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Gross Income Defined
All income from whaterver source derived, unless specifically excluded.
Computation of Income - General Rule
Income is dertermined by the amount of cash, property (FMV), or services obtained. In cases of noncash income, the amount of the income is the fair market value of the property or services received.
Realization requires the accrual or receipt of cash, property, or services, or a change in the form or the nature of the investment (a sale or exchange).
Recognition means that the realized gain must be included on the tax return (i.e. there is no provision that permits exclusion or deferral under the Internal Revenue Code).
Revenue is taxable when earned.
Recognition occurs in the period the reenue is actually or constructively received in cash or (FMV) property.
Characteristics of Income
- 1. Oridinary
- 2. Portfolio
- 3. Passive
- 4. Capital
Ordinary Income Defined (12)
- State and local tax refunds
- IRA and pension income
- Self-employment income
- Unemployment compensation
- Social security
- Taxable portion of scholarships and fellowships
- Gambling income
- And anything not falling into one of the other three baskets.
Portfolio Income Defined
Income a taxpayer would earn on his portfolio of assets, such as interest and dividends.
Passive Income (Rental Activity) Defined
- An activity in which a taxpayer did no actively particpate.
- Only passive losses may offset passive income.
- A net passive loss is not deductible on the tax return (it is suspended and carried forward until passive income exists to offset it.
Passive Income: Rental Income and Royalties
Rental income received on a property that a taxpayer owns and rents (as opposed to capital gain or loss that may exist when the property is sold) is gernerally deemed "passive," unless exceptions exist.
Passive Income: Beneficiaries of Trusts and investments in Partnerships, LLCs, and S Corporations
- Individuals (and companies) with investments in S Corporations, partnerships, LLCs, and beneficiary interest in trusts and estates will receive a Form K-1 from the entity each year.
- The K-1 is the investor's share of the earnings and deductions of each company.
- Schedule K combines the K-1s
- If an investment in a company is deemed limited (as opposed to general) for the investor, the income from the business activities will be deemed passive for tax purposes, and the passibe activity loss rule will apply.
Salaries and Wages: Money, Property, Cancellation of Debt, and Bargain Purchases.
- Included in Gross Income:
- All money received, credited or available.
- The FMV of all proprerty.
- All Debts cancelled.
- If an employer sells property to the employee for less than its FMV, the difference is income to the employee.
Salaries and Wages: Guaranteed Payments to a Partner
Included in gross income: guaranteed payments are reasonable compensation paid to a partner for services rendered (or use of capital) without regard to the partner's ratio of income. This earned compensation is also subject to self-employment tax.
Salaries and Wages: Taxable Fringe Benefits (incl. example)
The FMV of a fringe benefit not specifically excluded by law is includable in income.
Ex. employee's personal use of a company car is included as wages in an employee's income. This is subject to employment taxes and withholding.
Salaries and Wages: Partially Taxable Fringe Benefits - Portion of Life Insurance Premiums
- First $50,000 of employer paid premiums are not income.
- Anything above is taxable income to the recipient.
Non-taxable Fringe Benefits: Life Insurance Proceeds
- The proceeds of a life insurance plicy paid because of the death of the insured are gexcluded from the gross income.
- Accelerated death beneftis (insured receives money early for long-term care) are excluded from gross income.
- The interest income element on deferred payout arrangements is taxable.
Non-taxable Fringe Benefits: Accident, Medical, and Health Insurance (employer paid)
- Premium payments are excludable from the employee's income when the employer paid the insurance premiums, bu amounts paid to the employee under the policay are includable in income unless:
- Reimbursement for medical expenses actually incurred by the employee
- Compensation for the permanent loss or loss of use of a member or function of the body.
Non-taxable Fringe Benefits: De Minimis Fringe Benefits (incl. example)
De Minimis fringe benefits are so minimal that they are impractical to account for and may be excluded from income.
ex. employee's personal use of a company computer
Non-taxable Fringe Benefits: Meals and Lodging
The gross income of an employee does not include the value of meals or lodging funished to him in kind by the employer for the convenience of the employer on the employer's premises. In order to be nontaxable, the lodging must be required as a condition of employment.
Non-taxable Fringe Benefits: Employer Payment of Employee Educational Expenses
Up to $5,250 may be excluded from gross income of payments made by employer on behalf of an employee's educational expenses.
Non-taxable Fringe Benefits: Qualified Tutition Reductions
Employees of educational institutions studying at the undergraduate level who receive tuition reductions may exclude the tuition from income.
Graduate students may exclude tution reduction only if the are engaged in teaching or research activities and only if the tution reduction is in addition to the pay for the teaching or research.
Tuition reductions must be offered on a nondiscriminatory basis.
Non-taxable Fringe Benefits: Qualified Employee Discounts
Employee discounts on employer-provided merchandise and service are excludable as follows:
- Merchandise discounts: the excludable discount is limited to the employer's gross profit percentage.
- Service discounts: The excludable discount is limited to 20% of the FMV of the services
- Employer-provided parking: The value of employer -provided parking up to $230 (2010) per month may be excluded.
- Transit passes: The value of employer-provided transit passes up to $230 (2010) per month may be excluded.
Non-taxable Fringe Benefits: Qualified Pension, Profit-sharing, and Stock Bonus Plans
- Payments made by employer (non-taxable): payments made by an employer to a qualified pension, profit-sharing, or stock bonus plan are not income to the employee at the time of contribution. (Trust Account -- 401k)
- Benefits Received (taxable): The amount that is exempt from tax (plust income earned on such amount) is taxable to the employee in the year in which the amount is distributed or made available.
Non-taxable Fringe Benefits: Flexible Spending Arrangement Stems (FSAS)
This is a plan that allows employees to receive a pre-tax reimbursement of cerain (specified) incurred expenses.
- 1. Flexible spending accounts (up to $5,000/yr). These payments must be made via salary reduction, employee is not taxed on that income.
- 2. Funds not used within 2.5 months after year-end are forfeited.
Non-taxable Fringe Benefits: Economic Recovery Payments
For 2010, economic recovery payments ($250 person) are not taxable.
Taxable Interest Income - General Rule & 6 Examples
General Rule: All interest is taxable unless specifically excluded.
- 1. Federal bonds
- 2. Industrial bonds
- 3. Corporate bonds
- 4. Premiums received for opening a savings account (e.g., prizes and awards) are included at FMV.
- 5. Part of the proceeds from an isntallment sale is taxable as interest
- 6. Interest paid by federal or state goverment for late payment of tax refund is taxable.
Taxable Exempt Interest Income (reportable but not taxable) (4)
- 1. State and Local Government Bonds/Obligations
- 2. Bonds of a U.S. Possession
- 3. Series EE Bonds
- 4. Veterans Administration Insurance
State and Local Government Bonds/Obligations
- Interest on state an local bonds / obligations is tax exempt.
- Mutual fund dividends for funds invested in tax-free bonds are also tax exempt.
Bonds of a U.S. Possession
Interest on the obligation of a possession of the United States is tax exempt.
Series EE Bonds (U.S. Savings Bond)
EE = Educational Exepenses
- Interest on Series EE Savings Bonds is tax exempt when:
- 1. It is used to pay for higher education, reduced by tax-free scholarships, of the taxpayer, spouse, or dependents;
- 2. There is taxpayer or joint owendership (spouse);
- 3. Taxpayer is over age 24 when issued; and
- 4. The bonds are acquired after 1989
* Phae-out starts when modified AGI exceeds an indexed amount.
Veterans Administration Insurance
Interest on Veterans Administration Insurance is tax exempt.
Unearned Income of a Child Under 18 ("kiddie tax")
The net unearned income of a dependent child under 18 years of age (or, a child over age 18 to under age 24 who does not provide over half of his/her own support and is a full-time student) is taxed at the parent's higher tax rate.
Forfeited Interest (Adjustment) - Penalty on Withdrawal from Savings
- Forfeited interest is a penalty for early withdrawal of savings (generally on a time deposit, such as a CD).
- Bank credits the interest to the account and the removes certain interest as a penalty for withdrawing the funds before maturity.
- Interest = taxable
- Forfeited = deductible as an adjustment in the year the penalty is incurred.
Source Determines Taxability (4)
- E&P/Current = distribute by current year end : E&P is current = dividend
- E&P/accumulated = distribution date : accum. E&P by distribution date = dividend
- No E&P = Return of capital
- Capital gain distributions = No E&P/no basis : if you've got all your capital back, then its called a capital gain distribution.
All Dividends that represent distributions of a corporation's earnings and profits are includible in gross income.
Taxable Dividends: Taxable Amount: Cash vs. Property
- Cash = Amount Received
- Property = Fair Market Value
Taxable Dividends: Special (Lower) Tax Rate
The stock must be held for more than 60 days during the 120-day period that begins 60 days before the ex-dividend date (the date on which a purchased share no longer is entitled to any recently declared dividends).
Tax Free Distributions (4)
- 1. Return of Capital
- 2. Stock Split
- 3. Stock Dividend (unless cash or other property option/taxable FMV)
- 4. Life Insurance Dividend
Tax Free Distributions: Return of Capital
- When a company distributes funds but has no earnings
- and profits. The taxpayer will simply reduce (but not below zero) his/her basis in common stock held.
Tax Free Distributions: Stock Dividend
Unless the shareholder has the option to receive cash or other property (taxable), the basis of the shares after distribution depends on the type of stock received.
- a. same stock - original basis is divided by total shares
- b. different stock - original basis is allocated based on the relative FMV of the different stock