Generally, early distributions are amounts distributed from your traditional IRA account or annuity before you are age 59½, or amounts you receive when you cash in retirement bonds before you are age 59½. You must include early distributions of taxable amounts in your gross income. These taxable amounts are also subject to an additional 10% tax unless the distribution qualifies for an exception. See Tax on Early Distributions, later.

After you reach age 59½, you can receive distributions from your traditional IRA without having to pay the 10% additional tax. Even though you can receive distributions after you reach age 59½, distributions are not required until April 1 of the year following the year in which you reach age 70½.

If you are the owner of a traditional IRA, you must receive the entire balance in your IRA or start receiving periodic distributions from your IRA by April 1 of the year following the year in which you reach age 70½. See When Must I Withdraw IRA Assets? (Required Distributions) in Publication 590. If distributions from your traditional IRA(s) are less than the required minimum distribution for the year, you may have to pay a 50% excise tax for that year on the amount not distributed as required. See Tax on Excess Accumulation, later.

If you contributed to your pension or annuity and your annuity starting date is before 1987, you can continue to take your monthly exclusion for as long as you receive your annuity. The total exclusion may be more than your cost.

If your annuity starting date is after 1986, the total amount of annuity income you can exclude over the years as a recovery of the cost cannot exceed your total cost.

In either case, any unrecovered cost at your (or the last annuitant's) death is allowed as a miscellaneous itemized deduction on the final return of the decedent. This deduction is not subject to the 2%-of-adjusted-gross-income limit on miscellaneous deductions.

Before you can figure how much, if any, of your pension or annuity benefits is taxable, you must determine your cost in the plan (your investment). In general, your cost is your net investment in the contract as of the annuity starting date. This includes amounts your employer contributed that were taxable to you when paid.

From this total cost paid or considered paid by you, subtract any refunded premiums, rebates, dividends, unrepaid loans, or other tax-free amounts you received by the later of the annuity starting date or the date on which you received your first payment.

The annuity starting date is the later of the first day of the first period for which you received a payment from the plan or the date on which the plan's obligations became fixed.

The amount of your contributions to the plan may be shown in box 9b of any Form 1099–R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., that you receive.

If you worked abroad, certain amounts your employer paid into your retirement plan may be considered part of your cost. For details, see Foreign employment contributions in Publication 575.

Your pension, profit-sharing, stock bonus, annuity, or deferred compensation plan will withhold income tax on the taxable part of amounts paid to you. However, you can choose not to have tax withheld on the payments you receive, unless they are eligible rollover distributions. See Withholding Tax and Estimated Tax and Rollovers in Publication 575 for more information.

For payments other than eligible rollover distributions, you can tell the payer how to withhold by filing a Form W–4P, Withholding Certificate for Pension or Annuity Payments.

Under the Simplified Method, you figure the tax-free part of each annuity payment by dividing your cost by the total number of anticipated monthly payments. For an annuity that is payable over the lives of the annuitants, this number is based on the annuitants' ages on the annuity starting date and is determined from a table. For any other annuity, this number is the number of monthly annuity payments under the contract.

You generally must use the Simplified Method if your annuity starting date is after November 18, 1996, and you receive your pension or annuity payments from a qualified plan or annuity.

In addition, if your annuity starting date is after July 1, 1986, and before November 19, 1996, you generally could have chosen to use the Simplified Method for payments from a qualified plan.

You cannot use the Simplified Method and must use the General Rule if you receive pension or annuity payments from:

In addition, you must use the General Rule for payments from a qualified plan if your annuity starting date is after July 1, 1986, and before November 19, 1996, and you did not choose to use the Simplified Method. (You also must use the General Rule for payments from a qualified plan if your annuity starting date is before July 2, 1986, and you did not qualify to use the Three-Year Rule.)

Complete information on the General Rule, including the tables you need, is contained in Publication 939, General Rule for Pensions and Annuities.

Your annuity contract provides guaranteed payments if a minimum number of payments or a minimum amount (for example, the amount of your investment) is payable even if you and any survivor annuitant do not live to receive the minimum. If the minimum amount is less than the total amount of the payments you are to receive, barring death, during the first 5 years after payments begin (figured by ignoring any payment increases), you are entitled to less than 5 years of guaranteed payments.

Complete the Simplified Method Worksheet in the Form 1040 or Form 1040A instructions or in Publication 575 to figure your taxable annuity for 2003. If the annuity is payable only over your life, use your age on your annuity starting date to complete line 3 of the worksheet. If your annuity is payable over your life and the lives of other individuals, use your combined ages on the annuity starting date. (However, if your annuity starting date is before 1998, use the primary annuitant's age on the annuity starting date.) If the annuity does not depend on anyone's life expectancy, use the total number of monthly annuity payments under the contract.

Be sure to keep a copy of the completed worksheet; it will help you figure your taxable annuity in later years.

If you receive a survivor annuity because of the death of a retiree who had reported the annuity under the Three-Year Rule, include the total received in your income. (The retiree's cost has already been recovered tax free.)

If the retiree was reporting the annuity payments under the General Rule, you must apply the same exclusion percentage the retiree used to your initial payment called for in the contract. The resulting tax-free amount will then remain fixed. Any increases in the survivor annuity are fully taxable.

If the retiree was reporting the annuity payments under the Simplified Method, the part of each payment that is tax free is the same as the tax-free amount figured by the retiree at the annuity starting date. See Simplified Method, earlier.

If you file Form 1040, report your total annuity on line 16a, and the taxable part on line 16b. If your pension or annuity is fully taxable, enter it on line 16b. Do not make an entry on line 16a. For example, if you received monthly payments totaling $1,200 during 2003 from a pension plan that was completely financed by your employer, and you had paid no tax on the payments that your employer made to the plan, the entire $1,200 is taxable. You include $1,200 only on line 16b, Form 1040.

If you file Form 1040A, report your total annuity on line 12a, and the taxable part on line 12b. If your pension or annuity is fully taxable, enter it on line 12b. Do not make an entry on line 12a.

If you file a joint return and you and your spouse each receive one or more pensions or annuities, report the total of the pensions and annuities on line 16a, Form 1040, or line 12a, Form 1040A, and report the total of the taxable parts on line 16b, Form 1040, or line 12b, Form 1040A.

You should receive a Form 1099–R for your pension or annuity. Form 1099–R shows your pension or annuity for the year and any income tax withheld.

If you receive a lump-sum distribution from a qualified employee plan or qualified employee annuity and the plan participant was born before January 2, 1936, you may be able to elect optional methods of figuring the tax on the distribution. The part from active participation in the plan before 1974 may qualify as capital gain subject to a 20% tax rate. The part from participation after 1973 (and any part from participation before 1974 that you do not report as capital gain) is ordinary income. You may be able to use the 10-year tax option to figure tax on the ordinary income part.

If you receive a total distribution from a plan, you should receive a Form 1099–R. If the distribution qualifies as a lump-sum distribution, box 3 shows the capital gain. The amount in box 2a minus the amount in box 3 is the ordinary income.

For more detailed information on lump-sum distributions, get Publication 575 or Form 4972, Tax on Lump-Sum Distributions.

If an early withdrawal from a deferred annuity is otherwise subject to the 10% additional tax, a 5% rate may apply instead. A 5% rate applies to distributions under a written election providing a specific schedule for the distribution of your interest in the contract if, as of March 1, 1986, you had begun receiving payments under the election. On line 4 of Form 5329, multiply by 5% instead of 10%. Attach an explanation to your return.

The early distribution tax does not apply to any distribution that meets one of the following exceptions.

The tax does not apply to distributions that are:

The tax does not apply to distributions that are:

The tax does not apply to distributions that are:

If distribution code 1 (early distribution, no known exception) is shown in box 7 of Form 1099–R, multiply the taxable part of the early distribution by 10% and enter the result on line 57 of Form 1040. Write “No” on the dotted line. You do not have to file Form 5329.

You do not have to file Form 5329 if you qualify for an exception to the 10% tax and distribution code 2, 3, or 4 is shown in box 7 of Form 1099–R. However, you must file Form 5329 if the code is not shown or the code shown is incorrect (for example, code 1 is shown although you meet an exception).

If you own (or are considered to own under section 318 of the Internal Revenue Code) more than 5% of the company maintaining your qualified retirement plan, you must begin to receive distributions by April 1 of the year after the calendar year in which you reach age 70½.

If you do not receive the required minimum distribution, you are subject to an additional tax. The tax equals 50% of the difference between the amount that must be distributed and the amount that was distributed during the tax year. You can get this excise tax excused if you establish that the shortfall in distributions was due to reasonable error and that you are taking reasonable steps to remedy the shortfall.

You must file a Form 5329 if you owe a tax because you did not receive a minimum required distribution from your qualified retirement plan.

For more detailed information on the tax on excess accumulation, see Publication 575.

The first category is the amount of tier 1 railroad retirement benefits that equals the social security benefit that a railroad employee or beneficiary would have been entitled to receive under the social security system. This part of the tier 1 benefit is the social security equivalent benefit (SSEB) and is treated (for tax purposes) like social security benefits. (See Social Security and Equivalent Railroad Retirement Benefits, later.)

The second category consists of the rest of the tier 1 benefits, called the non-social security equivalent benefit (NSSEB), and any tier 2 benefit, vested dual benefit (VDB), and supplemental annuity benefit. This category of benefits is treated as an amount received from a qualified employee plan. This allows for the tax-free (nontaxable) recovery of employee contributions from the tier 2 benefits and the NSSEB part of the tier 1 benefits. Vested dual benefits and supplemental annuity benefits are fully taxable.

For more information about railroad retirement benefits, see Publication 575.

To figure the total of one-half of your benefits plus your other income, use the worksheet discussed later. If the total is more than your base amount, part of your benefits may be taxable.

Report your net benefits (the amount in box 5 of your Form SSA–1099 or Form RRB–1099) on line 20a and the taxable part on line 20b. If you are married filing separately and you lived apart from your spouse for all of 2003, also enter “D” to the right of the word “benefits” on line 20a.

Report your net benefits (the amount in box 5 of your Form SSA–1099 or Form RRB–1099) on line 14a and the taxable part on line 14b. If you are married filing separately and you lived apart from your spouse for all of 2003, enter “D” to the right of the word “benefits” on line 14a.

If none of your benefits are taxable, do not report any of them on your tax return. However, if you are married filing separately and you lived apart from your spouse for all of 2003, make the following entries: On Form 1040, enter “D” to the right of the word “benefits” on line 20a and “–0–” on line 20b. On Form 1040A, enter “D” to the right of the word “benefits” on line 14a and “–0–” on line 14b.

The taxable part of your benefits usually cannot be more than 50%. However, up to 85% of your benefits can be taxable if either of the following situations applies to you.

A worksheet to figure your taxable benefits is in the instructions for your Form 1040 or 1040A. You can use either that worksheet or Worksheet 1 in Publication 915, Social Security and Equivalent Railroad Retirement Benefits, unless any of the following situations applies to you.

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.

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.

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

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

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 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.

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.

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.

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.

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.

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

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.

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.

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.

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.

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.

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.

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 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:

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, health, or unforeseen circumstances. The maximum amount you can exclude will be reduced. See Publication 523, Selling Your Home, for more information.

If your spouse died and you did not remarry 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.

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.

You are considered to have used property as your main home during any period when:

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.

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 rents, that income is taxable to you. If property is given to a trust and the income from it is paid, credited, or distributed to you, that income also is taxable to you. If the gift, bequest, or inheritance is the income from property, that income is taxable to you.

Do not include in your income any veterans' benefits paid under any law, regulation, or administrative practice administered by the Department of Veterans Affairs (VA). See Publication 525.

Do not include in your income benefit payments from a public welfare fund, such as payments due to blindness.

These payments should not be included in the victims' incomes if they are in the nature of welfare payments. Do not deduct medical expenses that are reimbursed by such a fund.

Payments made under section 235 of the National Housing Act for mortgage assistance are not included in the homeowner's income. Interest paid for the homeowner under the mortgage assistance program cannot be deducted.

Payments made by a state to qualified people to reduce their cost of winter energy use are not taxable.

Food benefits you receive under the Nutrition Program for the Elderly are not taxable. If you prepare and serve free meals for the program, include in your income as wages the cash pay you receive, even if you also are eligible for food benefits.