Taxation: Chapter 5: Gross Income

Gross Income

"All income from whatever soruce derived; includes income realized in any form, whether in money, property, or services." -Taxpayers report realized and recognized income on their tax returns for the year. Income that is excluded or deferred is not included in gross income. - Excluded income is never taxed - Deferred income isnt taxed until reconized the next year.

What amounts are included in gross income? - Janus sued Construciton CO. 50,000 for medical cost and 100,000 in punitive damanges - Carl injured in car accident: insurance paid him 500 to reimburse medical expenses and additonal 250 for emotianl distress - Leinwan wins 20,000 in law suit with Mann in court D) Bevis laid off last month; this month he dreq unemployment of 800

A) Medical cost excluded. Punitive included B) Both excluded C) All 20,000 included D) 800 included

This year, Janelle received $200,000 in life insurance proceeds. Under the following scenarios, how much of the $200,000 is taxable? a. Janelle received the proceeds upon the death of her father, Julio. b. Janelle received the $200,000 proceeds because she was diagnosed with colon cancer (life expectancy of 6 months), and she needed the proceeds for her care. c. The proceeds related to a life insurance policy she purchased for $35,000 from a friend in need. After purchase, Janelle paid annual premiums that total $22,000.

A) None B) c) Taxable

Scholarship exclusion example:Ellen, Courtney's daughter received a 700 scholarship from Campbell. that pays 400 tuiton and provides 300 for books. Ellen spent 350 for books. How much may she exclude from gross income?

ALl of it. All of the 300 because all of it was used for books. If she had spent only 250, then the total amount exldued is only 650.

Gift and inheritance exclusion example: Ellen receive a 5,000 voucher for a cruise and a 1,500 from her aunt's estate

All is excluded

Fringe benefits example: Bladen County schools paid Mom 6,000 for their health insurance premiums and 150 for her 40,000 group life insruane policy. What can be exldued? B) In December mom mailed a newsletter to several dozen friends with a picute of Me, Cinnamon, and Donut. She printed them with the printer at work with permission form Bladen County schools. She would have paid $55 at Walart. How much she can exclude?

All of it. - all 55 because its de minimis (small in benefit and infrequent).

Return of capital principle

Applies when trying to realize income form a sale. Cost of an asset is called tax basis. Return of capital means the tax basis is excluded when calculating realized income. Gain from the sale is included in realized income.

Capital loss limitations

Capital losses form related parties are not deducted currently. Relaed party may subsquently be able to deduct all, a portion, or none of disallowed loss on subsqeuent sale or loss by the related party. - Wash rule: no loss on stock sold if the taxpayer purchases the same or "substantially identical" stock with 61 day period of sale date (30 days before sale, sale date, 30 days after). Ex. Person wants to reconize stock loss to offset other capital gains (up to 3,000) or offset ordinary income via a deducton. Problem is, she cant deduct the losses until she sells the stock. Problem because stock might appreciate in near future. Basically an arbritage opportunity. When applied to a new stock, realized losses are not reconized instead the unreconized loss is added to the basis in the stock.

Imputed income example for employer-provided services: To create more space for Edison, Courtney recieved EWD architechual design services as part of her compensation package and a substantial disocunt. Their services were valued at 35,000 but she was only charged 22,000. How much of the dsiount must she include in gross income?

Discount if 13,000. Since a discount on employer provided services, 35,000 X 0.2=7,000. 13,000-7,000=6,000 included in gross income.

Types of Income: Income from property

Gains or losses from sale of property, dividends, interest, rents, royalites, and annuites.

Income other than earned income and income form property: Awards and prizes

Prizes, awards, and gambling winning are included in gross income. -Excluded if: For scientific, literary or charitable acheivment, is not required to do anything substantial as condition of winning it, and transferrs it to state, federal, or local government or qualified chairity; employee safety or length of service acheivemetn (400 limit per employee of tangible property other than cash, cash equivalents, gift cards, tickets to events, meals, lodiging, stocks, bons, etc; if suspected to be disguised compensation, then its not excldued);Team USA athletes exepct if their AGI exceeds 1,000,000 (or 500,000 married filing joint)

Who recognizes the income

Question arises when income-shifitng stradegy is involved. - Assignment of income doctoirne: the taxpayer who earns it must reconize it. Income form dividends or rental reconized by person who owns the stock or land. - Community Property systems: Implemented by 9 states. Half of the income earned by 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. Property brought into the marriage is treated as that spouse's seperate property.

Typoes of income: capital gains and losses

See Return on Capital principle above. Capital assets are typically investment type or personal use assets (annuities, stocks, property, etc). Sale of capital assets generates capital gains and losses. - Taxpayers who havent adquetely tracked their basis in the proprty use FIFO. - If they do maintain good records, they can use specific ID.

What happens after netting capital gains and losses?

Tax consequences of resulting outcome must be calculated. - Net short gain: ordinary - Net long gain: preferenal. - Can deduct up to 3,000 (1,500 if married filing seperately) against ordinary income. Net over this retain their short or long term character and are carried foward and treated as though they were incurred in the subsequent year. -

Income other than earned income and income from property: SS benefits

Taxable up to 85% of SS benefits in gross income depending on filing status, SS benefits, and modified AGI. - Modified AGI is regular AGI + 50% of SS benefits) plus tax exemept interest income (ex. from municipal bonds), exluded foreign income, and certain other deductions fOR AGI. - If modified AGI is less than or equal to 25,000, SS not taxable - If greater than 25 but less than or equal to 34,000, 50% of benefits are taxable - If greater than 34,000, lesser of 85% of benefits or 85% modified AGI -34000 plus lesser of 4,500 or 50% of SS benefits - Ex. Gram recieved 7,200 of SS benefits; suppose his modified AGI is 16,000. What amount of SS is included in gross income? Answer: 0 since modified + 1/2 of benefits less than 25,000.

Form of receipt

Taxpayers can realize income whether they receive cash, stock, or serivces for a transaction.

Types of income Property dispositions

Taxpayers usually realize a gain or loss when disposing of an asset. A loss is realized when proceeds are less than the basis in the property. - Formula for calculaitng gain or loss on sale of asset: Sales proceeds-selling expenses= amount realized-basis on property=gain or loss on sale. - Short-term capital gains if held for less than a year; taxed at ordinary rates - Held for more than a year for long-term; taxed at prefferential rates (0,15,20%) - Sepcial long term gains: Unrecaptured 1250 gain on sale of depreciable real estate is taxed at a maximum rate of 25%. Long-term capital gains from collectibles taxed at maximum rate of 28%. - Long-term capital gains form qualified business stock purchased after setepmer/27/2010 and held for more than 5 years taxed at 0% - Can deduct up to 3,000 of net capital loss against ordinary income. remainder carries over indefinetely.

Income other than earned income and income form property: Alimoney

Transfer of CASH made under written separation or divroce decree, which does not designate it as nonalimoney. Spouses do not live together when payment is made and payments cannot continue after the death of reciepent.Property divisons and child support are not alimoney. For divorce decree executed after 2018 alimoney is not taxable to reciepent or deductible by payer; For those before jan 2019 this is not the case -Ex. As part of divorce agreement, Al transferred his interst in their joint residence to Courtney. They did not have any outstanding debt in the home. At time of divorce, it was valued at 500,000 and Al's share 250,000. Tax consequnces of the transfer of teh share to Courtney. - Answer: Not transfer of cash, so not alimony. So not reconized as income for her and not deducted for him

Exclusion: Fringe Benefits

Value of these benefits is included in employees gross income as compensation for services. Qualifing fringe benefits employer pays are excluded: medical and dental insurance coverage, life insurance coverage for up to 50,000 for group benefits, up to 5,250 for educaiton, rather job relatedor not, employers pay for, meals and lodging (if provided for employer's convince [keeping them on call] and employer accepts lodging is a benefitof employment), up to 5,000 for employer-provided child care for children under 13 and incompetent spouses, 260 per month for emloyer provided parking or transporttion, cafteria palsn (provide fringe benefit and/or cash; taxable for cash but not for qualified fringe benefits included), flexible spending accounts (allow employees to set aside a part of their paycehck to cover benefits like health and dependent care which must be used by year end; some employers allow up to 500 to be carried over to be used the next year; amount they can set aside for health expenses is 2,650 and 5,00 for dependent care expenses) and de minimis (small benefits that are limited like use of a copy machiene). Accoutbale plans that require documentation for employee work related expenses to be reimbursed allow it to be exldued from gross income and not deducted; if no such documentation, then they inlcude reimbursement in gross income but its not deducted.

Income from property: annuities

investment that pays a stream of equal cash flows over time. A portion of the annuity payment is nontaxable return on capital and the remainder is gross income. Annuity exlcusion ratio determines the nontaxable return on capital: orginal investment/expected value of annuity (# of annual paymetns X payment amounts). If taxapayer out lives the annuity or it estimate, then their payments start becoming fully taxable. If they die beforehand, orignal investment-amount recieved deducted on their fianl return. - For annuites with a fixed term, the expected value is teh number of payments X payment amount; for annuites paid over a person's lifetime # of payments comes from IRS tables. - Ex. Billy Graham purchased an annuity for 99,000. Annuity pays 10,000 per year for the next 15 years. How much of each 10000 payment should be included. 99,000/(10,000X15)=0.66. 10,000X0.66=6,600. 10,000-6,600=3,400

Why is certain income excluded or deferred? Municipal interest, gains on sale of perosnal residnece, fringe benefits

mitigate inquiry; subsidize or encourage certain activites. - Municipal interest is excluded - Gains on sale of personal residnce may exclude up to 250,000 (500,000 if married filing jointly) of gain on sale on principle residnece. Must satisfy ownership and use test: have onwed it for 2 of the five proceeding years beofre sale and used it as principle residence for 2 of the 5 years proceeding. Married filing joint elidgible if either spouse meets ownership test and both meet principle test; if either spouse aleady used exclusion on another home 2 years befoe date of sale they only get 250,000. Any excess over this usaly qualifies as long-term capital gain.

Pat Larkin owns 100 shares of spectrum stock that he purchased in June 2017 for $50 a share. In Dec 15th 2018. he sells them for $40 a share to generate cash for holidays. Capital loss is 1,000 (50X100 -40X100). Later he decides it might be a good long term investment after all. On Jan. 3rd he purchases 100 shares of cisco stock for 100 a share for 4,100. Can he realize a short or long term capital loss? How much of capital loss can be on 2018 tax return (filed in April)

Long term capital loss because Stock held for more than year. - None because wash rule violated for not waiting 30 days.

How to net capital gains and losses

Main reason for netting process is to figure out rates for which the net income (if there is any) will be taxed 1. Combine all short term capital gains and losses for year as well as any short term loss carryfoward 2. Combine all long term capital gains and losses for the year as well as any long term loss carryfoward 3. If results from 1 and 2 postive or negative stop there. Otherwise, net 1 and 2. net short capital gain if short gains exceed long losses, net short loss if short losses exceed long gains, vice vera...

Life insurance exclusion example: Papa received 200,000 of accelerated death benefits when diagnosed of cancer and had a life expectancy of less than one year. How much income would the payout generate. B) What if due to financial losses he transfeered his 100,000 life insruance policy to a business asscoaite for 5,000. Since then, the associate continued to pay the annual premiums, totaling 20,000 upon Papa's death. When he died, it apid the 100,000 face value. How much of the 100,000 payment is taxable?

None. He's terminally ill and expected to die in 24 month.s - Because it was purchased for valuble consideration, she can exclude up to 100,000 if the proceeds up to the point of the purchase price + any subsequent payments. So 100,000 -25,000=75,000

"Bill Nye reported $9,550 in itemized deductions including $3,500 of state income taxes paid last year (stanadrad deduciton was 9,350). In march of this year, he recieved 420 for a refund of the 3,500 state taxes deducted. Under economic benefit rule, how much of the $420 should Bill include in gross income this year?

$200.

Flow-through example: Courtney is a 40% partner in a partnership. The partnership reported 20,000 of business income and 3,000 of interest income for the year. They also distributed 1,000 cash to Courtney. What amount of gross income form the partnership does she report for the year?

(0.4X20,000) + (0.4 X 3,000) = basis - 1,000 distribtion less than basis, so its not included.

This year, Leron and Sheena sold their home for $750,000 after all selling costs. Under the following scenarios, how much taxable gain does the home sale generate for Leron and Sheena? a. Leron and Sheena bought the home three years ago for $150,000 and lived in the home until it sold. b. Leron and Sheena bought the home 1 year ago for $600,000 and lived in the home until it sold. c. Leron and Sheena bought the home five years ago for $500,000. They lived in the home for three years until they decided to buy a smaller home. Their home has been vacant for the past two years.

- 750,000-150,000=600,000. 500,000 excluded for couple so 100,000 for preferential rate. - All 150,000 capital gain since residence test fails from only 1 year and wonership test fails form only 1 year - 250,000 gain, which is all excluded

Qualified retirement plans: defined benefit or defined contribtuion plan. INCOMPLETE

- Defined benefit plans: uses formula to show benefits employee will receive upon retirement (based on years of service and compensation levels as they near retirement).Contribution to it not taxable. - Defined contribution plans: specify maximum annual amounts that employers and employees can contribute. Distributors form it are included in gross income; contirbtuons to it are not included. - Distributions from either taxed at ordinary rates; if received too early or too late a penalty is attached as well.

Whats included in gross income:

- Economic benefit: Necessary to have gross income. includes compensation for a service, proceeds from property sales, and income from investment and business activites. Borrowed funds not included because economic benefit recieved is matched by liability. - Tax defintion of income adopts Realizaition principle: Under this concept income is realized when, Two or more parties; transaction results in measurable change in property rights. - Reconition: Realized income is assumed to be reconized (included in gross income) absent an exclusion or refferal.

Exclusions that mitigate double taxation

- Gifts and inheritances: individuals may receive property from an estate. While the reciept of property is most certainly real income to reciept, value of gifts and inheritnces is excluded because already subject to federal gift and estate tax. - Life insurnace proceeds:amounts recieved due to death of insured excluded because they too typically subject to federal estate tax. If proceeds paid over a period of time rather than in a lump some, portion of payments represent interest and must be included in gross income. Excluison is forgone when policy is transferrd to another party for valuable consideration, in this case evenutal collected proceeds are exlcuded up to the pruchase price and any subsequent premiums; if recieving proceeds in excess of premiums paid; this overage amount is included; if whats paid exceeds whats recived no deductions. No taxable if they cash out in excess when terminally ill and expceted to die within 24 months. Not taxable for chronically ill excpet poriton over which is used to take care of expenses. -Foreign income: maximum of 103,900 of foreign earned income can be excluded for qualifiyng indivduals. Maximum of 14,546 of employer-provided foreign housing may also be excluded (but only to the extent that costs exceed 16,624 (16% of 103,900 and limited to a maximum of 14,546 [14% of statutory exlcusion amount]). To be elidble for either exclusion, taxpayer must be considerd resident of that country by living in it a full year or living in it for 330 days in a consectuive 12 month period.

Types of income: Earned income

- Income form labor (earned income) is most common source of gross income. Generated by efforts of taxpayer. Includes wages eared, inventory sold at business they own, unemployment, - Employee stock options: Employees may recieve stock as a form of compensation 1. NQO's: ordinary income taxed at bargin element (market price-amount paid) at excercise date 2. ISOS: No taxable income until sale date. Long term capital gain at sale unless disqualifying dispositon (fail to meet two and one year holding peirod requirements)

Deferrals

- Installment sales - Like-kind exchanges - Involuntary conversions - Cntributions to Roth account - EMployer provided qualified retirement plans:If defined benefit plan then limitations on annual benefit; If defined contributon plan: limitaons on maximum annual contribution; 10% penealty for early distrbutons; minimum distributon requirements.

Education-Related exclusions

- Scholarships: those that pay for tution, books, and things REQUIRED for courses are excluded; room and board schoalrships are inlucded. this applies only if they are not required to perform certain in exchange for recieving i (limited exeption in tuiton waivers for student employees and research assistants). Atheletic sscholarships nontaxable if they are expected but not required to play the sport, requires no activity in lieua of participation, and is not canclled if they dont participate; still only excluded to the extent that they pay for things REQUIRED by their courses. - Other educational subsides: taxpayers allowed to exclude from gross income earnings on investments in qualified education plans as long as earnings are used to pay for qualifiyng educational expenditures. Can exlude interest on series EE savings bonds when the redemption proceeds are used to pay qualified education expenss (exlcuded to taxpayers with modified AGI below certain limits)

Example of foreign income exclusion: Raj is considering a transfer to a college in India where he will be paid 120,000 anually. How much can he exclude if he meets the residency requiremetns? - What if his 12 month qualifiyng period includes only 200 days in the first year and 140 days in the second year. How much of his expected 65,000 salary in the first year can he exclude? - What if it were 200 days the first year and he expects his salry to be 45,000. - What if the company also pays his housing for 25,000 a year? How much of this can he exclude

- The full 103,900. - 103,900 full exclusion X 200/365 (days in foreign country/days in year)=56,932 - All 45,000. 103,900 X 200/365= 56,932 - Since all requirements met, he may also include the employer-provided hosuing cost that exceed 16,624. So 25,000 -16,624=8,376

Income other than earned income and income form property: Discharge of indebtness

- When debt is forgiven by lender, amount of debt relief usally included in gross income. - To provide tax relief for insolvent taxpayers, discharge of indebtness not taxable unless it makes them solvent; the taxapyer then reconizes income to the extent of solvency. Ex. If 30,000 discharged and causes him to be solvent by 10000 (after debt relief assets exceed liabilites by 10,000) the 10,000 isincluded in gross income

Deferrals: employee provided qualified retirement plans

-Defined benefit plan: spells out specific benefits they will recieve at retirement based on formula of years of service and employee compensation levels as they near retiement. - Defined contribution plan: spells out maximum annual contribtions employees and employers can make to retirement. Sum of contributoins from both is limited to 1. 55,0000 or 2. 100% of employee compensaiton for the year.

Sickness and injury related exclusions

-Workes comp:excluded - Paymetns associated with perosnal injury, rather physcial or emotional stress are excluded. Punitive damages are fully included - Health care reimbursement: reimbursements by health and accident insurance polices for medical expenses paid by taxpayer or empployer are excluded. - Disability insurnace/wage replacement insruance: If purchased directly, fully excluded. If purcahsed by employer and premimums considered to be taxable compensation and not nontaxable fringe benefit, then its still not included; if vice versa then it is.

Imputed income example for low interest loans: EWD provides Courtney with a 100,000 low interest loan as part of a compensation package. Applicable federal interest rate is 4%. She used the loan to aquire several personal use assets. What amount is she required to include in gross income in the current year. B) What is 10,000 loan isntead of 100,000?

0 interest Vs 4,000 interest. Therefore, 4,000 icnldued in gross income. B) 0 Imputed income.

Wage replacement insurance example: How much of payment of lost wages from disability insurance policy if her company paid for the insurance as a nontaxble fringe benefit? - How much exluded if she paid half the cost of the policy with after-tax dollars and her copany paid the other half as a taxable fringe benefit?

0 would be excluded since epolciy considered to be purcahsed by employer. - All 600 excluded. If employer had paid as a nontaxable fringe benefit, then only 300 excluded.

Income other than earned income and income from property:Imputed income

Certain kinds of employee discounts or low interest loans generate income via indirect benefits. For low interest loans, amount of imputed income is the difference between the amount of interest ussing applicable federal interest rate and amount of interest you're actually paying. - Imputed interest rules do not apply to aggregate loans of 10,000 or less - For bargin purchases, tax consequnces vary based on realtionship of parites. Bargin purchase by employee from an employer results in tax compensation income to the employlee**, bargin pruchase by shareholder from a corporatoin results in taxable dividend to sharedholder, and bargin purhcases from family memebrs deemed to be gift (which of course is nontaxable_ - **Limited exclsuion for bargins from employer to employee: A)They can exclude on employer provided goods as long as the dsiount does not exceed the employer's gross profit % on all property offered for sale to nonemployeed customers & B) if the discount is up to 20% employer provided discounts on services. Discounts in excess of this amount are subject o taxation.

When to recognize income

Individuals file tax returns for calendar year period. Corporations often use fiscal year end. - The method of accounting determines the year that realized income is reconied (and thus included in gross income) for each. - Corporaitons use accrual method of accounting: income reconized when earned and expenses deducted when liablites incurred. - Indivdiausl use the cash basis of accounting: Income reconzied when reiced rather than earned. Deductions reconzied when expenditures made rather than when they incur liabilites. Individuals may try to shift income from the current year to the next year (ex. not picking up paycheck), but Construtive reciept doctorine when it is "construtively recieved" (when its been credited to taxpayer's account or when its unconditonally avalibel, and the taxpayers aware of it and there are no restrictions on their control over it) - Claim of right: judical dortorine that states income has been realized if taxpayer recieves income and no restricotns on its use (ie has to pay it back) applies to situations in which taxpayer recieves income in one period but is required to return payment in subsequent period; this prevents the income from being realized since they have an obligaiton to repay teh amount. Ex. Cash bonus based on company earnings, despite potentailly having to pay it back in clawback, no restricitons on its use so its realized (included in gross income)

Income other than earned income and income from property: Income form flow-throguhs

Individuals may invest in various business entities. The legal form of the business effects how the income generated from the business is taxed (ex. C corp taxed at entity level and S corp owner level). Flow throughs like partnsherships and S corps have income and deducitons that flow through to the owner, meaning they report their income and deductions based on their % of onwership. - Any distributons for the entity are recieved, they're treated as return on capital and will not be included in gross income if less than the basis that they have in the flow through. If higher than the basis, they are taxed. - Ex. Merkler owns a 40% partnership in Voltswagon. She reports 20,000of business income and 3,000 in interest for the year. Volts also distributed 1,000 to her. What amount of gross income from her ownership would she report for the year? - Answer: business income (0.4 X 20,000) + interest income (0.4 X 3,000)=gross income. 1,000 not included because less than basis.

Recovery of amounts previously deducted

Individuals typically claim deductions in the year paid. Deductions may sometimes be reimbursed or refunded in subsequent year. - Tax benefit rule: refunds of expenditures deducted in prevrious year are included in gross income to the extent that the refund reduced taxes in the year of deduction. Ex. 1,000 business expense deducted FOR AGI; 250 subsequently reimbursed in 2018. The 250 is now included in gross income - More complex for individuals who use itimized deducitons. An itimized deduction only produces a benefit to the extent that total imimized deduction exceeds the standard deduciton. Ex. Individuals total itimized deductions exceed standard deduciton by 100. A total refund of 150 itimized deducitons would cause the itimized deductions to fall below the standard deduction. If the refund has occured in same year as expense, then they would have elected to take standard deduction. Therefore, only 100 included in gross income.

Although Hank is retired, he's a great handyman and works part time on small projects. Last week Mike offered to pay him $710 for minor repairs to his house. He completed the repairs in December of this year. He uses the cash method of accounting and is a calender year taxpayer. He computed gross income for this year under each of the following transactions: A) Mike paid hank 200 this december and promised the other 510 in April of next year. B) Mike paid him 192 in December of this year and gave him a negotiable promissory note (fully transferrable to other parties) for $568 due in three months with interest. He sold the note for $518 dollars. c) Mike gave him tickets for a big game. They have a face value of $71 but he could sell them for 568. He went to the game with his son. d) Mike bought new snow tires. They normally sell for 710, but he bought in 639

a) Gross income for this year is 200 b) Gross income is 710 c) Gross income 568 since this is the fair market value d) Gross income 639 since thi is the fair market value