Chapter 5 Flashcards
What is the Realization Principle?
Income is realized when a taxpayer ENGAGES in a transaction with another party resulting in a measurable change in property rights.
What forms of receipt can taxpayers recognize as income?
Taxpayers recognize income whether they receive money, property, or services.
What is the tax basis?
The COST of an asset.
What does the Return of Capital Principle allow?
It allows the tax basis to be EXCLUDED when calculating a gain or loss.
What is the Tax Benefit Rule?
Refunds of expenditures deducted in a prior year are included in gross income to the EXTENT that the refund reduced taxes in the year of the deduction.
What method of accounting do most individuals use?
Cash method.
What is the Constructive Receipt Doctrine?
A cash method taxpayer REALIZES and RECOGNIZES income when it is actually or constructively received.
What does the Claim of Right Doctrine address?
states that income has been realized if a taxpayer receives income and there are NO restrictions on the taxpayer’s use of income
What does the Assignment of Income Doctrine state?
The taxpayer WHO EARNS the income from services MUST RECOGNIZE the income.
What is “earned income”?
Income from labor generated by the efforts of the taxpayer.
What is “unearned income”?
Includes gains or losses from the sale of property, dividends, interest, rents, royalties, and annuities.
What is an annuity?
An investment that pays a STREAM OF EQUAL payments over time, usually purchased to supplement retirement income.
How is the annuity exclusion ratio calculated?
Initial Investment / Expected Return
What are flow-through entities?
Entities like partnerships or S corporations where INCOME and DEDUCTIONS flow through to the owners.
What are the four requirements for a payment to be considered alimony?
- A transfer of cash made under a divorce DECREE
- The divorce decree does not designate the payment as ‘non-alimony’
- The divorced spouses DO NOT live together when the payment is made
- Payments cannot continue after the DEATH of the recipient
What is the general rule for prizes and awards?
Prizes, awards, and gambling winnings ARE included in gross income.
What is the maximum percentage of Social Security benefits that may be included in gross income?
Up to 85%.
What happens when a taxpayer’s debt is forgiven?
The taxpayer MUST INCLUDE the amount of debt relief in gross income.
What is an EXCEPTION to the rule of discharge of indebtedness?
A discharge of indebtedness is NOT taxable if the taxpayer is INSOLVENT before and after the debt forgiveness.
What is the general tax status of municipal bond interest?
EXEMPT from federal income tax, generally recognized as a subsidy to state and local governments.
How much gain can taxpayers EXCLUDE on the sale of their principal residence?
Up to $250,000 ($500,000 if MFJ).
What are qualifying fringe benefits?
Certain fringe benefits EXCLUDED from income.
Scholarships used for required tuition, fees, books, and supplies are _______.
EXCLUDED from income.
What scholarships amounts are taxable?
Amounts used for room and board (personal expenses)
Are gifts and inheritances included in the income of the recipient?
NO
What happens to life insurance proceeds received due to the death of the insured?
EXCLUDED from the income of the recipient.
Early Cash Out, would the taxpayer recognize income?
- taxpayer would recognize to the EXTENT the proceeds received EXCEED the previous premiums paid in.
- if premiums paid > proceeds received then loss is NOT deductible
What are the EXCEPTIONS to early cash-out?
- taxpayer is TERMINALLY ILL (medically certified with an illness expected to cause death within 24 months)
- taxpayer is CHRONICALLY ILL (medically certified to require substantial assistance for daily living activities -or- due to cognitive impairment)
If the taxpayer is terminally ill how much of the cash-out is taxable?
None of it, there are NO restrictions on how the proceeds are used.
If the taxpayer is chronically ill, how much of the cash-out is taxable?
it is not taxable to the EXTENT the proceeds are used to pay for the taxpayer’s L/T care
What is the maximum amount of foreign-earned income that can be EXCLUDED from gross income for 2024?
$126,500.
What are the requirements for a taxpayer to qualify for the foreign-earned income exclusion?
- Must have tax home in a foreign country
- Must be a RESIDENT of the foreign country -OR- live there for 330 days in a consecutive 12-month period.
Workers’ compensation benefits are included in gross income.
FALSE
Unemployment compensation is FULLLY taxable for tax year 2024?
TRUE
What type of payments related to personal injury are EXCLUDED from gross income?
Awards and settlements compensating for PHYSICAL injury.
Compensatory damages for physical injury are _______.
NON-taxable.
What distinguishes disability benefits received from purchased insurance by an individual versus by an employer?
If purchased by the individual, benefits are excluded; if by the employer, benefits may be taxable.
What must be true for disability insurance premiums to be considered purchased by the employee?
The premiums must be taxable compensation to the employee.
What are punitive damages classified as for tax purposes?
ALWAYS taxable.
