This course is the first course in a five-course US Federal Tax Specialization. It covers and focuses on the U.S. federal tax system as it relates to individuals, employees, and sole proprietors. Key concepts covered include gross income and items that are statutorily included or excluded in it, personal and business expenses that qualify as tax deductions, and the differing tax treatments for employees versus self-employed taxpayers. Unlike many other introductory courses in tax and as part of this course’s comprehensive wrap-up, learners will be provided with practical and tangible experience reporting both income and expenses on the main individual tax return used in the US, Form 1040. If you have enjoyed this course, consider enrolling in our online graduate Accounting program. The University of Illinois at Urbana-Champaign, consistently ranked as one of the nation's top three accounting programs, now offers a master’s in accounting at a very affordable tuition rate and is completely online. The iMSA is a full Master of Accountancy program and students graduate with an MS that is highly recognized. Try an open course or two, then apply for admission into the credit-bearing version as you may be eligible to take credit-bearing courses during the application process. If you are missing any prerequisites for the full degree, you can complete Coursera courses to demonstrate readiness and strengthen your application for the iMSA. For more information on this exciting iMSA online program, refer to this link: https://www.coursera.org/degrees/imsa
Municipal Bond Interest, Gifts, Life Insurance Proceeds
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From the course by University of Illinois at Urbana-Champaign
Federal Taxation I: Individuals, Employees, and Sole Proprietors
6 ratings
University of Illinois at Urbana-Champaign
Federal Taxation I: Individuals, Employees, and Sole Proprietors
6 ratings
From the lesson
MODULE 4: GROSS INCOME: EXCLUSIONS
In this module, you will take a deeper dive into gross income, specifically regarding statutory exclusions. Congress, the Courts, and the IRS allow exclusions of money or property received by the taxpayer for various reasons.
Meet the Instructors
Petro Lisowsky, PhD, CPAAssociate Professor of Accountancy
College of Business: Department of Accountancy
Welcome back. So far, we've looked at items that are includable in gross income. In this video, we'll begin looking at items that are excludable from gross income or, exclusions, income that's not subject to tax. Recall that section 61 of the Internal Revenue Code states that, except as otherwise stated, gross income means all income from whatever source derived. That is, taxpayers should assume everything is income and thus must report that income on the tax return as such unless Congress has said that the item is not income. Exclusions fall into this, as otherwise stated, portion of Section 61. Exclusions appear in code sections 101-150, as well as are scattered around the code. Exclusions are modified to reflect new court decisions and to respond to specific events. For example, in the previous set of videos, we learned that during the Great Recession, Congress allowed individuals to exclude the first $2400 of their unemployment compensation from income. Therefore, this $2400 was an exclusion that responded to economic hardships. However, subsequent legislation removed this exclusion such that unemployment compensation is now fully includable in gross income. In this video, we'll look at various exclusion items including municipal bond interest income, gifts received, and life insurance proceeds. Let's start with municipal bond interest income. First, let's define it. Municipal bond interest income is interest earned on state, county, municipal, or other local bonds. For example, the city of Chicago might issue bonds in order to pay for new schools or roads. What happens when an individual receives the interest payments from the city of Chicago bonds? Well, the interest on these local bonds is excludable from federal gross income. Note that the interest is excludable but might be includable on one's state tax return. Because the municipal bond interest income is excluded from gross income, then any expenses incurred in earning that income is not deductible. For example, if you pay a fee to an investment adviser to manage your portfolio of municipal bonds, then the fees charged by the adviser are not deductible. This is an example of symmetric tax treatment. Because the interest is already tax-free, Congress will not also allow a deduction. That is a double tax benefit. On the other hand, if the interest is taxable or includable in the gross income, then the costs associated with generating that income is indeed deductible. If you pay your adviser to manage your portfolio of corporate bonds, those fees are deductible against your interest income. Also, note that the exclusion does not apply to the gains on the sale of the tax-exempt bonds. That is, if you sell the city of Chicago bond for more than what you paid for it, that gain is still includable and subject to federal income tax just like the gain on the stock would be. It's just the interest that's tax-free. Finally, interest on most U.S. government bonds, foreign government bonds, and corporate bonds as well as interest from your bank account are not excluded from gross income. Taxpayers must include this interest in their gross income and it will be subject to tax. Another important federal exclusion is when a person receives a gift or an inheritance. Congress allows the recipient of a gift or inheritance to exclude the value of the property from his or her own gross income. This applies to gifts made during the life of the donor, that is, inter vivos gifts, as well as the gifts made after the death of the donor in the case of a bequeath or inheritance. What qualifies as a gift? Well, a gift has to be a voluntary transfer of property from one person to another without adequate consideration or compensation. This means that if the payment, from one person to another, is for compensation related to services rendered or payment for a product, then the payment is not actually a gift. In fact, in this case, the payment is not a gift even if the payment is made without a legal obligation and even if the payer receives no economic benefit from the transfer. Bottom line, a gift has to be made out of affection, respect, admiration, charity, or like impulses. When you make a gift, you will not expect to receive anything in return. And, if you receive a gift, you are not obliged to perform a service or deliver a good after receiving the gift. Here's an interesting example of this concept at work. There was a U.S. Supreme Court decision in 1960 called Commissioner versus Duberstein. Here, Duberstein was an individual taxpayer and gave to a business acquaintance, upon request, the names of potential customers. The information was valuable, so the corporation reciprocated and gave Duberstein a Cadillac automobile. And, in fact, the corporation deducted the costs of the Cadillac on his tax return as a business expense. However, Duberstein did not include the value of the car on his personal tax return because he interpreted the Cadillac as a gift and did not even expect any compensation for helping his business acquaintance. However, Duberstein did accept the automobile. The U.S. Tax Court, supported by the Supreme Court, decided that the car was not actually a gift excludable from gross income. The Supreme Court concluded, "Despite the characterization of the transfer of the Cadillac by the parties (as a gift) and absence any obligation, even of a moral nature, to make it, it was at the bottom of a recompense for Duberstein's past service, or an inducement for him to be of further service in the future." The lesson here is that, if there is an exchange of property or services between two individuals, it looks like a transaction not a gift. Because with a gift, the recipient's of the gift is not required or should not be required to give anything in return for the gift. The third income exclusion relates to life insurance proceeds. The general rule here is that income received by a beneficiary upon the death of a person with life insurance will be excludable from the beneficiary's income. That means that if an owner cancels a life insurance policy and receives the value of the policy, gain must be recognized to the extent the amount received exceeds the basis represented by the premiums paid on the policy. In fact, no losses are recognised here. Definitely asymmetric treatment, taxed on the upside if you liquidate but no deduction on the downside if you liquidate. Now, there are a few exceptions here where the insured person doesn't necessarily need to die before having tax-free access to the funds within the policy. If the insured person is drawing on the insurance policy before death and the reason is related to medical hardship, then the federal tax law will allow tax-free access and use of the funds while the insured person is still alive. If the owner of the policy is terminally ill, any gains on the cash surrender value of the policy or the transfer of the policy to a third party is excluded from gross income. Here, a person is considered terminal if a medical doctor certifies that a person has an illness that will reasonably cause death within 24 months. In this situation, the person can use the funds for whatever they like, tax-free. They can spend it on their medical care or on something else. If the policy owner is chronically ill, that is, a doctor certifies that the person is unable to perform some daily activities without assistance, then there is also no gain on the proceeds. They are excluded from gross income but only if those proceeds are used for the long-term care of the insured. For example, if a person has emphysema and has trouble with daily activities, the person can cash out their life insurance policy and the proceeds will be tax-free if the person uses the proceeds for care such as paying for oxygen treatments or a nurse. In all municipal bond, interest income, gifts received, and life insurance proceeds are important examples of items excludable from federal gross income.
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