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Gross Income: Exclusions

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Income earned on gifts or inheritances is taxable under normal rules ... Gifts and Inheritances ( 5 of 5) Employee death benefits may be excludible as a gift if: ... – PowerPoint PPT presentation

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Title: Gross Income: Exclusions


1
Gross Income Exclusions
  • Chapter 5

2
Exclusions Defined
  • Items of income that are specifically designated
    as not included in gross income
  • Exclusions are generally found in Sections 101
    through 150

3
Exclusions from Gross Income
  • Learned previously, unless there is a specific
    exclusion in the law for an item of income, it is
    included in Gross Income.
  • An exclusion is not a deduction. Strictly
    speaking, for the most part the amount is never
    added in.

4
Gifts and Inheritances (slide 1 of 5)
  • Gifts are nontaxable to donee if
  • Transfer is voluntary without adequate
    consideration, and
  • Made out of affection, respect, admiration,
    charity, or donative intent
  • See Com. V. Duberstein, 363 U.S. 278, 1960 U.S.
    LEXIS 2030 (1960)

5
Gifts and Inheritances (slide 2 of 5)
  • Inheritances are nontaxable to beneficiary
  • Income earned on gifts or inheritances is taxable
    under normal rules
  • Example Father gifts corporate bond to daughter.
    Gift is excluded from daughters gross income,
    but interest income earned after gift date is
    taxable to her.

6
Gifts and Inheritances (slide 3 of 5)
  • Transfers by employers to employees do not
    qualify as excludible gifts
  • May be excludible under other provisions, e.g.,
    employee achievement awards
  • Victims of a qualified disaster who are
    reimbursed by their employers for living
    expenses, funeral expenses, and property damage
    can exclude the payments from gross income

7
Gifts and Inheritances (slide 4 of 5)
  • Employee death benefits amount paid by employer
    to deceased employees spouse, child, or others
  • If decedent had a nonforfeitable right to
    payments (e.g., accrued salary), amounts are
    taxable to employee

8
Gifts and Inheritances (slide 5 of 5)
  • Employee death benefits may be excludible as a
    gift if
  • Paid to surviving spouse or children (not
    employees estate),
  • Employer derived no benefit from payments,
  • Surviving spouse and children performed no
    services for employer,
  • Decedent had been fully compensated for services
    rendered, and
  • Payments made pursuant to board of directors
    resolution under a general company policy

9
Life Insurance Proceeds (slide 1 of 5)
  • Exempt income to beneficiary if paid solely due
    to death of insured
  • Relationship to decedent not determinative

10
Life Insurance Proceeds (slide 2 of 5)
  • If owner of life insurance policy cancels the
    policy and receives the cash surrender value
  • Gain must be recognized to extent amount received
    exceeds premiums paid on policy
  • Loss is not recognized

11
Life Insurance Proceeds (slide 3 of 5)
  • Accelerated death benefits
  • Gain on cash surrender or transfer of life
    insurance policy by terminally or chronically ill
    individual is excludible
  • Exclusion for chronically ill is limited to
    amounts used for long-term care

12
Life Insurance Proceeds (slide 4 of 5)
  • Transfers for valuable consideration
  • If policy is transferred for valuable
    consideration, proceeds are taxable to extent
    they exceed amount paid for policy plus
    subsequent premiums paid
  • Exceptions exist for policy transfers
  • To facilitate funding of buy-sell agreements,
  • Pursuant to a tax-free exchange, and
  • For receipt of a policy by gift

13
Life Insurance Proceeds (slide 5 of 5)
  • Investment earnings arising from the reinvestment
    of life insurance proceeds are generally subject
    to income tax
  • The beneficiary may elect to collect the
    insurance proceeds in installments
  • The annuity rules are used to apportion the
    installment payment between the principal element
    (excludible) and the interest element (includible)

14
Scholarships and Fellowships(slide 1 of 2)
  • An amount paid to or for the benefit of a student
    to aid in pursuing a degree at an educational
    institution
  • Nontaxable to extent of tuition and related
    expenses (e.g., fees, books, supplies, and
    equipment required for courses)
  • Amounts received for room and board are taxable

15
Scholarships and Fellowships(slide 2 of 2)
  • Qualified tuition waivers or reductions by
    nonprofit educational institutions are excluded
    from income
  • Generally limited to undergraduate tuition
    waivers
  • Exception for graduate teaching or research
    assistants

16
Qualified Tuition Programs
  • Amounts contributed must be used to pay qualified
    higher education expenses (tuition, fees, books,
    supplies, room and board, and equipment)
  • Earnings on contributions, including discounted
    tuition for plan participants, are not taxable if
    used for qualified higher education expenses
  • Refunds from program are taxable to the extent
    they exceed contributions

17
Other Education Benefits
  • Educational assistance programs
  • Employer-provided educational assistance for
    undergraduate and graduate education is
    excludible
  • Exclusion limited to 5,250 per year
  • Courses do not have to be job related.

18
Damages (slide 1 of 3)
  • Tax consequences of receipt of damages
  • Depends on type of harm taxpayer experienced
  • The taxpayer may seek damages for
  • Loss of income
  • Expenses incurred
  • Property destroyed
  • Personal injury

19
Damages (slide 2 of 3)
  • Tax treatment of damages received for
  • Loss of income
  • Generally, taxed the same as the income replaced
  • Exceptions exist related to personal injury
  • Reimbursement for expenses incurred
  • Not income, unless the expense was deducted
  • Damages that are a recovery of the taxpayers
    previously deducted expenses are generally
    taxable under the tax benefit rule

20
Damages (slide 3 of 3)
  • Tax treatment of damages received for
  • Property damaged or destroyed
  • Treated as an amount received in a sale or
    exchange of the property
  • Thus, taxpayer has realized gain if damage
    payments exceed propertys basis
  • Personal injury
  • Receives special treatment

21
Compensation for Injuries and Sickness (slide 1
of 3)
  • Personal injury damages
  • Compensatory damages received on account of
    physical personal injury or physical illness are
    excludible
  • Includes amounts received for loss of income
    associated with the physical personal injury or
    physical sickness
  • All other personal injury damages are taxable
  • Compensatory damages for nonphysical injury
  • All punitive damages

22
Compensation for Injuries and Sickness (slide 2
of 3)
  • Workers compensation
  • Although may be payment for loss of wages,
    workers compensation is specifically excluded
    from gross income

23
Compensation for Injuries and Sickness (slide 3
of 3)
  • Accident and health insurance benefits
  • Benefits received under policy purchased by
    taxpayer are excludible
  • Even if benefits are substitute for income

24
Employer-Sponsored Accident and Health Plans
(Also called disability plans, sickness and
accident, salary continuance) (slide 1 of 3)
  • Premiums paid by employer for insurance coverage
    of employee, spouse, and dependents are not
    taxable to employee
  • Amounts received from insurance are not taxable
    when received for medical care or for permanent
    loss of body part or function
  • Amounts received are included when based on the
    work time loss

25
Employer-Sponsored Accident and Health Plans
(slide 2 of 3)
  • Payments for expenses that do not meet the Codes
    definition of medical care must be included in
    gross income
  • Amounts received for medical expenses deducted on
    a prior return must be included in gross income

26
Employer-Sponsored Accident and Health Plans
(slide 3 of 3)
  • Health Savings Accounts (high deductible
    insurance plans)
  • Employer contribution to HSA and earnings on
    funds in the account are excludible
  • Contributions limited to 100 of deductible
    amount for individual or family coverage
  • Monthly deductible amount is limited to the
    lesser of
  • One twelfth of the annual deductible under a high
    deductible plan or
  • 2,850 for self-only (5,650 for family coverage)
  • Withdrawals from HSA are excludible to the extent
    used for qualified medical expenses

27
Long-Term Care Insurance
  • Employer paid insurance premiums for employees
    long-term care are excludible
  • Exclusion of benefits received from policy is
    limited to the greater of
  • 260 in 2007 for each day patient receives
    long-term care (indexed amount for 2006 is 250)
  • The actual cost of the care
  • Reduced by any amounts received from other third
    parties (e.g., damages received)

28
Meals and Lodging
  • Not taxable to employee if
  • Furnished by employer
  • On employers business premises
  • For convenience of employer
  • In the case of lodging, employee is required to
    accept lodging as a condition of employment

29
Other Fringe Benefits (slide 1 of 2)
  • Dependent care
  • Up to 5,000 of care costs paid for by employer
    can be excluded
  • Athletic facilities
  • Value of use of athletic facilities located on
    employer premises can be excluded

30
Other Fringe Benefits (slide 2 of 2)
  • Adoption assistance programs
  • Employee adoption expenses paid or reimbursed by
    employer are excludible
  • Exclusion limited to 11,390
  • Exclusion phases-out as AGI increases from
    170,820 to 210,820

31
Cafeteria Plans
  • Allow employees to choose between cash and
    certain nontaxable benefits
  • If cash is chosen, the amount received is taxable
  • If a nontaxable benefit is chosen, the benefit
    remains nontaxable
  • Provide tremendous flexibility in tailoring the
    employee pay package to fit individual needs

32
Flexible Spending Plans
  • Allow employees to accept lower cash compensation
    in return for employer agreeing to pay certain
    costs without the employee recognizing income
  • Called a use or lose plan since reduction in pay
    cannot be recovered if covered expenses are less
    than expected
  • Recently issued IRS rules allow a 2 ½ month
    grace period (until the 15th day of the 3rd month
    after the end of the plan year) to use the funds
    for qualified expenses

33
Classes of Nontaxable Employee Benefits
  • No-additional-cost services
  • Qualified employee discounts
  • Working condition fringes
  • De minimis fringes
  • Qualified transportation fringes
  • Qualified moving expense reimbursements
  • Qualified retirement planning services

34
No Additional Cost Services
  • Are nontaxable if
  • Employee receives services (not property)
  • Employer incurs no substantial additional cost in
    providing the services
  • Services offered are within line of business in
    which employee works
  • Benefit is offered on nondiscriminatory basis

35
Qualified Employee Discounts
  • Are nontaxable if
  • Discount is not on realty or investment property
  • Item discounted is from same line of business in
    which employee works
  • Discount cannot exceed gross profit on property
    or 20 on services
  • Benefit is offered on nondiscriminatory basis

36
Working Condition Fringes
  • Not taxable if employee could have deducted cost
    of item if they had actually paid for them
  • Includes personal use of auto by full-time auto
    salespeople and employee business expenses that
    would be eliminated by the 2 percent floor on
    miscellaneous deductions

37
De Minimis Fringes (slide 1 of 2)
  • These benefits are so small that accounting for
    them is impractical
  • Examples include
  • Supper money
  • Occasional personal use of company copying
    machine
  • Company cocktail parties
  • Picnics for employees

38
De Minimis Fringes (slide 2 of 2)
  • Subsidized eating facilities operated by employer
    are excluded if
  • Located on or near employers premises
  • Revenue equals or exceeds direct operating costs
  • Nondiscrimination requirements are met

39
Qualified Transportation Fringes
  • This fringe benefit is designed to encourage the
    use of mass transit for commuting to work
  • Includes
  • Transportation in commuter highway vehicle and
    transit passes (limited to 105 per month)
  • Qualified parking (limited to 200 per month)
  • May be provided directly by the employer or may
    be in the form of cash reimbursements
  • Plan may discriminate

40
Moving Expenses
  • Employer payment or reimbursement of employees
    qualified moving expenses is excludible
  • No deduction by employee is allowed for
    reimbursed moving expenses

41
Qualified Retirement Planning Services
  • Value of any retirement planning advice or
    information provided by employer who maintains a
    qualified retirement plan is excluded from income
  • Designed to motivate more employers to provide
    retirement planning services

42
Nondiscrimination Provisions
  • For no-additional-cost services, qualified
    employee discounts, and qualified retirement
    planning services
  • If the plan is discriminatory in favor of highly
    compensated employees, these key employees are
    denied exclusion treatment
  • Non-highly compensated employees can still
    exclude these benefits from income

43
Foreign Earned Income (slide 1 of 2)
  • Income from personal services in a foreign
    country can be excluded from income
  • To qualify for the exclusion, must be either
  • A bona fide resident of foreign country, or
  • Present in foreign country at least 330 days
    during any 12 consecutive months

44
Foreign Earned Income (slide 2 of 2)
  • Exclusion amount is limited to 85,700
  • For married persons, both of whom have foreign
    earned income, the exclusion is computed
    separately for each spouse
  • In addition, reasonable housing costs in excess
    of a base amount may be excluded from gross
    income
  • The base amount is 16 of the statutory amount
    (85,700 for 2007) assuming all days are
    qualifying days for the foreign earned income
    exclusion
  • The housing costs exclusion is limited to 30 of
    the statutory amount (as indexed) for the foreign
    earned income exclusion

45
Interest on State and Local Government Obligations
  • Interest from municipal bonds is tax exempt
  • Reduces borrowing costs of state and local
    governments
  • High-income taxpayers can increase after-tax
    yields with municipal bonds
  • Municipal interest is considered for Social
    Security benefits inclusion and may be considered
    for alternative minimum tax calculation

46
Dividends
  • Taxable to extent paid out of either current or
    accumulated earnings and profits (EP)
  • Dividends in excess of EP are treated
  • As return of capital to extent of stock basis
    (which is reduced)
  • As capital gain to extent in excess of basis

47
Stock Dividends
  • Stock dividends (e.g., common stock issued to
    common shareholders) are not taxable
  • If shareholder has the option to receive stock or
    cash, the dividend is taxable whether the
    shareholder receives cash or stock

48
Educational Savings Bonds
  • Interest on Series EE U.S. Savings Bonds may be
    excluded from income if
  • Proceeds used to pay for qualified higher
    educational expenses
  • Bonds issued after 12/31/89, and
  • Bonds issued to person at least 24 years old
  • Exclusion is phased-out once modified AGI exceeds
    threshold amount

49
Discharge from Indebtedness
  • Income from the forgiveness of debt is taxable
  • Certain discharge of indebtedness situations get
    special treatment
  • Creditors gifts
  • Discharges in bankruptcy and when debtor is
    insolvent
  • Discharge of farm debt
  • Discharge of qualified real property indebtedness
  • Sellers cancellation of buyers debt
  • Shareholders cancellation of corporations debt
  • Forgiveness of certain student loans

50
Tax Benefit Rule
  • If taxpayer receives a deduction for an item in
    one year and in a later year recovers all or a
    portion of the prior deduction, the recovery is
    included in gross income
  • Amount included in income is limited to the
    amount for which a tax benefit was received
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