Alimony
Alimony is a series payments made for support of a spouse that are agreed
to as part of a decree of divorce or separation. These receipts are part of
gross income of the recipient and are deductible for AGI by the payer. This
treatment requires that the following conditions be met. Payment should be
in cash and be required under a divorce or separation agreement,; parties
must live in separate resident and not file a joint return; the payments must
cease on the death of the payee, and payment should not be for child
support.
Alimony is recaptured under certain condition. The recaptured amount is
included in the gross income to the payer and is a deduction for AGI for the
receiver. The recaptured amount is subjected to a $15,000 floor. The
recapture rule seeks to prevent front-end loading of payments. To determine
the amount of recapture a three-year test is applied at the end of the third
post separation year. Recapture for the second year is the difference
between year two and year three. If the difference exceeds $15,000 the
excess is recaptured. Year three recapture is the payment in year one less
the average payments of year 1 and 2 to the extent that the difference
exceeds the $15,000 floor. In computing the average, year 2 recapture is
subtracted from year two payments. Total recapture in year 3 is the sum of
year two and year three recapture.
Annuities
An annuity is a series of payments paid at regular interval. Income under an
annuity consists of two components, a tax-free return of the original
investment and a taxable return on the investment. Annuity paid out on the
death of the insured is excluded from the gross income of the beneficiary. For
payouts not relating to the death of the insured a portion of the annual
payment is excluded from gross income. This percentage is determined by
dividing the investment in the contract by the total expected return. For
annuities starting after 1986, the exclusion percentage is applied until the
excluded amount equals the basis of the contract; thereafter all receipts are
included in gross income. The basis of the contract to the taxpayer is the
total amount paid as premium or other consideration. The basis is reduced
by the receipt of dividend or other payment received prior to the start of the
contract. The start of the contract is considered to be the first day of the first
period for which payment is received.
The total expected return depends on the term of the contract. For limited
term contract the expected return is the amount paid per period multiplied
by the number of periods. If the payments are base on life expectancy, then
the expected return is calculated by multiplying the payments by a factor
determined from IRS subscribed accrual tables. There are tables for single
life annuities and joint and survivor annuities. Joint and survivor annuity
tables are base on whether the purchase is joint or is purchase by just one
party and whether the purchasing party is expected to be the surviving
beneficiary.
If the annuity cost is borne by the employer all the derived income of the
employee is taxed. If the employee contributed, the exclusion is limited to
the amount contributed. If annuity payment cease before the contract basis
is fully recovered, unrecovered amounts are allowed as an itemized
deduction on the taxpayer final return.
Some annuities have a guaranteed refund provision. The present value of the
guaranteed amount reduces the basis of the contract. This adjusted amount
is used in the calculation of the exclusion percent. The adjustment is
computed as follows: divide the guaranteed amount by the annual receipt
and round up to the nearest whole year. Determine the percentage refund by
using the value of the Percent by using Value of Refund Feature accrual
table. Apply this percentage to the smaller of the original contract price or
the amount guaranteed. Subtract the computed amount from the original
contract basis. The result is the adjusted basis. Use this amount to calculate
the amount excluded from gross income.
Illegal Transaction
Gross income includes income derived from illegal activities, including an
illegal business. In the case of an illegal business, business expenses are
deductible to the extent that they meet the ordinary, necessary and
reasonable test. However illegal payments or payments related to the
trafficking of a control substance (section 285) is not allowed. Illegal
payments are: One, Kickback and bribes paid to US government officials and
employees, two payment to foreign government official or employees if they
violate use US Foreign Corrupt Practices Act, three bribes and kickbacks that
violate any state or federal law and four bribes and kickbacks that, though
not illegal, are paid by provider of items or services under a Medicare or
Medicaid program.
Awards and Prizes and Rewards
Income derived from prizes and awards from all sources are included in gross
income and is taxed. However the code provides exceptions and relief from
tax if certain conditions are met with respect to awards received from an
employer and scientific and charitable awards and prizes. Scientific and
charitable awards are excluded if the recipient assigns the award to a
charitable or non-tax entity prior to using or benefitting from the award. This
option is only available if two conditions are met. First, the taxpayer must
have been selected with any action on their part, such as applying for the
award and second the award should not commit the recipient to any material
future service obligation.
Employment award falls into two categories, A qualified plan reward and a
non-qualified plan reward. A qualified plan reward must be written and nondiscriminatory to top employees or employees who own 5% or more of the
company. Also the average annual ward should not exceed $400. From
qualified reward plans an amount up to $1600 per individual per year is
excluded from gross income. The excluded amount from a non-qualified plan
is $400 per person per year. It should be noted that with respect to an
individual taxpayer, the total amount of employer award excluded from
income can not exceed $1600 in any given year. If the award is for length of
service its does not qualify if received within the employee first five years or
the employee had received a long-service award in the last four preceding
years. If the plan is deemed discriminatory, then amounts received by highly
paid employees and employees who own more than 5% is fully taxed. This
does not change the tax status of regular employees. Management and
administrative employees do not qualify for safety awards.
Insider Profit
Insider profit comes from stock trading that is influence from prior knowledge
of events before these become public and so influence market behavior.
Insider trading is illegal when done by outsiders who improperly gain and
exploit internal company information. Directors and executives also do
insider trading legally when they sell their shares based on their intimate
knowledge of company status. Whatever legal or illegal income derived from
insider trading is included in gross income. However if trading meets the
threshold for being considered a for profit activity or activity for the
production of income then expenses related to the investment is deductible
as an itemized deduction from AGI. These expenses must be incurred for the
production of income, for the maintenance, conservation and management
have property used in the production of income or for the purposes of
calculating tax obligation and/or refund. Annual Investment interest is
deductible but restricted to net investment income.
Back Pay
Back pay is included in gross income in the year constructively received (for
cash basis taxpayers).
Interest Income
Interest income earned is included in gross income. For accrual basis tax
payers interest is accrued and reported as it is earned. For the cash basis
taxpayer interest is taxable when constructively received. For US saving
bonds holder, the cash basis taxpayer may elect to report interest on the
accrual basis. Once this election is made, the taxpayer has to report all us
saving bonds using this method in all subsequent years.
Under certain condition interest is exempt from gross income. Interest on
Municipal or federal bonds are exempt. US saving bonds interest are exempt
if used to meet a qualified education expenses. Qualified expenses must be
related to tuition and fees but does not include books and room and board.
The amount is applied to the expense net of scholarship or any other
reduction received. The taxpayer or a dependent must have incurred these
expenses in the year the bonds were redeemed. If the expense incurred is
greater than the aggregate receipt from the redemption (principal plus
interest) all of the interest in excluded. If the qualified expenses are less than
the aggregate, then the excludable interest is prorated using the formula,
qualified expense/bond proceed * interest amount = excluded interest. This
provision phase out for AGI of $115,750 -$145,750 for married filing jointly
and $77,200 - $92,200 for single and household heads. The phase-out
feature reduces the amount of excluded interest but not to zero. Phase-out
formula: Interest received [interest x excess AGI/dollars in range]. The
dollars in range for 2015 was $15,000 and $30,000 respectively.
The interest expense on qualified student loan is deductible for AGI (above
the line) up to $2,500 for taxpayers with AGI below $65,000 ($130,000 for
joint married filings). The amount is phased out between AGI of $65,000 and
$80,000 ($130,000 - $160,000). The phase out happens in the ratio of the
excess AGI divide by dollars in the phase out range (AGI excess/$15,000
{dollars in range}).
All interest incurred in pursuit of business or trade is deductible for AGI.
Below Market Interest
In below market interest loan transaction, the forgone interest is included in
the lenders gross income and is deductible for the borrower. There are
different types of below the market loans. These are:
Gift loans if qualified as a gift, forgone interest is excluded from
recipient gross income and not deductible to the lender.
Compensation related loans forgone interest treated as
compensation
Corporation/shareholder forgone interest treated as the payment of
dividend that is taxable to the receiver but not deductible as a
business expense.
Other below market loans that materially affect federal tax liability
forgone interest is included in the lender gross income and is
deductible to the borrower. Relief can be had if the taxpayer can show
that the loan does not material affect tax liability.
Forgone interest is the difference between interest computed using a IRS
provided rate and actual interest computed at the stated below market rate.
A loan is considered below market if the discounted present value of the
payments is less than the principal.
Gift Loans between individuals is exempted from this provision if the
aggregate outstanding balance is less than $10,000 and the loan is not a
business loan or used to buy income-producing property, and for
compensations loan and corporate shareholder if the aggregate is less than
$10,000 and the principal reason for the loan is not tax avoidance. Further
the following types of below market loans are exempted:
Loans offered to the public under similar terms
Loans subsidize by federal, state or municipal government
Certain Employee relocation loan
Bad Debt
The tax treatment for bad debt depends on whether the debt is personal or
business related. A business bad debt is deductible in the year in which it is
becomes partially or fully worthless, while a personal bad debt is only
deductible in the year when it becomes totally worthless. A business bad
debt is deducted for AGI while a personal bad debt is treated as a short-term
capital loss. Monies given to a business in exchange bonds and debenture or
buy shareholders to pay corporate debt are not considered debt but
investment. Cash basis taxpayers can only deducted debts if actual cash is
loss. The specific charge off method is used for all personal bad debts and
most business bad debts. Only small banks and thrift institution is allowed
the reserve method.
If a debt previously treated as bad is later recovered, the recovered amount
is entered into gross income.
Jury Duty Fees
Jury duty fees are included in gross income. Amounts remitted to employers
as compensation for employee absence due to jury duty is deductible from
gross income to the employee.
Bargain Purchase From Employer
A bargain purchase from an employer occurs when an employer transfer
property to the employee at less than it fair value. The difference between
the propertys fair value and the price paid by the employee is treated as
additional compensation and is included in gross income.
Kickbacks
Kickbacks are included in gross income, whether the payment received is
legal or illegal. Illegal kickbacks or kickbacks to provider of items or service
to Medicaid and Medicare are not deductible as business expense.
Bonus
Bonus is taxable income (included in gross income).
Mileage Allowance
Allowance received under an accountable reimbursement plan is not taxed.
An accountable plan is one in which excess payment is refunded to the
employer is not taxed but neither is any deductions allowed in relation to
those travel miles. Other wise Mileage allowance is taxed.
Damages for Breach of Contract
Per Diem payment is tax if flat amount included in gross income. However
this payment is excluded if payment is equal to or less than the federal rate
and the employee is required to submit an expense report.
Christmas Bonus and Prizes
Christmas bonus and prizes received is included in cross income.
Commission, Professional Fees and Compensation for Personal
Service
All these items are included in gross income.
Punitive Damages
Punitive damages are taxable unless for personal physical injury.
Debt Forgiveness
Debt forgiven for consideration is part of gross income for the amount
forgiven. Debt forgiven without consideration is a non-taxable gift. Exception
for debt forgiveness that is not a gift is forgiveness under chapter 11
bankruptcies or debt discharged because of taxpayer insolvency.
Rents and Directors FEE
Income from both these sources is included in net income. Rent income is
the amount received in consideration for others to use the taxpayers
property. Rental income include the fair value of any property or in kind item
received including if the tenant pays an obligation owed my the land lord. All
necessary, ordinary and reasonable expenses associated with the rental
property are deductible above the line. Prepaid rent is not deductible till due,
rent received in advance is tax immediately (regardless of accounting
method). Deposits are taxed unless they are refundable.
Royalties and Dividends
These are amounts received as payments such as payment for the right to
use intellectual property or gas and mineral rights. Income so derived is
taxed. Expenses are treated as investment expenses, but are deductible
above the line. If the taxpayer is self-employed and is the creator of the
royalty property as if the taxpayer as an operating interest in the property
the expenses are treated as trade and business expenses.
Dividends are included in gross income. Currently dividend is taxed at a top
marginal rate of 20% for taxpayers with GI exceeding $415,200, $439,000
and $44,850 respectively for single, heads of household and married filing
jointly.
Salaries, Wages, Employee Bonus and Severance Pay, Tips and
Gratuities
All these items are included in gross income in the year constructively
received.
Embezzlement Proceed
This is also included in gross income even though illegal. Remember income
from whatever source derived.
Retirement Pay
Included in gross income except for certain reduced uniform service
retirement pay and the excluded amounts relating to social security benefits.
Discounts
Discounts ate included in gross income but qualified employee discount are
excluded. A qualified discount is a none-discriminatory selling price discount
that does not exceed 20% of the sales price. Discounts on business
purchases are treated as adjustment of sales price and is excluded from
gross income.
Estate and Trust Income
Included in gross income
Unemployment and Supplemental unemployment Compensation
Included in gross income
Executors and Other Fees, Gains from Sale of Properties and
Securities
These are included in gross income.
US Saving Bonds Interest
Included in gross income except when used for qualified educational
expense.
Exclusions from Gross Income
Certain Debt Benefits
Gifts and Inheritance
Are excluded from net income. A gift is a transfer of property for no
consideration. Ownership control must pass to the receiver and the giver is
not allowed a deduction.
(26 U.S. Code 110 - Qualified lessee construction allowances for short-term
leases | US Law | LII / Legal Information Institute )