Gross Income
Introduction
Gross income is the starting point for computing an individual's federal income tax liability. Under IRC §61, gross income means "all income from whatever source derived," establishing one of the broadest definitions in the tax code. Before calculating gross income, however, a taxpayer must first determine whether a filing obligation exists and which filing status applies. This chapter covers filing requirements, filing status, dependency rules, and the major categories of gross income tested on the CPA exam.
Filing Requirements
Who Must File
An individual must file a federal income tax return when gross income equals or exceeds a threshold amount that depends on filing status, age, and dependency status. Even when gross income falls below the threshold, a return should be filed to claim refundable credits or to obtain a refund of withheld taxes.
Self-employed individuals must file a return if net self-employment income is $400 or more, regardless of total gross income.
Gross Income Thresholds
The standard threshold equals the standard deduction for the taxpayer's filing status. Thresholds are adjusted annually for inflation.
| Filing Status | Under 65 (2024 Approx.) | 65 or Older (2024 Approx.) |
|---|---|---|
| Single | $14,600 | $16,550 |
| Married Filing Jointly | $29,200 | $30,750 (one spouse 65+) |
| Married Filing Separately | $5 | $5 |
| Head of Household | $21,900 | $23,850 |
| Qualifying Surviving Spouse | $29,200 | $30,750 |
Married Filing Separately has a $5 filing threshold — virtually every MFS taxpayer must file.
Filing Status
A taxpayer's filing status is determined on the last day of the tax year (December 31 for calendar-year taxpayers). The five filing statuses are ranked below from most to least favorable tax brackets.
1. Married Filing Jointly (MFJ)
Both spouses report all income and deductions on one return. If one spouse dies during the year, the surviving spouse may still file jointly for that year.
2. Qualifying Surviving Spouse (QSS)
Available for two years after the year of the spouse's death if the taxpayer maintains a household for a dependent child. QSS uses the same tax brackets and standard deduction as MFJ.
3. Head of Household (HoH)
The taxpayer must meet all three requirements:
- Unmarried (or considered unmarried) on December 31.
- Paid more than half the cost of maintaining a home for the year.
- A qualifying person lived with the taxpayer for more than half the year (exception: a dependent parent need not live with the taxpayer if the taxpayer pays more than half the cost of the parent's home).
:::tip Exam Tip
A married individual who lived apart from their spouse for the last six months of the year and maintained a home for a dependent child may qualify as "considered unmarried" and file as Head of Household.
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4. Single
Unmarried taxpayers who do not qualify for HoH or QSS.
5. Married Filing Separately (MFS)
Either spouse may elect MFS. This status forfeits many credits and deductions but can reduce combined liability when one spouse has large medical expenses or miscellaneous deductions.
Dependency Exemptions
Although the personal exemption amount is $0 for 2018–2025 under the Tax Cuts and Jobs Act, dependency status still matters for Head of Household, the Child Tax Credit, the Earned Income Credit, and other provisions.
Qualifying Child (QC) — The CARES Test
| Test | Requirement |
|---|---|
| Close relative | Child, stepchild, foster child, sibling, or descendant of any of these |
| Age | Under 19, or under 24 if a full-time student, or permanently disabled at any age |
| Residency | Same principal place of abode for more than half the year |
| Eliminate gross income test | Not applicable — no income test for QC |
| Support | Child did not provide more than half of own support |
Qualifying Relative (QR)
| Test | Requirement |
|---|---|
| Not a qualifying child | Cannot meet the QC test for any taxpayer |
| Relationship or member of household | Relative listed in IRC §152(d)(2), or lives with the taxpayer all year |
| Gross income | Dependent's gross income must be less than the exemption amount ($5,050 for 2024) |
| Support | Taxpayer provides more than 50% of the dependent's support |
:::tip Exam Tip
A multiple support agreement (Form 2120) allows one member of a group to claim a dependent when no single person provides more than 50% of support, but the claimant must contribute more than 10%.
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Gross Income — Part 1: Common Income Items
Definition Under IRC §61
Gross income includes — but is not limited to — compensation for services, business income, gains from property, interest, rents, royalties, dividends, alimony (pre-2019), annuities, and income from discharge of indebtedness.
Wages, Salaries, and Tips
All cash and non-cash compensation is included in gross income. Tips of $20 or more in a month must be reported to the employer.
Example: Gies Co. pays its controller a $120,000 salary and provides a $5,000 country-club membership used for personal recreation. The controller reports $125,000 in gross income.
Interest Income
- Taxable interest — Interest on bank accounts, CDs, corporate bonds, and U.S. Treasury obligations is fully taxable for federal purposes.
- Tax-exempt interest — Interest on state and local municipal bonds is excluded from gross income under IRC §103 but may be a preference item for AMT (private-activity bonds).
U.S. Treasury bond interest is taxable for federal purposes but exempt from state income tax. Municipal bond interest is the reverse — exempt federally but often taxable by states other than the issuing state.
Dividend Income
| Type | Tax Treatment |
|---|---|
| Qualified dividends | Taxed at preferential long-term capital gains rates (0%, 15%, or 20%) |
| Nonqualified (ordinary) dividends | Taxed at ordinary income rates |
To be qualified, dividends must be paid by a U.S. corporation (or qualifying foreign corporation) and the shareholder must satisfy the holding-period requirement — holding the stock for more than 60 days during the 121-day period surrounding the ex-dividend date.
Rental Income and Expenses
Rental income is included in gross income and offset by deductible rental expenses such as mortgage interest, property taxes, insurance, repairs, and depreciation. Passive activity loss rules generally limit the deduction of rental losses.
Example: MAS Inc.'s sole shareholder rents a duplex and reports $18,000 of rental income. Deductible expenses total $22,000, creating a $4,000 rental loss. If the owner actively participates and has AGI under $100,000, up to $25,000 of the loss may be deducted against nonpassive income.
Alimony
| Divorce Agreement | Payer | Recipient |
|---|---|---|
| Executed before 2019 | Deductible (above-the-line) | Included in gross income |
| Executed after 2018 | Not deductible | Excluded from gross income |
Pre-2019 agreements that are modified after 2018 adopt the new rules only if the modification expressly states that the post-2018 rules apply.
Unemployment Compensation
Fully taxable as ordinary income.
Social Security Benefits
Up to 85% of Social Security benefits may be taxable depending on provisional income (AGI + tax-exempt interest + 50% of benefits).
| Provisional Income (Single) | Amount Taxable |
|---|---|
| Below $25,000 | 0% |
| $25,000 – $34,000 | Up to 50% |
| Above $34,000 | Up to 85% |
Prizes, Awards, and Gambling Income
- Prizes and awards are gross income unless assigned to charity under IRC §74(b).
- Gambling income is reported in full; gambling losses are deductible only as an itemized deduction, limited to gambling winnings.
Discharge of Indebtedness Income
Cancellation of debt generally produces gross income equal to the amount forgiven. Major exclusions apply when the taxpayer is:
- In a Title 11 bankruptcy proceeding.
- Insolvent (to the extent of insolvency).
- Discharging qualified farm indebtedness.
- Discharging qualified real property business indebtedness.
- Discharging qualified principal residence indebtedness (subject to sunset dates).
Example: Kingfisher Industries owes $200,000 on a business loan. The lender agrees to accept $150,000 in full settlement. Kingfisher has assets of $500,000 and liabilities of $600,000 (insolvent by $100,000). Of the $50,000 discharge, $100,000 of insolvency exceeds the discharge amount, so the entire $50,000 is excluded.
Life Insurance Proceeds
Proceeds received by a beneficiary on account of the insured's death are generally excluded from gross income under IRC §101(a). Exceptions include the transfer-for-value rule — if the policy was sold, proceeds in excess of the purchase price are taxable.
Scholarships and Fellowships
Amounts used for tuition and required fees, books, supplies, and equipment at a qualified educational institution are excluded. Amounts covering room, board, or other living expenses are taxable.
Gross Income — Part 2: Advanced Concepts
Community Property Income
In community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin), earned income is generally split equally between spouses. When spouses file separately, each reports 50% of community income.
Income From Flow-Through Entities
Owners of S corporations, partnerships, and LLCs taxed as partnerships report their distributive share of income whether or not cash is distributed. The character of each item (ordinary, capital gain, tax-exempt) passes through to the owner.
Example: BIF Partners earns $300,000 of ordinary business income and $40,000 of long-term capital gains. Partner A, a 25% partner, reports $75,000 of ordinary income and $10,000 of LTCG on her individual return, regardless of actual distributions.
Constructive Receipt Doctrine
Income is taxable when it is credited to the taxpayer's account, set apart, or otherwise made available — even if the taxpayer has not physically received the cash. A taxpayer cannot defer income by turning their back on it.
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A year-end bonus check available for pickup on December 30 is taxable in that year even if the employee waits until January 2 to pick it up.
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Assignment of Income Doctrine
Income is taxed to the person who earns it. A taxpayer cannot shift income by directing payment to another party. The "fruit and tree" metaphor from Lucas v. Earl (1930) holds that the fruit (income) is taxed to the tree (earner).
Example: Illini Entertainment's lead performer directs that $50,000 of her concert fees be paid directly to her brother. The performer must still include the $50,000 in her gross income.
Tax Benefit Rule
If a taxpayer received a tax benefit from a deduction in a prior year (e.g., a state tax refund after itemizing state taxes), the recovery must be included in gross income in the year received — but only to the extent the prior deduction reduced tax.
Example: Illini Security's owner deducted $6,000 of state income taxes in Year 1 (itemized deductions exceeded the standard deduction by $2,000). In Year 2, the owner receives a $1,500 state refund. Because the refund is less than the $2,000 excess benefit, the entire $1,500 is included in Year 2 gross income.
Summary
| Concept | Key Rule |
|---|---|
| IRC §61 | Gross income is all income from whatever source derived |
| Filing threshold | Generally equals the standard deduction for the filing status |
| Head of Household | Unmarried, pays >50% of home costs, qualifying person |
| Qualifying Child | CARES: Close relative, Age, Residency, Eliminate income test, Support |
| Qualified dividends | Taxed at LTCG rates (0%/15%/20%) |
| Alimony (post-2018) | Not deductible by payer; excluded by recipient |
| Social Security | Up to 85% taxable based on provisional income |
| Constructive receipt | Income taxable when made available, not when collected |
| Assignment of income | Income taxed to the earner |
The CPA exam frequently tests the boundaries of gross income — especially exclusions for municipal bond interest, life insurance proceeds, scholarships, and discharge of indebtedness. Memorize both the general rule and the exceptions.