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by: Nicolette Steuber


Nicolette Steuber
GPA 3.74


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This 12 page Class Notes was uploaded by Nicolette Steuber on Saturday September 12, 2015. The Class Notes belongs to ACCT 5400 at University of Georgia taught by Schwab in Fall. Since its upload, it has received 79 views. For similar materials see /class/202535/acct-5400-university-of-georgia in Accounting at University of Georgia.




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Date Created: 09/12/15
Chagter 5 Lecture Notes Chapter 4 Income Tax Formula Chapter 5 Income Chapter 6 Individual Deductions Chapter 7 Tax Computations and Credits I Overview a Overview i In chapter 4 we discussed gross income in general terms We learned that 1 Gross income is income that TPs realize recognize and report on their tax returns 2 Gross income Income realized 7 exclusions deferrals ii In chapter 5 we explain the requirements for TPs to recognize gross income and discuss the most common sources of gross income II Realization and Recognition of Income 01p 52 through 59 a What is included in gross income i IRC 6l all income from whatever source derived unless excluded by law includes income realized in any form whether in money property or services b TPs recognize income when three conditions are met List and discuss each condition below i TPs recognize gross income when 1 they receive an economic bene t 2 they realize the income a When is income realized 1 a taxpayer engages in a transaction with another party 2 the transaction results in a measurable change in property rights b Why is a transaction important 1 because parties to the transaction must agree to the value of the exchanged property rights the transaction allows the income to be measured objectively 2 the transaction often provides the TP with the wherewithal to pay taxes at least when the TP receives cash in the transaction 3 No tax provision allows them to exclude or defer the income from gross income for that year Example 1 Recognition of Income John owns a home that he rented to Melanie on January 1 2010 for the year John generally charges 300month for rent Rather than pay cash each month Melanie gave John stock worth 3600 How much income must John and Melanie recognize if Scenario 1 Melanie purchased the stock for 1000 on 112007 Scenario 2 Melanie purchased the stock for 3600 on 112007 c Other income concepts i Does the form of receipt ie cash property or services affect the realization or recognition of income Yes TPs realize income whether they receive money property or services in a transaction ii What is the return of capital principle When the tax basis exceeds the sale proceeds the principal generally applies to the extent ofthe sale proceeds The excess ofbasis over sale proceeds is generally not considered to be a return of capital but rather a loss that is deductible only if speci cally authorized by the tax code iii What is the tax bene t rule If the refund is made for an expenditure deducted in a previous year then the refund is included in gross income to the extent that the prior deduction produced a tax bene t Example 2 Tax Bene t Rule Lou prepays all of his haircuts for the next 2 years The place goes out of business before delivering all the haircuts but sends Lou a refund How much does Lou recognize as income from the refund Hint Personal expenses are generally not quot for tax purposes Example 31 Tax Bene t Rnle You paid 3000 in Georgia state income tax in YEAR 1 Your Standard Deduction in YEAR 1 is 5800 In YEAR 2 you receive arefund of 2000 How much ofthe refund is included as income in your YEAR 2 tax return Hint State income taxes are an itemized 1 Example 32 Tax Bene t Rnle Use the same facts as example 31 but assume that you now also made a 3800 charitable contribution in Year 1 d What determines the year in which realized income is recognized and included in gross income i A TP s method of accounting determines the year in which realized income is recognized and included in gross income 1 Accounting methods a Accrual method i Income 9 recognized when it is eamed ii Expenses 9 deducted when they are incurred b Cash method i Income 9 recognized when it is received or constructively received ii Expenses 9 deducted when they are paid 2 What judicial doctrines affect the timing of income recognition Explain each a Constructive receipt doctrine i Income is deemed realized if 1 It is unconditionally available even without physical possession 2 The taxpayer is aware of the income s availability 3 There are no restrictions or limits over taxpayer s control of the 1ncome b Claim of Right doctrine Income has been realized if a TP receives income and there are no restrictions on the TP s use of the income e Who recognizes the income i Based on the assignment of income doctrine 1 Income from services 9 TP who earnsperforms the service 2 Income from an incomeproducing asset 9 TP who owns the incomeproducing property ii Special rules depending on whether TP lives in a community property or common law state 1 half of the income earned from the services of one spouse is included in the gross income of the other spouse In contrast in common law states all of the income earned by one spouse is included in the gross income of the spouse who earned it 2 half of the income from property held as a community property by the married couple is included in the gross income of each spouse 3 in all common law states and in ve community property states AZ CA NV NM WA all of the income from property owned separately by one spouse is included in that spouse s gross income 4 in TX LA WI and ID half of the income from property owned separately by one spouse is included in the gross income of each spouse III What are the different types of income List and discuss each type below 01p 59 through a Income from services one of the most common sources of GI rarely exempt from taxation aka earned income includes salary wages and fees that a TP earns through services in a nonemployee capacity as well as unemployment compensation b Income from property aka unearned income gains or losses from the sale of property dividends interest rents royalties and annuities tax treatment of unearned income depends upon the types of income and in some circumstances the type of transaction generating the income Example 41 Dividends Curt s purchased 1000 shares of CocaCola stock this year He received a 350 dividend on those shares What portion of the dividend if any is included in Curt s gross income Example 42 Dividends How would your answer to example 41 change if Curt had elected to participate in a dividend reinvestment program which automatically uses his dividends to purchase additional shares of stock Example 43 Dividends How would your answer to example 42 change if the additional shares of stock purchased through the dividend reinvestment plan are worth 375 at yearend Example 44 Dividends How would your answer to example 41 change if Curt immediately transferred the dividend income to his daughter Kylar Annuities What is an annuity and how do you compute the taxable income from an annuity Annuity 7 an investment that pays a stream of equal payments over time Annuity exclusion ratio original investment return of capital percentage Expected value of annuity Taxable income from annuity annuity payment x l 7 return of capital Example 5 Fixed Annuity Chad purchases an annuity for 20000 The annuity will pay Chad 500 per month for the next 10 years How much of each payment is excluded from Chad s income C Example 6 Lifetime Annuity Grant is 68 years old In January he purchased an annuity for 20000 The annuity will pay Grant 200 per month for the rest of his life Using exhibit 51 on p5l2 how much of each payment is excluded from Grant s income ii Property Dispositions How do you compute the gainloss on a property disposition Sale proceeds Less Selling expenses amount realized Less Basis 39 in property sold Gain Loss on sale 1 Note Tax imposed on gains and deductibility of losses depend on whether the TP used the asset for business purposes investment purposes or personal purposes Chapters 10 and 11 will provide additional detail Example 7 Property Disposition Lucy purchased a piece of land for 10000 in 1999 In 2007 Lucy sold the land in an arm s length transaction for 18000 What is the gain on the transaction Assuming a 25 tax rate how much tax does Lucy owe on the transaction Other sources of income List and discuss each source below i Income from owthrough entities The income and deductions from a owthrough entity such as partnership or S corporation ow through to the owners of the entity The owners report income or deductions as though they operated a portion of the business personally ii iii Alimony l a transfer of cash made under a written separation agreement or divorce decree 2 the separation or divorce decree does not designate the payment as something other than alimony 3 the payments cannot continue after the death of the recipient payment is included in the GI of the person receiving it payment is deductible for AGI by the person paying it Example 8 Alimony Per their divorce decree Bob makes alimony payments to Midge of 80000 per year until their daughter Donna turns 18 Once Donna turns 18 Bob will pay Midge 50000 How much of Bob s 80000 should be treated as child support and how much as alimony Prizes Award and Gambling Winnings included in GI exceptions 1 awards for scientific literary or charitable achievement such as the Nobel prize are excluded form GI but only if the TP immediately transfers the award to a federal state or local governmental unit or qualified charity such as a church school or charitable organization 2 employee awards for length of service or safety achievement are nontaxable awards that are limited to 400 of tangible property other than cash per employee per year TPs must include the gross amount of their gambling winnings for the year in gross income TPs are allowed to deduct their gambling losses to the extent of their gambling winnings but the losses are usually deductible as misc itemized deductions iV Social Security 1 Partially taxable Include up to 85 depending on the amount of the taxpayer s social security bene ts and the taxpayer s ling status and modi ed AGI a What is a taxpayer modi ed AGI i Modi ed AGI AGI excluding SS bene ts taxexempt interest income excluded foreign income and certain other deductions for AGI the chart when SS is included in income Status bene ts bene ts taxable Low no High yes Medium V Imputed Income Income that includes realized indirect economic bene ts that TPs must include in gross income Ex Employer selling goods to employee at discount bargain purchases and employer lending an employee money at a zero or low interest rate belowmarket loans Example 1 7 Belowmarket loan A father tax rate of 35 loans his son tax rate of 10 200000 at an interest rate of 0 The son promises to repay his father the full 200000 in one year The son invests the proceeds of the loan in a money market account that pays interest at a rate of 10 Assume the federal interest rate is 10 Why do the father and son engage in this transaction How is this transaction treated for tax purposes vi Discharge of indebtedness Provides tax relief for insolvent TPs TPs with liabilities including tax liabilities exceeding their assets by not taxing a discharge of indebtedness if the TP is insolvent before and after the debt forgiveness IV Exclusion Provisions 01p 521 through 530 a Why does Congress allow exclusions and deferrals l to subsidize or encourage particular activities 2 to be fair to TPs such as mitigating the inequity of double taxation b What are some common exclusions Discuss each below Municipal interest 7 exclusion of interest on municipal bonds Generally recognized as a subsidy to state and local govs Gains on the Sale of Personal Residence 7 TPs meeting certain home ownership and use requirements can permanently exclude up to 250000 500000 if married filing jointly of realized gain on the sale of their principal residence To satisfy ownership test TP must have owned the residence house condo trailer or houseboat for a total of two or more years during the fiveyear period ending on the date of the sale To satisfy use test TP must have used the property as their principal residence for two or more years Tax law limits each TP to one exclusion every two years Fringe benefits 7 benefits that many employers provide to employees in addition to paying salary and wages They are usually included in the employee s gross income as compensation for services However certain fringe benefits called qualifying fringe benefits are excluded from gross income Refer to 524 for list c What are common educationalrelated exclusions discussed in more detail in Chap 11 Scholarships 7 college students seeking a degree can exclude from GI scholarships that pay for tuition fees books supplies and other equipment required for the student s courses Any excess scholarship amounts such as for room or meals are fully taxable Only applies if the recipient is not required to perform services in exchange for the scholarship Tuition waivers or reductions provided by an educational institution are not taxable 2 1 Other educational subsidies 7 TPs are allowed to exclude from GI earnings on investments in quali ed education plans such as 529 plans and Coverdell education savings accounts as long as they use the earnings to pay for qualifying educational expenditures also interest from Series EE bonds can be excluded if the redemption proceeds are used to pay for educational expenses of the TP TP s spouse or a dependent of the TP exclusion is partially reduced or eliminated for TPs exceeding a xed level of modi ed AGI What exclusions mitigate double taxation Gifts and Inheritances Gift 7 a property transferred from the transferor while the transferor is still alive Inheritance 7 a property transferred from the transferor who is deceased are subject to transfer taxes and not included in income by the recipient to avoid double taxation Life insurance proceeds 0 Life insurance proceeds are generally subject to estate taxation on the life insurance proceeds but are excluded from GI in order to avoid double taxation 0 When insurance proceeds are paid over a period of time rather than a lump sum a portion of the payments represents interest and must be included in G1 0 This exclusion generally does not apply when a life insurance policy is transferred to another party for valuable consideration 0 When this happens the eventual life insurance proceeds collected by the purchaser are excluded up to the sum of the purchase price of the policy and any subsequent premiums with remaining proceeds taxable as ordinary income 0 Generally if a TP simply cancels a life insurance contract and is paid the policy s cash surrender value she would recognize ordinary income to the extent the proceeds received exceed previous premiums paid 0 If premiums paid exceed the proceed received the loss is not deductible o If TP is terminally ill medically certi ed With an illness expected to cause death within 24 months early receipt of life insurance proceeds accelerated death bene ts are not taxable o If TP is chronically ill medically certi ed to require substantial assistance for daily living activities or due to cognitive impairment life insurance proceeds are not taxable to the extent they are used to pay for TP s longterm care Foreign earned income 0 Congress allows TPs to exclude foreigneamed income up to an annual amount in order to avoid double taxation Income from pensions annuities salary paid by the US gov or deferred compensation does not qualify for the exclusion Maximum exclusion is indexed for in ation in 2011 it was 92900 TPs may either claim this exclusion deduct foreign taxes paid as itemized deductions or claim the foreign tax credit for foreign taxes paid on their foreign ea1ned income To qualify for the foreigneamed income exclusion a TP must 0 Be considered a resident of the foreign country 0 Live in the foreign country for 330 days in a consecutive 12 month period I Because the exclusion is computed on a daily basis the maximum exclusion is reduced pro rata for each day during the calendar year the TP is not considered to be a resident of the foreign country or does not actually live in the foreign country 0 TPs meeting the requirements for this exclusion may also exclude from income reasonable housing costs provided by an employer that exceed 16 of the statutory foreigneamed income exclusion amount for the year 0 This is limited to a maximum of 14 of the statutory exclusion amount What are some common sickness and injuryrelated exclusions Workers Compensation 0 TPs receive workers compensation benefits when they are unable to work bc of a workrelated injury 0 Any payments a TP receives from a statesponsored workers compensation plan are excluded from the TP s income Payments associated with personal injury 0 Tax laws specify that nay payments on account of a physical injury or physical sickness are nontaxable o Damages TPs receive for emotional distress associated with physical injury are excluded 0 Punitive damages are fully taxable because they are intended to punish the harm doer rather than to compensate the TP for injuries


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