Ch5 Part4 Gross income and exclusions Flashcards
1
Q
Why does congress allow certain specific types of income to be excludes or deferred?
A
Subsidize or encourage particular activities
and to Provide equity
2
Q
1 Common Exclusions
A
- Municipal bond interest
- Gain on sale of personal residence
- Fringe benefits
3
Q
Municipal Bond Interest
A
- Muni bonds are issued by state and local
governments located in the U.S. (e.g, State of
Arizona, City of Tucson) - Interest is excluded from gross income
- Exclusion generally recognized as a subsidy to state and local governments
- Interest from U.S. Treasury bills are taxable for
federal tax purposes but tax-exempt for state/local tax
4
Q
Gain on Sale of Personal
Residence
A
- Taxpayers may exclude up to $250,000 ($500,000 if MFJ) of realized gain on the sale of their principal residence
- Only get exclusion once every 2 years
- Any excess gain generally qualifies as LTCG
- Loss? No deduction!
- Must satisfy ownership and use tests. For at least 2 years out of the past 5…
- Ownership test (1 spouse must meet): own home
- Use test (both spouses must meet): use home as main residence
5
Q
Fringe Benefits
A
- Value of employer-provided benefits generally
included in the employee’s gross income as
compensation for services - However, certain benefits, called “qualified” fringe benefits, are excluded from gross income
- Common qualified fringe benefits are health
insurance, life insurance, de minimis (small)
benefits - Generally non-discriminatory – any employee
eligible to get fringe benefit
6
Q
2 Education-Related Exclusions
A
- Congress excludes certain types of income if
the funds are used for education - Provides incentive for taxpayers to participate
in higher education - Example: Income earned from 529 investment
plans, Coverdell plans, U.S. Series EE bonds
are generally tax-free if funds spent on qualified
education expenses
7
Q
Scholarships
A
Exclude scholarships that pay for required tuition, fees, books, and supplies
- If using scholarship for housing, meal plan, etc. that is taxable
8
Q
3 Exclusions to Mitigate Double
Taxation
A
- Congress provides certain exclusions to
eliminate the potential double tax to ensure
fairness to taxpayers - Gifts and inheritances
- Life insurance proceeds
- Foreign income
9
Q
Gifts and Inheritances
A
- Individuals may receive property as gifts or
from a decedent’s estate (an inheritance) - Value of gifts and inheritances are excluded
from gross income because these transfers are
subject to the Federal Gift and Estate tax – a
different tax! - The recipient never pays tax on a gift or
inheritance
10
Q
Life Insurance Proceeds
A
- Amounts received due to the death of the insured are excluded from the income of the recipient because proceeds already subject to Federal Estate Tax
- Exclusion available for accelerated death benefits (cash out policy before death) in certain circumstances: terminally ill & < 24 months to live
- Exclusion generally does not apply when:
- Taxpayer purchased policy from third party or
- Taxpayer cancels life insurance contract and receives cash greater than premiums paid
11
Q
Foreign Income
A
- An annually-adjusted, set amount of foreign-earned income can be excluded from gross income for qualifying individuals
- Typically the income is already subject to tax in the foreign country
- Must meet certain residency requirements to be eligible for the exclusion (e.g., live in the foreign country for certain number of days)
12
Q
4 Sickness and Injury-Related
Exclusions
A
- Several exclusion provisions apply to taxpayers who
are sick or injured to reflect their inability to pay the tax
and facilitate recovery - Workers’ compensation
- Payments for personal injury
- Disability insurance
13
Q
Workers’ Compensation
A
- Payments from workers’ compensation plans
are excluded from gross income - These plans provide benefits when employee
can’t work because of work-related injury - Different from unemployment compensation,
which is included in gross income
14
Q
Payments Associated with
Personal Injury
A
- Awards for physical injury or sickness or costs
for treating emotional distress related to a
physical injury are excluded from gross income - Also applies to lost wages and other
compensatory damages - Other payments, including punitive damages,
are fully taxable
15
Q
Disability Insurance
A
- Also called “wage replacement insurance” - pays the insured individual for wages lost when the individual misses work due to injury or disability
- If an individual purchases disability insurance directly, premiums are not deductible but any disability benefits are excluded from gross income
- No double benefit of deduction and exclusion
