Chp 4 Gross Income Inclusions

Gross Income - Inclusions

No Tax on Tips
  • Deduction Limit: Can deduct up to $25,000 in qualified tips.
  • Definition of Qualified Tips: Voluntary cash or charged tips, including shared tips.
  • Requisite Occupation: Must work in an occupation that “customarily and regularly” receives tips, such as food service and beauty industries.
  • Reporting Requirement: Tips are reported on W-2, 1099, or another statement furnished to the individual.
  • Income Limit for Deduction: The deduction starts phasing out if Modified AGI exceeds:
    • $150,000 for single filers.
    • $300,000 for married filers.
  • Deduction Availability: Available for tax years 2025 - 2028.
IRC § 61 – General Definition of Gross Income
  • General Definition: Except as otherwise provided, gross income means all income from whatever source derived, including, but not limited to, the following items:
    1. Compensation for services (fees, commissions, fringe benefits, etc.)
    2. Gross income derived from business.
    3. Gains from dealings in property.
    4. Interest.
    5. Rents.
    6. Royalties.
    7. Dividends.
    8. Annuities.
    9. Income from life insurance and endowment contracts (under certain conditions).
    10. Pensions.
    11. Income from discharge of indebtedness.
    12. Distributive share of partnership gross income.
    13. Income in respect of a decedent.
    14. Income from an interest in an estate or trust.
Recovery of Capital Doctrine
  • Purpose: Prevents income from being taxed more than once.
  • Capital Definition: Capital is an accumulation of previously taxed income.
  • Supreme Court Ruling: Gross income is not synonymous with gross receipts; income is recognized only after recovering any capital invested in the item sold.
Example: Recovery of Capital
  • Scenario: Dr. Payne sells common stock for $15,000, originally purchased for $12,000.
    • Gross Receipts: $15,000 comprises:
    • $12,000 recovery of capital.
    • $3,000 gross income.
Economic and Accounting Concepts of Income
  • Economics Measurement: Income measured as:
    • The sum of the value of goods and services consumed.
    • Change in the value of net assets from the beginning to the end of a period.
  • Realization Principle: Taxability follows the realization principle; income is only recognized (and thereby taxable) when realized, not simply appreciated.
Financial Accounting Income vs. Taxable Income
  • Financial Accounting Income: Strays from the realization principle; recognizes increased value of marketable securities as income.
  • Taxable Income: Aims to capture a taxpayer’s ability to pay tax based on:
    • Form of receipt (income recognized whether in cash or “in-kind” equivalents).
    • Value of “In-Kind” Income: Equal to Fair Market Value (FMV) of property or services provided.
Knowledge Check: Peter's Gross Income Calculation
  • Scenario: Peter purchased common stock for $20,000 and sold for $25,000.
  • Options:
    • $25,000
    • $20,000
    • $5,000
    • $15,000
  • Answer: $5,000 (under the Recovery of Capital doctrine, the gross income equals $25,000 - $20,000 = $5,000).
Capital Gains
  • Definition: Income from stocks, bonds, etc. involves risk.
  • Types of Income:
    • Active Income: Earned income that requires presence; e.g. salary (trading hours for money).
    • Passive Income: Cash flow income where money works for you; e.g. royalties, rent.
IRC § 243 - Corporate Dividends Received
  • Deduction Percentage:
    1. 50% deduction for general dividends.
    2. 100% deduction for dividends from small business investment companies.
    3. 100% for qualifying dividends defined in subsection (b)(1).
Taxable Year
  • Definition: Annual accounting period is generally 12 months.
  • Individual Taxpayers: Typically use the calendar year.
  • Fiscal Year Option: Can elect a fiscal year ending on the last day of a month other than December (e.g., July 1 – June 30).
IRC § 441 – Period for Computation of Taxable Income
  • Rules:
    • Taxable income computed based on taxpayer’s taxable year.
    • Taxable year definitions:
    1. Taxpayer’s annual accounting period (calendar or fiscal).
    2. Calendar year if subsection (g) applies.
    3. Short period return for less than 12 months.
    4. Special cases for DISC filings.
Accounting Methods
  • Primary Methods:
    1. Cash Receipts and Disbursements Method: Recognizes income when actually or constructively received.
    2. Accrual Method: Recognizes income when earned.
  • Other Methods: Include hybrid methods, special accounting methods (e.g., installment method).
IRC § 446 – General Rule for Accounting Methods
  • General Rule: Taxable income computed under the method regularly used by taxpayer.
  • Exceptions: If no method is used or does not clearly reflect income, other methods may be applied.
Cash Method of Accounting
  • Recognition: Income is recognized in the year it is actually received or made available (constructive receipt).
Accrual Method of Accounting
  • Recognition: Income recognized in the year it is earned regardless of actual receipt.
  • Earning Definition: All events that fix taxpayer’s right to receive income and amount can be determined.
  • Taxpayer Exception: Small Business Taxpayers with gross receipts of $26 million or less over three prior tax years may have exceptions.
  • Income Subject to Refund: Reported in the year of sale; deductions allowed when claims accrue.
Claim of Right Doctrine
  • Definition: Income received before a dispute is settled must be recognized.
  • Reason: Taxpayer must have funds to pay tax, so government should collect tax once income is received.
Claim of Right Doctrine Example
  • Scenario: Dr. Payne refuses to pay a contractor until specifications are met. If payment occurs in 2025 but then is disputed, income recognized immediately upon receipt in 2025 regardless of dispute resolution in 2026.
Knowledge Check: Accounting Method with Constructive Receipt
  • Answer: Cash Method recognizes income under constructive receipt.
Income Sources
  • Personal Services: Taxable to the person performing the services.
  • Forms of Compensation: Wages, salaries, fees, bonuses, commissions, compensatory scholarships, etc.
  • Employee Services: Income from services performed for employer’s customers is taxable to employer while compensation is taxable to employee.
IRC § 316 – Definition of Dividend
  • General Rule: Any distribution of property to shareholders from earnings and profits accumulated after February 28, 1913, or from earnings and profits of the taxable year, computed without prior distributions.
Dividends and Double Taxation
  • Issue: Corporate earnings as dividends face double taxation.
  • Qualified Dividends Relief: Taxed at favorable rates as long-term capital gains.
  • Eligibility of Qualified Dividends: Typically, dividends from U.S.-based corporations or foreign corporations traded on U.S. markets.
Dividend Deduction for Corporations
  • Non-Eligible Dividends: Include those received by corporations, holding period requirements, and others that don’t satisfy reduced tax rates.
Knowledge Check: Identification of Dividends
  • Options: Dividends on savings accounts, cooperative patronage dividends, mutual insurance companies dividends, and corporate dividends.
  • Answer: Only corporate dividends paid to shareholders are considered dividends for tax purposes.
Income from Partnerships
  • Partnerships: Not separate taxable entities; file Form 1065.
  • Partner Reporting: Each partner reports distributive share of income and deductions.
  • Tax Implications: Partners pay tax on income as earned; distributions treated as tax-free recovery of capital (to the extent of basis).
Income from S Corporations
  • Taxation Method: Elect to be taxed similar to partnerships; shareholders pay tax on income instead of the corporation.
  • Limitations: Corporation type restrictions and maximum number of shareholders (100).
Income from Estates and Trusts
  • Tax Accountability: Beneficiaries taxed on income earned that is distributed or required to be distributed; undistrubuted income taxed to the estate or trust.
Alimony & Separate Maintenance Payments
  • Qualifying as Alimony: Must be in cash, under an agreement specifying no alimony, parties not cohabitating, and no liability after payee's death.
  • Pre-2019 Agreements:
    • Deductible by payor.
    • Included in gross income of recipient.
  • Post-2018 Agreements:
    • Not deductible by payor.
    • Not included in recipient’s gross income.
Child Support Payments
  • Definition: Payments satisfying legal obligations to support a child, non-taxable to recipient and non-deductible by payor.
  • Classification: Payments reducing post-event obligations to children (like age stipulations) classified as child support.
Property Settlements
  • Tax Effect: No gain or loss recognized upon transfer; no gross income is acknowledged, and basis carried over to transferee.
Knowledge Check: Alimony Requirements
  • Options for Requirements:
    • Non-cash payments, households together, liability after death.
  • Answer: b. Non-specification of payments not being alimony is correct.
Imputed Interest on Below-Market Loans
  • Scope: Applies to below-market loans including gift loans, compensation-related loans, and corporation-shareholder loans.
Gift Loans Exception
  • Exception: No imputed interest on total outstanding gift loans of $10,000 or less; not applicable for income-producing purchases.
  • $100,000 Rule: Imputed interest limited to borrower’s net investment income; no interest if under $1,000.
Interest-Related Loans**: Same $10,000 exception unless related to tax avoidance.
Prizes and Awards in Gross Income
  • Inclusion: FMV of prizes and awards is included in gross income unless exceptions apply:
    1. Award is for achievements in recognized fields.
    2. Recipient donates award to a qualified entity.
    3. Selection was non-participatory.
    4. No future service conditions.
Unemployment Insurance
  • Tax Status: Unemployment compensation is fully taxable.
  • 2020 Specific Exclusion: Up to $10,200 exclusion for taxes due to The American Rescue Plan Act of 2021.
Social Security Benefits
  • Taxability Factors: Based on taxpayer’s ability to pay and recovery of contributions; up to 85% taxable.
  • MAGI Determination: MAGI is calculated as AGI (excluding Social Security) + foreign earned income exclusion + tax-exempt income.
Social Security Income Thresholds
  • Thresholds: If MAGI plus 50% Social Security benefits don’t exceed $32,000 (married) or $25,000 (single), no inclusion in gross income is required.
FBAR Reporting Requirement
  • Form: FinCEN Form 114, report of foreign bank accounts.
  • Filing Criteria: Must file if aggregate foreign account balances exceed $10,000.
  • Due Dates: Filed electronically and separate from Form 1040; penalties for non-filing can reach 50% of account values.
Tax Planning Strategies Related to Gross Income
  • Objectives: Techniques to minimize included economic income, restructure transactions, defer recognition of gross income, and shift taxability to lower tax bracket taxpayers.
  • Focus: Tax planning emphasizes the timing of tax liabilities over quantum amounts owed, seeking to optimize net present value of tax liabilities.
Knowledge Check on Deferring Taxes
  • Options: Factors making tax deferral potentially unfavorable.
  • Answer: c. The tax rate for the shifted year may be higher.
Closing Notes
  • Upcoming Tasks:
    • Chapter 3 homework due tonight (1/20) by 11:55 pm.
    • Reading Chapter 5 for Thursday’s class.
    • Chapter 4 homework due Thursday (1/22) by 11:55 pm.
    • Review for midterm exam on 1/27; Midterm exam on 1/29.