Publication 525 |
2000 Tax Year |
Employee Compensation
Generally, you must include
in gross income everything you receive in payment for personal
services. In addition to wages, salaries, commissions, fees, and tips,
this includes other forms of compensation such as fringe benefits and
stock options.
You should receive a Form W-2, Wage and Tax Statement,
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.
Child-care providers.
If you provide child care,
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, Profit or Loss from Business,
or Schedule C-EZ, Net Profit or Loss from Business,
of Form 1040. You are generally 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 child-care providers apply to you.
Miscellaneous Compensation
This section discusses many types of employee compensation. The
subjects are arranged in alphabetical order.
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 to include in your income by the
repayment. However, if you repay the unearned commissions or other
amounts 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, later.
Allowances and reimbursements.
If you receive
travel, transportation, or other business expense allowances or
reimbursements from your employer, get Publication 463,
Travel,
Entertainment, Gift, and Car Expenses. If you are reimbursed for
moving expenses, get 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 can exclude its value from your income to
the extent of your employer's cost for all such awards you receive
during the year up to $1,600 ($400 for awards that are not qualified
plan awards). 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.
- A length-of-service award if you received it for fewer than
5 years of service or if you received another length-of-service award
during the year or the previous 4 years.
- A safety achievement award if you are a manager,
administrator, clerical employee, or other professional employee or if
more than 10% of eligible employees previously received safety
achievement awards during the year.
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, since 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 are generally included
in your income. However, these allowances are generally 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, get Publication 516,
U.S. Government Civilian Employees Stationed Abroad.
Cost-of-living allowances paid to Red Cross staff members stationed
outside the 48 contiguous states and the District of Columbia are
included in salary or wages.
Holiday gifts.
If your employer gives you a
turkey, ham, or other item of nominal value at Christmas or other
holidays, you do not have to 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.
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 an 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.
Amounts you receive as severance
pay are taxable. A lump-sum payment for cancellation of your
employment contract is income in the tax year you receive it and must
be reported in gross income.
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 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. You should attach to
your tax return a copy of the receipt or statement given to you by the
agency to which you make repayment to explain the difference between
the wages on your 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
resum� 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% 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.
- A welfare fund.
- A state sickness or disability fund.
- An association of employers or employees.
- An insurance company, if your employer paid for the
plan.
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 Other Sickness and Injury
Benefits under Sickness and Injury Benefits, later.
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 is also 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 income in the year
you use the right.
Work-training programs.
If you are enrolled in a
state or local work-training program under the Economic Opportunity
Act of 1964, payments you receive from the sponsor as compensation for
services are taxable wages.
Fringe Benefits
Fringe benefits you receive 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.
See Valuation of Fringe Benefits, later, in this
discussion, for information on how to determine the amount to include
in income.
Recipient of fringe benefit.
You are the
recipient of a fringe benefit if you perform the services for which
the fringe benefit is provided. You are considered to be the recipient
even if it is given to another person, such as a member of your
family. An example is a car your employer gives to your spouse for
services you perform. The car is considered to have been provided to
you and not to your spouse.
You do not have to be an employee of the provider to be a recipient
of a fringe benefit. If you are a partner, director, or independent
contractor, you can also be the recipient of a fringe benefit.
Provider of benefit.
Your employer or another
person for whom you perform services is the provider of a fringe
benefit regardless of whether that person actually provides the fringe
benefit to you. The provider can be a client or customer of an
independent contractor.
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.
- The general rule: benefits are reported for a full calendar
year (January 1 - December 31).
- The special accounting period rule: benefits provided during
the last 2 months of the calendar year (or any shorter period) are
treated as paid during the following calendar year. For example, each
year your employer reports the value of benefits provided during the
last 2 months of the prior year and the first 10 months of the current
year.
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 may also be
noted in box 12. 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 12.
Accident or Health Plan
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 are generally taxable, as explained later under Sickness and
Injury Benefits.
Long-term care coverage.
Contributions by
your employer to provide coverage for long-term care services are
generally not included in 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.
Medical savings account contributions.
Contributions by your employer to your
medical savings account are not included in your income. Their total
will be reported in box 13 of Form W-2 with code R designating
that it is excludable from income. You must report this amount on Form
8853, Medical Savings Accounts and Long-Term Care Insurance
Contracts, and attach the form to your return.
Executive health program.
If your employer
pays for a fitness program provided to you at an off-site resort hotel
or athletic club, the value of the program is included in your
compensation.
Adoption Assistance
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. The amounts must be paid or the expenses must be
incurred before January 1, 2002, as part of an adoption assistance
program. See Publication 968,
Tax Benefits for Adoption,
for more information.
Adoption benefits are reported by your employer in box 13 of Form
W-2 with code T. They are also 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.
Attach the form to your return.
Dependent Care Benefits
Dependent care benefits include:
- Amounts your employer pays directly to either you or your
care provider for the care of your qualifying person while you work,
and
- The fair market value of care in a day-care facility
provided or sponsored by your employer.
If your employer provides dependent care benefits under a qualified
plan, you may be able to exclude these benefits from your income. Your
employer can tell you whether your benefit plan qualifies. If it does,
you must complete Part III of either Form 2441, Child and
Dependent Care Expenses, or Schedule 2 (Form 1040A), Child
and Dependent Care Expenses for Form 1040A Filers, to claim the
exclusion. You cannot use Form 1040EZ.
The amount you can exclude is limited to the smallest of:
- The total amount of dependent care benefits you received
during the year,
- The total amount of qualified expenses you incurred during
the year,
- Your earned income,
- Your spouse's earned income, or
- $5,000 ($2,500 if married filing separately).
Your employer must show the total amount of dependent care benefits
provided to you during the year under a qualified plan in box 10 of
your Form W-2. Your employer will also include any dependent
care benefits over $5,000 in your wages shown in box 1 of your Form
W-2.
See the instructions for Form 2441 or Schedule 2 (Form 1040A) for
more information.
Educational Assistance
You can exclude from your income up to $5,250 of qualified
employer-provided educational assistance. The exclusion applies to
courses beginning before 2002. The exclusion does not apply to
graduate-level courses. For more information, get Publication 508,
Tax Benefits for Work-Related Education.
Financial Counseling Fees
Financial
counseling fees paid for you by your employer are included in your
income and must be reported as part of wages. If the fees are for tax
or investment counseling, they can be deducted on Schedule A (Form
1040) as a miscellaneous itemized deduction subject to the 2% limit.
Group-Term Life Insurance
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 to
the extent it is more than the cost of $50,000 of coverage reduced by
any amount you pay towards the purchase of the insurance.
For exceptions to this rule, 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 is also shown separately in box 13 with code
C.
Former employer.
If your former employer provides 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. It is also
shown separately in box 13 with code C. Box 13 will also 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 57, Form 1040, and
enter "UT" and the amount of the taxes on the dotted line next to
line 57.
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.
See Figuring the taxable cost, later. Reduce the amount you
figure by any amount reported with code C in box 13 of your Forms
W-2, add the result to the wages reported in box 1, and report
the total on your return.
Group-term life insurance.
This insurance is term life insurance protection (insurance for a
fixed period of time) that:
- Provides a general death benefit,
- Is provided to a group of employees,
- Is provided under a policy carried by the employer, and
- Provides an amount of insurance to each employee based on a
formula that prevents individual selection.
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.
Figuring the taxable cost.
You figure the taxable cost for each month of coverage by
multiplying the number of thousands of dollars of insurance coverage
for the month (figured to the nearest tenth), less 50, by the cost
from the following table. Use your age on the last day of the tax
year. You must prorate the cost from the table if less than a full
month of coverage is involved.
Cost Per $1,000 of Protection
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 |
Your payment.
If you pay any part of the cost of the insurance, your entire
payment reduces, dollar for dollar, the amount you would otherwise
include in your income. However, you cannot reduce the amount to
include in your income by:
- Payments for coverage in a different tax year,
- Payments for coverage through a cafeteria plan, unless the
payments are after-tax contributions, or
- Payments for coverage not taxed to you because of the
exceptions discussed later under Entire cost
excluded.
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:
Employer A coverage (in thousands) |
$ 35 |
Employer B coverage (in thousands) |
+ 45 |
Total coverage (in thousands) |
$ 80 |
Minus: Exclusion (in thousands) |
- 50 |
Excess amount (in thousands) |
$ 30 |
Multiply by cost per $1,000 per month,
age 51 (from table) |
x .23 |
Cost of excess insurance for 1 month |
$ 6.90 |
Multiply by number of full months
coverage at this cost |
x 12 |
Cost of excess insurance for tax year |
$82.80 |
Minus: Premiums you paid |
-49.80 |
Cost to include in income as wages |
$33.00 |
The total amount to include in income for the cost of excess
group-term life insurance is $33. Because neither employer provided
over $50,000 insurance coverage, the wages shown on your Forms
W-2 do not include any part of that $33. You must add it to the
wages shown on your Forms W-2 and include the total on your
return.
Entire cost excluded.
You are not taxed on the cost of group-term life insurance if any
of the following circumstances apply.
- You are permanently and totally disabled and have ended your
employment.
- Your employer is the beneficiary of the policy for the
entire period the insurance is in force during the tax year.
- A charitable organization to which contributions are
deductible is the only beneficiary of the policy for the entire period
the insurance is in force during the tax year. (You are not entitled
to a deduction for a charitable contribution for naming a charitable
organization as the beneficiary of your policy.)
- The plan existed on January 1, 1984, and:
- You retired before January 2, 1984, and were covered by the
plan when you retired, or
- You reached age 55 before January 2, 1984, and were employed
by the employer or its predecessor in 1983.
Entire cost taxed.
You are taxed on the entire cost of group-term life insurance if
either of the following circumstances apply.
- The insurance is provided by your employer through a
qualified employees' trust, such as a pension trust or a qualified
annuity plan.
- You are a key employee and your employer's plan
discriminates in favor of key employees.
Meals and Lodging
You do not include in your
income the value of meals and lodging provided to you and your family
by your employer at no charge if the following conditions are met.
- The meals are:
- Furnished on the business premises of your employer, and
- Furnished for the convenience of your employer.
- The lodging is:
- Furnished on the business premises of your employer,
- Furnished for the convenience of your employer, and
- A condition of your employment (you must accept it in order
to be able to properly perform your duties).
Faculty lodging.
If you are an employee of
an educational institution or an academic health center and you are
provided with lodging that does not meet the three conditions above,
you may not have to include in income the value of the lodging.
However, the lodging must be qualified campus lodging, and you must
pay an adequate rent.
Academic health center.
This is an organization that meets the following conditions.
- Its principal purpose or function is to provide medical or
hospital care or medical education or research.
- It receives payments for graduate medical education under
the Social Security Act.
- One of its principal purposes or functions is to provide and
teach basic and clinical medical science and research using its own
faculty.
Qualified campus lodging.
Qualified campus lodging is lodging furnished to you, your spouse,
or one of your dependents by, or on behalf of, the institution or
center for use as a home. The lodging must be located on or near a
campus of the educational institution or academic health center.
Adequate rent.
The amount of rent you pay for the year for qualified campus
lodging is considered adequate if it is at least equal to the smaller
of:
- 5% of the appraised value of the lodging, or
- The average of rentals paid by individuals (other than
employees or students) for comparable lodging held for rent by the
educational institution.
If the amount you pay is less than the smaller of these
amounts, you must include the difference in your income.
The lodging must be appraised by an independent appraiser and the
appraisal must be reviewed on an annual basis.
Example.
Carl Johnson, a sociology professor for State University, rents a
home from the university that is qualified campus lodging. The house
is appraised at $100,000. The average rent paid for comparable
university lodging by persons other than employees or students is
$7,000 a year. Carl pays an annual rent of $5,500. Carl does not
include in his income any rental value since the rent he pays equals
at least 5% of the appraised value of the house (5% x $100,000 =
$5,000). If Carl paid annual rent of only $4,000, he would have to
include $1,000 in his income ($5,000 - $4,000).
Transportation
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:
- Transportation in a commuter highway vehicle (such as a van)
between your home and work place,
- A transit pass, or
- Qualified parking.
Cash reimbursement by your employer for these expenses under a
bona fide reimbursement arrangement is also 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 $65 a
month, regardless of the total value of both benefits.
The exclusion for the qualified parking fringe benefit cannot be
more than $175 a month, regardless of its value.
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:
- For transporting employees between their homes and work
place, and
- On trips during which employees occupy at least half of the
vehicle's adult seating capacity (not including the driver).
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 in a commuter
highway vehicle or carpool. It does not include parking at or near the
employee's home.
Tuition Reduction
You can exclude a qualified tuition reduction from your income.
This is the amount of a reduction in tuition for education (below
graduate level) furnished by an educational institution to an employee
(or former employee) or his or her family. For more information, get
Publication 520.
Valuation of Fringe Benefits
If a fringe benefit is included in your income, the amount included
is generally its value determined under the general valuation
rule or under the special valuation rules. For an
exception, see Group-Term Life Insurance, earlier.
General valuation rule.
You must include in your income the amount by which the fair market
value of the fringe benefit is more than the sum of:
- The amount, if any, you paid for the benefit, and
- The amount, if any, specifically excluded from your income
by law.
If you pay fair market value for a fringe benefit, no amount is
included in your income.
Fair market value.
The fair market value of a fringe benefit is determined by all the
facts and circumstances. It is the amount you would have to pay a
third party to buy or lease the benefit. This is determined without
regard to:
- Your perceived value of the benefit, or
- The amount your employer paid for the benefit.
Employer-provided vehicles.
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.
Under the general valuation rules, the value of an
employer-provided vehicle is the amount you would have to pay a third
party to lease the same or a similar vehicle on the same or comparable
terms in the same geographic area where you use the vehicle. An
example of a comparable lease term is the amount of time the vehicle
is available for your use, such as a 1-year period. The value cannot
be determined by multiplying a cents-per-mile rate times the number of
miles driven unless you prove the vehicle could have been leased on a
cents-per-mile basis.
Flights on employer-provided aircraft.
Under the general valuation rules, if your flight on an
employer-provided piloted aircraft is primarily personal and you
control the use of the aircraft for the flight, the value is the
amount it would cost to charter the flight from a third party.
If there is more than one employee on the flight, the cost to
charter the aircraft must be divided among those employees. The
division must be based on all the facts, including which employee or
employees control the use of the aircraft.
Special valuation rules.
You generally can use a special valuation rule for a fringe benefit
only if your employer uses the rule. If your employer uses a special
valuation rule, you cannot use a different special rule to value that
benefit. You can always use the general valuation rule discussed
earlier, based on facts and circumstances, even if your employer uses
a special rule.
If you and your employer use a special valuation rule, you must
include in your income the amount your employer determines under the
special rule less the sum of:
- Any amount you repaid your employer, and
- Any amount specifically excluded from income by law.
The special valuation rules are the following.
- The automobile lease rule.
- The vehicle cents-per-mile rule.
- The commuting rule.
- The unsafe conditions commuting rule.
- The employer-operated eating-facility rule.
For more information on these rules, see Publication 15-B,
Employer's Tax Guide to Fringe Benefits.
For information on the non-commercial flight and commercial flight
valuation rules, see sections 1.61-21(g) and 1.61-21(h) of
the regulations.
Retirement Plan Contributions
You must include in
income amounts you pay into a retirement plan through payroll
deductions. You recover your contributions tax free when you retire
and receive benefits from the plan. See Publication 575
for
information about the tax treatment of retirement plan benefits.
Employer's contributions to qualified plan.
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.
Employer's contributions to nonqualified plan.
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 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 no longer subject to a substantial risk of forfeiture.
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. It 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.
- Cash or deferred arrangements (section 401(k) plans).
- Section 457 plans.
- The Thrift Savings Plan for federal employees.
- Salary reduction simplified employee pension (SARSEP) plans.
- Simple retirement account (SIMPLE) plans.
- Tax-sheltered annuities.
- Section 501(c)(18)(D) plans. (But see Reporting by
employer, later.)
Limit on deferrals.
For 2000, you generally should not have deferred more than a total
of $10,500 for all qualified plans by which you are
covered. This amount may be further limited if you are a highly
compensated employee. The amount deferred by a highly compensated
employee as a percentage of pay can be no more than 125% of the
average deferral percentage (ADP) of all eligible nonhighly
compensated employees. Your employer or plan administrator can
probably tell you the amount of the deferral limit under this ADP test
and whether it applies to you.
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
limit is not exceeded. Check with your employer or plan administrator
to learn the deferral limit for 2001.
If your deferrals exceed the annual limit, you must notify your
plan by the date required by the plan. If the plan permits, the excess
amount will be distributed to you. If you participate in more than one
plan, you can have the excess paid out of any of the plans that permit
these distributions. You must notify each plan by the date required by
that plan of the amount to be paid from that particular plan. The plan
must then pay you the amount of the excess, along with any income
earned on that amount, by April 15 of the following year (April 16,
2001, for a 2000 excess deferral). See Excess deferrals,
later.
Special limit for deferrals under SIMPLE plans.
If you are a participant in a SIMPLE plan, you generally should not
have deferred more than $6,000 in 2000. Amounts you defer under a
SIMPLE plan count toward the $10,500 overall limit and may affect the
amount you can defer under other elective deferral plans.
Special limit for deferrals under section 457 plans.
If you are a participant in a section 457 plan (a deferred
compensation plan for employees of state or local governments or
tax-exempt organizations), you should generally have deferred no more
than 1/3 of your compensation, up to $8,000 in 2000. Your
plan may also allow a special catch-up limit of up to $15,000 for each
of your last 3 years of service before reaching normal retirement age.
Amounts you defer under other elective deferral plans may affect your
limits under section 457 plans. Amounts you defer under section 457
plans may affect the amount you can defer in tax-sheltered annuities
under the special limit discussed next.
Special limit for tax-sheltered annuities.
If you are a participant in a tax-sheltered annuity plan with at
least 15 years of service for an educational organization, hospital,
home health service agency, health and welfare service agency, church,
or convention or association of churches (or associated organization),
the limit on elective deferrals to the plan for 2000 was $10,500 plus
the smaller of the following amounts.
- $3,000.
- $15,000, reduced by elective deferrals exceeding the basic
amount that you were allowed in earlier years because of this
years-of-service rule.
- $5,000 times the number of your years of service for the
organization, minus the total elective deferrals under the plan for
earlier years.
Reporting by employer.
Your employer generally should not include elective deferrals in
your wages in box 1 of Form W-2. Instead, your employer should
mark the "Deferred compensation" checkbox in box 15 and show the
total amount deferred in box 13.
Section 501(c)(18)(D) contributions.
Wages shown in box 1 of your Form W-2 should not have been
reduced for contributions you made to a section 501(c)(18)(D)
retirement plan. The amount you contributed should be identified with
code "H" in box 13. You may deduct the amount deferred subject to
the limits that apply. Include your deduction in the total on line 32
(Form 1040). Enter the amount and "501(c)(18)" on the dotted line
next to line 32.
Excess deferrals.
If the total you defer is more than the limit for the year, you
must include the excess in your income for the year of the deferral.
File Form 1040 to add the excess deferral amount to your wages on line
7. Do not use Form 1040A or Form 1040EZ to report excess deferral
amounts.
Excess not distributed.
If you do not take out the excess amount, you cannot include it in
the cost of the contract even though you included it in your income.
Therefore, you are taxed twice on the excess deferral left in the
plan--once when you contribute it, and again when you receive it
as a distribution.
Excess distributed to you.
If you take out the excess after the year of the deferral, do not
again include it in your income if you receive the corrective
distribution by April 15 of the following year. If you receive it
later, you must include it in income in both the year of the deferral
and the year you receive it. Any income on the excess deferral taken
out is taxable in the tax year in which you take it out. If you take
out part of the excess deferral and the income on it, allocate the
distribution proportionately between the excess deferral and the
income.
You should receive a Form 1099-R, Distributions From
Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs,
Insurance Contracts, etc., for the year in which the excess
deferral is distributed to you. Use the following rules to report a
corrective distribution shown on Form 1099-R for 2000.
- If the distribution was for a 2000 excess
deferral, your Form 1099-R should have the code "8"
in box 7. Report the excess deferral on your 2000 tax return.
- If the distribution was for a 1999 excess
deferral, your Form 1099-R should have the code "P"
in box 7. If you did not report the excess deferral on your 1999 tax
return, you must file an amended return on Form 1040X. If you did not
receive the distribution by April 17, 2000, you must also report it on
your 2000 tax return.
- If the distribution was for a 1998 excess
deferral, your Form 1099-R should have the code "D"
in box 7. If you did not report the excess deferral on your 1998 tax
return, you must file an amended return on Form 1040X. You must also
report the distribution on your 2000 income tax return.
- If the distribution was for the income earned on
an excess deferral, your Form 1099-R should have the code "8"
in box 7. Report the income on your 2000 income tax return regardless
of when the excess deferral was made.
Report a loss on a corrective distribution of an
excess deferral in the year the excess amount (reduced by the loss) is
distributed to you. Include the loss as a negative amount on line 21
(Form 1040) and identify it as "Loss on Excess Deferral
Distribution."
Even though a corrective distribution of elective deferrals is
reported on Form 1099-R, it is not otherwise treated
as a distribution from the plan. It cannot be rolled over into another
plan, and it is not subject to the additional tax on early
distributions.
Excess Contributions
If you are a highly compensated employee, the total of your
elective deferrals and other contributions made for you for any year
under a section 401(k) plan or SARSEP can be, as a percentage of pay,
no more than 125% of the average deferral percentage (ADP) of all
eligible nonhighly compensated employees. Your employer or plan
administrator should be able to tell you whether this ADP test applies
to you and the amount of elective deferrals allowed under the test.
If the total contributed to the plan is more than the amount
allowed under the ADP test, the excess contributions must be either
distributed to you or recharacterized as after-tax employee
contributions by treating them as distributed to you and then
contributed by you to the plan. You must include the excess
contributions in your income as wages on line 7 of Form 1040. You
cannot use Form 1040A or Form 1040EZ to report excess contribution
amounts.
If you receive excess contributions from a 401(k) plan and any
income earned on the contributions within 2 1/2 months
after the close of the plan year, you must include them in your income
in the year of the deferral. If you receive them later, or receive
less than $100 excess contributions, include the excess contributions
and earnings in your income in the year distributed. If the excess
contributions are recharacterized, you must include them in income in
the year a corrective distribution would have occurred. For a SARSEP,
the employer must notify you by March 15 following the year in which
excess contributions are made that you must withdraw the excess and
earnings. You must include the excess contributions in your income in
the year of the deferral (or the year of the notification if less than
$100) and include the earnings in your income in the year withdrawn.
You should receive a Form 1099-R for the year in which the
excess contributions are distributed to you (or are recharacterized).
Report excess contributions or earnings shown on Form 1099-R for
2000 on your 2000 tax return if code "8" is in box 7. If code
"P" or "D" is in box 7, you may have to file an amended 1999
or 1998 return on Form 1040X to report the excess contributions or
earnings.
Even though a corrective distribution of excess contributions is
reported on Form 1099-R, it is not otherwise treated
as a distribution from the plan. It cannot be rolled over into another
plan, and it is not subject to the additional tax on early
distributions.
Excess Annual Additions
The amount contributed in 2000 to a defined contribution plan is
generally limited to the lesser of 25% of your compensation or
$30,000. Under certain circumstances, contributions that exceed these
limits (excess annual additions) may be corrected by a distribution of
your elective deferrals or a return of your after-tax contributions
and earnings from these contributions.
A corrective payment of excess annual additions consisting of
elective deferrals or earnings from your after-tax contributions is
fully taxable in the year paid. A corrective payment consisting of
your after-tax contributions is not taxable.
If you received a corrective payment of excess annual additions,
you should receive a separate Form 1099-R for the year of the
payment with the code "E" in box 7. Report the total payment
shown in box 1 of Form 1099-R on line 16a of Form 1040 or line
12a of Form 1040A. Report the taxable amount shown in box 2a of Form
1099-R on line 16b of Form 1040 or line 12b of Form 1040A.
Even though a corrective distribution of excess annual additions is
reported on Form 1099-R, it is not otherwise treated
as a distribution from the plan. It cannot be rolled over into another
plan, and it is not subject to the additional tax on early
distributions.
Stock Options
If you receive a nonstatutory option to buy or sell stock or other
property as payment for your services, you will usually have income
either when you receive the option or when you exercise the option
(use it to buy or sell the stock or other property). However, if your
option is a statutory stock option (defined later), you usually will
not have any income until you sell or exchange your stock. Your
employer can tell you which kind of option you hold.
Nonstatutory Stock Options
If you are granted a nonstatutory stock option, the amount of
income to include and the time to include it depend on whether the
fair market value of the option can be readily determined. The fair
market value of an option can be readily determined if it is actively
traded on an established market.
The fair market value of an option that is not traded on an
established market can be readily determined only if all of the
following conditions exist.
- You can transfer the option.
- You can exercise the option immediately in full.
- The option or the property subject to the option is not
subject to any condition or restriction (other than a condition to
secure payment of the purchase price) that has a significant effect on
the fair market value of the option.
- The fair market value of the option privilege can be readily
determined.
The option privilege for an option to buy is the opportunity to
benefit during the option's exercise period from any increase in the
value of property subject to the option without risking any capital.
For example, if during the exercise period the fair market value of
stock subject to an option is greater than the option's exercise
price, a profit may be realized by exercising the option and
immediately selling the stock at its higher value. The option
privilege for an option to sell is the opportunity to benefit during
the exercise period from a decrease in the value of the property
subject to the option.
Option with readily determined value.
If you receive a nonstatutory stock option that has a readily
determined fair market value at the time it is granted to you, the
option is treated like other property received as compensation. See
Restricted Property, later, for rules on how much income to
include and when to include it. However, the rule described in that
discussion for choosing to include the value of property in your
income for the year of the transfer does not apply to a nonstatutory
option.
Option without readily determined value.
If the fair market value of the option is not readily determined at
the time it is granted to you (even if it is determined later), you do
not have income until you transfer or exercise the option. When you
exercise this kind of option, the restricted property rules apply to
the property received. The amount to include in your income is the
difference between the amount you pay for the property and its fair
market value when it becomes substantially vested. Your basis in the
property you acquire under the option is the amount you pay for it
plus any amount you must include in your gross income under this rule.
For more information on restricted property, see Restricted
Property, later.
If you transfer this kind of option in an arm's-length transaction,
you must include in your income the money or other property you
received for the transfer, as if you had exercised the option.
Statutory Stock Options
There are two kinds of statutory
stock options:
- Incentive stock options, and
- Options granted under employee stock purchase plans.
For either kind of option, you must be an employee of the company
granting the option, or a related company, at all times beginning with
the date the option is granted, until 3 months before you exercise the
option (for an incentive stock option, 1 year before if you are
disabled). Also, the option must be nontransferable except at death.
If you do not meet the employment requirements, or you receive a
transferable option, your option is a nonstatutory stock option. See
Nonstatutory Stock Options, earlier, in this discussion.
If you receive a statutory stock option, do not include any amount
in your income either when the option is granted or when you exercise
it. You have taxable income or deductible loss when you sell the stock
that you bought by exercising the option. Your income or loss is the
difference between the amount you paid for the stock (the option
price) and the amount you receive when you sell it. You generally
treat this amount as capital gain or loss and report it on Schedule D
(Form 1040), Capital Gains and Losses, for the year of the
sale.
However, you may have ordinary income for the year that you sell
the stock in either of the following situations.
- You do not meet the holding period requirement.
This situation applies only if you sell the stock within 1 year after
its transfer to you or within 2 years after the option was granted.
- You meet the holding period requirement but the option was
granted under an employee stock purchase plan for an option price that
was less than the stock's fair market value at that time.
Report your ordinary income as wages on line 7, Form 1040, for
the year of the sale.
Incentive stock options (ISOs).
If you sell stock acquired by exercising an ISO and meet the
holding period requirement, your gain or loss from the sale is capital
gain or loss.
If you do not meet the holding period requirement and you have a
gain from the sale, the gain is ordinary income up to the amount by
which the stock's fair market value when you exercised the option
exceeded the option price. Any excess gain is capital gain. If you
have a loss from the sale, it is a capital loss and you do not have
any ordinary income.
Example.
Your employer, X Corporation, granted you an ISO on March 11, 1998,
to buy 100 shares of X Corporation stock at $10 a share, its fair
market value at the time. You exercised the option on January 19,
1999, when the stock was selling on the open market for $12 a share.
On January 25, 2000, you sold the stock for $15 a share. Although you
held the stock for more than a year, less than 2 years had passed from
the time you were granted the option. In 2000, you must report the
difference between the option price ($10) and the value of the stock
when you exercised the option ($12) as wages. The rest of your gain is
capital gain figured as follows:
Selling price ($15 x 100 shares) |
$ 1,500 |
Purchase price ($10 x 100 shares) |
-1,000 |
Gain |
$ 500 |
Amount reported as wages
[($12 x 100 shares) - $1,000] |
- 200 |
Amount reported as capital gain |
$ 300 |
Alternative minimum tax (AMT).
For the AMT, you must treat stock acquired through the exercise of
an ISO as if no special treatment applied. This means that, when your
rights in the stock are transferable and no longer subject to a
substantial risk of forfeiture, you must include as an adjustment in
figuring alternative minimum taxable income the amount by which the
fair market value of the stock exceeds the option price. However, no
adjustment is required if you dispose of the stock in the same year
you exercise the option.
See Restricted Property, later, for more information.
Enter this adjustment on line 10 of Form 6251, Alternative
Minimum Tax--Individuals. Increase your AMT basis in any
stock you acquire by exercising the ISO by the amount of the
adjustment.
Example.
The facts are the same as in the previous example. On January 19,
2000, when the stock was selling on the open market for $14 a share,
your rights to the stock first became transferable. You include $400
($1,400 value when your rights first became transferable minus $1,000
purchase price) as an adjustment on line 10 of Form 6251.
Your AMT basis in stock acquired through an ISO is likely to differ
from your regular tax basis. Therefore, keep adequate records for both
the AMT and regular tax so that you can figure your adjusted gain or
loss.
Employee stock purchase plan.
If you sold
stock acquired by exercising an option granted under an employee stock
purchase plan, determine your ordinary income and your capital gain or
loss as follows.
Option granted at discount.
If you meet the holding period requirement and you have a gain from
the sale, the gain is ordinary income up to the amount by which the
stock's fair market value when the option was granted exceeded the
option price. Any excess gain is capital gain. If you have a loss from
the sale, it is a capital loss, and you do not have any ordinary
income.
Example.
Your employer, Y Corporation, granted you an option under its
employee stock purchase plan to buy 100 shares of stock of Y
Corporation for $20 a share at a time when the stock had a value of
$22 a share. Eighteen months later, when the value of the stock was
$23 a share, you exercised the option, and 14 months after that you
sold your stock for $30 a share. In the year of sale, you must report
as wages the difference between the option price ($20) and the value
at the time the option was granted ($22). The rest of your gain ($8)
is capital gain figured as follows:
Selling price ($30 x 100 shares) |
$ 3,000 |
Purchase price (option price)
($20 x 100 shares) |
-2,000 |
Gain |
$ 1,000 |
Amount reported as wages
[($22 x 100 shares) - $2,000] |
- 200 |
Amount reported as capital gain |
$ 800 |
Holding period requirement not met.
If you do not meet the holding period requirement, your ordinary
income is the amount by which the stock's fair market value when you
exercised the option exceeded the option price. This ordinary income
is not limited to your gain from the sale of the stock.
Increase your basis in the stock by the amount of this ordinary
income. The difference between your increased basis and the selling
price of the stock is a capital gain or loss.
Example.
The facts are the same as in the previous example, except that you
sold the stock only 6 months after you exercised the option. Because
you did not hold the stock long enough, you must report $300 as wages
and $700 as capital gain, figured as follows:
Selling price ($30 x 100 shares) |
$3,000 |
Purchase price (option price)
($20 x 100 shares) |
-2,000 |
Gain |
$1,000 |
Amount reported as wages
[($23 x 100 shares) - $2,000] |
- 300 |
Amount reported as capital gain
[$3,000 - ($2,000 + $300)] |
$700 |
Restricted Property
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 been substantially vested. (You can
choose to include the value of the property in your income in the year
it is transferred to you, as discussed later, rather than the year it
is substantially vested.)
Until the property becomes substantially vested, it is owned by the
person who makes the transfer to you, usually your employer. However,
any income from the property, or the right to use the property, is
included in your income as wages in the year you receive the income or
have the right to use the property.
When the property becomes substantially vested, you must include
its fair market value, minus any amount you paid for it, in your
income for that year.
Example.
Your employer, the RST Corporation, sells you 100 shares of its
stock at $10 a share. At the time of the sale the fair market value of
the stock is $100 a share. Under the terms of the sale, the stock is
under a substantial risk of forfeiture (you have a good chance of
losing it) for a 5-year period. Because your stock is not
substantially vested when it is transferred, you do not include any
amount in your income in the year you buy it. At the end of the 5-year
period, the fair market value of the stock is $200 a share. You must
include $19,000 in your income [100 shares x ($200 fair
market value - $10 you paid)]. Dividends paid by the RST
Corporation on your 100 shares of stock are taxable to you as wages
during the period the stock can be forfeited.
Substantially vested.
Property is
substantially vested when:
- It is transferable, or
- It is not subject to a substantial risk of forfeiture (you
do not have a good chance of losing it).
Transferable property.
Property is transferable if you can sell, assign, or pledge your
interest in the property to any person (other than the transferor),
and if the person receiving your interest in the property is not
required to give up the property, or its value, if the substantial
risk of forfeiture occurs.
Substantial risk of forfeiture.
A substantial risk of forfeiture exists if the rights in the
property transferred depend on the future performance (or refraining
from performance) of substantial services by any person, or the
occurrence of a certain condition related to the transfer.
Example.
The Spin Corporation transfers to you as compensation for services
100 shares of its corporate stock for $100 a share. Under the terms of
the transfer, you must resell the stock to the corporation at $100 a
share if you leave your job for any reason within 3 years from the
date of transfer. Because you must perform substantial services over a
period of time and you must resell the stock to the corporation at
$100 a share (regardless of its value) if you do not perform the
services, your rights to the stock are subject to a substantial risk
of forfeiture.
Choosing to include in income for year of transfer.
You can choose to
include the value of the property at the time of transfer (minus any
amount you paid for the property) in your income for the year it is
transferred. If you make this choice, the substantial vesting rules do
not apply and, generally, any later appreciation in value is not
included in your compensation when the property becomes substantially
vested. Your basis for figuring gain or loss when you sell the
property is the amount you paid for it, plus the amount you included
in income as compensation.
If you forfeit the property after you have included its value in
income, your loss is the amount you paid for the property minus any
amount you realized on the forfeiture.
If you make this choice, you cannot revoke it without the consent
of the Internal Revenue Service. Consent will be given only if you
were under a mistake of fact as to the underlying transaction.
How to make the choice.
You make the choice by filing a written statement with the Internal
Revenue Service Center where you file your return. You must file this
statement no later than 30 days after the date the property was
transferred. A copy of the statement must be attached to your tax
return for the year the property was transferred. You also must give a
copy of this statement to the person for whom you performed the
services and, if someone other than you received the property, to that
person.
You must sign the statement and indicate on it that you are making
the choice under section 83(b) of the Internal Revenue Code. The
statement must contain all of the following information.
- Your name, address, and taxpayer identification
number.
- A description of each property for which you are making the
choice.
- The date or dates on which the property was transferred and
the tax year for which you are making the choice.
- The nature of any restrictions on the property.
- The fair market value at the time of transfer (ignoring
restrictions except those that will never lapse) of each property for
which you are making the choice.
- Any amount that you paid for the property.
- A statement that you have provided copies to the appropriate
persons.
Dividends received on restricted stock.
Dividends you receive on restricted stock are extra compensation to
you. Your employer should include these payments on your Form
W-2. If they are also reported on a Form 1099-DIV,
Dividends and Distributions, you should list them on
Schedule B (Form 1040), Interest and Ordinary Dividends,
with a statement that you have included them as wages. Do not
include them in the total dividends received.
Stock you chose to include in your 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. You should receive a Form 1099-DIV showing these
dividends. Do not include the dividends in your wages on your return.
Report them as dividends.
Sale of property not substantially vested.
These rules apply to the sale or
other disposition of property that is not substantially vested and not
included in your income in the year transferred.
If you sell or otherwise dispose of the property in an arm's-length
transaction, include in your income as compensation for the year of
sale the amount realized minus the amount you paid for the property.
If you exchange the property in an arm's-length transaction for other
property that is not substantially vested, treat the new property as
if it were substituted for the exchanged property.
If you sell the property in a transaction that is not at arm's
length, include in your income as compensation for the year of sale
the total of any money you received and the fair market value of any
substantially vested property you received on the sale. In addition,
you will have to report income when the original property becomes
substantially vested, as if you still held it. Report as compensation
its fair market value minus the total of the amount you paid for the
property and the amount included in your income from the earlier sale.
Example.
In 1997, you paid your employer $50 for a share of stock that had a
fair market value of $100 and was subject to forfeiture until 2000. In
1999, you sold the stock to your spouse for $10 in a transaction not
at arm's length. You had wage income of $10 from this transaction. In
2000, when the stock had a fair market value of $120, it became
substantially vested. For 2000, you must report additional wage income
of $60, figured as follows:
Fair market value of stock at time of
substantial vesting |
| $120 |
Minus: Amount paid for stock |
$50 |
Minus: Compensation previously included in
income from sale to spouse |
10 |
-60 |
Additional income |
| $60 |
Inherited property not substantially vested.
If you inherit property not substantially vested at the time of the
decedent's death, any income you receive from the property is
considered income in respect of a decedent and is taxed according to
the rules for restricted property received for services. For
information about income in respect of a decedent, get Publication 559,
Survivors, Executors, and Administrators.
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