Question

A.

There are three types of taxable income; 1. active, 2. portfolio, 3. passive.  Describe each (in your own words) and make sure you understand the tax implications of these incomes.

B.

Debra Ferguson received the items and amounts of income shown below during 2016. Help her calculate, (a) her gross income and (b) that portion (dollar amount) of her income that is tax exempt.

Salary                                                      $33,500

Dividends                                                  800          

Gift from mother                                       500

Child support from ex-husband                3,600

Interest on savings account                        250

Rent                                                            900

Loan from bank                                          2000

Interest on state government bonds            300                

Answer 1

A.

1. ACTIVE INCOME:

Definition: Money earned from working that requires your time. You actively work, and you are paid for it.

Examples: Salary; wages; bonuses; contract work.

Tax implications: Earned income is taxed higher than any other income, at a rate of 10%-35%, plus Medicare, Social Security, and other taxes, which can reach close to 50% .

It’s hard to become wealthy solely from earned income for two reasons. 1.) It’s taxed at the highest rate, and 2.) There are only so many hours in the day for you to work (you can work and work and work, but if you have to be there to make the money, there’s a cap on your income because time is limited).

2. PORTFOLIO INCOME:

Definition: Money from selling an investment for more than what you paid (capital gains).

Examples: Stocks, bonds, mutual funds, interest, etc.; money from buying/selling real estate or other assets, such as automobiles.

Tax implications:Portfolio income is taxed at 10%-20% for investments held over 12 months. It’s taxed as regular earned income if held less than 12 months. However, portfolio income is not taxed for Medicare or Social Security. Capital gains can be offset by losses on other investments, which is a huge plus.

3. PASSIVE INCOME:

Definition: Money generated from assets you own, where you are not actively working.

Examples: Rental income, business income (only if you’re not required to be there), creating/selling intellectual property.

Tax implications: Passive income receives the most favorable tax treatment. However, losses in passive income cannot be offset against other income. For real estate income, you can avoid taxation altogether through a 1031 exchange, so long as you reinvest the income into something similar (i.e., another property).

Passive income is thought to be the key to building wealth. Once you have an investment that generates recurring income, you don’t have to do much to maintain it (so time is not a limitation).

B.

a). The following table shows the calculation of Gross Income of Debara Ferguson :-

Salary	$33,500
Dividends	$800
Interest on savings account	$250
Rent Income	$900
Total Gross Income	$35,450

Gross Income is obtained by adding Salary, Dividend, Interest on savings account and Rent Income. Hence Total Gross Income is $35,450.

b). Following table shows the Exempt Income:

Dividends	$800
Gift from mother	$500
Child support from ex-husband	$3600
Interest on savings account	$250
Interest on state government bonds	$300