Learning Center
Plans & pricing Sign in
Sign Out



									                         Gross Income: Concepts + Inclusions

Sec.61 defines GI as all income from whatever source defined (unless specifically
economic income = change in net worth from beg to end of year
accounting income = income recognized when realized (realization principle)
Tax  GAAP e.g., prepaid rent, bad debts
GAAP tries to report income conservatively with understatement better than
Tax has no estimates
 see Thor Power Tool Co. (1979)
GI = income realized in money, property or service

Recovery of capital doctrine  no income is subject to tax until the taxpayer has
recovered the capital invested
e.g., sale price of stock – cost basis = net income
e.g., annuities + installment sales

Tax Planning Objectives  Defer Income

Tax Year

Calendar year generally required
Fiscal year can be elected if T/P maintains adequate books + records

Tax Methods:

1) Cash Method – used by most individuals
Property or services received are included in the year of actual or constructive receipt
regardless of when it was earned (e.g., A/R not recognized until cash received
note receivable is considered property + T/P must recognize FMV of N/R
checks are treated as cash even if not deposited

A) Constructive Receipt – income not actually received by T/P but available to T/P + not
subject to any limitations/restrictions
 restrictions include ESOP’s, cash surrender value of life ins. policies

B) OID – original issue discount – difference between amount due at maturity + original
amount of loan = interest
Secs.1272 + 1273 says report OID interest as it is earned regardless of cash basis
does not include U.S. savings bonds or ST (<1 yr.) oblig.

C) Series E bonds can be exchanged for series HH + interest is deferred
T/P can make election not to defer interest
-to prevent bunching of income in one year after many yrs. of deferral

D) Amounts received w/obligation to repay are not income

2) Accrual Method
-income included in the year it is earned regardless of when collected
-all events test:
     a) all events have occurred that fix the right to receive income and
     b) the amount to be received can determined with reasonable accuracy

-rights to income accrue when title to property passes
-IF there is a potential refund claim (e.g., warranty) then deduction when claims accrue
-IF rights to income are untested (e.g., lawsuit)
pymt not received  no income until settlement
pymt not received  recognize income under Claim of Right Doctrine

a.) Prepaid income is income unless:
       1) Advance pymt for goods deferred IF accounting is the same for TAX + GAAP
       2) Rev. Proc. 71-21 allows deferral for advance payments for services to be
performed by the end of the tax year following the year of receipt

Income Sources

1) Personal services –
              Income earned by person providing service
assignment of income doesn’t shift tax liab.

2) Income from Property
-included in GI of owner of property
-for transfers of property in between income payment dates:
a.) interest – accrues daily so use a days allocation
gift  include acc’d int inc. when normal
sale include acc’d int. inc. in sales proceeds

b.) dividends – accrues at date of decl. when recorded thus person owning stock on date
of decl. has div. Income
who is the S/H on record date?
Saleafter decl. but before record date div. Taxed to purchaser unless it’s a gift

3) Income Received by Agent
recognize when received by agent
4) Income from Pships, S Corps, trusts, estates
-report income in yr. earned even if not distrib.
-generally report income required to be disbrib. to beneficiary – remainder taxed to estate
or trust

5) Income in Community Property States
Married filing separate issues
-all property is deemed community property unless it was acquired before marriage
-each spouse taxed on ½ community property income
-rules different state to state
         TX, LA, WI, IO  all items split ½
         All other states spouses may split separate property
-in all comm. prop. states personal service income is split ½

Items Specifically Included in GI

Payments for property settlement – not taxable

1) Alimony + Separate Maintenance Payments
-paymts reported in income if received + as deduction for AGI if paid
post 1984 agreements – paymts. classified as alimony if:
                     a.) payments are in cash
                     b.) not specified that pymts are not alimony
                     c.) don’t live together at time of pymt
                     d.) no liab to make pymt after death

-to prevent property settlements being disguised as alimony (post 1986)
For pymts > $15,000 in 1st or 2nd yr. then alimony recapture may result

from yr. 2
R = D + ERecapture from yr. 1                D = B – (C+$15000)
                                             
Amount recaptured in yr. 3                   Recap yr.2

E = A – (B-D+C/2 + $15000)
Recapture yr. 1

A, B, C = pymts in first (A), second (B), and third (C) yrs. of agreement
IF alimony paymts. decrease by $15,000 between first + third years
 exception: death of spouse or remarriage

Child Support  not incl. in income + not deducted
sometimes hard to tell if child support or alimony
look for amt. that ceases when child turns 18

2) Imputed Interest on Below Market Loans > 1989
use int. rate Fed. gov’t pays on new borrowings + compound semiannually – published

Rates are different if loan:
       ST (< 3 yrs.)
       MT (> 3 yrs. + < 9 yrs.)
       LT (> 9 yrs.)

-Interest imputed if 0% rate or if below IRS rate for:
    1) gift loans
    2) compensation related loans
    3) corp  SH loans

Example – Gift loans

1) Father loaned Sam $100,000 no interest
Current AFR 8%
100,000 x 8% = 8,000

Step 1
Father Interest Income        8,000
Son Interest Expense          8,000 (may be deductible)

Step 2
Father Gifts Sam  8,000
Sam Gift from Father 8,000

Loan is $50,000     Sam’s NII = 3,200
                     Father’s NII=10,500
       50,000 x 4,000

Step 1
Father Interest Income        3,200
Sam Interest Expense          3,200
Step 2
Father Gifts Sam  3,200
Sam Gift from Father 3,200

Loan is 9,000 used to buy a car
No interest to be imputed

Example – Compensation Loans

1) Employer corporation loans Sam 100,000 – no interest
AFR 8%
100,000 x 8% = 8,000

Employer corporation Interest Income        8,000
Sam                  Interest Expense       8,000

Employer corporation Comp. Exp.     8,000
Sam                  Comp. Inc.     8,000

Employee – Corp – S/H Loan

2) Corp. loan S/H Sam 100,000 – no interest
AFR 8%
100,000 x 8%

Corp. Inter. Income 8,000
Sam Inter. Expense 8,000

Corp. Dividend Distribution 8,000
Sam Dividend Inc. 8,000


Gift loan (SH loan + comp. loan)  interest imputed when > $10,000 unless gift is for
income prod. prop.
For loans <$100,000 between individuals imputed interest cannot exceed borrower’s
net investment income
-see summary 4-3 on page 4-27

3) Income from Annuities
Annuity  pay a fixed amount for right to receive future stream of payments
 most commonly used by insurance companies
 payments invested + increase cash value but not yet income to taxpayer b/c income
not constructively received b/c generally T/P must cancel policy to get $
Problem What is income + what is recovery capital

a.) Collections before annuity starting date
collections < 8/13/82 increase in cash value are income
collections> 8/13/82 increases in cash surrender value are treated as capital recovery
first and then income
10% penalty on early distrib. for T/P who is <59 ½ or not disabled

b.) Collections on and after annuity starting date

Exclusion amt. (recovery of capital)= Investment x annuity pymt.
                                    Expected return
                             Annual amt to be paid to annuitant x # yrs. payment will be
                             received which could be a certain # yrs. or for life

Multiples for life expectancy found in actuarial tables published by IRS (see p. 4-29)
Exclusion ratio applies until investment recovered then all pymts are taxable

c.) Simplified method – use Table 4-2 p. 4-30 for annuity pymts under qual. retirement

return of capital = investment in contract
                    # payments expected

4.) Prizes and Awards
FMV = income (exclude scholarships)
e.g., TV giveaway prizes, mag. publisher prizes, door prizes, employee service awards
Exception: prize/award not taxable IF
    a.) received in recognition of religious, char., scientific, educ., artistic, literary or
        civic achievement (e.g., Nobel or Pulitzer Prize)
    b.) prize/award is transferred to qualified gov’t unit or nonprofit org.
    c.) recipient did not enter him/herself
    d.) no future service required

Exception: Employee achievement award in tangible personal property up to $400 (i.e.,
gold watch)

5) Group Term Life Insurance
-premiums paid on the first $50,000 group term life insurance are excludable IF paid by
-for each $1,000 of coverage > $50,000 employee must include amounts from Table 4-3
(p. 4-33) in income
-IF plan discriminates in favor of key employees then those employees get no exclusion

6) Unemployment Comp.
Included in gross income

7) Social Security benefits
-up to 85% of SS benefits are taxable IF GI> base
IF MAGI + ½ SS benefits >
        1) $32,000 for MFJ                  2) $44,000 for MFJ
           $0 for MFS (+ live together)         $0 for MFS (+ live together)
           $25,000 for all others                $34,000 for all others

then taxable amount is:
        (1) lesser of:
        a.) ½ SS benefits or
        b.) ½ (MAGI + ½ SS benefits – first base amt.)

       (2) lesser of:
       a.) 85% SS benefits or
       sum lesser of
               1) amt included in (1)
               2) or $4500 (6,000 MFJ)
       of 85% [MAGI + ½ SS benefits – second base amt.]

To top