swft2025_v3_ppt_Ch05

Comprehensive
Volume, 48e
Chapter 5: Gross Income:
Exclusions
Young, Persellin, Nellen, Maloney, Cuccia, Lassar, & Cripe, Comprehensive Volume, 48th Edition. © 2025 Cengage. All Rights
Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 1
Icebreaker
1. The class will be broken up into groups.

2. Each group will have five students.
3. Each group will provide its insights on what are the items that are excluded from
gross income.
4. The groups can explain their ideas on the difference between exclusions and items
that are not income.
Chapter Objectives
By the end of this chapter, you should be able to:
• 05.01 Explain the difference between exclusions and items that are not income.
• 05.02 Describe commonly encountered income exclusions.
• 05.03 Determine the extent to which receipts can be excluded under the tax benefit
rule.
• 05.04 Identify tax planning strategies for obtaining the maximum benefit from
exclusions.
The Big Picture (1 of 4)
• Paul is a graduate accounting student and was an intern with a C P A firm this past
summer
− The C P A firm was so pleased with Paul’s work that at the conclusion of his
internship:
 He was given a bonus of $2,500 more than what the firm had agreed to pay
him
 The extra amount was intended to help with his graduate school expenses
 The C P A firm has offered him a full-time job after he completes his graduate
program in December
• Because of his excellent academic record, Paul was awarded with a graduate
assistantship that waives his tuition of $6,000 per semester and pays him $400 per
month
− Paul is required to teach a principles of accounting course each semester
− Paul has used the $400 per month for books and for room and board
In November, Paul was hit by a delivery van. The driver was found to be driving under
the influence of alcohol. Paul suffered a severe injury to his right arm that delayed his
starting date for work by three months. The delivery company’s insurance company
settled the case by paying the following damages:
Compensatory damages:
Medical expenses $ 30,000
Injury to Paul’s right arm 100,000
Pain and suffering 50,000
Loss of income 15,000
Legal fees 25,000
Punitive damages 160,000
$ 380,000
• Paul’s mother was with him in the crosswalk. Fortunately, the van did not hit her,
and she was not physically injured
− She did suffer emotional distress and received $25,000 in the settlement
• Besides being Paul’s friend, you also are a senior accounting major and have a keen
interest in taxation
− You tell Paul that you will look into the tax consequences of the settlement
• Read the chapter and formulate your response
Unit 01
Income Exclusions
Income Exclusions (1 of 2)
• Exclusion – something that should be in the tax base is removed per provisions in
the tax law
• Generally found in Code §§ 101 through 140
• Some exclusions
− Intended as tax relief measures
− To encourage and support certain activities
− Relate to design of the income tax
Income Exclusions (2 of 2)
• Exclusions versus non-income items

− Exclusions apply to specified income items that must constitute income to
possibly warrant an exclusion
 A gift is an income, but it is excluded (and not part of gross income)
− In contrast, borrowings from a bank are not income because there is an
offsetting liability to repay
 A return of capital is an example of something that is not income
Corporate Distributions (1 of 2)
• Payments made to shareholders with respect to their stock
• Distributions are taxed as dividends to shareholders to the extent of payments

made from either current or accumulated earnings and profits
• Distributions in excess of earnings and profits are treated:

− As nontaxable return of capital to the extent of stock basis (which is reduced)
− As capital gain to extent in excess of basis
Corporate Distributions (2 of 2)
• Stock dividends (for example, common stock issued to common shareholders) are
not taxable
− If shareholder has the option to receive stock or cash, the gross income is
taxable whether the shareholder receives cash or stock
Knowledge Check Activity 1
Which of the following is not a characteristic of exclusions?

a. They are intended as tax relief measures.
b. They encourage and support activities such as higher education.
c. They relate to the design of the income tax.
d. They are applicable to non-income items.
Knowledge Check Activity 1: Answer
Which of the following is not a characteristic of exclusions?
Answer: d. They are applicable to non-income items.

Exclusions apply to specified income items. That is, the item must
constitute income to possibly warrant an exclusion.
Unit 02
Gift and Inheritances
Gifts and Inheritances (1 of 3)
• Gifts are nontaxable to donee if:

− Transfer is voluntary without adequate consideration and
− Made out of affection, respect, admiration, charity or like impulses
− It is not intended to be for services rendered
• Inheritances are nontaxable to beneficiary
• Income earned on gifts or inheritances is taxable under normal rules

− Example – Father gifts corporate bond to daughter. Gift is excluded from
daughter’s gross income, but interest income earned after gift date is taxable to
her
• Transfers from employers to employees do not qualify as excludible gifts

− May be excludible under other provisions, for example, employee achievement
awards
− Victims of a qualified disaster who are reimbursed by their employers for living
expenses, funeral expenses, and property damage can exclude the payments
from gross income
• Employee death benefits – Amount paid by employer to deceased employee’s

surviving spouse, children, or other beneficiaries
− If decedent had a nonforfeitable right to payments (example – accrued salary),
amounts are taxable to recipient as if the employee had lived and collected the
payments
• Group-term life insurance – Many employers provide group-term life insurance for
employees in order to provide assistance to the deceased employee’s family
− Employer makes voluntary payments to the family of the deceased employee
 Facts and circumstances must be evaluated to determine if the payments are
a nontaxable gift or additional compensation attributable to the deceased
employee
• Income in respect of a decedent – Income earned by an employee that was not

received by the employee prior to his or her death
− It is not an employee death benefit
− It is taxable income to the decedent’s beneficiary
The Big Picture—Gifts to Employees
• Return to the facts of The Big Picture
• The $1,500 paid to Paul by his summer employer was compensation for his services
rather than a gift
− The payment was most likely not motivated by the employer’s generosity, but as
a result of business considerations
− Even if the payment had been made out of generosity, because the payment
was received from his employer, Paul could not exclude the “gift”
Unit 03
Life Insurance Proceeds
Life Insurance Proceeds (1 of 4)
• Paid to the beneficiary because of the death of the insured are excluded from gross
income
• Chosen to be exempt due to the following:

− Proceeds serve much the same purpose as a nontaxable inheritance
− Replace an economic loss suffered by the business
• Accelerated death benefits

− Gain on cash surrender or transfer of life insurance policy by terminally or
chronically ill individual is excludible
 Exclusion for chronically ill is limited to amounts used for long-term care
• Transfers for valuable consideration

− If policy is transferred for valuable consideration, proceeds are taxable to the
extent they exceed amount paid for policy plus subsequent premiums paid
− Exceptions exist for policy transfers to the following:
 The insured under the policy
 A partner of the insured
• Transfers for valuable consideration

 A partnership in which the insured is a partner
 A corporation in which the insured is an officer or shareholder
 A transferee whose basis in the policy is determined by reference to the
transferor’s basis
Applicable to policies transferred in a tax-free exchange or were received
by gift
• Investment earnings arising from the reinvestment of life insurance proceeds are
generally subject to income tax
− Beneficiary will elect to collect the insurance proceeds in installments
 Annuity rules are used to apportion the installment payment between the
principal element (excludible) and the interest element (includible)
Unit 04
Scholarships
Scholarships (1 of 2)
• An amount paid to or for the benefit of a student to aid in pursuing a degree at an

educational institution
− Nontaxable to the extent of tuition and related expenses (example – fees, books,
supplies, and equipment required for courses)
 Amounts received for room and board are taxable
• University teaching or research assistant is generally considered an employee, and

a stipend is taxable compensation
Scholarships (2 of 2)
• Qualified tuition waivers or reductions by nonprofit educational institutions are

excluded from income
− Generally limited to undergraduate tuition waivers
− Exception for graduate teaching or research assistants
• Scholarship recipient is a cash basis taxpayer who receives the money in one tax
year but pays the educational expenses in a subsequent year
− Amount eligible for exclusion may not be known at the time the money is
received
− Transaction will be held open until the educational expenses are paid
The Big Picture—Compensation For
Services
• Paul was paid $400 a month by the university for teaching

− This is reasonable compensation for his services
• Although he received the assistantship because of his excellent academic record,

the monthly pay of $400 must be included in his gross income (compensation for
his services)
− However, the $6,000 graduate tuition reduction can be excluded from gross
income
Unit 05
Compensation for Injuries, Sickness, and
Disaster Relief
Damages (1 of 3)
• Tax consequences of receipt of damages

− Depends on type of harm the taxpayer experienced
− The taxpayer may seek recovery for:
 Loss of income
 Expenses incurred
 Property destroyed, or
 Personal injury
Damages (2 of 3)
• Tax treatment of damages received for:

− Loss of income
 Generally, taxed the same as the income replaced
Exceptions exist related to personal injury
− Reimbursement for expenses incurred
 Not income, unless the expense was deducted
If the expense was deducted, the damages are generally taxable under the
tax benefit rule
Damages (3 of 3)
• Tax treatment of damages received for:

− Property damaged or destroyed
 Treated as an amount received in a sale or exchange of the property
Thus, the taxpayer has a realized gain if damage payments exceed
property’s basis
− Personal injury
 Receives special treatment under the code
Compensation for Injuries and Sickness (1 of
3)
• Personal injury damages
− Compensatory damages received on account of physical personal injury or
physical sickness are excludible
 Include amounts received for loss of income associated with the physical
personal injury or physical sickness
− All other personal injury damages are taxable
 Compensatory damages for nonphysical injury
 All punitive damages (paid by the person who caused the harm)
3)
• Wrongful incarceration
− Code § 139F, exempts amounts received as damages for being wrongfully
incarcerated
− Exclusion applies to an individual convicted of a Federal or state crime who is
later exonerated
• Workers’ compensation
− State workers’ compensation laws require the employer to pay fixed amounts for
specific job-related injuries
− Although payments are intended to compensate for a loss of future income,
workers’ compensation is specifically excluded from gross income
3)
• Accident and health insurance benefits
− Benefits received under a policy purchased by the taxpayer are excludible:
 Even if the benefits are a substitute for income
− Different rules apply if the accident and health insurance protection was
purchased by the individual’s employer
• Disaster relief benefits

− Qualified disaster relief payment is excluded
− Code § 123 provides an exclusion for insurance payments received by an
individual for living expenses when the individual is not able to use their
principal residence because of damage or destruction related to a casualty or
threat of a casualty
The Big Picture—Damages
• The damages Paul received were awarded as a result of a physical personal injury
− As a result, the compensatory damages can be excluded
− Even the compensation for the loss of income of $15,000 can be excluded
• The punitive damages Paul received, however, must be included in his gross income
• Paul’s mother did not suffer a personal physical injury

− Therefore, the $25,000 she received must be included in her gross income
Unit 06
Employer–Sponsored Accident and Health
Plans
Employer-Sponsored Accident and Health Plans
(1 of 2)
• Premiums paid by employer for insurance coverage of employee, spouse, and
dependents are deductible by the employer and excluded from the employee’s
income
• As per Code § 105(a), employee has includible income when she or he collects the
insurable benefits; two exceptions are provided
− Code § 105(b) generally excludes payments received for medical care of the
employee, spouse and dependents
− Code § 105(c) excludes payments for the permanent loss or the loss of the use
of a member or function of the body or the permanent disfigurement of the
employee, the spouse, or a dependent
Employer-Sponsored Accident and Health Plans
(2 of 2)
• Payments that are a substitute for salary are includible
• Payments received for expenses that do not meet the Code’s definition of medical
care must be included in gross income
• Amounts received for medical expenses that were deducted on a prior return must
be included in gross income
Medical Reimbursement Plans
• One way to provide a medical reimbursement plan for employees is as follows:

− The employer purchases a medical insurance plan with a high deductible and then makes
contributions to the employee’s Health Savings Account (H S A)
 Employer’s contribution to H S A and the earnings on the funds in the account are
excludible
 Contributions limited to 100% of the deductible amount for individual or family
coverage
Monthly deductible amount is limited to one-twelfth of $4,150 for self-only coverage
and one-twelfth of $8,300 for an individual who has family coverage under a high-
deductible plan
− Withdrawals from H S A must be used to reimburse the employee for the medical
expenses paid by the employee that are not covered under the high-deductible plan
Long-Term Care Insurance Benefits
• Employer-paid insurance premiums for employee’s long-term care are excludible

subject to annual limits
− Premiums paid by the employer
− Benefits collected under the employer’s plan
− Benefits collected from the individual’s policy
• Individual who purchases his or her own policy can exclude the benefits from gross
income
• Reduced by any amounts received from other third parties (for example, Medicare,
Medicaid)
Unit 07
Meals and Lodging
Meals and Lodging (1 of 2)
• Not taxable to employee if:

− Furnished by the employer
− On the employer’s business premises
− For the convenience of the employer
 In case of lodging, the employee is required to accept the lodging as a
condition of employment
Meals and Lodging (2 of 2)
− From 2018 through 2025, the employer may only deduct 50% of the cost of the
meals provided (rather than 100%)
 After 2025, employers may not claim any deduction for these meals
− If the employer continues to provide such meals, their value remains as an
exclusion for the employees
− The Regulations define business premises as ‘the place of employment of the
employee’
− The Regulations give examples where the “convenience” test is met
Other Housing Exclusions (1 of 2)
• Campus housing provided by the employer to an employee of an educational

institution
− If the employee pays annual rents equal to or greater than 5 percent of the
appraised value of the facility, it is excluded and other wise, the deficiency must
be included in the gross income
• Ministers of the gospel and other religious leaders can exclude

− The rental value of home furnished as compensation
− Rental allowance paid to them as compensation, to the extent allowance is used
to rent, buy or provide a home
− The rental value of home owned by the minister
Other Housing Exclusions (2 of 2)
• Housing allowance is a compensation for the conduct of religious worship, the

administration and maintenance of religious organizations, or the performance of
teaching and administrative duties at theological seminaries
• Military personnel are allowed housing exclusions under various circumstances
Unit 08
Employee Fringe Benefits
Employee Fringe Benefits (1 of 3)
• Benefits other than wages and salary that are provided to employees by the
employer are often referred to as fringe benefits
• Child and dependent care

− Up to $5,000 per year of care costs paid for by the employer can be excluded
($2,500 if married and filing separately)
• Athletic facilities
− Value of the use of athletic facilities located on the employer’s premises can be
excluded
• Educational assistance programs

− Employer-provided educational assistance for undergraduate and graduate
education is excludible
 Exclusion limited to $5,250 per year
 Includes tuition, fees, books, and supplies
 Through 2025, eligible assistance includes principal and interest on a student
loan
− Do not cover
 Meals, lodging, and transportation costs
 Educational payments for courses involving sports, games, or hobbies
• Adoption assistance programs

− Employee adoption expenses paid or reimbursed by the employer are excludible
 Exclusion limited to $16,810
 For 2024, the exclusion is phased out as A G I increases from $252,150 to
$292,150
Cafeteria Plans
• Allow employees to choose between cash and certain nontaxable benefits

− If cash is chosen, the amount received is taxable
− If a nontaxable benefit is chosen, the benefit remains nontaxable
• Provide tremendous flexibility in tailoring the employee pay package to fit individual
needs
Flexible Spending Plans
• Allow employees to accept lower cash compensation in return for the employer
agreeing to pay certain costs without the employee recognizing income
• Annual inflation-adjusted cap applies to these plans ($3,200 in 2024)

− Called use or lose plans since the reduction in pay cannot be recovered if the
covered expenses are less than expected
• I R S rules allow a two-and-a-half-month grace period to use the funds for qualified
expenses
General Classes of Excluded Benefits
• No-additional-cost services
• Qualified employee discounts
• Working condition fringes
• De minimis fringes
• Qualified transportation fringes
• Qualified moving expense reimbursements
• Qualified retirement planning services
• Qualified military base realignment and closure fringes
No-Additional-Cost Services
• Value of the services is nontaxable if:

− Employee receives services (not property)
− Employer incurs no substantial additional cost, including foregone revenue, in
providing the services
− Services offered are in the ordinary course of business in which the employee
works
− Exclusion is not allowed to highly compensated employees unless it is available
on a nondiscriminatory basis
Qualified Employee Discounts
• Are nontaxable if:

− Exclusion is not on real property or personal property commonly held for
investment
− Property or services must be from the same line of business in which the
employee works
− In case of property, exclusion is limited to the gross profit component of the
customer price
− In case of services, exclusion cannot exceed 20% of the customer price on
services
Working Condition Fringes
• Not taxable if the employee could deduct the cost of items if they had actually paid
for them
− Can be made available on a discriminatory basis and still qualify for the
exclusion
De Minimis Fringes (1 of 3)
• These benefits are so small that accounting for them is impractical and thus
excludible
− Examples include:
 Occasional supper money or taxi fare for employees because of overtime
work
 Occasional personal use of company copying machine
 Occasional company cocktail parties or picnics for employees
 Certain holiday gifts of property with a low fair market value
• Subsidized eating facilities operated by employer are excluded if:

− Located on or near employer’s business premises
− Revenue equals or exceeds direct operating costs
− Nondiscrimination requirements are met
• According to the I R S, cash or gift cards are not considered de minimis
• Value of a cell phone can be excluded if it is provided for business reasons

− Any personal use of the employer-provided cell phone will be excluded as a de
minimis fringe benefit
Qualified Transportation Fringes (1 of 2)
• This fringe benefit is designed to encourage the use of mass transit for commuting
to and from work
− Includes:
 Transportation in a commuter highway vehicle and transit passes
Annual limit on the exclusion for 2024 is $315 per month
 Qualified parking
Annual limit on the exclusion for 2024 is $315 per month
− May be provided directly by the employer or may be in the form of cash
reimbursements
Qualified Transportation Fringes (2 of 2)
• Employers are prohibited from deducting qualified transportation fringe benefits

provided to employees [§ 274(a)(4)]
− If the employer provides the benefit, though, the employee may exclude it from
income within the limits stated above
Qualified Moving Expense
Reimbursements
• Prior to 2018, employer payment or reimbursement of an employee’s qualified
moving expenses was excludible
− For 2018 through 2025, the exclusion only applies to members of the Armed
Forces on active duty
Qualified Retirement Planning
Services
• Value of any retirement planning advice or information provided by an employer
who maintains a qualified retirement plan is excluded from income
− Designed to motivate more employers to provide retirement planning services
Qualified Military Base Realignment
and Closure Fringe
• Payments made under the Demonstration Cities and Metropolitan Development Act
of 1966 are excluded from income
Nondiscrimination Provisions
• For no-additional-cost services, qualified employee discounts, and qualified

retirement planning services
− If the plan is discriminatory in favor of highly compensated employees, these
key employees are denied exclusion treatment
− Non-highly compensated employees can still exclude these benefits from income
Group Term Life Insurance
• Congress enacted § 79, which created a limited exclusion for group term life
insurance
− The premiums on the first $50,000 of group term life insurance protection are
excludible from the employee’s and former employee’s gross income
− The benefits of this exclusion are available only to employees; proprietors and
partners are not considered employees
− Applies only to term insurance
Unit 09
Foreign Earned Income
Foreign Earned Income (1 of 2)
• For income from personal services rendered in a foreign country, taxpayers can either:
− Include the foreign earned income in taxable income and then claim a credit for foreign
taxes paid
− Exclude up to $126,500 of foreign earned income from U.S. gross income
• Once an election is made:

− It applies to all subsequent years unless affirmatively revoked
− Revocation is effective for the year of the change and the four subsequent years
• To qualify for the exclusion, the taxpayer must be either:

− A bona fide resident of the foreign country
− Present in a foreign country for at least 330 days during any 12 consecutive months
Foreign Earned Income (2 of 2)
• Exclusion amount is limited to $126,500

− Exclusion must be computed on a daily basis when the exclusion period
straddles two years
− Tax on the income in excess of the excluded amount is taxed at the marginal
rate that would apply without the exclusion (i.e., as though the excluded income
were included in taxable income)
• Employee also can exclude a foreign housing amount if certain requirements are
met
− Employer must pay for all or a portion of the housing costs
Unit 10
Interest on Certain State and Local
Government Obligations
Interest on Certain State and Local
Government Obligations
• Interest from municipal bonds is tax exempt
− Reduces borrowing costs of state and local governments
− High-income taxpayers can increase after-tax yields with municipal bonds
• The current exempt status applies solely to state and local government bonds
• Income received from the accrual of interest on a condemnation award or an

overpayment of state income tax is fully taxable
Unit 11
Educational Savings Bonds
Educational Savings Bonds (1 of 2)
• Interest on Series E E U.S. government savings bonds may be excluded from

income if:
− Proceeds are used to pay for qualified higher educational expenses and
− Bonds are issued to a person at least 24 years old
• Exclusion is phased out once modified A G I exceeds threshold amount
Educational Savings Bonds (2 of 2)
• For 2024, the phaseout begins at $96,800 ($145,200 on a joint return)
• The phaseout is completed when M A G I exceeds the threshold amount by more

than $15,000 ($30,000 on a joint return)
Unit 12
Education Savings Programs (§ 529 and
§ 530 Plans)
Qualified Tuition Program (1 of 2)
• Amounts contributed must be used to pay qualified higher education expenses
• Qualified higher education expenses include:

− Tuition, fees, books, supplies, room and board, and equipment required for
enrollment or attendance
− Computers and peripheral equipment, including software that provides access to
the Internet
• Tuition paid to public, private, and religious K-12 schools are also included
Qualified Tuition Program (2 of 2)
• In addition, a lifetime maximum of $10,000 of funds in a § 529 account may be

used to pay principal or interest on a qualified education loan.
• Earnings on contributions, including discounted tuition for plan participants, are not
taxable if used for qualified higher education expenses
− Refunds from program are taxable to the extent they exceed contributions
Coverdell Education Savings Account
• Used to save for K-12 education as well as postsecondary education expenses
• Contributions are limited to $2,000 in a year
• Beneficiary must be under 18 or must be a special needs beneficiary
• Income to the beneficiary is nontaxable provided the funds are used for qualified
education expenses
Unit 13
Qualified A B L E Programs (§ 529A Plans)
Qualified A B L E Programs (§ 529A Plans) (1
of 2)
• The qualified A B L E (Achieving a Better Life Experience) program was created to
assist individuals who become blind or disabled before age 26
• Program allows for § 529A plans, or A B L E plans, similar in concept to § 529 plans
− The program must be established by a state
− The A B L E account must be for the benefit of a designated beneficiary’s
disability expenses
− The beneficiary must have a disability certification from the government
Qualified A B L E Programs (§ 529A Plans) (2
of 2)
• Contributions to the account must be in cash and may not, in the aggregate,
exceed the annual gift tax exclusion for the year ($18,000 for 2024 and $17,000 for
2023)
− Contributions to the account are not deductible
• The tax benefit of an A B L E account is that its earnings are not taxable
− Distributions from the account also are not taxable provided they do not exceed
the qualified disability expenses of the designated beneficiary
• Certain rollovers from a § 529 account to an A B L E account are permitted for 2018
through 2025
Unit 14
Income from Discharge of Indebtedness
Income from Discharge of Indebtedness (1 of
2)
• Income from the forgiveness of debt is taxable
− Certain discharge of indebtedness situations get special exclusion treatment:
 Creditors’ gifts
 Discharges under Federal bankruptcy law
 Discharge that occur when the debtor is insolvent
 Discharge of farm debt of a solvent taxpayer
 Discharge of qualified real property business indebtedness
 Seller’s cancellation of buyer’s indebtedness
Income from Discharge of Indebtedness (2 of
2)
 Shareholder’s cancellation of corporation’s indebtedness
 Forgiveness of certain student loans
 Discharge of indebtedness on taxpayer’s principal residence that occurs
between January 1, 2007, and January 1, 2026, and is the result of the
financial condition of the debtor
• Any portion of a student loan forgiven after December 31, 2020, and before January
1, 2026, is excludible from gross income
Regan is a full-time student at State University and is claimed by parents as a

dependent. Regan’s only source of income is an $8,000 scholarship ($800 for books,
$3,800 tuition, $200 student activity fee, and $3,200 room and board). Regan’s gross
income for the year is:
a. $0.
b. $200.
c. $3,200.
d. $3,400.
e. $8,000.
Knowledge Check Activity: 2 Answer
Regan is a full-time student at State University and is claimed by parents as a

dependent. Regan’s only source of income is an $8,000 scholarship ($800 for books,
$3,800 tuition, $200 student activity fee, and $3,200 room and board). Regan’s gross
income for the year is:
Answer: c. $3,200.
The portion included in gross income is $3,200 for room and board. The
books ($800), tuition ($3,800), and student activity fee ($200) qualify for
exclusion.
All employees of Basic Company are covered by a group hospitalization insurance plan, but the
employees must pay the premiums ($8,000 for each employee). None of the employees has
sufficient medical expenses to deduct the premiums. Instead of giving raises next year, Basic
Company is considering paying the employee’s hospitalization insurance premiums. If the
change is made, the employee’s after-tax and insurance pay will:
a. increase by the same amount for all employees.
b. increase more for the highly paid employees (32% marginal tax bracket).
c. increase more for the low-income (12% and 22% marginal tax brackets) employees.
d. decrease by the same amount for all employees.
e. decrease more for the highly paid employees (32% marginal tax bracket).
Knowledge Check Activity: 3 Answer
All employees of Basic Company are covered by a group hospitalization insurance plan, but the
employees must pay the premiums ($8,000 for each employee). None of the employees has
sufficient medical expenses to deduct the premiums. Instead of giving raises next year, Basic
Company is considering paying the employee’s hospitalization insurance premiums. If the
change is made, the employee’s after-tax and insurance pay will:
Answer: b. increase more for the highly paid employees (32% marginal tax bracket).
Each employee’s income, less taxes and insurance, would increase by the cost of
insurance times the employee’s marginal tax rate. The employees who are in the
higher tax brackets will benefit more from the change than the employees in the
lower tax brackets.
Unit 15
Tax Benefit Rule
Tax Benefit Rule
• If taxpayer claims a deduction for an item in one year and in a later year recovers
all or a portion of the prior deduction, the recovery is included in gross income
− Amount included in income is limited to the amount for which a tax benefit was
received
The tax benefit rule states that:

a. income should not be recognized upon the recovery of a deduction, or the portion
of a deduction, that did not yield a tax benefit in the year it was taken.
b. income should be recognized upon the recovery of a deduction, or the portion of a

deduction, that did not yield a tax benefit in the year it was taken.
c. income should not be recognized upon the recovery of a deduction, or the portion
of a deduction, that yields a tax benefit in the year it was taken.
d. income should be recognized upon the recovery of a deduction, or the portion of a

deduction, that yields a tax benefit in the year it was taken.
Knowledge Check Activity 4: Answer
The tax benefit rule states that:

Answer: a. income should not be recognized upon the recovery of a
deduction, or the portion of a deduction, that did not yield a tax benefit in
the year it was taken.
The tax benefit rule states that income should not be recognized upon the
recovery of a complete deduction or a portion of a deduction if it is not
yielding a tax benefit in the year in which it was taken.
Refocus on the Big Picture (1 of 3)
• You have looked into Paul’s tax situation and have the following information for him:
• Compensation - The amount Paul was paid for his internship is compensation for
services rendered and must be included in his gross income
− This includes both his base pay and the $1,500 bonus
• Graduate assistantship - The tuition waiver of $6,000 is excluded from Paul’s gross
income
− The related payments of $400 per month are intended as a form of
compensation and must be included in his gross income
• Damages - Damages awards that relate to personal physical injury or sickness can
be excluded from gross income if payments are for compensatory damages
− All of the compensatory damages of $220,000 can be excluded from gross
income
− The punitive damages of $160,000 must be included in Paul’s gross income
− Likewise, the compensatory damages of $25,000 received by Paul’s mother
must be included in her gross income
 Emotional distress does not qualify as personal physical injury or sickness
• What if?
• Can Paul do anything to reduce the amount of the punitive damages settlement that
must be included in his gross income?
− Paul cannot reduce the $160,000 punitive damages amount he must include in
gross income
− However, proper tax planning might have enabled Paul to reduce the amount
includible in gross income
− If a larger portion of the settlement had been assigned to compensatory
damages rather than punitive damages, Paul could have reduced the amount he
must include in his gross income
Self-Assessment
State the conditions that should be satisfied for a service to be treated as excludible
from the gross income of the employee.
What are the different alternatives available to the taxpayer to get relief from taxes
on foreign earned income?
What is the difference between exclusions and non-income items?
Summary
Now that the lesson has ended, you should have learned to:
• Explain the difference between exclusions and items that are not income.
• Discuss commonly encountered income exclusions.
• Determine the extent to which receipts can be excluded under the tax benefit rule.
• Identify tax planning strategies for obtaining the maximum benefit from exclusions.

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Comprehensive

1. The class will be broken up into groups.

By the end of this chapter, you should be able to:

• 05.02 Describe commonly encountered income exclusions.

• Read the chapter and formulate your response

• Generally found in Code §§ 101 through 140

• Exclusions versus non-income items

• Payments made to shareholders with respect to their stock

• Distributions are taxed as dividends to shareholders to the extent of payments

• Distributions in excess of earnings and profits are treated:

Which of the following is not a characteristic of exclusions?

Which of the following is not a characteristic of exclusions?

Answer: d. They are applicable to non-income items.

• Gifts are nontaxable to donee if:

• Inheritances are nontaxable to beneficiary

• Income earned on gifts or inheritances is taxable under normal rules

• Transfers from employers to employees do not qualify as excludible gifts

• Employee death benefits – Amount paid by employer to deceased employee’s

• Income in respect of a decedent – Income earned by an employee that was not

• Return to the facts of The Big Picture

• Chosen to be exempt due to the following:

• Accelerated death benefits

• Transfers for valuable consideration

• Transfers for valuable consideration

• An amount paid to or for the benefit of a student to aid in pursuing a degree at an

• University teaching or research assistant is generally considered an employee, and

• Qualified tuition waivers or reductions by nonprofit educational institutions are

• Paul was paid $400 a month by the university for teaching

• Although he received the assistantship because of his excellent academic record,

• Tax consequences of receipt of damages

• Tax treatment of damages received for:

• Tax treatment of damages received for:

• Disaster relief benefits

• Return to the facts of The Big Picture

• Paul’s mother did not suffer a personal physical injury

• One way to provide a medical reimbursement plan for employees is as follows:

• Employer-paid insurance premiums for employee’s long-term care are excludible

• Not taxable to employee if:

• Campus housing provided by the employer to an employee of an educational

• Ministers of the gospel and other religious leaders can exclude

• Housing allowance is a compensation for the conduct of religious worship, the

• Military personnel are allowed housing exclusions under various circumstances

• Child and dependent care

• Educational assistance programs

• Adoption assistance programs

• Allow employees to choose between cash and certain nontaxable benefits

• Annual inflation-adjusted cap applies to these plans ($3,200 in 2024)

• Qualified employee discounts

• Working condition fringes

• Qualified transportation fringes

• Qualified moving expense reimbursements

• Qualified retirement planning services

• Qualified military base realignment and closure fringes

• Value of the services is nontaxable if:

• Are nontaxable if:

• Subsidized eating facilities operated by employer are excluded if:

• According to the I R S, cash or gift cards are not considered de minimis

• Value of a cell phone can be excluded if it is provided for business reasons

• Employers are prohibited from deducting qualified transportation fringe benefits

• For no-additional-cost services, qualified employee discounts, and qualified