Chapter 4 Exclusions from Income

Chapter 4 Exclusions from Income
Accounting 421 Chapter 4 Exclusions from Income 9/22/05 Chapter 4

Gross Income - Exclusions
Exclusions are statutory; without a statute that provides for the specific exclusion it does not exist. They are a grant of “legislative grace.” 9/22/05 Chapter 4

Gifts and inheritances - property received through an inter-vivos or testamentary transfer are not taxable to the recipient. Why? Because Congress says so! Note: Income earned on gifted property is subject to income tax. 9/22/05 Chapter 4

Life insurance - The death benefit of a life insurance policy is not taxable to the recipient. Benefits that are paid in the form of an annuity are taxable on in any increase in value over the face amount of the policy Withdrawals of cash surrender value from a life insurance policy are generally not taxable Accelerated payment of proceeds for certain medical purposes are not taxable – special rules apply Dividends on mutual policies are a reduction in premium cost 9/22/05 Chapter 4

Awards for meritorious achievement - the exclusion applies in the following circumstances award or prize was for religious, charitable, scientific, educational, artistic, literary, or civic achievement the recipient was selected without action on his/her part the recipient is not under an obligation to perform substantial future services as a condition to receiving the award or prize the recipient designates a charity or government to take the money 9/22/05 Chapter 4

Scholarships amounts received by a degree seeking, undergraduate or graduate student for qualified tuition, books, fees, supplies, instructional equipment and related costs Note: the exclusion does not apply to room and board awards - it also does not apply to amounts received as compensation for teaching, research or similar service, even if such teaching, research or similar service is required to receive the degree 9/22/05 Chapter 4

Payments for sickness or injury payments for personal injuries Compensatory damages for a: physical injury - amount excluded non-physical injury - amount not excluded Punitive damages are always includable in income Worker’s compensation payments are for physical injury therefore not includible in income 9/22/05 Chapter 4

Medical payments are always excludible from income – Examples of payments - employer payments of premiums to insurance company payments to health services providers, Drs. hospitals, etc by insurance co or employer reimbursements to taxpayers for medical service costs paid by taxpayer from employer or insurance company Sick pay - in lieu of wages – therefore taxable Disability payments from an insurance policy – depends on who paid the premium? 9/22/05 Chapter 4

Employee fringe benefits a special benefit offered as a part of compensation. Sec. 61 includes the value of the fringe in gross income. Several statutes set forth exceptions to the rule of Sec 61 $100 in fringe benefit is better for an employee than $100 in compensation because the latter is taxable and the former is not - the after tax yield is considerably greater for fringes benefit payments 9/22/05 Chapter 4

Employee fringe benefits Some, but not all, fringe benefit exclusion rules contain a non-discrimination provision. Discrimination, for this purpose, is discrimination against the lower paid employees in favor of higher paid. That means that a fringe benefit may not be offered to executives unless offered to rank and file employees Discrimination is tested using employee coverage percentages; 70-80% But, what happens if 70% of the employees do not want to participate in a benefit plan, for example a child care fringe? 9/22/05 Chapter 4

Employee fringe benefits Cafeteria plan - Sec 125 plans were created to address the discrimination requirements for fringe benefits. The cafeteria plan is an umbrella under which individual fringe benefits are placed. Child care, life insurance, health insurance etc are individual plans under Sec 125 If 70-80% of the employees participate in the cafeteria plan then all the individual plans under it automatically meet the discrimination requirements. Therefore, a company may have a child care benefit plan that is non-discriminatory despite having fewer than 70% of its employees participating. 9/22/05 Chapter 4

Employee benefit plans Cafeteria plans Cash or deferral arrangement - CODA Salary reduction agreements - SRA 9/22/05 Chapter 4

Employee fringe benefits - Employer paid insurance - medical, dental, vision, disability, life insurance, accidental death, long term care and other insurance products are provided by some employers. If the cafeteria plan meets the fringe benefit exclusion rules the employer gets a current deduction for the premiums and the employee is free to taxation on the economic benefit provided. The rules must be carefully followed or the exclusion will not apply Generally, the exclusions are from both income tax and payroll tax 9/22/05 Chapter 4

Employee benefit plans Sec 79 group term life insurance exclusion. Group - non-discrimination requirement Term insurance only pure mortality Limit is the value of insurance on the first $50k in insurance - see table for inclusion of greater amounts Example - Employee, age 33, $150,000 in life insurance has current taxation of $8.00/month - see Uniform table The value of other life insurance is included in the employee’s compensation 9/22/05 Chapter 4

Employee fringe benefits Medical, dental, vision and related health insurance policies - the value of these fringes are excluded from employee wages. Also, excluded are reimbursements from self-insurance medical plans (special rules apply to S Corp plans) Disability insurance - this insurance provides a benefit for lost wages and compensation during a period of disability, illness or injury. The value of the premium paid by the employer is not taxable. However, a benefit is paid under the policy is taxable. If the policy premium is paid by the employee the benefit paid under the policy is excluded 9/22/05 Chapter 4

Employee fringe benefits Dependent care assistance exclusion non-discriminatory employee’s children or other dependents $5,000 annual limit Educational assistance to cover the costs of higher education for employee - tuition, books, fees, supplies and equipment and related costs no curricula requirement $5,250 annual limit 9/22/05 Chapter 4

Employee fringe benefits Adoption costs - an exclusion is allowed for up to $10,000 in adoption costs paid to an employee. The exclusion is subject to a phase out for taxpayers with an agi over $150k. The phase out is ratable between $150k and 190k qualified adoption costs are adoption fees, court costs, attorney fees and other expenses associated with the adoption 9/22/05 Chapter 4

Employee fringe benefits Sec. 132 benefits no additional cost benefits employee discounts - limited to employer gross profit working condition fringe - if the employee could personally deduct the cost on his/her Form 1040, the reimbursement of the cost is not taxable de minimus fringe - coffee, personal telephone or internet use, personal photocopier use - subject to limits of reasonable use parking ($185/month)and transportation ($100/month) use of employer-owned athletic facilities 9/22/05 Chapter 4

Employee fringe benefits Meals and lodging Sec 119 excludes the value of meals and lodging provided to the employee by the employer if provided as follows: meals - for the convenience of the employee and on the employer’s premises lodging - employee must be required to take the lodging as a condition of the employment The courts have added a business purpose requirement 9/22/05 Chapter 4

Discharge of indebtedness Generally, the discharge from a debt is income. Exception - when the discharge is in bankruptcy court Exception - to the extent that a taxpayer is insolvent Note: in both of these exceptions there are required off-sets of tax attributes Exception for student loan discharge pursuant to a public service forgiveness program 9/22/05 Chapter 4

Foreign earned income Up to $80,000 of compensation type income only 330 days abroad in 12 consecutive months election on a timely filed tax return taxpayer can not use the exclusion and foreign tax credit together. Taxpayer may not use the exclusion and itemized deduction together Foreign housing allowance exclusion excess housing costs over (16% of US Gov’t GS-14 wages) 9/22/05 Chapter 4

Chapter 4 Exclusions from Income

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