Chapter 5 -- Income Tax

Who recognizes the income?

  • assignment of income doctrine: taxpayer who earns the money pays the taxes on it

  • community property: half of income earned from the services of one spouse is included in the gross income of the other spouse


Types of income

  • Annuities

  • property dispositions: real estate, bonds, etc

    • taxpayers recognize a gain/loss when disposing of an asset

    • allowed to recover their investment in property (tax basis) before they realize any gain

    • sales proceeds

    • Less: Selling expenses

    • = amount realized

    • Less: tax basis (investment) in property

    • = Gain (loss) on sale → short term investments = ordinary income

  • Income from flow through entities:

    • ind’s may invest in various business enities

    • if entity is a flow through entity (partnership/S corp) the income and deductions of the entity “flow through” to the owners of the entity

    • LLC: members (owners)

    • S-corporations: less of now — LLCs are more common —limited to # of stockholders you can have — does not pay taxes, shareholders do — usually family owned

    • LLP: typically accountants, lawyers, doctors

  • Alimony

    • transfer of cash made under a written separation agreement/divorce degree

    • after 2018 → alimony is not taxable to the recipient or deductible by payor

    • before 2019 → alimony is taxable and deductible

    • property divisions and child support DO NOT qualify as alimony

  • Prizes, winnings, and awards

    • excluded only if made: 1. for scientific/charitable achievement, 2. for employee length of service/safety ($400 limit per employee), 3. USA athletes on account of competition

  • Social security benefits

    • taxable up to 85% of SS benefits in gross income depending on status, benefits, and AGI

    • different for each filing status

  • Imputed income/Interest

    • certain employee discounts or low interest loans generate income via indirect benefits

    • low interest loans: amt of imputed income is the difference between the amt of interest using the applicable federal interest rate and the amt the taxpayer actually pays

    • Ex → loan a friend $5,000 and get paid back in 2 years NO INTEREST. IRS thinks you should have collected interest, so you need to report that for taxation

    • IRS says: we’re still gonna tax you on what you should have charged for interest, whether you did charge for it or not

    • familial loans → just don’t tell anybody

    • does not apply if less than $10,000

  • Discharge of indebtedness

    • someone forgives a loan

    • taxpayer must include the amt of relief in gross income

    • some exceptions for certain types of loans


Exclusion provisions

  • municipal bond interest

  • gain on sale of personal residence (single → $250,000; married → $500,000)

  • fringe benefits

    • value of benefits included in employee’s gross income as compensation of services

    • some are excluded from gross income (common: medical and dental health insurance, life insurance—within limits, de minimis benefits)

  • scholarships (cover tuition, books, fees)

  • other educational subsidies (529 plans, EE savings bonds, Coverdell education savings accounts)


Exclusions that mitigate double taxation

  • gifts and inheritances (excluded from GI because these transfers are subject to a federal gift and estate tax)

  • life insurance if you are the beneficiary

  • foreign income can be excluded

  • workers’ compensation

  • payments associated with personal injury

  • health care reimbursement

  • disability insurance (covers wages lost when work missed due to injury/disability)

    • paid for by employee → excluded

    • employer purchased and premiums taxable compensation → excluded

    • employer purchased is a FRINGE benefit → taxable

  • deferral provisions (allow taxpayers to defer the recognition of certain types of realized income)

    • installment sales

    • like kind exchanges