3. Gross Income II: Interest, Security, Decedent

Question 1

What is interest?

Answer 1

Interest is value received or accrued for the use of money. All interest is gross income for tax purposes unless an exclusion applies.

Question 2

When is accrued interest on a deposit included in income if the interest may not be withdrawn at the close of an individual’s tax year because of an institution’s actual or threatened bankruptcy or insolvency?

Answer 2

It is included in the year in which such interest becomes withdrawable.

Question 3

What is a below-market demand loan?

Answer 3

A below-market demand loan is a loan on which interest is payable at a rate lower than the applicable federal rate.

Question 4

P2. Below-Market Loan
For which below-market loans do the imputed interest rules apply?

Answer 4

Loan Requiring imputed interest:
1.Gift loans
2.Loans between a corporation and a shareholder
3.Compensation-related loans for employees
4. Loans with tax avoidance as purpose

Question 5

P2. Test
When is no interest imputed on a below-market loan (BML) that is a gift?

Answer 5

If the BML (gift loan) between individuals is $10,000 or less, there is no interest imputation unless the loan was made to acquire income-producing assets.

Decisions from Relationships:
** Parent - child = May Automatically be gift**
** Employer - Employee = Potential disguised compensation **

Question 6

P.3
What is original issue discount (OID)?

Answer 6

OID is the excess, if any, of the stated redemption price at maturity over the issue price and is included in income based on the effective interest rate method of amortization.
Form 1099-OID has $10 int income

• Pays no interest
• Issued below face value
• Must impute interest

Question 7

When may all or part of the interest received on redemption of a Series EE, or I, U.S. Savings Bond be excluded?

Answer 7

If a taxpayer pays qualified higher education expenses during the year,
- all or part of the interest received on redemption of a Series EE, or I, U.S. Savings Bond may be excluded.

Question 8

P.4
What payments to a holder of a debt obligation are generally exempt from federal tax?

Answer 8

Payments to a holder of a debt obligation incurred
- by state or government (e.g., municipal or “muni” bonds)
* exempt from federal tax.

Question 9

Does tax-exempt interest need to be reported on the taxpayer’s federal income tax return?

Answer 9

Yes, tax-exempt interest is still reported on the taxpayer’s federal income tax return.

Sch B, Form 1099-INT

Question 10

Are amounts received as dividends generally treated as gross income?

Answer 10

Yes, these amounts are generally considered to be ordinary gross income.

Question 11

What are qualified dividends?

Answer 11

Qualified dividends are
- dividends from domestic corporations or a qualified foreign corporation and are taxed at a 0%, 15%, or 20% rate depending on filing status and taxable income.
- The dividends must be held for more than 60 days (90 days for preferred stock).

Question 12

What is a dividend for purposes of taxable income?

Answer 12

It is, generally, any distribution of money or other property made by a corporation to its shareholders, with respect to their stock, out of earnings and profits.

Question 13

Is a distribution in excess of earnings and profits from a corporation to a shareholder a taxable dividend?

Answer 13

No, any distribution in excess of earnings and profits (both current and accumulated) is considered a recovery of capital and is therefore not taxable.

Question 14

If a mutual fund invests in all tax-exempt securities, will the distributions from that mutual fund be tax-exempt?

Answer 14

Yes, distributions or dividends from a fund investing in tax-exempt securities will be tax-exempt intere

Question 15

Are capital gain distributions from a mutual fund, regardless of the actual period the mutual fund investment is held, treated as long-term or short-term?

Answer 15

Long-term.

Question 16

What is a dividend reinvestment plan?

Answer 16

A dividend reinvestment plan allows a taxpayer to use his or her dividends to buy more shares of stock in the corporation instead of receiving the dividends in cash.

Question 17

Is the value of a stock dividend generally included in gross income?

Answer 17

Generally, a shareholder does not include the value of a stock dividend in gross income.

Question 18

Does an employee recognize income for an incentive stock option that is granted or exercised?

Answer 18

An employee may not recognize income when an incentive stock option is granted or exercised depending upon certain restrictions.

Question 19

What is an employee stock option plan, and is income recognized under this type of plan?

Answer 19

An employee stock option plan is, generally, one permitting employees to buy stock in the employer corporation at a discount. Options issued under an employee stock purchase plan qualify for special tax treatment. No income is recognized under such a plan at the time the option is granted; the recognition is deferred until stock acquired under the plan is disposed of.

Question 20

P.7
NonSatutory Stock Options

Answer 20

Generally taxed at ordinary income rates
- taxed when
1) The option is granted,
2) The option is exercised,
3) The option is sold, or
4) The restrictions on the disposition of the option-acquired stock lapse.

Question 21

What is income in respect of a decedent (IRD)?

Answer 21

IRD is all amounts to which a decedent was entitled as gross income but that were not includible in computing taxable income on the final return.

Question 22

What items are not includible on the final income tax return of a cash-method taxpayer?

Answer 22

Not includible on the final income tax return of a cash-method (CM) taxpayer are amounts not received.

Question 23

What items are not includible on the final income tax return of an accrual-method taxpayer?

Answer 23

Not includible on the final income tax return of an accrual-method (AM) taxpayer are amounts not properly accrued.

Question 24

Who reports income in respect of a decedent (IRD)?

Answer 24

IRD is reported by the person receiving the income as if the recipient were the decedent. IRD is taxable as income to the recipient and is includible in the gross estate.

Question 25

What basis is used for a right to receive income in respect of a decedent (IRD)?

Answer 25

A right to receive IRD has a transferred basis. The basis is not stepped-up to FMV on the date of death, as is generally the case for property acquired from a decedent.

Question 26

Expenses accrued before death, but not deductible on the final return because the decedent used the cash method, are deductible when

Answer 26

Paid if otherwise deductible.

Question 27

P.10 ** Test***

The tax returns that would report income in respect of a decedent (IRD) include, but are not limited to

Answer 27

1.The decedent’s estate, Form 1041, if the decedent’s estate receives a right to the income.
2.The beneficiary’s Form 1040, if the right to income arising out of the decedent’s death is passed directly to the beneficiary and is never acquired by the decedent’s estate.
3.The Form 1040 of any person to whom the decedent’s estate properly distributes the income.
NOTE: The decedent’s final Form 1040 would not include IRD.

Question 28

The tax returns that would report income in respect of a decedent (IRD) include, but are not limited to

Answer 28

1.The decedent’s estate, Form 1041, if the decedent’s estate receives a right to the income.
2.The beneficiary’s Form 1040, if the right to income arising out of the decedent’s death is passed directly to the beneficiary and is never acquired by the decedent’s estate.
3.The Form 1040 of any person to whom the decedent’s estate properly distributes the income.
NOTE: The decedent’s final Form 1040 would not include IRD.

Question 29

What is interest?

Answer 29

Interest is value received or accrued for the use of money. All interest is gross income for tax purposes unless an exclusion applies.

Question 30

When is accrued interest on a deposit included in income if the interest may not be withdrawn at the close of an individual’s tax year because of an institution’s actual or threatened bankruptcy or insolvency?

Answer 30

It is included in the year in which such interest becomes withdrawable.

Question 31

What is a below-market demand loan?

Answer 31

A below-market demand loan is a loan on which interest is payable at a rate lower than the applicable federal rate.

Question 32

For which below-market loans do the imputed interest rules apply?

Answer 32

The imputed interest rules apply to
1.Gift loans
2.Loans between a corporation and a shareholder
3.Compensation-related loans between an employer and an employee or between an independent contractor and a person for whom the independent contractor provides services
4.Loans that have tax avoidance as one of their principal purposes

Question 33

When is no interest imputed on a below-market loan (BML) that is a gift?

Answer 33

If the BML (gift loan) between individuals is $10,000 or less, there is no interest imputation unless the loan was made to acquire income-producing assets.

Question 34

What is original issue discount (OID)?

Answer 34

OID is the excess, if any, of the stated redemption price at maturity over the issue price and is included in income based on the effective interest rate method of amortization.