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1. All-inclusive Income Concept
2. Legislative Grace Concept
1. Equity measures- avoid double taxation
2. Social goals- encourage provision of goods and services by private sector; encourage individuals to take actions that protect themselves medically and financially
Exclusion: permanent and never subject to taxation
Deferral: Not taxed in current period, but will be taxed at some point in the future
1. Donative Items
2. Employment-related exclusions
3. Returns of human capital
4. Investment-related exclusions
Name 4 donative items Congress has decided should not be taxed.
3. Life insurance proceeds
1. Income flows from property (interest, dividents, rents, royalties)
2. Gains from the sale of property
The treatment of business gifts falls under the _________ doctrine. Define.
1. Donor is subject to gift tax rules, so the exclusion of gifts from income tax prevents a double tax on gifts.
2. Property held in an estate is subject to estate tax, so income exclusion for inheritances avoids a double taxation of an inheritance.
The amount of unrecovered investment in an asset.
Excluded from Income Tax
Sometimes included in Estate Tax
Amount excluded= Cost of Contract
Number of Payment
1. payments on partnerships are deemed to be for legitimate business purposes rather than for speculative gain.
2. Allows business owners to maintain continuity of the business if one of the owners dies. 3. Funds buy-out agreements.
4. Exclusion applies even if there is a windfall to the business from the insurance proceeds.
1. Gratuitous in nature.
2. Cannot be a form of compensation for past, present, or future services.
3. Exclusion amount cannot exceed the direct cost of the student's college education: tuition, books, fees, and supplies.
4. Amounts received in excess of direct costs are taxable (room & board).
Employment Related Exclusions (behalf of an employee by an employer)
1. Deductible by the employer
2. Yield no tax revenue bc of exclusion of income granted the employee
1. Excluding up to $92900 of foreign earned income
2. Include foreign earned income in gross income and take a tax credit for foreign taxes paid (foreign tax credit cannot exceed US tax on FEI)
1. Be a bona-fide resident of the foreign country
2. Be present in the foreign country 330 days for 12 consecutive months
Tax on taxable income without exclusion
Less: Tax on exclusion amount
Equals: Tax on taxable income
1. Payments to qualified pension plans
2. Group term life insurance
3. Health and accident insurance premiums
4. Meals and lodging provided by the employer
Employee: Get benefits at no tax cost they would otherwise purchase, which increases the employee's effective pay rate
Employer: Realize a tax savings from a deduction for the payment of the taxfree benefit as an ordinary and necessary business expense; Increase the employee's after tax compensation without an increase in cash outflow; Fringe benefits are generally not subject to payroll taxes
1. Payments made by an employer to an employee's account in a qualified pension plan are not taxable in the period in which the payments are made.
2. The tax is deferred until the employee withdraws the payments from the plan.
3. Earnings on amounts paid into plans aren't taxed until they are withdrawn by the employee.
Employees may defer taxation of any amounts that they pay into such plans until they withdraw amounts from the plan.
Payments made by an employer to an employee's account are not taxable in the period the payments are made.
1. Time value of money savings is effected on the tax being deferred
2. Earnings in the plan accumulate tax-free
3. Employees have less income when they retire, which results in a tax on the deferred income @ a lower marginal tax rate.
Available only for term insurance that is provided to a group of employees on a nondiscriminatory basis.
-Payments made on whole life policies, term insurance purchased for individuals, or plans that discriminate in favor of highly compensated individuals are not eligible for exclusion
The exclusion applies to companies that choose to "self-insure" by making payments to a fund that is used to pay employees' medical expenses.
-Applies to employee, spouse, and dependents
1. Provided on the employer's premises
2. For the employer's convenience (noncompensatory business purpose)
1. No additional cost services
2. Employee Discounts
3. Working-condition fringes
De minimis fringe benefits
-Must be available to all employees on a nondiscriminatory basis
-must be in the same line of business
-Limited to GP% on goods purchased
-First 20% of service discount is excludable
Employee Discount-must be available to all employees in order to be excludible
Bargain Discount- available to select employees
Anything the employee could have deducted had the employee paid for the item
-Can be given on a discriminatory basis
-Examples: Free parking (max $230/month excludable from income), uniforms, professional organizations, etc.
-small items which are impossible to keep track of.
-free coffee, personal copies, holiday gifts
1. Employer provided child care ($5000 max)
2. Employers athletic facility (employees and families)
3. Nondiscriminatory Educational Assistance Plans ($5250 max)
1. Cafeteria Plan
2. Flexible Benefits/Salary Reduction Plan
3. Health Savings Accounts
-company provides a menu of tax-free benefits (benefits must be those that are excludable from tax) and their cost to the company.
-Each employee is allowed to choose a predetermined dollar amount of benefits from the plan or take the cash equivalent of benefits.
-Only benefits taken in cash are taxable.
-Employee contributes pre-determined amount into the plan out of each paycheck (gross salary is reduced).
-The amounts in the plan are used to reimburse the employee for medical and/or child care expenses.
-Employee chooses how much to contribute annually.
-Any amounts not spent are lost to the employee; they cannot be reimbursed nor can they be rolled to the next plan year for use
1. Employer contributions are excluded from income & individual contributions are deductible for AGI
2. Earnings on amounts in an HSA are excluded from gross income
3. Distributions from an HSA for medical expenses are excluded from income
4. Unused amounts from 1 year's contribution may be carried forward to pay future medical expenses
5. Must be covered by a high deductible health insurance plan ($2,400 family coverage, $1,200 single coverage) and no other health plan.
6.Max contribution = lesser of deductible or $6,150 for family coverage ($3050 single coverage) in 2011.
1. Workers' compensation
2. Damage payments for personal physical injuries or sickness
3. Pymts rec'd for personal injuries or sickness that are pd fr health & accident policies purchased by taxpayer
4. Pymts rec'd fr employer-provided h&a insurance
-can be provided by employer to employee or purchased separately by taxpayer
-Pymts for loss of income are excludable only if the pymt comes from a policy that the taxpayer purchased
-Only allowed to deduct unreimbursed medical expenses if they exceed 7.5% of the individual's AGI
-Tax Benefit Rule
1. Reimbursement for medical expenses- Yes
2. Reimbursement for loss of body part- Yes
3. Insurance policy purchased by taxpayer- Yes
4. Pymt for lost income from an employer-provided policy- No
5. Pymt amt based on amt of time the taxpayer was absent from the workplace- No
1. Municipal Bond Interest
2. Stock Dividends
3. Discharge of Indebtedness
4. Improvements by a lessee
-Interest earned on bonds issued by state and local governments of the US as well as those of US possession (Guam, Puerto Rico)
- Excluded from taxation
Explain when stock dividends are exempt from taxation.
-A dividend paid in the stock of the company issuing the dividend is excluded from tax
-The exclusion from tax is only for the shares of stock rec'd from a stock dividend.
-Any subsequent cash dividends rec'd on the stock are fully taxable
-If the receiver of the stock dividend chooses cash in lieu of stock, the cash dividend is taxed on the FMV of the shares even if the stock is taken
If a lender forgives all or a portion of the debt of the borrower, the borrower realizes an increase in wealth from the reduction of liability.
The borrower has a claim of right to the amount of debt forgiven.
The increase in wealth is known as a discharge of indebtedness and is taxable to the borrower
If the borrower is insolvent (liabilities exceed assets) after debt reduction, income does not have to be recognized.
If the borrower is solvent after debt reduction, income must be recognized to the extent of solvency
-Wherewithal to pay
-Applies to homeowners who been negatively affected by depressed real estate markets
-Up to $2 million of acquisition indebtedness on the taypayer's principal residence
-Acquisition debt is debt secured by the taxpayer's principal residence that's used to acquire, construct, or improve the residence
-A taxpayer can only have 1 principal residence
-exclusion doesn't apply to 2nd homes, business properties, or rental property
- Property's adjusted basis
-Excess of principal amount of debt over the FMV of property (cannot use this option if the property is worth less than what is owed on the property--property is insolvent)
Owner doesn't have income when a lessee makes improvements to the owner's property or when the improvements revert to the owner @ the end of the lease
Not having income allows the owner to defer the gain in the value of the property from the improvements until the property is sold, at which time the owner will have the witheral to pay the tax on the increased value from the improvements by the lessee
The $200,000 is excludable from income under the provision for receipt of life insurance proceeds. However, the subsequent earnings on the proceeds, $12,000 per year, are subject to tax.
$200,000 X 6% = $12,000
The $200,000 face value of the policy is excludable; however, Alice will receive a total of $320,000 under the installment plan. Thus, she must recognize the $120,000 ($320,000-200,000) in earnings as they are received.
Use annuity formula
Amt excluded = cost of contract/# of pymts
$200,000/10 = $20,000
$32,000 - $20,000 = $12,000
Exclude $90,000 from tax income:
Tax on $120,000- $1,7025 + (28% X ($120,000-$83,600)) $27,217
Less: Tax on $90,000-$17,025+ (28%X($90,000-$83,600)) (18,817)
Equals: Tax on $30,000 $8,400
Foreign Tax Creit:
17025+ (28% (120000-83600) $27,217
Tax credit for SA taxes pd (20,000)
Net tax due $7,217
Tax savings using credit option $1,183 (8400-7217)
H&A ins premiums pd by an employer on behalf of an employee are excludable fr income.
An employee who elects to take the $1200 in cash will be taxed on the receipt of cash
If the person was in a 28% tax bracket, an employee taking the cahs option would have only $864 (1200- (28% X 1200)) to purchase ins after paying the tax
Not good to take cash optionbc employee couldn't purchase a comparable ins plan for this amt
J can exclude the premiums pd on the first $50,000 of the group term life ins. The premiums pd on the $30,000 of excess coverage must be included in his GI.
Cost per $1000 of coverage for 33 yr old $0.96
Coverage in excess of $50,000 X 30
GI from excess coverage $29
Does Cory have tax income from the pymt of her medical expenses by the plan?
Bc the plan discriminates in favor of highly compensated employees, all pymts from the plan are taxable to Cory. Cory must include the $3700 reimbursement in her GI
Bc the provision of the meals serves a business purpose (keeping employees close @ hand during their meal breaks), the value of the meals is excluded from Hilda's income.
*This is the case even if Hilda eats her free meal before or after her shift starts
glasses, etc for his dependents. During the yr, Mel incurs $9500 in such costs, and B Corp reimburses him the $8000 that had been withheld. What's the tax effect on Mel of the flexible benefits plan?
Mel's salary is reduced by $8000 he pd in the plan, leaveing him w a GI of $37000. He isn't taxed on the amts he pd for reimbursements fr the plan ($8000)
effect of her participation on her AGI?
Aria's AGI from B is $59450 (62000-2550). Aria isn't taxed on B's $500 contribution to her HSA but can deduct her $2550 (3050 max aggregate contribution-$500 employer contribution) contribution for AGI. Aria isn't taxed on either the $250 spent on qualified med expenses or the $18 of earnings on the HSA
$8000 reimbursed medical expenses (6400 and 1600) are excludable.
$1000 loss of income is excludable bc Sean purchased the policy
$2200 sick pay is not excludable and must be incl in Sean's GI
*Pymts of loss income are excluded only if the pymt comes fr a polocy that the taxpayer purchased. Otherwise, loss of income are incl in GI
company reimburses her for $4500 of the medical costs. What's the proper treatment of the $4500 reimbursement?
Bc the medical costs she deducts on her 2010 tax return are reimbursed in 2011, Jo must include the reimbursement in her 2011 gross income to the extent she receives a tax benefit from the deduction. Her actual deduction is for $1000 b/c of medical deduction limitations. Therefore, she only includes the amt deducted on her 2010 tax return, $1000, in her 2011 GI
During the current year, Jo receives the following interest payments:
General Motor Bonds $350
Province of Ontario Bonds $220
State of OK bonds $330
Puerto Rico bonds $100
Total int rec'd $1000
How much of the $1000 in interest is taxable to Jo?
$430 (State of OK bonds, Puerto Rico Bonds)
*only interest on debt obligations of state and local govt's of the US and its possessions is excluded from GI
*Taxable interest income is $570
Tax will have to be pd on the taxable bond, so it will have to have a higher before-tax yield to provide the same 6% after-tax rtn on the city of Nashville bonds.
0.06 = X (1-0.33)
0.06 = X (0.67)
0.06/0.67 = X
0.0896 = X
Before the dividend, she owned 10% (100,000/1,000,000) of Smith.
After the dividend, she still owns 10% (120,000/1,200,000).
Therefore, Ima has not realized an increase of wealth from the dividend and isn't taxed on the value of the 20,000 shares rec'd.
Income from discharge of indebtedness is excluded only if the borrower is insolvent after the discharge. Income must be recognized to the extent that the broower is solvent after the debt reduction.
Kota's net worth after the discharge is $50,000(400,000-350,000), which must be included in its gross income
forgiveness of debt on the residence?
$60,000 of debt discharge income, which can be excluded bc the amt of the discharge is less than the qualified principal residence indebtedness
Same result if the bank had restructured the loan & reduced the mortgage to $240,000. Gil would reduce his basis in the residence by the $60,000 of excluded debt discharge income.
Same result if Gil had sold the property for $240,000 & bank cancelled the remaining $60,000 of debt (short sale of residence)
Bc the repair improvement was made in lieu of the rental payment, the $1800 is considered a rental pymt rec'd by Petros. It's not excludable as an improvement by a lessee.
Although Petros recognizes the income from the repairs, he is allowed a deduction for the repair costs as an ordinary and necessary expenses. The net effect of this situation for Petros is no increase in his income.
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