REGULATION 1 Individual Taxation

Gross Income
(Adjustments) deductions to arrive at AGI
Adjusted Gross Income AGI
(standard or itemized deductions) The greater
(Exemptions)
Taxable Income
x Tax rate equals
Federal Income Tax the regular tax or/and the AMT tax (alternative minimum tax)
(Tax credits)
other taxes
(payments)
Tax due or refund

General Rule: Must file tax return if income equal or greater than sum of:

personal exemption + standard deduction + additional standard deduction for over 65 or blind

Exceptions:
1- net earnings from self employment are $400 or more
2- can be claimed as dependents on another taxpayer's return, have unearned income, and gross income of
$950 or more
3- receive advance payments of earned income

Filing and paying due date: April 15

there is automatic six month extension (until October 15) for filing but not for paying any owed tax. the
extension is granted but still requested to file FORM 4868 by April 15

taxpayers who are out of the country:

out of USA on the filing date and have their principal place of bus. outside of USA or stationed outside USA,
have automatic two month extension to file without the need to file, but must include documentation

Filing Status:
A. Single/End of year test: single or legally separated December 31 decides status
B. Joint Returns/End of year test:
1. married , even if married and living apart, but not legally separated or divorced, (if divorced during the
year, they may not file joint return)
2. if one spouse dies during the year, a joint return may be filed

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C. Married filing separately: they still must report their own income, exemptions, credits, and deductions in a
community property state, most of the income, deductions, credits, etc. , are split 50/50

D. Qualifying widower (surviving spouse)

 In addition to the right to file a joint return for the year in which a spouse dies, for two years after spouse's
death, taxpayer may file as a surviving spouse and thus use the joint tax return standard deduction and
rates for the deceased spouse. The requirements that enable a taxpayer to be classified as a "qualifying
widow(er)" are:
1) The taxpayer's spouse died in one of the two previous years and the taxpayer did not remarry in the
current tax year,
2) The taxpayer has a child who can be claimed as a dependent child or stepchild.
3) This child lived in the taxpayer's home for the whole entire taxable year,
4) The taxpayer paid over half the cost of keeping up a home for the child,
5) The taxpayer could have filed a joint return in the year the spouse died.
unless he or she remarries.

 Note: an exemption for the deceased spouse is available in the year of death but is not available on the
return of the surviving spouse in the two years following death.

E. HEAD OF HOUSEHOLD: entitled for Lower taxes results with those conditions:

1. not married, legally separated , or married and lived apart for the last six months of the year
2. not a qualifying widower
3. not a nonresident alien
4. maintains a household that, for more than half the taxable year, is the principal residence of:
a. a son or daughter (Working Families Act) legally adopted children, stepchildren, and
grandchildren. Example: divorced mom
b. Father or mother (not required to live with provided the taxpayer maintains a home that was
the principal residence for the parent for the entire year)>> means contributing over half the
cost of upkeep. ex. nursing home
c. Dependent relatives (must live with): parents, grandparents, uncles, stepparents, parents in
law.. etc. NOTE: cousins, foster parents and unrelated dependents do NOT qualify

 Required time period for different filing statuses:

W – Widow = Whole year
H – Head of household = Half a year (more than)

Exemptions:
1. Personal Exemptions: an individual is entitled to a personal exemption that is indexed annually.

Remember that you get tested more about the number of the exemptions you are entitled to than the
amount.

 If eligible to be claimed as dependent on another's tax return, will not be allowed a personal
exemption on their own return.
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  for married taxpayers, each spouse receives personal exemption. So, wife and husband filing jointly
get two personal exemptions.
 married taxpayer who file separately is entitled only for his or her own personal exemption unless
the spouse has no gross income and was not claimed as a dependent on another taxpayer.
 if a person is born or dies during the year, he or she is entitled to a personal exemption for the
entire year. Exemptions are not prorated.

2. Dependency Exemptions: a taxpayer is entitled to an exemption for each qualifying child and qualifying
relative. Test first for qualifying child (CARES), then for qualifying relative (SUPORT)

 Qualifying Child: (CARES)

C - close relative: the child must the taxpayer's child, stepchild, brother, sister, stepbrother, stepsister,
or a descendent of any of these, legally adopted child, foster child.

A - Age limit: must be younger than the taxpayer, under age 19 ( or 24 of a full time student). No age
limit for permanently disabled child.

R - Residency and filing requirements: same household as taxpayer for more than half of the tax year
and can't file a joint tax return for the year unless for a refund claim only. (temporary absences due to
special circumstances are not treated as absences).

E - Eliminate gross income test: gross income test (SUPORT) doesn't apply to a qualifying child.
S - Support test changes: If the child didn't contribute more than one half of his support, the taxpayer
(parent) doesn't have to prove that they did.

 Qualifying Relative : (SUPORT)(or friend)

S - support test: the taxpayer must have supplied more than one-half (greater than 50%) of the
support of a person in order to claim him as a dependent. support means the actual expenses incurred
by or on behalf of the dependent.

 Multiple support agreements: If two or more people support more than 50%, only one can
claim the dependent (must contribute more than 10%). and the joint contributors are required
to file a multiple support declaration, form 2120.
 child of divorced parent: the parent who has the custody of the child for the greater part of the
year takes the exemption. If both parents have equal custody, then the one with higher AGI will
take the exemption, unless the custodial parent waives his right (form 8332 is a required written
declaration).

U - Under Exemption amount of taxable gross income: the dependent's taxable gross income should
be less than the exemption amount. (tax free income is ok).
• When doing gross income test, don' t consider non-taxable income Non-Taxable income:
Social Security (low income levels), tax-exempt interest income (state and municipal
interest),tax exempt scholarships
• No income test if meet age limit - CARES
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 P - Precludes dependent filing a joint return: can't claim dependent if they file joint tax return with
someone else, UNLESS the joint return is file solely for a refund or withheld for the taxable year (tax is
zero)
O - Only U.S citizens or residents of U.S/ Canada or Mexico
R - Relative test: does NOT include cousins or foster parents.
OR
T- Taxpayer lives with individual for the whole year IF NOT RELATIVE (cousins and foster parents
are considered non relatives)

 No additional exemption for being over 65 or blind. There is an increased standard deduction.

3. Phase out of personal and dependency exemptions: the items that help reduce tax liability, as
exemptions, standard deductions, tax credits, exclusions from income, itemized deductions, are available
when you are poor but when you get better financially, they start getting phased out.

GROSS INCOME:
Gross Income is the first step to determine tax liability. It means all income from whatever source derived,
UNLESS specifically excluded.

Computation of income: generally income is determined by the amount of cash, property, or services
obtained. in cases of noncash income, the amount of the income is the fair market value of the property or
services received.

General Rule: If a transaction occurs and it is identified as taxable, then we always use the FAIR MARKET
VALUE as the taxable amount, and that fair value become our basis. On the other hand, if there is a
transaction that is identified as non-taxable, then Non taxable means use the old Net book value. it doesn't
change because No income applied here.

Event Income Basis

Taxable = FMV FMV
Non-taxable = NONE NBV

Realization and Recognition: In order to be taxable, the gain must be both realized and recognized
Realized (real world) requires the accrual or receipt of cash, property or services or a sale of exchange.
Recognition (Record/report on tax return): the realized gain must be included on the tax return, i.e. it is
taxable (no provision to permits exclusion or deferral)

Timing of Revenue recognition:

1. Accrual method: recognition is required when earned

2. Cash method: recognition is required when cash or FMV received.

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 ***Whether on cash basis or accrual basis, taxpayers who sell stock and securities in the market must recognize
gains and losses on the trade date.***

Specific Items of Income and Exclusions:

A. Salaries and Wages included in Gross income:
1) Money
2) Property (FMV)
3) Cancelation of debt
4) Bargain purchases: the difference is income
5) Taxable Fringe Benefits (Non-Statutory) fringe benefit is compensation or other benefit provided by
the employer to the employee at no charge. examples include
health plans and life insurance.
The FMV of a fringe benefit not specifically excluded by law is includable in income. ex. personal use
of a company car is included as wages in an employee's income and it is subject to taxes.
6) Partially taxable Fringe benefits: portion of life insurance premiums: Premiums paid by an employer on
a group term life insurance policy covering his employees are not income to the employees up to the
cost on the first $50,000 of coverage per employee (non discriminatory plans only). premiums above
the first $50000 are taxable income to the recipient and normally included in W-2 wages.
7) Non-Taxable Fringe benefits:
a. Life Insurance proceeds: proceeds are the payments of the benefit. i.e. with life insurance it is the death
claim amount paid out.

The proceeds of a life insurance policy paid because of the death of the insured are
excluded from the gross income of the beneficiary. HOWEVER:

1) The interest income element on deferred payout arrangements is fully taxable.

2) accelerated death benefits by a terminally ill insured are not taxable if the proceeds are used to
pay for long term care.
b. Accident, Medical, and Health insurance (employer paid): premium payments are excludable from
the employee's income when the employer paid the insurance premiums.
c. De Minimis fringe benefits: benefits so minimal excluded from income.
d. Meals and lodging by the employer for the convenience of the employer on the employer's
premises.
e. Employer payment of employee's educational expenses up the $5250 may be excluded from gross
income. the exclusion applies to both graduate and undergraduate level education (MBA is ok)
f. Qualified Tuition Reductions at undergraduate level may be excluded from income. At graduate
level, only if students are engaged in teaching or research activities and if the reduction is in
addition to the pay for the teaching or research
g. Qualified employee discounts are excludable from tax income for:
1) Merchandise discounts: limited to the employer's gross profit percentage
2) Service discounts: limited to 20% of the fair market value of the service
3) Employer provided parking: up to $230 ( 2009) per month
4) Transit passes: up to $120 (2009) per month
h. Qualified Pension, profit sharing, and stock bonus plans.
 payments made by the employer are non taxable ex. upon the employer making a
contribution into the employee's 401K is excludible from income . It is taxable when the
employee receive the benefits (when the amount is distributed or made available to the
employee)

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 i. Flexible Spending arrangements (FSAs) allows employees to receive a pre-tax reimbursement of
certain expenses.
A type of savings account available in the United States that provides the account holder with specific tax
advantages. Set up by an employer for an employee, the account allows employees to contribute a portion of their regular
earnings to pay for qualified expenses, such as medical expenses or dependent care expenses.

One of the key benefits of a flexible spending account is that the funds contributed to the account are deducted from the
employee's earnings before they are made subject to payroll taxes. As such, regular contributions to an FSA can significantly
lower an employee's annual tax liabilities.

There are limits to how much can be contributed to an FSA account per year. For medical expense FSA accounts, the limit is
set by the employer, while the specified limit for dependent care accounts is $5,000 per year.

1) Employees can elect to have up to $5000 from their salaries deposited pre-tax into a flexible
spending account
2) Funds not used within 2 1/2 months after the year end or not claimed within a period of
time are forfeited.
j. Economic recovery payments ($250/person) are not taxable

B.INTEREST INCOME:

General Rule: all interest is taxable

1. Taxable interest:
 Federal bonds
 industrial development bonds
 corporate bonds
 premiums received for opening a saving account (prizes and awards) are included at FMV
 part of the proceeds from an installment sale is taxable as interest different
 Interest paid by federal or state government for late payment of tax refund is taxable type of
2. Tax exempt interest: reportable but not taxable state
 State and local government bonds/obligations interest
 Mutual fund dividends for funds invested in tax-free bonds are also tax exempt.
 bonds of a U.S. possession
 Series EE (U.S. savings bond). Usually U.S. savings bonds are taxable but interest is tax exempt
when:
a. EE = used for Educational Expenses (higher education) reduced by tax-free scholarship,
of the taxpayer, spouse, or dependents.
b. There is taxpayer or joint ownership (spouse)
c. Taxpayer is over age 24 when issued
d. they are acquired after 1989
e. phase-out starts when modified AGI exceeds and indexed amount.
 Interest on veterans administration insurance
3. Net Unearned income (ex. interest, dividends) of a child under 18, or under 24 if the child is a full time
student("kiddie tax") is taxed at his parents' higher tax rate but still reported on the child's tax return.

Net unearned income(taxable income) = total unearned income - child's standard deduction of $950 (or
investment expense if greater) - $950 ($1900 in total)

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 2009 child's Tax rate
unearned income
0 - $950 0%
$950 - $1,900 Child's
$1,901 and over Parent's

4. Forfeited interest (adjustment): penalty on withdrawal from savings

 if included as income when earned, then the forfeited interest is deductible as an adjustment in
the year incurred
 don't net with interest income

C. DIVIDEND INCOME:
Source determines taxability:
a. Earnings & profit / Current = By Year End dividend
b. Earnings & profit / Accumulated = Distribution Date
c. Return of Capital = No Earnings and Profits tax free
d. Capital Gain Distributions = No E&P / No Basis subject to favorable tax rate

Three Categories of Dividends

a. Taxable Dividends: all dividends that represent distributions of corporation’s E&P, it is included in gross
income
 Taxable amount (to shareholder receiving) _ Cash = Amount received _ Property = FMV
 Special (lower) tax rate:
o 15% for most taxpayers and 0% for those in the 15% or lower tax bracket
o qualified dividends holding period: Stock must be held for more than 60 days during the 120
day period, beginning 60 days before the ex-dividend dates
b. Tax-free distributions: (when the company has no earnings and profits)
The following are exempt from gross income:
1. Return of capital: company distributes funds but has no earnings and profits. Taxpayer will reduce
General (but not below zero) his basis in common stock held
Rule: 2. Stock split: shareholder will allocate the original basis over the total number of new shares
Non- 3. Stock dividend: UNLESS the shareholder had option to receive cash or property, but chose
taxable dividend, then it will be taxable at FMV. IF no option, just simply received stock dividend:
• Same stock = original basis is divided by total shares
• Different stock = original basis is allocated based on their cumulative FMVs _
4. Life insurance dividend = Dividend caused by ownership of insurance with a mutual
company (premium return). They are just treated as your premium being refunded to you.

C. Capital Gain Distribution: corporation has no earnings and profits, and the shareholder has recovered
his entire basis, then distribution is treated as taxable gross income

D. State and local tax refunds: taxable only if itemized in prior year
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The receipt of a state or local income tax refund in a subsequent year is not taxable if the taxes paid didn't
result in a tax benefit in the prior year.
1. Prior year itemized = taxable state or local refund
2. prior year used standard deduction (form 1040EZ) = non-taxable state or local refund
E. Payments Pursuant to a divorce
1. Alimony/spousal support(income): payments for the support of a spouse are income to the
spouse receiving the payments, and are deductible to arrive at AGI (adjustments) by the
contributing spouse. The following conditions should be met:
 Payments must be legally required
 payments must be in cash(or its equivalent)
 payments can't be extend beyond the death of the payee-spouse
2. Child support: portion of payments made for the support of minor child is not deductible to the
payee and non-taxable to the receiving ex-spouse.
 If the agreement specifies that the payments are to be made for both the alimony and
the support, but the payments fall short, then the payments will be allocated first to the
child support until the entire child support obligation is met then to alimony.
3. Property settlement (non taxable to either parties) This is not alimony
No deductions for payments made for the payee, and not includible in the gross income of the
spouse receiving the payments
F. Business Income or Loss, schedule C or C-EZ : Net income from self-employment is
computed on schedule C, the net income is then transferred to Form 1040 as one amount.
Gross business income - business expenses = profit OR loss self-employed

Farmer reports farming activities on Schedule F

Farming activities treated same as income from other business activities
Cash basis : most farmers use cash basis.
Inventories of produce, livestock, etc. Are NOT considered
Gross income = cash and value of other items received from sale of produce, livestock, etc. Raised by farmer
Accrual method : inventories must be taken at start and end of tax year.
Gross Profit = inventories + sales – inventories at beginning of year – cost of inventory purchased during year

Schedule C for sole-proprietorship (remember it is not for corporation or partnership)

 Gross Income: cash + property at FMV + cancellation of debt

 Expenses: It should be incurred and paid in order to be deductible for cash basis
1. Cost of goods
2. Salaries and commissions paid to others
3. State and local business taxes paid
4. office expenses
5. actual automobile expenses (only the portion used for business) or a standard mileage rate (55
cents/mile in 2009)
6. Business meal and entertainment expenses at 50%
7. Depreciation of business assets

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 8. Interest expense on business loans (note that interest expense paid in advance (prepaid
interest) by a cash basis taxpayer cant' be deducted until the tax year/period to which the
interest relates.. it is paid but not incurred). so, prepaid interest is deducted only if used accrual
method.
9. Employee benefits
10. legal and professional services
11. bad debts actually written off for accrual basis taxpayer only (direct write off method, not
allowance method). Bad debt expense for cash basis taxpayer is not deductible because he
never reported the income.
 Non-deductible expense on Schedule C
1. Salaries paid to the sole proprietor (they are considered "draw")
2. Federal income tax
3. personal portion of
 automobile and travel expenses
 personal meals and entertainment expenses
 Interest expense (this is itemized deduction if for mortgage or investment)
 State and local tax expense (itemized deduction)
 Health insurance of a sole proprietor (it is permitted as an adjustment)
4. bad debt expense of a cash basis taxpayer (since he never reported income)
5. charitable contributions (it is itemized deduction, use schedule A)
NOTE: It is important to only subtract business expenses from business income. Itemized
deductions and/or other adjustments are deducted elsewhere.
Note: Self employment taxes not deductible on Schedule C, they are an adjustment to AGI

 Net business income or loss is taxable

 Net business Income: There are two taxes on net taxable income:
1. Income tax
2. Federal self-employed tax (SE tax)
a. Adjustment to income is allowed for one-half (7.65% up to $102,000 in 2008) of SE tax
b. Sole proprietor can deduct the employer portion of the SE tax
c. All SE income = 2.9% Medicare tax + 12.4% Social Security tax = 15.3%
 Net taxable loss:
A business with a loss may deduct the loss against other sources of income:
o 2 year carry-back
o 2. 20 year carry-forward

Note that as a self-employed person, you pay tax for both the boss and the employee. So, you have to pay
both halves of that matching social security. You are paying twice as much as the normal employee. The extra
half is an adjustment.

** Schedule SE (form 1040) is for self-employment tax

 Uniform Capitalization Rules: Provide guidelines with respect to capitalizing or expensing certain costs.
Capitalize: to include (expenditures)in business accounts as assets instead of expenses.
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(i.e. taxes paid in connection with the acquisition of property are capitalized as part of the property's cost).

* In the first year of implementation, they generally cause an increase ( )in the carrying cost of ending
inventory, and a decrease ( ) in operating expenses. This causes and increase ( ) in taxable income.

*Types of property that the uniform capitalization rules apply to are the following:

a. Produced to use. ex. machine tools for use in the production

b. produced to sale: ex. manufacturer's inventory
c. Acquired for resale: real or tangible personal property acquired by the taxpayer for resale (ex.
retailer's inventory). HOWEVER, the uniform capitalization rules don't apply to inventory acquired
for resale IF the taxpayers average gross receipts for the preceding three tax years don't exceed
$10,000,000 annually ( so it doesn't apply on 2 millions)
 costs Required to be capitalized (expensed when sold):
1. Direct materials
2. direct labor (compensation, vacation pay, and payroll taxes)
3. certain indirect costs (utilities, warehousing costs, repairs, maintenance, indirect labor, rents, storage,
depreciation, insurance , pension, contributions, engineering and design, repackaging, spoilage, and
administrative supplies)

 costs Not required to be capitalized (expensed immediately): selling, advertising, and marketing expenses,
certain general and administrative expenses, research, and officer compensation not attributed to
production services.

For inventory, even a sole proprietor will be required to apply the following rules:
Capitalized as inventory Period expense
expensed Direct materials Selling expensed
when sold Direct labor General immediately
Factory overhead Administrative
Research & development

G. Gains and Losses on Disposition of Property: Gains or loss on the disposition of property is
measured by the difference between the amount realized and the adjusted basis. Gains and losses are given
tax effect (recognized) only when the asset is sold or disposed by other means.

Amount Realized - adjusted basis of assets sold = gain or loss realized

H. IRA (individual retirement accounts) Income when you withdraw the money
 General Rule (taxable when withdrawn): Generally, retirement money can't be withdrawn until the age of
59 1/2 or the individual elects to receive equal periodic distributions over his life expectancy. Required to
start withdrawals by the age of 70 1/2
 Taxation of distribution:

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 1. Traditional deductible IRA distributions (ordinary income): All $$$ is treated as regular
Regular income( regardless of the type: dividends, etc.) It is taxed at regular tax rate
Tax 2. distributions/benefits from Non deductible IRAs:
1. Roth IRA: all qualified benefits non taxable
2. Traditional non deductible IRA: benefits received from a traditional non-deductible IRA are
partially taxable. the principal is non-taxable but the accumulated earnings are taxable.
3. If individual withdraw before age 59 1/2 (premature distribution) then there is 10% penalty tax
additional to the regular tax ULESS the individual has met one of those exceptions:
1. Home buyer (1st time): $10,000 max if used towards first home
2. Insurance (Medical) after unemployment or self-employed
3. Medical expenses in excess of 7.5% of AGI
4. Disability (permanent)
5. Education
6. and
7. Death
I. Annuities (treated like depreciation): partially taxable and partially nontaxable, except when annuitant
outlives life expectancy, then all taxable.

Investment amount Example $60,000 = $230.77 non-taxable from 260 payments

# of months of life expectancy 260 months

** Live longer than actuarial payout period (life expectancy) ---> further payments are fully taxable
** Death before full recovery ---> the unrecovered portion of the investment amount is a miscellaneous
itemized deduction on the annuitant's final income tax return not subject to the 2% of AGI floor.
J. Rental Income (passive activity) : Schedule E is used to compute income and/or loss from:
a. Rental real estate
b. Royalties
c. Partnerships &LLC , S corporations, Estates, Trusts ----> all from schedule K-1
 The basic formula for the determination of net rental income or loss is :

Gross Rental Income

Prepaid Rental Income
Rent Cancellation Payment non-refundable deposits
Improvement in-lieu-of Rent
at FMV <Rental Expenses> instead of making rental payments
Net Rental Income
OR
Net Rental Loss

 Rental of Vacation Home

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  Rented less than 15 days : it is treated as personal residence. The rental income is excluded
from income, mortgage and real estate taxes are allowed as itemized deduction. Depreciation,
utilities, and repairs are NOT deductible
 Rented 15 or more days: If used for personal purposes for the greater of
1) more than 14 days or 2) more than 10% of the rental days ----> then is treated as personal
see
residence.
example
Expenses must be prorated between personal and rental use. However, a different pro-ration
on page
R1-36 method is used for mortgage interest and property taxes.
Rental use expenses are deductible only to the extent of rental income.
Prepaid rent or nonrefundable deposit is taxable when received

 Passive Activity Losses (PALs) : any activity in which the taxpayer doesn't materially participate.
 The rules apply to individuals, estates, trusts, personal service corporations, and closely held C
corporations.
 A net PAL may ONLY be deducted against a passive activities income, NOT against active
income ( wages, salaries, interest, dividends, or capital gains)
 Non-deductible PALs can be carried forward without any time limit unused PAL held in
suspension.
- suspended losses are used to offset passive income in future years.
- suspended losses become fully tax deductible in the year the property is sold/disposed.
- If taxpayer become an active participant (from passive) , unused PAL can be used to offset
active income.
 Exceptions: individual may deduct rental activity losses if either of the 2 conditions are met:
1. Mom & Pop exception --->
 taxpayers may deduct up to $25,000 PAL in rental real estate annually if now actively
participating (not to the extent to avoid passive activity classification)
 Phase out :
* over $100,000 ---> $25,000 allowance is reduced by 50% of excess of taxpayer's AGI (without
consideration of this loss deduction).
*over $150,000 ---> the allowance is eliminated completely
2. Real Estate professional (not passive activity): If the taxpayer is real estate person by
profession, then can deduct full losses against any income IF:
a. More than 50% of taxpayer's personal services during the year are performed in real
property businesses
b. The taxpayer performs more than 750 hours of services in real property businesses
during the year.
K. Unemployment compensation: (don't confuse this with work compensation): A taxpayer must include in
gross income the full amount received.
L.Social Security Income: depends on provisional income (MAGI)
Provisional income = AGI + tax-exempt interest + 50% of social security benefits.
Taxpayers must include in income the lesser of * 50% (or 85%) of SS received or 50% (or 85%) of excess
provisional income over threshold.

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Low Income = (income below single $25,000/MF J $32,000) ---> No social security benefits are taxable
Lower middle income ----> Less than 50% of social security
Middle income = (income up to single $25,000/MF J $32,000) ---> 50% of SS benefits are taxable
upper middle income ---> between 50% -65% of SS benefits are taxable
upper income = (income over single $34,000/MF J $44,000) ---> 85% of SS benefits are taxable

M.Taxable Miscellaneous Income

1. Prizes and awards: taxable at FMV unless given to charity or government.
2. Gambling winning and losses: winnings are included in gross income and losses are deducted to the
extent of gambling winnings. Allowable amount of these losses are deductible on Schedule A as
itemized deduction but are not subject to the 2% of AGI limit.
3. Business recovery: to decide if it is excludible, one must determine " in lieu of what the damages
paid were". if a damage award is compensation for lost profit, the award is income
4. Punitive damages: fully taxable as ordinary income if in business context, loss of personal
reputation, or personal injury.
N. Partially taxable miscellaneous items:
1. scholarships and fellowships: Degree seeking student scholarships and fellowship grants are excludible
only up to amounts actually spent on tuition, fees, books, and supplies, if: taxable:
a. The grant is made to a degree seeking student 1.room & board OR
b. No services are to be performed as a condition to receiving the grant 2. services requested
c. Grant is not made in consideration for past, present, or future services of the grantee
2. Non-degree-seeking student: Scholarships and fellowships are fully taxable at FMV
1.Tuition Reductions: graduate teaching assistants who receive tuition reductions are taxed on the
reduction if it is their only compensation, but not if the reduction is in addition to other taxable
compensation.
O.Nontaxable miscellaneous items:
1. Life Insurance proceeds: Proceeds are non-taxable. Interest income element on deferred payout is
fully taxable. Accelerated death benefits received by chronically ill insured are tax-free if used to
pay for long-term care
2. Gifts and inheritances
3. Medicare benefits
4. workers' compensation received for personal injury or sickness
5. Personal (physical) injury or illness award
6. Accident insurance: If premiums paid by taxpayer, then al payments received are non-taxable.
7. Foreign Earned income Exclusion: up to $91,400 ( 2009) may be excluded if taxpayer meets one of
Modified theAdjusted
followingGross
tests: Income (MAGI), also known as provisional income, includes the
i. Bona Fide Residence Test: is resident of foreign country for the entire taxable year.
following items:
• Any income ii. Physical presence
you excluded test: must
because be present
of the foreign in foreignincome
earned countryexclusion
for 330 full days out of 12
months.
• Any exclusion or deduction you claimed for foreign housing
 the
• Any interest income fromcan't
exclusion series EE the
exceed bonds that you
taxpayer's were earned
foreign able toincome
exclude because
reduced youtaxpayer's
by the paid
qualified higher foreign housing exclusion (max $27,240 in 2009, or 30% of the $91,400 max foreign income
education expenses
exclusion). the amount of excluded income and housing is used to determine the income
• Any deduction you (and
tax rate claimalternative
for student loan interest
minimum or for
tax rate) qualified tuitionfor
the taxpayer andtherelated
year. expenses
• Any employer-paid adoption expense you excluded
• Any deduction you claimed for an annual (non-rollover) contribution to a regular IRA.

In other words, the above items are not taken into account in determining AGI vs. MAGI 13
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