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Elements Included in Gross Income

Agreement not to Compete


An agreement not to compete is a contract in which one party agree not
compete against the other party by setting-up a competing business or
entering in a similar trade. These agreements are usual between employers
and key employees or between the buy and seller of a business. Any
payment received as consideration for an agreement not to compete is a
part of gross income and is a deduction for AGI for the payer. However for
transaction related to the sale of a business the agreement not to compete
should be separated from the sale transaction. Doing so allows the buyer the
entire amount paid. Otherwise for taxes purpose the consideration will be
treated as the acquiring of an intangible asset and amortized over a 15-year
period.
Gambling Winnings
Gambling winnings are reported on form 1040 as other income and are
taxable. Gambling losses can only be claimed as part as an itemize
deduction from AGI and the amount deducted is limited to the amount of
income from gambling that is being reported.
Hobby Income
A hobby from a tax perspective is different from a trade or business. The
primary motive of a trade or business is to derive profit. Other activities that
sometimes produce income, but for which the primary motive for pursuing
that activity is something other than profit, is treated as a hobby. Income
derived from a hobby is included in gross income, deductions relating to
hobbies are can only be claimed as an itemize deduction and is limited to the
amount of reportable income from the hobby. Further as an itemize
deduction allowable hobby expense is subjected to itemize deduction floor of
2% of AGI. Hobby expenses are group into three categories that determine
the order in which they are deducted.
1. Related expenses that are deductible whether are not they are
connected trade or business.
2. If hobby income exceeds deductions under category 1, then a further
deduction is allowed for hobby losses.
3. If hobby income exceeds the combine deductions in category 1 and 2
then a further deduction is allowed for elements that reduce the basis
of property related to the hobby. These include partial depreciation,
losses related to hobby properties, worthless related investment etc. If
these expenses exceed the remaining balance of hobby income, the
remaining balance is prorated among the properties on the basis of
their fair value.
Remember deductions relating to a hobby is always an itemize deduction
from AGI and the total deduction can never exceed hobby income.

Alimony
Alimony is a series payments made for support of a spouse that are agreed
to as part of a decree of divorce or separation. These receipts are part of
gross income of the recipient and are deductible for AGI by the payer. This
treatment requires that the following conditions be met. Payment should be
in cash and be required under a divorce or separation agreement,; parties
must live in separate resident and not file a joint return; the payments must
cease on the death of the payee, and payment should not be for child
support.
Alimony is recaptured under certain condition. The recaptured amount is
included in the gross income to the payer and is a deduction for AGI for the
receiver. The recaptured amount is subjected to a $15,000 floor. The
recapture rule seeks to prevent front-end loading of payments. To determine
the amount of recapture a three-year test is applied at the end of the third
post separation year. Recapture for the second year is the difference
between year two and year three. If the difference exceeds $15,000 the
excess is recaptured. Year three recapture is the payment in year one less
the average payments of year 1 and 2 to the extent that the difference
exceeds the $15,000 floor. In computing the average, year 2 recapture is
subtracted from year two payments. Total recapture in year 3 is the sum of
year two and year three recapture.
Annuities
An annuity is a series of payments paid at regular interval. Income under an
annuity consists of two components, a tax-free return of the original
investment and a taxable return on the investment. Annuity paid out on the
death of the insured is excluded from the gross income of the beneficiary. For
payouts not relating to the death of the insured a portion of the annual
payment is excluded from gross income. This percentage is determined by
dividing the investment in the contract by the total expected return. For
annuities starting after 1986, the exclusion percentage is applied until the
excluded amount equals the basis of the contract; thereafter all receipts are
included in gross income. The basis of the contract to the taxpayer is the
total amount paid as premium or other consideration. The basis is reduced
by the receipt of dividend or other payment received prior to the start of the
contract. The start of the contract is considered to be the first day of the first
period for which payment is received.
The total expected return depends on the term of the contract. For limited
term contract the expected return is the amount paid per period multiplied
by the number of periods. If the payments are base on life expectancy, then
the expected return is calculated by multiplying the payments by a factor
determined from IRS subscribed accrual tables. There are tables for single
life annuities and joint and survivor annuities. Joint and survivor annuity
tables are base on whether the purchase is joint or is purchase by just one
party and whether the purchasing party is expected to be the surviving
beneficiary.

If the annuity cost is borne by the employer all the derived income of the
employee is taxed. If the employee contributed, the exclusion is limited to
the amount contributed. If annuity payment cease before the contract basis
is fully recovered, unrecovered amounts are allowed as an itemized
deduction on the taxpayer final return.
Some annuities have a guaranteed refund provision. The present value of the
guaranteed amount reduces the basis of the contract. This adjusted amount
is used in the calculation of the exclusion percent. The adjustment is
computed as follows: divide the guaranteed amount by the annual receipt
and round up to the nearest whole year. Determine the percentage refund by
using the value of the Percent by using Value of Refund Feature accrual
table. Apply this percentage to the smaller of the original contract price or
the amount guaranteed. Subtract the computed amount from the original
contract basis. The result is the adjusted basis. Use this amount to calculate
the amount excluded from gross income.
Illegal Transaction
Gross income includes income derived from illegal activities, including an
illegal business. In the case of an illegal business, business expenses are
deductible to the extent that they meet the ordinary, necessary and
reasonable test. However illegal payments or payments related to the
trafficking of a control substance (section 285) is not allowed. Illegal
payments are: One, Kickback and bribes paid to US government officials and
employees, two payment to foreign government official or employees if they
violate use US Foreign Corrupt Practices Act, three bribes and kickbacks that
violate any state or federal law and four bribes and kickbacks that, though
not illegal, are paid by provider of items or services under a Medicare or
Medicaid program.
Awards and Prizes and Rewards
Income derived from prizes and awards from all sources are included in gross
income and is taxed. However the code provides exceptions and relief from
tax if certain conditions are met with respect to awards received from an
employer and scientific and charitable awards and prizes. Scientific and
charitable awards are excluded if the recipient assigns the award to a
charitable or non-tax entity prior to using or benefitting from the award. This
option is only available if two conditions are met. First, the taxpayer must
have been selected with any action on their part, such as applying for the
award and second the award should not commit the recipient to any material
future service obligation.
Employment award falls into two categories, A qualified plan reward and a
non-qualified plan reward. A qualified plan reward must be written and nondiscriminatory to top employees or employees who own 5% or more of the
company. Also the average annual ward should not exceed $400. From
qualified reward plans an amount up to $1600 per individual per year is
excluded from gross income. The excluded amount from a non-qualified plan

is $400 per person per year. It should be noted that with respect to an
individual taxpayer, the total amount of employer award excluded from
income can not exceed $1600 in any given year. If the award is for length of
service its does not qualify if received within the employee first five years or
the employee had received a long-service award in the last four preceding
years. If the plan is deemed discriminatory, then amounts received by highly
paid employees and employees who own more than 5% is fully taxed. This
does not change the tax status of regular employees. Management and
administrative employees do not qualify for safety awards.
Insider Profit
Insider profit comes from stock trading that is influence from prior knowledge
of events before these become public and so influence market behavior.
Insider trading is illegal when done by outsiders who improperly gain and
exploit internal company information. Directors and executives also do
insider trading legally when they sell their shares based on their intimate
knowledge of company status. Whatever legal or illegal income derived from
insider trading is included in gross income. However if trading meets the
threshold for being considered a for profit activity or activity for the
production of income then expenses related to the investment is deductible
as an itemized deduction from AGI. These expenses must be incurred for the
production of income, for the maintenance, conservation and management
have property used in the production of income or for the purposes of
calculating tax obligation and/or refund. Annual Investment interest is
deductible but restricted to net investment income.
Back Pay
Back pay is included in gross income in the year constructively received (for
cash basis taxpayers).

Interest Income
Interest income earned is included in gross income. For accrual basis tax
payers interest is accrued and reported as it is earned. For the cash basis
taxpayer interest is taxable when constructively received. For US saving
bonds holder, the cash basis taxpayer may elect to report interest on the
accrual basis. Once this election is made, the taxpayer has to report all us
saving bonds using this method in all subsequent years.
Under certain condition interest is exempt from gross income. Interest on
Municipal or federal bonds are exempt. US saving bonds interest are exempt
if used to meet a qualified education expenses. Qualified expenses must be
related to tuition and fees but does not include books and room and board.
The amount is applied to the expense net of scholarship or any other
reduction received. The taxpayer or a dependent must have incurred these
expenses in the year the bonds were redeemed. If the expense incurred is

greater than the aggregate receipt from the redemption (principal plus
interest) all of the interest in excluded. If the qualified expenses are less than
the aggregate, then the excludable interest is prorated using the formula,
qualified expense/bond proceed * interest amount = excluded interest. This
provision phase out for AGI of $115,750 -$145,750 for married filing jointly
and $77,200 - $92,200 for single and household heads. The phase-out
feature reduces the amount of excluded interest but not to zero. Phase-out
formula: Interest received [interest x excess AGI/dollars in range]. The
dollars in range for 2015 was $15,000 and $30,000 respectively.
The interest expense on qualified student loan is deductible for AGI (above
the line) up to $2,500 for taxpayers with AGI below $65,000 ($130,000 for
joint married filings). The amount is phased out between AGI of $65,000 and
$80,000 ($130,000 - $160,000). The phase out happens in the ratio of the
excess AGI divide by dollars in the phase out range (AGI excess/$15,000
{dollars in range}).
All interest incurred in pursuit of business or trade is deductible for AGI.
Below Market Interest
In below market interest loan transaction, the forgone interest is included in
the lenders gross income and is deductible for the borrower. There are
different types of below the market loans. These are:
Gift loans if qualified as a gift, forgone interest is excluded from
recipient gross income and not deductible to the lender.
Compensation related loans forgone interest treated as
compensation
Corporation/shareholder forgone interest treated as the payment of
dividend that is taxable to the receiver but not deductible as a
business expense.
Other below market loans that materially affect federal tax liability
forgone interest is included in the lender gross income and is
deductible to the borrower. Relief can be had if the taxpayer can show
that the loan does not material affect tax liability.
Forgone interest is the difference between interest computed using a IRS
provided rate and actual interest computed at the stated below market rate.
A loan is considered below market if the discounted present value of the
payments is less than the principal.
Gift Loans between individuals is exempted from this provision if the
aggregate outstanding balance is less than $10,000 and the loan is not a
business loan or used to buy income-producing property, and for
compensations loan and corporate shareholder if the aggregate is less than
$10,000 and the principal reason for the loan is not tax avoidance. Further
the following types of below market loans are exempted:
Loans offered to the public under similar terms
Loans subsidize by federal, state or municipal government
Certain Employee relocation loan

Loan to/from foreigners that is not connected to US business or trade


and not exempted under existing tax treaties.
Loans for which the taxpayer can show that the loan does not material
distort tax obligation.

Bad Debt
The tax treatment for bad debt depends on whether the debt is personal or
business related. A business bad debt is deductible in the year in which it is
becomes partially or fully worthless, while a personal bad debt is only
deductible in the year when it becomes totally worthless. A business bad
debt is deducted for AGI while a personal bad debt is treated as a short-term
capital loss. Monies given to a business in exchange bonds and debenture or
buy shareholders to pay corporate debt are not considered debt but
investment. Cash basis taxpayers can only deducted debts if actual cash is
loss. The specific charge off method is used for all personal bad debts and
most business bad debts. Only small banks and thrift institution is allowed
the reserve method.
If a debt previously treated as bad is later recovered, the recovered amount
is entered into gross income.
Jury Duty Fees
Jury duty fees are included in gross income. Amounts remitted to employers
as compensation for employee absence due to jury duty is deductible from
gross income to the employee.
Bargain Purchase From Employer
A bargain purchase from an employer occurs when an employer transfer
property to the employee at less than it fair value. The difference between
the propertys fair value and the price paid by the employee is treated as
additional compensation and is included in gross income.
Kickbacks
Kickbacks are included in gross income, whether the payment received is
legal or illegal. Illegal kickbacks or kickbacks to provider of items or service
to Medicaid and Medicare are not deductible as business expense.
Bonus
Bonus is taxable income (included in gross income).
Mileage Allowance
Allowance received under an accountable reimbursement plan is not taxed.
An accountable plan is one in which excess payment is refunded to the
employer is not taxed but neither is any deductions allowed in relation to
those travel miles. Other wise Mileage allowance is taxed.
Damages for Breach of Contract

These damages are taxable unless awarded to remedy personal physical


injury.
Military Pay
Military pay is included in gross income. Qualified military benefits are
excluded from gross income.
Buried Treasure
Income derived from buried treasure is taxed.
Notary Fee
Notary fees are treated as compensation for service and are included in
gross income.
Business Income
Business income is included in gross income and taxed. Business income is
reported net of cost of goods sold. Business expenses are deducted for AGI.
Debt Cancellation
Debt cancellation for consideration is included in gross income. Debt
cancellation without consideration is considered a gift and is not included in
the recipient gross income and not deductible by the giver.
Partnership Income
Partnership income is pass through to each partner in accordance with the
partnership agreement and is included in the partners gross income for tax.
This is irrespectively of whether the income is distributed.
Pension and Social Security Benefits
Pension is included in gross income. A portion of social security benefit is
included in gross income when provisional income exceeds $25,000 for
single taxpayer ($32,000 for married filing joint return). The included amount
is the lessor of half the SS benefit received or half of provisional income. If
provisional income exceeds $34,000 for single ($44,000 for married filing
jointly) then the included amount is 85% of the SS benefit received or 85% of
the provisional income plus the smaller of SS included under the lower base
or $4,500 for single and $6,000 for married filing jointly.
Lease Cancellation
Lease cancellation payment received by the landlord is included in gross
income. Lease cancellation payment to tenants is not included in gross
income but treated as a capital gain.
Per Diem Allowance

Per Diem payment is tax if flat amount included in gross income. However
this payment is excluded if payment is equal to or less than the federal rate
and the employee is required to submit an expense report.
Christmas Bonus and Prizes
Christmas bonus and prizes received is included in cross income.
Commission, Professional Fees and Compensation for Personal
Service
All these items are included in gross income.
Punitive Damages
Punitive damages are taxable unless for personal physical injury.
Debt Forgiveness
Debt forgiven for consideration is part of gross income for the amount
forgiven. Debt forgiven without consideration is a non-taxable gift. Exception
for debt forgiveness that is not a gift is forgiveness under chapter 11
bankruptcies or debt discharged because of taxpayer insolvency.
Rents and Directors FEE
Income from both these sources is included in net income. Rent income is
the amount received in consideration for others to use the taxpayers
property. Rental income include the fair value of any property or in kind item
received including if the tenant pays an obligation owed my the land lord. All
necessary, ordinary and reasonable expenses associated with the rental
property are deductible above the line. Prepaid rent is not deductible till due,
rent received in advance is tax immediately (regardless of accounting
method). Deposits are taxed unless they are refundable.
Royalties and Dividends
These are amounts received as payments such as payment for the right to
use intellectual property or gas and mineral rights. Income so derived is
taxed. Expenses are treated as investment expenses, but are deductible
above the line. If the taxpayer is self-employed and is the creator of the
royalty property as if the taxpayer as an operating interest in the property
the expenses are treated as trade and business expenses.
Dividends are included in gross income. Currently dividend is taxed at a top
marginal rate of 20% for taxpayers with GI exceeding $415,200, $439,000
and $44,850 respectively for single, heads of household and married filing
jointly.
Salaries, Wages, Employee Bonus and Severance Pay, Tips and
Gratuities
All these items are included in gross income in the year constructively
received.

Embezzlement Proceed
This is also included in gross income even though illegal. Remember income
from whatever source derived.
Retirement Pay
Included in gross income except for certain reduced uniform service
retirement pay and the excluded amounts relating to social security benefits.
Discounts
Discounts ate included in gross income but qualified employee discount are
excluded. A qualified discount is a none-discriminatory selling price discount
that does not exceed 20% of the sales price. Discounts on business
purchases are treated as adjustment of sales price and is excluded from
gross income.
Estate and Trust Income
Included in gross income
Unemployment and Supplemental unemployment Compensation
Included in gross income
Executors and Other Fees, Gains from Sale of Properties and
Securities
These are included in gross income.
US Saving Bonds Interest
Included in gross income except when used for qualified educational
expense.
Exclusions from Gross Income
Certain Debt Benefits
Gifts and Inheritance
Are excluded from net income. A gift is a transfer of property for no
consideration. Ownership control must pass to the receiver and the giver is
not allowed a deduction.

Interest on State and Local Bonds


Interest on these items is excluded and interest incurred to by these and
other tax-exempt property is not deductible.
Compensation for Injuries and sickness
Compensations for personal physical injury and sickness is excluded from
gross income. These include damages and insurance receipts as well
proceeds from accident and health plans.
Employer Contribution to Accident and Health Plans
These are excluded from the employee gross income and are deductible to
the employer. The plan can be individual or group and can cover the
employees dependents and spouse. The portion of the plan that covers
more than health or accident is taxed, if paid by the employer.
Rental value of Parsonage
The home provided to a minister of the gospel as compensation or rent
allowance used exclusively for renting a home that does not exceed the fair
value of the home is excluded from gross income (26 U.S. Code 107 Rental value of parsonages | US Law | LII / Legal Information Institute ).
Income From Discharge of Indebtedness
Excluded if under chapter 11 or when the taxpayer is insolvent, limited to the
amount of the insolvency.
Improvement by Lessee on Lessor Property
This is excluded from the Lessors gross income unless the improvement is
the responsibility of the lessor or done in lieu of rent. If so the fair value of
the improvement is income to the lessee.
Qualified Lessee Construction Allowance
Receipts of lessee from a landlord or the amounts received as rent reduction
are excluded from gross income if the total receipt or reduction is used to
improve retail space under a short-term lease or to improve qualified
property under long-term lease. The property must be used for trade or
business of the lessee (26 U.S. Code 110 - Qualified lessee construction
allowances for short-term leases | US Law | LII / Legal Information Institute ).

Recovery of Tax Benefits


Recovery of items previously deducted is included in gross income, limited to
the amount of the deduction.
Armed Force Combat Zone Compensation and Reduce Uniform
Service Retirement Pay
Certain combat pay is excluded from gross income.
Income of State and Municipalities
These are tax-exempt entities.
Qualified Scholarship
A qualified scholarship is one received by a degree candidate. These receipts
are excluded from GI to the extent that they are use to pay tuition or course
related expense such as books, supplies and equipment. Room and board is
not allowed. A non-degree candidate must include scholarship receipt in GI.
Contribution to the Capital of Corporation
Capital contributions received by a corporate entity are not included in the
corporations GI.
Meals and Lodgings
Meals and lodging provided to employees are excluded from GI if provided
for the convenience of the employer. Meals must be on the employers
property and lodging must be a job requirement.
Qualified Group Legal Service Plan
The value of legal service received under such a plan and the amounts paid
on behalf of the employee and his dependents is excluded from GI. The plan
should be written and non-discriminatory. Benefits to significant employees
or owner employees with more than 5% stake should not exceed 25% (this
include benefits to spouse and dependents).
Gain on Sale of Principal Residence
Gain on sale of principal residence is excluded from GI up $500,000 or
$250,000 for married filing separate return.

Cafeteria Plans and Certain Fringe Benefits


This is a menu of qualified fringe benefits or cash payment provided by an
employer and the employee is allowed to choice benefits from the menu.
These benefits are excluded from GI but if the employee chooses cash the
cash is included in GI. Statutory and qualified fringe benefits are also
excluded from GI. Statutory are those specifically exempted in the code. The
code also mandated the treatment of certain qualified non-statutory fringe
benefits that are excluded from GI. Example no additional service, qualified
employee discount, working condition fringe benefit and de minimis fringe
benefits.
Educational Assistance Program
A qualified educational plan is non-discriminatory, written and requires the
employer to keep records and file a return with respect to the plan. Games
and hobbies are excluded unless it is the business of the employer. Benefits
to highly paid employees or employee owning more than 5% should not
exceed 5%. Benefit received under such a plan is excluded from GI up to
$5,250. This amount should be books, tuition and supplies. Transportation
and meals are excluded as well cost of supplies retained after the completion
of the course. Benefits can be paid directly, reimbursed to the employee or
the education can be provided by the employer.

(26 U.S. Code 110 - Qualified lessee construction allowances for short-term
leases | US Law | LII / Legal Information Institute )