Chapter 4, Problem 1DQ

To determine

Discuss the two reasons most commonly advanced for excluding items from income with examples, and also explain the manner in which the purpose of exclusion is accomplished by them.

Explanation of Solution

For excluding items from income, encouraging taxpayers to engage in transactions for which relief is provided, and alleviating the effects of double taxation, are the two reasons which are most commonly advanced.

The example of the exclusions that encourage taxpayers to engage in specific transactions is that individuals are encouraged to purchase medical insurance, as all the payments received from the purchased medical insurance policies are excluded. The taxpayers are encouraged to invest in securities versus taxable investments, as the interest received on municipal bonds are excluded.

The examples of the exclusions that avoid double taxation are the exclusion of the foreign earned income. The income earned in foreign countries are prevented from being taxed in the Country U and also in the foreign country. Double taxation is prevented by the gift and estate tax, and income tax for the property received by inheritance or gift.