Gross Income: Inclusions Chapter 3 Gross Income: Inclusions

Learning Objectives Explain the difference between economic, accounting, and tax concepts of income Explain the principles used to determine who is taxed on a particular item of income

Learning Objectives Determine when a particular item of income is taxable under both the cash and accrual methods of accounting Apply the rules of sec. 61(a) to determine whether such items as compensation, dividends, alimony, and pensions are taxable

Learning Objectives Determine when a particular item of income is taxable under both the cash and accrual methods of accounting Apply the rules of sec. 61(a) to determine whether such items as compensation, dividends, alimony, and pensions are taxable 2

Concepts of Income ECONOMIC ACCOUNTING wealth that flows to individuals changes in value in individuals’ wealth unrealized gains gifts & inheritances are considered income ACCOUNTING values are measured by a transaction approach income realized as a result of completed transactions use historical cost 3

Tax concept of Income The tax concept of income has adopted the accountant’s concept of income. The reasons for this generally relates to Administrative convenience concept Wherewithal to pay concept 4

Tax Concept Of Income Administrative convenience concept the economic concept is considered too subjective. Objectivity is achieved at the price of equity.

Tax Concept Of Income Wherewithal to pay concept A tax should be collected when the taxpayer can most easily pay.

Gross Income Defined Section 61(a) defines gross income as “all income from whatever source derived,” including (but not limited to) the following items: Compensation for services, fees, commissions, and similar items Gross income derived from business Gains from dealings in property Interest 5

Gross Income Defined Rents Royalties Dividends Alimony and separate maintenance agreements Annuities Life insurance and endowments Pensions Income from discharge of indebtedness Distributive share from partnership Income in respect of a decedent Income from an interest in an estate or trust 6

Gross Income Defined Gross income is not limited to amounts received in the form of cash. Reg. Sec. 1.61-1a, income may be “realized in any form, whether in money, property, and services.”

To Whom Is Income Taxable ? Assignment of income Supreme Court in Lucas vs. Earl ruled that individual is taxed on the earnings from his or her personal services. 7

Assignment of Income Allocating income between Married People Community Property Common Law Earnings of a minor child are taxed to the child. 8

When is Income Taxable Taxpayer’s accounting method Cash method is used by most individual taxpayers and most non-corporate businesses that do not have inventory. 9

When Is Income Taxable? Constructive receipt - a taxpayer must report income in the year in which it is actually received. A check received after banking hours Interest credited to a bank savings account Bond interest coupons that have matured but have not been redeemed.

When Is Income Taxable? It is not considered to be constructively received if: It is subject to substantial limitations The payor does not have the funds necessary to make payment. The amount is unavailable to the taxpayer.,

When Is Income Taxable? There are exceptions to the basic rule: Interest on Series E or EE Savings Bonds Special rules apply to farmers and ranchers Small taxpayer exception for inventories

Accrual Method Report income in the year income is earned Right to income Amount can be determined with reasonable accuracy Prepaid income Generally taxable 11

Hybrid Method Accrual method for purchases and sales Cash method in computing all other income and expenses 12

Item of Gross Income Sec. 61(a) Compensation Business income Gains from property Interest Rents & royalties Dividends Alimony & separate maintenance 13

Item of Gross Income Sec. 61(a) Pensions & annuities Life insurance & endowment contracts Discharged indebtedness Income passed through to taxpayer 14

Other Items of Gross Income Prizes and Awards Gambling Winnings Treasure Finds 15

Other Items of Gross Income Illegal income Ransom Bookmaking Sale of narcotics Bribes Unemployment compensation Social Security benefits 16

Social Security Benefits The portion of social security benefits depends on the taxpayer’s provisional income See page 3-24 for formula. 17

Other Items of Gross Income Insurance proceeds Court awards Recovery of previously deducted amounts (State income tax refunds if taxpayer itemized the previous year) Claim of right 18

Tax Planning Considerations Shifting income from family members who are in a high tax bracket to family members who are in low tax brackets Alimony Prepaid income 19

Tax Planning Considerations Taxable, Tax-exempt or tax deferred bonds Savings bonds interest Deferred compensation 19

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 20