Gross Income

August 30, 2024

677 / Are Social Security and railroad retirement benefits taxable?

<div class="Section1"> Under certain circumstances, a portion of Social Security benefits and tier 1 railroad retirement benefits may be taxable. If a taxpayer’s modified adjusted gross income plus one-half of the Social Security benefits (including tier I railroad retirement benefits) received during the taxable year exceeds certain base amounts, then a portion of the benefits are includible in gross income as ordinary income. “Modified adjusted gross income” is a taxpayer’s adjusted gross income (disregarding foreign income, savings bonds, adoption assistance program exclusions, the deductions for education loan interest and for qualified tuition and related expenses) plus any tax-exempt interest income received or accrued during the taxable year.<a href="#_ftn1" name="_ftnref1">1</a>A taxpayer whose modified adjusted gross income plus one-half of his or her Social Security benefits exceed a base amount is required to include in gross income the lesser of (a) 50 percent of the excess of such combined income over the base amount, or (b) 50 percent of the Social Security benefits received during the taxable year.<a href="#_ftn2" name="_ftnref2">2</a> The “base amount” is $32,000 for married taxpayers filing jointly, $25,000 for unmarried taxpayers, and zero ($0) for married taxpayers filing separately who have not lived apart for the entire taxable year.<a href="#_ftn3" name="_ftnref3">3</a> In addition to the initial tier of taxation discussed above, a percentage of Social Security benefits that exceed an adjusted base amount will be includable in a taxpayer’s gross income. The “adjusted base amount” is $44,000 for married taxpayers filing jointly, $34,000 for unmarried taxpayers, and zero ($0) for married individuals filing separately who did not live apart for the entire taxable year.<a href="#_ftn4" name="_ftnref4">4</a> If a taxpayer’s modified adjusted gross income plus one-half of his or her Social Security benefits exceed the adjusted base amount, his or her gross income will include the lesser of (a) 85 percent of the Social Security benefits received during the year, or (b) the sum of – (i) 85 percent of the excess over the adjusted base amount, plus (ii) the smaller of – (A) the amount that is includable under the initial tier of taxation, or (B) $4,500 (single taxpayers) or $6,000 (married taxpayers filing jointly).<a href="#_ftn5" name="_ftnref5">5</a> <blockquote>Example 1. A married couple files a joint return. During the taxable year, they received $12,000 in Social Security benefits and had a modified adjusted gross income of $35,000 ($28,000 plus $7,000 of tax-exempt interest income). Their modified adjusted gross income plus one-half of their Social Security benefits [$35,000 + (½ of $12,000) = $41,000] is greater than the applicable base amount of $32,000 but less than the applicable adjusted base amount of $44,000; therefore, $4,500 [the lesser of one-half of their benefits ($6,000) or one-half of the excess of $41,000 over the base amount (½ × ($41,000 – $32,000), or $4,500)] is included in gross income. Example 2. During the taxable year, a single individual had a modified adjusted gross income of $33,000 and received $8,000 in Social Security benefits. His modified adjusted gross income plus one-half of his Social Security benefits [$33,000 + (½ of $8,000) = $37,000] is greater than the applicable adjusted base amount of $34,000. Thus, $6,550 [the lesser of 85 percent of his benefits ($6,800), or 85 percent of the excess of $37,000 over the adjusted base amount (85 percent × ($37,000 – $34,000), or $2,550) plus the lesser of $4,000 (the amount includable under the initial tier of taxation) or $4,500] is included in gross income.</blockquote> An election is available that permits a taxpayer to treat a lump sum payment of benefits as received in the year to which the benefits are attributable.<a href="#_ftn6" name="_ftnref6">6</a> Reductions of Social Security Benefits that do not Reduce the Amount Included in the Computation of Taxable Benefits Workers’ compensation pay that reduced the amount of Social Security received and any amounts withheld from a taxpayer’s Social Security benefits to pay Medicare insurance premiums do not reduce the amount that are included in the computation of taxable Social Security benefits.<a href="#_ftn7" name="_ftnref7">7</a> In Green v. Comm.,<a href="#_ftn8" name="_ftnref8">8</a> the taxpayer argued that his Social Security disability benefits were excludable from gross income<a href="#_ftn9" name="_ftnref9">9</a> because they had been paid in lieu of workers’ compensation. Thus, they should not be included in the computation of taxable Social Security benefits. The Tax Court determined, however, that Title II of the Social Security Act is not a form of workers’ compensation. Instead, the Act allows for disability payments to individuals regardless of employment. Consequently, the taxpayer’s Social Security disability benefits were includable in gross income. Similarly, in a case of first impression, the Tax Court held that a taxpayer’s Social Security disability insurance benefits (payable as a result of the taxpayer’s disability due to lung cancer caused from exposure to Agent Orange during his Vietnam combat service) were includable in gross income under IRC Section 86 and not excludable under IRC Section 104(a)(4). The court reasoned that Social Security disability insurance benefits do not take into consideration the nature or cause of the individual’s disability. Eligibility for purposes of Social Security disability benefits is determined on the basis of the individual’s prior work record, not the cause of the disability. Moreover, the amount of Social Security disability payments is computed under a formula that does not consider the nature or extent of the injury. Consequently, because the taxpayer’s Social Security disability insurance benefits were not paid for personal injury or sickness in military service within the meaning of IRC Section 104(a)(4), the benefits were not excluded from gross income under IRC Section 104(a)(4).<a href="#_ftn10" name="_ftnref10">10</a> Railroad retirement benefits (other than Tier I benefits) are taxed in the same way as benefits received under a qualified pension or profit sharing plan. For this purpose, the Tier II portion of the taxes imposed on employees and employee representatives is treated as an employee contribution, while the Tier II portion of the taxes imposed on employers is treated as an employer contribution.<a href="#_ftn11" name="_ftnref11">11</a> </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 86(b)(2). <a href="#_ftnref2" name="_ftn2">2</a>. IRC § 86(a)(1). <a href="#_ftnref3" name="_ftn3">3</a>. IRC § 86(c)(1). In a Tax Court case, the term “live apart” means living in separate residences. In that case, the taxpayer lived in the same residence as his spouse for at least thirty days during the tax year in question (even though maintaining separate bedrooms). The Tax Court ruled that he did not “live apart” from his spouse at all times during the year; therefore, the taxpayer’s base amount was zero. McAdams v. Commissioner, 118 TC 373 (2002). <a href="#_ftnref4" name="_ftn4">4</a>. IRC § 86(c)(2). <a href="#_ftnref5" name="_ftn5">5</a>. IRC § 86(a)(2). <a href="#_ftnref6" name="_ftn6">6</a>. IRC § 86(e). <a href="#_ftnref7" name="_ftn7">7</a>. Rev. Rul. 84-173, 1984-2 CB 16. <a href="#_ftnref8" name="_ftn8">8</a>. TC Memo 2006-39. <a href="#_ftnref9" name="_ftn9">9</a>. Under IRC § 104(a)(1). <a href="#_ftnref10" name="_ftn10">10</a>. Reimels v. Commissioner, 123 TC 245 (2004), aff’d, 436 F.3d 344 (2d Cir. 2006); Haar v. Commissioner, 78 TC 864, 866 (1982), aff’d, 709 F.2d 1206 (8th Cir. 1983), followed. <a href="#_ftnref11" name="_ftn11">11</a>. See IRC § 72(r)(1). </div>

June 14, 2024

698 / What is a “capital asset”?

<div class="Section1">For tax purposes, a “capital asset” is any property that, in the hands of the taxpayer, is not: (1) property (including inventory and stock in trade) held primarily for sale to customers; (2) real or depreciable property used in his trade or business; (3) copyrights and literary, musical, or artistic compositions (or similar properties) created by the taxpayer, or merely owned by him, if his tax basis in the property is determined (other than by reason of IRC Section 1022, which governs the basis determination of inherited property) by reference to the creator’s tax basis; (4) letters, memoranda, and similar properties produced by or for the taxpayer, or merely owned by him, if his tax basis is determined by reference to the tax basis of such producer or recipient; (5) accounts or notes receivable acquired in his trade or business for services rendered or sales of property described in (1), above; (6) certain publications of the United States government; (7) any commodities derivative financial instrument held by a commodities derivatives dealer; (8) any hedging instrument that is clearly identified as such by the required time; and (9) supplies of a type regularly used or consumed by the taxpayer in the ordinary course of his trade or business.<a href="#_ftn1" name="_ftnref1">1</a><div class="Section1"> Generally, any property held as an investment is a capital asset, except that rental real estate is generally not a capital asset because it is treated as a trade or business asset (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7791">7791</a>).<a href="#_ftn2" name="_ftnref2">2</a> </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 1221; Treas. Reg. § 1.1221-1. <a href="#_ftnref2" name="_ftn2">2</a>. See IRS Pub. 544. </div></div>

June 14, 2024

661 / Who is taxed on the income from property that is transferred to a minor under a uniform “Gifts to Minors” act?

<div class="Section1"> As a general rule, the income is taxable to the minor. However, in the case of unearned income (such as trust income) of most children under age nineteen (age 24, if the child is a full-time student), different rules may apply. Prior to 2018 and after 2019, the unearned income taxable to the child generally is taxed at the parents’ marginal rate when it exceeds $2,700 (in 2025, $2,600 in 2024, $2,500 in 2023, $2,300 in 2022 and $2,200 in 2015 to 2021, as adjusted for inflation).<a href="#_ftn1" name="_ftnref1">1</a> <hr /> Planning Point: Taxpayers had the option of applying a different set of rules in 2018 and 2019 under the 2017 tax reform legislation. If the election was made, earned income of minors would be taxed according to the individual income tax rates prescribed for single filers,<a href="#_ftn2" name="_ftnref2">2</a> and unearned income of minors would be taxed according to the applicable tax bracket that would apply if the income was that of a trust or estate (for both income that is subject to ordinary income tax rates and in determining the capital gains rate that will apply if long-term capital gains treatment is appropriate).<a href="#_ftn3" name="_ftnref3">3</a> <hr /> To the extent that income from the transferred property is used for the minor’s support, it may be taxed to the person who is legally obligated to support the minor.<a href="#_ftn4" name="_ftnref4">4</a> State laws differ as to a parent’s obligation to support. The income will be taxable to the parent only to the extent that it is actually used to discharge or satisfy the parent’s obligation under state law.<a href="#_ftn5" name="_ftnref5">5</a> The 2017 Tax Act aimed to simplify the treatment of unearned income of minors by applying the tax rates that apply to trusts and estates to this income. The SECURE Act<a href="#_ftn6" name="_ftnref6">6</a> repealed this rule for tax years beginning in 2020 and thereafter. For 2018 and 2019, taxpayers had the option of electing which set of rules to apply, and may apply for refunds if appropriate for these tax years. </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. Rev. Proc. 2021-45, Rev. Proc. 2022-38, Rev. Proc. 2023-34, Rev. Proc. 2024-40. <a href="#_ftnref2" name="_ftn2">2</a>. IRC § 1(j)(4)(B). <a href="#_ftnref3" name="_ftn3">3</a>. IRC § 1(j)(4). <a href="#_ftnref4" name="_ftn4">4</a>. Rev. Rul. 56-484, 1956-2 CB 23; Rev. Rul. 59-357, 1959-2 CB 212. <a href="#_ftnref5" name="_ftn5">5</a>. IRC § 677(b). <a href="#_ftnref6" name="_ftn6">6</a>. PL 116-94, 133 Stat. 2534 (12-20-2019) </div>

March 13, 2024

673 / What are the results if an installment sale between related parties is cancelled or payment is forgiven?

<div class="Section1">If an installment sale between related parties is canceled or payment is forgiven, the seller must recognize gain in an amount equal to the difference between the fair market value of the obligation on the date of cancellation (but in no event less than the face amount of the obligation) and the seller’s basis in the obligation.<a href="#_ftn1" name="_ftnref1">1</a> The seller’s basis in the obligation is the difference between the face value of the obligation less the amount of income that would be includible in gross income had the obligation been actually satisfied.<a href="#_ftn2" name="_ftnref2">2</a> <blockquote>Example: Asher sells a tractor to Samuel for $10,000 with an adjusted basis of $2,000. In exchange, Samuel conveys five installment notes ($2,000 each). Asher’s gross profit ratio would be 80 percent (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="666">666</a>) meaning that 80 percent of each payment would be included in gross income ($1,600) and 20 percent ($400) would be tax-free return of basis. Therefore, each note would have a basis of $400 ($2,000 face value less $1,600 income). So, if Asher were to forgive a $2,000 installment note, he would recognize a gain of $1,600 (the difference between the face amount of the note and his basis in the note). In other words, a forgiven note is essentially taxed in the same way as it would have been had the seller actually received payment.</blockquote> <div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 453B(f). <a href="#_ftnref2" name="_ftn2">2</a>. IRC § 453B(b). </div></div>

March 13, 2024

684 / Is a rollover from one education savings account to another permitted?

<div class="Section1">A rollover from one ESA to another ESA is not treated as a distribution (that would be potentially taxable) provided the beneficiaries of both ESAs are the same, or members of the same family. The new beneficiary must be under 30 years old as of the date of such distribution or change, except in the case of a special needs beneficiary.<a href="#_ftn1" name="_ftnref1">1</a> The rollover contribution must be made no later than 60 days after the date of the distribution from the original ESA. However, no more than one rollover may be made from an ESA during any 12-month period.<a href="#_ftn2" name="_ftnref2">2</a> Similarly, the beneficiary of an ESA may be changed without taxation or penalty if the new beneficiary is a member of the family of the previous ESA beneficiary and has not attained age 30 or is a special needs beneficiary.<a href="#_ftn3" name="_ftnref3">3</a> Transfer of an individual’s interest in an ESA can be made from one spouse to another pursuant to a divorce (or upon the death of a spouse) without changing the character of the ESA.<a href="#_ftn4" name="_ftnref4">4</a> Likewise, non-spouse survivors who acquire an original beneficiary’s interest in an ESA upon the death of the beneficiary will be treated as the original beneficiary of the ESA as long as the new beneficiary is a family member of the original beneficiary.<a href="#_ftn5" name="_ftnref5">5</a></div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 530(b)(1). <a href="#_ftnref2" name="_ftn2">2</a>. IRC § 530(d)(5). <a href="#_ftnref3" name="_ftn3">3</a>. IRC §§ 530(b)(1), 530(d)(6). <a href="#_ftnref4" name="_ftn4">4</a>. IRC § 530(d)(7). <a href="#_ftnref5" name="_ftn5">5</a>. IRC § 530(d)(7). </div>

March 13, 2024

693 / What is the tax basis of property that is acquired by purchase or exchange?

<div class="Section1">A taxpayer’s tax basis in property acquired by purchase or in a taxable exchange is its cost (money paid or the fair market value exchanged).<a href="#_ftn1" name="_ftnref1">1</a><div class="Section1"> Special rules apply to stock exchanges made pursuant to a plan of corporate reorganization.<a href="#_ftn2" name="_ftnref2">2</a> For the final regulations under IRC Section 358 providing guidance regarding the determination of the basis of stock or securities received in exchange for, or with respect to, stock or securities in certain transactions, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7517">7517</a>. For the rules applicable to stock received in a demutualization, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7517">7517</a>. Proposed regulations relating to redemptions of stock in which the redemption proceeds are treated as a dividend distribution have been withdrawn.<a href="#_ftn3" name="_ftnref3">3</a> </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 1012. <a href="#_ftnref2" name="_ftn2">2</a>. See IRC § 354. <a href="#_ftnref3" name="_ftn3">3</a>. See 71 Fed. Reg. 20044 (4-19-2006). </div></div>

March 13, 2024

697 / What is the tax basis of property acquired from a spouse or incident to a divorce?

<div class="Section1">Where property is transferred between spouses, or former spouses incident to a divorce, after July 18, 1984 pursuant to an instrument in effect after that date, the transferee’s basis in the property is generally the adjusted basis of the property in the hands of the transferor immediately before the transfer and no gain or loss is recognized at the time of transfer (unless, under certain circumstances, the property is transferred in trust).<a href="#_ftn1" name="_ftnref1">1</a> These rules may apply to transfers made after 1983 if both parties elect.<a href="#_ftn2" name="_ftnref2">2</a> See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="789">789</a> regarding transfers incident to divorce.<div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>. IRC §§ 453B(g), 1041; Temp. Treas. Reg. § 1.1041-1T, A-1. <a href="#_ftnref2" name="_ftn2">2</a>. Temp. Treas. Reg. § 1.1041-1T, A-16. </div></div>

March 13, 2024

658 / What is an insurance premium rebate?

An insurance premium rebate, which is illegal in most states, is a transaction in which a life insurance agent returns all or a portion of a commission to the purchaser, or simply pays the policy’s first-year premium without contribution from the purchaser. The transaction is economically feasible to the insurance agent because the commission, allowance and/or bonus paid by the insurance company to the agent for the sale of the policy often exceeds the policy premium. As a result, the purchaser may ultimately receive free or less expensive life insurance coverage. See Q <a href="javascript:void(0)" class="accordion-cross-reference" id="659">659</a> and Q <a href="javascript:void(0)" class="accordion-cross-reference" id="660">660</a> for the tax consequences of insurance premium rebating to the insurance agent and the purchaser, respectively.

March 13, 2024

695 / How is the tax basis of property acquired by gift determined?

<div class="Section1">If the property was acquired by gift after 1920, the basis for determining gain is generally the same as in the hands of the donor. However, in the case of property acquired by gift after September 1, 1958 and before 1977, this basis may be increased by the amount of any gift tax paid, but total basis may not exceed the fair market value of the property at the time of gift. In the case of property received by gift after 1976, the donee takes the donor’s basis plus a part of the gift tax paid. The added fraction is the amount of the gift tax paid that is attributable to appreciation in the value of the gift over the donor’s basis. The amount of attributable gift tax bears the same ratio to the amount of gift tax paid as net appreciation bears to the value of the gift.<a href="#_ftn1" name="_ftnref1">1</a></div> <div class="Section1"> For the purpose of determining loss, the basis of property acquired by gift after 1920 is the foregoing substituted basis or the fair market value of the property at the time of gift, whichever is lower.<a href="#_ftn2" name="_ftnref2">2</a> As to property acquired by gift before 1921, basis is the fair market value of the property at time of acquisition.<a href="#_ftn3" name="_ftnref3">3</a> </div> <div class="refs"> <hr align="left" size="1" width="33%" /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 1015. <a href="#_ftnref2" name="_ftn2">2</a>. IRC § 1015(a). <a href="#_ftnref3" name="_ftn3">3</a>. IRC § 1015(c). </div>

March 13, 2024

705 / What lower rates apply for qualified dividend income?

<div class="Section1">Under prior law, dividends were treated as ordinary income and, thus, were subject to ordinary income tax rates. Under JGTRRA 2003, “qualified dividend income” (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="706">706</a>) is treated as “net capital gain” ( Q <a href="javascript:void(0)" class="accordion-cross-reference" id="706">706</a>) and is, therefore, subject to capital gains tax rates. This treatment continues after the 2017 tax reform law was enacted, but the income thresholds for determining which rate applies were changed. For capital gains rates, see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="704">704</a>.<div class="Section1"> The preferential treatment of qualified dividends as net capital gains was scheduled to “sunset” (expire) on December 31, 2012, after which time the prior treatment of dividends was to become effective.<a href="#_ftn1" name="_ftnref1">1</a> In other words, dividends were once again to be taxed at ordinary income tax rates. The American Taxpayer Relief Act of 2012 prevented this sunset and made the treatment of qualified dividend income as net capital gain permanent.<a href="#_ftn2" name="_ftnref2">2</a> </div><div class="refs"> <hr align="left" size="1" width="33%"> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 1(h)(1); TIPRA 2005 § 102, amending JGTRRA 2003 § 303. <a href="#_ftnref2" name="_ftn2">2</a>. ATRA 2012, Pub. Law No. 112-240. </div></div>