Chapter 1 – GROSS INCOME

1) What Incomes are Taxable? Or what is Gross Income?

Gross Income is the total of earned income and unearned Income.

Gross Income = Earned Income + Unearned Income

 Earned income includes salaries, wages, tips, professional fees, taxable

scholarships and fellowship grants.
 Unearned Income includes, unemployment compensation, taxable social
security benefits, Pensions, annuity, cancelled debt, unearned income from a
trust, taxable interest, dividends and capital gains.

a. Wages, Salaries and Tips

b. Interest Income
c. Dividend Income
d. IRA’s, Pension and Annuity
e. Social Security Benefits
f. State & Local Refunds
g. Business Income
h. Alimony
i. Capital Gains
j. Other Gains
k. Rents, Royalties
l. Income from Partnerships, S-Corp and C-Corp (Pass Through Entities)
m. Farm Income
n. Unemployment Compensation
o. Other Income
p. Commissions
q. Income from Estate or Trusts
r. Income received by Legal Heir
s. Gifts
t. Illegal/Unlawful Income
u. Gambling/Lotteries/Casino Incomes/Horse Races
v. Hobby Income
w. Crypto Currencies/Bit Coins /Virtual Currencies
x. Cancelled Debts
y. Scholarships and Grants
z. Court/Government awards/Barter Income/Jury Duty Pay.

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 Chapter 2 – WAGE INCOME (W2)

Wage Statement

Regular Corrected Substitute

Form W2 Form W2-C Form 4852

Jan 31st Immediately Self Prepared

Income from Employment:

[Link]/Salaries
b. Bonus or Incentives or Commissions
c. Employee Benefits / Fringe Benefits (De Minimis)
d. Parking Allowance up to $270 - 2021 per month
e. Prices / Rewards / Awards and Recognitions
i. Exempt up to $1600 for Qualified plans
ii. Exempt up to $400 Non- Qualified plan awards
f. Allowances (Food, Housing, etc.)
g. Education Program assistance up to $5,250 is exempt
h. Retirement Benefits
i. Employee Stock Options
j. Insurance/Third Party Sick Pay
k. Compensation in case of Injuries/Sickness
l. Dependent Care Benefits (up to $5,000 for MFJ & $2500 for MFS)
m. Reimbursements for Moving Expense
n. Work Expense reimbursements
o. Transportation Allowances
p. Foreign Income
q. Employer provided life insurance (Group Term) (up to $50,000)
r. Tip Income
s. Scholarship / Fellowship Grants
t. Adoption assistance - $14,440 -2021

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 Chapter 2 – WAGE INCOME (W2)

Copies of Form W2

W2

 Employer
 Employee
 IRS
 State
 Local –City – County
 SSA

Contributions (Tax Savings)

Contributions

Pre- Tax Post Tax

1) IRA (Individual Retirement
1) 401(K) Plan Account
2) 403(b) Plan 2) HSA ( Health Saving Account)
3) 457 Plan 3) ESA ( Education Saving Account)
4) FSA ( Flexible spending
Accounts) Paid from Net Salary
5) FICA (SST+MCT) Example :- LIC in India
Paid from Gross Salary
Example :- PF in India

FICA Taxes

FICA Taxes

Social Security Taxes @6.2%.

Medicare Taxes @1.45%. Total
Total Employer and Employee Employer and Employee
Contribution - 12.40% Contribution -2.90%

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 Chapter 2 – WAGE INCOME (W2)

Additional Medicare Tax (AMT) @ 0.90% on top of the Regular 1.45%

**1.45% will be 2.35% if Income >$200K (MFJ - $250K)

 The Box 3 of W2 (SSW) is limited to $142,800 for 2021.

 Both SST and MCT are deposited in SSB Account with the SSA.
 These SSB (Social Security Benefits) will be paid to the Taxpayer at the end of
Retirement, Death /Disability, whichever is EARLIER.

Service

Contractor (Independent) - FORM 1099 -

Employee (Full time/Part MISC- Rent , Royalties and other income
Time) - Form W2 Form 1099-NEC- Non Employee
Compensation

TIP INCOME
 Tips received will also be considered as Income and will be subject to Federal Income
Tax, SST and MCT.
 The Employee must report all Tips to the Employer if the Tip Income is >$20 for Each
Month.
 Non-Cash Tips such as Tickets, Passes or other items of Value must also be reported
to IRS.

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 Chapter 2 – WAGE INCOME (W2)

 No FICA Taxes on Non-Cash Tips

 All Tips must be reported to the Employer by the 10th of the Following month.
 FORM 4137 is used to calculate SST and MCT on Tips not reported to the Employer
 Penalty on unpaid SST and MCT due on the unreported TIP Income is equal to 50%

*Additional Points To Be Included in Class Notes:-*

A) What to do if a taxpayer does not receive his Form W2/ 1099R?

 If a taxpayer does not receive his Form W-2 or Form 1099-R by January 31, or if the
information is incorrect (including his name, Social Security number, address, or
amount), he should contact the employer/payer.
 If the taxpayer does not receive the missing or corrected form by February 14 from
the employer (payer), he may call the IRS at 1800-829-1040 for assistance. The IRS will
contact the employer/payer and request the missing form. The IRS will also send the
taxpayer a Form 4852, Substitute for Form W-2 or Form 1099-R.
 If the taxpayer does not receive the missing form in sufficient time to file his tax return
timely, Form 4852 may be used. If the missing or corrected Form W-2 or Form 1099 is
received after the taxpayer files his return and a correction is needed, use Form 1040X,
Amended U.S. Individual Income Tax Return.
 Using pay stubs or other non-W-2s prepare Form 4852 and e-file a client's tax return.

B) What to do if the employer withheld Excess S.S.T from an employee’s paycheck?

 If an employer withheld too much Social Security tax from an employee's paychecks,
the employee should advise the employer of the error and the employer should
correct and reissue the W2.
 If the employer does not correct the over-collection, the taxpayer can file a claim for
refund using Form 843, Claim for Refund and Request for Abatement.

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 Chapter 2 – WAGE INCOME (W2)

C) How to deal with the errors in Form 1099-MISC?

 If the issuer of the incorrect information return is contacted before the transmission
due date, the issuer may be able to destroy the incorrect one and issue a new form.
 However, just in case the issuer has already transmitted the erroneous information,
even though you are told the incorrect amount(s) had not been transmitted, ask for
a letter from the company saying that they issued an erroneous form, destroyed it,
and then properly issued a correct form.
 When a payor issues a revised information return, a check will be in the "corrected"
box on the form.

D) Other payment types that are reported on Form 1099-MISC include,

 Fees paid to attorneys and the amount of gross proceeds of a settlement award
 Crop insurance proceeds
 Reimbursement for damage awards / settlements
 Direct sales of consumer products for resale
 Director's fees
 Proceeds paid to fishing boat crew members
 Fish purchases paid in cash
 Punitive damages awards / settlements
 Rents paid
 Royalties paid
 Other income

E) Other payment types that are reported on Form 1099-NEC include,

 Auto expense reimbursements paid to non-employees
 Awards paid to non-employees
 Bonuses paid to non-employees
 Compensation paid to non-employees
 Fees paid to non-employees
 Golden parachutes paid to non-employees

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 Chapter 2 – WAGE INCOME (W2)

 Mileage paid to non-employees

 Vacation allowance paid to non-employees.

F) What is a 1099 LTC for?

 Payments received under a long-term care insurance contract and accelerated death
benefits paid under a life insurance contract or by a viatical settlement provider are
reported to the recipient on Form 1099-LTC.
 These forms are typically issued in January for the previous year.

E) What About Form W-2G?

 A payer is required to issue a Form W-2G for certain gambling winnings or if the
taxpayer has any gambling winnings subject to federal income tax withholding.
 The requirements for reporting and withholding depend on the type of gambling, the
amount of the gambling winnings, and generally the ratio of the winnings to the
wager.

F) How is a service member's enlistment and reenlistment bonuses generally accounted for?

 The payments and withholdings for the enlistment and reenlistment bonuses are
reflected on the service member's Form W-2.
 All includible military income will generally be shown in Form W-2, box 1, and reported
on Form 1040.
 Not all reenlistment bonuses are taxable.
 The service member's reenlistment bonus may be excluded from gross income
although received in a month that he was outside a combat zone if he completed the
necessary action for entitlement to the reenlistment bonus in a month during which
he served in a combat zone.

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 Chapter 2 – WAGE INCOME (W2)

G) What amount must the employee include in income in case of company's qualified
employee achievement awards program?

If an employee receives tangible personal property (other than cash, a gift certificate, or an
equivalent item) as an award for length of service or safety achievement, the employee can
exclude its value from income. However, the amount excluded is limited to the employer's
cost and cannot be more than $1,600 ($400 for awards that are non-qualified plan awards)
for all such awards the employee receives during the year
The employer must make the award as part of a meaningful ceremony, under conditions and
circumstances that do not create a significant likelihood of it being disguised pay.

However, the exclusion does not apply to the following awards:

1. A length-of-service award if you received it for less than 5 years of
presentation service or if you received another length-of-service award during
the year or the previous 4 years.

2.A safety achievement award if you are a manager, Administrator, clerical

employee, or other professional employee or if more than 10% of eligible
employees previously received safety achievement awards during the year.

Notes:-

 An information return is a tax document certain taxpayers are required to file to report
certain business transactions to the IRS.
 Employers are required to deduct Social Security and Medicare Taxes from each wage
payment even if the taxpayer does not expect to qualify for Social Security or Medicare
benefits.

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 Chapter 3 – INTEREST INCOME – FORM 1099 INT

INTEREST

 Payer
 Recipient
 IRS
 State
 Local

General Notes

Interest is Taxable the moment it is credited to the Tax payer Account and is
ready for withdrawal.

 Interest on State / Municipal Bonds is Exempt.

 Interest from US Treasury bills /bonds is taxable (exempt in State/Local).
 Gifts received from Banks for opening Bank account is exempt, if the gift is
less than $10. If the amount deposited in the bank account is more than
$5000 then the gifts are taxable, if it is worth >$20.

Deposit Taxable
<= $5000 >$10
>$5000 >$20

 Interest on tax Refunds is also taxable.

 Interest received as a Nominee is also Taxable
 Interest from US Savings Bond (Series I, E, EE) are :-
o Exempt, if used for qualified education expenses
o Taxable, if used for non-qualified education expenses
o These Bonds are also known as Education Savings Bond Program (Form
8815)
o TP should be >24 years old before the bonds issue rate, the bond can be
used to pay the college costs of TP,SP,QC or QR.
 Interest received via Form 1099-INT for interest on frozen deposits is to be
reported on Schedule B (Form 1040), Part 1.

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 Chapter 3 – INTEREST INCOME – FORM 1099 INT

Original Issue Discount:

 It is a form of Interest and is the difference between:-

 Redemption price at maturity (Face value of Bonds) and the
 The Original Issue Price
 It is usually called De minimis OID and is reported on FORM 1099-OID

 The OID rules do not apply to the following debt instruments:

 Tax-exempt obligations
 U.S. savings bonds
 Short-term debt instruments ( One year or less)

 Original Issue Discount (OID) must be included in income as it accrues

over the term of the debt instrument, whether or not any payments are
received from the issuer.

Reporting Forms

 Any Interest Income is reported by the payer to various authorities

including the recipients on FORM 1099 INT.
 A Taxpayer with Taxable Interest/Ordinary dividends >$1500 must
attach Schedule B

*Additional Points To Be Included in Class Notes:-*

A) Nominee Distributions

If a taxpayer receives a Form 1099-INT for the real owner or co-owner, report
the full amount shown as interest on the Form 1099-INT on line 1 Schedule B
(Form 1040 or 1040-SR ). Then, below a subtotal of all interest income listed,
write "Nominee Distribution" and the amount that actually belongs to someone
else. Subtract that amount from the interest income subtotal. Enter the result
on line 2 Schedule B (Form 1040 or 1040-SR ).

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 Chapter 3 – INTEREST INCOME – FORM 1099 INT

B) File Form 1099-INT with the IRS

If a taxpayer receives interest as a nominee, the taxpayer must file a Form

1099-INT for that interest with the IRS.

C) Reporting Tax-Exempt Interest

Tax-exempt interest must be reported on line 2a of form 1040 or 1040-SR.

D) Schedule B, Part 1, must be completed if the taxpayer has any of the

following:
 Over $1,500 of total taxable interest income.
 Over $1,500 of total taxable dividends.
 A financial interest in, or signature authority over, a financial account
in a foreign country or if he received a distribution from, or was a
grantor of, or transferor to, a foreign trust. (Part III of Schedule B has
questions about foreign accounts and trusts.)
 Interest received as part of seller financed mortgage and the buyer used
the property as a personal residence.
 Interest income on a bond is reduced by the amount of amortizable
bond premium.

If the taxpayer has $1,500 or more in total interest (Schedule B, line 4) or

total dividends (Schedule B, line 6), Schedule B, Part III, Foreign Accounts
and Trusts, must also be completed.

E) Interest from bonds issued by the following is exempt from federal income
tax:

 State and political subdivisions (county or city)

 District of Columbia
 U.S. possessions and political subdivisions
 Port authorities
 Toll-road commissions
 Utility service authorities
 Community redevelopment agencies
 Qualified volunteer fire departments.
 Amounts indicated on broker statements as tax-exempt interest or tax-
exempt dividends.

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 Chapter 3 – INTEREST INCOME – FORM 1099 INT

F) Gift Loans & Imputed Interest:

 The value of the gift is determined by the COST to the financial

institution, not the FMV of the gift.

 For gift loans between individuals, there is no imputed interest if the

loan is $10,000 or less.

 For gift loans of $100,000 or less to a child to buy a home, the imputed
interest rules do not apply as long as the child has investment income
less than $1,000.

 If the child has investment income greater than $1,000, the imputed
interest cannot exceed actual investment income.

G) Market Discount Bonds:

 Market discount bonds are bonds (OTHER THAN short-term, tax-

exempts, and U.S. Savings Bonds) purchased at a discount.
 Market discount arises when the value of a debt obligation decreases
after its issue date, generally because of an increase in interest rates.

H) Equation to Calculate excludable amount of Qualified Education Expenses

(QEE) Savings Bond Proceeds:

 To determine the excludable amount, multiply the interest part of the

proceeds by a fraction.
 The numerator (top part) of the fraction is the qualified higher educational
expenses paid during the year.
 The denominator (bottom part) of the fraction is the total proceeds taxpayer
received during the year.

= Interest x (QEE Paid/Total Proceeds Received).

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 CHAPTER 4 – DIVIDEND INCOME (FORM -1099 DIV)

TYPES OF DIVIDENDS AND DISTRIBUTIONS

A) Ordinary Dividends:
 Paid by the company to the Shareholder.
 Taxable at ordinary Income Tax rates
 Paid out of Earnings and Profits of the company

B) Qualified Dividends:
 These are Dividends taxed at Special Rates (0%, 15% or 20%)
 The taxpayer must hold the stock for more than 60 days before the Ex-
Dividend date.
 The Ex-Dividend date is the date following the dividend declaration date.
 Beginning in 2013, under the American Taxpayer Relief Act of 2012, the
2012 rates on qualified dividends were permanently extended, but a 20%
rate was added for taxpayers in the highest tax bracket. That rule still
exists, except that the highest rate is 37% in 2021.

C) Reinvested Dividends:
 Under this method, the TP purchases more stock in the Corporation than
receiving dividend in cash.
 When TP is purchasing more stock then Dividend Income is FMV of
Additional Stock Purchased.
 Reinvested dividends are taxable in the year paid and added to the basis
of the stock or mutual fund.
 Reinvested dividends are treated as ordinary dividends.
 A dividend reinvestment plan allows taxpayer to choose to use the
dividends to buy (through an agent) more shares of stock in the corporation
instead of receiving the dividends in cash.
 If taxpayer is a member of this type of plan and uses the dividends to buy
more stock at a price equal to its fair market value, dividends still must be
reported as income

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 CHAPTER 4 – DIVIDEND INCOME (FORM -1099 DIV)

D) Deemed Dividend:
A shareholder is deemed to have received a dividend:
o If the Corporation paid the debt of its shareholder.
o The shareholder receives services from the Corporation.
o The shareholder is allowed to use company property.

E) Dividend on Insurance policy:

 Insurance policy dividends that the insurer keeps and uses to pay your
premiums are not taxable.
 However, you must report as taxable interest income, the interest that is
paid or credited as dividends.

F) Money market funds

 A taxpayer must report any Income from Money market funds as Taxable
dividend income
 Money market funds could be Treasury bills, commercial paper,
certificate of Deposit or any other Investment in short term debt. In
other words, they are a type of Mutual funds

G) Return of Capital:
 They are not dividends.
 It reduces the basis of your stock in the company
 If the basis in stock is reduced to ZERO because of return of capital and
still amount is paid to the shareholder then it is Non-Dividend Distribution
taxable as Capital Gain.

H) Capital Gain Distribution:

 They are taxable as Long Term Capital Gains (LTCG)
 This includes distributions from:
o REIT (Real Estate Investment Trust)
o ETFs (Exchange Traded Funds)
o MMFs (Money Market Funds)
o RICs (Regulated Investment Companies)

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 CHAPTER 4 – DIVIDEND INCOME (FORM -1099 DIV)

Annuities: - Annuities are also taxable as Retirement distributions if the

amounts were invested in the company under any of the qualified Retirements
plans.

Annuitization: - The process of converting an annuity into a series of periodic

payments. Payments may occur over a period or for the life of the annuitant.

Note:- If a Shareholder receives dividends as Nominee, then it should be

reported in Form 1099 DIV.

*If a taxpayer received dividends as a nominee, the taxpayer must file a Form
1099-DIV with the IRS. Send the Form 1099-DIV with a Form 1096 to the IRS
Center.

*Additional Points To Be Included in Class Notes:-*

A) Regarding when distributions of stock dividends and stock rights are taxable,
all of the listed distributions are taxable.

*Distributions of stock dividends and stock rights are taxable if:

1. Any shareholder has the choice to receive cash or other property instead
of stock or stock rights.

2. The distribution gives cash or other property to some shareholders and

an increase in the percentage of interest in the corporation's assets or
earnings and profits to other shareholders.

3. The distribution is in convertible preferred stock and has the same result
as in (2).

4. The distribution gives preferred stock to some common stock

shareholders and gives common stock to other common stock
shareholders.

5. The distribution is on preferred stock.

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 CHAPTER 4 – DIVIDEND INCOME (FORM -1099 DIV)

* However, if the stock dividend is taxable when received, the basis of the new
stock is its FMV on the date of distribution. The basis of the old stock does not
change.

* If the taxpayer receives dividends through a partnership, an estate, a

trust, or an S-corporation (STEP), he should receive a Schedule K-1 from
that entity indicating the amount of taxable dividends.

B) If a taxpayer invests more cash to buy shares of stock at a price less than
FMV, the difference between the cash invested and the FMV of the stock must
be included in income.

 If taxpayer is a member of a dividend reinvestment plan that allows the

taxpayer to buy more stock at a price less than its FMV, taxpayer must
report as dividend income the FMV of the additional stock on the
dividend payment date.

 Taxpayer also must report as dividend income any service charge

subtracted from the cash dividends before the dividends are used to buy
the additional stock.

C) However, REIT dividends will qualify for a lower tax rate in the following
instances:

 When the individual taxpayer is subject to a lower marginal income tax

rate.

 When a REIT makes a capital gains distribution (15% maximum tax rate;
20% if the taxpayer is in the 37% regular tax bracket).

 When a REIT makes a return of capital distribution.

 When a REIT distributes dividends received from a taxable REIT

subsidiary or other corporation (15% maximum tax rate; 20% if the
taxpayer is in the 37% regular tax bracket).

 When permitted, a REIT pays corporate taxes and retains earnings (15%
maximum tax rate; 20% if the taxpayer is in the 37% regular tax
bracket).

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 CHAPTER 4 – DIVIDEND INCOME (FORM -1099 DIV)

 If a regulated investment company (mutual fund) or real estate

investment trust (REIT) declares a dividend (including any exempt-
interest dividend or capital gain distribution) in October, November, or
December payable to shareholders of record on a date in one of those
months but actually pays the dividend during January of the next
calendar year, the taxpayer is considered to have received the dividend
on December 31.

D) Generally, S-Corporation distributions are a NONTAXABLE return of basis in

the corporation stock.

However, in certain cases, part of the distributions may be taxable as a

dividend, or as a long-term or short-term capital gain, or both.

E) A constructive dividend is an undeclared dividend by the corporation, usually

paid to one or only a few shareholders. It can be a direct payment of money
(e.g., salary), or some other indirect economic benefit to the shareholder, like
paying a shareholder's rent.

 If a corporation makes a distribution or payment from profits to a

shareholder and does not report the payment as a taxable dividend, the
IRS may reclassify the distribution as a constructive dividend.

 Generally, problems with constructive dividends occur with small, closely-

held corporations. Shareholders of these companies often treat the
corporation and its cash as personal property and use both as they see
Fit.

F) Mutual fund dividends are taxable in the year declared regardless of

whether taxpayer elected to leave them in the fund or not.

 Capital gain distributions (also called capital gain dividends) are paid or
credited to the taxpayer's account by regulated investment companies
(commonly called mutual funds or RICs).

 They will be shown in Box 2a of the Form 1099-DIV the taxpayer

receives from the mutual fund.

 Report capital gain distributions as long-term capital gains regardless of

how long the taxpayer owned the shares in the mutual fund or REIT.

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 CHAPTER 5 – SOCIAL SECURITY BENEFITS ( SSA -1099)

Computation of Taxable Social Security Benefits

A. Calculation of Provisional Income :

a) 50% of Social Security Benefits received. XXX
b) Add all incomes (including tax exempt income). XXX
c) Less foreign earned income (XXX)
XXX

B. Calculation of Base amount limits

Filing Status 0% Tax Base 50% Tax Base 85% Tax Base

Single
HOH
QWDC up to $25,000 >$25000 to above $34,000
MFS <=$34,000

MFJ up to $32,000 above $44,000

>$32000 to
<=$44,000

C. Calculation of Taxable SSB:

Lower of:
1. 85% of SSB, or
2. Base Amount in Step 2

Maximum Taxable Part

1) If all other income, including tax-exempt interest, plus one-half social

security benefits are more than the base amounts but less than $34,000
(44,000 if MFJ), taxable social security benefits is the smaller of the
following:

 One-half of net benefits received, or

 One-half of excess of (all other income + tax-exempt income + ½ net
benefits) over the base amount.

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 CHAPTER 5 – SOCIAL SECURITY BENEFITS ( SSA -1099)

Generally, up to 50% of social security benefits will be taxable. However, up to

85% of social security benefits can be taxable if either of the following applies:

 The total of one-half of social security benefits and all other income is
more than $34,000 ($44,000 if married filing jointly).
 Married filing separately and lived with spouse at any time during the
year.

2) If the sum of modified AGI and one-half social security benefits are more
than $34,000 ($44,000 if married filing jointly), taxable social security
benefits are the smaller of the following:

 85% of the net benefits received, or

 85% of the amount by which the sum of modified AGI and one-half Social
Security benefits exceed $34,000 ($44,000 if married filing jointly),
plus the smaller of:
 50% of social security benefits,
 50% of the amount by which the sum of AGI, nontaxable income
and one-half the social security benefits exceed $34,000
($44,000 if married filing jointly), or
 $34,000 ($44,000 if married filing jointly).

Case study:-1 (MFJ – Filing status)

Mr & Mrs Nanda had the following Incomes during the tax year

- Social Security Benefits - $30000

- Interest on Municipal Bonds -$10000
- IRA Distributions - $35000

Calculate Taxable SSB?

Step – A: Calculation of Provisional Income

- 50% of SSB Received ($30000* 50%) = $15000

- Add:- All Income ( Int+IRA) = $45000
$60000 ( provisional Income)

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 CHAPTER 5 – SOCIAL SECURITY BENEFITS ( SSA -1099)

Step: - B
Step A is $60000

Base Amount up to $32000 * 0% = $0

($44000-$32000) $12000* 50%=$6000

($60000-$44000) $16000*85% =$13600

$19600 - Base Amount

Step C:
Lower of:
1. 85% of SSB = $25,500 ($30000X85%), or
2. Base Amount in Step 2 = $19600

Taxable SSB = $19600

Case Study: 2 (Others – Filing status)

Single Status

Provisional Income

Step A= $60000 Same as Case Study 1

Step B

$25000 *0% = $0

($34000-$25000) $9000*50%= $4500

($60000- $34000) $26000*85%= $22100

Base Amount = $26600

Step C

Base Amount = $26600 Whichever is lower

$25500 is the Taxable SSB
85% of SSB = $25500

($30000X85%)

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 CHAPTER 5 – SOCIAL SECURITY BENEFITS ( SSA -1099)

*Additional Points To Be Included in Class Notes:-*

A) Form W4-P is used for withholding certificates for Pension or Annuity

payments.

Form W4-V is used to request withholding from Social Security or

Unemployment Compensation benefit payments. Unless a taxpayer is subject to
back-up withholding is considered "voluntary," hence Form W4-V.

Employees fill out a Form W-4 to inform employers how much tax to
withhold from their paycheck based on filing status, dependents, anticipated
tax credits, and deductions.

B) When making this comparison, do not reduce income for any exclusions for:
 Interest from qualified U.S. savings bonds
 Employer-provided adoption benefits
 Foreign earned income or foreign housing, or
 Income earned in American Samoa or Puerto Rico by bona fide residents

C) Any repayment of Social Security Benefits made during the tax year must be
subtracted from the gross benefits received in the tax year. It does not matter
whether the repayment was for a benefit received in the current tax year or in an
earlier tax year.

In some situations, the total benefits repaid are more than the gross benefits
received. If this occurred, the net benefits will be a negative figure shown in
parentheses and none of the benefits will be taxable.

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 Chapter 6 – EXEMPT INCOME

Exempt Incomes
Below are the incomes that are exempt from the Regular federal income tax:
 Municipal Bond interest
 Gain on Sale of Main home – up to $250000 is Exempt ($500,000 for
MFJ)
 Social Security benefits Minimum 15 % is Exempt from the gross income.
 Cancelled debt due to Bankruptcy and Insolvency
 Employee achievement awards up to $1600.
 Housing allowance for member of clergy (Pastors, Priests, Ministers of
God)
 Military and government disability pensions.
 Gifts and inheritances
 Interest on Series EE and I savings bonds.
 Workers compensation sickness or injury.
 Life insurance proceeds
 Discharge of Qualified Principal residence indebtedness in 2021 is up to
$7,50,000 ($375000 if filing separately)
 Foreign earned Income exclusion – up to $108,700 of foreign earnings Per
qualifying person in 2021.
 Scholarships and fellowships used for Qualified Educational expenses.
These Expense include Tuition Fees , books, Supplies and Equipments
required for Enrollment/Attendance at an Eligible Educational
Institutions (Not Room/Boarding Charges)
ACRONYM - MCQ, FLAGSHIP, PWC.

*Additional Points To Be Included in Class Notes:-*

A) Exclusion from wages:-

An employer can generally exclude the value of achievement awards given to an

employee from the employee's wages if their cost is not more than the amount
that the employer can deduct as a business expense for the year.

If the cost of awards given to an employee is more than the allowable deduction,
the LARGER of the following amounts is included in the employee's wages:

 The part of the COST that is more than the employer's allowable deduction
(up to the value of the awards)

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 Chapter 6 – EXEMPT INCOME

 The amount by which the VALUE of the awards exceeds the allowable
deduction.

B) For Federal tax purposes, the U.S. Armed Forces includes?

For federal tax purposes, the U.S. Armed Forces includes:-

1) commissioned officers,

2) warrant officers, and

3) Enlisted personnel in all regular and reserve units under control of the
Secretaries of the Defence,

4) Army,

5) Navy, and

6) Air Force.

7) The U.S. Armed forces also includes the Coast Guard.

# However, it does NOT include members of the U.S. Merchant Marine or the
American Red Cross, members of the U.S. Merchant Marines.

C) What are the military allowances are excluded from gross income.

The following military allowances are excluded from gross income:

 Basic Allowance for Housing

 Moving allowance for dislocation
 Temporary Lodging allowance

D) The tax liabilities forgiveness applies to:

 The tax year death occurred and

 Any earlier tax year in the period beginning with the year before the year
in which the wounds or injury occurred.

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 Chapter 6 – EXEMPT INCOME

E) All About VA disability compensation (Veterans Affairs)

 VA disability compensation is a monetary benefit paid to veterans who are

disabled because of injury or disease incurred or aggravated during active
military service.

 The service of the veteran must have been terminated through separation
or discharge under honorable conditions.

 Disability compensation varies with the degree of disability and the number
of dependents, and is paid monthly. The benefits are NOT subject to
federal or state income tax.

 The VA does not issue Form W-2, nor any other document for non-taxed
veteran's disability benefits.

 Once the VA sends the letter of determination, all pension payments are
offset by the disability amount paid directly from the VA, which is NOT
taxable and NOT included in any Form W-2.

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 Chapter 7 – IRA (INDIVIDUAL RETIREMENT ARRANGEMENT)

Publication -590A Contributions to IRA

Publication -590 B Distributions from IRA

Individual Retirement Arrangements (IRA)

[Link] Description Traditional IRA Roth IRA

1 Who can Contribute  Taxpayer and Spouse  Taxpayer and Spouse

 Out of taxable  Out of taxable
compensation compensation
 Age 70 ½ rule:-For tax  No age limit (Not QC/QR)
years beginning after
December 31,2019 the rule
that a tax payer is not able
to Make contributions to a
traditional IRA for the year
in which he or she reaches
age 70 ½ and all later Years
has been repealed and no
longer applies

2 What is Taxable  Wages & salaries  Wages & salaries

compensation  Commission  Commission
 Self employment income  Self employment income
 Alimony  Alimony
 Separate Maintenance  Separate Maintenance
 Non taxable combat pay  Non taxable combat pay

3 What is NOT Taxable  Rental Income  Rental Income

compensation  Interest Income  Interest Income
 Dividend Income  Dividend Income
 Pension / Annuities  Pension / Annuities
 Deferred compensations  Deferred compensations
received (past year) received (past year)
 Foreign earned income.  Foreign earned income.

4 Where to setup / open  Bank  Bank

an IRA?  Federally insured credit  Federally insured credit
union union
 Savings and loan association  Savings and loan
association

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 Chapter 7 – IRA (INDIVIDUAL RETIREMENT ARRANGEMENT)

 Any entity approved by the  Any entity approved by the

IRS to act as trustee / IRS to act as trustee /
custodian custodian

5 How much can be Least of: Least of:

contributed?
 $6,000 or compensation  $6000 or compensation
received received
 Additional $1,000 if TP or  Additional $1,000 if TP/SP
SP is 50 years or older in is 50 years or older
2021  IRA contribution can be
 IRA contribution can be made even if spouse had no
made even if spouse had no income.
income.

6 Is my contributions tax Yes, subject to income No

deductible? limitations. Eg: LIC (India)

7 What is the deadline  April 15th of next year  April 15th of next year
for making  No extensions  No extensions
contributions

8 What if excess 6% Excise Tax will be imposed 6% Excise Tax will be is

contributions are on excess contribution imposed on excess
made? contribution

9 Are distributions  Taxable, if withdrawn after  Not taxable, if withdrawn

taxable? 59 ½ years of age after 5 years of holding
 10% additional tax will be period
levied for early withdrawal  If you withdraw within 5
before 59 ½ years of age. years and you are under 59
 In other words, both ½ years of age, then 10%
regular & additional tax are additional tax will be
payable in case of Early levied.
withdrawals before 59 1/2  In other words, regular tax
years of Age. + additional tax both are
payable in case of Early
withdrawals before 59 1/2
years of age.

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 Chapter 7 – IRA (INDIVIDUAL RETIREMENT ARRANGEMENT)

10 What are the  10% additional tax doesn’t  10% additional tax doesn’t
exceptions available to apply in case of: apply in case of:
early withdrawals / o Death o Death
o Disability o Disability
pre-mature
o Medical expenses > 7.5% o Medical expenses >
distributions?
of AGI 7.5% of AGI
o Qualified higher o Qualified higher
educational expenses educational expenses
o Qualified first-time o Qualified first-time
home buyer up to home buyer up to
$10,000 $10,000
o Qualified domestic o Qualified domestic
relations order relations order
o Qualified military o Qualified military
reservists reservists
o Unemployed health o Unemployed health
insurance premium insurance premium
o Levy by IRS o Levy by IRS
o Govt 457 distributions o Govt 457 distributions

Exception for withdrawal for 59 ½ yrs :-

From a qualified retirement plan (other than an IRA) after your separation from service
in or after the year you reached age 55 (age 50 for qualified public safety employees).

Note: - Please see Publication 590-A Page 13 for IRA deduction limits.

IRA distributions, pensions or annuities etc. are reported on FORM 1099-R

Caution: The Early withdrawals cannot be from defined benefit plan

RECHARACTERIZATION

A recharacterization allows the taxpayer to treat a regular contribution

made to a Roth IRA or to a traditional IRA as having been made to the other
type of IRA.

To recharacterize a regular IRA contribution, the taxpayer instructs the

trustee of the financial institution holding the IRA to transfer the amount

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 Chapter 7 – IRA (INDIVIDUAL RETIREMENT ARRANGEMENT)

of the contribution plus earnings to a different type of IRA (either a Roth

or traditional).

If this Recharacterisation is done by the Due Date for filing the Tax return
(Including Extension) then the taxpayer can treat the contribution as if it
is made to the New/Second IRA for that particular year.

Rollover:

 Distributions from one retirement plan can be rolled over to another retirement plan.
 This rollover must be done within 60 days from the date of distribution.
 Any amount withdrawn but not rolled over within this period (60 days) will be taxable.
 A rollover cannot be deducted. It is not a Contribution.
 Only one rollover is permitted in a year.

Inherited IRAs:

 Contributions made to an inherited IRA are deductible only if inherited from

SPOUSE.
 IRAs inherited from anyone other than spouse, is not deductible.

INHERITED IRA - INHERITED BEFORE 2020 (PRE-SECURE ACT OF 2019)

 Beneficiaries of a traditional IRA from decedents who die before January 1,

2020, must begin withdrawals from a traditional IRA by December 31 of the
year following the IRA owner's death.
 For non-spouse designated beneficiaries (not a trust or estate), these required
distributions must occur under one of the following methods:

 Lump-sum – Distribute the entire account immediately.

 Life expectancy – Use the divisor from the Single Life Table, minus one each
year.
 Five-year deferral – The IRS does not allow this method when an IRA owner is
beyond the required beginning date at the time of death. A beneficiary who is
an individual may be required to take the entire account by the end of the fifth
year following the year of the owner's death. If this rule applies, no distribution
is required for any year before that fifth year.

SECURE ACT – Effective January 1, 2020, for account owners who die after December
31, 2019, (with a delayed effective date for certain collectively bargained plans), the
Secure Act requires the entire balance of the participant’s account to be distributed

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 Chapter 7 – IRA (INDIVIDUAL RETIREMENT ARRANGEMENT)

within ten years. There is an exception for a surviving spouse, a child who has not
reached the age of majority, a disabled or chronically ill person, or a person not more
than ten years younger than the employee or IRA account owner. The 10-year rule applies
regardless of whether the participant dies before, on, or after, the required beginning
date, which is age 72.

Non-deductable IRA (Form 8606):

 The amount of contribution that is not deducted because of higher income limitation
is called non-deductible contribution.
 And these Non – Deductible Contributions are reported on FORM 8606

Full Partial/No
Case Contribution Deduction IRA Deduction
Assume $4000 - Deductible on
FORM 1040
1) Single +401K+70K-W2 $6,000 Partial Deduction $2000 - Not reported on FORM
8606.
Non Deductable
Assumed $9000 Deductable on
2) Married +SP+401K+200K FORM 1040
$12,000 Partial Deduction
both W2 $3000 - Reported on FORM 8606
Non Deductable

Qualified Charitable Distributions (QCD):

1. If the IRA Distributions are transferred to a qualified charitable organization is
called QCD
2. QCD’s up to $100,000 are excluded from income.
3. The Excludible portion of QCD is reduced by IRA Deduction once Tax payer attains
701/2 years of age

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 Chapter 7 – IRA (INDIVIDUAL RETIREMENT ARRANGEMENT)

Required Minimum Distribution:

1. Generally No contributions were to be made to an IRA once taxpayer reaches 70 ½
years of age. However from 2020 even Tax payers over 70 1/2 years of Age can
contribute to Traditional IRA.
2. The taxpayer must take FIRST DISTRUBUTION BY APRIL 1ST of the year
following the year taxpayer reaches 72 years of age and second RMD by December
31st.
3. There is no age limit for contributions to Roth IRA.
4. All other ANNUAL DISTRIBUTIONS can be taken by December 31st of each year.
5. The RMD rules prevent taxpayer from leaving money in IRA.
6. Failure to take RMD will result in penalty equal to 50% of the Required Distribution
Amount.

401 (K) Plan:

This is a Retirement plan Sponsored by Employer.

This is a Pre-tax Contribution.

The Annual Contribution limit for 2021 is $19500.

Employees also make matching contributions to this 401 K plan.

If the TP/Employee is 50 or older then an additional amount of $6500 can

be made this is called catch-up contribution.

Excess Contributions to 401 k plan will be subject to 6% excise tax and such
excess contributions will be included in the taxable income of the taxpayer.

Sole proprietors and partners deduct contributions for their SEP, SIMPLE, or qualified
retirement plans on Form 1040 as an adjustment to gross income.
A partner's contributions to his own plan are reported on the Partnership's Form 1065,
Schedule K-1 as well.

SIMPLE IRAs - Withdrawals and Distributions

Tax Treatment of Distributions

Distributions from a SIMPLE IRA are subject to IRA rules and generally are includible
in income for the year received. Tax-free rollovers can be made from one SIMPLE IRA

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 Chapter 7 – IRA (INDIVIDUAL RETIREMENT ARRANGEMENT)

into another SIMPLE IRA. However, a rollover from a SIMPLE IRA to a non-SIMPLE IRA
can be made tax free only after a 2-year participation in the SIMPLE IRA plan.

Tax on Early Distribution

Early withdrawals generally are subject to a 10% additional tax. However, the additional
tax is increased to 25% if funds are withdrawn within 2 years of beginning participation

Prohibited transactions from IRA:

 Selling property to IRA.

 Using it (IRA) as a security.
 Borrowing money from IRA.
 Buying personal property.
 Receiving unreasonable compensation for managing IRA.

*Additional Points To Be Included in Class Notes:-*

A) There are two primary ways to categorize pension plans:

 Contributory and Non contributory plans

 In a contributory plan, contributions to a retirement plan are made jointly by

employees and employers.

 In a NONCONTRIBUTORY plan, the contributions are made SOLELY by the

employer.

B) What are the Conditions in which Pensions or annuity Payments are fully taxable?

In general, pension or annuity payments are fully taxable, if one or more of the following
conditions are met:

 Taxpayer did not pay any part of the cost of her pension or annuity.
 Employer did not withhold part of the cost from the taxpayer's pay.

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 Chapter 7 – IRA (INDIVIDUAL RETIREMENT ARRANGEMENT)

 Employer withheld part of the cost from the taxpayer's before tax pay.

C) Types of distributions received from the IRA in Box 7 of Form 1099-R ?

A letter code in Box 7, of Form 1099-R identifies the type of distribution received from
the IRA.

 The code number 7 in Box 7 indicates a NORMAL distribution.

 If code 1, 5, or 8 appears in Box 7 of Form 1099-R, the taxpayer is probably
subject to a penalty or additional tax.

 Code 1 = Early distribution - no known exception (in most cases, distribution was
made before age 59 1/2)

 Code 5 = Prohibited transaction

 Code 8 = Excess contributions plus earnings/excess deferrals (and/or earnings)

taxable in the current tax year

D) SPOUSAL IRA LIMIT:

In case of a married couple with unequal compensation who file a joint return, the
deduction for contributions to the traditional IRA of the spouse with less compensation
is limited to the smaller of the following two amounts:

1. $6,000, ($7,000 if age 50 or over), or

2. The total compensation includible in the gross income of both spouses for the
year REDUCED by the following two amounts:
a. Any deduction allowed for contributions to the traditional IRAs of the
spouse with more compensation
b. Any contributions for the year to a Roth IRA on BEHALF of the other
spouse.

E) How to treat an inherited IRA from a person other than spouse?

 If taxpayer inherits a traditional IRA from anyone other than taxpayer's

deceased spouse, taxpayer cannot treat the inherited IRA as his own.

 This means that taxpayer cannot make any contributions to the IRA.

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 Chapter 7 – IRA (INDIVIDUAL RETIREMENT ARRANGEMENT)

 It also means taxpayer cannot rollover any amounts into or out of the inherited
IRA.

F) Beginning after January 1, 2015, only one rollover can be made from an IRA to
another (or the same) IRA in any 12-month period, regardless of the number of IRAs
the taxpayer owns.

The one-per year limit does not apply to:

 Rollover from traditional IRAs to Roth IRAs (conversions)

 Trustee-to-trustee transfers to another IRA
 IRA-to-plan rollovers
 Plan-to-IRA rollovers
 Plan-to-plan rollovers

G) Form W-4P & Form W-4V

 Generally, Form W-4P, Withholding Certificate for Pension and Annuity Payments,
is used to request a change in withholding on a pension.

 Sometimes taxpayers are not aware that they can request federal income tax to
be withheld from their retirement income by filing Form W-4P, Withholding
Certificate for Pension or Annuity Payments. This form is sent to the payer.

 Also, Form W-4V, Voluntary Withholding Request, is used to request withholding

from Social Security benefits. This form is sent to the Social Security
Administration.

H) Investment in collectibles as a prohibited IRA transaction includes:

 Art work
 Rugs
 Antiques
 Metals
 Gems
 Stamps
 Coins
 Alcoholic beverages
 Certain other tangible personal property.

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 Chapter 7 – IRA (INDIVIDUAL RETIREMENT ARRANGEMENT)

 An IRA can invest in one, one-half, one-quarter, or one-tenth ounce U.S.

gold coins, or one-ounce silver coins minted by the Treasury Department.

 It can also invest in certain platinum coins and certain gold, silver, palladium, and
platinum bullion.

I) Different kinds of IRAs can be set-up with a variety of organizations.

1. An IRA can be set-up through a brokerage account.

2. An IRA can be an individual retirement account or annuity.
3. An IRA can be part of either a simplified employee pension (SEP) or an employer
or employee association trust account.

J) To qualify for treatment as a first-time homebuyer distribution, the distribution must

meet all of the following requirements:

1. It must be used to pay qualified acquisition costs before the close of the 120th
day after the day the taxpayer received it.
2. It must be used to pay qualified acquisition costs for the main home of a first-
time homebuyer.
3. When added to all prior qualified first-time homebuyer distributions, if any total
qualifying distributions cannot be more than $10,000.

 If both spouses are first-time homebuyers, each of them can receive

distributions up to $10,000 for a first home without paying the 10% additional
tax.
 Each person's $10,000 exemption only applies to a distribution from his own IRA.

K) Qualified education expenses are NOT reduced by amounts paid with the funds
student receives as:

 Payment for services, such as wages

 A loan
 A gift
 An inheritance given to either the student or the individual making the withdrawal,
or
 A withdrawal from personal savings (including savings from a qualified tuition
program (QTP))

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 Chapter 7 – IRA (INDIVIDUAL RETIREMENT ARRANGEMENT)

L) Beginning in 2008, a taxpayer may now also rollover into a Roth IRA all or part of an
eligible rollover distribution received from his (or his deceased spouse):

 Employer's qualified pension, profit-sharing or stock bonus plan (including a 401(k)

plan)
 Annuity plan
 Tax-sheltered annuity plan (Section 403(b) plan)
 Governmental deferred compensation plan (Section 457 plan)

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 Chapter 8 – EDUCATION SAVINGS ACCOUNT (ESA)

Education Related Benefits

1. What is Coverdell ESA?

a. It is a trust/custodial account setup solely for paying Qualified
Education Expenses.

Qualified Education Expenses includes expenses for:

i. Elementary education
ii. Secondary education
iii. Higher education

2. Who can be the beneficiary?

a. Beneficiary must be under 18 years of age.
b. Beneficiary can be ANYONE (TP/SP/QC/QR).

3. Are Contributions Deductable?

a. Contributions to Coverdell ESA are NON-DEDUCTABLE.
b. Contributions can be made up to “$2,000” per beneficiary per year.
c. The total contribution to all accounts of a beneficiary in any year
CANNOT EXCEED $2,000.
d. 6% EXCISE TAX is payable in case of Excess contribution.

4. Are Distributions Taxable?

a. Distributions from Coverdell ESA are NON TAXABLE if they are
used to pay Qualified Education Expenses.
b. 10% penalty is applicable if the distributions are used for non
qualified education expenses.
c. The funds in Coverdell ESA must be distributed once beneficiary
reaches 30 YEARS of age.

5. What are Qualified Education Expenses?

a. Tuition fees e. Special needs services
b. Books f. Uniforms
c. Supplies g. Transportation
d. Equipments h. Computer related equipment

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 Chapter 8 – EDUCATION SAVINGS ACCOUNT (ESA)

6) What is the difference between 529 plan and Coverdell ESA?

529 plan Coverdell ESA

Beneficiary must be under 18 and the funds
Beneficiaries can be any one at any must be used before beneficiary is 30
age years
Applies to qualified Applies to qualified
Educational Expenses at colleges and Education Expenses at K-12 colleges and
universities universities
Allows only $2000 Annual contribution per
Allows for unlimited contributions Beneficiary
This plan is offered by Banks and other
This plan is offered by states Financial Institutions
If the Taxpayer (MAGI) Modified
Adjusted gross Income is above $110K
Contributions can be made regardless (Above $220K if married) then No
of any Income limits contributions can be made.

 Scholarship and Fellowship Grants 1099-T

Exclusion from Income

Only a candidate for a degree can exclude amounts received as a qualified

scholarship. The amounts excluded must be used for:

 Tuition and fees, and

 Fees, books, supplies, and equipment required for courses at the
institution.
 Room and Board
 Amounts used for room and board do not qualify for the exclusion.

Payment for Services

In most cases, include in income the part of any scholarship or fellowship that
represents payment for past, present, or future teaching, research, or other

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 Chapter 8 – EDUCATION SAVINGS ACCOUNT (ESA)

services. This applies even if all candidates for a degree must perform the
services to receive the degree.

VA Payments

Allowances paid by the Department of Veterans Affairs are not included in

income. These allowances are not considered scholarship or fellowship grants.

*Additional Points To Be Included in Class Notes:-*

A) What is the annual contribution limit for Qualified Tuition Plans (also
known as Section 529 Plans)?

 There is no annual contribution limit for Qualified Tuition Plans.

 Unlike ESAs, for QTPs, there is NO annual contribution limit. However,
account balance limits are set by the plan.
 Contributions to a QTP on behalf of any beneficiary cannot be more than
the amount necessary to provide for the qualified education expenses of
the beneficiary.
 There are no income restrictions on the individual contributors.

B) The balance of a Coverdell Education Savings Account (ESA):

 The balance in a Coverdell ESA generally must be distributed within 30

days after the earlier of the following events:

 The beneficiary reaches age 30, unless the beneficiary is a special needs
beneficiary
 The beneficiary's death

 When the account is established, the designated beneficiary must be

under age 18 or a special needs beneficiary.

 Assets can be rolled over from one Coverdell ESA to another. The
designated beneficiary can be changed and the beneficiary's interest can
be transferred to a spouse or former spouse because of divorce or to
certain family members.

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 Chapter 8 – EDUCATION SAVINGS ACCOUNT (ESA)

 Not all withdrawals are tax-free. If withdrawals from an ESA during a

tax year are not more than a designated beneficiary's qualified education
expenses at an eligible educational institution, the beneficiary will not
owe tax on the withdrawals.

C) What all are Covered Under eligible school?

 This is any college, university, vocational school, or other IRS educational

institution administered by the Department of Education.
 It includes virtually all accredited public, non profit, and proprietary
(privately owned profit-making) institutions.
 Certain educational institutions located outside the U.S. also participate
in the U.S. Department of Education's Federal Student Aid (FSA)
programs.
 Eligible elementary or secondary school. This is any public, private, or
religious school that provides elementary or secondary education
(kindergarten through grade 12), as determined under state law.

D) The Coverdell Education Savings Account (ESA) 10% additional tax does
NOT apply to following distributions:
 Paid to the beneficiary (or the estate of the designated beneficiary) on
or after the death of the designated beneficiary
 Made because the beneficiary is disabled
 Included in income because the designated beneficiary received:
 A tax-free scholarship or fellowship
 Veterans' educational assistance
 Employer-provided educational assistance
 Any other non-taxable payments (other than gifts or inheritances)
received as educational assistance
 Included in income only because the qualified education expenses were
taken into account in determining the American opportunity, or lifetime
learning credit.

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 Chapter 9 – OTHER INCOMES

1) State and Local Tax Refunds ( FORM 1099-G)

Tax Refunds

 Federal – State & Local

Generally Exempt
 If Standard deduction was
 Taxable in Iowa
claimed last year, then it is
State
Exempt
 If Itemized deduction was
claimed last year then it is
Taxable

Note :- Form 8888 – Deposit of Refund in other than bank accounts.

2) Unemployment Compensation (FORM 1099-G)

It is the payment made by the government in case the taxpayer losses his job for an
Act of God or other acceptable reasons.

Deposit of Refund in other than Bank account

The TP can get his refund deposited in:-

 More than one bank account

 Series I paper saving bonds (up to $5000)
 Traditional IRA/Roth IRA/SEP IRA ( NOT SIMPLE IRA)
 US Treasury Marketable Securities
 FORM 8888 Allocation of Refund must be filed with IRS.

Taxpayer with MAGI <$150,000 can claim exemption of $10,200 from any
unemployment compensation received during the year. In other words, unemployment
compensation received >$10200 will be Taxable.

3) Bartering Income
Bartering is a exchanging of service,
The TP must report the FMV of Property or Services received in bartering as
income.
FMV at the Time of exchange of service must be considered.

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 Chapter 9 – OTHER INCOMES

4) Cancelled Debt
If the creditor cancels or forgives the debt, then the debtor must report the
cancelled or forgiven amount as income.
Exception: - If the debt cancelled by the creditor as a gift or bequest, the debtor
does not have to report it as income.

Do not consider the below incomes as cancelled debt:-

 -Bankruptcy
 -Insolvency
 -Price reduction
 -Certain student loan indebtedness.

5) Gambling winnings
 They Include winnings from lotteries, Horse racing’s, Casino’s etc.
 Gambling Losses can be claimed as Itemized Deductions on Schedule A only to
the extent of Gambling Winnings.
 Even Hobby Income, Hobby losses/Expenses can be claimed only to the Extent
of Hobby Income.

6) Jury Duty Pay

 If you Serve Jury duty and you received pay from the court then such Income is
Taxable.

 Employers who pay their Employees for Jury Duty often require the Employees
to return any earnings they received from the court.
 In Such a Situation you would claim the payment as Income and then take a tax
deduction for the jury duty pay you returned to your Employer
Example :-
 Court Awards and Damages
 Settlement amounts received by the tax payer are considered as
ordinary income, which includes the below:-
 Punitive damages
 Compensation for lost wages.
7) Farm Income
 Farm income/loss is reported in Schedule F.
 File it with form 1040.
 Figure Farm Net Earnings.
 If gross income is $8820 or less - then net earnings are equal to Two – thirds of
gross farm income.
If the gross Income is more than $8820 for 2021 then the net farm income will
be Taxable.

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 Chapter 9 – OTHER INCOMES

8) Virtual Currencies
For federal tax purposes, virtual currency is treated as property. Transactions
using virtual currency (such as Bitcoin) must be reported in U.S. dollars. General
tax principles that apply to property transactions apply to transactions using
virtual currency. Among other things, this means that:

 Wages paid to employees using virtual currency are taxable to the

employee, must be reported by an employer on a Form W-2, and are
subject to federal income tax withholding and payroll taxes.

 Payments using virtual currency made to independent contractors and

other service providers are taxable and self-employment tax rules
generally apply. Normally, payers must issue Form 1099.

 The character of gain or loss from the sale or exchange of virtual

currency depends on whether the virtual currency is a capital asset in
the hands of the taxpayer.

 A payment made using virtual currency is subject to information

reporting to the same extent as any other payment made in property

 Reporting Virtual Currency

If a taxpayer engages in any transaction involving virtual currency, he or she

must check the “Yes” box next to the question on virtual currency at the top of
Form 1040. A transaction involving virtual currency includes the following.
 The receipt or transfer of virtual currency for free (without providing
any consideration), including from an airdrop or following a hard fork.
 An exchange of virtual currency for goods or services.
 A sale of virtual currency.
 An exchange of virtual currency for other property, including for
another virtual currency.

If a taxpayer disposes of any virtual currency that was held as a capital asset, use
Form 8949 to figure the capital gain or loss and report it on Schedule D (Form 1040 or
1040-SR).

If a taxpayer received any virtual currency as compensation for services, report as

wages on Form 1040 or 1040-SR, line 1.

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 Chapter 9 – OTHER INCOMES

*Additional Points To Be Included in Class Notes:-*

A) Tip Income:-

 The taxpayer must report the difference between tips received and the tips
reported to employer.
 The difference is needed to be added to other wages reported on Line 8 of Form
1040.
 Employers must allocate tips among employees who receive them if the total tips
reported to the employer during any payroll period are less than 8% (or an
approved lower rate, if applicable), of the organization's gross receipts for that
pay period.

Allocated tips are tips that an employer assigned to his employees in addition to the tips
the employees reported to the employer for the year. The employer will have done this
only if:

 The employee worked in an establishment (restaurant, cocktail lounge, or similar

business) that must allocate tips to employees,
 The tips the employee reported to the employer were less than his share of 8%
of food and drink sales, and
 The employee did not participate in his employer's Attributed Tip Income
Program (ATIP).

B) Qualified accounts eligible for Direct Deposit.

*Taxpayers may elect the Direct Deposit option to receive their refunds.

*Refunds may be directly deposited into qualified accounts.

 Qualified accounts include:

 savings,
 checking,
 share draft, or
 consumer asset accounts [for example, a traditional IRA, a Roth IRA, a
SEP-IRA (but not a SIMPLE IRA),
 A money market account,
 health savings account (HSA),
 Archer MSA,
 Coverdell Education Savings Account (ESA), or U.S. Treasury Direct
online account in the taxpayer's name].

 Qualified accounts must be held by financial institutions within the U. S. and

established primarily for personal, family, or household purposes.

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 Chapter 9 – OTHER INCOMES

 Qualifying institutions may be

 National banks,
 state banks (including the District of Columbia and political sub divisions
of the 50 states),
 savings and loan associations,
 mutual savings banks, and
 credit unions.

 If an adjustment results in a smaller than expected refund, the IRS uses a

bottom-up rule and deducts the difference from the direct deposit amount
designated for the last account shown on Form 8888.

 If the difference exceeds the amount designated to the last account, the IRS
deducts the remainder from the amount designated to the next account, until the
amount due is paid.

C) Refund Direct Deposits Rules:-

 IRS delay will result in entire direct deposit into the first account listed.

 Preparers should caution taxpayers that their entire refund may be deposited
into the first account listed on Form 8888 if there are any delays in the
processing of the return by the IRS.

 Hence, taxpayers should be coached to list as the first account on Form 8888 an
account into which the taxpayer would want the entire refund deposited.

 Direct Deposit fees by preparers are prohibited.

 Preparers must never charge a separate fee for Direct Deposit and must accept
any Direct Deposit election by a taxpayer to any eligible financial institution.

 Refunds due to Amended returns are not eligible for direct deposit.

 Do not attach Form 8888 to Form 1040X.

 A refund on an amended return cannot be directly deposited to an account or

used to buy U.S. Savings Bonds.

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 Chapter 9 – OTHER INCOMES

 Limit of 3 direct deposit refunds per year.

 In an effort to combat fraud and identity theft, the IRS limits the number of
direct deposits into a single financial account or prepaid debit card to three
refunds per year.

 Taxpayers who exceed this limit will receive a notice and a refund check.

A refund may be reduced by certain taxpayer's liabilities. The refund reductions

(offsets) are taken to satisfy liabilities in the following specific order:

1. Current federal income tax owed.

2. Past due child support.

3. Past due legally enforceable debt owed to a federal agency.

4. Past due legally enforceable state income tax debt.

5. Future federal income tax liability.

D) Access (sharing) economy income is taxable either as self-employment income or as

other income. Also referred to as the on-demand, or access economy, the sharing
economy allows individuals and groups to utilize technology advancements to arrange
transactions to generate revenue from assets they possess - (such as cars and homes) -
or services they provide - (such as household chores or technology services).

 Although this is a developing area of the economy, there are tax implications for
the companies that provide the services and the individuals who perform the
services. This means if a taxpayer receives income from a sharing economy
activity, it is generally taxable even if the taxpayer does not receive a
 Form 1099-MISC,
 Miscellaneous Income,
 Form 1099-K,
 Payment Card and
 Third Party Network Transactions,
 Form W-2,
 Wage and Tax Statement, or some other income statement.

 The income is taxable even if it is the result of a side job or just as a part-time
business.
 All payments even if received in cash is reportable as income.

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 Chapter 9 – OTHER INCOMES

However, depending upon the circumstances, some or all of the income may be
considered hobby income (reported on Form 1040, Schedule 1, line 21), or self-
employed income (Schedule C reporting required).

Applicable expenses incurred in generating the income may be deductible as business

expenses on Schedule C/C-EZ. However, if it is from a hobby, those expenses are no
longer deductible.

E) Undistributed mutual fund capital gains reported to the taxpayer on Form 2439 are
then classified as long-term capital gains on Schedule D (Form 1040), Line 11.

 Line 11 on Schedule D is where other types of capital gains/losses are reported

that are not initially reported on Form 8949.
 Line 11 entries on Schedule D come from Forms 4797, 2439, 6252, 4684, 6781,
and 8824.
 Taxpayers must report the undistributed capital gains on Schedule D, line 11,
and may claim a credit for the amount of tax paid on Form 1040, in the
"Payments" section. Check the box next to "2439." Copy B of Form 2439 must
be submitted with the return.

F) Following lawsuit settlements would NOT be taxable?

 Personal injury or sickness damages are not taxable, including damages for lost
wages, earnings capacity, or emotional distress caused by the physical injury.

 Whether a settlement or award is taxable depends on the item the settlement

replaces. If the item replaced would be taxable income, the settlement or award
is taxable.

 Punitive damages generally are taxable. It does not matter if they relate to a
physical injury or physical sickness.

 Slander and defamation awards are taxable.

 The attorney fees are deductible on Schedule A, subject to 2% limitation.

G) Special rules apply to members of the clergy with regard to housing:

 The home or allowance must be provided as compensation for their duties as an

ordained, licensed, or commissioned minister.

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 Chapter 9 – OTHER INCOMES

 However, they must include the rental value of the home or the housing allowance
as earnings from SELF-EMPLOYMENT on Schedule SE if subject to self-
employment tax.
 When an employee meets the rules for an accountable expense plan, there is no
need to include any reimbursements in income.
 If the expenses equal the reimbursement, there is no deduction since the
expenses and reimbursement are equal.

H) Services performed in the exercise of a ministry are covered by Social Security and
Medicare under SECA. Earnings from these services are subject to self-employment tax
(SE tax) unless one of the following applies:

 The person is a member of a religious order who has taken a vow of poverty.
 The person asks the IRS for an exemption from SE tax for his services and the
IRS approves the request.
 The person is subject only to the Social Security laws of a foreign country under
the provisions of a Social Security agreement between the U.S. and that country.

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 Chapter 10 – RENT & ROYALTIES (1099-MISC)

Rental Income

 Any Advance rent received is Taxable in the year it is received regardless of the period
covered or the method of accounting used.
 Security Deposits received are Not Taxable if they have to be returned to the tenant
at the end of the lease
 Rental Income from a Personal dwelling unit (E.G. Villas, Farmhouses/Cottages)
is also taxable.

Rental Expenses

 Repairs
A repair keeps the property in good working condition and does not materially add to the
value of the property. The costs of repairs are deductible. Repainting the property
inside or out, fixing gutters or floors, fixing leaks, plastering, and replacing broken
windows are examples of repairs. If repairs are made as part of an extensive
remodelling or restoration of the property, the whole job is an improvement.

 Improvements
An improvement adds to the value of the property, prolongs its useful life, or adapts it
to new uses. The costs of improvements increase the basis of the property and are not
deductible. The cost of improvements must be capitalized (added to basis). The
capitalized cost can generally be depreciated as if the improvement were separate
property. Improvements include, but are not limited to, the following items:

Improvement made to building (27.5 years Improvements made to land (15 years Interior
recovery) recovery) Improvements
(5 years recovery)
Bedroom Heating system Landscaping Appliances
Bathroom Central A/C Driveway Flooring
Deck Furnace Walkway Carpet
Garage Duct work Fence Furniture
Porch Central humidifier Retaining wall
Patio Filtration system Sprinkler system
New Roof Water pipes Swimming pool
Wiring upgrades Venting
Windows, doors Central vacuum

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 Chapter 10 – RENT & ROYALTIES (1099-MISC)

 Any Expenses paid by the tenant is taxable if paid towards:

 Electricity
 Maintenance
 Repairs
 Property Tax etc..
 If the dwelling is rented for LESS THAN 15 DAYS during the year:
 Rental income is NOT TAXABLE and
 Rental expense is NOT DEDUCTABLE.
 If TP receives property in exchange for services rendered then:
 FMV of the property received will be treated as Income and is Taxable.
 If the services were performed for a price agreed beforehand then the agreed
on price will be treated as Income and will be taxable.
 If the Taxpayer pays Insurance premiums for more than 12 months in advance then the
Taxpayer cannot deduct the entire premium payment in the year it was paid instead it
will be claimed in the year it belongs to.
 Any Property that was changed from personal use to rental use then divide the annual
expenses between personal and rental use.
 Expense related to personal use will be deducted on Schedule A
 Expenses related to Rental use will be deducted on Schedule E
 Income on loss due to vacancy of the Rental property is not deductable.
 Any uncollected rent is deducted as Bad Business debt.
 Any property i.e not rented for profit, the expenses can be deducted only up to the
amount of Income. Losses cannot be carried forward to the next year.

Depreciation of Rental Property:-

Three factors determine how much depreciation to deduct each year:

 The basis in the property,

 The recovery period for the property, and
 The depreciation method used.

Section 179 deduction

The section 179 deduction is not allowed for property used in connection with residential rental
property.

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 Chapter 10 – RENT & ROYALTIES (1099-MISC)

When Does Depreciation Begin and End?

Begin depreciating rental property when it is placed in service for the production of income.
Stop depreciating the property either when the property has been fully depreciated or when
the property is retired from service, whichever happens first.

Depreciation Methods

Use the Modified Accelerated Cost Recovery System (MACRS) to depreciate residential rental
property placed in service after 1986.

MACRS recovery periods for property used in rental activities

Type of property GDS ADS

Computers 5 years 5 years

Office machinery (typewriters & copiers) 5 years 5 years

Automobiles 5 years 5 years

Appliances (stoves & refrigerators) 5 years 9 years

Carpets 5 years 9 years

Furniture used in rental property 5 years 9 years

Office furniture (desks and files) 7 years 10 years

Fences, roads, and shrubbery 15 years 20 years

Residential rental property 27.5 years 40 years

Nonresidential real property (Placed in service after May 12, 1993) 39 years 40 years

Nonresidential real property (Placed in service before May 13, 1993) 31.5 years 40 years

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 Chapter 10 – RENT & ROYALTIES (1099-MISC)

* Figuring the Depreciation Deduction

Residential rental property. Use the straight line method and a mid-month convention for
residential rental property.

Limits on Rental Losses

 A taxpayer can deduct up to $25,000 ($12,500 if married filing separate (MFS)

and living apart from spouse for entire year; $0 if MFS and not living apart from
spouse) of losses from passive rental real estate activities (in which the
taxpayer actively participated) from non-passive income.
 A taxpayer actively participated in a real estate activity if he or she (and
spouse) owned at least 10% of the rental property and made management
decisions in a significant bona fide sense.
 Management decisions include approving new tenants, deciding on rental terms,
approving expenditures, and similar decisions. The $25,000 ($12,500) offset
phases out at the rate of $0.50 for each dollar by which AGI, computed with
certain modifications, exceeds $100,000 ($50,000 if MFS).

At-Risk Rules

 Any loss from an activity subject to the at-risk rules is allowed only to the
extent of the amount a taxpayer has at risk in the activity at the end of the
year.
 A taxpayer is considered at risk to the extent of cash and the adjusted basis of
other property he or she contributed to the activity and certain amount
borrowed for use in the activity. Losses from passive activities are first subject
to the at-risk rules.

Passive Activity Limits

 Passive activity losses can only be deducted from passive activity income. A
rental activity is a passive activity even if a taxpayer materially participated
unless the taxpayer materially participated as a real estate professional.
 If the taxpayer actively participated in a passive real estate activity the
taxpayer can deduct losses up to $25,000. If the taxpayer materially
participated as a real estate professional it is not a passive activity and there is
no limit on the rental losses.

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 Chapter 10 – RENT & ROYALTIES (1099-MISC)

Real Estate Professional

A taxpayer is a real estate professional if the time spent performing services in real
property trades or businesses in which the taxpayer materially participated was:

 More than half of the time spent performing all personal services in all trades
and businesses during the year, and
 More than 750 hours.

How to Report Rental Income and Expenses?

 Schedule E (Form 1040 or 1040-SR)

Use Schedule E (Form 1040 or 1040-SR) for reporting residential rental income and
expenses. However, do not use that schedule to report a not-for-profit activity.
 Schedule C (Form 1040 or 1040-SR)
If providing substantial services that are primarily for the tenant's convenience, such as
regular cleaning, changing linen, or maid service, report rental income and expenses on
Schedule C (Form 1040 or 1040-SR), Profit or Loss From Business. Substantial services
do not include the furnishing of heat and light, cleaning of public areas, trash collection,
etc.
 Form 1065
Use Form 1065, U.S. Return of Partnership Income, if the rental activity is a
partnership (including a partnership with a spouse unless it is a qualified joint venture).

Royalties
 Royalties are payments to an owner from people who use a right belonging
to that owner.
 Royalties from copyrights, patents, and oil, gas, and mineral properties
are taxable as ordinary income. In most cases royalties are reported in
Part I of Schedule E (Form 1040 or 1040-SR).
 However, if the taxpayer holds an operating oil, gas, or mineral interest
or is in business as a self-employed writer, inventor, artist, etc., report
income and expenses on Schedule C (Form 1040 or 1040-SR).

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 Chapter 11 CAPITAL GAINS – FORM 1040
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# 1 Types from Property:

Tangible
Personal
Property Intangible
Real
Examples:

Real Tangible Intangible

Land (Non-Depreciable) Automobiles Goodwill

Building Inventory Patents

Structures attached to Shares/Stock/Bonds Trademarks

land

Copyrights/Knowhow

#2 Basis:-

1. Cost Basis: - Basis is the amount that the Taxpayer has invested in a Property.

Includes Excludes
Purchase Price ,Commission Depreciation
Sales tax, Freight, and testing Charges Casualty loss
Legal and accounting fees Certain Credits
Excise taxes, revenue stamps , recording fees and SEC 179
real estate taxes. Deduction /Easements
Theft Losses/Non-dividend
Settlement and closing costs /Capital Improvements. distributions

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 Chapter 11 CAPITAL GAINS – FORM 1040
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Note: - Investment Property includes stocks, Bonds, Gold, silver, gems, stamps, coins
etc.

Loss on Sale of personal property is not Deductable.

2. Settlement and closing costs

Includes Excludes
Abstract fees Casualty insurance premiums
Rent for occupancy of property before
Charges for installing utility services closing
Charges for utilities or other services
Legal fees related to the property before closing
Recording fees/Registration Fees Charges connected with getting a loan
Survey fees Fees for refinancing a mortgage.
Transfer taxes Amounts placed in escrow.
Owners title insurance
Any other amount buyer agrees to pay for the
seller.

#3 Adjusted Basis (8 Letters in the Word Adjusted – 8 Situations)

A Tax payer acquires property in any one/more of the following ways :-

a) Purchase
b) Exchange for another Asset
c) Exchange for services rendered
d) Inheritance
e) Converting a personal asset into a Business Asset
f) Gifts
g) Installment sales
h) Related Party Transactions.

a. Computation of basis in case of PURCHASE:

1. Cash paid for the property XXX
2. Add debt taken by the TP. XXX
3. FMV of property or services given in exchange XXX
XXX

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 Chapter 11 CAPITAL GAINS – FORM 1040
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b. Computation of basis in case of EXCHANGE FOR ANOTHER ASSET:

1. FMV of the new asset at the time of exchange. XXX
2. Add any payments made/cash price XXX
3. Less any payments received (XXX)
XXX

Note: These exchanges could be:

 Like kind exchange
 Stock for property
 Involuntary conversion/principle residence

C) Computation of Basis in case of Exchange of services

1. FMV of the services rendered is considered as basis
2. If there was an agreed on price before hand then the agreed on price will
be the basis.

D) Computation of Basis in case of INHERITANCE

a. FMV on the date of DEATH or Alternative valuation date.
Whichever
b. FMV on the date of Sale is lower
( If property is sold within 6 months from the date of death)

Appreciated Property
The above rule does not apply to appreciated property received from a decedent
if a taxpayer or taxpayer’s spouse originally gave the property to the decedent
within 1 year before the decedent's death. The taxpayer’s basis in this property
is the same as the decedent's adjusted basis in the property immediately
before his or her death, rather than its FMV. Appreciated property is any
property whose FMV on the day it was given to the decedent is more than its
adjusted basis.

Community Property
In community property states (Arizona, California, Idaho, Louisiana, Nevada,
New Mexico, Texas, Washington, and Wisconsin), married individuals are each
usually considered to own half the community property. When either spouse
dies, the total value of the community property, even the part belonging to the

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 Chapter 11 CAPITAL GAINS – FORM 1040
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surviving spouse, generally becomes the basis of the entire property. For this
rule to apply, at least half the value of the community property interest must be
includable in the decedent's gross estate, whether or not the estate must file a
return.

Qualified Joint Interest

Include one-half of the value of a qualified joint interest in the decedent's
gross estate. It does not matter how much each spouse contributed to the
purchase price. Also, it does not matter which spouse dies first.

E) Computation of Basis in case of conversion from PERSONAL TO BUSINESS

c. LOWER of COST or Which ever
d. FMV on the date of conversion is lower

F) Computation of basis in case of GIFTS:

GIFTS

Non-
Depreciable
Depreciable
Property
Property

ABTD FMV>AB FMV<AB FMV<SP<AB

No Gain
ABTD Sold for GAIN Sold for LOSS
No Loss

FMV on Date SP
ABTD
of Gift

AB = Adjusted Basis
FMV = Fair Market Value

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 Chapter 11 CAPITAL GAINS – FORM 1040
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SP = Selling Price
ABTD = Adjusted Basis to Donor
Figuring the Basis

The following three amounts must be known to figure the basis of property received by
gift:

 The fair market value (FMV) of property at time of gift.

 Adjusted basis in hand of donor.
 Amount of gift tax paid.

Gift received before 1977: Increase basis by the total gift tax paid.
Gift received after 1976: Increase basis by part of the gift tax paid:

Donee's basis = Donor's adjusted basis + gift tax × ((FMV - Donor's adj. basis) ÷ (FMV -
annual gift tax exclusion for the year of the gift))

Case Study: Ms. Deepthi Nandan received 10 Acres of Land from her uncle who
purchase the Land at $120,000. The Land had FMV of $100,000 when Ms Deepthi
received it. What is the Basis, if Ms Deepthi sold the land for:
a) $2,00,000 b) $80,000 c) $1,10,000

Case 1: Sold for $200,000

a. It is a Gift
b. It is a non-depreciable property
c. In this case FMV<AB Therefore AB = ABTD i.e.$120,000
d. It is sold for GAIN because SP > FMV

Case 2: Sold for $80,000

a. It is a Gift
b. It is a non-depreciable property
c. In this case FMV<AB AB = FMV on the date of Gift i.e.
$1,00,000
d. It is sold for LOSS because FMV>SP

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Case 3: Sold for $110,000

a. It is Gift
b. It is a non-depreciable property
c. In this case FMV<AB AB = SP i.e $1,10,000
d. It is sold for NO GAIN NO LOSS because FMV<SP<AB.

Property Transfers between Spouses

No gain or loss is recognized on a transfer of property from an individual to (or in trust
for the benefit of) a spouse or, if incident to a divorce, a former spouse. This
nonrecognition rule does not apply in the following situations:

 The recipient spouse or former spouse is a nonresident alien.

 Property is transferred in trust. Gain must be recognized to the extent the
amount of the liabilities assumed by the trust, plus any liabilities on the
property, exceed the adjusted basis of the property.

Basis in Transferred Property

The transferee's basis in the property will be the same as the adjusted basis of the
transferor. However, for property transferred in trust, the basis is adjusted for any
gain recognized by the transferor if the liabilities assumed, plus the liabilities to which
the property is subject, are more than the adjusted basis of the property transferred.

G) Installment Sale:
 An installment sale is one where TP receives at least one payment after the tax
year of sale.
 If TP realizes GAIN on installment sale then:
o The TP can report gain when each installment is received, or
o The TP can report entire gain in year of sale.
o Gain is calculated using gross profit percentage method.
 Gross percentage = Gross Profit × 100
Contract sale price
 If TP realizes LOSS on installment sale
o Installment sale method cannot be used.
o The loss must be reported in the year of sale.
o Year of sale is the first year (kind of accrual sale).

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 Chapter 11 CAPITAL GAINS – FORM 1040
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Installment
Sale

GAIN LOSS

1st Year of Each year of Can't use

sale sale this method

SP-CP GP Method

SP = Sale Price
CP = Cost Price
GP = Gross Percentage

Case Study:
 Ram sales a piece of land with an adjusted basis of $110,000 to Krishna for
$200,000.
 Krishna paid $50,000 as down payment in 2021 and agreed to pay $30,000 every
year for the next 5 years beginning Jan 2022.
 Ram incurred brokerage of $10,000 in 2021.
 What is the amount of gain Ram must include in his Gross Income for each
payment?

Step 1: Computation of Gross Profit Percentage

a. Sale Price = $200,000
b. Less: Cost Price
i. Adjusted Basis $110,000
ii. Brokerage $10,000 = $120,000
c. Gross Profit = $80,000

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 Chapter 11 CAPITAL GAINS – FORM 1040
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d. Gross Profit Percentage = c × 100 = $80,000 × 100 =40%

a $200,000

Computation of Gain under installment sale method:

Particulars 2021 2022 2023 2024 2025 2026

Installment or $50,000 $30,000 $30,000 $30,000 $30,000 $30,000

payment received

GP Percentage 40% 40% 40% 40% 40% 40%

(step 1)

Gain to be $20,000 $12,000 $12,000 $12,000 $12,000 $12,000

reported

Gross Profit = $80,000

H) Computation of Basis in case of Related Party Transactions

1. Who is the related party?

 Ancestors or spouses or siblings or descendants (Not nephew or niece)
 Trusts and beneficiaries
 Controlled entities and its members > 50% ownerships

2. What is the Tax Treatment of Gain/Loss?

 GAIN on sale of an asset to a related person is TAXABLE
 LOSS on sale of an asset to a related party is NOT DEDUCTABLE unless it is
sold to a third party

Example :- Ram Sold Building with an adjusted basis of $150,000 to his brother
lakshman for $100,000. Lakshman later sold the building to Ravan, an unrelated
party for $200,000

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 Chapter 11 CAPITAL GAINS – FORM 1040
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Compute the Following

a) Gain/Loss on Related party Transactions.
b) Realized gain, Recognized gain.

Step 1:- Computation of Gain/Loss when sold to Related party.

a) Sale price to Lakshman $100,000
b) Less: Adjusted Basis to Ram $150,000
C) Related Party Loss $50,000

Step 2:- Computation of Gain/Loss when sold to un Related party.

a) Sale Price to Lakshman $200,000
b) Less: Purchase price of Lakshman ($100,000)
C) Realized Gain (a-b) $100,000
d) Less Related Party Loss (Step -1) $50,000
e) Recognized Gain $50000

3) How about Special situations?

Employer Employee Transactions Inter Spouse Transfer

No Gain & No Loss is Recognized on

Employee is not a Related party to the Employer transfer of property between spouses
If the Employer sells an asset to the Employee for
a price <FMV then the Difference (FMV-SP) is Even in case of Divorce/Gifts. No
Taxable in the hands of the employee gains/Loss is Recognized
Spouse must not be Non- Resident Alien

Section 83 (b) section

Qualified employee discount

Any Property received from employer below FMV the difference Income between the
FMV and the actual purchase price is Taxable in the hands of the Employee as
Qualified employee Discount.

If a property is received with restrictions Eg:- vesting periods, purchase only incase of
performance etc then the basis of property is FMV unless the Taxpayer makes section
83(b) Election

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In case of section 83(b) election, the basis of the properly will be FMV on the date of
sale and not FMV on the date of vesting /Grant/Exercise.

#4 Capital loss carryovers, setoff and carry forward

 Capital gains or losses depend on HOLDING PERIOD:

o The holding period must be calculated from the date of purchase to the date
of sale.
o Property held for MORE THAN ONE YEAR is treated as LONG TERM
o Property held for One Year Or Less will be treated SHORT TERM
 Any Capital gain/loss is reported on FORM 1040 through calculations in:
o Schedule D( Non Investment property)
o Form 8949 (Investment property, Non Business bad debts, Involuntary
conversions)
 Any Capital loss must be:
o First setoff against capital gains ( short term/Long Term)
o The Remaining Loss must be setoff against ordinary Income to the Extent of
$3000 ($1500 incase of MFS)
 Any Remaining loss after setoff can be carried forward until it is fully setoff

 The Short terms capital gains are treated at ordinary income tax rates as per the
filing status that is applicable.

 The Long term capital gains tax rates are 0%, 15%, 20% depending on the ( Income
Tax rates) Taxable income limits and these are usually lower than the short term
capital gain tax rates.

The following are the capital gain tax rates for:

o 28% - Gain on collectables/Qualified small business stock
o 25% - unrecaptured section 1250 gain
o 20% - All other capital gains.

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Home for Sale/Sale of Home /Personal residence

Sale of Home

Gain (Taxable) Loss (Not

deductable)

Ownership Test Use Test ( 2 out of 5

(Own/Mortgage) years)

 Sale of Home Exclusion

 If TP has capital gain from sale of MAIN HOME then he can exclude UP TO
$250,000 from that gain. The TP can exclude UP TO $500,000 if he is filing
return MFJ with his spouse.

 The TP must meet both Ownership Test and Use Test.

 The TP must be the owner of the house and the TP must have used this home as
main home for at least 2 out of 5 years before the Date of sale.

Exceptions to Ownership and Use Tests for taxpayers with a Disability. There is an
exception to the use test if:

 The taxpayer becomes physically or mentally unable to care for himself or

herself, and
 Owned and lived in the home as a main home for a total of at least 1 year during
the 5-year period before the sale of the home.

Under this exception, the taxpayer is considered to live in his or her home during any
time within the 5-year period that the taxpayer own the home and live in a facility

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(including a nursing home) licensed by a state or political subdivision to care for persons
in the taxpayer’s condition.

If the taxpayer meets this exception to the use test, the taxpayer still has to meet
the 2-out-of-5-year ownership test to claim the exclusion.

Reduced Maximum Exclusion

If the taxpayer fails to meet the requirements to qualify for the exclusion, the
taxpayer can still qualify for a reduced exclusion. To qualify for a reduced exclusion,
the sale of the home must be due to one of the following reasons:
1. A change in place of employment.
2. Health.
3. Unforeseen circumstances (occurrence of an event that could not have been
reasonably anticipated before buying the home such as loss of employment).

Exclusion on Sale of Main Home by Surviving Spouse

If spouse dies, surviving spouse may qualify to exclude up to $500,000 of any gain from
the sale of a main home. To qualify, surviving spouse must not remarry, meet all the
requirements for exclusion and the sale takes place within 2 years after the date of
death of spouse. (in lines with QQDC Rule)

Business Use or Rental of Home

A taxpayer can exclude a gain from the sale of a home that was used for business or to
produce rental income if the taxpayer meets the ownership and use tests.

Depreciation for Business Use after May 6, 1997

A taxpayer cannot exclude part of the gain equal to any depreciation allowed or
allowable as a deduction for periods after May 6, 1997.

Home Acquired Through Transfer from Spouse

If a taxpayer's home was transferred by a spouse or former spouse (whether in
connection with a divorce or not), the taxpayer can count any time when the spouse
owned the home as time owned by the taxpayer to meet the ownership test.

Death of Spouse
If a taxpayer sell his or her home within 2 years of the death of a spouse and the
taxpayer has not remarried as of the sale date, the taxpayer can count any time the

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deceased spouse owned the home as time owned by the taxpayer to meet the ownership
test.

 The TP cannot claim Exclusion if he has already excluded the gain from Another
Main home within 2 years from the date of sale.

Reporting the Gain

Do not report the sale of a main home on the tax return unless:
 There is a gain on the sale and the gain does not qualify for full exclusion,
 There is a gain and the taxpayer chooses not to exclude it, or
 The taxpayer receives Form 1099-S.

If any of these conditions apply report the entire gain or loss on Form 8949, Sales
and Other Dispositions of Capital Assets, and Schedule D (Form 1040 or 1040-SR),
Capital Gains and Losses.

#5 Property used in Trade/Business

Description Sec 1231 Property Sec 1245 Property Sec 1250 Property

Nature of All real or depreciable Depreciable personal Depreciable Real

Property property used in property (both property
business tangible and
intangible)

Examples of Apartment buildings, Manufacturing or Building or

property parking lots, production structural
equipments, equipment, goodwill, component
structures, etc live stock, patents,
etc

Holding period Property must be held Property is Property must be

for more than one considered placed in held for more than
year service when it is one year
ready and available
for use. One year or
less.

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Property DOES Personal use property Buildings or Depreciable

NOT include and inventory structural personal property
components (Sec (Sec 1245)
1231)

Tax Treatment of Gain/Loss on SEC 1231, 1245 and 1250.

#1. Sold for Gain

Asset - Building
Cost - $100k
Depreciation - $40K
Adjusted Basis -$60K ($100K-40K)
Selling Price - $150K

Step 1 :- Computation of Net Gain

a) SP $1,50,000
b) Less AB $ 60,000
c) Net Gain(a-b) $90,000

Step 2:- Computation of Ordinary Income and long term gain

A. Ordinary Income $40000

(Least of ( i) Net Gain or
(ii) Accumulated Depreciation

B. SEC 1231 long term Gain $50000

Net Gain – Ordinary Income $90000

#2 If sold for Loss

Asset – Building
Cost - $100K
Depreciation - $40K
Adjusted Basis - $60K ($100K-40K)

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Selling Price - $50K

Step 1: Computation of Net Loss

a. SP $50,000
b. Less AB ($60,000)
c. Net Loss (a-b) ( $10,000)

Step 2: Treatment of Net Loss

a. Loss can be Fully adjusted against ordinary Income

b. The $3000 limit of Set off Rules is Not applicable.

Summary of Sec 1231, 1245 and 1250 Transactions

SEC 1231/1245/1250 Transactions

Net Loss
NET GAIN

Claim fully as Ordinary

Loss (No 3K limits for 3
Ordinary Long Term Sections Property)
income (Lesser capital gain
of Net gain or (Balance)
accumulated
Depreciation

Note: FORM 4797 reports the following sales of a Business property:

 Sales/Exchange of Property
 Disposition of Non Capital assets
 Disposition of capital assets NOT REPORTED on Schedule D
 Involuntary conversions

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 Recapture of Depreciation

LIKE KIND EXCHANGE (Sec 1031)

 If TP Exchanges his Business/Investment/Real property (RBI) for another RBI

property, it is called sec 1031 exchange.
 The TP recognizes NO gain or loss until the property is SOLD.
 The TP may recognize a gain to the extent of cash or FMV of the unlike
property received.
 The Exchange must be completed within earlier of :
o 180 days from the Date property was transferred or
o The Regular due date for filing Tax Return (Including Extensions)

 Certain Exchanges between related parties are Non Taxable of either party do
not dispose of the property within 2 years after the date of transfer except in
case of Death/Involuntary conversations.

Not Like-Kind Property

The rules of like-kind exchanges do not apply to the following property:

1. Real property used for personal purposes such as a home.

2. Real property held primarily for sale.

3. Any personal or intangible property.

Basis of Property

The basis of property received in a non-taxable exchange is the same as the basis of
the property exchanged:

1. Decreased by any money received and any loss recognized on the exchanged, and

2. Increased by any additional cost incurred and any gain recognized on the
exchange.

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#6 Stocks, Shares and Options

a) Stock basis

 The basis of stocks or bonds is generally:

o Purchase Price XXX
o Add: Commissions/recording/transfer fees XXX
XXX
 The basis of additional stock received by the tax payer is:
o The adjusted basis of old stock allocated among the new number of shares
o This situation normally comes in case of:
 Non-taxable stock dividend or
 stock split.

Example: Non-taxable Stock dividend.

Shares @ $10 each for 1000 share = $10,000
Dividend @10% ($10,000 × 10%) = $1,000
Additional Stock = $1,000 = 100 shares
$10
Total stocks = 1000+100 = 1100 shares

Example: Stock Split

Shares @$10 for 1000 shares = $10,000
FMV fall down to $5 each
Stock Split ratio = 2:1
i.e., 1000×2 = 2000 shares

Stock Split
- Decrease in Basis Share Value
- Increase in stock No of shares

b) Wash Sale Rule:-

A wash sale occurs when the Tax payer sells securities at a loss and with in 30 days ,
before /After the sale, the TP obtains the same securities or the rights to acquire
identical securities then such losses are Not deductable.

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Instead , such disallowed loss is added to the cost of new securities.

Donot Include the Date of Sale in calculation of 30 days.

C) Worth less Securities

Securities that become completely worthless (Including abandoned) are treated as if

sold on the last day of the year.

To claim such loss the Tax payer must permanently surrender and relinquish all rights in
the security and receive No consideration in exchange of it.

Non Business Bad debts

It is deductable as short term capital loss in the year the debt becomes totally
worthless.

The amount that was given as debt must have been included in the Taxpayer Income.

A Taxpayer can Amend a prior Return to claim bad debts or worthless securities within
7 years the debt/security becomes worthless.

SECTION 1244 SMALL BUSINESS STOCK

The sale of stock of a small business corporation resulting in a capital loss may be
claimed as an ordinary loss (upto $50000 every year) $100,000 if MFJ.

Stock must be issued for Money/Property received in order to claim the loss.

The Total money the corporation received cannot exceed $1Million.

The taxpayer must be the original owner of the stock to receive ordinary loss
treatment.

Incomes such as Royalties, rents, dividends, Interest, Annuities etc. Must be less than
50% of Total gross receipts in last 5 years.

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#7 Depreciation

It is an income tax deduction that allows a business to recover the cost basis of
certain property.
It is an annual allowance for the wear and tear, deterioration, or obsolescence of the
property.

There are 3 factors that determine how much depreciation you can deduct each year:
(1) your basis in the property,
(2) the recovery period for the property, and
(3) the depreciation method used.

You can’t simply deduct your mortgage or principal payments, or the cost of Asset as an
expense.
Depreciation reduces your basis for figuring gain or loss on a later sale or exchange.
Only property held for Rental purposes can be depreciated not the main home
You can deduct depreciation only for the period the asset was acquired and ready for
use.
The basis for depreciation is the Lower/Lesser of the following amounts:

- The Adjusted Basis of the Property, or

- The FMV of the Property on the Date of Charge

b) Types of Depreciable property:

Description 5 year 7 Year Residential Nonresidential
Property Property

Property  Automobile  Agricultural  Residential  Office

includes  Computers machinery and property buildings
 Office equipment (personal  Warehouse
machinery  Metal dwelling  Stores
 Research or Furniture like units)
experiment desktop,
property boards, stage
 Appliances
Furniture, etc

Depreciation 5 years 7 years 27.5 years 39 years

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Period

Note: Depreciation is calculated

1. Under MACRS method
2. MACRS Stands for Modified Accelerated Cost Recovery System.

C) Treatment of Repairs and Improvements

Modifications to property can be:

 Improvements that can be capitalized or

 Repairs that are currently deductible and do not affect the basis.

Improvements mean an addition to the property or A partial Replacement of the

Property for the betterment of the property.

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Business

Entity
Individual

 LLC – Single
Self Employed Contractor member /Multiple
member
 S -Corp
 C- Corp
 Partnership

Business use of Home

Home – 4000 sft

3000 sft 3:1 Ratio 1000 sft

personal Business

Electricity - $30000 $10,000

Interest -$3000 $1000

Taxes -$6000 $2000

Form 8829

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Schedule SE (Self Employment Tax)

FICA TAX

SST MCT

1.45% - Employer
6.2% - Employer
7.65%
1.45% - Employee
6.2% - Employee
7.65%

15.30% SE Tax

Note : For Taxpayer to pay self employment Taxes the Net earnings should be >$400

B) Income of Clergy/Ordained Minister/Church Employee (Sch SE)

All of there Earnings Including wages , offerings and fees one receives for performing
marriages, baptisms, Funerals etc are subject to Income Tax if their Incomes is $108.28 or
more (annual).

Direct payments to religious institutions for above services are Not taxable .

Exclude Rental value of Home ( Including utilities) housing allowances etc.

C) Material Participation

Test 1: The Taxpayer participation in the Activity for more than 500 hrs.

Test 2: The Taxpayers participation was substantially, All of the participation in the activity of
all individuals for the taxpayer.

Test 3: The Taxpayer participated in the activity for more than 100 hours during the tax year.

D) Net operating Loss (NOL)

A Taxpayer with annual business deductions that exceed business income may have a net
operating loss.

Some typical losses that produce an NOL include losses incurred from the following:

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 A Trade/Business
 Casualty /Theft
 Rental property

The NOL deduction cannot exceed 80% of Taxable Income for losses incurred after 2017.

NOL’s can be carried forward indefinitely.

1) 2021 – ($200,000) 2) $200,000

2022 – $1,000,000 – 80% = $800,000 100,000 = 80% = 80,000

Profit – $600,000 Profit - $20,000

To be Carried Forward Loss - NIL To be Carried Forward Loss - $120,000

A loss resulting from Non-Business deduction that are not connected to a

trade/business/employment cannot be considered as NOL.

Examples of Non- Business deductions include:

 Alimony Paid
 Contributions to IRA/Self Employed Retirement plan.
 Contributions to HSA of TP/SP/QC/QR.
 Personal itemized deductions ( except casualty & Theft losses and state Income tax on
Business profit)
 Interest Income earned from personal saving account.

E) SECTION 1202 (Qualified small business stock) Exclusion

Certain C- corporations with Gross assets under $50Million qualify for special treatment under
section 1202.

A Taxpayer selling qualified small business stock held for more than 5 years can exclude upto
100% of the eligible gain from Income.

The amount of gain that can be excluded is greater of

- $10 million 10,000,000 or

- 10 times the adjusted basis.

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F) Qualified Business Income deduction (QBID)

1) Who is Eligible for QBID?

A ) The following Taxpayers may deduct 20% of qualified Business Income:

Individuals

Trusts and Estates

Qualified REIT Dividends ( REIT – Real estate Investment Trust)

Qualified PTP ( PTP- Publicly Traded partnership)

2) What is QBI? ( Qualified Business Income)

Includes Excludes
Income From Sole
propreitor Income from C-Corporations
Income from
partnerships Performing services as an Employee
Income from S-
Corporations Capital gains
Income from
Trusts/Estate Interest
Dividends
Specified Service/Trade/Business

Note : The QBID will be limited if :

Filing status Threshold limits

MFJ 329,800
Others 164,900

Partnership Income

A partnership generally is not a taxable entity. The income, gains, losses, deductions,
and credits of a partnership are passed through to the partners based on each
partner's distributive share of these items.

Partner's Distributive Share

A taxpayer’s distributive share of partnership income, gains, losses, deductions, or

credits generally is based on the partnership agreement. A taxpayer must report his or

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her distributive share of these items on his or her return whether or not they actually
are distributed to the taxpayer. However, the taxpayer’s distributive share of the
partnership losses is limited to the adjusted basis of taxpayer’s partnership interest at
the end of the partnership year in which the losses took place.

Partnership Return

Although a partnership generally pays no tax, it must file an information return on Form
1065, U.S. Return of Partnership Income. This shows the result of the partnership's
operations for its tax year and the items that must be passed through to the partners.

Schedule K-1 (Form 1065)

Each partner should receive from the partnership a copy of Schedule K-1 (Form 1065),
Partner's Share of Income, Deductions, Credits, etc., showing the partner’s share of
income, deductions, credits, and tax preference items of the partnership for the tax
year.

Partner's Return

A partner generally must report partnership items on his or her individual return the
same way as they are reported on the partnership return. That is, if the partnership
had a capital gain, the partner reports his or her share on Schedule D (Form 1040 or
1040-SR). The partner reports his or her share of partnership ordinary income on
Schedule E (Form 1040 or 1040-SR).

S Corporation Income

In general, an S corporation does not pay tax on its income. Instead, the income, losses,
deductions, and credits of the corporation are passed through to the shareholders
based on each shareholder's pro rata share. Shareholders must report their share of
these items on their returns. Generally, the items passed through to the shareholders
will increase or decrease the basis of the shareholder’s S corporation stock as
appropriate.

S Corporation Return

An S corporation must file a return on Form 1120S, U.S. Income Tax Return for an S
Corporation..

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Schedule K-1 (Form 1120S)

A shareholder should receive from the S corporation a copy of Schedule K-1 (Form
1120S), Shareholder's Share of Income, Deductions, Credits, etc., showing his or her
share of income, losses, deductions, and credits, of the S corporation for the tax year.

Shareholder's Return

A shareholder’s distributive share of the items of income, losses, deductions, or

credits of the S corporation must be shown separately on the shareholder’s Form 1040
or 1040-SR. The character of these items generally is the same as if the shareholder
had realized or incurred them personally.

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