Gross Income: Concepts + InclusionsTax YearCalendar year generally requiredIncome SourcesItems Specifically Included in GIExample – Gift loansStep 1Step 2Father Gifts Sam 8,000Step 1Father Interest Income 3,200Step 2Father Gifts Sam 3,200Example – Compensation LoansAFR 8%Employee – Corp – S/H LoanExceptionsGross Income: Concepts + InclusionsDefinition:Sec.61 defines GI as all income from whatever source defined (unless specifically excepted) economic income = change in net worth from beg to end of yearaccounting income = income recognized when realized (realization principle)Tax  GAAP e.g., prepaid rent, bad debtsGAAP tries to report income conservatively with understatement better than overstatement Tax has no estimates see Thor Power Tool Co. (1979)GI = income realized in money, property or serviceRecovery of capital doctrine  no income is subject to tax until the taxpayer has recovered the capital investede.g., sale price of stock – cost basis = net incomee.g., annuities + installment salesTax Planning Objectives  Defer IncomeTax YearCalendar year generally requiredFiscal year can be elected if T/P maintains adequate books + recordsTax Methods:1) Cash Method – used by most individuals Property or services received are included in the year of actual or constructive receipt regardless of when it was earned (e.g., A/R not recognized until cash received note receivable is considered property + T/P must recognize FMV of N/Rchecks are treated as cash even if not depositedExceptionsA) Constructive Receipt – income not actually received by T/P but available to T/P + notsubject to any limitations/restrictions  restrictions include ESOP’s, cash surrender value of life ins. policiesB) OID – original issue discount – difference between amount due at maturity + original amount of loan = interest Secs.1272 + 1273 says report OID interest as it is earned regardless of cash basis does not include U.S. savings bonds or ST (<1 yr.) oblig.C) Series E bonds can be exchanged for series HH + interest is deferredT/P can make election not to defer interest-to prevent bunching of income in one year after many yrs. of deferralD) Amounts received w/obligation to repay are not income2) Accrual Method-income included in the year it is earned regardless of when collected-all events test: a) all events have occurred that fix the right to receive income andb) the amount to be received can determined with reasonable accuracy-rights to income accrue when title to property passes-IF there is a potential refund claim (e.g., warranty) then deduction when claims accrue-IF rights to income are untested (e.g., lawsuit) pymt not received  no income until settlementpymt not received  recognize income under Claim of Right DoctrineExceptions: a.) Prepaid income is income unless: 1) Advance pymt for goods deferred IF accounting is the same for TAX + GAAP2) Rev. Proc. 71-21 allows deferral for advance payments for services to be performed by the end of the tax year following the year of receiptIncome Sources1) Personal services –Income earned by person providing serviceassignment of income doesn’t shift tax liab.2) Income from Property-included in GI of owner of property-for transfers of property in between income payment dates: a.) interest – accrues daily so use a days allocationgift  include acc’d int inc. when normalsale include acc’d int. inc. in sales proceedsb.) dividends – accrues at date of decl. when recorded thus person owning stock on date of decl. has div. Incomewho is the S/H on record date?Saleafter decl. but before record date div. Taxed to purchaser unless it’s a gift 3) Income Received by Agentrecognize when received by agent4) Income from Pships, S Corps, trusts, estates-report income in yr. earned even if not distrib.-generally report income required to be disbrib. to beneficiary – remainder taxed to estateor trust5) Income in Community Property StatesMarried filing separate issues-all property is deemed community property unless it was acquired before marriage-each spouse taxed on ½ community property income-rules different state to state TX, LA, WI, IO  all items split ½ All other states spouses may split separate property -in all comm. prop. states personal service income is split ½ Items Specifically Included in GIPayments for property settlement – not taxable1) Alimony + Separate Maintenance Payments-paymts reported in income if received + as deduction for AGI if paidpost 1984 agreements – paymts. classified as alimony if:a.) payments are in cashb.) not specified that pymts are not alimonyc.) don’t live together at time of pymtd.) no liab to make pymt after death-to prevent property settlements being disguised as alimony (post 1986)For pymts > $15,000 in 1st or 2nd yr. then alimony recapture may resultRecapture from yr. 2 R = D + ERecapture from yr. 1 D = B – (C+$15000)  Amount recaptured in yr. 3 Recap yr.2 E = A – (B-D+C/2 + $15000)Recapture yr. 1A, B, C = pymts in first (A), second (B), and third (C) yrs. of agreementIF alimony paymts. decrease by $15,000 between first + third years exception: death of spouse or remarriageChild Support  not incl. in income + not deducted sometimes hard to tell if child support or alimonylook for amt. that ceases when child turns 182) Imputed Interest on Below Market Loans > 1989use int. rate Fed. gov’t pays on new borrowings + compound semiannually – publishedmonthlyRates are different if loan:ST (< 3 yrs.)MT (> 3 yrs. + < 9 yrs.)LT (> 9 yrs.)-Interest imputed if 0% rate or if below IRS rate for:1) gift loans2) compensation related loans 3) corp  SH loansExample – Gift loans1) Father loaned Sam $100,000 no interest Current AFR 8%100,000 x 8% = 8,000Step 1Father Interest Income 8,000Son Interest Expense 8,000 (may be deductible)Step 2Father Gifts Sam 8,000Sam Gift from Father 8,000Loan is $50,000 Sam’s NII = 3,200Father’s NII=10,50050,000 x 4,000Step 1Father Interest Income 3,200Sam Interest Expense 3,200Step 2Father Gifts Sam 3,200Sam Gift from Father 3,200Loan is 9,000 used to buy a carNo interest to be imputedExample – Compensation Loans1) Employer corporation loans Sam 100,000 – no interestAFR 8%100,000 x 8% = 8,000Employer corporation Interest Income 8,000Sam Interest Expense 8,000Employer corporation Comp. Exp. 8,000Sam Comp. Inc. 8,000Employee – Corp – S/H Loan2) Corp.