Chapter 5 gross income PDF

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Professor Jay Wright, Lecture 5 notes, contains bulleted list of important topics covered....

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ACCT 401 CHAPTER 5 GROSS INCOME Gross income- all income from whatever source derived, whether in money, property, or services Unless a tax provision says otherwise, gross income includes all income. Requirements for recognizing gross income: receive economic benefit, realize income, and no tax provision allows them to exclude or defer the income from gross income for that year Taxpayers must receive an economic benefit to have gross income Economic benefit examples- compensation for services, proceeds from property sales, income from investments or business activities. Taxes adopt the realization principle (income is realized when a taxpayer engages in a transaction and the transaction ends in a measurable change i.e. they get PAID) Realization principle for defining gross income has two major advantages: transaction allows the income to be measured objectively, transaction provides taxpayer with the wherewithal to pay taxes (however, if they get land or services rather than money, they still have gross income) Barter clubs- facilitate the exchange of rights to goods and services between members Taxpayers have the legal and ethical responsibility to report realized income no matter the form of it or whether the IRS knows the taxpayer received it. Tax basis- the amount of a taxpayers unrecovered cost of or investment in an asset Return of capital- the portion of proceeds from a sale (or distribution) representing a return of the original cost of the underlying property Tax benefit rule- holds that a refund of an amount deducted in a previous period is only included in income to the extent that the deduction reduced taxable income Accrual method- used by most large corporations, income is recognized when earned and expenses are deducted in the period when liabilities are incurred Cash method- used by most individuals, recognize income in the period they receive it and claim deductions when they make expenditures. Constructive receipt doctrine- cash-method taxpayer realizes and recognizes income when it is actually or constructively received. Constructive receipt occurs when- the income has been credited to the taxpayers account, or when the income is available to the taxpayer, they’re aware of it, and there are no restrictions on the taxpayers control over the income Assignment of income doctrine- eared income is taxed to the taxpayer providing the service, and that income from property is taxed to the individual who owns the property when the interest accrues Assignment of income is basically saying that in order to transfer income to another person, the person must also transfer ownership of the property or stuff to the other person Payments for services including salary, wages, and fees that a taxpayer earns through services in a nonemployee capacity are all considered income from services *and so is unemployment compensation*

Income from services = earned income Income from property = unearned income Income from property- gains or losses on sale of property, dividends, interest, rents, royalties, and annuities Annuity- an investment that pays a stream of equal payments over time Two basic types of annuities- paid over a fixed period, paid over a persons life (as long as they live) Annuity exclusion ratio = original investment/expected value of annuity = return of capital percentage Taxpayers use the annuity exclusion ratio to determine the portion of each payment that should be a nontaxable return of capital Fixed annuity expected value = number of payments * amount of the payment Return of capital for annuity payable over a fixed term = original investment/number of payments Expected value of life annuity = number of annual payments from the table (or expected return multiple)* annual payment amount Investment in annuity contract / number of payments = return of capital per payment Amount of each payment – return of capital per payment = gross income per payment Taxpayers are allowed to recover their investment in property before they realize any gain A loss on sale does not necessarily reduce the taxpayers taxable income, it only does if it is eligible to be deducted Sales proceeds – selling expenses = amount realized – tax 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 Flow through entity- legal entities, like partnerships, limited liability companies, and S corporations, that do not pay income tax. Income and losses from flow through entities are allocated to their OWNERS. Each partner or shareholder on a flow through reports their share of the entities income and deductions, generally in proportion to their ownership %, on their own tax return. Owners of flow through entities are taxed on their share of the income whether or not cash is actually given to them Alimony- a transfer of cash made under a written separation agreement or divorce decree that stipulates that the separation or divorce decree does not designate the payment as something other than alimony, in the case of legally separated or divorced people- they do not live together and the payments do not continue after the death of the recipient. After January 1 2019- alimony is not included in gross income of recipient- before then, it was.

Child support payments are not includable in gross income for recipient and they are not deductible by the payor (no date required) Prizes, awards, and gambling winnings ARE included in gross income However, awards for scientific, literary, or charitable achievement are excluded from gross income BUT ONLY IF::: the recipient was selected without any action on their part, recipient is not required to render future services as a condition to the prize, the payor of the prize transfers the prize to a federal, state, or local government unit or qualified charity designated by the taxpayer. Designating an award for payment to a charity has the same effect as claiming it as a deduction for AGI (charitable contribution deduction) Second exception is for employee awards for length of service or safety achievement- up to $400 per employee per year of tangible property. Third exception is for Olympians (except those who make over 1 million per year) Taxpayers must include the GROSS amount of their gambling winnings for the year in gross income, however, they can deduct gambling losses and expenses. Modified AGI::: AGI – social security benefits + tax exempt interest income – foreign income Social security benefits of taxpayers with relatively low taxable income are not taxed, and that 85% of social security benefits of taxpayers with moderate to high taxable income are taxed. Imputed income- income from an economic benefit the taxpayer receives indirectly rather than directly Taxpayers sometimes recognize indirect economic benefits that they must include in gross income Bargain purchases (goods sold by an employer to an employee at a discount) and below market loans (loan from employer to employee at a zero or very low interest rate) are two common examples of taxable indirect economic benefits Employees may exclude a discount on employer provided goods as long as the discount does not exceed the employers gross profit percentage on all property offered for sale to customers and up to 20 percent employer provided discounts on services. Discounts in excess of these amounts are taxable as compensation When a taxpayers debt is forgiven by a lender, the taxpayer must include the amount of debt relief in gross income Discharge of indebtedness 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. (solvent- assets exceed liabilities by x amount) Nonrecognition provisions- tax laws allowing exclusions or deferrals Congress allows exclusions and deferrals because: to subsidize or encourage particular activities or to be fair to taxpayers. There is an exclusion of interest on municipal bonds (bonds issued by state and local governments in the USA)

Taxpayers meeting certain home ownership requirements (owned for a total of two+ years during the five year period ending on date of sale, used for a total of 2+ years, limited to one exclusion every two years) are allowed to exclude up to 250000 of realized gain on the sale of their principal residence Fringe benefits- noncash benefits provided to an employee as a form of compensation Common qualified fringe benefits (excluded from gross income)- medical and dental health coverage, life insurance coverage, meals and lodging for employers provided convenience, employee assistance education, employee discounts, transportation benefits, etc. Accountable plan- employers reimbursement plan under which employees must submit documentation supporting expenses to receive reimbursement College students can exclude scholarships from gross income as long as they pay for tuition, fees, books, supplies and other equipment required for the students courses Taxpayers can exclude from gross income earnings on investment in qualified education plans (such as a 529 plan) If transferer is alive at the time of the transfer= gift. If transferer is dead = inheritance. Gifts and inheritances are subject to federal transfer tax, not income tax Decedent is subject to estate taxation on the amount of the life insurance proceeds If taxpayer is terminally ill (expected to die in 2 years)- early receipt of life insurance is qualified as accelerated death benefits and is not taxable Foreign income is also taxed in foreign countries so is not included in gross income in the US as long as it is under $107,600. (provided they live in foreign country for 330 days in a one year period) Any payments received because of workers comp is excluded from taxpayers income (pretty much only for physical injuries) Any reimbursement a taxpayer gets from a health and accident insurance policy for medical expenses is excluded from gross income...