Wadsworth by renata.vivien1

VIEWS: 0 PAGES: 44

									  Chapter 3


Income Sources


  Kevin Murphy
  Kevin Murphy
  Mark Higgins
  Mark Higgins
    ©2007 South-Western
    ©2007 South-Western
                       What is Income?

  v All-inclusive Income Concept
       F Defined by exception: “Except as
         otherwise provided…” § 61


  v Judicial findings
       F Income is the gain derived from labor and
         capital
       F Any increase in wealth that has been
         realized is income

© 2007 South-Western
© 2007 South-Western                        Transparency 3-2
                                            Transparency 3-2
                       What is Income?

  v Current View
       F A change in the form and/or substance of
         the taxpayer’s property, and
       F The involvement of a second party in the
         income process




© 2007 South-Western
© 2007 South-Western                       Transparency 3-3
                                           Transparency 3-3
                       Types of Income

  v   Earned
  v   Unearned
  v   Transfer
  v   Imputed
  v   Capital Gains and Losses




© 2007 South-Western
© 2007 South-Western                     Transparency 3-4
                                         Transparency 3-4
  Earned Income: Definition

     Compensation received for the
     provision of labor is earned income.
  v Two problems may arise when
    determining taxability of earned income
       F Cash-equivalent approach
       F Assignment of income




© 2007 South-Western
© 2007 South-Western                   Transparency 3-5
                                       Transparency 3-5
  Unearned Income: Definition

    The earnings from investments and
    gains from the sale, exchange or
    disposition of investment assets is
    unearned income.
  v Examples of unearned income are:
       F Interest and Dividend Income
       F Rental and Royalty Income
       F Annuities

© 2007 South-Western
© 2007 South-Western                    Transparency 3-6
                                        Transparency 3-6
  Unearned Income: Annuities

  v An annuity is a series of equal
    payments received at set time intervals
    for a determinable period
  v Capital Recovery Concept excludes the
    amount of original investment from
    taxable income
       F Must be spread over the time of receipt



© 2007 South-Western
© 2007 South-Western                        Transparency 3-7
                                            Transparency 3-7
                       Annuity Exclusions

  v If the payment term and amount are
    fixed:

      Exclusion Ratio =        Cost of the contract
                               Total expected return




© 2007 South-Western
© 2007 South-Western                           Transparency 3-8
                                               Transparency 3-8
                       Annuity Exclusions

  v If the payment term depends on the life
    of the taxpayer
       F Must estimate the number of payments
       F Use the “simplified method”




© 2007 South-Western
© 2007 South-Western                        Transparency 3-9
                                            Transparency 3-9
                       Annuity Exclusions
                       Simplified Method

  v Annuity payments beginning after
    November 18, 1996
       F use Tables 3-1 or 3-2 to determine number
         of payments

           Excluded portion =   Contract Cost
                             Number of payments




© 2007 South-Western
© 2007 South-Western                        Transparency 3-10
                                            Transparency 3-10
                        Annuity Example


 George, age 64, purchased an annuity for $30,000. He
 begins receiving $300 per month in January. What
 amount is included in his gross income?


 From Table 3-1, the number of payments to use is 260.
            $30,000 / 260 = $115 monthly exclusion
            $115 X 12 = $1,380 excluded per year
            $300 X 12 = $3,600 amount received
                       $3,600 - $1,380 exclusion = $2,220 gross income



© 2007 South-Western
© 2007 South-Western                                        Transparency 3-11
                                                            Transparency 3-11
Unearned Income: Gains and Losses
Unearned Income: Gains and Losses

Gains or losses may occur upon disposal
of investment property.

                 Proceeds from sale or disposition
           less: Selling expenses
                 Amount realized from disposition
           less: Adjusted basis of property
                 Gain or loss from disposition



© 2007 South-Western
© 2007 South-Western                        Transparency 3-12
                                            Transparency 3-12
  Unearned Income:
  Income from Conduit Entities

  v Income from a conduit entity is reported
    by the owners and taxed on the owners’
    returns
  v Distributions from conduit entities to the
    owners are treated as a recovery of
    capital




© 2007 South-Western
© 2007 South-Western                  Transparency 3-13
                                      Transparency 3-13
  Transfer Income: Definition

      Some amounts of income are neither
      fully earned nor fully unearned.
       F Prizes and Awards
       F Unemployment Compensation
       F Social Security Benefits
       F Alimony Received




© 2007 South-Western
© 2007 South-Western                 Transparency 3-14
                                     Transparency 3-14
  Transfer Income: Prizes and Awards

      Amounts received as prizes and awards
      are generally taxable.
       F Exceptions exist for:
             VScientific and literary achievements
                  è must be given by recipient to a qualified charity or
                    government unit
             VEmployee achievements
                  è must be given to employee for length of service or
                    safety
                  è amount is limited to $400 per employee (or $1,600 if
                    qualified plan)


© 2007 South-Western
© 2007 South-Western                                           Transparency 3-15
                                                               Transparency 3-15
  Transfer Income:
  Unemployment Compensation

      Amounts received from unemployment
      compensation plans are considered
      substitutes for earned income and are
      always taxable.




© 2007 South-Western
© 2007 South-Western                 Transparency 3-16
                                     Transparency 3-16
  Transfer Income:
  Social Security Benefits

      A portion of Social Security benefits
      received may be taxable if modified AGI
      exceeds certain limits.

                 Adjusted gross income
           plus: 1/2 social security benefits
           plus: tax exempt income
           plus: foreign earned income exclusions
                 Modified AGI

© 2007 South-Western
© 2007 South-Western                       Transparency 3-17
                                           Transparency 3-17
                  Modified AGI Example

A single taxpayer received $3,000 from Social
Security payments. Her AGI without the SS is
$30,000.


Modified AGI = $30,000 + $1,500
                       = $31,500




© 2007 South-Western
© 2007 South-Western                    Transparency 3-18
                                        Transparency 3-18
  Transfer Income:
  Social Security Benefits - Tier One

  v Unmarried individuals with modified AGI
    between $25,000 and $34,000, and
  v MFJ individuals with modified AGI
    between $32,000 and $44,000




© 2007 South-Western
© 2007 South-Western               Transparency 3-19
                                   Transparency 3-19
  Tier One Calculation

  The taxable portion of Social Security is equal to
  the lesser of:

             1. 1/2 Social Security received,
  OR         2. 1/2 of the amount by which
                modified AGI exceeds the base amount.

  where the base amounts are $25,000 for unmarried
  individuals, $32,000 for MFJ, and $0 for others




© 2007 South-Western
© 2007 South-Western                         Transparency 3-20
                                             Transparency 3-20
                       Example continued

With modified AGI = $31,500, the taxable portion of
her $3,000 Social Security income is the lesser of:
           1.          $1,500, or
           2.          1/2 ($31,500 - $25,000) = $3,250


Therefore, taxable SS is $1,500




© 2007 South-Western
© 2007 South-Western                              Transparency 3-21
                                                  Transparency 3-21
  Transfer Income:
  Transfer Income:
  Social Security Benefits - Tier Two
  Social Security Benefits - Tier Two

  • For individuals whose income exceeds
      Tier One amounts . . .




© 2007 South-Western
© 2007 South-Western              Transparency 3-22
                                  Transparency 3-22
  Tier Two Calculation
The taxable portion of Social Security is equal to the lesser
of:
      1. 85% of Social Security received,
OR    2. 85% of the amount by which
         modified AGI exceeds the base amount*,
         PLUS the smaller of
             a. the amount of SS benefits included under
                 the 50% formula, or
             b. $4,500 for unmarried individuals ($6,000 for
                 MFJ)

*Where the base amounts are $34,000 for unmarried
individuals, $44,000 for MFJ, and $0 for others

© 2004 South-Western College Publishing
© 2004 South-Western College Publishing
                         Example for Tier Two

If our taxpayer receives Social Security of $12,000
and has AGI of $50,000 before SS:
Modified AGI = $50,000 + $6,000* = $56,000
Taxable SS is $10,200, which is the smaller of:
1. .85( $12,000) = $10,200, or
2. [.85 ($56,000 - $34,000)] + [(1/2 of $12,000 SS) or $4,500]
    = $18,700 + $4,500
    = $23,200.

  © 2007 South-Western
  © 2007 South-Western                              Transparency 3-24
                                                    Transparency 3-24
  Transfer Income: Alimony Received

 Amounts received for alimony payments are
 taxable income if:
   F the payments are made in cash
   F there is a written agreement
   F the payments are not disguised child support
   F the payments cannot be made to payee’s estate
   F the payer and payee do not live in the same
     household


© 2007 South-Western
© 2007 South-Western                   Transparency 3-25
                                       Transparency 3-25
  Imputed Income:
  Personal Consumption

  v The value of the goods and services
    produced by individuals for personal
    consumption generally are not taxable
     FRealization concept
     FAdministrative Convenience concept




© 2007 South-Western
© 2007 South-Western               Transparency 3-26
                                   Transparency 3-26
  Imputed Income:
  Below Market-Rate Loans

  v Interest income and expense are
    imputed on below market-rate loans.
       F The relationship between the lender and
         the borrower determines the tax treatment
             VThe lender has imputed interest income
             VThe borrower has imputed interest expense
       F Administrative Convenience grants
         exceptions for
             Vloans of $10,000 or less
             Vgift loans of $100,000 or less

© 2007 South-Western
© 2007 South-Western                             Transparency 3-27
                                                 Transparency 3-27
  Imputed Income:
  Payment of Expense by Others

    A taxpayer whose expenses are paid by
    another has realized an increase in
    wealth.

  v Payments made by family members
    may be considered nontaxable gifts
  v Payments made by employers are
    taxable income


© 2007 South-Western
© 2007 South-Western               Transparency 3-28
                                   Transparency 3-28
  Imputed Income: Bargain Purchases

      When a bargain purchase price does
      not result from an arms-length
      transaction, the bargain amount is
      taxable income.




© 2007 South-Western
© 2007 South-Western                Transparency 3-29
                                    Transparency 3-29
  Capital Gains and Losses:
  Introduction
     A capital asset is any asset other than
     inventory, receivables, and depreciable
     or real property used in a trade or
     business.

  v A sale or other disposition of capital assets
    results in a capital gain or loss
  v Capital gains and losses receive special tax
    treatment


© 2007 South-Western
© 2007 South-Western                      Transparency 3-30
                                          Transparency 3-30
               Capital Gains and Losses:
                    Holding Period

  v The holding period for capital assets is
    how long the taxpayer owned the asset.
       F Short Term = held for < 12 months
       F Long Term = held for > 12 months
  v Determining holding period is the first
    step in determining tax treatment.




© 2007 South-Western
© 2007 South-Western                         Transparency 3-31
                                             Transparency 3-31
  Capital Gains and Losses:
  Netting Procedures

   Long-term gains
                            Net Long-term
     netted against     =   Gain or Loss
   Long-term losses




    Short-term gains
                            Net Short-term
      netted against    =   Gain or Loss
    Short-term losses



© 2007 South-Western
© 2007 South-Western                Transparency 3-32
                                    Transparency 3-32
  Capital Gains and Losses:
  Netting Procedures

If one is a loss and one is a gain, then:


 Net Short-term Gain or Loss
                                                Net Capital
       netted against                       =   Gain or Loss
 Net Long-term Gain or Loss




If both are losses or both are gains, no further netting is
done.


© 2007 South-Western
© 2007 South-Western                              Transparency 3-33
                                                  Transparency 3-33
Tax Treatment for Net Gains

  v Net short-term capital gain is taxed as
    ordinary income
  v Adjusted net long-term capital gain is
    taxed at a maximum 15%
       F Adjusted NLTG = NLTG - [28% rate gain -
         Unrecaptured §1250 gain + Eligible
         dividends]
       F 28% rate gain = [Net collectibles gain +
         Small business stock gain - STCL - LTCL
         carryover]
© 2007 South-Western
© 2007 South-Western                      Transparency 3-34
                                          Transparency 3-34
  Tax Treatment for Net Gains

  v Net Collectibles gain and Small
    Business Stock gain is taxed at a
    maximum 28%
  v Unrecaptured §1250 gain is taxed at a
    maximum 25%




© 2007 South-Western
© 2007 South-Western               Transparency 3-35
                                   Transparency 3-35
  Capital Gains and Losses:
  Holding Period & Maximum Rate




© 2007 South-Western
© 2007 South-Western       Transparency 3-36
                           Transparency 3-36
  Tax Treatment for Net Losses by
  Individuals

  v Only $3,000 of net capital losses may
    be deducted in one year
       F Use short-term losses first
       F Carryover net loss > $3,000
  v Capital gains and losses of conduit
    entities flow-through to owners’ returns




© 2007 South-Western
© 2007 South-Western                   Transparency 3-37
                                       Transparency 3-37
              When is Income Reported?

      The Accounting Method chosen by a
      taxpayer dictates when income is
      reported.
       F Cash Method taxpayers report income
         when cash is actually or constructively
         received
       F Accrual Method taxpayers report income
         when it is earned
       F Hybrid Method taxpayers mix accrual and
         cash methods

© 2007 South-Western
© 2007 South-Western                     Transparency 3-38
                                         Transparency 3-38
                       Accounting Method
                             Cash

      Cash method taxpayers must follow the
      Constructive Receipt Concept.
       F Exceptions to the cash method:
             VTaxpayers who sell inventory may not use the
              cash method for inventory
             VTaxpayers must use the accrual and the
              effective interest method with Original Issue
              Discount securities
             VTaxpayers who hold Series EE Bonds may
              elect to use the accrual method
© 2007 South-Western
© 2007 South-Western                                Transparency 3-39
                                                    Transparency 3-39
                       Accounting Method
                            Accrual

    Under tax law, income is accrued when
  v All events have occurred that fix the
    right to receive the income, and
  v The amount of income earned can be
    determined




© 2007 South-Western
© 2007 South-Western                       Transparency 3-40
                                           Transparency 3-40
                        Accounting Method
                        Accrual Exceptions
v Exceptions to the accrual method:
    F The Wherewithal-to-Pay concept requires
      income be reported in the year pre-payment is
      received for rents, insurance, interest and
      royalties
    F One year deferral is allowed for some pre-
      payments
         VReport amount = Financial Accounting in first year
         VRemainder of amount in full in second year
    F Pre-payments for goods may be accrued if the
      payment is less than the Cost of Goods Sold.
 © 2007 South-Western
 © 2007 South-Western                             Transparency 3-41
                                                  Transparency 3-41
                       Accounting Method
                            Hybrid

      Taxpayers may mix the cash and
      accrual methods, using accrual for
      sales of inventories and cash for other
      revenues and expenses.




© 2007 South-Western
© 2007 South-Western                       Transparency 3-42
                                           Transparency 3-42
                 Accounting Method
              Exceptions to All Methods

      Installment Sales Method: Any time one
      payment is received after the year of sale,
      taxpayers must recognize income
      proportionately as the selling price is received
      unless they elect to report in the year of sale.
      Long-term Construction Contracts: The
      percentage-of-completion method must be
      used for all long-term construction.



© 2007 South-Western
© 2007 South-Western                         Transparency 3-43
                                             Transparency 3-43
                       End of Chapter 3




© 2007 South-Western
© 2007 South-Western                      Transparency 3-44
                                          Transparency 3-44

								
To top