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GROSS INCOME: EXCLUSIONS ® Items that are not income ® Major statutory exclusions ® Tax planning considerations ® Compliance and procedural considerations Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -2

Items that Are Not Income ® Unrealized income ® Self-help income ® Rental value of personal-use property ® Selling price of property Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -3

Unrealized Income ® Example: Land valued at $20, 000 beginning of year appreciates to $45, 000 at end of year ¬The $25, 000 increase in value is unrealized income and not taxable Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -4

Self-Help Income ® The amount saved is not subject to tax Cleaning your own

Selling Price of Property ® Only gain on sale of property is taxable Selling price – Basis in property Gain on sale of property Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -6

Major Statutory Exclusions (1 of 2) ® Gifts and inheritances ® Life insurance proceeds ® Adoption expenses ® Awards for meritorious achievement ® Scholarships and fellowships ® Distributions from qualified tuition programs Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -7

Major Statutory Exclusions (2 of 2) ® Payments for injury and sickness ® Employee fringe benefits ® Foreign-earned income exclusion ® Income from the discharge of a debt ® Exclusion for gain from small business stock ® Other exclusions Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -8

Life Insurance Proceeds ® Paid by reason of death Generally ® Policy non-taxable surrendered not for death Excess of proceeds over the premiums paid taxable to recipient ® Dividends on life insurance and endowment policies non-taxable Considered return of premiums paid Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -9

Adoption Expenses ® Adoption credit Tax credits or an exclusion for amounts paid pursuant to an adoption assistance plan created by an employer Employee may exclude up to $12, 650 Phased out between $189, 710 - $229, 710 Only for special needs adoptions after 2012 © 2013 Pearson Inc. publishing as Prentice Hall ¬Credit. Copyright reduced to. Education, $6, 000 4 -10

Awards for Meritorious Achievement ® Awards for religious, charitable, scientific, etc. are not taxable if ALL criteria are met: Did not enter contest Is not required to perform substantial future services Designates a qualified charitable organization to receive the payment Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -11

Scholarships and Fellowships ® Scholarships excluded for degree candidates used for qualified tuition and related expenses Required for courses of instruction at an educational institution ¬Tuition, fees, books, supplies, equipment Not room and board Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -12

Distributions from Qualified Tuition Programs: § 529 Plans (1 of 2) ® Earnings while in § 529 plan not taxable ® Earnings distributed excluded from income if used by beneficiary for qualified tuition and related expenses Tuition, fees, books, supplies, equipment, AND Room and board if ≥ half-time student Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -13

Distributions from Qualified Tuition Programs: § 529 Plans (2 of 2) ® Distributions of income not used for qualified tuition expenses Income determined by annuity rules Included in beneficiary’s income, AND subject to a 10% penalty ¬Beneficiary must be “family” member ¬Beneficiary may be changed w/o tax consequences Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -14

Payments for Injury and Sickness ® Injury includes both physical and mental Pmts for emotional distress excluded if pmts for medical expenses or attributable to a physical injury ® Disability income policy is nontaxable if purchased by taxpayer Taxable if purchased by employer Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -15

Employee Fringe Benefits (1 of 2) ® In general ® Employer-paid insurance ® § 132 fringe benefits ® Employer awards ® Meals and lodging ® Meals and entertainment ® Employee death benefits Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -16

Employee Fringe Benefits (2 of 2) ® Dependent care ® Educational assistance ® Cafeteria plans Flexible spending plans ® Interest-free loans Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -17

Employee Fringe Benefits in General ® Compensation generally taxable ® Law encourages certain types of fringe benefits by treating the benefits as Nontaxable to the employee, AND Deductible by the employer Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -18

Employer-Paid Insurance (1 of 2) ® Premiums on health, accident, disability and qualifying group term insurance ® Most employee life insurance premiums ® Benefits from non-discriminatory selfinsured plans ® See Topic Review 1 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -19

Employer-Paid Insurance (2 of 2) ® 2010 Affordable Care Act Penalizes individuals who do not obtain medical insurance Penalizes larger employers not providing adequate employee health benefits Other taxes apply to high-income individuals and large employers who do not provide employee coverage 4 -20 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall

§ 132 Fringe Benefits ® No additional cost benefits ® Employee discounts ® Working condition benefits ® De minimis benefits ® Transportation fringes ® Athletic facilities ® See Topic Review 2 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -21

Employee Awards ® Employee achievement awards and qualified plan awards Must be tangible personal property Limited to average of $400/employee ¬Max award $1, 600 Includes safety or length of service Must not discriminate in favor of highly paid employees Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -22

Meals and Lodging ® Provided on employer’s premises ® For the convenience of employer ® Lodging must be a condition of employment to be nontaxable Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -23

Meals and Entertainment ® 50% of meal or cost of entertaining customers is deductible Includes cost of employee’s meal or entertainment Employer gets deduction if employer pays or reimburses employee ¬Employee does NOT recognize income Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -24

Employee Death Benefits ® § 101(b) provides exclusion up to $5, 000 ® Amounts over $5, 000 may be nontaxable gifts depending on facts and circumstances, including employer’s intention Gift is NOT deductible by employer Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -25

Dependent Care ® Employer-financed programs ® Employee may exclude up to $5, 000 of assistance each year ® Cannot discriminate in favor or highly compensated employees Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -26

Educational Assistance ® Employers pay employee educational costs ® Employee may exclude up to $5, 250 per year for tuition, fees, books, supplies, and equipment Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -27

Cafeteria Plans ® Also called flexible spending accounts Employee has option of receiving any combination of benefits up to a certain amount, including cash Only receipt of cash is taxable Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -28

Interest-Free Loans ® Interest must generally be imputed on interest-free loans Imputed interest generally deductible by employer and taxable to employee Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -29

Foreign-Earned Income Exclusion Eligible Taxpayers ®U. S. citizens subject to U. S. income tax on worldwide income Subject to double taxation if foreign income taxed by foreign country Foreign tax credit (FTC) mitigates double taxation Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -30

Foreign-Earned Income Exclusion Amount ®Foreign-earned income exclusion alternative to FTC May exclude up to $95, 100 of foreign-earned income Add’l exclusion foreign housing costs ¬Foreign housing costs in excess of $15, 216 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -31

Foreign-Earned Income Exclusion Residency Tests ® To qualify foreign earned income exclusion Must be bonafide resident of foreign country(ies) for entire taxable year, OR Be physically present in foreign country for 330 days during a 12 -month period ¬If 12 -month period spans two tax years, exclusion pro rated based on [# days/365] Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -32

Income from the Discharge of a Debt (1 of 2) ® Generally, taxpayer may have to include amount of debt forgiveness in gross income Exceptions: nontaxable situations ¬Discharge occurs in bankruptcy ¬Discharge occurs when taxpayer is insolvent Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -33

Income from the Discharge of a Debt (2 of 2) ® Student loans Discharge excluded from gross income if discharge contingent on performing certain public services for a specified time period in certain professions ® Home mortgage forgiveness Exclude debt up to $2 M on acquisition or improvement of principle residence Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -34

Exclusion for Gain from Small Business Stock (1 of 2) ®% of gain may be excluded from gross income if held > five years 50% if acquired 8/11/1993 – 2/17/2009 75% if acquired 2/18/2009 – 9/27/2010 100% if acquired 9/28/2010 – 12/31/2011 50% if acquired after 12/31/2011 ® Eligible amount limited to greater of Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -35

Exclusion for Gain from Small Business Stock (2 of 2) ® Taxable gain not recognized if proceeds reinvested in other small business stock w/in 60 days Taxable gain recognized to extent amount realized > amount reinvested ® Maximum tax rate on taxable amount is 28% Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -36

Other Exclusions (1 of 2) ® Gain from sale of personal residence ® Annuities paid to survivors of public safety officers ® Certain military-related payments ® Housing allowance for ministers ® Campus housing Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -37

Other Exclusions (2 of 2) ® Rural letter carrier’s allowance ® Roth IRA distributions ® Education IRA distributions ® Personal foreign currency gains ® See Table 2 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -38

Tax Planning Considerations ® Employee fringe benefits Cafeteria plans can help provide valuable benefits to employees or cash if they don’t need the benefits offered ® Self-help income and use of personally owned property Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -39

Compliance and Procedural Considerations ® Fringe benefits and Form W-2 Nontaxable benefit may be excluded from employees’ W-2 Taxable benefits subject to withholding and reported on employees’ W-2 Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -40

Comments or questions about Power. Point Slides? Contact Dr. Richard Newmark at University of Northern Colorado’s Kenneth W. Monfort College of Business richard. newmark@Ph. Duh. com Copyright © 2013 Pearson Education, Inc. publishing as Prentice Hall 4 -41