1. John Smith tax issues: a. How is the $300,000 treated for purposes of federal tax income?
John is to report the $300,000 as earned income. This gross income can be filed on Schedule C of his individual tax return or as gross income on the LLC return. Our course text book defines gross income as gross income is defined by the Code as including gross income derived from a business. Income is the fundamental concept of income is set forth in the Sixteenth Amendment, “incomes from whatever source derived”. The reason why he can report this income on the individual return or LLC return is a result of the variance in state laws as to whether a single person LLC can report on a business return or not. For the states that don’t allow separate reporting, then John cannot file this income on the individual return. The $300,000 is considered taxable income in this case. Gross income, for income tax purposes, refers to all income that is taxable. The law enumerates specific items of income that are not to be included in gross income and, therefore, are nontaxable. With these exceptions, all income is includible in gross income. Gross income includes all items of income from whatever source unless specifically excluded. All compensation received by the individual is included in gross income. b. How is the $25,000 treated for purposes of federal tax income?
Assuming that John had $25,000 in expenses that was incurred and paid in the same year, and if this is true, then $25,000 would be treated and reported as income for that year. Even if the expenses are reported in two different years, the net effect is still zero. It would not have been reported as a deductible expense following the matching principle. Wikipedia defines matching principle as is a culmination of accrual accounting and the revenue recognition principle. They both determine the accounting period, in