exam 2 chapter 5
6. Social Security Benefits
Taxpayers may be required to include up to 85% of Social Security benefits in gross income, depending on the taxpayer's filing status, amount of Social Security benefits, and amount of modified AGI. Base amounts are higher for married filing joint.
f. Gene won $740 in the office March Madness pool.
740 Gene should include $740 in his gross income.
5. Gifts and Inheritances
Not included in income of the recipient. These transfers may be subject to the Federal transfer taxes (estate and/or gift tax), not the income tax. This exclusion helps reduce possible double-taxation (transfer tax and income tax) on these transfers.
"TCJA" (Tax Cuts & Jobs Act, tax reform)
impact on alimony: For divorces finalized before January 1, 2019, alimony is included in gross income of the recipient and deductible "for" AGI by the payor. For divorces finalized after 2018, alimony is not taxable to the recipient or deductible by the payor.
Annuity exclusion ratio
original investment/expected return of the annuity
b. Terry paid $3,880 in premiums for his disability insurance this year.
$0. The disability pay of $5,950 is excluded from Terry's gross income because Terry paid the insurance premiums. Note: the cost of disability insurance premiums is not deductible as a medical expense.
a. Elmer was an extremely diligent employee this year and his employer gave him three additional days off with pay (Elmer's gross pay for the three days totaled $1,600, but his net pay was only $1,264).
1600 Elmer should include in gross income the $1,600 gross pay he received for the three days he was not required to work but still received compensation.
b. How much income will Anne recognize over the term of the annuity?
8555 per year x 10 years 85,550
Generally, 85 percent of Social Security benefits are included in income of high-income taxpayers.
True
b. Ted won a compact car worth $17,900 in a TV game show. Ted plans to sell the car next year.
17,900 The value of the car, $17,900, is economic income realized this year and is, therefore, included in gross income.
Lanny and Shirley divorced in 2018 and do not live together. Shirley has custody of their child, Art, and Lanny pays Shirley $24,750 per year. All property was divided equally. c. How much should Shirley include in income if Lanny's payments drop to $17,200 once Art reaches the age of 18?
17200 $17,200 is includible in Shirley's gross income as alimony. The additional $7,550 in payments is treated as child support because these payments cease upon the happening of a specific contingency related to the child.
b. Amax purchased new office furniture and allowed each employee to take home old office furniture valued at $290.
290 Amax employees should include the value of the furniture ($290) in gross income.
3. Fringe Benefits
Certain fringe benefits, called "qualifying" fringe benefits are excluded from income.
life time annuity
Expected return multiple*Number of annual payments* amount of payment = expected return initial investment / expected return = ratio ratio * annual payout = gross income per payment
2. Gain on the sale of personal residence
Taxpayers may exclude up to $250,000 ($500,000 if MFJ) of gain on the sale of their principal residence. Must satisfy ownership and use tests. (more details in Chapter 14) Any excess gain generally qualifies as long-term capital gain.
Calculating gain (loss) from sale of asset
sale proceeds less: selling expenses ------------------------- =amount realized less: tax basis (investment) in property sold --------------------------- =gain (loss) on sale of asset
c. Al Bore won the Nobel Peace Prize of $707,500 this year. Rather than take the prize, Al designated that the entire award should go to Weatherhead Charity, a tax-exempt organization.
0 The entire award is excluded and therefore tax exempt. The award is excluded because it was for scientific, literary, or charitable achievement, and the taxpayer immediately transferred the award to a qualified charity.
Terry's employer paid the $3,880 in premiums for Terry, but Terry elected to have his employer include the $3,880 as compensation on Terry's W-2.
$0. Even though his employer paid the premium, the premium is taxable compensation to Terry, so he is treated as though he paid the premiums. Thus, the answer is the same as for part b.
c. Last year Louis claimed itemized deductions of $8,260. Louis's itemized deductions included state income taxes paid of $3,260. How much of the refund, if any, must Louis include in gross income under the following independent scenarios? Assume the standard deduction last year was $6,350.
1120 Louis received a tax benefit for the lesser of the refund ($1,120) or the excess of the itemized deductions above the standard deduction ($8,260 − $6,350 = $1,910). Hence, Louis must include the entire $1,120 refund in gross income.
b. Suppose that Fred's employer has offered Fred a six-month overseas assignment beginning on January 1 of next year. How much U.S. gross income will Fred report next year if he accepts the six-month assignment abroad and returns home on July 1 of next year?
117,600 Fred will earn $61,800 during the first half of the year and $55,800 during the second half of the year. However, because he is not physically abroad for 330 days during a consecutive 12-month period (and he would not have a foreign tax home), Fred will not be able to claim any foreign earned income exclusion. So, he will report $117,600 of gross income next year.
If Fred's employer also provides him free housing abroad (cost of $16,150 next year), how much of the $16,150 is excludable from Fred's income? Assume that Fred will be abroad for 305 days out of 365 days next year.(Do not round intermediate calculations. Round your final answer to the nearest whole dollar amount.)
16,150*(305/365)*16% = 13,918. higher than this to deduct 16,150 *(305/354)*14% =12,178 maximum to deduct = lesser of 16150 - 13918 =2232 or =maximum of 12,178 =2232
c. Ajax published a story about Pete and as a result Pete sued Ajax for damage to his reputation. Ajax lost in court and paid Pete an award of $25,000.
25,000 Pete must include the payments in gross income because the payments are not associated with a physical injury.
d. Jerry was awarded $3,200 from his employer, Acme Toons, when he was selected most handsome employee for Valentine's Day this year.
3,200 All $3,200 is economic income realized this year and is, therefore, included in gross income.
If Fred's employer also provides him free housing abroad (cost of $20,300), how much of the $20,300 is excludable from Fred's income?
3,644 Since Fred meets the requirements for the foreign-earned income exclusion, he may also exclude the employer-provided housing costs that exceed $16,656 (16% x $104,100), up to a maximum exclusion of $14,574 (14% x $104,100). Thus, Fred may exclude $3,644 (the lesser of (a) ($20,300 housing cost less $16,656 = $3,644) or (b) $14,574). Thus, Fred includes $16,656 ($20,300 - $3,644 exclusion) of the employer-provided housing in gross income.
Courtney is a 40% partner of abc company. Abc reported 20,000 business income and 3,000 interest income. Abc also distributed 1,000 cash to Courtney. What amount of gross income from her ownership in abc would Courtney report for the current year.
40% x 20,000= 8,000 40% x 3,000 = 1,200 =9,200 dont include the 1,000 because it was a return on her investment
Terry was ill for three months and missed work during this period. During his illness, Terry received $5,950 in sick pay from a disability insurance policy. Terry has disability insurance provided by his employer as a nontaxable fringe benefit. Terry's employer paid $3,880 in disability premiums for Terry this year. What amounts are included in Terry's gross income under the following independent circumstances? (Leave no answer blank. Enter zero if applicable.)
5950 $5,950. The disability pay of $5,950 is included in Terry's gross income because Terry's employer paid the insurance premiums as a nontaxable fringe benefit to Terry. Consequently, the disability insurance premiums of $3,880 paid by Terry's employer are excluded from Terry's gross income.
Louis's itemized deductions included state income taxes paid of $2,035. Louis files as a single taxpayer. In April of this year he received a $1,120 refund of state income taxes that he paid last year. Last year Louis claimed itemized deductions of $6,426. How much of the refund, if any, must Louis include in gross income under the following independent scenarios? Assume the standard deduction last year was $6,350.
76 Louis received a tax benefit for the lesser of the refund ($1,120) or the excess of the itemized deductions above the standard deduction ($6,426 − $6,350 = $76). Hence, Louis must include $76 of the $1,120 refund in gross income.
6. Life Insurance Proceeds
Amounts received due to the death of the insured are excluded from the income of the recipient (beneficiary). If the life insurance proceeds are paid over a period of time as payments rather than in a lump sum, a portion of the payments that represent interest must be included in gross income.
3. Income from Flow-Through Entities
If the entity is a flow-through entity such as a partnership or S corporation, the income and deductions of the entity "flow through" to the owners of the entity (partners or shareholders). Specifically, each partner or S-corporation shareholder reports his/her share of the entity's income and deductions (usually based on % of ownership) on his/her individual tax return. Flow-through entities report to each partner or shareholder the share of the income (or loss) on Schedule K-1.
Early cash-out
If the life insurance policy has a cash surrender value (cash-out value) and the taxpayer cashes-out before death, then the taxpayer would recognize income to the extent the proceeds received exceed the previous premiums paid in. If premiums paid exceed the proceeds received, the loss is not deductible.
Modified AGI is computed as:
Regular AGI + tax exempt interest income + excluded foreign income (discussed later in this chapter) + certain other deductions "for" AGI (student loan interest, Trad IRA contributions) =modified AGI
In addition, taxpayers meeting the requirement for the foreign-earned income exclusion may also exclude from income reasonable housing costs paid by an employer that exceed 16% of the statutory foreign-earned income exclusion amount for the year:
So, for 2018, the housing amount must exceed $16,624 (16% X $103,900) to be able to exclude some of the employer paid housing costs from income. Note: The housing exclusion amount is limited to ("capped") a maximum of 14% of the statutory amount: $14,546 (14% X $103,900).
7. Foreign-Earned Income
U.S. citizens are subject to tax on all income whether it is generated in the U.S. or in foreign countries. Must elect this treatment using Form 2555. According to your book, a maximum of $103,900 (2018) of foreign-earned income can be excluded from gross income for qualifying individuals.
option 2 If modified AGI + 50% of Social Security benefits is > $25,000, but ≤$34,000, then taxable Social Security benefits are the lesser of:
-) 50% of the Social Security benefits, or -) 50% of (modified AGI + 50% of Social Security benefits − $25,000).
Bonnie and Howard got divorced in 2018. Under the terms of the decree Bonnie will pay Howard $100,000 in cash in each of the next ten years (or until Howard's death or remarriage). In addition, Bonnie will transfer a residence worth $2,000,000 to Howard and pay $30,000 per year to support their daughter, Kristina, until she turns 19 years old. What amount (if any) is included in Howard's gross income this year?
$100,000 Property settlements and child support are not included in gross income, but alimony payments (cash) are includible.
There are two types of annuities:
1. annuities paid over a fixed term 2. annuities paid over a person's life
Nine states implement community property systems (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin).
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.
Scholarships
Students seeking a college degree can exclude scholarships (including Pell Grants) that pay for required tuition, fees, books, and supplies. Any excess scholarship amounts (such as room & board) are taxable. Exclusion applies only if the recipient is not required to perform services in exchange for receiving the scholarship. In other words, so-called "scholarships" that represent compensation for past, current, or future services are taxable.
8. Workers' Compensation
Taxpayers receive workers' compensation benefits when they are unable to work because of a work- related injury. Payments from workers' compensation plans are excluded from gross income. *******This is usually confused with "unemployment compensation". Be sure to note that unemployment compensation is taxable and must be included in gross income.
Anne purchased an annuity from an insurance company that promised to pay her $29,000 per year for the next 10 years. Anne paid $204,450 for the annuity, and in exchange she will receive $290,000 over the term of the annuity.
a. How much of the first $29,000 payment should Anne include in gross income? (Do not round intermediate calculations.) 204450 / 29000 x 10 =.705 29000 x .705 =20445 29000-20445 8555
When to Recognize Income?
Individual taxpayers usually file tax returns for a calendar-year period. Most large corporations usually file tax returns using a fiscal year-end. The method of accounting generally determines the calendar year in which realized income is recognized and included in gross income: -Most large corporations use the accrual method of accounting (income recognized when earned and expenses deducted in the period incurred). -Most individuals use the cash method (income recognized in the period they receive it and expenses deducted when they pay it).
Lanny and Shirley divorced in 2018 and do not live together. Shirley has custody of their child, Art, and Lanny pays Shirley $24,750 per year. All property was divided equally. b. How much should Shirley include in income if $13,650 of Lanny's payments is designated as "nonalimony" in the divorce decree?
$11,100 is includible in Shirley's gross income as alimony. Amounts designated as "nonalimony" in the divorce or written separation agreement are not treated as alimony for tax purposes.
Gram sold her 50 shares of abc corporation for $40 a share. Gram also paid $150 in broker commissions on the sale. Gram had originally purchased the shares in April of this year for $30 per share. How much gross income does gram recognize from stock of the sale?
$2000 Sale proceeds ($40 x 50 shares) - 150 selling expenses =amount realized 1850 - tax basis (investment) in property sold ($30 x 50 shares) 1500 =gain (loss) on asset 350
Terry has disability insurance whose cost is shared with his employer. Terry's employer paid $2,700 in disability premiums for Terry this year as a nontaxable fringe benefit, and Terry paid the remaining $1,180 of premiums from his after-tax salary. (Do not round intermediate calculations. Round your answer to the nearest whole dollar amount.)
$4,140. A portion of the disability pay is excluded from Terry's gross income because Terry paid a portion of the insurance premiums. Terry can exclude $1,810 = [($1,180 / $3,880) × $5,950].
Example: Courtney is considering an assignment with her current employer that will transfer her to their overseas affiliate. She will be paid $120,000 for this one-year assignment. Assume that her 12-month qualifying period includes only 200 days in the first year and 140 days in the second year. Assume during the first year, she is expected to earn a $65,000 salary for the overseas assignment. How much of the $65,000 can Courtney exclude?
$56,932 can be excluded with the foreign-earned income exclusion. [$103,900 full exclusion × 200 days/365 days (days in foreign country/days in year)]
Larry purchased an annuity from an insurance company that promises to pay him $1,500 per month for the rest of his life. Larry paid $144,540 for the annuity. Larry is in good health, and he is 72 years old. Larry received the first annuity payment of $1,500 this month. Use the expected number of payments in Exhibit 5-1 for this problem.
(14.6 * 12 * 1,500) =262,800 =144,540 / 262,800 =55% =55% x 1500 =825 deducted =675 gross income per payment
option 3 If modified AGI + 50% of Social Security benefits is > $34,000, then taxable Social Security benefits are the lesser of:
(a) 85% of Social Security benefits, or (b) 85% of (modified AGI + 50% of Social Security benefits − $34,000), PLUS!!!!! the lesser of: (1) $4,500, or (2) 50% of Social Security benefits.
Note important distinction:
- If the disability insurance premiums are taxable compensation to the employee, the policy is considered to have been purchased by the employee. - If the disability insurance premiums paid by the employer is a non-taxable fringe benefit to the employee, the policy is considered to have been purchased by the employer.
- To be considered alimony for tax purposes, must meet ALL four requirements
-A transfer of cash made under a divorce decree. -The divorce decree does not designate the payment as "non-alimony". -The divorced spouses do not live together when the payment is made. -The payments cannot continue after the death of the recipient.
Annuities:
-An investment that pays a stream of equal payments over time. Usually purchased from an insurance company (or other 3rd party) to help supplement retirement income. -Tax law deems a portion of each annuity payment as a nontaxable return of capital and the remainder as gross income. -Taxpayers use the annuity exclusion ratio to determine the return of capital (nontaxable) portion of each payment.
1. Municipal bond interest
-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. -In contrast, interest earned on U.S. government obligations (such as Treasury Bills) is taxable for federal purposes, but is tax exempt for state and local tax purposes.
Recovery of amounts previously deducted: "Tax Benefit Rule"
-Individuals typically claim deductions in the year paid ("cash basis" taxpayers). -Deductions may sometimes be reimbursed or refunded in a subsequent year. -Tax benefit rule - Refunds of expenditures deducted in a prior year are included in gross income to the extent that the refund reduced taxes in year of the deduction.
10. Disability Insurance (Also called wage replacement insurance)
-Pays the insured individual for wages lost when the individual misses work due to injury or disability
Examples of payments that do NOT qualify as alimony:
-Property divisions (who gets the car, house, furniture, dog?) -Child support payments *: If any payment amount is contingent on something associated with the child, that portion of the amount is NOT considered alimony for tax purposes. It is child support for tax purposes, regardless if the amount is called alimony in the divorce decree.
Form of receipt - Does it matter?
-Taxpayers recognize income whether they receive money, property, or services in a transaction. -When receiving property or services, the FMV of the goods and/or services is included in income.
Return of capital principle
-When taxpayers sell assets, they must determine the extent to which they include the sale proceeds in gross income. -The cost of an asset is called the "tax basis". -Return of capital principle allows the tax basis to be excluded when calculating a gain (loss).
a. Janelle received the proceeds upon the death of her father, Julio.
0 None of the $360,000 is taxable as life insurance proceeds are generally not taxable for income tax purposes. The $360,000 proceeds, however, would be included in her father's estate, and thus, may be subject to estate tax.
b. Janelle received the $360,000 proceeds because she was diagnosed with colon cancer (life expectancy of 6 months), and she needed the proceeds for her care.
0 None. Because Janelle was medically certified as terminally ill with an illness expected to cause death within 24 months.
b. Carl was injured in a car accident. Carl's insurance paid him $700 to reimburse his medical expenses and an additional $350 for the emotional distress Carl suffered as a result of the accident.
0 The reimbursed medical costs and the payment for emotional distress associated with a physical injury are excluded.
d. Bevis was laid off from his job last month. This month he drew $1,200 in unemployment benefits.
1,200 Bevis must include the unemployment benefits in his gross income because unemployment benefits are a replacement for lost wages.
e. Ellen won a $1,550 cash prize in a school essay contest. The school is a tax-exempt entity, and Ellen plans to use the funds to pay her college education.
1,550 All $1,550 is economic income realized this year and is, therefore, included in gross income.
Fred currently earns $9,300 per month. Fred has been offered the chance to transfer for three to five years to an overseas affiliate. His employer is willing to pay Fred $10,300 per month if he accepts the assignment. Assume that the maximum foreign-earned income exclusion for next year is $104,100. a-1. How much U.S. gross income will Fred report if he accepts the assignment abroad on January 1 of next year and works overseas for the entire year?
10,300 x 12= 123,600 - maximum of 104,100 = gross income report of 19,500
Lanny and Shirley divorced in 2018 and do not live together. Shirley has custody of their child, Art, and Lanny pays Shirley $24,750 per year. All property was divided equally. a. How much should Shirley include in income if Lanny's payments are made in cash but will cease if Shirley dies or remarries?
24750 $24,750 is includible in Shirley's gross income as alimony. The payments do not continue after Shirley's death. It is not important that the payments may cease earlier than Shirley's death.
What amounts are included in gross income for the following taxpayers? (Leave no answers blank. Enter zero if applicable.) Janus sued Tiny Toys for personal injuries from swallowing a toy. Janus was paid $40,000 for medical costs and $300,000 for punitive damages.
300,000 The $40,000 is excluded from Janus's gross income because it is a payment for a physical injury. However, the $300,000 of punitive damages is included in Janus's gross income because the payment is intended to punish Tiny Toys rather than compensate Janus for her injuries.
. Suppose that Fred's employer offers Fred a permanent overseas assignment beginning on March 1 of next year. How much U.S. gross income will Fred report next year if he accepts the permanent assignment abroad? Assume that Fred will be abroad for 305 days out of 365 days next year. (Do not round intermediate calculations. Round your final answer to the nearest whole dollar amount.)
34,612 Fred will earn $18,600 during January-February and $103,000 during the remainder of the year. 104,100 exclusion x 305/365 =86988 18,600+103,000-86988 =61,612
Geoff purchased a life annuity for $4,800 that will provide him monthly payments of $100 as long as he lives. Based on IRS tables, Geoff's life expectancy is 240 months. How much of the first $100 payment will George include in his gross income?
4800 / 100 * 240 4800 / 24000 =..2 100 * .2 = 20 100 - 20 = 80
a. Phil won $780 in the scratch-off state lottery. There is no state income tax.
All $780 is economic income realized this year and is, therefore, included in gross income.
For annuities with a fixed term, the "expected return" is the number of payments X the payment amount. In January, Gram purchased an annuity for $99,000. The annuity pays her $10,000 per year for the next 15 years. How much of each $10,000 payment should Gram include in her gross income?
Answer: $3,400 should be included in gross income because the exclusion ratio is $99,000/$150,000 or 66 percent. exclude the amount u get from ratio 10,000 monthly - 6600 exclusion amount = 3400
4. Education-Related Exclusions
As an incentive for taxpayers to participate in higher education, Congress excludes certain types of income if the funds are used for certain expenses in higher education.
9. Payments Associated with Personal Injury
Awards and settlements that relate to compensating a taxpayer for a physical injury (including payments for past, current, and future lost wages) are excluded from gross income. Tax law specifies that compensatory damages on account of physical injury (or physical sickness) are non-taxable. THUS, damages taxpayers receive for medical costs and/or emotional distress associated with physical injury are non-taxable.
c. What are the tax consequences if Larry dies just after he receives the 100th payment?
Because Larry has only recognized $82,500 as a return of his original investment (100 × $825), his executor will be entitled to deduct the remaining $62,040 ($144,540 − $82,500) on Larry's final tax return as a miscellaneous itemized deduction.
If Larry lives more than 15 years after purchasing the annuity, how much of each additional payment should he include in gross income?
Because Larry has received all of his original investment as a return of capital by the end of year 15, the entire $1,500 monthly payment is included in gross income.
. Last year Louis had itemized deductions of $4,020 and he chose to claim the standard deduction. Louis's itemized deductions included state income taxes paid of $2,035. How much of the refund, if any, must Louis include in gross income under the following independent scenarios? Assume the standard deduction last year was $6,350.
Because he didn't itemize his deductions, Louis received no tax benefit from the $1,120 tax overpayment. Hence, none of the refund is included in his gross income.
5. Prizes and Awards
In general, prizes, awards, and gambling winnings (raffle, sweepstakes, lottery, etc.) are included in gross income Exception to the general rule: Taxpayer can exclude the prize/award from income if made: 1)For scientific, literary, or charitable achievement and transferred to a qualified charity 2)For employee length of service or safety achievement (Nontaxable awards are limited per employee, per year, to $400 tangible property) 3)To Team USA athletes from U.S. Olympic Committee on account of their competition in Olympic and Paralympic games (exclusion does not apply if AGI exceeds $1 million)
Income from property (unearned income)
Includes gains or losses from sale of property, dividends, interests, rents, royalties, and annuities Tax treatment depends on type of income and type of transaction generating income
Income from services (earned income)
Income from labor most common source of gross income; generated by the efforts of taxpayer (salary, wages, sole-proprietor, etc.)
Specific Types of Income Subject to Tax
Income from services (earned income) Income from property (unearned income) Income from Flow-Through Entities Alimony: Prize and Awards Social security benefits
Who Recognizes the Income?
Our focus in this class will be the "common law system". This is the general rule because it includes the majority of states. As a side note: there are "community property systems" only used by nine states. We will not cover the community property topic since it is not common in our area.
Shelly is a student who has received an academic scholarship to the University. The scholarship paid $4,000 for tuition, $500 for fees, and $400 for books. What amount must Shelly include in her gross income?
Zero - none of the above benefits is included in gross income. College students seeking a degree are allowed to exclude from gross income scholarships 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. The scholarship exclusion applies only if the recipient is not required to perform services in exchange for receiving the scholarship.
