Tax Study Guide-4-Gross Income Inclusions

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Study Guide Questions from Individual Income Taxes

The general definition of gross income is found in Section 61(a) of the Internal Revenue Code.

True

The term "income" is used in the Code, but is not separately defined

True

Economic income is the sum of the taxpayer's change in net worth and the actual consumption of goods and services during the tax period.

True

The accountant's concept of income is based on the recognition principle.

False. The accountant's concept is based on the realization principle.

For any individual taxpayer, financial income and taxable income are always the same amount.

True

Payments must be made in cash to qualify as deductible alimony.

True

If two taxpayers exchange services, neither one realizes any gross income since there was not an exchange of cash.

False. Gross income is not limited to cash received. It includes income realized in any form whether in money, property, or services.

Corporate taxpayers must always use the cash method of accounting.

False. Most corporations use the accural method.

A cash basis taxpayer defers income recognition on an account receivable until it is collected.

True

The benefits of the group term life insurance premium exclusion are not available to proprietors and partners.

True

The interest on U.S. "Series EE" savings bonds must always be reported using the cash method of accounting.

False. Taxpayers may elect the accural method.

Prepaid income received is not always income in the year payment is received.

True. In some cases, an accrual basis taxpayer may be able to defer recognition of the income under Rev.Proc. 71-21.

Taxable income from personal services can be shifted to other taxpayers such as family members.

False. The assignment of income does not shift the tax liability.

In all community property states (Texas, California, etc.), income derived from separate property is separate income.

False. In Texas, Louisiana, Wisconsin, and Idaho income derived from separate property is community income.

On the sale of stock, dividends are generally taxed to the person who is entitled to receive the dividends.

True

Income from property must be included in the gross income of the owner of the property

True

If a taxpayer is entitled to receive income, which is made available to him, he cannot "turn his back" on it.

True

Most individual taxpayers use the cash method of accounting.

True

The recovery of capital doctrine means that the amount received from a sale of property is reduced by the adjusted basis in arriving at the gross income on the property sold.

True

There is a maximum amount of Social Security benefits that must be taxable income of an individual taxpayer.

True

The premiums on the first $50,000 worth of nondiscriminatorv insurance provided to an employee can generally be excluded from the employee's gross income.

True

If the interest rate on a loan to certain related parties is less than the Federal rate the imputed interest is the difference between the amount that would have been charged at the Federal rate and the amount actually charged.

True

If a group term life insurance plan discriminates in favor of key employees, the key employees must include in gross income the lesser of the actual premiums paid by the employer or the amount calculated from the Uniform Premium Table.

False. The GREATER of the actual premiums paid by the employer or the amount calculated from the Uniform Premiums table must be included in the key employee's gross income.

A cash basis taxpayer must recognize income when a check is received, even if the check is received after backing hours.

True

A taxpayer includes funds received from an agent (such as an auctioneer) in the year the funds are received from the agent, not in the year the agent collected the funds.

False

Child support payments are deductible by the payor and includible in the gross income of the payee.

False.

An annuitant can exclude from income the amount calculated using the exclusion ratio until the annuitant has recovered his or her investment in the contract.

True

For a corporate dividend received by a taxpayer to be "qualified dividend income," stock on which a dividend is paid must have been held for more than 90 days during the 120-day period beginning 60 days before the ex-dividend date.

False. The stock has to be held 60 days out of 120 days.

Roberto is in the 33% tax bracket, and in 2010, he has 1,000 in dividend income from Wal-Mart stock (Wal-Mart stock is qualified stock). His tax on the Walmart dividends is $330.

False. The tax is 15% x 1,000 = 150

When govenment bonds (Series EE) are purchased by parents for their children , the children generally should file a return and elect to report the income on the accrual basis.

True.

Luke is laid off when his job is outsourced to India. As a result, in 2010, he receives 5,000 in unemployment compensation during the year. The $5,000 is excluded from Luke's income for the year.

False. In 2010 (assuming an extension from 2009), the first $2,400 is excluded and the balance of the $5,000 is included from Luke's income for the year.

A bank deposits $500 in interest in a savings account on December 31, 2009. The depositor withdraws $2,000 on January 3, 2010. How much income must be recognized for 2009?

500. Only the interest income

On December 1 of the current year. Drew receives $9,000 for three months rent (December, January, and February) of an office building. Drew is an accrual basis taxpayer. How much income must be recognized in the current year?

The entire $9,000 is taxable when received.

Chris is a 30-year-old single taxpayer. He has one dependent child living with him. During the current year, Chris received all of the following items:
Salary $25,000
Child support $6,000
Alimony $9,000
Unemployment compensation $6,400
Interest on U.S. Treasury bonds $400
Lotto Winnings (Net) $600
Of the above amounts, how much must Chris include in his gross income for 2010?

25,000 + $9,000 + $4,000 ($6,400 - $2,400) + $400 + $600 = $39,000

During the year, Dan earned a salary of $50,000 and his wife earned a salary of $40,000. If Dan and his wife file separate income tax returns, Dan would report how much income?

50% ($50,000 + $40,000) = $45,000

Which of the following is not a community property state?
Texas
Georgia
California
Arizona
Washington

Georgia is not a community property state

Pablo, a calendar year taxpayer, owns 30 percent of Wirra Corporation, an S Corporation. Wirra Corporation had taxable income of $100,000. During the year, the corporation made distributions of $20,000 to Pablo. Pablo's dividend income from other corporations was $25,000. What is Pablo's taxable income from the corporations?

30% ($100,000) + $25,000 = $55,000

Jill, a single taxpayer, received $10,000 in Social Security benefits. Her adjusted gross income was $31,000 and she had no tax-free interest income. How much of the Social Security benefits shuld Jill include in her income?

5,000 = lessor of 50%x $10,000 = $5,000, or (2) 50% x [$31,000 + 50 %($10,000)? $25,000] = $5,500

Rita, a single taxpayer, received $10,000 in Social Security benefits. Her adjusted gross income was $70,000 and she had no tax-free interest income. How much of the Social Security benefits should Rita include in her income?

$8,500 = Lesser of: (1) 85%(10,000)=8,500 or Sum of : 85% [70,000] + 50%($10,000) - $34,000] = $34,850,plus lesser of: (a) $5,000, amount from first formula or (b) $4,500 = $34,850 + $4,500 = $39,350

Judy has savings bonds (Series EE), which increased in redemption value by $600 during the current year. In addition, Judy has $1,000 in interest on her savings account at Big Town Savings & Loan. If Judy has not made any elections and she is a cash basis taxpayer, she should report taxable interest income of:

The increase in the redemption value of the Series EE bonds is not taxable.

A lawyer drafts a will for a dentist in exchange for dental work. The dentist would normally have charged $400 for this work. Since the attorney normally charges $300 for drafting a will, he paid the dentist $100 in cash. Based on this transaction, how much should the dentist include in his gross income?

400. 300 + 100

Erin, a 27 year-old cash basis calendar year taxpayer, received the following from her employer during the current year:
Salary $50,000
Bonus 6,000
Group term life insurance premiums
paid by Erin's employer for 50,000
of term life coverage for Erin 2,000
Rental value of company car used
for vacation 700
What is Erin's gross income from the above Items?

$50,000 + $6,000 + 700 = $56,700

Lisa owned stock in Nulabor Corporation, which originally cost $100,000 She sold the stock for $75,000 plus 10 percent of Nulabor's income in the year of sale plus 10 percent of the next 5 additional years of income. The value of the future income cannot be determined in the year of sale. In the first year, Lisa received payments of $84,000 from the purchaser. What is Lisa's taxable gain in the first year?

The $84,000 is a recovery of capital.

In November 2009, John entered into a contract to deliver goods to a customer in March 2010 for $12,000. John uses the accrual method of accounting for both financial and tax purposes. He collected $8,000 in 2009 and the balance in 2010. John did not have the goods in stock on December 31,2009. The cost of the goods to him is $9,000. How much net inome must John report in 2009?

The income is reported in 2010

Sky Corporation sells service contracts for 12 and 24-month periods. In September 2009, the company sold $8,000 of the 12-month contracts and $10,000 of the 24-month contracts. If the company services each customer each month (October, November, and December 2009), how much income should be reported for 2009 if Sky Corporation follows Rev. Proc. 71-21.

12,000. 3/12 ($8,000)+ $10,000 = $12,000

Vicki owns 25 percent of K&A partnership. The partnership had net income of $200,000. During the year, Vicki withdrew $35,000 from the partnership. What is Vicki's reported share of net income from K&A?

50,000. 25% ($200,000) = $50,000

On July 15, the Board of Directors of Goolwa Corporation declared a $1 dividend payable July 30 to shareholders of record on July 25. As of July 15, Norman owned 1,000 shares. On July 16, he sold 700 shares to Sam for the fair market value, and he gave 300 shares to his son. How much dividend income must Norman report?

300. Norman is taxed on the dividends related to 300 shares because the gift was made afterthe declaration date. He is not taxed on the shares sold.

Dave, an employee of Purple, Inc., is covered by a group term life insurance policy that has a face amount of $60,000. The company pays all the policy premiums, which amount to $500 per year. Accordmg to Reg. Section 1.79-3, the cost of a policy for a man Dave's age is 43 cents per $1,000 per month. How much income should Dave report on his tax return?

51.60. $•43 X [($60,000 - 50,000)/$ 1,000] x 12 months = $51.60

Robert is divorced in the current year. He makes cash payments to his ex-wife of $1,000 per month. When their son, who is in his wife's custody turns 18 years-old, the payments are reduced to 600 per month. How much can Robert deduct as alimony each month?

600. The $400 is a contingent amount related to a child-and, thus, is nondeductible child support.

Nicky goes on a game show, Wheel-of-a-Deal. She wins cash of $15 000 and a new car with a fair market value of $20,000. How much income must Nicky report from these winnings?

35,000. All the winnings are income.

In the current year, Dave receives stock from his employer worth $25,000. The stock cannot be sold by Dave for seven years. Dave estimates that the stock will be worth $60,000 after the seven years. In the current year, how much income must Dave recognize?

0. The stock is restricted property

Hank retired last year after investing $100,000 in an annuity, which pays $12,000 per year. Hank had a life expectancy of ten years at the annuity starting date. What is Hank's income for the current year assuming Hank receives $12,000 during the current year?

2,000. $100,000/($12,000 X 10 years) x $12,000 = $10,000 excluded; $12,000 -10,000 = $2,000 included.

Lany, a cash basis taxpayer, paid $42,000 for an 18-month certificate-of-deposit with a maturity value of $50,000. The effective interest rate on the certificate was 12 percent. If Larry bought the certificate on June 30 of the current year, how much interest income should he report?

2,520. (.12 X $42,000) x 1/2 year = $2,520

Under a divorce decree granted three years ago, Oliver has to pay his ex-wife alimony. The cash payments are as follows:
2008 $32,000
2009 $25,000
2010 $-0-
What is Oliver's alimony deduction for 2008?

32,000. First year alimony is deductible.

Under a divorce decree granted three years ago, Oliver has to pay his ex-wife alimony. The cash payments are as follows:
2008 $32,000
2009 $25,000
2010 $-0-
What is Oliver's alimony recapture for 2010?

D = 25,000 - ($0 + $15,000) = $10,000, E = $32,000 - [($25,000 - $10,000 + 0)/2 +$15,000] = $9,500, R = $10,000 + $9,500 = $19,500

Under a divorce decree granted last year, Vance transfers appreciated property to his ex-wife. The property has a fair market value of $150,000 and an adjusted basis to Miguel of $60,000 If Miguel's ex-wife were to sell the property three years later for $160,000, how much gain should she report?

$160,000-$60,000 = $100,000

Assume during the first six months of the current year the Federal imputed interest rate is nine percent and during the second six months it is ten percent. On January 1, a father gives his son an interest-free loan of $50,000. The son has $5,000 of investment income for the year. For the current year, what is the interest income that the father must recognize, and what amount of interest expense is the son deemed to have incurred?

$4,863 = $2,250 (9% x $50,000 x 1/2 year for January 1 to June 30) + $2,613 (10% $52,250 X 1/2 year for July 1 to December 31)

Assume during the first six months of the current year the Federal imputed interest rate is nine percent and during the second six months, it is ten percent. On January 1, a father gives his son an interest-free loan of $50,000. The son has $5,000 of investment income for the year. How much of a "gift" has the father made to his son?

4,863. The imputed interest is a gift for tax purposes.
$4,863 = $2,250 (9% x $50,000 x 1/2 year for January 1 to June 30) + $2,613 (10% $52,250 X 1/2 year for July 1 to December 31)

Kathy, a cash basis taxpayer gave away Green, Inc. bonds with a face amount of $10,000 to her son. Bill. The bonds have a stated annual interest rate of nine percent. The gift was made on February 10, 2010 and interest was paid to Bill on December 31, 2010. How much interest income must Kathy recognize in 2010?

101. 9% X $10,000 X (41 days/365 days) = $101

Mabel owned the following stock on January 1,2010:
Basis FMV
Red Corp. $200 $220
Yellow Corp. $175 $170
During the year, Mabel sold the Red stock for $215 and the Yellow stock for $180. Mabel's income under the economic concept of income is:

5. Economic income is the change in the FMV of the taxpayer's assets. ($215 - $220) + ($180-$170) = $5

Bob and Sally, a married couple, reside in Arizona. Bob owned an office building prior to their marriage. During the current year, income from the building was 20,000. Bob earned 62,000in wages and Sally earned 44,000 in wages during the current year. At the beginning of the current year, Sally inherited 100,000 from her mother, which she put in a separate account and earned 8,000 of interest. They also have a joint savings account, which earned 4,000 during the current year. What is Bob's gross income for the current year?

Bob's gross income for the current year is $75,000 [($62,000 + $44,000 + $4,000) / 2 + 20,000

Gold Corporation purchased a group term life insurance plan that covered only management and officers of the company. Mr. Gold received $250,000 of life insurance under this plan. Premiums of 43,100 were paid by Gold Corporation for Mr. Gold's insurance. The Uniform Premiums fable amount for each $1,000 of insurance for a man Gold's age is $9 annual. Mr. Gold must include in gross income:

The plan is discriminatory, therefore, the greater of the actual premiums paid or the Uniform Premiums table amount is included in income.

Peg owns a life insurance policy with a face amount of $100 000. On January1, 2010, the policy had a cash surrenderer value of $15,000 and on December 31, 2010, the cash surrender value was $16,500. During the year, Peg paid premiums on the policy of $2 500. What must Peg report from this insurance policy for 2010?

The increase in value is not taxed because of 'substantial restrictions" on the life insurance policy.

Donna, age 54, purchased an annuity for $100,000 under which she is to receive $600 per month for life. Her life expectancy is 29.5 years at the annuity starting date. Thus, her expected return is $600 x 12 x 29.5 = 212,400 and the annual exclusion amount is 3,390[($100,000/$212,400 x$7,200)]. If Donna dies after four years, how much is the deduction (if any) from the annuity on her final return?

$100,000-(4 X $3,390) = $86,440

Bill, age 57, receives an annuity distribution of $600 per month for life from a qualified retirement plan. His investment in the contract is $139,500. How much of each payment is excluded from Bill's income using the Simplified Method for Annuity Distributions from Qualified Retirement Plans?

$139,500 / 310 months = $450

Which of the following dividend distributions would qualify for the 2009 0%/15% long-term capital gain rate?
S corporation dividends
Regular dividends from a publicly traded U.S. corporation
Dividends from a corporation located in a country that does not have a tax treaty with the US

Dividends from publicly traded U.S. corporations are qualified dividends for purposes of the special 2009 0%/15% tax rate.

The U.S. tax law would favor which of the following investments?
Land that is appreciating at 9% per year.
A corporate bond that pays 9% per year.
60-month bank certificate of deposit paying 9%
A 30-year U.S. Treasury bond paying 9% a year.

The annual gain on the land would be deferred while the income on the other investments would be taxed each year.

Damon (a cash basis taxpayer) receives a check from one of his customers on December 25. The check is dated December 28, however, the customer asks Damon not to cash the check until December 30. Damon actually cashes the check on January 2 of the next year. Which of the following dates should Damon recognized the income from the check?
December 25
December 28
December 30
January 2

December 30. The check is income on the date the check can be cashed.

Steve, a cash basis taxpayer, gave his son.,Josh, bonds with a face amount of $20,000 and a 6% stated annual interest rate. The gift was made on January 31, 2010, and the interest was paid on December 31,2010. How much interest income must Steve report in 2010?

$102 = $20,000 X 6% X 31/365.

Accounting income

The accountant's concept of income is generally based upon the realization principle. Financial accounting income may differ from taxable income (e.g., accelerated depreciation might be used for Federal income tax and straight-line depreciation for financial accounting purposes). Differences are included in a reconciliation of taxable and accounting income on Schedule M-1 or Schedule M-3 of Form 1120 for corporations. Seventy-five percent of the excess of adjusted current earnings over alternative minimum taxable income is an adjustment for alternative minimum tax purposes for a corporation. See also alternative minimum tax and economic income.

Accounting method

The method under which income and expenses are determined for tax purposes. Major accounting methods are the cash basis and the accrual basis. Special methods are available for the reporting of gain on installment sales, recognition of income on construction projects (the completed contract and percentage of completion methods), and the valuation of inventories (last-in, first-out and first-in, first-out). §§ 446-474. See also accrual method, cash receipts method, completed contract method, percentage of completion method, etc.

Accrual method

A method of accounting that reflects expenses incurred and income earned for any one tax year. In contrast to the cash basis of accounting, expenses do not have to be paid to be deductible nor does income have to be received to be taxable. Unearned income (e.g., prepaid interest and rent) generally is taxed in the year of receipt regardless of the method of accounting used by the taxpayer. § 446(c)(2). See also accounting method, cash receipts method, and unearned income.

Alimony and separate maintenance payments

Alimony and separate maintenance payments are includible in the gross income of the recipient and are deductible by the payor. The payments must be made in discharge of a legal obligation arising from a marital or family relationship. Child support and voluntary payments are not treated as alimony. Alimony is deductible for AGI. §§ 62(10), 71, and 215. See also child support payments.

Alimony recapture

The amount of alimony that previously has been included in the gross income of the recipient and deducted by the payor that now is deducted by the recipient and included in the gross income of the payor as the result of front-loading. § 71(f ).

Annuity

A fixed sum payable to a person at specified intervals for a specific period of time or for life. Payments represent a partial return of capital and a return (interest) on the capital investment. Therefore, an exclusion ratio must be used to compute the amount of nontaxable income. The exclusion ratio is used until the annuitant has recovered his or her investment in the annuity contract. Thereafter, all of the annuity payments received are included in gross income. If the annuitant dies before his or her investment is recovered, a deduction is allowed. § 72. See also qualified pension or profit sharing plan.

Assignment of income

A procedure whereby a taxpayer attempts to avoid the recognition of income by assigning the property that generates the income to another. Such a procedure will not avoid the recognition of income by the taxpayer making the assignment if it can be said that the income was earned at the point of the transfer. In this case, usually referred to as an anticipatory assignment of income, the income will be taxed to the person who earns it.

Cash receipts method

A method of accounting under which the taxpayer generally reports income when cash is collected and reports expenses when cash payments are made. However, for fixed assets, the cash basis taxpayer claims deductions through depreciation or amortization in the same manner as an accrual basis taxpayer. Prepaid expenses must be capitalized and amortized if the life of the asset extends "substantially beyond" the end of the tax year. See also constructive receipt.

Claim of right doctrine

A judicially imposed doctrine applicable to both cash and accrual basis taxpayers that holds that an amount is includible in income upon actual or constructive receipt if the taxpayer has an unrestricted claim to the payment. For the tax treatment of amounts repaid when previously included in income under the claim of right doctrine, see § 1341.

Community property

Louisiana, Texas, New Mexico, Arizona, California, Washington, Idaho, Nevada, and Wisconsin have community property systems. In Alaska, spouses can choose to have the community property rules apply. The rest of the states are classified as common law jurisdictions. The difference between common law and community property systems centers around the property rights possessed by married persons. In a common law system, each spouse owns whatever he or she earns. Under a community property system, one-half of the earnings of each spouse is considered owned by the other spouse. Assume, for example, Alice and Jeff are husband and wife and their only income is the $50,000 annual salary Jeff receives. If they live in New York (a common law state), the $50,000 salary belongs to Jeff. If, however, they live in Texas (a community property state), the $50,000 salary is divided equally, in terms of ownership, between Jeff and Alice. See also separate property.

Constructive receipt

If income is unqualifiedly available, it will be subject to the income tax even though it is not physically in the taxpayer's possession. An example is accrued interest on a savings account. Under the constructive receipt of income concept, the interest will be taxed to a depositor in the year it is available rather than the year actually withdrawn. The fact that the depositor uses the cash basis of accounting for tax purposes is irrelevant. See Reg. §1.451-2.

Economic income

The change in the taxpayer's net worth, as measured in terms of market values, plus the value of the assets the taxpayer consumed during the year. Because of the impracticality of this income model, it is not used for tax purposes. See also accounting income.

Fruit and tree metaphor

The courts have held that an individual who earns income from property or services cannot assign that income to another. For example, a father cannot assign his earnings from commissions to his child and escape income tax on those amounts.

Gross income

Income subject to the Federal income tax. Gross income does not include income for which the Code permits exclusion treatment (e.g., interest on municipal bonds). For a manufacturing or merchandising business, gross income means gross profit (gross sales or gross receipts less cost of goods sold). § 61 and Reg. § 1.61-3(a).

Group term life insurance

Life insurance coverage permitted by an employer for a group of employees. Such insurance is renewable on a year-to-year basis and does not accumulate in value (i.e., no cash surrender value is built up). The premiums paid by the employer on the insurance are not taxed to an employee on coverage of up to $50,000 per person. § 79 and Reg. § 1.79-1(a).

Hybrid method

A combination of the accrual and cash methods of accounting. That is, the taxpayer may account for some items of income on the accrual method (e.g., sales and cost of goods sold) and other items (e.g., interest income) on the cash method.

Imputed interest

For certain long-term sales of property, the IRS can convert some of the gain from the sale into interest income if the contract does not provide for a minimum rate of interest to be paid by the purchaser. The application of this procedure has the effect of forcing the seller to recognize less long-term capital gain and more ordinary income (interest income). §§ 483 and 1274 and the Regulations thereunder. In addition, interest income and interest expense are imputed (deemed to exist) on interest-free or below-market rate loans between certain related parties. § 7872. See also interest-free loans.

Income

For tax purposes, an increase in wealth that has been realized.

Original issue discount (OID)

The difference between the issue price of a debt obligation (e.g., a corporate bond) and the maturity value of the obligation when the issue price is less than the maturity value. OID represents interest and must be amortized over the life of the debt obligation using the effective interest method. The difference is not considered to be original issue discount for tax purposes when it is less than one-fourth of 1 percent of the redemption price at maturity multiplied by the number of years to maturity. §§ 1272 and 1273(a)(3).

Partnerships

A partnership is treated as a conduit and is not subject to taxation. Various items of partnership income, expenses, gains, and losses flow through to the individual partners and are reported on the partners' personal income tax returns. §§ 701 and 702.

Recovery of capital doctrine

When a taxable sale or exchange occurs, the seller may be permitted to recover his or her investment (or other adjusted basis) in the property before gain or loss is recognized. See also open transaction.

Taxable year

The annual period over which income is measured for income tax purposes. Most individuals use a calendar year, but many businesses use a fiscal year based on the natural business year. See also accounting period and fiscal year.

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