Week 1 Writing Project
OfficialADMIN
Chapter3.pptxFundamentals of Taxation 2020 Edition Cruz, Deschamps, Niswander, Prendergast, Schisler
Chapter 3
Gross Income: Inclusions and Exclusions
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No reproduction or further distribution permitted without the prior written consent of McGraw-Hill.
Learning Objective #1: When and How to Record Income for Tax Purposes
Income Recognition for Tax Purposes
Similar to the recognition for accounting purposes.
Income must be realized and earned.
However, three additional conditions must be present when the transaction occurs:
Economic benefit of the transaction.
Conclusion of the transaction.
Income from the transaction must not be tax-exempt income.
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Learning Objective #1: When and How to Record Income for Tax Purposes-Concept Check 3-1 1
An individual must recognize income on his or her tax return if the transaction meets three conditions.
Name the three conditions:
Economic benefit
Conclusion
Not tax-exempt income
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Learning Objective #1: When and How to Record Income for Tax Purposes-Concept Check 3-1 2
An individual can exclude certain income from taxation even though a transaction that has economic benefits has occurred. True or false?
True
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Learning Objective #2: The Cash Method of Accounting as It Applies to Income Taxes
Cash Receipts and Disbursements Method
Used by almost all individuals to file their tax returns.
Constructive receipt.
Income is reported in the year the taxpayer receives the right to control the income rather than the year in which it’s earned.
Receipt of property or services will trigger income recognition.
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Learning Objective #2: The Cash Method of Accounting as It Applies to Income Taxes Concept Check 3-2
Income may be realized in any form, whether in money, property, or services. True or false?
True
If you provide consulting services to your friend and, in exchange, he fixes your car, you and your friend must report on both tax returns the fair market value of the services provided. True or false?
True
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Learning Objective #3: The Taxability of Components of Gross Income: Interest, Dividends, Tax Refunds, and Social Security Benefits 1
Interest.
Taxability.
Interest from banks, savings and loans, or credit unions is reported on a 1099-INT and is taxable.
Interest earned on Series E and EE U.S. Savings Bonds is taxable but can be reported gradually on an annual basis or fully at maturity.
Some interest received is tax-exempt if the debt is issued by a state, U.S. possession, or subdivision thereof.
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Learning Objective #3: The Taxability of Components of Gross Income: Interest, Dividends, Tax Refunds, and Social Security Benefits 2
Other types of interest that must be reported.
Payments received from seller-financed mortgages.
Receipts from installment sale receivables.
Imputed interest on loans made at below-market interest rate.
Interest on bonds sold between interest dates.
How to report interest.
If the amount of interest is more than $1,500, use Schedule B of Form 1040.
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Learning Objective #3: The Taxability of Components of Gross Income: Interest, Dividends, Tax Refunds, and Social Security Benefits 3
Dividends.
Taxability.
Dividends are distributions to shareholders, thus, income that must be reported on the tax return.
Qualified dividends (1) are made from the earnings and profits of the payer corporation and (2) are from domestic corporations or qualified foreign corporations.
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Learning Objective #3: The Taxability of Components of Gross Income: Interest, Dividends, Tax Refunds, and Social Security Benefits 4
The Tax Cuts and Jobs Act of 2017 provides for taxability of qualified dividends based on taxable income thresholds.
For married filing jointly with taxable income of less than $78,750, head of household with taxable income of less than $52,750, and married filing separately or single with taxable income of less than $39,375, the dividends are taxed at 0%. Thereafter, dividends are taxed at 15% for income up to $488,850 for married filing jointly, $244,425 for married filing separately, $461,700 for head of household, and $434,550 for single taxpayers. A 20% tax rate on dividends applies for taxable income above those amounts.
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Learning Objective #3: The Taxability of Components of Gross Income: Interest, Dividends, Tax Refunds, and Social Security Benefits 5
Other types of dividends.
Stock dividends and stock splits are generally not taxable to the shareholders.
How to report dividends.
If the amount of dividends is more than $1,500, use Schedule B of Form 1040.
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Learning Objective #3: The Taxability of Components of Gross Income: Interest, Dividends, Tax Refunds, and Social Security Benefits 6
Refund from the State and Local Governments.
Taxability.
Refunds are taxable if, in the prior tax year, the refund was deducted as an itemized deduction.
The taxable amount is:
The lesser of (a) the amount received, (b) the amount deducted on Schedule A, or (c) the amount by which the itemized deductions exceed the standard deduction.
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Learning Objective #3: The Taxability of Components of Gross Income: Interest, Dividends, Tax Refunds, and Social Security Benefits 7
Social Security Benefits.
Taxability.
Part of the social security benefits may be taxable.
Provisional income (also called modified adjusted gross income) must be calculated and compared to the threshold amounts to determine taxability.
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Learning Objective #3: The Taxability of Components of Gross Income: Interest, Dividends, Tax Refunds, and Social Security Benefits 8
Provisional income defined.
Adjusted gross income (before social security benefits) plus:
Interest on U.S. Savings Bonds excluded for educational purposes.
Most tax-exempt interest.
Employer-provided adoption benefits.
Excluded foreign income.
Deducted interest on educational loans.
Deducted tuition and fees (Tax Extenders Act of 2008).
50% of Social Security Benefits.
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Learning Objective #3: The Taxability of Components of Gross Income: Interest, Dividends, Tax Refunds, and Social Security Benefits 9
If provisional income exceeds certain thresholds, 50 percent of social security benefits are taxable.
As provisional income increases, the amount taxable increases to as much as 85 percent.
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Learning Objective #3: The Taxability of Components of Gross Income: Interest, Dividends, Tax Refunds, and Social Security Benefits 10
Chart with Threshold Amounts showing the lower and upper limits of provisional income.
Married Filing Jointly
| Lower Limit | $32,000 |
| Upper Limit | $44,000 |
Single, Head of Household, or Qualifying Widow(er)
| Lower Limit | $25,000 |
| Upper Limit | $34,000 |
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Learning Objective #3: The Taxability of Components of Gross Income: Interest, Dividends, Tax Refunds, and Social Security Benefits 11
Calculations.
Example:
Karen files a return as a qualifying widow. She received $7,000 of social security benefits, $19,000 of interest income, and $5,000 of nontaxable municipal bond interest. Her provisional income is $27,500.
Karen will report taxable social security benefits equal to the lesser of 50 percent of Social Security benefits ($3,500) or 50 percent of the excess of provisional income over $25,000 ($1,250). Thus, her taxable benefits are $1,250.
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Learning Objective #3: The Taxability of Components of Gross Income: Interest, Dividends, Tax Refunds, and Social Security Benefits 12
Other types of taxable income:
Jury duty.
Prizes and awards.
Forgiveness of debt.
Insurance proceeds in excess of the adjusted basis of the property.
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Learning Objective #3: The Taxability of Components of Gross Income: Interest, Dividends, Tax Refunds, and Social Security Benefits Concept Check 3-3
All interest received from state or local bonds is not taxable. True or false?
False
A Schedule B is required if an individual receives $1,500 of interest for the tax year. True or false?
False
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Learning Objective #3: The Taxability of Components of Gross Income: Interest, Dividends, Tax Refunds, and Social Security Benefits Concept Check 3-4
Qualified dividends arise from the earnings and profits of the payer corporation. True or false?
True
A corporation can pay only cash dividends to its shareholders. True or false?
False
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Learning Objective #3: The Taxability of Components of Gross Income: Interest, Dividends, Tax Refunds, and Social Security Benefits Concept Check 3-5
Linda and Mason file a joint return. Their AGI before social security was $22,000, social security benefits received were $9,000, and tax exempt interest was $1,250. What is the amount of their provisional income?
$27,750 ($22,000 + $4,500 + $1,250)
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Learning Objective #3: The Taxability of Components of Gross Income: Interest, Dividends, Tax Refunds, and Social Security Benefits Concept Check 3-6
Name a type of income item that is listed on line 8 of Schedule 1.
Jury duty, gambling winnings
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Learning Objective #4: The Rules Concerning Items Excluded from Gross Income 1
Income excluded from gross income.
Fringe benefits qualify if they meet the nondiscrimination rules.
Examples:
No-additional-cost services provided to an employee.
Unsold hotel room or airline seats.
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Learning Objective #4: The Rules Concerning Items Excluded from Gross Income 2
Discounts provided to employees for products or services normally sold by the business.
In case of products, the discount cannot exceed the gross profit percentage.
In case of services, the maximum discount is 20 percent of the normal selling price.
Qualified transportation benefits.
De minimis benefits.
Holiday turkeys, company picnics.
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Learning Objective #4: The Rules Concerning Items Excluded from Gross Income 3
Nontaxable fringe benefits with certain limitations.
Examples:
Life insurance.
Premiums for coverage up to $50,000.
Educational assistance.
Up to $5,250 may be reimbursed to the employee.
Dependent care assistance.
Up to $5,000 of exclusion, but cannot exceed earned income of the employee.
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Learning Objective #4: The Rules Concerning Items Excluded from Gross Income 4
Other nontaxable income:
Some of these items have certain requirements or limitations that must be met:
Scholarships and fellowships.
Qualified tuition program (Q T P) withdrawals.
Life insurance proceeds.
Gifts and inheritances.
Compensation for sickness or injury.
Child support.
Welfare.
Employer-provided adoption assistance.
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Learning Objective #4: The Rules Concerning Items Excluded from Gross Income Concept Check 3-7
Holiday turkeys given to employees are included in gross income. True or false?
False
In general, scholarships are not taxable if the use of the money is to pay tuition, fees, books, supplies and equipment. True or false?
True
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Learning Objective #5: The Rules Associated with Tax Accounting for Savings Bond Interest Used for Education Expenses, Below-Market Interest Loans, Gift Loans, and Original Issue Discount Debt 1
Savings Bond Interest.
Taxability.
Not taxable if used to pay qualified higher education expenses for the taxpayer, spouse or dependent children.
Full exclusion allowed if the education expenses paid exceed the redemption amount.
Limitation applies if modified A G I exceeds $121,600 on a joint return or $81,100 on other returns.
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Learning Objective #5: The Rules Associated with Tax Accounting for Savings Bond Interest Used for Education Expenses, Below-Market Interest Loans, Gift Loans, and Original Issue Discount Debt 2
Below-Market Interest Loans.
If the debt instrument was created with interest rates that materially vary from market rates at the time of issuance, then interest is required to be imputed.
Examples of when imputed interest does not apply:
Sales of property for $3,000 or less.
Sales in which all payments are due in six months or less.
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Learning Objective #5: The Rules Associated with Tax Accounting for Savings Bond Interest Used for Education Expenses, Below-Market Interest Loans, Gift Loans, and Original Issue Discount Debt 3
Gift Loans.
Imputed interest rules apply to gift loans over $15,000 where foregone interest is in the form of a gift.
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Learning Objective #5: The Rules Associated with Tax Accounting for Savings Bond Interest Used for Education Expenses, Below-Market Interest Loans, Gift Loans, and Original Issue Discount Debt 4
Original Issue Discount (O I D).
Equal to the difference between the acquisition price and the maturity value.
The holder must report part of the O I D as income every year.
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Learning Objective #5: The Rules Associated with Tax Accounting for Savings Bond Interest Used for Education Expenses, Below-Market Interest Loans, Gift Loans, and Original Issue Discount Debt 5
O I D is not applicable to:
Tax-exempt debt.
U.S. Savings Bonds.
Debt with a maturity of 1 year or less on the date of issue.
Any obligation issued by a natural person before March 2, 19 84.
Non-business loans of $10,000 or less between natural persons.
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Learning Objective #5: The Rules Associated with Tax Accounting for Savings Bond Interest Used for Education Expenses, Below-Market Interest Loans, Gift Loans, and Original Issue Discount Debt Concept Check 3-8 1
An individual is required to impute interest on a deferred payment contract where no interest, or a low rate of interest, is stated. True or false?
True
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Learning Objective #5: The Rules Associated with Tax Accounting for Savings Bond Interest Used for Education Expenses, Below-Market Interest Loans, Gift Loans, and Original Issue Discount Debt Concept Check 3-8 2
If someone purchases a debt instrument (such as a bond) from an issuer for an amount less than par value, the transaction creates original issue discount (O I D). True or false?
True
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