3-1 ©2010 Pearson Education, Inc. Publishing as Prentice Hall

3-2 GROSS INCOME: INCLUSIONS (1 of 2)  Economic and accounting concepts of income  Tax concept of income  To whom is income taxable?  When is income taxable?  Items of gross income ©2010 Pearson Education, Inc. Publishing as Prentice Hall

3-3 GROSS INCOME INCLUSIONS (2 of 2)  Other items of gross income  Tax planning considerations  Compliance and procedural considerations ©2010 Pearson Education, Inc. Publishing as Prentice Hall

3-4 Concepts of Income Economic Concepts of Income  Wealth that flows to individuals  Changes in value in individuals’ wealth  Unrealized gains  Gifts & inheritances considered income ©2010 Pearson Education, Inc. Publishing as Prentice Hall

3-5 Concepts of Income Accounting Concepts of Income  Accounting concepts of income  Values are measured by a transaction approach  Income realized as result of completed transactions  Use historical cost ©2010 Pearson Education, Inc. Publishing as Prentice Hall

3-6 Tax Concept of Income  Conditions to make income taxable  Administrative convenience  Wherewithal to pay  Gross income defined ©2010 Pearson Education, Inc. Publishing as Prentice Hall

3-7 Conditions to Make Income Taxable  Economic benefit to taxpayer  Income must be realized  Earnings process complete  Income must be recognized ©2010 Pearson Education, Inc. Publishing as Prentice Hall

3-8 Administrative Convenience  Economic concept is considered too subjective  Objectivity achieved at price of equity ©2010 Pearson Education, Inc. Publishing as Prentice Hall

3-9 Wherewithal to Pay  A tax should be collected when the taxpayer can most easily pay ©2010 Pearson Education, Inc. Publishing as Prentice Hall

3-10 Gross Income Defined (1 of 2)  Section 61(a) defines gross income  “all income from whatever source derived,” including (but not limited to) the following items:  Compensation, income derived from business, gains from dealings in property, interest, rents, royalties, dividends, alimony, annuities, life insurance, pensions ©2010 Pearson Education, Inc. Publishing as Prentice Hall

3-11 Gross Income Defined (2 of 2)  Form of receipt  Gross income not limited to cash  §1.61-1a, income may be “realized in any form, whether in money, property, and services”  Indirect economic benefit  Items indirectly benefiting taxpayers excluded from gross income ©2010 Pearson Education, Inc. Publishing as Prentice Hall

3-12 To whom Is Income Taxable?  Assignment of income  Allocating income between married people  Income of minor children ©2010 Pearson Education, Inc. Publishing as Prentice Hall

3-13 Assignment of Income  Supreme Court in Lucas v. Earl (1930)  Ruled that individual taxed the earnings from his personal services  Helvering v. Horst (1940)  Ruled that assignment of income doctrine applies to property ©2010 Pearson Education, Inc. Publishing as Prentice Hall

3-14 Allocating Income between Married People (1 of 2)  Common law property system  Used in 42 states  Income taxed to person who earns it or who owns the income-producing property  Joint income comes from jointly owned property ©2010 Pearson Education, Inc. Publishing as Prentice Hall

3-15 Allocating Income between Married People (2 of 2)  Community property states  All income deemed to be earned equally by spouses except income from separate property  Separate property  Property owned by each spouse prior to marriage  May be community income or separate income, depending on state of residence ©2010 Pearson Education, Inc. Publishing as Prentice Hall

3-16 Income of Minor Children  Taxed to child regardless of state’s property law system  Unearned income of minor under 24 may be taxed at parent’s higher rate  See Chapter I2 ©2010 Pearson Education, Inc. Publishing as Prentice Hall

3-17 When Is Income Taxable?  Cash method  Accrual method  Hybrid method  See Topic Review 1 ©2010 Pearson Education, Inc. Publishing as Prentice Hall

3-18 Cash Method (1 of 3)  Used by most individual taxpayers and most non-corporate businesses that do not have inventory  Constructive receipt  Report income in year actually received  Check received after banking hours  Bond interest coupons that have matured but not redeemed ©2010 Pearson Education, Inc. Publishing as Prentice Hall

3-19 Cash Method (2 of 3)  No constructive receipt if  It is subject to substantial limitations  Payor does not have funds necessary to make payment  Amount is unavailable to taxpayer ©2010 Pearson Education, Inc. Publishing as Prentice Hall

3-20 Cash Method (3 of 3)  Exceptions to basic cash method  Interest on Series E or EE Savings Bonds  Special rules apply to farmers and ranchers  Small taxpayer exception for inventories ©2010 Pearson Education, Inc. Publishing as Prentice Hall

3-21 Accrual Method  Report income in year income earned  Right to income  Amount can be determined with reasonable accuracy  Prepaid income  Generally taxable when received  Exceptions in Rev. Proc ©2010 Pearson Education, Inc. Publishing as Prentice Hall

3-22 Hybrid Method  Accrual method for purchases and sales  Cash method in computing all other income and expenses ©2010 Pearson Education, Inc. Publishing as Prentice Hall

3-23 Items of Gross Income (1 of 2)  Compensation  Business income  Gains from dealings in property  Interest  Series EE bond interest exception  Rents and royalties  Dividends ©2010 Pearson Education, Inc. Publishing as Prentice Hall

3-24 Items of Gross Income (2 of 2)  Alimony and separate maintenance payments  Pensions and annuities  Income from life insurance and endowment contracts  Income from discharge of indebtedness  Income passed through to taxpayer ©2010 Pearson Education, Inc. Publishing as Prentice Hall

3-25 Dividends (1 of 3)  Included in shareholder gross income  Results in double taxation  Earnings taxed at corporate level  Earnings taxed at shareholder level when distributed as a dividend  C corps allowed a 70, 80, or 100% div received deduction based on ownership %  Relief from multiple levels of taxation ©2010 Pearson Education, Inc. Publishing as Prentice Hall

3-26 Dividends (2 of 3)  Individuals taxed at 15% on dividends  0% if in 10% or 15% tax bracket  Reduces effects of double taxation  Must hold stock for at least 60 days  Scheduled to be taxed at ordinary rates after 2010  Distributions to extent they are out of corporate earnings and profits ©2010 Pearson Education, Inc. Publishing as Prentice Hall

3-27 Dividends (3 of 3)  Stock dividends  Not taxable  Basis in stock allocated to new shares  Capital gain dividends  Taxed at long-term capital gain rates  Constructive dividends  Taxed as regular dividends ©2010 Pearson Education, Inc. Publishing as Prentice Hall

3-28 Alimony and Separate Maintenance Payments  Only receipt of alimony is taxable  Alimony is deductible by one who pays  Child support not taxable  Property settlement not taxable ©2010 Pearson Education, Inc. Publishing as Prentice Hall

3-29 Pensions and Annuities  Income portion of annuity taxable  Investment portion is excluded  Exclusion ratio  Basis in annuity ÷ Expected Return  Expected return  Payment x # of expected payments ©2010 Pearson Education, Inc. Publishing as Prentice Hall

3-30 Income Passed Through to Taxpayer  Income from flow-through entities taxed directly to owners  Income from partnership  Income from S corporation  Income in respect of a decedent  Income from an estate or trust  Income from RIC or REIT ©2010 Pearson Education, Inc. Publishing as Prentice Hall

3-31 Other Items of Gross Income (1 of 2)  Prizes, awards, gambling winnings, and treasure finds – taxable  Illegal income – taxable  Unemployment compensation - taxable  Social security benefits – up to 85% taxable ©2010 Pearson Education, Inc. Publishing as Prentice Hall

3-32 Other Items of Gross Income (2 of 2)  Insurance proceeds and court awards  Special rules apply  Recovery of previously deducted amounts – taxable  Revenue received that is disputed must still be reported as income  Previously reported income that is subsequently refunded is deductible ©2010 Pearson Education, Inc. Publishing as Prentice Hall

3-33 Tax Planning Considerations (1 of 2)  Shifting income  From high income family members to low income family members  Alimony  Deductible by payor and includible by payee  Prepaid income ©2010 Pearson Education, Inc. Publishing as Prentice Hall

3-34 Tax Planning Considerations (2 of 2)  Taxable, tax-exempt, or tax-deferred bonds  Need to compare present value of after-tax returns  Reporting savings bond interest  Deferred compensation arrangements ©2010 Pearson Education, Inc. Publishing as Prentice Hall

3-35 Compliance and Procedural Considerations  Form 1040 – Wages, Salaries and tips  Schedule B – Interest and Dividends  Schedule C – Business Income  Schedule D – Capital gains  Schedule E – Rents and Royalties  Schedule F – Farm Income ©2010 Pearson Education, Inc. Publishing as Prentice Hall

Comments or questions about PowerPoint Slides? Contact Dr. Richard Newmark at University of Northern Colorado’s Kenneth W. Monfort College of Business 3-36 ©2010 Pearson Education, Inc. Publishing as Prentice Hall