Ch5 part 2 gross income and exclusions Flashcards
Unearned Income
Income from owning property and investments
Examples:
* Own bonds, bank accounts: earn interest
* Taxable unless muni bond!
* Own stock: earn dividends or sell for
gain/loss
* Preferential tax rate if qualified dividends or
long-term capital gain
“Ordinary income”
income that is taxed at ordinary rates (i.e., use the normal tax brackets)
* Salary and wages
* Interest income
* Annuity income
Income that gets preferential treatment
Some types of income get preferential treatment
via lower tax rates (different tax brackets)
* Long-term capital gains
* Qualified dividends
types of income
ordinary income
income that gets preferential treatment
- long term capital gains
Annuities
An investment you can purchase that pays a stream of equal payments over time
- A portion of each payment is non-taxable
return of capital (why?) and the remainder is
included in gross income
For annuities with a fixed term, the expected value is the number of payments times the payment amount
- For annuities over a life, taxpayers must use IRS tables to determine the expected value based upon the taxpayer’s life expectancy. Multiply annual payment amount by: expected return multiple <table given on the exam
Annuity exclusion ratio
Original Investment/Expected value of annuity
Income from Selling Assets
- Taxpayers usually realize a gain or loss when disposing of an asset
- Taxpayers are allowed to recover their investment in property (tax basis) before they realize any gain (why?) because it is the return of principle kicking in
Formula for Calculating Gain or Loss from Sale of Asset:
Sales proceeds
Less: Selling expenses
= Amount realized
Less: Tax basis
= Gain (Loss) on sale
Capital Gains/Losses
- Capital assets are typically investment or personal-use assets
- So not A/R, inventory, or assets used in trade or
business - Sale of capital assets generates capital gains
and losses - Long-term if asset held > 1 year
- Short-term if asset held ≤ 1 year
Capital gains
- Net short-term capital gains taxed at ordinary rates
- Net long-term capital gains generally taxed at a
maximum preferential rate of 0%,15%, or 20%
Capital losses
- Individuals allowed to deduct up to $3,000 of net
capital loss against ordinary income. Remainder
carries over indefinitely to subsequent years.
Are losses on personal-use assets deductible?
Losses on personal-use assets are NOT deductible
Capital Gains/Losses - Netting Process
Netting Procedure:
* Step 1: Combine all short-term capital gains and losses for the year and any short-term capital loss carryforward. (net all ST)
* Step 2: Combine all long-term capital gains and losses for the year and any long-term capital loss carryforward. (net all LT)
* Step 3: If steps 1 and 2 are both positive or negative, stop the netting process. Otherwise, net the results from steps 1 and 2. (if net ST and LT have different signs, net them together one more time)
Capital Loss Limitations
- Losses from sales to “related parties” are not
deducted currently (more in Ch.11) - E.g., I sell stocks at a loss to my brother
- Losses arising from a “wash sale” are
disallowed
Wash Sales
- The “wash sale” rule disallows the loss on stocks
sold if the taxpayer purchases the same or
“substantially identical” stock within a 30-day
window (before OR after sale) - Cannot recognize the loss! Instead, must add the loss into your basis
Adjusted basis Wash sale formula
Adjusted basis = tax basis of new shares + disallowed loss
