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2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible ebsite, in hole or in part.
Comprehensive Volume
1
Chapter !
"ross #nco$e%Concepts and #nclusions
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&he 'ig (icture
Calculation )* "ross #nco$e+slide 1 o* -
At the beginning o* the year, /r. Cli** (ayne opened
his dental practice as a sole proprietorship.
or his ne business, he selected a /ece$ber 1
yearend. e also entered into a contract to have a building
constructed *or his $edical practice.
e used 312,000 o* e4tra $oney to purchase so$estoc.
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&he 'ig (icture
Calculation )* "ross #nco$e+slide 2 o* -
&he *olloing *inancial in*or$ation shos the results o* /r.(ayne6s *irst year o* operation.
Revenues +a$ounts billed patients *or dental services- 375,000
Accounts receivable% 8anuary 1 909Accounts receivable% /ece$ber 1 52,000
&he accounts receivable represent a$ounts billed patients.
/uring the year, :a$ 8ones, a contractor ho oed /r. (ayne3!,000 *or dental services, satis*ied the account by installingsolar panels on the roo* o* /r. (ayne6s ne $edical building.
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&he 'ig (icture
Calculation )* "ross #nco$e+slide o* -
'ased on his accounting records he concludes
that gross inco$e *or ederal inco$e ta4
purposes is the 375,000 he billed his patients
*or dental services rendered.
as /r. (ayne correctly calculated the gross
inco$e o* this dental practice;
9Read the chapter and *or$ulate your response.
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"ross #nco$e +slide 1 o* -
/e*inition% "ross inco$e includes all inco$e
*ro$ hatever source derived, unless
speci*ically e4cluded under the Code
Concept is interpreted broadly by the courts
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"ross #nco$e +slide 2 o* -
&a4ability o* inco$e *ollos the reali
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"ross #nco$e +slide o* -
#nco$e is recogni cash e?uivalents +i.e.,
property or services-
9&he a$ount o* inco$e *ro$ =inind> receipts is
e?ual to the M@ o* the property or services
#nco$e does not include recovery o* the
ta4payer6s capital invest$ent
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&he 'ig (icture 4a$ple 1
Recovery )* Capital /octrine
Return to the *acts o* &he 'ig (icture on p. !1.
9/r. (ayne sells co$$on stoc *or 315,000.
e had purchased the stoc *or 312,000.
9/r. (ayne6s gross receipts are 315,000.
&his a$ount consists o* a 312,000 recovery o* capital
and 3,000 o* gross inco$e.
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Accounting (eriods
&a4able year is generally a 12$onth period
9&a4able year *or $ost individual ta4payers is the
calendar year
9Afiscalyear can be elected i* ta4payer $aintains
ade?uate records
Afiscalyear is a 12$onth period ending on the last
day o* a $onth other than /ece$ber9 4a$ple% 8uly 1 to 8une 0
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Accounting Methods +slide 1 o* 2-
&here are pri$ary $ethods o* accounting *or
ta4 purposes%
9Cash receipts and disburse$ents $ethod
9Accrual $ethod
9ybrid $ethod
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Accounting Methods +slide 2 o* 2-
#n addition to overall accounting $ethods,
ta4payers $ay choose +elect- ta4 treat$ent *or
various transactions, *or e4a$ple
9&a4payers can elect to use the installment method
9Certain contractors $ay elect to use either the
percentage of completion methodor the completed
contract method
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Cash Receipts Method
#nco$e is recogni
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&he 'ig (icture 4a$ple 10
Constructive Receipt +slide 1 o* 2-
Return to the *acts o* &he 'ig (icture on p. !1.
9)n /ece$ber 1, /r. (ayne has 310,000 in
patientsB checs that have not been deposited.
)ne chec *or 3,000 is *ro$ a patient ho ased hi$not to deposit it until a*ter 8anuary ! th, because her
account did not contain su**icient *unds to pay the debt.
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&he 'ig (icture 4a$ple 10
Constructive Receipt +slide 2 o* 2-
nder the cash $ethod, /r. (ayne $ust recogni
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&he 'ig (icture 4a$ple 12
Constructive Receipt +slide 1 o* 2-
Return to the *acts o* &he 'ig (icture on p. !1.
Assu$e /r. (ayne elected to use the cash basis o*
accounting.
9 #* he accepted credit cards, /r. (ayne ould receivei$$ediate credit in his ban account *or EFG o* the
charge.
&he other !G ould be retained by the credit card issuer.
9 &o avoid the !G charge, /r. (ayne chose not to acceptcredit cards.
#nstead, his policy re?uired all bills to be paid ithin 0 days a*ter
dental services ere provided.
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&he 'ig (icture 4a$ple 12
Constructive Receipt +slide 2 o* 2-
At year end, several patients oed a co$bined32,000.9&hey o**ered to pay ith credit cards, but his
o**ice reHected their o**ers.9&he 32,000 as not constructively received at the
end o* the year. /r. (ayne could have received pay$ent by credit card,
he contracted to receive pay$ent at a later date be*orethe dental services ere per*or$ed.
Moreover, the !G charge by the credit card co$panyould be a IIsubstantial li$itation.66
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4ceptions &o Cash
Receipts Method
)riginal #ssue /iscount +)#/- interest is
ta4able hen earned rather than hen interest
is received
:eries and bonds are not subHect to the
)#/ rules
9oever, a cash basis ta4payer $ay elect to
recogni
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Accrual Method +slide 1 o* 2-
#nco$e is recogni
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Accrual Method +slide 2 o* 2-
Clai$ o* right doctrine
9Re?uires a$ounts received to be included in
inco$e even though the a$ount is in dispute and
$ight be returned to the payor at a later date
9#* pay$ent has not been received, no inco$e is
recogni
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&he 'ig (icture 4a$ple D
Clai$ )* Right /octrine
Return to the *acts o* &he 'ig (icture on p. !1.
)n co$pleting construction o* the $edical o**ice
building in 201!, the contractor sub$itted a bill.
9 /r. (ayne re*used to pay the bill, clai$ing the contractorhad not $et speci*ications.
9 &he contractor did not reach a settle$ent ith /r. (ayne
until 2015.
Jo inco$e accrues to the contractor until 2015.9 #* /r. (ayne had paid *or the or, then *iled suit, the
contractor could not de*er the inco$e
&he inco$e ould be ta4able in 201!.
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4ceptions to Accrual Method+slide 1 o* 2-
&a4payer can elect to de*er recognition o*
inco$e *ro$ advance payment for goodsi*
sa$e $ethod o* accounting is used *or ta4 and
*inancial reporting purposes
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4ceptions to Accrual Method+slide 2 o* 2-
Advance payment for servicesto be per*or$ed
a*ter yearend is included in inco$e in the year
*olloing receipt
9&he portion o* the advance pay$ent that is earned
in the current year is included in inco$e in the
year o* receipt
(repaid rents or interest inco$e are alaysrecogni
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ybrid Method
A co$bination o* cash and accrual $ethods
"enerally, used hen inventory is a $aterial
inco$eproducing *actor, *or e4a$ple
9se accrual $ethod to account *or inventory
9se cash $ethod *or other inco$e and e4penses
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#nco$e :ources +slide 1 o* 2-
#nco$e *ro$ personal services is ta4able to the
person ho per*or$s the services
9ruit and tree $etaphor
#nco$e *ro$ property is ta4able to the oner
o* the property
9Assign$ent o* inco$e is not per$itted
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#nco$e :ources +slide 2 o* 2-
#nterest inco$e accrues daily
9#* interest bearing instru$ent +e.g., bonds- is
trans*erred, $ust allocate interest inco$e beteen
trans*eror and trans*eree based on the nu$ber o*
days during the period that each oned the
property
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Return to the *acts o* &he 'ig (icture on p. !1.
9Assu$e that instead o* operating as a sole
proprietorship, /r. (ayne incorporated his dental
practice to li$it his liability.
e entered into an e$ploy$ent contract ith his
corporation and as to receive a salary.
All patients contract to receive their services *ro$ the
corporation.
9 &hose services are provided by the corporation6s e$ployee,
/r. (ayne.
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&he 'ig (icture 4a$ple 20
:ervices o* an $ployee+slide 1 o* 2-
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&he 'ig (icture 4a$ple 20
:ervices o* an $ployee+slide 2 o* 2-
Return to the *acts o* &he 'ig (icture on p. !1.
9&hus, the corporation earned the inco$e *ro$
patients6 services and $ust include the patients6*ees in its gross inco$e.
9/r. (ayne $ust include his salary in his gross
inco$e.
&he corporation is alloed a deduction *or the
reasonable salary paid to /r. (ayne.
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/ividends +slide 1 o* !-
nlie interest, dividends do not accrue on a
daily basis
/ividends are generally ta4ed to the party ho
is entitled to receive the$
9&he shareholder o* record as o* the corporation6s
record date
/ividends on stoc trans*erred by gi*t a*ter
declaration date but be*ore record date are
generally ta4ed to the donor
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/ividends +slide 2 o* !-
Recent legislation has provided partial relie* *ro$
double ta4ation o* corporate dividends
9 "enerally, dividends received are ta4ed at the sa$e
$arginal rate that is applicable to a net capital gain &hus, individuals otherise subHect to the 10G or 15G $arginal
ta4 rates in 201! pay 0G ta4 on ?uali*ied dividends received
#ndividuals subHect to the 25, 27, , or 5 percent $arginal ta4
rates pay a 15G ta4 on ?uali*ied dividends
#ndividuals subHect to the E.FG $arginal ta4 rate pay a 20G ta4on ?uali*ied dividends
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/ividends +slide o* !-
&he *olloing dividends are not eligible *orthe reduced ta4 rates9/ividends *ro$ certain *oreign corporations,
9/ividends *ro$ ta4e4e$pt entities, and9/ividends that do not satis*y the holding period
re?uire$ent :toc on hich the dividend is paid $ust have been
held *or $ore than F0 days during the 121day periodbeginning F0 days be*ore the e4dividend date to?uali*y *or the reduced ta4 rates
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/ividends +slide ! o* !-
/ividends *ro$ *oreign corporations are
eligible *or ?uali*ied dividend status only i*%
9&he *oreign corporation6s stoc is traded on an
established .:. securities $aret, or
9&he *oreign corporation is eligible *or the bene*its
o* a co$prehensive inco$e ta4 treaty beteen its
country o* incorporation and the nited :tates
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#nco$e Received 'y An Agent
#nco$e received by the ta4payer6s agent is
considered to be received by the ta4payer
9A cash basis principal $ust recogni
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#nco$e ro$ (artnerships
A partnership is not a separate ta4able entity9iles an in*or$ation return +or$ 10F5-
(rovides data necessary *or deter$ining each partner6s
distributive share o* partnership6s inco$e anddeductions
ach partner reports distributive share o* partnershipinco$e and deductions
9 Reported in year earned, even i* not actually distributed
'ecause a partner pays ta4 on inco$e as the partnershipearns it, distributions are treated under the recovery o*capital rules
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#nco$e ro$ : Corporations
A s$all business corporation $ay elect to be
ta4ed si$ilarly to a partnership
9Re*erred to as an : corporation
&he shareholders, rather than the corporation, pay the
ta4 on the corporation6s inco$e
"enerally, shareholders report their share o* the corp6s
inco$e and deductions *or the year, even i* not actually
distributed
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#nco$e ro$ states And &rusts
'ene*iciaries o* estates and trusts
9"enerally, ta4ed on the inco$e earned by the
estates or trusts that is actually distributed or
re?uired to be distributed to the$9Any inco$e not ta4ed to the bene*iciaries is
ta4able to the estate or trust
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#nco$e #n Co$$unity
(roperty :tates
All property is dee$ed either to be separately oned
by the spouse or to belong to the $arital co$$unity
9 Co$$unity inco$e is allocable e?ually to each spouse
9 :eparate inco$e $ay be allocable to onerspouse :eparate property $ay produce co$$unity inco$e
+e.g., &K, LA-
Jo allocation o* co$$unity inco$e *or so$e spouses
living apart *or entire year and *iling separately
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Ali$ony and :eparate Maintenance
(ay$ents +slide 1 o* !-
Ali$ony is%
9/eductible by payor
9#ncludible in gross inco$e o* recipient
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Ali$ony and :eparate Maintenance
(ay$ents +slide 2 o* !-
(ay$ents $ay ?uali*y as ali$ony i*%
9(ay$ents are in cash
9Agree$ent or decree does not speci*y that the
pay$ents are not ali$ony
9(ayor and payee are not $e$bers o* the sa$e
household at the ti$e the pay$ents are $ade
9&here is no liability to $ae the pay$ents *or anyperiod a*ter the death o* the payee
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Ali$ony and :eparate Maintenance
(ay$ents +slide o* !-
(roperty settle$ents
9&rans*er o* property to *or$er spouse
9Jo deduction or recogni
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Ali$ony and :eparate Maintenance
(ay$ents +slide ! o* !-
Child support pay$ents
9 (ay$ents $ade to satis*y legal obligation to support child
o* ta4payer
9Jondeductible by payor and not ta4ed to recipient +orchild-
May be di**icult to deter$ine hether an a$ount
received is ali$ony or child support
9 #* a$ount o* pay$ent ould be reduced due to so$e *utureevent related to the child +e.g., child reaches age 21-, such
reduction is dee$ed child support
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#$puted #nterest on 'eloMaret
Loans +slide 1 o* !-
#nterest is i$puted, using ederal govern$ent rates,
hen a loan does not carry a $aret rate o* interest
9 #$puted interest the di**erence beteen the a$ount that
ould have been charged at the ederal rate and thea$ount actually charged
Applies to% "i*t loans
Co$pensationrelated loans Corporateshareholder loans
&a4 avoidance loans
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#$puted #nterest on 'eloMaret
Loans +slide 2 o* !-
Concept Summary 4.2
The table below presents the eect o certa!n below"mar#et loans on the
len$er an$ borrower
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#$puted #nterest on 'eloMaret
Loans +slide o* !-
"i*t loans
94e$ption *or loans o* 310,000 beteen
individuals
#* loan proceeds are used to purchase inco$eproducingproperty, the *olloing li$itation applies
9)n loans o* 3100,000 or less beteen individuals
#$puted interest is li$ited to borroer6s net invest$ent
inco$e *or year
Jo i$puted interest i* net invest$ent inco$e is 31,000
or less
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#$puted #nterest on 'eloMaret
Loans +slide ! o* !-
310,000 e4e$ption also applies to
co$pensationrelated and corporation
shareholder loans
9Jo e4e$ption i* principal purpose o* loan is ta4
avoidance
Maes practically all loans o* this type suspect
#nterest e4pense i$puted to borroer $ay bedeductible
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Annuity #nco$e+slide 1 o* F-
(urchaser pays *i4ed a$ount *or the right toreceive a *uture strea$ o* pay$ents9"enerally, early collections and loans against
annuity increases in cash value are included ingross inco$e
A$ounts N increases in cash value are treated as arecovery o* capital until cost recoveredO additionala$ounts are included in inco$e
9arly distributions $ay also be subHect to a 10Gpenalty
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Annuity #nco$e+slide 2 o* F-
or collections on and a*ter the annuity
starting date
9&he e4clusion ratio is applied to annuitypay$ents received under contract to deter$ine
a$ount e4cludable%
4clusion ratio #nvest$ent in contract4pected return under contract
9)nce invest$ent is recovered, re$aining
pay$ents are ta4able in *ull
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Annuity #nco$e+slide o* F-
4a$ples%
9&a4payer pays 310,000 *or annuity that ill pay
31,000 a year
A% or a ter$ o* 15 years
'% or li*eti$e +li*e e4pectancy 15 years-
94clusion ratio *or A P '
310,000 .FFD315,000
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Annuity #nco$e+slide ! o* F-
4a$ple +cont6d-
9A% 15 years o* annuity pay$ents
Qears 115% 3 ta4able and 3FFD e4cludable
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Annuity #nco$e+slide 5 o* F-
4a$ple +cont6d-
9'% Li*eti$e pay$ents and ta4payer lives 17 years
Qears 115% 3 ta4able and 3FFD e4cludable
Qears 1F17% 31,000 ta4able each year
9'% Li*eti$e pay$ents and ta4payer lives 10 years
Qears 110% 3 ta4able and 3FFD e4cludable, and
3,0 deduction on *inal return
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Annuity #nco$e+slide F o* F-
&he si$pli*ied $ethod is re?uired *or annuity
distributions *ro$ a ?uali*ied retire$ent plan
94clusion a$ount is invest$ent in contract
divided by nu$ber o* anticipated $onthlypay$ents +table a$ount based on age-
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(ri
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"roup &er$ Li*e #nsurance
4clude pre$iu$s paid by e$ployer on *irst 350,000o* coverage9 (re$iu$s on e4cess coverage are included in gross inco$e
#nclusion a$ount based on #R: provided tables
#* plan discri$inates in *avor o* ey e$ployees +e.g.,o**icers-, ey e$ployees are not eligible *or e4clusion9 #n such a case, the ey e$ployees $ust include in gross
inco$e the greater o*%
&he actual pre$iu$s paid by the e$ployer, or
&he a$ount calculated *ro$ the ni*or$ (re$iu$s table
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ne$ploy$ent Co$pensation
ne$ploy$ent co$pensation is ta4able in *ull
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:ocial :ecurity 'ene*its+slide 2 o* F-
or$ula 1 #* MA"# plus S o* :ocial :ecurity
bene*its e4ceeds the base a$ounts belo, but not the
second set o* base a$ounts,
9 #nclude in inco$e the lesser o*% .50 +:ocial :ecurity 'ene*its-, or
.50 TMA"# .50 +::'- base a$ountU
9 'ase a$ounts%
9 32,000 M8,9 30 M: and not living apart,
9 325,000 *or all other ta4payers
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:ocial :ecurity 'ene*its+slide o* F-
or$ula 2 #* MA"# plus S o* :ocial :ecuritybene*its e4ceeds the base a$ounts belo9 #nclude in inco$e the lesser o*%
.75+:ocial :ecurity bene*its-, or
:u$ o*% .75TMA"# .50+:ocial :ecurity bene*its- second basea$ountU, and the lesser o*%
9 A$ount included through application o* the *irst *or$ula
9 3!,500 +3F,000 *or $arried *iling Hointly-.
'ase a$ounts%9 3!!,000 M8,
9 30 M: and not living apart
9 3!,000 *or all other ta4payers
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:ocial :ecurity 'ene*its+slide ! o* F-
4a$ple o* :ocial :ecurity inco$e%
9A% Married ith A"# 30,000O ta4 e4e$pt
interest inco$e 3,000O :ocial :ecurity bene*its
310,0009'% Married ith A"# 3!0,000O ta4 e4e$pt
interest inco$e 3F,000O :ocial :ecurity bene*its
310,000
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:ocial :ecurity 'ene*its+slide 5 o* F-
4a$ple +cont6d-
9A% or$ula 1% Lesser o*%
.50 +310,000- 35,000, or
.50 T+30,000 3,000- .50 +310,000- 32,000-U 3,000
&here*ore, 3,000 o* :ocial :ecurity bene*its included
in gross inco$e
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:ocial :ecurity 'ene*its+slide F o* F-
4a$ple +cont6d-9'% or$ula 2% Lesser o*%
.75 +310,000- 37,500, or
:u$ o*9 .75T+3!0,000 3F,000- .50 +310,000- 3!!,000U 35,E50,
and
9 Lesser o*%
9 .50 +310,000- 35,000, or
9 3F,000 &here*ore, 37,500 o* :ocial :ecurity bene*its included
in gross inco$e
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