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3-1©2010 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
©2010 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
©2010 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
©2010 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
©2010 Pearson Education, Inc. Publishing as Prentice Hall
3-6
Tax Concept of IncomeTax Concept of Income
Conditions to make income taxable
Administrative convenienceWherewithal to payGross income defined
©2010 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
©2010 Pearson Education, Inc. Publishing as Prentice Hall
3-8
Administrative Convenience
Economic concept is considered too subjective
Objectivity achieved at price of equity
©2010 Pearson Education, Inc. Publishing as Prentice Hall
3-9
Wherewithal to Pay
A tax should be collected when the taxpayer can most easily pay
©2010 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
©2010 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
©2010 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
©2010 Pearson Education, Inc. Publishing as Prentice Hall
3-13
Assignment of Income
Supreme 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
©2010 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
©2010 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
©2010 Pearson Education, Inc. Publishing as Prentice Hall
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 rateSee Chapter I2
©2010 Pearson Education, Inc. Publishing as Prentice Hall
3-17
When Is Income Taxable?When Is Income Taxable?
Cash methodAccrual methodHybrid methodSee Topic Review 1
©2010 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
©2010 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
©2010 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
©2010 Pearson Education, Inc. Publishing as Prentice Hall
3-21
Accrual Method
Report income in year income earnedRight to incomeAmount can be determined with
reasonable accuracyPrepaid income
Generally taxable when receivedExceptions in Rev. Proc. 2004-34
©2010 Pearson Education, Inc. Publishing as Prentice Hall
3-22
Hybrid Method
Accrual method for purchases and sales
Cash method in computing all other income and expenses
©2010 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 propertyInterest
Series EE bond interest exceptionRents and royaltiesDividends
©2010 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
©2010 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
©2010 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 taxationMust hold stock for at least 60 daysTaxed at ordinary rates after 2010
Distributions to extent they are out of corporate earnings and profits
©2010 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
©2010 Pearson Education, Inc. Publishing as Prentice Hall
3-28
Alimony and Separate Maintenance Payments
Only receipt of alimony is taxable Alimony is deductible by one who
paysChild support not taxableProperty settlement not taxable
©2010 Pearson Education, Inc. Publishing as Prentice Hall
3-29
Pensions and Annuities
Income portion of annuity taxableInvestment portion is excluded
Exclusion ratioBasis in annuity ÷ Expected ReturnExpected return
Payment x # of expected payments
©2010 Pearson Education, Inc. Publishing as Prentice Hall
3-30
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
©2010 Pearson Education, Inc. Publishing as Prentice Hall
3-31
Other Items of Gross Other Items of Gross IncomeIncome
(1 of 2)(1 of 2)
Prizes, awards, gambling winnings, and treasure finds – taxable
Illegal income – taxable Unemployment compensation -
taxableSocial security benefits – up to 85%
taxable
©2010 Pearson Education, Inc. Publishing as Prentice Hall
3-32
Other Items of Gross Other Items of Gross IncomeIncome
(2 of 2)(2 of 2)
Insurance proceeds and court awardsSpecial rules apply
Recovery of previously deducted amounts – taxable
Revenue received that is disputed must still be reported as incomePreviously reported income that is
subsequently refunded is deductible
©2010 Pearson Education, Inc. Publishing as Prentice Hall
3-33
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
©2010 Pearson Education, Inc. Publishing as Prentice Hall
3-34
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
©2010 Pearson Education, Inc. Publishing as Prentice Hall
3-35
Compliance and Compliance and Procedural Procedural
ConsiderationsConsiderations
Form 1040 – Wages, Salaries and tips
Schedule B – Interest and DividendsSchedule C – Business Income Schedule D – Capital gainsSchedule E – Rents and RoyaltiesSchedule F – Farm Income
©2010 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 Businessrichard.newmark@PhDuh.com
3-36©2010 Pearson Education, Inc. Publishing as Prentice Hall
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