Chapter 5 - Gross Income (What is included and excluded) Flashcards
What is economic income
any change in net worth
why is economic income problematic
impractical, liquidity problems and prone to disputes
ex: unless you sell something its hard to prove its worth sometimes
What is accounting income?
bad because it is based on the realization principle, and is conservative (underreport income) and objective
*exchange has to happen to recognize something
What is included in Gross income
any income from whatever source derived unless tax provisions say otherwise
-could be money, property, or services
Why does accounting income not work for tax purposes?
accounting objectives may lead to understatement of income, and tax goals are to preserve revenue
what is accounting incomes goal
to share useful information with outsiders
what is the tax goal
the equitable collection of revenue
Asia owns stock that is listed on the New York Stock Exchange, and this year the stock increased in value by $20,000.
what is the economic income and gross income
economic: 20,000 because there was an increase in net worth
gross: 0 because there was no sale or transaction
when do tax payers recognize income?
when taxpayers engage in a transaction that results in a measurable change in property rights (ex: cash or assets)
when property is exchanged how is the income recognized
realize at market value however they can reduce the proceeds by their unrecovered investments
If someone has stock and it increases in value throughout the year but they do not sell the stock then what is their taxable income from it
0, no sale of the stock
What does form of receipt mean
it means that income can be received in any form (cash, property or service)
How is dividend income taxed differently
- maybe subject to a lower
Taxable income shares the return of capital principal with economic income, what does that mean?
when you sell something at a gain the full amount of sales price isn’t taxable just the gain and the rest is considered return on capital
how is dividend income taxed
lower tax rates than interest income of 15% as long as the stock was held for a min. of 60 days during the 120 days window around the ex-dividend date
these dividends are called qualified dividends
What is the equation for figuring out how much is taxed for property exchanges
what is amount realized and adjusted basis of property entail?
The amount realized from the sale - adjusted basis of the property = realized gain/loss
amount realized = cash + FMV property received + reduction sellers debt - selling expense
Adjusted bases = cost + capital additions - depreciation
What are the special rules for capital gains
long term have smaller rates
short-term: (<year) = same tax rates as ordinary income
long-term (>year) = 20, 15 or 0%
medicare: 3.8%
what are individual NET capital loss deductions limited to?
$3000/year to offset ordinary income
why is capital gains good?
because capital losses can only be used to offset capital gains (except for the $3000 that is allowed to be deduced from ordinary)
is ordinary loss or capital loss better?
ordinary loss because it is easier to deduct than capital losses
What is the tax benefit rule?
if you made a payment in prior years and it was deductible and later on you were reimbursed for it you have to tax that by the amount you deducted it
During 2023, Deb spends 15,000 on medical expenses and had no other itemized deductions, in 2024 she received 1000 worth of reimbursement. The standard deduction was 13,000
how much income is taxable in 2024 and also what principal is this
1000 in taxable income is because she took the itemized deduction so therefore since it was deducted in the prior year this reimbursement is taxable in 2024
this is the tax benefit rule
During 2023, Deb spends 5000 on medical expenses and had no other itemized deductions, in 2024 she received 500 worth of reimbursement. The standard deduction was 13,000
how much income is taxable in 2024 and also what principal is this
none of it is taxable since she took the the standard deduction so the 5000 medical expenses never gave her a tax benefit in the previous year
this is tax benefit rule
If you receive discharge of indebtedness (meaning you don’t have to pay your debt anymore) is it taxable?
it is taxable income
what are the exceptions for debt indebtedness in terms of taxable income?
you don’t have it as taxable income for federal bankruptcy, insolvency and also the mortgagee debt relief of 2017
If you enter yourself into a competition and win a prize is that income taxable
yes
if someone enters you into a competition and win a prize is that income taxable?
yes because it is based off of a selection process with some criteria to be selected
Are gifts considered taxable income?
no they are excluded from gross income if the transfer was made voluntary and made because of a affective or donative intent
when are gifts considered taxable income
when they are from an employer or from someone you are conducting business with (technically considered compensation)
are inheritances taxable income?
no but any income generated from the inheritance is taxable
Example:
you are a wait-person at lake park bistro and a regular gives you $100 that says a gift as a token of my appreciation is that taxable?
yes because you wouldn’t have gotten it if you weren’t working for them
if you get reimbursed for expenses are they taxable
no as long as it was not previously deducted
*considered to be restoring you to where you previously were
is compensation for loss wages taxable income
yes because if you were able to work it would of been taxable income so it keeps you in the same position
is payment to damage to or destruction of property taxable income?
no as long as they don’t give you more than it was worth
is compensation for emotional distress taxable income?
yes as long as it wasn’t associated with a physical injury
are punitive damages taxable income
yes anytime you punish someone and win money it is taxable because it is not about restoring you to your current condition
Example: Jane sued her employer for age discrimination and was awarded 5000 to cover medical bills, 20000 to punish the employer for discrimination and 10,000 to compensate for loss wages
what is taxable
30,000 (20,000 emotional distress and 10,000 wage compensation)
5000 isn’t because it is a reimbursement for expenses
In a divorce settlement when a property settlement happens what is the tax effect
there is no tax effect (not taxable or deductible)
in a divorce settlement what is the tax effect of child support payments
they are not deductible by the person paying them and are not taxed to the person receiving them
- not deductible and not taxable income
what is alimoney
a higher earning spouse in a divorce settlement may pay the lower earning spouse as longer as they are not members of the same household
what is the tax effect of alimony
they are deductible by the payor and taxable income to the recipient if divorce settled prior to 2019
Example
under the terms of their divorce agreement in 2018, James is to transfer common stock (cost of 25,000 and FMV of 60,000) to Nina, James and nina have a 14 year old child, and james is to pay 300 a month as child support. In addition Nina recieves $1000 per month for 10 years . However payments will be reduced to 750 a month when the child reaches 21. In the first year under the agreement Nina receives common stock and correct cash payments for 6 months
how does this affect her gross income
stock isn’t taxable because it is a property settlement and the child payments arnt either
750 x 6 = 4500 of it is taxable since it is considered alimony
*since 250 stops when the child is 21 it is considered child support
are scholarships taxable income?
it depends
- it is not taxable if
1. you are a candidate for a degree at a educational institution
2. it is used for books, tuitions fees and supplies
it is taxable if
1. it is used for room and board
2. payments are disguised as compensation
3. scholarship is a form of tuition waver
Alejandro was awarded an academic scholarship to State University
for the 2023-2024 academic year. He received $5,000 in August
and $6,000 in December 2023. Alejandro had enough personal
savings to pay all expenses as they came due. Alejandro’s
expenditures for the relevant period were as follows
Tuition, August 2023 $3,300
Tuition, December 2023 $3,400
Room and board
August-December 2023 $3,000
January-May 2024 $2,400
Books and educational supplies
August-December 2023 $1,000
January-May 2024 $1,200
Determine the effect on Alejandro’s
gross income for 2023 and 2024.
2023: none
2024: it would be scholarship minus the amount he payed in fees not related to room and board
11,000- 3300-3400-1000-1200 = 2100 is taxable income
What is imputed interest
when a loan is made between related parties at a rate that is below market interest rate then the lender is deemed to have received interest and paid back the difference between the market and state interest rates
Example:
Tim (MTR=36%) loans his son Matt (MTR=15%)
$50,000 interest-free. Matt invests the $50,000 and
earns 10% (the same rate that Tim can earn). How
much in income taxes does the family save with this
plan?
1050
5000(.35)-5000(.15)
why does the imputed interest rule exist?
to prevent the shifting of income for tax purposes
What are the three steps to determining if we have to impute interest
Step 1. type of loan
Step 2. Calculate imputed interest
Step 3. are there any exceptions
what are the types of loans for imputed interest
gift loan: family
compensation loan: employer or doing work
corporation-shareholder loan:
how do you calculate max imputed amount
loan amount x Applicable market rate
What are the exceptions that apply for imputed interest
1: If it is a loan that is $10,000 you don’t impute unless… it is not a gift loan and the purpose is tax avoidance or if it is a gift loan and they use it to buy income producing property
- if it is less than 1000 you don’t impute
- Sasha loans $5,000 to her son Jeff. Jeff uses the
proceeds to pay his daughters college tuition. - Sasha loans $5,000 to her son Jeff. Jeff uses the
proceeds to invest in real estate
Impute or not?
- do not impute
- Impute
For each scenario, discuss the income tax implications for both
parties. Assume the applicable Federal interest rate is 8%.
1) Alamo Corporation loans Sandy, an employee, $15,000 on Jan. 1. The loan is to be repaid over 4 years, and the full amount of the loan is outstanding at the end of the year. Sandy uses the proceeds to buy a used automobile. She has $1,100 in investment income during the year.
On Alamo: 1200 interest income - 1200 compensation expense (deductible) = 0
On sandy: 1200 compensation expense - 1200 interest expense (ND) = 1200
*interest expense was for a personal use
Sasha loans $50,000 to her son Jeff. Jeff uses the
proceeds to pay his daughters college tuition. His net investment
income for the year is $1,200.
What is imputed
1200 because capped at investment income
Sasha loans $50,000 to her son Jeff. Jeff uses the
proceeds to invest in real estate. His net investment income
for the year is $500. Do not Impute Interest
Imputed interest is limited to $1,200
What is imputed
don’t impute because exception 2 applies and investment income is less than 1000
is municipal bond interest income taxable
no its is excluded from taxable income
are life insurance proceeds taxable
no it is excluded from taxable income
What is the assignment of income doctrine?
income earned from personal services must be reported by the taxpayer who performs the services
who reports income for pass through entity
owners rather than the entity
who reports income from property
- from the actual property
-from interest income
-from dividend income
owner of the property
dividend income: whoever gets the dividend
interest income: however long you have had it for
