Tax Exam 1

What are de minimis fringe benefits?

A de minimis fringe benefit is defined in the Internal Revenue Code as "any property or service the value of which is (after taking into account the frequency with which similar fringes are provided by the employer to the employer's employees) so small as to make accounting for it unreasonable or administratively impractica- ble." De minimis fringes are considered to be minimal or small and can be excluded from the employee's gross income.

How is an annuity contract annuitized and how are the tax consequences of each annuity payment determined?

An annuity contract is annuitized when regular periodic (such as monthly or annual) payments begin for life or for a specified period of time in excess of one year. When a contract is annuitized, each payment is deemed to include both a nontaxable return of invested money and gross income. The amount of each payment that is a nontaxable return of investment is determined using the exclusion formula

What are no-additional-cost services?

An employee can exclude the value of any service provided to the employee by the employer if (1) the service is offered for sale to customers, (2) in the line of business in which the employee works, and (3) the employer incurs no substantial additional costs (including foregone revenue) in providing the service to the employee. Examples of no-additional-cost services include providing airline tickets, bus tickets, train tickets, hotel accommodations, or telephone services at no cost or at reduced prices to employees who work in those lines of business.

Under what circumstances can the value of lodging furnished by an employer be excluded from the employee's gross income?

An employee is allowed to exclude from gross income the value of lodging furnished by an employer to the employee if the lodging is furnished (1) on the employer's business premises, (2) for the convenience of the employer, and (3) the employee is required to accept the lodging as a condition of employment. Note that the first two requirements are the same as for meals. The third requirement applies only to lodging.

How much group term life insurance can be provided to employees without causing inclusion in gross income?

An employer can deduct the cost of up to $50,000 (face or death benefit amount) of group term life insurance for each employee, and the employee can exclude the premium from gross income if certain requirements are met. The cost, as determined under the Uniform Premium Table provided by the IRS, of any death benefit coverage in excess of $50,000 is taxable to the employee.

How much can an individual deduct from his AGI?

An individual taxpayer is allowed to deduct the greater of (1) the standard deduction or allowable itemized deductions and (2) personal and dependency exemptions.

What are exclusions and where do they come from?

Exclusions are income items that are not subject to income tax. Each exclusion must be specifically allowed by Congress in the Internal Revenue Code or must be deemed to be outside of the definition of income by the courts.

What is the legal basis for today's income tax?

The 16th Amendment, adopted on February 25, 1913, gives Congress the power to lay and collect taxes. The Revenue Act of 1913 actually imposed the first income tax.

What are the administrative sources of tax law?

The administrative sources of tax law are Treasury regulations, rulings from the IRS, determination letters from the IRS, and revenue procedures from the IRS.

When is the amount of debt forgiven not included in gross income?

The amount of debt forgiven need not be included in gross income in certain circumstances, including the fol- lowing: • Certain forgiven student loans, • Debts forgiven in Title 11 bankruptcy, • Debts forgiven when a taxpayer is insolvent (up to the amount of a taxpayer's insolvency), • Debt cancelled as a result of Hurricane Katrina, • Forgiveness of qualified farm indebtedness, • Forgiveness of qualified real property business indebtedness, • Forgiveness by a seller of a buyer's debt, and • Forgiveness of debt as a gift.

What are the requirements to file as a surviving spouse?

The taxpayer's spouse must have died during either of the two preceding tax years. The taxpayer must main- tain (pay for more than half of ) a household as his or her home which is also the principal place of residence of a dependent child. The taxpayer must not have remarried. The taxpayer and his or her spouse must have been eligible to file a joint return for the spouse's year of death.

What are the three primary sources of tax law?

The three primary sources of tax law are statutory sources, administrative sources, and judicial sources.

What is the accrual method of accounting?

Under an accrual method of accounting, income or revenue is normally reported when it is earned rather than when it is received in cash, and expenses are normally deducted when they are incurred rather than when they are paid.

What is the cash receipts and disbursements method of accounting?

Under the cash receipts and disbursements method of accounting, income items (or revenues) are normally reported on a tax return for the tax year in which they are received in cash and expenses are normally deducted in the year in which they are paid with cash (including currency, checks, and similar payments).

Describe the circumstances under which disability insurance benefits are excludible from gross income.

If the disability insurance premiums are paid by the employer and deducted by the employer as a business expense, the premiums are excluded from the employee's gross income. However, when an employer pays the premium and the premium is excluded from the employee's gross income, any disability insurance benefit received by the employee must be included in the employee's gross income. On the other hand, if the employee pays the entire premium with after-tax income or the employer pays the premium and the employee includes the premium payment in gross income, any benefits received can be excluded from the employee's gross income. If the employer and employee each pay part of the premium, the prorated part of the benefits associated with the employer's contribution is taxable to the employee.

Who must file a tax return?

If the gross income of a taxpayer is equal to or greater than the deductions allowed for personal (not depen- dency) exemptions, the basic standard deduction, and any additional standard deductions for age (not blind- ness), then the taxpayer is required to file a tax return. Special rules apply for dependents.

Under what circumstances is the statute of limitations extended?

If there is a substantial understatement of income on the tax return, the statute of limitations is extended to six years. If a taxpayer commits fraud when filing his or her return, there is no statute of limitations.

How is income defined?

Income, broadly defined, means the total amount of money, property, services, or other accretion to wealth received, but it does not include borrowed money or the return of invested dollars.

What are the different filing statuses available to taxpayers?

Married filing jointly, married filing separately, surviving spouse, head of household, and single.

Describe the taxation of ISOs.

No gross income is recognized by the employee on the date the ISO is granted nor on the date the ISO is exer- cised. When stock acquired through the exercise of an ISO is sold, any gain or loss on the sale is normally treated as a capital gain or loss unless the employee sells the stock within two years from the day the ISO was granted or within one year from the day the ISO was exercised. If either holding period requirement is not met, any gain or loss on the sale is treated as an ordinary gain to the extent of the difference between the value of the stock and the option price on the day the option is exercised; any remaining gain is a capital gain. Any loss on the sale is a capital loss.

Discuss the tax treatment of child support payments.

Child support payments are excluded from the gross income of the payee and are not deductible by the payor since these payments simply satisfy the legal obligation of the payor to support the children.

What is a barter transaction and how is income associated with such a transaction reported?

Bartering is an exchange of property and/or services for other property and/or services. The value of goods or services received in a barter transaction must be included in gross income. The value received can be offset by the basis of goods given up in the transaction. When goods or services are received by a taxpayer in exchange for services, the services provided by the taxpayer normally have a basis of zero. When barter transactions are made through a barter exchange, an organization established to facilitate the trading of goods and services, the transaction must be reported to the taxpayer and the Internal Revenue service by the barter exchange.

How do cafeteria plans help manage the costs of fringe benefits?

A cafeteria plan is a way of managing fringe benefit costs to the employer by individually pricing each benefit. Such plans help give employees an appreciation of the value of their benefit package by allowing them to choose the cash or purchase the benefit. Cafeteria plans can also help control employer costs of providing ben- efit packages because the employer does not pay for benefits that are not used by the employees.

For whom is a dependency exemption allowed?

A dependency exemption is allowed for each person who is a qualifying child or a qualifying relative of the tax- payer.

In what situation would a flexible spending account be appropriate?

A flexible spending account is appropriate in any of the following situations: • An employer wants to expand employee benefit choices without significant employer out-of-pocket costs (or possibly realize some actual dollar savings), • Many employees have employed spouses with duplicate medical coverage, • An employer wants employees to contribute to health insurance costs, • The employer's medical plans have large deductibles or coinsurance (co-pay) provisions, • There is a need for benefits that are difficult to provide on a group basis, such as dependent care, and/or • The costs of employee benefit plans, such as health insurance, have increased and the employer must impose additional employee cost sharing in the form of increased employee contributions and deductibles.

What is the difference between a procedural regulation and an interpretive regulation?

A procedural regulation does not deal with substantive tax issues, but provides housekeeping instructions for how the Treasury and the IRS will conduct their affairs. Interpretive regulations provide official interpretations and explanations of the Internal Revenue Code.

Under what circumstances may a taxpayer be entitled to an additional standard deduction?

Additional standard deductions are allowed for individuals who are age 65 or older and/or blind. The amount of each additional deduction depends on the taxpayer's filing status.

What is adjusted gross income and what is its significance?

Adjusted gross income is gross income less above-the-line deductions. AGI is important because it is used to determine limitations on several below-the-line deductions, income tax credits, and other items on the federal income tax return.

Give several examples of income generated by investment activities that are included in gross income.

Capital gains, interest income, original issue discount (OID), dividend income, rental and royalty income, income from annuities, income from life insurance and endowment contracts, income from IRAs, income from partnerships, income from S corporations, income from LLCs, and income from trusts and estates.

How is compensation received by an independent contractor reported?

Compensation received by an independent contractor (a self-employed person) must normally be reported to that contractor as nonemployee compensation on Form 1099-MISC by a business that receives services from the independent contractor. All income (or revenue) received by an independent contractor, including revenue reported on Forms 1099-MISC, must normally be reported as income on Schedule C, Profit or Loss from Business (Sole Proprietorship). If payments received by a self-employed person relate to an agricultural busi- ness of that taxpayer, the revenues must be reported on Schedule F, Profit or Loss from Farming.

List some examples of items that would be included in gross income.

Compensation, interest income, dividend income, alimony received, gross income from self-employment, gains from the sale of assets, distributions from retirement plans, rental income, royalty income, and unem- ployment compensation benefits.

Compare and contrast compensatory damages and punitive damages.

Compensatory damages may be intended to compensate for damage to property, for recovery of expenses incurred, for income lost, or for personal injury. Punitive damages, on the other hand, are intended to punish the offending party. Punitive damages must be included in the recipient's gross income. Compensatory dam- ages may be excluded from gross income under certain circumstances (e.g., damages for physical personal injury). The tax treatment for the receipt of such payments is the same whether the payments are received as a result of court action or not. The treatment is also the same whether the payment is received from the injuring party or from an insurance company.

What are the two forms of dispute resolution with the IRS?

Dispute resolution with the IRS takes two forms. The first is an internal appeals process that permits taxpayers to request a second review of their cases from the IRS Appeals Office, which is separate from the IRS examina- tion division. The second dispute resolution process involves the use of the courts.

Define gross income.

Gross income includes all income items that must be reported on the federal income tax return and are subject to the federal income tax.

Under what circumstances can a prize or award be excluded from the recipient's gross income?

If a prize is received and it is paid directly to a qualified charity at the request of the recipient, the recipient is allowed to exclude the prize from gross income if three requirements are met: (1) the prize or award must be given primarily in recognition of religious, charitable, scientific, educational, artistic, literary, or civic achieve- ment; (2) the recipient must not apply for the award; and (3) the recipient must not be required to render sub- stantial future services to receive the prize or award. Also, an exclusion is allowed if the prize is excluded under IRC Section 74(c) from employment.

What are the penalties for noncompliance?

If a taxpayer fails to file her income tax return on time, the failure to file penalty is 5% of the unpaid tax bal- ance for each month the return is late up to a maximum failure to file penalty of 25%. If a tax return is filed more than 60 days late, the minimum failure to file penalty is the lower of $135 or the amount of tax due. If the failure to file the tax return is due to fraud, the failure to file penalty is increased to 15% per month, up to a maximum penalty of 75% of the tax due. If a taxpayer fails to pay the tax due on the due date, a failure to pay penalty of 0.5% per month is imposed on the balance that remains unpaid, up to a maximum penalty of 25%. Furthermore, an accuracy-related penalty is imposed on taxpayers who file incorrect returns under cer- tain circumstances. The penalty imposed is generally 20% of the underpayment amount, but can be increased to 30% when certain transactions are involved.

When can a determination letter be issued?

If a taxpayer has already engaged in a transaction, the taxpayer can request a determination letter from the dis- trict director of the IRS if he or she would like to know how to report the transaction for tax purposes. The district director will issue a determination letter only if the issue is clearly covered by statute, Treasury decision or regulation, or a ruling or opinion of a Court decision published in the Internal Revenue Bulletin.

How do nondiscrimination requirements affect the taxation of fringe benefits?

If non-discrimination requirements apply and the fringe benefit is provided primarily to highly compensated employees (or key employees), and the benefit is not available on substantially the same terms to non-highly compensated (or non-key) employees, then the fringe benefit is deemed to be discriminatory. If the provision of a fringe benefit is discriminatory, then the exclusion may be lost by all employees (or by the favored group of employees), resulting in the value of the fringe benefit being included in the recipient employee's gross income.

How do community property regimes affect the reporting of income?

In community property states, half of the income earned (wages, salaries, etc.) by a spouse is deemed to be earned by each spouse and half of the income earned from community property is deemed to be the income of each spouse. If a married couple files as married filing jointly, this division of income makes no difference. It may make a significant difference, however, if the couple files as married filing separately or if they divorce during the year.

Under what circumstances are meals provided by an employer excludable from the employee's gross income?

In general, an employee can exclude from gross income the value of meals provided in-kind (not as cash reim- bursement) to the employee as long as the meals are furnished (1) on the employer's business premises, and (2) for the convenience of the employer.

What are the requirements for treating a payment made between divorcing spouses as alimony?

In order to be treated as alimony, a payment related to divorce must meet all of the following requirements: • It must be paid in cash; • It must be received by a spouse under a divorce or separation instrument; • The divorce or separation instrument must not identify the payment as anything other than alimony; • The payee and the payor must not be members of the same household at the time of the payment; and • There cannot be any liability to make payments after the death of the payee spouse.

Under what circumstances will a taxpayer be required to itemize his deductions?

In the following three situations, the taxpayer must itemize his deductions: • A married individual who files a separate return cannot use a standard deduction if that person's spouse itemizes deductions; • A nonresident alien is not allowed to use a standard deduction; and • An individual who files a tax return for less than 12 months because of a change in annual accounting period is not allowed to use a standard deduction.

To whom is investment income normally taxable?

Income from investments is normally taxable to the owner of the investment. The owner of the investment cannot attribute the income to another person simply by having the income paid to another person.

What types of investments generate interest income and how is interest income reported?

Interest income is generated by a variety of debt instruments, including bank accounts, money market instru- ments, corporate bonds, government agency securities, Treasury securities, and municipal bonds. Interest income of $10 or more per year is normally reported to a taxpayer on Form 1099-INT by the payor of the interest, but the interest must be recognized by the taxpayer even when this form is not received or when the interest income is less than $10.

Under what circumstances are life insurance proceeds excluded from gross income?

Life insurance proceeds paid to a beneficiary because of the death of the insured person are normally excluded from gross income. The entire death benefit is excludable regardless of the amount. If the beneficiary chooses to receive the death benefit in periodic installment payments, part of each payment is excludable as part of the death benefit and part is includible in gross income as interest income. Accelerated death benefits paid by an insurance company under a life insurance policy before the death of the insured are excluded from gross income if the insured person is terminally ill.

Summarize the limitations on imputed interest.

No interest is generally imputed if the total amount of loans from the lender to the borrower is $10,000 or less. For gift loans only, no interest is imputed if the total amount of loans from the lender to the borrower is $100,000 or less unless the borrower has net investment income of more than $1,000 for the year. If the bor- rower has more than $1,000 of net investment income for the year, interest is imputed, but it will not be greater than the amount of the borrower's net investment income for the year. If the loan is more than $100,000, the imputed interest is equal to the interest calculated using the AFR less interest calculated using the stated rate of the loan.

Compare and contrast proposed regulations, temporary regulations, and final regulations.

Proposed regulations are regulations that have been drafted by the Treasury, but have not been formally adopted in compliance with the provisions of the Administrative Procedures Act. Temporary regulations are issued by the Treasury when taxpayers need guidance quickly. Temporary regulations have the same preceden- tial authority as final regulations. Final regulations are regulations that have been formally adopted in compli- ance with the Administrative Procedures Act. Final regulations are binding on both the Treasury and taxpayers.

What are the requirements for a dividend to be a qualified dividend?

Qualified dividends must meet all three of the following requirements: (1) they must be paid by a U.S. corpo- ration or a qualified foreign corporation; (2) the dividend must not be a type of dividend excluded by law from the definition of a qualified dividend; and (3) the shareholder must meet a holding period requirement.

Describe the rules regarding qualified employee discounts.

Qualified employee discounts on qualified property and services can be excluded from an employee's gross income. Qualified employee discounts on property cannot exceed the employer's gross profit percentage of the price at which the employer offers the property for sale to customers. Qualified employee discounts on services cannot exceed 20 percent of the price at which the employer offers the services for sale to customers. Qualified property means any property other than real property or personal property of a kind that is held for invest- ment (such as stocks or bonds) which is offered for sale to customers in the line of business in which the employee works. Qualified services means any services offered by the employer to customers in the line of business in which the employee provides services.

What are the requirements for a qualified savings bond?

Qualified savings bonds must meet the following requirements: (1) the bonds must be series EE bonds issued after December 31, 1989; (2) the bonds must be issued in the name of the taxpayer or the names of the tax- payer and the taxpayer's spouse; and (3) the bond owner(s) must be at least 24 years of age on the issue date of the bonds.

Discuss the two types of rulings issued by the IRS.

Revenue rulings are based on a set of facts that are common to many taxpayers. Private letter rulings, on the other hand, are requested by an individual taxpayer and are binding only on the requesting taxpayer with regard to that particular situation.

What is the kiddie tax?

Some of the unearned income of a child under the age of 19 or a full-time student under the age of 24 and claimed as a dependent on the parent's tax return may be subject to income tax at the parent's marginal tax rate. The first $1,000 of unearned income is the standard deduction if the child has no earned income. The second $1,000 is taxed to the child at the child's rate. Any unearned income in excess of $2,000 is taxed at the parent's marginal tax rate.

What is the general statute of limitations before which the IRS may examine a tax return?

The IRS generally has three years from the date a tax return is filed to examine the return.

What are the statutory sources of tax law?

The Internal Revenue Code is the only statutory source of tax law. The IRC has been codified three times: 1939, 1954, and 1986.

How is the standard deduction calculated for someone who can be claimed as a dependent by another taxpayer?

The basic standard deduction for someone who can be claimed as a dependent by another taxpayer is deter- mined using a three-step process: • The minimum basic standard deduction is $1,000 for 2014; • If larger, the basic standard deduction is equal to the earned income of the taxpayer plus $350 (2014); and • The maximum standard deduction is equal to the normal basic standard deduction for the taxpayer's filing status.

What types of accounting periods are available to taxpayers?

The calendar year, the fiscal year, and the 52-53 week year are the accounting periods that are available to tax- payers.

How is marital status determined for the purpose of selecting a filing status?

The determination of whether a taxpayer is married is normally made as of the last day of the year. However, if a taxpayer's spouse dies during the year, the marital status of the taxpayer is determined on the date of the spouse's death. A taxpayer who is legally separated from his spouse under a decree of divorce or of separate maintenance is not considered to be married for federal income tax purposes.

List the various ways that an employer can provide an employee with benefits for medical care.

The employer may (1) establish and pay part or all of the premiums for group medical insurance, (2) pay part or all of the premiums for private medical insurance policies, (3) contribute to a separate trust or fund that provides medical benefits to employees, or (4) directly pay or reimburse employee medical expenses. Such medical plans are normally written, but they need not be written to enjoy favorable tax benefits.

What are the three types of relief provided by Section 66 to spouses?

The first type of relief is separated spouse relief. For income earned through personal services, community property laws are ignored and each spouse reports his or her own earned income for federal income tax pur- poses if the married couple lives apart at all times during the year, they do not file a joint return with each other, and none of the earned community income is transferred between them during the year. The second type of relief is innocent spouse relief. A married taxpayer with community income from a spouse may be able to exclude that income if the taxpayer does not file a joint return, establishes that he or she did not know of or have reason to know of that community income, and it is inequitable to include that community income in the taxpayer's gross income. The third type of relief is equitable relief. Even if the requirements for separated spouse relief or innocent spouse relief are not met, the Internal Revenue Service is authorized to allow a taxpayer not to report half of the community income of the taxpayer's spouse if, taking into account all of the facts and circumstances, the failure to grant such relief would be "inequitable."

Discuss the various types of compensation and whether they must be included in gross income.

The general rule is that compensation for services must be included in gross income, regardless of what that compensation may be called. Therefore, salary, wages, commissions, fees, tips, or any other type of compensa- tion earned by an employee is subject to income taxation. Although compensation is normally received in cash, it may be received in some other form, including non-cash property, services, or other benefits. If such non-cash compensation is a substitute for salary, wages, and other familiar forms of compensation, it must be included in gross income unless specifically excluded.

What tests must a qualifying child meet?

The relationship test, the abode test, the age test, and the support test. In addition, a qualifying child must meet a joint return test and a citizenship or residency test.

What tests must a qualifying relative meet?

The relationship test, the gross income test, the support test, the not-a-qualifying-child test, the joint return test, and the citizenship or residency test.

What are the three trial courts that may hear tax-related matters and what are the requirements of each?

The three trial courts that may hear tax-related matters are the Tax Court, the U.S. District Court, and the U.S. Court of Federal Claims. In order to bring an action before the U.S. District Court or the U.S. Court of Claims, the taxpayer must first pay any deficiency. The U.S. District Court is the only one of the three in which the taxpayer can get a jury trial.

What are the two types of deductions?

The two types of deductions are: (1) deductions for gross income, also known as above-the-line deductions; and (2) deductions from gross income, also known as below-the-line deductions.

Under what circumstances can the value of athletic facilities be excluded from an employee's income?

The value of the use of on-premises gyms and other athletic facilities can be excluded from an employee's income if (1) the facilities are located on the premises of the employer, (2) the employer operates the facilities, and (3) substantially all the use of the facilities is by employees of the employer, their spouses, and their depen- dent children. The facilities have to be on premises owned or leased by the employer; the facilities do not have to be on the business premises of the employer.

Explain the bona fide resident test and the physical presence test.

To be considered a bona fide resident of a foreign country (or countries), an individual must generally intend to work there for an indefinite or extended period and must establish permanent quarters in the foreign coun- try for himself and his family. In order to meet the physical presence test, an individual must be present in a foreign country or countries for at least 330 full days during any period of 12 consecutive months.

When is a married taxpayer allowed to file using the head of household filing status?

To be eligible to file as head of household, a married taxpayer must meet all of the following requirements: • Married; • Files a separate tax return from his or her spouse; • Maintains his or her home as a household, which, for more than one-half of the taxable year, is the princi- pal place of abode of a child who is a dependent; • Furnishes over one-half of the cost of maintaining the household; and • The spouse is not a member of the household during the last six months of the tax year.

Under what circumstances can foreign earned income be excluded from gross income?

To exclude foreign earned income, a qualified individual must have a tax home in a foreign country and must either (1) qualify as a bona fide resident of a foreign country or countries for an uninterrupted period which includes an entire taxable year (bona fide resident test) or (2) qualify by being present in a foreign country or countries for at least 330 full days during any period of twelve consecutive months (physical presence test).

When are fringe benefits included in the gross income of employees?

Under the general gross income provisions of IRC Section 61, all fringe benefits provided to an employee must be included in gross income as wages unless a specific provision of the IRC excludes the benefit from taxation or unless the employee pays fair value for the fringe benefit. Although a fringe benefit may not be specifically excluded, the value of the fringe benefit is not taxable if it is paid for by the employee.

What is the all events test?

Under this test, income is includible in gross income when all the events have occurred that fix the taxpayer's right to receive the income and allow the amount of income to be determined with reasonable accuracy.

Describe the taxation of unemployment compensation.

Unemployment compensation must be included in gross income unless the employee made after-tax contribu- tions to a government or private unemployment compensation fund. Since unemployment compensation benefits are normally funded by employer contributions to government programs, benefits received by an employee are normally taxable. Any unemployment taxes paid by the employer to fund the program can be deducted by the employer and excluded from gross income by the employee. F

What percentage of Social Security benefits are taxable?

When an employee receives Social Security retirement or other benefits, up to 85 percent of the benefits may be included in the employee's gross income, depending on the employee's modified adjusted gross income (MAGI) for the year. If a retired taxpayer's only income is from Social Security retirement benefits, the benefits will be completely excludable. If a taxpayer receives Social Security benefits and has significant amounts of other income for the year as well, a portion of the Social Security benefits, up to a maximum of 85 percent of such benefits, must be included in gross income for the year.

What are the tax consequences of taking distributions from an annuity without annuitizing?

When distributions are taken from an annuity without annuitizing, every dollar distributed must be included in gross income until all of the income in the contract has been included in gross income. Only then is a tax- free return of invested dollars allowed. This is a LIFO (last-in, first-out) approach in which the last dollars in the contract (the income) is deemed to come out of the contract before the first dollars (the investment) in the contract.

What are the tax consequences of surrendering a life insurance contract?

When the owner of a life insurance policy surrenders a life insurance policy to the issuing insurance company in exchange for the cash surrender value of the policy, the owner of the policy must recognize gross income equal to the amount of money received minus the owner's adjusted basis (cost) for the policy. The gain is rec- ognized as ordinary income. The owner's adjusted basis in the policy is equal to the total premiums paid on the policy less any refunded premiums, rebates, dividends, or existing loans against the policy.