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3-1©2009 Pearson Education, Inc. Publishing as Prentice Hall
3-2
GROSS INCOME: GROSS INCOME: INCLUSIONSINCLUSIONS
(1 of 2)(1 of 2)
Economic and accounting concepts of income
Tax concept of incomeTo whom is income taxable?When is income taxable?Items of gross income
©2009 Pearson Education, Inc. Publishing as Prentice Hall
3-3
GROSS INCOME GROSS INCOME INCLUSIONSINCLUSIONS
(2 of 2)(2 of 2)
Other items of gross incomeTax planning considerationsCompliance and procedural
considerations
©2009 Pearson Education, Inc. Publishing as Prentice Hall
3-4
Concepts of IncomeConcepts of IncomeEconomic Concepts of IncomeEconomic Concepts of Income
Wealth that flows to individualsChanges in value in individuals’
wealthUnrealized gains Gifts & inheritances considered
income
©2009 Pearson Education, Inc. Publishing as Prentice Hall
3-5
Concepts of IncomeConcepts of IncomeAccounting Concepts of IncomeAccounting Concepts of Income
Accounting concepts of incomeValues are measured by a
transaction approachIncome realized as result of
completed transactionsUse historical cost
©2009 Pearson Education, Inc. Publishing as Prentice Hall
3-6
Tax Concept of IncomeTax Concept of IncomeConditions to make income
taxableAdministrative convenienceWherewithal to payGross income defined
©2009 Pearson Education, Inc. Publishing as Prentice Hall
3-7
Conditions to MakeIncome Taxable
Economic benefit to taxpayerIncome must be realized
Earnings process completeIncome must be recognized
©2009 Pearson Education, Inc. Publishing as Prentice Hall
3-8
Administrative ConvenienceEconomic concept is considered
too subjectiveObjectivity achieved at price of
equity
©2009 Pearson Education, Inc. Publishing as Prentice Hall
3-9
Wherewithal to PayA tax should be collected when
the taxpayer can most easily pay
©2009 Pearson Education, Inc. Publishing as Prentice Hall
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
3-11
Gross Income Defined(2 of 2)
Form of receiptGross 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
3-12
To whom Is Income To whom Is Income Taxable?Taxable?
Assignment of incomeAllocating income between
married peopleIncome of minor children
©2009 Pearson Education, Inc. Publishing as Prentice Hall
3-13
Assignment of IncomeSupreme Court in Lucas v. Earl
(1930)Ruled that individual taxed the
earnings from his personal servicesHelvering v. Horst (1940)
Ruled that assignment of income doctrine applies to property
©2009 Pearson Education, Inc. Publishing as Prentice Hall
3-14
Allocating Income between Married People (1 of 2)
Common law property systemUsed in 42 statesIncome taxed to person who
earns it or who owns the income-producing propertyJoint income comes from jointly
owned property
©2009 Pearson Education, Inc. Publishing as Prentice Hall
3-15
Allocating Income between Married People (2 of 2)
Community property statesAll income deemed to be earned
equally by spouses except income from separate property
Separate propertyProperty owned by each spouse prior to
marriageMay be community income or separate
income, depending on state of residence
©2009 Pearson Education, Inc. Publishing as Prentice Hall
3-16
Income of Minor ChildrenTaxed to child regardless of
state’s property law systemUnearned income of minor
under 24 may be taxed at parent’s higher rateSee Chapter I2
©2009 Pearson Education, Inc. Publishing as Prentice Hall
3-17
When Is Income Taxable?When Is Income Taxable?Cash methodAccrual methodHybrid method
©2009 Pearson Education, Inc. Publishing as Prentice Hall
3-18
Cash Method(1 of 3)
Used by most individual taxpayers and most non-corporate businesses that do not have inventory
Constructive receiptReport income in year actually received
Check received after banking hoursBond interest coupons that have
matured but not redeemed
©2009 Pearson Education, Inc. Publishing as Prentice Hall
3-19
Cash Method(2 of 3)
No constructive receipt ifIt is subject to substantial
limitations Payor does not have funds
necessary to make paymentAmount is unavailable to taxpayer
©2009 Pearson Education, Inc. Publishing as Prentice Hall
3-20
Cash Method(3 of 3)
Exceptions to basic cash methodInterest on Series E or EE Savings
BondsSpecial rules apply to farmers and
ranchersSmall taxpayer exception for
inventories
©2009 Pearson Education, Inc. Publishing as Prentice Hall
3-21
Accrual MethodReport income in year income
earnedRight to incomeAmount can be determined with
reasonable accuracyPrepaid income
Generally taxable©2009 Pearson Education, Inc. Publishing as Prentice Hall
3-22
Hybrid MethodAccrual method for purchases
and salesCash method in computing all
other income and expenses
©2009 Pearson Education, Inc. Publishing as Prentice Hall
3-23
Items of Gross IncomeItems of Gross Income(1 of 2)(1 of 2)
CompensationBusiness incomeGains from dealings in propertyInterestRents and royaltiesDividends
©2009 Pearson Education, Inc. Publishing as Prentice Hall
3-24
Items of Gross IncomeItems of Gross Income(2 of 2)(2 of 2)
Alimony and separate maintenance payments
Pensions and annuitiesIncome from life insurance and
endowment contractsIncome from discharge of indebtednessIncome passed through to taxpayer
©2009 Pearson Education, Inc. Publishing as Prentice Hall
3-25
Dividends(1 of 3)
Included in shareholder gross incomeResults in double taxation
Earnings taxed at corporate levelEarnings taxed at shareholder level when
distributed as a dividendC 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
3-26
Dividends(2 of 3)
Individuals taxed at 15% on dividends5% if in 10% or 15% tax bracketReduces effects of double taxation
Distributions to extent they are out of corporate earnings and profits
Stock dividendsNot taxableBasis in stock allocated to new shares
©2009 Pearson Education, Inc. Publishing as Prentice Hall
3-27
Dividends(3 of 3)
Stock dividendsNot taxableBasis in stock allocated to new shares
Capital gain dividendsTaxed at long-term capital gain rates
Constructive dividendsTaxed as regular dividends
©2009 Pearson Education, Inc. Publishing as Prentice Hall
3-28
AnnuitiesIncome portion of annuity taxable
Investment portion is excludedExclusion ratio
Basis in annuity ÷ Expected returnExpected return
Payment x # of expected payments
©2009 Pearson Education, Inc. Publishing as Prentice Hall
3-29
Income Passed Through to Taxpayer
Income from flow-through entities taxed directly to ownersIncome from partnershipIncome from S corporationIncome in respect of a decedentIncome from an estate or trustIncome from RIC or REIT
©2009 Pearson Education, Inc. Publishing as Prentice Hall
3-30
Other Items of Gross Other Items of Gross IncomeIncome
(1 of 2)(1 of 2)
Prizes, awards, gambling winnings, and treasure finds
Illegal incomeUnemployment compensationSocial Security benefitsInsurance proceeds and court
awards©2009 Pearson Education, Inc. Publishing as Prentice Hall
3-31
Other Items of Gross Other Items of Gross IncomeIncome
(2 of 2)(2 of 2)
Recovery of previously deducted amounts
Claim of right
©2009 Pearson Education, Inc. Publishing as Prentice Hall
3-32
Social Security BenefitsThe portion of social security
benefits depends on the taxpayer’s provisional income
Up to 85% of benefits taxableSee pages 3-24 and 3-25 for
formula
©2009 Pearson Education, Inc. Publishing as Prentice Hall
3-33
Claim of RightRevenue received that is
disputed must still be reported as incomePreviously reported income that is
subsequently refunded is deductible
©2009 Pearson Education, Inc. Publishing as Prentice Hall
3-34
Tax Planning Tax Planning ConsiderationsConsiderations
(1 of 2)(1 of 2)
Shifting incomeFrom high income family members
to low income family membersAlimony
Deductible by payor and includible by payee
Prepaid income©2009 Pearson Education, Inc. Publishing as Prentice Hall
3-35
Tax Planning Tax Planning ConsiderationsConsiderations
(2 of 2)(2 of 2)
Taxable, tax-exempt, or tax-deferred bondsNeed to compare present value of
after-tax returnsReporting savings bond interestDeferred compensation
arrangements©2009 Pearson Education, Inc. Publishing as Prentice Hall
3-36
Compliance and Compliance and Procedural Procedural
ConsiderationsConsiderationsForm 1040 – Wages, salaries and tipsSchedule B – Interest and DividendsSchedule C – Business Income Schedule D – Capital gainsSchedule E – Rents and RoyaltiesSchedule F – Farm Income
©2009 Pearson Education, Inc. Publishing as Prentice Hall
Comments or questions about PowerPoint Slides?Contact Dr. Richard Newmark at University of Northern Colorado’s
Kenneth W. Monfort College of [email protected]
3-37©2009 Pearson Education, Inc. Publishing as Prentice Hall