Lump-Sum Election

You must include the taxable part of a lump-sum (retroactive) payment of benefits received in 2002 in your 2002 income, even if the payment includes benefits for an earlier year.

This type of lump-sum benefit payment should not be confused with the lump-sum death benefit that both the SSA and RRB pay to many of their beneficiaries. No part of the lump-sum death benefit is subject to tax.

Generally, you use your 2002 income to figure the taxable part of the total benefits received in 2002. However, you may be able to figure the taxable part of a lump-sum payment for an earlier year separately, using your income for the earlier year. You can elect this method if it lowers your taxable benefits. See Publication 915 for more information.

Repayments More Than Gross Benefits

In some situations, your Form SSA-1099 or Form RRB-1099 will show that the total benefits you repaid (box 4) are more than the gross benefits (box 3) you received. If this occurred, your net benefits in box 5 will be a negative figure (a figure in parentheses) and none of your benefits will be taxable. If you receive more than one form, a negative figure in box 5 of one form is used to offset a positive figure in box 5 of another form for that same year.

If you have any questions about this negative figure, contact your local Social Security Administration office or your local U.S. Railroad Retirement Board field office.

Joint return.   If you and your spouse file a joint return, and your Form SSA-1099 or RRB-1099 has a negative figure in box 5 but your spouse's does not, subtract the amount in box 5 of your form from the amount in box 5 of your spouse's form. You do this to get your net benefits when figuring if your combined benefits are taxable.

Repayment of benefits received in an earlier year.   If the total amount shown in box 5 of all of your Forms SSA-1099 and RRB-1099 is a negative figure, you can take an itemized deduction for the part of this negative figure that represents benefits you included in gross income in an earlier year.

If this deduction is $3,000 or less, it is subject to the 2%-of-adjusted-gross-income limit that applies to certain miscellaneous itemized deductions. Claim it on line 22, Schedule A (Form 1040).

If this deduction is more than $3,000, you have some special instructions to follow. Get Publication 915 for those instructions.

Sickness and Injury Benefits

Most payments you receive as compensation for illness or injury are not taxable. These include the following.

Workers' compensation.   Amounts you receive as workers' compensation for an occupational sickness or injury are fully exempt from tax if they are paid under a workers' compensation act or a statute in the nature of a workers' compensation act. The exemption also applies to your survivor(s).

If part of your workers' compensation reduces your social security or equivalent railroad retirement benefits received, that part is considered social security (or equivalent railroad retirement) benefits and may be taxable. For a discussion of the taxability of these benefits, see Social Security and Equivalent Railroad Retirement Benefits, earlier.

Return to work.   If you return to work after qualifying for workers' compensation, payments you continue to receive while assigned to light duties are taxable as wages.

Federal Employees' Compensation Act (FECA).   Payments received under this Act for personal injury or sickness, including payments to beneficiaries in case of death, are not taxable. However, you are taxed on amounts you receive under this Act as continuation of pay for up to 45 days while a claim is being decided. Also, pay for sick leave while a claim is being processed is taxable and must be included in your income as wages.

If part of the payments you receive under FECA reduces your social security or equivalent railroad retirement benefits received, that part is considered social security (or equivalent railroad retirement) benefits and may be taxable. For a discussion of the taxability of these benefits, see Social Security and Equivalent Railroad Retirement Benefits, earlier.

Benefits under an accident or health insurance policy.   Benefits you receive under an accident or health insurance policy are not taxable if:

• You paid the premiums, or
• Your employer paid the premiums and you included the premiums in your gross income.

Long-term care insurance contracts.   Long-term care insurance contracts generally are treated as accident and health insurance contracts. Amounts you receive from them (other than policyholder dividends or premium refunds) generally are excludable from income as amounts received for personal injury or sickness. However, the amount you can exclude may be limited. Long-term care insurance contracts are discussed in more detail in Publication 525.

Compensation for permanent loss or disfigurement.   Compensation you receive for permanent loss or loss of use of a part or function of your body, or for your permanent disfigurement is not taxable. This compensation must be based only on the injury and not on the period of your absence from work. These benefits are not taxable even if your employer pays for the accident and health plan that provides these benefits.

Disability benefits.   Benefits you receive for loss of income or earning capacity as a result of injuries under a no-fault car insurance policy are not taxable.

Disability Income

Generally, if you retire on disability, you must report your pension or annuity as income.

If you were 65 or older by the end of 2002, or you were retired on permanent and total disability and received taxable disability income, you may be able to claim the credit for the elderly or the disabled. See Credit for the Elderly or the Disabled, later.

Taxable disability pensions or annuities.   Generally, you must report as income any amount you receive for your disability through an accident or health insurance plan that is paid for by your employer. However, certain payments may not be taxable to you. See Sickness and Injury Benefits, earlier.

Cost paid by you.   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 your plan reimbursed you for medical expenses you deducted in an earlier year, you may have to include some, or all, of the reimbursement in your income.

Accrued leave payment.   If you retire on disability, any lump-sum payment you receive for accrued annual leave is a salary payment. The payment is not a disability payment. Include it in your income in the year you receive it.

Workers' compensation.   If part of your disability pension is workers' compensation, that part is exempt from tax. The exemption also applies to your survivors.

How to report.   You must report all your taxable disability income as wages on line 7 of Form 1040 or Form 1040A, until you reach minimum retirement age. Generally, this is the age at which you can first receive a pension or annuity if you are not disabled.

Beginning on the day after you reach minimum retirement age, the payments you receive are taxable as a pension. Report them on lines 16a and 16b of Form 1040 or on lines 12a and 12b of Form 1040A.

Life Insurance Proceeds

Life insurance proceeds paid to you because of the death of the insured person are not taxable unless the policy was turned over to you for a price. This is true even if the proceeds were paid under an accident or health insurance policy or an endowment contract.

Proceeds not received in installments.   If death benefits are paid to you in a lump sum or other than at regular intervals, include in your income only the benefits that are more than the amount payable to you at the time of the insured person's death. If the benefit payable at death is not specified, you include in your income the benefit payments that are more than the present value of the payments at the time of death.

Proceeds received in installments.   If you receive life insurance proceeds in installments, you can exclude part of each installment from your income.

To determine the excluded part, divide the amount held by the insurance company (generally the total lump sum payable at the death of the insured person) by the number of installments to be paid. Include anything over this excluded part in your income as interest.

Installments for life.   If, as the beneficiary under an insurance contract, you are entitled to receive the proceeds in installments for the rest of your life without a refund or period-certain guarantee, you figure the excluded part of each installment by dividing the amount held by the insurance company by your life expectancy. If there is a refund or period-certain guarantee, the amount held by the insurance company for this purpose is reduced by the actuarial value of the guarantee.

Surviving spouse.   If your spouse died before October 23, 1986, and insurance proceeds paid to you because of the death of your spouse are received in installments, you can exclude up to $1,000 a year of the interest included in the installments. If you remarry, you can continue to take the exclusion.

Surrender of policy for cash.   If you surrender a life insurance policy for cash, you must include in income any proceeds that are more than the cost of the life insurance policy. You should receive a Form 1099-R showing the total proceeds and the taxable part. Report these amounts on lines 16a and 16b of Form 1040, or lines 12a and 12b of Form 1040A.

Endowment Proceeds

Endowment proceeds paid in a lump sum to you at maturity are taxable only if the proceeds are more than the cost of the policy. To determine your cost, add the aggregate amount of premiums (or other consideration) paid for the contract and subtract any amount that you previously received under the contract and excluded from your income. Include the part of the lump-sum payment that is more than your cost in your income.

Endowment proceeds that you choose to receive in installments instead of a lump-sum payment at the maturity of the policy are taxed as an annuity. This is explained in Publication 575. For this treatment to apply, you must choose to receive the proceeds in installments before receiving any part of the lump sum. This election must be made within 60 days after the lump-sum payment first becomes payable to you.

Accelerated Death Benefits

Certain payments made as accelerated death benefits under a life insurance contract or viatical settlement before the insured's death are excluded from income if the insured is terminally or chronically ill. See Exception later. For a chronically ill individual, the payments must be for costs incurred for qualified long-term care services or made on a periodic basis without regard to the costs.

In addition, if any portion of a death benefit under a life insurance contract on the life of a terminally or chronically ill individual is sold or assigned to a viatical settlement provider, the amount received also is excluded from income. Generally, a viatical settlement provider is one who regularly engages in the business of buying or taking assignment of life insurance contracts on the lives of insured individuals who are terminally or chronically ill.

To claim an exclusion for accelerated death benefits made on a per diem or other periodic basis, you must file Form 8853, Archer MSAs and Long-Term Care Insurance Contracts, with your return.

Terminally or chronically ill defined.   A terminally ill person is one who has been certified by a physician as having an illness or physical condition that reasonably can be expected to result in death within 24 months from the date of the certification. A chronically ill person is one who is not terminally ill but has been certified (within the previous 12 months) by a licensed health care practitioner as meeting either of the following conditions.

• The person is unable to perform (without substantial help) at least two activities of daily living for a period of 90 days or more because of a loss of functional capacity.
• The person requires substantial supervision to protect himself or herself from threats to health and safety due to severe cognitive impairment.

Exception.   The exclusion does not apply to any amount paid to a person other than the insured if that other person has an insurable interest in the life of the insured:

• Because the insured is a director, officer, or employee of the other person, or
• Because the insured has a financial interest in the business of the other person.

Sale of Home

You may be able to exclude from income any gain up to $250,000 ($500,000 on a joint return in most cases) on the sale of your main home. If you can exclude all of the gain, you do not need to report the sale on your tax return.

Maximum Amount of Exclusion

You can exclude up to $250,000 of the gain on the sale of your main home if all of the following are true.

1. You meet the ownership test.
2. You meet the use test.
3. During the 2-year period ending on the date of the sale, you did not exclude gain from the sale of another home.

You can exclude up to $500,000 of the gain on the sale of your main home if all of the following are true.

1. You are married and file a joint return for the year.
2. Either you or your spouse meets the ownership test.
3. Both you and your spouse meet the use test.
4. During the 2-year period ending on the date of the sale, neither you nor your spouse excluded gain from the sale of another home.

Ownership and Use Tests

To claim the exclusion, you must meet the ownership and use tests. This means that during the 5-year period ending on the date of the sale, you must have:

1. Owned the home for at least 2 years (the ownership test), and
2. Lived in the home as your main home for at least 2 years (the use test).

Exception.   If you owned and lived in the property as your main home for less than 2 years, you still can claim an exclusion in some cases. Generally, you must have sold the home due to a change in place of employment or health. The maximum amount you can exclude will be reduced. See Publication 523, Selling Your Home, for more information.

Married Persons

If you and your spouse file a joint return for the year of sale, you can exclude gain if either spouse meets the ownership and use tests. (See Maximum Amount of Exclusion, earlier.)

Death of spouse before sale.   If your spouse died before the date of sale, you are considered to have owned and lived in the property as your main home during any period of time when your spouse owned and lived in it as a main home.

Home transferred from spouse.   If your home was transferred to you by your spouse (or former spouse if the transfer was incident to divorce), you are considered to have owned it during any period of time when your spouse owned it.

Use of home after divorce.   You are considered to have used property as your main home during any period when:

• You owned it, and
• Your spouse or former spouse is allowed to live in it under a divorce or separation instrument.

Business Use or Rental of Home

You may be able to exclude your gain from the sale of a home that you have used for business or to produce rental income. But, you must meet the ownership and use tests. See Publication 523 for more information.

Depreciation after May 6, 1997.   If you were entitled to take depreciation deductions because you used your home for business purposes or as rental property, you cannot exclude the part of your gain equal to any depreciation allowed or allowable as a deduction for periods after May 6, 1997. See Publication 523 for more information.

Reporting the Gain

Do not report the 2002 sale of your main home on your tax return unless:

• You have a gain and you do not qualify to exclude all of it, or
• You have a gain and you choose not to exclude it.

If you have any taxable gain on the sale of your main home that cannot be excluded, report the entire gain on Schedule D (Form 1040). If you used your home for business or to produce rental income, you may have to use Form 4797, Sale of Business Property, to report the sale of the business or rental part. See Publication 523 for more information.

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