Chapter 3
Gross Income Inclusions
Problems in Recognizing Gross Income
Taxpayers face two problems:
" Recognizing potential income items
o What (cash or property) and when (accrual vs. cash basis and constructive receipt)
" Identifying those income items specifically excluded by law
Most items are taxable
It's easier to know what isn't taxable
Compensation
" Fees
" Bonuses
" Commissions
" Salaries
" Wages
" Property - Fair Market Value
" Honorariums for making a speech
" So-called gifts received for helping other taxpayers (barter)
" Employee fringe benefits (not all)
" Military service pay, but not combat pay
Tips
" Income, shows up on W-2
" If employee fails or is not required to report tips, the employee must file
o Form 1040EZ or 1040A if tips are less than $20 per month
o Form 1040 if tips are greater than $20 per month
o Form 4137 - page 3-6
Calculates Social Security & Medicare Tax
Divorce and Separation Agreements
Three money issues arise:
" Division of property acquired during the marriage (property settlement) - nontaxable
" Support of the children (child support) - nontaxable
" Spousal support (alimony) - taxable to recipient & deductible to payer - Form 1040 page 1
o Only cash payments
o Cannot be child support
o Only payments labeled as alimony under a legal divorce decree or separate maintenance
o Ends at recipients death
o Cannot live in the same household at payment time
o Recapture
Happens when payments decrease by more than $15,000 in second or third year
" If in arrears, payments go to child support first
Dividend Income - Schedule B
" Information comes from 1099-DIV
" Ordinary dividends
o Qualified - taxed at lower rates
0% if taxpayer is in 10% or 15% tax bracket
15 % if taxpayer is in a bracket higher than 15%
o Nonqualified - taxed at ordinary rates
" Nominee dividends - taxable to?
" Dividend Reinvestment Plans (DRIPs) - taxable
o Increases basis
" Return-of-Capital distributions - nontaxable
o Reduces basis
" Distributions of mutual funds - can be all of the above + exempt interest + Foreign investment dividends + capital gain
" Stock Dividends & Stock Splits - generally nontaxable
Interest Income - Schedule B
" Form 1099-INT
" Savings accounts and certificates
" Interest as dividends - credit unions
" Interest on insurance dividends
" Interest on life insurance proceeds
" U.S. savings bonds
o Series E Bond NOT taxable for California
" U.S. Treasury bills, notes, and bonds
o NOT taxable for California
Interest Income
" Corporate Bonds
o Accrued interest
o Original Issue Discount (OID) bonds - 1099 OID
o Bond premiums on taxable bonds
Decrease interest income annually or
Have a higher basis
" Interest paid by individuals
" How to report interest on Schedule B
Interest Income
" Imputed interest
o Stated interest rate lower than AFR (applicable federal rate)
o Examples - parents & children; corporations & shareholders; employers & employees; tax avoidance loans
o Exceptions - page 3-19
Loans of $10,000 or less between individuals
Loan of $100,000 or less between individuals if the borrower's net investment income does not exceed $1,000
Kiddie Tax
Children
" under age 18 with Unearned Income of more than $1,900
" 18 years old or full time students between the ages of 19 and 23 who have earned income in excess of $1,900
" California has not yet conformed - still uses under age 14 for
Pay tax at parent's highest marginal rate on unearned income
o Why was this law enacted?
Children can file their own return or can be part of parents return
o Child must fill out Form 8615 and include with child's return
o If child does not file their own tax return, parent must fill out Form 8814 and include with parent's return
Net Unearned Income (NUI)
Total unearned income
Less: $950
Less: The greater of
(1) $950 of the standard deduction or
(2) Itemized deductions directly related to the production of the unearned income
Equals: Net Unearned Income
x parent's highest rate
Plus: Remaining taxable income x child's tax rate
Equals: Child's total tax
Net Effect - 1st $900 = $0 tax; 2nd $950 = Tax at 10%; above $1,900 = Tax at parent's rate
Individual Retirement Accounts (IRAs), Pension & Annuities
" General rule - if you were able to deduct the contribution to the retirement plan you have to pick up the distributions as income
" Rollovers, if done properly are not a taxable event
" Roth IRAs - nontaxable if you follow the rules (Chapter 4)
" Traditional IRAs can be deductible or non-deductible, therefore taxable or partially taxable
" 1099-R
Nontaxable IRA Distribution Formula
Total nondeductible contributions
x Distribution = Nontaxable Distribution
Total value of IRA
(including contributions and earnings)
Caution: California laws were different for the period of 1975 to 1986; therefore, if a taxpayer contributed to an IRA during that time frame, the taxable IRA amount will be less than the federal amount.
Pension/Annuity Starting Date after November 18, 1996
Taxpayer's investment in contract
= Amount excluded
Number of anticipated monthly payments
Age of Annuitant on Annuity Starting Date Number of Anticipated Monthly Payments
55 and under 360
56-60 310
61-65 260
66-70 210
71 and over 160
Do not use this formula for IRA distributions
Excludable Portion of Annuity Proceeds - Pre November 18, 1996 or Life Annuity
Amount Paid for the Annuity
x Amount received = Nontaxable proceeds
Total expected return on contract
Social Security Benefits
" Form SSA-1099
" Taxability depends upon "provisional income" and filing status
" Taxable up to 85%
" Not taxable for California
State Income Tax Refunds - Form 1099-G
" NONTAXABLE for California
" Maybe/Maybe not taxable for federal
o If you didn't itemize your deductions, it is not taxable
o Tax Benefit Rule comes into play when you do itemize
Tax Benefit Rule
You benefited by deduction on a previous year's tax return and received a refund the following year.
A taxpayer uses three factors to determine taxable amount:
" Itemized deduction amount for the prior year
" Standard deduction amount for that year
" Amount recovered (refund)
Other Gross Income Inclusions
" Rent & Royalty - Chapter 9
" Unemployment Compensation- Form 1099-G
o NONTAXABLE for California
" Illegal Income
" Lottery- CA?
" Farm - Schedule F
" Business - Schedule C (Chapter 7)
" Prizes
" Other - see Master Tax Guide or Publication
End of Chapter 3
