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Inclusion and Exclusion of Income and Deductions in Taxation

Learn which sources of income are included or excluded from gross income and understand the deductions available for AGI and itemized deductions in the tax system.

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Inclusion and Exclusion of Income and Deductions in Taxation

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  1. Which of the following are included in gross income and which are excluded? • Prizes and awards • Scholarships • Alimony received • Child support received • Property settlements pursuant to divorce • Employee fringe benefits • Imputed Income • Below market-rate loans • Payment of expenses by others • Bargain purchases

  2. Which of the following are included in gross income and which are excluded? • Gifts and inheritances • Life insurance proceeds • Welfare payments • Social Security benefits • Medical insurance payments • Workmen’s compensation • Compensation for injuries • Unemployment benefits • Punitive damages • Payment for lost wages

  3. Deductions ‘for’ AGI • Trade or business deductions • Moving expenses (with limitations) • Net Capital Losses up to $3,000 • Alimony paid (but not child support) • 50% of self-employment tax paid and 40% of a self-employed person’s medical insurance premiums • Net operating loss deduction • IRA contributions • Up to $2,500 of post-secondary tuition, phased out for higher income taxpayers

  4. Itemized Deductions • Medical expenses • Payments to health care practitioners, medical facilities, insurance premiums, medical aids, prescription drugs • Only unreimbursed costs • Deductible in excess of 7.5% of AGI • Charitable contributions • Cash or FMV of property contributed to a qualified tax-exempt organization • Subject to many limitations • deduction for gifts to public charities may not exceed 50% of AGI

  5. Itemized Deductions continued • Interest Deductions • Trade or business interest deducted for AGI • Investment interest expense • Deduction limited to amount of net investment income • Qualified residence interest • Deduction limited to interest on up to $1 million of acquisition debt plus $100,000 of home equity debt • Available for a primary and one secondary residence

  6. Itemized Deductions continued • Taxes • Income taxes • State, local, and foreign, NOT federal • Real property taxes • Personal property taxes based on value • Other state, local and foreign business-related taxes deducted for AGI • What common tax we all pay is not deductible?

  7. Itemized Deductions continued • Personal Casualty and Theft losses • A casualty loss is a loss of property caused by some sudden, unusual or unexpected external force, such as a natural disaster • Theft means an illegal taking of property, not just loss due to carelessness • Deduction subject to a $100 per event floor and a reduction of 10% of AGI • Casualty and theft losses of business property deductible for AGI

  8. Itemized Deductions continued • Miscellaneous itemized deductions • Deductible only in excess of 2% of AGI • Include: • Unreimbursed business expenses • Investment expenses • Tax return preparation fees • hobby expenses • Gambling losses • Deductible only against gambling winnings

  9. Other Issues • Use of property for both personal and business-related purposes may introduce considerable complexity into the calculation of individual taxable income • Two common examples: • office in the home • vacation home

  10. Vacation Home • Treatment of income and expenses of a vacation home depends on extent of rental and personal use • If rented 14 or fewer days of year and used personally the remainder of the year, the property is treated as a personal residence. Rental income is not reported and rental expenses are not deductible

  11. Vacation Home continued • If rented more than 14 days: • And used personally for more than 14 days or more than 10% of the number of rental days: • Income reported as taxable • Allocable portion of expenses deductible, limited to rental income • And used personally for less than 14 days or 10% or less than the number of rental days: • Income reported as taxable • Allocable portion of expenses deductible

  12. Sale of Personal Residence • Up to $250,000 ($500,000 MFJ) of gain excluded from taxation • Dwelling must have been owned and used as taxpayer’s principal residence for 2 of last 5 years • Exclusion applies to only one sale every 2 years • Reduced exclusion available if sold due to change in employment, health reasons, or unforeseen circumstances • Reduced exclusion = maximum X lesser of ownership period exclusion or time since prior sale two years

  13. Tax Subsidies for Higher Education • Tax credits • HOPE scholarship credit • Lifetime learning credit • Interest rules • Exclude from income interest earned on Series EE savings bonds used for tuition and fees • Itemized deduction allowed for interest paid on qualified education loans • Education savings account • Maximum nondeductible contribution of $2,000 per year • Withdrawals nontaxable if used for beneficiary’s education expenses

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