Gross Income
Compensation for
services, including Gross income
Gain derived from
fees, commissions, derived from
dealings in property
fringe benefits, and business
similar items
Items Interest Rents Royalties
Included in
Gross Dividends Annuities Pensions
Income
Income from
discharge of
indebtedness
Tax Accounting
Methods
Cash Method: Income is
recognized when cash is received.
Accrual Method: Income is
recognized when a transaction is
consummated, the services are
rendered, and the right of claim
to the income arises.
N.B.: These concepts are not
identical to their financial
accounting counterpart.
“What is income?”
The Economic Benefit
Doctrine is a judicial
doctrine that supplements
Economic IRC 61.
Benefit Any amount of compensation
granted or paid to the
Doctrine individual for services
rendered, be it cash, bonus,
profit sharing, compensation
in kind, or any other
ingenious method of
payment, must be included
in gross income.
“When is income taxable?”
Constructive Generally, any compensation
Receipt granted to an individual to
which the individual has an
Doctrine absolute right is regarded as
constructively received
income.
“To whom is the income
taxable?”
Assignment
Income is taxes to the
of Income individual who earned it,
even if the right to the
Doctrine income has been transferred
to another individual prior to
recognition.
Community Property
Community Property Income
Property acquired after marriage
is community property.
• Income from community property is
community income
Property acquired before
marriage remains separate
property.
• What happens to income from separate
property?
California Rule – Income from
separate property remains
separate. Applies to California,
Arizona, Nevada, New Mexico,
Community Washington and Wisconsin.
Property Texas Rule - Income from separate
Income property is community income.
Therefore, if spouses filed
separate returns, the income
would be shared between them.
Applies to Texas, Idaho and
Louisiana.
Compensation vs. Gift
RULE: FACTS:
• The facts and • Grandma offers 16-year-old Billy
circumstances dictate
whether something $10,000 if he quits smoking and
received is taxable playing pinball over the next five
compensation or an years. He does, and upon attaining
‘income tax free’ gift the age of 21, she pays him $10,000.
(not free from gift tax,
however). Gifts are made
from detached and QUESTION:
disinterested generosity,
whereas income is • Is the $10,000 received by Billy
derived in return for taxable income or a gift?
economic benefit.
• Compensation is
generally included in
SOLUTION:
gross income.
• Gifts are generally
• The $10,000 is taxable income since
excluded from gross there were strings attached.
income.
Prizes and Awards
Prizes and awards are generally
taxable based on fair market
value at time of receipt.
However, if ALL of the following 4
conditions occur, then they are
excludable :
1. Connected with the fields of
science, charity, or the arts
2. Involuntary selection process
(i.e., through no effort of
recipient)
3. No future services required
of recipient
4. Assigned to a governmental
agency or tax-exempt
charitable organization (rather
than constructively received).
FACTS:
• Mother Tanesha, a U.S. citizen, is awarded the Nobel Peace
Prize, which includes a $500,000 cash award. The award was
unsolicited and no future services were required of Mother
Tanesha. Furthermore, she endorsed the check over to the
Sisters of Charity, a qualified tax-exempt charity, rather than
depositing it in her bank account.
Prizes and QUESTION:
Awards • Does Mother Tanesha have taxable income?
Example SOLUTION:
• YES! She constructively received the $500,000 when she
endorsed the check over to the charity. By endorsing the
check, she exercised dominion and control over the money,
even though she did not deposit it. She could have avoided
taxable income if she had directed the Nobel Committee to
pay the Sisters of Charity directly. The key here is that she did
not assign her check to the charity, but rather she accepted the
check and then paid the money to the charity (thus
unnecessarily subjecting herself to income tax on $500,000).
Employee Achievement Awards
Employee achievement awards are generally taxable,
except that the value of awards for length of service
or safety achievement delivered at a “meaningful
presentation” are excluded up to
$400 if the plan is non-qualified (i.e.,
discriminates in favor of highly paid employees),
or
$1,600 if the plan is qualified (i.e., does not
discriminate in favor of highly paid employees).
(If an employee receives both qualified and
nonqualified awards, then the overall exclusion may
not exceed $1,600.)
The value of scholarships or fellowships are generally
taxable, but may be excluded if they are:
1. To a degreed candidate attending an educational
institution
Scholarships
and 2. For tuition and course related material (not room
and board)
Fellowships
3. As a result of academic achievement, and not
connected with services provided.
Example: A “scholarship” received by a contestant on
cooking TV show would actually be a taxable award for
services rendered, even if she were a degree candidate
and the money was spent on tuition. It would really be
compensation disguised as a scholarship.
Business Income
Sole proprietor Partnerships and S corps
Include all business income (less Partnerships and S corporations
cost of goods sold) in gross are not taxed, but their taxable
income. income is taxed to individual
partners and shareholders.
Partners and shareholders of S
corporations must include their
proportionate share of business
income in their gross income,
regardless of whether or not the
income was distributed.
Below-Market Interest Loans
Types of Loans
All of the following loans are subject to imputed
interest:
• Gift loans (made out of love or generosity). Note that the
“gift” is NOT the principal portion of the loan, rather, the
amount of interest that is below market.
• Compensation-related loans (employer loans to employees)
• Corporation-shareholder loans (a corporation’s loans to ANY of
its shareholders)
But only if all of the following apply:
• Interest charged is less than the applicable federal rate (AFR)
• Sum of all loans between lender and borrower exceeds $10,000
(de minimis rule)
• The loan was made after June 7, 1984
The two steps for each of the three
below-market interest loans are not easy to
Below- conceptualize.
Market Step 1: “Pretend” that the borrower has
“paid” the imputed interest to the
Interest
lender as an interest payment.
Step 2: “Pretend” that the lender has
Loans—Tax returned the imputed interest back to
the borrower as either a gift,
Effect compensation, or a dividend.
Below-Market Interest Loans—
Tax Effect
What is the tax effect of imputed interest on below-market loans?
Type of Loan Step Lender Borrower
Gift Loan Step 1: Interest income. Interest expense.
Step 2: Nondeductible gift, possibly subject to gift Tax-free gift received.
tax.
Compensation- Step 1: Interest income. Interest expense.
related Loan Step 2: Compensation expense. Compensation income.
Corporation to Step 1: Interest income. Interest expense.
Shareholder Step 2: Nondeductible dividend deemed paid. Dividend income.
Loan
Rental Income
RULE: FACTS:
• Business tenant pays Landlord $10,000,
• Tax Effect on
covering the first and last year’s rent.
Landlord: ALL rent
received is taxable
QUESTION:
income, including
future years’ rent • What is the tax effect on Landlord and
received in advance. Tenant?
• Tax Effect on Tenant
with a Business Lease: SOLUTION:
If rent is paid in
advance, no deduction • $10,000 taxable income to Landlord;
for rent expense is $5,000 deduction to Business Tenant.
allowed until the year • Pointer: personal rent is non deductible.
the payment is due. IRC 212.
Payments made on behalf of
others
If a person makes payments on behalf of another, that
payment may be considered income or gift depending on the
circumstances.
E.g., grandfather pays $1,000 in utility bills accrued by
grandchild. The payment is likely a gift.
E.g., employer pays a $50 parking ticket incurred by
employee while driving his private vehicle during off-duty
hours. The employee will have to include the $50 in
compensation income.
The term “dividend” means
any distribution of property
made by a corporation to its
shareholders out of its
earnings and profits.
Dividend
Income
There are two common types
of dividends:
Stock Dividends
Cash Dividends
– generally not
– taxable.
taxable.
Alimony and Child Support
(before 2018)
What is the tax treatment for alimony and child support?
Alimony Child Support
Taxable to Recipient? Yes No
Deductible to Payor? Yes No
Alimony and Child Support
(after 2018)
What is the tax treatment for alimony and child support?
Alimony Child Support
Taxable to Recipient? No No
Deductible to Payor? No No
Forgiveness of debt is generally
includable in gross income. There are 2
exceptions in which forgiveness of debt is
not taxed:
1. The debt is discharged in a Chapter 11
bankruptcy filing. Discharge
The borrower is insolvent* outside of
2.
bankruptcy. of Debt
*(i.e., Liabilities > FMV of assets immediately
prior to discharge). However, the amount
excluded from gross income cannot exceed the
amount by which the taxpayer is insolvent.
Income Exclusions
Life insurance proceeds. IRC 101.
Gifts and inheritances. IRC 102.
First $250,000 of capital gains from the General
sale of primary residence. IRC 121.
Exclusions
Interest received on state and local
government bonds is generally
excludable from gross income. IRC 103.
Life insurance proceeds are not
considered income to the
beneficiary when the insured dies.
Life
Insurance In cases where the insured is
declared terminally ill (life
expectancy of two years or less) and
the life insurance policy has a cash
value, the insured can cash his/her
own life insurance without paying
income tax.
Gifts may be subject to gift tax
(which is not an income tax).
However, the gift tax is paid by
the donor. Gifts are always free
of income tax to the recipient.
Gifts and
Inheritance Inherited property may be
subject to estate tax (which is
not an income tax). However,
the estate tax is paid by the
estate. Inheritance is always
free of income tax to the heir.
Retirement Income is always
taxable to the recipient unless it is
Social Security benefits (only
partly taxable) or distributions
from a Roth IRA (not taxable at all).
Retirement
Income
Distributions from Traditional IRAs
are taxable, but distributions from
Roth IRAs are not taxable.
Social Security Benefits
A portion of Social
Security income is
taxable to the extent
that a taxpayer’s
provisional income
exceeds certain base
amounts.
Provisional income
equals adjusted gross
income, plus one-half
of Social Security
received, plus tax
exempt interest.
Social Security Benefits
1st threshold base amounts
$25,000 for single
$32,000 for married filing
jointly
If a taxpayer’s provisional
income exceeds the 1st
threshold (but does not
exceed the 2nd threshold), the
taxable portion of Social
Security is the lesser of:
50% of Social Security
benefits or
50% of the excess of the
taxpayer’s provisional
income over the base.
Social Security Benefits
2nd threshold base amounts
$34,000 for single
$44,000 for married filing
jointly
If a taxpayer’s provisional
income exceeds the 2nd
threshold, the taxable portion of
Social Security is the lesser of:
85% of Social Security
benefits OR
85% of the amount that
provisional income exceeds
the threshold plus $4,500
for unmarried taxpayers or
$6,000 for married filing
jointly.
Social Security Benefits
Married taxpayers filing separately have no
base amount and must include in gross income
the lesser of
85% of Social Security benefits OR
85% of their provisional income
Tip: Use IRS Publication 915 and related
worksheets to figure out the taxable amount of
social security benefits.
Interest
Payments
Interest payments
received are income
unless they are paid by
a state and local
government.
Interest on federal
bonds is taxable (except
for federal education
bonds), while interest
on state, county, and
city bonds is not.
Interest from savings
accounts or any other
source is likewise
taxable.
The general rule is that
interest on U.S. savings
Interest on bonds is fully taxable.
U.S.
Savings Cash basis taxpayers may
report interest income on a
Bonds yearly basis or defer the
recognition of interest
income until the bonds
mature.
Interest earned on U.S. savings bonds may be
excluded if the proceeds are used to finance the
higher education of the taxpayer, taxpayer’s spouse or
dependents.
Tuition and fees qualify. Room and board and
expenses incurred outside of the degree program
(e.g., sports, clubs) do not qualify.
The bonds must be redeemed during the same tax
year in which qualified educational expenses are
incurred.
EE Bonds
If the qualified educational expenses exceed the
Series EE proceeds (principal and interest), then all
Used for
the interest may be excluded, subject to the income
phase out rules. Education
If the qualified educational expenses are less than the
Series EE proceeds (principal and interest), then only
a portion of the interest may be excluded based on
the following formula:
(Qualified educational expenses/Series EE
proceeds) * Interest on EE savings bond
Damage Awards
Tax Treatment for Damages
Type Damages
Physical Injury or Sickness Excluded from taxable income
1
Taxable, except if damages are used to pay
2 Non Physical Injury or Sickness for medical expenses related to emotional
distress.
3 Lost Wages Taxable Income
4 Punitive Damages Taxable Income
Employment Benefits
Anything of value that an employee
receives from an employer is called
“fringe benefit.”
Fringe benefits are taxable to the
employee unless an exception
apples.
Therefore, free lunches, clothing,
travel benefits, or anything else is
taxable unless it fits a specific
exception.
Fringe Benefits Excluded from Gross
Income
No-additional-cost services: Example: Free travel is offered
Generally excluded from gross to airline employees who fly on
income if no significant additional standby. Spouses and dependent
costs are incurred by the children may be included with no
employer and the service income tax consequences.
provided is offered for sale to
customers in the ordinary course
of the line of business for which
the employee is working.
Fringe Benefits Excluded from Gross
Income
Qualified employee discounts: For Example: Coffee shop employees
property purchased at a discount, may purchase coffee drinks at
the exclusion may not exceed the 20% off retail price.
employer’s gross profit margin.
For services purchased at a
discount, the exclusion may not
exceed 20%.
Fringe Benefits Excluded from Gross
Income
Working condition fringe benefits: Example: Cell phone used by the
The fair market value of any employee for the primary
property or services provided to convenience of the employer, but
an employee is excluded by that also available for personal use;
employee if it represents an subscriptions to business
ordinary and necessary business periodicals; on-the-job training;
deduction to the employer and/or inventory being tested by the
is a condition of employment. employees outside of the
employer’s workplace.
Fringe Benefits Excluded from Gross
Income
De minimis fringe benefits: Example: Using the copy
Excluded when the value of machine for personal purposes;
property or services provided to occasional tickets to sports
the employee are so minimal that events, coffee and snacks,
accounting for it would be occasional company picnics.
unreasonable.
Group Life Insurance
An employee can exclude the cost of
group term life insurance provided by
an employer as long as the face value
of the policy does not exceed
$50,000.
If over $50,000 of coverage is
provided by an employer, the cost of
the premium for the excess coverage
must be included in the gross income
of the employee.
Cafeteria Plans (IRC 125)
Cafeteria plans are employer-sponsored
benefit packages that offer employees
a choice between taking cash or
benefits.
Tax Advantage of Cafeteria Plans:
Employees are not subject to federal
income tax if they choose to take the
benefits, but if they take the cash they
would need to report income. In
addition, the cost of these fringes is
deductible as compensation to the
employer.
Group-term life insurance coverage
below $50,000
Health and accident protection and
Nontaxable dental plans
Items Under Child care
Cafeteria
Vacation days
Plans
Dependent care assistance
Adoption assistance
Employee Tuition
Reduction Plans
Payments of up to $5,250
per year paid by an
employer to, or on behalf
of, an employee for
tuition and course-related
material may be excluded
from employee income.
Qualified educational
expenses includes the
payment or provision of
tuition, fees, books,
supplies, and equipment.
An employee may receive tax benefits in the form
of income exclusion and tax credit for up to
$14,890 (2022) in adoption expenses per child,
where such expenses are paid for by the taxpayer’s
employer under a qualified adoption assistance
program.
Qualified adoption expenses include ordinary
Adoption and necessary adoption expenses, court costs,
attorney fees and other expenses incurred for
Assistance the principal purpose of the legal adoption of a
child.
The exclusion is phased out for taxpayers with
an adjusted gross income between $223,410 and
$263,410 (2022).
Dependent
Care Assistance
Program
A qualified dependent care
assistance program is a
separate written plan of an
employer under which the
employer pays or incurs
dependent care costs for the
exclusive benefit of
employees. Employees can
exclude up to $5,000 ($2,500
for married persons filing
separately).