Entire cost excluded.   You are not taxed on the cost of group-term life insurance if any of the following circumstances apply.

1. You are permanently and totally disabled and have ended your employment.
2. Your employer is the beneficiary of the policy for the entire period the insurance is in force during the tax year.
3. 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.)
4. The plan existed on January 1, 1984, and:
   1. You retired before January 2, 1984, and were covered by the plan when you retired, or
   2. 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.

1. The meals are:
   1. Furnished on the business premises of your employer, and
   2. Furnished for the convenience of your employer.
2. The lodging is:
   1. Furnished on the business premises of your employer,
   2. Furnished for the convenience of your employer, and
   3. A condition of your employment. (You must accept it in order to be able to properly perform your duties.)

You also do not include in your income the value of meals or meal money that qualifies as a de minimis fringe benefit. See De Minimis (Minimal) Benefits, earlier.

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 still may not have to include the value of the lodging in income. 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 lesser 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 lesser 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 because the rent he pays equals at least 5% of the appraised value of the house (5% × $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).

Moving Expense Reimbursements

Generally, if your employer pays for your moving expenses (either directly or indirectly) and the expenses would have been deductible if you paid them yourself, the value is not included in your income. Get Publication 521 for more information.

No-Additional-Cost Services

The value of services you receive from your employer for free, at cost, or for a reduced price is not included in your income if your employer:

• Offers the same service for sale to customers in the ordinary course of the line of business in which you work, and
• Does not have a substantial additional cost (including any sales income given up) to provide you with the service (regardless of what you paid for the service).

Generally, no-additional-cost services are excess capacity services, such as airline, bus, or train tickets, hotel rooms, and telephone services.

Example.   You are employed as a flight attendant for a company that owns both an airline and a hotel chain. Your employer allows you to take personal flights (if there is an unoccupied seat) and stay in any one of their hotels (if there is an unoccupied room) at no cost to you. The value of the personal flight is not included in your income. However, the value of the hotel room is included in your income because you do not work in the hotel business.

Retirement Planning Services

If your employer has a qualified retirement plan, qualified retirement planning services provided to you (and your spouse) by your employer are not included in your income. Qualified services include retirement planning advice, information about your employer's retirement plan, and information about how the plan may fit into your overall individual retirement income plan. You cannot exclude the value of any tax preparation, accounting, legal, or brokerage services provided by your employer. Also, see Financial Counseling Fees, earlier.

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 $100 a month, regardless of the total value of both benefits.

The exclusion for the qualified parking fringe benefit cannot be more than $185 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 education furnished to a graduate student at an educational institution if the graduate student is engaged in teaching or research activities for that institution.
• Representing payment for teaching, research, or other services if you receive the amount under the National Health Service Corps Scholarship Program or the Armed Forces Health Professions Scholarship and Financial Assistance Program.

For more information, get Publication 520.

Working Condition Benefits

If your employer provides you with a product or service and the cost of it would have been deductible as a business expense or depreciation if you paid for it yourself, the cost is not included in your income.

Example.   You work as an engineer and your employer provides you with a subscription to an engineering trade magazine. The cost of the subscription is not included in your income because the cost would have been deductible to you if you had paid for the subscription yourself.

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:

1. The amount, if any, you paid for the benefit, plus
2. 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 always can 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 minus the sum of:

1. Any amount you repaid your employer, plus
2. 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

Your employer's contributions to a qualified retirement plan for you are not included in income at the time contributed. (Your employer can tell you whether your retirement plan is qualified.) However, the cost of life insurance coverage included in the plan may have to be included. See Group-Term Life Insurance, earlier, under Fringe Benefits.

If your employer pays into a nonqualified plan for you, you generally must include the contributions in your income as wages for the tax year in which the contributions are made. However, if your interest in the plan is 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.

1. Cash or deferred arrangements (section 401(k) plans).
2. The Thrift Savings Plan for federal employees.
3. Salary reduction simplified employee pension plans (SARSEP).
4. Savings incentive match plans for employees (SIMPLE plans).
5. Tax-sheltered annuity plans (403(b) plans).
6. Section 501(c)(18)(D) plans. (But see Reporting by employer, later.)
7. Section 457 plans.

Overall limit on deferrals.   For 2002, you generally should not have deferred more than a total of $11,000 of contributions to the plans listed in (1) through (6) above. You should not have deferred more than the lesser of your includible compensation (defined later) or $11,000 of contributions to the plan listed in (7) above (section 457 plan). These limits will increase by $1,000 each year until it reaches $15,000 in 2006.

Your employer or plan administrator should apply the proper annual limit when figuring your plan contributions. However, you are responsible for monitoring the total you defer to ensure that the deferrals are not more than the overall limit.

Catch-up contributions.   You may be allowed catch-up contributions (additional elective deferrals) if you are age 50 or older. For more information about catch-up contributions to 403(b) plans, see chapter 6 of Publication 571, Tax Sheltered Annuity Plans (403(b) plans).

For more information about additional elective deferrals to:

• SEPs (SARSEPs), see What Is a Salary Reduction Arrangement in chapter 3 of Publication 590, Individual Retirement Arrangements.
• Simple plans, see How Much Can Be Contributed on My Behalf in chapter 4 of Publication 590.
• Section 457 plans, see Limit for deferrals under section 457 plans, later.

Limit for deferrals under SIMPLE plans.   If you are a participant in a SIMPLE plan, you generally should not have deferred more than $7,000 in 2002. This amount will increase by $1,000 each year until it reaches $10,000 in 2005. Amounts you defer under a SIMPLE plan count toward the overall limit ($11,000 for 2002) and may affect the amount you can defer under other elective deferral plans.

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 have deferred no more than the lesser of your includible compensation or $11,000. However, if you are within 3 years of normal retirement age, you may be allowed an increased limit if the plan allows it. See Increased limit, later.

includible compensation.   This is the pay you received for the year from the employer who maintained the section 457 plan. It generally includes all the following payments.

1. Wages and salaries.
2. Fees for professional services.
3. The value of any employer-provided qualified transportation fringe benefit (defined under Transportation, earlier) that is not included in your income.
4. Other amounts received (cash or noncash) for personal services you performed, including, but not limited to, the following items.
   1. Commissions and tips.
   2. Fringe benefits.
   3. Bonuses.
5. Employer contributions (elective deferrals) to:
   1. The section 457 plan.
   2. Qualified cash or deferred arrangements (section 401(k) plans) that are not included in your income.
   3. A salary reduction simplified employee pension (SARSEP).
   4. A tax-sheltered annuity (section 403(b) plan).
   5. A savings incentive match plan for employees (SIMPLE plan).
   6. A section 125 cafeteria plan.

Instead of using the amounts listed above to determine your includible compensation, your employer can use any of the following amounts.

• Your wages as defined for income tax withholding purposes.
• Your wages as reported in box 1 of Form W-2, Wage and Tax Statement.
• Your wages that are subject to social security withholding (including elective deferrals).

Increased limit.   During any, or all, of the last 3 years ending before you reach normal retirement age under the plan, your plan may provide that your limit is the lesser of:

1. Twice the dollar limit for the year, or
2. The limit for prior years minus the amount you deferred in prior years plus the lesser of:
   1. Your includible compensation for the current year, or
   2. The dollar limit for the current year.

Catch-up contributions.   You generally can have additional elective deferrals made to your section 457 plan if:

• You reached age 50 by the end of the year, and
• No other elective deferrals can be made for you to the plan for the year because of limits or restrictions.

If you qualify, your limit can be the lesser of your includible compensation or $11,000 ($12,000 for 2003), plus $1,000 ($2,000 for 2003). However, if you are within 3 years of retirement age and your plan provides the increased limit earlier, that limit may be higher.

Limit for tax-sheltered annuities.   If you are a participant in a tax-sheltered annuity plan (403(b) plan), the limit on elective deferrals for 2002 generally is $11,000 ($12,000 for 2003). However, if you have at least 15 years of service with a public school system, a hospital, a home health service agency, a health and welfare service agency, a church, or a convention or association of churches (or associated organization), the limit on elective deferrals is increased by the least of the following amounts.

1. $3,000.
2. $15,000, reduced by increases to the overall limit that you were allowed in earlier years because of this years-of-service rule.
3. $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 Retirement plan checkbox in box 13 and show the total amount deferred in box 12.

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 12. You may deduct the amount deferred subject to the limits that apply. Include your deduction in the total on line 34 (Form 1040). Enter the amount and 501(c)(18) on the dotted line next to line 34.

Excess deferrals.   If your deferrals exceed the 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.

You must include the excess deferral 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 and you receive the corrective distribution by April 15 of the following year, do not include it in income again in the year you receive it. 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 2002.

• If the distribution was for a 2002 excess deferral, your Form 1099-R should have the code 8 in box 7. Add the excess deferral amount to your wages on your 2002 tax return.
• If the distribution was for a 2001 excess deferral, your Form 1099-R should have the code P in box 7. If you did not add the excess deferral amount to your wages on your 2001 tax return, you must file an amended return on Form 1040X, Amended U.S. Individual Income Tax Return. If you did not receive the distribution by April 16, 2002, you also must add it to your wages on your 2002 tax return.
• If the distribution was for a 2000 excess deferral, your Form 1099-R should have the code D in box 7. If you did not add the excess deferral amount to your wages on your 2000 tax return, you must file an amended return on Form 1040X. You also must add it to your wages on your 2002 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. Add the income amount to your wages on your 2002 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 excess 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.

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 2½ months after the close of the plan year, you must include them in your income in the year of the contribution. 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 contribution (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). Add excess contributions or earnings shown on Form 1099-R for 2002 to your wages on your 2002 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 2001 or 2000 return on Form 1040X to add the excess contributions or earnings to your wages in the year of the contribution.

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 2002 to a defined contribution plan is generally limited to the lesser of 100% of your compensation or $40,000. 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.

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