Gross Income: Inclusions

1
Chapter 3

• Gross Income Inclusions

2
Gross Income (slide 1 of 3)

• Definition Gross income includes all income from
  whatever source derived, unless specifically
  excluded under the Code
• Concept is interpreted broadly by the courts

3
Gross Income (slide 2 of 3)

• Taxability of income follows the realization
  principle from accounting, i.e., income is
  recognized (taxed) when realized
• But not always the same as accounting income
  (book)
• Mere appreciation in wealth (economic income) is
  not considered realized income

4
Gross Income (slide 3 of 3)

• Income is recognized whether it is in the form of
  cash, or in-kind cash equivalents (i.e.,
  property or services)
• The amount of income from in-kind receipts is
  equal to the FMV of the property or services
• Income does not include recovery of the
  taxpayers capital investment

5
Income Sources(slide 1 of 5)

• Sec. 61 includes in gross income all income from
  whatever source derived
• Examples in the Code
• Compensation for services
• Business income
• Gains from sale or exchange of property
• Interest
• Rents
• Royalties

6
Income Sources(slide 2 of 5)

• Examples in the Code (continued)
• Dividends
• Alimony
• Pensions and annuities
• Income from certain life insurance contracts
• Income from the discharge of indebtedness
• Distributive share of partnership or S-corp
  income
• Income in respect of a decedent (IRD)
• Income from an estate or trust

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Income Sources(slide 3 of 5)

• Income from personal services is taxable to the
  person who performs the services
• Fruit and tree doctrine
• Income from property is taxable to the owner of
  the property
• Assignment of income is not permitted

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Income Sources (slide 4 of 5)

• Income from pass-through entities is taxable at
  owner level rather than the entity level
• Pass-through entities
• Partnerships
• S corporations
• Estates and trusts

9
Income Sources (slide 5 of 5)

• Community property issues
• Community versus separate property
• Community income allocable equally to each spouse
• Separate income allocable to owner-spouse
• Separate property may produce community income
  (community property states,i.e., TX, LA)

10
Accounting Methods

• Cash Method
• Income reported in year of actual or constructive
  receipt (when TP has access to income, but has
  not actually received)
• Accrual Method - report in year earned
• all events have occurred to fix the right to
  income
• amount can be determined with reasonably accuracy

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Accounting Methods

• Accrual Method
• Prepaid income generally taxable in year of
  receipt except
• accrual basis TPs prepayment of goods not on hand
• advance payments for services not rendered until
  the following year (not available if payment
  covers period beyond end of tax year following
  year of receipt)
• Hybrid Method
• Must use accrual method for purchases and sales
  when maintain inventories
• Certain small business may use cash method in
  computing all other income and expense

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Gross Income - Section 61

• Compensation
• Salaries, wages, fees, commissions, tips, bonuses
  and other special forms
• Business Income
• Total receipts are gross income for services
  business
• Gross margin (Sales less COGS) is gross income
  for manufacturing, merchandising and mining
  business

13
Gross Income - Section 61

• Gains from Dealings in Property
• Taxable unless excludible
• Involuntary conversions, like-kind exchanges,
  sale of personal residence, and reorganizations
• Interest is generally included in gross income
• Interest on certain municipal bonds is excludible
• Interest on Series EE U.S. saving bonds is
  excludible if used to pay certain college
  expenses

14
Gross Income - Section 61

• Rents and Royalties
• Security deposits not income until forfeited
• Losses subject to passive activity loss rules
• Leasehold improvements in lieu of rent are
  includible at FMV
• Amounts received to cancel or modify lease are
  includible

15
Gross Income - Section 61

• Dividends
• Distributions to shareholders are taxable as
  dividends to the extent of shareholders pro rata
  share of current or accumulated earnings and
  profits (EP)
• Distributions exceeding E P are treated as a
  return of capital to extent of shareholders
  adjusted basis in the stock
• Distributions that exceed E P and adjusted
  basis are subject to gain (usually capital gain)

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Alimony and Separate Maintenance Payments (slide
1 of 4)

• Deductible by payor
• Includible in gross income of recipient

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Alimony and Separate Maintenance Payments (slide
2 of 4)

• Alimony defined
• Paid in cash
• Pursuant to divorce or separation instrument
• Payor and recipient are not members of same
  household
• Payments terminate no later than death of
  recipient
• Payments not called something other than alimony
  in agreement or decree

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Alimony and Separate Maintenance Payments (slide
3 of 4)

• Property settlements
• Transfer of property to former spouse
• No deduction or recognized gain or loss for payor
• No gross income and carryover of payors basis
  for recipient
• Front-loading of alimony payments
• Alimony recapture (gross income) for payor
• Deduction (FOR AGI) for recipient

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Alimony and Separate Maintenance Payments (slide
4 of 4)

• Child support payments
• Payments made to satisfy legal obligation to
  support child of taxpayer
• Nondeductible by payor and not taxed to recipient
  (or child)

20
Annuity Income

• Purchaser pays fixed amount for the right to
  receive a future stream of payments
• Early collections and loans against annuity can
  be included in gross income
• Early distributions also subject to 10 penalty

21
Annuity Income

• Annuities and pensions starting prior to
  11/19/96
• Exclusion ratio applied to amounts (called
  rents) received on contract to determine amount
  excludable
• Exclusion ratio (investment in
  contract/expected return under contract)

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Annuity Income

• Annuities and pensions starting after 11/18/96
• Use simplified method
• Exclusion amount is investment in contract
  divided by number of anticipated monthly payments
  (table amount based on age)
• Only actual cost is excludible even if TP
  outlives calculated life expectancy
• If TP dies before cost is recovered, remaining
  cost is deducted on final tax return

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Other Income Items

• Life insurance proceeds are generally exempt from
  tax
• However, interest income from life insurance
  proceeds left with insurance company is taxable
• Income from Discharge of Indebtedness
• Generally includible in income, except for
  bankruptcy and other insolvency situations
• Income Passed Through to Taxpayer
• Partnerships, S corporations, estates, trusts, IRD

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Other Income Items

• Prizes and Awards
• General rule FMV of item is included in income
• See Chapter 4 for exceptions
• Illegal Income
• Must be included in gross income

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Other Income Items

• Group Term Life Insurance
• Exclude premiums paid by employer on first
  50,000 of coverage
• Premiums on excess are included in gross income
• Inclusion amount based on IRS provided tables

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Other Income Items

• Unemployment Compensation
• Taxable in full
• Tax Benefit Rule
• Recovery of previously deducted amounts are
  includible as income
• e.g. Taxpayer itemized deductions and claimed
  700 deduction for state income taxes paid in
  1999, then received a refund of 200 in 2000 for
  overpayment of state tax for the 1999 year. TP
  must include the 200 as income on her 2000
  federal tax return.

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Social Security Benefits

• A maximum of 85 of social security benefits may
  be included in gross income
• The amount of taxable SS depends on amount of
  provisional income and filing status
• Provisional income
• AGI, excluding SS benefits, Plus
• Tax-exempt interest
• Excluded foreign income
• 50 of SS benefits

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Social Security Benefits

• Married filing joint (MFJ) TPs
• Prov. Inc.
• Prov.Inc. 32,000 benefits equal the lesser of
• 50 of SS benefits, or
• 50 of excess Prov.Inc. over 32,000
• Prov.Inc. 44,000, taxable SS equal to lesser
  of
• 85 of SS benefits, or
• 85 of Prov.Inc. over 44,000, plus the lesser of
  
• (1) 6,000, or
• (2) 50 of SS benefits

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Social Security Benefits

• Single TPs
• Prov. Inc.
• Prov.Inc. 25,000 benefits equal the lesser of
• 50 of SS benefits, or
• 50 of excess Prov.Inc. over 25,000
• Prov.Inc. 34,000, taxable SS equal to lesser
  of
• 85 of SS benefits, or
• 85 of Prov.Inc. over 34,000, plus the lesser of
  
• (1) 4,500, or
• (2) 50 of SS benefits

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Insurance Proceeds and Court Awards

• Amounts received because of physical injury or
  sickness are generally excludible
• Punitive damages are taxable even if awarded on
  basis of sickness or physical injury
• Recoveries of lost profits are includible in
  gross income