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2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible ebsite, in hole or in part.

Comprehensive Volume

1

Chapter !

"ross #nco$e%Concepts and #nclusions

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&he 'ig (icture

Calculation )* "ross #nco$e+slide 1 o* -

At the beginning o* the year, /r. Cli** (ayne opened

his dental practice as a sole proprietorship.

or his ne business, he selected a /ece$ber 1

yearend. e also entered into a contract to have a building

constructed *or his $edical practice.

e used 312,000 o* e4tra $oney to purchase so$estoc.

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&he 'ig (icture

Calculation )* "ross #nco$e+slide 2 o* -

&he *olloing *inancial in*or$ation shos the results o* /r.(ayne6s *irst year o* operation.

Revenues +a$ounts billed patients *or dental services- 375,000

Accounts receivable% 8anuary 1 909Accounts receivable% /ece$ber 1 52,000

&he accounts receivable represent a$ounts billed patients.

/uring the year, :a$ 8ones, a contractor ho oed /r. (ayne3!,000 *or dental services, satis*ied the account by installingsolar panels on the roo* o* /r. (ayne6s ne $edical building.

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&he 'ig (icture

Calculation )* "ross #nco$e+slide o* -

'ased on his accounting records he concludes

that gross inco$e *or ederal inco$e ta4

purposes is the 375,000 he billed his patients

*or dental services rendered.

as /r. (ayne correctly calculated the gross

inco$e o* this dental practice;

9Read the chapter and *or$ulate your response.

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"ross #nco$e +slide 1 o* -

/e*inition% "ross inco$e includes all inco$e

*ro$ hatever source derived, unless

speci*ically e4cluded under the Code

Concept is interpreted broadly by the courts

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"ross #nco$e +slide 2 o* -

&a4ability o* inco$e *ollos the reali

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"ross #nco$e +slide o* -

#nco$e is recogni cash e?uivalents +i.e.,

property or services-

9&he a$ount o* inco$e *ro$ =inind> receipts is

e?ual to the M@ o* the property or services

#nco$e does not include recovery o* the

ta4payer6s capital invest$ent

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&he 'ig (icture 4a$ple 1

Recovery )* Capital /octrine

Return to the *acts o* &he 'ig (icture on p. !1.

9/r. (ayne sells co$$on stoc *or 315,000.

e had purchased the stoc *or 312,000.

9/r. (ayne6s gross receipts are 315,000.

&his a$ount consists o* a 312,000 recovery o* capital

and 3,000 o* gross inco$e.

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Accounting (eriods

&a4able year is generally a 12$onth period

9&a4able year *or $ost individual ta4payers is the

calendar year

9Afiscalyear can be elected i* ta4payer $aintains

ade?uate records

Afiscalyear is a 12$onth period ending on the last

day o* a $onth other than /ece$ber9 4a$ple% 8uly 1 to 8une 0

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Accounting Methods +slide 1 o* 2-

&here are pri$ary $ethods o* accounting *or

ta4 purposes%

9Cash receipts and disburse$ents $ethod

9Accrual $ethod

9ybrid $ethod

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Accounting Methods +slide 2 o* 2-

#n addition to overall accounting $ethods,

ta4payers $ay choose +elect- ta4 treat$ent *or

various transactions, *or e4a$ple

9&a4payers can elect to use the installment method

9Certain contractors $ay elect to use either the

percentage of completion methodor the completed

contract method

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Cash Receipts Method

#nco$e is recogni

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Constructive Receipt +slide 1 o* 2-


9)n /ece$ber 1, /r. (ayne has 310,000 in

patientsB checs that have not been deposited.

)ne chec *or 3,000 is *ro$ a patient ho ased hi$not to deposit it until a*ter 8anuary ! th, because her

account did not contain su**icient *unds to pay the debt.

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nder the cash $ethod, /r. (ayne $ust recogni

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Assu$e /r. (ayne elected to use the cash basis o*

accounting.

9 #* he accepted credit cards, /r. (ayne ould receivei$$ediate credit in his ban account *or EFG o* the

charge.

&he other !G ould be retained by the credit card issuer.

9 &o avoid the !G charge, /r. (ayne chose not to acceptcredit cards.

#nstead, his policy re?uired all bills to be paid ithin 0 days a*ter

dental services ere provided.

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At year end, several patients oed a co$bined32,000.9&hey o**ered to pay ith credit cards, but his

o**ice reHected their o**ers.9&he 32,000 as not constructively received at the

end o* the year. /r. (ayne could have received pay$ent by credit card,

he contracted to receive pay$ent at a later date be*orethe dental services ere per*or$ed.

Moreover, the !G charge by the credit card co$panyould be a IIsubstantial li$itation.66

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4ceptions &o Cash

Receipts Method

)riginal #ssue /iscount +)#/- interest is

ta4able hen earned rather than hen interest

is received

:eries and bonds are not subHect to the

)#/ rules

9oever, a cash basis ta4payer $ay elect to

recogni

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Accrual Method +slide 1 o* 2-

#nco$e is recogni

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Accrual Method +slide 2 o* 2-

Clai$ o* right doctrine

9Re?uires a$ounts received to be included in

inco$e even though the a$ount is in dispute and

$ight be returned to the payor at a later date

9#* pay$ent has not been received, no inco$e is

recogni

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&he 'ig (icture 4a$ple D

Clai$ )* Right /octrine


)n co$pleting construction o* the $edical o**ice

building in 201!, the contractor sub$itted a bill.

9 /r. (ayne re*used to pay the bill, clai$ing the contractorhad not $et speci*ications.

9 &he contractor did not reach a settle$ent ith /r. (ayne

until 2015.

Jo inco$e accrues to the contractor until 2015.9 #* /r. (ayne had paid *or the or, then *iled suit, the

contractor could not de*er the inco$e

&he inco$e ould be ta4able in 201!.

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4ceptions to Accrual Method+slide 1 o* 2-

&a4payer can elect to de*er recognition o*

inco$e *ro$ advance payment for goodsi*

sa$e $ethod o* accounting is used *or ta4 and

*inancial reporting purposes

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4ceptions to Accrual Method+slide 2 o* 2-

Advance payment for servicesto be per*or$ed

a*ter yearend is included in inco$e in the year

*olloing receipt

9&he portion o* the advance pay$ent that is earned

in the current year is included in inco$e in the

year o* receipt

(repaid rents or interest inco$e are alaysrecogni

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ybrid Method

A co$bination o* cash and accrual $ethods

"enerally, used hen inventory is a $aterial

inco$eproducing *actor, *or e4a$ple

9se accrual $ethod to account *or inventory

9se cash $ethod *or other inco$e and e4penses

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#nco$e :ources +slide 1 o* 2-

#nco$e *ro$ personal services is ta4able to the

person ho per*or$s the services

9ruit and tree $etaphor

#nco$e *ro$ property is ta4able to the oner

o* the property

9Assign$ent o* inco$e is not per$itted

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#nco$e :ources +slide 2 o* 2-

#nterest inco$e accrues daily

9#* interest bearing instru$ent +e.g., bonds- is

trans*erred, $ust allocate interest inco$e beteen

trans*eror and trans*eree based on the nu$ber o*

days during the period that each oned the

property

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9Assu$e that instead o* operating as a sole

proprietorship, /r. (ayne incorporated his dental

practice to li$it his liability.

e entered into an e$ploy$ent contract ith his

corporation and as to receive a salary.

All patients contract to receive their services *ro$ the

corporation.

9 &hose services are provided by the corporation6s e$ployee,

/r. (ayne.

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:ervices o* an $ployee+slide 1 o* 2-

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:ervices o* an $ployee+slide 2 o* 2-


9&hus, the corporation earned the inco$e *ro$

patients6 services and $ust include the patients6*ees in its gross inco$e.

9/r. (ayne $ust include his salary in his gross

inco$e.

&he corporation is alloed a deduction *or the

reasonable salary paid to /r. (ayne.

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/ividends +slide 1 o* !-

nlie interest, dividends do not accrue on a

daily basis

/ividends are generally ta4ed to the party ho

is entitled to receive the$

9&he shareholder o* record as o* the corporation6s

record date

/ividends on stoc trans*erred by gi*t a*ter

declaration date but be*ore record date are

generally ta4ed to the donor

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/ividends +slide 2 o* !-

Recent legislation has provided partial relie* *ro$

double ta4ation o* corporate dividends

9 "enerally, dividends received are ta4ed at the sa$e

$arginal rate that is applicable to a net capital gain &hus, individuals otherise subHect to the 10G or 15G $arginal

ta4 rates in 201! pay 0G ta4 on ?uali*ied dividends received

#ndividuals subHect to the 25, 27, , or 5 percent $arginal ta4

rates pay a 15G ta4 on ?uali*ied dividends

#ndividuals subHect to the E.FG $arginal ta4 rate pay a 20G ta4on ?uali*ied dividends

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/ividends +slide o* !-

&he *olloing dividends are not eligible *orthe reduced ta4 rates9/ividends *ro$ certain *oreign corporations,

9/ividends *ro$ ta4e4e$pt entities, and9/ividends that do not satis*y the holding period

re?uire$ent :toc on hich the dividend is paid $ust have been

held *or $ore than F0 days during the 121day periodbeginning F0 days be*ore the e4dividend date to?uali*y *or the reduced ta4 rates

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/ividends +slide ! o* !-

/ividends *ro$ *oreign corporations are

eligible *or ?uali*ied dividend status only i*%

9&he *oreign corporation6s stoc is traded on an

established .:. securities $aret, or

9&he *oreign corporation is eligible *or the bene*its

o* a co$prehensive inco$e ta4 treaty beteen its

country o* incorporation and the nited :tates

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#nco$e Received 'y An Agent

#nco$e received by the ta4payer6s agent is

considered to be received by the ta4payer

9A cash basis principal $ust recogni

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#nco$e ro$ (artnerships

A partnership is not a separate ta4able entity9iles an in*or$ation return +or$ 10F5-

(rovides data necessary *or deter$ining each partner6s

distributive share o* partnership6s inco$e anddeductions

ach partner reports distributive share o* partnershipinco$e and deductions

9 Reported in year earned, even i* not actually distributed

'ecause a partner pays ta4 on inco$e as the partnershipearns it, distributions are treated under the recovery o*capital rules

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#nco$e ro$ : Corporations

A s$all business corporation $ay elect to be

ta4ed si$ilarly to a partnership

9Re*erred to as an : corporation

&he shareholders, rather than the corporation, pay the

ta4 on the corporation6s inco$e

"enerally, shareholders report their share o* the corp6s

inco$e and deductions *or the year, even i* not actually

distributed

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#nco$e ro$ states And &rusts

'ene*iciaries o* estates and trusts

9"enerally, ta4ed on the inco$e earned by the

estates or trusts that is actually distributed or

re?uired to be distributed to the$9Any inco$e not ta4ed to the bene*iciaries is

ta4able to the estate or trust

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#nco$e #n Co$$unity

(roperty :tates

All property is dee$ed either to be separately oned

by the spouse or to belong to the $arital co$$unity

9 Co$$unity inco$e is allocable e?ually to each spouse

9 :eparate inco$e $ay be allocable to onerspouse :eparate property $ay produce co$$unity inco$e

+e.g., &K, LA-

Jo allocation o* co$$unity inco$e *or so$e spouses

living apart *or entire year and *iling separately

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Ali$ony and :eparate Maintenance

(ay$ents +slide 1 o* !-

Ali$ony is%

9/eductible by payor

9#ncludible in gross inco$e o* recipient

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(ay$ents +slide 2 o* !-

(ay$ents $ay ?uali*y as ali$ony i*%

9(ay$ents are in cash

9Agree$ent or decree does not speci*y that the

pay$ents are not ali$ony

9(ayor and payee are not $e$bers o* the sa$e

household at the ti$e the pay$ents are $ade

9&here is no liability to $ae the pay$ents *or anyperiod a*ter the death o* the payee

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(ay$ents +slide o* !-

(roperty settle$ents

9&rans*er o* property to *or$er spouse

9Jo deduction or recogni

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(ay$ents +slide ! o* !-

Child support pay$ents

9 (ay$ents $ade to satis*y legal obligation to support child

o* ta4payer

9Jondeductible by payor and not ta4ed to recipient +orchild-

May be di**icult to deter$ine hether an a$ount

received is ali$ony or child support

9 #* a$ount o* pay$ent ould be reduced due to so$e *utureevent related to the child +e.g., child reaches age 21-, such

reduction is dee$ed child support

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#$puted #nterest on 'eloMaret

Loans +slide 1 o* !-

#nterest is i$puted, using ederal govern$ent rates,

hen a loan does not carry a $aret rate o* interest

9 #$puted interest the di**erence beteen the a$ount that

ould have been charged at the ederal rate and thea$ount actually charged

Applies to% "i*t loans

Co$pensationrelated loans Corporateshareholder loans

&a4 avoidance loans

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Loans +slide 2 o* !-

Concept Summary 4.2

The table below presents the eect o certa!n below"mar#et loans on the

len$er an$ borrower

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Loans +slide o* !-

"i*t loans

94e$ption *or loans o* 310,000 beteen

individuals

#* loan proceeds are used to purchase inco$eproducingproperty, the *olloing li$itation applies

9)n loans o* 3100,000 or less beteen individuals

#$puted interest is li$ited to borroer6s net invest$ent

inco$e *or year

Jo i$puted interest i* net invest$ent inco$e is 31,000

or less

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Loans +slide ! o* !-

310,000 e4e$ption also applies to

co$pensationrelated and corporation

shareholder loans

9Jo e4e$ption i* principal purpose o* loan is ta4

avoidance

Maes practically all loans o* this type suspect

#nterest e4pense i$puted to borroer $ay bedeductible

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Annuity #nco$e+slide 1 o* F-

(urchaser pays *i4ed a$ount *or the right toreceive a *uture strea$ o* pay$ents9"enerally, early collections and loans against

annuity increases in cash value are included ingross inco$e

A$ounts N increases in cash value are treated as arecovery o* capital until cost recoveredO additionala$ounts are included in inco$e

9arly distributions $ay also be subHect to a 10Gpenalty

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or collections on and a*ter the annuity

starting date

9&he e4clusion ratio is applied to annuitypay$ents received under contract to deter$ine

a$ount e4cludable%

4clusion ratio #nvest$ent in contract4pected return under contract

9)nce invest$ent is recovered, re$aining

pay$ents are ta4able in *ull

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Annuity #nco$e+slide o* F-

4a$ples%

9&a4payer pays 310,000 *or annuity that ill pay

31,000 a year

A% or a ter$ o* 15 years

'% or li*eti$e +li*e e4pectancy 15 years-

94clusion ratio *or A P '

310,000 .FFD315,000

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Annuity #nco$e+slide ! o* F-

4a$ple +cont6d-

9A% 15 years o* annuity pay$ents

Qears 115% 3 ta4able and 3FFD e4cludable

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4a$ple +cont6d-

9'% Li*eti$e pay$ents and ta4payer lives 17 years

Qears 115% 3 ta4able and 3FFD e4cludable

Qears 1F17% 31,000 ta4able each year

9'% Li*eti$e pay$ents and ta4payer lives 10 years

Qears 110% 3 ta4able and 3FFD e4cludable, and

3,0 deduction on *inal return

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Annuity #nco$e+slide F o* F-

&he si$pli*ied $ethod is re?uired *or annuity

distributions *ro$ a ?uali*ied retire$ent plan

94clusion a$ount is invest$ent in contract

divided by nu$ber o* anticipated $onthlypay$ents +table a$ount based on age-

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(ri

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"roup &er$ Li*e #nsurance

4clude pre$iu$s paid by e$ployer on *irst 350,000o* coverage9 (re$iu$s on e4cess coverage are included in gross inco$e

#nclusion a$ount based on #R: provided tables

#* plan discri$inates in *avor o* ey e$ployees +e.g.,o**icers-, ey e$ployees are not eligible *or e4clusion9 #n such a case, the ey e$ployees $ust include in gross

inco$e the greater o*%

&he actual pre$iu$s paid by the e$ployer, or

&he a$ount calculated *ro$ the ni*or$ (re$iu$s table

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ne$ploy$ent Co$pensation

ne$ploy$ent co$pensation is ta4able in *ull

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:ocial :ecurity 'ene*its+slide 2 o* F-

or$ula 1 #* MA"# plus S o* :ocial :ecurity

bene*its e4ceeds the base a$ounts belo, but not the

second set o* base a$ounts,

9 #nclude in inco$e the lesser o*% .50 +:ocial :ecurity 'ene*its-, or

.50 TMA"# .50 +::'- base a$ountU

9 'ase a$ounts%

9 32,000 M8,9 30 M: and not living apart,

9 325,000 *or all other ta4payers

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:ocial :ecurity 'ene*its+slide o* F-

or$ula 2 #* MA"# plus S o* :ocial :ecuritybene*its e4ceeds the base a$ounts belo9 #nclude in inco$e the lesser o*%

.75+:ocial :ecurity bene*its-, or

:u$ o*% .75TMA"# .50+:ocial :ecurity bene*its- second basea$ountU, and the lesser o*%

9 A$ount included through application o* the *irst *or$ula

9 3!,500 +3F,000 *or $arried *iling Hointly-.

'ase a$ounts%9 3!!,000 M8,

9 30 M: and not living apart

9 3!,000 *or all other ta4payers

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:ocial :ecurity 'ene*its+slide ! o* F-

4a$ple o* :ocial :ecurity inco$e%

9A% Married ith A"# 30,000O ta4 e4e$pt

interest inco$e 3,000O :ocial :ecurity bene*its

310,0009'% Married ith A"# 3!0,000O ta4 e4e$pt

interest inco$e 3F,000O :ocial :ecurity bene*its

310,000

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:ocial :ecurity 'ene*its+slide 5 o* F-

4a$ple +cont6d-

9A% or$ula 1% Lesser o*%

.50 +310,000- 35,000, or

.50 T+30,000 3,000- .50 +310,000- 32,000-U 3,000

&here*ore, 3,000 o* :ocial :ecurity bene*its included

in gross inco$e

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:ocial :ecurity 'ene*its+slide F o* F-

4a$ple +cont6d-9'% or$ula 2% Lesser o*%

.75 +310,000- 37,500, or

:u$ o*9 .75T+3!0,000 3F,000- .50 +310,000- 3!!,000U 35,E50,

and

9 Lesser o*%

9 .50 +310,000- 35,000, or

9 3F,000 &here*ore, 37,500 o* :ocial :ecurity bene*its included

in gross inco$e

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Documents

Ch4 - 2015