413sol4-04 - Chapter 4 Income Exclusions 4-1 CHAPTER 4...

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Chapter 4: Income Exclusions 4-1 CHAPTER 4 INCOME EXCLUSIONS DISCUSSION QUESTIONS 1. What are the two reasons most commonly advanced for excluding items from income? Give examples of each and explain how they accomplish the purpose of the exclusion. The two reasons commonly advanced for the exclusion of income items are 1) to alleviate the effects of double taxation, and 2) to encourage taxpayers to engage in transactions for which relief is provided. Exclusions that avoid double taxation include the foreign earned income exclusion (credit), which prevents income earned in foreign countries from being taxed in the foreign country and in the United States. The exclusion for property received by gift or inheritance prevents double taxation by the income tax and the gift and estate tax on the same transaction. Most other exclusions encourage taxpayers to engage in specific transactions. For example, the exclusion of all payments received from medical insurance policies purchased by individuals encourages individuals to purchase medical insurance. The exclusion for interest received on municipal bonds encourages taxpayers to invest in such securities versus taxable investments. 2. What is the difference between an exclusion of income and a deferral of income? An income item that is excluded is never subject to tax - either in the current period or a future period. Deferred income items are not subject to tax in the current period, but will be taxed in some future period. Most items are deferred until the taxpayer has the wherewithal-to-pay the tax. 3. How can gifts be used to lower the overall tax paid by a family? Because gifts are not subject to income tax, a high bracket taxpayer can make a gift of income producing property to a low bracket member of his/her family (father to son, grandmother to granddaughter, etc.). By using the annual gift tax exclusion and the lifetime gift and estate tax exclusion, payment of the gift tax on the gift property can also be avoided. When the property produces income, it will be taxed at a lower marginal tax rate, thus reducing the overall tax paid by the family. 4. Why are life insurance proceeds excluded from the gross income of the beneficiary of the policy? Because, in most instances, life insurance proceeds are counted as part of a decedent's estate, they resemble inherited property, which is excluded from tax. Thus, to provide equity with other forms of inherited property, they are excluded from tax. 5. Explain the circumstances under which a scholarship would not be excluded from gross income.
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Chapter 4: Income Exclusions 4-2 Most scholarships are excluded from tax. However, the amount of the exclusion is limited to the direct costs of education - tuition, fees, books, lab equipment, etc.
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413sol4-04 - Chapter 4 Income Exclusions 4-1 CHAPTER 4...

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