Tax USA Assignment 3

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Week09.2_pope_phft2014_ind_pp_03.pptx

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Gross Income: Inclusions

Chapter 3

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GROSS INCOME: INCLUSIONS

Economic and acct concepts of inc.

To whom is income taxable?

When is income taxable?

Items of gross income

Tax planning considerations

Compliance & procedural considerations

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Concepts of Income

Economic concepts of income

Accounting concepts

Tax concept of income

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Economic Concepts of Income

Wealth that flows to individuals

Changes in value in individuals’ wealth

Unrealized gains

Gifts & inheritances considered income

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Accounting Concepts of Income

Values are measured by a transaction approach

Income realized as result of completed transactions

Use historical cost

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Tax Concept of Income

Conditions to make income taxable

Administrative convenience

Wherewithal to pay

Gross income defined

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Conditions to Make Income Taxable

Economic benefit to taxpayer

Income must be realized

Earnings process complete

Income must be recognized

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Administrative Convenience

Economic concept is considered too subjective

Objectivity achieved at price of equity

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Wherewithal to Pay

A tax should be collected when the taxpayer can most easily pay

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Gross Income Defined (1 of 2)

Section 61(a) defines gross income

“all income from whatever source derived,” including (but not limited to) the following items:

Compensation, income derived from business, gains from dealings in property, interest, rents, royalties, dividends, alimony, annuities, life insurance, pensions

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Form of receipt

Gross income not limited to cash

§1.61-1a, income may be “realized in any form, whether in money, property, and services”

Indirect economic benefit

Items indirectly benefiting taxpayers excluded from gross income

Gross Income Defined (2 of 2)

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To whom Is Income Taxable?

Assignment of income

Allocating income between married people

Income of minor children

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Assignment of Income

Supreme Court in Lucas v. Earl (1930)

Ruled that individual taxed the earnings from his personal services

Helvering v. Horst (1940)

Ruled that assignment of income doctrine applies to property

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Allocating Income between Married People (1 of 2)

Common law property system

Used in 42 states

Income taxed to person who earns it or who owns the income-producing property

Joint income comes from jointly owned property

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Community property states

All income deemed to be earned equally by spouses except income from separate property

Separate property of each spouse

Property owned prior to marriage

May be community income or separate income, depending on state of residence

Allocating Income between Married People (2 of 2)

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Income of Minor Children

Taxed to child regardless of state’s property law system

Unearned income of minor under 24 may be taxed at parent’s higher rate

See Chapter 2

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When Is Income Taxable?

Cash method

Accrual method

Hybrid method

See Topic Review 1

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Cash Method (1 of 3)

Cash receipts and disbursements

Used by most individuals, and most non-corp. bus. with no inventory

Constructive receipt

Report inc. in year actually received

Check received after banking hours

Bond interest coupons that have matured but not redeemed

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Cash Method (2 of 3)

No constructive receipt if

It is subject to substantial limitations

Payor does not have funds necessary to make payment

Amount is unavailable to taxpayer

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Cash Method (3 of 3)

Exceptions to basic cash method

Interest on Series E or EE Savings Bonds

Special rules apply to farmers and ranchers

Small taxpayer exception for inventories

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Accrual Method

Report income in year income earned

Right to income

Amount can be determined with reasonable accuracy

Prepaid income

Generally taxable when received

Exceptions in Rev. Proc. 2004-34

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Hybrid Method

Accrual method for purchases and sales

Cash method in computing all other income and expenses

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Items of Gross Income (1 of 2)

Compensation

Business income

Gains from dealings in property

Interest

Series EE bond interest exception

Rents and royalties

Dividends

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Items of Gross Income (2 of 2)

Alimony and separate maint. pmts.

Pensions and annuities

Income from life insurance and endowment contracts

Inc. from discharge of indebtedness

Income passed through to taxpayer

Other items of gross income

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Dividends (1 of 3)

Included in shareholder gross inc.

Results in double taxation

Earnings taxed at corporate level

Earnings taxed at shareholder level when distributed as a dividend

C corps allowed a 70, 80, or 100% div. rec. deduction based on ownership %

Relief from multiple levels of taxation

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Dividends (2 of 3)

Individuals taxed up to 20% on dividends

Reduces effects of double taxation

Must hold stock for at least 60 days

Distributions to extent they are out of corporate E&P

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Dividends (3 of 3)

Stock dividends

Not taxable

Basis in stock allocated to new shares

Capital gain dividends

Taxed at long-term capital gain rates

Constructive dividends

Taxed as regular dividends

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Alimony and Separate Maintenance Payments

Only receipt of alimony is taxable

Alimony is deductible by one who pays

Child support not taxable

Property settlement not taxable

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Pensions and Annuities

Income portion of annuity taxable

Investment portion is excluded

Exclusion ratio

Basis in annuity ÷ Expected Return

Expected return

Payment x # of expected payments

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Income Passed Through to Taxpayer

Income from flow-through entities taxed directly to owners

Income from partnership

Income from S corporation

Income in respect of a decedent

Income from an estate or trust

Income from ETF, RIC, or REIT

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Other Items of Gross Income (1 of 2)

Prizes, awards, gambling winnings, and treasure finds – taxable

Illegal income – taxable

Unemployment compensation - taxable

Social security benefits – up to 85% taxable

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Other Items of Gross Income (2 of 2)

Insurance proceeds & court awards

Special rules apply

Recovery of previously deducted amounts – taxable

Revenue received that is disputed must still be reported as income

Previously reported income that is subsequently refunded is deductible

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Tax Planning Considerations (1 of 2)

Shifting income

From high-income family members to low-income family members

Alimony

Deductible by payor and includible by payee

Prepaid income

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Tax Planning Considerations (2 of 2)

Taxable, tax-exempt, or tax-deferred bonds

Need to compare present value of after-tax returns

Reporting savings bond interest

Deferred compensation arrangements

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Compliance & Procedural Considerations

Form 1040 – Wages, Salaries & Tips

Schedule B – Interest and Dividends

Schedule C – Business Income

Schedule D – Capital Gains

Schedule E – Rents and Royalties

Schedule F – Farm Income

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END Chapter 3

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