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Types of Income

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Is severance pay taxable?

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 with your other salaries and wages. For additional information on wages, salaries, and other earnings, refer to Chapter 6 of Publication 17, Your Federal Income Tax, or Tax Topic 201, Wages and Salaries.

My Form W-2 includes allocated tips. What are they, and are they taxable?

Certain employers must allocate tips if the percentage of tips reported by employees falls below a required minimum percentage of gross sales. To "allocate tips" means to assign an additional amount as tips to each employee whose reported tips are below the required percentage. For additional information on how the rules for tip allocation work, refer to Chapter 7 of Publication 17, Your Federal Income Tax. All tips you receive are taxable. If you do not have adequate records for your actual tips, you must include the allocated tips shown on your Form W-2 as additional tip income on your return. For more information on the requirements, see Tip Allocation in Publication 531, Reporting Tip Income. Refer to Tax Topic 402, Tips, for other important information.

I received dividends from my credit union. How do I report this income?

Certain distributions commonly referred to as dividends are actually interest. They include "dividends" on deposits or share accounts in cooperative banks, credit unions, domestic savings and loan associations, and mutual savings banks.

Report interest income on line 8a of Form 1040 or 1040A, or line 2 of Form 1040EZ. If your taxable interest income is more than $400, be sure to show that income on Schedule B of Form 1040, or on Schedule 1 of Form 1040A. You cannot file Form 1040EZ if your interest income is more than $400. Refer to Tax Topic 403, Interest Received, for additional information on interest income.

Do I have to pay tax on reinvested dividends?

Dividend reinvestment plans let 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 use your dividends to buy more stock at a price equal to its fair market value, you 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 income the fair market value of the additional stock on the dividend payment date.

Other rules may apply. For additional information, refer to Chapter 9 of Publication 17, Your Federal Income Tax, and Tax Topic 404, Dividends.

I received a Form 1099-G, for my state tax refund. Do I have to include this amount as income on my return?

If you itemized deductions on your federal tax return for 1997 or a prior year, and received a refund of state or local taxes in 1998, you may have to include all or part of the refund as income on your 1998 tax return.

If you did not itemize your deductions on your federal tax return for the same year as the refund, do not report any of the refund as income. Refer to Tax Topic 405, Refund of State and Local Taxes, and Publication 525 , Taxable and Nontaxable Income, for further information.

Are alimony payments considered taxable income?

Alimony, separate maintenance, and similar payments from your spouse or former spouse are taxable to you in the year received. The amount is reported on line 11 of Form 1040. You cannot use Form 1040A or Form 1040EZ. Refer to Tax Topic 406, Alimony Received, or Publication 504, Divorced or Separated Individuals.

I made some money repairing radios and television sets last year. How do I report this income?

A sole proprietor files Schedule C, or in some cases, Schedule C-EZ, Form 1040, to figure the profit or loss from the business, and Schedule SE, Form 1040, to figure self- employment tax. Refer to Tax Topic 407, Business Income, Publication 533, Self-Employment Tax, and Publication 334, Tax Guide for Small Business, for additional information.

I am a sole proprietor. Can I use Schedule C-EZ instead of Schedule C?

You can use Schedule C-EZ to determine your net profit if you have only one sole proprietorship and you meet all of the following requirements; your business expenses were not more than $2,500, and you did not have a net loss from your business, you use the cash method of accounting, and you did not have an inventory during the year. There are five other requirements. Refer to page 1 of Schedule C-EZ to see if you qualify. Additional information is also available in Tax Topic 408, Sole Proprietorship.

How much am I allowed to deduct as a capital loss this year?

Your allowable capital loss deduction for any tax year, figured on Schedule D, is limited to the lesser of:

  1. $3,000 ($1,500 if you are married and file a separate return), or
  2. Your capital loss as shown on line 18 of Schedule D.

If you have a capital loss on line 18 of Schedule D that is more than the yearly limit on capital loss deductions, you can carry over the unused part to later years until it is completely used up. Refer to Publication 17, Your Federal Income Tax, or Tax Topic 409, Capital Gains and Losses, for additional information.

This is the first year that I received retirement benefits. Are any of my benefits taxable?

If you receive retirement benefits in the form of pension or annuity payments, the amounts you receive may be fully taxable, or partly taxable. Refer to Tax Topic 410, Pensions and Annuities, for detailed information or Publication 575, Pension and Annuity Income.  For social security and equivalent railroad retirement benefits, refer to Topic 424 or Publication 915, Social Security and Equivalent Railroad Retirement Benefits.

Will the IRS figure how much of my pension is taxable under the General Rule?

If you cannot use the Simplified General Rule, you can ask the IRS to figure the tax-free part of your pension under the General Rule. There is a $75 fee for this service. Publication 939, Pension General Rule (Nonsimplified Method), contains a detailed explanation of the information required to be furnished with your request. Also see Tax Topic 411, Pensions - The General Rule and the Simplified General Rule, for additional information. If your annuity starting date is after November 18, 1996, you generally cannot use the General Rule for annuity payments from a qualified plan.

I received a lump-sum distribution when I retired. Is there any special tax treatment on lump-sum distribution?

A lump-sum distribution is the distribution or payment, within a single tax year, of an employee's entire balance from all of the employer's qualified plans of one kind (pension, profit-sharing, or stock bonus plans). The distribution must have been made under specific conditions. For details, refer to Tax Topic 412 which discusses Lump- Sum Distributions or Publication 575, Pension and Annuity Income (Including Simplified General Rule).

How long do I have to roll over a retirement distribution to an IRA account?

You must complete the rollover by the 60th day following the day on which you receive the distribution. (This 60-day period is extended for the period during which the distribution is in a frozen deposit in a financial institution.) A written explanation of rollover must be given to you by the issuer making the distribution. For information on distributions which qualify for rollover treatment, refer to Tax Topic 413, Rollovers from Retirement Plans. For information on the Direct Rollover Option, refer to Chapter 11 of Publication 17, Your Federal Income Tax.

I rent my home out for two weeks each year. Do I have to show the income on my return?

If you use a dwelling as a home and rent it for fewer than 15 days during the year, do not report any of the rental income and do not deduct any expenses as rental expenses. In this case, you may deduct some expenses on Schedule A (Form 1040), such as mortgage interest, property taxes, and any casualty losses. For additional information, refer to Tax Topic 415, Renting Vacation Property/Renting to Relatives.

I am renting a house to my son and daughter-in-law. Can I claim rental expenses?

If you receive income from the rental of a dwelling unit, such as a house or apartment, there are certain expenses you may deduct. These expenses reduce the amount of rental income that is taxed. However, if you also use the dwelling unit as a home, or rent it at less than fair rental value, certain restrictions apply to the deduction of your rental expenses. Refer to Tax Topic 414, Rental Income and Expenses, Tax Topic 415, Renting Vacation Property/Renting to Relatives, or Publication 527, Residential Rental Property, for more information on what expenses you are able to deduct.

Most of my income is from farming. Are there any special provisions related to estimated tax payments for farmers?

If you have income from farming, you may be able to avoid making estimated tax payments by filing your return and paying the entire tax due on March 1 of the year your return is due. If March 1 falls on a weekend or legal holiday, you have until the next business day to file and pay tax. This estimated tax rule generally applies if at least 2/3 of your total gross income is from farming this year. Refer to Publication 505, Tax Withholding and Estimated Tax, and Tax Topic 416, Farming and Fishing Income, for additional information.

Are housing allowances taxable to ministers?

A housing allowance paid to you as part of your salary is not income to the extent you use it, in the year received, to provide a home or to pay utilities for a home with which you are provided. The amount of the housing allowance that you can exclude from your income cannot be more than the reasonable compensation for your services as a minister. The church or organization that employs you must officially designate the payment as a housing allowance before the payment is made. A definite amount must be designated; the amount of the housing allowance cannot be determined at a later date. Other provisions may apply. For additional information on housing allowances, refer to Chapter 6 of Publication 17, Your Federal Income Tax. For information on earnings for clergy, refer to Tax Topic 417.

Is there a way to have federal income tax withheld from unemployment compensation, in lieu of making estimated tax payments?

You may have federal income tax withheld from unemployment compensation. Use Form W-4V, Voluntary Withholding Request. Refer to Tax Topic 155, Forms and Publications - How to Order, for information on how to obtain Form W-4V. For additional information on unemployment compensation, refer to Tax Topic 418.

I won $250 in a charity raffle. Where do I show this on my return?

Gambling winnings are fully taxable and must be reported on your tax return. You must file Form 1040 and include all your winnings on line 21 (other income). For information on deducting gambling losses, refer to Tax Topic 419, Gambling Income and Expenses.

I did some carpentry work in exchange for dental services. Do I report this on my federal tax return?

Bartering occurs when you exchange goods or services without money exchanging. The goods or services exchanged have a dollar or fair market value, and this value must be included in the income of both parties. For further information, refer to Tax Topic 420, Bartering Income.

I received an academic scholarship that is designated to be used for tuition and books. Is this taxable?

Qualified scholarships and fellowships are treated as tax- free amounts if all of the following conditions are met:

  1. You are a candidate for a degree at an educational institution,
  2. Amounts you receive as a scholarship or fellowship are used for tuition and fees required for enrollment or attendance at the educational institution, or for books, supplies, and equipment required for courses of instruction, and
  3. The amounts received are not a payment for your services.

For additional information on Scholarship and Fellowship Grants, refer to Tax Topic 421, and Publication 520, Scholarships and Fellowships.

Are child support payments considered taxable income?

No. Some types of income taxpayers receive are not taxable and child support is one of them. When you total your gross income to see if you are required to file a tax return, do not include your nontaxable income. For additional information, refer to Tax Topic 422, Nontaxable Income, or Publication 525, Taxable and Nontaxable Income.

I retired last year, and started receiving social security benefits. Are social security benefits taxable?

To find out whether any of your benefits are taxable, compare the base amount for your filing status with the total of:

  1. One-half your benefits, plus
  2. All your other income, including tax-exempt interest. (Do not reduce your income by any exclusions for interest from Series EE U.S. savings bonds, for foreign earned income or foreign housing, or for income earned in American Samoa or Puerto Rico by bona fide residents.)

If your income is more than your base amount, part of your benefits will be taxable. The taxable amount of your benefits is figured on a worksheet in the Form 1040 or 1040A instruction book. Refer to Tax Topic 423, Social Security and Equivalent Railroad Retirement Benefits, for base amounts, and additional information regarding taxability and reporting requirements.

Can I take an IRA deduction for the amount I contributed to a 401(k) plan last year?

No. A 401(k) plan is not an IRA. However, the amount you contributed is not included as income in box 1 of your W-2 form so you don't pay tax on it for last year. For more information, refer to Tax Topic 424, 401(k) Plans, Publication 575, Pension and Annuity Income (Including Simplified General Rule), or Publication 560, Retirement Plans for the Self-Employed.

 

I have losses from a passive rental real estate activity in which I actively participate. Can I offset the losses against my nonpassive income?

If your rental of real estate is a passive activity, you may generally offset a loss of up to $25,000 against your nonpassive income if you actively participate in the activity. However, married persons filing separate returns who lived together at any time during the year may not claim this offset. Married persons filing separate returns who lived apart at all times during the year are each allowed a $12,500 maximum offset for passive real estate activities. For additional information on limits on rental losses, refer to Chapter 10 of Publication 17, Your Federal Income Tax, and Tax Topic 425, Passive Activities - Losses and Credits.

Are gifts, bequests, or inheritances taxable?

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 rentals, that income is taxable to you. For additional information, refer to Chapter 13 of Publication 17, Your Federal Income Tax.

If you inherited an Individual Retirement Arrangement (IRA) or proceeds from a retirement (pension) plan, special rules apply. Refer to Publication 590, Individual Retirement Arrangements (IRAs), Publication 575, Pension and Annuity Income, for further information.

How do I report a non-statutory stock option on my tax return?

If you are granted a non-statutory stock option, the amount of income to include and the time to include it depend on whether the fair market value (FMV) of the option can be readily determined. For specific information and reporting requirements, refer to Publication 525, Taxable and Nontaxable Income.

How do I report an employee stock purchase plan on my tax return?

If your stock option is granted under an employee stock purchase plan, you do not include any amount in your gross income as a result of the grant or exercise of your option. You report income or loss when you sell the stock that you purchased by exercising the option. For additional information on tax treatment and holding period requirements, refer to Publication 525, Taxable and Nontaxable Income.

How do I report incentive stock options on my tax return?

You generally treat income or loss from the sale of the stock as a capital gain or loss. However, if you do not meet the special holding period tests, you may have ordinary income up to the amount of the gain. For further information, refer to Publication 525, Taxable and Nontaxable Income.

Is the money received from my settlement taxable?

For court awards and damages, to determine if settlement amounts you receive by compromise or judgement must be included in your income, you must consider the item which the settlement replaces. Include the following as ordinary income:

  1. Interest on any award.
  2. Compensation for lost wages or lost profits in most cases.
  3. Punitive damages.
  4. Amounts received in settlement of pension rights (if you did not contribute to the plan).
  5. Damages for:
    1. Patent or copyright infringement.
    2. Breach of contract.
    3. Interference with business operations.
  6. Any recovery under the Age Discrimination in Employment Act.

Do not include in your income compensatory damages for the following:

  1. Personal physical injury or physical sickness (whether received in a lump-sum or installments). Special rules apply for amounts received after August 20, 1996. Refer to Chapter 13 of Publication 17, Your Federal Income Tax, for additional information.
  2. Damages to your character.
  3. Alienation of affection.
  4. Surrender of custody of a minor child.

For additional information, refer to Chapter 13 of Publication 17, Your Federal Income Tax, or Tax Topic 422, Nontaxable Income.

How do I report income received as a prize or award?

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 line 21, Form 1040. If you receive merchandise, you must report the fair market value of the item(s) as income. See Chapter 13 of Publication 17, Your Federal Income Tax, for additional information.

Because of my age, my employer wanted to terminate my employment. I signed a statement not to sue and received a lump-sum payment from my employer for age discrimination. Is this payment taxable?

A lump-sum payment for cancellation of your employment is taxable income in the year you receive it and must be reported with your other salary and wages. This is true even if the payment was received (by suit or agreement) as settlement under the Age Discrimination and Employment Act.

Reference: Revenue Ruling 96-65 and Comm'r v. Schleier, 115 US 2159 (1995)

Refer to Publication 525, Taxable and Nontaxable Income, for more details.

I received damages for emotional distress suffered as a result of employment discrimination. Is the money I received taxable?

Emotional distress is not considered a physical injury or sickness. Damages for emotional distress are includible in income, except to the extent they are paid for medical care attributable to emotional distress.

Reference: Revenue Ruling 96-65.

I am receiving long term disability. Is it considered taxable?

Generally, you must report as income any amount you receive for your disability through an accident or health insurance plan paid for by your employer.

If both you and your employer pay for the plan, only the amount you receive for your disability that is due to your employer's payments is reported as income. If you pay the entire cost of a health or accident insurance plan, do not include any amounts you receive for your disability as income on your tax return. If you pay the premiums of a health or accident insurance plan through a cafeteria plan, and the amount of the premium was not included as taxable income to you; the premiums are considered paid by your employer.

See  Publication 525, Taxable and Nontaxable Income, for more details. If the amounts are taxable, you can submit a Form W-4S to the insurance company for withholding, or make estimated tax payments by filing Form 1040ES.

Amounts you receive from your employer while you are sick or injured are part of your salary or wages. Report the amount you receive on line 7, Form 1040; line 7, Form 1040A; or line 1, Form 1040EZ. You must include in your income sick pay from any of the following:

  • 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.

Payments you receive from qualified long-term care insurance contracts are generally excluded from income as amounts received for personal injury or sickness. Also, certain payments received under a life insurance contract on the life of a terminally or chronically ill individual (accelerated death benefits) can be excluded from income.

You may be able to deduct your out of pocket expenses for medical care above any reimbursements, if you are eligible to itemize your deductions. You will need to review Publication 502, Medical and Dental Expenses.

For more information, refer to Publication 907, Tax Highlights for Persons with Disabilities.

My house was foreclosed on and the lender has sent me a Form 1099. What do I do? Must I report this?

You may have received either a Form 1099-A or Form 1099-C, or both. You must compute whether you have discharge of indebtedness income. You have discharge of indebtedness income if the debt discharged exceeds the fair market value of the property at the time of the transfer. Discharge of indebtedness income is taxable as other income on line 21 of Form 1040.

You may be able to exclude discharge of indebtedness income if you have filed bankruptcy; are insolvent; or have a qualified farm debt. See Publication 908, Bankruptcy Tax Guide, and Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness for more information.

You may also have to compute gain or loss on disposition of the property. You must still follow this step even if you have no discharge of indebtedness income from step one. The difference between the amount realized less any reportable discharge of indebtedness income and your adjusted basis is your gain or loss. If the property is business property, report on Form 4797, Sales of Business Property, and follow the normal rules. If the property is a personal home, report on Form 2119, Sale of Your Home, following the normal rules for sale of a main home. See Publication 523, Selling Your Home, and Publication 544, Sales and Other Dispositions of Assets, for more information.

If you repossess your property after making an installment sale, see Publication 537, Installment Sales, under "Repossession" for special rules for computing your gain or loss and the new basis in the repossessed property.

I received a stock option from my company, is this taxable? I participated in an incentive stock option (ISO) plan at work. How do I pay tax on this?

If your stock option is granted under an employee stock purchase plan, you generally do not include any amount in your gross income as a result of the grant or exercise of your option. You report income or loss when you sell the stock that you purchased by exercising the option.

For more information, see Publication 550, Investment income and Expenses, and Publication 551, Basis of Assets.

I purchased stock from my employer. Now I have received a 1099B from selling it. How do I report this?

You generally treat gain or loss from the sale of the stock as capital gain or loss. However, you may have ordinary income if:

  1. The option price of the stock was below the stock's fair market value at the time the option was granted, or
  2. You did not meet the holding period requirement, explained next.

You must hold the stock for more than two years from the time the stock option is granted to you and for more than one year from when the stock was transferred to you. If you meet the holding period requirement and the option price was below the fair market value of the stock at the time the option was granted, you report the difference as ordinary income (wages) when you sell the stock. However, this ordinary income cannot be more than your gain on the sale. If your gain is more than the amount you report as ordinary income, the remainder is a capital gain reported on Schedule D (Form 1040). If you sell the stock for less than the option price, your loss is a capital loss.

For more information, see Publication 550, Investment income and Expenses, and Publication 551, Basis of Assets.

How do I report this 1099DIV from my mutual fund?

The gross dividends (1a) are shown on line 5 of Schedule B. Capital gains distributions (1c) are shown on line 7 of Schedule B. Nontaxable distributions (1d) are shown on line 8 of Schedule B. You then subtract the capital gains and nontaxable distributions, and report the remaining amount (which is ordinary dividends from 1b) on line 10 of Schedule B, which then goes to line 9 of Form 1040. The capital gains from line 7 go to Schedule D, line 14 (or line 13 of Form 1040 if you do not have to otherwise file Schedule D.) Nontaxable distributions that are return of capital distributions reduce your cost basis and are not taxable until your basis is reduced to zero.

Can I deduct my investment expenses as business expenses?

The proper classification is important to determine how income and expenses are to be reported. Investors trade solely for their own account and do not carry on a trade or business. Their securities sales result in capital gain or loss and their deductible expenses are itemized deductions. Dealers sell securities to customers in the ordinary course of trade or business. Their sales result in ordinary gain or loss and their deductible expenses are trade or business expenses. Traders buy and sell securities frequently but have no customers. Their purchases and sales result in capital gain and loss, and their deductible expenses are trade or business expenses.

Even if you engage in extensive securities activities, you are an investor, not a dealer or trader, if you do not seek profit primarily in swings in daily market movements, and do not personally engage in or direct the purchases or sales. An investor trades for profit- motivated reasons such as long-term appreciation, dividends and interest. Whether the activities of an individual constitute trade or business or investment is determined from the facts in each case. These distinctions have been established through court cases.

How is the dollar limit for 403(b) plans affected by the nondiscrimination requirements related to highly compensated employees?

A 403(b) plan is a tax-sheltered annuity plan for employees of public schools and certain tax-exempt organizations. Under a special coverage and nondiscrimination rule, if any employee may make elective deferrals, the plan is considered discriminatory unless the opportunity to make elective deferrals of more than $200 is available to all employees on a basis that does not discriminate in favor of highly compensated employees. See IRC 403(b)(1)(D),(12)(A)(ii).

Generally, no more than $10,000 of elective deferrals may be made under a 403(b) program in any tax year. This $10,000 limit operates somewhat like the annual dollar limit on elective deferrals under a cash or deferred arrangement (CODA).

A CODA satisfies special CODA nondiscrimination requirements for a plan year only if the elective contributions under the arrangement, or the elective contributions in combination with qualified non-elective contributions and qualified matching contributions that are treated as elective contributions under the arrangement, satisfy the actual deferral percentage (ADP) test. See IRC 401(k)(3)(A)(ii); Reg 1.401(k)-1(b)(2)

If a CODA satisfies the ADP test, the arrangement satisfies the nondiscrimination requirements relative to highly compensated employees with respect to the amount of elective deferrals. See IRC 401(k)(3)(C); Reg. 1.401(k)-1(b)(2)(ii).

For more information about 403(b) plans, see Publication 571, Tax Sheltered Annuity Programs for Employees of Public Schools and Certain Tax-Exempt Organizations.

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