Chapter 4 – Gross Income
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Cash v Accrual (pages 4-1 to 4-17) …… “exceptions to”
Community Property
Alimony / Child Support
Annuities
Prizes / Awards
Group Term Life
Gifts to Individuals and Employees
Social Security Benefits
Problem 29
Economic Income
(vs Accounting)
Problem 30
• Bought House 1984 for $125,000 ……..
FMV today is $250,000.
Do I have taxable income?
• Bought 1,000 shs of Starbucks in 1992 for
$10,000.
FMV today is $150,000.
Do I have taxable income?
When is income RECOGNIZED?
There must be a transaction (sale) to have recognized income
Problem 31
Tax Years
Cash Basis versus Accrual Basis
Problem 41
Problem 35
• Know the tax year (fiscal or calendar).
• Issues: j When was the income earned?
k When was the payment received?
• Are we (individuals) cash basis taxpayers or accrual
basis taxpayers?
Tax Years
Cash Basis versus Accrual Basis (con’t)
• Example: Springs Inds. declares a
dividend on December 15th (declaration date)
for shareholders of record on December
20th (date of record). The dividend is paid on
December 30th (payment date).
• Harry Emerson receives the dividend of $1,000
in the mail on January 3rd.
When is the dividend taxable to HBE?
Exceptions to Cash Basis
Problem 35, 41
• Constructive Receipt Doctrine –
income has not been received but
taxpayer has the right to receive.
• Employee can “contract” for services
that he has not yet earned. This is done
prior to the beginning of the year.
• Note concept of Substantial Limitation.
Exceptions to Cash Basis
Problem 55
(con’t)
• Loans – loans are an exception to the
cash basis of accounting and the
constructive receipt of doctrine. Loans
are not taxable. There is an obligation to
repay.
What if obligation is relieved?
i.e “forgiveness of indebtedness”
Exception to Accrual Basis
• Prepaid Income – included in income in the year of
receipt …….. prepaid rent is the best example. Except
for this exception, accrual basis taxpayers would not
recognize income until it was “earned”.
• Advance Payment for Services – Income
recognition is deferred if payment is made for
services to be performed on or before the end of the
tax year following receipt, but not more than one tax
year beyond year of receipt.
example: Calendar year taxpayer. Payment received
on July 1, 2003 for services to be performed over the
next 36 months.
Income Sources
(p. 3-14 to 3-16)
Problem 30
• Income and the resulting tax liability cannot be
“assigned”. Lucas versus Earl
• Services performed by an employee for the employer
is considered performed by the employer.
• Interest accrues daily on bonds, so when there is a
sale, income has to be allocated.
• Dividends do not accrue daily ….. considered earned
on the date of record. Corporations pay tax on
earnings. Shareholders pay tax on dividends that are
paid to them.
Problem 42
Income Sources
(p. 3-14 to 3-16) con’t
• Agents – income received by an agent is
considered received by the taxpayer.
• Partnerships, S-Corps, Trusts -- the
entity is not taxed. Rather, the income and
deductions are passed through to the
partners, shareholders or beneficiaries.
Community Property States
Problem 44
• There are 10 “community property” states
(mostly western states). The remaining
states are “common law” states.
• Separately owned property – either acquired
before the marriage or received during the
marriage by gift or inheritance.
• Marital Property – All other property; that
which is acquired during the marriage.
Community Property States (con’t)
• Wages belong to the community – split 50/50
• Unearned income (interest & dividends) on
marital property is split 50/50.
• Unearned income on separate property is
treated two different ways:
• Texas – income is considered community
property despite the fact that the property is
individually owned.
• California – income is not split 50/50, but is
taxed to the spouse that owns the property
Alimony
Problem 45
Problem 47
• Income to the recipient and deductible for AGI by
the payor.
• Must have characteristics of alimony versus a
property settlement.
• Payments must be in cash.
• Agreement does not say payments are not
alimony.
• Payor and Payee do not live together.
• Not required to be paid after death of recipient.
Child Support
• No income recognized by the recipient; no
deduction to the payor.
• Payments usually ceases when child reaches
majority.
Below Market Loans
• Below market amount is deemed to be income (or gift
received) to the recipient and interest expense (or gift
paid) by the lender.
• Government publishes going rate (Applicable Federal
Rates or AFR). Note 3 different rates.
• Considered to be gifts between family members,
compensation (W-2) between ER / EE, and dividend
between shareholder / corp.
• Loans whose principle purpose is tax
avoidance are not recognized by the Service.
Below Market Loans (page 4-26)
• Exception for loans between individuals of
less than $10,000
• Exceptions for loans between individuals of
less than $100,000 where investment
income of the recipient is < $1,000.
• Exception for loans between corporation
and employee where loan is < $10,000.
Annuties
Workbook 10, 11, 12
Problem 23, 52
• Purchaser pays a fixed amount for a future stream
of payments. Income not recognized until the
taxpayer begins to receive payments.
Example: Taxpayer purchases for $100,000 a 20 year annuity
from an insurance company. The annuity pays taxpayer $1,000
per month for 24 months.
What is the basis?
What is the profit?
Recovery of Capital Doctrine – page 4-6
Annuities (continued)
Problem 52
• Same example …………
• How much of each payment is includable in
income?
• Assume annuity starts on October 15th, 2005.
How much income is included for 2005?
How much income is included for 2006?
• Investment
Expected Return
X
Annuity Payment
=
Exclusion
Annuities (continued)
• How do we handle lifetime annuities?
(answer: use tables p. 4-29
and 4-30)
• What happens when the recipient outlives the life expectancy?
• What happens when the recipient dies early (what happens
tax-wise)?
Age 54. Paid $90,000 for a lifetime annuity of $500 per month.
Taxation of Social Security
• For low income taxapayers (income <
$25,000), social security is not taxable.
• For higher income taxpayers (say, income >
$44,000), 85% of social security is taxable.
• There is a complicated formula in which
part of the social security is taxable. The
computer handles this fantastically.
• For purposes of calculating income, inlcude
one-half of the social security benefit and
tax free interest.
Prizes and Awards
Problem 53
• Generally, included in income.
• Exception:
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Prize is in recognition of religious, charitable, et. al.
Prize given to a nonprofit
Recipient did not enter contest or apply for the prize
Recipient not required to perform services.
• 2nd Exception:
• Employee Achievement Awards ……… < $400
• Recognition for length of service or safety
Miscellaneous Other
(p. 3-31)
Workbook 15, 16
• Group Term Life – First $50,000 of premiums
tax exempt …… balance is added to W-2. See
chart on p. 4-32.
• Unemployment Compensation – taxable