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Unformatted text preview: Individual Income Tax Chapter 5 - Notes This chapter focuses on exclusions from income. These are items that would otherwise be includable in income if they were not specifically exempted. The material in the chapter overlaps the material in chapter 4. 1) Gifts and Inheritances Gifts are excluded from income (although non-charitable gifts over an exclusion amount potentially trigger gift tax). A gift must be given for "love, affection, or generosity. " A payment made for past or expected future services will generally invalidate gift status. A gift generally cannot be made under a contractual obligation. The characterization of a compensatory payment or gift often turns on the facts of the case. Gifts to employees may be deducted by the employer and excluded by the employee under limited circumstances. Exclusions are available for relatively small payments for employee achievement awards for longevity and safety. A payment to a deceased employees spouse or family may be regarded as a gift if it does not represent compensation and the employer makes the gift without obligation. Inheritances are not income to a recipient unless part of the inheritance represents income in respect of a decedent (income realized but not recognized for tax purposes during the life of the taxpayer). 2) Interest on state and local bonds (also interest on obligations of US possessions like Puerto Rico) - excludable if bond interest (state and local interest attributable to damage awards or tax refunds is not excludable). Expenses allocable to tax-exempt interest are not deductible so if a taxpayer borrowed to purchase state and local bonds, the interest expense would not be deductible as investment interest. Interest on private activity bonds (bonds where the local government is the guarantor and issuer bu the recipient of the proceeds is a private developer) are subject to AMT (alternative minimum tax). 3) US interest is taxable but interest on EE bonds may be deferred until redemption. Exception: Interest on US savings bonds used to finance higher education may be excluded provided taxpayers meet requirements of income level and purpose in expending funds (see formulas in text). 4) Life insurance proceeds paid to estate, individual beneficiary, or business beneficiary are excludable. Premiums for these policies are also not deductible (expenses of tax exempt income). Exception: transfers for valuable consideration (for example, someone signs over a life insurance policy in satisfaction of some obligation) here, the beneficiary will have a gain in the amount of the difference between what was paid to the original owner and the amount received at death of the insured. This type of arrangement might occur when life insurance benefits are used to secure some type of purchase contract. Another example of this kind of arrangement occurs for original payor of accelerated death benefits (see below)....
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- Spring '08