Taxable Income Notes

Taxable Income | Casualty Loss Example

Prizes are taxable income

Scholarships may be excluded

Gifts are not taxable

Inheritance is not taxable

Insurance proceeds are not taxable


Legal settlements are taxable

-unless due to injury or illness



No gain or loss on transfer of property

Alimony is taxable and deductible

Child support is not taxable


Government transfer of wealth

Need based payments is nontaxable

Unemployment is taxable


Social Security

0%, 50% and 85%


Collectible Assets

Gain on sale of capital is taxable

28% for items held over a year

Standard tax rate for less than a year


Personal Expenses

No tax deduction unless:

Medical expense

Local, state and foreign tax



Medical Expenses

Expenses – .075(AGI) = deduction


Local, state and foreign taxes

Can deduct either state and local income tax OR sales tax

Can deduct cost of filing taxes


Example on pg 536

Deducted local property tax


Charity can be deducted up to 50% of AGI

If property is donated:

Long term capital asset deduction is equal to FMV

If not a capital asset, deduction is the lesser of FMV or basis

Tax subsidies

Can excluded interest earned on EE savings bond

Can report qualified tuition expenses as above the line, limited to $4000

–          Not allowed anymore

Can above the line deduction interest on qualified education loans, up to $2500

American Opportunity credit is $2500 based on cost of 4 yr education

Lifetime learning credit is based on 20% tuition expense, up to $2000

CAN NOT claim deduction and credit on the same expenses

Can contribute up to $2000 per yr for tax exempt Coverdell savings acct

Can contribute to tax exempt qualified tuition programs sponsored by the govt


Losses on sales of personal assets

Personal losses is non-deductible


Casualty and theft losses

Lesser of tax basis or decrease in value

Reduced by $100

Reduced by insurance reimbursements



I lost $10,000 on damaged car

Casualty loss = 10,000

Insurance proceeds = (2,000)

Unreimbursed loss = 8,000

$100 floor =                 (100)

Deduction is $7,900


Hobby and gambling

Deduction for expenses is limited to revenue

Miscellaneous deductions subject to 2% limitation

Deduction – .02(AGI) = miscellaneous itemized deduction


Gambling is not classified as miscellaneous and therefore not subject to 2% rule

Losses can be deducted to the extent of gains


Home ownership

Beneficial to own a home










Home mortgage interest deduction

Deduction for mortgage is up to $1 million

Deduction for equity debt is up to $100,000


Example: Mortgage is $600,000

Second mortgage is $120,000

Interest payment is $55,000


Qualifying debt for deduction is: $600,000 and $100,000 = $700,000

($700,000 qualifying debt / $720,000 total debt) x $55,000 = deduction


Can only do this for primary residence and one other residence


Vacation Homes:

If rented out: can deduct expenses of maintaining up to revenue amount

Also allowed depreciation deduction based on the number of rental days

Aggregation of these is limited to gross rents – mortgage interest and prop taxes in rental period



Family uses vacation home on weekends and june and july. Rents it out during August and September


Rent revenue: $6,400

Mortgage interest and prop tax for august and September: $3,505

Maintenance expense for august and September: $3,760

Depreciation for August and September: $1,200


Gross rents:                                        6400

Interest and property tax deduction: (3505)

Equals:                                                 2895

Maintenance deduction:                      (2895)     limited to rents

Depreciation deduction:                      0

Net rental income:                                 0


Gain on sale of residence

Not income if house was used for 2 years of 5.

-exclusion only applies for one sale every 2 years

-limited to $250,000 or $500,000 for mfj



May apply for a 6 month extension for filing taxes

–          Does not extend time to pay taxes

Payments made late is charged an interest by the government

-federal short term rate + 3%



Govt has 45 days to refund excess or else pay interest

Same rate

Corporation overpayment rate depends on size of overpayment

$10,000 or less = short term + 2%

$10,000 or more = short term + .5%


Late filing and late payment penalty

5% of the balance due for each month

Have to pay 5% of balance due + interest

5% rate runs for 5 months and then drops to .5% for up to 45 months


Statute of limitations- just because govt cashes check or mails refund does not mean they certify its accuracy

IRS has 3 years to find mistakes

If an omission is greater than 25% of gross income, IRS has 6 years


Audit Process

DIF score determines which filings are examined


Correspondence exam is easy and over the phone or mail

Office exam is at IRS office conducted by auditor

Field exam is at the home by a revenue agent


Deficiency is difference in what was paid and what was supposed to be paid

Interest charge

Corporations may deduct deficiencies as expense


Taxpayer Bill of Rights- 1989

Bill of Rights 2- 1996

Bill of Rights 3 –

National taxpayer Advocate – aid taxpayers


Noncompliance penalties

People who challenge IRS on basis of legal grounds can be fined $5,000 for frivolous return

Negligence- no effort made to be correct – 20% of understatement fee

Civil fraud- attempt to cheat government- 75% fine on understatement

Criminal Fraud- tax evasion


Tax return preparer penalties

Must sign the tax returns

Include id number

Give clients copies of completed returns

Retain copies

$50 fine for not signing

Max penalty is $25,000

Penalty for messing up w/o excuse is greater of $1,000 or 50% of payment to prepare

If intentional it is $5,000 or greater of 50%




Contesting audit result


Us tax court if taxpayer refuses to pay deficiency

Us court of federal claims or us district court if paid but decides to sue

Jury = district court

May appeal to 13 u.s. circuit court of appeals

May appeal to supreme court

Small Tax case division: deficiency of 50k or less. $60 filing fee


IRS collection procedures

Taxpayer that cannot pay may request an installment agreement

-must accept if payment is under $10,000

-gives 3 years


If taxpayer cannot ever pay they can take an offer in compromise


Innocent spouse rule- protects joint filers

Must be spouse’s fault

Must have not known about incorrect filing

Inequitable to hold souse responsible




Taxable Income | Casualty Loss Example

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