Week Three Problem Set

Week Three Problem Set

Determining whether income is included or excluded from gross income takes into account the all-inclusive definition of income, which specifies all income is included from whatever source derived unless a tax provision indicates otherwise (Spilker, et al., 2010). Once gross income has been determined, deductions directly and indirectly related to business activities, and deductions subsidizing specific activities are analyzed to calculate adjusted gross income (AGI). Such deductions are commonly referred to as for AGI deductions. To reach the next important reference point in the tax formula, taxpayers reduce their AGI by deductions from AGI to determine taxable income. The following comprehensive problems depict transactions effecting gross income, adjusted gross income, and taxable business income for three separate taxpayer groups.

Comprehensive Problem 67 (Ch. 5)

Ken is a single taxpayer and although retired, he is still very active. His reported financial information was used in determining his 2009 gross income, which was calculated as $58,000. Relevant information related to each reported transaction is as follows:

a) Gross income includes income from all sources; both legal and illegal. Therefore, Ken’s $1,200 gain from the illegal game of poker is included as a component of gross income.

b) Consistent with the return of capital principle, taxpayers are allowed to recover their tax basis before realizing any gain when disposing of an asset. Thus, Ken’s gain from selling 1,000 shares of stocks is $1,000 as depicted in Table 1:

Ken's Stock Sale

Sales proceeds ($32 x 1,000 shares) $32,000

Less: Tax basis (investment) in property sold ($31 x 1,000 shares) 31,000

Gain (Loss) on sale $1,000

Table 1. Stock Gain (Loss) Calculation

c) An annuity is an investment type that pays a stream of equal payments over time. The tax law deems a portion of each annuity payment as a nontaxable return of capital and the remainder as gross income (Spilker, et al., 2010). Table 2 depicts Ken’s gross income per annuity payment.

Annuity Income

Description Amount Explanation

Investment in annuity contract $210,000

Number of payments 20

Return of capital per payment 10,500 (1)/(2)

Amount of each payment 25,000

Gross income per payment 14,500 (4) - (3)

Table 2. Annuity Income Calculation

d) Depending upon the amount