Chapter 5: Gross Income: Exclusions

Question 1

Accelerated death benefits

Answer 1

The amount received from a life insurance policy by the insured who is terminally ill or chronically ill. Any realized gain may be excluded from the gross income of the insured if the policy is surrendered to the insurer or is sold to a licensed viatical settlement provider. § 101(g).

Question 2

Accident and health insurance benefits

Answer 2

See accident and health benefits.

Question 3

Cafeteria plan

Answer 3

An employee benefit plan under which an employee is allowed to select from among a variety of employer-provided fringe benefits. Some of the benefits may be taxable, and some may be statutory nontaxable benefits (e.g., health and accident insurance and group term life insurance). The employee is taxed only on the taxable benefits selected. A cafeteria benefit plan is also referred to as a flexible benefit plan. § 125.

Question 4

Compensatory damages

Answer 4

Damages received or paid by the taxpayer can be classified as compensatory damages or as punitive damages. Compensatory damages are paid to compensate one for harm caused by another. Compensatory damages are excludible from the recipient’s gross income.

Question 5

Coverdell education savings account (§ 530 plan)

Answer 5

Coverdell education savings account exempts from tax the earnings on amounts placed in a qualified account for the education expenses of a named beneficiary. Contributions are limited to $2,000 per year per beneficiary and the proceeds can be withdrawn without tax provided the funds are used to pay qualified educational expenses for primary, secondary, or higher education. The account is named for the late Senator Paul Coverdell (R-GA), who sponsored the legislation in Congress. § 530.

Question 6

De minimis fringe

Answer 6

Benefits provided to employees that are too insignificant to warrant the time and effort required to account for the benefits received by each employee and the value of those benefits. Such amounts are excludible from the employee’s gross income. § 132.

Question 7

Death benefit

Answer 7

A payment made by an employer to the beneficiary or beneficiaries of a deceased employee on account of the death of the employee.

Question 8

Educational savings bonds

Answer 8

U.S. Series EE bonds whose proceeds are used for qualified higher educational expenses for the taxpayer, the taxpayer’s spouse, or a dependent. The interest may be excluded from gross income, provided the taxpayer’s adjusted gross income does not exceed certain amounts. § 135.

Question 9

Flexible spending plans

Answer 9

An employee benefit plan that allows the employee to take a reduction in salary in exchange for the employer paying benefits that can be provided by the employer without the employee being required to recognize income (e.g., medical and child care benefits).

Question 10

Foreign earned income exclusion

Answer 10

The Code allows exclusions for earned income generated outside the United States to alleviate any tax base and rate disparities among countries. In addition, the exclusion is allowed for housing expenditures incurred by the taxpayer’s employer with respect to the non-U.S. assignment, and self-employed individuals can deduct foreign housing expenses incurred in a trade or business. The exclusion is limited to $101,300 per year for 2016 ($100,800 in 2015). § 911

Question 11

Fringe benefits

Answer 11

Compensation or other benefit received by an employee that is not in the form of cash. Some fringe benefits (e.g., accident and health plans, group term life insurance) may be excluded from the employee’s gross income and therefore are not subject to the Federal income tax.

Question 12

Health Savings Account (HSA)

Answer 12

A medical savings account created in legislation enacted in December 2003 that is designed to replace and expand Archer Medical Savings Accounts.

Question 13

Life insurance proceeds

Answer 13

A specified sum (the face value or maturity value of the policy) paid to the designated beneficiary of the policy by the life insurance company upon the death of the insured.

Question 14

Long-term care insurance

Answer 14

Insurance that helps pay the cost of care when the insured is unable to care for himself or herself. Such insurance is generally thought of as insurance against the cost of an aged person entering a nursing home. The employer can provide the insurance, and the premiums may be excluded from the employee’s gross income. § 7702B.

Question 15

No-additional-cost service

Answer 15

Services the employer may provide the employee at no additional cost to the employer. Generally, the benefit is the ability to utilize the employer’s excess capacity (e.g., vacant seats on an airliner). Such amounts are excludible from the recipient’s gross income.

Question 16

Punitive damages

Answer 16

Damages received or paid by the taxpayer can be classified as compensatory damages or as punitive damages. Punitive damages are those awarded to punish the defendant for gross negligence or the intentional infliction of harm. Such damages are includible in gross income. § 104.

Question 17

Qualified ABLE program

Answer 17

A state program that allows funds to be set aside for the benefit of an individual who became disabled or blind before age 26. Cash may be put into the fund annually up to the annual gift tax exclusion amount. Distributions to the designated beneficiary are not taxable provided they do not exceed qualified disability expenses for the year. § 529A.

Question 18

Qualified employee discount

Answer 18

Discounts offered employees on merchandise or services that the employer ordinarily sells or provides to customers. The discounts must be generally available to all employees. In the case of property, the discount cannot exceed the employer’s gross profit (the sales price cannot be less than the employer’s cost). In the case of services, the discounts cannot exceed 20 percent of the normal sales price. § 132.

Question 19

Qualified real property business indebtedness

Answer 19

Indebtedness that was incurred or assumed by the taxpayer in connection with real property used in a trade or business and is secured by such real property. The taxpayer must not be a C corporation. For qualified real property business indebtedness, the taxpayer may elect to exclude some or all of the income realized from cancellation of debt on qualified real property. If the election is made, the basis of the property must be reduced by the amount excluded. The amount excluded cannot be greater than the excess of the principal amount of the outstanding debt over the fair market value (net of any other debt outstanding on the property) of the property securing the debt. § 108(c).

Question 20

Qualified transportation fringes

Answer 20

Transportation benefits provided by the employer to the employee. Such benefits include (1) transportation in a commuter highway vehicle between the employee’s residence and the place of employment, (2) a transit pass, and (3) qualified parking. Qualified transportation fringes are excludible from the employee’s gross income to the extent categories (1) and (2) above do not exceed $255 per month in 2016 and category (3) does not exceed $255 per month in 2016. These amounts are indexed annually for inflation. § 132.

Question 21

Qualified tuition program

Answer 21

A program that allows college tuition to be prepaid for a beneficiary. When amounts in the plan are used, nothing is included in gross income provided they are used for qualified higher education expenses. § 529.

Question 22

Scholarships

Answer 22

Scholarships are generally excluded from the gross income of the recipient unless the payments are a disguised form of compensation for services rendered. However, the Code imposes restrictions on the exclusion. The recipient must be a degree candidate. The excluded amount is limited to amounts used for tuition, fees, books, supplies, and equipment required for courses of instruction. Amounts received for room and board are not eligible for the exclusion. § 117.

Question 23

Tax benefit rule

Answer 23

A provision that limits the recognition of income from the recovery of an expense or a loss properly deducted in a prior tax year to the amount of the deduction that generated a tax saving. Assume that last year Gary had medical expenses of $4,000 and adjusted gross income of $30,000. Because of the AGI limitation, Gary could deduct only $1,000 of these expenses [$4,000 ? (10% × $30,000)]. If this year Gary is reimbursed in full by his insurance company for the $4,000 of expenses, the tax benefit rule limits the amount of income from the reimbursement to $1,000 (the amount previously deducted with a tax saving).

Question 24

Working condition fringes

Answer 24

A type of fringe benefit received by the employee that is excludible from the employee’s gross income. It consists of property or services provided (paid or reimbursed) by the employer for which the employee could take a tax deduction if the employee had paid for them. § 132.