4.2 Specific inclusions in gross income

Gross income includes various forms of compensation and benefits. From wages and bonuses to fringe benefits and stock options, the IRS casts a wide net. Understanding what's taxable helps taxpayers accurately report income and avoid surprises come tax time.

Interest, dividends, and debt forgiveness also factor into gross income calculations. While some items like municipal bond interest may be tax-exempt, others like cancelled debt can create unexpected taxable income. Knowing these nuances is crucial for proper tax planning and compliance.

Compensation in Gross Income

Common Forms of Taxable Compensation

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• Wages, salaries, and tips reported on Form W-2 by employers constitute the most prevalent types of taxable compensation
• Bonuses and commissions fully taxed as ordinary income in the year received, regardless of when earned
• Stock options have specific tax implications depending on their type (qualified or non-qualified) and exercise date
• Severance pay and unemployment compensation generally included in gross income and subject to federal income tax
• Back pay awards and retroactive pay increases taxed in the year received, even if attributable to prior years (back wages from a lawsuit settlement)
• Non-cash compensation included in gross income at fair market value (company car valued at $5,000 per year)
• Certain forms of deferred compensation may be taxable when earned rather than when received (contributions to non-qualified plans)

Special Considerations for Compensation

• Bartering transactions result in taxable income equal to the fair market value of goods or services received (dentist performs dental work in exchange for accounting services)
• Signing bonuses treated as wages and subject to income tax and employment taxes in the year received
• Performance-based compensation often has specific tax rules, especially for executives (stock options tied to company performance metrics)
• Constructive receipt doctrine may cause income to be taxable before it is actually received (available bonus not taken until the following year)
• Phantom stock and stock appreciation rights (SARs) create taxable income when paid, based on the increase in stock value

Tax Treatment of Fringe Benefits

General Rules and Valuation

• Fringe benefits included in an employee's gross income unless specifically excluded by the Internal Revenue Code
• Fair market value of fringe benefits must be determined to calculate the taxable amount (company-provided gym membership valued at $50 per month)
• Specific valuation rules exist for certain benefits (personal use of company car)
• De minimis fringe benefits excluded from gross income due to small value and administrative impracticality (occasional pizza lunches)

Specific Types of Fringe Benefits

• Qualified employee discounts on products or services offered to customers excludable up to certain limits (20% discount on retail items)
• Working condition fringe benefits excludable from gross income if deductible as a business expense if paid by the employee (job-related training courses)
• Employer-provided health insurance premiums generally excludable from an employee's gross income, subject to certain limitations
• Transportation fringe benefits have specific exclusion limits adjusted annually for inflation (monthly parking pass worth $270)
• No-additional-cost services provided to employees excluded if offered in the ordinary course of business (free standby flights for airline employees)
• Qualified moving expense reimbursements may be excludable for certain moves (military relocations)

Taxability of Interest and Dividends

Interest Income Classifications

• Interest income from most sources fully taxable as ordinary income (savings accounts, certificates of deposit, corporate bonds)
• Interest from U.S. Treasury securities and other federal obligations taxable for federal income tax purposes but may be exempt from state and local taxes
• Municipal bond interest generally exempt from federal income tax but may be subject to state taxes or the alternative minimum tax (AMT)
• Original issue discount (OID) on debt instruments generally taxable as interest income as it accrues, even if not received in cash (zero-coupon bonds)

Dividend Income and Special Considerations

• Qualified dividends meeting specific holding period requirements taxed at preferential capital gains rates (long-term stock holdings)
• Ordinary (non-qualified) dividends taxed as ordinary income at the taxpayer's marginal tax rate (recently purchased stocks)
• Dividend equivalents from certain financial products treated as dividends for tax purposes and may be subject to withholding (total return swaps)
• Constructive dividends may arise from transactions between closely held corporations and their shareholders (personal use of corporate assets)
• Return of capital distributions reduce the taxpayer's basis in the stock and are not immediately taxable (distributions exceeding earnings and profits)

Alimony and Separate Maintenance Payments

Pre-2019 Divorce or Separation Agreements

• Alimony payments generally includible in the recipient's gross income and deductible by the payer
• Specific requirements for payments to qualify as alimony (made under a divorce or separation instrument)
• Child support payments not considered alimony and not includible in the recipient's gross income or deductible by the payer
• Recapture rules may apply if alimony payments decrease substantially within the first three post-separation years (payments of $50,000,$40,000, and $10,000 in years 1, 2, and 3 respectively)

Post-2018 Agreements and Special Considerations

• Tax treatment of alimony changed for agreements executed after December 31, 2018, making payments non-taxable to the recipient and non-deductible for the payer
• Separate maintenance payments follow the same tax rules as alimony (payments made while spouses are still legally married but living apart)
• Property settlements in divorce generally not taxable events, but transfers of certain assets may have tax implications (transfer of appreciated property)
• Modifications to pre-2019 agreements may alter the tax treatment if they expressly provide that the post-2018 rules apply

Discharge of Indebtedness Income

General Rules and Inclusions

• Discharge of indebtedness generally included in gross income under IRC Section 61(a)(12), referred to as "cancellation of debt" (COD) income
• Amount of COD income typically the difference between the debt's face value and the amount paid in satisfaction of the debt ($10,000 debt settled for$6,000 results in $4,000 of COD income)
• Timing of recognition for COD income varies based on circumstances of the discharge and taxpayer's accounting method (cash basis vs. accrual method)

Exclusions and Special Considerations

• Certain exclusions apply to COD income, such as debts discharged in bankruptcy, insolvency, or for qualified principal residence indebtedness
• Student loan forgiveness may be excludable under specific programs or circumstances (Public Service Loan Forgiveness program)
• Forgiveness of Paycheck Protection Program (PPP) loans specifically excluded from gross income by legislation
• When COD income excluded, tax attributes may need to be reduced (net operating losses, credit carryovers, basis in property)
• Form 1099-C issued by lenders for cancelled debts of $600 or more, but taxpayers may still qualify for exclusions
• Debt modifications may result in COD income if the modified terms are considered a significant modification under tax regulations (interest rate reduction from 8% to 3%)