1. 3-1 ©2009 Pearson Education, Inc. Publishing as Prentice Hall

2. 3-2 GROSS INCOME: INCLUSIONS (1 of 2)  Economic and accounting concepts of income  Tax concept of income  To whom is income taxable?  When is income taxable?  Items of gross income ©2009 Pearson Education, Inc. Publishing as Prentice Hall

3. 3-3 GROSS INCOME INCLUSIONS (2 of 2)  Other items of gross income  Tax planning considerations  Compliance and procedural considerations ©2009 Pearson Education, Inc. Publishing as Prentice Hall

4. 3-4 Concepts of Income Economic Concepts of Income  Wealth that flows to individuals  Changes in value in individuals’ wealth  Unrealized gains  Gifts & inheritances considered income ©2009 Pearson Education, Inc. Publishing as Prentice Hall

5. 3-5 Concepts of Income Accounting Concepts of Income  Accounting concepts of income  Values are measured by a transaction approach  Income realized as result of completed transactions  Use historical cost ©2009 Pearson Education, Inc. Publishing as Prentice Hall

6. 3-6 Tax Concept of Income  Conditions to make income taxable  Administrative convenience  Wherewithal to pay  Gross income defined ©2009 Pearson Education, Inc. Publishing as Prentice Hall

7. 3-7 Conditions to Make Income Taxable  Economic benefit to taxpayer  Income must be realized  Earnings process complete  Income must be recognized ©2009 Pearson Education, Inc. Publishing as Prentice Hall

8. 3-8 Administrative Convenience  Economic concept is considered too subjective  Objectivity achieved at price of equity ©2009 Pearson Education, Inc. Publishing as Prentice Hall

9. 3-9 Wherewithal to Pay  A tax should be collected when the taxpayer can most easily pay ©2009 Pearson Education, Inc. Publishing as Prentice Hall

10. 3-10 Gross Income Defined (1 of 2)  Section 61(a) defines gross income  “all income from whatever source derived,” including (but not limited to) the following items:  Compensation, income derived from business, gains from dealings in property, interest, rents, royalties, dividends, alimony, annuities, life insurance, pensions ©2009 Pearson Education, Inc. Publishing as Prentice Hall

11. 3-11 Gross Income Defined (2 of 2)  Form of receipt  Gross income not limited to cash  §1.61-1a, income may be “realized in any form, whether in money, property, and services”  Indirect economic benefit  Items indirectly benefiting taxpayers excluded from gross income ©2009 Pearson Education, Inc. Publishing as Prentice Hall

12. 3-12 To whom Is Income Taxable?  Assignment of income  Allocating income between married people  Income of minor children ©2009 Pearson Education, Inc. Publishing as Prentice Hall

13. 3-13 Assignment of Income  Supreme Court in Lucas v. Earl (1930)  Ruled that individual taxed the earnings from his personal services  Helvering v. Horst (1940)  Ruled that assignment of income doctrine applies to property ©2009 Pearson Education, Inc. Publishing as Prentice Hall

14. 3-14 Allocating Income between Married People (1 of 2)  Common law property system  Used in 42 states  Income taxed to person who earns it or who owns the income-producing property  Joint income comes from jointly owned property ©2009 Pearson Education, Inc. Publishing as Prentice Hall

15. 3-15 Allocating Income between Married People (2 of 2)  Community property states  All income deemed to be earned equally by spouses except income from separate property  Separate property  Property owned by each spouse prior to marriage  May be community income or separate income, depending on state of residence ©2009 Pearson Education, Inc. Publishing as Prentice Hall

16. 3-16 Income of Minor Children  Taxed to child regardless of state’s property law system  Unearned income of minor under 24 may be taxed at parent’s higher rate  See Chapter I2 ©2009 Pearson Education, Inc. Publishing as Prentice Hall

17. 3-17 When Is Income Taxable?  Cash method  Accrual method  Hybrid method ©2009 Pearson Education, Inc. Publishing as Prentice Hall

18. 3-18 Cash Method (1 of 3)  Used by most individual taxpayers and most non-corporate businesses that do not have inventory  Constructive receipt  Report income in year actually received  Check received after banking hours  Bond interest coupons that have matured but not redeemed ©2009 Pearson Education, Inc. Publishing as Prentice Hall

19. 3-19 Cash Method (2 of 3)  No constructive receipt if  It is subject to substantial limitations  Payor does not have funds necessary to make payment  Amount is unavailable to taxpayer ©2009 Pearson Education, Inc. Publishing as Prentice Hall

20. 3-20 Cash Method (3 of 3)  Exceptions to basic cash method  Interest on Series E or EE Savings Bonds  Special rules apply to farmers and ranchers  Small taxpayer exception for inventories ©2009 Pearson Education, Inc. Publishing as Prentice Hall

21. 3-21 Accrual Method  Report income in year income earned  Right to income  Amount can be determined with reasonable accuracy  Prepaid income  Generally taxable ©2009 Pearson Education, Inc. Publishing as Prentice Hall

22. 3-22 Hybrid Method  Accrual method for purchases and sales  Cash method in computing all other income and expenses ©2009 Pearson Education, Inc. Publishing as Prentice Hall

23. 3-23 Items of Gross Income (1 of 2)  Compensation  Business income  Gains from dealings in property  Interest  Rents and royalties  Dividends ©2009 Pearson Education, Inc. Publishing as Prentice Hall

24. 3-24 Items of Gross Income (2 of 2)  Alimony and separate maintenance payments  Pensions and annuities  Income from life insurance and endowment contracts  Income from discharge of indebtedness  Income passed through to taxpayer ©2009 Pearson Education, Inc. Publishing as Prentice Hall

25. 3-25 Dividends (1 of 3)  Included in shareholder gross income  Results in double taxation  Earnings taxed at corporate level  Earnings taxed at shareholder level when distributed as a dividend  C corps allowed a 70, 80, or 100% div received deduction based on ownership %  Relief from multiple levels of taxation ©2009 Pearson Education, Inc. Publishing as Prentice Hall

26. 3-26 Dividends (2 of 3)  Individuals taxed at 15% on dividends  5% if in 10% or 15% tax bracket  Reduces effects of double taxation  Distributions to extent they are out of corporate earnings and profits  Stock dividends  Not taxable  Basis in stock allocated to new shares ©2009 Pearson Education, Inc. Publishing as Prentice Hall

27. 3-27 Dividends (3 of 3)  Stock dividends  Not taxable  Basis in stock allocated to new shares  Capital gain dividends  Taxed at long-term capital gain rates  Constructive dividends  Taxed as regular dividends ©2009 Pearson Education, Inc. Publishing as Prentice Hall

28. 3-28 Annuities  Income portion of annuity taxable  Investment portion is excluded  Exclusion ratio  Basis in annuity ÷ Expected return  Expected return  Payment x # of expected payments ©2009 Pearson Education, Inc. Publishing as Prentice Hall

29. 3-29 Income Passed Through to Taxpayer  Income from flow-through entities taxed directly to owners  Income from partnership  Income from S corporation  Income in respect of a decedent  Income from an estate or trust  Income from RIC or REIT ©2009 Pearson Education, Inc. Publishing as Prentice Hall

30. 3-30 Other Items of Gross Income (1 of 2)  Prizes, awards, gambling winnings, and treasure finds  Illegal income  Unemployment compensation  Social Security benefits  Insurance proceeds and court awards ©2009 Pearson Education, Inc. Publishing as Prentice Hall

31. 3-31 Other Items of Gross Income (2 of 2)  Recovery of previously deducted amounts  Claim of right ©2009 Pearson Education, Inc. Publishing as Prentice Hall

32. 3-32 Social Security Benefits  The portion of social security benefits depends on the taxpayer’s provisional income  Up to 85% of benefits taxable  See pages 3-24 and 3-25 for formula ©2009 Pearson Education, Inc. Publishing as Prentice Hall

33. 3-33 Claim of Right  Revenue received that is disputed must still be reported as income  Previously reported income that is subsequently refunded is deductible ©2009 Pearson Education, Inc. Publishing as Prentice Hall

34. 3-34 Tax Planning Considerations (1 of 2)  Shifting income  From high income family members to low income family members  Alimony  Deductible by payor and includible by payee  Prepaid income ©2009 Pearson Education, Inc. Publishing as Prentice Hall

35. 3-35 Tax Planning Considerations (2 of 2)  Taxable, tax-exempt, or tax-deferred bonds  Need to compare present value of after-tax returns  Reporting savings bond interest  Deferred compensation arrangements ©2009 Pearson Education, Inc. Publishing as Prentice Hall

36. 3-36 Compliance and Procedural Considerations  Form 1040 – Wages, salaries and tips  Schedule B – Interest and Dividends  Schedule C – Business Income  Schedule D – Capital gains  Schedule E – Rents and Royalties  Schedule F – Farm Income ©2009 Pearson Education, Inc. Publishing as Prentice Hall

37. Comments or questions about PowerPoint Slides? Contact Dr. Richard Newmark at University of Northern Colorado’s Kenneth W. Monfort College of Business richard.newmark@PhDuh.com 3-37 ©2009 Pearson Education, Inc. Publishing as Prentice Hall