REG, Regulation

Sources for Regulation Core: Gross Income, Contracts, Entity Taxation

Last reviewed 2026-09-14

The standards and authorities behind PocketCPA's REG lessons on Regulation Core: Gross Income, Contracts, Entity Taxation. The topic rests on IRC Sec. 61, 101, 102, 103, 108, 117, 119, 121, 129, 132, 152, 2, 7703, 1012 through 1091, 1361 through 1377; UCC Article 2; the common law of contracts.

About this topic

REG asks two questions over and over. What must a taxpayer report, and which body of law governs a bargain that has gone wrong. Stated technically, the section blends federal taxation with business law and professional responsibilities.

Two habits carry most of the section, and both are habits of order.

Key points

• Gross income includes all income from whatever source derived unless specifically excluded by the Code.
• The three major exclusions from gross income are life insurance proceeds (Sec. 101), gifts and inheritances (Sec. 102), and municipal bond interest (Sec. 103).
• A contract requires offer, acceptance, consideration, capacity, and legality to be enforceable.
• Entity choice (C corp, S corp, partnership, LLC) determines how income is taxed and who pays the tax.

What the lessons cover

1. Gross income and exclusions
2. Basis of property
3. Filing status
4. Business law: contracts
5. Entity taxation: S corporations
6. Fringe benefits and employer-provided exclusions
7. Annuities, Social Security benefits, and below-market loans
8. Discharge of indebtedness and the principal residence exclusion
9. Dependency: the qualifying child and qualifying relative tests
10. Disallowed losses, nonrecognition exchanges, and the holding period
11. Contract performance, breach, and remedies
12. S corporation basis, distributions, and entity-level taxes

Authoritative references

Where these requirements sit in the literature.

• UCC Sec. 2-601, the perfect tender rule, gives the buyer in a single-delivery sale its rights when the goods or the tender of delivery fail in any respect to conform to the contract. The buyer may reject the whole, accept the whole, or accept any commercial unit or units and reject the rest. Installment contracts are governed instead by Sec. 2-612, which uses a substantial-impairment standard.
• IRC Sec. 152(c) defines a qualifying child and carries its four tests.
  • Relationship, under Sec. 152(c)(2), a child or descendant of the taxpayer, or a sibling or descendant of one.
  • Residency, the same principal place of abode for more than half the year.
  • Age, under 19, or a student under 24, and younger than the taxpayer.
  • Support, the individual did not provide over half of their own support.
• IRC Sec. 101(a)(1) excludes from gross income amounts received under a life insurance contract if paid by reason of the death of the insured. A lump-sum death benefit is therefore not taxable to the beneficiary; interest paid on proceeds left with the insurer is a different matter and is taxable.
• IRC Sec. 61(a) defines gross income as all income from whatever source derived, including (but not limited to) fourteen enumerated items. Sec. 61(b) points to part II for specific inclusions and part III, beginning at Sec. 101, for specific exclusions. Former Sec. 61(a)(8), alimony, was struck by Pub. L. 115-97 Sec. 11051(b)(1)(A), and Sec. 11051(c) applies the repeal by reference to the execution date of the divorce or separation instrument. Five of the enumerated items are the most heavily tested.
  • Sec. 61(a)(1), compensation for services, including fringe benefits.
  • Sec. 61(a)(4), interest.
  • Sec. 61(a)(7), dividends.
  • Sec. 61(a)(11), income from discharge of indebtedness.
  • Sec. 61(a)(13), income in respect of a decedent.
• IRC Sec. 102 covers gifts and inheritances. Subsection (a) excludes the value of property acquired by gift, bequest, devise, or inheritance, and subsection (b)(1) refuses to exclude the income from that property. Subsection (c)(1) refuses to exclude any amount transferred by or for an employer to, or for the benefit of, an employee. Subsection (c)(2) cross-references the only two rescues, the Sec. 74(c) employee achievement award and the Sec. 132(e) de minimis fringe.
• IRC Sec. 101(a)(2) caps the death-benefit exclusion where the contract was transferred for a valuable consideration, holding it to the actual value of the consideration plus premiums and other amounts subsequently paid by the transferee. Its second sentence then carries two exceptions to that cap: a carryover-basis transfer under subparagraph (A), and, under subparagraph (B), a transfer to any of four recipients.
  • The insured.
  • A partner of the insured.
  • A partnership in which the insured is a partner.
  • A corporation in which the insured is a shareholder or officer.
• Sec. 101(a)(3)(A) turns that second sentence off for a reportable policy sale, defined in Sec. 101(a)(3)(B) as an acquisition by a person with no substantial family, business, or financial relationship with the insured. Sec. 101(c) taxes interest on proceeds held under an agreement to pay interest, and Sec. 101(d)(1) prorates an installment payout, excluding the prorated amount and including the rest.
• IRC Sec. 103 covers State and local bond interest. Subsection (a) excludes it except as provided in subsection (b); subsection (c)(1) defines a State or local bond as an obligation of a State or political subdivision. The three exceptions in subsection (b) are a private activity bond that is not a qualified bond under Sec. 141, an arbitrage bond under Sec. 148, and a bond failing the registration requirements of Sec. 149. Gain on the sale of a municipal bond is outside the section entirely.
• IRC Sec. 108 governs discharge of indebtedness.
  • Subsection (a)(1) lists the exclusions, of which (A) title 11 and (B) insolvency are the exam's staples.
  • Subsection (a)(3) limits the insolvency exclusion to the amount of insolvency.
  • Subsection (d)(3) defines insolvent as the excess of liabilities over the fair market value of assets, determined immediately before the discharge.
  • Subsection (b)(1) applies the excluded amount to reduce tax attributes.
  • Subsection (e)(2), which operates before any exclusion is needed, realizes no income to the extent payment would have given rise to a deduction.
  • Subsection (e)(5), which also operates first, recharacterizes a seller's reduction of purchase-money debt owed by a solvent buyer as a purchase price adjustment, which reduces basis instead of creating income.
• IRC Sec. 121 excludes gain on the sale of a principal residence owned and used as such for periods aggregating 2 years or more during the 5-year period ending on the sale date.
  • Subsection (b)(1) caps the exclusion at 250,000, and subsection (b)(2)(A) substitutes 500,000 on a qualifying joint return.
  • Subsection (b)(3) bars the exclusion where subsection (a) applied to another sale in the 2-year period ending on the date of sale.
  • Subsection (c) supplies a reduced dollar limitation, not a reduced gain, where the sale is by reason of a change in place of employment, health, or other unforeseen circumstances.
  • Subsection (d)(6) denies the exclusion to gain not exceeding post-May 6, 1997 depreciation adjustments, and subsection (b)(5) allocates gain to periods of nonqualified use.
• IRC Sec. 132 is the fringe benefit menu. Subsection (a) lists the eight excludable fringes.
  • Subsection (b) defines a no-additional-cost service by two conjunctive tests. The service must be offered for sale to customers in the ordinary course of the line of business in which the employee performs services, and the employer must incur no substantial additional cost including forgone revenue.
  • Subsection (c)(1) caps a qualified employee discount at the gross profit percentage for property and at 20 percent for services, and subsection (c)(2)(A) defines the gross profit percentage.
  • Subsection (d) covers a working condition fringe, subsection (e)(1) a de minimis fringe, and subsection (j)(4) an on-premises athletic facility.
  • Subsection (g)(2) suspends the qualified moving expense reimbursement exclusion with no expiration, excepting only Armed Forces members moving pursuant to military orders and, for years beginning after 2025, intelligence community employees and new appointees moving pursuant to a change in assignment requiring relocation.
  • Subsection (h)(2)(A) treats use by an employee's spouse or dependent child as use by the employee, and subsection (j)(1) imposes nondiscrimination on the subsection (a)(1) and (a)(2) exclusions only.
• IRC Sec. 2(a) defines a surviving spouse on four conditions.
  • Death in either of the two taxable years immediately preceding.
  • A household maintained as the taxpayer's home that is for the taxable year the principal place of abode of a dependent son, stepson, daughter, or stepdaughter.
  • No remarriage before the close of the year.
  • A year-of-death joint return that could have been made.
• Sec. 2(b)(1) defines head of household in three branches, and its flush language requires the taxpayer to furnish over half the cost of maintaining the household.
  • Clause (A)(i), for a qualifying child under Sec. 152(c) determined without regard to Sec. 152(e).
  • Clause (A)(ii), for any other dependent.
  • Subparagraph (B), for a father or mother, which omits the words as his home.
• Sec. 2(b)(2) supplies three deeming rules and Sec. 2(b)(3) two disqualifications, and Sec. 2(c) imports the abandoned-spouse test of Sec. 7703(b).
• IRC Sec. 7703 determines marital status. Subsection (a)(1) tests it at the close of the taxable year, or at the time of death if the spouse dies during the year. Subsection (a)(2) treats an individual legally separated under a decree of divorce or of separate maintenance as not married. Subsection (b) supplies the three-condition abandoned-spouse test, whose third condition requires the spouse to be absent for the whole of the last 6 months of the year.
• IRC Sec. 1012(a) sets basis at cost, and subsection (b) keeps out real property taxes treated under Sec. 164(d) as imposed on the taxpayer. IRC Sec. 1016(a)(2) reduces basis by depreciation allowed but not less than the amount allowable, and subsection (b) requires the transferor's adjustments to be made first where basis is a substituted basis. IRC Sec. 1015(a) gives a donee the donor's basis, with a fair market value loss basis where the donor's basis exceeded date-of-gift value. Sec. 1015(e) routes a Sec. 1041(a) transfer to Sec. 1041(b)(2) instead, which preserves a built-in loss in full.
• IRC Sec. 1014 gives property acquired from a decedent a date-of-death fair market value basis under subsection (a)(1), or the alternate valuation figure under subsection (a)(2). Subsection (b)(6) extends a new basis to the survivor's own half of community property, and subsection (c) shuts the section off for income in respect of a decedent under Sec. 691. Subsection (e)(1) denies the step-up on appreciated property gifted to the decedent within 1 year of death that passes back to the donor or the donor's spouse.
• IRC Sec. 1361(b)(1) carries the four small business corporation tests, and Sec. 1361(b)(2) defines an ineligible corporation exhaustively. Sec. 1361(c)(1) aggregates a husband and wife and all members of a family as one shareholder each, with the 6-generation ceiling on a common ancestor in Sec. 1361(c)(1)(B)(ii). Sec. 1361(c)(2)(A) lists the permitted trusts and its flush sentence excludes any foreign trust. Sec. 1361(c)(4) disregards voting differences among common shares, and Sec. 1361(c)(5) supplies the three-condition straight debt safe harbor.
• IRC Sec. 1362 governs the election.
  • Subsection (a)(2) requires all shareholders to consent to make it, and subsection (b)(1)(B) sets the 15th day of the 3d month deadline.
  • Subsections (b)(2) and (b)(3) push a defective or late election into the following year, and subsection (b)(5) allows reasonable cause relief.
  • Subsection (d)(1)(B) requires only more than one-half of the shares to revoke, and subsections (d)(1)(C) and (D) fix the effective date.
  • Subsection (d)(2) terminates on the date of cessation.
  • Subsection (d)(3) terminates for 3 consecutive years of passive investment income over 25 percent with accumulated E&P.
  • Subsection (e) splits an S termination year, and subsection (f) grants inadvertent termination relief on four conditions.
  • Subsection (g) imposes the 5-year wait before a new election without the Secretary's consent.
• IRC Sec. 1368 orders S corporation distributions. With no accumulated E&P, subsection (b) applies: tax free to the extent of stock basis, then gain from the sale or exchange of property. With accumulated E&P, subsection (c) runs three tiers, the accumulated adjustments account under (c)(1), a dividend to the extent of accumulated E&P under (c)(2), and back to subsection (b) under (c)(3). Subsection (e)(1)(A) builds the account like Sec. 1367 except that no adjustment is made for tax-exempt income and related expenses and the phrase but not below zero is disregarded. Subsection (e)(1)(C) disregards a net negative adjustment for the year in applying the section to that year's distributions.

How PocketCPA uses these sources

Every lesson is written in original words and cites the paragraph each rule comes from. No standard's text is reproduced. How lessons and questions are written and checked is set out in our methodology.

See also

• Sources for every REG topic
• Free REG sample questions
• The CPA exam glossary