Accy 405 - Chapter 4: Gross Income Concepts and Inclusions
Harvey purchased a corporate bond at its face amount of $20,000 on January 1, 2020. The bond pays 5% interest on each December 31. On April 30, 2020, Harvey sold the bond for $21,000. How much interest income in 2020 must Harvey recognize on the bond?
$333.33 Harvey must realize interest income of $333.33 (5% × $20,000 × 4/12) on the bond
In 2020, Raphael spends $30,000 per year on food, clothing, and other personal expenditures. On December 31, 2020, he has assets of $150,000 (fair market value) and liabilities of $5,000. The imputed rental value of the home he owns and occupies is $15,000. What is his total consumption for 2020?
$45,000 Raphael's total consumption for 2020 is $45,000, or $30,000 + $15,000
Alimony deductions result from the payment of a legal obligation arising from the termination of a marital relationship. Payments designated as alimony generally are included in the gross income of the recipient & are deductible for AGI by the payor. For divorce or separation instruments executed after Dec. 31, 2018, alimony is neither gross income for the recipient nor deductible by the payor.
Alimony & separate maintenance payments
A fixed sum of money payable to a person at specified times for a specified period of time or for life. If the party making the payment (the obligor) is regularly engaged in this type of business (an insurance company), the arrangement is classified as a commercial annuity. A so-called private annuity involves an obligor that isn't regularly engaged in selling annuities (a charity or family member)
Annuity
Orin painted his house which saved him $2,000. According to the realization requirement, he must recognize $2,000 of income. True or False?
False, Orin did not realize income because he did not engage in a transaction with another party.
Alex, an accrual basis taxpayer, collects the rent for December 2020 and January 2021 on December 1, 2020. Alex must include the December 2020 rent but not the January 2021 rent in his 2020 gross income. True or False?
False, both payments must be included in Alex's 2020 gross income. For tax purposes, unearned income often is taxed in the year of receipt.
The Internal Revenue Code does not precisely define the term gross income. True or False?
False, the Code does not precisely define income, but gross income is defined in § 61(a) as follows: Except as otherwise provided in this subtitle, gross income means all income from whatever source derived.
In December 2020, Bella collected the December 2020 and January 2021 rent from a tenant. Bella is a cash basis taxpayer. The amount collected in December 2020 for the 2021 rent should be included in her 2021 gross income. True or False?
False, the cash basis taxpayer must report the rent income in gross income for the year it is received, 2020, rather than the year in which it is earned.
Bigham Corporation, an accrual basis calendar year taxpayer, sells its services under 12- and 24-month contracts. The corporation provides services to each customer every month. On July 1, 2020, Bigham sold the following customer contracts: Length of Contract: 12 months and 24 months Total Proceeds: $14,000(12 months) $24,000(24 months) Determine the income to be recognized in taxable income in 2020 and 2021.
Income to be recognized in 2020 = Income recognized for 12 month service contract + Income recognized for 24 month service contract $7,000 = $14,000 * (6 months/12 months) $6,000 = $24,000 * (6 months/24 months) Income recognized (2020) = ($7,000 + $6,000) = $13,000 Income to be recognized in 2021 = Income recognized for 12 month service contract + Income recognized for 24 month service contract = [$14,000 * (6 months/12 months)] + [$24,000 * (18 months/24 months)] Income recognized (2021) = ($7,000 + $18,000) = $25,000
FinCEN Form 114, Report of Foreign Bank & Financial Accounts (FBAR), must be filed by individuals & some businesses if they have foreign bank, brokerage or similar accounts where at any time during the calendar yr. the aggregate balance exceeds $10,000. The form is filed electronically w/ the U.S. Department of the Treasury & is due by April 15 w/ an automatic extension to Oct. 15. Significant penalties apply for failure to file the FBAR. The form isn't attached to the income tax return (it's separately filed), but any interest earned by the foreign accounts is generally included in the account holder's U.S. taxable income.
Report of Foreign Bank & Financial Accounts (FBAR)
The designation for a corporation that elects to be taxed similarly to a partnership. See also Subchapter S.
S corporation
Marlene, a cash basis taxpayer, invests in Series EE U.S. government savings bonds and bank certificates of deposit (CDs). Determine the tax consequences of the following on her 2020 gross income: a) On September 30, 2020, she cashed in Series EE bonds for $10,000. She purchased the bonds in 2010 for $7,090. The yield to maturity on the bonds was 3.5%. b) On July 1, 2019, she purchased a CD for $10,000. The CD matures on June 30, 2021, and will pay $10,816, yielding a 4% annual return. c) On July 1, 2020, she purchased a CD for $10,000. The maturity date on the CD was June 30, 2021, when Marlene would receive $10,300.
a) $2,910 = ($10,000 -$7,090) b) $408 = [($10,816 - $10,000) + ($10,000 * 4% * 1/2 year)] * 4% c) In this case, the CD is issued for a period of one year and given that CD is not subject to the original issue discount rules.Marlene, as a cash basis taxpayer, is not required to recognize any income until 2021 when the CD matures
Selma operates a contractor's supply store. She maintains her books using the cash method. At the end of 2020, her accountant computes her accrual basis income that is used on her tax return. For 2020, Selma had cash receipts of $1,400,000, which included $200,000 collected on accounts receivable from 2019 sales. It also included the proceeds of a $100,000 bank loan. At the end of 2020, she had $250,000 in accounts receivable from customers, all from 2020 sales. a) Compute Selma's accrual basis gross receipts for 2020. b) Selma paid cash for all of the purchases. The total amount paid for merchandise in 2020 was $1,300,000. At the end of 2019, she had merchandise on hand with a cost of $150,000. At the end of 2020, the cost of merchandise on hand was $300,000. Compute Selma's gross income from merchandise sales for 2020.
a) Accrual Gross Receipts = $1,350,000 ($1,400,000 - $200,000 - $100,000 + $250,000) Cost of goods sold = $1,150,000 ($1,300,000 - $150,000) b) Gross Profit = $200,000 ($1,350,000 - $1,150,000)
Determine the taxpayer's gross income for tax purposes in each of the following situations: a) Deb, a cash basis taxpayer, traded a corporate bond with accrued interest of $300 for corporate stock with a fair market value of $12,000 at the time of the exchange. Deb's cost of the bond was $10,000. The value of the stock had decreased to $11,000 by the end of the year. b) Deb needed $10,000 to make a down payment on her house. She instructed her broker to sell some stock to raise the $10,000. Deb's cost of the stock was $3,000. Based on her broker's advice, instead of selling the stock, she borrowed the $10,000 using the stock as collateral for the debt. c) Deb's boss gave her two tickets to the Rabid Rabbits rock concert because she met her sales quota. At the time she received the tickets, each ticket had a face price of $200 and was selling on eBay for $300. On the date of the concert, the tickets were selling for $250 each. Deb and her son attended the concert.
a) Deb must recognize $300 interest income and $1,700 gain ($11,700 - $10,000) when she exchanged the bond for stock. Of the value of the corporate stock she received,$300 was for her accrued interest. The remaining $11,700 was in exchange for the bond whose cost was $10,000. The fact that the stock decreased in value after the exchange is not relevant because she still owns the stock and thus has not realized the loss in value. b) Deb did not realize income when she borrowed on the property. Her net worth did not increase - assets and liabilities increased by an equal amount. c) Deb must recognize compensation income of $600 ($300 × 2), the fair market value of the tickets at the time she received them.
A taxpayer, age 64, purchases an annuity from an insurance company for $50,000. She is to receive $300 per month for life. Her life expectancy is 20.8 years from the annuity starting date. Assuming that she receives $3,600 this year, (a) what is the exclusion percentage, and (b) how much is included in her gross income? *Round the exclusion percentage to two decimal places. Round the final answer for the income to the nearest dollar.
a) Expected return is $300 x 12 x 20.8 = $74,880 Exclusion % is ($50,000 ÷ $74,880) = 66.77% b) (66.77% * $3,600) = $2,404 nontaxable Included in Income = ($3,600 - $2,404) = $1,196
On January 1, 2020, Kunto, a cash basis taxpayer, pays $46,228 for a 24-month certificate. The certificate is priced to yield 4% (the effective interest rate) with interest compounded annually. No interest is paid until maturity, when Kunto receives $50,000. In your computations: a) Compute Kunto's gross income from the certificate for 2020. b) Compute Kunto's gross income from the certificate for 2021.
a) Gross Income (2020) = ($46,228 * 4%) = $1,849 b) Interest Income = ($46,228 + $1,849) * 4% = $1,923 Capital = ($50,000 - $46,228) = $3,772 Total Gross Income = $3,772 + $1,849 = $5,621
Determine Amos's gross income in each of the following cases: a) In the current year, Amos purchased an automobile for $25,000. As part of the transaction, Amos received a $1,500 rebate from the manufacturer. b) Amos sold his business. In addition to the selling price of the stock, he received $50,000 for a covenant not to compete—an agreement that he will not compete with his former business for five years. c) Amos owned some land he held as an investment. As a result of a change in the zoning rules, the property increased in value by $20,000.
a) The $1,500 is a reduction in the cost of the automobile and is not income. b) The $50,000 payment received under the covenant is included in Amos's gross income because the payment is an increase in wealth realized. c) The change in the zoning rules that caused the property to increase in value is economic gain but is not a realized gain for tax purposes. Amos's wealth increased, but the realization requirement is not satisfied because he did not receive any additional property, nor were any improvements made to his property. Amos will not realize this increase in wealth for tax purposes until he sells the property.
Casper and Cecile divorced in 2018. As part of the divorce settlement, Casper transferred stock to Cecile. Casper purchased the stock for $25,000, and it had a market value of $43,000 on the date of the transfer. Cecile sold the stock for $40,000 a month after receiving it. In addition, Casper is required to pay Cecile $1,500 a month in alimony. He made five payments to her during the year. What are the tax consequences for Casper and Cecile regarding these transactions? a) How much gain or loss does Casper recognize on the transfer of the stock? b) Does Casper receive a deduction for the $7,500 alimony paid? c) How much income does Cecile have from the $7,500 alimony received? d) When Cecile sells the stock, how much does she report?
a. $0 b. yes c. $7500.00 d. gain and $15000.00 (40000-25000) Alimony and separate maintenance payments are deductible by the party making the payments and are includible in the gross income of the party receiving the payments. Thus, income is shifted from the income earner to the income beneficiary, who is better able to pay the tax on the amount received.A transfer of property other than cash to a former spouse under a divorce decree or agreement is not a taxable event. The transferor is not entitled to a deduction and does not recognize gain or loss on the transfer. The transferee does not recognize income and has a cost basis equal to the transferor's basis.
Simba and Zola are married but file separate returns. Simba received $80,000 of salary and $1,200 of taxable dividends on stock he purchased in his name and paid from the salary that he earned since the marriage. Zola collected $900 in taxable interest on a certificate of deposit she inherited from her aunt. Compute Zola's gross income under two assumptions as to the state of residency of the couple. If an amount is zero, enter "0". Idaho (Community Property State) Dividends $ a. Interest $ b. Salary $ c. South Carolina(Common Law State) Dividends $ d. Interest $ e. Salary $ f.
a. $600 = ($1,200 * 50%) b. $450 = ($900 * 50%) c. $40,000 = ($80,000 * 50%) d. 0 e. $900 f. 0 Under a community property system, all property is deemed either to be separately owned by the spouse or to belong to the marital community. Property may be held separately by a spouse if it was acquired before marriage or received by gift or inheritance following marriage. Otherwise, any property is deemed to be community property. For Federal tax purposes, each spouse is taxed on one-half of the income from property belonging to the community. The laws of Texas, Louisiana, Wisconsin, and Idaho distinguish between separate property and the income it produces. In these states, the income from separate property belongs to the community. Accordingly, for Federal income tax purposes, each spouse is taxed on one-half of the income. In the remaining community property states, separate property produces separate income that the owner-spouse must report on his or her Federal income tax return.In all community property states, income from personal services (e.g., salaries, wages, and income from a professional partnership) is generally treated as if one-half is earned by each spouse.
Jarvis, a single taxpayer, retired from his job as a public school teacher in 2020. He is to receive a retirement annuity of $1,000 each month and his life expectancy is 150 months. He contributed $30,000 to the pension plan during his 35-year career, so his adjusted basis is $30,000. Which of the following is the correct method for reporting the pension income? a.For the first 150 months, 20% ($30,000/$150,000) of the amount received is a nontaxable recovery of capital and the balance is included in gross income. b.Since Jarvis is no longer working, none of the pension must be included in his gross income. c.The first $30,000 received is a nontaxable recovery of capital, and all subsequent annuity payments are taxable. d.For the first 150 months, 80% of the amount received is a nontaxable recovery of capital that must be included in gross income. e.The first $120,000 he receives is taxable, and the last $30,000 is a nontaxable recovery of capital.
a.For the first 150 months, 20% ($30,000/$150,000) of the amount received is a nontaxable recovery of capital and the balance is included in gross income. Jarvis is collecting under an annuity contract and the cost must be allocated among the payments received on the basis of the cost/expected return, until the total cost has been recovered. Thus, for each annuity payment received for the 150-month period, $200 ($1,000 × 20%) is excluded from gross income and $800 ($1,000 × 80%) is included in gross income. Any payments received after the 150-month period are included in his gross income.
Molly operates a gym. She sells memberships that entitle the member to use the facilities at any time. A one-year membership costs $360 ($360/12 = $30 per month); a two-year membership costs $600 ($600/24 = $25 per month). Cash payment is required at the beginning of the membership period. On July 1, 2020, Molly sold a one-year membership and a two-year membership. I. If Molly is a cash basis taxpayer, her 2020 gross income from the contracts is $960 ($360 + $600). II. If Molly is an accrual basis taxpayer, her 2020 gross income from the contracts is $330 [(6/12 × $360) + (6/24 × $600)]. III. If Molly is an accrual basis taxpayer, her 2021 gross income from the contracts is $630 [(6/12 × $360) + $450]. a.I, II, and III are true. b.Only I is true. c.Only I and II are true. d.Neither I, II, nor III is true. e.Only II and III are true.
a.I, II, and III are true. A cash basis taxpayer recognizes the income when it is actually or constructively received. The accrual basis taxpayer who receives prepaid income for services can prorate the income in the year of receipt but must include the balance of the income in the second year. This limited deferral is provided under Revenue Procedure 2004-34.
On January 5, 2020, Louise purchased a bond paying interest at 6% for $30,000. On September 30, 2020, she gave the bond to Gerard. The bond pays $1,800 interest on December 31. Louise and Gerard are cash basis taxpayers. When Gerard collects the interest in December 2020: a.Louise reports $1,350 of interest income in 2020, and Gerard reports $450 of interest income in 2020. b.Louise must include all the interest in her gross income. c.Gerard must include all the interest in his gross income. d.Neither Louise nor Gerard has taxable income from this transaction. e.Louise reports $450 of interest income in 2020, and Gerard reports $1,350 of interest income in 2020.
a.Louise reports $1,350 of interest income in 2020, and Gerard reports $450 of interest income in 2020. Louise held the bond for nine months before she gave it to Gerard, who held the bond for the other three months that the interest accrued. Therefore, Louise must recognize $1,350 (9/12 × $1,800), and Gerard must recognize $450 (3/12 × $1,800).
Shane, a cash basis taxpayer, gave 1,000 shares of Iris Company common stock to his daughter on September 29, 2020. Iris Company is a publicly held company that has declared a $1.00 per share dividend on September 30 every year for the last 20 years. Just as Shane had expected, Iris Company declared a $1.00 per share dividend on September 30, payable on October 15, to stockholders of record as of October 10. The daughter received the $1,000 dividend on October 18, 2020. Which of the following statements is true? a.The daughter must recognize the income because she owned the stock when the dividend was declared and she received the $1,000. b.Shane must recognize the $1,000 dividend as his income because he knew the dividend would be paid. c.Shane must recognize $750 of the dividend because he owned the stock for three-fourths of the year. d.Neither Shane nor his daughter must recognize income. e.Shane must recognize the income of $1,000 because he constructively received the $1,000.
a.The daughter must recognize the income because she owned the stock when the dividend was declared and she received the $1,000. The gift of the stock is made prior to the declaration date. If a donor makes a gift of stock to someone (e.g., a family member) after the declaration date but before the record date, the Tax Court has held that the donor does not shift the dividend income to the receiver.
The accountant's concept of income is generally based upon the realization principle. Financial accounting income may differ from taxable income (accelerated depreciation might be used for Federal income tax & straight-line depreciation for financial accounting purposes). Differences are included in a reconciliation of taxable & accounting income on Schedule M-1 or Schedule M-3 of Form 1120 for corporations
accounting income
The method under which income & expenses are determined for tax purposes. Important accounting methods include the cash basis & the accrual basis. Special methods are available for the reporting of gain on installment sales, recognition of income on construction projects (the completed contract & percentage of completion methods), & the valuation of inventories (LIFO & FIFO). §§ 446-474.
accounting method
A method of accounting that recognizes expenses as incurred & income as earned. In contrast to the cash basis of accounting, expenses need not be paid to be deductible, nor need income be received to be taxable. § 446(c)(2).
accrual method
The amount of alimony that previously has been included in the gross income of the recipient & deducted by the payor that now is deducted by the recipient & included in the gross income of the payor as the result of front-loading. Alimony recapture is applicable for divorce or separation agreements executed before 2019. § 71(f).
alimony recapture
A taxpayer attempts to avoid the recognition of income by assigning to another the property that generates the income. Such a procedure will not avoid income recognition by the taxpayer making the assignment if the income was earned at the point of the transfer. In this case, the income is taxed to the person who earns it.
assignment of income
The imputed interest rules apply to all of the following types of loans, except: a.Loans made between two objective parties at the market rate of interest. b.Gift loans made out of love or affection. c.Compensation-related loans. d.Corporation-shareholder loans. e.Loans from an employer to an employee.
c.Compensation-related loans. There is a presumption of an arm's-length objective transaction, imputed interest rules do not apply to loans made between two objective parties at the market rate of interest.
A method of accounting that reflects deductions as paid & income as received in any 1 tax year. However, deductions for prepaid expenses that benefit more than 1 tax year (prepaid rent & prepaid interest) usually are spread over the period benefited rather than deducted in the year paid. § 446(c)(1).
cash receipts method
A judicially imposed doctrine applicable to both cash & accrual basis taxpayers that holds that an amount is includible in income upon actual or constructive receipt if the taxpayer has an unrestricted claim to the payment. For the tax treatment of amounts repaid when previously included in income under the claim of right doctrine, see § 1341.
claim of right doctrine
Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, & Wisconsin have community property systems. Alaska residents can elect community property status for assets. The rest of the states are common law property jurisdictions. The difference between common law & community property systems centers around the property rights possessed by married persons. In a common law system, each spouse owns whatever he/she earns. Under a community property system, one-half of the earnings of each spouse is considered owned by the other spouse. For example, Assume that Jeff & Alice are husband & wife & that their only income is the $50,000 annual salary Jeff receives. If they live in New York (a common law state), the $50,000 salary belongs to Jeff. If, however, they live in Texas (a community property state), the $50,000 salary is owned one-half each by Jeff & Alice.
community property
If income is unqualifiedly available although not physically in the taxpayer's possession, it still is subject to the income tax. An example is accrued interest on a savings account. Under the constructive receipt concept, the interest is taxed to a depositor in the year available, rather than the year actually w/drawn. The fact that the depositor uses the cash basis of accounting for tax purposes is irrelevant. See Reg. § 1.451-2.
constructive receipt
Which of the following is not a requirement for alimony under pre-2019 agreements? a.There is no liability to make the payments for any period after the death of the payee. b.The payments are in cash. c.The agreement or decree does not specify that the payments are not alimony. d.The payments must be made before the divorce decree is final. e.The payor and payee are not members of the same household at the time the payments are made.
d.The payments must be made before the divorce decree is final. All of these are objective rules developed by Congress except for "The payments must be made before the divorce decree is final".
The change in the taxpayer's net worth, as measured in terms of market values, plus the value of the assets the taxpayer consumed during the year. B/c of the impracticality of this income model, it is not used for tax purposes.
economic income
The courts have held that an individual who earns income from property or services cannot assign that income to another. For example, a father cannot assign his earnings from commissions to his child & escape income tax on those amounts.
fruit & tree metaphor
Income subject to the Federal income tax. Gross income doesn't include all economic income. That is, certain exclusions are allowed (interest on municipal bonds). For a manufacturing or merchandising business, gross income usually means gross profit (gross sales or gross receipts less COGS). § 61 & Reg. § 1.61-3(a).
gross income
A combination of the accrual & cash methods of accounting. That is, the taxpayer may account for some items of income on the accrual method (sales & COGS) & other items (interest income) on the cash method.
hybrid method
For certain long-term sales of property, under §§ 483 & 1274 the IRS can convert some of the gain from the sale into interest income if the contract doesn't provide for a minimum rate of interest to be paid by the purchaser. The seller recognizes less long-term capital gain & more ordinary income (interest income). Imputed interest rules also apply on certain below-market loans under § 7872.
imputed interest
For tax purposes, an increase in wealth that has been realized
income
The difference between the issue price of a debt obligation (a corporate bond) & the maturity value of the obligation when the issue price is less than the maturity value. An original issue discount (OID) represents interest & must be amortized over the life of the debt obligation using the effective interest method. The difference isn't considered to be original issue discount for tax purposes when it is less than one-fourth of 1% of the redemption price at maturity multiplied by the number of years to maturity. §§ 1272 and 1273(a)(3).
original issue discount
For income tax purposes, it includes a syndicate, group, pool, or joint venture as well as ordinary partnerships. In an ordinary partnership, 2 or more parties combine capital &/or services to carry on a business for profit as co-owners. § 7701(a)(2).
partnership
When a taxable sale or exchange occurs, the seller may be permitted to recover his or her investment (or other adjusted basis) in the property before gain or loss is recognized.
recovery of capital doctrine
The annual period over which income is measured for income tax purposes. Most individuals use a calendar year, but many businesses use a fiscal year based on the natural business year. Certain entities, including S corporations, have a required taxable year. §§ 441, 706, and 1378.
taxable year
