Gross Income

<div class="Section1"><br /> <br /> 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 <em>exceeds</em> 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) <em>plus</em> 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 <em>lesser</em> of (a) 50 percent of the excess of such combined income over the base amount, <em>or</em> (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><br /> <br /> 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 <em>lesser</em> of (a) 85 percent of the Social Security benefits received during the year, <em>or</em> (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><br /> <blockquote><em>Example 1.</em> 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 <em>base amount</em> of $32,000 but less than the applicable <em>adjusted base amount</em> 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.<br /> <br /> <em>Example 2.</em> 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 <em>adjusted base amount</em> 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><br /> 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><br /> <p style="text-align: center;"><strong>Reductions of Social Security Benefits that do not Reduce the</strong><br /> <strong>Amount Included in the Computation of Taxable Benefits</strong></p><br /> 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><br /> <br /> In <em>Green v. Comm</em>.,<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 <em>not</em> 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.<br /> <br /> 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><br /> <br /> 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><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.   IRC § 86(b)(2).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.   IRC § 86(a)(1).<br /> <br /> <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. <em>McAdams v. Commissioner</em>, 118 TC 373 (2002).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.   IRC § 86(c)(2).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.   IRC § 86(a)(2).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>.   IRC § 86(e).<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>.   Rev. Rul. 84-173, 1984-2 CB 16.<br /> <br /> <a href="#_ftnref8" name="_ftn8">8</a>.   TC Memo 2006-39.<br /> <br /> <a href="#_ftnref9" name="_ftn9">9</a>.   Under IRC § 104(a)(1).<br /> <br /> <a href="#_ftnref10" name="_ftn10">10</a>. <em>Reimels v. Commissioner</em>, 123 TC 245 (2004), <em>aff’d</em>, 436 F.3d 344 (2d Cir. 2006); <em>Haar v. Commissioner</em>, 78 TC 864, 866 (1982), <em>aff’d</em>, 709 F.2d 1206 (8th Cir. 1983), followed.<br /> <br /> <a href="#_ftnref11" name="_ftn11">11</a>.  See IRC § 72(r)(1).<br /> <br /> </div>

<div class="Section1"><br /> <br /> As a general rule, the income is taxable to the minor. However, in the case of <em>unearned</em> 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.<br /> <br /> 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><br /> <br /> <hr /><br /> <br /> <strong>Planning Point:</strong> 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><br /> <br /> <hr /><br /> <br /> 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><br /> <br /> 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.<br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. Rev. Proc. 2021-45, Rev. Proc. 2022-38, Rev. Proc. 2023-34, Rev. Proc. 2024-40.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC § 1(j)(4)(B).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. IRC § 1(j)(4).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>. Rev. Rul. 56-484, 1956-2 CB 23; Rev. Rul. 59-357, 1959-2 CB 212.<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>. IRC § 677(b).<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>. PL 116-94, 133 Stat. 2534 (12-20-2019)<br /> <br /> </div>

<p>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&rsquo;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.</p><br />

<div class="Section1">Under prior law, dividends were treated as ordinary income and, thus, were subject to ordinary income tax rates. Under JGTRRA 2003, &ldquo;qualified dividend income&rdquo; (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="706">706</a>) is treated as &ldquo;net capital gain&rdquo; ( 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"><br /> <br /> The preferential treatment of qualified dividends as net capital gains was scheduled to &ldquo;sunset&rdquo; (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><br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;IRC &sect; 1(h)(1); TIPRA 2005 &sect; 102, <em>amending</em> JGTRRA 2003 &sect; 303.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;ATRA 2012, Pub. Law No. 112-240.<br /> <br /> </div></div><br />

<div class="Section1">Commissions on a life insurance policy purchased by the agent, on the agent’s own life or on the life of another, are taxable to the agent as ordinary income. Such commissions are considered compensation, not a reduction in the cost of the underlying policy.<a href="#_ftn1" name="_ftnref1">¹</a> This rule applies to brokers as well as to other life insurance salesmen.<a href="#_ftn2" name="_ftnref2">²</a></div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. <em>Ostheimer v. U.S.</em>, 264 F.2d 789 (3rd Cir. 1959); Rev. Rul. 55-273, 1955-1 CB 221.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. <em>Commissioner v. Minzer</em>, 279 F.2d 338 (5th Cir. 1960); <em>Bailey v. Commissioner</em>, 41 TC 663 (1964); <em>Mensik v. Commissioner</em>, 37 TC 703 (1962), <em>aff’d</em>, 328 F.2d 147 (7th Cir. 1964).<br /> <br /> </div>

<div class="Section1">Form 1099-DIV contains boxes to allow for the reporting of qualified dividends (Box 1b) and post-May 5, 2003 capital gain distributions (Box 2b). Likewise, boxes have also been added to Form 1099-B for reporting post-May 5, 2003 profits or losses from regulated futures or currency contracts.<a href="#_ftn1" name="_ftnref1">¹</a> Payments made in lieu of dividends (“substitute payments”) are <em>not</em> eligible for the lower rates applicable to qualified dividends.<a href="#_ftn2" name="_ftnref2">²</a> For the information reporting requirements for such payments, see Notice 2003-67;<a href="#_ftn3" name="_ftnref3">³</a> Announcement 2003-75;<a href="#_ftn4" name="_ftnref4">⁴</a> Treasury Regulation Section 1.6045-2(a)(3)(i); TD 9103.<a href="#_ftn5" name="_ftnref5">⁵</a></div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. Announcement 2003-55, 2003-38 IRB 597.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. H.R. Rep. No. 108-94, 108th Cong., 1st Sess. 31 n. 36 (2003).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. 2003-40 IRB 752.<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>. 2003-49 IRB 1195.<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>. 68 Fed. Reg.74847 (Dec. 29, 2003).<br /> <br /> </div>

<div class="Section1"><em>Editor&rsquo;s Note:</em> For tax years beginning after 2017, the nonrecognition treatment provided under IRC Section 1031 is limited to exchanges of real property that is not held primarily for sale.<a href="#_ftn1" name="_ftnref1">¹</a> This provision applies to exchanges occurring after December 31, 2017. An exception existed if either: (1) the property involved in the exchange was disposed of on or before December 31, 2017, or (2) the property received in the exchange was received on or before December 31, 2017.<a href="#_ftn2" name="_ftnref2">²</a> The new rules also provide that real property located within the U.S. and foreign real property are not of a like-kind.<a href="#_ftn3" name="_ftnref3">³</a><div class="Section1"><br /> <br /> <em>Receipt of &ldquo;boot.&rdquo;</em> If the taxpayer receives only like-kind property in the exchange, no taxable gain or loss is reported on his income tax return as a result of the exchange regardless of his tax basis in and value of the respective properties.<a href="#_ftn4" name="_ftnref4">⁴</a> However, if in addition to like-kind property, the taxpayer receives cash or other property that is different in kind or class from the property he transferred (i.e., nonlike-kind property is often referred to as &ldquo;boot&rdquo;), any gain he realizes in the exchange will be taxable to the extent of the sum of the amount of cash and the fair market value of the nonlike-kind property received; any loss realized in such an exchange may <em>not</em> be taken into account in calculating the taxpayer&rsquo;s income tax.<a href="#_ftn5" name="_ftnref5">⁵</a><br /> <br /> If the taxpayer receives only like-kind property, but transfers cash or other nonlike-kind property as part of the exchange, regulations indicate that the nonrecognition rules apply to the like-kind properties, but not to the &ldquo;boot.&rdquo;<a href="#_ftn6" name="_ftnref6">⁶</a><br /> <br /> <em>Recapture</em>. In a like-kind exchange where boot is given or received, the recapture provisions applicable to certain depreciable property apply (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="716">716</a>). If property for which an investment credit was taken is exchanged before the investment credit recapture period ends, a percentage will be recaptured (see Q <a href="javascript:void(0)" class="accordion-cross-reference" id="7893">7893</a>).<a href="#_ftn7" name="_ftnref7">⁷</a><br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp;IRC &sect; 1031(a)(1).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp;IRC &sect; 1031(a)(2).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>.&nbsp;IRC &sect; 1031(h).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>.&nbsp;IRC &sect; 1031(a).<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>.&nbsp;IRC &sect;&sect; 1031(b), 1031(c); Treas. Reg. &sect; 1.1031(b)-1.<br /> <br /> <a href="#_ftnref6" name="_ftn6">6</a>.&nbsp;Treas. Reg. &sect;&sect; 1.1031(a)-1(a)(2), 1.1031(d)-1(e). <em><em>See</em> Allegheny County Auto Mart</em>, 12 TCM (CCH) 427, <em>aff&rsquo;d per curiam</em>, 208 F.2d 693 (3d Cir. 1953); <em>W.H. Hartman Co. v. Commissioner</em>, 20 BTA 302 (1930).<br /> <br /> <a href="#_ftnref7" name="_ftn7">7</a>.&nbsp;IRC &sect; 50(a)(1).<br /> <br /> </div></div><br />

<div class="Section1"><em>Editor’s Note:</em> For tax years beginning after 2017, the nonrecognition treatment provided under IRC Section 1031 is limited to exchanges of real property that is not held primarily for sale.<a href="#_ftn1" name="_ftnref1">¹</a> This provision applies to exchanges occurring after December 31, 2017. An exception existed if either: (1) the property involved in the exchange was disposed of on or before December 31, 2017, or (2) the property received in the exchange was received on or before December 31, 2017.<a href="#_ftn2" name="_ftnref2">²</a> The new rules also provide that real property located within the U.S. and foreign real property are not of a like-kind.<a href="#_ftn3" name="_ftnref3">³</a></div><br /> <div class="Section1"><br /> <br /> The tax basis of like-kind property received in a tax-free (or partially tax-free) like-kind exchange is generally equal to the adjusted tax basis of the like-kind property given. There are, however, two exceptions. First, if an individual transfers cash or nonlike-kind property or assumes a liability of the other party to the exchange (i.e., the transferee) that exceeds the liabilities (if any) assumed by the transferee, the individual’s tax basis in the like-kind property received is equal to his adjusted tax basis in the property given <em>increased by</em> the <em>sum of</em> (1) the amount of cash and the fair market value of nonlike-kind property given and (2) the net liability assumed.<br /> <br /> Second, if liabilities assumed by the transferee exceed the liabilities (if any) assumed by the individual (transferor) and no other cash or boot is transferred by the individual, the individual’s tax basis in the like-kind property he receives is equal to his adjusted tax basis in the like-kind property given <em>decreased by</em> the net amount of liabilities assumed by the transferee.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> The tax basis of any nonlike-kind property received in a like-kind exchange is the fair market value of the nonlike-kind property on the date of the exchange.<a href="#_ftn5" name="_ftnref5">⁵</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 1031(a)(1).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC § 1031(a)(2).<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. IRC § 1031(h).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>. IRC § 1031(d), Treas. Reg. § 1.1031(d)-2.<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>. Treas. Reg. § 1.1031(d)-1(c).<br /> <br /> </div>

<div class="Section1">If distributions from the ESA exceed the amount of the designated beneficiary’s “adjusted qualified education expenses” (qualified education expenses less any tax-free educational assistance) for the year, the recipient will be taxed on a portion of the excess distribution and a portion will be treated as the recovery of “basis.” This is because a portion of the ESA is comprised of after-tax contributions and a portion is comprised of earnings generated by the account. Thus, the latter amount is non-taxable and there is an amount includable in gross income. In determining the taxable portion of an ESA excess distribution, consider the following based on the example in IRS Publication 970:</div><br /> <div class="Section1"><br /> <p style="padding-left: 40px;"><em>Example</em>: In 2024, Asher receives a distribution of $850 from an ESA of which $1,500 had been contributed in 2023. Asher’s qualified education expenses for that year are $700. In 2024, there were no contributions to the account. Because the 2024 distribution was Asher’s first distribution from the account, his basis is $1,500 (the amount contributed). As of December 31, 2024, the balance in the ESA is $950. The taxable portion of Asher’s distribution is computed as follows:</p><br /> <p style="padding-left: 40px;">Step 1 – Determine the basis portion of the distribution. Multiply the amount distributed ($850) by a fraction, the numerator is Asher’s basis in the account at the end of 2023 ($1,500) plus the balance in the account as of December 31, 2022 ($0) and the denominator is the balance of the account as of<br /> December 31, 2023 ($950) plus the amount distributed in 2023 ($850), or</p><br /> <br /> <table style="margin-left: 40px;" border="1" align="center"><br /> <tbody style="padding-left: 40px;"><br /> <tr style="padding-left: 40px;"><br /> <td style="padding-left: 40px;" rowspan="2" width="40"><br /> <p style="text-align: left;">$850 *</p><br /> </td><br /> <td style="text-align: left;" width="52">$1,500</td><br /> <td style="text-align: left;" rowspan="2" width="66">= $708</td><br /> </tr><br /> <tr><br /> <td width="52"><br /> <p style="text-align: left;">$1,800</p><br /> </td><br /> </tr><br /> </tbody><br /> </table><br /> <p style="padding-left: 40px;">Step 2 – Determine the earnings included in the distribution. Subtract the basis portion of the distribution ($708) from the amount of the distribution ($850). $850 minus $708 = $142 (the earnings portion of the distribution),</p><br /> <p style="padding-left: 40px;">Step 3 – Determine the tax-free (return of basis) portion of the distribution. Multiply the earnings portion of the distribution ($142) by a fraction, the numerator is Asher’s 2024 qualified education expenses and the denominator is the total amount distributed to Asher ($850), or</p><br /> <br /> <table style="margin-left: 40px;" border="1" align="center"><br /> <tbody style="padding-left: 40px;"><br /> <tr style="padding-left: 40px;"><br /> <td style="padding-left: 40px;" rowspan="2" width="41">$142 *</td><br /> <td width="32">$700</td><br /> <td rowspan="2" width="140"> = $117 (tax-free earnings)</td><br /> </tr><br /> <tr style="padding-left: 40px;"><br /> <td style="padding-left: 40px;" width="32">$850</td><br /> </tr><br /> </tbody><br /> </table><br /> <p style="padding-left: 40px;">Step 4 – Determine the taxable earnings. Subtract the tax-free earnings ($117) from the earnings portion of the distribution ($142). $142 minus $117 + $25 (the taxable earnings).</p><br /> In addition to income tax, the portion of an ESA includable in gross income is subject to an additional 10 percent penalty tax unless the distribution is (1) made after the death of the beneficiary of the ESA, (2) attributable to the disability of such beneficiary (within the meaning of IRC Section 72(m)(7)), (3) made in an amount equal to a scholarship, allowance, or other payment under IRC Section 25A(g)(2), or (4) includable in income because expenses were reduced by the amount claimed as a Hope Scholarship Credit, Lifetime Learning Credit, or American Opportunity Credit.<a href="#_ftn1" name="_ftnref1">¹</a> The penalty tax also does not apply to any distribution of an excess contribution and the earnings thereon if such contribution and earnings are distributed before the first day of the sixth month of the taxable year following the taxable year in which the contribution was made.<a href="#_ftn2" name="_ftnref2">²</a> However, the earnings are includable in the contributor’s income for the taxable year in which such excess contribution was made.<br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. IRC § 530(d)(4).<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. IRC § 530(d)(4)(C).<br /> <br /> </div>

<div class="Section1">If, before retiring, an insurance agent enters into an irrevocable agreement with the insurance company to receive renewal commissions in level installments over a period of years, only the amount of the annual installment will be taxable each year – instead of the full amount of commissions as they accrue.<a href="#_ftn1" name="_ftnref1">¹</a> Although the <em>Oates</em> case and Revenue Ruling 60-31 concern deferred compensation arrangements during retirement years, the same principle should apply if the agent, during the agent’s lifetime, elects a level commission arrangement for payments after death.</div><br /> <div class="Section1"><br /> <br /> In a private letter ruling, the IRS determined that an insurance agent’s contributions of commissions to his company’s nonqualified deferred compensation plan will not be includable in the agent’s gross income or subject to self-employment tax until actually distributed.<a href="#_ftn2" name="_ftnref2">²</a> In <em>Olmsted</em>, the insurance company, by agreement with the agent, substituted an annuity contract for its obligation to pay future renewal commissions. The Tax Court and the U.S. Court of Appeals for the Eighth Circuit held that the agreement was effective to defer tax until payments were received under the annuity.<a href="#_ftn3" name="_ftnref3">³</a> The IRS did not acquiesce to the <em>Olmsted</em> decision.<a href="#_ftn4" name="_ftnref4">⁴</a><br /> <br /> However, since 2005, IRC Section 409A specifically covers commission compensation of agents as employees and brokers as independent contractors (both of which are referred to as “service providers”) if there is a “deferral of compensation” with the creation of a “nonqualified deferred compensation plan” (even for a single individual). Although <em>additive</em> constructive receipt income tax law that does not replace prior income law and doctrines, Section 409A requires nearly all mandatory and voluntary deferral arrangements for commissions to comply with both the Section 409A written form and operational requirements to achieve and defer income taxation of commissions and other compensation connected to the sale and placement of life insurance and other investments.<br /> <br /> Under the regulations to Section 409A, the initial elections to defer such compensation must specifically be made irrevocable prior to January 1 of the calendar year in which bona fide sales/renewal commissions are earned in the case of sales commissions. In the case of investment commissions based upon the value of assets under management, an irrevocable initial election must be made prior to January 1 of the calendar year in which the date for each 12-month measuring period begins.<a href="#_ftn5" name="_ftnref5">⁵</a><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>. <em>Commissioner v. Oates</em>, 207 F.2d 711 (7th Cir. 1953); Rev. Rul. 60-31, 1960-1 CB 174; Let. Ruls. 9540033, 9245015.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>. Let. Rul. 9609011.<br /> <br /> <a href="#_ftnref3" name="_ftn3">3</a>. <em>Commissioner v. Olmsted Inc. Life Agency</em>, 35 TC 429 (1960), <em>aff’d</em>, 304 F.2d 16 (8th Cir. 1962).<br /> <br /> <a href="#_ftnref4" name="_ftn4">4</a>. Non-acq., 1961-2 CB 6.<br /> <br /> <a href="#_ftnref5" name="_ftn5">5</a>. See specifically, Treas. Reg. §§ 1.409A-2(a)(12)(i)-(iii), and 1.409A-2(b)(9), Examples 7-9. See <em>Keels v. Commissioner,</em> TC Memo 2020-25 (Feb. 19, 2020) in which the deferred compensation plan of State Farm Insurance Company for deferred commissions forms part of the basis of the opinion on a broker’s disputed tax liability. Also see generally IRC § 409A and the regulations thereto.<br /> <br /> </div>