Chapter 4

1. Chapter 4 Gross Income - Exclusions

2. Major Statutory Exclusions • Gifts and inheritances • Scholarships and fellowships • Life insurance proceeds • Awards for Meritorious Achievement • Distributions from Qualified State Tuition Programs • Payments for Injury and Sickness • Foreign earned income exclusion

3. Major Statutory Exclusions - cont’d • Employee Benefits • Adoption Expenses • Meals and Lodging • Meals and Entertainment • Dependent Care • Educational Assistance • Cafeteria Plans • Certain Income from discharge of indebtedness • Exclusion for gain from small business stock

4. Gifts and Inheritances • Transfers of property with donative intent are excludable from gross income whether made during life (gift) or at death (inheritance) • Income earned from such property is subject to the income tax rules

5. Scholarships and Fellowships • Scholarships for tuition, fees, books, supplies, and equipment are excluded for degree candidates • Amounts received for room and board are includible in gross income

6. Life Insurance Proceeds • Life insurance proceeds paid for reason of death of the insured are excludible • Amounts in excess of face value are taxable • Policies purchased from another individual treated as investment • If surrendered, excess of proceeds over premiums paid is taxable • exclusion is available for accelerated death benefits paid to terminally ill person • Dividends earned on life policies are nontaxable to extent of premiums paid • Interest earned on the dividends is taxable

7. Awards for Meritorious Achievement • Awards are generally taxable • Awards for religious, charitable, scientific, educational, artistic, literary, or civic achievement are excluded from income if taxpayer: • did not enter the contest • is not required to perform substantial additional services • designates a qualified charitable organization to receive the payment

8. Scholarships and Fellowships • Scholarships for tuition, fees, books, supplies, and equipment are excluded • Amounts received for room and board must be included in gross income

9. Distributions from Qualified State Tuition Programs • Distributions made from qualified state tuition programs are taxable only to the extent they exceed donor contributions • 2001 Tax Act • Expanded scope of qualified tuition plans to include private institutions • Distributions from state-sponsored plans will be excludable if made in 2002 and after • Distributions from non-state programs will be excludable if made in 2004 and after

10. Payments for Injury and Sickness • Amounts received for physical injury or physical sickness are excluded whether paid by insurance or from damages • Damages on nonphysical injury are taxable • Punitive damages are taxable

11. Employee Benefits • Adoption Expenses • An employee is allowed a $5,000 per child exclusion for qualified adoption expenses paid by employer • Exclusion increases for child with special needs and phased out at high AGI levels • Alternate adoption credit is available (Chapter 14)

12. Employee Benefits • Meals and Lodging • Employer provided meals and lodging are excluded if • provided on the employer’s premises • for the convenience of the employer • and, for lodging to be excludible the employee is required go accept the lodging as a condition of employment

13. Employee Benefits • Meals and Entertainment • Only 50% of the cost of meals and entertainment are excludible • Dependent Care • Up to $5,000 of dependent care provided by employer is excludible • Educational Assistance • Up to $5,250 of employer paid undergraduate educational reimbursement is excludible • Under the new tax law this exclusion has be extended to include graduate expenses incurred after 12/31/2001 and the provision has been made permanent

14. Employee Benefits • Cafeteria Plans • Employees may select from cash or nontaxable fringe benefits • Two types of plans • Supplemental wage plans • Wage reduction plans • Employee Achievement Awards (non cash) • Awarded for length of service and safety • Employee achievement - limited to $400 value each • for length of service must be more than 5 years • Qualified plan awards (e.g. safety) • limited to $1,600 max and $400 average per employee

15. Employee Benefits • Section 132 Fringe Benefits (Table I4-2) • No additional cost • Employee Discounts • Services limited to 20% • Merchandise limited to gross profit % • De minimis - so small accounting is unreasonable • Qualified transportation • Limited to $175/mo. parking and $65 for other • Recreation and athletic facilities

16. Foreign Earned Income Exclusion • U.S. citizens can exclude $76,000 of foreign- earned income in 2000 in lieu of taking the foreign tax credit • Both spouses can take the exclusion if each has sufficient earned income • If change from exclusion method to credit method may not change back for 5 years without approval • Must prorate unless TP is resident of foreign country for entire tax year or 330 days during 12 consecutive months • Deductions directly attributable to foreign income are disallowed • Additional exclusion for high housing costs

17. Income from Discharge of Indebtedness • General Rule: income is recognized on a discharge of indebtedness • Exception when: • Discharge is a gift • Discharge is a bequest (forgiven through will) • Discharge occurs in bankruptcy • Discharge occurs when TP is insolvent and discharge does not make TP solvent (but, must reduce tax attributes) • Discharge is from student loan for certain approved post-education employment

18. Exclusion for Gain from Small Business Stock • Noncorporate TP’s may exclude 50% of the gain on disposition of certain qualified small business stock: • must be issued after August 10, 1993 • held more than 5 years • a C corporation with not more than $50 million of gross assets, with 80% of value of assets used in active trade or business • Cannot be professional services, financial services, hospitality, mining/oil/gas production • Exclusion limited to $10 million or 10 times basis of stock disposed of during year.

19. Holocaust Restitution Payments • Restitution payments received after 1999 by victims of Nazi persecution or their heirs or estates are not includable in gross income for federal income tax purposes • 2001 Tax Act change