1.5 Gross Income - Inclusions

1. Gross Income Defined 

Code Sec.61

2. Timing of Recognition 

1) Overall Accounting Methods

(1) Cash receipts and disbursements method
(Exception) prepaid interest expenses

(2) Accrual method
(Exception) prepaid rental income, prepaid interest income

(3) Hybrid method

2) Special Accounting Methods

(1) Long-term contract

(2) Installment method <Form 6252>
a) Recognize when cash is received
b) Gross profit percentage

3. Specific Items of Gross Income 

1) Salaries, Wages, Tip (Compensation for Services)

2) Interest Income <Schedule B>

(1) Taxable interest
a) Federal bonds (U.S. obligations)
b) Industrial development bonds
c) Corporate bonds
d) Premiums received for opening a savings account (e.g., prize and awards) are included at FMV
e) Part of the proceeds from an installment sale is taxable as interest.
f) Interest paid by federal or state government for late payment of tax refund is taxable.

(2) Tax-exempt interest (Reportable but not taxable)
a) State and local government bonds (municipal bonds)
b) Bonds of a U.S. possession
c) Series EE (U.S. government savings) bounds

(3) Amortization of bond premium

(4) Unearned income of a child under 18 ("Kiddie Tax")

3) Dividend Income <Schedule B>

(a) Dividends = return on investments (earnings & profits) *lower tax rate

(b) Return of capital = return of investments *nontaxable

(c) Capital gain distribution

4) IRA Distributions (Traditional IRA Income)

5) Pensions and Annuities

6) Social Security Benefits (Social Security Income)

0 - 85% taxable
Provisional income = AGI + Tax-exempt interest + 50% of SS benefits

7) Tax Refund

(1) Tax Refund of State & Local Taxes
a) Prior year itemized deduction: taxable
b) Prior year used standard deduction: nontaxable

(2) Tax Refund of Federal Income Taxes: nontaxable

8) Payment Pursuant to a Divorce

(1) Alimony and spousal support: taxable (before 12/31/2018)
(2) Child support: nontaxable
(3) Property settlement pursuant to divorce: nontaxable

9) Business Income or (Loss) <Schedule C>

(1) Gross Business Income

Uniform Capitalization (UNICAP) Rules
a) Produced for use
b) Produced for sale
c) Acquired for resale

(2) Business Expenses

a) Deductible business expenses
  1 Salaries and commissions paid to others
  2 State and local business taxes paid
  3 Office expenses and rent expenses
  4 Business travel expenses
  5 Business meal expenses at 50% (directly related or associated with)
  6 Depreciation, repair, and maintenance of business assets
  7 Interest expense on business loans
  8 Insurance expense for business
  9 Employee fringe benefits
10 Legal and professional services
11 Bad debts (accrual basis taxpayer only)
12 Business gift ($25 per donee per year)
b) Nondeductible expenses
  1 Personal (Non-business) expenses
  2 Salaries paid to a sole proprietor
  3 Federal income taxes (above the line deduction)
  4 Business entertainment expenses
  5 Bad debt loss of a cash basis taxpayer
  6 Bribes, kickbacks, fines, penalties, and other payments
  7 Political contributions and state/federal lobbying expenses
  8 Charitable contributions (itemized deductions)
c) Expenses of an office in the home

(!) Nonbusiness (personal) bad debts: short-term capital loss (Schedule D)

(3) Federal Self-Employment Tax <Schedule SE>

(4) Net business losses - Net operating losses (NOL)

10) Gains (Losses) on Disposition of Property

Capital assets: capital gain - Schedule D
Business property: ordinary gain - Form 4797

11) Rental Income or (Loss) <Schedule E>

(1) Security deposit (refundable or non-refundable)
(2) Prepaid rental income
(3) Leasehold improvements made by lessees (FMV)
(4) Lease cancellation payment (taxable)
(5) Rental of a vacation home
a) Less than 15 days: personal residence
b) 15 or more days: Schedule E

12) Income From Partnership, S Corporation, Estates, Trust <Schedule E>

13) Farm Income or (Loss) <Schedule F>

14) Unemployment Compensation (Unemployment Benefits)

4. Other Items of Gross Income

1) Prizes and Awards

2) Gambling Winnings

3) Illegal Income

4) Income from Discharge of Indebtedness (Cancellation of Debt: C.O.D)
Generally, all debts canceled are included in gross income (other income.)
Business loan - Schedule C

5) Income in Respect of a Decedent
IRD is gross income that the decedent earned before death was not includible on the decedent's income tax return.

6) Jury Duty Pay

1.4 Dependency Requirements

1. Taxpayer and Spouse Information

Form 1040 page 1

2. Dependent's Information

1) Qualifying Child

(a) Close relationship - taxpayer's son, daughter, stepson, stepdaughter

(b) Age limit - under age 19 or age 24 in the case of a full-time student

(c) Residency requirement - the child must have the same principal place of abode as the taxpayer for more than half of the tax year.

(d) Eliminate gross income

(e) Support (modified) - The support test has modified to determine if the child did not contribute more than one-half of his or her own support.

(f) Joint return

(g) Citizenship

2) Qualifying Relative

(a) Support test - more than one-half (>50%) of the support of a person
*Multiple support agreements, Child of a divorced parent

(b) Gross income test - the dependent's (taxable) gross income is less than $4,200 (2019).

(c) Joint return test - unless the joint return is filed solely for a refund of all taxes paid or withheld for the taxable year (i.e., the tax is zero).

(d) Citizenship

(e) Relationship test - closer than a cousin, OR resided with the taxpayer for the whole year

1.3 Filing Status

1. Tax Rate Schedule and Tax Calculation

There are seven tax brackets applicable to individual taxpayers:
10%, 12%, 22%, 24%, 32%, 35%, and 37% (2019).

2. Filing Status

1) MFJ: Married Filing Jointly (Joint Return)

Not divorced or legally separated
(!) If one spouse dies during the taxable year, a joint return may be filed.

2) MFS: Married Filing Separately (Separate Return)

3) Single

4) Qualifying Widow(er) (Surviving Spouse)

Two taxable years following the year of death of the spouse
(a) Has not remarried at year-end
(b) Was qualified to file a joint return in the year of death
(c) Maintain principal residence for a dependent child for the whole year

5) Head of Household

(a) The individual is not married, is legally separated, or is married and has lived apart from the spouse for the last six months
(b) U.S. citizen or resident
(c) Maintain as a household for more than half-year is the principal residence of a dependent relative, child, or parent.

1.2 Payment of Tax

1. Tax Payments

A taxpayer typically makes "pre-payments" of tax during the year. These payments reduce the amount shown as "total tax" on the tax return and result in the calculation of tax due to the IRS or refund due to the taxpayer at the bottom of Form 1040.

2. Withholding of Taxes

An employer is required to withhold income taxes and FICA tax (Social Security and Medical tax) from employee compensation. This procedure is not necessary for independent contractors.

Form W-4: Employee's Withholding Allowance Certificate
(Income Tax Withholding Table)

Generally, compensation for withholding purposes include salaries, tips, bonuses, termination payments, vacation pay, and taxable fringe benefits. Taxes may also be withheld from certain other income including pensions and annuities, commissions, gambling winnings, unemployment compensation, and certain federal payments, such as social security.

3. Estimated Tax Payments

(1) $1,000 or more tax liability and
(2) Inadequate withholding - less than the smaller of:
a) 90% of current year's tax
b) 100% of prior Year's tax

1) Underpayment Penalty

2) Withholding Tax Treated as Estimated Tax Payments

1.1 Overview of Individual Income Tax

1. The Formula for Individual Income Tax

1) Taxable Income

2) Gross Income (GI) - inclusions / Nontaxable Income - exclusions

3) Deductions

2. Form 1040: Individual Income Tax Return

1) Above the Line Deductions (Adjustments)

2) Below the Line Deductions
(1) Itemized Deductions or Standard Deduction
(2) Qualified Business Income Deductions

3. Filing

1) Filing Requirements

(1) General Rule
A taxpayer must file a return if his or her gross income is equal to or greater than the sum of:
a) The regular standard deduction (except for married filing separately) plus
b) The additional standard deduction for taxpayers age 65 or over or blind (except for married filing separately).

If a taxpayer has a gross income of less than the standard deductions and has withholding tax taken out of his/her pay, he/she needs to file a return in order to receive a tax refund, but there are no filing requirements.

(2) Exceptions
Certain individuals must file income tax returns even if their gross income is lower than the "general rule" requirement.
a) Individuals whose net earnings from self-employment are $400 or more must file.
b) Individuals who can be claimed as dependents on another taxpayer's return, have unearned income, and gross income of $1,100 (2019) or more must file.

2) Taxable Year

Annual accounting periods are used to measure taxable income. The taxable year maybe a calendar year or a fiscal year under certain restrictions.

3) When to File?

(1) Due Date: April 15
Individual taxpayers must file on or before the fifteenth day of the fourth month following the close of the taxpayer's taxable year which is April 15.

(2) Extension
An automatic six-month extension (until October 15) is available for those taxpayers who are unable to file on the April 15 due date. Although granted automatically, the six-month extension must be requested by the taxpayer by filing Form 4868 by April 15.
(!) The automatic six-month extension is not an extension for the payment of any taxes owed. The due date for payment of the taxes remains April 15. If the tax liability is not paid by this date, penalties will be imposed for late payment (failure-to-pay penalty).

4. Penalties Imposed on Taxpayer

(1) Failure-to-File (Late Filing) Penalty
The Penalty is 5% of the amount of tax due for each month (or any fraction thereof) the return is not filed. The penalty cannot exceed a maximum of 25% of the amount of tax due.

(2) Failure-to-Pay (Late Payment) Penalty
The penalty is 0.5% per month (or fraction of month) up to a maximum of 25% of the unpaid tax. (tax delinquency penalty)

* Interest on Penalties
Interest, compounded daily, is charged on any unpaid tax from the tax return due date until the date of payment (federal short-term interest).