Discussion Questions

Copyright © 2026 Pearson Education, Inc.

I:3-1

Chapter I:3

Gross Income: Inclusions

Discussion Questions

I:3-1 The phrase “income from whatever source derived” appears in both the 16th Amendment to the Constitution and in Sec. 61(a). This overlapping terminology was adopted to assure the

constitutionality of the income tax. p. I:3-2.

I:3-2 Economists define income as the amount that an individual could consume during a period and remain as well off at the end of the period as he or she was at the beginning of the period. In accounting, income is measured by a transactions approach. Accountants measure income when it is realized in a completed transaction. pp. I:3-2 and I:3-3.

I:3-3 It is much easier to administer the tax law based on the accounting concept of income instead of the economic concept. Also, wherewithal-to-pay is greater when income is taxed as it is realized. pp. I:3-3 and I:3-4.

I:3-4 The concept of wherewithal-to-pay means that a tax should be imposed when the taxpayer can most easily pay. A taxpayer who owns property that has increased in value does not necessarily have the funds needed to pay any tax. Taxing the gain when it is realized often means that the tax becomes due at the same time the taxpayer collects the sales price. pp. I:3-4 and

I:3-5.

I:3-5 A loan repayment is not consistent with the normal meaning given to the word income.A taxpayer is no better off because a loan is repaid. There has been no economic benefit. As a result the repayment of a loan is not taxable simply because it is not income. p. I:3-3.

I:3-6 Congress taxes prepaid rental income because of concern that taxpayers who spend the money will be unable to pay the tax when it comes due. Taxing such amounts is to tax income when taxpayers have the greatest wherewithal to pay. The problem created for taxpayers is that they are taxed before they incur related expenses. Repairs, insurance, depreciation, interest and other expenses are incurred as the income is earned. Therefore, there is a mismatching of revenue and expense. pp. I:3-4 and I:3-11 through I:3-12.

I:3-7 Such arrangements might cause the IRS to question whether the improvements are being made in lieu of rent. If such was the case then the owner of the property may be required to include the value of the improvements in gross income. pp. I:3-15 and I:3-16.

I:3-8 No. The form of payment (cash, property, or services) is usually unimportant. The important question is whether the taxpayer receives economic benefit. pp. I:3-4 and I:3-5.

I:3-9 In the 1930 case of Lucas v. Earl, the Supreme Court held that earnings from labor are taxed to the person who performs the services rather than the person who receives the income. In the 1940 case of Helvering v. Horst, the Supreme Court held that income from property is taxed 1 / 2

Copyright © 2026 Pearson Education, Inc.

I:3-2

to the person who owns the property rather than the person who receives the income. One cannot

assign income by arranging to have payment made to another person. p. I:3-6.

I:3-10 Under community property law, community income is divided equally between the spouses. The question of who performed services that produce the income is ignored. In one sense this is contrary to Lucas v. Earl. In another sense the services of both spouses contribute to income production. A spouse who works at home frees the other spouse to work outside the home. pp. I:3-6 and I:3-7.

I:3-11 Jane is taxed even if her father is the employer. Jane is taxed even if her wages are paid to one of her parents. If a child under age 18 (and under age 24 in some cases) has unearned income over $2,700, that income is, however, taxed at higher rates (per the kiddie tax rules). Since Jane has earned income, the $3,000 of wages are not subject to the kiddie tax rules. This is true even

though Jane is under age 18. p. I:3-8.

I:3-12 a. Under the concept of constructive receipt, income is taxed when it becomes available to the taxpayer. The taxpayer cannot defer the tax by refusing to accept payment.

• Income is not constructively received if (1) the receipt is subject to substantial

limitations or restrictions, (2) the payor does not have the funds necessary to make payment, or (3) the amount is unavailable to the taxpayer. pp. I:3-9 and I:3-10.

I:3-13 A territorial system has been adopted, effective 2018. In general, dividends received by

• S. corporations from a 10% or greater foreign subsidiary are eligible for a dividend received

deduction. The dividend received deduction is 100% if all of the subsidiary’s accumulated earnings are from foreign sources, effectively exempting the income from the U. S. corporate income tax. The deduction is prorated if a portion of the subsidiary’s earnings are from domestic sources. This recognizes that host countries tax locally earned income. p. I:3-16.

I:3-14 Income is considered to be earned by an accrual basis taxpayer when all the events have occurred which fix the right to receive the income and the amount of income can be determined

with reasonable accuracy. p. I:3-11.

I:3-15 a. Prepaid income is usually taxable when it is received. This is unlike financial accounting where income is reported as it accrues.

• The concept of wherewithal-to-pay and the desire by the Federal Government to

raise tax revenues are the reasons that the tax law does not conform with financial accounting.

• One problem with this system is that taxpayers must often report income before

expenses related to the income are incurred. The result is a mismatching of revenue and expenses. pp. I:3-11 and I:3-12.

I:3-16 The three conditions that must be met by an accrual basis taxpayer who wishes to defer reporting amounts received in connection with the sale of goods are (1) the goods are not on hand, (2) the amount received is less than the cost of the item, and (3) the income is deferred for financial accounting purposes. pp. I:3-11 and I:3-12.

• / 2