Chapter 5

Question 1

What is the Realization Principle?

Answer 1

Income is realized when a taxpayer ENGAGES in a transaction with another party resulting in a measurable change in property rights.

Question 2

What forms of receipt can taxpayers recognize as income?

Answer 2

Taxpayers recognize income whether they receive money, property, or services.

Question 3

What is the tax basis?

Answer 3

The COST of an asset.

Question 4

What does the Return of Capital Principle allow?

Answer 4

It allows the tax basis to be EXCLUDED when calculating a gain or loss.

Question 5

What is the Tax Benefit Rule?

Answer 5

Refunds of expenditures deducted in a prior year are included in gross income to the EXTENT that the refund reduced taxes in the year of the deduction.

Question 6

What method of accounting do most individuals use?

Answer 6

Cash method.

Question 7

What is the Constructive Receipt Doctrine?

Answer 7

A cash method taxpayer REALIZES and RECOGNIZES income when it is actually or constructively received.

Question 8

What does the Claim of Right Doctrine address?

Answer 8

states that income has been realized if a taxpayer receives income and there are NO restrictions on the taxpayer’s use of income

Question 9

What does the Assignment of Income Doctrine state?

Answer 9

The taxpayer WHO EARNS the income from services MUST RECOGNIZE the income.

Question 10

What is “earned income”?

Answer 10

Income from labor generated by the efforts of the taxpayer.

Question 11

What is “unearned income”?

Answer 11

Includes gains or losses from the sale of property, dividends, interest, rents, royalties, and annuities.

Question 12

What is an annuity?

Answer 12

An investment that pays a STREAM OF EQUAL payments over time, usually purchased to supplement retirement income.

Question 13

How is the annuity exclusion ratio calculated?

Answer 13

Initial Investment / Expected Return

Question 14

What are flow-through entities?

Answer 14

Entities like partnerships or S corporations where INCOME and DEDUCTIONS flow through to the owners.

Question 15

What are the four requirements for a payment to be considered alimony?

Answer 15

1. A transfer of cash made under a divorce DECREE
2. The divorce decree does not designate the payment as ‘non-alimony’
3. The divorced spouses DO NOT live together when the payment is made
4. Payments cannot continue after the DEATH of the recipient

Question 16

What is the general rule for prizes and awards?

Answer 16

Prizes, awards, and gambling winnings ARE included in gross income.

Question 17

What is the maximum percentage of Social Security benefits that may be included in gross income?

Answer 17

Up to 85%.

Question 18

What happens when a taxpayer’s debt is forgiven?

Answer 18

The taxpayer MUST INCLUDE the amount of debt relief in gross income.

Question 19

What is an EXCEPTION to the rule of discharge of indebtedness?

Answer 19

A discharge of indebtedness is NOT taxable if the taxpayer is INSOLVENT before and after the debt forgiveness.

Question 20

What is the general tax status of municipal bond interest?

Answer 20

EXEMPT from federal income tax, generally recognized as a subsidy to state and local governments.

Question 21

How much gain can taxpayers EXCLUDE on the sale of their principal residence?

Answer 21

Up to $250,000 ($500,000 if MFJ).

Question 22

What are qualifying fringe benefits?

Answer 22

Certain fringe benefits EXCLUDED from income.

Question 23

Scholarships used for required tuition, fees, books, and supplies are _______.

Answer 23

EXCLUDED from income.

Question 24

What scholarships amounts are taxable?

Answer 24

Amounts used for room and board (personal expenses)

Question 25

Are gifts and inheritances included in the income of the recipient?

Answer 25

NO

Question 26

What happens to life insurance proceeds received due to the death of the insured?

Answer 26

EXCLUDED from the income of the recipient.

Question 27

Early Cash Out, would the taxpayer recognize income?

Answer 27

- taxpayer would recognize to the EXTENT the proceeds received EXCEED the previous premiums paid in. - if premiums paid > proceeds received then loss is NOT deductible

Question 28

What are the EXCEPTIONS to early cash-out?

Answer 28

1. taxpayer is TERMINALLY ILL (medically certified with an illness expected to cause death within 24 months) 2. taxpayer is CHRONICALLY ILL (medically certified to require substantial assistance for daily living activities -or- due to cognitive impairment)

Question 29

If the taxpayer is terminally ill how much of the cash-out is taxable?

Answer 29

None of it, there are NO restrictions on how the proceeds are used.

Question 30

If the taxpayer is chronically ill, how much of the cash-out is taxable?

Answer 30

it is not taxable to the EXTENT the proceeds are used to pay for the taxpayer's L/T care

Question 31

What is the maximum amount of foreign-earned income that can be EXCLUDED from gross income for 2024?

Answer 31

$126,500.

Question 32

What are the requirements for a taxpayer to qualify for the foreign-earned income exclusion?

Answer 32

1. Must have tax home in a foreign country 2. Must be a RESIDENT of the foreign country -OR- live there for 330 days in a consecutive 12-month period.

Question 33

Workers' compensation benefits are included in gross income.

Answer 33

FALSE

Question 34

Unemployment compensation is FULLLY taxable for tax year 2024?

Answer 34

TRUE

Question 35

What type of payments related to personal injury are EXCLUDED from gross income?

Answer 35

Awards and settlements compensating for PHYSICAL injury.

Question 36

Compensatory damages for physical injury are _______.

Answer 36

NON-taxable.

Question 37

What distinguishes disability benefits received from purchased insurance by an individual versus by an employer?

Answer 37

If purchased by the individual, benefits are excluded; if by the employer, benefits may be taxable.

Question 38

What must be true for disability insurance premiums to be considered purchased by the employee?

Answer 38

The premiums must be taxable compensation to the employee.

Question 39

What are punitive damages classified as for tax purposes?

Answer 39

ALWAYS taxable.