Essentials of taxation 2016 cengage chapter 04

Gross Income slide 2 of 3principle from accounting – Income is recognized taxed when realized income is not considered realized income... Gross Income slide 2 of 3 principle from account

Chapter 4

Gross Income

The Big Picture (slide 1 of 3)

• Dr Cliff Payne opens his new dental practice as a

qualified personal service corporation

of accounting

• During the year, Dr Payne billed patients and

insurance companies for $385,000 of dental services

collected

• Dr Payne also earns the following:

District.

The Big Picture (slide 2 of 3)

$10,000 per month

– However, he did not cash his December payroll

check until January

parents loaned him $150,000

– They did not charge him any interest

from $7,000 at the beginning of the year to

The Big Picture (slide 3 of 3)

classes in college, he would like your help in

calculating his gross income and the gross

income of the corporation

Components Of The Tax Formula

(slide 1 of 3)

Components Of The Tax Formula

(slide 2 of 3)

• Income (Broadly Conceived)

• Essentially equivalent to gross receipts

• Does not include

– A return of capital, or– Borrowed funds

• Exclusions

base

• Principal income exclusions that apply to all entities are

– Life insurance proceeds – State and local bond interest

Components Of The Tax Formula

(slide 3 of 3)

• Deductions

expenses are deductible

• Cost of goods sold

• Salaries

• Wages

• Operating expenses (such as rent and utilities)

• Research and development expenditures

• Interest,

Gross Income (slide 1 of 3)

from whatever source derived, unless

specifically excluded under the Code

Gross Income (slide 2 of 3)

principle from accounting

– Income is recognized (taxed) when realized

income) is not considered realized income

Gross Income (slide 2 of 3)

principle from accounting

– Income is recognized (taxed) when realized

income) is not considered realized income

Gross Income (slide 2 of 3)

principle from accounting

– Income is recognized (taxed) when realized

income) is not considered realized income

Gross Income (slide 2 of 3)

principle from accounting

– Income is recognized (taxed) when realized

income) is not considered realized income

The Big Picture - Example 2

Economic Income vs Gross Income

• Dr Payne’s portfolio has increased in value by more

than 250% during the tax year

• The Federal income tax law does not include the

value increase in Dr Payne’s gross income

say, a margin loan from his broker.

The Big Picture - Example 2

Economic Income vs Gross Income

• Dr Payne’s portfolio has increased in value by more

than 250% during the tax year

• The Federal income tax law does not include the

value increase in Dr Payne’s gross income

say, a margin loan from his broker.

Gross Income (slide 3 of 3)

of cash, or “in-kind” cash equivalents (i.e.,

property or services)

– The amount of income from “in-kind” receipts is

equal to the FMV of the property or services

taxpayer’s capital investment

Accounting Periods

– Taxable year for most individual taxpayers is the

calendar year

– Fiscal year can be elected if taxpayer maintains

adequate records

of a month other than December

– Example: July 1 to June 30

Accounting Methods (slide 1 of 2)

tax purposes:

– Cash receipts and disbursements method

– Accrual method

– Hybrid method

Accounting Methods (slide 2 of 2)

taxpayers may choose (elect) tax treatment for

various transactions, for example

– Taxpayers can elect to use the installment method

– Certain contractors may elect to use either the

percentage of completion method or the completed

contract method

Cash Receipts Method

or constructively received in cash or cash

equivalent

is set aside and made available to taxpayer

without substantial restrictions

Exceptions To Cash Receipts Method

taxable when earned rather than when interest

is received

– However, a cash basis taxpayer may elect to

recognize the interest when earned

Accrual Method (slide 1 of 2)

• Income is recognized in the year that it is earned

regardless of when it is collected

• Income is earned when:

income, and

• The accrual method is required for determining

purchases and sales when inventory is an

income-producing factor

Accrual Method (slide 2 of 2)

– Requires amounts received to be included in

income even though the amount is in dispute and

might be returned to the payor at a later date

– If payment has not been received, no income is

recognized until the claim is settled

Exceptions to Accrual Method

(slide 1 of 2)

income from advance payment for goods if

same method of accounting is used for tax and

financial reporting purposes

Exceptions to Accrual Method

(slide 2 of 2)

• Advance payment for services to be performed

after year-end is included in income in the year following receipt

– The portion of the advance payment that is earned

in the current year is included in income in the

year of receipt

recognized in the year received rather than

when earned

Example 17 - Advance Payment

For Services (slide 1 of 2)

Example 17 - Advance Payment

For Services (slide 2 of 2)

Hybrid Method

income-producing factor

– Use accrual method to account for inventory

– Use cash method for other income and expenses

Income Sources

person who performs the services

– Fruit and tree metaphor

of the property

– Assignment of income is not permitted

The Big Picture - Example 18

• Return to the facts of The Big Picture on p 4-1.

• Assume that Dr Payne entered into an employment

contract with his corporation and receives a salary

• All patients contract to receive their services from the

corporation

employee, Dr Payne.

The Big Picture - Example 18

patients’ services and must include the

patients’ fees in its gross income

gross income

reasonable salary paid to Dr Payne.

Interest Income

– If interest bearing instrument (e.g., bonds) is

transferred, must allocate interest income between

transferor and transferee based on the number of

days during the period that each owned the

property

Dividends (slide 1 of 4)

is entitled to receive them

– Dividends on stock transferred by gift after

declaration date but before record date are

generally taxed to the donor

Dividends (slide 2 of 4)

from double taxation of corporate dividends

– Generally, qualified dividends are taxed at the

same marginal rates applicable to a net capital gain

marginal tax rates in 2013 pay 0% tax on qualified dividends received

marginal tax rates pay a 15% tax on qualified dividends

Dividends (slide 3 of 4)

the reduced tax rates

– Dividends from certain foreign corporations,

– Dividends from tax-exempt entities, and

– Dividends that do not satisfy the holding period

requirement

held for more than 60 days during the 121-day period beginning 60 days before the ex-dividend date to

qualify for the reduced tax rates

Dividends (slide 4 of 4)

eligible for qualified dividend status only if:

– The foreign corporation’s stock is traded on an

established U.S securities market, or

– The foreign corporation is eligible for the benefits

of a comprehensive income tax treaty between its

country of incorporation and the United States

Income Received By An Agent

considered to be received by the taxpayer

– A cash basis principal must recognize the income

at the time it is received by the agent

Income Received By An Agent

considered to be received by the taxpayer

– A cash basis principal must recognize the income

at the time it is received by the agent

Imputed Interest on Below-Market Loans

(slide 1 of 4)

• Interest is imputed, using Federal government rates,

when a loan does not carry a market rate of interest

would have been charged at the Federal rate and the

amount actually charged

Imputed Interest on Below-Market Loans

(slide 2 of 4)

property, the following limitation applies

– On loans of $100,000 or less between individuals

income for year

or less

Imputed Interest on Below-Market Loans

(slide 4 of 4)

compensation-related and

corporation-shareholder loans

– No exemption if principal purpose of loan is tax

avoidance

deductible

The Big Picture - Example 28

Imputed Interest On Gift Loans

• Dr Payne’s loan from his parents likely is a gift loan,

as his parents are not shareholders in the personal

service corporation

• Imputed interest must be computed annually with

regard to this loan by both Dr Payne and his parents

asset

Tax Benefit Rule

one year and in a later year recovers all or a

portion of the prior deduction, the recovery is

included in gross income

– Amount included in income is limited to the

amount for which a tax benefit was received

Tax Benefit Rule

one year and in a later year recovers all or a

portion of the prior deduction, the recovery is

included in gross income

– Amount included in income is limited to the

amount for which a tax benefit was received

Interest on State and Local Government Obligations

– Reduces borrowing costs of state and local

governments

– High-income taxpayers can increase after-tax

yields with municipal bonds

– Municipal interest is considered for Social Security

benefits inclusion and may be considered for

alternative minimum tax calculation

Interest on State and Local Government Obligations

– Reduces borrowing costs of state and local

governments

– High-income taxpayers can increase after-tax

yields with municipal bonds

– Municipal interest is considered for Social Security

benefits inclusion and may be considered for

alternative minimum tax calculation

Interest on State and Local Government Obligations

– Reduces borrowing costs of state and local

governments

– High-income taxpayers can increase after-tax

yields with municipal bonds

– Municipal interest is considered for Social Security

benefits inclusion and may be considered for

alternative minimum tax calculation

The Big Picture - Example 33

Tax Exempt Municipal Bonds Interest

interest income from the bank’s money market

account, but not the $500 that is earned on the

Whitehall School District bonds.

Improvements on Leased Property

– Excluded from landlord’s gross income unless the

improvement is made to the property in lieu of rent

Life Insurance Proceeds

(slide 1 of 4)

due to death of insured

– Relationship to decedent not determinative

Life Insurance Proceeds

(slide 2 of 4)

policy and receives the cash surrender value

– Gain must be recognized to extent amount received

exceeds premiums paid on policy

– Loss is not recognized

Life Insurance Proceeds

(slide 3 of 4)

– If policy is transferred for valuable consideration,

proceeds are taxable to extent they exceed amount

paid for policy plus subsequent premiums paid

– Exceptions exist for policy transfers:

Life Insurance Proceeds

(slide 3 of 4)

– If policy is transferred for valuable consideration,

proceeds are taxable to extent they exceed amount

paid for policy plus subsequent premiums paid

– Exceptions exist for policy transfers:

Life Insurance Proceeds

(slide 4 of 4)

reinvestment of life insurance proceeds are

generally subject to income tax

– e.g., Beneficiary elects to collect the insurance

proceeds in installments

gross income

Discharge from Indebtedness

• Income from the forgiveness of debt is taxable

treatment:

• Creditors’ gifts

• Discharges in bankruptcy and when debtor is insolvent

• Discharge of farm debt

• Discharge of qualified real property business indebtedness

• Seller’s cancellation of buyer’s debt

• Shareholder’s cancellation of corporation’s debt

• Forgiveness of certain student loans

• Discharge of indebtedness on taxpayer’s principal residence that

Discharge from Indebtedness

• Income from the forgiveness of debt is taxable

treatment:

• Creditors’ gifts

• Discharges in bankruptcy and when debtor is insolvent

• Discharge of farm debt

• Discharge of qualified real property business indebtedness

• Seller’s cancellation of buyer’s debt

• Shareholder’s cancellation of corporation’s debt

• Forgiveness of certain student loans

• Discharge of indebtedness on taxpayer’s principal residence that

occurs between 2007 and 2014, and is the result of the financial condition of the debtor

Discharge from Indebtedness

• Income from the forgiveness of debt is taxable

treatment:

• Creditors’ gifts

• Discharges in bankruptcy and when debtor is insolvent

• Discharge of farm debt

• Discharge of qualified real property business indebtedness

• Seller’s cancellation of buyer’s debt

• Shareholder’s cancellation of corporation’s debt

• Forgiveness of certain student loans

• Discharge of indebtedness on taxpayer’s principal residence that

Gains and Losses from Property

Transactions (slide 1 of 3)

(included in gross income), they must be

realized:

– Realized gain (loss) = amount realized – adjusted

basis

Gains and Losses from Property

Transactions (slide 2 of 3)

specific tax provision provides otherwise (e.g.,

nontaxable exchanges)

depending on the circumstances

– Generally, losses on the sale or disposition of

personal use property are not recognized

Gains and Losses from Property

Transactions (slide 3 of 3)

determined, they must be classified as

ordinary or capital

– Ordinary gains are fully taxable

– Ordinary losses are fully deductible

tax treatment

Gains and Losses from Capital Asset

Transactions (slide 1 of 2)

• Capital assets are defined as any property other than:

• Most personal use assets owned by individuals are

capital assets

Gains and Losses from Capital Asset

Transactions (slide 2 of 2)

transactions must be netted

– Net gains and losses by holding period

– If excess losses result, tax treatment depends on

whether taxpayer is an individual or corporation

Max Tax Rates for Net Capital

Gains of Individuals

Treatment of Capital Losses

(slide 1 of 2)

for AGI up to $3,000 yearly

– Excess capital losses are carried over to the next

tax year

– When carried over, capital losses retain their

classification as short- or long-term

Treatment of Capital Losses

– Capital losses can only offset capital gains

ordinary income

then carried forward 5 years to offset capital gains in those years

Refocus On The Big Picture (slide 1 of 4)

gross income recognized by Dr Cliff Payne’s

corporation would be $385,500

– This includes the entire $385,000 of revenue

earned from providing services to patients during

the year and the $500 of interest income earned on

the money market account

from gross income

Refocus On The Big Picture (slide 2 of 4)

• Dr Payne’s gross income includes $120,000 of salary

earned during the year

January.

• He constructively received the income since it was readily

available to him.

• Dr Payne may be able to reduce his taxable income

by the imputed interest expense on the below-market

loan from his parents

• The increase in value on his stock does not result in

gross income until he sells the stock and realizes a

gain or loss

Refocus On The Big Picture (slide 3 of 4)

What If?

if Dr Payne had chosen to use the cash method

of accounting for his business?

– Using the cash method is acceptable for certain

personal service corporations

Refocus On The Big Picture (slide 4 of 4)

What If?

company’s gross income from $385,000 to

$333,000 ($385,000 amount billed less

$52,000 still to be received), this is only part

of the picture

some of the corporation’s expenses not being

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If you have any comments or suggestions concerning this

PowerPoint Presentation for South-Western Federal

Taxation, please contact:

Dr Donald R Trippeer, CPA trippedr@oneonta.edu

SUNY Oneonta