Income Taxation
This domain tests whether you can move from a fact pattern to the correct amount and character of income: what is included in gross income, when it is recognized, what basis the taxpayer carries into a later sale, and how deductions and capital-gain netting reduce or recharacterize the result. Expect computation questions, not definition recall.
Gross income and realization
IRC §61 defines gross income as all income from whatever source derived. The courts add the Glenshaw Glass test: an undeniable accession to wealth, clearly realized, over which the taxpayer has complete dominion. Appreciation alone is not taxed; a sale or other disposition triggers realization. Timing follows constructive receipt - cash-basis taxpayers report income when it is made available without substantial restriction, even if not yet deposited.
Common exclusions
Gifts and inheritances; life insurance proceeds paid by reason of death; interest on state and municipal bonds; qualified employer fringe benefits; meals and lodging furnished for the convenience of the employer under §119; qualified scholarships covering tuition and required fees. Exclusions never become itemized deductions - they never enter gross income at all.
Basis
Cost basis is adjusted upward for capital improvements and downward for depreciation and casualty losses. Gifted property carries over the donor's basis; where fair market value at the date of gift is below that basis, the dual-basis rule applies - gain measured from the donor's basis, loss from FMV, and a sale price in between produces no gain or loss. Inherited property generally takes a basis equal to FMV at the date of death under §1014.
Deductions and capital gains
Above-the-line adjustments (self-employed health insurance, HSA contributions, deductible IRA contributions) reduce gross income to arrive at AGI; the greater of the standard deduction or itemized deductions then reduces AGI. Long-term capital gains (holding period more than one year) are netted against short-term gains and losses; a net long-term gain is taxed at 0/15/20 percent, while a net short-term gain is ordinary income.
Worked example
A parent gives stock with a donor basis of $12,000 when FMV is $8,000. The donee sells for $9,000. Because the price falls between FMV at the date of gift ($8,000) and carryover basis ($12,000), the sale produces no gain or loss. At $13,000 the gain is $1,000 ($13,000 − $12,000); at $6,000 the loss is $2,000 ($8,000 − $6,000). The rule stops a donee from converting the donor's unrealized loss into a deduction.
Traps that cost marks
- Treating tax-exempt interest as an itemized deduction instead of an exclusion.
- Using FMV at the date of gift as basis in every case.
- Wrong netting order: short-term losses offset long-term gains before the preferential rate applies.
- Missing constructive receipt when a check arrives in December but is deposited in January.