Chapter 4: Gross Income From Personal & Investment Activities

Question 1

Taxable Year

Answer 1

• generally a 12 month period
• calander year used by most taxpayers
• fiscal year can be elected if adequate records are maintained
• 52-53 week year
  
  • ends on specified day of week of last month of tax year

Question 2

methods of accounting

cash basis

Answer 2

• recognize income when its received or set aside. (wait until the check is received)
• recognid deductions when they pay the bill
• utilized by individuals and some businesses

Question 3

methods of accounting

accrual basis

Answer 3

• recognize income when it is earned but not yet received
• most businesses use accrual method
• businesses with less than 29million a year in the last 3 years dont have to use accrual, can use cash method

Question 4

methods of accounting

hybrid method

Answer 4

• used when inventory is a material incoem producing factor

Question 5

Realization vs Recognition

realization

Answer 5

occurs when income is received or when a gain on a property trtansaction becomes fixed

Question 6

realization vs recognition

recognition

Answer 6

occurs when the income is reported on the tax return

Question 7

realized gains

Answer 7

all realized gains are recognized, unless an exception applies

Question 8

recognition of income

follows realization principal from accounting

Answer 8

income is recognized (taxed) when realized unless an exception applies

Question 9

recognition of income

generally, any accretion to wealth is income

Answer 9

• mere appreciation in wealth (economic income) that is not fixed and measurable at a particular point in time is not considered realized income
• Congress has excluded certain accretions of wealth from the definition of income for tax purposes

Question 10

recognition of income

income is recognized if received:

Answer 10

• received in cash
• in kind (property or services)
  
  • barter services
• income does not include recovery of capital investment (capital recovery doctrine)

Question 11

sources of income

Investment Income

Answer 11

• doctrine of the fruit & the tree
  
  • income taxed to the owner
  • whoever ownd the bond owns the interest income from the bond
  • whoever owns the stock owns the income from the dividends

Question 12

sources of income

employment income

Answer 12

• doctrine of the fruit & the tree
  
  • income taxed to earner
  • income may not all be going to the earners pocket, but the earner is getting taxed on it all
• self-employment income
• wages

Question 13

sources of income

income from personal activities

Answer 13

• alimony (pre 2019 divorce)

Question 14

income tax & community property

income tax & community property

Answer 14

• half of the income earned belongs to each spouse
  
  • same impact as married filing jointly (MFJ) for income tax
• married filed separately (MFS)
  
  • community property income split equally
  • poses a problem if spouses are not cooperating

Question 15

income from investing activities

income from investment activities

Answer 15

• capital gains
• interest
  
  • original issue discount
• dividend income
• rental and royalty income
• annuity distributions
• income from life insurance and endowment contracts
• traditional IRA’s
• income from partnerships, S-Corps, & LLC’s
• income from Trusts & Estates

Question 16

income from investment activities

Capital gains exceptions

cap gains tax rate

Answer 16

• collectibles: tax rate of 28% + 3.8%
• Unrecaptured Section 1250 gain: 25% +3.8%

dont forget to tack on the additional 3.8% Medicare tax imposed by the Affordable Care Act

Question 17

income from investment activities

effective rate may be more than maximum

cap gains tax rate

Answer 17

• capital gains increase a taxpayers AGI
• increased AGI may lead to phaseouts

Question 18

income from investment activities

Original Issue Discount (OID)

Answer 18

• doctrine of constructive receipt
• taxpayer recognizes imputed interest each year. as interest is recognized:
  
  • OID is amortized (reduced by the amount recognized)
  • the taxpayers basis increases (by the amo=unt recognized)

Question 19

income from investment activities

Original Issue Discount (OID) equation

Answer 19

• OID = Maturity value - purchase price

Question 21

income from investment activities

Original Issue Discount Exceptions

Answer 21

• series E & EE savings bonds
• or any government bonds that have a maturity less than 1 year

Question 21

phantom income

Answer 21

• didnt actually receive the cash but have to pay tax on income

Question 22

income tax issues

income tax issues associated with gifts of debt instruments

Answer 22

• donee and donor report interest income based on # of days the instrument was held, regardless of who receives the payment
• there may also be gift, estate & generation-skipping transfer tax consequences

Question 23

income from investment activities

Dividends

Answer 23

• distribution of earnings by corporations
• taxable to shareholders to extent of earnings
  
  • if distribution exceeds earnings, its taxed:
    
    • first as a return of basis
    • then as capital
• qualified dividends

Question 24

income from investing activities

qualified dividends

Answer 24

• tax rates
  
  • follow the capital gains rate table
• paid by the US corporation or qualified foreign corporation
• shareholder must meet holding period requirement

dont forget the 3.8% medicar tax imposed by the Affordable Care Act

Question 25

# annuity taxation annuity

Answer 25

is a tax favored investment

Question 26

# annuity taxation annuity taxation

Answer 26

- for annuity starting dates after 12/31/1986 - total exlcusion cannot ecveed investment in the contract - un-recovered iinvestment is taken as a deduction on the annuitants final income tax return

Question 27

# annuity taxation exclusion ratio

Answer 27

= (investment in the contract/expected return) x distribution received

Question 28

# annuity taxation annuity taxation

Answer 28

- withdrawls before age 59.5 are also subject to a 10% early distribution penalty - exceptions: dealth & disability - distributions prior to annuitization are taxed on LIFO basis

Question 29

# income taxation & life insurance Endowment contracts

Answer 29

payout before dealth = taxable income - if we have a cash basis policy and taking distributions as the decedent, before they die, they are taking the distributions out...this is taxable income

Question 30

# income taxation & life insurance surrender

Answer 30

amount realized - basis = taxable income - say the cash value (amount realized was 90,000 but they paid 60,000 in premiums) = 30,000 in taxable income theyd want now instead of waiting for say a 500k death benefit when they die

Question 31

# income taxation & life insurance death benefit (excluded from income) (see exclusions) | if the decedent dies

Answer 31

- unless transfer for value rule applies - ## Footnote the death benefit for this beneficiary, the spouse when they receive it, is gonna be excluded from income

Question 32

# income taxation & IRA's traditional IRA

Answer 32

- deduction when $ is put in, and taxed when distributed down the road

Question 33

# income taxation & IRA's Roth IRA

Answer 33

- no deduction when $ put in, and if you meet the conditions, then the $ comes out tax free

Question 34

# income taxation & IRA's Traditional IRA taxation

Answer 34

- generally the $ coming out of a TIRA is ordinary income - not all IRA contributions are deductible

Question 35

# income taxation & IRA's traditional IRA taxation (exceptions)

Answer 35

return of basis - use exclusion ratio

Question 36

# income taxation & IRA's traditional IRA taxation (penalties)

Answer 36

- if you take out distributions too early (early distribution penalty before age of 59.5): its a 10% penalty - if you contribute too much (excess contribution penalty): 6% penalty - take distrubutions out too late (starty at age 73) (late required distribution): 50% penalty - Secure 2.0 Act: tax years after 12/29/22, penalty decreased from 50% to 25% (or 10% if failure corrected timely)

Question 37

# income taxation of business entities pass-through entities

Answer 37

- partnerships - limited liability corporations - S-corporations

Question 38

# income taxation of business entities taxation of pass through entities

Answer 38

- income is taxed to owners based on ownership % - depending on the type of business, adjustments may be necessary to calculate the amount of business income subject to tax in the owner's hands - as inome is recognized, owner's basis increases

Question 39

5 exceptions to the Transfer-for-Value Rule

Answer 39

the death benefit its received income tax free by the beneficiary if the policy is transferred for valuable consideration to: 1. the insured 2. a corporation in which the insured is a shareholder 3. a partnership in which the insured is a partner 4. a partner of the insured 5. a transferee who takes the transferor's basis

Question 40

# subjecting gross income to taxation: tax year & accounting method cash receipts & disbursements method

Answer 40

cash method - gross income of a cash method taxpayer is reported in the tax year in whcih cash is received or a benefit is conferred in the form of a cash equivalent

Question 41

# subjecting gross income to taxation: tax year & accounting method accrual method

Answer 41

- gross income is normally reported when earned rather than when received

Question 42

# subjecting gross income to taxation: tax year & accounting method hybrid method

Answer 42

- other than the cash or accrual method unless the IRS decides that it does not clearly reflect income

Question 43

# subjecting gross income to taxation gains normally taxed when realized

Answer 43

- gains from property transactinos are normally taxed when they can be objectively determiend through a sale or exchange

Question 44

# gains normally taxed when realized realized gain

Answer 44

a gain that is objectively determined

Question 45

# gains normally taxed when realized unrealized gain

Answer 45

- those that cannot yet be objectively determined and therefore are not subject to tax until they are objectively determined

Question 46

# subjecting gross income to taxation barter transactions (bartering) ## Footnote gains normally taxed when realized

Answer 46

- is an exchange of property and or services for other services as opposed to an exchange for cash - the value of a good or service received in a barter transaction must be included in gross income - the value received can be offset by the cost or other tax basis of goods given up in the transaction - when goods or servivces are received by a taxpayer in exchange for services, the services provided by the taxpayer normally have a tax basis of zero

Question 47

# types of gross income & exclusions gains on property are normally taxed upon sale or exchange

Answer 47

true

Question 48

# gains normally taxed when realized barter transactions are not reportable for income tax purposes

Answer 48

false

Question 49

# sources of income individual taxpayers receive income from: 3 sources of income

Answer 49

1. investments 2. personal activities 3. employment & self-employment

Question 50

# sources of income investments generate what type of income

Answer 50

1. dividend income 2. interest income 3. gains from the sale of the investments

Question 51

# sources of income investments taxation

Answer 51

the taxation of investment income generally follows the Doctrine of the Fruit and the Tree

Question 52

# sources of income personal activities normally generate this type of income

Answer 52

1. receipt of alimony from a former spouse 2. receipt of prizes and awards

Question 53

# sources of income typically income generated from employment/self-employment

Answer 53

1. wages 2. salaries 3. commissions 4. fringe benefits 5. other income generated from providing services to an employer 6. engaging in the conduct of a trade or business generates self-employment income

Question 54

# sources of income investment income

Answer 54

- normally taxable to the owner of the investment - the owner of the tree gets taxed on the fruit that the tree produces

Question 55

# sources of income income from personal activities

Answer 55

- gross income generated from personal activities is normally taxable to the recipient - it is easier to collect an income tax from the taxpayer who has the cash rather than from the taxpayer who paid the cash

Question 56

# sources of income employment income

Answer 56

- gross income from services provided to an employer or form self employment is normally taxable to the person who performs the services and receives the payment - gross income cannot normally be assigned to another person by the person who earns it since it violates the Doctrine of the Fruit & the Tree

Question 57

# sources of income community property ## Footnote special issues for persons liviing in community property states

Answer 57

- one half of the incime earned by a spouse is deemed to be earned by each spouse and on ehalf of the incie earned from community property is deemed to be the income of each spouse

Question 58

# sources of income section 66 of the IRC provides relief solutions, which are the following: ## Footnote special issues for persons liviing in community property states

Answer 58

- separated spouse relief - innocent spouse relief - equitable relief - disallowance of community property treatment

Question 59

# sources of income section 66 of the IRC provides relief solutions: what is (separated spouse relief) ## Footnote special issues for persons liviing in community property states

Answer 59

- for income earned through personal services, community property laws are ignored and each spouse reports his or her own earned income for federal income tax purposes if the married couple lives apart at all times during the year - they do not file a joint return with each other, and none of the earned community income is transferred between them during the year

Question 60

# sources of income section 66 of the IRC provides relief solutions: what is (innocent spouse relief) ## Footnote special issues for persons liviing in community property states

Answer 60

- may be able to exclude that income if the taxpayer does not file a joint return, does not include in gross income an item of community income of the spouse, establishes that the taxpayer did not know of or hae reason to know of that community income, and it is inequitable to inckdue that community income in the taxpayers gross income

Question 61

# sources of income section 66 of the IRC provides relief solutions: what is (equitable relief) ## Footnote special issues for persons liviing in community property states

Answer 61

- even if the requiremetns for separated spouse relief or innocent spouse relief are not met, the IRS is authorized to allow a taxpayer not to report half of the community income of the taxpayers spouse, if taking into account all of the facts and circumstances, the failure to grant such relief would be "inequitable"

Question 62

# sources of income section 66 of the IRC provides relief solutions: what is (disallowance of community property treatment) ## Footnote special issues for persons liviing in community property states

Answer 62

- the secratary of the Treasury is given authority in IRC section 66 to disallow benefits of any community property law (splitting of income) to any taxpayer who acts as if they are solely entitled to the community income and who fails to notify their sppouse about the income before the due date (including extensions) for filing a tax return for the year

Question 63

# income from investing activities Capital Gains ## Footnote investment items Included in Gross Income

Question 64

# income from investing activities interest income ## Footnote investment items included in gross income

Answer 64

- generated by a variety of debt instruments: - bank accounts - momney market instruments - corporate bonds - gov agency securities - treasury securities - municipal bonds

Question 65

# income from investing activities original issue discount bonds (OID) ## Footnote investments items included in gross income

Answer 65

-

Question 66

# income from investing activities gifting of debt instruments ## Footnote investments items included in gross income

Question 67

# income from investing activities dividend income ## Footnote investments items included in gross income

Question 68

# income from investment activities investment income EXCLUDED from Gross Income ## Footnote investment income items EXCLUDED from gross income

Answer 68

- municipal bond interest - some exceptions apply - life insurance - death benefits - accelerated death benefits - Roth IRA's - education-related exclusions - savings bond interest - qualified tuition programs/529 plans - coverdell savings accounts - Improvement by Tenant to Landlord's Property

Question 69

# income from investing activities Municipal Bond Interest ## Footnote investment income items EXCLUDED from gross income

Answer 69

- interest is exempt for regular tax purposes - interest may also be excluded from state taxation - capital gains are taxable - Tax Equivalent Yield - TEY = (tax free rate) / (1 - marginal tax rate)

Question 70

# income from investing activities Tax Equivalent Yield (TEY) ## Footnote investment income items EXCLUDED from Gross Income

Answer 70

= (tax free rate) / (1 - marginal tax rate)

Question 71

# income from investing activites Life Insurance Proceeds ## Footnote investment income items EXCLUDED from Gross Income

Answer 71

- death benefits paid by reason of the death of the insured are exempt from income tax - exception: Transfer for Value Rule - Distributions from regular in-force policies - first, treated as return of basis - next, treated as a loan - Modified Endowment Contracts - FIFO basis: distributions are taxable to extent of the gain - Accelerated Death Benefits are excluded from gross income if: - terminally ill: death expected in 24 months, or if - chronically ill: unable to perform 2 of 6 activities of daily living

Question 72

# income from investing activites Life Insurance Proceeds ## Footnote investment income items EXCLUDED from Gross Income

Answer 72

- death benefits paid by reason of the death of the insured are exempt from income tax - exception: Transfer for Value Rule - Distributions from regular in-force policies - first, treated as return of basis - next, treated as a loan - Modified Endowment Contracts - FIFO basis: distributions are taxable to extent of the gain - Accelerated Death Benefits are excluded from gross income if: - terminally ill: death expected in 24 months, or if - chronically ill: unable to perform 2 of 6 activities of daily living

Question 73

# income from investing activites Life Insurance Proceeds ## Footnote investment income items EXCLUDED from Gross Income

Answer 73

- death benefits paid by reason of the death of the insured are exempt from income tax - exception: Transfer for Value Rule - Distributions from regular in-force policies - first, treated as return of basis - next, treated as a loan - Modified Endowment Contracts - FIFO basis: distributions are taxable to extent of the gain - Accelerated Death Benefits are excluded from gross income if: - terminally ill: death expected in 24 months, or if - chronically ill: unable to perform 2 of 6 activities of daily living

Question 74

# income from investing activities Roth IRA's ## Footnote investment income items EXCLUDED from Gross Income

Answer 74

- contributions are not deductible - distribution is tax free if qualified... must meet 5 year rule AND be made: - after 59.5 years of age - after death or disability of owner - for first time home purchase (up to $10,000) - FIFO treatment applies - basis distributions are always tax free and penalty free ## Footnote not always gonna be tax free

Question 75

# income from investing activities education savings exclusions ## Footnote investment income items EXCLUDED from Gross Income

Answer 75

- savings bonds interest - qualified tuition programs/529 plans - coverdell savings accounts

Question 76

# income from investing activities educational savings bonds interest income exclusions - to exclude interest from income, qualified savings bonds must meet the following requirements: ## Footnote investment income items EXCLUDED from Gross Income

Answer 76

- Qualified US Savings Bond: - must be EE bonds issued after Dec 31,1989 - issued in the name of the taxpayer and/or spouse - bond owner mus tbe at least 24 years old on date of issue - subject to phaseout

Question 77

# income from investing activities 529 Plan interest income exclusion ## Footnote investment income items EXCLUDED from Gross Income

Answer 77

- distributions are tax free if used to cover Qualified education expenses - sponsored by states or higher educational institutions - can front-load with 5 annual exclusion gifts per donor per beneficiary - $17,000 x 5 = $85,000 for 2023 per donor / per donee (for each of the kids) - can prepay for up to 5 years worth but you have to live during those 5 years - no income phaseouts apply ## Footnote probably a mutual fund, probably a target date mf

Question 78

# income from investing activities qualified education expense ## Footnote investment income items EXCLUDED from Gross Income

Answer 78

- must be paid to an eligible institution - they include tuition fees paid for the taxpayer, spouse, or dependent, contributions to a qualified tuition program, or contributions to a coverdell educationo savings account. - do NOT include expenses from room and board or from courses related to sports, games or hobbies that are not part of the students degree or certificate program

Question 79

# income from invest activities Coverdell Education Savings Accounts ## Footnote investment income items EXCLUDED from Gross Income

Answer 79

- $2,000 max per year until beneficiary reaches age 18 - distributions are tax free if used to cover educational expenses, including: - qualified elementary/secondary school expenses - special needs expenses - contributions to 529 plans - account must be used or rolled over by the time the beneficiary reaches the age of 30 - income phaseouts apply

Question 80

# income from investing activities the amount of interest that can be excluded form gross income may be reduced or completely eliminated if the taxpayers "____ ____" exceeds specified amounts

Answer 80

modified adjusted gross income (MAGI) there are phaseout levels

Question 81

529 plans come in two varieties

Answer 81

prepaid tuition prgrams & college savings plans

Question 82

# income from personal activities prizes & awards

Answer 82

- if paid directly to charity at request of recipient, excluded from gross income if: - the prize was given primarily in recognition of religious, charitable, scientific, educational, artistic, literary, or civic achievement - the recipient must not apply for the award - the recipient must not be required to render substantial future services ## Footnote the general rule is that prizes and awards are included in income unless stated otherwise

Question 83

# income from personal activities employee achievement awards

Answer 83

these are excluded from gross income if: - award is not in excess of $400 - total awards to employee cannot exceed $1,600 - awards must be in the form of tangible personal property

Question 84

# income from personal activities paymetns to former spouses

Answer 84

alimonmy pursuant to a decree entered into ***on or prior*** to Dec 31, 2018: - is deducted (above the line) by payor - taxable to payee alimony pursuant to a decree entered into after Dec 31, 2018 or a decree substantially modified after that date: - no deduction by payor - not taxable to payee

Question 85

# income from personal activities payments to former spouses in terms of child support

Answer 85

no deduction is permitted - its never been deductible by the payor - never has been includable in the income by the payee

Question 86

# income from personal activities payments to former spouses in terms of property settlement

Answer 86

no deduction is permitted

Question 87

# income from personal activities alimony

Answer 87

- payment in cash - pursuant to a divorce or separation instrument - instrument must not designate the payment as something other than alimony (such as child support or property settlement) - parties are not members of the same household (they cannot be living under the same roof) - payments do not extend beyond death of payee - not between spouses filing jointly

Question 88

# income from personal activities what is NOT Alimony

Answer 88

- elective non-alimony payments - child support - payments reduced upon a contingency specifically relating to a child will be treated as child support - rent-free occupancy of the home

Question 89

# income from personal activities property settlement at divorce

Answer 89

- transfer porperty between divorcing spouses - no income tax deduction avaialble - treated as a GIFT to a spouse for Income tax purposes (IRC Section 1014) - no gain/loss recognized - there is carry over basis

Question 90

# income from personal activities special issues with divorce settlements (Medical Insurance)

Answer 90

treated as alimony in entirety if the agreement does not specify what part was for the chidls support

Question 91

# income from personal activities special issues with divorce settlements: (life insurance)

Answer 91

- payee sposue is owner - premium payments made by payor spouse are alimony - cash values are not considered to be alimony - payee spouse is names as beneficiary - premium payments are not alimony - death benefit included in payor spouses estate - death beneift is tax free to payee spouse - abandoned spouse rule: - legal fees: if one spouse paid the legal fees for the other, thats deductable could be alimony - tax related advice, talk to the attorney, there is no deduction with legal fees associated with divorce* ## Footnote married filing separately is a pain in the butt of a filing process, but head of household filing status is wonderful

Question 92

# income from personal activities discharge of indebtedness

Answer 92

- it is a beneift, it is income, debt forgiveness is an accretion to wealth - to the extent the taxpayer is solvent, must include debt forgiven as income other exceptions where it will not be included as income and will be tax free: - certain student loans - debt forgiven as a gift - debt discharged as qualified principal residence indebtedness which is discharged before January 1, 2026

Question 93

# income from personal activities Below-market Loans (a corporation to a shareholder)

Answer 93

- treated as a dividend to shareholder - returned to employer as interest income

Question 94

# income from personal activities Below-market Loans (loan to employee)

Answer 94

- treated as paid compensation for employee - subject to employment taxes - returned to employer as interest income - not deductible by the employee - taxable to the employer

Question 95

# income from personal activities below-market rules

Answer 95

these rules apply to: - term or demand loans that are gift loans, or - tax avoidance loans

Question 96

de minimis exceptions | loan value of 0 <= 10,000

Answer 96

$0 if nit used for acquiring income producing assets

Question 97

de mini | 10001

Question 98

de mini | > 100,000

Question 99

# income from personal activities Child support

Answer 99

- child support is not deductible by the person paying it - child support is niot taxable to the person receiving it

Question 100

# income from personal activities tax benefit rule: 2 situations

Answer 100

seen in 2 situations: 1. state tax refunds 2. medical expenses

Question 101

# income from personal activities tax benefit rule

Answer 101

- taxpayer takes a deduction in one tax year, and - recovers (receives a refund) part or all of the expenditure in a later year, - the recovered amount should be included in gross income in that later year (to the extent of the tax benefit derived from the deduction)

Question 102

# income from personal activities other personal source income

Answer 102

- gambling winnings - fees for: - jury duty - serving as executor, administrator, or personal represetnatives of an estate (unless you are a professional) - income from a hobby

Question 103

personal exclusions

Answer 103

- gifts - inheritances - scholarships - compensation for injuries and sickness (limited) - child support and property settlements - gain on the sale of personal residences (limited) - amounts received under insurance contracts for certain living expenses - qualified foster care payments - disaster relief payments

Question 104

scholarships

Answer 104

income is excluded if: - candidate for a degree - at an eligible educational institution - proceeds are used for qualified tuition and related expenses - tuition - fees - course-related expenses (books, supplies, equipment, NO ROOM + BOARD) *** - room + board is taxable. it cannot be tax free***

Question 105

scholarships (Qualified tuition reductions)

Answer 105

- excluded from income - pell grants

Question 106

compensation for injuries & sickness ## Footnote inclusion or exclusion of compensation for damages from injuries:

Answer 106

| insert picture of chart*

Question 107

qualified disaster relief payments

Answer 107

received for: - payment of reasonable and necessary expenses as a result of a qualified disaster - personal, family, living or funeral expenses - expenses to repair or rehabilitate a personal residence or its contents - promoting general welfare - paid by common carrier by reason of the death or personal physical injuries incurred - these are "additional standard deductions if you have a "qualified disaster""

Question 108

qualified disaster relief payments (What are Qualified Disasters)

Answer 108

- terroristic/military action - presidentially declared disaster - accidents involving common carriers