Federal Income Tax: Mechanics And Gross Income

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Mechanics
1. Det. gross income
2. Subtract above line deducations -->AGI
3. From AGI, subtract standard deduction OR itemized deductions (whichever's larger)

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4. Subtract personal and dependency exemptions to reach taxable income

5. Apply graduated tax rates

6. Subtact credits from gross tax--> net tax due

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Exclusion: not included in gross income to begin with [ex: gift; tax-free fringe benefits]

Deduction: deducted from gross income or adjusted gross income (savings depends on marginal tax rate) [ex: home mortgage interest expense incurred by owner]

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Credit: one-for-one reduction of taxes owed [earned income credit; Hope and Lifetime Learning Credit; child care credit]

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Gross income: all realized accretions (increase) in wealth; includes stuff received in kind, and windfalls (doesn't have to be "earned")

Ownership in litigation isn't taxed until litigation is resolved

Claim of Right rule: If taxpayer asserts to a claim to property and uses it as if it were her own, amount's includible in her gross income (tho it turns out she must repay amount in a later year)

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Money embezzled, extorted, or stolen in one year and repaid in another is taxable in the year stolen, and later deducted when repaid (tho technically not a claim of right)

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Assignment of Income- Services

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Does not avoid taxes-- *income is taxable to person who earns it

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* Gains from sale of property are included in income. Gain is equal to amount received in sale less seller's adjusted basis in the property (what they paid originally)

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* Gain from property is taxed only when it's realized, i.e., when property is sold or exchanged.

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* Gifts, devises, bequests and inheritances are not included in gross income.

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Exception: Bequest made in consideration for past services is included in gross income.

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* In normal situation where, at time of gift, the property is appreciated, the basis of property acquired by gift is the donor's basis increased by the gift tax allocable to any appreciation in the property as of the gift.

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Carryover basis rule preserves the gain in property to be realized.

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* When a person dies owning property, property's basis is adjusted to equal the fair market value of the property on death date. Thus, appreciation in property isn't taxed under income tax.

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Applies to both appreciated and depreciated property.

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Business gift isn't taxable as income.

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In order to be excludable as gift, the transfer must stem from:

Detached and disinterested generosity and not be quid pro quo.

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When money is taken in recognition of consensual obligation to repay (loan) no net increase in wealth.

But, discharge of debt generally results in gross income.

But if insolvent or in bankrupcy, not taxable (don't want to kick ppl while they're down)

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If lender relative and canceled as gift, it's not taxable.

If cancel debt in property purchase, cancelled debt isn't income. It is treated as reduction in basis of property.

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If employers reimburse for moving expenses, it's not income.

* Translation: if employee didn't move, length of commute would increase by at least 50 miles.

During yr that follows move, works full time for at least 39 weeks. If no reimbursement for moves, may deduct expenses on tax return.

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* No deduction for indirect expenses (temporary housing, house hunting trips, meals while moving)

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Employer paid group term life insurance: employer can deduct premiums as business expense, employee not included in gross income

Insurance coverage: employer deducts as business expense; employee taxed on value of extra coverage

No exclusion for key employees unless plan is nondiscriminatory

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If $52k (insurance and interest) paid to beneficiary, then taxable portion is $2k.

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If employer maintains accident/health insurance policy and pays premium:

- employer deducts as bus expense
- not taxed to employee

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Insurance company payment of bills isn't taxed either.

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* Gross income doesn't include scholarship for tuition, fees, books, supplies and equipment for courses at an educational institution if: Primary purpose is to further education; money used for tuition/books/fees; scholarship not for past/future services.

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If scholarship w/requirement to return to job after degree completion, then scholarship IS taxable.

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Prizes and awards are always included in income.

*Basis includes amounts included in income. Rule avoids having to pay tax on the same income twice.

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Prize/award may be excludeable from income only if:

- prize for relig/charitable/sci achiev
- selected w/o action on her part
- not compensation for past/future serv AND
- right to it is assigned to charity before it's received

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Physical personal injury awards are not taxable. Legal fees are not deductible because they were incurred to received damage award that's excluded from income and untaxed.

All punitive awards are taxed. They're increase in wealth. Lawyers' fees allocable to punitive damage award are deductible.

Allocation of legal fees between categories is necessary.

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Defendant may deduct compensatory damages or punitive damages as business expenses. BUT can't deduct fines paid to government for violation of a law.

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If receive damages for emotional distress stemming from a physical injury, it's not taxable. BUT if emotional distress stems from nonphysical injury, then it's taxable.

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Business torts: damages are taxed (lost profits, punitive damages)

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Property damages

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Treat damages as though there was sale (calculate amount realized from sale less basis to determine gain)

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Breach of employment contract damages is taxable. Not personal injury!

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Tax consequences of rent?

Landlord: income, increse in wealth
Tenant: not deductible (personal expense); if business lease- then deductible