ACC 3410 Chapter 5 Review

Gross Income

Includes all income from whatever source derived (money, property, or services) unless specifically excluded by law.

Three Requirements for Recognition

Economic Benefit, Realization Principle, Recognition

Recognition Requirement: Economic Benefit

Taxpayer must receive an item of value; borrowing money is NOT an economic benefit due to the liability to repay.

Recognition Requirement: Realization Principle

Income is realized when a transaction with another party results in a measurable change in property rights.

Recognition Requirement: Recognition

Realized income is recognized (taxed) unless a specific provision allows for exclusion or deferral.

Return of Capital Principle

Taxpayers recover their investment (tax basis) tax-free; only the gain above basis is included in income.

Gain (Loss) on Sale Formula

Amount Realized (Sales proceeds - Selling expenses) minus Tax Basis.

Tax Benefit Rule

A refund of a prior deduction is included in gross income only to the extent the original deduction reduced taxable income.

Accrual Method of Accounting

Income is recognized when earned; typically used by larger corporations.

Cash Method of Accounting

Income is recognized when actually or constructively received; used by most individual taxpayers.

Constructive Receipt Doctrine

Income is deemed received when it is credited to an account or made unconditionally available without restriction.

Claim of Right Doctrine

Income must be recognized when there are no restrictions on its use (e.g., no obligation to repay).

Assignment of Income Doctrine

Income from services is taxed to the person who earns it; income from property is taxed to the owner of the property.

Income Shifting

The practice of moving income to related parties in lower tax brackets to reduce the overall tax burden.

Common Law System (Income)

Income from services belongs to the earner; income from property belongs to the legal owner.

Community Property System

Used in 9 states; income earned by one spouse is generally treated as belonging equally to both spouses.

Community Property States

AZ, CA, ID, LA, NV, NM, TX, WA, and WI.

Income from Services (Earned Income)

Salary, wages, and fees generated by the efforts of the taxpayer in employee or nonemployee capacities.

Income from Property (Unearned Income)

Gains/losses from property sales, dividends, interest, rents, royalties, and annuities.

Annuity (Definition)

An investment that pays a stream of equal payments over a fixed period or over a person’s life.

Annuity Payment Composition

Each payment is split into a nontaxable return of capital and a taxable gross income portion.

Fixed Annuity: Return of Capital Shortcut

Original Investment divided by the Total Number of Payments.

Life Annuity: Expected Value

Calculated using IRS tables to determine the expected total value based on life expectancy.

Property Disposition: Amount Realized

Sales Proceeds minus Selling Expenses.

Property Disposition: Gain or Loss Formula

Amount Realized minus Tax Basis equals Gain (or Loss) on sale.

Personal-Use Asset Losses

Generally NOT deductible for tax purposes.

Capital Asset Categories

Investment-type assets and personal-use assets (excludes inventory and business-use assets).

Long-term Capital Gain (LTCG) Rate

Taxed at preferential rates of 0%, 15%, or 20% if held for more than one year.

Short-term Capital Gain (STCG) Rate

Taxed at ordinary income rates if held for one year or less.

Net Capital Loss Deduction

Deductible up to $3,000 against ordinary income; any excess is carried forward indefinitely.

Flow-Through Entities

Partnerships and S-corps where income/deductions "flow through" to owners and are taxed at the owner level.

Alimony Requirements

Cash transfer, written agreement, spouses live apart, payments cease upon recipient's death, not child support.

Alimony: Pre-2019 Agreements

Taxable to the recipient and deductible "For AGI" by the payor.

Alimony: Post-2018 Agreements

Neither taxable to the recipient nor deductible by the payor.

Child Support vs. Alimony

Child support is never taxable to the recipient and never deductible by the payor.

Prizes and Awards General Rule

Generally included in gross income at Fair Market Value.

Scientific/Charitable Award Exclusion

Excludable only if the recipient immediately transfers the award to a qualified charity.

Employee Achievement Awards

Excludable up to $400 if for safety or length of service and paid in tangible property.

Social Security Benefit Taxation

Taxpayers include 0%, 50%, or up to 85% of benefits in gross income depending on filing status and modified AGI.

Imputed Income (Below-Market Loans)

Borrower is treated as paying interest at the federal rate; lender is treated as receiving and returning that interest.

Discharge of Indebtedness

Debt relief is generally taxable income unless the taxpayer is insolvent (liabilities > assets).

Solvency Exception (Debt Discharge)

If debt discharge makes an insolvent taxpayer solvent, they only recognize income to the extent of their new solvency.

Municipal Bond Interest Exclusion

Interest on state and local bonds is permanently excluded; U.S. Government bond interest is fully taxable.

Gain on Sale of Personal Residence

Exclude up to $250,000 ($500,000 MFJ) of gain if ownership and use tests are met.

Residence Use/Ownership Test

Taxpayer must have owned and lived in the home as a principal residence for 2 of the 5 years before the sale.

Fringe Benefits (Excludable)

Qualified benefits like health/dental insurance and life insurance premiums (up to $50k) are excluded from gross income.

Accountable Plans

Employee reimbursements for business expenses are excluded from income if the employer uses an "accountable plan."

Scholarship Exclusion (Qualified)

Excludable for degree-seeking students if used for tuition, fees, books, and required supplies.

Scholarship Exclusion (Taxable)

Amounts used for room and board or payments requiring services (like teaching) are fully taxable.

529 Plans & Coverdell Accounts

Earnings are excluded from gross income if used for qualifying educational expenditures.

Team USA Exclusion

Olympic/Paralympic winnings are excludable for athletes, subject to AGI limits.

Gift and Inheritance Exclusion

The value of property received is excluded from gross income to avoid double taxation (as they are subject to federal transfer taxes).

Life Insurance Proceeds

Generally excluded from income; however, if proceeds are paid over time, the interest portion is taxable.

Foreign-Earned Income Exclusion (2025)

Qualifying individuals can exclude up to $130,000 if they have a foreign tax home and meet residency requirements.

Foreign-Earned Income: Residency Test

Must be a resident for the entire calendar year OR live in a foreign country for 330 days in a consecutive 12-month period.

Workers’ Compensation

Payments received from workers’ compensation plans are permanently excluded from gross income.

Personal Injury: Physical Injury/Sickness

Compensation for physical injury and medical costs for emotional distress are excluded; punitive damages are fully taxable.

Health Care Reimbursements

Insurance reimbursements for medical expenses paid by the taxpayer are excluded from gross income.

Disability Insurance: Individually Purchased

Benefit payments are EXCLUDED from gross income if the taxpayer paid the premiums.

Disability Insurance: Employer-Purchased (Taxable)

Benefit payments are TAXABLE if the employer paid the premiums as a nontaxable fringe benefit.

Defined Benefit Plan

Specifies a fixed retirement benefit based on a formula; contributions are not taxable, but distributions are ordinary income.

Defined Contribution Plan

Specifies maximum annual contributions (e.g., 401(k)); contributions (except Roth) are not taxable; distributions are ordinary income.

Early Distribution Penalty (Retirement)

Distributions before age 59½ are generally subject to a 10% nondeductible penalty plus ordinary income tax.

Required Minimum Distribution (RMD)

Must begin by April 1 following the later of age 73 or retirement; failure to do so results in a penalty.

Punitive Damages

Payments intended to punish the doer rather than compensate the victim; these are always fully taxable.