Chapter 4 Notes In Class - Chapter 4 Gross Income Chapters...

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Chapter 4Gross IncomeChapters 4 & 5 concentrate on the issues of what constitutes income subject to tax, items that are excluded from taxable income, and special income computation situations. Some of the material below relates more specifically to Chapter 5 but the chapters are very similar in focus.I. Tax Concept of Income – Mostly income must be realized before it can be recognized for tax purposes. The tax law doesn’t require recognition of unrealized gains (nor does it allow recognitionof unrealized losses in most cases). The realization requirement follows from a couple of different concerns.A.Administrative ConvenienceObjectivity and administrative convenience support taxing realized, rather than unrealized appreciation.EXAMPLE:If a piece of land owned by the taxpayer appreciates from $100,000 at the beginning of the tax year to $130,000 at the end of the tax year, there is no tax onthe $30,000 appreciation until the disposal of the land. The appreciation above would be considered income in an economic sense but not in a tax sense. Atone time, appreciation was never accounting income either but that principle has been eroded somewhat. Taxing unrealized gains and losses would also have valuation problems when we are talking about gains and losses on items that aren’t easily valued. Finally, the fluctuations in asset values may introduce more variability and less predictability into the tax system if they were included in taxable income. The variability problem has been a concern in accounting for those who did not wish to include unrealized gains and losses in income.B.Wherewithal-to-PayTaxing unrealized appreciation would cause cash flow problems for taxpayers.EXAMPLE:If the $30,000 appreciation described in the previous example was taxedat 20%, the taxpayer might be hard pressed to come up with the $6,000 tax due without liquidation of the investment.II) Gross Income DefinedCode Sec. 61 includes in gross income "all income from whatever source derived." Specific examples listed in the statute include:1.Compensation for services2.Business income3.Gains from sale or exchange of property4.Interest5.Rents6.Royalties7.Dividends8.Alimony9.Pensions and annuities
10.Income from certain life insurance contracts11.Income from the discharge of indebtedness12.Distributive share of partnership or S-corporation income13.Income in respect of a decedent14.Income from an estate or trust15. Prizes and awardsSome of the types of income listed above may be excluded under certain exclusion provisions in thetax code.III.To Whom is Income Taxable?A.Assignment of Income – Refers to directing income to someone other than the person earning it. Although a taxpayer earning income may indicate that the income should be paid to someone else, the taxpayer earning the income must report the income and be taxed on it.

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