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Chapter4_Lecture - Chapter 4 Gross Income Gross Income...

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Chapter 4 Gross Income Gross Income Definition: Gross income includes all income from whatever source derived, unless specifically excluded under the Code Concept is interpreted broadly by the courts Gross Income Taxability of income follows the realization principle from accounting o Income is recognized (taxed) when realized Mere appreciation in wealth (economic income) is not considered realized income Gross Income Income is recognized whether it is in the form of cash, or “in-kind” cash equivalents (i.e., property or services) o The amount of income from “in-kind” receipts is equal to the FMV of the property or services Income does not include recovery of the taxpayer’s capital investment Accounting Periods Taxable year is generally a 12-month period o Taxable year for most individual taxpayers is the calendar year o Fiscal year can be elected if taxpayer maintains adequate records Fiscal year is a 12-month period ending on the last day of a month other than December Example: July 1 to June 30 Accounting Methods There are 3 primary methods of accounting for tax purposes: o Cash receipts and disbursements method o Accrual method o Hybrid method Accounting Methods In addition to overall accounting methods , taxpayers may choose (elect) tax treatment for various transactions, for example o Taxpayers can elect to use the installment method o Certain contractors may elect to use either the percentage of completion method or the completed contract method Cash Receipts Method Income is recognized in the year it is actually or constructively received in cash or cash equivalent An amount is constructively received when it is set aside and made available to taxpayer without substantial restrictions
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Cash Receipts Method Example - Constructive receipt o An employer issued a bonus check to an employee on December 31 st but asked her to hold it for a few days until the company could make deposits to cover the check. The income was not constructively received on December 31 since the issuer did not have sufficient funds in its account to pay the debt. Exceptions To Cash Receipts Method Original Issue Discount (OID) interest is taxable when earned rather than when interest is received Accrual Method Income is recognized in the year that it is earned regardless of when it is collected Income is earned when: o All events have occurred that fix taxpayer’s right to the income, and o The amount can be determined with reasonable accuracy The accrual method is required for determining purchases and sales when inventory is an income-producing factor Accrual Method Claim of right doctrine o Requires amounts received to be included in income even though the amount is in dispute and might be returned to the payor at a later date o If payment has not been received, no income is recognized until the claim is settled
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