Federal Income Tax Course - Chapter 7 - Income

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Taxable income

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is any income that is subject to federal income tax. All taxable income must be reported on a tax return unless the amount is so small that the individual is not required to file a return.

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Most employment compensation is taxable, including:

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1) Wages, salaries, bonuses, and commissions

2) Certain fringe benefits

3) Tips and compensation for personal services.

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Other forms of taxable income include

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Interest, Dividends, Refunds of state and local taxes, Alimony or separate maintenance payments received, Business income, Capital gains, Sale or conversion of property

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Taxable income may also include

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IRA distribution (part or all may be nontaxable), Pensions and annuities (part may be nontaxable), Rents, royalties, and estate or trust income received, Unemploymend compensation and supplemental benefits, Railroad retirement benefits (Part or all may be nontaxable), SS benefits (part or all may be nontaxable)

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Form 1099-R

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is used to report the distributions from pensions, annuities, retirement or profit-sharing plans, IRAs, Insurance Contracts, etc.

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Pensions are reported on the

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"Pensions and Annuities" line of the return

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The following taxable income is included in the "Other Income" total on Form 1040's line 21:

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1) Jury Duty pay 2) Executor fees 3) Gambling winnings 4) Hobby income (hobby losses are not deductible) 5) Non-qualifying scholarships and fellowships 6) Payments for punitive damages and damages not attributable to physical injuries or sickness 7) certain long-term care benefits 8) 1099 MISC income reported in Box 3

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Nontaxable income

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is income that is exempt from tax. Most nontaxable income is not reported. Some types of nontaxable income will be shown on the return, but will not be added into the amount of income subject to tax.

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The following types of income are nontaxable:

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1) Child Support

2) Federal income tax refunds

3) Certain life insurance proceeds and accelerated death benefits of the terminally ill

4) Sales proceeds of life insurance to a viatical settlement company by the terminally ill

5) Gifts and bequests

6) Inheritances

7) Insurance and certain other payments for physical injury and sickness

8) The 65% subsidy for payment of COBRA health care coverage continuation premiums is not taxable for federal income tax purposes.

9) Gifts and bequests may be exempt from federal income taxes, but may be subject to state and local taxes.

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The following types of income is also exempt from taxes:

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1) Interest on certain Series EE and Series I savings bonds redeemed to pay for qualified higher education expenses

2) Interest on certain state and local obligations

3) Most life insurance proceeds paid upon death

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Other nontaxable forms of income include:

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1) Public assistance payments

2) Certain railroad retirement benefits

3) Social security benefits

4) Department of Veterans Affairs disability benefits

5) Workers' comp

6) Accident and health insurance benefits for personal injuries or sickness

7) Qualified scholarships and fellowships

8) Certain dependent care services provided by employer

9) certain employer-provided educational benefits (up to $5,250)

10) Interest on insurance dividends left with VA

11) Employer-provided assistance for qualifying adoption expenses

12)Restitution payments and excludable interest received by Holocaust victims, their estates or their heirs

13) Certain long-term care benefits

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Certain types of stock transactions are non taxable events:

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1) Comm Stock for Comm stock or Pref for pref of the same corporation.

2) Exchanges of stock for other stock in the same or different corp that occurs because of a merger, acquisition, recapitalization or some other form of reorganization

3) Conversion of a convertible bond into shares of stock or convertible preferred shares of stock into common shares of stock.

4) Transfers of property to a corporation in exchange for stock in the corp provided the taxpayer or the group of investors own at least 80% of the corp after the transfer

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Combat pay

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is federally tax-exempt. However, members of the military in combat can still claim the Earned Income Tax Credit and the Additional Child Tax Credit. There are Special Rules for Members of the Armed Forces.

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Benefits of lowering taxpayer's AGI

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The lowering of AGI can increase: 1) Casualty and theft losses (allowable only to the extent such uninsured losses exceed $100 for each casualty or theft, plus 10% of AGI)

2) Medical Expenses (deductible only for the amount above 10% of AGI)

3) Most miscellaneous itemized deductions (allowable for the portion above 2% of AGI)

It can also increase the amounts deductible for contributions for traditional IRA and for losses on rental properties. It can also decreae the amount the taxpayer is taxed on his or her Social Security benefits.

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Earned income received for services performed

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wages, salaries and tips are the primary. If a property is received as a tip, it should be reported at fair value.

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Form W2 - Wage and Tax Statement

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report's the employee's earned income for the year.

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Some fringe benefits are treated differently than regular income for tax purposes. The benefits to which special rules apply are:

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Dependent Care Benefits, Adoption Benefits, Employer's contributions to an Archer Medical Savings Account.

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There are special income tax rules that apply to ordained rabbis, ministers and cantors

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1) Housing Allowances (see special rules)

2) If the offerings for performing special religious ceremonies are made to the religious organization (not the clergy member himself), then it is not taxable.

3) other income tax rules

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Employer Provided Automobiles

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The employee may be able to deduct the actual expenses of operating the vehicle for business purposes. The amount the employee can deduct depends on the amount that the employer included in his income and the business and personal miles driven during the year. The employer can figure and report either the actual value of the employee's personal use of the car or the value of the car as if the employee used it only for personal purposes (100% income inclusion). Use special table to calculate the lease value of employer provided vehicle benefits.

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The employee can deduct the value of the business use of an employer provided car if

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the employer reported 100% of the value of the car in the employee's income.

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To claim expenses for Vehicle use

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complete Part 2, Section A and C, of Form 2106. Enter the actual expenses on line 23 of Section C and include the entire value of the employer provided car on line 25. If less than the full amount of lease value of the car was included on Form W-2, this means that Form W-2 only includes the value of the employee's personal use of the car. Do not enter this value on Form 2106 as it is not deductible.

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If the employee paid any actual costs to operate the car, that the employer did not provide or reimburse the employee for:

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the employee can deduct the business portion of those costs.

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Household Employees

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If a house hold employee earns less than $1,800 a year while working in the employer's home, the employer is not required to provide the employee with a Form W2. However, it is required if the employer withholds federal income taxes.

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If the Household employer pays cash wages of $1900 in 2013 to any one household employee. (do not count wages paid to: spouse, child under the age of 21, parent, any employee under the age of 18 at any time in 2013

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then the employer must withhold and pay Social Security and Medicare taxes on all wages, including the first $1,900. The taxes are 15.3% of cash wages

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If the Household employer pays cash wages of $1,000 or more in any calendar quarter of 2012 or 2013 to household employees (do not count wages paid to: spouse, child under the age of 21, parent)

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then the employer must pay federal unemployment tax (FUTA). The tax is 6.2% of cash wages. Wages over $7,000 a year per employee are not taxable. The employer may also owe state unemployment tax.

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Form 1099-MISC

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Taxpayers who receive earnings reported on form 1099-MISC Miscellaneous Income, may be considered self-employed, Box 7 1099-MISC is used to report Nonemployee compensation. these should be reported on Schedule C-EZ - Net Profit from Business or Schedule C - Profit or Loss from Business. Net losses and profits are carried over to line 12 of Form 1040.

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Tip Income

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Individuals who receive $20 or more per month in tips from one job must report their tip income to their employer. Tips that are reported to employers are included with wages on Form W-2, box 1. If individuals do not report their tips, then they have to report the social security and Medicare taxes on the unreported tips on Form 1040 (only). Use Form 4137 - Social Security and Medicare Tax on Unreported Tip Income to compute and report the additional tax.

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Tips of less than $20 per month or non-cash tips are:

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1) Exempt from social security and Medicare taxes

2) Subject to Federal income tax and must be reported on line 7 of Form 1040 or Form 1040A, or line 1 of Form 1040EZ

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Allocated tips

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are tips an employer assigns to an employee. They are in addition to the tips the employee reports to the employer. Allocating tips is shown separately in box 8 of Form W-2, Allocated tips. They are not included in the amount in box 1.

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Scholarships and Fellowships

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some of Scholarships and Fellowships may be partially taxable regardless of whether or not the taxpayer received a Form W-2 for the scholarship or fellowship.

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Students who receive academic scholarships may

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exclude from taxable income the amount required for tuition, fees, books and supplies.

However, they must report as taxable income any academic scholarship funds used for other expenses, such as room and board.

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Qualified academic scholarships and fellowships are treated as tax free amounts if all of the following conditions are met:

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1) The student is a candidate for a degree at an educational institution.

2) Amounts received for academic scholarship or fellowship are used for tuition and fees required for enrollment or attendance at the college, or for books, supplies, and equipment required for college courses of instruction, and

3) the amounts received as an academic scholarship are not a payment for the students services, such as teaching other students

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Interest income

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Money earn interest when: 1) deposited in accounts in banks, saving and loans, and credit unions, or 2) Used to buy certificates of deposit or bonds, or 3) Lent to another person or business

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Amounts received from money market mutual funds

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should be reported as dividends, not interest

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Amortizable bond premiums

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If the taxpayer paid a premium to purchase a bond, he can make an election to deduct a portion of the premium each year while he holds the bond. If he makes this election he must make it for every bond he owns and for every bond he purchases in the future until he revokes the election. His broker can determine the amount of the premium paid and the amount of amortization to deduct each year.

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Series EE U.S. savings bonds

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are the most common type of U.S. saving bonds. They are issued at a discount and the interest is the difference between the purchase price and the amount received when the bonds are cashed in.

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Series 1 U.S. savings bonds

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are issued at face value with a maturity periad of 30 years. The interest is paid when bonds are redeemed.

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Taxpayer have 3 options for paying income tax on US savings bonds

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1) Declare and pay tax on interest each year without cashing the bonds

2) Delay reporting the interest and let it accumulate until the bonds are cashed.

3) Trade the EE bonds for HH bonds, which pay current income.

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Series HH U.S. Savings Bonds

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are issued at face value and pay interest twice a year. Taxpayers must report interest in the year it is paid.

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Interest on other US obligations, such as US Treasury Notes, Bonds, and Bills

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is fully taxable when received.

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Deffered Interest Accounts

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pay interest at fixed intervals. Some examples are certain certificates of deposit (CDs), certain money market certificates, and some US Treasury bonds.

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If interest on a CD is deferred for more than one year

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the taxpayer must include a part of the interest in income each year. The taxpayer should receive form 1099-INT - Interest Income stating the amounts to report.

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Long-term obligations that pay no interest before maturity at a discount. Original Issue Discount (OID) is

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the amount by which the bond's or note's principal amount exceeds its issue price. Taxpayers include OID in their income as it accrues over the term of the obligation, whether or not an income is received.

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Form 1099-OID - Original Issue Discount

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reports the amount of OID income that the taxpayer should report as income for the year

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Income from estates and trusts

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trusts and estates are recognized as separate taxable entities for federal income tax purposes. Estates and trusts with Gross income of 4600 or more file their own income tax return on Form 1041 - US Income Tax Return for Estates and Trusts. For 2014 once the estate or Trust has taxable income in excess of $12,150, the top tax rates of 39.6% for ordinary income and 20% for long-term capital gains apply. Additionally, the 3.8% Medicare surtax applies.

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Each estate's beneficiary's share of income, deductions, credits and other tax items is reported to them on

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Shedule K-1 - Beneficiary's Share of Income, Deductions, Credits, etc. A copy of each Schedule K-1 is filed with the IRS along with the estate or Trust's Form 1041 and each beneficiary receives a copy.

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Schedule K-1 from an estate or trust is not filed with Form 1040

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each item that is separately stated on the Schedule K-1 is transferred to the appropriate section of the taxpayer's Form 1040. For instance, Line 1 of the taxpayer's Schedule K-1, "Interest Income" should be transferred to Line 1, Part 1, of the taxpayer's Schedule B.

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Members of the Armed Forces in regular and reserve units controlled be the Secretaries of Defence, Navy, Army, Air Force, and Coast Guard receive the following tax benefits

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1) Tax Free Income (there is a list of tax free income that members of Armed Forces receive)

2) Tax Deduction (special list of itemized deductions, subject to 2% of AGI floor are available to members of Armed Forces)

3) Filing Deadline for service members on duty outside the US and Puerto rica receive and automatic 2 month extension.

4) Tax Forgiveness Upon Death (for the year of death and previous years served in combat zone)

5) Filing deadline for members in a combat zone or serving in a contingenct operation service (special rules)

6) There are also other special rules that are applicable to the members of special forces.