Chapter 1: Individual Tax - Gross Income Flashcards Preview

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Flashcards in Chapter 1: Individual Tax - Gross Income Deck (38):

What is the personal exemption for 2014?

Is it prorated for birth or death during the year?


It is not prorated for birth or death during the year.


Define gross income.

Gross income includes all income from whatever source derived, unless specifically excluded.


When should a cash basis taxpayer report income?

In the year which income is either actually or constructively received, whether in cash or property.


4 categories of individual income?

1) Ordinary (wages, salaries, tax refunds, alimony, IRA, pension, unemployment, SS, prizes, etc)  

  • i.e. anything not falling under the other 3 baskets

2) Portfolio (dividends, interest)

3) Passive (real estate investment and limited partnership income)

  • passive: an activity in which a taxpayer did not actively participate
  • only passive losses may offset passive income
  • rental income received on a property that a taxpayer owns and rents
  • K-1 in R4

4) Capital

  • sales of capital assets create capital gains and losses, definition in R4


Give an example of a taxable fringe benefit.

An employee's personal use of a company car is included as wages in an employee's income.


Name some nontaxable fringe benefits (exclusions from income).

1) De minimis fringe benefit (i.e. so minimal that they are impractical to account for)

  • ex: employees personal use of a computer

2) Qualified tuition reduction

  • employees of educational institutions who receive tuition reductions may exclude the reduction from income
  • if grad student, may only exclude reduction if they are engaged in teaching or research activities

3) Qualified employee discounts

4) Employer paid premiums for accident, medical, and health insurance

5) life insurance proceeds (but, the interest income element on deferred payout is fully taxable)

6) meals and lodging (must be required as a condition of employment)

7) Employer paid employee's educational expenses (up to $5,250 may be excluded)

8) Qualified employee discounts

9) Flexible Spending Arrangements (FSAs)

  • employees have the ability to elect to have part of their salary deposited into pretax into a flexible spending account designated for them.


- Unless specifically excluded by law, the fringe is includible in gross income.


Are life insurance premiums paid by an employer taxable to employee?

Premiums on the first $50,000 (face amount) of group term life insurance are not includible in gross income. Premiums paid for coverage above $50,000 should be included in gross income.


Examples of exempt interest?

1) State and local govt bonds

  • interest on state and local bonds
  • includes mutual fund dividends invested in tax-free bonds

2) Bonds of US possession

  • interest on the obligation of a possession of the U.S., such as Guam or Puerto Rico

3) Series EE (US Savings Bond) if used for higher education

  • EE = Educational Expenses
  • reduced by tax-free scholarships, and
  • taxpayer or joint ownership, and
  • taxpayer is over 24 yrs of age, and
  • bonds are acquired after 1989
    • phase out starts when modified AGI exceeds $76k for single & HH, and $113,950 for MFJ)
    • no exclusion for MFS status

4) Interest on Veterans Admin insurance


General rule: all interest income is taxable, unless specifically excluded


What is the tax treatment of unearned income of a child who falls under the "Kiddie tax" rules?

Net unearned income of a dependent child who falls under the "Kiddie tax" rules is taxed at his parents higher tax rate. The income in excess of $2k is taxed at parent's marginal tax rate.

Net unearned income:

Child's total unearned income

(child's standard deduction of $1,000, or investment expenses, if greater)

 (an additional $1,000 (which is generally taxed at the child's rate of 10% or 15%).)

Net unearned Income


Tax Rates for Dividend Income

  • 15% - Most taxpayers
  • 0% - Low income taxpayers (those in the 10% or 15% ordinary income tax bracket)
  • 20% - High income taxpayers (those in the 39.6% ordinary income tax bracket)


What are the reqs for alimony to be deductible by the paying former spouse and includible by the recipient?

1) Payments must be legally required pursuant to a written divorce (or separation) agreement

2) Payments must be in cash (or equivalent, i.e. pay credit card bills or pay college fees)

3) Payments can not extend beyond death of payee

4) Payments can not be made to members of same household

5) No joint tax return filed.

6) Payments must not be designated as anything other than alimony

- Before alimony is taxable by the recipient, any child support due must be paid.


State the tax treatment of property settlements in a divorce.

The transferring spouse gets no deduction for payments made (or property transferred), and the payments are not includible in the gross income of spouse receiving the payment or property.


Describe the self employment tax

1) All net self employment income is subject to the 2.9% Medicare tax, but only self employment income up to $110,100 (2012) is subject to the 12.4% Social Security tax.

2) An adjustment to income for one half (7.65% on up to $110,100 self employment income for 2012) of self employment tax (Medicare plus Social Security) paid.


Deductible Expenses for Business Income

  1. COGS
  2. Salaries & commissions paid to others (not yourself)
  3. state and local business taxes paid
  4. office expenses
  5. actual automobile expenses (depreciation expense is limited to only that portion used for business, or a standard mileage rate, 56 cents per mile)
  6. Business meal and entertainment at 50% (unless for charity, then 100% deductible)
  7. Depreciation of business assets
  8. Interest expense on business loans (must be incurred and paid)
  9. Employee benefits
  10. legal and professional services
  11. bad debt are written off for accrual basis taxpayer only


On what property do the uniform capitalization rules apply?

1) Real or tangible personal property produced by the taxpayer for use in his trade or business

2) Real or tangible personal property produced by the taxpayer for sale to customers (manufacturer's inventory)

3) Real or tangible personal property purchased by the taxpayer for resale (retailer's inventory) - Exception: The uniform capitalization rules do not apply to (retailer's inventory) property purchased for resale if the taxpayer's gross receipts for the preceding three tax years do not exceed $10,000,000 anually.


When are funds in a nondeductible IRA taxable?

Withdrawals from nondeductible IRAs are partially taxable.

When withdrawn, amounts previously contributed (principal) are nontaxable.

Any earnings on those contributions are taxable when withdrawn.

A pro rata allocation is generally applied to the distribution to determine the taxable amount.


Principal: nontaxable

Accumulated Earnings: taxable (when withdrawn)


Premature distribution is subject to a 10% penalty tax


Exceptions to Penalty Tax for a premature distribution of IRA Income


  • Home buyer (first time): $10k maximum exclusion applies if the distribution is used toward the purchase of a first home (within 120 days of distribution)
  • Insurance (medical)
    • unemployed with 12 consecutive weeks of unemployment compensation
    • self-employed (who are otherwise eligible for unemployment compensation)
  • Medical expenses in excess of 10% of AGI
  • Disability 
    • permanent, but not temporary
  • Education: college tuition, books, fees, etc
  • and
  • Death


What is the formula to determine the excludable portion of an annuity?

Excludable amount in current year = (Investment in contract / Age Factor (in months))

Note: If the annuitant lives longer than the factor in months, further payments are fully taxable.

If the annuitant dies before the factor payments are collected, the unrecovered portion of the investments is a miscellaneous itemized deduction on the annuitant's final tax return (not subject to the 2% limitation).


In premature distributions of an IRA, what are the exceptions to the penalty tax? HIM DEAD

1) Home buyer (first time): $10,000 max if used toward first home (within 120 days) 2) Insurance (medical) A) Unemployed with 12 consecutive weeks of unemployment compensation B) Self employed (who are otherwise eligible for unemployment compensation) 3) Medical expenses in excess of 7.5% AGI 4) Disability 5) Education: College, tuition, books, fees, etc. 5) and 6) Death


The basic formula for the determination of net rental income or loss

Gross rental income

+ Prepaid rental income: nonrefundable deposits

+ Rent cancellation payment

+ Improvement in-lieu-of rent

( Rental Expenses )

Net Rental Income


Net Rental Loss



How is rental income from a vacation house treated?

Good example on R1-42

1) If rented fewer than 15 days: Treat as personal residence.

  • i.e. rental income is excluded from income,
  • mortgage interest (first and second home) and real estate taxes are allowed as itemized deductions
  • depreciation, utilities, and repairs are not deductible

2) If rented 15 or more days and personal use is not more than the greater of 14 days or 10% of days rented, if greater: Treat as rental property

3) If rented more than 15 days and personal use is the greater of 14 days or 10% of days rented: Allocate rental expenses to extent of rental income.

  • Expenses must be prorated between personal and rental use
  • however, a different proration method is used for mortgage interest and property taxes, than for other property-related expenses (i.e. utilities, insurance, depreciation, etc)
    • interest and taxes: allocated based on rental period/total annual period
      • deductible on Schedule A
    • utilities, depreciation, etc.: allocated based on rental period/total annual usage
      • not deductible
  • Rental use expenses are deductible only to the extent of rental income

- If treated as personal, income is excluded and deductions for mortgage interest and taxes are reported on Schedule A. Other expenses are not deductible. - If the vacation property is treated as a rental property, the taxpayer reports income and deductions on Schedule E.


Define passive activity. Give some examples.

A passive activity is any activity in which the taxpayer does not materially participate.


1) Rental activities

2) Interests in limited partnerships

3) S corporations

4) Most tax shelters



What is the tax treatment of nondeductible passive activity losses?

A net passive activity loss may not be deducted against wages, salaries, and other active income or against portfolio (interest and dividends) or capital gains income. Expenses related to passive activities can be deducted only to the extent of income from all passive activities.


Carry forward without any time limit unused passive activity losses held in suspension.

1) Suspended losses are used to offset passive income in future years. 

2) If still unused, suspended losses become fully tax deductible in the year the property is disposed of (sold).

3) Fully tax deductible in the year the property is disposed of (sold).


PAL (Disallowed Net Loss) Exceptions

An individual may deduct rental activity losses if either of the following two conditions are met:

  1. Mom and Pop Exception
    • ​​$25,000 and "Active"
      • Taxpayers may deduct up to $25k (per year) of net passive losses attributable to rental real estate annually if the individuals are
      • actively participating/managing and
      • own more than 10% of the rental activity
  • Carryforward
    • An excess would be carried forward indefinitely as an usued PAL. An estate can qualify for 2 years following the decendent's death if the decendent actively participated in the operation.
  • Phase-Out
    • The $25k allowance is reduced by 50% of the excess of the taxpayer's AGI (without consideration of the loss deduction) over $100k. The allowance is eliminated completely when AGI exceeds $150 
  1. Real Estate Professional/Agent (not passive activity)
  • if the following conditions are met and the taxpayer is deemed to have material participation, the rental activies are not considered passive and the taxpayer can fully deduct losses from the rental activities against other income:
    • More than 50% of taxpayer's personal services during the year are performed in real property business, and
    • The taxpayer performs more than 750 hours of services in real property businesses


What are the rules to determine taxable Social Security benefits?

Taxpayers are classified into 5 categories depending on the level of provisional income, which is defined as:

AGI + tax exempt interest + 50% of SS benefits.

1) Low income: No SS benefits are taxable (income below: single $25k, MFJ$32k)

2) Lower middle income: Less than 50% of SS benefits are taxable

3) Middle income (over single $25,000/MFJ $32,000): 50% of SS benefits are taxable

4) Upper middle income: Between 50% and 85% of SS benefits are taxable

5) Upper income (over single $34,000/MFJ $44,000): 85% of SS benefits are taxable


Are scholarships and fellowships includible in gross income?

For a degree-seeking student, scholarships and fellowships are excludable up the amounts spent on tuition, fees, books, and supplies (not room and board). No services are to be performed as a condition to receiving the grant.

  • All remaining amounts are includible in gross income.
  • Taxable: room & board, and services required

- For a nondegree-seeking student, all amounts are includible in gross income, i.e. fully taxable.


How are prizes and awards taxed?

Taxable Miscellaneous Income:

The FMV is taxable income. 

Exception: the winner is selected without entering into a contest, and assigns the award directly to a governmental unit or charity


How are gambling winnings and losses taxed?

Taxable Miscellaneous Income:

  • Winnings: fully taxable
  • Losses: gambling losses may only be deducted to the extent of gambling winnings
    • the allowable amt are deductible on Schedule A as an itemized deduction, but the amt is not subject to the 2% of AGI limitation on misc. itemized deductions


How are punitive damages taxed?

Taxable Miscellaneous Income:

Fully taxable as ordinary income if received in a business context or for loss of personal reputation.

Also, if received for a personal injury case, they are taxable except in wrongful death cases where state law has limited wrongful death awards to punitive damages only


What are the tests for foreign-earned income exclusion?

Taxpayers working abroad may exclude from GI up to $99,200 of their foreign-earned income. Must satisfy one the following:

1) Bona fide residence test (entire tax year)

2) Physical presence test (330 full days out of 12 consecutive months)


List some nontaxable miscellaneous income items (exclusions).

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1) Life insurance proceeds

  • interest income element on deferred payout is fully taxable

2) Gifts and inheritances

3) Medicare benefits

4) Workers Comp

  • for personal injury or sickness

5) Personal (physical) injury or illness award

6) Accident insurance-premiums paid by taxpayer

7) Foreign-earned income exclusion


What is the personal exemption for 2014?

Is it prorated for birth or death during the year?


It is not prorated for birth or death during the year


What form or schedule do you file for interest income?

Schedule B 


What are the taxes on net business income?

  1. Income Tax
  2. Federal self employment tax


Net Income from Self Employment is computed on what schedule?

Schedule C. The net income is then transferred to Form 1040 as one amount, i.e. profit or loss.


What is the schedule for Social Security/Self Employment Tax?

Schedule SE


What is the formula for gross profit for Farmers when using the Accrual Method?

End of Year Inventory

+ Proceeds from sales during the year

( Value of Inventory at Beginning of Year)

( Cost of Inventory Purchased during the year)

Gross Profit


Schedule E is used to compute supplemental income and/or loss from:

  • Rental real estate
  • Royalties
  • Partnerships and Limited Liability Companies (from schedule K-1)
  • S corporations (from schedule K-1)
  • Estates (from schedule K-1)
  • Trusts (from schedule K-1)