Individual Taxation: Gross Income

Question 1

What is included in gross income?

Answer 1

All income (money, property, and services at FMV) from all sources except as tax laws provides certain exclusions

Question 2

What is the difference between an exclusion from income and a deduction from income?

Answer 2

Exclusions are never even mentioned on a tax return, while deductions have to be specified to count as deductions

Question 3

When does income become taxable?

Answer 3

When the taxpayer (a) realizes and (b) recognizes it

Question 4

What is the difference between actual receipt of income and constructive receipt?

Answer 4

Actual = income is in physical possession

Constructive = income is credited and taxpayer has control in determining how it will be paid

Question 5

What is income in respect of a decedent (IRD)?

Answer 5

Income due to a deceased person – needs to be included in heir’s tax return or decedent’s last tax return

Can include income for years after death (e.g. pension plans)

Question 6

How does life insurance relate to gross income?

Answer 6

(1) proceeds due to death are excluded
(2) if proceeds are received in installments, the part attributable to interest IS income
(3) “dividends” received (i.e. returns of premiums) are excluded

Question 7

How do annuities relate to gross income?

Answer 7

They are excluded inasmuch as they are returns of the original investment

If the recipient dies before receiving the original capital, the remainder can be deducted on his last tax return

Question 8

Regarding annuities, what is the simplified method?

Answer 8

Required method (since 1996) for taxpayers to determine portion of annuity income that is a return of investment

original investment
/ expected # of payments
= excludable portion

Question 9

How do gifts and inheritances relate to gross income?

Answer 9

All gifts, inheritances, and bequests are excluded, but not any income or capital gain derived from them

Question 10

How do prizes and awards relate to gross income?

Answer 10

Generally included in GI, with a few exceptions

Question 11

Under what circumstances are prizes and awards excluded from gross income?

Answer 11

If all of these obtain:

(1) award is for scientific, charitable, artistic, religious, etc. accomplishment(s)
(2) taxpayer did not act to enter the contest
(3) future services are not imposed upon the taxpayer
(4) recipient transfers award to gov’t entity or charitable entity

Question 12

How do scholarships and fellowships relate to gross income?

Answer 12

Qualified scholarships for a student to earn a degree at a school are excluded from GI

Qualified = used to pay for books, tuition, fees, and related educational ends

Question 13

How do gains when selling a principal residence relate to gross income?

Answer 13

A portion can be excluded

-add to this card, or delete it if covered elsewhere

Question 14

How do personal injury awards relate to gross income?

Answer 14

Workers’ comp, received damages, insurance proceeds, and disability benefits are excluded from GI

Also includes restitution payments for Holocaust sufferings

Question 15

When are personal injury awards included in gross income?

Answer 15

(a) when received damages are punitive

b) when insurance proceeds are attributable to employer contributions (i.e. not to employee income

Question 16

How does tax-exempt government debt relate to gross income?

Answer 16

Any interest from government bonds is excluded

Doesn’t apply to arbitrage and hedge bonds or to U.S. Treasury bonds (T-bonds)

Question 17

How are social security benefits related to gross income?

Answer 17

They can be partially taxed depending on filing status and provisional income (PI)

Question 18

What is provisional income (PI)?

Answer 18

AGI
\+ tax-exempt income
= Modified AGI (MAGI)
\+ 50% of SS/welfare benefits
= PI

AGI does not here include educational deductions (e.g. student loan interest, tuition)

Question 19

Under what circumstances are social security and welfare benefits taxable?

Answer 19

(1) S/HH/SS status
- 50% taxable if PI is between $25k and $34k
- 85% taxable if $34k or more
(2) MFJ status
- 50% taxable if PI is between $32k and $44k
- 85% taxable if $44k or more
(3) MFS status
- always 85% taxable

Question 20

How is the taxable amount of SS/welfare benefits determined for 50% taxable portions?

Answer 20

The taxable portion can be taken either (a) from the entirety of the benefits received, or (b) from the amount of provisional income above the relevant threshold

E.g. if someone with a SS status received $5k in SS benefits and had a PI of $28k, then he could elect his taxable benefits to be either from all $5k, or from the portion of his PI over the $25k threshold – which would be $3k. Thus, he would elect to have only $1,500 taxable rather than $2,500.

Question 21

How is the taxable amount of SS/welfare benefits determined for 85% taxable portions?

Answer 21

85% taxed persons have a choice:

(a) they can pay 85% on the entire SS benefits
(b) they can pay 85% on the benefits above the relevant threshold (i.e. $34k or $44k) plus a further portion to account for the zone below the threshold (e.g. between $32k and $44k)

This further portion is the lesser of (a) 50% of all SS/welfare benefits or (b) a fixed amount depending on filing status – $4,500 for S/HH/SS and $6,000 for MFJ (i.e. 50% of the zone below the 85% threshold)

MFS does not have this further portion to account for, since all benefits are 85% taxable

Question 22

What is an example of an 85% taxable portion of SS benefits?

Answer 22

If a couple with MFJ status received $8k in SS benefits and had a PI of $49k, then they must first calculate 85% of total benefits
-$8,000 x 85% = $6,800

This must be compared to the sum of (1) a portion to account for the 85% taxable zone and (2) a further portion to account for the 50% taxable zone

(1) is the 85% of the portion of PI over the threshold: $49k - $44k = $5k x 85% = $4,250
(2) is the lesser of (a) 50% of all benefits ($8k / 2 = $4k) or (b) a fixed amount for MFJ status ($6k)
(1) + (2) = $4,250 + $4,000 = $8,250

Since $6,800 is less than $8,250, the couple will select $6,800 as the taxable amount, i.e. the amount subject to their income tax rate

Question 23

How do property settlements relate to gross income?

Answer 23

Property transferred between spouses or from a divorce are excluded

Transfer counts as “from a divorce” if it is within one year of the divorce or otherwise related to it

Question 24

How do child support and alimony relate to gross income?

Answer 24

Child support is excluded from GI for the recipient and nondeductible for the giver

Alimony is included in GI for the recipient and deductible for the giver

Question 25

Under what circumstances are contingent reductions in alimony requirements treated as child support?

Answer 25

If they are contingent upon the child marrying or becoming an adult/non-dependent (e.g. reaching age 18)

E.g. if $300 of alimony is due monthly, but only $250 will be due when the child reaches age 18, then even before the child reaches that age, $250 of each payment will be deemed alimony and $50 will be deemed child support

Question 26

What occurs if a taxpayer must pay both alimony and child support each month, but fails to pay the total amount due for a given year?

Answer 26

The year-long liability for child support is first taken from the amount; the rest is deemed alimony

E.g. if a man is supposed to pay $200 of alimony and $100 of child support per month, but only ends up paying $2,000 total for the year, then $1,200 ($100 x 12 mos.) will be deemed child support and the rest ($800) alimony – as opposed to 2/3 of it being alimony and 1/3 child support

Question 27

Which fringe employee benefits are excluded from gross income?

Answer 27

(1) services which do not have an additional cost (e.g. free standby flights for air workers)
(2) employee discounts on employer products
(3) benefits related to work (e.g. using a company car for business purposes)
(4) de minimis benefits

Question 28

How are insurance-related employee benefits related to gross income?

Answer 28

(1) employer-paid premiums for group term life insurance are excludable up to $50k
(2) employer-paid premiums for health insurance are excludable only if they are compensation for:
(a) earnings lost due to injury or illness, and the employer’s contributions are ordinarily included in his income
(b) reimbursed medical expenses for the employee or his dependents
(c) permanent injury

Question 29

Are child care services, as an employer-provided benefit, excluded from gross income?

Answer 29

Yes, but only if part of a written plan that is nondiscriminatory

Excludable amount is limited to $5,000 ($2,500 for MFS status)

Question 30

What are flexible spending accounts (FSAs)?

Answer 30

Savings accounts which an employer arranges for employees, into which an employee can make a certain annual amount of tax-free contributions

Funds in the account must be spent on qualifying expenses, e.g. medical expenses and childcare (i.e. dependent care) expenses

Question 31

How do (1) meals and lodging, (2) workers’ comp, and (3) adoption expenses relate to gross income?

Answer 31

(1) meals and lodging done for the employer’s convenience on his premises are excludable for employees
(2) workers’ compensation received is excludable
(3) qualified adoption expenses paid by employers are excludable inasmuch as they qualify for a tax credit

Question 32

How do transportation or parking employee benefits relate to gross income?

Answer 32

These benefits, if provided by an employer, are excludable from employee income up to $245 per month for 2013

If an employer gives the employee a choice to receive these benefits or cash, the benefits would still be excludable but the cash includable

Question 33

How do retirement planning services, as employee benefits, relate to gross income?

Answer 33

If qualified, the services are excludable

Question 34

How do retirement plans relate to gross income?

Answer 34

Since an employee can have tax-deferred or tax-free contributions to a retirement plan, they are excluded from gross income

This occurs for both defined benefit and defined contribution plans

Question 35

When are payments related to loan forgiveness programs or state loan repayments excluded from income?

Answer 35

When the purpose of the programs is to increase healthcare in areas where healthcare is lacking

Question 36

What are U.S. savings bonds?

Answer 36

Bonds endorsed by the federal gov’t which carry a fixed interest rate and are taxed at the federal level only

Question 37

When are U.S. savings bonds related to gross income?

Answer 37

Interest income from these bonds are excludable if used for qualifying higher education costs for the taxpayer or his family and if the taxpayer’s income is not too high
-to qualify, taxpayer must solely own the bonds, or jointly own them with his spouse

There are “phase-out ranges” related to the taxpayer’s income – below which all interest income is excluded, above which none is, and within which some is

Question 38

What are the 2013 phase-out ranges for interest income from U.S. savings bonds?

Answer 38

For MFJ status: from $112,050 to $142,050

For others: from $74,700 to $89,700

Question 39

How do survivor annuities relate to gross income?

Answer 39

A deceased “public safety officer’s” survivor annuity is tax-exempt to his spouse, ex-spouse, or child

Public safety officer = cop, fireman, prison guard, etc.

Question 40

What compensation is included in gross income?

Answer 40

Salary, bonuses, wages, commissions, tips, most interest, dividends, etc.

Any non-monetary compensation is valuated at FMV

Question 41

How does jury duty relate to gross income?

Answer 41

An employee can trade his jury duty pay in exchange for salaried pay during jury service, in which case the jury duty amount is deductible to AGI

Question 42

How are employee business expenses related to gross income?

Answer 42

(1) reimbursements for such expenses are deductible from AGI if the employer includes them within the employee’s income
(2) excess reimbursement (i.e. more than the expenses) must be included in AGI
(3) unreimbursed expenses can be deductible within certain limits

Question 43

How can unreimbursed business expenses be deductible from AGI?

Answer 43

Unreimbursed expenses for meals and entertainment can be deducted 50%, club dues cannot be deducted at all, and all others can be deducted 100%

Question 44

How are tax refunds related to gross income?

Answer 44

Refunds for which the taxpayer received some tax benefit in the past (usually a deduction) must be included in GI

Question 45

What are the requirements for a payment to count as alimony?

Answer 45

The payment must be…

(1) part of a divorce/separation agreement
(2) cash
(3) to someone living in a different household
(4) ended when the spouse dies (not to her estate)
(5) not designated as anything besides alimony, like child support

Question 46

What is the alimony recapture rule?

Answer 46

Since property transfers in divorces are non-deductible while alimony payments are deductible, it is possible for a spouse to pretend that property transfers are actually “alimony” in order to avoid taxes on them

Thus, if the first three years’ worth of alimony payments drop substantially, the alimony-paying spouse can be retroactively liable for this “recaptured” income – it is no longer deductible to him, nor taxable to his spouse

Question 47

What causes any recapture rule to always be inapplicable?

Answer 47

If the alimony-receiving spouse remarries, or if either dies, then the rule cannot apply for any amount of alimony payment

Question 48

Per the alimony recapture rule, when do alimony payments count as “substantially decreasing”?

Answer 48

(1) if the average of year 2 and year 3 payments is more than $15,000 less than the year 1 payment
(2) if the year 3 alimony payment is more than $15,000 less than the year 2 payment

(1) points to an excess payment in year 1, and (2) points to an excess payment in year 2 – i.e. where the excess must be recaptured

Question 49

How is the recaptured amount of alimony calculated?

Answer 49

The year 2 excess must be calculated first, since it affects the calculation of year 1 excess

The amount by which the year 2 payment exceeds (year 3 pmt. + $15k) is the year 2 excess – which is then subtracted from the year 2 pmt. to get the “true” amount

The amount by which the year 1 payment exceeds [(the avg. of the yr 3 and true yr 2 pmts.) + $15k] is the year 1 excess

Question 50

What is an example of an alimony recapture calculation?

Answer 50

Year 1 payment = $60k, year 2 = $40k, year 3 = $5k

Yr. 2 excess = $40k - $5k - $15k = $20k
True yr. 2 pmt. = $40k - $20k = $20k

Yr. 1 excess = $60k - ($20k + $5k)/2 - $15k = $32.5k

Total excess (i.e. total recapture) = $32.5k + $20k = $52,500

Question 51

Under what circumstance can joint owners of a business elect not to be treated as a partnership?

Answer 51

If the business is run by a married couple – though they would then still (if filing separately) need to report their income as sole proprietors

Question 52

What are capital gains and losses?

Answer 52

If property is sold for more or less than it was bought, then it is a capital gain or loss respectively

This applies only to “capital assets,” which excludes various kinds of property

Question 53

What kind of property does not count as a capital asset?

Answer 53

(1) inventory
(2) receivables
(3) property used in the course of business
(4) copyrights or other properties whose basis is determined from the creator (e.g. art)

Question 54

How do capital gains and losses relate to gross income?

Answer 54

(1) Capital losses can be deducted from capital gains, and can be carried forward to deduct future capital gains indefinitely
(2) $3,000 can be deducted from a net capital gain as well
(3) The rest is taxed at the capital gains tax rate, which differs from an ordinary income tax rate
(4) However, personal gains (i.e. capital gains from capital assets that are for personal use) are always taxable, and personal losses are not deductible

Question 55

How does unemployment compensation relate to gross income?

Answer 55

It is included (i.e. taxable)

Question 56

How do gambling winnings relate to gross income?

Answer 56

They are included (i.e. taxable), though gambling losses can be an itemized deduction to offset gambling winnings (but not anything else)

Question 57

How does the cancellation of debt relate to gross income?

Answer 57

A forgiven debt counts as taxable income from the debtor except if he is insolvent/bankrupt, the forgiven debt is a gift, or it is forgiven in exchange for some service of the debtor (usually with student loans)

If discharged due to insolvency, income is non-taxable only to the extent that it makes the debtor solvent

Question 58

What is a passive activity?

Answer 58

An activity of trade or business in which someone doesn’t materially participate – includes most rental activities (with exceptions among those whose business is real estate)

Question 59

How are passive activities different for real estate professionals?

Answer 59

Such professionals can deduct passive activity losses from normal income

Question 60

How are passive activity incomes and losses taxed?

Answer 60

Passive activity losses can be deducted from present or future passive activity income, but not from any other income

If there is a passive activity loss when the activity is sold, then that loss may be deducted from other income (not just passive activity income)

Question 61

What exceptions for passive activity losses exist with rental activity?

Answer 61

$25k of rental activity loss can be deducted against normal income if the taxpayer actively participates – taxpayer must also have 10% interest in the activity

$25k is phased out between $100k and $150k

Question 62

How are rental and royalty income taxed?

Answer 62

They are taxed in the period when the payments are received, irrespective of the taxpayer’s basis of accounting

Question 63

How do vacation homes provide a complication for income?

Answer 63

Their classification as personal property or rental property (and thus for taxable income and deductible expenses) depends on how much they are proportionately used for personal or rental purposes

Question 64

Under what circumstances are vacation homes not counted as rental property?

Answer 64

If rented for fewer than 15 days in the year

Not rental property = income isn’t taxable and expenses aren’t deductible

Question 65

Under what circumstances is a vacation home counted as rental property?

Answer 65

If it is…
(a) rented for at least 15 days, and
(b) personally used for less than the greater of (i) 15 days or (ii) 10% of the days it was rented out
…then it is treated as a rental property

If the personal use is greater than in (b), then deductible rental expenses are limited