Ch5 Gross Income and Exclusions Flashcards
What is Gross Income?
The Internal Revenue Code defines gross
income broadly as ‘‘except as otherwise
provided… all income from whatever
source derived’’ and it “includes income
realized in any form, whether in money,
property, or services” (“All inclusive” income concept - everything is income unless tax law specifically says it isn’t!)
Gross income
Income that the taxpayer realizes, recognizes, and reports on tax return
for the year.
When does a taxpayer recognizes income in gross income?
- They receive an economic benefit,
- They realize the income, and
- The tax law does not allow for exclusion or deferral
Economic Benefit
Taxpayer receives something of value
* Earn compensation for your labor
* Sell an asset and receive proceeds
* Receive income from investments
Realization
Complete a transaction with another party
and transaction results in a measurable
exchange in property rights
* You exchange assets or services for cash or other assets
* A change in wealth alone does not satisfy
realization
* Compare holding stock that appreciates vs. selling stock for a gain
Recognition
Realized income is assumed to be recognized unless there is a rule allowing exclusion or deferral
* Income that is excluded never taxed, never shows up in gross income
* Income that is deferred taxed later, shows up in gross income in a future year
Form of Receipt
Does not matter if you exchange money,
property, or services in a transaction!
* A dentist performs a root canal for someone who cannot pay cash, but who repairs his roof (FMV $4,000 for the repair). Is this income?
* You owe the bank $10,000 for your car loan, but they accept $8,000 as the full repayment. Is this income?
Return of Capital
Gross income includes gains from sale or
disposition of assets, not gross proceeds
* Example: You pay $50 for Starbucks stock and sell it for $80. What should you pay tax on?
* Return of capital means your cost or investment in an asset is not considered income
* In other words, what you paid for an asset does not represent an economic benefit. You’re just recouping your cost.
- Return of capital states that you don’t get taxed on what you paid for an asset
- If you buy a stock for $100 and sell for $120, $100 of your proceeds is “return of capital” and only $20 is taxable gain
Tax basis is a related concept – it
represents your investment in an asset
* Your tax basis in the stock was $100 at the time
of sale
Tax Benefit Rule
- Individuals typically claim deductions in the year you pay for an expense. A deduction is a tax benefit.
- Deductions may sometimes be reimbursed or refunded in a subsequent year.
- Tax benefit rule - Refunds of expenses
deducted in a prior year are included in gross income to the extent that the refund reduced taxes in year of the deduction.
When to Recognize Income?
- Individuals generally file tax returns for a calendar-year period
- The method of accounting tells you when realized income is recognized and included in gross income (timing)
- Cash method: income recognized when received, expenses deducted when paid
- Accrual method: income recognized when
earned, expenses deducted when liabilities are incurred - Constructive Receipt
- Taxpayer must realize and recognize income when it is actually or constructively received
- Deemed to occur when the income is credited to the taxpayers account or basically available to the taxpayer
- Dolly’s client mailed her a check for $1,500 on Dec. 28 to pay for services. Dolly decided not to check her mail until Jan. 3 of the next year. What year is the payment included in gross income?
Constructive Receipt
- Taxpayer must realize and recognize income when it is actually or constructively received
- Deemed to occur when the income is credited to the taxpayers account or basically available to the taxpayer
prevents taxpayers from delaying recognition of income even if you did not physically receive it (“but I didn’t cash the check” doesn’t work!)
Claim of Right
- Income recognized when there are no restrictions on use of income (e.g., no obligation to repay)
- Example: must recognize cash bonus received even though it has a “clawback” provision
forces recognition of income when you received it even if there is a chance you have to pay it back
* If you do have to pay any money back, you may be allowed a deduction for the repayment
Assignment of Income Doctrine
The taxpayer who earns salary/wages must recognize the income
* Income from property (dividends, interest) is taxable to the person who actually owns the property
* To shift income from property to another person, a taxpayer must also transfer the ownership in the property to the other person
Ties salary/wages to the taxpayer who actually earned the income
- Ties other forms of income to the taxpayer that owns the underlying asset generating the income
Taxpayer that earns the income pays the tax
* If you provide the service, you get the income.
* If you own the property, you get the income.
* Helvering v Horst (1940)
* Mr. Horst owned bonds. He detached the interest coupons and gave the coupons to his son “as a gift.”
* Horst therefore gave up the legal right to receive the interest. His son had full rights to demand interest from the company that issues the bond
Common Law
Whoever earned the salary or
wages recognizes the income
Whoever owned the property
that generated income
recognizes the income
Half of the income generated by
joint property is recognized by
each spouse
Community Property
Half of the salary or wages
earned by one spouse is
recognized by the other spouse
How income from separately
owned property is treated varies
by state
Half of the income generated by
property held as community
property is recognized by each
spouse
