Chapter 4 - Income Exclusions

Chapter 4 - Income Exclusions - Chapter 4 Income Exclusions...

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Chapter 4 – Income Exclusions I. Introduction a. After identifying all the sources of income received during an accounting period, the next step in calculating taxable income is determining which, if any, of the income sources do not have to be included in the current period’s gross income i. All-Inclusive Concept ii. Legislative Grace Concept II. Donative Items a. Gifts: i. Value of property acquired by gift has been excluded from income taxation since 1913 1. Gifts received aren’t subject to income taxation; however, the donor is subject to gift tax rules on the making of a gift a. Prevents double tax on a gift ii. Only the receipt of a gift is a nontaxable event; any subsequent earnings from property received as a gift are subject to taxation b. Inheritances: i. Rationale for exclusions follows that for a gift—property held in an estate is subject to an estate tax; thus, the income tax exclusion for inheritances avoids a double taxation of the property of a deceased tax payer c. Life Insurance Proceeds: i. Generally excludable; however, life insurance proceeds may be included in the decedent’s gross estate and subject to the estate tax ii. Life insurance proceeds exclusion applies to such payments even if the payments are received in installments, although any earning included in the installment are taxable 1. Annuity Exclusion Formula a. Amount Excluded = Cost of Contract/Number of payments
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iii. If you purchase a policy for consideration, on the life of another, the receipt of the life insurance is taxable minus any additional investment put forth on the policy 1. Treated as realization of an investment a. Excluded for partners or partnerships in which the insured is a partner or a corporation in which the insured is an officer or a shareholder d. Scholarships: i. Excluded if the award doesn’t require the student to perform any future services such as teaching, grading papers, or tutoring 1. Limited to the direct costs of the student’s college education a. Tuition, fees, books, supplies, etc i. Any excess is taxable, for example, the amounts used for room and board III. Employment-Related Exclusions a. Foreign-Earned Income: i. To provide relief from double taxation for U.S citizens working in foreign countries, the tax law allows individuals two options: 1. May include the foreign-earned income in their taxable income, calculate the U.S tax on the income, and take a tax credit for any foreign taxes paid a. Amount of the allowable tax credit is the less of: i. The actual foreign taxes paid, or ii. The U.S. tax that would have been paid on the foreign-earned income 2. Individuals may exclude up to $91,500 in foreign-earned income for each full year they work in a foreign country a. Must be a bona fide resident of the foreign country or must be present in the foreign country for 330 days in any 12 consecutive months
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i. Tax under the exclusion is equal to the difference between the tax on taxable income without the exclusion and the tax on the
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Chapter 4 - Income Exclusions - Chapter 4 Income Exclusions...

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