Chapter 4
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Chapter 4. Gross Income - Exclusions. Major Statutory Exclusions. Gifts and inheritances Scholarships and fellowships Life insurance proceeds Awards for Meritorious Achievement Distributions from Qualified State Tuition Programs Payments for Injury and Sickness

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Chapter 4 l.jpg

Chapter 4

Gross Income - Exclusions


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Major Statutory Exclusions

  • Gifts and inheritances

  • Scholarships and fellowships

  • Life insurance proceeds

  • Awards for Meritorious Achievement

  • Distributions from Qualified State Tuition Programs

  • Payments for Injury and Sickness

  • Foreign earned income exclusion


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Major Statutory Exclusions - cont’d

  • Employee Benefits

    • Adoption Expenses

    • Meals and Lodging

    • Meals and Entertainment

    • Dependent Care

    • Educational Assistance

    • Cafeteria Plans

  • Certain Income from discharge of indebtedness

  • Exclusion for gain from small business stock


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Gifts and Inheritances

  • Transfers of property with donative intent are excludable from gross income whether made during life (gift) or at death (inheritance)

  • Income earned from such property is subject to the income tax rules


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Scholarships and Fellowships

  • Scholarships for tuition, fees, books, supplies, and equipment are excluded for degree candidates

  • Amounts received for room and board are includible in gross income


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Life Insurance Proceeds

  • Life insurance proceeds paid for reason of death of the insured are excludible

  • Amounts in excess of face value are taxable

  • Policies purchased from another individual treated as investment

  • If surrendered, excess of proceeds over premiums paid is taxable

    • exclusion is available for accelerated death benefits paid to terminally ill person

  • Dividends earned on life policies are nontaxable to extent of premiums paid

    • Interest earned on the dividends is taxable


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Awards for Meritorious Achievement

  • Awards are generally taxable

  • Awards for religious, charitable, scientific, educational, artistic, literary, or civic achievement are excluded from income if taxpayer:

    • did not enter the contest

    • is not required to perform substantial additional services

    • designates a qualified charitable organization to receive the payment


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Scholarships and Fellowships

  • Scholarships for tuition, fees, books, supplies, and equipment are excluded

  • Amounts received for room and board must be included in gross income


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Distributions from Qualified State Tuition Programs

  • Distributions made from qualified state tuition programs are taxable only to the extent they exceed donor contributions

  • 2001 Tax Act

    • Expanded scope of qualified tuition plans to include private institutions

    • Distributions from state-sponsored plans will be excludable if made in 2002 and after

    • Distributions from non-state programs will be excludable if made in 2004 and after


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Payments for Injury and Sickness

  • Amounts received for physical injury or physical sickness are excluded whether paid by insurance or from damages

  • Damages on nonphysical injury are taxable

  • Punitive damages are taxable


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Employee Benefits

  • Adoption Expenses

    • An employee is allowed a $5,000 per child exclusion for qualified adoption expenses paid by employer

    • Exclusion increases for child with special needs and phased out at high AGI levels

    • Alternate adoption credit is available (Chapter 14)


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Employee Benefits

  • Meals and Lodging

    • Employer provided meals and lodging are excluded if

      • provided on the employer’s premises

      • for the convenience of the employer

      • and, for lodging to be excludible the employee is required go accept the lodging as a condition of employment


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Employee Benefits

  • Meals and Entertainment

    • Only 50% of the cost of meals and entertainment are excludible

  • Dependent Care

    • Up to $5,000 of dependent care provided by employer is excludible

  • Educational Assistance

    • Up to $5,250 of employer paid undergraduate educational reimbursement is excludible

    • Under the new tax law this exclusion has be extended to include graduate expenses incurred after 12/31/2001 and the provision has been made permanent


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Employee Benefits

  • Cafeteria Plans

    • Employees may select from cash or nontaxable fringe benefits

    • Two types of plans

      • Supplemental wage plans

      • Wage reduction plans

  • Employee Achievement Awards (non cash)

    • Awarded for length of service and safety

    • Employee achievement - limited to $400 value each

      • for length of service must be more than 5 years

    • Qualified plan awards (e.g. safety)

      • limited to $1,600 max and $400 average per employee


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Employee Benefits

  • Section 132 Fringe Benefits (Table I4-2)

    • No additional cost

    • Employee Discounts

      • Services limited to 20%

      • Merchandise limited to gross profit %

    • De minimis - so small accounting is unreasonable

    • Qualified transportation

      • Limited to $175/mo. parking and $65 for other

    • Recreation and athletic facilities


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Foreign Earned Income Exclusion

  • U.S. citizens can exclude $76,000 of foreign- earned income in 2000 in lieu of taking the foreign tax credit

  • Both spouses can take the exclusion if each has sufficient earned income

  • If change from exclusion method to credit method may not change back for 5 years without approval

  • Must prorate unless TP is resident of foreign country for entire tax year or 330 days during 12 consecutive months

  • Deductions directly attributable to foreign income are disallowed

  • Additional exclusion for high housing costs


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Income from Discharge of Indebtedness

  • General Rule: income is recognized on a discharge of indebtedness

  • Exception when:

    • Discharge is a gift

    • Discharge is a bequest (forgiven through will)

    • Discharge occurs in bankruptcy

    • Discharge occurs when TP is insolvent and discharge does not make TP solvent (but, must reduce tax attributes)

    • Discharge is from student loan for certain approved post-education employment


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Exclusion for Gain from Small Business Stock

  • Noncorporate TP’s may exclude 50% of the gain on disposition of certain qualified small business stock:

    • must be issued after August 10, 1993

    • held more than 5 years

    • a C corporation with not more than $50 million of gross assets, with 80% of value of assets used in active trade or business

    • Cannot be professional services, financial services, hospitality, mining/oil/gas production

    • Exclusion limited to $10 million or 10 times basis of stock disposed of during year.


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Holocaust Restitution Payments

  • Restitution payments received after 1999 by victims of Nazi persecution or their heirs or estates are not includable in gross income for federal income tax purposes

    • 2001 Tax Act change


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