Gross Income - Individual

Question 1

What is the difference between an exclusion and a deduction?

Answer 1

An exclusion is an item that is specifically required by law to not be included with gross income. We do not use exclusions to mathematically compute our gross income. A deduction is an actual adjustment of the gross income.

Question 2

What are the exclusions, meaning items that are not taxable?

Answer 2

Child support Property settlement payments

Life insurance proceeds

Group Term Life Insurance up to $50K Reimbursement for medical expenses NOT taken as a deduction (it is one or the other)

“Cafeteria plan” benefits

Interest on muni bonds

Pro Rata interest on EE bonds

Scholarships

Leasehold improvements NOT made in lieu of rent (not income to the landlord)

Stock dividends distributed via COMMON shares

Worker’s compensation

Gifts, bequests, inheritances

Damages for being made WHOLE, not punitive, e.g. received personal injury award that was WORK-related

Question 3

When are dividends paid through a life insurance policy taxable and not taxable?

Answer 3

Whenever life insurance dividends exceed the accumulated paid premiums b/c they are not offsetting the cost of the premium, so it now taxable income. When the dividends are LESS than accumulated paid premiums, not taxable as they are a reduction of the premiums paid into the plan.

Question 4

How do we compute the amount of pension contributions to exclude from our taxable income? Why do we exclude that portion?

Answer 4

(Cost / Est’d Pmts) x Pmt received = Exclusion amount B/c that portion is actually a return of the cash paid into the pension plan, like a return OF capital.

Question 5

When should the amount, including interest, redeemed from EE bonds be taxed?

Answer 5

While redeemed EE bond proceeds, including interest, are tax-free, they become taxable if they are not used for higher education expenses and/or exceed the actual education expenses. We compute the pro-rata amount for the taxable portion. EX - Redeemed $6K face plus $4K interest = $10K Actual education expenses = $9K $1K left not used up This means 10% of the interest is taxable since not 100% of the proceeds were used up ($1K / 10K) = 10% x $4K interest = $400 taxable interest

Question 6

How do we determine which tax year that tips should be assigned to?

Answer 6

Rules are: 1) >$20 in tips = must report 2) Report must be made w/in 10 days of the next month aka Reporting Month Ex - Sally the Stripper made $300 in tips in December 2012. She reported the tips to the strip club in January 2014 as required. Since the reporting month falls in 2014 tax year, her $300 tips are reported in the 2014 tax filing.

Question 7

When do we include and exclude leasehold improvements as the landlord?

Answer 7

Whenever our tenants make an improvement to our townhouse in lieu of rent, it is reportable income to us. If our tenants made improvements to our townhouse, but did not make it in lieu of rent and continued to pay regular rent, then it is NOT income to us. We have to exclude. We don’t get to deduct the LI either.

Question 8

When do scholarships become taxable?

Answer 8

Only if they are received as a form of compensation, used for room and board, or in the form of grants for teaching, research, or other activities = still a form of compensation

Question 9

When do we get to exclude Joe Jr’s scholarships?

Answer 9

when used for tuition, course fees, books, supplies, and equipment AND must not have any condition to give the appearance of compensation

Question 10

What is the threshold on Group Term Life Insurance paid through work and how does it work?

Answer 10

Employers can pay for GTL insurance up to $50K tax-free to the taxpayer. Anything past $50K is TAXABLE, include the excess in Gross Income. EX - iGov pays $70K in GTL insurance for you. $50K of that $70K is tax-free, the $20K excess is taxable to you.

Question 11

When do is dividend income taxable?

Answer 11

In the year that the taxpayer actually receives the dividend payment. Ex - Apple, Inc. paid dividends on 12/30/2012 and mailed the dividend payments. We got our dividend payment in our mail on 1/2/2013. We have to pay tax on the dividends in 2013. That is the year we actually received the dividend payments. The payments represent FMV.

Question 12

Are foreign dividends taxable?

Answer 12

Yes, include foreign dividends in our gross income.

Question 13

When are stock dividends taxable and not taxable?

Answer 13

Stock dividends distributed through common shares ownership are not taxable. Stock dividends distributed through preferred shares is taxable @ FMV received.

Question 14

Qualified dividends on Form 1040 are…

Answer 14

Ordinary dividends that qualify for being taxed at a lower long-term capital gains tax rate rather than at higher tax rate for an individual’s ordinary income. All dividends are taxable unless they are stock dividends distributed through common share ownership.

Question 15

EE bonds must be owned by

Answer 15

the buyer (the redeemer) or joint owner with the spouse.

Question 16

Items that are includible in Gross Income

Answer 16

Compensation received - wages, salaries, bonuses, commissions, fees, and tips, and property received @ FMV Non-deductible reimbursements

Distributive share of Partnership or S-Corp income

Gain from sale or exchange of property - installment basis (Schedule D)

Rents & royalties = passive income

Dividends (not from life insurance proceeds unless exceeds the premiums paid)

Interest on savings, CD’s, US Federal bonds, t-bills,

Interest on tax refunds Interest on loans made, imputed or prepaid @ prorated amount

Alimony

Alimony recaptured (if you tried to screw over your ex)

Up to 85% of Social Security benefits if you’re in upper bracket Income in respect of decedent Unemployment compensation

Sale of stocks acquired either as compensation (Incentive Stock Option) or as your own investment

Foster child payments used for your own needs

Punitive damages received, e.g. personal injury award for something not work-related

Gambling winnings

Tax benefits incurred by taking itemized deduction on last year’s tax return

Question 17

How are alimony payments applied when they are less than full?

Answer 17

Apply 100% of the payments to the children as child support. Whatever is left over counts as alimony and include it in your gross b/c it is taxable. Will have to sue the bastard for remainder of alimony, but still got to pay taxes on any alimony not used as child support.

Question 18

Does alimony count as child support? What about property settlement payments like paying the mortgage to your ex?

Answer 18

No, alimony is separate from child support and property settlement payments (e.g. mortgage on the house). Only when alimony is not paid in full is when we apply these alimony payments as child support and the remainder, if any, counts as alimony and is taxable. Property settlement payments such as paying the mortgage on the home that existed during the marriage do not count as alimony. They are not tax-deductible for the payer and not includible in recipient’s gross income. This is where angry ex’s try to pass off property settlement payments as alimony payments in order to take the deduction and this is why we have the alimony recapture mechanism in place.

Question 19

What is the tax treatment for child support?

Answer 19

It is not taxable to the recipient and is not deductible by the payer. We exclude child support from gross income of the recipient.

Question 20

Alimony Recapture and its tax impact

Answer 20

Applies to situations where the payer tries to screw the ex by over-paying alimony (front-loading) in x1 then less in x2 and x3 (3 years) in order to jack up the ex’s tax liability in year 1. The alimony recapture is a mechanism for “recapturing” what the alimony should have been due to the ex and adjust the tax burden accordingly to recapture a credit for being forced to overpay on tax (inflated gross income due to the overpaid alimony). x2 Excess over x3 ($15,000) = x2 recapture amt x1 alimony (avg alimony rec’d in x2 & x3 altogether LESS x2 recapture amt) ($15,000) =x1 recapture amt x2 recapture + x1 recapture = TOTAL recapture

Question 21

How can taxpayers reduce their taxable interest on US bonds?

Answer 21

Taxpayers can elect to amortize the bond premium on the US bonds and offset the amortization against the taxable interest amount to REDUCE the taxable interest before including in the gross income. Less taxable interest = less gross income to tax. Available for U.S. federal bonds bought after 1987, e.g. HH bonds

Question 22

What is “tax benefit” on the 1040 and when does it have to be reported for taxation?

Answer 22

Tax benefit is where you got a refund on last year’s tax return because you used the itemized deduction. You can also get a refund by using the standard deduction. However, IRC says tax benefits obtained by using the ITEMIZED deduction are taxable in the following year’s 1040. Itemized deduction & refund on last year’s = taxable Standard deduction & refund on last year’s = not taxable

Question 23

Can alimony also be payment for the ex’s college tuition?

Answer 23

Yes, alimony can be paid in cash or its equivalent. The goal of alimony is to help the ex get back on his/her feet financially.

Question 24

What do we need to worry about Incentive Stock Options (ISO)?

Answer 24

When the shares obtained through the ISO are sold, the gains on these shares are taxable. We don’t care when the company granted the ISO. We care about whether the taxpayer actually exercised the ISO and got shares then sold these shares b/c we want to tax on these gains made on the sale.

Question 25

Can we ever get away without having to pay taxes on a monetary award that we did not have to compete for and did not have to render any services?

Answer 25

Nope, we will always have to pay taxes on these monetary awards unless we donate the money to a qualified organization. Otherwise, it is taxed as compensation.

Question 26

What is the IRC’s stand on using cash basis?

Answer 26

Cannot use cash basis for inventory (or where the business primary relies on inventory to make income), C-corporations, and tax shelters. Can use cash basis for personal service corporations (e.g. lawyers, CPA’s) or small businesses with less than $1M in average gross receipts.

Question 27

If a business’s purchases and sales heavily involve inventory for making income, what is the tax accounting method to use?

Answer 27

IRC says must use accrual basis.

Question 28

When is income taxable in a cash basis business?

Answer 28

When the income is either actually received (cold hard cash) or “constructively received”, meaning there is nothing to stop the business from getting the cash owed.

Question 29

What’s the IRC view on pre-paid rents and advance royalties?

Answer 29

Taxable regardless of what period the rents or royalties cover. Tax when received. Ditto for security deposits and lease cancellation fees. The IRC does not care what caused the money to come into your business. It is includible in gross income.

Question 30

When does the IRC require us to the Installment Sales method? How do we apply the installment method?

Hint: Schedule D

Answer 30

Apply when we sell property that is NOT held for sale in our business, e.g. I sell my old printer and photocopier that I use in my CPA practice. I don’t sell printers or photocopiers as a CPA. I sell my services as a CPA, not printer and photocopier equipment.

IRC requires us to apply the installment sales method to capture the taxable gains on the sale of my office equipment. I sell the equipment on an installment basis to XYZ for 10 equal payments totalling $100K. My basis is $80K. I did not get that gain all upfront b/c I have not gotten all 10 payments. IRS can only tax on what cash I actually received from XYZ. The gain is built into the payments being paid in installments. XYZ also took on my mortgage on the equipment, $65K.

Sale Price - My basis = GP

Sales Price - Liabs assumed = Contract Price

(GP / Contract Price) x Installment Payment rece’d so far = Taxable Gain

$100K - $80K = $20K GP

$100K - $60K = $40K contract price

($20K / $40K) x $10K rec’d so far = $5K taxable gain –> report on 1040 as a gain

**This gain can either be LTCG or STCG.

Held > 1 yr = LTCG

Held < 1yr = STCG

Report on Schedule D, flows to the 1040

Question 31

Can the taxpayer take the depreciation deduction on an asset that was sold on installment during the year?

Answer 31

No, back in the depreciation expense and INCREASE the basis then compute the amount of taxable gain. Don’t forget to add the depreciation amount to the taxable gain. The deprecation is “recaptured” to be taxed in addition to the gain. We don’t get to keep the deduction since we got rid of the asset.

EX - I sold a photocopier that I used in my CPA practice for $50K cash plus $50K note. It costed me $90K, but I deducted a depreciation of $40K over the time I owned the asset. My basis is $50K at the time of the sale. I don’t get to keep the $40K deduction. I have to put it back as a “recaptue” in my GP computation and add it to my taxable gain computation:

$100K - ($50K basis + back in $40K dep) = $10K GP

($10K GP / $100K contract price) x $50K pmt received = $5K

Amount to report = $40K “recaptured dep” + $5K = $45K to be taxed

Question 32

What is depreciation recapture?

Answer 32

IRS requires taxpayers to recapture the depreciation taken over the years as a deduction b/c the taxpayers sold the asset as a gain. IRS taxes on that gain plus the recaptured depreciation. Why? Because the asset provided an offset to ordinary income for taxpayer as a depreciation expense, which was deductible. It is only fair that the IRS gets to come back and recapture that taxable amount through the disposal (sale) of the asset.

Depreciation recapture is the USA Internal Revenue Service (IRS) procedure for collecting income tax on a gain realized by a taxpayer when the taxpayer disposes of an asset that had previously provided an offset to ordinary income for the taxpayer through depreciation. - http://en.wikipedia.org/wiki/Depreciation_recapture