Gross Income Concepts & Inclusions
Income • “If it comes in, it’s income.” • Generally must be a transfer or transaction. • When Mark McGwire hit his 62nd homerun, a groundskeeper retrieved the ball. A collector offered him $1Mil. For the ball. Is the ball taxable to the groundskeeper? • Subsequently, the groundskeeper gave the ball to McGwire. Should he now pay gift tax?
Whose Income? • Fruit of the tree doctrine • Community property • Not followed if spouses live apart for the entire year, are not MFJ, do not transfer income between them • Alimony (review),* not including front-end loading which must be recaptured • Property placed in trust • Flow-through income • S-Corporation (1120S) • Partnership, LLC (1065)
Sample Test Question • 11. F’s share of income from various sources is as follows for the current year: Source F’s share F’s Dist. ABC Partnership after partner’s salary $ 6,000 $ 9,000F’s salary from ABC Partnership n/a 30,000XYZ Corporation, a C corporation 80,000 10,000Interest from bank savings account 40,000 n/aF’s A.G.I. (ignoring the deduction for one‑half of any self‑employment tax) is how much?a. $89,000b. $156,000c. $86,000d. $56,000
Robert Lucas wins the Nobel Prize! • …and received $1Mil. In 1995. • However, when he divorced in 1988, he agreed to give his wife ½ should he win before 10/31/95. • He won 10/10/95. • The terms of the agreement are sealed, but worst case: he’s taxed on all, and left with…. • $100,000 at a 40% state & fed rate
Income • Income recognized under either cash or accrual basis, as prescribed by law or by hybrid method where allowed • Cash basis: • Cash method includes “constructive receipt.” • Payment can be made with borrowed funds: • Credit card expenses deductible when charged • Prepayments of expenses for longer than 1-year must be amortized. • Valued at FMV of most objective side of transaction • Note receivable is consideration for cash basis taxpayer; A/R is not. • Original Issue Discounts (OID): cash basis taxpayer taxed same as accrual basis • Restricted property not recognized until lapse • Straddles not recognized until closed
Accrual Basis Income • Corporations must use accrual unless less than <$5mil in gross receipts • Many exceptions that accelerate income recognition and defer expense recognition • Prepaid income in year of receipt if prepaid longer than one year • Prepaid rent, generally year of receipt • Prepaid interest, generally year of receipt • All events test for deductions • Recurring expenses often allowed • Reserves (e.g. bad debts, warranties) generally not allowed.
Hybrid Method • Accrual for sales & inventory items • Cash for all other expenses
Sample Question • 16. T Corporation manufactures the Banana, a clone of a popular computer. Its gross receipts for the last several years have averaged $4 million. Which of the following accounting methods can T adopt?a. The cash method to account for all receipts and disbursements.b. The accrual method to account for all receipts and disbursements is the only method allowed.c. The cash method for some items and the accrual method for other items as it desires.d. The cash method for some items but is required to use the accrual method for other items.
Watch for Income… • That is imputed • OID • Prizes & awards • Below market loans: Gift loans > $10,000, employee loans, shareholder loans • Incident to divorce
TV Tax • Reba’s husband, Brock is a dentist who divorces her to marry his pregnant dental hygienist, leaving her with their 3 children. She gets the house in the settlement. • Describe the difference between community property & common law states • How is alimony, if any, treated? • How is child support treated? • How is a 5-year distribution of marital property for her share of the value of his practice treated?
Sample Question • 17. L purchased twenty REX Corporation bonds on March 5 for $21,120. The bonds have a $1,000 par value and pay interest at an annual rate of 10 percent semiannually on January 1 and July 1. On July 1, L received his first interest check of $1,000. Immediately after he received the interest payment, which of the following is true?a. His basis in the bonds is $21,120.b. His interest income is more than $1,000.c. His interest income is less than $1,000.d. His basis in the bonds is more than $21,120.
Below Market Loans • Gift loan first creates interest income/expense to donor/donee. • Then, donor gives interest back to donee (additional gift). • Compensation loan creates interest income/expense to employer/employee • Then, when the employer is not pd, is “written off” as compensation expense. • Shareholder loan creates interest income/expense to corporation/shareholder. • Then, interest income is paid back to shareholder as a dividend. • Exception: between individuals unless for tax avoidance: loans of $100,000 or less are limited to: • Investment income • $0 if borrower’s investment income is < $1,000.
Sample Test Question • 18. The application of Code § 7872 to interest‑free or below‑market loans has certain tax consequences for the lender and borrower. They includea. the borrower may be allowed an itemized deduction for the interest hypothetically paid to the lender.b. the lender is not required to report the hypothetical payment as interest income until the loan is repaid.c. the borrower treats the hypothetical payment as earned income.d. the lender is deemed to have made a completed gift of the loan amount.
Gross Income • Income less exclusions • Exclusions include: • Gifts & inheritances • Tax-exempt income • Most welfare/social aid • Property transferred incident to divorce • Child support • Most scholarships • Employee achievement awards *if* personal property *and* for length of service or achievement • $50,000 group term life insurance coverage • 1st 230 per month for carpooling and transit passes
NOT Excluded • Unemployment payments above $2,400 • Some Social Security benefits: • First $25,000 S; $32,000 MFJ of AGI + foreign income exclusion and tax-exempt income, exempt • Amt over exemption up to $34,000S, $44,000 MFJ: 50% benefits is taxable • Amt over above: 85% benefits taxable
Boardwalk:McDonalds => St. Judes • One individual received the exclusive Boardwalk ticket in the McDonalds Monopoly give-away • Coupled with an easily found Park Place, s/he mailed the pieces to St. Judes. Tax implications? • Exempt if: Transferred to gov’t. or qualified NFP *and* no action to enter contest *and* not req’d. to serve further.
Annuities • Part income, part return of capital • Fixed period annuity • Annuity for life • Reconciliation to actual life
Sample Question • 19. B, who is single and 59 years old, purchased a single premium immediate annuity on January 1 of the current year for $12,000 that will pay him $100 every month for life beginning on January 15. Based on actuarial tables published by the IRS, his life expectancy multiple is 25.0. B’s nontaxable return of capital for the current year isa. $0.b. $1,200.c. $480.d. $720.
Percentage Completion • Used only for long-term construction contracts • Generally not home-builders • Similar to GAAP accounting: • Figure % of total costs spent to date • That much revenue should be recognized to date; matching costs to revenue.
Cancellation of Indebtedness • 1099s • Unless bankruptcy or some foreclosures • In some cases, recognized over 5 years