Publication 334 |
2001 Tax Year |
Kinds of Income
You must report on your tax return all income you receive from your
business unless it is excluded by law. In most cases, your business
income will be in the form of cash, checks, and credit card charges.
But business income can be in other forms, such as property or
services. These and other types of income are explained next.
If you are a U.S. citizen who has business income from sources
outside the United States (foreign income), you must report that
income on your tax return unless it is exempt from tax under U.S. law.
If you live outside the United States, you may be able to exclude part
or all of your foreign-source business income. For details, see
Publication 54,
Tax Guide for U.S. Citizens and Resident Aliens
Abroad.
Bartering for Property or Services
Bartering is an exchange of property or services. You must include
in your gross receipts, 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 on
the value of the services, that value will be accepted as the fair
market value unless the value can be shown to be otherwise.
Example 1.
You are a self-employed lawyer. You perform legal services for a
client, a small corporation. In payment for your services, you receive
shares of stock in the corporation. You must include the fair market
value of the shares in income.
Example 2.
You are an artist and create a work of art to compensate your
landlord for the rent-free use of your apartment. You must include the
fair rental value of the apartment in your gross receipts. Your
landlord must include the fair market value of the work of art in his
or her rental income.
Example 3.
You are a self-employed accountant. Both you and a house painter
are members of a barter club, an organization that each year gives its
members a directory of members and the services each member provides.
Members get in touch with other members directly and bargain for the
value of the services to be performed.
In return for accounting services you provided for the house
painter's business, the house painter painted your home. You must
include in gross receipts the fair market value of the services you
received from the house painter. The house painter must include the
fair market value of your accounting services in his or her gross
receipts.
Example 4.
You are a member of a barter club that uses credit units to credit
or debit members' accounts for goods or services provided or received.
As soon as units are credited to your account, you can use them to buy
goods or services or sell or transfer the units to other members.
You must include the value of credit units you received in your
gross receipts for the tax year in which the units are credited to
your account.
The dollar value of units received for services by an employee of
the club, who can use the units in the same manner as other members,
must be included in the employee's gross income for the tax year in
which received. It is wages subject to social security and Medicare
taxes (FICA), federal unemployment taxes (FUTA), and income tax
withholding. See Publication 15, Circular E, Employer's Tax
Guide.
Example 5.
You operate a plumbing business and use the cash method of
accounting. You join a barter club and agree to provide plumbing
services to any member for a specified number of hours. Each member
has access to a directory that lists the members of the club and the
services available.
Members contact each other directly and request services to be
performed. You are not required to provide services unless requested
by another member, but you can use as many of the offered services as
you wish without paying a fee.
You must include the fair market value of any services you receive
from club members in your gross receipts when you receive them even if
you have not provided any services to club members.
Information returns.
If you are involved in a bartering transaction, you may have to
file either of the following forms.
- Form 1099-B, Proceeds From Broker and
Barter Exchange Transactions.
- Form 1099-MISC, Miscellaneous Income.
For information about these forms, see the General
Instructions for Forms 1099, 1098, 5498, and W-2G.
Real Estate Rents
If you are a real estate dealer who receives income from renting
real property or an owner of a hotel, motel, etc., who provides
services (maid services, etc.) for guests, report the rental income
and expenses on Schedule C or C-EZ. If you are not a real estate
dealer or the kind of owner described in the preceding sentence,
report the rental income and expenses on Schedule E, instead of on
Schedule C or C-EZ.
Prepaid rent.
Advance payments received under a lease that does not put any
restriction on their use or enjoyment are income in the year you
receive them. This is true no matter what accounting method or period
you use.
Lease bonus.
A bonus you receive from a lessee for granting a lease is an
addition to the rent. Include it in your gross receipts in the year it
is received.
Lease cancellation payments.
Report payments you receive from your lessee for canceling a lease
in gross receipts in the year received.
Payments to third parties.
If your lessee makes payments to someone else under an agreement to
pay your debts or obligations, include the payments in your gross
receipts when the lessee makes the payments. A common example of this
kind of income is a lessee's payment of your property taxes on leased
real property.
Settlement payments.
Payments you receive in settlement of a lessee's obligation to
restore the leased property to its original condition are income in
the amount that the payments exceed the adjusted basis of the
leasehold improvements destroyed, damaged, removed, or disconnected by
the lessee.
Personal Property Rents
If you are in the business of renting personal property (equipment,
vehicles, formal wear, etc.), include the rental amount you receive in
your gross receipts on Schedule C or C-EZ. Prepaid rent and
other payments described in the preceding Real Estate Rents
discussion can also be received for renting personal property.
If you receive any of those payments, include them in your gross
receipts as explained in that discussion.
Interest and Dividend Income
Interest and dividends may be considered business income.
Interest.
Interest received on notes receivable that you have accepted in the
ordinary course of business is business income. Interest received on
loans is business income if you are in the business of lending money.
Uncollectible loans.
If a loan payable to you becomes uncollectible during the tax year
and you use an accrual method of accounting, you must include in gross
income interest accrued up to the time the loan became uncollectible.
If the accrued interest later becomes uncollectible, you may be able
to take a bad debt deduction. See Bad Debts in chapter 8.
Unstated interest.
If little or no interest is charged on an installment sale, you may
have to treat a part of each payment as unstated interest. See
Unstated Interest and Original Issue Discount in
Publication 537,
Installment Sales.
Dividends.
Generally, dividends are business income to dealers in securities.
For most sole proprietors and statutory employees, however, dividends
are nonbusiness income. If you hold stock as a personal investment
separately from your business activity, the dividends from the stock
are nonbusiness income.
If you receive dividends from business insurance premiums you
deducted in an earlier year, you must report all or part of the
dividend as business income on your return. To find out how much you
have to report, see Recovery of items previously deducted
under Other Income, later.
Canceled Debt
The following explains the general rule for including canceled debt
in income and the exceptions to the general rule.
General Rule
Generally, if your debt is canceled or forgiven, other than as a
gift or bequest to you, you must include the canceled amount in your
gross income for tax purposes. Report the canceled amount on line 9 of
Schedule C if you incurred the debt in your business. If the debt is a
nonbusiness debt, report the canceled amount on line 21 of Form 1040.
Exceptions
The following discussion covers some exceptions to the general rule
for canceled debt.
Price reduced after purchase.
If you owe a debt to the seller for property you bought and the
seller reduces the amount you owe, you generally do not have income
from the reduction. Unless you are bankrupt or insolvent, treat the
amount of the reduction as a purchase price adjustment and reduce your
basis in the property.
Deductible debt.
You do not realize income from a canceled debt to the extent the
payment of the debt would have led to a deduction.
Example.
You get accounting services for your business on credit. Later, you
have trouble paying your business debts, but you are not bankrupt or
insolvent. Your accountant forgives part of the amount you owe for the
accounting services. How you treat the canceled debt depends on your
method of accounting.
- Cash method - You do not include the canceled debt in
income because payment of the debt would have been deductible as a
business expense.
- Accrual method - You include the canceled debt in
income because the expense was deductible when you incurred the
debt.
For information on the cash and accrual methods of accounting, see
chapter 2.
Exclusions
Do not include canceled debt in income in the following situations.
However, you may be required to file Form 982,
Reduction of Tax Attributes Due to Discharge of
Indebtedness. For more information, see Form 982.
- The cancellation takes place in a bankruptcy case under
title 11 of the U.S. Code (relating to bankruptcy). See Publication 908, Bankruptcy Tax Guide.
- The cancellation takes place when you are insolvent. You can
exclude the canceled debt to the extent you are insolvent. See
Publication 908.
- The canceled debt is a qualified farm debt owed to a
qualified person. See chapter 4 in Publication 225,
Farmer's Tax
Guide.
- The canceled debt is a qualified real property business
debt. This situation is explained later.
If a canceled debt is excluded from income because it takes
place in a bankruptcy case, the exclusions in situations (2), (3), and
(4) do not apply. If it takes place when you are insolvent, the
exclusions in situations (3) and (4) do not apply to the extent you
are insolvent.
Debt.
For purposes of this discussion, debt includes any debt for which
you are liable or which attaches to property you hold.
Qualified real property business debt.
You can choose to exclude (up to certain limits) the cancellation
of qualified real property business debt. If you make the choice, you
must reduce the basis of your depreciable real property by
the amount excluded. Make this reduction at the beginning of your tax
year following the tax year in which the cancellation occurs. However,
if you dispose of the property before that time, you must reduce its
basis immediately before the disposition.
Cancellation of qualified real property business debt.
Qualified real property business debt is debt (other than qualified
farm debt) that meets all the following conditions.
- It was incurred or assumed in connection with real property
used in a trade or business.
- It was secured by such real property.
- It was incurred or assumed at either of the following
times.
- Before January 1, 1993.
- After December 31, 1992, if incurred or assumed to acquire,
construct, or substantially improve the real property.
- It is debt to which you choose to apply these rules.
Qualified real property business debt includes refinancing of debt
described in (3) above, but only to the extent it does not exceed the
debt being refinanced.
You cannot exclude more than either of the following amounts.
- The excess (if any) of:
- The outstanding principal of qualified real property
business debt (immediately before the cancellation), over
- The fair market value (immediately before the cancellation)
of the business real property that is security for the debt, reduced
by the outstanding principal amount of any other qualified real
property business debt secured by this property immediately before the
cancellation.
- The total adjusted bases of depreciable real property held
by you immediately before the cancellation. These adjusted bases are
determined after any basis reduction due to a cancellation in
bankruptcy, insolvency, or of qualified farm debt. Do not take into
account depreciable real property acquired in contemplation of the
cancellation.
Choice.
To make this choice, complete Form 982 and attach it to your income
tax return for the tax year in which the cancellation occurs. You must
file your return by the due date (including the extensions). If you
timely filed your return for the year without making the choice, you
can still make the choice by filing an amended return within 6 months
of the due date of the return (excluding extensions). For more
information, see When to file in the form instructions.
Other Income
The following discussion explains how to treat other types of
business income you may receive.
Restricted property.
Restricted property is property that has certain restrictions that
affect its value. If you receive restricted stock or other property
for services performed, the fair market value of the property in
excess of your cost is included in your income on Schedule C or
C-EZ when the restriction is lifted. However, you can choose to
be taxed in the year you receive the property. For more information on
including restricted property in income, see Publication 525,
Taxable and Nontaxable Income.
Gains and losses.
Do not report on Schedule C or C-EZ a gain or loss from the
disposition of property that is neither stock in trade nor held
primarily for sale to customers. Instead, you must report these gains
and losses on other forms. For more information, see chapter 3.
Promissory notes.
Report promissory notes and other evidences of debt issued to you
in a sale or exchange of property that is stock in trade or held
primarily for sale to customers on Schedule C or C-EZ. In
general, you report them at their stated principal amount (minus any
unstated interest) when you receive them.
Lost income payments.
If you reduce or stop your business activities, report on Schedule
C or C-EZ any payment you receive for the lost income of your
business from insurance or other sources. Report it on Schedule C or
C-EZ even if your business is inactive when you receive the
payment.
Damages.
You must include in gross income compensation you receive during
the tax year as a result of any of the following injuries connected
with your business.
- Patent infringement.
- Breach of contract or fiduciary duty.
- Antitrust injury.
Economic injury.
You may be entitled to a deduction against the income if it
compensates you for actual economic injury. Your deduction is the
smaller of the following amounts.
- The amount you receive or accrue for damages in the tax year
reduced by the amount you pay or incur in the tax year to recover that
amount.
- Your loss from the injury that you have not yet deducted.
Punitive damages.
You must also include punitive damages in income.
Kickbacks.
If you receive any kickbacks, include them in your income on
Schedule C or C-EZ. However, do not include them if you properly
treat them as a reduction of a related expense item, a capital
expenditure, or cost of goods sold.
Recovery of items previously deducted.
If you recover a bad debt or any other item deducted in a previous
year, include the recovery in income on Schedule C or C-EZ.
However, if all or part of the deduction in earlier years did not
reduce your tax, you can exclude the part that did not reduce your
tax. If you exclude part of the recovery from income, you must include
with your return a computation showing how you figured the exclusion.
Example.
Joe Smith, a sole proprietor, had gross income of $8,000, a bad
debt deduction of $300, and other allowable deductions of $7,700. He
also had 2 personal exemptions of $5,800. He would not pay income tax
even if he did not deduct the bad debt. Therefore, he will not report
as income any part of the $300 he may recover in any future year.
Exception for depreciation.
This rule does not apply to depreciation. You recover depreciation
using the rules explained next.
Recapture of depreciation.
In the following situations, you have to recapture the depreciation
deduction. This means you include in income part or all of the
depreciation you deducted in previous years.
Listed property.
If your business use of listed property (explained in chapter 8
under Depreciation) falls to 50% or less in a tax year
after the tax year you placed the property in service, you may have to
recapture part of the depreciation deduction. You do this by including
in income on Schedule C part of the depreciation you deducted in
previous years. Use Part IV of
Form 4797, Sales of
Business Property, to figure the amount to include on Schedule
C. See Do the Business-Use Limits Apply? in chapter 4 of
Publication 946,
How To Depreciate Property. That chapter
explains how to determine whether property is used more than 50% in
your business.
Section 179 property.
If you take a section 179 deduction (explained in chapter 8 under
Depreciation) for an asset and before the end of the
asset's recovery period the percentage of business use drops to 50% or
less, you must recapture part of the section 179 deduction. You do
this by including in income on Schedule C part of the deduction you
took. Use Part IV of Form 4797 to figure the amount to include on
Schedule C. See chapter 2 in Publication 946
to find out when you
recapture the deduction.
Sale or exchange of depreciable property.
If you sell or exchange depreciable property at a gain, you may
have to report as income all or part of the gain due to depreciation.
You figure the income due to depreciation recapture in Part III of
Form 4797. For more information, see chapter 4 in Publication 544,
Sales and Other Dispositions of Assets.
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