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Answered: - What is the definition of accounting ? dfjkdfjdkfjdfj ksjdfkf jk

What is the definition of ?accounting ? dfjkdfjdkfjdfj ksjdfkf jk

ACC 331 Spring 2016


Class Notes


Chapter 10


Individuals: Income, Deductions, and Credits


1-3. Income ? Inclusions and Exclusions


What gets reported to the IRS?


Gross Income ? all (worldwide) income from whatever source derived (legal or


illegal) except as otherwise provided (exclusions and deferrals)?..(IRC ?61)




All income is considered taxable unless the tax code specifically allows for exclusion


for deferral to a later tax period.



Examples of Items Specifically Included in Income


1) Alimony versus Child Support Payments


Alimony is taxable income to the recipient


Deductible by the payer (as a For AGI deduction),


To be treated as alimony, the following conditions must be satisfied:


o Payment must be in the form of cash


o There isn?t a written agreement that says the payment is something


other than alimony (e.g., divorce agreement)


o The ex-spouse cannot live in the same household (i.e., not living




o The payments must stop on death of recipient (payments can stop






Child support (i.e., maintenance payments) is NOT considered taxable


income; and is not deductible by the payer





Transfer of property under a divorce agreement is considered a division of


property can is NOT treated as taxable income or a gift to the recipient


(recipient assumes carry-over basis in the property acquired)





Bob pays Midge child support payments of $80,000 per year until their daughter, Donna, turns


18. Once Donna turns 18, Bob will pay Midge $50,000. How much of Bob?s $80,000 should be


treated as child support and how much as alimony?


Just because he thinks of this as child support, it is not because of how it is structured.


Substance ? over ? form doctrine





Structure of Bob and midge payments suggest the 50,000 is alimony. Balance of 30,000 is treated


as child support.



2) Prizes and Awards


A prize or award is gross income to recipient (valued at FMV); it is not treated


as a gift.




Exceptions: a taxpayer can exclude a prize/award under the following






If the award if for literary, scientific, or charitable achievement and


the award is transferred/donated to a government agency or a


qualified charitable organization. To qualify:


i. Taxpayer must transfer the entire award


ii. Taxpayer must not have taken any action to win the award


(e.g., submitting a project or paper to a competition


disqualifies the taxpayer)




Taxpayer must not receive any future services connected


with making the award


EXAMPLE ? Nobel Prize winner transfers monetary award to MSU, then


award is non-taxable.





Employment Achievement Awards are non-taxable if the award is:




Based on length of service or safety




Paid in the form of property (i.e., non-cash)


And below the following amount:




$400 / employee per year (non-qualified plan)




$1,600 / employee per year (qualified plan)


A qualified plan is a non-discriminatory award (i.e., open to all





EXAMPLE: A factory worker receiving a watch (FMV $350) for 30-years


of service to the firm


3) Unemployment Compensation


Unemployment benefits are taxable income (considered substitute income)


However, workman?s compensation, which is payment for injury on the job is


NOT taxable (considered a return of human capital)


4) Social Security Benefits


Portion of social security benefits are taxable if taxpayer has other sources of


income (?86). For example, single taxpayer:





o Mod AGI ? 25K => all social security benefits is non-taxable


o 25K < Mod AGI ? 34K => 50% of social security benefits is taxable


o Mod AGI > 34K => 85% of social security benefits is taxable


NOTE: Mod AGI is defined in the textbook.


Will be given Mod AGI in this class


Examples of Excluded (Non-Taxable) or Deferred Income


1) Gifts and Inheritances


Donates made during donor?s life (i.e., gifts); and transfers upon death of donor


(i.e., inheritances or bequests) are not taxable income to the recipient (?102).




Donor is potentially subject to gift or estate tax (recall from Chapter 1)





Note however that the income generated by the gift after it is transferred into the


hands of the recipient is taxable (e.g., future interest income earned on a bond


received as a gift)





Transfers from employer to employee generally does not qualify as a gift; instead


it is treated as compensation income (recall Imputed Income from Chapter 4)



2) Scholarships


If funds are used for tuition, fees, books, supplies, and other equipment required


for student?s course, then scholarship funds are non-taxable.


o Scholarship funds used for any other activities are taxable.





Payments made in exchange for services provided by the student are considered


compensation, not scholarships (e.g., stipend received by research or teacher


assistant). Special exception made for student athletes.



3) Damages and Compensation


Reimbursements for expenses incurred (e.g., employee travel expenses, medical


expenses from accident) or property destroyed (insurance proceeds) are nontaxable unless


o The reimbursement exceeds expense/damage suffered, then the excess


is taxable income; or


o If the taxpayer claims the expense/damage as a deduction on her tax


return, then the full reimbursement has to be included as income





Compensation for personal injury or sickness is non-taxable (e.g., in a car


accident), however, compensation for loss of income or award of punitive


damages is taxable income to the recipient.






4) Workers Compensation


Employer payments for specific job-related injuries are non-taxable



5) Accident and Health Benefits


Proceeds/benefits collected from an accident or health insurance policy purchased


by the taxpayer is non-taxable





Tax rules are more complex for employer purchased policies (covered in Ch. 11,


not covered in this course)



6) Educational Savings Bonds


Interest earned on U.S. Series EE bonds are non-taxable if the proceeds of the


bonds are used to pay for qualified higher education expenses.




The proceeds can be used to pay the higher education expense of the taxpayer, her


spouse, or a dependent



7) Foreign-earned income


The first $100,800 of foreign earnings are non-taxable, provided the taxpayer:


(i) Is a resident of foreign country; or


(ii) Lives in the foreign country for 330 days in a 12- month period.




Otherwise include total foreign income in gross income and


(i) Deduct income taxes paid to foreign gov?t as a from AGI deduction, or


foreign tax credit



8) Other Exclusions


Gain on sale of personal residence


o Single ? exclude the first $250,000 of gain ($500,000 ? MFJ)


o must live in residence for 2 of last 5 years


Roth retirement accounts ? all earnings from Roth accounts are tax exempted.




9) Deferrals


Gain/Loss on exchange-related disposals (where-withal to pay concept)


o Gains/Losses on Like-kind exchanges


o Gains on Involuntary conversions (e.g., property seized through eminent







o Gains/Losses on transfer of property to separate legal entities, e.g.,


formation of C-Corp (?351) or Partnership (?721) (See chapters 12 & 14)


o Gains on Installment sales




Deferred compensation


o Contributions to qualified retirement accounts


o Contributions under non-qualified deferred compensation plans








For each of the following independent situations, indicate the amount the taxpayer must include


in gross income and explain your answer:


a. Phil won $500 in the scratch-off state lottery. There is no state income tax.


The award is taxable


b. Ted won a compact car worth $17,000 in a TV game show. Ted plans to sell the


car next year for $15,000.


It is taxable in the year that he receives it.


c. Al Bore won the Nobel Peace Prize of $500,000 this year. Rather than take the


prize, Al designated that the entire award should go to Weatherhead Charity, a taxexempt organization.


No, because donated it to a tax-exempt organization


d. Jerry was awarded $2,500 from his employer, Acme Toons, when he was selected


most handsome employee for Valentine?s Day this year.


Its taxable because it is cash. Its not related to safety or length of service. Its over


the 1,600 limit. Fails all three test


e. Ellen won a $1,000 cash prize in a school essay contest. The school is a taxexempt entity, and Ellen plans to use the funds to pay her college education.


She has to report because she enters a contest. It is award. When she uses the


money for her education she can claim a deduction



f. Gene won $400 in the office March Madness pool.








4. Itemized Deductions


As discussed in Ch. 9, Congress allows for the deduction of specific expenses as a from AGI


deduction. Here are some examples


1) Medical Expenses


Medical expenses for care of taxpayer, spouse, and/or dependents that has not


been reimbursed by health insurance or other source.





Deductible medical expenses include any payments for the ? care, prevention,


diagnosis, cure, mitigation, treatment or prevention of disease. Including:


o health insurance premiums


o transportation and lodging for medical care


o nursing home care (stay must be primarily for medical care)


o medically necessary capital expenditure (e.g., renovating home to be


wheelchair accessible)





Medical expenses are subject to a 10% AGI floor (for taxpayers ? 65 years old the


AGI floor is reduce to 7.5%). That is, only the amount in excess of the 10% of


AGI is deductible on the tax return





Contributions to health savings account are a For AGI deduction;





Payments for cosmetic surgery, unless medically necessary (e.g., reconstructive


surgery after an accident), are generally not deductible.



2) Taxes (State, Local and Foreign)


To provide relieve from double-taxation, the following taxes are deductible:


Income taxes paid to state and/or local gov?t.


o Taxpayers can elect to deduct sales tax paid to the state instead of


income taxes (beneficial for taxpayers living in states without an


income tax, e.g., Florida).




Foreign income taxes paid (hardly done, in most cases claiming foreign


income taxes paid as a tax credit generates greater tax savings)





Property taxes on real property (both investment and personal-use property),


and ad-valorem taxes on personal property (e.g., taxes on motor vehicle)



Recall Tax benefit rule from Chapter 4 - refund of state, local and foreign taxes are


included as taxable income to the extent taxpayer?s taxable income would have been


higher had she not taken the excess deduction in the prior year(s).








You paid $3,000 in Michigan state income tax in 20x1 (this is your only itemized deduction).


Your standard deduction in 20x1 is $6,300. On April 15, 20x2 you claim a refund of $1,800 on


your state income tax return for 20x1. Rather than receive a check, you decide to have the tax


refund applied to your 20x2 state income tax return.


a) How much of the refund is included as income on your 20x2 tax return?


Yr. 20x1


Itemized deduction


Michigan income tax




Standard Deduction 6,300 (would have claimed this)


Therefore, tax benefit 20x1 from overpaying state income taxes. No tax benefit,


so none of 1,800 is treated as income in 20x2



b) In addition to the $3,000 Michigan state income tax you also have charitable


contributions of $4,500. How much of the refund is included as income in your 20x2 tax




Yr. 20x1


Itemized deduction


Michigan income tax 3,000


Charitable Contributions 4,300


Total 7,3000 (chose this one)


Standard 6,300


Tax benefit from overpaying by 1,800. Your taxable income 7,300-6,300= 1,000


lower because of overpayment so 1,000 is gross income in 20x2


If you had not overpaid


Itemized deduction


Mich. Income tax 1,200


Charitable contributions 4,300


Total 5,5000


Standard 6,300






3) Interest Expense




Mortgage Interest ?


o Mortgage interest on qualified residence (taxpayer?s principal residence


plus one other residence), and interest on ?home-equity? loans


o Mortgage interest limited to interest on the first $1 million of mortgage




o Home-equity interest limited to lesser of


(i) (FMV - acquisition debt) at time loan was executed; or


(ii) $100k


o To qualify as residence, the structure must have sleeping accommodations,


toilet and cooking facilities


o Mortgage proceeds must be used to acquire, construct or substantially


improve a qualified residence. There are no restrictions on the use of


home-equity loans.





Investment interest expense ? Deduction is limited to net investment income (NII)


NII =Investment income?Investment related Expense


o Excess investment interest expense is carried forward to deduct in next tax







Expenses related to Tax-Exempt Securities ? Interest expense on debt incurred to


purchase tax-exempted securities (e.g., interest expense on loan taken out to


purchase municipal bonds) are disallowed.





Interest on Qualified Student Loans - Taxpayers may be able to deduct up to


$2,500 of student loan interest as a For AGI deduction.)








This year Randy paid $28,000 of mortgage interest (Randy borrowed $450,000 to buy his


residence, and it is currently worth $500,000). Randy also paid $2,500 of interest on his car loan


and $4,200 of margin interest to his stockbroker (investment interest expense). How much of


this interest expense can Randy deduct as an itemized deduction under the following




a) Randy received $2,200 of interest income this year and had no other investment income


or expenses. His AGI is $75,000.


Mortgage interest 28,000 (loan <1M, the interest expense is fully deductible)


Car loan interest 2,500 (non-deductible, personal use asset)


Investment int expense 4,200 (can only deduct 2,200, cannot exceed investment income.


2,000 is carried forward?. Does not expire)



b) Randy had no investment income this year, and his AGI is $75,000.


Investment int expense deduction is now 0






4) Charitable Contributions


Donations (cash, ordinary income property or capital gain property) made to a


qualified domestic charity (?170) are deductible.


o If the donor receives any tangible benefits in return for the donation, then


the donation is not considered a charitable contribution (e.g., purchase of


raffle or bingo ticket is not deductible as a charitable contribution)


o Currently contribution of services/time does not qualify as a charitable


contribution (unable to accurately measure FMV of service/time)




Individual taxpayers are limited on how much charitable contributions can be


deducted in any one tax year. The limit depends on the type of charity and the


form of the contribution:


Summary of Charitable Contribution Limitation Rules


Public Charity/




Form of Contribution


Operating Foundation




Cash/Ordinary Income property




Lesser of Basis or FMV Lesser of Basis or FMV


AGI Limit






Capital gain property








AGI Limit






* If public charity puts the donated property to non-charity use then the amount


deducted is limited to basis in property


** If donation is a publicly-traded stock the donor can deduct at FMV.





Excess charitable contributions are carried forward for 5 years.








Warren is contemplating making a charitable contribution of $20,000 cash to either a public


charity or a private non-operating foundation. Warren?s tax rate in 20x1 is 32% and in 20x2 it


will be 35%. The market rate of interest is 10%, Warren?s AGI is $50,000 each year and Warren


also has $18,000 in mortgage interest expense in both 20x1 and 20x2.


Should Warren make the donation to the public charity or the private non-operating foundation?



5) Casualty losses ? losses from a sudden, unexpected or unusual event (e.g., house fire,


theft of jewelry) of personal-use assets are deductible (losses from normal wear and


tear are not). Deduction for casualty losses are computed as follows:


o For each incident, loss is equal to the lesser of the decline in FMV or the


tax basis of asset


o The loss is reduced by any reimbursement received (e.g., insurance




o Amount deductible subject to two floors:


(i) First, reduce losses by $100 per incident (i.e., the first $100 of


losses is not deductible), and


(ii) Second, sum the remaining casualty losses for the year and reduce


by 10% of AGI (i.e., only the amount in excess of the 10% of AGI


is deductible)






6) Miscellaneous Itemized Deductions


There are two types of miscellaneous itemized deductions:


(i) Miscellaneous items subject to 2% AGI Floor - Miscellaneous items are


aggregated and the total is then subjected to the 2% AGI Floor, common examples




o Unreimbursed employee business expenses


o Hobby expenses (deduction cannot exceed income from hobby)


o Tax preparer fees


o Investment expenses (e.g., safe deposit box fees, subscriptions, advisory




o Professional dues, cost of uniforms (not suitable for normal wear),


o Job hunting expenses


(ii) Other Miscellaneous items NOT subject to 2% AGI Floor:


o Gambling losses, deduction cannot exceed amount of gambling winnings




o Casualty and theft losses on investment property


o Unrecovered capital invested in life-time annuity


o Impairment-related work expenses of a handicapped person



Phase-out of Itemized Deductions




Some itemized deductions are subject to phase-out for high income




o The following items are not subject to phase-out: medical expenses,


investment interest expense, gambling losses, non-business casualty and


theft losses


(iv) Taxpayers with AGI that exceeds $258,250 ($309,900 for MFJ) - itemized


deductions are reduced by the lesser of:


o 3% * (AGI - $258,250) for single taxpayers; 3% * (AGI - $309,900) for


MFJ, or


o 80% of the itemized deductions subject to phase-out.






5. Individual Tax Credits


Unlike tax deductions which reduce taxable income, tax credits reduce tax liability.


o A dollar of tax credit reduces tax liability by a dollar


o A dollar of deduction reduces tax liability by $1 * Marginal Tax Rate


Therefore a dollar of tax credit is more valuable than a dollar of tax deduction.


There are major types of tax credits:


1) Non-refundable tax credits ? These credits reduce tax liability to zero, but cannot


result in a tax refund. Any excess credit is either lost or carried forward to use in the


next tax year.


2) Refundable tax credits ? Unlike non-refundable tax credits, these tax credits result in


a tax refund if the tax credit is greater than the tax liability.


Examples of tax credits available to individuals:


Adoption Expenses Credit ? Provide tax relief/subsidy for the initial cost of adoption (e.g.


adoption fees, attorney fees, court costs, social service review costs, and transportation


costs). To qualify:


o Adopted child must be < 18 years old, or physically/mentally disable


o For 2015, the maximum credit is $13,400 per child; the credit is reduced for


taxpayers with AGI> $201,010.


o The credit is non-refundable, however excess credit can be carried forward up to


five years.


Child Tax Credit ? maximum of $1,000 per qualifying child


o Child must be < 17 years old, a U.S. citizen, and claimed as a dependent on the


taxpayer?s tax return


o The credit is phased-out by $50 for each $1,000 the taxpayer?s AGI exceeds


$75,000 ($110,000 for MFJ)


o The child tax credit is non-refundable and cannot be carried forward






Dependent Care Credit ? Provide tax subsidy/relief for working taxpayers with young


children. The credit encourages both parents to seek work outside of the home.


o Dependent must be < 13 years old; or


o Dependent/spouse who is physically or mentally incapable of caring for self and


lives with taxpayer for more than ? year


o Tax credit is a percentage (based on taxpayer?s AGI) of eligible care expenses


1 child ? max. eligible expenses $3,000


2 or more children ? max. eligible expenses $6,000


If MFJ, eligible expenses cannot exceed earned income of the taxpayer


with the lowest earned income


o Child care payments made to relatives < 19 years old are disallowed (e.g., cannot


claim amounts paid to your 15 yr. old niece for babysitting)


Education Tax Credits ? subsidize the cost of higher education and continuous learning.


Two types of educations tax credits:


1) American Opportunity Credit (AOC)


Available for the first four years of postsecondary education


Available per eligible student (taxpayer, spouse or dependent); student


must be at least half-time for one term/semester


Covers tuition, books and related course material


Tax credit is 100% of first $2,000 spent and then 25% of next $2,000


(i.e., maximum credit of $2,500 in 2015)


Subject to phase-out:


Phaseout =





( ModAGI ?160 K )


( ModAGI ?80 K )











40% of allowable AOC is refundable



2) Lifetime Learning Credit


Covers postsecondary education or any course that acquires or


improves a taxpayer?s job skills (much broader than AOC).


Available per taxpayer unit (i.e., one credit for all members of




20% of the first $10,000 of qualifying expenses (tuition)


Subject to phase-out:


( ModAGI ?110 K )


( ModAGI?55 K )


Phaseout =




other ;







o Taxpayer has to choose between claiming the education expense as a tax credit or


a for AGI deduction, not both.





o Expenses paid with tax-exempt income cannot be claimed (e.g., tuitions paid by


scholarships) or reimbursed by your employer.


o Cannot claim both AOC and Lifetime credits for the same expense/student




Tim and Mandy file married filing jointly and have a modified AGI of $116,000. They have


two children, Liz and Peter. Liz is a university sophomore and incurs $8,000 for tuition and


$500 for books for 2015. Peter is a senior at the university but is in his fifth year because he


changed majors. Peter?s expenses are $5,000 for tuition and $600 for books. Both children


live at home and are qualifying children on Tim and Mandy?s tax return.


What is Tim and Mandy?s education tax credit for 2015?



Earned Income Credit ? designed to help offset the effect of employment taxes (social


security and medicare) on the earned income of low-income taxpayers and encourage the


poor to seek employment.


o Qualifying individuals:


A taxpayer with at least one qualifying child; or


Taxpayer ? 25 but < 65, and not claimed as a dependent on someone else tax




o Taxpayers with investment income > $3,400 are not eligible


o Maximum earned income credit for 2015 (subject to phase-out)















Earned Income


(lower limit to get


max. credit)













































Foreign Tax Credit (FTC) ? U.S. Citizens working abroad owe taxes abroad and at home


o Taxpayer can claim income taxes paid to foreign government as a tax credit (subject


to limitations)


o Taxpayer cannot claim credit if income is excluded


Live in country 330 days of year


Exclude up to $100,800 of income


o Taxpayer can choose to deduct foreign taxes paid as itemized (if foreign income is


included in gross income)


o FTC may only reduce taxpayer?s tax liability to zero. Excess FTC can be carried


back one year or forward up to 10 years.



Affordable Care Act (ACA) Provisions




ACA?s ?individual mandate? - requires all taxpayers to have health insurance,


otherwise taxpayer required to pay a tax penalty for each month they do not have


health insurance.


o Tax Penalty - Individual Share Responsibility Payment (ISRP) for 2015 is


the greater of:


1) $325 per adult plus $162.50 per child up to a maximum of $975; or


2) 2% of household income (measured as AGI ? standard deduction ?


personal exemptions)


o Taxpayers can apply for exemption from the ISRP on a variety of grounds


including financial hardship, religious objections, incarceration (see page


10-34 of text for list of factors).





Premium Tax Credit ? low-income taxpayers can receive a federal subsidy to


secure health insurance on the Health Insurance Marketplace.


o Household income must be between 100% - 400% of the federal poverty




o Tax credit ranges between 2.01% to 9.56% of household income


o Tax credit can be claimed in advance at the start of the year or claim as a


refund when filing tax return for the year (file on IRS Form 8962)






Additional Problems




Aaron, age 45, had AGI of $40,000 for 2015. He was injured in a skiing accident and paid


$3,600 for hospital expenses and $1,400 for doctor bills. Aaron also incurred medical expenses


of $1,200 for his child, who lives with his former wife and is claimed as a dependent by her. In


2016, Aaron was reimbursed $1,300 by his insurance company for the medical expenses


attributable to the skiing accident.


a) Compute Aaron?s deduction for medical expenses in 2015.



b) Assume that Aaron would have elected to itemize his deductions even if he had no


medical expenses in 2015. How much, if any, of the $1,300 reimbursement must be


included in gross income in 2016?



c) Assume that Aaron?s other itemized deductions in 2015 were $8,000 and that he filed as a


head of household. How much of the $1,300 reimbursement must he include in gross


income in 2016?








Ross, who is single, purchased a personal resid...


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