Ch. 5 Tax - Gross Income and Exclusions

return of capital

when the tax basis exceeds the sale proceeds - return of capital principle generally applies to the extent of the sale proceeds

constructive receipt doctrine

-a taxpayer realizes and recognizes income when it is actually or constructively received -deemed to occur when the income has been credited to the taxpayer's account or when the income is unconditionally available to the taxpayer, the taxpayer is aware of the income's availability, and there are no restrictions on the taxpayer's control over the income

common law system

-all of the income earned from the services of one spouse is included in the gross income of the spouse who earned it -for property owned separately, all of the income from the separately owned property is included in that spouse's gross income -for property owned jointly - not separately - each co-owner is taxed on the income attributable to his or her share of the property. - if owned by more than 2 split up based on his or her respective ownership share

personal injury

-all pmts associated with compensating a taxpayer for a physical injury(including pmts for past, current, future lost wages) are excluded from gross income. -compensatory damages on account of a physical injury or physical sickness are nontaxable -damages received for emotional distress that IS associated with a physical injury are also excluded -punitive damages are fully taxable - because they are intended to punish the harm-doer rather than to compensate the taxpayer for injuries.

deferral provisions

-allow taxpayers to defer the recognition of certain types of realized income -installment sales -like-kind exchanges -involuntary conversions -contributions to non-Roth qualified retirement accounts

annuity

-an investment that pays a stream of equal payments over time -annuities paid over a fixed period -annuities paid over a person's life *first PMT - Investment/# of PMTS = Return of capital per payment -PMT - Return per payments *investment/expected return=return of capital % %*PMT = Return of capital per Payment Return - PMT = Taxable income per PMT 2 types: 1.annuities paid over a fixed period 2.annuities paid over a person's life(for as long as the person lives) FIXED- expected value is the number of pmts x amount of pmt *use expected return multiple -number found here is gross income per payment ENTIRE LIFE ANNUITY - extra pmts aka lives longer than expected - are all included in gross income because the taxpayer has completely recovered her investment in the annuity by the time she receives them. -if the taxpayer dies before receiving the expected number of pmts, the amount of the unrecovered investment is deducted on the taxpayer's final income tax return AFTER they have received original investment in annuity - all fully taxable - gross income memorize exhibit 5-1???

Worker's Compensation

-any pmts received from a state-sponsored workers' compensation plan are excluded from the taxpayer's income -opposite of the treatment for unemployment compensation - fully taxable

health care reimbursement

-any reimbursement a taxpayer receives from a health and accident insurance policy for medical expenses paid by the taxpayer during the current year is excluded from gross income -doesn't matter who purchased health plan -tax benefit rule may require inclusion of reimbursements of medical expenses that were deducted by the taxpayer in a prior year

fringe benefits

-automobile for personal purposes -pay for employees health club -pay for employees home security -contributions to retirement plans -contributions to retirement plans------not currently included in the employee's gross income but are deferred until the employee withdraws the contributions and related earnings from the plan

imputed income

-bargain purchases - discount received is taxable - but tax consequences vary based on the relationship of parties *employees may exclude **A)a discount on goods as long as the discount does not exceed the employer's gross profit percentage on all property offered to sell to customers **B)up to 20 percent employer-provided discount on services - taxed in excess of 20 -below market loans - 1.the borrower paid the lender the difference between the applicable federal interest rate(compounded semiannually) and the actual interest paid (this difference is called imputed interest) 2. The lender then returned the imputed interest to the borrower -imputed interest rules do not apply to loans of $10,000 or less!

Foreign-earned income

-exclude an annual amount of foreign-earned income -2013 - exclusion - 97,600 -rather than claim this exclusion taxpayers may deduct foreign taxes paid as itemized deductions or they may claim the foreign tax credit for foreign taxes paid on their foreign-earned credit -ELIGIBLE - 1) be considered a resident of the foreign country 2) live in the foreign country for 330 days in a consecutive 12-month period -maximum exclusion is reduced pro rata for each day during the calendar year the taxpayer is not considered to be a resident of the foreign country or does not actually live in the foreign country -may also exclude reasonable housing costs(provided by an employer) that exceed 16 percent of the statutory foreign-earned income exclusion amount for that year(16% x 97,600 = 15,616) -exclusion is limited to a maximum of 14% of the statutory exclusion amount -ex. if a taxpayer incurs housing costs(provided by an employer) exceeding 15,616, she may exclude excess costs up to 13,664 -housing exclusion limit is also subject to daily proration if the taxpayer is not considered a resident of the foreign country for the entire year or does not actually live in the foreign country the entire year

Other educational subsidies

-exclude earnings on investments in qualified education plans such as 529 plans and Coverdell education saving accounts as long as they use the earnings to pay for qualifying educational expenditures -fed govt. issues bonds - don't generate any cash until taxpayer redeems the bond - at redemption the amount of the redemption price in excess of the acquisition price is interest included in gross income -exclusion is available for interest from Series EE bonds -exclusion requires that the redemption proceeds be used to pay for the higher education expenses of the taxpayer, the taxpayer's spouse or a dependent of the taxpayer -taxpayers may also exclude interest income if they contribute proceeds to a qualified tuition program -the exclusion is partially reduced or eliminated for taxpayers exceeding a fixed level of modified adjusted gross income(gross income before educations savings bond exclusion, the foreign earned income exclusion, and certain other deductions. -if taxpayers modified AGI exceeds the thresholds in the redemption year, the exclusion is phased out (gradually reduced) until all of the interest from the bonds is taxed

Education related Scholarships

-exclude scholarships(including Pell grants) that pay for tuition, fees, books, supplies, and other equipment REQUIRED for the student's courses. -any excess scholarship amounts(such as for room or meals) are fully taxable. -exclusion applies only if the recipient is not required to perform services in exchange for receiving the scholarship -scholarships that represent compensation for past, current, future service are fully taxable -tuition waivers or reductions provided by an educational institution for undergraduate courses for student employees or for graduate courses for teaching or research assistants are not taxable -athletic scholarships- value of athletic scholarship may not exceed expenses for tuition, fees, room, board, necessary supplies; are awarded to students by a university that expects but does not require the students to participate in a particular sport; require no particular activity in lieu of participation; and are not cancelled if the student cannot participate---is excludable from gross income

Gifts and Inheritances

-gifts and inheritances not included -individuals may transfer property to other taxpayers without receiving or expecting to receive value in return -gift and estate taxes are imposed on transfer of the property and not included in income by the recipient

gross income - what is included in gross income?

-gross income means all income from whatever source derived unless excluded by law. Gross income includes income realized in any form, whether in money, property or services -all-inclusive definition of income - 1) receive an economic benefit 2) realize the income 3) no tax provision allows them to exclude or defer the income from gross income for that year

disability insurance

-if an individual purchases disability insurance directly, the cost of the policy is not deductible, but any disability benefits are excluded from gross income -when an employer purchases - and pays insurance premiums the employer may allow employees whether the pmts on behalf are to be considered taxable compensation or a nontaxable fringe benefit -if premiums paid on the employee's behalf are taxable compensation to the employee, the policy is considered to have been purchased by the employee -if the premium paid for by the employer is a nontaxable fringe benefit to the employee, the policy is considered to have been purchased by the employer IMPORTANT B/C -only pmts taxpayers receive from an employee-purchased policy are excluded from an employee's gross income -if the employer pays the premiums for an employee as a nontaxable fringe benefit, the employee must include all disability benefits in gross income

income from services

-income from labor -unemployment compensation -earned income

claim of right

-income has been realized if a taxpayer receives income and there are no restrictions on the taxpayer's use of the income(no obligation to repay)

cash method

-most individuals use -recognize income in the period they receive it -because of this control over when taxpayers can receive - can more easily use the timing tax strategy to lower present value of tax bill

accrual method

-most large corporations use -income is generally recognized when earned, expenses are generally deducted in the period when liabilities are incurred

municipal interest

-municipal bonds include bonds issued by state and local governments located in the United States -this exclusion is generally recognized as a subsidy to state and local governments

assignment of income doctrine

-prevents taxpayers from arbitrarily transferring the taxation on their income to others -to shift income from property to another person, a taxpayer must also transfer ownership in the property to the other person

tax benefit rule

-refund not typically included -if the refund is made for an expenditure deducted in a previous year, then under the tax benefit rule the refund is included in gross income *to the extent that the prior deduction produced a tax benefit -itemized deduction only produces a tax benefit to the extent that total itemized deductions exceed the standard deduction -itemized deductions - exceeded standard deduction by 100 - a refund of 150 of itemized deductions would only have $100 claimed under the tax benefit rule

gain on sale of personal residence

-taxpayers meeting requirements can exclude 250,000(500,000 married-jointly) *OWNERSHIP TEST - taxpayer must have owned the residence for a total of two or more years during the 5 year period ending on the date of the sale. *PRINCIPAL-USE TEST - taxpayer must have used the property as her principal residence for a total of two or more year during the 5 year period -one exclusion every two years -married couples filing joint returns are eligible for the full 500,000 exclusion if *either spouse meets the ownership test and *both spouses meet the principal-use test -if either spouse is ineligible for the exclusion because he or she personally used the 250,000 exclusion on another home sale during the two years before the date of the current sale, the couple's available exclusion is reduced to 250,000

income from property

-unearned income -gain or losses from the sale of property, dividends, interest, rents, royalties, annuities

economic benefit

-when a taxpayer borrows money there is no economic benefit - the cash received is completely offset by the liability the taxpayer is required to pay from borrowing the funds

discharge of indebtedness

-when a taxpayer's debt is forgiven by a lender - the taxpayer must include the amount of relief in gross income -is NOT taxable if the taxpayer is insolvent before and after the debt forgiveness -if the discharge of indebtedness makes the taxpayer solvent, the taxpayer recognizes gross income to the extent of his solvency.

Life Insurance

-when payments are made over time instead of one lump sum...portion of payments represents and interests which is included in gross income -if a taxpayer simply cancels a life insurance contract and is paid the policy's cash surrender value, she would recognize ordinary income to the extent the proceeds received exceed previous premiums paid - if premiums paid exceed the proceeds received, the loss is not deductible -if terminally ill - 24 months - early receipt of life insurance proceeds are not taxable -if a taxpayer is chronically ill - life insurance proceeds are not taxable to the extent they are used to pay for the taxpayer's long-term care

memorize exhibit 5-3??

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realization principle

1) a taxpayer engages in a transaction with another party 2) the transaction results in a measurable change in property rights---assets or services are exchanged for cash, claims to cash, or other assets with determinable value

Alimony

1) a transfer of cash made under a written separation agreement or divorce decree 2) the separation or divorce decree does not designate the PMT as something other than alimony 3) in the case of legally separated(or divorced) taxpayers under a divorce, spouses do not live together when the PMT is made 4)PMTs cannot continue after death NOT ALIMONY: -property divisions -child support payments fixed by the divorce or separation agreement -if not alimony - the recipient of transfer does NOT count as income - person transferring is not allowed to deduct the value *The additional $7,000 in payments is treated as child support because these payments cease upon the happening of a specific contingency related to the child. *if there is a specific contingency do not count it as alimony

community property systems

9 states - AZ, CA, ID, LO, NV, NM, TX, WA, WS -income earned from services by one spouse is treated as though it was earned equally by both spouses -half of the income earned from the services of one spouse is included in the gross income of the other spouse -half of the income from property held as community property by the married couple is included in the gross income of each spouse ?? do we need more specific? -in AZ CA NV NM WA - all of the income from property owned separately by one spouse is included in that spouse's gross income - TX, LO, WS, ID - half of the income from property owned separately by one spouse is included in the gross income of each spouse

s corporations

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Common exclusions

EXCLUSIONS OF: -municipal interest -gain on the sale of a personal residence -fringe benefits -education -double taxation -sickness -injury

property dispositions

Sale proceeds - Selling expenses = amount realized -- amount realized - basis(investment) in property sold = gain(loss) on sale. -deductions for net capital losses realized by individuals are limited to $3000 per year -losses realized on assets used for personal purposes are generally not deductible

Prizes, awards, gambling winnings

TWO EXCEPTIONS - 1) awards for scientific, literary, or charitable achievement are excluded from gross income if----the recipient was selected without any action on his part to enter the contest---AND---the recipient is not required to render substantial future services as a condition to receive the prize or award---AND---payor of the prize or award transfers the prize or award to a federal, state, or local governmental unit or qualified charity such as a church, school, charitable organization 2) employee awards for length of service or safety achievement. - limited to $400 of tangible property other than cash per employee per year -must include the gross amount of their gambling winnings for the year in gross income -taxpayers are allowed to deduct their gambling losses to the extent of their gambling winnings, but the losses are usually deductible as miscellaneous itemized deductions - professional - losses are deductible to the extent of gambling winnings - for AGI

social security benefits

look up = 5-18 ask if we need to know this in detail???? ???

Recognition

taxpayer who realize an economic benefit must include the benefit in gross income unless a specific provision of the tax code says otherwise