Module 36 – P1

Page 378

A. In General

1. Gross income includes all income from whatever source derived, unless specifically excluded

2. Distinction between exclusions; deductions, and credits

a. Exclusions-income items which are not included in gross income (i.e., income item that are not
taxable in your tax return. Eg., interest income on municipule bonds

b. Deductions-amounts that are subtracted from income to arrive at adjusted gross income (AGI) or
taxable income

1) Deductions for adjusted gross income (above the line deductions – Shown on Face of
1040 )-amounts deducted from gross income to arrive at adjusted gross income (AGI)

2) temized deductions (below the line deductions – Shown on Sch. A)-amounts deducted from
adjusted gross income to arrive at taxable income l

c. c. Credits - amounts subtracted from the computed tax to arrive at taxes payable (A credit is just a
reduction of your tax liability to the government. There are variouse credits, eg., )

B. Exclusions ro Gross Income (not reportable / not taxable ) _

1. Payments received for support of minor children
a. Must be children of the parent making the payments
b. Decree of divorce or separate maintenance generally must specify the amount to
be treated as child support, otherwise payments may be treated as alimony
2. Property (not cash) settlement (division of capital) received in a divorce
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4. Life insurance proceeds (face amount of policy) are generally excluded if paid by reason
of death
a. If Insurance proceeds (Face amount of policy or principle) are received in
installments, amounts received in excess of pro rata part of face amount are
taxable as interest

b. Dividends on unmatured insurance policies are excluded to the extent not in excess of
cumulative premiums paid.

MCQ No 5 , 3 ,

c.

d.
e. If insurance proceeds are paid for reasons other than death or under c. above, or
if the policy was obtained by the beneficiary in exchange for valuable
consideration from a person other'than the insurance company, all proceeds in
excess of cost are taxableAnnuity rules apply to installment payments.

EXAMPLE: Able was the owner and beneficiary of a $30,000 life insurance policy on Baker.
Able sold the policy for $10,000 to Carr who subsequently paid $6,000 of premiums. If
Baker dies, Carr's gross income from the proceeds of the life insurance policy would total
$30,000 - ($10,000 + $6,000) = $14,000.

MCQ No 2

5. Certain employee benefits are excluded

a. Group-term life insurance premiums paid by employer (the cost of up to $50,000 of
insurance coverage is excluded). Exclusion not limited if beneficiary is the employer
or a qualified charity.

a. Insurance premiums employer pays to fund an accident or health plan for employees are
excluded.
b. Accident and health benefits provided by employer are excluded if benefits are for
(1) Permanent injury or loss of bodily function
(2) Reimbursement for medical care of employee, spouse, or dependents

(a) Employee cannot take itemized deduction for reimbursed medical expenses

(b) Exclusion may not apply to highly compensated individuals if reimbursed under
a discriminatory self-insured medical plan
MCQ No 7

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There are 2 types of Savings Accounts for Medical Insurnace that you can have (on the
book, they mention to one type only (MSA) but there is another one called Health
Savings Account (HSA) )

Why you would have these MSA or HSA? These accounts are set up at a bank and if you
have insurance policy as a high deductible, what happens? A deductible means that
you have to pay for that out of your pocket but if you have some type of savings
accounts that have been set up to cover that amount that you have to pay out of your
pocket before the insurance comoany has to start paying

1st Type which is MSA (which is on the book)

d. Employees of small businesses (50 or fewer employees) and self-employed individuals

may qualify for a medical savings account (MSA) if covered under a high-deductible
health insurance plan. An MSA is similar to an IRA, except used for health care.

(1) Employer contributions to an employee's MSA are excluded from gross income
(except if made through a cafeteria plan), and employee contributions are
deductible for AGI.

(2) Contributions are limited to 65% (75% for family coverage) of the annual health
insurance deductible amount. ,

(3) Earnings of an MSA are not subject to tax; distributions from an MSA used to pay
qualified medical expenses are excluded from gross income.

2nd Type which is HSA ( in the handout)

The advanteges of HSA over MSA are:

1) It does not say specific no of emplyee (50) it can cover more

2) Whatever you don’t use on HSA, you can carry it over to subseqent years with
being taxable, but what happen in MSA the non used contribution in the same
year that amount become taxable to you

3) It doesn’t say how many empolyee you may have

 4) If you don’t spend all the money over the year you cannot be taxed as income for
that amount left in HSA, it just can be acrry over to future years

5) Deductibel to arrive to AGI (above the line deduction)

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i. Employee fringe benefits are generally excluded if :

(6) Qualified moving expense reimbursement-an individual can exclude any

amount received from an employer as payment for (or reimbursement of)
expenses which would be deductible as moving expenses if directly paid or
incurred by the individual. The exclusion does not apply to any payment (or
reimbursement of) an expense actually deducted by the individual in a
prior taxable year.

j. Workers' compensation is fully excluded if received for an occupational sickness or

injury and is paid under a workers' compensation act or statute.

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6. Damages for physical (personal) injury or physical sickness are excluded.

c. Punitive damages generally must be included in gross income, even if related to a

physical injury or physical sickness. .

8. Gifts, bequests, devises, or inheritances are excluded.

a. Income subsequently derived from property so acquired is not excluded (e.g., interest or
rent).
b. "Gifts" from employer except for noncash holiday presents are generally not excluded.

MCQ 10

9. The receipt of stock dividends (or stock rights) is generally excluded from income (see page
492 for basis and holding period), but the FMV of the stock received will be included in
income if the distribution:
a. Is on preferred stock
b. Is payable, at the election of any shareholder, in stock or property
c. Results in the receipt of preferred stock by some common shareholders, and the
 receiptof common stock by other common shareholders
d. Results in the receipt of property by some shareholders, and an increase in the
proportionate interests of other shareholders in earnings or assets of the corporation

Note that cash dividend is taxable (Sch B – Dividend & Interest), however, if you have
insurance policy and the insurance company gives you a dividend. That dividend is not
taxable becasuse dividends on insurance policy are considered return on premium. Well,
when actualy made a premium to insurance company, premiumus are not deductible so when
you get a divided which is considered a rturn on premiums, are non taxable

When Preferred stockholder get dividends either PS or CS, these dividends are taxable. What
are going to do is, you will multiple the # of shares X FMV at date of distribution = taxable
income (Sch. B). The taxable amount is also the new basis.

If you are a commom shareholder and you got a P/S as a stock dividend or C/S, it is non
taxable. The only case the Common Shareholder become taxable is when he has a choice
whether to get cash divided or stock dividend.

MCQ No 14