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CCH Federal TaxationBasic PrinciplesChapter 4 Gross Income: 

CCH Federal Taxation Basic Principles Chapter 4 Gross Income ©2004, CCH INCORPORATED 4025 W. Peterson Ave. Chicago, IL 60646-6085 800 248 3248 http://tax.cchgroup.com

Chapter 4 Exhibits: 

Chapter 4 Exhibits 1. Accounting Income 2. Economic Benefit Doctrine 3. Constructive Receipt Doctrine 4. Assignment of Income Doctrine 5. Compensation vs. Gift 6. Items Included in Gross Income 7. Prizes and Awards 8. Employee Achievement Awards 9. Scholarships and Fellowships 10. Below-Market Interest Loans—Types of Loans 11. Below-Market Interest Loans—Definitions 12. Below-Market Interest Loans—Tax Effect Chapter 4, Exhibit Contents A

Chapter 4 Exhibits: 

13. Below-Market Interest Loans—Examples 14. Rent and Royalty Income 15. Tenant Improvements 16. Dividend Income 17. Pre-1985 Agreements 18. Post-1984 Agreements 19. Alimony and Child Support (Post-1984 Divorces) 20. Bankruptcy and Insolvency 21. Restricted Stock Plans 22. Incentive Stock Option Plans 23. Employee Stock Purchase Plans 24. Nonstatutory Stock Option Plans Chapter 4 Exhibits Chapter 4, Exhibit Contents B

Accounting Income: 

Accounting Income Income, from the accounting point of view, is the excess of revenues over the costs incurred in producing those revenues. The emphasis for the accountant is on completed transactions. All gains must be “realized” before they are includible in income. Chapter 4, Exhibit 1a

Accounting Income: 

Accounting Income Accrual method—income is recognized when a transaction is consummated, even if cash or property has not yet been received. Cash method—income is recognized only when cash or property is received. Chapter 4, Exhibit 1b

Economic Benefit Doctrine: 

Economic Benefit Doctrine This doctrine answers the question “What is income?” Any amount of compensation granted or paid to the individual for services rendered, be it cash, bonus, profit sharing, compensation in kind, or any ingenious method of payment, must be included in gross income. Gross income is defined under the Code as “all income from whatever source derived.” Thus, taxable income may consist of cash, receivables, property, land, or any other form of economic benefit. Chapter 4, Exhibit 2

Constructive Receipt Doctrine: 

Constructive Receipt Doctrine This doctrine answers the question “When is it taxable income?” Generally, any compensation granted to an individual to which the individual has an absolute right is regarded as constructively received income. Where the individual has only a conditional right, the courts hold that no present income was received. Accrual basis taxpayers are not affected by this doctrine because they recognize income the moment it is “earned.” Chapter 4, Exhibit 3

Assignment of Income Doctrine: 

Assignment of Income Doctrine This doctrine answers the question “To whom is this income taxable?” If a person only has physical possession over the income of another person, he or she has no tax liability. Regardless of whether or not the person received it as an agent or creditor, it is taxed to the owner of the property. The rules that govern the assignment of income apply both to income from property as well as to income from services. For example, a taxpayer has the employer forward a portion of the salary to one of the taxpayer’s creditors instead of to the taxpayer. The taxpayer would have to recognize this as income inasmuch as the taxpayer received benefit from the proceeds and had control of the income. Chapter 4, Exhibit 4

Compensation vs. Gift : 

Compensation vs. Gift The facts and circumstances dictate whether something received is taxable compensation or a tax-free gift (Code Sec. 102(a)).   Compensation. Taxable income arises if the value of property received by a payee-taxpayer was intended by the payor as a return of some value.   Gift. Generally, the value of property received by a taxpayer is a tax-free gift if it arises from a “detached and disinterested generosity.” (Duberstein, 60-2 USTC ¶ 9515.) Simply put, there must be no strings attached. Chapter 4, Exhibit 5

Items Included in Gross Income: 

Items Included in Gross Income Compensation for services, including fees, commissions, fringe benefits, and similar items Gross income derived from business Gain derived from dealings in property Interest Rents Royalties Dividends Alimony and separate maintenance payments Annuities Income from life insurance and endowment contracts Pensions Income from discharge of indebtedness Distributive share of partnership gross income Income in respect of a decedent Income from an interest in an estate or trust Code Sec. 61(a) lists 15 items that generally must be included in gross income: Chapter 4, Exhibit 6 Special circumstances may result in the exclusion or deferral of any of these items.

Prizes and Awards: 

Prizes and Awards Chapter 4, Exhibit 7 Prizes and awards are generally taxed 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 rather than constructively received

Employee Achievement Awards: 

Employee Achievement Awards Employee achievement awards are generally taxable, except that Chapter 4, Exhibit 8

Scholarships and Fellowships: 

Scholarships and Fellowships Chapter 4, Exhibit 9

Below-Market Interest Loans—Types of Loans: 

Below-Market Interest Loans—Types of Loans Chapter 4, Exhibit 10

Below-Market Interest Loans—Definitions: 

Below-Market Interest Loans—Definitions Chapter 4, Exhibit 11

Below-Market Interest Loans—Tax Effect: 

Below-Market Interest Loans—Tax Effect Chapter 4, Exhibit 12a

Below-Market Interest Loans—Tax Effect: 

Below-Market Interest Loans—Tax Effect Chapter 4, Exhibit 12b

Below-Market Interest Loans— Examples: 

Below-Market Interest Loans— Examples Chapter 4, Exhibit 13a

Below-Market Interest Loans— Examples: 

Chapter 4, Exhibit 13b Below-Market Interest Loans— Examples

Below-Market Interest Loans— Examples: 

Chapter 4, Exhibit 13c Below-Market Interest Loans— Examples

Below-Market Interest Loans— Examples: 

Below-Market Interest Loans— Examples Chapter 4, Exhibit 13d

Rent and Royalty Income: 

Rent and Royalty Income Chapter 4, Exhibit 14

Tenant Improvements : 

Tenant Improvements Chapter 4, Exhibit 15

Dividend Income: 

Dividend Income The term “dividend” means any distribution of property made by a corporation to its shareholders out of its earnings and profits. There are two common types of dividends: Cash Stock (dividends and rights) Chapter 4, Exhibit 16a

Dividend Income: 

Dividend Income Cash dividend Mutual funds Life insurance and annuity contracts Stock dividends Stock rights Chapter 4, Exhibit 16b

Alimony—Pre-1985 Agreements: 

Alimony—Pre-1985 Agreements If the following four conditions exist, then the recipient must include the alimony payments in gross income and the person making the payments is entitled to a tax deduction for adjusted gross income: Payments are required under the terms of the decree of divorce or separate maintenance or a written separation agreement or a decree of support Payments must be to discharge the legal obligation of support Payments must be periodic Payments must not be for child support Chapter 4, Exhibit 17

Alimony—Post-1984 Agreements: 

Alimony—Post-1984 Agreements Payments under instruments executed after December 31, 1984, that meet the following requirements are deductible as alimony: Payments must be made in cash Payments must be made under a divorce or separation instrument Parties must live in separate households after a divorce or separation decree is entered Alimony must end at the payee’s death Parties involved may not file a joint return Chapter 4, Exhibit 18

Alimony and Child Support (Post-1984 Divorces): 

Alimony and Child Support (Post-1984 Divorces) Chapter 4, Exhibit 19a

Alimony and Child Support (Post-1984 Divorces): 

Chapter 4, Exhibit 19b Alimony and Child Support (Post-1984 Divorces)

Bankruptcy and Insolvency: 

Bankruptcy and Insolvency Forgiveness of debt is generally includable in gross income. There are 2 exceptions in which taxes on a forgiveness of debt are deferred:   1. The debt is discharged in a Chapter 11 bankruptcy filing. 2. The borrower is insolvent outside of bankruptcy (i.e., Liabilities > FMV of assets immediately prior to discharge) so forgiveness of debt income is postponed to the extent of insolvency. Chapter 4, Exhibit 20a

Bankruptcy and Insolvency: 

Chapter 4, Exhibit 20b Bankruptcy and Insolvency Limits on ordinary income deferral. Code Sec. 1017(b)(2) provides that the deferral must not exceed (i)—(ii), where: (i) = Aggregate of the bases of property immediately after the discharge (ii) = Aggregate of liabilities immediately after the discharge. Therefore, a borrower cannot defer that portion of ordinary income from debt forgiveness that is equal to his or her book equity after debt forgiveness.

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Chapter 4, Exhibit 20c Bankruptcy and Insolvency

Bankruptcy and Insolvency: 

Bankruptcy and Insolvency Code Sec. 108(b)(5) election to first reduce basis of assets. Code Sec. 108(b)(5) offers a special election to first reduce the tax basis of depreciable property or real property held as inventory. Chapter 4, Exhibit 20d

Bankruptcy and Insolvency: 

Bankruptcy and Insolvency Recapture of ordinary income. Under Code Sec. 1017(d), the amount deferred from gross income under Code Sec. 108(a), which applied in reduction of basis under Code Sec. 108(b)(2) or (b)(5), would be recaptured as if it were a Code Sec. 1245 asset. Chapter 4, Exhibit 20e

Deferred Compensation—Restricted Stock Plans: 

Deferred Compensation— Restricted Stock Plans As a general rule, the value of any property transferred in connection with services rendered is taxable as compensation, whether the property is goods, common stock, a partnership interest, or any other property. Stock or other property is taxable whenever the right to it is “substantially vested” which means that it is either transferable or not subject to a substantial risk of forfeiture. Chapter 4, Exhibit 21a

Deferred Compensation—Restricted Stock Plans: 

Deferred Compensation— Restricted Stock Plans Compensation results if property is transferred “in connection with” services rendered. Thus, it does not matter whether: Services are rendered as an employee or independent contractor. The property was transferred by the employer or another person, such as a shareholder. The property was transferred to the compensated person or to anyone else, (e.g., a beneficiary, a trust, a corporation, or other agent). Any income received, (e.g., dividends) before the property is substantially vested is also treated as compensation. Chapter 4, Exhibit 21b

Deferred Compensation—Restricted Stock Plans: 

Deferred Compensation— Restricted Stock Plans If property transferred in connection with services rendered is not “substantially vested,” an election may nevertheless be made to include the current fair market value of the property in gross income. There are two advantages of making the election: Any future appreciation will qualify as a capital gain, historically taxed at rates lower than ordinary income. The appreciation between the date of transfer and the date of substantial vesting is not taxed until the eventual disposition of the property in a taxable sale or exchange. Chapter 4, Exhibit 21c

Deferred Compensation—Incentive Stock Option Plans: 

Deferred Compensation— Incentive Stock Option Plans For options to qualify as ISOs, the following conditions must be met: The term of the option may not exceed 10 years. The option price must be no less than the fair market value of the stock on the date of issuance. The option must be transferable by inheritance only. The option plan must specify the aggregate number of shares that may be issued and the employees eligible to receive the option. The option must be granted within 10 years of the earlier of the date of adoption of the plan or the date it was approved by the shareholders. If the employee owns more than 10% of the company, the option price must be at least 110% of the market value and its term may not exceed 5 years. Chapter 4, Exhibit 22

Deferred Compensation—Employee Stock Purchase Plans: 

Deferred Compensation— Employee Stock Purchase Plans An employee stock option plan is, generally, one permitting employees to buy stock in the employer corporation at a discount. No income is recognized under such a plan at the time the option is granted; the recognition is deferred until stock acquired under the plan is disposed of. Chapter 4, Exhibit 23

Deferred Compensation—Nonstatutory Stock Option Plans: 

Deferred Compensation— Nonstatutory Stock Option Plans Nonstatutory stock options are options that do not qualify for the favorable tax treatment accorded to options that are covered by a specific Code provision as are qualified stock options, incentive stock options, employee stock purchase plans, restricted stock plans. While statutory options are generally not taxed until the taxpayer disposes of the options and any gains on the dispositions are taxed at capital gains rates, nonstatutory stock options usually are taxed at ordinary compensation income rates at the time they are granted, the options being considered compensation for services rendered by the employee. Chapter 4, Exhibit 24