Intermediate Other Income

Chapter 1
What is income? All income, from whatever source derived. This could be cash or property, from all worldwide sources.

Which of the following best describes gross income?
All income earned from working in the U.S.
All worldwide income from all sources.
All income earned from investments outside the U.S.
All income earned in the country of which the client holds citizenship.

Which of the following statements is accurate
Only the receipt of cash is considered income.
Only the receipt of cash in exchange for services is considered income
The receipt of cash or property may be considered income.
Only the receipt of cash which is deposited in a bank account is considered income

What income is not taxable? Items specifically excluded, such as life insurance proceeds, gifts and inheritances, compensation for personal injury.

Which of the following is not included in gross income?
Income not specifically referenced in the Internal Revenue Code.
Income not taxable under state law
Any income from a country with which the U.S. has a valid tax treaty.
Income exempted by the Internal Revenue Code

In 2008, Kathy received the following: $36,700 wages from her job; $300 interest from her regular savings account; $150 interest from her regular checking account; $4,800 child support from her ex-husband. What is Kathy's gross income for 2008?
$36,700
$37,150
$41,500
$41,950

Some income is not taxable but still must be reported. Example: a client purchases a painting for $500 and sells it for $500 a year later. The sale does not result in income but still must be reported.

In 2006, Kevin purchased a painting for $1,500. In 2008, Kevin sold the painting for $1,500. Which of the following is correct?
Kevin has $1,500 of income from the sale and must report it on his 2008 tax return.
Kevin has no income from the sale, but he must report the sale on his 2008 tax return
Kevin has no income from the sale and therefore does not need to report it on his 2008 tax return.
Kevin effectively traded the painting for the money and since he came out even, he has no income from the sale and does not need to report it.

Earned income is in exchange for services performed; unearned income is everything else.

Which of the following is considered earned income?
Wages
Interest on a municipal bond
Rental income
Child support

Disability Pensions are generally reported as income. Until the client reaches the minimum retirement age for the plan, disability pension income is reported as wages received (earned income for EIC purposes). When the client reaches retirement age according to the plan, the pension will be reported as a normal pension.
For the purpose of accurately reporting disability pension income received under an employer-paid plan, what is “minimum retirement age”?
The age at which the client could begin drawing social security benefits
The age at which the client could first have received a pension from the employer if the client was not disabled.
The age at which the client qualifies for full retirement benefits from the employer.
The age at which the client fully vests in the employer-sponsored retirement plan.

Until the client reaches minimum retirement age, how are disability pension payments received under a plan paid for by the employer reported?
As wage income
As pension income
As social security income
As other income

Social Security Disability income is the same as other Social Security for tax purposes.

Other Miscellaneous Receipts: other types of income may be taxable, such as:

• Bartering Income: FMV of goods or services received is taxable, probably Sch. C.
• Canceled Debts: if debt is forgiven, there may be income from the cancellation.
• Credit Card Insurance Payments: payments received are taxable, IRS says you can subtract current year premiums from taxable amount.

Gifts, Life Insurance Proceeds, Inheritances, and Welfare/Public Assistance are not taxable.


Chapter 2:

Recoveries:
A recovery is a return of an amount for which a deduction or credit was taken in an earlier year. The most common recovery is a state tax refund. The recovery may be taxable income, but the taxable amount is limited to the extent by which the original deduction or credit created a tax benefit in the earlier year. Interest paid on any recovery should be reported as taxable interest income.

How should the client treat interest received on any recovery item?
If the recovery is taxable, interest paid on the recovery is taxable.
If the recovery is partially taxable, interest paid on recovery is pro-rated based on the taxable portion of the recovery.
Interest paid on any recovery is taxable and must be reported as interest income in the year received.
Interest paid on the recovery should be included in the amount of the recovery which is taxable.

Hobby Income:
Some activities that produce a profit may be considered as hobbies. The general rule is that an activity is presumed to be for profit if it was profitable in three of the last five years. However, the specifics of each case should be considered. If a determination cannot be made at the beginning of an activity, the client may file a 5213 to postpone the decision, but we do not recommend this.

The Nine Profit Factors

1. Businesslike Manner
2. Expertise
3. Time and Effort
4. Expectation of Appreciation
5. Success in Other Activities
   
6. History of Income and Losses
7. Occasional Profits
8. Dependency on Income
9. Element of Personal Pleasure

If an activity is considered a hobby, income should be reported on form 1040, line 21. Expenses are claimed, to the extent of income reported, on Schedule A as a Miscellaneous Deduction (subject to 2% AGI limit).

Hobby expenses claimed fall into three categories (apply in this order, to the extent of hobby income reported):
Category 1: deductions that could be claimed as personal deductions otherwise (mortgage interest, real estate taxes)
Category 2: deductions that do not affect the basis of assets (regular business expenses)
Category 3: deductions that decrease the basis of assets (depreciation)

How should a client report expenses associated with a hobby activity?
Hobby expenses to the extent of hobby income are deducted as a miscellaneous itemized deduction on Form 1040, Schedule A.
Subtract the expenses from any hobby income and report the net income.
Income and expenses from a hobby do not need to be reported.
Hobby expenses should be reported on Form 1040, Schedule C.

Intermediate Other Income

A few other items in the Pub 17 that are not covered in the class (see also Pub 525 for a much longer list):

Credit Card insurance: Benefits paid during the year that are more than premiums paid during the year. (Text for the class is not clear on this.)

Peace of Mind payments are taxable. They are reported to the client on a 1099-Misc as other income, should be reported on line 21.

Jury Duty pay is taxable. In Jefferson County, the pay is usually $5 per day (plus $7.50 not taxable to cover parking and lunch). If you must turn the pay over to your employer, the turned over amount is deductible on line 36.

Host or Hostess: If you host a party at which sales are made, any gift you receive for giving the party is a payment for helping a direct seller make sales. You must report it as income at its FMV. Your expenses for hosting are subject to the 50% limit for meals and entertainment and can be deducted on Schedule A, Miscellaneous Deductions (subject to the 2% AGI limit) up to the amount of income reported from this activity.

Also in this category is a free tour from travel agency, if it is given in exchange for you recruiting other paid customers on the trip.

Fees for Services: generally taxable income. Examples: Executor of an estate, election precinct official, notary public.

Alaska Permanent Fund Income: given to Alaska residents, they'll get a statement for it

Bribes: yes, you must report bribes as income

Campaign Contributions received: only taxable if diverted for personal use

Illegal Activites: income from illegal activities must be reported. On Schedule C if this is your business.

Stolen property: you must include the value of property you steal as income unless you return it to its owner in the same year.

Found Property: report FMV as income when you have free title to property

Cash Rebates, such as rebate by mail for the purchase of a computer system, are not income, but reduce your basis in the property.

Employee Awards: should be on your W-2 if taxable. Raffle type prizes are taxable, but service awards are not, unless worth over $1600.

Kickbacks: incentive amounts from businesses are taxable. Example: if you as a car salesperson refer your clients to a certain car insurance company and get cash incentives, these are taxable. If this is part of your regular business, it may need to go on a Schedule C.

Foster Care providers: Generally not taxable.

Court Awards and Damages
A court award (legal settlement) is very likely taxable, but it depends on the reason for the award.

Taxable awards:

• compensation for lost wages or profit
• punitive damages
• in settlement of pension rights
• back pay
• attorney fees (if the underlying award is included in income)

Non-taxable awards:

• awards for physical sickness or injury
• awards for emotional injury or distress

For most taxable legal awards, you may deduct your legal fees on Schedule A, miscellaneous deductions (subject to 2%).

In the case of unlawful discrimination, you may be able to net out the legal fees. This provision includes all workplace discrimination, such as racial and gender discrimination, as well as whistleblowers. To do this on a tax return (first verify with the client and attorney that the award qualifies for this tax treatment) report the full gross award on line 21, and the legal expenses on line 36.

Intermediate Cancellation of Debt 2009 Chapter Summaries

Intermediate Cancellation of Debt 2009

Chapter 1

Cancellation of Debt occurs when a lender/seller cancels or forgives a debt. Generally, the debtor/buyer will have taxable income from a cancellation of debt.

Recourse vs. Nonrecourse debt:

• Recourse debt occurs when the buyer is personally responsible for the full amount of the debt, even if the property that secures it is worth less than the debt. With recourse debt, the lender may be able to collect any shortfall (deficiency) from the buyer’s other assets and income. If the buyer does not collect the deficiency, the cancelled amount is income from cancellation of debt.

• Nonrecourse debt occurs when the buyer is only responsible for the debt up to the value of whatever property secures the debt. If there is a deficiency, the lender cannot collect from other assets or income of the buyer, and there will be no income from cancellation of debt.

Cancelled debt is reported to the buyer on Form 1099-C. If the debt is personal debt, the tax preparer will report it on form 1040, line 21. If the debt is business debt, it would be reported on the business form (Schedule C, E, or F most often.)

In a foreclosure or other surrender of property, there may be debt that is not satisfied by the value of the property. If the debt is recourse debt and the seller does not collect this deficiency from the buyer, there will be ordinary income from the cancelled debt.

A buyer may also have cancelled debt from unsecured debt such as credit cards or student loans. This debt is usually ordinary income from cancellation of debt.




Exceptions and Exclusions:

Exceptions:

• Gift: if the debt is cancelled as a gift, no income is recognized
• Deductible debt: if the debt would have been deductible if paid, no income is recognized
• Purchase price reduction: buyer is solver, but seller reduces purchase price and forgives part of the debt from the original purchase
• Nonrecourse debt
• Student loans: There are some programs that allow student loan debt to be forgiven for students who work in certain states in specific professions. If the terms of the forgiveness program are met, no income is recognized. (Kentucky has Best in Care and Best in Class)

Exclusions (must be applied in this order):

• Debt cancelled in Title 11 bankruptcy**
• Debt cancelled when the buyer is insolvent (has more debts than assets), excludible to the extent of insolvency
• Qualified Midwestern disaster area indebtedness
• Qualified farm indebtedness
• Qualified real property business debt
• Qualified principal residence indebtedness

**Chapters 7, 11, and 13 bankruptcies all fall under Title 11. Chapter 11 is most often used for businesses. Chapter 13 has a pay-down plan; Chapter 7 is usually a write-off.

Reporting Cancellation of Debt

Form 1099-A: If a client has a foreclosure Form 1099-A that shows recourse debt and a FMV less than the outstanding debt amount, there may be cancellation of debt income. If the client has not also received a Form 1099-C, you may need to research to determine whether the deficiency is still owed or has been cancelled.


Form 1099-C: Debts of $600 or more than are cancelled should generate a Form 1099-C. This includes personal debt, student loan debt, and secured/real property debt.

Remember the Recourse/Nonrecourse rule: if cancelled debt is recourse, there is income. If cancelled debt is nonrecourse, there is no income.

Purchase Price Reduction vs. Loan Workout:
This is an exception to the nonrecourse rule!

• Situation 1: lender (who is also property seller) agrees to reduce purchase price after the sale is final, reduction of debt is not taxable income to buyer. This is a Purchase Price Reduction.
• Situation 2: lender (who is not property seller) agrees to reduce debt amount after sale is final, reduction of debt is taxable to buyer even if nonrecourse. This is a Loan Workout or Loan Restructuring.

Chapter 2

Reduction of Tax Attributes and/or Basis

If any income from cancellation of debt will be excluded, the taxpayer’s tax attributes must be reduced, using Form 982.

Tax attributes are certain deductions and credit carryovers that reduce either taxable income or tax liability.

Tax attributes are reduced in a certain order, depending on the reason for the exclusion.

Bankruptcy, Insolvency, and Midwestern Disaster Area indebtedness:
If the only tax attributes are personal property basis, reduce the basis in personal property. If there are other tax attributes, reduce them in this order:

1. Net Operating Loss (NOL) (NOL from year of discharge first, then carryovers)
2. General business credit carryovers
3. Minimum tax credit
4. Net capital losses
5. Basis of property (other than money)
6. Passive activity loss or credit carryovers
7. Foreign tax credit carryovers

Election to Reduce Basis First:
A taxpayer may elect to reduce basis in depreciable property before reducing other tax attributes. This basis reduction will be treated as depreciation claimed when the property is sold or disposed of.

Principal Residence: If the taxpayer is using the qualified principal residence exclusion to exclude cancellation of debt income and the taxpayer continues to own the home, their basis of the residence must be reduced by the amount of excluded income.

Forms and worksheets:
Statement of Income from Discharge of Indebtedness is used to figure taxable income from the discharge of indebtedness in bankruptcy or insolvency, or as qualified farm indebtedness.

• Note: Our Peace of Mind claims department will require this statement for all returns that have a claim due to cancelled debt, even if the taxpayer was not insolvent.

Form 982 is used to reduce tax attributes (in order) after exclusion amount is determined on the Statement of Income from Discharge of Indebtedness.

Insolvency
A taxpayer is insolvent if his/her debts exceed his/her assets immediately preceding the discharge of debt. (Also known as “negative net worth”.)


Special Rules for Mortgage Debt Forgiveness:

• Under the 2007 Mortgage Forgiveness Debt Relief Act, there are special tax breaks for home owners who have mortgage debt forgiven. If qualified, a taxpayer may exclude cancellation of debt income that would otherwise be taxed.
• Tax relief only applies to purchase price plus cost of improvements.
• Principal residence only (no vacation homes or business property).
• Not permanent: only applies in 2007, 2008 and 2009.
• Limited to $2 million.
• When this relief is applied, taxpayer’s basis in the property is reduced by the excluded amount.

Intermediate Cancellation of Debt 2009 Q

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