Federal Taxation Week 2 lecture 2
Federal Taxation Week 2 lecture 2
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Date Created: 11/15/15
Federal Taxation Week 2 lecture 2 In the previous lesson we discussed Gross Income Concepts and Inclusions In this lesson we will discuss Gross Income Exclusions Next Slide The previous lessons discussed the concepts and judicial doctrines that affect the determination of gross income If an income item is within the all inclusive de nition of gross income the item can be excluded only if the taxpayer can locate speci c authority for doing so This session focuses on the exclusions that Congress has authorized Next Slide After completing this lesson you should be able to Understand that statutory authority is required to exclude an item from gross income Identify the circumstances under which various items are excludible from gross income Determine the extent to which receipts can be excluded under the tax bene t rule and Describe the circumstances under which income must be reported from discharge of indebtedness Next Slide For a taxpayer not to include an item as income on the tax return speci c guidance within the Internal Revenue Code must state that the item is excluded Sections oneohone through one fty of the code provide the authority for excluding speci c items from gross income In addition other exclusions are scattered throughout the Code Each exclusion has its own legislative history and reason for enactment Certain exclusions are intended as a form of indirect welfare payments Other exclusions prevent double taxation of income or provide incentives for socially desirable activities Next Slide Beginning with the Income Tax Act of 1913 and continuing to the present Congress has allowed the recipient of a gift to exclude the value of the property from gross income The exclusion applies to gifts made during the life of the donor and transfers that take effect upon the death of the donor Gifts are nontaxable to the donee if the transfer is voluntary without adequate consideration and made because of affection respect admiration charity or donative intent Transfers by employers to employees do not qualify as excludible gifts Sometimes an employer makes payments known as death bene ts to a deceased employee39s surviving spouse children or other bene ciaries If the decedent had a nonforfeitable right to the payments such as accrued salary the amounts are generally taxable to the recipient just the same as if the employee had lived and collected the payments Next Slide In most situations life insurance proceeds paid to the bene ciary because of the death of the insured are exempt from income tax Congress chose to exempt life insurance proceeds for the following reasons For family members life insurance proceeds serve much the same purpose as a nontaxable inheritance And In a business context life insurance proceeds replace an economic loss suffered by the bene ciary Under the accelerated death bene ts provisions exclusion treatment is available for insured taxpayers who are either terminally ill or chronically iii A terminally ill taxpayer can collect the cash surrender value of the policy from the insurance company or assign the policy proceeds to a quali ed party A life insurance policy may be transferred after it is used by the insurance company If the policy is transferred for valuable consideration the insurance proceeds are incudabe in the gross income of the transferee to the extent the proceeds received exceed the amount paid for the policy by the transferee plus any subsequent premiums paid Next Slide Congress wanted to help students that quali ed for scholarships by making scholarships nontaxable to the extent that the scholarship is used for tuition and other related educational expenses such as fees books supplies and equipment required for courses Amounts received for room and board are taxable Payments or bene ts received by a student at an educational institution may be compensation for services a gift or a scholarship If the payments or bene ts are received as compensation for services the fact that the recipient is a student generally does not render the amounts received nontaxable The scholarship rules are intended to provide exclusion treatment for educationrelated bene ts that cannot qualify as gifts but are not compensation for services Frequently the scholarship recipient is a cash basis taxpayer who receives the money in one tax year but pays the educational expenses in a subsequent year The amount eligible for exclusion may not be known at the time the money is received In that case the transaction is held open until the educational expenses are paid Some employees make scholarships available solely to the children of key employees The tax objective of these plans is to provide a nontaxable fringe bene t to the executives by making the payment to the child in the form of an excludable scholarship Employees of nonpro t educational institutions are allowed to exclude a tuition waiver from gross income if the waiver is pursuant to a quali ed tuition reduction plan These plans are generally limited to undergraduate tuition waivers However there is an exception for graduate teaching or research assistants Next Slide A person who suffers harm caused by another is entitled to compensatory damages The tax consequences of the receipt of damages depend on the type of harm the taxpayer has experienced The taxpayer may seek recovery for a loss of income expenses incurred property destroyed or personal injury Compensatory damages received on account of physical injury or physical illness are excludible All other personal injuries such as 10 11 compensatory damages for a nonphysical injury and punitive damages are taxable The legal theory of personal injury damages is that the amount received is intended quotto make the plaintiff whole as before the injuryquot It follows that if the damage payments received were subject to tax the after tax amount received would be less than the actual damages incurred and the injured party would not be quotwhole as before the injuryquot Compensatory damages are intended to compensate the taxpayer for the damages incurred State workers compensation laws require the employer to pay xed amounts for speci c jobrelated injuries The state laws were enacted so that the employee will not have to go through the ordeal of a lawsuit to recover damages Although workers39 compensation may be payment for loss of wages it is speci cally excluded from income The income tax treatment of accident and health insurance bene ts depends on whether the policy providing the bene ts was purchased by the taxpayer or taxpayer39s employer Bene ts collected under an accident and health insurance policy purchased by the taxpayer are excludable Next Slide Congress encourages employers to provide employees retired former employees and their dependents with accident and health bene ts disability insurance and longterm care plans The premiums are deductible by the employer and excluded from the employees39 income Amounts received by the taxpayer from insurance companies are not taxable when received for medical care or for permanent loss of body function Health savings accounts are high deductible insurance plans Employer contributions to the health savings account and earnings on funds in the account are excludible from income Generally longcontributions to the health savings account and earnings on funds in the account are excludible from income Generally long term care insurance which covers expenses such as the cost of care in a nursing home is treated the same as accident and health insurance bene ts Thus the employee does not recognize income when the employer pays the premiums Next Slide Meals and lodging can be considered income however there are speci c circumstances when the value of meals and lodging are excluded from income Meals are excluded from taxable income if they are provided by the employer on the employer s premises and for the convenience of the employer Lodging is excluded from income if the employee is required to accept the lodging as a condition of employment Next Slide Fringe bene ts are an important part of an employees total compensation package Congress has enacted exclusions to encourage employers to nance and make available child care facilities provide athletic facilities for employees nance certain employees39 education and pay or reimburse child adoption expenses Some of the speci c fringe bene ts that are excluded are the following Up to vethousand dollars of dependent care costs paid for by 12 13 14 employer can be excluded Value of the use of athletic facilities located on employer premises can be excluded Employerprovided educational assistance for undergraduate and graduate education is excludible and Employee adoption expenses paid or reimbursed by the employer are excludible An employer can confer numerous forms and types of economic bene ts on employees Under the allinclusive concept of income the bene ts are taxable unless one of the provisions previously discussed speci cally excludes the item from gross income the amount of the income is the fair market value of the bene t Generally an employee is not required to include in gross income the cost of property or services provided by the employer if the employee could deduct the cost of those items if he or she had actually paid for them These bene ts are called working condition fringes If the fringe bene ts cannot qualify for any of the speci c exclusions or do not t into any of the general classes of excluded bene ts the taxpayer must recognize gross income equal to the fair market value of the bene ts Next Slide A US citizen is generally subject to US tax on his or her income regardless of the income39s geographic origin The income may also be subject to tax in the foreign country which could subject the taxpayer to double taxation To encourage US citizens to work abroad the taxpayer can elect either to include the foreign income in his or her taxable income and then claim a credit for foreign taxes paid or exclude the foreign earnings from his or her US gross income Although interest income is generally taxable to the taxpayer if the interest income is from municipal bonds such as certain state and local government obligations then the interest is excluded from taxable income Dividends to the shareholders are taxable only to the extent the payments are made from either the corporation39s current earnings and pro ts or its accumulated earnings and pro ts Congress has attempted to assist lowtomiddle income parents in saving for their children39s college education The assistance is in the form of an interest income exclusion on educational saving bonds The interest on Series EE US government savings bonds may be excluded from gross income if the bond proceeds are used to pay quali ed higher education expenses To help alleviate the cost of higher education the earnings on quali ed tuition programs are excluded from income provided that the contributions are used to pay for quali ed higher education expenses Next Slide If a taxpayer obtains a deduction for an item in one year and in a later year recovers all or a portion of the prior deduction the recovery is included in gross income in the year received The amount included in income is limited to the amount for which a tax bene t was received Next Slide Income from the forgiveness of debt is taxable However certain discharge of indebtedness situations get special treatment under the Internal Revenue 15 Code The following is a list of the situations Creditors39 gifts Discharges in bankruptcy and when debtor is insolvent Discharge of farm debt Discharge of quali ed real property indebtedness Seller39s cancellation of buyer39s debt Shareholder39s cancellation of corporation39s debt and Forgiveness of certain student loans Next Slide This lesson discussed items that are speci cally excluded from gross income Even though a de nition of gross income is provided in the Code Congress has considered it necessary to indicate explicitly how certain items are to be treated either for the sake of clarity or for the purpose of ensuring some sense of equity Congress has acted on its own initiative at times in de ning gross income butjudicial and administrative in uences also have played an important role in the evolution of the de nition and scope of gross income
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