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Chapter 4 Notes

Chapter 4 Notes - Bob Ryan DePaul University Class Notes...

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Bob Ryan DePaul University Class Notes Accounting 380 Tax Treatment of Individuals and Property Transactions Chapter 4 – Gross Income Concept and Inclusion 2012 Text 1. Gross Income: a. Definitions: Gross income includes all income from whatever source derived, unless specifically excluded under the Code. b. Concept is interpreted broadly by the courts. c. Taxability of income follows the realization principle from accounting: 1. Income is recognized (taxed) when realized. d. Mere appreciation in wealth (economic income) is not considered realized income. e. Income is recognized whether it is in the form of cash, or “in kind” cash equivalents i.e. property or services (also called barter). 1. The amount of income from “in-kind” receipts is equal to the FMV of the property or services. f. Income does not include recovery of the taxpayer’s capital investment. 2. Accounting Period: a. Taxable year is generally a 12 month period 1. taxable year for most individuals is a calendar year 2. fiscal year can be elected if taxpayer maintains adequate records. 3. Accounting Methods: a. There are three primary methods of accounting for tax purposes: 1. cash receipts and disbursement method 2. accrual method 3. hybrid method 1
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b. In addition to “overall accounting methods”, taxpayers may chose (elect) tax treatment for various transactions, for example: 1. taxpayers can elect to use the “installment method” 2. certain contractors may elect to use either the “percent of completion ” or the “completed contract method” . 4. Cash Receipts Method: a. Income is recognized in the year it is actually or constructively received in cash or cash equivalents b. An amount is constructively received when it is set aside and made available to taxpayers without substantial restrictions. c. Example: An employer issued a bonus check to an employee an 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 accounts to pay the debt. 5. Exceptions to Cash Receipts Method: a. Original Issue Discount (OID) interest is taxable when earned rather than when interest is received. b. Series E and EE bonds are not subject to the OID rule; however cash basis taxpayer many elect to recognize the interest when earned. A cash basis taxpayer may elect to recognize the interest when earned. Why would someone due that? 6. Accrual Method: a. Income is recognized in the year that it is earned regardless of when it is collected. b. Income is earned when: 2
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1. all events have occurred that fix taxpayer’s right to the income, and 2. the amount can be determined with reasonable accuracy. c. The accrual method is “required” for determining purchases and sales when inventory is an income producing factor.
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