Chapter 3: Gross Income: Inclusions Flashcards
1
Q
Gross income
A
Defined by law as “except as otherwise noted…gross income means all income from whatever source derived”
2
Q
Economist definition of income
A
The amount an individual could consume during a period and remain as well off at the end of the period as they were at the beginning
= Consumption + change in wealth (includes unrealized gains and adjustments for inflation)
3
Q
Realization as per income for accounting purposes
A
Occurs when there is:
- a change in the form or substance of a taxpayer’s property (sale or purchase)
- a transaction with a second party
4
Q
General condition for income to be taxable
A
- there must be economic benefit
- income must be realized
- income must be recognized (specific recognition rules may apply) (income may be exempt by statute)
Also determined by
- administrative convenience
- wherewithal to pay
5
Q
Administrative convenience
A
There is a need for objectivity in taxation and using the economic concept of income has too much subjective valuation to be functional
6
Q
Wherewithal to pay
A
Concept holds that a tax should be collected when the taxpayer is in the best position to pay the tax (when money has been collected from a sale rather then when property increases in value)
This is why prepaid (but unearned) income is taxed
7
Q
Sources of income explicitly included in tax code
A
Income is not limited to only these items
- compensation for services (inc benefits, commissions)
- gross income from business
- gains from property deals
- interest
- rents
- royalties
- dividends
- 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
8
Q
Why should taxpayers who are using the cash method of accounting be required to include in gross income the value or property or services received?
A
Because otherwise people would get paid in non taxable property or services instead of cash
9
Q
Taxable income
A
All sources of income are presumed taxable unless specifically provided for by law
Burden to prove item is excluded from taxable income is on the taxpayer
10
Q
Form of receipt of income
A
Income is not limited to cash received, can be income realized in any form “money, property, or services”
11
Q
Valuing barter transactions
A
Generally cost basis of property received less cost basis of property given up = income
12
Q
Indirect economic benefit
A
Excluded from gross income
Judicial rule: benefit is excludable if made primarily to serve business needs of employer and benefit to employees is secondary/incidental
13
Q
Can income be assigned to another person?
A
No. An individual is taxed on the earnings from their personal service. Cannot assign to another to avoid taxation
Income from property is taxed to the owner of the property - to transfer tax property must be transfered
14
Q
Common law property system
A
Income generally taxed to the individual who earns it via labor or capital
Generally only joint income is income from jointly owned properly
Law in most states
15
Q
Community property system
A
Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, Wisconsin
Income may be separate or community
Community income belongs equally to the spouses. Income from personal efforts & income from community property considered community income
Normally each spouse is expected to report one half of community income
16
Q
Separate property
A
All property owned before marriage and gifts and inheritance acquired after marriage
Whether income from separate property is separate or community depends on the state
17
Q
Innocent spouse provisions
A
Spouse who had no knowledge or reason to know about a community income item protected from repercussions of failure to report income
Provision also permits it’s to include the entire amount in the income of the other spouse
18
Q
Income of minor children
A
Taxes regardless of property law system earnings of a child from personal income or property are taxes to the child not the parents
Subject to kiddie tax law
19
Q
Accounting methods for taxpayers
A
May choose between
- cash receipts and disbursements
- accrual
- hybrid
BUT whatever method must clearly reflect income as determined by the IRS and may be changed if it’s determines if method fails to clearly reflect income
20
Q
Who must use accrual methid
A
Businesses with inventories
(Many exceptions exist for small business)
21
Q
Who is allowed to use the cash method
A
- taxpayers (not tax shelters) whose average gross receipts for three years prior do not exceed $26 million
- businesses without inventories regardless of size
22
Q
Cash receipts and disbursements method
A
Most common method of accounting
Income is taxed in the year the taxpayer actually or constructively received the income (not year income earned)
Promise to pay has no affect on taxable income
23
Q
Issues with prepaid income and the cash method
A
Income is taxed when received but if prepaid the corresponding expenses may not be incurred till in income (which has already been taxed) is earned . May lead to a lack of funds
24
Q
Constructive receipt
A
The income is made available to the taxpayer so that they may drawn in it at any time.
Cannot refuse to accept payment to avoid taxes
If taxpayer control of income has substantial limitations/restrictions, the payer lacks the funds to make payment, or the amount is otherwise unavailable then the taxpayer has not constructively received it.
25
Cash basis reporting exception: series E and EE U.S. savings bonds
Interest need not be reported until final maturity date, or even later if bonds exchanged within one year of maturity date for series HH Us savings bonds
26
Cash basis reporting exception: farmers and ranchers
- farmers may report crop insurance proceeds in year following receipt if crop would ordinarily have been sold that following year
- ranchers who sell livestock on account of extreme weather conditions may delay reporting if cab show livestock sale would otherwise have taken place in a later year
27
Cash basis reporting exception: small taxpayer inventory exception
Small taxpayers can deduct purchases of inventory in the year of purchase (vs the year of sale) IF
- the inventory purchases are paid for by the end of the year
- the inventory is actually sold in such year
28
accrual method reporting for taxable income
income is considered earned when all events have occured that fix the right to receive the income and when the amount of incme can be determined with resonable accuracy
per TCJA income can be reported no later than the year it is included on financial statements
29
treatment of prepaid income under accrual method
taxable in the year of receipt
some deferrments allowed:
- may defer advance payments for goods (inventory) IF taxpayer's method of accounting for the sale is the same for tax and financial purposes
- may defer payments for future services to the year following the year in which the payment is received (even if payment is for multiple future years. if for current year reported in current year)
latter does not apply to: warranties included in the sale of a product, rent with no services included, insurance premiums, or interest
30
hybriid method of accounting for taxaable income
some income items reported cash method, some reported accrual method
often used by small businesses required to use acccrual method for inventorys (purchase and sale of goods) but use cash method for everything else for simplicity
31
compensation
payment for personal services
includes comissions, tips, bonuses, specialized compensation (various fees)
exclusions for some employer-provided fringe benefits (life insurance, health insurance, employee discounts, retirement contributions, education beneftis)
- limited exclusion to foreign earned income
32
Gross income
Gross income for tax purposes is comparable to gross profit for financial accounting purposes
(COGS as return of capitaland not subject to income tax, only profits subject to income tax)
33
gains realized from property transactions
included in gross incme unless a nonrecognition rule applies
(deduct cost of property from receipt from sale to get gain)
34
losses from dealings in property
not offset against gains in computing gross income - mostly entered as deductions FOR AGI
this is only business losses, losses from sale or disposition of asset held for personal use are not deductable
35
net capital loss deduction limitation
only $3,000 in net capital losses can be deducted from other income per year
36
interest
compensation for the use of money
mostly taxable
37
tax-exempt interest
interest on obligations of states, territories, and U.S. posessions as well as bonds issued by school districts and other special purpose government entities
section 501(c)(3) orgs can issue up to $225 million of tax exempt bonds
GAINS from the sale of these bonds are still taxable
interest on state and local tax refunds is taxabl
38
series EE savings bonds
may be purchased and redeemed tax free if the proceeds are used to pay certain colege expenses for holder, their spouse, or dependents
- must be purchased after 1989 by a person who was 24 or older at the time
- bond must be purchased by owner (not a gift)
- receiptss must be used for tuition and fees (which are first reduced by tax exemt scholarships, tax credits, veterans benefits)
- married couples living together must file a joint return
39
Amount of series EE saving bond interest excluded from tax
- total interest ONLY if combined amount of principle + interest received in the year doesn't exceed the taxpayers (reduced) quallified educational expenses AND taxpayers gross income is not over $83,200 (single), exclusion phased out after this level, (fully phased out if AGI is over $98,200)
if net qualified educational expenses are less than total interest eclusion is equal to:
series EE interest x (net qualified educational expenses / (series EE interest + principal))
(this exclusion is also reduuced after AGI exceds $83,200 (singe)
40
computing reduction in series EE interest exclusion
if AGI over $83,200 (single) or $12,800 (married)
= otherwise excludable amount x (excess modified AGI / $15,000 single or $30,000 joint)
exclusion based on income year bonds redeemed, not the year they are purchased
41
Security deposits on rental units
not included in gross income as returnable to tenants at the expiration of the lease
(deposit included in goss income in year kept ONLY if not refunded)
42
tax on royalties
taxable as ordinary income
43
paying to amend a lease
amounts paid to lessor to cancel, amend, or moodifiy a lease are taxable
44
are improvements by lessees taxable
improvements mae by a lessee that increase the value of leased property are included in lessor's income ony if improvements are made in leiu of rent or if they cause rent to be reduced
in such cases improvements are included in gross income at FMV when made
if not made in lieu of rent then no adjustment made to basis in te property and no recognition till property is disposed of
45
what determines if improvements are made in lieu of rent
intention of the parties
consideration may include
- rental rate
- terms of rentl agreement
- if improvements have estimated useful life exceeding term of the lease
46
Dividends received deduction
Available to c corporations receiving dividends from other domestic c corporations
Deduction of:
50% for dividends received by Corp owning less than 20% of the distributing Corp
65% for dividends received by Corp owning over 20% but less than 80% of the distributing corp
100% for dividends received by Corp owning 80% or more of the distributing corp
47
Dividend received deduction foreign dividebds
Per TCJA
100% deduction for dividends received from 10% or greater subsidiaries with ONLY foreign earnings
Prorated if sub has both foreign and domestic earnings
48
Dividends of closely held corps
Taxes as ordinary income
49
Dividends and investment income tax
For taxpayers with AGI above $200,000 ($250,000 MFJ) dividends are included in the additional 3.8% tax on net investment income
50
Qualified dividends
Qualified dividends are generally dividends from shares in domestic corporations and certain qualified foreign corporations which you have held for at least a specified minimum period of time, known as a holding period. Another requirement is that the shares be unhedged; that is, there were no puts, calls, or short sales associated with the shares during the holding period.
51
Preferential tax rates on qualified dividends
2021 numbers
0% on qualified dividends if taxable income < $40,400 (single)
15% if taxable income is over $40,400 but less than or equal to $445,850
20% if taxable income over $445,850
Only if dividends qualify and generally only from domestic corps
52
Taxes for Shareholders of s corps
Taxed on their percentage of income. Not on dividends which are viewed as a return of capital.
Tax rate depends on nature of income from s corp (preferential rates if earned from capital gains or qualified dividends, ordinary tax rate of from operations)
53
Distribution in excess of current or accumulated earnings and profits
Treated as nontaxable recovery of capital, reduce shareholders basis in stock
If I excess of basis treated as capital gains
54
Stock dividend
Distribution by a corporation to it's shareholders of the corporation's own stock
Used to be totally excluded from income now may be taxed under certain circumstances
Nontaxable stock dividend has no effect on income and the holding period is presumed to be the same as the old stock
55
When a stock dividend is taxable
- if shareholder has the option to receive cash or stock taxed on *either*
- if distribution is made up of preferred and common stock (even if shareholders only received one or other)
Amount included in income = basis of shares received
56
Capital gain dividend
Distribution by a regulated investment company (mutual fund) of capital gains realized from the sale of investments in the fund
Includes undistributed capital gains allocated to shareholders
Always long term
57
Constructive dividend
Amounts not declared as dividends that offer benefits to the shareholders that are effectively dividends
- excess compensation or other economic benefits
- often distributions intended to be deducted from taxation (compensation) or to produce some other non-reportable benefit for the company or shareholder
ARE TAXABLE
58
Alimony and separate maintenance payments
Divorce agreements BEFORE dec 31, 2018: taxable for recipient and deductable for payer
After 2018 are NEITHER
59
Are property settlements and child support taxable?
No, neither taxable or deductible
60
Requirements for payments to count as alimony
(settlements before Dec 31 2018)
- payment made in cash
- pursuant to divorce, separation, or written agreement between spouses
- terminates with death of payee
- not designated as something other than alimony
- made between people living in separate householda
61
Property settlements
Division of property pursuant to a divorce
Each spouse entitled to property brought into the marriage and a share in property accumulated during marriage
Does NOT result in any income (or deduction). Basis remains unchanged
62
Recapture provision for alimony
If the amount of payments declines in the second or third year a portion of the early payments may have to be recaptured as income by the payer (if previously deducted) the payee may deduct the same recaptured amount
To prevent large property settlements from being disguised as alimony to produce a deduction for the payer
Payments originally counted as alimony essentially reclassified as property settlements
63
Annuity
Regular payments for a fixed period or until death of recipient. Purchases from insurance companies
Cost of annuity may be recovered tax free but remaining portion of annuity is taxed
64
Finding the nontaxable portion of the annuity
Expected return multiple x amount of annual payment = expected return (only the amounts received as an annuity. does not include any amounts to be paid after death or expected dividends)
Cost of contract (investment) / expected return = exclusion ratio
Exclusion ratio x amount received in the year = amount excluded from taxes
Once entire cost of annuity has been recovered any amount received after is taxible
65
Expected return multiple
The number of years that the annuity is expected to continue
If term = taxpayers life, multiple is determined by referring to a table designed by the IRS
66
If person dies before recovering entire cost of an annuity
Remaining cost may be deducted we on final tax return
67
Annuities from qualified retirement plans
Employees cost (as in cost to be recovered?) Is only the AFTER tax amounts contributed by the employee (not employer contributions or pre tax contributions)
68
Simplified method to determine taxable portion of qualified retirement plan annuity
Nontaxable portion = employees total after tax investment / anticipated number of payments determined by the table
69
Qualified retirement plan anticipated payments tqble
Age of primary annuitant on start date:
55 or under = 360 payments
55-60 = 310 payments
61 - 65 = 260 payments
66 - 70 = 210 payments
71 and over = 160 payments
70
Roth plan
Retirement plan that has only after tax contributions. If requirements are met, distribution is tax free
71
Advance payment of pension
Any amount withdrawn before starting date considered recovery of employee contributions. After all contributions withdrawn all additional withdrawals are taxable
Generally there is also a penalty (10%) for early withdrawal + some portion of each withdrawal is taxable
72
Who is subject to the early withdrawal penalty
Taxpayers under age 59 1/2
73
Tax on life insurance
Face amount received on death: not taxable
Interest earned on proceeds left with the insurance company: taxable
74
Taxation on forgiveness of debt
Generally the person who owes the money must report amount forgiven as income (there are exceptions)
75
Flow-through entities
Income taxed to the owners not the entities
Includes:
- partnership income
- income in respect of a decedent
- income from an interest in an estate or trust
- S corp income
- income from regulated investment companies (RICs) and real estate investment trust (REITs)
76
Income from a partnership or s corp
Each partner or shareholder reports their share of income and deducts their share of expenses whether money is distributed or not
77
Phantom income
When a partner or shareholder is required to report income on their tax return but no distributions have been made
78
Regulated investment companies
RICs
Include mutual funds and exchange traded funds
Invest in securities and are required to distribute their income to shareholders, who are then taxed on the distributions
Distributions retain their tax status when reported by investors
79
Real estate investment truste
REITs
Invest in real estate and real estate loans and are required to distribute their income to shareholders, who are then taxed on the distributions
Distributions retain their tax status when reported by investors
80
Income in respect to a decedent
Income earned by an individual before death that is paid to another after death
Recipient is taxes on the income if it has not been taxed to the decedent before death
81
Estates and trusts
Semi-flow-through or hybrid entities
Any income distributed to the beneficiary is taxed to the beneficiary
Any undistributed income is taxed to the estate or trust
82
Taxability of prizes, awards, gambling winnings, and treasure finds
All generally taxable, including fair market value of non-cash prizes
83
Treatment of gambling losses
May be deducted (itemized deduction) but only up to amount of current year's winnings
84
Value of treasure find
Taxed based on value in the year in which it is reduced to undisputed posession
85
Illegal income
Is taxable
Government doesn't have to prove that income source was illegal just that there was unreported income
Basically includes any illegal profit
86
Unemployment compensation
Taxable
Excluded from income till 1978
Federal taxation limited during covid
87
Welfare payments
Generally not included in gross income (unless fraudulently received)
88
Social security benefits
Partially Taxable
Up to 85% of benefits may be taxable
Portion taxable depends on provisional income and filing status
Threshold numbers not adjusted for inflation
SS benefits include: monthly retirement and disability benefits paid under SS + tier-one railroad retirement benefits
Does not include supplementary Medicare benefits
89
Provisional income
AGI (excluding social security benefits)
+ Tax exempt interest
+ Excluded foreign income
+ 50% of social security benefits
= Provisional income
90
Taxable social security benefits: married filing separately
Taxable amount is the lesser of:
85% of social security benefits
or
85% of provisional income
91
Taxable social security benefits: married filing jointly
- provisional income = $32,000 or less: no tax on SS benefits
- provisional income > $32,000 but not over $44,000 taxable benefits = the lesser of 50% SS benefits or 50% provisional income over 32000
- provisional income > $44,000 taxable benefits = lesser of 1) 85% of SS benefits or 2) 85% provisional income over $44,000, plus the lesser of $6,000 or 50% of social security benefits
92
Taxable social security benefits: single taxpayers
Also married persons LIVING separately
- provisional income = $25, 000 or less: no tax on SS benefits
- provisional income > $25,000 but not over $34,000 taxable benefits = the lesser of 50% SS benefits or 50% provisional income over 25,000
- provisional income > $34,000 taxable benefits = lesser of 1) 85% of SS benefits or 2) 85% provisional income over $34,000, plus the lesser of $4,500 or 50% of social security benefits
93
Insurance proceeds and court awards
Generally taxable
- accident & health insurance benefits not taxable
- face amount of life insurance not taxable
- insurance proceeds/court awards from destruction of property included only to extent proceeds exceed the basis of the property (if proceeds less than adjusted basis = reduce the amount of deductable loss)
- damages (other than punitive) awarded on account of physical injury or illness
94
Involuntary conversion provisions
Taxpayers can avoid being taxed on insurance proceeds/ court awards on distruction of property if they reinvest in a qualified replacement property
95
Insurance against loss of profits because of casualty
Proceeds taxable
96
Recovery of previously deducted amounts
If an amount is deducted one year but recovered in a subsequent year (ex: refund of state taxes withheld) generally the amount must be declared as gross income in the year it was recovered
97
Tax benefit rule
Recovery of amount previously deducted need not been included in gross email if the deduction failed to reduce the tax for the year of the deduction
98
Deductions of state and local taxes
Taxpayers may deduct up to $10,000 ($5,000 mfs) of either state and local income taxes or state and local sales taxes - but not both
If expect a refund from state / local income tax better to deduct sales tax
99
Claim of right doctrine
The recipient of a disputed amount must include the amount receiver in gross income we long as the use of the funds is unrestricted (even if appeal is pending)
No tax if taxpayer does not have control of the funds
If later have to repay the disputed amount may deduct the previously reported amount in year of payment. (If repayment over $3000 have option of reducing the current tax by tax paid in prior year/years on repaid amount)
100
Deciding between taxable bonds and tax exempt bonds
Assuming risk to be equal
Invest in tax exempt bonds if:
Return on tax exempt bonds > (return on taxable bonds * (1- marginal tax rate))
101
Choosing between taxable bonds and tax deferred bonds
Tax deferred bonds may be preferred if taxpayer expects to be in lower tax bracket when bond matures
102
Child-owned series EE bonds
Interest must be reported annually by filing a return BUT there is no income tax as long as child's annual income is less than $1,100
103
Savings bond interest: changing from deferral to annual reporting
May change to annual reporting but required to report both current and previously accrued interest in the year of the change
104
Savings bond interest: changing from annual to deferral methid
May do without IRS approval but are bound by the election for five years
105
Deferred compensation arrangements
Advanced contractual agreements arranging for payments at future dates can defer taxes on that income. Allows for avoidance of constructive receipt of income
106
Schedule 1
Additional income and adjustments to income
Totals to to form 1040
107
Types of income directly on the form 1040
Wages, interest, dividends, retirement income, social security benefits
108
Schedule C
Business income and related business expenses
Totals transferred to 1040
109
Schedule C
Business income and related business expenses
Totals transferred to 1040
110
Schedule B
Interest and ordinary dividends
(Amounts exceeding $1,500)
