Chapter 4: Exclusions From Gross Income Flashcards
Loans
Not income because of obligation to repay
Not statutory, considered obvious
Scholarships
Not income. Specifically excluded (section 117)
Source of income exclusions
- specific items contained in IRC (enacted by Congress)
- administrative exclusions (allowed by provision in IRC as interpreted by the IRS)
- judicial exclusions (IRC statute as interpreted by the court)
Items that are not income
- unrealized income (unrealized appreciation/gain)
- self-help income
- rental value of personal use property (economic benefits of living in own home)
- gross selling price of property (recovery of capital)
Ordinary stock dividends
Excluded from gross income as do not fit definition of income (no value realized)
Self-Help income
Benefits (savings) arising from work the taxpayer does for themselves (if hired someone else would have to pay for) are not income per taxes
Also does not change basis of property
Major statutory exclusions: social policy reasoning
- gifts and inheritances
- life insurance proceeds
- public assistance payments
- qualified adoption expenses
- payments for personal sickness or injury
- discharge of indebtedness during bankruptcy or insolvency
- gain on sale of personal residence
- partial exclusion on social security benefits
Major statutory exclusions: economic incentive reasoning
- awards for meritorious achievement
- certain employee fringe benefits
- partial exclusions for scholarships
- foreign earned income
- interest on state and local obligation
Gifts and inheritances
Not taxable for receiver
May be taxable to donor (gift tax)
Income received after transfer from property that was gifted is taxable
Gifts vs prices/ additional compensation
Depends on the intent of the donorn
Transfer of property in family business: gift vs salary/wages
Depends on the FMV of services actually preformed by person receiving payment. Amounts that exceed fair value of services excess is a gift
Life insurance proceeds
Proceeds paid to beneficiary on death are not taxable whether paid in lump sum or in installments
Any amounts received in excess of face amount of policy usually ARE taxable as interest
Exception to complete exclusion of life insurance from income
If insurance policy is obtained by the beneficiary in exchange for valuable consideration from a person other than the insurance company. (Selling life insurance policy for cash)
Exclusion then limited to consideration paid (+ premiums/ other sums subsequently paid by the buyer)
Under what circumstances are the proceeds fro a transferred life insurance policy still excludable from gross income?
if the beneficiary’s basis is found by reference to the transferor’s basis (gift) of if transferred to the insured, the insured’s partner, a partnership that includes the insured or a corporation in which the insured is a shareholder or officer
Tax consequences if life insurance policy is surrendered or sold
if the policy is sold or surrendered before death any excess of the proceeds over net premiums paid is taxable (no loss recognized if premiums higher than proceeds)
Accelerated death benefits
payments made to a terminally ill person or periodic payments made to a chronically ill person
payments excluded from gross income if
- terminally ill person likely to die within 24 months
- for chronically ill persons exclusions limited to greater of $400/day or actual daily cost of care
dividends on life insurance and endowment policies
normally not taxable
considered partial return of premiums paid
if exceed total of premiums paid are taxable.
if left with the insurance company to earn interest, the interest is taxable
Awards for meritorious achievement non-taxable IF
- award and prize for religious, charitable, scientific, educational, artistic, literary, or civic achievement
- recipient was selected without action on their part to enter into the contest/ proceeding
- recipient does not have to perform substantial future services as a condition to receiving award
AND: they designate that the payor pay the amount of the award to either a government unit or charitable org
becomes an exclusion from AGI (rather than deduction from)
Limitations of exclusion of scholarships from gross income
exclusion for scholarships is limited to the amount the scholarship is used for qualified tuition and related expenses
these expenses do NOT include costs of living (room/ board) or the value of those things if supplied
includes work-study earnings
Qualified tuition plans
QTP
section 529 plans - must be maintained by state government or private educational institution
contributions made after tax and the savings grow tax-free (but over a certain amount may be subject to gift tax)
withdrawals are tax free as long as the amounts are used for qualified education expenses (in this case cost of living is included)
donors may change beneficiary to another member of the original beneficiary’s family without tax consequences
Qualified Tuition plan exclusion limitations
- if used for elementary or secondary education exclusion is ONLY for tuition and limited to $10,000 per student per year
- amount of QTP withdrawal excluded from gross income is reduced by American Opportunity credit and lifetime learning credit
- if not all used for education expenses the amount treated as income determined by annuity rules and may be subject to a 10% penalty
payments for injury and sickness: damages
Damages awarded for injury or sickness are excludable from gross income (even if award exceeds expense)
does not include: punitive damages, damages for non-physical injuries (though medical expenses related to nonphysical injuries are included, as are payments for emotional distress attributable to a physical injury) amounts awarded to compensate for lost income
payments for injury and sickness: accident and health insurance policy
If policy purchased by taxpayer: all benefits excluded from gross income (even if award exceeds expense)
- if long-term care the exclusion is limited to the greater of $400/day or the actual cost of care
If policy is purchased by the taxpayer’s employer: all benefits must be included in gross income
if cost of coverage is split: amount taxable is prorated proportionately
payments for injury and sickness:medical expense deduction
If medical expense reimbursements were excluded from gross income they cannot also be an itemized deduction
Employee fringe benefits that may be excluded from gross income
employer-paid insurance
section 132 benefits
meals and lodging
dependent care
cafeteria plans
certain employee awards
educational assistance
adoption expense assistance
Employee fringe benefits: employer-paid insurance
Premiums Generally: employers may deduct premiums paid and employee is except from having to include them in their gross income (not including some types of life insurance)
medical, health, group term life insurance coverage benefits : generally excludable
disability coverage benefits: generally taxable (but may qualify for credits)
Premiums paid by employee
If the premiums are paid by the employee the benefits are excluded from gross income but the premiums are not deductable (except for medical insurance as a medical expense. Subject to ago limitations)