Tax Consequences of

Personal Activities

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Chapter 17

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Gross IncomeGross Income

• Section 61 states that gross income means all income from whatever source derived – even income from personal activities

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Gratuitous ReceiptsGratuitous Receipts

• Prizes and awards are included in gross income

• Scholarships are excluded to the extent spent on:• Tuition, books, fees, equipment

required by institution

• Gifts, inheritances, and life insurance death benefits are excluded from gross income

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Legal Settlements and Government PaymentsLegal Settlements and Government Payments

• Legal settlements are included in gross income unless compensation for physical injury or illness

• Workers’ compensation payments are excluded• Unemployment compensation payments are included• Need-based payments such as welfare and food stamps

are excluded• Social security:

• 85%, 50%, or 0% included in gross income depending on income level

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DivorceDivorce

• Property settlements are nontaxable• Transferred property

takes a carryover basis

• Alimony is taxable to the recipient, deductible above-the line by the payer

• Child support is neither taxable nor deductible

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Personal Use Assets and Personal Use Assets and Personal ExpensesPersonal Expenses

• Personal use assets• Personal use assets may not be depreciated• Gains on sale are generally capital gain• Losses on sale are not deductible

• No deduction is allowed for personal, living, or family expenses except for:• Medical expenses• Local, state, and foreign income tax payments• Home mortgage interest• Charitable contributions

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Personal Expenses - MedicalPersonal Expenses - Medical

• Taxpayers may deduct the excess of unreimbursed expenses over 7.5% of AGI as an itemized deduction

• Qualifying medical expenses include:• Clinics, hospitals, long-term care facilities• Medical aids (e.g., hearing aids, crutches)• Prescription drugs• Medical insurance premiums• Doctors, dentists, chiropractors

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Personal Expenses - TaxesPersonal Expenses - Taxes

• Individuals are allowed an itemized deduction for:• Real or personal property taxes paid on nonbusiness

assets• Either state and local sales taxes or state and local

income taxes

• Costs of tax compliance (e.g. tax preparation fees) are miscellaneous itemized deductions

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Personal Expenses – Charitable ContributionsPersonal Expenses – Charitable Contributions

• General limit – Itemized deduction limited to 50% of AGI for cash donation (less for capital assets) • Carryover excess as an itemized deduction for 5 years

• Deduction amount• LT capital assets = FMV of property• Other property = lesser of FMV or basis

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Tax Subsidies for EducationTax Subsidies for Education

• EE Savings Bonds• Deduction for qualified tuition and fees • Deduction for interest on qualified education loans• American Opportunity Credit• Lifetime Learning Credit• Coverdell education savings accounts• Qualified tuition programs

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Casualty LossesCasualty Losses

• Casualty and theft losses• Loss equals lesser of adjusted basis or

decline in FMV of property resulting from casualty or theft• Loss reduced by insurance

reimbursement

• Loss in excess of $100 floor per casualty is deductible

• Deduction limited to excess of aggregate losses over 10% AGI

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Hobby and Gambling LossesHobby and Gambling Losses

• Activity not entered into for profit (hobby)• Revenue is included in gross income• Expenses are miscellaneous itemized deductions

limited to the amount of revenue from hobby• If the activity generates a profit in 3 of 5 years, the IRS

presumes it is a business and losses are deductible

• Gambling losses• Itemized deduction but not miscellaneous• Limited to gambling winnings

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Home Mortgage InterestHome Mortgage Interest

• Qualified residence interest is an itemized deduction• Interest on acquisition debt up to $1 million • Interest on home equity debt up to $100,000

• Deduction is available for mortgage on principal residence and one other personal residence

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Vacation Home RentalVacation Home Rental

• Residence is subject to vacation home rules if the owner’s days of personal use exceed the greater of 14 days or 10% of rental days

• Expenses attributable to rental days are deductible to the extent of rental revenues• Vacation home rental can’t generate a net loss deductible

against other income • Nondeductible loss carries forward

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Gain on Sale of Principal ResidenceGain on Sale of Principal Residence

• $250,000 exclusion of gain on sale of home• Owner must have used the home as a principal residence for two

years out of the five years ending on date of sale• Exclusion doubled to $500,000 for MFJ

• Exclusion applies to only one sale in a two-year period

• Owners who sell a home but don’t satisfy the above requirements may be eligible for a reduced exclusion if the sale was necessitated by:• Change of employment• Health reasons• Unforeseen circumstances

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Itemized Deductions as AMT AdjustmentsItemized Deductions as AMT Adjustments

• Medical deductions are allowed only to the extent they exceed 10% AGI

• Deductions for state and local taxes are disallowed • Miscellaneous itemized deductions are disallowed• Interest on home equity debt is disallowed