Federal Taxation Flashcards
Debt Forgiveness
Generally debt cancellation constitutes taxable income in the amount cancelled. But there is an exception for student loans forgiven for students working in specific professions (public service) for a certain period. This type of loan forgiveness is excluded from gross income.
Life Insurance Proceeds
Life insurance proceeds paid to a beneficiary upon the death of the insured are excluded from the beneficiary’s gross income.
Inheritance of Property
An inheritance of property is excludable from gross income. The person inheriting the property takes a “stepped-up” basis in the property, which is the fair market value of the decedent’s property on the date of death.
Awards from Employers
Awards from employers are generally includable in employee’s gross income in the year received, with exceptions for length of service and safety awards under $400.
Minimis Fringe Benefit
A good or service with little value, and accounting for it would be unreasonable and administratively impractical (e.g., holiday gifts).
Damages
Damages, including settlement payments or compensation for personal physical injuries or sickness as well as lost wages are excluded from gross income. A taxpayer may not deduct a casualty loss attributable to personal property, unless the loss is attributable to a federally declared disaster.
Sale of Home
Gain from the sale or exchange of a principal residence is excluded from gross income, subject to a cap of $250,000. Married individuals, if filing jointly, can exclude up to $500,000. To qualify for this exclusion, the taxpayer must have occupied the residence for at least two years during the five-year period ending on the date of the sale.
Unemployment Compensation
Unemployment compensation greater than $2,400 is includable in gross income
Basis in Property
To determine the basis in property, the initial basis is adjusted by the cost of capital improvements and/or any depreciation.
Deduction for Home Mortgage Interest
Interest paid on debt that is secured by the taxpayer’s principal residence or second residence is generally deductible as an itemized deduction.
Personal Expenses
Generally, personal, living, or family expenses are not deductible unless subject to an exception. The determination of whether an expense is a business or personal expense depends on the origin of the expense. Hence, if the origin of the expense is for business, it may be deducted.
Ordinary and Necessary Expenses
An ordinary and necessary trade or business expense is generally deductible. An “ordinary” expense is a cost that is customary or expected in the life of a business. An expense need not be a common or frequently occurring expense to be ordinary; it merely must be reasonably related to conduct of the business. A “necessary” expense is a cost that is appropriate and helpful to the business.
Capital Cost
A capital cost is a purchase that will yield benefits extending beyond one year, whereas an expense is a purchase that will yield benefits for one year or less. Traditionally, capital costs could not be expensed immediately, but had to be taken incrementally over the useful life of the asset through depreciation. However, taxpayers may now elect to deduct from gross income the cost of tangible personal property (subject to an annual $1 million cap).
Calculating Tax Liability
To determine an individual’s tax liability for each item, gross income must first be calculated (i.e., all income from whatever source derived). Then, after reducing that number by certain deductions, the adjusted gross income (AGI) can be determined.
Salary
An employee must include compensation for services from an employer in the form of wages or salary in the employee’s gross income. Unless expressly excluded by statute, any accession to wealth is includable in gross income, as ordinary income.
Employer-Paid Qualified Plan Retirement Contribution
Contributions made by an employer to a qualified retirement plan are not included in an employee’s gross income.
Medical Insurance Premium
An employer contribution to a health plan is excludable from the employee’s gross income.
Fringe Benefits
Gross income does not include certain fringe benefits, including working condition fringe benefits. These benefits are provided by the employer but would require business expense deduction if purchased by the employee.
Stock
If an employee receives employer stock as compensation that is subject to a risk of forfeiture and the transfer is not pursuant to a qualified plan, the employee is not required to report the value of the stock as income until the employee is substantially vested in the stock. This requires the employee to have the right to transfer the stock to anyone, and the substantial risk of forfeiture must have lapsed. An employee may elect to include the value of the shares at the time of receipt or when they vest.
Reimbursement of Moving Expenses
Moving expenses are nontaxable only if the taxpayer is a member of the armed forces on active duty and, due to a military order, taxpayer, taxpayer’s spouse, or the taxpayer’s dependents move because of a permanent change of station.
Gifts
If property is received as a gift, the done generally takes the donor’s adjusted basis in the property (i.e., a “carryover” basis). However, if the donor’s adjusted basis in the property exceeds the fair market value (“FMV”) of the property at the time of the gift, the donee’s basis is the FMV of the property instead.
Long-Term Capital Gain
A capital asset that has a holding period of more than one year, gain or loss on its sale or exchange is characterized as long-term. Long-term capital gain is taxed at a lower rate than income.
Capital Gain
Capital gain is calculated by subtracting the original purchase price from the amount the taxpayer sold the property for.