

What are the special tax rates for qualified dividends?

Answer 18

Qualified dividends are taxed at special 0%, 15% or 20%, similar to long-term capital gains.

Question 19

Define qualified dividend.

Answer 19

Qualified dividends are from a domestic corporation and certain qualified foreign corporations. The taxpayer must hold the stock for 60+ days during 121-day period beginning 60 days prior to ex-dividend date.

Question 20

What is not taxed as dividend income?

Answer 20

Life insurance dividend - return on premium (but interest on the dividend is taxable)
Dividends received from an S corporation
Stock dividends or stock splits on common stock
Liquidating dividend - return on capital

Question 21

What is a guaranteed payment?

Answer 21

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 use of capital and are taxable as ordinary income to the recipient partner.

Question 22

What is a qualified retirement plan?

Answer 22

Qualified retirement plans are employer-sponsored plans that meet the requirements of the IRC and ERISA to receive tax-favored status.

Question 23

How do employers benefit from a qualified retirement plan?

Answer 23

For employers, the contributions are tax deductible, the plan can be a way to attract and retain good employees, and the business may receive tax credits to help offset the costs.

Question 24

How do employees benefit from a qualified retirement plan?

Answer 24

For employees, contributions to traditional plans and investment gains are deferred until distributed, Roth plans allow tax-free growth, and both provide an easy way to accumulate retirement income.

Question 25

When are withdrawals from a qualified retirement plan taxed?

Answer 25

Depending on the type of plan, the distribution may be includible in gross income.
Distributions from traditional IRAs are taxed as ordinary income and early distributions (before age 59.5) are generally subject to a 10% penalty. The penalty applies to the earnings portion of the early withdrawal.
Qualified distributions from Roth plans are not taxable.

Question 26

What is an annuity?

Answer 26

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.

Question 27

What determines the tax treatment of distributions from an annuity?

Answer 27

How the annuity is funded determines the tax treatment of the distributions.

Question 28

When is compensation related to injury excludible from income?

Answer 28

If the action generating a payment is due to a physical injury or illness, and the reimbursement of medical expenses paid were not itemized on Schedule A, then all damages received including pain and suffering and workers’ compensation, are excludible from income.

Question 29

When is compensation related to injury includible in income?

Answer 29

Punitive damages that a court might award to punish the defendant are always includible in income even if they are related to a physical injury or sickness.
Nonphysical injuries, such as age or race discrimination, slander, or libel, then punitive damages, and lost business profits are taxable and included in gross income.

Question 30

What are examples of a capital asset?

Answer 30

Stocks, bonds, business interests, artwork, virtual currencies.

Question 31

When selling an asset, how does a taxpayer calculate the realized gain or loss?

Answer 31

Taxpayers need to calculate the amount realized on the sale and the adjusted basis of each asset being sold to determine the realized gain or loss. The amount realized is the total value of everything received from the buyer minus any selling costs.

Question 32

How is the adjusted basis of an asset determined?

Answer 32

The adjusted basis of an asset is determined based upon how the asset was acquired by the taxpayer.

Question 33

What are examples of asset acquisition?

Answer 33

Purchase; Converted from personal to business use; Wash sales; Inheritance; Gift.

Question 34

When an asset is purchased, how is the adjusted basis determined?

Answer 34

Cost + Capital improvements - Cost recovery deductions

Question 35

When an asset is converted from personal to business use, how is the adjusted basis determined?

Answer 35

If FMV > Basis; Basis = Adjusted basis
If FMV < Basis; Basis = lower of adjusted basis of FMV at date of conversion.

Question 36

When an asset is acquired via a wash sale, how is the adjusted basis determined?

Answer 36

Adjusted basis of new securities = Cost + Deferred loss from the wash sale

Question 37

When an asset is inherited, how is the adjusted basis determined?

Answer 37

FMV at date of death or alternate valuation date

Question 38

When as asset is acquired via a gift, how is the adjusted basis determined?

Answer 38

If FMV > Basis; Basis = adjusted basis of donor
If FMV < Basis; Lower of adjusted basis or FMV at date of gift

Question 39

True or false: The receipt of an inheritance is nontaxable.

Answer 39

True.

Question 40

How are the estate taxes for the decedent determined?

Answer 40

The basis of inherited property is the basis used to determine estate taxes for the decedent. Usually, this is FMV on the date of death. If, however, an election is properly made in the filing of the estate tax return to use the alternate valuation date, then the basis will be the earlier of: the date the property was transferred to the beneficiary or six months after the date of death.

Question 41

True of false: Gifts are excluded from gross income.

Answer 41

True.
The donor of a gift may have to report and pay gift taxes in some case, the recipient of the gift generally does not report any taxable income on the receipt of the gift.

Question 42

What happens when the FMV of the asset is greater than the donor’s basis on the date of the gift?

Answer 42

The basis and holding period carry over to the recipient.

Question 43

What happens when the value of the property on the date of the gift is lower than the donor basis?

Answer 43

The donee must keep track of both the donor’s basis and FMV (i.e. dual-basis rules).

Question 44

What happens when the dual basis rules apply?

Answer 44

The donor’s basis (higher amount) is used to calculate a subsequent gain on sale, and the holding period includes that of the donor.
The FMV (lower amount) is used to calculate a subsequent loss on sale, and the holding period begins the day after the gift is made.
If the selling price is between the donor’s basis and FMV, no gain or loss is recognized; therefore the holding period is irrelevant.

Question 45

Why is an asset’s character important?

Answer 45

An asset’s character is important because it determines the tax treatment of any gain or loss recognized when the asset is sold or disposed of.

Question 46

What are the three asset categories?

Answer 46

Ordinary, capital, and Section 1231

Question 47

When are capital assets taxed at preferential rates?

Answer 47

Capital assets have preferential rates if held for more than a year, while those held for one year or less do not.

Question 48

How are Section 1231 gains and losses handled?

Answer 48

A net gain becomes a long-term capital gain
A net loss become an ordinary loss

Question 49

Define Section 1231 assets.

Answer 49

Section 1231 assets are assets used in the trade or business and held longer than one year, whose eventual sale or disposal is only incidental to the business.

Question 50

Define Ordinary assets.

Answer 50

Generally refers to assets that were acquired or produced with the intention of being sold in the ordinary course of business and that generate ordinary income or loss when sold.

Question 51

Define Capital assets.

Answer 51

Capital assets are assets that do not qualify as ordinary or Section 1231 assets. The most common type of capital assets are investment assets or personal use assets.

Question 52

How would a personal computer be characterized for the manufacturer, the business that purchased it, and a consumer?

Answer 52

Manufacturer - ordinary asset
Business that purchased it - Section 1231 asset
Consumer - capital asset

Question 53

What are gross income exclusions?

Answer 53

Gross income exclusions are a set of tax laws that allow certain types of income to be excluded from an individua’s gross income for tax purposes.

Question 54

What are examples of gross income exclusions?

Answer 54

Inheritances, scholarships, and compensation for certain injuries.

Question 55

True or false: Interest earned on state and local bonds (municipal bonds) is tax-exempt.

Answer 55

True.

Question 56

What are Series I and EE Savings Bonds?

Answer 56

Series I and EE Savings Bonds are nonmarketable bonds issued by the U.S. Treasury that pay interest on redemption. The interest is taxable at the federal level and exempt from state taxation.

Question 57

What exclusions eliminate double taxation?

Answer 57

Congress has established specific exclusions to eliminate the double taxation of gifts, inheritances, and life insurance payouts.

Question 58

Are taxpayers required to include their social security benefits in gross income?

Answer 58

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