Chapter 2

Question 1

What is the meaning of the term “gross income”?

Answer 1

Gross income is income that must be included on a taxpayer’s income tax return. The Internal Revenue Code defines gross income as “all income from whatever source derived.

Question 2

What is the difference between “income” and “capital” for income tax purposes?

Answer 2

example of an item that is not considered “income” is where a creditor receives repayment of the principal amount of a debt. The repayment of the principal by the debtor is not gross income to the creditor. The creditor is simply receiving back the amount of money that was, in a sense, “invested” in the debtor. However, any interest payments on the debt received by the creditor would generally be includible in gross income.

Question 3

What is the doctrine of constructive receipt?

Answer 3

There is an exception to the general rule that income is reported by a cash-basis taxpayer only when it is actually received. The exception is known as the theory or doctrine of constructive receipt. A taxpayer does not have to reduce income to actual possession before it has to be reported. An individual must report it as soon as it is either actually received or constructively received.
The taxpayer is deemed to have constructively received it in the taxable year during which (1) it is credited to the taxpayer’s account, (2) set apart for the taxpayer, or (3) otherwise made available to be drawn from at any time.

Question 4

Cash-basis method of accounting?

Answer 4

The cash-basis method of accounting means that an individual reports income in the year it is received.
For example, suppose your client—a doctor using the cash-basis method of accounting—renders services but is not paid for them until January of next year. The income will not be includible in the doctor’s income for this year (even though the services were performed this year) but it will be reportable next year.

Question 5

With constructive receipt what is the effect when there are substantial limitations or restrictions placed on a taxpayer’s right to receive income?

Answer 5

The regulations qualify the rules on inclusion of constructively received income by stating that income will not be constructively received if the taxpayer’s control of its receipt is subject to substantial limitations or substantial restrictions. For example, suppose Lee, a pension consultant, signs a contract to perform actuarial services during this year. Lee actually performs those services during this year. However, the contract specifies that payment will not be made until 5 years from now. Lee has no right to require earlier payment.

Question 6

2 types of deferred-compensation methods: Funded and Unfunded

Answer 6

A funded deferred-compensation agreement entails the actual deposit of funds by the employer into a trust, escrow, or custodial account.
Unfunded deferred compensation implies that no funds are irrevocably set aside (that is, outside the corporation’s control and beyond the reach of its creditors) by an employer.

Where the agreement can be classified as funded the deferred compensation will be taxable to the employee in (1) the first year the employee’s rights are not subject to a substantial risk of forfeiture, or (2) the first year the employee’s rights can be transferred to another party.
If the agreement can be classified as unfunded such compensation will not be taxable.

Question 7

What is the economic-benefi t theory?

Answer 7

sec. 61 of the Internal Revenue Code defines gross income as including “income from whatever source derived. . . .” In cases dealing with this section of the Code, courts have held that the language of the section is “broad enough to include as taxable income any economic or financial benefit conferred on the employee as compensation, whatever the form or mode by which it is effected.”This concept has appropriately been entitled the economic-benefit theory.

Question 8

Difference between constructive receipt and tThe Economic-Benefit Theory?

Answer 8

The constructive receipt doctrine forces the inclusion of income when the employee has a unqualified choice to take or not take the income.

The economic-bene t theory or doctrine, on the other hand, forces the inclusion of income, even if the employee cannot take the income. All that is necessary under the economic-benefit theory is that the employee receive from an employer the equivalent of cash, something with a (1) current, (2) real, and (3) measurable value.

Question 9

What is the principle of assignment of income?

Answer 9

The principle of assignment of income requires the taxpayer whose personal efforts generate income or who is the owner of property that generates income to report or declare the income on his or her own tax return. It provides that the taxation of income cannot be shifted from one taxpayer to another merely by transferring or assigning to another taxpayer the right to receive the income.

Question 10

How can a taxpayer successfully shift the burden of taxation of income to another taxpayer who is in a lower tax bracket?

Answer 10

There is no reliable legal way to shift taxation to another taxpayer.

In the case of property income the legal transfer of property will result in income being transferred to the new owner. This may constitute a gift or other taxable events however.

Certain types of trusts or methods can be used to shift income to minor children effectively.However, the principal that the donor must give up ownership and control still holds true.

Question 11

What are the 15 items specifically included the IRS definition of gross income?

Answer 11

• compensation for services, including fees, commissions, fringe bene ts, and similar items
• gross income derived from business
• gains derived from dealings in property
• interest
• rents
• royalties
• dividends
• alimony and separate maintenance payments for divorce and separation agreements signed before January 1, 2019
• annuities
• income from life insurance and endowment contracts
• pensions
• income from discharge of indebtedness
• distributive share of partnership gross income
• income in respect of a decedent
• income from an interest in an estate or trust

Question 12

All income is includible in a taxpayer’s gross income unless it is specifically excluded by the Code.

Answer 12

True

Question 13

Although there are 15 items listed in the Code that are specifically included in gross income, the definition is not limited to these specifically listed items.

Answer 13

True

Question 14

When a taxpayer receives a return of capital, the return of capital is subject to income tax.

Answer 14

False.

A return of capital is not “income” for tax purposes.

Question 15

The release of an obligation to pay a debt generally results in taxable income to the debtor.

Answer 15

True

Question 16

Under the doctrine of constructive receipt, income becomes taxable in the year in which it is constructively received, although it may not actually be in the taxpayer’s possession.

Answer 16

True

Question 17

The doctrine of constructive receipt determines whether or not a taxpayer has received a taxable economic benefit.

Answer 17

False.
The doctrine of constructive receipt is used in determining when an item is included in income, not in determining which item is income.

Question 18

When an employer lends an employee a company automobile for personal use, the employee has no income attributable to that use.

Answer 18

False.
The economic-benefit theory taxes as income any economic or financial benefit conferred on the employee regardless of its form, as long as the employee receives something with a current, real, and measurable value. Use of a car for personal purposes constitutes such an economic benefit.

Question 19

When a taxpayer assigns income to another taxpayer, the burden of the income tax is shifted to the other individual.

Answer 19

False.
Income is always taxed to the person who earns it, creates the right to receive it, or enjoys its benefit, or to the person who earns or controls the property that is the source of the income. Therefore, while it is possible to assign income that one has earned to another person, it will still be taxed to the person who earned the income.