2. Chapter 5 Exhibits
1. Social Security Benefits
2. Interest on U.S. Savings Bonds
3. EE Bonds Used for Education
4. Fringe Benefits
5. Group Life Insurance
6. Annuities
7. Compensation for Injuries and Sickness
8. Insurance Reimbursement Summary
9. Damage Awards
Chapter 5, Exhibit Contents A CCH Federal Taxation Basic Principles 2 of 34
3. Chapter 5 Exhibits
10. Cafeteria Plans
11. Adoption Assistance
12. Employee Tuition Reduction Plans
13. Dependent Care Assistance Program
Chapter 5, Exhibit Contents B CCH Federal Taxation Basic Principles 3 of 34
4. Social Security Benefits
A portion of Social Security income is taxable to the
extent that a taxpayer’s provisional income exceeds
certain base amounts.
Provisional income equals adjusted gross income, plus
one-half of Social Security received, plus some non-
taxable items such as tax exempt interest.
Chapter 5, Exhibit 1a CCH Federal Taxation Basic Principles 4 of 34
5. Social Security Benefits
1st threshold base amounts - $25,000 for single
- $32,000 for married filing jointly
If a taxpayer’s provisional income exceeds the 1st threshold (but
does not exceed the 2nd threshold), the taxable portion of Social Security
is the lesser of:
A. 50% of Social Security benefits or
B. 50% of the excess of the taxpayer’s provisional income over the
base.
Chapter 5, Exhibit 1b CCH Federal Taxation Basic Principles 5 of 34
6. Social Security Benefits
2nd threshold base amounts - $34,000 for single
- $44,000 for married filing jointly
If a taxpayer’s provisional income exceeds the 2nd threshold, the
taxable portion of Social Security is the lesser of:
A. 85% of Social Security benefits OR
B. 85% of the amount that provisional income exceeds the threshold
plus the smaller of
(1) the amount of SS benefits included under the prior law
or
(2) $4,500 for unmarried taxpayers or $6,000 for
married filing jointly.
Chapter 5, Exhibit 1c CCH Federal Taxation Basic Principles 6 of 34
7. Social Security Benefits
Married taxpayers filing separately have no base amount and must
include in gross income the lesser of
A. 85% of Social Security benefits OR
B. 85% of their provisional income
Chapter 5, Exhibit 1d CCH Federal Taxation Basic Principles 7 of 34
8. Interest on U.S. Savings Bonds
The general rule is that interest on U.S. savings bonds is fully
taxable.
Cash basis taxpayers may report interest income on a yearly
basis or defer the recognition of interest income until the
bonds mature.
Chapter 5, Exhibit 2 CCH Federal Taxation Basic Principles 8 of 34
9. EE Bonds Used for Education
However, interest earned on U.S. savings bonds may be
excluded if the proceeds are used to finance the higher education
of the taxpayer, taxpayer’s spouse or dependents.
Qualified higher education expenses. Tuition and fees qualify.
Room and board and expenses incurred outside of the degree
program (e.g., sports, clubs) do not qualify. The bonds must be
redeemed during the same tax year in which qualified educational
expenses are incurred.
Chapter 5, Exhibit 3a CCH Federal Taxation Basic Principles 9 of 34
10. EE Bonds Used for Education
1. If the qualified educational expenses exceed the Series EE proceeds
(principal and interest), then all the interest may be excluded, subject to
the income phase out rules.
2. If the qualified educational expenses are less than the Series EE
proceeds (principal and interest), then only a portion of the interest may
be excluded based on the following formula:
Exclusion amount=
Interest on EE savings bond x Qualified educational expenses
Series EE proceeds
Chapter 5, Exhibit 3b CCH Federal Taxation Basic Principles 10 of 34
11. EE Bonds Used for Education
The phase out thresholds in 2012 are:
Modified AGI
Ceiling Floor Phaseout Range
(Ceiling – Floor)
Married filing jointly $139,250 $109,250 $30,000
Single and head of household $ 87,850 $72,850 $15,000
Married filing separately (not eligible) N/A N/A N/A
Chapter 5, Exhibit 3c CCH Federal Taxation Basic Principles 11 of 34
12. EE Bonds Used for Education
Example 1
Mary, a single mother, has modified AGI of $81,850. She redeems Series EE bonds and
receives $5,000 of principal and $2,500 of interest. Mary’s daughter attends college and
has qualified educational expenses of $8,000. How much of the $2,500 interest may be
excluded from gross income?
Answer
The qualified educational expenses of $8,000 exceed the Series EE proceeds of $7,500.
Mary would have been able to exclude the full $2,500 except for the fact that she is
subject to the phase out for higher income taxpayers.
Chapter 5, Exhibit 3d CCH Federal Taxation Basic Principles 12 of 34
13. EE Bonds Used for Education
Example
The phaseout amount of the exclusion is calculated as:
[(Income – phaseout floor) / phaseout range] x Interest
[($81,850 - $72,850) ÷ $15,000] x $2,500 = $1,500
Interest income excluded is $1,000 ($2,500 – $1,500).
Therefore, taxable interest income is $1,500.
Chapter 5, Exhibit 3e CCH Federal Taxation Basic Principles 13 of 34
14. Fringe Benefits
The following 4 non-statutory fringe benefits are excluded from
gross income.
1. No-additional-cost services
Generally excluded from gross income if:
no significant additional costs are incurred by the employer and
the service provided is offered for sale to customers in the
ordinary course of the line of business for which the employee is
working.
Example: Free travel is offered to airline employees who fly on
standby. Spouses and dependent children may be included with no
income tax consequences.
Chapter 5, Exhibit 4a CCH Federal Taxation Basic Principles 14 of 34
15. Fringe Benefits
2. Qualified employee discounts
Generally excluded from gross income.
For property purchased at a discount, the exclusion may not exceed
the employer’s gross profit margin. For services purchased at a
discount, the exclusion may not exceed 20%.
Chapter 5, Exhibit 4b CCH Federal Taxation Basic Principles 15 of 34
16. Fringe Benefits
3. Working condition fringe benefits
The fair market value of any property or services provided to an
employee is excluded by that employee if it represents an ordinary and
necessary business deduction to the employer.
Examples: Cell phone used by the employee for the primary
convenience of the employer, but also available for personal use;
subscriptions to business periodicals; on-the-job training; inventory
being tested by the employees outside of the employer’s workplace.
Chapter 5, Exhibit 4c CCH Federal Taxation Basic Principles 16 of 34
17. Fringe Benefits
4. De minimis fringe benefits
Excluded when the value of property or services provided to the
employee are so minimal that accounting for it would be
unreasonable.
Examples: Using the copy machine for personal purposes;
occasional tickets to sports events, coffee and snacks, occasional
company picnics
Chapter 5, Exhibit 4d CCH Federal Taxation Basic Principles 17 of 34
18. Group Life Insurance
An employee can exclude the cost of group term life
insurance provided by an employer as long as the face value
of the policy does not exceed $50,000.
If over $50,000 of coverage is provided by an employer, the
cost of the premium for the excess coverage must be included
in the gross income of the employee.
Chapter 5, Exhibit 5 CCH Federal Taxation Basic Principles 18 of 34
19. Annuities
Income received as an annuity from an annuity, endowment
or life insurance contract generally consists of 2 parts:
1) non-taxable return of investment
2) taxable gain on investment
Chapter 5, Exhibit 6a CCH Federal Taxation Basic Principles 19 of 34
20. Annuities
The tax free portion of the annuity is spread evenly over the
taxpayer’s lifetime.
The amount of the annuity payment that may be excluded
from gross income is the annuity payments received
multiplied by the exclusion ratio
Exclusion Ratio = Investment in contract
expected return under the contract*
* expected return is calculated by multiplying the annual
annuity payment by the multiplier on the appropriate table.
Chapter 5, Exhibit 6b CCH Federal Taxation Basic Principles 20 of 34
21. Annuities
Example:
John retired at age of 70 and purchased an annuity contract for
$19,000. The annuity contract provides for him to receive $150 per
month for life.
Step One: Compute expected return under the contract.
Multiplier from Table 2 16.0
x Annual annuity payments $1,800 ($150 x 12)
= Expected return $28,800
Chapter 5, Exhibit 6c CCH Federal Taxation Basic Principles 21 of 34
22. Annuities
Step Two: Compute the exclusion ratio
Exclusion Ratio = Investment in the contract
Expected return under the contract
66% = $19,000
$28,800
Chapter 5, Exhibit 6d CCH Federal Taxation Basic Principles 22 of 34
23. Annuities
Step Three: Compute amount excluded
Total payment for the year x Exclusion ratio = Amount of
exclusion
$1,800 x 66% = $1,188
The remainder of the annuity payment received
($1,800 - $1,188 = $612) is included in gross income.
Chapter 5, Exhibit 6e CCH Federal Taxation Basic Principles 23 of 34
24. Compensation for Injuries and Sickness
Worker’s Compensation
Amounts received as compensation for occupational personal injury or
sickness are excluded from gross income.
Amounts received as compensation for non-occupational personal
injury or sickness are taxable.
Chapter 5, Exhibit 7a CCH Federal Taxation Basic Principles 24 of 34
25. Compensation for Injuries and Sickness
Accident and Health Insurance Plans
Benefits received from employee-paid plans are excluded from gross
income.
Benefits received from employer-paid plans are taxable UNLESS the
following conditions are met:
1. Permanent injury or loss of bodily function if amounts are paid
on the nature of the injury and not on work time lost.
2. Reimbursement for actual medical expenses incurred by
employee, spouse or dependents.
Chapter 5, Exhibit 7b CCH Federal Taxation Basic Principles 25 of 34
26. Insurance Reimbursement Summary
Insurance Plan Excluded from gross income Included in gross income
Workers’
Compensation Amounts received as
Amounts received as compensation for an
Plans compensation for an occupational
personal injury or sickness. non-occupational personal injury
or sickness.
Accident and
Amounts received for personal Amounts received for personal
Health Plans
injury or sickness from employee- injury or sickness from employer-
paid plans. paid plans.
Note: For the above exclusions to apply, the benefits must be on account of
1. personal physical injuries or sickness or
2. emotional distress, limited to actual medical expenses incurred.
Chapter 5, Exhibit 8 CCH Federal Taxation Basic Principles 26 of 34
27. Damage Awards
Tax Treatment for Damages
Type Damages
1 Physical Injury or Sickness Excluded from taxable income
2 Non Physical Injury or Sickness Taxable, except if damages are used to pay for
medical expenses related to emotional distress.
3 Lost Wages Taxable Income
4 Punitive Damages Taxable Income
Chapter 5, Exhibit 9a CCH Federal Taxation Basic Principles 27 of 34
28. Damage Awards
Example:
Sally’s professional reputation is damaged as a result of a false
credit report. As a result of her ensuing emotional distress,
Sally makes several visits to a qualified counselor, incurring
medical expenses totaling $5,000. Later, she receives a
$25,000 non-punitive award for damage to professional
reputation. $5,000 of the $25,000 award is excludable.
Chapter 5, Exhibit 9b CCH Federal Taxation Basic Principles 28 of 34
29. Cafeteria Plans
Tax Advantage of Cafeteria Plans
Under a cafeteria plan, each employee is permitted to choose
between cash or nontaxable benefits. Employees are not
subject to federal income tax for the amount of menu items
that are nontaxable. In addition, the cost of these fringes is
deductible as compensation to the employer.
Chapter 5, Exhibit 10a CCH Federal Taxation Basic Principles 29 of 34
30. Cafeteria Plans
Nontaxable Items Allowable Under Cafeteria Plans
Group-term life insurance coverage below $50,000
Health and accident protection and dental plans
Child care
Vacation days
Dependent care assistance
Adoption assistance
Unused benefits from one plan year may not be
accumulated by an employee and carried over to
succeeding years.
Chapter 5, Exhibit 10b CCH Federal Taxation Basic Principles 30 of 34
31. Adoption Assistance
An employee may exclude from gross income of up to $12,650
of adoption expenses per child, where such expenses are paid for
by the taxpayer’s employer under a qualified adoption assistance
program.
Qualified adoption expenses include ordinary and necessary
adoption expenses, court costs, attorney fees and other expenses
incurred for the principal purpose of the legal adoption of a
child.
The exclusion is phased out for taxpayers with an adjusted gross
income between $189,710 and $229,710.
Chapter 5, Exhibit 11 CCH Federal Taxation Basic Principles 31 of 34
32. Employee Tuition Reduction Plans
Payments of up to $5,250 per year paid by an employer to, or
on behalf of, an employee for tuition and course-related
material may be excluded from employee income.
Qualified educational expenses includes the payment or
provision of tuition, fees, books, supplies, and equipment.
Chapter 5, Exhibit 12 CCH Federal Taxation Basic Principles 32 of 34
33. Dependent Care Assistance Program
$5,000 exclusion
A qualified dependent care assistance program is a separate
written plan of an employer under which the employer
pays or incurs dependent care costs for the exclusive
benefit of employees. Employees can exclude up to $5,000
($2,500 for married persons filing separately).
Chapter 5, Exhibit 13a CCH Federal Taxation Basic Principles 33 of 34
34. Dependent Care Assistance Program
The exclusion is subject to an earned income limitation. An
unmarried taxpayer may not exclude more than his or her
earned income for the year. A married taxpayer may not
exclude more than the lesser of his or her earned income or the
spouse’s earned income.
The earned income of an incapacitated or student spouse is
deemed to be $250 per month for one qualifying dependent or
$500 per month for 2 or more qualifying dependents.
Chapter 5, Exhibit 13b CCH Federal Taxation Basic Principles 34 of 34
