chapter 5 gross income: exclusions copyright ©2005 south-western/thomson learning eugene willis,...
TRANSCRIPT
Chapter 5Chapter 5
Gross Income: ExclusionsGross Income: Exclusions
Copyright ©2005 South-Western/Thomson LearningCopyright ©2005 South-Western/Thomson Learning
Eugene Willis, William H. Hoffman, Jr.,Eugene Willis, William H. Hoffman, Jr.,David M. Maloney, and William A. RaabeDavid M. Maloney, and William A. Raabe
C5 - 2
Exclusions DefinedExclusions Defined
• Items of income that are specifically designated as not included in gross income
• Exclusions are generally found in Sections 101 through 150
• Items of income that are specifically designated as not included in gross income
• Exclusions are generally found in Sections 101 through 150
C5 - 3
Gifts and Inheritances (slide 1 of 5)
Gifts and Inheritances (slide 1 of 5)
• Gifts are nontaxable to donee if:– Transfer is voluntary without adequate
consideration, and– Made because of affection, respect, admiration,
charity, or donative intent
• Gifts are nontaxable to donee if:– Transfer is voluntary without adequate
consideration, and– Made because of affection, respect, admiration,
charity, or donative intent
C5 - 4
Gifts and Inheritances (slide 2 of 5)
Gifts and Inheritances (slide 2 of 5)
• Inheritances are nontaxable to beneficiary
• Income earned on gifts or inheritances is taxable under normal rules– Example: Father gifts corporate bond to
daughter. Gift is excluded from daughter’s gross income, but interest income earned after gift date is taxable to her.
• Inheritances are nontaxable to beneficiary
• Income earned on gifts or inheritances is taxable under normal rules– Example: Father gifts corporate bond to
daughter. Gift is excluded from daughter’s gross income, but interest income earned after gift date is taxable to her.
C5 - 5
Gifts and Inheritances (slide 3 of 5)
Gifts and Inheritances (slide 3 of 5)
• Transfers by employers to employees do not qualify as excludible gifts– May be excludible under other provisions, e.g.,
employee achievement awardsQuestion 3
• Transfers by employers to employees do not qualify as excludible gifts– May be excludible under other provisions, e.g.,
employee achievement awardsQuestion 3
C5 - 6
Gifts and Inheritances (slide 4 of 5)
Gifts and Inheritances (slide 4 of 5)
• Employee death benefits: amount paid by employer to deceased employee’s spouse, child, or others– If decedent had a nonforfeitable right to
payments (e.g., accrued salary), amounts are taxable to employee
• Employee death benefits: amount paid by employer to deceased employee’s spouse, child, or others– If decedent had a nonforfeitable right to
payments (e.g., accrued salary), amounts are taxable to employee
C5 - 7
Gifts and Inheritances (slide 5 of 5)
Gifts and Inheritances (slide 5 of 5)
• Employee death benefits may be excludible as a gift if:
• Paid to surviving spouse or children (not employee’s estate),
• Employer derived no benefit from payments,
• Surviving spouse and children performed no services for employer,
• Decedent had been fully compensated for services rendered, and
• Payments made pursuant to board of director’s resolution under a general company policy
• Employee death benefits may be excludible as a gift if:
• Paid to surviving spouse or children (not employee’s estate),
• Employer derived no benefit from payments,
• Surviving spouse and children performed no services for employer,
• Decedent had been fully compensated for services rendered, and
• Payments made pursuant to board of director’s resolution under a general company policy
C5 - 8
Life Insurance Proceeds (slide 1 of 4)
Life Insurance Proceeds (slide 1 of 4)
• Exempt income to beneficiary if paid solely due to death of insured– Relationship to decedent not determinative
• Exempt income to beneficiary if paid solely due to death of insured– Relationship to decedent not determinative
C5 - 9
Life Insurance Proceeds (slide 2 of 4)
Life Insurance Proceeds (slide 2 of 4)
• If owner of life insurance policy cancels the policy and receives the cash surrender value– Gain must be recognized to extent amount
received exceeds premiums paid on policy– Loss is not recognized
• If owner of life insurance policy cancels the policy and receives the cash surrender value– Gain must be recognized to extent amount
received exceeds premiums paid on policy– Loss is not recognized
C5 - 10
Life Insurance Proceeds (slide 3 of 4)
Life Insurance Proceeds (slide 3 of 4)
• Accelerated death benefits– Gain on cash surrender or transfer of life
insurance policy by terminally or chronically ill individual is excludible
• Exclusion for chronically ill is limited to amounts used for long-term care
• Accelerated death benefits– Gain on cash surrender or transfer of life
insurance policy by terminally or chronically ill individual is excludible
• Exclusion for chronically ill is limited to amounts used for long-term care
C5 - 11
Life Insurance Proceeds (slide 4 of 4)
Life Insurance Proceeds (slide 4 of 4)
• Transfers for valuable consideration– If policy is transferred for valuable
consideration, proceeds are taxable to extent they exceed amount paid for policy plus subsequent premiums paid
– Exceptions exist to facilitate funding of buy-sell agreements, transfers pursuant to a tax-free exchange and receipt of a policy by gift
• Transfers for valuable consideration– If policy is transferred for valuable
consideration, proceeds are taxable to extent they exceed amount paid for policy plus subsequent premiums paid
– Exceptions exist to facilitate funding of buy-sell agreements, transfers pursuant to a tax-free exchange and receipt of a policy by gift
C5 - 12
Scholarships and Fellowships(slide 1 of 2)
Scholarships and Fellowships(slide 1 of 2)
• An amount paid to or for the benefit of a student to aid in pursuing a degree at an educational institution– Nontaxable to extent of tuition and related
expenses (e.g., fees, books, supplies, and equipment required for courses)
• Amounts received for room and board are taxableProblem 34
• An amount paid to or for the benefit of a student to aid in pursuing a degree at an educational institution– Nontaxable to extent of tuition and related
expenses (e.g., fees, books, supplies, and equipment required for courses)
• Amounts received for room and board are taxableProblem 34
C5 - 13
Scholarships and Fellowships(slide 2 of 2)
Scholarships and Fellowships(slide 2 of 2)
• Qualified tuition waivers or reductions by nonprofit educational institutions are excluded from income– Generally limited to undergraduate tuition
waivers– Exception for graduate teaching or research
assistants (included as income)
• Qualified tuition waivers or reductions by nonprofit educational institutions are excluded from income– Generally limited to undergraduate tuition
waivers– Exception for graduate teaching or research
assistants (included as income)
C5 - 14
Compensation for Injuries and Sickness (slide 1 of 3)
Compensation for Injuries and Sickness (slide 1 of 3)
• Personal injury damages– Compensatory damages received on account of
physical personal injury or physical illness are excludible
• All other personal injury damages taxable– Compensatory damages for nonphysical injury– All punitive damages
– Payments solely for loss of income are also taxable
Problem 37
• Personal injury damages– Compensatory damages received on account of
physical personal injury or physical illness are excludible
• All other personal injury damages taxable– Compensatory damages for nonphysical injury– All punitive damages
– Payments solely for loss of income are also taxable
Problem 37
C5 - 15
Compensation for Injuries and Sickness (slide 2 of 3)
Compensation for Injuries and Sickness (slide 2 of 3)
• Workers’ compensation– Although may be payment for loss of wages,
workers’ compensation is specifically excluded from gross income
• Workers’ compensation– Although may be payment for loss of wages,
workers’ compensation is specifically excluded from gross income
C5 - 16
Compensation for Injuries and Sickness (slide 3 of 3)
Compensation for Injuries and Sickness (slide 3 of 3)
• Accident and health insurance benefits– Benefits received under policy purchased by
taxpayer are excludible• Even if benefits are substitute for income
• Accident and health insurance benefits– Benefits received under policy purchased by
taxpayer are excludible• Even if benefits are substitute for income
C5 - 17
Employer-Sponsored Accident and Health Plans (slide 1 of 2)
Employer-Sponsored Accident and Health Plans (slide 1 of 2)
• Premiums paid by employer for insurance coverage of employee, spouse, and dependents are not taxable to employee
• Amounts received from insurance are not taxable when received for medical care or for permanent loss of body part or function
• Premiums paid by employer for insurance coverage of employee, spouse, and dependents are not taxable to employee
• Amounts received from insurance are not taxable when received for medical care or for permanent loss of body part or function
C5 - 18
Employer-Sponsored Accident and Health Plans (slide 2 of 2)
Employer-Sponsored Accident and Health Plans (slide 2 of 2)
• Health Savings Accounts (high deductible insurance plans)– Employer contribution to HSA and earnings on funds in
the account are excludible • Contributions limited to 100% of deductible amount for
individual or family coverage– Monthly deductible amount is limited to the lesser of:
• One twelfth of the annual deductible under a high deductible plan or
• $2,250 for self-only ($4,500 for family coverage)
– Withdrawals from HSA are excludible to the extent used for qualified medical expenses
• Health Savings Accounts (high deductible insurance plans)– Employer contribution to HSA and earnings on funds in
the account are excludible • Contributions limited to 100% of deductible amount for
individual or family coverage– Monthly deductible amount is limited to the lesser of:
• One twelfth of the annual deductible under a high deductible plan or
• $2,250 for self-only ($4,500 for family coverage)
– Withdrawals from HSA are excludible to the extent used for qualified medical expenses
C5 - 19
Long-Term Care InsuranceLong-Term Care Insurance
• Employer paid insurance premiums for employee’s long-term care are excludible, limited to the greater of:
• $230 in 2004 for each day patient receives long-term care (indexed amount for 2003 is $220)
• The actual cost of the care
– Reduced by any amounts received from other third parties (e.g., damages received)
Problem 38 (a) (b)
• Employer paid insurance premiums for employee’s long-term care are excludible, limited to the greater of:
• $230 in 2004 for each day patient receives long-term care (indexed amount for 2003 is $220)
• The actual cost of the care
– Reduced by any amounts received from other third parties (e.g., damages received)
Problem 38 (a) (b)
C5 - 20
Meals and LodgingMeals and Lodging
• Not taxable to employee if:– Furnished by employer
• On employer’s business premises• For convenience of employer
– In the case of lodging, employee is required to accept lodging as a condition of employment
Problem 43
• Not taxable to employee if:– Furnished by employer
• On employer’s business premises• For convenience of employer
– In the case of lodging, employee is required to accept lodging as a condition of employment
Problem 43
C5 - 21
Other Fringe Benefits (slide 1 of 3)
Other Fringe Benefits (slide 1 of 3)
• Dependent care– Up to $5,000 of care costs paid for by employer
can be excluded
• Athletic facilities– Value of use of athletic facilities located on
employer premises can be excluded
• Dependent care– Up to $5,000 of care costs paid for by employer
can be excluded
• Athletic facilities– Value of use of athletic facilities located on
employer premises can be excluded
C5 - 22
Other Fringe Benefits (slide 2 of 3)
Other Fringe Benefits (slide 2 of 3)
• Educational assistance programs– Employer-provided educational assistance for
undergraduate and graduate education is excludible
• Exclusion limited to $5,250 per year
• Educational assistance programs– Employer-provided educational assistance for
undergraduate and graduate education is excludible
• Exclusion limited to $5,250 per year
C5 - 23
Other Fringe Benefits (slide 3 of 3)
Other Fringe Benefits (slide 3 of 3)
• Adoption assistance programs– Employee adoption expenses paid or
reimbursed by employer are excludible• Exclusion limited to $10,390
• Exclusion phases-out as AGI increases from $155,860 to $195,860
• Adoption assistance programs– Employee adoption expenses paid or
reimbursed by employer are excludible• Exclusion limited to $10,390
• Exclusion phases-out as AGI increases from $155,860 to $195,860
C5 - 24
Cafeteria Plans Cafeteria Plans
• Allows employees to choose between cash and certain nontaxable benefits– If cash is chosen, the amount received is
taxable– If a nontaxable benefit is chosen, the benefit
remains nontaxable
• Allows employees to choose between cash and certain nontaxable benefits– If cash is chosen, the amount received is
taxable– If a nontaxable benefit is chosen, the benefit
remains nontaxable
C5 - 25
Flexible Spending Plans Flexible Spending Plans
• Allows employees to accept lower cash compensation in return for employer agreeing to pay certain costs without the employee recognizing income– Called a use or lose plan since reduction in pay
cannot be recovered if covered expenses are less than expected
Problem 38 (c), 40
• Allows employees to accept lower cash compensation in return for employer agreeing to pay certain costs without the employee recognizing income– Called a use or lose plan since reduction in pay
cannot be recovered if covered expenses are less than expected
Problem 38 (c), 40
C5 - 26
Classes of Nontaxable Employee Benefits
Classes of Nontaxable Employee Benefits
• No-additional-cost services (N-D)
• Qualified employee discounts (N-D)
• Working condition fringes
• De minimis fringes
• Qualified transportation fringes
• Qualified moving expense reimbursements
• Qualified retirement planning services (N-D)
• No-additional-cost services (N-D)
• Qualified employee discounts (N-D)
• Working condition fringes
• De minimis fringes
• Qualified transportation fringes
• Qualified moving expense reimbursements
• Qualified retirement planning services (N-D)
C5 - 27
No Additional Cost Services No Additional Cost Services
• Are nontaxable if:– Employee receives services (not property)– Employer incurs no substantial additional cost
in providing the services– Services offered are within line of business in
which employee works– Benefit is offered on nondiscriminatory basis
• Are nontaxable if:– Employee receives services (not property)– Employer incurs no substantial additional cost
in providing the services– Services offered are within line of business in
which employee works– Benefit is offered on nondiscriminatory basis
C5 - 28
Qualified Employee DiscountsQualified Employee Discounts
• Are nontaxable if:– Discount is not on realty or investment property– Item discounted is from same line of business
in which employee works– Discount cannot exceed gross profit on
property or 20% on services– Benefit is offered on nondiscriminatory basis
• Are nontaxable if:– Discount is not on realty or investment property– Item discounted is from same line of business
in which employee works– Discount cannot exceed gross profit on
property or 20% on services– Benefit is offered on nondiscriminatory basis
C5 - 29
Working Condition FringesWorking Condition Fringes
• Not taxable if employee could have deducted cost of item if they had actually paid for them– Includes personal use of auto by full-time auto
salespeople and employee business expenses that would be eliminated by the 2 percent floor on miscellaneous deductions
– Can be discriminatory
• Not taxable if employee could have deducted cost of item if they had actually paid for them– Includes personal use of auto by full-time auto
salespeople and employee business expenses that would be eliminated by the 2 percent floor on miscellaneous deductions
– Can be discriminatory
C5 - 30
De Minimis Benefits (slide 1 of 2)De Minimis Benefits (slide 1 of 2)
• These benefits are so small that accounting for them is impractical
• Examples include:– Supper money
– Occasional personal use of company copying machine
– Company cocktail parties – Picnics for employees
• These benefits are so small that accounting for them is impractical
• Examples include:– Supper money
– Occasional personal use of company copying machine
– Company cocktail parties – Picnics for employees
C5 - 31
De Minimis Benefits (slide 2 of 2)De Minimis Benefits (slide 2 of 2)
• Subsidized eating facilities operated by employer are excluded if:– Located on or near employer’s premises
– Revenue equals or exceeds direct operating costs
– Nondiscrimination requirements are met
• Subsidized eating facilities operated by employer are excluded if:– Located on or near employer’s premises
– Revenue equals or exceeds direct operating costs
– Nondiscrimination requirements are met
C5 - 32
Qualified TransportationQualified Transportation
• This fringe benefit is designed to encourage the use of mass transit for commuting to work– Includes:
• Transportation in commuter highway vehicle and transit passes (limited to $100 per month)
• Qualified parking (limited to $195 per month)
• Employee can choose between employer-provided benefit and cash without loss of exclusion
• This fringe benefit is designed to encourage the use of mass transit for commuting to work– Includes:
• Transportation in commuter highway vehicle and transit passes (limited to $100 per month)
• Qualified parking (limited to $195 per month)
• Employee can choose between employer-provided benefit and cash without loss of exclusion
C5 - 33
Moving ExpensesMoving Expenses
• Employer reimbursement of employee’s moving expenses is excludible– No deduction is allowed for reimbursed moving
expensesProblem 48
• Employer reimbursement of employee’s moving expenses is excludible– No deduction is allowed for reimbursed moving
expensesProblem 48
C5 - 34
Qualified Retirement Planning Services
Qualified Retirement Planning Services
• Value of any retirement planning advice or information provided by employer who maintains a qualified retirement plan is excluded from income
• Designed to motivate more employers to provide retirement planning services
• Value of any retirement planning advice or information provided by employer who maintains a qualified retirement plan is excluded from income
• Designed to motivate more employers to provide retirement planning services
C5 - 35
Foreign Earned Income (slide 1 of 3)
Foreign Earned Income (slide 1 of 3)
• Income from personal services in a foreign country can be excluded from income
• To qualify for the exclusion, must be either:– A bona fide resident of foreign country, or– Present in foreign country at least 330 days
during any 12 consecutive months
• Income from personal services in a foreign country can be excluded from income
• To qualify for the exclusion, must be either:– A bona fide resident of foreign country, or– Present in foreign country at least 330 days
during any 12 consecutive months
C5 - 36
Foreign Earned Income (slide 2 of 3)
Foreign Earned Income (slide 2 of 3)
• Exclusion amount is limited to $80,000 – For married persons, both of whom have
foreign earned income, the exclusion is computed separately for each spouse
• In addition, reasonable housing costs in excess of a base amount may be excluded from gross income – The base amount is 16% of the U.S.
government pay scale for a GS–14 (Step 1) employee
• Exclusion amount is limited to $80,000 – For married persons, both of whom have
foreign earned income, the exclusion is computed separately for each spouse
• In addition, reasonable housing costs in excess of a base amount may be excluded from gross income – The base amount is 16% of the U.S.
government pay scale for a GS–14 (Step 1) employee
C5 - 37
Foreign Earned Income (slide 3 of 3)
Foreign Earned Income (slide 3 of 3)
• Example of foreign earned income exclusion:– Taxpayer lived in Japan from August 1, 2003 to
July 19, 2004. For 2004, taxpayer has $90,000 foreign earned income.
– Exclusion for 2004 = $77,377 (354/366 x $80,000)
• Example of foreign earned income exclusion:– Taxpayer lived in Japan from August 1, 2003 to
July 19, 2004. For 2004, taxpayer has $90,000 foreign earned income.
– Exclusion for 2004 = $77,377 (354/366 x $80,000)
C5 - 38
Interest on State and Local Government Obligations
Interest on State and Local Government Obligations
• Interest from municipal bonds is tax exempt– 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 from municipal bonds is tax exempt– 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
C5 - 39
DividendsDividends
• Taxable to extent paid out of either current or accumulated earnings and profits (E&P)
• Dividends in excess of E&P are treated:– As return of capital to extent of stock basis
(which is reduced) – As capital gain to extent in excess of basis
• Taxable to extent paid out of either current or accumulated earnings and profits (E&P)
• Dividends in excess of E&P are treated:– As return of capital to extent of stock basis
(which is reduced) – As capital gain to extent in excess of basis
C5 - 40
Stock DividendsStock Dividends
• Stock dividends (e.g., common stock issued to common shareholders) are not taxable– If shareholder has the option to receive stock or
cash, the dividend is taxable whether the shareholder receives cash or stock
• Stock dividends (e.g., common stock issued to common shareholders) are not taxable– If shareholder has the option to receive stock or
cash, the dividend is taxable whether the shareholder receives cash or stock
C5 - 41
Educational Savings BondsEducational Savings Bonds
• Interest on Series EE U.S. Savings Bonds may be excluded from income if:– Proceeds used to pay for qualified higher
educational expenses– Bonds issued after 12/31/89, and– Bonds issued to person at least 24 years old
• Exclusion is phased-out once modified AGI exceeds threshold amount
• Interest on Series EE U.S. Savings Bonds may be excluded from income if:– Proceeds used to pay for qualified higher
educational expenses– Bonds issued after 12/31/89, and– Bonds issued to person at least 24 years old
• Exclusion is phased-out once modified AGI exceeds threshold amount
C5 - 42
Qualified Tuition ProgramsQualified Tuition Programs
• Amounts contributed must be used to pay qualified higher education expenses (tuition, fees, books, supplies, room and board, and equipment)– Earnings on contributions, including discounted
tuition for plan participants, are not taxable if used for qualified higher education expenses
– Refunds from program are taxable to the extent they exceed contributions
• Amounts contributed must be used to pay qualified higher education expenses (tuition, fees, books, supplies, room and board, and equipment)– Earnings on contributions, including discounted
tuition for plan participants, are not taxable if used for qualified higher education expenses
– Refunds from program are taxable to the extent they exceed contributions
C5 - 43
Tax Benefit RuleTax Benefit Rule
• If taxpayer receives a deduction for an item in 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 receivedProblem 50
• If taxpayer receives a deduction for an item in 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 receivedProblem 50
C5 - 44
Discharge from IndebtednessDischarge from Indebtedness
• Income from the forgiveness of debt is taxable – Certain discharge of indebtedness situations
get special treatment:• Creditors’ gifts• Discharges in bankruptcy and when debtor is
insolvent• Discharge of farm debt• Discharge of qualified real property indebtedness• Seller’s cancellation of buyer’s debt• Shareholder’s cancellation of corporation’s debt• Forgiveness of certain student loans
Problem 58
• Income from the forgiveness of debt is taxable – Certain discharge of indebtedness situations
get special treatment:• Creditors’ gifts• Discharges in bankruptcy and when debtor is
insolvent• Discharge of farm debt• Discharge of qualified real property indebtedness• Seller’s cancellation of buyer’s debt• Shareholder’s cancellation of corporation’s debt• Forgiveness of certain student loans
Problem 58
C5 - 45
That’s it, Folks!
Do not forget to go to the Meet the Firm Night
6:00- 9:00 PM
Wednesday, October 20
Upper Common
That’s it, Folks!
Do not forget to go to the Meet the Firm Night
6:00- 9:00 PM
Wednesday, October 20
Upper Common