 Hello and welcome to the session in which we would look at the definition of gross income and look at basic concepts when it comes to the IRC the internal revenue code definition. Well, here's the definition pretty straightforward The taxpayer gross income includes all income from whatever source derived unless specifically Execluded. So here's what they're telling us Congress and the IRS says based on our internal revenue code Everything that you receive is income Unless we tell you it's not income So you don't look in the code to determine whether this amount is taxable or not you look to see if it's executed So the definition is all inclusive definition all income Show me it's executed if you can show me in the code. It's executed. It's executed. Otherwise. It's included in this concept Of gross income applies to individual Corporations partnership or a state it's very Inclusive definition so I can give you for example of an income that's executed just to make sure kind of you understand what executed is For example interest on municipal bonds. It's executed if you buy a bond from a local or state municipality You earn interest from that bond the interest on that bond is Execluded as far as the IRS. It's a specifically stated that municipal bond are Execluded now why they're executed when we talk about interest I will discuss why but the point is if it's not explicitly Excluded it's included now the definition is very broad but bear in mind not every amount you receive in cash To be included in your gross income. For example, if you borrowed money from the bank, that's cash But that's not income. Why it's a liability you have to pay it back as it comes do also Income may not be in cash So sometimes you might have income considered income for tax purposes, but it's not cash an example will be bartering Exchange of services. For example, I am a teacher. Well, guess what? I will give you two hours of tutoring in return. You will give me something else. Well, that's an exchange of services I did receive for example, let's assume my hourly rate is one hundred and fifty dollars. Well, I gave you two hours of tutoring That's three hundred dollars. Well, you don't have you don't have three hundred dollars. You gave me your old iPhone I said, okay, that's fine. Well, guess what? I did not receive any cash, but I do have Income under those circumstances I'm sorry exchange of services means let's assume you You painted my house instead or you gave me your phone, which is the fair value of property received So both of these situation no cash exchange hand. Nevertheless, I do have to include the value in my gross income Before we proceed any further. I have a public announcement about my company farhat lectures comm Farhat accounting lectures is a supplemental educational tool That's gonna help you with your CPA exam preparation as well as your accounting courses My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles My accounting courses are aligned with your accounting courses broken down by chapter and topics. My resources consist of Lectures, multiple choice questions, true-false questions, as well as exercises. Go ahead start your free trial today No obligation, no credit card required We need to be aware of something called recovery of capital doctrine or ROC return or return of capital ROC Well, the amount received is not taxable until the taxpayer recovered their original amount their basis How is that applied? For example, when you sell an item if you're in the business of selling product? Well, guess what? You sell an item for ten dollars. You paid for its sex. That's your cost So you are taxed only on the additional four dollars. So first you have to recover your basis So the profit is taxable the four dollar is taxable This concept will see it later on when we deal with sale of capital asset where you have a basis and you only pay Prof you only pay taxes on the gain. Let's actually take a look at an example in year one Celine acquired 1,000 shares of XYZ company for ten dollars per share. Well She paid $10,000 in year four in order to make a down payment on a on a new home Celine sold the 1,000 shares at 22. Well, she sold them when she sold them. She sold them for $22,000. That's good. So amount realized 22 cost basis is 12 or adjusted basis is 12 Celine will have a gain of 12,000 okay, so she took this money. Celine paid the collected 22,000 to her bank. How does this transaction affect her gross income? Only 12,000 is included in gross income because that's the gain realized From the sale and that's the gain. That's that's taxable as well It's worth noting that had Celine borrowed the money She needed to make the down payment. She wouldn't have to report any gain on her gross income So she could have borrowed this money then that that's not taxable. Okay She sold her asset and paid taxes on the difference Recognition of income. What does that mean? It means when do we? record Recognize income you should be familiar with this concept from Financial accounting in general the timing of income depend on the basis. We have cash basis We have a cruel basis and we also have other hybrid basis under the cash basis Well, the receipt of cash triggered the recognition of income. It's cash basis. I receive the cash I have income. Well, if I pay the cash, I have a deduction. I have an expense under the cruel basis of accounting revenue is reported when earned and Expenses are deducted when incurred for income tax purposes tax payer will have to choose their accounting method Usually for it most individuals and small businesses. It's we use the cash method now We're not gonna stop about this topic. But for now, we're gonna stop discussing this Which accounting method that that's gonna have one future lesson later on? Also when talking about income, we have to differentiate What's economic income and what's accounting income because if you understand the difference between economic and accounting income? It's gonna help you understand how the IRS comes up with this income. You have a gross income You have income so let's start with economic income. How is economic income measured? Well, it's the difference between it's the difference between the fair value of your net asset, which is assets not asserts assets Minus liabilities at the beginning of the period as compared at the end of the period Plus value of consumption. So let's assume for the sake of simplicity. I purchased a home for $300,000 At the beginning of the at the beginning of year one at the end of the year. My home is worth $370,000. Well, I have an increase Let's assume home has no more get just simply put to keep it simple So the value of my doesn't have to be a home the value of my net assets started at 300 end up at 370 I have an increase in my wealth of 70,000. That's an increase increase in my wealth That's economic income and let's assume for the sake of illustration. I spent $30,000 in consumption. So My my assets went up in 70. I consumed 30 basically am overall $100,000 better off. Well, we don't use this economic income Just think about it from a practical perspective You have to keep track of your assets your liabilities the difference between them and the value of your consumption It's a big headache. So what do we do? We use accounting income. How do you use accounting income? Well, the income must be realized. So to have an income There's there must be an exchange between two parties and we're assuming those two parties are external parties They're not related party and the amount it is objectively measured think about trying to Measure the fair value of your assets at the beginning of the period versus the end of the period now if you have stocks That's easy Assuming they are publicly traded because you know the price. Let's assume you have car a boat a motorcycle several homes Computers printers. Those are your assets. How are you gonna measure the fair value of those at the end of the period? And this is why it's a big headache Therefore we use the accounting income simply put the accounting income if you realize the income It doesn't matter how it's realized and it can be objectively measured. For example, if an employee embezzles money That's income to the employee. Why because there's an exchange the the exchange of what the employee took the money The income is realized took the money from the other party, of course That's an external party, right and the amount is measured because we know how much the employee embezzled Let's assume you grow a garden and consume the product. That's not taxable. Yes, you grow the garden Now you are better off, but you consume the product. Let's assume you sold Those fruits and vegetables from the garden then the amount is taxable notice once if you consumed it with your family Let's assume you grew it for the sake of illustration 700 worth of fruits and vegetables in your garden and you consume the whole thing So if you went to the market, you'd have to pay 700 you did not you grow it Well, that's fine if you consumed it not taxable if you take that fruit and vegetables and you sell it Let's assume you sell it for 700 you might you know deduct expenses. Whatever is left is Taxable, let's assume you had no expenses for the sake of illustration the whole amount is taxable So if you sold it to a third party, it's taxable Also, we need to be aware of advanced payment because every time we receive cash It doesn't have to be income for now, but the rules are a little bit different advanced payment Is when you receive money for services to be performed later. So what we're talking about here is unearned revenue Or the third revenue. How does it work from tax perspective? Individual taxpayers Receiving advanced payment for future delivery of goods or services again What we are talking about unearned or the third revenue are required to recognize the income in the year in which the cash is received So a little bit different than gap now why The concept is this if you receive the cash It means you have the ability to pay We have something called the ability the ability to pay concept the ability to pay concept means if you have the cash in your hand The irs wants their share you have the money to pay Therefore it's taxable. However, there's small shifting you can defer or shift your income a little bit Taxpayer using a cruel basis of accounting may elect to the third recognition of income up to one year following the tax year So if you're using a cruel basis, you can defer the income but a little bit more Up to the following tax year. Okay, so they give you some leeway Okay, right. He is a guitar instructor. She uses the cruel basis of accounting. Okay, there's some room for deferring income And is a calendar year taxpayer. It means December 31st They elected to defer advanced payment receipt for you for future services to the extent possible So here's the deal on august 15 20x1 she collected five thousand two hundred and fifty 50 for a contract consisting of 100 lessons So the 52 50 If we divide this by 100 each lesson will earn Rod he 52 dollars and 50 cent The lessons are expected to start november year x1 14 less 14 lessons will be held in year one So this is year one And the remaining lessons will be eventually split between year two And year three so What can we do? We receive the money here? Well, since we are Using a cruel if we're not using a cruel if you're using cash basis The whole amount will be taxable here if we're using a cruel the first year what you're going to do You're going to spread that money Over the 14 lessons. Those are the 14 lessons then the remaining They cannot go over year two then the remaining will be which is 100 minus 14 100 minus 14 86 lessons will be in year two now, although some of them in actuality will not deliver them in year three It doesn't matter. Yes, you can defer them but up to one year So make sure you're aware of this and we'll talk about that later We'll we'll have when we talk about accounting method. So should so rod he should report 735 of income which is 14 lessons times 52 dollars and 50 cent The remaining will be reported in year X2 although some of the service will not be provided to x3 You got the money we give you we gave you a little bit of time to defer Up to one year or being very generous. Thank you very much Also, we need to be aware of something called constructive receipt of income Okay, so sometimes what happens is you may not have the money physically but you have access to it This is what the constructive receipt of income is you have to recognize It means include income and your taxes in the period in which the right of the property is obtained If you have the right to the money You you obtained that right as long as there's no substantial restriction It's taxable. Okay restriction means let's let's assume someone gave you a check But the funds are not available in the bank account of the person that gave you the check Well, that's a restriction, but let's let's assume The amount is readily available Well, guess what it's income Let's assume Your favorite company send you a dividend check you invest in a company and they send you a dividend check The check is in the mailbox on December 31st The check in the mailbox and you decided not to walk to the mailbox pick it up and deposit it in the bank Well, guess what that's income Let's assume you have a bank account and interest earned in that bank account You never touched the money the money stayed at the bank It does not matter as long as you can get it. It's called constructive income Also, we need to be aware of a concept called assignment of income Simply put the concept is this The fruit and the three are connected together So the fruit that the the fruit that comes out of the tree belongs to that tree Simply put you cannot assign your income to another individual So the person that earned is the person that paid the taxes Why well If you could assign your income what you will do is you will shift your wages to someone in the family That has a lower tax bracket For example, you will shift your wages to your kid or to your father who who you claim is helping you Well, you can give them the money, but you cannot tell your employer to cut the check to them So you cannot have this shifting of income Also, we need to be aware of something called the tax benefit rule What does that mean? It means if you pay an amount in year one and that amount was deducted in year one a good example will be medical expense So let's assume in year one And we'll talk about medical expenses later. You paid $800 in a particular medical expense now. Don't you know, I'm not gonna get technical here Okay, and you were able to deduct it. In other words, this was a deduction on your taxes Well, guess what in year two You paid this amount and you took the deduction in year two the insurance company reimbursed you the $800 Is the amount $800 taxable? Well, it is taxable if the benefit was realized in year one So if you deducted if this amount was deducted And and you realized a tax deduction you realized a saving because of this $800 Well, let's make it $8000 or $80,000. It doesn't really matter That's made at eight. Let's make it $8000 Well, if you deducted $8000 from those medical expenses and in year two you receive the money Well, guess what it's taxable So if the amount was deducted to the extent that it benefited you it's taxable If the amount was not deducted in year one, then it's not taxable in year two So if you did not take an advantage of that Payment and they gave you the money they basically giving you back your money that you paid The IRS has nothing to do with it because you did not take advantage of that Now about the tax benefit rule, we're going to have a separate session because we need to talk about State and local taxes and sometimes you you may get an advantage You may get advantage means a tax deduction in one year Then you get a refund in year to what do we have to do? So but this is the general idea So all in all here's a list of sources of income that you need to be aware of Income sources include but are not limited to why because unless it's executed, it's included what could be it Compensation for services here. We're talking about w2 business income gain on disposition of property royalty income rental income interest income dividend income elimony payment And we'll talk about those later received under a divorce agreement executed on or before December 31st 2018 annuities Distributive shares of flow through entities seek or partnership bartering in the list is unlimited Now in the next session, I'm going to focus on one thing only and start with w2 Then I'm going to talk about each one of these income separately in a separate session because that's important Now we get we get the big idea now. We need to talk about each income separately What should you do now go to far hat lectures? 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