Tax Chapter 5
definition of gross income for tax purposes- §61(a): - ANS- Except as otherwise provided in this subtitle,
gross income means all income from whatever source derived (emphasis added)
- includes all income
-broadly defined
Reg. §1.61-(a) provides further insight into the definition of gross income - ANSGross income means all
income from whatever source derived, unless excluded by law. Gross income includes income realized in
any form, whether in money, property, or services.
§61(a), Reg. §1.61-(a): taxpayers recognize gross income when - ANS(1) they receive an economic
benefit
(2) they realize the income
(3) no tax provision allows them to exclude or defer the income from gross income for that year
Economic Benefit - ANS- Taxpayers must receive an item of value to have gross income
- EX: receiving compensation for services, proceeds from property sales, income from investments or
business activities
- not when taxpayer borrows money
Realization principle - ANS- the proposition that income only exists when there is a transaction with
another party resulting in a measurable change in property rights.
- closely parallels the concept of realization for financial accounting purposes
- Requiring a transaction to trigger realization reduces the uncertainty associated with determining the
amount of income because a change in rights can typically be traced to a specific moment in time and is
generally accompanied by legal documentation
income is realized when: - ANS(1) a taxpayer engages in a transaction with another party, and
(2) the transaction results in a measurable change in property rights.
,- In other words, assets or services are exchanged for cash, claims to cash, or other assets with
determinable value.
Adopting the realization principle for defining gross income provides two major advantages: - ANS1) the
transaction allows the income to be measured objectively
2) the transaction often provides the taxpayer with the wherewithal to pay taxes
Wherewithal to pay - ANS- the ability or resources to pay taxes due from a particular transaction
- it reduces the possibility that the taxpayer will be required to sell other assets to pay the taxes on the
income from the transaction
Recognition - ANS- Taxpayers who realize an economic benefit must include the benefit in gross income
unless a specific provision of the tax code says otherwise
- taxpayers are generally required to recognize all realized income by reporting it as gross income on
their tax returns
-through exclusions Congress allows taxpayers to permanently exclude certain types of income from
gross income and through deferrals it allows taxpayers to defer certain types of income from gross
income until a subsequent year
Form of Receipt - ANS- taxpayers realize income whether they receive money, property, or services in a
transaction.
- when members exchange property, they realize and recognize income at the market price, the amount
that outsiders are willing to pay for the goods or services
Return of Capital Principle - ANS- when receiving a payment for property, taxpayers are allowed to
recover the cost of the property tax-free. Consequently, when taxpayers sell property, they are allowed
to reduce the sale proceeds by their unrecovered investment in the property to determine the realized
gain from the sale
- When the tax basis exceeds the sale proceeds, the return of capital principle generally applies to the
extent of the sale proceeds
Return of capital - ANSthe portion of proceeds from a sale (or distribution) representing a return of the
original cost of the underlying property.
, asset dispositions - ANSThe return of capital principle gets complicated when taxpayers sell assets and
collect the sale proceeds over several periods. In these cases, the principle is usually modified by law to
provide that the return of capital occurs pro rata as the proceeds are collected over time
Recovery of Amounts Previously Deducted - ANS- A refund is not typically included in gross income
because it usually represents a return of capital
- if the refund is made for an expenditure deducted in a previous year, then under the tax benefit rule
the refund is included in gross income to the extent that the prior deduction produced a tax benefit
- more complex for individuals who itemize deductions - ANS- An itemized deduction only produces a tax
benefit to the extent that total itemized deductions exceed the standard deduction
When Do Taxpayers Recognize Income? - ANSIndividual taxpayers generally file tax returns reporting
their taxable income for a calendar-year period, whereas corporations often use a fiscal year-end. In
either case, the taxpayer's method of accounting generally determines the year in which realized income
is recognized and included in gross income.
Accounting Methods - ANSaccrual method
cash method
accrual method - ANS- Most large corporations use the accrual method of accounting
- a method of accounting that generally recognizes income in the period earned and recognizes
deductions in the period that liabilities are incurred.
cash method - ANS- indiv
- the method of accounting that recognizes income in the period in which cash, property, or services are
received and recognizes deductions in the period paid.
- claim deductions when they make expenditures, rather than when they incur liabilities
- simplifies the computation of income
- taxpayers may have some control over when income is received and expenses are paid
Constructive Receipt - ANSthe judicial doctrine that provides that a taxpayer must recognize income
when it is actually or constructively received. Constructive receipt is deemed to have occurred if the
definition of gross income for tax purposes- §61(a): - ANS- Except as otherwise provided in this subtitle,
gross income means all income from whatever source derived (emphasis added)
- includes all income
-broadly defined
Reg. §1.61-(a) provides further insight into the definition of gross income - ANSGross income means all
income from whatever source derived, unless excluded by law. Gross income includes income realized in
any form, whether in money, property, or services.
§61(a), Reg. §1.61-(a): taxpayers recognize gross income when - ANS(1) they receive an economic
benefit
(2) they realize the income
(3) no tax provision allows them to exclude or defer the income from gross income for that year
Economic Benefit - ANS- Taxpayers must receive an item of value to have gross income
- EX: receiving compensation for services, proceeds from property sales, income from investments or
business activities
- not when taxpayer borrows money
Realization principle - ANS- the proposition that income only exists when there is a transaction with
another party resulting in a measurable change in property rights.
- closely parallels the concept of realization for financial accounting purposes
- Requiring a transaction to trigger realization reduces the uncertainty associated with determining the
amount of income because a change in rights can typically be traced to a specific moment in time and is
generally accompanied by legal documentation
income is realized when: - ANS(1) a taxpayer engages in a transaction with another party, and
(2) the transaction results in a measurable change in property rights.
,- In other words, assets or services are exchanged for cash, claims to cash, or other assets with
determinable value.
Adopting the realization principle for defining gross income provides two major advantages: - ANS1) the
transaction allows the income to be measured objectively
2) the transaction often provides the taxpayer with the wherewithal to pay taxes
Wherewithal to pay - ANS- the ability or resources to pay taxes due from a particular transaction
- it reduces the possibility that the taxpayer will be required to sell other assets to pay the taxes on the
income from the transaction
Recognition - ANS- Taxpayers who realize an economic benefit must include the benefit in gross income
unless a specific provision of the tax code says otherwise
- taxpayers are generally required to recognize all realized income by reporting it as gross income on
their tax returns
-through exclusions Congress allows taxpayers to permanently exclude certain types of income from
gross income and through deferrals it allows taxpayers to defer certain types of income from gross
income until a subsequent year
Form of Receipt - ANS- taxpayers realize income whether they receive money, property, or services in a
transaction.
- when members exchange property, they realize and recognize income at the market price, the amount
that outsiders are willing to pay for the goods or services
Return of Capital Principle - ANS- when receiving a payment for property, taxpayers are allowed to
recover the cost of the property tax-free. Consequently, when taxpayers sell property, they are allowed
to reduce the sale proceeds by their unrecovered investment in the property to determine the realized
gain from the sale
- When the tax basis exceeds the sale proceeds, the return of capital principle generally applies to the
extent of the sale proceeds
Return of capital - ANSthe portion of proceeds from a sale (or distribution) representing a return of the
original cost of the underlying property.
, asset dispositions - ANSThe return of capital principle gets complicated when taxpayers sell assets and
collect the sale proceeds over several periods. In these cases, the principle is usually modified by law to
provide that the return of capital occurs pro rata as the proceeds are collected over time
Recovery of Amounts Previously Deducted - ANS- A refund is not typically included in gross income
because it usually represents a return of capital
- if the refund is made for an expenditure deducted in a previous year, then under the tax benefit rule
the refund is included in gross income to the extent that the prior deduction produced a tax benefit
- more complex for individuals who itemize deductions - ANS- An itemized deduction only produces a tax
benefit to the extent that total itemized deductions exceed the standard deduction
When Do Taxpayers Recognize Income? - ANSIndividual taxpayers generally file tax returns reporting
their taxable income for a calendar-year period, whereas corporations often use a fiscal year-end. In
either case, the taxpayer's method of accounting generally determines the year in which realized income
is recognized and included in gross income.
Accounting Methods - ANSaccrual method
cash method
accrual method - ANS- Most large corporations use the accrual method of accounting
- a method of accounting that generally recognizes income in the period earned and recognizes
deductions in the period that liabilities are incurred.
cash method - ANS- indiv
- the method of accounting that recognizes income in the period in which cash, property, or services are
received and recognizes deductions in the period paid.
- claim deductions when they make expenditures, rather than when they incur liabilities
- simplifies the computation of income
- taxpayers may have some control over when income is received and expenses are paid
Constructive Receipt - ANSthe judicial doctrine that provides that a taxpayer must recognize income
when it is actually or constructively received. Constructive receipt is deemed to have occurred if the
