Tax USA Assignment 3

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Gross Income: Exclusions

Chapter 4

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GROSS INCOME: EXCLUSIONS

Items that are not income

Major statutory exclusions

Tax planning considerations

Compliance and procedural considerations

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Items that Are Not Income

Unrealized income

Self-help income

Rental value of personal-use property

Selling price of property

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Unrealized Income

Example:

Land valued at $20,000 beginning of year appreciates to $45,000 at end of year

The $25,000 increase in value is unrealized income and not taxable

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Self-Help Income

The amount saved is not subject to tax

Cleaning your own carpet

Repairing your car

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Selling Price of Property

Only gain on sale of property is taxable

Selling price

– Basis in property

Gain on sale of property

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Major Statutory Exclusions (1 of 2)

Gifts and inheritances

Life insurance proceeds

Awards for meritorious achievement

Scholarships and fellowships

Distributions from qualified tuition programs

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Major Statutory Exclusions (2 of 2)

Payments for injury and sickness

Employee fringe benefits

Foreign-earned income exclusion

Income from the discharge of a debt

Exclusion for gain from small business stock

Other exclusions

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Life Insurance Proceeds

Paid by reason of death

Generally non-taxable

Policy surrendered not for death

Excess of proceeds over the premiums paid taxable to recipient

Dividends on life insurance and endowment policies non-taxable

Considered return of premiums paid

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Awards for Meritorious Achievement

Awards for religious, charitable, scientific, etc. are not taxable if ALL criteria are met:

Did not enter contest

Is not required to perform substantial future services

Designates a qualified charitable organization to receive the payment

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Scholarships and Fellowships

Scholarships excluded for degree candidates used for qualified tuition and related expenses

Required for courses of instruction at an educational institution

Tuition, fees, books, supplies, equipment

Not room and board

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Distributions from Qualified Tuition Programs: §529 Plans (1 of 2)

No tax on earnings while in §529 plan

Exclusion for distributed earnings if used by beneficiary for qualified tuition and related expenses

Tuition, fees, books, supplies, equipment, AND

Room and board if ≥ half-time student

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Distributions of income not used for qualified tuition expenses

Income determined by annuity rules

Included in beneficiary’s income, AND subject to a 10% penalty

Beneficiary must be “family” member

No tax consequences if beneficiary changed

Distributions from Qualified Tuition Programs: §529 Plans (2 of 2)

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Payments for Injury and Sickness

Injury includes physical and mental

Medical expense pmts. for emotional distress excluded if expenses attributable to a physical injury

Disability income policy is non-taxable if purchased by taxpayer

Taxable if purchased by employer

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Employee Fringe Benefits (1 of 2)

In general

Employer-paid insurance

§132 fringe benefits

Employer awards

Meals and lodging

Meals and entertainment

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Employee Fringe Benefits (2 of 2)

Employee death benefits

Dependent care

Adoption expenses

Educational assistance

Cafeteria plans

Flexible spending plans

Interest-free loans

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Employee Fringe Benefits in General

Compensation generally taxable

Law encourages certain types of fringe benefits by treating the benefits as

Nontaxable to the employee, AND

Deductible by the employer

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Employer-Paid Insurance (1 of 2)

Premiums on health, accident, disability and qualifying group term insurance

Most employee life ins. premiums

Benefits from non-discriminatory self-insured plans

See Topic Review 1

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Employer-Paid Insurance (2 of 2)

2010 Affordable Care Act

Penalizes individuals w/o med. ins.

Penalizes larger employers not providing adequate employee health benefits

Other taxes apply to high-income individuals and large employers who do not provide employee coverage

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§132 Fringe Benefits

No additional cost benefits

Employee discounts

Working condition benefits

De minimis benefits

Transportation fringes

Athletic facilities

See Topic Review 2

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Employee Awards

Employee achievement awards and qualified plan awards

Must be tangible personal property

Limited to avg. of $400 per employee

Max award $1,600

Includes safety or length of service

Must not discriminate in favor of highly paid employees

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Meals and Lodging

Provided on employer’s premises

For the convenience of employer

Lodging must be a condition of employment to be nontaxable

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Meals and Entertainment

50% of meal or cost of entertaining customers is deductible

Includes cost of employee’s meal or entertainment

Employer gets deduction if employer pays or reimburses employee

Employee does NOT recognize income

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Employee Death Benefits

§101(b) provides exclusion up to $5,000 ($2,500 MFS)

Amounts over $5,000 may be nontaxable gifts depending on facts and circumstances, including employer’s intention

Gift is NOT deductible by employer

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Dependent Care

Employer-financed programs

Employee may exclude up to $5,000 of assistance each year

$2,500 MFS

Cannot discriminate in favor of highly compensated employees

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Adoption Expenses

Exclusion for amounts paid pursuant to an adoption assistance plan created by an employer

Employee may exclude up to $12,970

Phased out between $194,580 -$234,580

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Educational Assistance

Employers pay employee educational costs

Employee may exclude up to $5,250 per year for tuition, fees, books, supplies, and equipment

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Cafeteria Plans

Also called flexible spending accounts

Employee has option of receiving any combination of benefits up to a certain amount, including cash

Only receipt of cash is taxable

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Interest-Free Loans

Interest must generally be imputed on interest-free loans

Imputed interest generally deductible by employer and taxable to employee

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Foreign-Earned Income Exclusion Eligible Taxpayers

U.S. citizens subject to U.S. income tax on worldwide income

Subject to double taxation if foreign income taxed by foreign country

Foreign tax credit (FTC) mitigates double taxation

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Foreign-Earned Income Exclusion Exclusion Amount

Foreign-earned income exclusion alternative to FTC

May exclude up to $97,600 of foreign earned income

Add’l exclusion for foreign housing costs

Foreign housing costs in excess of $15,616

Max housing exclusion is $13,664

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Foreign-Earned Income Exclusion Residency Tests

To qualify for foreign-earned income exclusion

Must be bonafide resident of foreign country(ies) for entire taxable year, OR

Physical presence in foreign country for 330 days during a 12-month period

If 12-month period spans two tax years, exclusion prorated based on [# days/365]

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Income from the Discharge of a Debt (1 of 2)

Generally, taxpayer may have to include amount of debt forgiveness in gross income

Exceptions: nontaxable situations

Discharge occurs in bankruptcy

Discharge occurs when taxpayer is insolvent

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Income from the Discharge of a Debt (2 of 2)

Student loans

Discharge excluded from gross income if discharge contingent on performing certain public services for a specified time period in certain professions

Home mortgage forgiveness

Exclude debt up to $2M on acquisition or improvement of principle residence

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Exclusion for Gain from Small Business Stock (1 of 2)

% of gain may be excluded from gross income if held > five years

50% if acquired prior to 2/17/2009

75% if acquired 2/18/2009 – 9/27/2010

100% if acquired after 9/28/2010

Eligible amount limited to greater of $10M or 10x adjusted basis in stock

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Exclusion for Gain from Small Business Stock (2 of 2)

Taxable gain not recognized if proceeds reinvested in other small business stock w/in 60 days

Taxable gain recognized to extent amount realized > amount reinvested

Maximum tax rate on taxable amount is 28%

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Other Exclusions (1 of 2)

Gain from sale of personal residence

Annuities paid to survivors of public safety officers

Certain military-related payments

Housing allowance for ministers

Campus housing

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Other Exclusions (2 of 2)

Foster care payments

Rural letter carrier’s allowance

Roth IRA distributions

Education IRA distributions

Personal foreign currency gains

See Table 2

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Tax Planning Considerations

Employee fringe benefits

Cafeteria plans can help provide valuable benefits to employees or cash if they don’t need the benefits offered

Self-help income and use of personally owned property

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Fringe benefits and Form W-2

Nontaxable benefit may be excluded from employees’ W-2

Taxable benefits subject to withholding and reported on employees’ W-2

Compliance & Procedural Considerations

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END Chapter 4

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