The eight chapters in this part discuss many kinds of income. They explain which income is and is not taxed. See Part Three for information on gains and losses you report on Schedule D (Form 1040) and for information on selling your home.
Health savings accounts (HSA). You can fund your HSA with a one-time direct transfer from your individual retirement plan, health reimbursement account, or health flexible spending account and exclude the amount of the transfer from income.
However, you must include the amount transferred in your income, as well as pay a 10% additional tax, if you do not remain an eligible individual for at least 12 months after the month of the transfer.
Foreign income. If you are a U.S. citizen or resident alien, you must report income from sources outside the United States (foreign income) on your tax return unless it is exempt by U.S. law. This is true whether you reside inside or outside the United States and whether or not you receive a Form W-2, Wage and Tax Statement, or Form 1099 from the foreign payer. This applies to earned income (such as wages and tips) as well as unearned income (such as interest, dividends, capital gains, pensions, rents, and royalties).
If you reside outside the United States, you may be able to exclude part or all of your foreign source earned income. For details, see Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad.
This chapter discusses compensation received for services as an employee, such as wages, salaries, and fringe benefits. The following topics are included.
The chapter explains what income is included in the employee's gross income and what is not included.
Useful Items
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Publication
This section discusses various types of employee compensation including fringe benefits, retirement plan contributions, stock options, and restricted property.
Form W-2. If you are an employee, you should receive Form W-2 from your employer showing the pay you received for your services. Include your pay on line 7 of Form 1040 or Form 1040A, or on line 1 of Form 1040EZ, even if you do not receive a Form W-2.
If you performed services, other than as an independent contractor, and your employer did not withhold social security and Medicare taxes from your pay, you must file Form 8919, Uncollected Social Security and Medicare Tax on Wages, with your Form 1040. These wages must be included on line 7 of Form 1040. See Form 8919 for more information.
Child care providers. If you provide childcare, either in the child's home or in your home or other place of business, the pay you receive must be included in your income. If you are not an employee, you are probably self-employed and must include payments for your services on Schedule C (Form 1040), Profit or Loss From Business, or Schedule C-EZ (Form 1040), Net Profit From Business. You generally are not an employee unless you are subject to the will and control of the person who employs you as to what you are to do and how you are to do it.
Babysitting. If you babysit for relatives or neighborhood children, whether on a regular basis or only periodically, the rules for childcare providers apply to you.
This section discusses different types of employee compensation.
Advance commissions and other earnings. If you receive advance commissions or other amounts for services to be performed in the future and you are a cash-method taxpayer, you must include these amounts in your income in the year you receive them.
If you repay unearned commissions or other amounts in the same year you receive them, reduce the amount included in your income by the repayment. If you repay them in a later tax year, you can deduct the repayment as an itemized deduction on your Schedule A (Form 1040), or you may be able to take a credit for that year. See Repayments in chapter 12.
Allowances and reimbursements. If you receive travel, transportation, or other business expense allowances or reimbursements from your employer, see Publication 463. If you are reimbursed for moving expenses, see Publication 521, Moving Expenses.
Back pay awards. Include in income amounts you are awarded in a settlement or judgment for back pay. These include payments made to you for damages, unpaid life insurance premiums, and unpaid health insurance premiums. They should be reported to you by your employer on Form W-2.
Bonuses and awards. Bonuses or awards you receive for outstanding work are included in your income and should be shown on your Form W-2. These include prizes such as vacation trips for meeting sales goals. If the prize or award you receive is goods or services, you must include the fair market value of the goods or services in your income. However, if your employer merely promises to pay you a bonus or award at some future time, it is not taxable until you receive it or it is made available to you.
Employee achievement award. If you receive tangible personal property (other than cash, a gift certificate, or an equivalent item) as an award for length of service or safety achievement, you generally can exclude its value from your income. However, the amount you can exclude is limited to your employer's cost and cannot be more than $1,600 ($400 for awards that are not qualified plan awards) for all such awards you receive during the year. Your employer can tell you whether your award is a qualified plan award. Your employer must make the award as part of a meaningful presentation, under conditions and circumstances that do not create a significant likelihood of it being disguised pay.
However, the exclusion does not apply to the following awards.
Example. Ben Green received three employee achievement awards during the year: a nonqualified plan award of a watch valued at $250, and two qualified plan awards of a stereo valued at $1,000 and a set of golf clubs valued at $500. Assuming that the requirements for qualified plan awards are otherwise satisfied, each award by itself would be excluded from income. However, because the $1,750 total value of the awards is more than $1,600, Ben must include $150 ($1,750 -- $1,600) in his income.
Government cost-of-living allowances. Cost-of-living allowances generally are included in your income. However, they are not included in your income if you are a federal civilian employee or a federal court employee who is stationed in Alaska, Hawaii, or outside the United States.
Allowances and differentials that increase your basic pay as an incentive for taking a less desirable post of duty are part of your compensation and must be included in income. For example, your compensation includes Foreign Post, Foreign Service, and Overseas Tropical differentials. For more information, see Publication 516, U.S. Government Civilian Employees Stationed Abroad.
Nonqualified deferred compensation plans. Your employer will report to you the total amount of deferrals for the year under a nonqualified deferred compensation plan. This amount is shown on Form W-2, box 12, using code Y. This amount is not included in your income.
However, if at any time during the tax year, the plan fails to meet certain requirements, or is not operated under those requirements, all amounts deferred under the plan for the tax year and all preceding tax years are included in your income for the current year. This amount is included in your wages shown on Form W-2, box 1. It also is shown on Form W-2, box 12, using code Z.
For information on the requirements and the amount to include in income, see Internal Revenue Code section 409A and Notice 2005-1. The notice is on page 274 of Internal Revenue Bulletin 2005-2 at www.irs.gov/pub/irs-irbs/irb05-02.pdf.
Caution: For tax years beginning after 2007, portions of Notice 2005-1 are obsolete and replaced by final regulations issued under section 409A. For information on the applicability of the regulations, see the preamble to Treasury Decision 9321 on page 1123 of Internal Revenue Bulletin 2007-19 at www.irs.gov/pub/irs-irbs/irb07-19.pdf.
Note received for services. If your employer gives you a secured note as payment for your services, you must include the fair market value (usually the discount value) of the note in your income for the year you receive it. When you later receive payments on the note, a proportionate part of each payment is the recovery of the fair market value that you previously included in your income. Do not include that part again in your income. Include the rest of the payment in your income in the year of payment.
If your employer gives you a nonnegotiable unsecured note as payment for your services, payments on the note that are credited toward the principal amount of the note are compensation income when you receive them.
Severance pay. You must include in income amounts you receive as severance pay and any payment for the cancellation of your employment contract.
Accrued leave payment. If you are a federal employee and receive a lump-sum payment for accrued annual leave when you retire or resign, this amount will be included as wages on your Form W-2.
If you resign from one agency and are reemployed by another agency, you may have to repay part of your lump-sum annual leave payment to the second agency. You can reduce gross wages by the amount you repaid in the same tax year in which you received it. Attach to your tax return a copy of the receipt or statement given to you by the agency you repaid to explain the difference between the wages on the return and the wages on your Forms W-2.
Outplacement services. If you choose to accept a reduced amount of severance pay so that you can receive outplacement services (such as training in résumé writing and interview techniques), you must include the unreduced amount of the severance pay in income.
However, you can deduct the value of these outplacement services (up to the difference between the severance pay included in income and the amount actually received) as a miscellaneous deduction (subject to the 2% of adjusted gross income (AGI) limit) on Schedule A (Form 1040).
Sick pay. Pay you receive from your employer while you are sick or injured is part of your salary or wages. In addition, you must include in your income sick pay benefits received from any of the following payers.
However, if you paid the premiums on an accident or health insurance policy, the benefits you receive under the policy are not taxable. For more information, see Publication 525.
Social security and Medicare taxes paid by employer. If you and your employer have an agreement that your employer pays your social security and Medicare taxes without deducting them from your gross wages, you must report the amount of tax paid for you as taxable wages on your tax return. The payment also is treated as wages for figuring your social security and Medicare taxes and your social security and Medicare benefits. However, these payments are not treated as social security and Medicare wages if you are a household worker or a farm worker.
Stock appreciation rights. Do not include a stock appreciation right granted by your employer in income until you exercise (use) the right. When you use the right, you are entitled to a cash payment equal to the fair market value of the corporation's stock on the date of use minus the fair market value on the date the right was granted. You include the cash payment in your income in the year you use the right.
Fringe benefits received in connection with the performance of your services are included in your income as compensation unless you pay fair market value for them or they are specifically excluded by law. Abstaining from the performance of services (for example, under a covenant not to compete) is treated as the performance of services for purposes of these rules.
Accounting period. You must use the same accounting period your employer uses to report your taxable noncash fringe benefits. Your employer has the option to report taxable noncash fringe benefits by using either of the following rules.
Your employer does not have to use the same accounting period for each fringe benefit, but must use the same period for all employees who receive a particular benefit.
You must use the same accounting period that you use to report the benefit to claim an employee business deduction (for use of a car, for example).
Form W-2. Your employer reports your taxable fringe benefits in box 1 (Wages, tips, other compensation) of Form W-2. The total value of your fringe benefits also may be noted in box 14. The value of your fringe benefits may be added to your other compensation on one Form W-2, or you may receive a separate Form W-2 showing just the value of your fringe benefits in box 1 with a notation in box 14.
Generally, the value of accident or health plan coverage provided to you by your employer is not included in your income. Benefits you receive from the plan may be taxable, as explained later under Sickness and Injury Benefits.
For information on the items covered in this section, other than Long-term care coverage, see Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans.
Long-term care coverage. Contributions by your employer to provide coverage for long-term care services generally are not included in your income. However, contributions made through a flexible spending or similar arrangement (such as a cafeteria plan) must be included in your income. This amount will be reported as wages in box 1 of your Form W-2.
Contributions you make to the plan are discussed in Publication 502, Medical and Dental Expenses.
Archer MSA contributions. Contributions by your employer to your Archer MSA generally are not included in your income. Their total will be reported in box 12 of Form W-2 with code R. You must report this amount on Form 8853, Archer MSAs and Long-Term Care Insurance Contracts. File the form with your return.
If your employer does not make contributions to your MSA, you can make your own contributions to your MSA. These contributions are discussed in Publication 969. Also, see Form 8853.
Health flexible spending arrangement (health FSA). If your employer provides a health FSA that qualifies as an accident or health plan, the amount of your salary reduction, and reimbursements of your medical care expenses and those of your spouse and dependents, generally are not included in your income.
Qualified HSA distribution. A health FSA can make a qualified HSA distribution. This distribution is a direct transfer to your HSA trustee by your employer. Generally, the distribution is not included in your income and is not deductible. See Publication 969 for the requirements for these qualified HSA distributions.
Health reimbursement arrangement (HRA). If your employer provides an HRA that qualifies as an accident or health plan, coverage and reimbursements of your medical care expenses and those of your spouse and dependents generally are not included in your income.
Qualified HSA distribution. An HRA can make a qualified HSA distribution. This distribution is a direct transfer to your HSA trustee by your employer. Generally, the distribution is not included in your income and is not deductible. See Publication 969 for the requirements for these qualified HSA distributions.
Health savings accounts (HSA). If you are an eligible individual, you and any other person, including your employer or a family member, can make contributions to your HSA. Contributions, other than employer contributions, are deductible on your return whether or not you itemize deductions. Contributions made by your employer are not included in your income. Distributions from your HSA that are used to pay qualified medical expenses are not included in your income. Distributions not used for qualified medical expenses are included in your income.
Contributions by a partnership to a bona fide partner's HSA are not contributions by an employer. The contributions are treated as a distribution of money and are not included in the partner's gross income. Contributions by a partnership to a partner's HSA for services rendered are treated as guaranteed payments that are includible in the partner's gross income. In both situations, the partner can deduct the contribution made to the partner's HSA.
Contributions by an S corporation to a 2% shareholder-employee's HSA for services rendered are treated as guaranteed payments and are includible in the shareholder-employee's gross income. The shareholder-employee can deduct the contribution made to the shareholder-employee's HSA.
Qualified HSA funding distribution. You can make a one-time distribution from your individual retirement account (IRA) to an HSA and you generally will not include any of the distribution in your income. See Publication 590 for the requirements for these qualified HSA funding distributions.
Failure to maintain eligibility. If your HSA received qualified HSA distributions from a health FSA or HRA (discussed earlier) or a qualified HSA funding distribution, you must be an eligible individual for HSA purposes for the period beginning with the month in which the qualified distribution was made and ending on the last day of the 12th month following that month. If you fail to be an eligible individual during this period, other than because of death or disability, you must include the distribution in your income for the tax year in which you become ineligible. This income is also subject to an additional 10% tax.
You may be able to exclude from your income amounts paid or expenses incurred by your employer for qualified adoption expenses in connection with your adoption of an eligible child. See the Instructions for Form 8839 for more information.
Adoption benefits are reported by your employer in box 12 of Form W-2 with code T. They also are included as social security and Medicare wages in boxes 3 and 5. However, they are not included as wages in box 1. To determine the taxable and nontaxable amounts, you must complete Part III of Form 8839, Qualified Adoption Expenses. File the form with your return.
If your employer provides you with a product or service and the cost of it is so small that it would be unreasonable for the employer to account for it, the value is not included in your income. Generally, the value of benefits such as discounts at company cafeterias, cab fares home when working overtime, and company picnics are not included in your income.
Holiday gifts. If your employer gives you a turkey, ham, or other item of nominal value at Christmas or other holidays, do not include the value of the gift in your income. However, if your employer gives you cash, a gift certificate, or a similar item that you can easily exchange for cash, you include the value of that gift as extra salary or wages regardless of the amount involved.
You can exclude from your income up to $5,250 of qualified employer-provided educational assistance. For more information, see Publication 970, Tax Benefits for Education.
If your employer provides a car (or other highway motor vehicle) to you, your personal use of the car is usually a taxable noncash fringe benefit.
Your employer must determine the actual value of this fringe benefit to include in your income. For more information, see Publication 525.
Tip: Certain employer-provided transportation can be excluded from gross income. See the discussion on Transportation, later.
Generally, the cost of up to $50,000 of group-term life insurance coverage provided to you by your employer (or former employer) is not included in your income. However, you must include in income the cost of employer-provided insurance that is more than the cost of $50,000 of coverage reduced by any amount you pay toward the purchase of the insurance.
For exceptions, see Entire cost excluded, and Entire cost taxed, later.
If your employer provided more than $50,000 of coverage, the amount included in your income is reported as part of your wages in box 1 of your Form W-2. It also is shown separately in box 12 with code C.
Group-term life insurance. This insurance is term life insurance protection (insurance for a fixed period of time) that:
Permanent benefits. If your group-term life insurance policy includes permanent benefits, such as a paid-up or cash surrender value, you must include in your income, as wages, the cost of the permanent benefits minus the amount you pay for them. Your employer should be able to tell you the amount to include in your income.
Accidental death benefits. Insurance that provides accidental or other death benefits but does not provide general death benefits (travel insurance, for example) is not group-term life insurance.
Former employer. If your former employer provided more than $50,000 of group-term life insurance coverage during the year, the amount included in your income is reported as wages in box 1 of Form W-2. Also, it is shown separately in box 12 with code C. Box 12 also will show the amount of uncollected social security and Medicare taxes on the excess coverage, with codes M and N. You must pay these taxes with your income tax return. Include them in your total tax on line 63, Form 1040, and enter "UT" and the amount of the taxes on the dotted line next to line 63.
Two or more employers. Your exclusion for employer-provided group-term life insurance coverage cannot exceed the cost of $50,000 of coverage, whether the insurance is provided by a single employer or multiple employers. If two or more employers provide insurance coverage that totals more than $50,000, the amounts reported as wages on your Forms W-2 will not be correct. You must figure how much to include in your income. Reduce the amount you figure by any amount reported with code C in box 12 of your Forms W-2, add the result to the wages reported in box 1, and report the total on your return.
Figuring the taxable cost. Use the following worksheet to figure the amount to include in your income.
Worksheet 5-1. Figuring the Cost of Group-Term Life Insurance To Include in Income
-----------------------------------------------
1. Enter the total amount of
your insurance coverage
from your employer(s) 1. _______
2. Limit on exclusion for
employer-provided
group-term life insurance
coverage 2. 50,000
3. Subtract line 2 from line 1 3. _______
4. Divide line 3 by $1,000.
Figure to the nearest tenth 4. _______
5. Go to Table 5-1. Using your
age on the last day of the tax
year, find your age group in
the left column, and enter the
cost from the column on the
right for your age group 5. _______
6. Multiply line 4 by line 5 6. _______
7. Enter the number of full
months of coverage at this
cost 7. _______
8. Multiply line 6 by line 7 8. _______
9. Enter the premiums
you paid per month 9. _______
10. Enter the number
of months you
paid the premiums 10. _______
11. Multiply line 9 by line 10 11. _______
12. Subtract line 11 from line 8.
Include this amount in your
income as wages 12. _______
-----------------------------------------------
Example. You are 51 years old and work for employers A and B. Both employers provide group-term life insurance coverage for you for the entire year. Your coverage is $35,000 with employer A and $45,000 with employer B. You pay premiums of $4.15 a month under the employer B group plan. You figure the amount to include in your income as follows.
Worksheet 5-1. Figuring the Cost of Group-Term Life Insurance to Include in Income--Illustrated
-----------------------------------------------
1. Enter the total amount of
your insurance coverage
from your employer(s) 1. 80,000
2. Limit on exclusion for
employer-provided
group-term life insurance
coverage 2. 50,000
3. Subtract line 2 from line 1 3. 30,000
4. Divide line 3 by $1,000.
Figure to the nearest tenth 4. 30.0
5. Go to Table 5-1. Using your
age on the last day of the tax
year, find your age group in
the left column, and enter the
cost from the column on the
right for your age group 5. .23
6. Multiply line 4 by line 5 6. 6.90
7. Enter the number of full
months of coverage at this
cost 7. 12
8. Multiply line 6 by line 7 8. 82.80
9. Enter the premiums
you paid per month 9. 4.15
10. Enter the number
of months you paid
the premiums 10. 12
11. Multiply line 9 by line 10 11. 49.80
12. Subtract line 11 from line 8.
Include this amount in your
income as wages 12. 33.00
-----------------------------------------------
Table 5-1. Cost of $1,000 of Group-Term Life Insurance for One Month
Age Cost
Under 25 $ .05
25 through 29 .06
30 through 34 .08
35 through 39 .09
40 through 44 .10
45 through 49 .15
50 through 54 .23
55 through 59 .43
60 through 64 .66
65 through 69 1.27
70 and older 2.06
Entire cost excluded. You are not taxed on the cost of group-term life insurance if any of the following circumstances apply.
Entire cost taxed. You are taxed on the entire cost of group-term life insurance if either of the following circumstances apply.
If your employer has a qualified retirement plan, qualified retirement planning services provided to you (and your spouse) by your employer are not included in your income. Qualified services include retirement planning advice, information about your employer's retirement plan, and information about how the plan may fit into your overall individual retirement income plan. You cannot exclude the value of any tax preparation, accounting, legal, or brokerage services provided by your employer.
If your employer provides you with a qualified transportation fringe benefit, it can be excluded from your income, up to certain limits. A qualified transportation fringe benefit is:
Cash reimbursement by your employer for these expenses under a bona fide reimbursement arrangement also is excludable. However, cash reimbursement for a transit pass is excludable only if a voucher or similar item that can be exchanged only for a transit pass is not readily available for direct distribution to you.
Exclusion limit. The exclusion for commuter highway vehicle transportation and transit pass fringe benefits cannot be more than a total of $110 a month.
The exclusion for the qualified parking fringe benefit cannot be more than $215 a month.
If the benefits have a value that is more than these limits, the excess must be included in your income.
Commuter highway vehicle. This is a highway vehicle that seats at least six adults (not including the driver). At least 80% of the vehicle's mileage must reasonably be expected to be:
Transit pass. This is any pass, token, farecard, voucher, or similar item entitling a person to ride mass transit (whether public or private) free or at a reduced rate or to ride in a commuter highway vehicle operated by a person in the business of transporting persons for compensation.
Qualified parking. This is parking provided to an employee at or near the employer's place of business. It also includes parking provided on or near a location from which the employee commutes to work by mass transit, in a commuter highway vehicle, or by carpool. It does not include parking at or near the employee's home.
Your employer's contributions to a qualified retirement plan for you are not included in income at the time contributed. (Your employer can tell you whether your retirement plan is qualified.) However, the cost of life insurance coverage included in the plan may have to be included. See Group-Term Life Insurance, earlier, under Fringe Benefits.
If your employer pays into a nonqualified plan for you, you generally must include the contributions in your income as wages for the tax year in which the contributions are made. However, if your interest in the plan is not transferable or is subject to a substantial risk of forfeiture (you have a good chance of losing it) at the time of the contribution, you do not have to include the value of your interest in your income until it is transferable or is no longer subject to a substantial risk of forfeiture.
Tip: For information on distributions from retirement plans, see Publication 575, Pension and Annuity Income (or Publication 721, Tax Guide to U.S. Civil Service Retirement Benefits, if you are a federal employee or retiree).
Elective deferrals. If you are covered by certain kinds of retirement plans, you can choose to have part of your compensation contributed by your employer to a retirement fund, rather than have it paid to you. The amount you set aside (called an elective deferral) is treated as an employer contribution to a qualified plan. An elective deferral, other than a designated Roth contribution (discussed later), is not included in wages subject to income tax at the time contributed. However, it is included in wages subject to social security and Medicare taxes.
Elective deferrals include elective contributions to the following retirement plans.
Overall limit on deferrals. For 2007, you generally should not have deferred more than a total of $15,500 of contributions to the plans listed in (1) through (3) and (5) above. The limit for SIMPLE plans is $10,500. The limit for section 501(c)(18)(D) plans is the lesser of $7,000 or 25% of your compensation. The limit for section 457 plans is the lesser of your includible compensation or $15,500.
Designated Roth contributions. Employers with section 401(k) and section 403(b) plans can create qualified Roth contribution programs so that you may elect to have part or all of your elective deferrals to the plan designated as after-tax Roth contributions.
Excess deferrals. Your employer or plan administrator should apply the proper annual limit when figuring your plan contributions. However, you are responsible for monitoring the total you defer to ensure that the deferrals are not more than the overall limit.
If you set aside more than the limit, the excess generally must be included in your income for that year, unless you have an excess deferral of a designated Roth contribution. See Publication 525 for a discussion of the tax treatment of excess deferrals.
Catch-up contributions. You may be allowed catch-up contributions (additional elective deferral) if you are age 50 or older by the end of your tax year.
If you receive a nonstatutory option to buy or sell stock or other property as payment for your services, you usually will have income when you receive the option, when you exercise the option (use it to buy or sell the stock or other property), or when you sell or otherwise dispose of the option. However, if your option is a statutory stock option, you will not have any income until you sell or exchange your stock. Your employer can tell you which kind of option you hold. For more information, see Publication 525.
Generally, if you receive property for your services, you must include its fair market value in your income in the year you receive the property. However, if you receive stock or other property that has certain restrictions that affect its value, you do not include the value of the property in your income until it has substantially vested. (You can choose to include the value of the property in your income in the year it is transferred to you.) For more information, see Restricted Property in Publication 525.
Dividends received on restricted stock. Dividends you receive on restricted stock are treated as compensation and not as dividend income. Your employer should include these payments on your Form W-2.
Stock you chose to include in income. Dividends you receive on restricted stock you chose to include in your income in the year transferred are treated the same as any other dividends. Report them on your return as dividends. For a discussion of dividends, see chapter 8.
For information on how to treat dividends reported on both your Form W-2 and Form 1099-DIV, see Dividends received on restricted stock in Publication 525.
This section deals with special rules for people in certain types of employment: members of the clergy, members of religious orders, people working for foreign employers, military personnel, and volunteers.
If you are a member of the clergy, you must include in your income offerings and fees you receive for marriages, baptisms, funerals, masses, etc., in addition to your salary. If the offering is made to the religious institution, it is not taxable to you.
If you are a member of a religious organization and you give your outside earnings to the organization, you still must include the earnings in your income. However, you may be entitled to a charitable contribution deduction for the amount paid to the organization. See chapter 24.
Pension. A pension or retirement pay for a member of the clergy is usually treated as any other pension or annuity. It must be reported on lines 16a and 16b of Form 1040 or on lines 12a and 12b of Form 1040A.
Housing. Special rules for housing apply to members of the clergy. Under these rules, you do not include in your income the rental value of a home (including utilities) or a designated housing allowance provided to you as part of your pay. However, the exclusion cannot be more than the reasonable pay for your service. If you pay for the utilities, you can exclude any allowance designated for utility cost, up to your actual cost. The home or allowance must be provided as compensation for your services as an ordained, licensed, or commissioned minister. However, you must include the rental value of the home or the housing allowance as earnings from self-employment on Schedule SE (Form 1040) if you are subject to the self-employment tax. For more information, see Publication 517, Social Security and Other Information for Members of the Clergy and Religious Workers.
If you are a member of a religious order who has taken a vow of poverty, how you treat earnings that you renounce and turn over to the order depends on whether your services are performed for the order.
Services performed for the order. If you are performing the services as an agent of the order in the exercise of duties required by the order, do not include in your income the amounts turned over to the order.
If your order directs you to perform services for another agency of the supervising church or an associated institution, you are considered to be performing the services as an agent of the order. Any wages you earn as an agent of an order that you turn over to the order are not included in your income.
Example. You are a member of a church order and have taken a vow of poverty. You renounce any claims to your earnings and turn over to the order any salaries or wages you earn. You are a registered nurse, so your order assigns you to work in a hospital that is an associated institution of the church. However, you remain under the general direction and control of the order. You are considered to be an agent of the order and any wages you earn at the hospital that you turn over to your order are not included in your income.
Services performed outside the order. If you are directed to work outside the order, your services are not an exercise of duties required by the order unless they meet both of the following requirements.
If you are an employee of a third party, the services you perform for the third party will not be considered directed or required of you by the order. Amounts you receive for these services are included in your income, even if you have taken a vow of poverty.
Example. Mark Brown is a member of a religious order and has taken a vow of poverty. He renounces all claims to his earnings and turns over his earnings to the order.
Mark is a schoolteacher. He was instructed by the superiors of the order to get a job with a private tax-exempt school. Mark became an employee of the school, and, at his request, the school made the salary payments directly to the order.
Because Mark is an employee of the school, he is performing services for the school rather than as an agent of the order. The wages Mark earns working for the school are included in his income.
Special rules apply if you work for a foreign employer.
U.S. citizen. If you are a U.S. citizen who works in the United States for a foreign government, an international organization, a foreign embassy, or any foreign employer, you must include your salary in your income.
Social security and Medicare taxes. You are exempt from social security and Medicare employee taxes if you are employed in the United States by an international organization or a foreign government. However, you must pay self-employment tax on your earnings from services performed in the United States, even though you are not self-employed. This rule also applies if you are an employee of a qualifying wholly owned instrumentality of a foreign government.
Employees of international organizations or foreign governments. Your compensation for official services to an international organization is exempt from federal income tax if you are not a citizen of the United States or you are a citizen of the Philippines (whether or not you are a citizen of the United States).
Your compensation for official services to a foreign government is exempt from federal income tax if all of the following are true.
Waiver of alien status. If you are an alien who works for a foreign government or international organization and you file a waiver under section 247(b) of the Immigration and Nationality Act to keep your immigrant status, different rules may apply. See Foreign Employer in Publication 525.
Employment abroad. For information on the tax treatment of income earned abroad, see Publication 54.
Payments you receive as a member of a military service generally are taxed as wages except for retirement pay, which is taxed as a pension. Allowances generally are not taxed. For more information on the tax treatment of military allowances and benefits, see Publication 3, Armed Forces' Tax Guide.
Military retirement pay. If your retirement pay is based on age or length of service, it is taxable and must be included in your income as a pension on lines 16a and 16b of Form 1040 or on lines 12a and 12b of Form 1040A. Do not include in your income the amount of any reduction in retirement or retainer pay to provide a survivor annuity for your spouse or children under the Retired Serviceman's Family Protection Plan or the Survivor Benefit Plan.
For more detailed discussion of survivor annuities, see chapter 10.
Disability. If you are retired on disability, see Military and Government Disability Pensions under Sickness and Injury Benefits, later.
Veterans' benefits. Do not include in your income any veterans' benefits paid under any law, regulation, or administrative practice administered by the Department of Veterans Affairs (VA). The following amounts paid to veterans or their families are not taxable.
The tax treatment of amounts you receive as a volunteer worker for the Peace Corps or similar agency is covered in the following discussions.
Peace Corps. Living allowances you receive as a Peace Corps volunteer or volunteer leader for housing, utilities, household supplies, food, and clothing are exempt from tax.
Taxable allowances. The following allowances must be included in your income and reported as wages.
Example. Gary Carpenter, a Peace Corps volunteer, gets $175 a month as a readjustment allowance during his period of service, to be paid to him in a lump sum at the end of his tour of duty. Although the allowance is not available to him until the end of his service, Gary must include it in his income on a monthly basis as it is credited to his account.
Volunteers in Service to America (VISTA). If you are a VISTA volunteer, you must include meal and lodging allowances paid to you in your income as wages.
National Senior Services Corps programs. Do not include in your income amounts you receive for supportive services or reimbursements for out-of-pocket expenses from the following programs.
Service Corps of Retired Executives (SCORE). If you receive amounts for supportive services or reimbursements for out-of-pocket expenses from SCORE, do not include these amounts in income.
Volunteer tax counseling. Do not include in your income any reimbursements you receive for transportation, meals, and other expenses you have in training for, or actually providing, volunteer federal income tax counseling for the elderly (TCE).
You can deduct as a charitable contribution your unreimbursed out-of-pocket expenses in taking part in the volunteer income tax assistance (VITA) program. See chapter 24.
This section discusses sickness and injury benefits including disability pensions, long-term care insurance contracts, workers' compensation, and other benefits.
Generally, if you retire on disability, you must report your pension or annuity as income.
Tip: You may be entitled to a tax credit if you were permanently and totally disabled when you retired. For information on this credit and the definition of permanent and total disability, see chapter 33.
For information on disability payments from a governmental program provided as a substitute for unemployment compensation, see chapter 12.
Disability income. Generally, you must report as income any amount you receive for personal injury or sickness through an accident or health plan that is paid for by your employer. If both you and your employer pay for the plan, only the amount you receive that is due to your employer's payments is reported as income. However, certain payments may not be taxable to you. Your employer should be able to give you specific details about your pension plan and tell you the amount you paid for your disability pension. In addition to disability pensions and annuities, you may be receiving other payments for sickness and injury.
Tip: Do not report as income any amounts paid to reimburse you for medical expenses you incurred after the plan was established.
Cost paid by you. If you pay the entire cost of a health or accident insurance plan, do not include any amounts you receive from the plan for personal injury or sickness as income on your tax return. If your plan reimbursed you for medical expenses you deducted in an earlier year, you may have to include some, or all, of the reimbursement in your income. See Reimbursement in a later year in chapter 21.
Cafeteria plans. Generally, if you are covered by an accident or health insurance plan through a cafeteria plan, and the amount of the insurance premiums was not included in your income, you are not considered to have paid the premiums and you must include any benefits you receive in your income. If the amount of the premiums was included in your income, you are considered to have paid the premiums, and any benefits you receive are not taxable.
Retirement and profit-sharing plans. If you receive payments from a retirement or profit-sharing plan that does not provide for disability retirement, do not treat the payments as a disability pension. The payments must be reported as a pension or annuity. For more information on pensions, see chapter 10.
Accrued leave payment. If you retire on disability, any lump-sum payment you receive for accrued annual leave is a salary payment. The payment is not a disability payment. Include it in your income in the tax year you receive it.
How to report. If you retired on disability, you must include in income any disability pension you receive under a plan that is paid for by your employer. You must report your taxable disability payments as wages on line 7 of Form 1040 or Form 1040A, until you reach minimum retirement age. Minimum retirement age generally is the age at which you can first receive a pension or annuity if you are not disabled.
Beginning on the day after you reach minimum retirement age, payments you receive are taxable as a pension or annuity. Report the payments on lines 16a and 16b of Form 1040 or on lines 12a and 12b of Form 1040A. The rules for reporting pensions are explained in How To Report in chapter 10.
Military and Government Disability Pensions
Certain military and government disability pensions are not taxable.
Service-connected disability. You may be able to exclude from income amounts you receive as a pension, annuity, or similar allowance for personal injury or sickness resulting from active service in one of the following government services.
Conditions for exclusion. Do not include the disability payments in your income if any of the following conditions apply.
Pension based on years of service. If you receive a disability pension based on years of service, you generally must include it in your income. However, if the pension qualifies for the exclusion for a service-connected disability (discussed earlier), do not include in income the part of your pension that you would have received if the pension had been based on a percentage of disability. You must include the rest of your pension in your income.
Retroactive VA determination. If you retire from the armed services based on years of service and are later given a retroactive service-connected disability rating by the VA, your retirement pay for the retroactive period is excluded from income up to the amount of VA disability benefits you would have been entitled to receive. You can claim a refund of any tax paid on the excludable amount (subject to the statute of limitations) by filing an amended return on Form 1040X for each previous year during the retroactive period.
If you receive a lump-sum disability severance payment and are later awarded VA disability benefits, exclude 100% of the severance benefit from your income. However, you must include in your income any lump-sum readjustment or other nondisability severance payment you received on release from active duty, even if you are later given a retroactive disability rating by the VA.
Terrorist attack or military action. Do not include in your income disability payments you receive for injuries resulting directly from a terrorist or military action.
Long-Term Care Insurance Contracts
Long-term care insurance contracts generally are treated as accident and health insurance contracts. Amounts you receive from them (other than policyholder dividends or premium refunds) generally are excludable from income as amounts received for personal injury or sickness. To claim an exclusion for payments made on a per diem or other periodic basis under a long-term care insurance contract, you must file Form 8853 with your return.
A long-term care insurance contract is an insurance contract that only provides coverage for qualified long-term care services. The contract must:
Qualified long-term care services. Qualified long-term care services are:
Chronically ill individual. A chronically ill individual is one who has been certified by a licensed health care practitioner within the previous 12 months as one of the following.
Limit on exclusion. You generally can exclude from gross income up to $260 a day for 2007. See Limit on exclusion, under Long-Term Care Insurance Contracts, under Sickness and Injury Benefits in Publication 525 for more information.
Amounts you receive as workers' compensation for an occupational sickness or injury are fully exempt from tax if they are paid under a workers' compensation act or a statute in the nature of a workers' compensation act. The exemption also applies to your survivors. The exemption, however, does not apply to retirement plan benefits you receive based on your age, length of service, or prior contributions to the plan, even if you retired because of an occupational sickness or injury.
Caution: If part of your workers' compensation reduces your social security or equivalent railroad retirement benefits received, that part is considered social security (or equivalent railroad retirement) benefits and may be taxable. For more information, see Publication 915, Social Security and Equivalent Railroad Retirement Benefits.
Return to work. If you return to work after qualifying for workers' compensation, salary payments you receive for performing light duties are taxable as wages.
Other Sickness and Injury Benefits
In addition to disability pensions and annuities, you may receive other payments for sickness or injury.
Railroad sick pay. Payments you receive as sick pay under the Railroad Unemployment Insurance Act are taxable and you must include them in your income. However, do not include them in your income if they are for an on-the-job injury.
If you received income because of a disability, see Disability Pensions, earlier.
Federal Employees' Compensation Act (FECA). Payments received under this Act for personal injury or sickness, including payments to beneficiaries in case of death, are not taxable. However, you are taxed on amounts you receive under this Act as continuation of pay for up to 45 days while a claim is being decided. Report this income on line 7 of Form 1040 or Form 1040A or on line 1 of Form 1040EZ. Also, pay for sick leave while a claim is being processed is taxable and must be included in your income as wages.
Caution: If part of the payments you receive under FECA reduces your social security or equivalent railroad retirement benefits received, that part is considered social security (or equivalent railroad retirement) benefits and may be taxable. For a discussion of the taxability of these benefits, see Social security and equivalent railroad retirement benefits under Other Income, in Publication 525.
You can deduct the amount you spend to buy back sick leave for an earlier year to be eligible for nontaxable FECA benefits for that period. It is a miscellaneous deduction subject to the 2% of AGI limit on Schedule A (Form 1040). If you buy back sick leave in the same year you used it, the amount reduces your taxable sick leave pay. Do not deduct it separately.
Other compensation. Many other amounts you receive as compensation for sickness or injury are not taxable. These include the following amounts.
Reimbursement for medical care. A reimbursement for medical care is generally not taxable. However, it may reduce your medical expense deduction. For more information, see chapter 21.
This chapter is for employees who receive tips.
All tips you receive are income and are subject to federal income tax. You must include in gross income all tips you receive directly, charged tips paid to you by your employer, and your share of any tips you receive under a tip-splitting or tip-pooling arrangement.
The value of noncash tips, such as tickets, passes, or other items of value are also income and subject to tax.
Reporting your tip income correctly is not difficult. You must do three things.
This chapter will explain these three things and show you what to do on your tax return if you have not done the first two. This chapter will also show you how to treat allocated tips.
Useful Items
You may want to see:
Publication
Form (and Instructions)
Why keep a daily tip record? You must keep a daily tip record so you can:
How to keep a daily tip record. There are two ways to keep a daily tip record. You can either:
You should keep your daily tip record with your personal records. You must keep your records for as long as they are important for administration of the federal tax law. For information on how long to keep records, see Publication 552, Recordkeeping for Individuals.
If you keep a tip diary, you can use Form 4070A, Employee's Daily Record of Tips. To get Form 4070A, ask the Internal Revenue Service (IRS) or your employer for Publication 1244. Publication 1244 includes a 1-year supply of Form 4070A. Each day, write in the information asked for on the form.
If you do not use Form 4070A, start your records by writing your name, your employer's name, and the name of the business (if it is different from your employer's name). Then, each workday, write the date and the following information.
Caution: Do not write in your tip diary the amount of any service charge that your employer adds to a customer's bill and then pays to you and treats as wages. This is part of your wages, not a tip.
Electronic tip record. You can use an electronic system provided by your employer to record your daily tips. If you do, you must receive and keep a paper copy of this record.
Why report tips to your employer? You must report tips to your employer so that:
What tips to report. Report to your employer only cash, check, debit, or credit card tips you receive.
If your total tips for any one month from any one job are less than $20, do not report the tips for that month to that employer.
If you participate in a tip-splitting or tip-pooling arrangement, report only the tips you receive and retain. Do not report to your employer any portion of the tips you receive that you pass on to other employees.
Do not report the value of any noncash tips, such as tickets or passes, to your employer. You do not pay social security and Medicare taxes or railroad retirement tax on these tips.
How to report. If your employer does not give you any other way to report tips, you can use Form 4070. Fill in the information asked for on the form, sign and date the form, and give it to your employer. To get a 1-year supply of the form, ask the IRS or your employer for Publication 1244.
If you do not use Form 4070, give your employer a statement with the following information.
You must sign and date the statement. You should keep a copy with your personal records.
Your employer may require you to report your tips more than once a month. However, the statement cannot cover a period of more than one calendar month.
Electronic tip statement. Your employer can have you furnish your tip statements electronically.
When to report. Give your report for each month to your employer by the 10th of the next month. If the 10th falls on a Saturday, Sunday, or legal holiday, give your employer the report by the next day that is not a Saturday, Sunday, or legal holiday.
Example 1. You must report your tips received in April 2008 by May 12, 2008. May 10th is a Saturday, and the 12th is the next day that is not a Saturday, Sunday, or legal holiday.
Example 2. You must report your tips received in May 2008 by June 10, 2008.
Final report. If your employment ends during the month, you can report your tips when your employment ends.
Penalty for not reporting tips. If you do not report tips to your employer as required, you may be subject to a penalty equal to 50% of the social security and Medicare taxes or railroad retirement tax you owe on the unreported tips. (For information about these taxes, see Reporting social security and Medicare taxes on tips not reported to your employer under Reporting Tips on Your Tax Return, later.) The penalty amount is in addition to the taxes you owe.
You can avoid this penalty if you can show reasonable cause for not reporting the tips to your employer. To do so, attach a statement to your return explaining why you did not report them.
Giving your employer money for taxes. Your regular pay may not be enough for your employer to withhold all the taxes you owe on your regular pay plus your reported tips. If this happens, you can give your employer money until the close of the calendar year to pay the rest of the taxes.
If you do not give your employer enough money, your employer will apply your regular pay and any money you give to the taxes in the following order.
Any taxes that remain unpaid can be collected by your employer from your next paycheck. If withholding taxes remain uncollected at the end of the year, you may be subject to a penalty for underpayment of estimated taxes. See Publication 505, Tax Withholding and Estimated Tax, for more information.
Caution: Uncollected taxes. You must report on your tax return any social security and Medicare taxes or railroad retirement tax that remained uncollected at the end of 2007. See Reporting uncollected social security and Medicare taxes on tips under Reporting Tips on Your Tax Return, later. These uncollected taxes will be shown in box 12 of your 2007 Form W-2 (codes A and B).
Tip Rate Determination and Education Program
Your employer may participate in the Tip Rate Determination and Education Program. The program was developed to help employees and employers understand and meet their tip reporting responsibilities.
There are two agreements under the program: the Tip Rate Determination Agreement (TRDA) and the Tip Reporting Alternative Commitment (TRAC). In addition, employers in the food and beverage industry may be able to get approval of an employer-designed EmTRAC program. For information on the EmTRAC program, see Notice 2001-1, which is on page 261 of Internal Revenue Bulletin 2001-2 at www.irs.gov/pub/irs-irbs/irb01-02.pdf.
If you are employed in the gaming industry, your employer may have a Gaming Industry Tip Compliance Agreement Program. See Revenue Procedure 2007-32, which is on page 1322 of Internal Revenue Bulletin No. 2007-22 at www.irs.gov/pub/irs-irbs/irb07-22.pdf.
If you are employed in the food and beverage industry, your employer may participate in an Attributed Tip Income Program (ATip). See Revenue Procedure 2006-30, which is on page 110 of Internal Revenue Bulletin No. 2006-31 at www.irs.gov/pub/irs-irbs/irb06-31.pdf.
Your employer can provide you with a copy of any applicable agreement. To find out more about these agreements, visit www.irs.gov and type "restaurant tip reporting" in the Keyword search box. You may also call 1-800-829-4933 or visit www.irs.gov/localcontacts for the IRS Taxpayer Assistance Center in your area; or send an email to Tip.Program@irs.gov and request information on this program.
How to report tips. Report your tips with your wages on line 1 of Form 1040EZ or line 7 of Form 1040A or Form 1040.
What tips to report. You must report all tips you received in 2007 on your tax return, including both cash tips and noncash tips. Any tips you reported to your employer for 2007 are included in the wages shown in box 1 of your Form W-2. Add to the amount in box 1 only the tips you did not report to your employer.
Caution: If you received $20 or more in cash and charge tips in a month and did not report all of those tips to your employer, see Reporting social security and Medicare taxes on tips not reported to your employer, later.
Caution: If you did not keep a daily tip record as required and an amount is shown in box 8 of your Form W-2, see Allocated Tips, later.
If you kept a daily tip record and reported tips to your employer as required under the rules explained earlier, add the following tips to the amount in box 1 of your Form W-2.
Example. John Allen began working at the Diamond Restaurant (his only employer in 2007) on June 30 and received $10,000 in wages during the year. John kept a daily tip record showing that his tips for June were $18 and his tips for the rest of the year totaled $7,000. He was not required to report his June tips to his employer, but he reported all of the rest of his tips to his employer as required.
John's Form W-2 from Diamond Restaurant shows $17,000 ($10,000 wages plus $7,000 reported tips) in box 1. He adds the $18 unreported tips to that amount and reports $17,018 as wages on his tax return.
Reporting social security and Medicare taxes on tips not reported to your employer. If you received $20 or more in cash and charge tips in a month from any one job and did not report all of those tips to your employer, you must report the social security and Medicare taxes on the unreported tips as additional tax on your return. To report these taxes, you must file a return even if you would not otherwise have to file. You must use Form 1040. (You cannot file Form 1040EZ or Form 1040A.)
Use Form 4137 to figure these taxes. Enter the tax on line 59, Form 1040, and attach Form 4137 to your return.
Caution: If you are subject to the Railroad Retirement Tax Act, you cannot use Form 4137 to pay railroad retirement tax on unreported tips. To get railroad retirement credit, you must report tips to your employer.
Reporting uncollected social security and Medicare taxes on tips. If your employer could not collect all the social security and Medicare taxes or railroad retirement tax you owe on tips reported for 2007, the uncollected taxes will be shown in box 12 of your Form W-2 (codes A and B). You must report these amounts as additional tax on your return. You may have uncollected taxes if your regular pay was not enough for your employer to withhold all the taxes you owe and you did not give your employer enough money to pay the rest of the taxes.
To report these uncollected taxes, you must file a return even if you would not otherwise have to file. You must use Form 1040. (You cannot file Form 1040EZ or Form 1040A.) Include the taxes in your total tax amount on line 63, and write "UT" and the total of the uncollected taxes on the dotted line next to line 63.
If your employer allocated tips to you, they are shown separately in box 8 of your Form W-2. They are not included in box 1 with your wages and reported tips. If box 8 is blank, this discussion does not apply to you.
What are allocated tips? These are tips that your employer assigned to you in addition to the tips you reported to your employer for the year. Your employer will have done this only if:
How were your allocated tips figured? The tips allocated to you are your share of an amount figured by subtracting the reported tips of all employees from 8% (or an approved lower rate) of food and drink sales (other than carryout sales and sales with a service charge of 10% or more). Your share of that amount was figured using either a method provided by an employer-employee agreement or a method provided by IRS regulations based on employees' sales or hours worked. For information about the exact allocation method used, ask your employer.
Must you report your allocated tips on your return? You must report allocated tips on your tax return unless either of the following exceptions applies.
If either exception applies, report your actual tips on your return. Do not report the allocated tips. See What tips to report under Reporting Tips on Your Tax Return, earlier.
How to report allocated tips. If you must report allocated tips on your return, add the amount in box 8 of your Form W-2 to the amount in box 1. Report the total as wages on line 7 of Form 1040. (You cannot file Form 1040EZ or Form 1040A.)
Because social security and Medicare taxes were not withheld from the allocated tips, you must report those taxes as additional tax on your return. Complete Form 4137, and include the allocated tips on line 1 of the form. See Reporting social security and Medicare taxes on tips not reported to your employer under Reporting Tips on Your Tax Return, earlier.
Foreign-source income. If you are a U.S. citizen with interest income from sources outside the United States (foreign income), you must report that income on your tax return unless it is exempt by U.S. law. This is true whether you reside inside or outside the United States and whether or not you receive a Form 1099 from the foreign payer.
This chapter discusses the following topics.
In general, any interest you receive or that is credited to your account and can be withdrawn is taxable income. Exceptions to this rule are discussed later in this chapter.
You may be able to deduct expenses you have in earning this income on Schedule A (Form 1040) if you itemize your deductions. See chapter 28.
Useful Items
You may want to see:
Publication
Form (and Instructions)
A few items of general interest are covered here.
Records: Recordkeeping. You should keep a list showing sources and amounts of interest received during the year. Also, keep the forms you receive that show your interest income (Forms 1099-INT, for example) as an important part of your records.
Tax on investment income of a child under age 18. Part of a child's 2007 investment income may be taxed at the parent's tax rate. This may happen if all the following are true.
If all these statements are true, Form 8615, Tax for Children Under Age 18 With Investment Income of More Than $1,700, must be completed and attached to the child's tax return. If any of these statements is not true, Form 8615 is not required and the child's income is taxed at his or her own tax rate.
However, the parent can choose to include the child's interest and dividends on the parent's return if certain requirements are met. Use Form 8814, Parents' Election To Report Child's Interest and Dividends, for this purpose.
For more information about the tax on investment income of children and the parents' election, see chapter 31.
Beneficiary of an estate or trust. Interest you receive as a beneficiary of an estate or trust is generally taxable income. You should receive a Schedule K-1 (Form 1041), Beneficiary's Share of Income, Deductions, Credits, etc., from the fiduciary. Your copy of Schedule K-1 and its instructions will tell you where to report the income on your Form 1040.
Social security number (SSN). You must give your name and SSN to any person required by federal tax law to make a return, statement, or other document that relates to you. This includes payers of interest.
SSN for joint account. If the funds in a joint account belong to one person, list that person's name first on the account and give that person's SSN to the payer. (For information on who owns the funds in a joint account, see Joint accounts, later.) If the joint account contains combined funds, give the SSN of the person whose name is listed first on the account.
These rules apply both to joint ownership by a married couple and to joint ownership by other individuals. For example, if you open a joint savings account with your child using funds belonging to the child, list the child's name first on the account and give the child's SSN.
Custodian account for your child. If your child is the actual owner of an account that is recorded in your name as custodian for the child, give the child's SSN to the payer. For example, you must give your child's SSN to the payer of interest on an account owned by your child, even though the interest is paid to you as custodian.
Penalty for failure to supply SSN. If you do not give your SSN to the payer of interest, you may have to pay a penalty. See Failure to supply social security number under Penalties in chapter 1. Backup withholding also may apply.
Backup withholding. Your interest income is generally not subject to regular withholding. However, it may be subject to backup withholding to ensure that income tax is collected on the income. Under backup withholding, the payer of interest must withhold, as income tax, 28% of the amount you are paid.
Backup withholding may also be required if the Internal Revenue Service (IRS) has determined that you underreported your interest or dividend income. For more information, see Backup Withholding in chapter 4.
Reporting backup withholding. If backup withholding is deducted from your interest income, the payer must give you a Form 1099-INT for the year that indicates the amount withheld. The Form 1099-INT will show any backup withholding as "Federal income tax withheld."
Joint accounts. If two or more persons hold property (such as a savings account or bond) as joint tenants, tenants by the entirety, or tenants in common, each person's share of any interest from the property is determined by local law.
Income from property given to a child. Property you give as a parent to your child under the Model Gifts of Securities to Minors Act, the Uniform Gifts to Minors Act, or any similar law becomes the child's property.
Income from the property is taxable to the child, except that any part used to satisfy a legal obligation to support the child is taxable to the parent or guardian having that legal obligation.
Savings account with parent as trustee. Interest income from a savings account opened for a child who is a minor, but placed in the name and subject to the order of the parents as trustees, is taxable to the child if, under the law of the state in which the child resides, both of the following are true.
Form 1099-INT. Interest income is generally reported to you on Form 1099-INT, or a similar statement, by banks, savings and loans, and other payers of interest. This form shows you the interest you received during the year. Keep this form for your records. You do not have to attach it to your tax return.
Report on your tax return the total amount of interest income that you receive for the tax year.
Interest not reported on Form 1099-INT. Even if you do not receive Form 1099-INT, you must still report all of your taxable interest income. For example, you may receive distributive shares of interest from partnerships or S corporations. This interest is reported to you on Schedule K-1 (Form 1065) or Schedule K-1 (Form 1120S).
Nominees. Generally, if someone receives interest as a nominee for you, that person will give you a Form 1099-INT showing the interest received on your behalf.
If you receive a Form 1099-INT that includes amounts belonging to another person, see the discussion on nominee distributions under How To Report Interest Income in chapter 1 of Publication 550, or see the Schedule 1 (Form 1040A) or Schedule B (Form 1040) instructions.
Incorrect amount. If you receive a Form 1099-INT that shows an incorrect amount (or other incorrect information), you should ask the issuer for a corrected form. The new Form 1099-INT you receive will be marked "Corrected."
Form 1099-OID. Reportable interest income may also be shown on Form 1099-OID, Original Issue Discount. For more information about amounts shown on this form, see Original Issue Discount (OID), later in this chapter.
Exempt-interest dividends. Exempt-interest dividends you receive from a mutual fund or other regulated investment company are not included in your taxable income. (However, see Information-reporting requirement, next.) Exempt-interest dividends should be shown in box 8 of Form 1099-INT.
Information-reporting requirement. Although exempt-interest dividends are not taxable, you must show them on your tax return if you have to file. This is an information-reporting requirement and does not change the exempt-interest dividends into taxable income.
Note. Exempt-interest dividends paid from specified private activity bonds may be subject to the alternative minimum tax. See Alternative Minimum Tax in chapter 30 for more information. Chapter 1 of Publication 550 contains a discussion on private activity bonds under State or Local Government Obligations.
Interest on VA dividends. Interest on insurance dividends that you leave on deposit with the Department of Veterans Affairs (VA) is not taxable. This includes interest paid on dividends on converted United States Government Life Insurance and on National Service Life Insurance policies.
Individual retirement arrangements (IRAs). Interest on a Roth IRA generally is not taxable. Interest on a traditional IRA is tax deferred. You generally do not include it in your income until you make withdrawals from the IRA. See chapter 17.
Taxable interest includes interest you receive from bank accounts, loans you make to others, and other sources. The following are some other sources of taxable interest.
Dividends that are actually interest. Certain distributions commonly called dividends are actually interest. You must report as interest so-called "dividends" on deposits or on share accounts in:
Money market funds. Generally, amounts you receive from money market funds should be reported as dividends, not as interest.
Certificates of deposit and other deferred interest accounts. If you open any of these accounts, interest may be paid at fixed intervals of 1 year or less during the term of the account. You generally must include this interest in your income when you actually receive it or are entitled to receive it without paying a substantial penalty. The same is true for accounts that mature in 1 year or less and pay interest in a single payment at maturity. If interest is deferred for more than 1 year, see Original Issue Discount (OID), later.
Interest subject to penalty for early withdrawal. If you withdraw funds from a deferred interest account before maturity, you may have to pay a penalty. You must report the total amount of interest paid or credited to your account during the year, without subtracting the penalty. See Penalty on early withdrawal of savings in chapter 1 of Publication 550 for more information on how to report the interest and deduct the penalty.
Money borrowed to invest in certificate of deposit. The interest you pay on money borrowed from a bank or savings institution to meet the minimum deposit required for a certificate of deposit from the institution and the interest you earn on the certificate are two separate items. You must report the total interest you earn on the certificate in your income. If you itemize deductions, you can deduct the interest you pay as investment interest, up to the amount of your net investment income. See Interest Expenses in chapter 3 of Publication 550.
Example. You deposited $5,000 with a bank and borrowed $5,000 from the bank to make up the $10,000 minimum deposit required to buy a 6-month certificate of deposit. The certificate earned $575 at maturity in 2007, but you received only $265, which represented the $575 you earned minus $310 interest charged on your $5,000 loan. The bank gives you a Form 1099-INT for 2007 showing the $575 interest you earned. The bank also gives you a statement showing that you paid $310 interest for You must include the $575 in your income. If you itemize your deductions on Schedule A (Form 1040), you can deduct $310, subject to the net investment income limit.
Gift for opening account. If you receive non-cash gifts or services for making deposits or for opening an account in a savings institution, you may have to report the value as interest.
For deposits of less than $5,000, gifts or services valued at more than $10 must be reported as interest. For deposits of $5,000 or more, gifts or services valued at more than $20 must be reported as interest. The value is determined by the cost to the financial institution.
Example. You open a savings account at your local bank and deposit $800. The account earns $20 interest. You also receive a $15 calculator. If no other interest is credited to your account during the year, the Form 1099-INT you receive will show $35 interest for the year. You must report $35 interest income on your tax return.
Interest on insurance dividends. Interest on insurance dividends left on deposit with an insurance company that can be withdrawn annually is taxable to you in the year it is credited to your account. However, if you can withdraw it only on the anniversary date of the policy (or other specified date), the interest is taxable in the year that date occurs.
Prepaid insurance premiums. Any increase in the value of prepaid insurance premiums, advance premiums, or premium deposit funds is interest if it is applied to the payment of premiums due on insurance policies or made available for you to withdraw.
U.S. obligations. Interest on U.S. obligations, such as U.S. Treasury bills, notes, and bonds, issued by any agency or instrumentality of the United States is taxable for federal income tax purposes.
Interest on tax refunds. Interest you receive on tax refunds is taxable income.
Interest on condemnation award. If the condemning authority pays you interest to compensate you for a delay in payment of an award, the interest is taxable.
Installment sale payments. If a contract for the sale or exchange of property provides for deferred payments, it also usually provides for interest payable with the deferred payments. That interest is taxable when you receive it. If little or no interest is provided for in a deferred payment contract, part of each payment may be treated as interest. See Unstated Interest and Original Issue Discount in Publication 537, Installment Sales.
Interest on annuity contract. Accumulated interest on an annuity contract you sell before its maturity date is taxable.
Usurious interest. Usurious interest is interest charged at an illegal rate. This is taxable as interest unless state law automatically changes it to a payment on the principal.
Interest income on frozen deposits. Exclude from your gross income interest on frozen deposits. A deposit is frozen if, at the end of the year, you cannot withdraw any part of the deposit because:
The amount of interest you must exclude is the interest that was credited on the frozen deposits minus the sum of:
If you receive a Form 1099-INT for interest income on deposits that were frozen at the end of 2007, see Frozen deposits under How To Report Interest Income in chapter 1 of Publication 550, for information about reporting this interest income exclusion on your tax return.
The interest you exclude is treated as credited to your account in the following year. You must include it in income in the year you can withdraw it.
Example. $100 of interest was credited on your frozen deposit during the year. You withdrew $80 but could not withdraw any more as of the end of the year. You must include $80 in your income and exclude $20 from your income for the year. You must include the $20 in your income for the year you can withdraw it.
Bonds traded flat. If you buy a bond at a discount when interest has been defaulted or when the interest has accrued but has not been paid, the transaction is described as trading a bond flat. The defaulted or unpaid interest is not income and is not taxable as interest if paid later. When you receive a payment of that interest, it is a return of capital that reduces the remaining cost basis of your bond. Interest that accrues after the date of purchase, however, is taxable interest income for the year it is received or accrued. See Bonds Sold Between Interest Dates, later, for more information.
Below-market loans. In general, a below-market loan is a loan on which no interest is charged or on which interest is charged at a rate below the applicable federal rate. See Below-Market Loans in chapter 1 of Publication 550 for more information.
This section provides tax information on U.S. savings bonds. It explains how to report the interest income on these bonds and how to treat transfers of these bonds.
For other information on U.S. savings bonds, write to:
For series EE and I:
Bureau of the Public Debt
Division of Customer Assistance
P.O. Box 7012
Parkersburg, WV 26106-7012
For series HH/H:
Bureau of the Public Debt
Division of Customer Assistance
P.O. Box 2186
Parkersburg, WV 26106-2186
Or, on the Internet, visit: www.treasurydirect.gov/indiv/products/products.htm.
Accrual method taxpayers. If you use an accrual method of accounting, you must report interest on U.S. savings bonds each year as it accrues. You cannot postpone reporting interest until you receive it or until the bonds mature. Accrual methods of accounting are explained in chapter 1 under Accounting Methods.
Cash method taxpayers. If you use the cash method of accounting, as most individual taxpayers do, you generally report the interest on U.S. savings bonds when you receive it. The cash method of accounting is explained in chapter 1 under Accounting Methods.
Series HH bonds. These bonds were issued at face value. Interest is paid twice a year by direct deposit to your bank account. If you are a cash method taxpayer, you must report interest on these bonds as income in the year you receive it.
Series HH bonds were first offered in 1980; they were last offered in August 2004. Before 1980, series H bonds were issued. Series H bonds are treated the same as series HH bonds. If you are a cash method taxpayer, you must report the interest when you receive it.
Series H bonds have a maturity period of 30 years. Series HH bonds mature in 20 years.
Series EE and series I bonds. Interest on these bonds is payable when you redeem the bonds. The difference between the purchase price and the redemption value is taxable interest.
Series EE bonds. Series EE bonds were first offered in January 1980. They have a maturity period of 30 years.
Before July 1980, series E bonds were issued. The original 10-year maturity period of series E bonds has been extended to 40 years for bonds issued before December 1965 and 30 years for bonds issued after November 1965. Paper series EE and series E bonds are issued at a discount. The face value is payable to you at maturity. Electronic series EE bonds are issued at their face value. The face value plus accrued interest is payable to you at maturity.
Owners of paper series E and EE bonds can convert them to electronic bonds. These converted bonds do not retain the denomination listed on the paper certificate but are posted at their purchase price (with accrued interest).
Series I bonds. Series I bonds were first offered in 1998. These are inflation-indexed bonds issued at their face amount with a maturity period of 30 years. The face value plus all accrued interest is payable to you at maturity.
Reporting options for cash method tax-payers. If you use the cash method of reporting income, you can report the interest on series EE, series E, and series I bonds in either of the following ways.
Note. Series E bonds issued in 1977 matured in 2007. If you have used method 1, you generally must report the interest on these bonds on your 2007 return.
You must use the same method for all series EE, series E, and series I bonds you own. If you do not choose method 2 by reporting the increase in redemption value as interest each year, you must use method 1.
Tip: If you plan to cash your bonds in the same year that you will pay for higher education expenses, you may want to use method 1 because you may be able to exclude the interest from your income. To learn how, see Education Savings Bond Program, later.
Change from method 1. If you want to change your method of reporting the interest from method 1 to method 2, you can do so without permission from the IRS. In the year of change you must report all interest accrued to date and not previously reported for all your bonds.
Once you choose to report the interest each year, you must continue to do so for all series EE, series E, and series I bonds you own and for any you get later, unless you request permission to change, as explained next.
Change from method 2. To change from method 2 to method 1, you must request permission from the IRS. Permission for the change is automatically granted if you send the IRS a statement that meets all the following requirements.
You must attach this statement to your tax return for the year of change, which you must file by the due date (including extensions).
You can have an automatic extension of 6 months from the due date of your return for the year of change (excluding extensions) to file the statement with an amended return. At the top of the statement, enter "Filed pursuant to section 301.9100-2." To get this extension, you must have filed your original return for the year of change by the due date (including extensions).
By the date you file the original statement with your return, you must also send a copy to the address below.
Internal Revenue Service
Attention: CC:IT&A (Automatic Rulings Branch)
P.O. Box 7604
Benjamin Franklin Station
Washington, DC 20044
If you use a private delivery service, send the copy to the address below.
Internal Revenue Service
Attention: CC:IT&A (Automatic Rulings Branch)
1111 Constitution Avenue, NW
Washington, DC 20224
Instead of filing this statement, you can request permission to change from method 2 to method 1 by filing Form 3115. In that case, follow the form instructions for an automatic change. No user fee is required.
Co-owners. If a U.S. savings bond is issued in the names of co-owners, such as you and your child or you and your spouse, interest on the bond is generally taxable to the co-owner who bought the bond.
One co-owner's funds used. If you used your funds to buy the bond, you must pay the tax on the interest. This is true even if you let the other co-owner redeem the bond and keep all the proceeds. Under these circumstances, since the other co-owner will receive a Form 1099-INT at the time of redemption, the other co-owner must provide you with another Form 1099-INT showing the amount of interest from the bond that is taxable to you. The co-owner who redeemed the bond is a "nominee." See Nominee distributions under How To Report Interest Income in chapter 1 of Publication 550 for more information about how a person who is a nominee reports interest income belonging to another person.
Both co-owners' funds used. If you and the other co-owner each contribute part of the bond's purchase price, the interest is generally taxable to each of you, in proportion to the amount each of you paid.
Community property. If you and your spouse live in a community property state and hold bonds as community property, one-half of the interest is considered received by each of you. If you file separate returns, each of you generally must report one-half of the bond interest. For more information about community property, see Publication 555, Community Property.
Table 7-1. These rules are also shown in Table 7-1.
Table 7-1. Who Pays the Tax on U.S. Savings Bond Interest
---------------------------------------------------------------------
THEN the interest must be
IF... reported by...
---------------------------------------------------------------------
you buy a bond in your name you.
and the name of another person
as co-owners, using only your
own funds
---------------------------------------------------------------------
you buy a bond in the name of the person for whom you bought
another person, who is the the bond.
sole owner of the bond
---------------------------------------------------------------------
you and another person buy a both you and the other co-owner,
bond as co-owners, each in proportion to the amount each
contributing part of the paid for the bond.
purchase price
---------------------------------------------------------------------
you and your spouse, who live you and your spouse. If you file
in a community property state, separate returns, both you and
buy a bond that is community your spouse generally report
property one-half of the interest.
---------------------------------------------------------------------
Ownership transferred. If you bought series E, series EE, or series I bonds entirely with your own funds and had them reissued in your co-owner's name or beneficiary's name alone, you must include in your gross income for the year of reissue all interest that you earned on these bonds and have not previously reported. But, if the bonds were reissued in your name alone, you do not have to report the interest accrued at that time.
This same rule applies when bonds (other than bonds held as community property) are transferred between spouses or incident to divorce.
Purchased jointly. If you and a co-owner each contributed funds to buy series E, series EE, or series I bonds jointly and later have the bonds reissued in the co-owner's name alone, you must include in your gross income for the year of reissue your share of all the interest earned on the bonds that you have not previously reported. The former co-owner does not have to include in gross income at the time of reissue his or her share of the interest earned that was not reported before the transfer. This interest, however, as well as all interest earned after the reissue, is income to the former co-owner.
This income-reporting rule also applies when the bonds are reissued in the name of your former co-owner and a new co-owner. But the new co-owner will report only his or her share of the interest earned after the transfer.
If bonds that you and a co-owner bought jointly are reissued to each of you separately in the same proportion as your contribution to the purchase price, neither you nor your co-owner has to report at that time the interest earned before the bonds were reissued.
Example 1. You and your spouse each spent an equal amount to buy a $1,000 series EE savings bond. The bond was issued to you and your spouse as co-owners. You both postpone reporting interest on the bond. You later have the bond reissued as two $500 bonds, one in your name and one in your spouse's name. At that time neither you nor your spouse has to report the interest earned to the date of reissue.
Example 2. You bought a $1,000 series EE savings bond entirely with your own funds. The bond was issued to you and your spouse as co-owners. You both postpone reporting interest on the bond. You later have the bond reissued as two $500 bonds, one in your name and one in your spouse's name. You must report half the interest earned to the date of reissue.
Transfer to a trust. If you own series E, series EE, or series I bonds and transfer them to a trust, giving up all rights of ownership, you must include in your income for that year the interest earned to the date of transfer if you have not already reported it. However, if you are considered the owner of the trust and if the increase in value both before and after the transfer continues to be taxable to you, you can continue to defer reporting the interest earned each year. You must include the total interest in your income in the year you cash or dispose of the bonds or the year the bonds finally mature, whichever is earlier.
The same rules apply to previously unreported interest on series EE or series E bonds if the transfer to a trust consisted of series HH or series H bonds you acquired in a trade for the series EE or series E bonds. See Savings bonds traded, later.
Decedents. The manner of reporting interest income on series E, series EE, or series I bonds, after the death of the owner, depends on the accounting and income-reporting methods previously used by the decedent. This is explained in chapter 1 of Publication 550.
Savings bonds traded. If you postponed reporting the interest on your series EE or series E bonds, you did not recognize taxable income when you traded the bonds for series HH or series H bonds, unless you received cash in the trade. (You cannot trade series I bonds for series HH bonds. After August 31, 2004, you cannot trade any other series of bonds for series HH bonds.) Any cash you received is income up to the amount of the interest earned on the bonds traded. When your series HH or series H bonds mature, or if you dispose of them before maturity, you report as interest the difference between their redemption value and your cost. Your cost is the sum of the amount you paid for the traded series EE or series E bonds plus any amount you had to pay at the time of the trade.
Example. In 2004, you traded series EE bonds (on which you postponed reporting the interest) for $2,500 in series HH bonds and $223 in cash. You reported the $223 as taxable income in 2004, the year of the trade. At the time of the trade, the series EE bonds had accrued interest of $523 and a redemption value of $2,723. You hold the series HH bonds until maturity, when you receive $2,500. You must report $300 as interest income in the year of maturity. This is the difference between their redemption value, $2,500, and your cost, $2,200 (the amount you paid for the series EE bonds). (It is also the difference between the accrued interest of $523 on the series EE bonds and the $223 cash received on the trade.)
Choice to report interest in year of trade. You could have chosen to treat all of the previously unreported accrued interest on the series EE or series E bonds traded for series HH bonds as income in the year of the trade. If you made this choice, it is treated as a change from method 1. See Change from method 1 under Series EE and series I bonds, earlier.
Form 1099-INT for U.S. savings bonds interest. When you cash a bond, the bank or other payer that redeems it must give you a Form 1099-INT if the interest part of the payment you receive is $10 or more. Box 3 of your Form 1099-INT should show the interest as the difference between the amount you received and the amount paid for the bond. However, your Form 1099-INT may show more interest than you have to include on your income tax return. For example, this may happen if any of the following are true.
For more information on including the correct amount of interest on your return, see How To Report Interest Income, later. Publication 550 includes examples showing how to report these amounts.
Tip: Interest on U.S. savings bonds is exempt from state and local taxes. The Form 1099-INT you receive will indicate the amount that is for U.S. savings bond interest in box 3.
Education Savings Bond Program
You may be able to exclude from income all or part of the interest you receive on the redemption of qualified U.S. savings bonds during the year if you pay qualified higher educational expenses during the same year. This exclusion is known as the Education Savings Bond Program.
You do not qualify for this exclusion if your filing status is married filing separately.
Form 8815. Use Form 8815 to figure your exclusion. Attach the form to your Form 1040 or Form 1040A.
Qualified U.S. savings bonds. A qualified U.S. savings bond is a series EE bond issued after 1989 or a series I bond. The bond must be issued either in your name (sole owner) or in your and your spouse's names (co-owners). You must be at least 24 years old before the bond's issue date. For example, a bond bought by a parent and issued in the name of his or her child under age 24 does not qualify for the exclusion by the parent or child.
Caution: The issue date of a bond may be earlier than the date the bond is purchased because the issue date assigned to a bond is the first day of the month in which it is purchased.
Beneficiary. You can designate any individual (including a child) as a beneficiary of the bond.
Verification by IRS. If you claim the exclusion, the IRS will check it by using bond redemption information from the Department of the Treasury.
Qualified expenses. Qualified higher educational expenses are tuition and fees required for you, your spouse, or your dependent (for whom you can claim an exemption) to attend an eligible educational institution.
Qualified expenses include any contribution you make to a qualified tuition program or to a Coverdell education savings account.
Qualified expenses do not include expenses for room and board or for courses involving sports, games, or hobbies that are not part of a degree or certificate granting program.
Eligible educational institutions. These institutions include most public, private, and nonprofit universities, colleges, and vocational schools that are accredited and are eligible to participate in student aid programs run by the Department of Education.
Reduction for certain benefits. You must reduce your qualified higher educational expenses by all of the following tax-free benefits.
Amount excludable. If the total proceeds (interest and principal) from the qualified U.S. savings bonds you redeem during the year are not more than your adjusted qualified higher educational expenses for the year, you may be able to exclude all of the interest. If the proceeds are more than the expenses, you may be able to exclude only part of the interest.
To determine the excludable amount, multiply the interest part of the proceeds by a fraction. The numerator of the fraction is the qualified higher educational expenses you paid during the year. The denominator of the fraction is the total proceeds you received during the year.
Example. In February 2007, Mark and Joan, a married couple, cashed a qualified series EE U.S. savings bond they bought in April 1996. They received proceeds of $7,512 representing principal of $5,000 and interest of $2,512. In 2007, they paid $4,000 of their daughter's college tuition. They are not claiming an education credit for that amount, and their daughter does not have any tax-free educational assistance. They can exclude $1,338 ($2,512 × ($4,000 ÷ $7,512)) of interest in 2007. They must pay tax on the remaining $1,174 ($2,512 - $1,338) interest.
Modified adjusted gross income limit. The interest exclusion is limited if your modified adjusted gross income (modified AGI) is:
You do not qualify for the interest exclusion if your modified AGI is equal to or more than the upper limit for your filing status.
Modified AGI, for purposes of this exclusion, is adjusted gross income (Form 1040A, line 21 or Form 1040, line 37) figured before the interest exclusion, and modified by adding back any:
Use the worksheet in the instructions for line 9, Form 8815, to figure your modified AGI. If you claim any of the exclusion or deduction items listed above (except items 6, 7, and 8), add the amount of the exclusion or deduction (except any deduction for tuition and fees, student loan interest, or domestic production activities) to the amount on line 5 of the worksheet, and enter the total on Form 8815, line 9, as your modified AGI.
If you have investment interest expense incurred to earn royalties and other investment income, see Education Savings Bond Program in chapter 1 of Publication 550.
Records: Recordkeeping. If you claim the interest exclusion, you must keep a written record of the qualified U.S. savings bonds you redeem. Your record must include the serial number, issue date, face value, and total redemption proceeds (principal and interest) of each bond. You can use Form 8818, Optional Form To Record Redemption of Series EE and I U.S. Savings Bonds Issued After 1989, to record this information. You should also keep bills, receipts, canceled checks, or other documentation that shows you paid qualified higher educational expenses during the year.
U.S. Treasury Bills, Notes, and Bonds
Treasury bills, notes, and bonds are direct debts (obligations) of the U.S. Government.
Taxation of interest. Interest income from Treasury bills, notes, and bonds is subject to federal income tax, but is exempt from all state and local income taxes. You should receive Form 1099-INT showing the amount of interest (in box 3) that was paid to you for the year.
Payments of principal and interest generally will be credited to your designated checking or savings account by direct deposit through the TREASURY DIRECT system.
Treasury bills. These bills generally have a 4-week, 13-week, or 26-week maturity period. They are issued at a discount in the amount of $1,000 and multiples of $1,000. The difference between the discounted price you pay for the bills and the face value you receive at maturity is interest income. Generally, you report this interest income when the bill is paid at maturity.
Treasury notes and bonds. Treasury notes have maturity periods of more than 1 year, ranging up to 10 years. Maturity periods for Treasury bonds are longer than 10 years. Both notes and bonds generally pay interest every 6 months. Generally, you report this interest for the year paid. For more information, see U.S. Treasury Bills, Notes, and Bonds in chapter 1 of Publication 550.
For other information on Treasury notes or bonds, write to:
Bureau of The Public Debt
P.O. Box 7015
Parkersburg, WV 26106 -- 7015
Or, on the Internet, visit: www.treasurydirect.gov/indiv/indiv.htm
For information on series EE, series I, and series HH savings bonds, see U.S. Savings Bonds, earlier.
Treasury inflation-protected securities (TIPS). These securities pay interest twice a year at a fixed rate, based on a principal amount that is adjusted to take into account inflation and deflation. For the tax treatment of these securities, see Inflation-Indexed Debt Instruments under Original Issue Discount (OID), in Publication 550.
Bonds Sold Between Interest Dates
If you sell a bond between interest payment dates, part of the sales price represents interest accrued to the date of sale. You must report that part of the sales price as interest income for the year of sale.
If you buy a bond between interest payment dates, part of the purchase price represents interest accrued before the date of purchase. When that interest is paid to you, treat it as a return of your capital investment, rather than interest income, by reducing your basis in the bond. See Accrued interest on bonds under How To Report Interest Income in chapter 1 of Publication 550 for information on reporting the payment.
Life insurance proceeds paid to you as beneficiary of the insured person are usually not taxable. But if you receive the proceeds in installments, you must usually report a part of each installment payment as interest income.
For more information about insurance proceeds received in installments, see Publication 525, Taxable and Nontaxable Income.
Annuity. If you buy an annuity with life insurance proceeds, the annuity payments you receive are taxed as pension and annuity income from a nonqualified plan, not as interest income. See chapter 10 for information on pension and annuity income from nonqualified plans.
State or Local Government Obligations
Interest on a bond used to finance government operations generally is not taxable if the bond is issued by a state, the District of Columbia, a possession of the United States, or any of their political subdivisions.
Bonds issued after 1982 by an Indian tribal government are treated as issued by a state. Interest on these bonds is generally tax exempt if the bonds are part of an issue of which substantially all of the proceeds are to be used in the exercise of any essential government function.
Interest on arbitrage bonds issued by state or local governments after October 9, 1969, is taxable.
Interest on a private activity bond that is not a qualified bond is taxable. For more information on whether such interest is taxable or tax exempt, see State or Local Government Obligations in chapter 1 of Publication 550.
Information reporting requirement. If you must file a tax return, you are required to show any tax-exempt interest you received on your return. This is an information-reporting requirement only. It does not change tax-exempt interest to taxable interest.
Original issue discount (OID) is a form of interest. You generally include OID in your income as it accrues over the term of the debt instrument, whether or not you receive any payments from the issuer.
A debt instrument generally has OID when the instrument is issued for a price that is less than its stated redemption price at maturity. OID is the difference between the stated redemption price at maturity and the issue price.
All debt instruments that pay no interest before maturity are presumed to be issued at a discount. Zero coupon bonds are one example of these instruments.
The OID accrual rules generally do not apply to short-term obligations (those with a fixed maturity date of 1 year or less from date of issue). See Discount on Short-Term Obligations in chapter 1 of Publication 550.
De minimis OID. You can treat the discount as zero if it is less than one-fourth of 1% (.0025) of the stated redemption price at maturity multiplied by the number of full years from the date of original issue to maturity. This small discount is known as "de minimis" OID.
Example 1. You bought a 10-year bond with a stated redemption price at maturity of $1,000, issued at $980 with OID of $20. One-fourth of 1% of $1,000 (stated redemption price) times 10 (the number of full years from the date of original issue to maturity) equals $25. Because the $20 discount is less than $25, the OID is treated as zero. (If you hold the bond at maturity, you will recognize $20 ($1,000 - $980) of capital gain.)
Example 2. The facts are the same as in Example 1, except that the bond was issued at $950. The OID is $50. Because the $50 discount is more than the $25 figured in Example 1, you must include the OID in income as it accrues over the term of the bond.
Debt instrument bought after original issue. If you buy a debt instrument with de minimis OID at a premium, the discount is not includible in income. If you buy a debt instrument with de minimis OID at a discount, the discount is reported under the market discount rules. See Market Discount Bonds in chapter 1 of Publication 550.
Exceptions to reporting OID. The OID rules discussed in this chapter do not apply to the following debt instruments.
Form 1099-OID. The issuer of the debt instrument (or your broker, if you held the instrument through a broker) should give you Form 1099-OID, Original Issue Discount, or a similar statement, if the total OID for the calendar year is $10 or more. Form 1099-OID will show, in box 1, the amount of OID for the part of the year that you held the bond. It also will show, in box 2, the stated interest that you must include in your income. A copy of Form 1099-OID will be sent to the IRS. Do not file your copy with your return. Keep it for your records.
In most cases, you must report the entire amount in boxes 1 and 2 of Form 1099-OID as interest income. But see Refiguring OID shown on Form 1099-OID, later in this discussion, for more information.
Form 1099-OID not received. If you had OID for the year but did not receive a Form 1099-OID, see www.irs.gov, which lists total OID on certain debt instruments and has information that will help you figure OID. If your debt instrument is not listed, consult the issuer for further information about the accrued OID for the year.
Nominee. If someone else is the holder of record (the registered owner) of an OID instrument that belongs to you and receives a Form 1099-OID on your behalf, that person must give you a Form 1099-OID.
Refiguring OID shown on Form 1099-OID. You must refigure the OID shown in box 1 or box 6 of Form 1099-OID if either of the following apply.
For information about figuring the correct amount of OID to include in your income, see Figuring OID on Long-Term Debt Instruments in Publication 1212.
Refiguring periodic interest shown on Form 1099-OID. If you disposed of a debt instrument or acquired it from another holder during the year, see Bonds Sold Between Interest Dates, earlier, for information about the treatment of periodic interest that may be shown in box 2 of Form 1099-OID for that instrument.
Certificates of deposit (CDs). If you buy a CD with a maturity of more than 1 year, you must include in income each year a part of the total interest due and report it in the same manner as other OID.
This also applies to similar deposit arrangements with banks, building and loan associations, etc., including:
Bearer CDs. CDs issued after 1982 generally must be in registered form. Bearer CDs are CDs that are not in registered form. They are not issued in the depositor's name and are transferable from one individual to another.
Banks must provide the IRS and the person redeeming a bearer CD with a Form 1099-INT.
More information. See chapter 1 of Publication 550 for more information about OID and related topics, such as market discount bonds.
When to report your interest income depends on whether you use the cash method or an accrual method to report income.
Cash method. Most individual taxpayers use the cash method. If you use this method, you generally report your interest income in the year in which you actually or constructively receive it. However, there are special rules for reporting the discount on certain debt instruments. See U.S. Savings Bonds and Original Issue Discount, earlier.
Example. On September 1, 2005, you loaned another individual $2,000 at 12%, compounded annually. You are not in the business of lending money. The note stated that principal and interest would be due on August 31, 2007. In 2007, you received $2,508.80 ($2,000 principal and $508.80 interest). If you use the cash method, you must include in income on your 2007 return the $508.80 interest you received in that year.
Constructive receipt. You constructively receive income when it is credited to your account or made available to you. You do not need to have physical possession of it. For example, you are considered to receive interest, dividends, or other earnings on any deposit or account in a bank, savings and loan, or similar financial institution, or interest on life insurance policy dividends left to accumulate, when they are credited to your account and subject to your withdrawal. This is true even if they are not yet entered in your passbook.
You constructively receive income on the deposit or account even if you must:
Accrual method. If you use an accrual method, you report your interest income when you earn it, whether or not you have received it. Interest is earned over the term of the debt instrument.
Example. If, in the previous example, you use an accrual method, you must include the interest in your income as you earn it. You would report the interest as follows: 2005, $80; 2006, $249.60; and 2007, $179.20.
Coupon bonds. Interest on coupon bonds is taxable in the year the coupon becomes due and payable. It does not matter when you mail the coupon for payment.
Generally, you report all of your taxable interest income on Form 1040, line 8a; Form 1040A, line 8a; or Form 1040EZ, line 2.
You cannot use Form 1040EZ if your interest income is more than $1,500. Instead, you must use Form 1040A or Form 1040.
Form 1040A. You must complete Schedule 1 (Form 1040A), Part I, if you file Form 1040A and any of the following are true.
List each payer's name and the amount of interest income received from each payer on line 1. If you received a Form 1099-INT or Form 1099-OID from a brokerage firm, list the brokerage firm as the payer.
You cannot use Form 1040A if you must use Form 1040, as described next.
Form 1040. You must use Form 1040 instead of Form 1040A or Form 1040EZ if:
Schedule B. You must complete Schedule B (Form 1040), Part I, if you file Form 1040 and any of the following apply.
On Part I, line 1, list each payer's name and the amount received from each. If you received a Form 1099-INT or Form 1099-OID from a brokerage firm, list the brokerage firm as the payer.
Form 1099-INT. Your taxable interest income, except for interest from U.S. savings bonds and Treasury obligations, is shown in box 1 of Form 1099-INT. Add this amount to any other taxable interest income you received. You must report all of your taxable interest income even if you do not receive a Form 1099-INT.
If you forfeited interest income because of the early withdrawal of a time deposit, the deductible amount will be shown on Form 1099-INT in box 2. See Penalty on early withdrawal of savings in chapter 1 of Publication 550.
Box 3 of Form 1099-INT shows the amount of interest income you received from U.S. savings bonds, Treasury bills, Treasury notes, and Treasury bonds. Add the amount shown in box 3 to any other taxable interest income you received, unless part of the amount in box 3 was previously included in interest income. If part of the amount shown in box 3 was previously included in your interest income, see U.S. savings bond interest previously reported, later.
Box 4 of Form 1099-INT (federal income tax withheld) will contain an amount if you were subject to backup withholding. Report the amount from box 4 on Form 1040EZ, line 7, on Form 1040A, line 38, or on Form 1040, line 64 (federal income tax withheld).
Box 5 of Form 1099-INT shows investment expenses you may be able to deduct as an itemized deduction. See chapter 3 of Publication 550 for more information about investment expenses.
U.S. savings bond interest previously reported. If you received a Form 1099-INT for U.S. savings bond interest, the form may show interest you do not have to report. See Form 1099-INT for U.S. savings bonds interest, earlier, under U.S. Savings Bonds.
On Schedule B (Form 1040), Part I, line 1, or on Schedule 1 (Form 1040A), Part I, line 1, report all the interest shown on your Form 1099-INT. Then follow these steps.
More information. For more information about how to report interest income, see chapter 1 of Publication 550 or the instructions for the form you must file.
Foreign income. If you are a U.S. citizen with dividend income from sources outside the United States (foreign income), you must report that income on your tax return unless it is exempt by U.S. law. This is true whether you reside inside or outside the United States and whether or not you receive a Form 1099 from the foreign payer.
This chapter discusses the tax treatment of:
This chapter also explains how to report dividend income on your tax return.
Dividends are distributions of money, stock, or other property paid to you by a corporation. You also may receive dividends through a partnership, an estate, a trust, or an association that is taxed as a corporation. However, some amounts you receive that are called dividends are actually interest income. (See Dividends that are actually interest under Taxable Interest in chapter 7.)
Most distributions are paid in cash (or check). However, distributions can consist of more stock, stock rights, other property, or services.
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This section discusses general rules for dividend income.
Tax on investment income of a child under age 18. Part of a child's 2007 investment income may be taxed at the parent's tax rate. This may happen if all of the following are true.
If all of these statements are true, Form 8615, Tax for Children Under Age 18 With Investment Income of More Than $1,700, must be completed and attached to the child's tax return. If any of these statements is not true, Form 8615 is not required and the child's income is taxed at his or her own tax rate.
However, the parent can choose to include the child's interest and dividends on the parent's return if certain requirements are met. Use Form 8814, Parents' Election To Report Child's Interest and Dividends, for this purpose.
For more information about the tax on investment income of children and the parents' election, see chapter 31.
Beneficiary of an estate or trust. Dividends and other distributions you receive as a beneficiary of an estate or trust are generally taxable income. You should receive a Schedule K-1 (Form 1041), Beneficiary's Share of Income, Deductions, Credits, etc., from the fiduciary. Your copy of Schedule K-1 and its instructions will tell you where to report the income on your Form 1040.
Social security number (SSN). You must give your name and SSN (or individual taxpayer identification number (ITIN)) to any person required by federal tax law to make a return, statement, or other document that relates to you. This includes payers of dividends. If you do not give your SSN or ITIN to the payer of dividends, you may have to pay a penalty.
For more information on SSNs and ITINs, see Social security number (SSN) in chapter 7.
Backup withholding. Your dividend income is generally not subject to regular withholding. However, it may be subject to backup withholding to ensure that income tax is collected on the income. Under backup withholding, the payer of dividends must withhold, as income tax, 28% of the amount you are paid.
Backup withholding may also be required if the Internal Revenue Service (IRS) has determined that you underreported your interest or dividend income. For more information, see Backup Withholding in chapter 4.
Stock certificate in two or more names. If two or more persons hold stock as joint tenants, tenants by the entirety, or tenants in common, each person's share of any dividends from the stock is determined by local law.
Form 1099-DIV. Most corporations use Form 1099-DIV, Dividends and Distributions, to show you the distributions you received from them during the year. Keep this form with your records. You do not have to attach it to your tax return.
Dividends not reported on Form 1099-DIV. Even if you do not receive Form 1099-DIV, you must still report all of your taxable dividend income. For example, you may receive distributive shares of dividends from partnerships or subchapter S corporations. These dividends are reported to you on Schedule K-1 (Form 1065) and Schedule K-1 (Form 1120S).
Reporting tax withheld. If tax is withheld from your dividend income, the payer must give you a Form 1099-DIV that indicates the amount withheld.
Nominees. If someone receives distributions as a nominee for you, that person will give you a Form 1099-DIV, which will show distributions received on your behalf.
Form 1099-MISC. Certain substitute payments in lieu of dividends or tax-exempt interest that are received by a broker on your behalf must be reported to you on Form 1099-MISC, Miscellaneous Income, or a similar statement. See Reporting Substitute Payments under Short Sales in chapter 4 of Publication 550 for more information about reporting these payments.
Incorrect amount shown on a Form 1099. If you receive a Form 1099 that shows an incorrect amount (or other incorrect information), you should ask the issuer for a corrected form. The new Form 1099 you receive will be marked "Corrected."
Dividends on stock sold. If stock is sold, exchanged, or otherwise disposed of after a dividend is declared, but before it is paid, the owner of record (usually the payee shown on the dividend check) must include the dividend in income.
Dividends received in January. If a mutual fund (or other regulated investment company) or real estate investment trust (REIT) declares a dividend (including any exempt-interest dividend or capital gain distribution) in October, November, or December payable to shareholders of record on a date in one of those months but actually pays the dividend during January of the next calendar year, you are considered to have received the dividend on December 31. You report the dividend in the year it was declared.
Ordinary (taxable) dividends are the most common type of distribution from a corporation. They are paid out of the earnings and profits of a corporation and are ordinary income to you. This means they are not capital gains. You can assume that any dividend you receive on common or preferred stock is an ordinary dividend unless the paying corporation tells you otherwise. Ordinary dividends will be shown in box 1a of the Form 1099-DIV you receive.
Qualified Dividends
Qualified dividends are the ordinary dividends that are subject to the same 5% or 15% maximum tax rate that applies to net capital gain. They should be shown in box 1b of the Form 1099-DIV you receive.
Qualified dividends are subject to the 15% rate if the regular tax rate that would apply is 25% or higher. If the regular tax rate that would apply is lower than 25%, qualified dividends are subject to the 5% rate.
To qualify for the 5% or 15% maximum rate, all of the following requirements must be met.
Holding period. You must have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date. The ex-dividend date is the first date following the declaration of a dividend on which the buyer of a stock will not receive the next dividend payment. Instead, the seller will get the dividend.
When counting the number of days you held the stock, include the day you disposed of the stock, but not the day you acquired it. See the examples later.
Exception for preferred stock. In the case of preferred stock, you must have held the stock more than 90 days during the 181-day period that begins 90 days before the ex-dividend date if the dividends are due to periods totaling more than 366 days. If the preferred dividends are due to periods totaling less than 367 days, the holding period in the previous paragraph applies.
Example 1. You bought 5,000 shares of XYZ Corp. common stock on June 28, 2007. XYZ Corp. paid a cash dividend of 10 cents per share. The ex-dividend date was July 6, 2007. Your Form 1099-DIV from XYZ Corp. shows $500 in box 1a (ordinary dividends) and in box 1b (qualified dividends). However, you sold the 5,000 shares on August 1, 2007. You held your shares of XYZ Corp. for only 34 days of the 121-day period (from June 29, 2007, through August 1, 2007). The 121-day period began on May 7, 2007 (60 days before the ex-dividend date), and ended on September 4, 2007. You have no qualified dividends from XYZ Corp. because you held the XYZ stock for less than 61 days.
Example 2. Assume the same facts as in Example 1 except that you bought the stock on July 5, 2007 (the day before the ex-dividend date), and you sold the stock on September 6, 2007. You held the stock for 63 days (from July 6, 2007, through September 6, 2007). The $500 of qualified dividends shown in box 1b of your Form 1099-DIV are all qualified dividends because you held the stock for 61 days of the 121-day period (from July 6, 2007, through September 4, 2007).
Example 3. You bought 10,000 shares of ABC Mutual Fund common stock on June 28, 2007. ABC Mutual Fund paid a cash dividend of 10 cents a share. The ex-dividend date was July 6, 2007. The ABC Mutual Fund advises you that the portion of the dividend eligible to be treated as qualified dividends equals 2 cents per share. Your Form 1099-DIV from ABC Mutual Fund shows total ordinary dividends of $1,000 and qualified dividends of $200. However, you sold the 10,000 shares on August 1, 2007. You have no qualified dividends from ABC Mutual Fund because you held the ABC Mutual Fund stock for less than 61 days.
Holding period reduced where risk of loss is diminished. When determining whether you met the minimum holding period discussed earlier, you cannot count any day during which you meet any of the following conditions.
For information about how to apply condition (3), see Regulations section 1.246-5.
Qualified foreign corporation. A foreign corporation is a qualified foreign corporation if it meets any of the following conditions.
Table 8-1. Income Tax Treaties
------------------------------------------- Income tax treaties the United States has with the following countries satisfy requirement (2) under Qualified foreign corporation. ------------------------------------------- Australia Indonesia Romania Austria Ireland Russian Bangladesh1 Israel Federation Barbados2 Italy Slovak Belgium Jamaica Republic Canada Japan Slovenia China Kazakhstan South Africa Cyprus Korea Spain Czech Latvia Sri Lanka3 Republic Lithuania Sweden Denmark Luxembourg Switzerland Egypt Mexico Thailand Estonia Morocco Trinidad and Finland Netherlands Tobago France New Zealand Tunisia Germany Norway Turkey Greece Pakistan Ukraine Hungary Philippines United Iceland Poland Kingdom India Portugal Venezuela 1 Effective for dividends paid after August 6, 2006. 2 Effective for dividends paid after December 19, 2004. 3 Effective for dividends paid after July 11, 2004. ===========================================
Exception. A corporation is not a qualified foreign corporation if it is a passive foreign investment company during its tax year in which the dividends are paid or during its previous tax year.
Readily tradable stock. Any stock (such as common, ordinary stock, or preferred stock) or an American depositary receipt in respect of that stock is considered to satisfy requirement (3) if it is listed on one of the following securities markets: the New York Stock Exchange, the NASD-AQ Stock Market, the American Stock Exchange, the Boston Stock Exchange, the Cincinnati Stock Exchange, the Chicago Stock Exchange, the Philadelphia Stock Exchange, or the Pacific Exchange, Inc.
Dividends that are not qualified dividends. The following dividends are not qualified dividends. They are not qualified dividends even if they are shown in box 1b of Form 1099-DIV.
Dividends Used to Buy More Stock
The corporation in which you own stock may have a dividend reinvestment plan. This plan lets you choose to use your dividends to buy (through an agent) more shares of stock in the corporation instead of receiving the dividends in cash. If you are a member of this type of plan and you use your dividends to buy more stock at a price equal to its fair market value, you still must report the dividends as income.
If you are a member of a dividend reinvestment plan that lets you buy more stock at a price less than its fair market value, you must report as dividend income the fair market value of the additional stock on the dividend payment date.
You also must report as dividend income any service charge subtracted from your cash dividends before the dividends are used to buy the additional stock. But you may be able to deduct the service charge. See chapter 28 for more information about deducting expenses of producing income.
In some dividend reinvestment plans, you can invest more cash to buy shares of stock at a price less than fair market value. If you choose to do this, you must report as dividend income the difference between the cash you invest and the fair market value of the stock you buy. When figuring this amount, use the fair market value of the stock on the dividend payment date.
Money Market Funds
Report amounts you receive from money market funds as dividend income. Money market funds are a type of mutual fund and should not be confused with bank money market accounts that pay interest.
Capital gain distributions (also called capital gain dividends) are paid to you or credited to your account by mutual funds (or other regulated investment companies) and real estate investment trusts (REITs). They will be shown in box 2a of the Form 1099-DIV you receive from the mutual fund or REIT.
Report capital gain distributions as long-term capital gains regardless of how long you owned your shares in the mutual fund or REIT.
Undistributed capital gains of mutual funds and REITs. Some mutual funds and REITs keep their long-term capital gains and pay tax on them. You must treat your share of these gains as distributions, even though you did not actually receive them. However, they are not included on Form 1099-DIV. Instead, they are reported to you on Form 2439, Notice to Shareholder of Undistributed Long-Term Capital Gains.
Report undistributed capital gains (box 1a of Form 2439) as long-term capital gains on Schedule D (Form 1040), column (f), line 11.
The tax paid on these gains by the mutual fund or REIT is shown in box 2 of Form 2439. You take credit for this tax by including it on Form 1040, line 70, and checking box a on that line. Attach Copy B of Form 2439 to your return, and keep Copy C for your records.
Basis adjustment. Increase your basis in your mutual fund, or your interest in a REIT, by the difference between the gain you report and the credit you claim for the tax paid.
Additional information. For more information on the treatment of distributions from mutual funds, see Publication 564.
A nondividend distribution is a distribution that is not paid out of the earnings and profits of a corporation. You should receive a Form 1099-DIV or other statement from the corporation showing the nondividend distribution. On Form 1099-DIV, a nondividend distribution will be shown in box 3. If you do not receive such a statement, you report the distribution as an ordinary dividend.
Basis adjustment. A nondividend distribution reduces the basis of your stock. It is not taxed until your basis in the stock is fully recovered. This nontaxable portion is also called a return of capital. It is a return of your investment in the stock of the company. If you buy stock in a corporation in different lots at different times, and you cannot definitely identify the shares subject to the nondividend distribution, reduce the basis of your earliest purchases first.
When the basis of your stock has been reduced to zero, report any additional nondividend distribution that you receive as a capital gain. Whether you report it as a long-term or short-term capital gain depends on how long you have held the stock. See Holding Period in chapter 14.
Example. You bought stock in 1995 for $100. In 1998, you received a nondividend distribution of $80. You did not include this amount in your income, but you reduced the basis of your stock to $20. You received a nondividend distribution of $30 in 2007. The first $20 of this amount reduced your basis to zero. You report the other $10 as a long-term capital gain for 2007. You must report as a long-term capital gain any nondividend distribution you receive on this stock in later years.
Liquidating Distributions
Liquidating distributions, sometimes called liquidating dividends, are distributions you receive during a partial or complete liquidation of a corporation. These distributions are, at least in part, one form of a return of capital. They may be paid in one or more installments. You will receive a Form 1099-DIV from the corporation showing you the amount of the liquidating distribution in box 8 or 9.
For more information on liquidating distributions, see chapter 1 of Publication 550.
Distributions of Stock and Stock Rights
Distributions by a corporation of its own stock are commonly known as stock dividends. Stock rights (also known as "stock options") are distributions by a corporation of rights to acquire the corporation's stock. Generally, stock dividends and stock rights are not taxable to you, and you do not report them on your return.
Taxable stock dividends and stock rights. Distributions of stock dividends and stock rights are taxable to you if any of the following apply.
The term "stock" includes rights to acquire stock, and the term "shareholder" includes a holder of rights or of convertible securities.
If you receive taxable stock dividends or stock rights, include their fair market value at the time of the distribution in your income.
Preferred stock redeemable at a premium. If you hold preferred stock having a redemption price higher than its issue price, the difference (the redemption premium) generally is taxable as a constructive distribution of additional stock on the preferred stock. For more information, see chapter 1 of Publication 550.
Basis. Your basis in stock or stock rights received in a taxable distribution is their fair market value when distributed. If you receive stock or stock rights that are not taxable to you, see Stocks and Bonds under Basis of Investment Property in chapter 4 of Publication 550 for information on how to figure their basis.
Fractional shares. You may not own enough stock in a corporation to receive a full share of stock if the corporation declares a stock dividend. However, with the approval of the shareholders, the corporation may set up a plan in which fractional shares are not issued, but instead are sold, and the cash proceeds are given to the shareholders. Any cash you receive for fractional shares under such a plan is treated as an amount realized on the sale of the fractional shares. You must determine your gain or loss and report it as a capital gain or loss on Schedule D (Form 1040). Your gain or loss is the difference between the cash you receive and the basis of the fractional shares sold.
Example. You own one share of common stock that you bought on January 3, 1999, for $100. The corporation declared a common stock dividend of 5% on June 30, 2007. The fair market value of the stock at the time the stock dividend was declared was $200. You were paid $10 for the fractional-share stock dividend under a plan described in the above paragraph. You figure your gain or loss as follows:
Fair market value of old stock $200.00
Fair market value of stock dividend
(cash received) +10.00
-------
Fair market value of old stock and
stock dividend $210.00
=======
Basis (cost) of old stock after the
stock dividend (($200 ÷ $210) × $100) $95.24
Basis (cost) of stock dividend (($10 ÷
$210) × $100) + 4.76
-------
Total $100.00
=======
Cash received $10.00
Basis (cost) of stock dividend - 4.76
-------
Gain $5.24
=======
Because you had held the share of stock for more than 1 year at the time the stock dividend was declared, your gain on the stock dividend is a long-term capital gain.
Scrip dividends. A corporation that declares a stock dividend may issue you a scrip certificate that entitles you to a fractional share. The certificate is generally nontaxable when you receive it. If you choose to have the corporation sell the certificate for you and give you the proceeds, your gain or loss is the difference between the proceeds and the portion of your basis in the corporation's stock that is allocated to the certificate.
However, if you receive a scrip certificate that you can choose to redeem for cash instead of stock, the certificate is taxable when you receive it. You must include its fair market value in income on the date you receive it.
You may receive any of the following distributions during the year.
Exempt-interest dividends. Exempt-interest dividends you receive from a mutual fund or other regulated investment company are not included in your taxable income. Exempt-interest dividends should be shown on box 8 of Form 1099-INT.
Information reporting requirement. Although exempt-interest dividends are not taxable, you must show them on your tax return if you have to file a return. This is an information reporting requirement and does not change the exempt-interest dividends to taxable income.
Alternative minimum tax treatment. Exempt-interest dividends paid from specified private activity bonds may be subject to the alternative minimum tax. See Alternative Minimum Tax in chapter 30 for more information.
Dividends on insurance policies. Insurance policy dividends that the insurer keeps and uses to pay your premiums are not taxable. However, you must report as taxable interest income the interest that is paid or credited on dividends left with the insurance company.
If dividends on an insurance contract (other than a modified endowment contract) are distributed to you, they are a partial return of the premiums you paid. Do not include them in your gross income until they are more than the total of all net premiums you paid for the contract. Report any taxable distributions on insurance policies on Form 1040, line 21.
Dividends on veterans' insurance. Dividends you receive on veterans' insurance policies are not taxable. In addition, interest on dividends left with the Department of Veterans Affairs is not taxable.
Patronage dividends. Generally, patronage dividends you receive in money from a cooperative organization are included in your income.
Do not include in your income patronage dividends you receive on:
These rules are the same whether the cooperative paying the dividend is a taxable or tax-exempt cooperative.
Alaska Permanent Fund dividends. Do not report these amounts as dividends. Instead, report these amounts on Form 1040, line 21, Form 1040A, line 13, or Form 1040EZ, line 3.
Generally, you can use either Form 1040 or Form 1040A to report your dividend income. Report the total of your ordinary dividends on line 9a of Form 1040 or Form 1040A. Report qualified dividends on line 9b of Form 1040 or Form 1040A.
If you receive capital gain distributions, you may be able to use Form 1040A or you may have to use Form 1040. See Capital gain distributions only in chapter 16. If you receive nondividend distributions required to be reported as capital gains, you must use Form 1040. You cannot use Form 1040EZ if you receive any dividend income.
Form 1099-DIV. If you owned stock on which you received $10 or more in dividends and other distributions, you should receive a Form 1099-DIV. Even if you do not receive Form 1099-DIV, you must report all of your taxable dividend income.
See Form 1099-DIV for more information on how to report dividend income.
Form 1040A. You must complete Schedule 1 (Form 1040A), Part II, and attach it to your Form 1040A, if:
List on line 5 each payer's name and the amount of ordinary dividends you received. If you received a Form 1099-DIV from a brokerage firm, list the brokerage firm as the payer.
Enter on line 6 the total of the amounts listed on line 5. Also enter this total on Form 1040A, line 9a.
Form 1040. You must fill in Schedule B, Part II, and attach it to your Form 1040, if:
If your ordinary dividends are more than $1,500, you must also complete Schedule B, Part III.
List on Schedule B, Part II, line 5, each payer's name and the amount of ordinary dividends you received. If your securities are held by a brokerage firm (in "street name"), list the name of the brokerage firm that is shown on Form 1099-DIV as the payer. If your stock is held by a nominee who is the owner of record, and the nominee credited or paid you dividends on the stock, show the name of the nominee and the dividends you received or for which you were credited.
Enter on line 6 the total of the amounts listed on line 5. Also enter this total on Form 1040, line 9a.
Qualified dividends. Report qualified dividends (Form 1099-DIV, box 1b) on line 9b of Form 1040 or Form 1040A. The amount in box 1b is already included in box 1a. Do not add the amount in box 1b to, or substract it from, the amount in box 1a. Do not include any of the following on lines 9b.
If you have qualified dividends, you must figure your tax by completing the Qualified Dividends and Capital Gain Tax Worksheet in the Form 1040 or 1040A instructions or the Schedule D Tax Worksheet in the Schedule D instructions, whichever applies. Enter qualified dividends on line 2 of the worksheet.
Investment interest deducted. If you claim a deduction for investment interest, you may have to reduce the amount of your qualified dividends that are eligible for the 5% or 15% tax rate. Reduce it by the amount of qualified dividends you choose to include in investment income when figuring the limit on your investment interest deduction. This is done on the Qualified Dividends and Capital Gain Tax Worksheet or the Schedule D Tax Worksheet. For more information about the limit on investment interest, see Interest Expenses in chapter 23.
Expenses related to dividend income. You may be able to deduct expenses related to dividend income if you itemize your deductions on Schedule A (Form 1040). See chapter 28 for general information about deducting expenses of producing income.
More information. For more information about how to report dividend income, see chapter 1 of Publication 550 or the instructions for the form you must file.
This chapter discusses rental income and expenses. It covers the following topics.
If you sell or otherwise dispose of your rental property, see Publication 544, Sales and Other Dispositions of Assets.
If you have a loss from damage to, or theft of, rental property, see Publication 547, Casualties, Disasters, and Thefts.
If you rent a condominium or a cooperative apartment, some special rules apply to you even though you receive the same tax treatment as other owners of rental property. See Publication 527, Residential Rental Property, for more information.
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You generally must include in your gross income all amounts you receive as rent. Rental income is any payment you receive for the use or occupation of property. In addition to amounts you receive as normal rent payments, there are other amounts that may be rental income.
When to report. If you are a cash basis taxpayer, you report rental income on your return for the year you actually or constructively receive it. You are a cash basis taxpayer if you report income in the year you receive it, regardless of when it was earned. You constructively receive income when it is made available to you, for example, by being credited to your bank account.
For more information about when you constructively receive income, see Accounting Methods in chapter 1.
Advance rent. Advance rent is any amount you receive before the period that it covers. Include advance rent in your rental income in the year you receive it regardless of the period covered or the method of accounting you use.
Example. You sign a 10-year lease to rent your property. In the first year, you receive $5,000 for the first year's rent and $5,000 as rent for the last year of the lease. You must include $10,000 in your income in the first year.
Security deposits. Do not include a security deposit in your income when you receive it if you plan to return it to your tenant at the end of the lease. But if you keep part or all of the security deposit during any year because your tenant does not live up to the terms of the lease, include the amount you keep in your income in that year.
If an amount called a security deposit is to be used as a final payment of rent, it is advance rent. Include it in your income when you receive it.
Payment for canceling a lease. If your tenant pays you to cancel a lease, the amount you receive is rent. Include the payment in your income in the year you receive it regardless of your method of accounting.
Expenses paid by tenant. If your tenant pays any of your expenses, the payments are rental income. You must include them in your income. You can deduct the expenses if they are deductible rental expenses. See Rental Expenses, later, for more information.
Property or services. If you receive property or services, instead of money, as rent, include the fair market value of the property or services in your rental income.
If the services are provided at an agreed upon or specified price, that price is the fair market value unless there is evidence to the contrary.
Rental of property also used as a home. If you rent property that you also use as your home and you rent it fewer than 15 days during the tax year, do not include the rent you receive in your income and do not deduct rental expenses. However, you can deduct on Schedule A (Form 1040) the interest, taxes, and casualty and theft losses that are allowed for nonrental property. See Personal Use of Dwelling Unit (Including Vacation Home), later.
Part interest. If you own a part interest in rental property, you must report your part of the rental income from the property.
This part discusses expenses of renting property that you ordinarily can deduct from your rental income. It includes information on the expenses you can deduct if you rent part of your property, or if you change your property to rental use. Depreciation, which you can also deduct from your rental income, is discussed later.
When to deduct. You generally deduct your rental expenses in the year you pay them.
Vacant rental property. If you hold property for rental purposes, you may be able to deduct your ordinary and necessary expenses (including depreciation) for managing, conserving, or maintaining the property while the property is vacant. However, you cannot deduct any loss of rental income for the period the property is vacant.
Pre-rental expenses. You can deduct your ordinary and necessary expenses for managing, conserving, or maintaining rental property from the time you make it available for rent.
Depreciation. You can begin to depreciate rental property when it is ready and available for rent. See ""Placed-in-Service Date" under Depreciation in Publication 527.
Expenses for rental property sold. If you sell property you held for rental purposes, you can deduct the ordinary and necessary expenses for managing, conserving, or maintaining the property until it is sold.
Personal use of rental property. If you sometimes use your rental property for personal purposes, you must divide your expenses between rental and personal use. Also, your rental expense deductions may be limited. See Personal Use of Dwelling Unit (Including Vacation Home), later.
Part interest. If you own a part interest in rental property, you can deduct your part of the expenses that you paid.
Uncollected rent. If you are a cash basis taxpayer, you do not report uncollected rent. Because you do not include it in your income, you cannot deduct it.
If you use an accrual method, you report income when you earn it. If you are unable to collect the rent, you may be able to deduct it as a business bad debt. See chapter 10 of Publication 535 for more information about business bad debts.
You can deduct the cost of repairs to your rental property. You cannot deduct the cost of improvements. You recover the cost of improvements by taking depreciation (explained later).
Records: Separate the costs of repairs and improvements, and keep accurate records. You will need to know the cost of improvements when you sell or depreciate your property.
Repairs. A repair keeps your property in good operating condition. It does not materially add to the value of your property or substantially prolong its life. Repainting your property inside or out, fixing gutters or floors, fixing leaks, plastering, and replacing broken windows are examples of repairs.
If you make repairs as part of an extensive remodeling or restoration of your property, the whole job is an improvement.
Improvements. An improvement adds to the value of property, prolongs its useful life, or adapts it to new uses. Improvements include the following items.
If you make an improvement to property, the cost of the improvement must be capitalized. The capitalized cost can generally be depreciated as if the improvement were separate property.
Other expenses you can deduct from your rental income include advertising, cleaning and maintenance, utilities, fire and liability insurance, taxes, interest, commissions for the collection of rent, ordinary and necessary travel and transportation, and other expenses, discussed next.
Rental payments for property. You can deduct the rent you pay for property that you use for rental purposes. If you buy a leasehold for rental purposes, you can deduct an equal part of the cost each year over the term of the lease.
Rental of equipment. You can deduct the rent you pay for equipment that you use for rental purposes. However, in some cases, lease contracts are actually purchase contracts. If so, you cannot deduct these payments. You can recover the cost of purchased equipment through depreciation.
Insurance premiums paid in advance. If you pay an insurance premium for more than one year in advance, each year you can deduct the part of the premium payment that will apply to that year. You cannot deduct the total premium in the year you pay it.
Local benefit taxes. Generally, you cannot deduct charges for local benefits that increase the value of your property, such as charges for putting in streets, sidewalks, or water and sewer systems. These charges are nondepreciable capital expenditures. You must add them to the basis of your property. You can deduct local benefit taxes if they are for maintaining, repairing, or paying interest charges for the benefits.
Travel expenses. You can deduct the ordinary and necessary expenses of traveling away from home if the primary purpose of the trip was to collect rental income or to manage, conserve, or maintain your rental property. You must properly allocate your expenses between rental and nonrental activities. You cannot deduct the cost of traveling away from home if the primary purpose of the trip was the improvement of your property. You recover the cost of improvements by taking depreciation. For information on travel expenses, see chapter 26.
Records: To deduct travel expenses, you must keep records that follow the rules in chapter 26.
Local transportation expenses. You can deduct your ordinary and necessary local transportation expenses if you incur them to collect rental income or to manage, conserve, or maintain your rental property.
Generally, if you use your personal car, pickup truck, or light van for rental activities, you can deduct the expenses using one of two methods: actual expenses or the standard mileage rate. For 2007, the standard mileage rate for all business miles is 48 1/2 cents a mile. For more information, see chapter 26.
Records: To deduct car expenses under either method, you must keep records that follow the rules in chapter 26. In addition, you must complete Form 4562, Part V, and attach it to your tax return.
Tax return preparation. You can deduct, as a rental expense, the part of tax return preparation fees you paid to prepare Schedule E (Form 1040), Part I. For example, on your 2007 Schedule E, you can deduct fees paid in 2007 to prepare your 2006 Schedule E, Part I. You can also deduct, as a rental expense, any expense (other than federal taxes and penalties) you paid to resolve a tax underpayment related to your rental activities.
If you do not rent your property to make a profit, you can deduct your rental expenses only up to the amount of your rental income. You cannot carry forward to the next year any rental expenses that are more than your rental income for the year. For more information about the rules for an activity not engaged in for profit, see Not-for-Profit Activities in chapter 1 of Publication 535.
Where to report. Report your not-for-profit rental income on Form 1040, line 21. You can include your mortgage interest and any qualified mortgage insurance premiums (if you use the property as your main home or second home), real estate taxes, and casualty losses on the appropriate lines of Form 1040, Schedule A, if you itemize your deductions.
Claim your other rental expenses, subject to the rules explained in chapter 1 of Publication 535, as miscellaneous itemized deductions on Form 1040, Schedule A, line 23. You can deduct these expenses only if they, together with certain other miscellaneous itemized deductions, total more than 2% of your adjusted gross income.
Property Changed to Rental Use
If you change your home or other property (or a part of it) to rental use at any time other than the beginning of your tax year, you must divide yearly expenses, such as taxes and insurance, between rental use and personal use.
You can deduct as rental expenses only the part of the expense that is for the part of the year the property was used or held for rental purposes.
For depreciation purposes, treat the property as being placed in service on the conversion date.
You cannot deduct depreciation or insurance for the part of the year the property was held for personal use. However, you can include the home mortgage interest, qualified mortgage insurance premiums, and real estate tax expenses for the part of the year the property was held for personal use as an itemized deduction on Schedule A (Form 1040).
Example. Your tax year is the calendar year. You moved from your home in May and started renting it out on June 1. You can deduct as rental expenses seven-twelfths of your yearly expenses, such as taxes and insurance.
Starting with June, you can deduct as rental expenses the amounts you pay for items generally billed monthly, such as utilities.
If you rent part of your property, you must divide certain expenses between the part of the property used for rental purposes and the part of the property used for personal purposes, as though you actually had two separate pieces of property.
You can deduct the expenses related to the part of the property used for rental purposes, such as home mortgage interest, qualified mortgage insurance premiums, and real estate taxes, as rental expenses on Schedule E (Form 1040). You can also deduct as a rental expense a part of other expenses that normally are nondeductible personal expenses, such as expenses for electricity or painting the outside of your house.
You can deduct the expenses for the part of the property used for personal purposes, subject to certain limitations, only if you itemize your deductions on Schedule A (Form 1040).
You cannot deduct any part of the cost of the first phone line even if your tenants have unlimited use of it.
You do not have to divide the expenses that belong only to the rental part of your property. For example, if you paint a room that you rent, or if you pay premiums for liability insurance in connection with renting a room in your home, your entire cost is a rental expense. If you install a second phone line strictly for your tenants' use, all of the cost of the second line is deductible as a rental expense. You can deduct depreciation, discussed later, on the part of the property used for rental purposes as well as on the furniture and equipment you use for rental purposes.
How to divide expenses. If an expense is for both rental use and personal use, such as mortgage interest or heat for the entire house, you must divide the expense between the rental use and the personal use. You can use any reasonable method for dividing the expense. It may be reasonable to divide the cost of some items (for example, water) based on the number of people using them. However, the two most common methods for dividing an expense are one based on the number of rooms in your home and one based on the square footage of your home.
If you have any personal use of a dwelling unit (including a vacation home) that you rent, you must divide your expenses between rental use and personal use. See Figuring Days of Personal Use and How To Divide Expenses, later.
If you used a dwelling unit for personal purposes, it may be considered a "dwelling unit used as a home." If it is, you cannot deduct rental expenses that are more than your rental income for the unit. See Dwelling Unit Used as Home andHow To Figure Rental Income and Deductions, later. If your dwelling unit is not considered a dwelling unit used as a home, you can deduct rental expenses that are more than rental income for the unit subject to certain limits. See Limits on Rental Losses, later.
Exception for minimal rental use. If you use the dwelling unit as a home and you rent it fewer than 15 days during the year, do not include any of the rent in your income and do not deduct any of the rental expenses. To determine if you use a dwelling unit as a home, see Dwelling Unit Used as Home, later.
Dwelling unit. A dwelling unit includes a house, apartment, condominium, mobile home, boat, vacation home, or similar property. A dwelling unit has basic living accommodations, such as sleeping space, a toilet, and cooking facilities. A dwelling unit does not include property used solely as a hotel, motel, inn, or similar establishment.
Property is used solely as a hotel, motel, inn, or similar establishment if it is regularly available for occupancy by paying customers and is not used by an owner as a home during the year.
Example. You rent a room in your home that is always available for short-term occupancy by paying customers. You do not use the room yourself, and you allow only paying customers to use the room. The room is used solely as a hotel, motel, inn, or similar establishment and is not a dwelling unit.
The tax treatment of rental income and expenses for a dwelling unit that you also use for personal purposes depends on whether you use it as a home. (See How To Figure Rental Income and Deductions, later.)
You use a dwelling unit as a home during the tax year if you use it for personal purposes more than the greater of:
See Figuring Days of Personal Use, later.
If a dwelling unit is used for personal purposes on a day it is rented at a fair rental price, do not count that day as a day of rental use in applying (2) above. Instead, count it as a day of personal use in applying both (1) and (2) above. This rule does not apply when dividing expenses between rental and personal use.
Fair rental price. A fair rental price for your property generally is the amount of rent that a person who is not related to you would be willing to pay. The rent you charge is not a fair rental price if it is substantially less than the rents charged for other properties that are similar to your property.
Examples
The following examples show how to determine whether you used your rental property as a home.
Example 1. You converted the basement of your home into an apartment with a bedroom, a bathroom, and a small kitchen. You rented the basement apartment at a fair rental price to college students during the regular school year. You rented to them on a 9-month lease (273 days). You figured 10% of the total days rented to others at a fair rental price is 27 days.
During June (30 days), your brothers stayed with you and lived in the basement apartment rent free.
Your basement apartment was used as a home because you used it for personal purposes for 30 days. Rent-free use by your brothers is considered personal use. Your personal use (30 days) is more than the greater of 14 days or 10% of the total days it was rented (27 days).
Example 2. You rented the guest bedroom in your home at a fair rental price during the local college's homecoming, commencement, and football weekends (a total of 27 days). Your sister-in-law stayed in the room, rent free, for the last 3 weeks (21 days) in July. You figured 10% of the total days rented to others at a fair rental price is 3 days.
The room was used as a home because you used it for personal purposes for 21 days. That is more than the greater of 14 days or 10% of the 27 days it was rented (3 days).
Example 3. You own a condominium apartment in a resort area. You rented it at a fair rental price for a total of 170 days during the year. For 12 of those days, the tenant was not able to use the apartment and allowed you to use it even though you did not refund any of the rent. Your family actually used the apartment for 10 of those days. Therefore, the apartment is treated as having been rented for 160 (170 - 10) days. You figure 10% of the total days rented to others at a fair rental price is 16 days. Your family also used the apartment for 7 other days during the year.
You used the apartment as a home because you used it for personal purposes for 17 days. That is more than the greater of 14 days or 10% of the 160 days it was rented (16 days).
Use As Main Home Before or After Renting
For purposes of determining whether a dwelling unit was used as a home, you may not have to count days you used the property as your main home before or after renting it or offering it for rent as days of personal use. Do not count them as days of personal use if:
This special rule does not apply when dividing expenses between rental and personal use.
A day of personal use of a dwelling unit is any day that the unit is used by any of the following persons.
Main home. If the other person or member of the family in (1) or (2) above has more than one home, his or her main home is ordinarily the one he or she lived in most of the time.
Shared equity financing agreement. This is an agreement under which two or more persons acquire undivided interests for more than 50 years in an entire dwelling unit, including the land, and one or more of the co-owners is entitled to occupy the unit as his or her main home upon payment of rent to the other co-owner or owners.
Donation of use of property. You use a dwelling unit for personal purposes if:
Examples
The following examples show how to determine days of personal use.
Example 1. You and your neighbor are co-owners of a condominium at the beach. You rent the unit to vacationers whenever possible. The unit is not used as a main home by anyone. Your neighbor uses the unit for 2 weeks every year.
Because your neighbor has an interest in the unit, both of you are considered to have used the unit for personal purposes during those 2 weeks.
Example 2. You and your neighbors are co-owners of a house under a shared equity financing agreement. Your neighbors live in the house and pay you a fair rental price.
Even though your neighbors have an interest in the house, the days your neighbors live there are not counted as days of personal use by you. This is because your neighbors rent the house as their main home under a shared equity financing agreement.
Example 3. You own a rental property that you rent to your son. Your son has no interest in this property. He uses it as his main home. He pays you a fair rental price for the property.
Your son's use of the property is not personal use by you because your son is using it as his main home, he has no interest in the property, and he is paying you a fair rental price.
Example 4. You rent your beach house to Joshua. Joshua rents his house in the mountains to you. You each pay a fair rental price.
You are using your house for personal purposes on the days that Joshua uses it because your house is used by Joshua under an arrangement that allows you to use his house.
Days Used for Repairs and Maintenance
Any day that you spend working substantially full time repairing and maintaining (not improving) your property is not counted as a day of personal use. Do not count such a day as a day of personal use even if family members use the property for recreational purposes on the same day.
If you use a dwelling unit for both rental and personal purposes, divide your expenses between the rental use and the personal use based on the number of days used for each purpose. You can deduct expenses for the rental use of the unit under the rules explained in How To Figure Rental Income and Deductions, later.
When dividing your expenses, follow these rules.
Example. Your beach cottage was available for rent from June 1 through August 31 (92 days). Your family uses the cottage during the last 2 weeks in May (14 days). You were unable to find a renter for the first week in August (7 days). The person who rented the cottage for July allowed you to use it over a weekend (2 days) without any reduction in or refund of rent. The cottage was not used at all before May 17 or after August 31.
You figure the part of the cottage expenses to treat as rental expenses as follows.
When determining whether you used the cottage as a home, the July weekend (2 days) you used it is personal use even though you received a fair rental price for the weekend. Therefore, you had 16 days of personal use and 83 days of rental use for this purpose. Because you used the cottage for personal purposes more than 14 days and more than 10% of the days of rental use (8 days), you used it as a home. If you have a net loss, you may not be able to deduct all of the rental expenses. See Property Used as a Home in the following discussion.
How To Figure Rental Income and Deductions
How you figure your rental income and deductions depends on whether you used the dwelling unit as a home (see Dwelling Unit Used as Home, earlier) and, if you used it as a home, how many days the property was rented at a fair rental price.
Property Not Used as a Home
If you do not use a dwelling unit as a home, report all the rental income and deduct all the rental expenses. See How To Report Rental Income and Expenses, later.
Your deductible rental expenses can be more than your gross rental income. However, see Limits on Rental Losses, later.
Property Used as a Home
If you use a dwelling unit as a home during the year (see Dwelling Unit Used as Home, earlier), how you figure your rental income and deductions depends on how many days the unit was rented at a fair rental price.
Rented fewer than 15 days. If you use a dwelling unit as a home and you rent it fewer than 15 days during the year, do not include any rental income in your income. Also, you cannot deduct any expenses as rental expenses.
Rented 15 days or more. If you use a dwelling unit as a home and rent it 15 days or more during the year, you include all your rental income in your income. See How To Report Rental Income and Expenses, later. If you had a net profit from the rental property for the year (that is, if your rental income is more than the total of your rental expenses, including depreciation), deduct all of your rental expenses. However, if you had a net loss, your deduction for certain rental expenses is limited.
To figure your deductible rental expenses and any carryover to next year, use Worksheet 9-1.
Worksheet 9-1. Worksheet for Figuring Rental Deductions for a Dwelling Unit Used as a Home
Keep for Your Records
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Use this worksheet only if you answer "yes" to all the following
questions.
Did you use the dwelling unit as a home this year? (See Dwelling
Unit Used as Home.)
Did you rent the dwelling unit 15 days or more this year?
Is the total of your rental expenses and depreciation more than
your rental income?
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1. Enter rents received ______
2a. Enter the rental portion of deductible home
mortgage interest and qualified mortgage insurance
premiums (see instructions) ______
b. Enter the rental portion of real estate taxes ______
c. Enter the rental portion of deductible casualty
and theft losses (see instructions) ______
d. Enter direct rental expenses (see instructions) ______
e. Fully deductible rental expenses. Add lines 2a-2d
(See instructions) ______
3. Subtract line 2e from line 1. If zero or less,
enter -0- ______
4a. Enter the rental portion of expenses directly
related to operating or maintaining the dwelling
unit (such as repairs, insurance, and utilities) ______
b. Enter the rental portion of excess mortgage
interest and qualified mortgage insurance premiums
(see instructions) ______
c. Add lines 4a and 4b ______
d. Allowable expenses. Enter the smaller of line 3 or
line 4c (See instructions) ______
5. Subtract line 4d from line 3. If zero or less,
enter -0- ______
6a. Enter the rental portion of excess casualty and
theft losses (see instructions) ______
b. Enter the rental portion of depreciation of the
dwelling unit ______
c. Add lines 6a and 6b ______
d. Allowable excess casualty and theft losses and
depreciation. Enter the smaller of line 5 or line
6c (See instructions) ______
7a. Operating expenses to be carried over to next year.
Subtract line 4d from line 4c ______
b. Excess casualty and theft losses and depreciation
to be carried over to next year. Subtract line 6d
from line 6c ______
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Worksheet Instructions
Follow these instructions for the worksheet above. To find the rental
portion of your expenses for lines 2a-2c, 4a-4b, and 6a-6b, follow the
directions given earlier under How To Divide Expenses. If you were
unable to deduct all your expenses last year because of the rental
income limit, add these unused amounts to your expenses for this year.
Line 2a. Figure the mortgage interest on the dwelling unit that
you could deduct on Schedule A (Form 1040) if you had not rented the
unit. Do not include interest on a loan that did not benefit the
dwelling unit. For example, do not include interest on a home equity
loan used to pay off credit cards or other personal loans, buy a car,
or pay college tuition. Include interest on a loan used to buy, build,
or improve the dwelling unit, or to refinance such a loan. Include
the rental portion of this interest in the total you enter on line 2a
of the worksheet.
Figure the qualified mortgage insurance premiums on the dwelling unit
that you could deduct on Schedule A (Form 1040), line 13, if you
had not rented the unit. See page A-7 of the Schedule A (Form 1040)
instructions. However, figure your adjusted gross income
(Form 1040, line 38) without your rental income and expenses from
the dwelling unit. See Line 4b below to deduct part of the
qualified mortgage insurance premiums not allowed because of the
adjusted gross income limit. Include the rental portion of the amount
from Schedule A, line 13, in the total you enter on line 2a of the
worksheet.
Note. Do not file this Schedule A or use it to figure the amount
to deduct on line 13 of that schedule. Instead, figure the personal
portion on a separate Schedule A.
Line 2c. Figure the casualty and theft losses related to the
dwelling unit that you could deduct on Schedule A (Form 1040) if
you had not rented the dwelling unit. To do this, complete Form
4684, Casualties and Thefts, Section A, treating the losses as
personal losses. On Form 4684, line 17, enter 10% of your
adjusted gross income figured without your rental income and expenses
from the dwelling unit. Enter the rental portion of the result from
Form 4684, line 18, on line 2c of this worksheet.
Note. Do not file this Form 4684 or use it to figure your
personal losses on Schedule A. Instead, figure the personal portion
on a separate Form 4684.
Line 2d. Enter the total of your rental expenses that are directly
related only to the rental activity. These include interest on loans
used for rental activities other than to buy, build, or improve the
dwelling unit. Also include rental agency fees, advertising, office
supplies, and depreciation on office equipment used in your rental
activity.
Line 2e. You can deduct the amounts on lines 2a, 2b, 2c, and 2d as
rental expenses on Schedule E even if your rental expenses are more
than your rental income. Enter the amounts on lines 2a, 2b, 2c, and
2d on the appropriate lines of Schedule E.
Line 4b. On line 2a, you entered the rental portion of the mortgage
interest and qualified mortgage insurance premiums you could deduct on
Schedule A if you had not rented the dwelling unit. Enter on line 4b
of this worksheet the rental portion of the mortgage interest and
qualified mortgage insurance premiums you could not deduct on Schedule
A because it is more than the limit on home mortgage interest or
qualified mortgage insurance premiums. Do not include interest on a
loan that did not benefit the dwelling unit (as explained in the line
2a instructions).
Line 4d. You can deduct the amounts on lines 4a and 4b as rental
expenses on Schedule E only to the extent they are not more than the
amount on line 4d.
Line 6a. To find the rental portion of excess casualty and theft
losses, use the Form 4684 you prepared for line 2c of this
worksheet.
A. Enter the amount from Form 4684, line 10 __________
B. Enter the rental portion of line A __________
C. Enter the amount from line 2c of this worksheet __________
D. Subtract line C from line B. Enter the result
here and on line 6a of this worksheet __________
Allocating the limited deduction. If you cannot deduct all of the
amount on line 4c or 6c this year, you can allocate the allowable
deduction in any way you wish among the expenses included on line 4c
or 6c. Enter the amount you allocate to each expense on the
appropriate line of Schedule E, Part I.
Line 6d. You can deduct the amounts on lines 6a and 6b as rental
expenses on Schedule E only to the extent they are not more than the
amount on line 6d.
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You recover the cost of income producing property through yearly tax deductions. You do this by depreciating the property; that is, by deducting some of the cost on the tax return each year.
Three basic factors determine how much depreciation you can deduct. They are: (1) your basis in the property, (2) the recovery period for the property, and (3) the depreciation method used. You cannot simply deduct your mortgage or principal payments, or the cost of furniture, fixtures and equipment, as an expense.
You can deduct depreciation only on the part of your property used for rental purposes. Depreciation reduces your basis for figuring gain or loss on a later sale or exchange.
You may have to use Form 4562 to figure and report your depreciation. See How To Report Rental Income and Expenses, later.
Claiming the correct amount of depreciation. You should claim the correct amount of depreciation each tax year. Even if you did not claim depreciation that you were entitled to deduct, you must still reduce your basis in the property by the full amount of depreciation that you could have deducted. If you did not deduct the correct amount of depreciation for property in any year, you may be able to make a correction for that year by filing Form 1040X, Amended U.S Individual Income Tax Return. If you are not allowed to make the correction on an amended return, you can change your accounting method to claim the correct amount of depreciation. See Claiming the correct amount of depreciation in Publication 527 for more information.
Changing your accounting method to deduct unclaimed depreciation. To change your accounting method, you must file Form 3115, Application for Change in Accounting Method, to get the consent of the IRS. In some instances, that consent is automatic. For more information, see chapter 1 of Publication 946.
Land. You can never depreciate the cost of land because land does not wear out, become obsolete, or get used up. The costs of clearing, grading, planting, and landscaping are usually all part of the cost of land and cannot be depreciated.
More information. See Publication 527 for more information about depreciating rental property and see Publication 946 for more information about depreciation.
Other Rules About Depreciable Property
In addition to the rules about what methods you can use, there are other rules you should be aware of with respect to depreciable property.
Gain from disposition. If you dispose of depreciable property at a gain, you may have to report, as ordinary income, all or part of the gain. See Publication 544, Sales and Other Dispositions of Assets.
Alternative minimum tax. If you use accelerated depreciation, you may have to file Form 6251. Accelerated depreciation can be determined under MACRS, ACRS, and any other method that allows you to deduct more depreciation than you could deduct using a straight line method.
Rental real estate activities are generally considered passive activities, and the amount of loss you can deduct is limited. Generally, you cannot deduct losses from rental real estate activities unless you have income from other passive activities. However, you may be able to deduct rental losses without regard to whether you have income from other passive activities if you "materially" or "actively" participated in your rental activity. See Passive Activity Limits, later.
Losses from passive activities are first subject to the at-risk rules. At-risk rules limit the amount of deductible losses from holding most real property placed in service after 1986.
Exception. If your rental losses are less than $25,000, and you actively participated in the rental activity, the passive activity limits probably do not apply to you. See Losses From Rental Real Estate Activities, later.
Property used as a home. If you used the rental property as a home during the year, the passive activity rules do not apply to that home. Instead, you must follow the rules explained under Personal Use of Dwelling Unit (Including Vacation Home), earlier.
The at-risk rules place a limit on the amount you can deduct as losses from activities often described as tax shelters. Losses from holding real property (other than mineral property) placed in service before 1987 are not subject to the at-risk rules.
Generally, any loss from an activity subject to the at-risk rules is allowed only to the extent of the total amount you have at risk in the activity at the end of the tax year. You are considered at risk in an activity to the extent of cash and the adjusted basis of other property you contributed to the activity and certain amounts borrowed for use in the activity. See Publication 925 for more information.
In general, all rental activities (except those meeting the exception for real estate professionals, below) are passive activities. For this purpose, a rental activity is an activity from which you receive income mainly for the use of tangible property, rather than for services.
Limits on passive activity deductions and credits. Deductions for losses from passive activities are limited. You generally cannot offset income, other than passive income, with losses from passive activities. Nor can you offset taxes on income, other than passive income, with credits resulting from passive activities. Any excess loss or credit is carried forward to the next tax year.
For a detailed discussion of these rules, see Publication 925.
You may have to complete Form 8582 to figure the amount of any passive activity loss for the current tax year for all activities and the amount of the passive activity loss allowed on your tax return.
Exception for real estate professionals. Rental activities in which you materially participated during the year are not passive activities if, for that year, you were a real estate professional. For a detailed discussion of the requirements, see Publication 527. For a detailed discussion of material participation, see Publication 925.
Losses From Rental Real Estate Activities
If you or your spouse actively participated in a passive rental real estate activity, you can deduct up to $25,000 of loss from the activity from your nonpassive income. This special allowance is an exception to the general rule disallowing losses in excess of income from passive activities. Similarly, you can offset credits from the activity against the tax on up to $25,000 of nonpassive income after taking into account any losses allowed under this exception.
If you are married, filing a separate return, and lived apart from your spouse for the entire tax year, your special allowance cannot be more than $12,500. If you lived with your spouse at any time during the year and are filing a separate return, you cannot use the special allowance to reduce your nonpassive income or tax on nonpassive income.
The maximum amount of the special allowance is reduced if your modified adjusted gross income is more than $100,000 ($50,000 if married filing separately).
Active participation. You actively participated in a rental real estate activity if you (and your spouse) owned at least 10% of the rental property and you made management decisions in a significant and bona fide sense. Management decisions include approving new tenants, deciding on rental terms, approving expenditures, and similar decisions.
More information. See Publication 925 for more information on the passive loss limits, including information on the treatment of unused disallowed passive losses and credits and the treatment of gains and losses realized on the disposition of a passive activity.
If you rent buildings, rooms, or apartments, and provide only heat and light, trash collection, etc., you normally report your rental income and expenses on Form 1040, Schedule E, Part I. However, do not use that schedule to report a not-for-profit activity. See Not Rented for Profit, earlier.
If you provide significant services that are primarily for your tenant's convenience, such as regular cleaning, changing linen, or maid service, you report your rental income and expenses on Schedule C (Form 1040), Profit or Loss From Business or Schedule C-EZ, Net Profit From Business (Sole Proprietorship). Significant services do not include the furnishing of heat and light, cleaning of public areas, trash collection, etc. For information, see Publication 334, Tax Guide for Small Business. You also may have to pay self-employment tax on your rental income.
Form 1098. If you paid $600 or more of mortgage interest on your rental property to any one person, you should receive a Form 1098, Mortgage Interest Statement, or similar statement showing the interest you paid for the year. If you and at least one other person (other than your spouse if you file a joint return) were liable for, and paid interest on the mortgage, and the other person received the Form 1098, report your share of the interest on Form 1040, Schedule E, line 13. Attach a statement to your return showing the name and address of the other person. In the left margin of Schedule E (Form 1040), next to line 13, enter "See attached."
Schedule E (Form 1040)
Use Schedule E (Form 1040), Part I, to report your rental income and expenses. List your total income, expenses, and depreciation for each rental property. Be sure to answer the question on line 2.
If you have more than three rental or royalty properties, complete and attach as many Schedules E as are needed to list the properties. Complete lines 1 and 2 for each property. However, fill in the "Totals" column on only one Schedule E. The figures in the "Totals" column on that Schedule E should be the combined totals of all Schedules E.
Page 2 of Schedule E is used to report income or loss from partnerships, S corporations, estates, trusts, and real estate mortgage investment conduits. If you need to use Schedule E, page 2, use page 2 of the same Schedule E you used to enter the combined totals in Part I.
On Schedule E, page 1, line 20, enter the depreciation you are claiming. You must complete and attach Form 4562 for rental activities only if you are claiming:
Otherwise, figure your depreciation on your own worksheet. You do not have to attach these computations to your return.
Rollover of after-tax contributions. For tax years beginning in 2007, the nontaxable part of an eligible rollover distribution (such as after-tax contributions) from a qualified retirement plan can be rolled over to another qualified retirement plan that is either a qualified employee plan or an annuity contract described in section 403(b). Previously, this part of the distribution could be rolled over only to another qualified retirement plan that was a defined contribution plan.
The rollover must be a direct trustee-to-trustee transfer. The plan to which the rollover is made must separately account for these contributions and the earnings on them. See Rollover of nontaxable amounts under Rollovers, later, for more information.
Rollovers by nonspouse beneficiary. For distributions beginning in 2007, a nonspouse designated beneficiary may have a distribution from an eligible retirement plan of a deceased employee directly transferred (trustee-to-trustee) to his or her own IRA set up to receive the distribution. The transfer will be treated as an eligible rollover distribution and the receiving plan will be treated as an inherited IRA. See Rollovers by nonspouse beneficiary under Rollovers, later, for more information.
Retired public safety officers. For distributions beginning in 2007, an eligible retired public safety officer can elect to exclude from income distributions of up to $3,000 made directly from a governmental retirement plan to the providers of accident, health, or long-term care insurance. See Insurance Premiums for Retired Public Safety Officers in Publication 575, Pension and Annuity Income, for more information.
Rollovers to Roth IRAs. After 2007, you can roll over distributions directly from a qualified retirement plan to a Roth IRA if, for the tax year of the distribution, your modified adjusted gross income for Roth IRA purposes is not more than $100,000, and your filing status is not married filing separately. See Rollovers to Roth IRAs, in Publication 575, for more information.
Hurricane tax relief. Special rules apply to retirement funds received by qualified individuals who suffered an economic loss as a result of Hurricane Katrina, Rita, or Wilma. See Hurricane-Related Relief, in Publication 575, or Publication 4492, Information for Taxpayers Affected by Hurricanes Katrina, Rita, and Wilma, for information on these special rules.
This chapter discusses the tax treatment of distributions you receive from:
What is not covered in this chapter. The following topics are not discussed in this chapter.
The General Rule. This is the method generally used to determine the tax treatment of pension and annuity income from nonqualified plans (including commercial annuities). For a qualified plan, you generally cannot use the General Rule unless your annuity starting date is before November 19, 1996. For more information about the General Rule, see Publication 939, General Rule for Pensions and Annuities.
Civil service retirement benefits. If you are retired from the federal government (either regular or disability retirement), see Publication 721, Tax Guide to U.S. Civil Service Retirement Benefits. Publication 721 also covers the information that you need if you are the survivor or beneficiary of a federal employee or retiree who died.
Individual retirement arrangements (IRAs). Information on the tax treatment of amounts you receive from an IRA is in chapter 17.
Useful Items
You may want to see:
Publication
Form (and Instructions)
Disability pensions. If you retired on disability, you generally must include in income any disability pension you receive under a plan that is paid for by your employer. You must report your taxable disability payments as wages on line 7 of Form 1040 or Form 1040A until you reach minimum retirement age. Minimum retirement age generally is the age at which you can first receive a pension or annuity if you are not disabled.
Tip: You may be entitled to a tax credit if you were permanently and totally disabled when you retired. For information on this credit, see chapter 33.
Beginning on the day after you reach minimum retirement age, payments you receive are taxable as a pension or annuity. Report the payments on Form 1040, lines 16a and 16b, or on Form 1040A, lines 12a and 12b.
Tip: Disability payments for injuries incurred as a direct result of a terrorist attack directed against the United States (or its allies) are not included in income. For more information about payments to survivors of terrorist attacks, see Publication 3920, Tax Relief for Victims of Terrorist Attacks.
For more information on how to report disability pensions, including military and certain government disability pensions, see chapter 5.
More than one program. If you receive benefits from more than one program under a single trust or plan of your employer, such as a pension plan and a profit-sharing plan, you may have to figure the taxable part of each pension or annuity contract separately. Your former employer or the plan administrator should be able to tell you if you have more than one pension or annuity contract.
Designated Roth accounts. A designated Roth account is a separate account created under a qualified Roth contribution program to which participants may elect to have part or all of their elective deferrals to a 401(k) or 403(b) plan designated as Roth contributions. Elective deferrals that are designated as Roth contributions are included in your income. However, qualified distributions are not included in your income. See Publication 575 for more information.
Railroad retirement benefits. Part of the railroad retirement benefits you receive is treated for tax purposes like social security benefits, and part is treated like an employee pension. For information about railroad retirement benefits treated as social security benefits, see Publication 915, Social Security and Equivalent Railroad Retirement Benefits. For information about railroad retirement benefits treated as an employee pension, see Railroad Retirement Benefits in Publication 575.
Credit for the elderly or the disabled. If you receive a disability pension or annuity, you may be able to take the credit for the elderly or the disabled. See chapter 33.
Withholding and estimated tax. The payer of your pension, profit-sharing, stock bonus, annuity, or deferred compensation plan will withhold income tax on the taxable parts of amounts paid to you. You can choose not to have tax withheld unless they are eligible rollover distributions. See Eligible rollover distributions under Rollovers, later. You make this choice by filing Form W-4P.
For payments other than eligible rollover distributions, you can tell the payer how much to withhold by filing Form W-4P. If you receive an eligible rollover distribution, 20% will generally be withheld. There is no withholding on a direct rollover of an eligible rollover distribution. See Direct rollover option under Rollovers, later. If you choose not to have tax withheld or you do not have enough tax withheld, you may have to pay estimated tax.
For more information, see Pensions and Annuities under Withholding in chapter 4.
Loans. If you borrow money from your qualified pension or annuity plan, tax-sheltered annuity program, government plan, or contract purchased under any of these plans, you may have to treat the loan as a nonperiodic distribution unless certain exceptions apply. This means that you must include in income all or part of the amount borrowed. Even if you do not have to treat the loan as a nonperiodic distribution, you may not be able to deduct the interest on the loan in some situations. For details, see Loans Treated as Distributions in Publication 575. For information on the deductibility of interest, see chapter 23.
Qualified plans for self-employed individuals. Qualified plans set up by self-employed individuals are sometimes called Keogh or H.R. 10 plans. Qualified plans can be set up by sole proprietors, partnerships (but not a partner), and corporations. They can cover self-employed persons, such as the sole proprietor or partners, as well as regular (common-law) employees.
Distributions from a qualified plan are usually fully taxable because most recipients have no cost basis. If you have an investment (cost) in the plan, however, your pension or annuity payments from a qualified plan are taxed under the Simplified Method. For more information about qualified plans, see Publication 560, Retirement Plans for Small Business.
Section 457 deferred compensation plans. If you work for a state or local government or for a tax-exempt organization, you may be able to participate in a section 457 deferred compensation plan. If your plan is an eligible plan, you are not taxed currently on pay that is deferred under the plan or on any earnings from the plan's investment of the deferred pay. You are generally taxed on amounts deferred in an eligible state or local government plan only when they are distributed from the plan. You are taxed on amounts deferred in an eligible tax-exempt organization plan when they are distributed or otherwise made available to you.
This chapter covers the tax treatment of benefits under eligible section 457 plans, but it does not cover the treatment of deferrals. For information on deferrals under section 457 plans, see Retirement Plan Contributions under Employee Compensation in Publication 525, Taxable and Nontaxable Income.
For general information on these deferred compensation plans, see Section 457 Deferred Compensation Plans in Publication 575.
Purchased annuities. If you receive pension or annuity payments from a privately purchased annuity contract from a commercial organization, such as an insurance company, you generally must use the General Rule to figure the tax-free part of each annuity payment. For more information about the General Rule, get Publication 939. Also, see Variable Annuities in Publication 575 for the special provisions that apply to these annuity contracts.
Tax-free exchange. No gain or loss is recognized on an exchange of an annuity contract for another annuity contract if the insured or annuitant remains the same. However, if an annuity contract is exchanged for a life insurance or endowment contract, any gain due to interest accumulated on the contract is ordinary income. See Transfers of Annuity Contracts in Publication 575 for more information about exchanges of annuity contracts.
If you file Form 1040, report your total annuity on line 16a and the taxable part on line 16b. If your pension or annuity is fully taxable, enter it on line 16b; do not make an entry on line 16a.
If you file Form 1040A, report your total annuity on line 12a and the taxable part on line 12b. If your pension or annuity is fully taxable, enter it on line 12b; do not make an entry on line 12a.
More than one annuity. If you receive more than one annuity and at least one of them is not fully taxable, enter the total amount received from all annuities on Form 1040, line 16a, or Form 1040A, line 12a, and enter the taxable part on Form 1040, line 16b, or Form 1040A, line 12b. If all the annuities you receive are fully taxable, enter the total of all of them on Form 1040, line 16b, or Form 1040A, line 12b.
Joint return. If you file a joint return and you and your spouse each receive one or more pensions or annuities, report the total of the pensions and annuities on Form 1040, line 16a, or Form 1040A, line 12a, and report the taxable part on Form 1040, line 16b, or Form 1040A, line 12b.
Before you can figure how much, if any, of a distribution from your pension or annuity plan is taxable, you must determine your cost (your investment in the contract) in the pension or annuity. Your total cost in the plan includes everything that you paid. It also includes amounts your employer paid that were taxable to you when paid. Cost does not include any amounts you deducted or excluded from income.
From this total cost, subtract any refunds of premiums, rebates, dividends, unrepaid loans, or other tax-free amounts you received by the later of the annuity starting date or the date on which you received your first payment.
Your annuity starting date is the later of the first day of the first period for which you received a payment, or the date the plan's obligations became fixed.
Designated Roth accounts. Your cost in these accounts is your designated Roth contributions that were included in your income as wages subject to applicable withholding requirements.
Foreign employment contributions. If you worked in a foreign country and contributions were made to your retirement plan, special rules apply in determining your cost. See Publication 575.
Fully taxable payments. Generally, if you did not pay any part of the cost of your employee pension or annuity and your employer did not withhold part of the cost from your pay while you worked, the amounts you receive each year are fully taxable. You must report them on your income tax return.
Partly taxable payments. If you paid part of the cost of your annuity, you are not taxed on the part of the annuity you receive that represents a return of your cost. The rest of the amount you receive is generally taxable. Your annuity starting date determines which method you must or may use.
If you contributed to your pension or annuity plan, you figure the tax-free and the taxable parts of your annuity payments under either the Simplified Method or the General Rule. If your annuity starting date is after November 18, 1996, and your payments are from a qualified plan, you must use the Simplified Method. Generally, you must use the General Rule only for nonqualified plans.
If you had more than one partly taxable pension or annuity, figure the tax-free part and the taxable part of each separately.
If your annuity is paid under a qualified plan and your annuity starting date is after July 1, 1986, and before November 19, 1996, you could have chosen to use either the General Rule or the Simplified Method.
Under the Simplified Method, you figure the tax-free part of each annuity payment by dividing your cost by the total number of anticipated monthly payments. For an annuity that is payable for the lives of the annuitants, this number is based on the annuitants' ages on the annuity starting date and is determined from a table. For any other annuity, this number is the number of monthly annuity payments under the contract.
Who must use the Simplified Method. You must use the Simplified Method if your annuity starting date is after November 18, 1996, and you receive pension or annuity payments from a qualified employee plan, qualified employee annuity, or a tax-sheltered annuity (403(b)) plan, unless you were at least 75 years old and entitled to annuity payments from a qualified plan that are guaranteed for 5 years or more.
Guaranteed payments. Your annuity contract provides guaranteed payments if a minimum number of payments or a minimum amount (for example, the amount of your investment) is payable even if you and any survivor annuitant do not live to receive the minimum. If the minimum amount is less than the total amount of the payments you are to receive, barring death, during the first 5 years after payments begin (figured by ignoring any payment increases), you are entitled to less than 5 years of guaranteed payments.
Who must use the General Rule. You must use the General Rule if you receive pension or annuity payments from:
Annuity starting before November 19, 1996. If your annuity starting date is after July 1, 1986, and before November 19, 1996, you had to use the General Rule for either circumstance described earlier. You also had to use it for any fixed-period annuity. If you did not have to use the General Rule, you could have chosen to use it. If your annuity starting date is before July 2, 1986, you had to use the General Rule unless you could use the Three-Year Rule.
If you had to use the General Rule (or chose to use it), you must continue to use it each year that you recover your cost.
Who cannot use the General Rule. You cannot use the General Rule if you receive your pension or annuity from a qualified plan and none of the circumstances described in the preceding discussions apply to you. See Who must use the Simplified Method, earlier.
More information. For complete information on using the General Rule, including the actuarial tables you need, see Publication 939.
Exclusion limit. Your annuity starting date determines the total amount that you can exclude from your taxable income over the years.
Exclusion limited to cost. If your annuity starting date is after 1986, the total amount of annuity income that you can exclude over the years as a recovery of the cost cannot exceed your total cost. Any unrecovered cost at your (or the last annuitant's) death is allowed as a miscellaneous itemized deduction on the final return of the decedent. This deduction is not subject to the 2%-of-adjusted-gross-income limit.
Exclusion not limited to cost. If your annuity starting date is before 1987, you can continue to take your monthly exclusion for as long as you receive your annuity. If you chose a joint and survivor annuity, your survivor can continue to take the survivor's exclusion figured as of the annuity starting date. The total exclusion may be more than your cost.
How to use the Simplified Method. Complete the Simplified Method Worksheet in Publication 575 to figure your taxable annuity for 2007. If the annuity is payable only over your life, use your age at the annuity starting date to determine the total number of expected monthly payments for your annuity. For annuity starting dates beginning in 1998, if your annuity is payable over your life and the lives of other individuals, use the combined ages of you and the youngest survivor annuitant at the annuity starting date. However, if your annuity starting date began before January 1, 1998, the total number of monthly annuity payments expected to be received is based on the primary annuitant's age at the annuity starting date.
Tip: Be sure to keep a copy of the completed worksheet; it will help you figure your taxable annuity in later years.
Example. Bill Smith, age 65, began receiving retirement benefits in 2007, under a joint and survivor annuity. Bill's annuity starting date is January 1, 2007. The benefits are to be paid for the joint lives of Bill and his wife Kathy, age 65. Bill had contributed $31,000 to a qualified plan and had received no distributions before the annuity starting date. Bill is to receive a retirement benefit of $1,200 a month, and Kathy is to receive a monthly survivor benefit of $600 upon Bill's death.
Bill must use the Simplified Method to figure his taxable annuity because his payments are from a qualified plan and he is under age 75. Because his annuity is payable over the lives of more than one annuitant, he uses his and Kathy's combined ages and Table 2 at the bottom of the worksheet in completing line 3 of the worksheet. His completed worksheet is shown in Worksheet 10-A.
Bill's tax-free monthly amount is $100 ($31,000 ÷ 310) as shown on line 4 of the worksheet. Upon Bill's death, if Bill has not recovered the full $31,000 investment, Kathy will also exclude $100 from her $600 monthly payment. The full amount of any annuity payments received after 310 payments are paid must be included in gross income.
If Bill and Kathy die before 310 payments are made, a miscellaneous itemized deduction will be allowed for the unrecovered cost on the final income tax return of the last to die. This deduction is not subject to the 2%-of-adjusted gross-income limit.
Worksheet 10-A. Simplified Method Worksheet for Bill Smith
----------------------------------------------------------------------
1. Enter the total pension or annuity payments received
this year. Also, add this amount to the total for
Form 1040, line 16a, or Form 1040A, line 12a 1. 14,400
2. Enter your cost in the plan (contract) at
the annuity starting date plus any death
benefit exclusion* 2. 31,000
Note: If your annuity starting date was
before this year and you completed this
worksheet last year, skip line 3 and
enter the amount from line 4 of last
year's worksheet on line 4 below.
Otherwise, go to line 3.
3. Enter the appropriate number from Table 1
below. But if your annuity starting date
was after 1997 and the payments are for
your life and that of your beneficiary,
enter the appropriate number from Table 2
below 3. 310
4. Divide line 2 by the number on line 3 4. 100
5. Multiply line 4 by the number of months
for which this year's payments were made.
If your annuity starting date was before
1987, enter this amount on line 8 below
and skip lines 6, 7, 10, and 11.
Otherwise, go to line 6 5. 1,200
6. Enter any amounts previously recovered
tax free in years after 1986. This is the
amount shown on line 10 of your worksheet
for last year 6. -0-
7. Subtract line 6 from line 2 7. 31,000
8. Enter the smaller of line 5 or line 7 8. 1,200
9. Taxable amount for year. Subtract line 8 from line 1.
Enter the result, but not less than zero. Also, add
this amount to the total for Form 1040, line 16b, or
Form 1040A, line 12b 9. 13,200
Note: If your Form 1099-R shows a larger taxable
amount, use the amount on line 9 instead. If you are
a retired public safety officer, see Insurance
Premiums for Retired Public Safety Officers in
Publication 575 before entering an amount on your tax
return.
10. Was your annuity starting date before 1987?
[] Yes. STOP. Do not complete the rest of this
worksheet.
[] No. Add lines 6 and 8. This is the amount you have
recovered tax free through 2007. You will need this
number if you need to fill out this worksheet next
year 10. 1,200
11. Balance of cost to be recovered. Subtract line 10
from line 2. If zero, you will not have to complete
this worksheet next year. The payments you receive
next year will generally be fully taxable 11. 29,800
----------------------------------------------------------------------
Table 1 For Line 3 Above
AND your annuity starting date was--
IF the age at annuity before November 19, after November 18,
starting date 1996, enter on line 1996, enter on line
was... 3... 3...
55 or under 300 360
56-60 260 310
61-65 240 260
66-70 170 210
71 or older 120 160
----------------------------------------------------------------------
Table 2 For Line 3 Above
IF the combined ages
at annuity starting THEN enter
date were... on line 3...
110 or under 410
111-120 360
121-130 310
131-140 260
141 or older 210
----------------------------------------------------------------------
* A death benefit exclusion (up to $5,000) applied to certain benefits
received by employees who died before August 21, 1996.
======================================================================
Nonperiodic distributions are also known as amounts not received as an annuity. They include all payments other than periodic payments and corrective distributions.
Corrective distributions of excess plan contributions. Generally, if the contributions made for you during the year to certain retirement plans exceed certain limits, the excess is taxable to you. To correct an excess, your plan may distribute it to you (along with any income earned on the excess). For information on plan contribution limits and how to report corrective distributions of excess contributions, see Retirement Plan Contributions under Employee Compensation in Publication 525.
Figuring the taxable amount of nonperiodic payments. How you figure the taxable amount of a nonperiodic distribution depends on whether it is made before the annuity starting date or on or after the annuity starting date. The annuity starting date is either the first day of the first period for which you receive an annuity payment under the contract or the date on which the obligation under the contract becomes fixed, whichever is later. If it is made before the annuity starting date, its tax treatment also depends on whether it is made under a qualified or nonqualified plan and, if it is made under a nonqualified plan, whether it fully discharges the contract, is received under certain life insurance or endowment contracts, or is allocable to an investment you made before August 14, 1982.
If you receive a nonperiodic payment from your annuity contract on or after the annuity starting date, you generally must include all of the payment in gross income.
If you receive a nonperiodic distribution before the annuity starting date from a qualified retirement plan, you generally can allocate only part of it to the cost of the contract. You exclude from your gross income the part that you allocate to the cost. You include the remainder in your gross income.
If you receive a nonperiodic distribution before the annuity starting date from a plan other than a qualified retirement plan, it is generally allocated first to earnings (the taxable part) and then to the cost of the contract (the tax-free part). This allocation rule applies, for example, to a commercial annuity contract you bought directly from the issuer.
For more information, see Figuring the Taxable Amount, under Taxation of Nonperiodic Payments, in Publication 575.
A lump-sum distribution is the distribution or payment in 1 tax year of a plan participant's entire balance from all of the employer's qualified plans of one kind (for example, pension, profit-sharing, or stock bonus plans). A distribution from a nonqualified plan (such as a privately purchased commercial annuity or a section 457 deferred compensation plan of a state or local government or tax-exempt organization) cannot qualify as a lump-sum distribution.
The participant's entire balance from a plan does not include certain forfeited amounts. It also does not include any deductible voluntary employee contributions allowed by the plan after 1981 and before 1987. For more information about distributions that do not qualify as lump-sum distributions, see Distributions that do not qualify under Lump-Sum Distributions in Publication 575.
If you receive a lump-sum distribution from a qualified employee plan or qualified employee annuity and the plan participant was born before January 2, 1936, you may be able to elect optional methods of figuring the tax on the distribution. The part from active participation in the plan before 1974 may qualify as capital gain subject to a 20% tax rate. The part from participation after 1973 (and any part from participation before 1974 that you do not report as capital gain) is ordinary income. You may be able to use the 10-year tax option, discussed later, to figure tax on the ordinary income part.
Use Form 4972 to figure the separate tax on a lump-sum distribution using the optional methods. The tax figured on Form 4972 is added to the regular tax figured on your other income. This may result in a smaller tax than you would pay by including the taxable amount of the distribution as ordinary income in figuring your regular tax.
How to treat the distribution. If you receive a lump-sum distribution, you may have the following options for how you treat the taxable part.
The first three options are explained in the following discussions.
Electing optional lump-sum treatment. You can choose to use the 10-year tax option or capital gain treatment only once after 1986 for any plan participant. If you make this choice, you cannot use either of these optional treatments for any future distributions for the participant.
Taxable and tax-free parts of the distribution. The taxable part of a lump-sum distribution is the employer's contributions and income earned on your account. You may recover your cost in the lump sum and any net unrealized appreciation (NUA) in employer securities tax free.
Cost. In general, your cost is the total of:
You must reduce this cost by amounts previously distributed tax free.
Net unrealized appreciation (NUA). The NUA in employer securities (box 6 of Form 1099-R) received as part of a lump-sum distribution is generally tax free until you sell or exchange the securities. (For more information, see Distributions of employer securities under Taxation of Nonperiodic Payments in Publication 575.)
Capital Gain Treatment
Capital gain treatment applies only to the taxable part of a lump-sum distribution resulting from participation in the plan before 1974. The amount treated as capital gain is taxed at a 20% rate. You can elect this treatment only once for any plan participant, and only if the plan participant was born before January 2, 1936.
Complete Part II of Form 4972 to choose the 20% capital gain election. For more information, see Capital Gain Treatment under Lump-Sum Distributions in Publication 575.
10-Year Tax Option
The 10-year tax option is a special formula used to figure a separate tax on the ordinary income part of a lump-sum distribution. You pay the tax only once, for the year in which you receive the distribution, not over the next 10 years. You can elect this treatment only once for any plan participant, and only if the plan participant was born before January 2, 1936.
The ordinary income part of the distribution is the amount shown in box 2a of the Form 1099-R given to you by the payer, minus the amount, if any, shown in box 3. You also can treat the capital gain part of the distribution (box 3 of Form 1099-R) as ordinary income for the 10-year tax option if you do not choose capital gain treatment for that part.
Complete Part III of Form 4972 to choose the 10-year tax option. You must use the special Tax Rate Schedule shown in the instructions for Part III to figure the tax. Publication 575 illustrates how to complete Form 4972 to figure the separate tax.
If you withdraw cash or other assets from a qualified retirement plan in an eligible rollover distribution, you can defer tax on the distribution by rolling it over to another qualified retirement plan or a traditional IRA.
For this purpose, the following plans are qualified retirement plans.
See Rollovers to Roth IRAs under Rollovers in Publication 575, for information on rollovers after 2007 from a qualified retirement plan to a Roth IRA.
Time for making rollover. You generally must complete the rollover by the 60th day following the day on which you receive the distribution from your employer's plan. (This 60-day period is extended for the period during which the distribution is in a frozen deposit in a financial institution.) For all rollovers to an IRA, you must irrevocably elect rollover treatment by written notice to the trustee or issuer of the IRA.
Tip: The IRS may waive the 60-day requirement where the failure to do so would be against equity or good conscience, such as in the event of a casualty, disaster, or other event beyond your reasonable control.
Eligible rollover distributions. Generally, an eligible rollover distribution is any distribution of all or the balance to your credit in a qualified retirement plan. For information about exceptions to eligible rollover distributions, see Publication 575.
Rollover of nontaxable amounts. You may be able to roll over the nontaxable part of a distribution (such as your after-tax contributions) made to another qualified retirement plan that is a qualified employee plan or a 403(b) plan, or to a traditional IRA. The transfer must be made either through a direct rollover to a qualified plan or 403(b) plan that separately accounts for the taxable and nontaxable parts of the rollover or through a rollover to a traditional IRA.
If you roll over only part of a distribution that includes both taxable and nontaxable amounts, the amount you roll over is treated as coming first from the taxable part of the distribution.
Designated Roth accounts. You can roll over an eligible rollover distribution from a designated Roth account only into another designated Roth account or a Roth IRA. If you want to roll over the part of the distribution that is not included in income, you must make a direct rollover of the entire distribution or you can roll over the entire amount (or any portion) to a Roth IRA. For more information on rollovers from designated Roth accounts, see Publication 575.
Direct rollover option. You can choose to have any part or all of an eligible rollover distribution paid directly to another qualified plan (if permitted) or to a traditional IRA. If you decide on a rollover, it is generally to your advantage to choose this direct rollover option. Under this option, the plan administrator would not withhold tax from any part of the distribution that is directly paid to the other plan.
Withholding tax. If you choose to have all or any part of the distribution paid to you, it is taxable in the year distributed unless you roll it over to another qualified plan or to a traditional IRA within 60 days. The plan administrator must withhold income tax of 20% from the amount of the distribution paid to you. (See Pensions and Annuities under Withholding in chapter 4.)
Caution: If you decide to roll over an amount equal to the distribution before withholding, your contribution to the new plan or IRA must include other money (for example, from savings or amounts borrowed) to replace the amount withheld.
The administrator must give you a written explanation of your distribution options within a reasonable period of time before making an eligible rollover distribution.
Rollover by surviving spouse. You may be able to roll over tax free all or part of a distribution from a qualified retirement plan you receive as the surviving spouse of a deceased employee. The rollover rules apply to you as if you were the employee. You can roll over a distribution into a qualified retirement plan or a traditional IRA.
A distribution paid to a beneficiary other than the employee's surviving spouse is generally not an eligible rollover distribution. However, see Rollovers by nonspouse beneficiary, next.
Rollovers by nonspouse beneficiary. If you are a designated beneficiary (other than a surviving spouse) of a deceased employee, you may be able to roll over tax free all or a portion of a distribution you receive from an eligible retirement plan of the employee. The distribution must be a direct trustee-to-trustee transfer to your IRA that was set up to receive the distribution. The transfer will be treated as an eligible rollover distribution and the receiving plan will be treated as an inherited IRA. For information on inherited IRAs, see Publication 590.
Qualified domestic relations order (QDRO). You may be able to roll over tax free all or part of a distribution from a qualified retirement plan that you receive under a QDRO. If you receive the distribution as an employee's spouse or former spouse (not as a nonspousal beneficiary), the rollover rules apply to you as if you were the employee. You can roll over the distribution from the plan into a traditional IRA or to another eligible retirement plan. See Publication 575 for more information on benefits received under a QDRO.
Retirement bonds. If you redeem a retirement bond purchased under a qualified bond purchase plan, you can defer the tax on the amount received that exceeds your basis by rolling it over to an IRA as discussed in Publication 590 or qualified employer plan.
More information. For more information on the rules for rolling over distributions, see Publication 575.
To discourage the use of pension funds for purposes other than normal retirement, the law imposes additional taxes on early distributions of those funds and on failures to withdraw the funds timely. Ordinarily, you will not be subject to these taxes if you roll over all early distributions you receive, as explained earlier, and begin drawing out the funds at a normal retirement age, in reasonable amounts over your life expectancy. These special additional taxes are the taxes on:
These taxes are discussed in the following sections.
If you must pay either of these taxes, report them on Form 5329. However, you do not have to file Form 5329 if you owe only the tax on early distributions and your Form 1099-R correctly shows a "1" in box 7. Instead, enter 10% of the taxable part of the distribution on Form 1040, line 60 and write "No" under the heading "Other Taxes" to the left of line 60.
Even if you do not owe any of these taxes, you may have to complete Form 5329 and attach it to your Form 1040. This applies if you meet an exception to the tax on early distributions but box 7 of your Form 1099-R does not indicate an exception.
Most distributions (both periodic and nonperiodic) from qualified retirement plans and nonqualified annuity contracts made to you before you reach age 59 1/2 are subject to an additional tax of 10%. This tax applies to the part of the distribution that you must include in gross income.
For this purpose, a qualified retirement plan is:
5% rate on certain early distributions from deferred annuity contracts. If an early withdrawal from a deferred annuity is otherwise subject to the 10% additional tax, a 5% rate may apply instead. A 5% rate applies to distributions under a written election providing a specific schedule for the distribution of your interest in the contract if, as of March 1, 1986, you had begun receiving payments under the election. On line 4 of Form 5329, multiply the line 3 amount by 5% instead of 10%. Attach an explanation to your return.
Exceptions to tax. Certain early distributions are excepted from the early distribution tax. If the payer knows that an exception applies to your early distribution, distribution code "2," "3," or "4" should be shown in box 7 of your Form 1099-R and you do not have to report the distribution on Form 5329. If an exception applies but distribution code "1" (early distribution, no known exception) is shown in box 7, you must file Form 5329. Enter the taxable amount of the distribution shown in box 2a of your Form 1099-R on line 1 of Form 5329. On line 2, enter the amount that can be excluded and the exception number shown in the Form 5329 instructions.
Tip: If distribution code "1" is incorrectly shown on your Form 1099-R for a distribution received when you were age 59 1/2 or older, include that distribution on Form 5329. Enter exception number "12" on line 2.
General exceptions. The tax does not apply to distributions that are:
Additional exceptions for qualified retirement plans. The tax does not apply to distributions that are:
Qualified reservist distributions. A qualified reservist distribution is not subject to the additional tax on early distributions. A qualified reservist distribution is a distribution (a) from elective deferrals under a section 401(k) or 403(b) plan, (b) to an individual ordered or called to active duty (because he or she is a member of a reserve component) for a period of more than 179 days or for an indefinite period, and (c) made during the period beginning on the date of the order or call and ending at the close of the active duty period. You must have been ordered or called to active duty after September 11, 2001, and before December 31, 2007. For more information, see Publication 575.
Additional exceptions for nonqualified annuity contracts. The tax does not apply to distributions that are:
Tax on Excess Accumulation
To make sure that most of your retirement benefits are paid to you during your lifetime, rather than to your beneficiaries after your death, the payments that you receive from qualified retirement plans must begin no later than on your required beginning date (defined next). The payments each year cannot be less than the required minimum distribution.
Required beginning date. Unless the rule for 5% owners applies, you must begin to receive distributions from your qualified retirement plan by April 1 of the year that follows the later of:
However, your plan may require you to begin to receive distributions by April 1 of the year that follows the year in which you reach age 70 1/2, even if you have not retired.
For this purpose, a qualified retirement plan includes:
Age 70 1/2. You reach age 70 1/2 on the date that is 6 calendar months after the date of your 70th birthday.
For example, if you are retired and your 70th birthday was on June 30, 2007, you were age 70 1/2 on December 30, 2007. If your 70th birthday was on July 1, 2007, you reached age 70 1/2 on January 1, 2008.
5% owners. If you are a 5% owner of the company maintaining your qualified retirement plan, you must begin to receive distributions by April 1 of the calendar year that follows the year in which you reach age 70 1/2, regardless of when you retire.
Required distributions. By the required beginning date, as explained earlier, you must either:
Additional information. For more information on this rule, see Tax on Excess Accumulation in Publication 575.
Required distributions not made. If the actual distributions to you in any year are less than the required minimum distribution, you are subject to an additional excise tax. The tax equals 50% of the part of the required minimum distribution that was not distributed. You can get this excise tax waived if you establish that the shortfall in distributions was due to reasonable error and that you are taking reasonable steps to remedy the shortfall. See the instructions for Form 5329 for the procedure to follow if you believe you may qualify for a waiver of this tax.
State insurer delinquency proceedings. You might not receive the minimum distribution because assets are invested in a contract issued by an insurance company in state insurer delinquency proceedings. If your payments are reduced below the minimum due to these proceedings, you should contact your plan administrator. Under certain conditions, you will not have to pay the excise tax.
Form 5329. You must file a Form 5329 if you owe a tax because you did not receive a minimum required distribution from your qualified retirement plan.
If you receive a survivor annuity because of the death of a retiree who had reported the annuity under the Three-Year Rule and recovered all of the cost tax free, include the total received in income.
If the retiree was reporting the annuity payments under the General Rule, you must apply the same exclusion percentage to your initial survivor annuity payment called for in the contract. The resulting tax-free amount will then remain fixed. Any increases in the survivor annuity are fully taxable.
If the retiree was reporting the annuity payments under the Simplified Method, the part of each payment that is tax free is the same as the tax-free amount figured by the retiree at the annuity starting date. This amount remains fixed even if the annuity payments are increased or decreased. See Simplified Method, earlier.
In any case, if the annuity starting date is after 1986, the total exclusion over the years cannot be more than the cost.
If you are the survivor of an employee, or former employee, who died before becoming entitled to any annuity payments, you must figure the taxable and tax-free parts of your annuity payments using the method that applies as if you were the employee.
Estate tax deduction. If your annuity was a joint and survivor annuity that was included in the decedent's estate, an estate tax may have been paid on it. You can deduct, as a miscellaneous itemized deduction, the part of the total estate tax that was based on the annuity. This deduction is not subject to the 2%-of-adjusted-gross-income limit. The deceased annuitant must have died after the annuity starting date. (For details, see section 1.691(d)-1 of the regulations.) This amount cannot be deducted in 1 year. It must be deducted in equal amounts over your remaining life expectancy.
If the decedent died before the annuity starting date of a deferred annuity contract and you receive a death benefit under that contract, the amount you receive (either in a lump sum or as periodic payments) in excess of the decedent's cost is included in your gross income as income in respect of a decedent for which you may be able to claim an estate tax deduction.
See Publication 559, Survivors, Executors, and Administrators, for more information on the estate tax deduction.
This chapter explains the federal income tax rules for social security benefits and equivalent tier 1 railroad retirement benefits. It explains the following topics.
Social security benefits include monthly retirement, survivor, and disability benefits. They do not include supplemental security income (SSI) payments, which are not taxable.
Equivalent tier 1 railroad retirement benefits are the part of tier 1 benefits that a railroad employee or beneficiary would have been entitled to receive under the social security system. They are commonly called the social security equivalent benefit (SSEB) portion of tier 1 benefits.
If you received these benefits during 2007, you should have received a Form SSA-1099, Social Security Benefit Statement, or Form RRB-1099, Payments by the Railroad Retirement Board, (Form SSA-1042S, Social Security Benefit Statement, or Form RRB-1042S, Statement for Nonresident Alien Recipients of: Payments by the Railroad Retirement Board, if you are a nonresident alien). These forms show the amounts received and repaid, and taxes withheld for the year. You may receive more than one of these forms for the same year. You should add the amounts shown on all forms you receive for the year to determine the "total" amounts received and repaid, and taxes withheld for that year. See the Appendix at the end of Publication 915 for more information.
Note. When the term "benefits" is used in this chapter, it applies to both social security benefits and the SSEB portion of tier 1 railroad retirement benefits.
What is not covered in this chapter. This chapter does not cover the tax rules for the following railroad retirement benefits.
For information on these benefits, see Publication 575, Pension and Annuity Income.
This chapter also does not cover the tax rules for foreign social security benefits. These benefits are taxable as annuities, unless they are exempt from U.S. tax or treated as a U.S. social security benefit under a tax treaty.
Useful Items
You may want to see:
Publication
Forms (and Instructions)
To find out whether any of your benefits may be taxable, compare the base amount for your filing status with the total of:
When making this comparison, do not reduce your other income by any exclusions for:
Figuring total income. To figure the total of one-half of your benefits plus your other income, use Worksheet 11-1 later in this discussion. If the total is more than your base amount, part of your benefits may be taxable.
If you are married and file a joint return for 2007, you and your spouse must combine your incomes and your benefits to figure whether any of your combined benefits are taxable. Even if your spouse did not receive any benefits, you must add your spouse's income to yours to figure whether any of your benefits are taxable.
Tip: If the only income you received during 2007 was your social security or the SSEB portion of tier 1 railroad retirement benefits, your benefits generally are not taxable and you probably do not have to file a return. If you have income in addition to your benefits, you may have to file a return even if none of your benefits are taxable.
Base amount. Your base amount is:
Worksheet 11-1. You can use Worksheet 11-1 to figure the amount of income to compare with your base amount. This is a quick way to check whether some of your benefits may be taxable.
Worksheet 11-1. A Quick Way To Check if Your Benefits May be Taxable
----------------------------------------------------- A. Enter the amount from box 5 of all your Forms SSA-1099 and RRB-1099. Include the full amount of any lump-sum benefit payments received in 2007, for 2007 and earlier years. (If you received more than one form, combine the amounts from box 5 and enter the total.) A. _______ Note. If the amount on line A is zero or less, stop here; none of your benefits are taxable this year. B. Enter one-half of the amount on line A B. _______ C. Enter your taxable pensions, wages, interest, dividends, and other taxable income C. _______ D. Enter any tax-exempt interest income (such as interest on municipal bonds) plus any exclusions from income (listed earlier) D. _______ E. Add lines B, C, and D E. _______ Note. Compare the amount on line E to your base amount for your filing status. If the amount on line E equals or is less than the base amount for your filing status, none of your benefits are taxable this year. If the amount on line E is more than your base amount, some of your benefits may be taxable. You need to complete Worksheet 1 in Publication 915 (or the Social Security Benefits Worksheet in your tax form instruction booklet). -----------------------------------------------------
Example. You and your spouse (both over 65) are filing a joint return for 2007 and you both received social security benefits during the year. In January 2008, you received a Form SSA-1099 showing net benefits of $7,500 in box 5. Your spouse received a Form SSA-1099 showing net benefits of $3,500 in box 5. You also received a taxable pension of $20,000 and interest income of $500. You did not have any tax-exempt interest income. Your benefits are not taxable for 2007 because your income, as figured in Worksheet 11-1 on the next page, is not more than your base amount ($32,000) for married filing jointly.
Even though none of your benefits are taxable, you must file a return for 2007 because your taxable gross income ($20,500) exceeds the minimum filing requirement amount for your filing status.
Filled-in Worksheet 11-1. A Quick Way To Check if Your Benefits May be Taxable
----------------------------------------------------- A. Enter the amount from box 5 of all your Forms SSA-1099 and RRB-1099. Include the full amount of any lump-sum benefit payments received in 2007, for 2007 and earlier years. (If you received more than one form, combine the amounts from box 5 and enter the total.) A. $ 11,000 Note. If the amount on line A is zero or less, stop here; none of your benefits are taxable this year. B. Enter one-half of the amount on line A B. 5,500 C. Enter your taxable pensions, wages, interest, dividends, and other taxable income C. 20,500 D. Enter any tax-exempt interest income (such as interest on municipal bonds) plus any exclusions from income (listed earlier) D. -0- E. Add lines B, C, and D E. $26,000 Note. Compare the amount on line E to your base amount for your filing status. If the amount on line E equals or is less than the base amount for your filing status, none of your benefits are taxable this year. If the amount on line E is more than your base amount, some of your benefits may be taxable. You then need to complete Worksheet 1 in Publication 915 (or the Social Security Benefits Worksheet in your tax form instruction booklet). -----------------------------------------------------
Who is taxed. The person who has the legal right to receive the benefits must determine whether the benefits are taxable. For example, if you and your child receive benefits, but the check for your child is made out in your name, you must use only your part of the benefits to see whether any benefits are taxable to you. One-half of the part that belongs to your child must be added to your child's other income to see whether any of those benefits are taxable to your child.
Repayment of benefits. Any repayment of benefits you made during 2007 must be subtracted from the gross benefits you received in 2007. It does not matter whether the repayment was for a benefit you received in 2007 or in an earlier year. If you repaid more than the gross benefits you received in 2007, see Repayments More Than Gross Benefits, later.
Your gross benefits are shown in box 3 of Form SSA-1099 or RRB-1099. Your repayments are shown in box 4. The amount in box 5 shows your net benefits for 2007 (box 3 minus box 4). Use the amount in box 5 to figure whether any of your benefits are taxable.
Tax withholding and estimated tax. You can choose to have federal income tax withheld from your social security benefits and/or the SSEB portion of your tier 1 railroad retirement benefits. If you choose to do this, you must complete a Form W-4V. You can choose withholding at 7%, 10%, 15%, or 25% of your total benefit payment.
If you do not choose to have income tax withheld, you may have to request additional withholding from other income or pay estimated tax during the year. For details, get Publication 505, Tax Withholding and Estimated Tax, or the instructions for Form 1040-ES.
If part of your benefits are taxable, you must use Form 1040 or Form 1040A. You cannot use Form 1040EZ.
Reporting on Form 1040. Report your net benefits (the amount in box 5 of your Form SSA-1099 or Form RRB-1099) on line 20a and the taxable part on line 20b. If you are married filing separately and you lived apart from your spouse for all of 2007, also enter "D" to the right of the word "benefits" on line 20a.
Reporting on Form 1040A. Report your net benefits (the amount in box 5 of your Form SSA-1099 or Form RRB-1099) on line 14a and the taxable part on line 14b. If you are married filing separately and you lived apart from your spouse for all of 2007, also enter "D" to the right of the word "benefits" on line 14a.
Benefits not taxable. If you are filing Form 1040EZ, do not report any benefits on your tax return. If you are filing Form 1040 or Form 1040A, report your net benefits (the amount in box 5 of your Form SSA-1099 or Form RRB-1099) on Form 1040, line 20a, or Form 1040A, line 14a. Enter -0- on Form 1040, line 20b, or Form 1040A, line 14b. If you are married filing separately and you lived apart from your spouse for all of 2007, also enter "D" to the right of the word "benefits" on Form 1040, line 20a, or Form 1040A, line 14a.
If part of your benefits are taxable, how much is taxable depends on the total amount of your benefits and other income. Generally, the higher that total amount, the greater the taxable part of your benefits.
Maximum taxable part. Generally, up to 50% of your benefits will be taxable. However, up to 85% of your benefits can be taxable if either of the following situations applies to you.
Which worksheet to use. A worksheet to figure your taxable benefits is in the instructions for your Form 1040 or Form 1040A. You can use either that worksheet or Worksheet 1 in Publication 915, unless any of the following situations applies to you.
Lump-sum election. You must include the taxable part of a lump-sum (retroactive) payment of benefits received in 2007 in your 2007 income, even if the payment includes benefits for an earlier year.
Tip: This type of lump-sum benefit payment should not be confused with the lump-sum death benefit that both the SSA and RRB pay to many of their beneficiaries. No part of the lump-sum death benefit is subject to tax.
Generally, you use your 2007 income to figure the taxable part of the total benefits received in 2007. However, you may be able to figure the taxable part of a lump-sum payment for an earlier year separately, using your income for the earlier year. You can elect this method if it lowers your taxable benefits.
Making the election. If you received a lump-sum benefit payment in 2007 that includes benefits for one or more earlier years, follow the instructions in Publication 915 under Lump-Sum Election to see whether making the election will lower your taxable benefits. That discussion also explains how to make the election.
Caution: Because the earlier year's taxable benefits are included in your 2007 income, no adjustment is made to the earlier year's return. Do not file an amended return for the earlier year.
The following are a few examples you can use as a guide to figure the taxable part of your benefits.
Example 1. George White is single and files Form 1040 for 2007. He received the following income in 2007:
Fully taxable pension $18,600
Wages from part-time job 9,400
Taxable interest income 990
-------
Total $28,990
=======
George also received social security benefits during 2007. The Form SSA-1099 he received in January 2008 shows $5,980 in box 5. To figure his taxable benefits, George completes the worksheet shown here.
Worksheet 1. Figuring Your Taxable Benefits
-----------------------------------------------------------
1. Enter the total amount from box 5 of ALL
your Forms SSA-1099 and RRB-1099.
Also enter this amount on Form 1040, line
20a, or Form 1040A, line 14a $5,980
2. Enter one-half of line 1 2,990
3. Enter the total of the amounts from:
Form 1040: Lines 7, 8a, 9a, 10 through
14, 15b, 16b, 17 through 19, and 21.
Form 1040A: Lines 7, 8a, 9a, 10, 11b,
12b, and 13 28,990
4. Enter the amount, if any, from
Form 1040 or 1040A, line 8b -0-
5. Form 1040 filers: Enter the total of any
exclusions/adjustments for:
Qualified U.S. savings bond
interest (Form 8815, line 14),
Adoption benefits (Form 8839, line
30),
Foreign earned income or housing
(Form 2555, lines 45 and 50, or
Form 2555-EZ, line 18), and
Certain income of bona fide
residents of American
Samoa (Form 4563, line 15)
or Puerto Rico
Form 1040A filers: Enter the total of
any exclusions for qualified U.S.
savings bond interest (Form 8815, line
14) or for adoption benefits
(Form 8839, line 30) -0-
6. Add lines 2, 3, 4, and 5 31,980
7. Form 1040 filers: Enter the amount from
Form 1040, lines 23 through 32, and any
write-in adjustments you entered on the
dotted line next to line 36.
Form 1040A filers: Enter the amount
from Form 1040A, lines 16 and 17 -0-
8. Is the amount on line 7 less than the
amount on line 6?
No. STOP None of your social security benefits are
taxable. Enter -0- on Form 1040, line 20b, or
Form 1040A, line 14b.
Yes. Subtract line 7 from line 6 31,980
9. If you are:
Married filing jointly, enter $32,000
Single, head of household, qualifying
widow(er), or married filing separately
and you lived apart from your spouse
for all of 2007, enter $25,000 25,000
Note. If you are married filing separately
and you lived with your spouse at any time
in 2007, skip lines 9 through 16; multiply
line 8 by 85% (.85) and enter the result on
line 17. Then go to line 18.
10. Is the amount on line 9 less than the
amount on line 8?
No. STOP None of your benefits are
taxable. Enter -0- on Form 1040, line 20b,
or on Form 1040A, line 14b. If you are
married filing separately and you lived
apart from your spouse for all of 2007, be
sure you entered "D" to the right of the
word "benefits" on Form 1040, line 20a, or
on Form 1040A, line 14a.
Yes. Subtract line 9 from line 8 6,980
11. Enter $12,000 if married filing jointly;
$9,000 if single, head of household,
qualifying widow(er), or married filing
separately and you lived apart from your
spouse for all of 2007 9,000
12. Subtract line 11 from line 10. If zero or
less, enter -0- -0-
13. Enter the smaller of line 10 or line 11 6,980
14. Enter one-half of line 13 3,490
15. Enter the smaller of line 2 or line 14 2,990
16. Multiply line 12 by 85% (.85). If line 12 is
zero, enter -0- -0-
17. Add lines 15 and 16 2,990
18. Multiply line 1 by 85% (.85) 5,083
19. Taxable benefits. Enter the smaller of
line 17 or line 18. Also enter this amount
on Form 1040, line 20b, or Form 1040A,
line 14b $2,990
======
-----------------------------------------------------------
The amount on line 19 of George's worksheet shows that $2,990 of his social security benefits is taxable. On line 20a of his Form 1040, George enters his net benefits of $5,980. On line 20b, he enters his taxable benefits of $2,990.
Example 2. Ray and Alice Hopkins file a joint return on Form 1040A for 2007. Ray is retired and received a fully taxable pension of $15,500. He also received social security benefits, and his Form SSA-1099 for 2007 shows net benefits of $5,600 in box 5. Alice worked during the year and had wages of $14,000. She made a deductible payment to her IRA account of $1,000. Ray and Alice have two savings accounts with a total of $250 in taxable interest income. They complete Worksheet 1 and find that none of Ray's social security benefits are taxable. On line 3 of the worksheet, they enter $29,750 ($15,500 + $14,000 + $250). On Form 1040A, they enter $5,600 on line 14a and -0- on line 14b.
Worksheet 1. Figuring Your Taxable Benefits
-----------------------------------------------------------
1. Enter the total amount from box 5 of ALL
your Forms SSA-1099 and RRB-1099.
Also enter this amount on Form 1040, line
20a, or Form 1040A, line 14a $5,600
2. Enter one-half of line 1 2,800
3. Enter the total of the amounts from:
Form 1040: Lines 7, 8a, 9a, 10 through
14, 15b, 16b, 17 through 19, and 21.
Form 1040A: Lines 7, 8a, 9a, 10, 11b,
12b, and 13 29,750
4. Enter the amount, if any, from Form 1040
or 1040A, line 8b -0-
5. Form 1040 filers: Enter the total of any
exclusions/adjustments for:
Qualified U.S. savings bond
interest (Form 8815, line 14),
Adoption benefits (Form 8839, line
30),
Foreign earned income or housing
(Form 2555, lines 45 and 50, or
Form 2555-EZ, line 18), and
Certain income of bona fide
residents of American
Samoa (Form 4563, line 15)
or Puerto Rico
Form 1040A filers: Enter the total of
any exclusion for qualified U.S. savings
bond interest (Form 8815, line 14) or for
adoption benefits (Form 8839, line 30). -0-
6. Add lines 2, 3, 4, and 5 32,550
7. Form 1040 filers: Enter the amount from
Form 1040, lines 23 through 32, and any
write-in adjustments you entered on the
dotted line next to line 36.
Form 1040A filers: Enter the amount from
Form 1040A, lines 16 and 17 1,000
8. Is the amount on line 7 less than the
amount on line 6?
No. STOP None of your benefits are taxable. Enter
-0- on Form 1040, line 20b, or Form 1040A, line
14b.
Yes. Subtract line 7 from line 6 31,550
9. If you are:
Married filing jointly, enter $32,000
Single, head of household, qualifying
widow(er), or married filing separately
and you lived apart from your spouse
for all of 2007, enter $25,000 32,000
Note. If you are married filing separately
and you lived with your spouse at any time
in 2007, skip lines 9 through 16; multiply
line 8 by 85% (.85) and enter the result on
line 17. Then go to line 18.
10. Is the amount on line 9 less than the
amount on line 8?
No. STOP None of your benefits are
taxable. Enter -0- on Form 1040, line 20b,
or on Form 1040A, line 14b. If you are
married filing separately and you lived
apart from your spouse for all of 2007, be
sure you entered "D" to the right of the
word "benefits" on Form 1040, line 20a, or
on Form 1040A, line 14a.
Yes. Subtract line 9 from line 8 ______
11. Enter $12,000 if married filing jointly;
$9,000 if single, head of household,
qualifying widow(er), or married filing
separately and you lived apart from your
spouse for all of 2007 ______
12. Subtract line 11 from line 10. If zero or
less, enter -0- ______
13. Enter the smaller of line 10 or line 11 ______
14. Enter one-half of line 13 ______
15. Enter the smaller of line 2 or line 14 ______
16. Multiply line 12 by 85% (.85). If line 12 is
zero, enter -0- ______
17. Add lines 15 and 16 ______
18. Multiply line 1 by 85% (.85) ______
19. Taxable benefits. Enter the smaller of line
17 or line 18. Also enter this amount on
Form 1040, line 20b, or Form 1040A, line
14b
======
-----------------------------------------------------------
Example 3. Joe and Betty Johnson file a joint return on Form 1040 for 2007. Joe is a retired railroad worker and in 2007 received the social security equivalent benefit (SSEB) portion of tier 1 railroad retirement benefits. Joe's Form RRB-1099 shows $10,000 in box 5. Betty is a retired government worker and receives a fully taxable pension of $38,000. They had $2,300 in taxable interest income plus interest of $200 on a qualified U.S. savings bond. The savings bond interest qualified for the exclusion. They figure their taxable benefits by completing Worksheet 1. On line 3 of the worksheet, they enter $40,300 ($38,000 + $2,300).
Worksheet 1. Figuring Your Taxable Benefits
-----------------------------------------------------------
1. Enter the total amount from box 5 of ALL
your Forms SSA-1099 and RRB-1099.
Also enter this amount on Form 1040,
line 20a, or Form 1040A, line 14a $10,000
2. Enter one-half of line 1 5,000
3. Enter the total of the amounts from:
Form 1040: Lines 7, 8a, 9a, 10
through 14, 15b, 16b, 17 through 19,
and 21.
Form 1040A: Lines 7, 8a, 9a, 10, 11b,
12b, and 13 40,300
4. Enter the amount, if any, from Form 1040
or 1040A, line 8b -0-
5. Form 1040 filers: Enter the total of any
exclusions/adjustments for:
Qualified U.S. savings bond
interest (Form 8815, line 14),
Adoption benefits (Form 8839, line
30),
Foreign earned income or housing
(Form 2555, lines 45 and 50, or
Form 2555-EZ, line 18), and
Certain income of bona fide
residents of American
Samoa (Form 4563, line 15)
or Puerto Rico
Form 1040A filers: Enter the total of
any exclusions for qualified U.S.
savings bond interest (Form 8815, line
14) or for adoption benefits
(Form 8839, line 30) 200
6. Add lines 2, 3, 4, and 5 45,500
7. Form 1040 filers: Enter the amount from
Form 1040, lines 23 through 32, and any
write-in adjustments you entered on the
dotted line next to line 36.
Form 1040A filers: Enter the amount
from Form 1040A, lines 16 and 17 -0-
8. Is the amount on line 7 less than the
amount on line 6?
No. STOP None of your benefits are taxable. Enter
-0- on Form 1040, line 20b, or Form 1040A, line
14b.
Yes. Subtract line 7 from line 6 45,500
9. If you are:
Married filing jointly, enter $32,000
Single, head of household, qualifying
widow(er), or married filing
separately and you lived apart from
your spouse for all of 2007, enter
$25,000 32,000
Note. If you are married filing separately
and you lived with your spouse at any
time in 2007, skip lines 9 through 16;
multiply line 8 by 85% (.85) and enter the
result on line 17. Then go to line 18
10. Is the amount on line 9 less than the
amount on line 8?
No. STOP None of your benefits are
taxable. Enter -0- on Form 1040, line
20b, or on Form 1040A, line 14b. If you
are married filing separately and you lived
apart from your spouse for all of 2007,
be sure you entered "D" to the right
of the word "benefits" on Form 1040, line
20a, or on Form 1040A, line 14a.
Yes. Subtract line 9 from line 8 13,500
11. Enter $12,000 if married filing jointly;
$9,000 if single, head of household,
qualifying widow(er), or married filing
separately and you lived apart from your
spouse for all of 2007 12,000
12. Subtract line 11 from line 10. If zero or
less, enter -0- 1,500
13. Enter the smaller of line 10 or line 11 12,000
14. Enter one-half of line 13 6,000
15. Enter the smaller of line 2 or line 14 5,000
16. Multiply line 12 by 85% (.85). If line 12 is
zero, enter -0- 1,275
17. Add lines 15 and 16 6,275
18. Multiply line 1 by 85% (.85) 8,500
19. Taxable benefits. Enter the smaller of
line 17 or line 18. Also enter this amount
on Form 1040, line 20b, or Form 1040A,
line 14b $6,275
=======
-----------------------------------------------------------
More than 50% of Joe's net benefits are taxable because the income on line 8 of the worksheet ($45,500) is more than $44,000. Joe and Betty enter $10,000 on Form 1040, line 20a, and $6,275 on Form 1040, line 20b.
You may be entitled to deduct certain amounts related to the benefits you receive.
Disability payments. You may have received disability payments from your employer or an insurance company that you included as income on your tax return in an earlier year. If you received a lump-sum payment from SSA or RRB, and you had to repay the employer or insurance company for the disability payments, you can take an itemized deduction for the part of the payments you included in gross income in the earlier year. If the amount you repay is more than $3,000, you may be able to claim a tax credit instead. Claim the deduction or credit in the same way explained under Repayments More Than Gross Benefits, later.
Legal expenses. You can usually deduct legal expenses that you pay or incur to produce or collect taxable income or in connection with the determination, collection, or refund of any tax.
Legal expenses for collecting the taxable part of your benefits are deductible as a miscellaneous itemized deduction on Schedule A (Form 1040), line 23.
Repayments More Than Gross Benefits
In some situations, your Form SSA-1099 or Form RRB-1099 will show that the total benefits you repaid (box 4) are more than the gross benefits (box 3) you received. If this occurred, your net benefits in box 5 will be a negative figure (a figure in parentheses) and none of your benefits will be taxable. Do not use a worksheet in this case. If you receive more than one form, a negative figure in box 5 of one form is used to offset a positive figure in box 5 of another form for that same year.
If you have any questions about this negative figure, contact your local SSA office or your local RRB field office.
Joint return. If you and your spouse file a joint return, and your Form SSA-1099 or RRB-1099 has a negative figure in box 5, but your spouse's does not, subtract the amount in box 5 of your form from the amount in box 5 of your spouse's form. You do this to get your net benefits when figuring if your combined benefits are taxable.
Example. John and Mary file a joint return for 2007. John received Form SSA-1099 showing $3,000 in box 5. Mary also received Form SSA-1099 and the amount in box 5 was ($500). John and Mary will use $2,500 ($3,000 minus $500) as the amount of their net benefits when figuring if any of their combined benefits are taxable.
Repayment of benefits received in an earlier year. If the total amount shown in box 5 of all of your Forms SSA-1099 and RRB-1099 is a negative figure, you can take an itemized deduction for the part of this negative figure that represents benefits you included in gross income in an earlier year.
Deduction $3,000 or less. If this deduction is $3,000 or less, it is subject to the 2%-of-adjusted-gross-income limit that applies to certain miscellaneous itemized deductions. Claim it on Schedule A (Form 1040), line 23.
Deduction more than $3,000. If this deduction is more than $3,000, you should figure your tax two ways:
Compare the tax figured in methods (1) and (2). Your tax for 2007 is the smaller of the two amounts. If method (1) results in less tax, take the itemized deduction on Schedule A (Form 1040), line 28. If method (2) results in less tax, claim a credit for the amount from step 2(c) above on Form 1040, line 70, and enter "I.R.C. 1341" in the margin to the left of line 70. If both methods produce the same tax, deduct the repayment on Schedule A (Form 1040), line 28.
Qualified joint venture. A qualified joint venture conducted by you and your spouse may not be treated as a partnership if you file a joint return for the tax year. See Partnership Income, later.
Expiration of relief granted for Hurricane Katrina. The exclusion from income for the discharge of certain nonbusiness debt as a result of Hurricane Katrina expired.
You must include on your return all income you receive in the form of money, property, and services unless the tax law states that you do not include them. Some items, however, are only partly excluded from income. This chapter discusses many kinds of income and explains whether they are taxable or nontaxable.
This chapter begins with discussions of the following income items.
These discussions are followed by brief discussions of other income items arranged in alphabetical order.
Useful Items
You may want to see:
Publication
Bartering is an exchange of property or services. You must include in your income, at the time received, the fair market value of property or services you receive in bartering. If you exchange services with another person and you both have agreed ahead of time as to the value of the services, that value will be accepted as fair market value unless the value can be shown to be otherwise.
Generally, you report this income on Schedule C, Profit or Loss From Business, or Schedule C-EZ, Net Profit From Business (Form 1040). However, if the barter involves an exchange of something other than services, such as in Example 3 below, you may have to use another form or schedule instead.
Example 1. You are a self-employed attorney who performs legal services for a client, a small corporation. The corporation gives you shares of its stock as payment for your services. You must include the fair market value of the shares in your income on Schedule C or Schedule C-EZ (Form 1040) in the year you receive them.
Example 2. You are self-employed and a member of a barter club. The club uses "credit units" as a means of exchange. It adds credit units to your account for goods or services you provide to members, which you can use to purchase goods or services offered by other members of the barter club. The club subtracts credit units from your account when you receive goods or services from other members. You must include in your income the value of the credit units that are added to your account, even though you may not actually receive goods or services from other members until a later tax year.
Example 3. You own a small apartment building. In return for 6 months rent-free use of an apartment, an artist gives you a work of art she created. You must report as rental income on Schedule E, Supplemental Income and Loss (Form 1040), the fair market value of the artwork, and the artist must report as income on Schedule C or Schedule C-EZ (Form 1040) the fair rental value of the apartment.
Form 1099-B from barter exchange. If you exchanged property or services through a barter exchange, Form 1099-B, Proceeds From Broker and Barter Exchange Transactions, or a similar statement from the barter exchange should be sent to you by January 31, 2008. It should show the value of cash, property, services, credits, or scrip you received from exchanges during 2007. The IRS also will receive a copy of Form 1099-B.
Generally, if a debt you owe is canceled or forgiven, other than as a gift or bequest, you must include the canceled amount in your income. You have no income from the canceled debt if it is intended as a gift to you. A debt includes any indebtedness for which you are liable or which attaches to property you hold.
If the debt is a nonbusiness debt, report the canceled amount on Form 1040, line 21. If it is a business debt, report the amount on Schedule C or Schedule C-EZ (Form 1040) (or on Schedule F, Profit or Loss From Farming (Form 1040), if the debt is farm debt and you are a farmer).
Form 1099-C. If a Federal Government agency, financial institution, or credit union cancels or forgives a debt you owe of $600 or more, you will receive a Form 1099-C, Cancellation of Debt. The amount of the canceled debt is shown in box 2.
Interest included in canceled debt. If any interest is forgiven and included in the amount of canceled debt in box 2, the amount of interest also will be shown in box 3. Whether or not you must include the interest portion of the canceled debt in your income depends on whether the interest would be deductible if you paid it. See Deductible debt, under Exceptions, later.
If the interest would not be deductible (such as interest on a personal loan), include in your income the amount from Form 1099-C, box 2. If the interest would be deductible (such as on a business loan), include in your income the net amount of the canceled debt (the amount shown in box 2 less the interest amount shown in box 3).
Discounted mortgage loan. If your financial institution offers a discount for the early payment of your mortgage loan, the amount of the discount is canceled debt. You must include the canceled amount in your income.
Mortgage relief upon sale or other disposition. If you are personally liable for a mortgage (recourse debt), and you are relieved of the mortgage when you dispose of the property, you may realize gain or loss up to the fair market value of the property. To the extent the mortgage discharge exceeds the fair market value of the property, it is income from discharge of indebtedness unless it qualifies for exclusion under Excluded debt, later. Report any income from discharge of indebtedness on nonbusiness debt that does not qualify for exclusion as other income on Form 1040, line 21.
If you are not personally liable for a mortgage (nonrecourse debt), and you are relieved of the mortgage when you dispose of the property (such as through foreclosure or repossession), that relief is included in the amount you realize. You may have a taxable gain if the amount you realize exceeds your adjusted basis in the property. Report any gain on nonbusiness property as a capital gain.
See Foreclosures and Repossessions in Publication 544 for more information.
Stockholder debt. If you are a stockholder in a corporation and the corporation cancels or forgives your debt to it, the canceled debt is a constructive distribution that is generally dividend income to you. For more information, see Publication 542, Corporations.
If you are a stockholder in a corporation and you cancel a debt owed to you by the corporation, you generally do not realize income. This is because the canceled debt is considered as a contribution to the capital of the corporation equal to the amount of debt principal that you canceled.
Repayment of canceled debt. If you included a canceled amount in your income and later pay the debt, you may be able to file a claim for refund for the year the amount was included in income. You can file a claim on Form 1040X if the statute of limitations for filing a claim is still open. The statute of limitations generally does not end until 3 years after the due date of your original return.
There are several exceptions to the inclusion of canceled debt in income. These are explained next.
Student loans. Certain student loans contain a provision that all or part of the debt incurred to attend the qualified educational institution will be canceled if you work for a certain period of time in certain professions for any of a broad class of employers.
You do not have income if your student loan is canceled after you agreed to this provision and then performed the services required. To qualify, the loan must have been made by:
Section 501(c)(3) organizations are defined in Publication 525.
A loan to refinance a qualified student loan also will qualify if it was made by an educational institution or a tax-exempt 501(a) organization under its program designed as described in (3)(b) above.
Education loan repayment assistance. Education loan repayments made to you by the National Health Service Corps Loan Repayment Program (NHSC Loan Repayment Program) or a state education loan repayment program eligible for funds under the Public Health Service Act are not taxable if you agree to provide primary health services in health professional shortage areas.
Deductible debt. You do not have income from the cancellation of a debt if your payment of the debt would be deductible. This exception applies only if you use the cash method of accounting. For more information, see chapter 5 of Publication 334, Tax Guide for Small Business.
Price reduced after purchase. Generally, if the seller reduces the amount of debt you owe for property you purchased, you do not have income from the reduction. The reduction of the debt is treated as a purchase price adjustment and reduces your basis in the property.
Excluded debt. Do not include a canceled debt in your gross income in the following situations.
If you host a party at which sales are made, any gift you receive for giving the party is a payment for helping a direct seller make sales. You must report it as income at its fair market value.
Your out-of-pocket party expenses are subject to the 50% limit for meal and entertainment expenses. These expenses are deductible as miscellaneous itemized deductions subject to the 2% of AGI limit on Schedule A (Form 1040), but only up to the amount of income you receive for giving the party.
For more information about the 50% limit for meal and entertainment expenses, see 50% Limit in Publication 463, Travel, Entertainment, Gift, and Car Expenses.
Life insurance proceeds paid to you because of the death of the insured person are not taxable unless the policy was turned over to you for a price. This is true even if the proceeds were paid under an accident or health insurance policy or an endowment contract.
Proceeds not received in installments. If death benefits are paid to you in a lump sum or other than at regular intervals, include in your income only the benefits that are more than the amount payable to you at the time of the insured person's death. If the benefit payable at death is not specified, you include in your income the benefit payments that are more than the present value of the payments at the time of death.
Proceeds received in installments. If you receive life insurance proceeds in installments, you can exclude part of each installment from your income.
To determine the excluded part, divide the amount held by the insurance company (generally the total lump sum payable at the death of the insured person) by the number of installments to be paid. Include anything over this excluded part in your income as interest.
Surviving spouse. If your spouse died before October 23, 1986, and insurance proceeds paid to you because of the death of your spouse are received in installments, you can exclude up to $1,000 a year of the interest included in the installments. If you remarry, you can continue to take the exclusion.
More information. For more information, see Life Insurance Proceeds in Publication 525.
Surrender of policy for cash. If you surrender a life insurance policy for cash, you must include in income any proceeds that are more than the cost of the life insurance policy. In general, your cost (or investment in the contract) is the total of premiums that you paid for the life insurance policy, less any refunded premiums, rebates, dividends, or unrepaid loans that were not included in your income.
You should receive a Form 1099-R showing the total proceeds and the taxable part. Report these amounts on lines 16a and 16b of Form 1040 or lines 12a and 12b of Form 1040A.
An endowment contract is a policy under which you are paid a specified amount of money on a certain date unless you die before that date, in which case, the money is paid to your designated beneficiary. Endowment proceeds paid in a lump sum to you at maturity are taxable only if the proceeds are more than the cost of the policy. To determine your cost, subtract any amount that you previously received under the contract and excluded from your income from the total premiums (or other consideration) paid for the contract. Include the part of the lump sum payment that is more than your cost in your income.
Certain amounts paid as accelerated death benefits under a life insurance contract or viatical settlement before the insured's death are excluded from income if the insured is terminally or chronically ill.
Viatical settlement. This is the sale or assignment of any part of the death benefit under a life insurance contract to a viatical settlement provider. A viatical settlement provider is a person who regularly engages in the business of buying or taking assignment of life insurance contracts on the lives of insured individuals who are terminally or chronically ill and who meets the requirements of section 101(g)(2)(B) of the Internal Revenue Code.
Exclusion for terminal illness. Accelerated death benefits are fully excludable if the insured is a terminally ill individual. This is a person who has been certified by a physician as having an illness or physical condition that can reasonably be expected to result in death within 24 months from the date of the certification.
Exclusion for chronic illness. If the insured is a chronically ill individual who is not terminally ill, accelerated death benefits paid on the basis of costs incurred for qualified long-term care services are fully excludable. Accelerated death benefits paid on a per diem or other periodic basis are excludable up to a limit. This limit applies to the total of the accelerated death benefits and any periodic payments received from long-term care insurance contracts. For information on the limit and the definitions of chronically ill individual, qualified long-term care services, and long-term care insurance contracts, see Long-Term Care Insurance Contracts under Sickness and Injury Benefits in Publication 525.
Exception. The exclusion does not apply to any amount paid to a person (other than the insured) who has an insurable interest in the life of the insured because the insured:
Form 8853. To claim an exclusion for accelerated death benefits made on a per diem or other periodic basis, you must file Form 8853, Archer MSAs and Long-term Care Insurance Contracts, with your return. You do not have to file Form 8853 to exclude accelerated death benefits paid on the basis of actual expenses incurred.
Public Safety Officer Killed in the Line of Duty
If you are a survivor of a public safety officer who was killed in the line of duty, you may be able to exclude from income certain amounts you receive.
For this purpose, the term public safety officer includes law enforcement officers, firefighters, chaplains, and rescue squad and ambulance crew members. For more information, see Publication 559, Survivors, Executors, and Administrators.
A partnership generally is not a taxable entity. The income, gains, losses, deductions, and credits of a partnership are passed through to the partners based on each partner's distributive share of these items.
Schedule K-1 (Form 1065). Although a partnership generally pays no tax, it must file an information return on Form 1065, U.S. Return of Partnership Income, and send Schedule K-1 (Form 1065) to each partner. In addition, the partnership will send each partner a copy of the Partner's Instructions for Schedule K-1 (Form 1065) to help each partner report his or her share of the partnership's income, deductions, credits, and tax preference items.
Records: Keep Schedule K-1 (Form 1065) for your records. Do not attach it to your Form 1040.
For more information on partnerships, see Publication 541, Partnerships.
Qualified joint venture. If you and your spouse materially participate as the only members of a jointly owned and operated business, and you file a joint return for the tax year, you can make a joint election to be taxed as a qualified joint venture instead of a partnership. To make this election, you must divide all items of income, gain, loss, deduction, and credit between you and your spouse in accordance with your respective interests in the venture. Each of you must file a separate Schedule C or Schedule C-EZ (Form 1040).
In general, an S corporation does not pay tax on its income. Instead, the income, losses, deductions, and credits of the corporation are passed through to the shareholders based on each shareholder's pro rata share.
Schedule K-1 (Form 1120S). An S corporation must file a return on Form 1120S, U.S. Income Tax Return for an S Corporation, and send Schedule K-1 (Form 1120S) to each shareholder. In addition, the S corporation will send each shareholder a copy of the Shareholder's Instructions for Schedule K-1 (Form 1120S) to help each shareholder report his or her share of the S corporation's income, losses, credits, and deductions.
Records: Keep Schedule K-1 (Form 1120S) for your records. Do not attach it to your Form 1040.
For more information on S corporations and their shareholders, see Instructions for Form 1120S.
A recovery is a return of an amount you deducted or took a credit for in an earlier year. The most common recoveries are refunds, reimbursements, and rebates of deductions itemized on Schedule A (Form 1040). You also may have recoveries of non-itemized deductions (such as payments on previously deducted bad debts) and recoveries of items for which you previously claimed a tax credit.
Tax benefit rule. You must include a recovery in your income in the year you receive it up to the amount by which the deduction or credit you took for the recovered amount reduced your tax in the earlier year. For this purpose, any increase to an amount carried over to the current year that resulted from the deduction or credit is considered to have reduced your tax in the earlier year. For more information, see Publication 525.
Federal income tax refund. Refunds of federal income taxes are not included in your income because they are never allowed as a deduction from income.
State tax refund. If you received a state or local income tax refund (or credit or offset) in 2007, you generally must include it in income if you deducted the tax in an earlier year. The payer should send Form 1099-G, Certain Government Payments, to you by January 31, 2008. The IRS also will receive a copy of the Form 1099-G. Use the State and Local Income Tax Refund worksheet in the 2007 Form 1040 instructions for line 10 to figure the amount (if any) to include in your income. See Publication 525 for when you must use another worksheet.
After 2003, you could choose to deduct for a tax year either:
For 2007, the maximum refund that you may have to include in income is limited to the excess of the tax you chose to deduct for that year over the tax you did not choose to deduct for that year. For examples, see Publication 525.
Mortgage interest refund. If you received a refund or credit in 2007 of mortgage interest paid in an earlier year, the amount should be shown in box 3 of your Form 1098, Mortgage Interest Statement. Do not subtract the refund amount from the interest you paid in 2007. You may have to include it in your income under the rules explained in the following discussions.
Interest on recovery. Interest on any of the amounts you recover must be reported as interest income in the year received. For example, report any interest you received on state or local income tax refunds on Form 1040, line 8a.
Recovery and expense in same year. If the refund or other recovery and the expense occur in the same year, the recovery reduces the deduction or credit and is not reported as income.
Recovery for 2 or more years. If you receive a refund or other recovery that is for amounts you paid in 2 or more separate years, you must allocate, on a pro rata basis, the recovered amount between the years in which you paid it. This allocation is necessary to determine the amount of recovery from any earlier years and to determine the amount, if any, of your allowable deduction for this item for the current year. For information on how to compute the allocation, see Recoveries in Publication 525.
If you recover any amount that you deducted in an earlier year on Schedule A (Form 1040), you generally must include the full amount of the recovery in your income in the year you receive it.
Where to report. Enter your state or local income tax refund on Form 1040, line 10, and the total of all other recoveries as other income on Form 1040, line 21. You cannot use Form 1040A or Form 1040EZ.
Standard deduction limit. You generally are allowed to claim the standard deduction if you do not itemize your deductions. Only your itemized deductions that are more than your standard deduction are subject to the recovery rule (unless you are required to itemize your deductions). If your total deductions on the earlier year return were not more than your income for that year, include in your income this year the lesser of:
Example. For 2006, you filed a joint return. Your taxable income was $60,000 and you were not entitled to any tax credits. Your standard deduction was $10,300, and you had itemized deductions of $12,000. In 2007, you received the following recoveries for amounts deducted on your 2006 return:
Medical expenses $200
State and local income tax refund 400
Refund of mortgage interest 325
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Total recoveries $925
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None of the recoveries were more than the deductions taken for 2006. The difference between the state and local income tax you deducted and your local general sales tax was more than $400.
Your total recoveries are less than the amount by which your itemized deductions exceeded the standard deduction ($12,000 - 10,300 = $1,700), so you must include your total recoveries in your income for 2007. Report the state and local income tax refund of $400 on Form 1040, line 10, and the balance of your recoveries, $525, on Form 1040, line 21.
Standard deduction for earlier years. To determine if amounts recovered in 2007 must be included in your income, you must know the standard deduction for your filing status for the year the deduction was claimed. Standard deduction amounts for 2006, 2005, and 2004, are in Publication 525.
Example. You filed a joint return for 2006 with taxable income of $45,000. Your itemized deductions were $10,650. The standard deduction that you could have claimed was $10,300. In 2007, you recovered $2,100 of your 2006 itemized deductions. None of the recoveries were more than the actual deductions for 2006. Include $350 of the recoveries in your 2007 income. This is the smaller of your recoveries ($2,100) or the amount by which your itemized deductions were more than the standard deduction ($10,650 - 10,300 = $350).
Recovery limited to deduction. You do not include in your income any amount of your recovery that is more than the amount you deducted in the earlier year. The amount you include in your income is limited to the smaller of:
Example. During 2006 you paid $1,700 for medical expenses. From this amount you subtracted $1,500, which was 7.5% of your adjusted gross income. Your actual medical expense deduction was $200. In 2007, you received a $500 reimbursement from your medical insurance for your 2006 expenses. The only amount of the $500 reimbursement that must be included in your income for 2007 is $200 -- the amount actually deducted.
Other recoveries. See Recoveries in Publication 525 if:
If you rent out personal property, such as equipment or vehicles, how you report your income and expenses is generally determined by:
Generally, if your primary purpose is income or profit and you are involved in the rental activity with continuity and regularity, your rental activity is a business. See Publication 535, Business Expenses, for details on deducting expenses for both business and not-for-profit activities.
Reporting business income and expenses. If you are in the business of renting personal property, report your income and expenses on Schedule C or Schedule C-EZ (Form 1040). The form instructions have information on how to complete them.
Reporting nonbusiness income. If you are not in the business of renting personal property, report your rental income on Form 1040, line 21. List the type and amount of the income on the dotted line next to line 21.
Reporting nonbusiness expenses. If you rent personal property for profit, include your rental expenses in the total amount you enter on Form 1040, line 36. Also enter the amount and "PPR" on the dotted line next to line 36.
If you do not rent personal property for profit, your deductions are limited and you cannot report a loss to offset other income. See Activity not for profit, under Other Income, later.
If you had to repay an amount that you included in your income in an earlier year, you may be able to deduct the amount repaid from your income for the year in which you repaid it. Or, if the amount you repaid is more than $3,000, you may be able to take a credit against your tax for the year in which you repaid it. Generally, you can claim a deduction or credit only if the repayment qualifies as an expense or loss incurred in your trade or business or in a for-profit transaction.
Type of deduction. The type of deduction you are allowed in the year of repayment depends on the type of income you included in the earlier year. You generally deduct the repayment on the same form or schedule on which you previously reported it as income. For example, if you reported it as self-employment income, deduct it as a business expense on Schedule C or Schedule C-EZ (Form 1040) or Schedule F (Form 1040). If you reported it as a capital gain, deduct it as a capital loss on Schedule D (Form 1040). If you reported it as wages, unemployment compensation, or other nonbusiness income, deduct it as a miscellaneous itemized deduction on Schedule A (Form 1040).
Repayment of $3,000 or less. If the amount you repaid was $3,000 or less, deduct it from your income in the year you repaid it. If you must deduct it as a miscellaneous itemized deduction, enter it on Schedule A (Form 1040), line 23.
Repayment over $3,000. If the amount you repaid was more than $3,000, you can deduct the repayment (as explained under Type of deduction, earlier). However, you can choose instead to take a tax credit for the year of repayment if you included the income under a claim of right. This means that at the time you included the income, it appeared that you had an unrestricted right to it. If you qualify for this choice, figure your tax under both methods and compare the results. Use the method (deduction or credit) that results in less tax.
Method 1. Figure your tax for 2007 claiming a deduction for the repaid amount. If you must deduct it as a miscellaneous itemized deduction, enter it on Schedule A (Form 1040), line 28.
Method 2. Figure your tax for 2007 claiming a credit for the repaid amount. Follow these steps.
If method 1 results in less tax, deduct the amount repaid. If method 2 results in less tax, claim the credit figured in (3) above on Form 1040, line 70, and enter "I.R.C. 1341" in the column to the right of line 70.
An example of this computation can be found in Publication 525.
Repaid social security benefits. If you repaid social security benefits, see Repayment of benefits in chapter 11.
Royalties from copyrights, patents, and oil, gas, and mineral properties are taxable as ordinary income.
You generally report royalties in Part I of Schedule E (Form 1040). However, if you hold an operating oil, gas, or mineral interest or are in business as a self-employed writer, inventor, artist, etc., report your income and expenses on Schedule C or Schedule C-EZ (Form 1040).
Copyrights and patents. Royalties from copyrights on literary, musical, or artistic works, and similar property, or from patents on inventions, are amounts paid to you for the right to use your work over a specified period of time. Royalties generally are based on the number of units sold, such as the number of books, tickets to a performance, or machines sold.
Oil, gas, and minerals. Royalty income from oil, gas, and mineral properties is the amount you receive when natural resources are extracted from your property. The royalties are based on units, such as barrels, tons, etc., and are paid to you by a person or company who leases the property from you.
Depletion. If you are the owner of an economic interest in mineral deposits or oil and gas wells, you can recover your investment through the depletion allowance. For information on this subject, see chapter 9 of Publication 535.
Coal and iron ore. Under certain circumstances, you can treat amounts you receive from the disposal of coal and iron ore as payments from the sale of a capital asset, rather than as royalty income. For information about gain or loss from the sale of coal and iron ore, see Publication 544.
Sale of property interest. If you sell your complete interest in oil, gas, or mineral rights, the amount you receive is considered payment for the sale of section 1231 property, not royalty income. Under certain circumstances, the sale is subject to capital gain or loss treatment on Schedule D (Form 1040). For more information on selling section 1231 property, see chapter 3 of Publication 544.
If you retain a royalty, an overriding royalty, or a net profit interest in a mineral property for the life of the property, you have made a lease or a sublease, and any cash you receive for the assignment of other interests in the property is ordinary income subject to a depletion allowance.
Part of future production sold. If you own mineral property but sell part of the future production, you generally treat the money you receive from the buyer at the time of the sale as a loan from the buyer. Do not include it in your income or take depletion based on it.
When production begins, you include all the proceeds in your income, deduct all the production expenses, and deduct depletion from that amount to arrive at your taxable income from the property.
The tax treatment of unemployment benefits you receive depends on the type of program paying the benefits.
Unemployment compensation. You must include in your income all unemployment compensation you receive. You should receive a Form 1099-G, Certain Government Payments, showing the amount paid to you. Generally, you enter unemployment compensation on line 19 of Form 1040, line 13 of Form 1040A, or line 3 of Form 1040EZ.
Types of unemployment compensation. Unemployment compensation generally includes any amount received under an unemployment compensation law of the United States or of a state. It includes the following benefits.
Governmental program. If you contribute to a governmental unemployment compensation program and your contributions are not deductible, amounts you receive under the program are not included as unemployment compensation until you recover your contributions. If you deducted all of your contributions to the program, the entire amount you receive under the program is included in your income.
Repayment of unemployment compensation. If you repaid in 2007 unemployment compensation you received in 2007, subtract the amount you repaid from the total amount you received and enter the difference on line 19 of Form 1040, line 13 of Form 1040A, or line 3 of Form 1040EZ. On the dotted line next to your entry enter "Repaid" and the amount you repaid. If you repaid unemployment compensation in 2007 that you included in income in an earlier year, you can deduct the amount repaid on Schedule A (Form 1040), line 23, if you itemize deductions. If the amount is more than $3,000, see Repayments, earlier.
Tax withholding. You can choose to have federal income tax withheld from your unemployment compensation. To make this choice, complete Form W-4V, Voluntary Withholding Request, and give it to the paying office. Tax will be withheld at 10% of your payment.
Caution: If you do not choose to have tax withheld from your unemployment compensation, you may be liable for estimated tax. For more information on estimated tax, see chapter 4.
Supplemental unemployment benefits. Benefits received from an employer-financed fund (to which the employees did not contribute) are not unemployment compensation. They are taxable as wages and are subject to withholding for income tax. They may be subject to social security and Medicare taxes. For more information, see Supplemental Unemployment Benefits in section 5 of Publication 15-A, Employer's Supplemental Tax Guide. Report these payments on line 7 of Form 1040 or Form 1040A or on line 1 of Form 1040EZ.
Repayment of benefits. You may have to repay some of your supplemental unemployment benefits to qualify for trade readjustment allowances under the Trade Act of 1974. If you repay supplemental unemployment benefits in the same year you receive them, reduce the total benefits by the amount you repay. If you repay the benefits in a later year, you must include the full amount of the benefits received in your income for the year you received them.
Deduct the repayment in the later year as an adjustment to gross income on Form 1040. (You cannot use Form 1040A or Form 1040EZ.) Include the repayment on Form 1040, line 36, and enter "Sub-Pay TRA" and the amount on the dotted line next to line 36. If the amount you repay in a later year is more than $3,000, you may be able to take a credit against your tax for the later year instead of deducting the amount repaid. For more information on this, see Repayments, earlier.
Private unemployment fund. Unemployment benefit payments from a private (nonunion) fund to which you voluntarily contribute are taxable only if the amounts you receive are more than your total payments into the fund. Report the taxable amount on Form 1040, line 21.
Payments by a union. Benefits paid to you as an unemployed member of a union from regular union dues are included in your income on Form 1040, line 21. However, if you contribute to a special union fund and your payments to the fund are not deductible, the unemployment benefits you receive from the fund are includible in your income only to the extent they are more than your contributions.
Guaranteed annual wage. Payments you receive from your employer during periods of unemployment, under a union agreement that guarantees you full pay during the year, are taxable as wages. Include them on line 7 of Form 1040 or Form 1040A or on line 1 of Form 1040EZ.
State employees. Payments similar to a state's unemployment compensation may be made by the state to its employees who are not covered by the state's unemployment compensation law. Although the payments are fully taxable, do not report them as unemployment compensation. Report these payments on Form 1040, line 21.
Do not include in your income governmental benefit payments from a public welfare fund based upon need, such as payments due to blindness. Payments from a state fund for the victims of crime should not be included in the victims' incomes if they are in the nature of welfare payments. Do not deduct medical expenses that are reimbursed by such a fund. You must include in your income any welfare payments that are compensation for services or that are obtained fraudulently.
Alternative trade adjustment assistance (ATAA) payments. Payments you receive from a state agency under the Demonstration Project for Alternative Trade Adjustment Assistance for Older Workers (ATAA) must be included in your income. The state must send you Form 1099-G to advise you of the amount you should include in income. The amount should be reported on Form 1040, line 21.
Persons with disabilities. If you have a disability, you must include in income compensation you receive for services you perform unless the compensation is otherwise excluded. However, you do not include in income the value of goods, services, and cash that you receive, not in return for your services, but for your training and rehabilitation because you have a disability. Excludable amounts include payments for transportation and attendant care, such as interpreter services for the deaf, reader services for the blind, and services to help mentally retarded persons do their work.
Disaster relief grants. Do not include post-disaster grants received under the Disaster Relief and Emergency Assistance Act in your income if the grant payments are made to help you meet necessary expenses or serious needs for medical, dental, housing, personal property, transportation, or funeral expenses. Do not deduct casualty losses or medical expenses that are specifically reimbursed by these disaster relief grants. If you have deducted a casualty loss for the loss of your personal residence and you later receive a disaster relief grant for the loss of the same residence, you may have to include part or all of the grant in your taxable income. See Recoveries, earlier. Unemployment assistance payments under the Act are taxable unemployment compensation. See Unemployment compensation under Unemployment Benefits, earlier.
Disaster relief payments. You can exclude from income any amount you receive that is a qualified disaster relief payment. A qualified disaster relief payment is an amount paid to you:
You can exclude this amount only to the extent any expense it pays for is not paid for by insurance or otherwise. The exclusion does not apply if you were a participant or conspirator in a terrorist action or his or her representative.
A qualified disaster is:
For amounts paid under item (4), a disaster is qualified if it is determined by an applicable federal, state, or local authority to warrant assistance from the federal, state, or local government, agency, or instrumentality.
Disaster mitigation payments. You also can exclude from income any amount you receive that is a qualified disaster mitigation payment. Like qualified disaster relief payments, qualified disaster mitigation payments are also most commonly paid to you in the period immediately following damage to property as a result of a natural disaster. However, disaster mitigation payments are grants you use to mitigate (reduce the severity of) potential damage from future natural disasters. They are paid to you through state and local governments based on the provisions of the Robert T. Stafford Disaster Relief and Emergency Assistance Act or the National Flood Insurance Act.
You cannot increase the basis or adjusted basis of your property for improvements made with nontaxable disaster mitigation payments.
Mortgage assistance payments. Payments made under section 235 of the National Housing Act for mortgage assistance are not included in the homeowner's income. Interest paid for the homeowner under the mortgage assistance program cannot be deducted.
Medicare. Medicare benefits received under title XVIII of the Social Security Act are not includible in the gross income of the individuals for whom they are paid. This includes basic (part A (Hospital Insurance Benefits for the Aged)) and supplementary (part B (Supplementary Medical Insurance Benefits for the Aged)).
Old-age, survivors, and disability insurance benefits (OASDI). OASDI payments under section 202 of title II of the Social Security Act are not includible in the gross income of the individuals to whom they are paid. This applies to old-age insurance benefits, and insurance benefits for wives, husbands, children, widows, widowers, mothers and fathers, and parents, as well as the lump-sum death payment.
Nutrition Program for the Elderly. Food benefits you receive under the Nutrition Program for the Elderly are not taxable. If you prepare and serve free meals for the program, include in your income as wages the cash pay you receive, even if you are also eligible for food benefits.
Payments to reduce cost of winter energy. Payments made by a state to qualified people to reduce their cost of winter energy use are not taxable.
The following brief discussions are arranged in alphabetical order. Income items that are discussed in greater detail in another publication include a reference to that publication.
Activity not for profit. You must include on your return income from an activity from which you do not expect to make a profit. An example of this type of activity is a hobby or a farm you operate mostly for recreation and pleasure. Enter this income on Form 1040, line 21. Deductions for expenses related to the activity are limited. They cannot total more than the income you report and can be taken only if you itemize deductions on Schedule A (Form 1040). See Not-for-Profit Activities in chapter 1 of Publication 535 for information on whether an activity is considered carried on for a profit.
Alaska Permanent Fund dividend. If you received a payment from Alaska's mineral income fund (Alaska Permanent Fund dividend), report it as income on line 21 of Form 1040, line 13 of Form 1040A, or line 3 of Form 1040EZ. The state of Alaska sends each recipient a document that shows the amount of the payment with the check. The amount also is reported to IRS.
Alimony. Include in your income on Form 1040, line 11, any alimony payments you receive. Amounts you receive for child support are not income to you. Alimony and child support payments are discussed in chapter 18.
Bribes. If you receive a bribe, include it in your income.
Campaign contributions. These contributions are not income to a candidate unless they are diverted to his or her personal use. To be exempt from tax, the contributions must be spent for campaign purposes or kept in a fund for use in future campaigns. However, interest earned on bank deposits, dividends received on contributed securities, and net gains realized on sales of contributed securities are taxable and must be reported on Form 1120-POL, U.S. Income Tax Return for Certain Political Organizations. Excess campaign funds transferred to an office account must be included in the officeholder's income on Form 1040, line 21, in the year transferred.
Cash rebates. A cash rebate you receive from a dealer or manufacturer of an item you buy is not income, but you must reduce your basis by the amount of the rebate.
Example. You buy a new car for $9,000 cash and receive a $400 rebate check from the manufacturer. The $400 is not income to you. Your basis in the car is $8,600. This is your basis on which you figure gain or loss if you sell the car, and depreciation if you use it for business.
Casualty insurance and other reimbursements. You generally should not report these reimbursements on your return, unless you are figuring gain or loss from the casualty or theft. See Publication 547, Casualties, Disasters, and Thefts, for more information.
Child support payments. You should not report these payments on your return. See Publication 504, Divorced or Separated Individuals, for more information.
Court awards and damages. To determine if settlement amounts you receive by compromise or judgment must be included in your income, you must consider the item that the settlement replaces. The character of the income as ordinary income or capital gain depends on the nature of the underlying claim. Include the following as ordinary income.
Do not include in your income compensatory damages for personal physical injury or physical sickness (whether received in a lump sum or installments).
Emotional distress. Emotional distress itself is not a physical injury or physical sickness, but damages you receive for emotional distress due to a physical injury or sickness are treated as received for the physical injury or sickness. Do not include them in your income.
If the emotional distress is due to a personal injury that is not due to a physical injury or sickness (for example, employment discrimination or injury to reputation), you must include the damages in your income, except for any damages you receive for medical care due to that emotional distress. Emotional distress includes physical symptoms that result from emotional distress, such as headaches, insomnia, and stomach disorders.
Deduction for costs involved in unlawful discrimination suits. You may be able to deduct attorney fees and court costs paid to recover a judgment or settlement for a claim of unlawful discrimination under various provisions of federal, state, and local law listed in Internal Revenue Code section 62(e), a claim against the United States government, or a claim under section 1862(b)(3)(A) of the Social Security Act. For more information, see Publication 525.
Credit card insurance. Generally, if you receive benefits under a credit card disability or unemployment insurance plan, the benefits are taxable to you. These plans make the minimum monthly payment on your credit card account if you cannot make the payment due to injury, illness, disability, or unemployment. Report on Form 1040, line 21, the amount of benefits you received during the year that is more than the amount of the premiums you paid during the year.
Down payment assistance. If you purchase a home and receive assistance from a nonprofit corporation to make the down payment, that assistance is not included in your income. If the corporation qualifies as a tax-exempt charitable organization, the assistance is treated as a gift and is included in your basis of the house. If the corporation does not qualify, the assistance is treated as a rebate or reduction of the purchase price and is not included in your basis.
Employment agency fees. If you get a job through an employment agency, and the fee is paid by your employer, the fee is not includible in your income if you are not liable for it. However, if you pay it and your employer reimburses you for it, it is includible in your income.
Energy conservation subsidies. You can exclude from gross income any subsidy provided, either directly or indirectly, by public utilities for the purchase or installation of an energy conservation measure for a dwelling unit.
Energy conservation measure. This includes installations or modifications that are primarily designed to reduce consumption of electricity or natural gas, or improve the management of energy demand.
Dwelling unit. This includes a house, apartment, condominium, mobile home, boat, or similar property. If a building or structure contains both dwelling and other units, any subsidy must be properly allocated.
Estate and trust income. An estate or trust, unlike a partnership, may have to pay federal income tax. If you are a beneficiary of an estate or trust, you may be taxed on your share of its income distributed or required to be distributed to you. However, there is never a double tax. Estates and trusts file their returns on Form 1041, U.S. Income Tax Return for Estates and Trusts, and your share of the income is reported to you on Schedule K-1 (Form 1041).
Current income required to be distributed. If you are the beneficiary of an estate or trust that must distribute all of its current income, you must report your share of the distributable net income, whether or not you actually received it.
Current income not required to be distributed. If you are the beneficiary of an estate or trust and the fiduciary has the choice of whether to distribute all or part of the current income, you must report:
up to the amount of your share of distributable net income.
How to report. Treat each item of income the same way that the estate or trust would treat it. For example, if a trust's dividend income is distributed to you, you report the distribution as dividend income on your return. The same rule applies to distributions of tax-exempt interest and capital gains.
The fiduciary of the estate or trust must tell you the type of items making up your share of the estate or trust income and any credits you are allowed on your individual income tax return.
Losses. Losses of estates and trusts generally are not deductible by the beneficiaries.
Grantor trust. Income earned by a grantor trust is taxable to the grantor, not the beneficiary, if the grantor keeps certain control over the trust. (The grantor is the one who transferred property to the trust.) This rule applies if the property (or income from the property) put into the trust will or may revert (be returned) to the grantor or the grantor's spouse.
Generally, a trust is a grantor trust if the grantor has a reversionary interest valued (at the date of transfer) at more than 5% of the value of the transferred property.
Expenses paid by another. If your personal expenses are paid for by another person, such as a corporation, the payment may be taxable to you depending upon your relationship with that person and the nature of the payment. But if the payment makes up for a loss caused by that person, and only restores you to the position you were in before the loss, the payment is not includible in your income.
Fees for services. Include all fees for your services in your income. Examples of these fees are amounts you receive for services you perform as:
Nonemployee compensation. If you are not an employee and the fees for your services from the same payer total $600 or more for the year, you may receive a Form 1099-MISC. You may need to report your fees as self-employment income. See Self-Employed Persons, in chapter 1, for a discussion of when you are considered self-employed.
Corporate director. Corporate director fees are self-employment income. Report these payments on Schedule C or Schedule C-EZ (Form 1040).
Personal representatives. All personal representatives must include in their gross income fees paid to them from an estate. If you are not in the trade or business of being an executor (for instance, you are the executor of a friend's or relative's estate), report these fees on Form 1040, line 21. If you are in the trade or business of being an executor, report these fees as self-employment income on Schedule C or Schedule C-EZ (Form 1040). The fee is not includible in income if it is waived.
Manager of trade or business for bankruptcy estate. Include in your income all payments received from your bankruptcy estate for managing or operating a trade or business that you operated before you filed for bankruptcy. Report this income on Form 1040, line 21.
Notary public. Report payments for these services on Schedule C or Schedule C-EZ (Form 1040). These payments are not subject to self-employment tax. (See the separate instructions for Schedule SE (Form 1040) for details.)
Election precinct official. You should receive a Form W-2 showing payments for services performed as an election official or election worker. Report these payments on line 7 of Form 1040 or Form 1040A or on line 1 of Form 1040EZ.
Foster care providers. Payments you receive from a state, political subdivision, or a qualified foster care placement agency for providing care to qualified foster individuals in your home generally are not included in your income. However, you must include in your income payments received for the care of more than 5 individuals age 19 or older and certain difficulty-of-care payments.
A qualified foster individual is a person who:
Difficulty-of-care payments. These are additional payments that are designated by the payer as compensation for providing the additional care that is required for physically, mentally, or emotionally handicapped qualified foster individuals. A state must determine that the additional compensation is needed, and the care for which the payments are made must be provided in your home.
You must include in your income difficulty-of-care payments received for more than:
Maintaining space in home. If you are paid to maintain space in your home for emergency foster care, you must include the payment in your income.
Reporting taxable payments. If you receive payments that you must include in your income, you are in business as a foster care provider and you are self-employed. Report the payments on Schedule C or Schedule C-EZ (Form 1040). See Publication 587, Business Use of Your Home (Including Use by Daycare Providers), to help you determine the amount you can deduct for the use of your home.
Found property. If you find and keep property that does not belong to you that has been lost or abandoned (treasure-trove), it is taxable to you at its fair market value in the first year it is your undisputed possession.
Free tour. If you received a free tour from a travel agency for organizing a group of tourists, you must include its value in your income. Report the fair market value of the tour on Form 1040, line 21, if you are not in the trade or business of organizing tours. You cannot deduct your expenses in serving as the voluntary leader of the group at the group's request. If you organize tours as a trade or business, report the tour's value on Schedule C or Schedule C-EZ (Form 1040).
Gambling winnings. You must include your gambling winnings in income on Form 1040, line 21. If you itemize your deductions on Schedule A (Form 1040), you can deduct gambling losses you had during the year, but only up to the amount of your winnings. See chapter 28 for information on recordkeeping.
Lotteries and raffles. Winnings from lotteries and raffles are gambling winnings. In addition to cash winnings, you must include in your income the fair market value of bonds, cars, houses, and other noncash prizes.
Tip: If you win a state lottery prize payable in installments, see Publication 525 for more information.
Form W-2G. You may have received a Form W-2G, Certain Gambling Winnings, showing the amount of your gambling winnings and any tax taken out of them. Include the amount from box 1 on Form 1040, line 21. Include the amount shown in box 2 on Form 1040, line 64, as federal income tax withheld.
Gifts and inheritances. Generally, property you receive as a gift, bequest, or inheritance is not included in your income. However, if property you receive this way later produces income such as interest, dividends, or rents, that income is taxable to you. If property is given to a trust and the income from it is paid, credited, or distributed to you, that income is also taxable to you. If the gift, bequest, or inheritance is the income from the property, that income is taxable to you.
Inherited pension or IRA. If you inherited a pension or an individual retirement arrangement (IRA), you may have to include part of the inherited amount in your income. See chapter 10 if you inherited a pension. See chapter 17 if you inherited an IRA.
Hobby losses. Losses from a hobby are not deductible from other income. A hobby is an activity from which you do not expect to make a profit. See Activity not for profit, earlier.
Caution: If you collect stamps, coins, or other items as a hobby for recreation and pleasure, and you sell any of the items, your gain is taxable as a capital gain. (See chapter 16.) However, if you sell items from your collection at a loss, you cannot deduct the loss.
Holocaust victims restitution. Restitution payments you receive as a Holocaust victim (or the heir of a Holocaust victim) and interest earned on the payments, including interest earned on amounts held in certain escrow accounts or funds, are not taxable. You also do not include them in any computations in which you would ordinarily add excludable income to your adjusted gross income, such as the computation to determine the taxable part of social security benefits. If the payments are made in property, your basis in the property is its fair market value when you receive it.
Excludable restitution payments are payments or distributions made by any country or any other entity because of persecution of an individual on the basis of race, religion, physical or mental disability, or sexual orientation by Nazi Germany, any other Axis regime, or any other Nazi-controlled or Nazi-allied country, whether the payments are made under a law or as a result of a legal action. They include compensation or reparation for property losses resulting from Nazi persecution, including proceeds under insurance policies issued before and during World War II by European insurance companies.
Illegal income. Illegal income, such as money from dealing illegal drugs, must be included in your income on Form 1040, line 21, or on Schedule C or Schedule C-EZ (Form 1040) if from your self-employment activity.
Indian fishing rights. If you are a member of a qualified Indian tribe that has fishing rights secured by treaty, executive order, or an Act of Congress as of March 17, 1988, do not include in your income amounts you receive from activities related to those fishing rights. The income is not subject to income tax, self-employment tax, or employment taxes.
Interest on frozen deposits. In general, you exclude from your income the amount of interest earned on a frozen deposit. See Interest income on frozen deposits in chapter 7.
Interest on qualified savings bonds. You may be able to exclude from income the interest from qualified U.S. savings bonds you redeem if you pay qualified higher educational expenses in the same year. For more information on this exclusion, see Education Savings Bond Program under U.S. Savings Bonds in chapter 7.
Job interview expenses. If a prospective employer asks you to appear for an interview and either pays you an allowance or reimburses you for your transportation and other travel expenses, the amount you receive is generally not taxable. You include in income only the amount you receive that is more than your actual expenses.
Jury duty. Jury duty pay you receive must be included in your income on Form 1040, line 21. If you must give the pay to your employer because your employer continues to pay your salary while you serve on the jury, you can deduct the amount turned over to your employer as an adjustment to your income. Enter the amount you repay your employer on Form 1040, line 36. Enter "Jury Pay" and the amount on the dotted line next to line 36.
Kickbacks. You must include kickbacks, side commissions, push money, or similar payments you receive in your income on Form 1040, line 21, or on Schedule C or Schedule C-EZ (Form 1040), if from your self-employment activity.
Example. You sell cars and help arrange car insurance for buyers. Insurance brokers pay back part of their commissions to you for referring customers to them. You must include the kickbacks in your income.
Medical savings accounts (MSAs). You generally do not include in income amounts you withdraw from your Archer MSA or Medicare Advantage MSA if you use the money to pay for qualified medical expenses. Generally, qualified medical expenses are those you can deduct on Schedule A (Form 1040), Itemized Deductions. For more information about qualified medical expenses, see chapter 21. For more information about Archer MSAs or Medicare Advantage MSAs, see Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans.
Prizes and awards. If you win a prize in a lucky number drawing, television or radio quiz program, beauty contest, or other event, you must include it in your income. For example, if you win a $50 prize in a photography contest, you must report this income on Form 1040, line 21. If you refuse to accept a prize, do not include its value in your income.
Prizes and awards in goods or services must be included in your income at their fair market value.
Employee awards or bonuses. Cash awards or bonuses given to you by your employer for good work or suggestions generally must be included in your income as wages. However, certain noncash employee achievement awards can be excluded from income. See Bonuses and awards in chapter 5.
Pulitzer, Nobel, and similar prizes. If you were awarded a prize in recognition of accomplishments in religious, charitable, scientific, artistic, educational, literary, or civic fields, you generally must include the value of the prize in your income. However, you do not include this prize in your income if you meet all of the following requirements.
See Publication 525 for more information about the conditions that apply to the transfer.
Qualified tuition programs (QTPs). A qualified tuition program (also known as a 529 program) is a program set up to allow you to either prepay or contribute to an account established for paying a student's qualified higher education expenses at an eligible educational institution. A program can be established and maintained by a state, an agency or instrumentality of a state, or an eligible educational institution.
The part of a distribution representing the amount paid or contributed to a QTP is not included in income. This is a return of the investment in the program.
The beneficiary generally does not include in income any earnings distributed from a QTP if the total distribution is less than or equal to adjusted qualified higher education expenses. See Publication 970 for more information.
Railroad retirement annuities. The following types of payments are treated as pension or annuity income and are taxable under the rules explained in chapter 11.
Rewards. If you receive a reward for providing information, include it in your income.
Sale of home. You may be able to exclude from income all or part of any gain from the sale or exchange of a personal residence. See chapter 15.
Sale of personal items. If you sold an item you owned for personal use, such as a car, refrigerator, furniture, stereo, jewelry, or silverware, your gain is taxable as a capital gain. Report it on Schedule D (Form 1040). You cannot deduct a loss.
However, if you sold an item you held for investment, such as gold or silver bullion, coins, or gems, any gain is taxable as a capital gain and any loss is deductible as a capital loss.
Example. You sold a painting on an online auction website for $100. You bought the painting for $20 at a garage sale years ago. Report your gain as a capital gain on Schedule D (Form 1040).
Scholarships and fellowships. A candidate for a degree can exclude amounts received as a qualified scholarship or fellowship. A qualified scholarship or fellowship is any amount you receive that is for:
Amounts used for room and board do not qualify for the exclusion. See Publication 970 for more information on qualified scholarships and fellowship grants.
Payment for services. Generally, you must include in income the part of any scholarship or fellowship that represents payment for past, present, or future teaching, research, or other services. This applies even if all candidates for a degree must perform the services to receive the degree.
For information about the rules that apply to a tax-free qualified tuition reduction provided to employees and their families by an educational institution, see Publication 970.
VA payments. Allowances paid by the Department of Veterans Affairs are not included in your income. These allowances are not considered scholarship or fellowship grants.
Prizes. Scholarship prizes won in a contest are not scholarships or fellowships if you do not have to use the prizes for educational purposes. You must include these amounts in your income on Form 1040, line 21, whether or not you use the amounts for educational purposes.
Stolen property. If you steal property, you must report its fair market value in your income in the year you steal it unless in the same year, you return it to its rightful owner.
Transporting school children. Do not include in your income a school board mileage allowance for taking children to and from school if you are not in the business of taking children to school. You cannot deduct expenses for providing this transportation.
Union benefits and dues. Amounts deducted from your pay for union dues, assessments, contributions, or other payments to a union cannot be excluded from your income.
You may be able to deduct some of these payments as a miscellaneous deduction subject to the 2% of AGI limit if they are related to your job and if you itemize deductions on Schedule A (Form 1040). For more information, see Union Dues and Expenses in chapter 28.
Strike and lockout benefits. Benefits paid to you by a union as strike or lockout benefits, including both cash and the fair market value of other property, are usually included in your income as compensation. You can exclude these benefits from your income only when the facts clearly show that the union intended them as gifts to you.
Utility rebates. If you are a customer of an electric utility company and you participate in the utility's energy conservation program, you may receive on your monthly electric bill either:
The amount of the rate reduction or nonrefundable credit is not included in your income.
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Part One. The Income Tax Return
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