| Pub. 525, Taxable and Nontaxable Income |
2004 Tax Year |
Main Contents
This is archived information that pertains only to the 2004 Tax Year. If you
are looking for information for the current tax year, go to the Tax Prep Help Area.
Generally, you must include in gross income everything you receive in payment for personal services. In addition to wages,
salaries, commissions,
fees, and tips, this includes other forms of compensation such as fringe benefits and stock options.
You should receive a Form W-2, Wage and Tax Statement, from your employer showing the pay you
received for your services. Include your pay on line 7 of Form 1040 or Form 1040A or on line 1 of Form 1040EZ, even if you
do not receive a Form W-2.
Childcare providers.
If you provide child care, either in the child's home or in your home or other place of business, the pay you receive
must be included in your
income. If you are not an employee, you are probably self-employed and must include payments for your services on Schedule
C (Form 1040), Profit or
Loss From Business, or Schedule C-EZ (Form 1040), Net Profit From Business. You generally are not an employee unless you are
subject to the will and
control of the person who employs you as to what you are to do and how you are to do it.
Baby-sitting.
If you baby-sit for relatives or neighborhood children, whether on a regular basis or only periodically, the rules
for childcare providers apply to
you.
Miscellaneous Compensation
This section discusses many types of employee compensation. The subjects are arranged in alphabetical order.
Advance commissions and other earnings.
If you receive advance commissions or other amounts for services to be performed in the future and you are a cash-method
taxpayer, you must include
these amounts in your income in the year you receive them.
If you repay unearned commissions or other amounts in the same year you receive
them, reduce the amount included in your income by the repayment. If you repay them in a later tax year, you can deduct the
repayment as an itemized
deduction on your Schedule A (Form 1040), or you may be able to take a credit for that year. See Repayments, later.
Allowances and reimbursements.
If you receive travel, transportation, or other business expense allowances or reimbursements from your
employer, see Publication 463, Travel, Entertainment, Gift, and Car Expenses. If you are reimbursed for moving expenses, see
Publication 521, Moving
Expenses.
Back pay awards.
Include in income amounts you are awarded in a settlement or judgment for back pay. These include payments made to
you for damages, unpaid life
insurance premiums, and unpaid health insurance premiums. They should be reported to you by your employer on Form W-2.
Bonuses and awards.
Bonuses or awards you receive for outstanding work are included in your income and should be shown on your
Form W-2. These include prizes such as vacation trips for meeting sales goals. If the prize or award you receive is goods
or services, you must
include the fair market value of the goods or services in your income. However, if your employer merely promises to pay you
a bonus or award at some
future time, it is not taxable until you receive it or it is made available to you.
Employee achievement award.
If you receive tangible personal property (other than cash, a gift certificate, or an equivalent item) as an award
for length-of-service or safety
achievement, you generally can exclude its value from your income. However, the amount you can exclude is limited to your
employer's cost and cannot
be more than $1,600 ($400 for awards that are not qualified plan awards) for all such awards you receive during the year.
Your employer can tell you
whether your award is a qualified plan award. Your employer must make the award as part of a meaningful presentation, under
conditions and
circumstances that do not create a significant likelihood of it being disguised pay.
However, the exclusion does not apply to the following awards.
-
A length-of-service award if you received it for less than 5 years of service or if you received another length-of-service
award during the
year or the previous 4 years.
-
A safety achievement award if you are a manager, administrator, clerical employee, or other professional employee or if more
than 10% of
eligible employees previously received safety achievement awards during the year.
Example.
Ben Green received three employee achievement awards during the year: a nonqualified plan award of a watch valued at $250,
and two qualified plan
awards of a stereo valued at $1,000 and a set of golf clubs valued at $500. Assuming that the requirements for qualified plan
awards are otherwise
satisfied, each award by itself would be excluded from income. However, because the $1,750 total value of the awards is more
than $1,600, Ben must
include $150 ($1,750 - $1,600) in his income.
Government cost-of-living allowances.
Cost-of-living allowances generally are included in your income. However, they are not included in your income if
you are a federal civilian
employee or a federal court employee who is stationed in Alaska, Hawaii, or outside the United States.
Allowances and differentials that increase your basic pay as an incentive for taking a less desirable post of duty
are part of your compensation
and must be included in income. For example, your compensation includes Foreign Post, Foreign Service, and Overseas Tropical
differentials. For more
information, see Publication 516, U.S. Government Civilian Employees Stationed Abroad.
Note received for services.
If your employer gives you a secured note as payment for your services, you must include the fair market value (usually
the discount value) of the
note in your income for the year you receive it. When you later receive payments on the note, a proportionate part of each
payment is the recovery of
the fair market value that you previously included in your income. Do not include that part again in your income. Include
the rest of the payment in
your income in the year of payment.
If your employer gives you a nonnegotiable unsecured note as payment for your services, payments on the note that
are credited toward the principal
amount of the note are compensation income when you receive them.
Severance pay.
Amounts you receive as severance pay are taxable. A lump-sum payment for cancellation of your employment contract
must be included in your income
in the tax year you receive it.
Accrued leave payment.
If you are a federal employee and receive a lump-sum payment for accrued annual leave when you retire or resign, this
amount will be included as
wages on your Form W-2.
If you resign from one agency and are reemployed by another agency, you may have to repay part of your lump-sum annual
leave payment to the second
agency. You can reduce gross wages by the amount you repaid in the same tax year in which you received it. Attach to your
tax return a copy of the
receipt or statement given to you by the agency you repaid to explain the difference between the wages on your return and
the wages on your Forms W-2.
Outplacement services.
If you choose to accept a reduced amount of severance pay so that you can receive outplacement services (such as training
in résumé
writing and interview techniques), you must include the unreduced amount of the severance pay in income.
However, you can deduct the value of these outplacement services (up to the difference
between the severance pay included in income and the amount actually received) as a miscellaneous deduction (subject to the
2% limit) on Schedule A
(Form 1040).
Sick pay.
Pay you receive from your employer while you are sick or injured is part of your salary or wages. In addition, you
must include in your income sick
pay benefits received from any of the following payers.
-
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.
However, if you paid the premiums on an accident or health insurance policy, the benefits you receive under the policy are
not taxable. For
more information, see Other Sickness and Injury Benefits under Sickness and Injury Benefits, later.
Social security and Medicare taxes paid by employer.
If you and your employer have an agreement that your employer pays your social security and Medicare taxes without
deducting them from your gross
wages, you must report the amount of tax paid for you as taxable wages on your tax return. The payment is also treated as
wages for figuring your
social security and Medicare taxes and your social security and Medicare benefits. However, these payments are not treated
as social security and
Medicare wages if you are a household worker or a farm worker.
Stock appreciation rights.
Do not include a stock appreciation right granted by your employer in income until you exercise (use) the right. When
you use the right, you are
entitled to a cash payment equal to the fair market value of the corporation's stock on the date of use, minus the fair market
value on the date the
right was granted. You include the cash payment in income in the year you use the right.
Fringe benefits received in connection with the performance of your services are included in your income as compensation unless
you pay fair market
value for them or they are specifically excluded by law. Abstaining from the performance of services (for example, under a
covenant not to compete) is
treated as the performance of services for purposes of these rules.
See Valuation of Fringe Benefits, later in this discussion, for information on how to determine the amount to include in income.
Recipient of fringe benefit.
You are the recipient of a fringe benefit if you perform the services for which the fringe benefit is provided. You
are considered to be the
recipient even if it is given to another person, such as a member of your family. An example is a car your employer gives
to your spouse for services
you perform. The car is considered to have been provided to you and not to your spouse.
You do not have to be an employee of the provider to be a recipient of a fringe benefit. If you are a partner, director,
or independent contractor,
you can also be the recipient of a fringe benefit.
Provider of benefit.
Your employer or another person for whom you perform services is the provider of a fringe benefit regardless of whether
that person actually
provides the fringe benefit to you. The provider can be a client or customer of an independent contractor.
Accounting period.
You must use the same accounting period your employer uses to report your taxable noncash fringe benefits. Your employer
has the option to report
taxable noncash fringe benefits by using either of the following rules.
-
The general rule: benefits are reported for a full calendar year (January 1 – December 31).
-
The special accounting period rule: benefits provided during the last 2 months of the calendar year (or any shorter period)
are treated as
paid during the following calendar year. For example, each year your employer reports the value of benefits provided during
the last 2 months of the
prior year and the first 10 months of the current year.
Your employer does not have to use the same accounting period for each fringe benefit, but must use the same period for all
employees who
receive a particular benefit.
You must use the same accounting period that you use to report the benefit to claim an employee business deduction
(for use of a car, for example).
Form W-2.
Your employer reports your taxable fringe benefits in box 1 (Wages, tips, other compensation) of Form W-2. The total
value of your fringe benefits
may also be noted in box 12. The value of your fringe benefits may be added to your other compensation on one Form W-2, or
you may receive a separate
Form W-2 showing just the value of your fringe benefits in box 1 with a notation in box 12.
Generally, the value of accident or health plan coverage provided to you by your employer is not included in your income.
Benefits you receive from
the plan may be taxable, as explained, later, under Sickness and Injury Benefits.
Long-term care coverage.
Contributions by your employer to provide coverage for long-term care services generally are not included in your
income. However, contributions
made through a flexible spending or similar arrangement (such as a cafeteria plan) must be included in your income. This amount
will be reported as
wages in box 1 of your Form W-2.
Archer MSA contributions.
Contributions by your employer to your Archer MSA generally are not
included in your income. Their total will be reported in box 12 of Form W-2, with code R. You must report this amount on Form
8853, Archer MSAs and
Long-Term Care Insurance Contracts. File the form with your return.
Health flexible spending arrangement (health FSA).
If your employer provides a health FSA that qualifies as an accident or health plan, the amount of your salary reduction,
and reimbursements of
your medical care expenses and those of your spouse and dependents, generally are not included in your income.
Health reimbursement arrangement (HRA).
If your employer provides an HRA that qualifies as an accident or health plan, coverage and reimbursements of your
medical care expenses and those
of your spouse and dependents generally are not included in your income.
See also Reimbursement for medical care under Other Sickness and Injury Benefits, later.
You may be able to exclude from your income amounts paid or expenses incurred by your employer for qualified adoption expenses
in connection with
your adoption of an eligible child. See Publication 968, Tax Benefits for Adoption, for more information.
Adoption benefits are reported by your employer in box 12 of Form W-2 with code T. They also are
included as social security and Medicare wages in boxes 3 and 5. However, they are not included as wages in box 1. To determine
the taxable and
nontaxable amounts, you must complete Part III of Form 8839, Qualified Adoption Expenses. File the form with your return.
If your employer provides you with the free or low-cost use of an employer-operated gym or other athletic club on your employer's
premises, the
value is not included in your compensation. The gym must be used primarily by employees, their spouses, and their dependent
children.
If your employer pays for a fitness program provided to you at an off-site resort hotel or athletic club, the value of the
program is included in
your compensation.
De Minimis (Minimal) Benefits
If your employer provides you with a product or service and the cost of it is so small that it would be unreasonable for the
employer to account
for it, the value is not included in your income. Generally, the value of benefits such as discounts at company cafeterias,
cab fares home when
working overtime, and company picnics are not included in your income. Also see Employee Discounts, later.
Holiday gifts.
If your employer gives you a turkey, ham, or other item of nominal value at Christmas or other holidays, do not include
the value of the gift in
your income. However, if your employer gives you cash, a gift certificate, or a similar item that you can easily exchange
for cash, you include the
value of that gift as extra salary or wages regardless of the amount involved.
If your employer provides dependent care benefits under a qualified plan, you may be able to exclude these benefits from your
income. Dependent
care benefits include:
-
Amounts your employer pays directly to either you or your care provider for the care of your qualifying person while you work,
and
-
The fair market value of care in a daycare facility provided or sponsored by your employer.
The amount you can exclude is limited to the lesser of:
-
The total amount of dependent care benefits you received during the year,
-
The total amount of qualified expenses you incurred during the year,
-
Your earned income,
-
Your spouse's earned income, or
-
$5,000 ($2,500 if married filing separately).
Your employer must show the total amount of dependent care benefits provided to you during the year under a qualified plan
in box 10 of your Form
W-2. Your employer also will include any dependent care benefits over $5,000 in your wages shown in box 1 of your Form W-2.
To claim the exclusion, you must complete either Part III of Form 2441, Child and
Dependent Care Expenses, or Part III of Schedule 2 (Form 1040A), Child and Dependent Care Expenses for Form 1040A Filers.
(You cannot use Form
1040EZ.)
See the instructions for Form 2441 or Schedule 2 (Form 1040A) for more information.
You can exclude from your income up to $5,250 of qualified employer-provided educational assistance. The exclusion applies
to undergraduate and
graduate-level courses. For more information, see Publication 970.
If your employer sells you property or services at a discount, you may be able to exclude the amount of the discount from
your income. The
exclusion applies to discounts on property or services offered to customers in the ordinary course of the line of business
in which you work. However,
it does not apply to discounts on real property or property commonly held for investment (such as stocks or bonds).
The exclusion is limited to the price charged nonemployee customers multiplied by the following percentage.
-
For a discount on property, your employer's gross profit percentage (gross profit divided by gross sales) on all property
sold during the
employer's previous tax year. (Ask your employer for this percentage.)
-
For a discount on services, 20%.
Financial Counseling Fees
Financial counseling fees paid for you by your employer are included in your income and must be
reported as part of wages. If the fees are for tax or investment counseling, they can be deducted on Schedule A (Form 1040)
as a miscellaneous
deduction (subject to the 2% limit).
Qualified retirement planning services paid for you by your employer may be excluded from your
income. For more information, see Retirement Planning Services, later.
Group-Term Life Insurance
Generally, the cost of up to $50,000 of group-term life insurance coverage provided to you by your employer (or former employer)
is not included in
your income. However, you must include in income the cost of employer-provided insurance that is more than the cost of $50,000
of coverage reduced by
any amount you pay toward the purchase of the insurance.
For exceptions to this rule, see Entire cost excluded, and Entire cost taxed, later.
If your employer provided more than $50,000 of coverage, the amount included in your income is reported as part of your wages
in box 1 of your Form
W-2. It is also shown separately in box 12 with code C.
Group-term life insurance.
This insurance is term life insurance protection (insurance for a fixed period of time) that:
-
Provides a general death benefit,
-
Is provided to a group of employees,
-
Is provided under a policy carried by the employer, and
-
Provides an amount of insurance to each employee based on a formula that prevents individual selection.
Permanent benefits.
If your group-term life insurance policy includes permanent benefits, such as a paid-up or cash surrender value, you
must include in your income,
as wages, the cost of the permanent benefits minus the amount you pay for them. Your employer should be able to tell you the
amount to include in your
income.
Accidental death benefits.
Insurance that provides accidental or other death benefits but does not provide general death benefits (travel insurance,
for example) is not
group-term life insurance.
Former employer.
If your former employer provides more than $50,000 of group-term life insurance coverage during the year, the amount
included in your income is
reported as wages in box 1 of Form W-2. Also, it is shown separately in box 12 with code C. Box 12 also will show the amount
of uncollected social
security and Medicare taxes on the excess coverage, with codes M and N. You must pay these taxes with your income tax return.
Include them in your
total tax on line 62, Form 1040, and enter “ UT” and the amount of the taxes on the dotted line next to line 62.
Two or more employers.
Your exclusion for employer-provided group-term life insurance coverage cannot exceed the cost of $50,000 of coverage,
whether the insurance is
provided by a single employer or multiple employers. If two or more employers provide insurance coverage that totals more
than $50,000, the amounts
reported as wages on your Forms W-2 will not be correct. You must figure how much to include in your income. Reduce the amount
you figure by any
amount reported with code C in box 12 of your Forms W-2, add the result to the wages reported in box 1, and report the total
on your return.
Figuring the taxable cost.
Use the following worksheet to figure the amount to include in your income.
Worksheet 1. Figuring the Cost of Group-Term Life Insurance To Include in Income
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1.
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Enter the total amount of your insurance coverage from your employer(s)
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1.
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2.
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Limit on exclusion for employer-provided group-term life insurance coverage
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2.
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50,000 |
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3.
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Subtract line 2 from line 1
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3.
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4.
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Divide line 3 by $1,000. Figure to the nearest tenth
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4.
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5.
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Go to Table 1. Using your age on the last day of the tax year, find your age group in the left
column, and enter the cost from the column on the right for your age group
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5.
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6.
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Multiply line 4 by line 5
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6.
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| |
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7.
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Enter the number of full months of coverage at this cost
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7.
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8.
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Multiply line 6 by line 7
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8.
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9.
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Enter the premiums you paid per month
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9.
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10.
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Enter the number of months you paid the premiums
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10.
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11.
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Multiply line 9 by line 10.
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11.
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12.
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Subtract line 11 from line 8. Include this amount in your income as wages |
12.
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If you pay any part of the cost of the insurance, your entire payment reduces, dollar for dollar, the amount you would otherwise
include in your
income. However, you cannot reduce the amount to include in your income by:
-
Payments for coverage in a different tax year,
-
Payments for coverage through a cafeteria plan, unless the payments are after-tax contributions, or
-
Payments for coverage not taxed to you because of the exceptions discussed later under Entire cost excluded.
Example.
You are 51 years old and work for employers A and B. Both employers provide group-term life insurance coverage for you for
the entire year. Your
coverage is $35,000 with employer A and $45,000 with employer B. You pay premiums of $4.15 a month under the employer B group
plan. You figure the
amount to include in your income as follows.
Worksheet 1. Figuring the Cost of Group-Term Life Insurance To Include in Income—Illustrated
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1.
|
Enter the total amount of your insurance coverage from your employer(s)
|
1.
|
80,000
|
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2.
|
Limit on exclusion for employer-provided group-term life insurance coverage
|
2.
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50,000 |
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3.
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Subtract line 2 from line 1
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3.
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30,000
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4.
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Divide line 3 by $1,000. Figure to the nearest tenth
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4.
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30.0
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5.
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Go to Table 1. Using your age on the last day of the tax year, find your age group in the left
column, and enter the cost from the column on the right for your age group
|
5.
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.23
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6.
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Multiply line 4 by line 5
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6.
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6.90
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7.
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Enter the number of full months of coverage at this cost.
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7.
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12
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8.
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Multiply line 6 by line 7
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8.
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82.80
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9.
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Enter the premiums you paid per month
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9.
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4.15
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10.
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Enter the number of months you paid the premiums
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10.
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12
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11.
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Multiply line 9 by line 10.
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11.
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49.80
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12.
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Subtract line 11 from line 8. Include this amount in your income as wages |
12.
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33.00
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The total amount to include in income for the cost of excess group-term life insurance is $33. Neither employer provided over
$50,000 insurance
coverage, so the wages shown on your Forms W-2 do not include any part of that $33. You must add it to the wages shown on
your Forms W-2 and include
the total on your return.
Entire cost excluded.
You are not taxed on the cost of group-term life insurance if any of the following circumstances apply.
-
You are permanently and totally disabled and have ended your employment.
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Your employer is the beneficiary of the policy for the entire period the insurance is in force during the tax year.
-
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.)
-
The plan existed on January 1, 1984, and:
-
You retired before January 2, 1984, and were covered by the plan when you retired, or
-
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.
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.
-
The meals are:
-
Furnished on the business premises of your employer, and
-
Furnished for the convenience of your employer.
-
The lodging is:
-
Furnished on the business premises of your employer,
-
Furnished for the convenience of your employer, and
-
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. See 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.
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:
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.
The exclusion for the qualified parking fringe benefit cannot be more than $195 a month.
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 by mass transit, in a commuter highway vehicle, or by carpool. It does not include parking
at or near the
employee's home.
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, former employee who retired or
became disabled,
or his or her spouse and dependent children.
-
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, see Publication 970.
Working Condition Benefits
If your employer provides you with a product or service and the cost of it would have been allowable as a business or depreciation
deduction 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 allowable to you as a business deduction 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:
-
The amount, if any, you paid for the benefit, plus
-
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:
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:
-
Any amount you repaid your employer, plus
-
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 not transferable or 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
transferable or is no longer subject to a substantial risk of forfeiture.
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.
-
Cash or deferred arrangements (section 401(k) plans).
-
The Thrift Savings Plan for federal employees.
-
Salary reduction simplified employee pension plans (SARSEP).
-
Savings incentive match plans for employees (SIMPLE plans).
-
Tax-sheltered annuity plans (403(b) plans).
-
Section 501(c)(18)(D) plans. (But see Reporting by employer, later.)
-
Section 457 plans.
Overall limit on deferrals.
For 2004, you generally should not have deferred more than a total of $13,000 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 $13,000 of contributions
to the plan listed in (7)
above (section 457 plan).
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 by the end of
your tax year. 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 Salary Reduction Simplified Employee Pension in Publication 560, Retirement Plans for Small
Business.
-
SIMPLE plans, see How Much Can Be Contributed on Your Behalf in chapter 3 of Publication 590, Individual Retirement Arrangements
(IRAs).
-
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 $9,000 in 2004. Amounts
you defer under a SIMPLE plan
count toward the overall limit ($13,000 for 2004) 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 $13,000. 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.
-
Wages and salaries.
-
Fees for professional services.
-
The value of any employer-provided qualified transportation fringe benefit (defined under Transportation, earlier) that is not
included in your income.
-
Other amounts received (cash or noncash) for personal services you performed, including, but not limited to, the following
items.
-
Commissions and tips.
-
Fringe benefits.
-
Bonuses.
-
Employer contributions (elective deferrals) to:
-
The section 457 plan.
-
Qualified cash or deferred arrangements (section 401(k) plans) that are not included in your income.
-
A salary reduction simplified employee pension (SARSEP).
-
A tax-sheltered annuity (section 403(b) plan).
-
A savings incentive match plan for employees (SIMPLE plan).
-
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:
-
Twice the dollar limit for the year, or
-
The limit for prior years minus the amount you deferred in prior years plus the lesser of:
-
Your includible compensation for the current year, or
-
The dollar limit for the current year.
Catch-up contributions.
You generally can have additional elective deferrals made to your governmental 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 $13,000 ($14,000 for 2005), plus $3,000 ($4,000
for 2005).
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 2004 generally
is $13,000 ($14,000 for
2005). 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.
-
$3,000.
-
$15,000, reduced by increases to the overall limit that you were allowed in earlier years because of this years-of-service
rule.
-
$5,000 times your number of years of service for the organization, minus the total elective deferrals under the plan for earlier
years.
For more information, see Publication 571, Tax-Sheltered Annuity Plans (403(b) Plans).
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 Form 1040, line 35. Enter the amount and “ 501(c)(18)(D)” on the dotted line next to line 35.
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 2004.
-
If the distribution was for a 2004 excess deferral, your Form 1099-R should have the code “8” in box 7. Add the excess deferral amount
to your wages on your 2004 tax return.
-
If the distribution was for a 2003 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 2003 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 15, 2004, you also must add it to your wages on your 2004 tax return.
-
If the distribution was for a 2002 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 2002 tax return, you must file an amended return on Form 1040X. You also must add it
to your wages on your 2004
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 2004 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 Form 1040, line 21 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.
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
non-highly
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 Form 1040, line 7.
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 2004 to your wages on your
2004 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 2003 or 2002 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.
The amount contributed in 2004 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.
If you receive a nonstatutory option to buy or sell stock or other property as payment for your services, you usually will
have income when you
receive the option, when you exercise the option (use it to buy or sell the stock or other property), or when you sell or
otherwise dispose of the
option. However, if your option is a statutory stock option (defined later), you will not have any income until you sell or
exchange your stock. Your
employer can tell you which kind of option you hold.
Nonstatutory Stock Options
If you are granted a nonstatutory stock option, the amount of income to include and the time to
include it depend on whether the fair market value of the option can be readily determined. The fair market value of an option
can be readily
determined if it is actively traded on an established market.
The fair market value of an option that is not traded on an established market can be readily determined only
if all of the following conditions exist.
-
You can transfer the option.
-
You can exercise the option immediately in full.
-
The option or the property subject to the option is not subject to any condition or restriction (other than a condition to
secure payment of
the purchase price) that has a significant effect on the fair market value of the option.
-
The fair market value of the option privilege can be readily determined.
The option privilege for an option to buy is the opportunity to benefit during the option's exercise period from any increase
in the value of
property subject to the option without risking any capital. For example, if during the exercise period the fair market value
of stock subject to an
option is greater than the option's exercise price, a profit may be realized by exercising the option and immediately selling
the stock at its higher
value. The option privilege for an option to sell is the opportunity to benefit during the exercise period from a decrease
in the value of the
property subject to the option.
If you or a member of your family is an officer, director, or more-than-10% owner of an expatriated corporation, you may owe
an excise tax on the
value of nonstatutory options and other stock-based compensation from that corporation. For more information on the excise
tax, see Internal Revenue
Code section 4985.
Option with readily determined value.
If you receive a nonstatutory stock option that has a readily determined fair market value at the time it is granted
to you, the option is treated
like other property received as compensation. See Restricted Property, later, for rules on how much income to include and when to include
it. However, the rule described in that discussion for choosing to include the value of property in your income for the year
of the transfer does not
apply to a nonstatutory option.
Option without readily determined value.
If the fair market value of the option is not readily determined at the time it is granted to you (even if it is determined
later), you do not have
income until you transfer or exercise the option. When you exercise this kind of option, the restricted property rules apply
to the property received.
The amount to include in your income is the difference between the amount you pay for the property and its fair market value
when it becomes
substantially vested. Your basis in the property you acquire under the option is the amount you pay for it plus any amount
you must include in your
gross income under this rule. For more information on restricted property, see Restricted Property, later.
Unrelated person.
If you transferred this kind of option in an arm's-length transaction to an unrelated person, you must include in
your income the money or other
property you received for the transfer, as if you had exercised the option.
Related person.
If you transferred this kind of option in an arm's-length transaction to a related person after July
1, 2003, the option is not treated as exercised or closed at that time, and you do not include in your income the money or
other property you received
for the transfer at that time. See Temporary Regulations section 1.83-7T for the definition of a related person.
Recourse note in satisfaction of the exercise price of an option.
If you are an employee, and you issue a recourse note to your employer in satisfaction of the exercise price of an
option to acquire your
employer's stock, and your employer and you subsequently agree to reduce the stated principal amount of the note, you generally
recognize compensation
income at the time and in the amount of the reduction.
Tax form.
If you receive compensation from employer-provided nonstatutory stock options, it is reported in box 1 of Form W-2.
It is also reported in box 12
using code “ V.”
If you are a nonemployee spouse and you exercise nonstatutory stock options you
received incident to a divorce, the income is reported to you on Form 1099-MISC, Miscellaneous Income, in box 3.
There are two kinds of statutory stock options.
For either kind of option, you must be an employee of the company granting the option, or a related company, at all times
beginning with the date
the option is granted, until 3 months before you exercise the option (for an incentive stock option, 1 year before if you
are disabled). Also, the
option must be nontransferable except at death. If you do not meet the employment requirements, or you receive a transferable
option, your option is a
nonstatutory stock option. See Nonstatutory Stock Options, earlier in this discussion.
If you receive a statutory stock option, do not include any amount in your income either when the option is granted or when
you exercise it. You
have taxable income or a deductible loss when you sell the stock that you bought by exercising the option. Your income or
loss is the difference
between the amount you paid for the stock (the option price) and the amount you receive when you sell it. You generally treat
this amount as capital
gain or loss and report it on Schedule D (Form 1040), Capital Gains and Losses, for the year of the sale.
However, you may have ordinary income for the year that you sell or otherwise dispose of the stock in either of the following
situations.
-
You do not meet the holding period requirement. This situation generally applies if you sell the stock within 1 year after
its transfer to
you or within 2 years after the option was granted. However, you are considered to meet the holding period requirement for
certain sales after October
22, 2004, to comply with conflict-of-interest requirements.
-
You meet the conditions described under Option granted at a discount, under Employee stock purchase plan,
later.
Report your ordinary income as wages on Form 1040, line 7, for the year of the sale.
Incentive stock options (ISOs).
If you sell stock acquired by exercising an ISO and meet the holding period requirement, your
gain or loss from the sale is capital gain or loss.
If you do not meet the holding period requirement and you have a gain from the sale, the gain is ordinary income up
to the amount by which the
stock's fair market value when you exercised the option exceeded the option price. Any excess gain is capital gain. If you
have a loss from the sale,
it is a capital loss and you do not have any ordinary income.
Example.
Your employer, X Corporation, granted you an ISO on March 11, 2002, to buy 100 shares of X Corporation stock at $10 a share,
its fair market value
at the time. You exercised the option on January 17, 2003, when the stock was selling on the open market for $12 a share.
On January 24, 2004, you
sold the stock for $15 a share. Although you held the stock for more than a year, less than 2 years had passed from the time
you were granted the
option. In 2004, you must report the difference between the option price ($10) and the value of the stock when you exercised
the option ($12) as
wages. The rest of your gain is capital gain, figured as follows:
Alternative minimum tax (AMT).
For the AMT, you must treat stock acquired through the exercise of an ISO as if no special treatment
applied. This means that, when your rights in the stock are transferable or no longer subject to a substantial risk of forfeiture,
you must include as
an adjustment in figuring alternative minimum taxable income the amount by which the fair market value of the stock exceeds
the option price. Enter
this adjustment on Form 6251, line 13, Alternative Minimum Tax—Individuals. Increase your AMT basis in any stock you acquire
by exercising the
ISO by the amount of the adjustment. However, no adjustment is required if you dispose of the stock in the same year you exercise
the option.
See Restricted Property, later, for more information.
Your AMT basis in stock acquired through an ISO is likely to differ from your regular tax basis. Therefore, keep adequate
records for both the AMT
and regular tax so that you can figure your adjusted gain or loss.
Example.
The facts are the same as in the previous example. On January 17, 2004, when the stock was selling on the open market for
$14 a share, your rights
to the stock first became transferable. You include $400 ($1,400 value when your rights first became transferable minus $1,000
purchase price) as an
adjustment on Form 6251, line 13.
Employee stock purchase plan.
If you sold stock acquired by exercising an option granted under an employee stock purchase plan, determine your ordinary
income and your capital
gain or loss as follows.
Option granted at a discount.
If at the time the option was granted, the option price per share was less than 100% (but not less than 85%) of the
fair market value of the share,
and you dispose of the share after meeting the holding period requirement, or you die while owning the share, you must include
in your income as
compensation, the lesser of:
-
The amount, if any, by which the price paid under the option was exceeded by the fair market value of the share at the time
the option was
granted, or
-
The amount, if any, by which the price paid under the option was exceeded by the fair market value of the share at the time
of the
disposition or death.
For this purpose, if the option price was not fixed or determinable at the time the option was granted, the option price is
figured as if the
option had been exercised at the time it was granted.
Any excess gain is capital gain. If you have a loss from the sale, it is a capital loss,
and you do not have any ordinary income.
Example.
Your employer, Y Corporation, granted you an option under its employee stock purchase plan to buy 100 shares of stock of Y
Corporation for $20 a
share at a time when the stock had a value of $22 a share. Eighteen months later, when the value of the stock was $23 a share,
you exercised the
option, and 14 months after that you sold your stock for $30 a share. In the year of sale, you must report as wages the difference
between the option
price ($20) and the value at the time the option was granted ($22). The rest of your gain ($8 per share) is capital gain,
figured as follows:
Holding period requirement not met.
If you do not meet the holding period requirement, your ordinary income is the amount by which the stock's fair market
value when you exercised the
option exceeded the option price. This ordinary income is not limited to your gain from the sale of the stock. Increase your
basis in the stock by the
amount of this ordinary income. The difference between your increased basis and the selling price of the stock is a capital
gain or loss.
Example.
The facts are the same as in the previous example, except that you sold the stock only 6 months after you exercised
the option. You did not hold the stock long enough, so you must report $300 as wages and $700 as capital gain, figured as
follows:
Generally, if you receive property for your services, you must include its fair market value in your income in the year you
receive the property.
However, if you receive stock or other property that has certain restrictions that affect its value, you do not include the
value of the property in
your income until it has been substantially vested. (You can choose to include the value of the property in your income in
the year it is transferred
to you, as discussed later, rather than the year it is substantially vested.)
Until the property becomes substantially vested, it is owned by the person who makes the transfer to you, usually your employer.
However, any
income from the property, or the right to use the property, is included in your income as additional compensation in the year
you receive the income
or have the right to use the property.
When the property becomes substantially vested, you must include its fair market value, minus any amount you paid for it,
in your income for that
year.
Example.
Your employer, the RST Corporation, sells you 100 shares of its stock at $10 a share. At the time of the sale the fair market
value of the stock is
$100 a share. Under the terms of the sale, the stock is under a substantial risk of forfeiture (you have a good chance of
losing it) for a 5-year
period. Your stock is not substantially vested when it is transferred, so you do not include any amount in your income in
the year you buy it. At the
end of the 5-year period, the fair market value of the stock is $200 a share. You must include $19,000 in your income [100
shares × ($200 fair
market value - $10 you paid)]. Dividends paid by the RST Corporation on your 100 shares of stock are taxable to you as additional
compensation
during the period the stock can be forfeited.
Substantially vested.
Property is substantially vested when:
Transferable property.
Property is transferable if you can sell, assign, or pledge your interest in the property to any person (other than
the transferor), and if the
person receiving your interest in the property is not required to give up the property, or its value, if the substantial risk
of forfeiture occurs.
Substantial risk of forfeiture.
A substantial risk of forfeiture exists if the rights in the property transferred depend on performing (or not performing)
substantial services, or
on a condition related to the transfer, and the possibility of forfeiture is substantial if the condition is not satisfied.
Example.
The Spin Corporation transfers to you as compensation for services 100 shares of its corporate stock for $100 a share. Under
the terms of the
transfer, you must resell the stock to the corporation at $100 a share if you leave your job for any reason within 3 years
from the date of transfer.
You must perform substantial services over a period of time and you must resell the stock to the corporation at $100 a share
(regardless of its value)
if you do not perform the services, so your rights to the stock are subject to a substantial risk of forfeiture.
Choosing to include in income for year of transfer.
You can choose to include the value of restricted property at the time of transfer (minus any amount you paid for
the property) in your income for
the year it is transferred. If you make this choice, the substantial vesting rules do not apply and, generally, any later
appreciation in value is not
included in your compensation when the property becomes substantially vested. Your basis for figuring gain or loss when you
sell the property is the
amount you paid for it plus the amount you included in income as compensation.
If you make this choice, you cannot revoke it without the consent of the Internal Revenue Service. Consent will be given only
if you were under a
mistake of fact as to the underlying transaction.
If you forfeit the property after you have included its value in income, your loss is the amount you paid for the
property minus any amount you
realized on the forfeiture.
You cannot make this choice for a nonstatutory stock option.
How to make the choice.
You make the choice by filing a written statement with the Internal Revenue Service Center where you file your return.
You must file this statement
no later than 30 days after the date the property was transferred. A copy of the statement must be attached to your tax return
for the year the
property was transferred. You also must give a copy of this statement to the person for whom you performed the services and,
if someone other than you
received the property, to that person.
You must sign the statement and indicate on it that you are making the choice under section 83(b) of the Internal
Revenue Code. The statement must contain all of the following information.
-
Your name, address, and taxpayer identification number.
-
A description of each property for which you are making the choice.
-
The date or dates on which the property was transferred and the tax year for which you are making the choice.
-
The nature of any restrictions on the property.
-
The fair market value at the time of transfer (ignoring restrictions except those that will never lapse) of each property
for which you are
making the choice.
-
Any amount that you paid for the property.
-
A statement that you have provided copies to the appropriate persons.
Dividends received on restricted stock.
Dividends you receive on restricted stock are treated as compensation and not as dividend income. Your employer should
include these payments on
your Form W-2. If they are also reported on a Form 1099-DIV, Dividends and Distributions, you should list them on Schedule
B (Form 1040) or Schedule 1
(Form 1040A), Interest and Ordinary Dividends for Form 1040A Filers, with a statement that you have included them as wages.
Do not include them in the
total dividends received.
Stock you chose to include in your income.
Dividends you receive on restricted stock you chose to include in your income in the year transferred are treated
the same as any other dividends.
You should receive a Form 1099-DIV showing these dividends. Do not include the dividends in your wages on your return. Report
them as dividends.
Sale of property not substantially vested.
These rules apply to the sale or other disposition of property that you did not choose to include in your income in
the year transferred and that
is not substantially vested.
If you sell or otherwise dispose of the property in an arm's-length transaction, include in your income as compensation
for the year of sale the
amount realized minus the amount you paid for the property. If you exchange the property in an arm's-length transaction for
other property that is not
substantially vested, treat the new property as if it were substituted for the exchanged property.
The sale or other disposition of a nonstatutory stock option to a related person after July 1, 2003, is not considered
an arm's-length transaction.
See Temporary Regulations section 1.83-7T for the definition of a related person.
If you sell the property in a transaction that is not at arm's length, include in your income as compensation for
the year of sale the total of any
money you received and the fair market value of any substantially vested property you received on the sale. In addition, you
will have to report
income when the original property becomes substantially vested, as if you still held it. Report as compensation its fair market
value minus the total
of the amount you paid for the property and the amount included in your income from the earlier sale.
Example.
In 2001, you paid your employer $50 for a share of stock that had a fair market value of $100 and was subject to forfeiture
until 2004. In 2003,
you sold the stock to your spouse for $10 in a transaction not at arm's length. You had compensation of $10 from this transaction.
In 2004, when the
stock had a fair market value of $120, it became substantially vested. For 2004, you must report additional compensation of
$60, figured as follows:
|
Fair market value of stock at time of substantial vesting
|
|
$120
|
|
Minus: Amount paid for stock
|
$50
|
|
|
Minus: Compensation previously included in income from sale to spouse
|
10
|
-60
|
| Additional income |
|
$60
|
Inherited property not substantially vested.
If you inherit property not substantially vested at the time of the decedent's death, any income you receive
from the property is considered income in respect of a decedent and is taxed according to the rules for restricted property
received for services. For
information about income in respect of a decedent, see Publication 559.
Special Rules for Certain Employees
This part of the publication deals with special rules for people in certain types of employment: members of the clergy, members
of religious
orders, people working for foreign employers, military personnel, and volunteers.
If you are a member of the clergy, you must include in your income offerings and fees you receive for marriages, baptisms,
funerals, masses, etc.,
in addition to your salary. If the offering is made to the religious institution, it is not taxable to you.
If you are a member of a religious organization and you give your outside earnings to the organization, you still must include
the earnings in your
income. However, you may be entitled to a charitable contribution deduction for the amount paid to the organization. See Publication
526, Charitable
Contributions. Also, see Members of Religious Orders, later.
Pension.
A pension or retirement pay for a member of the clergy usually is treated as any other pension or annuity. It must
be reported on lines 16a and 16b
of Form 1040 or on lines 12a and 12b of Form 1040A.
Special rules for housing apply to members of the clergy. Under these rules, you do not include in your income the rental
value of a home
(including utilities) or a designated housing allowance provided to you as part of your pay. However, the exclusion cannot
be more than the reasonable
pay for your service. If you pay for the utilities, you can exclude any allowance designated for utility cost, up to your
actual cost. The home or
allowance must be provided as compensation for your services as an ordained, licensed, or commissioned minister. However,
you must include the rental
value of the home or the housing allowance as earnings from self-employment on Schedule SE (Form 1040), Self-Employment Tax,
if you are subject to the
self-employment tax. For more information, see Publication 517, Social Security and Other Information for Members of the Clergy
and Religious Workers.
Members of Religious Orders
If you are a member of a religious order who has taken a vow of poverty, how you treat earnings that you renounce and turn
over to the order
depends on whether your services are performed for the order.
Services performed for the order.
If you are performing the services as an agent of the order in the exercise of duties required by the order, do not
include in your income the
amounts turned over to the order.
If your order directs you to perform services for another agency of the supervising church or an associated institution,
you are considered to be
performing the services as an agent of the order. Any wages you earn as an agent of an order that you turn over to the order
are not included in your
income.
Example.
You are a member of a church order and have taken a vow of poverty. You renounce any claims to your earnings and turn over
to the order any
salaries or wages you earn. You are a registered nurse, so your order assigns you to work in a hospital that is an associated
institution of the
church. However, you remain under the general direction and control of the order. You are considered to be an agent of the
order and any wages you
earn at the hospital that you turn over to your order are not included in your income.
Services performed outside the order.
If you are directed to work outside the order, your services are not an exercise of duties required by the order unless
they meet both of the
following requirements.
-
They are the kind of services that are ordinarily the duties of members of the order.
-
They are part of the duties that you must exercise for, or on behalf of, the religious order as its agent.
If you are an employee of a third party, the services you perform for the third party will not be considered directed or required
of you by the
order. Amounts you receive for these services are included in your income, even if you have taken a vow of poverty.
Example 1.
Mark Brown is a member of a religious order and has taken a vow of poverty. He renounces all claims to his earnings and turns
over his earnings to
the order.
Mark is a schoolteacher. He was instructed by the superiors of the order to get a job with a private tax-exempt school. Mark
became an employee of
the school, and, at his request, the school made the salary payments directly to the order.
Because Mark is an employee of the school, he is performing services for the school rather than as an agent of the order.
The wages Mark earns
working for the school are included in his income.
Example 2.
Gene Dennis is a member of a religious order who, as a condition of membership, has taken vows of poverty and obedience. All
claims to his earnings
are renounced. Gene received permission from the order to establish a private practice as a psychologist and counsels members
of religious orders as
well as nonmembers. Although the order reviews Gene's budget annually, Gene controls not only the details of his practice
but also the means by which
his work as a psychologist is accomplished.
Gene's private practice as a psychologist does not make him an agent of the religious order. The psychological services provided
by Gene are not
the type of services that are provided by the order. The income Gene earns as a psychologist is earned in his individual capacity.
Gene must include
in his income the earnings from his private practice.
Special rules apply if you work for a foreign employer.
U.S. citizen.
If you are a U.S. citizen who works in the United States for a foreign government, an international organization,
a foreign embassy, or any foreign
employer, you must include your salary in your income.
Social security and Medicare taxes.
You are exempt from social security and Medicare employee taxes if you are employed in the United States by an international
organization or a
foreign government. However, you must pay self-employment tax on your earnings from services performed in the United States,
even though you are not
self-employed. This rule also applies if you are an employee of a qualifying wholly owned instrumentality of a foreign government.
Employees of international organizations or foreign governments.
Your compensation for official services to an international organization is exempt from federal income tax if you
are not a citizen of the United
States or you are a citizen of the Philippines (whether or not you are a citizen of the United States).
Your compensation for official services to a foreign government is exempt from federal income tax
if all of the following are true.
-
You are not a citizen of the United States or you are a citizen of the Philippines (whether or not you are a citizen of the
United
States).
-
Your work is like the work done by employees of the United States in foreign countries.
-
The foreign government gives an equal exemption to employees of the United States in its country.
Waiver of alien status.
If you are an alien who works for a foreign government or international organization and you file a waiver under section
247(b) of the Immigration
and Nationality Act to keep your immigrant status, any salary you receive after the date you file the waiver is not exempt
under this rule. However,
it may be exempt under a treaty or agreement. See Publication 519, U.S. Tax Guide for Aliens, for more information about treaties.
Nonwage income.
This exemption applies only to employees' wages, salaries, and fees. Pensions and other income do not qualify for
this exemption.
Employment abroad.
For information on the tax treatment of income earned abroad, see Publication 54.
Payments you receive as a member of a military service generally are taxed as wages except for retirement pay, which is taxed
as a pension.
Allowances generally are not taxed. For more information on the tax treatment of military allowances and benefits, see Publication
3, Armed Forces'
Tax Guide.
Military retirement pay.
If your retirement pay is based on age or length of service, it is taxable and must be included in your income as
a pension on lines 16a and 16b of
Form 1040 or on lines 12a and 12b of Form 1040A. Do not include in your income the amount of any reduction in retirement or
retainer pay to provide a
survivor annuity for your spouse or children under the Retired Serviceman's Family Protection Plan or the Survivor Benefit
Plan.
For a more detailed discussion of survivor annuities, see Publication 575.
Disability.
If you are retired on disability, see Military and Government Disability Pensions under Sickness and Injury Benefits, later.
Veterans' benefits.
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). The following amounts paid to veterans or their families are not taxable.
-
Education, training, and subsistence allowances.
-
Disability compensation and pension payments for disabilities paid either to veterans or their families.
-
Grants for homes designed for wheelchair living.
-
Grants for motor vehicles for veterans who lost their sight or the use of their limbs.
-
Veterans' insurance proceeds and dividends paid either to veterans or their beneficiaries, including the proceeds of a veteran's
endowment
policy paid before death.
-
Interest on insurance dividends left on deposit with the VA.
-
Benefits under a dependent-care assistance program.
-
The death gratuity paid to a survivor of a member of the Armed Forces who died after September 10, 2001.
Rehabilitative program payments.
VA payments to hospital patients and resident veterans for their services under the VA's therapeutic or rehabilitative
programs are not treated as
nontaxable veterans' benefits. Report these payments as income on Form 1040, line 21.
The tax treatment of amounts you receive as a volunteer worker for the Peace Corps or similar agency is covered in the following
discussions.
Peace Corps.
Living allowances you receive as a Peace Corps volunteer or volunteer leader for housing, utilities, household supplies,
food, and clothing are
exempt from tax.
Taxable allowances.
The following allowances must be included in your income and reported as wages.
-
Allowances paid to your spouse and minor children while you are a volunteer leader training in the United States.
-
Living allowances designated by the Director of the Peace Corps as basic compensation. These are allowances for personal items
such as
domestic help, laundry and clothing maintenance, entertainment and recreation, transportation, and other miscellaneous expenses.
-
Leave allowances.
-
Readjustment allowances or termination payments. These are considered received by you when credited to your account.
Example.
Gary Carpenter, a Peace Corps volunteer, gets $175 a month as a readjustment allowance during his period of service, to be
paid to him in a lump
sum at the end of his tour of duty. Although the allowance is not available to him until the end of his service, Gary must
include it in his income on
a monthly basis as it is credited to his account.
Volunteers in Service to America (VISTA).
If you are a VISTA volunteer, you must include meal and lodging allowances paid to you in your income as wages.
National Senior Service Corps programs.
Do not include in your income amounts you receive for supportive services or reimbursements for out-of-pocket expenses
from the following programs.
-
Retired Senior Volunteer Program (RSVP).
-
Foster Grandparent Program.
-
Senior Companion Program.
Service Corps of Retired Executives (SCORE).
If you receive amounts for supportive services or reimbursements for out-of-pocket expenses from SCORE, do not include
these amounts in gross
income.
Volunteer tax counseling.
Do not include in your income any reimbursements you receive for transportation, meals, and other expenses you have
in training for, or actually
providing, volunteer federal income tax counseling for the elderly (TCE).
You can deduct as a charitable contribution your unreimbursed out-of-pocket expenses in taking part in the volunteer
income tax assistance (VITA)
program.
Business and Investment Income
This section provides information on the treatment of income from certain rents and royalties, and from interests in partnerships
and S
corporations. For additional information about business and investment income, you may want to see the following publications.
-
Publication 334, Tax Guide for Small Business (For Individuals Who Use Schedule C or C-EZ).
-
Publication 527, Residential Rental Property (Including Rental of Vacation Homes).
-
Publication 541, Partnerships.
-
Publication 544, Sales and Other Dispositions of Assets.
-
Publication 550, Investment Income and Expenses (Including Capital Gains and Losses).
Income from sales at auctions, including online auctions, may be business income. For more information, see Publication 334.
Rents From Personal Property
If you rent out personal property, such as equipment or vehicles, how you report your income and expenses is generally determined
by:
-
Whether or not the rental activity is a business, and
-
Whether or not the rental activity is conducted for profit.
Generally, if your primary purpose is income or profit and you are involved in the rental activity with continuity and regularity,
your rental
activity is a business. See Publication 535, Business Expenses, for details on deducting expenses for both business and not-for-profit
activities.
Reporting business income and expenses.
If you are in the business of renting personal property, report your income and expenses on Schedule C or Schedule
C-EZ (Form 1040). The form
instructions have information on how to complete them.
Reporting nonbusiness income.
If you are not in the business of renting personal property, report your rental income on Form 1040, line 21. List
the type and amount of the
income on the dotted line next to line 21.
Reporting nonbusiness expenses.
If you rent personal property for profit, include your rental expenses in the total amount you enter on Form 1040,
line 35. Also, enter the amount
and “ PPR” on the dotted line next to line 35.
If you do not rent personal property for profit, your deductions are limited and you cannot report a loss to offset
other income. See Activity
not for profit under Other Income in the discussion of Miscellaneous Income, later.
Royalties from copyrights, patents, and oil, gas, and mineral properties are taxable as ordinary income.
You generally report royalties in Part I of Schedule E (Form 1040), Supplemental Income and Loss. However, if you
hold an operating oil, gas, or mineral interest or are in business as a self-employed writer, inventor, artist, etc., report
your income and expenses
on Schedule C or Schedule C-EZ (Form 1040).
Copyrights and patents.
Royalties from copyrights on literary, musical, or artistic works, and similar property, or from patents on inventions,
are amounts paid to you for
the right to use your work over a specified period of time. Royalties generally are based on the number of units sold, such
as the number of books,
tickets to a performance, or machines sold.
Oil, gas, and minerals.
Royalty income from oil, gas, and mineral properties is the amount you receive when natural resources are extracted
from your property. The
royalties are based on units, such as barrels, tons, etc., and are paid to you by a person or company who leases the property
from you.
Depletion.
If you are the owner of an economic interest in mineral deposits or oil and gas wells, you can recover your investment
through the depletion
allowance. For information on this subject, see chapter 10 of Publication 535.
Coal and iron ore.
Under certain circumstances, you can treat amounts you receive from the disposal of coal and iron ore as payments
from the sale of a capital asset,
rather than as royalty income. For information about gain or loss from the sale of coal and iron ore, see Publication 544.
Sale of property interest.
If you sell your complete interest in oil, gas, or mineral rights, the amount you receive is considered payment for
the sale of section 1231
property, not royalty income. Under certain circumstances, the sale is subject to capital gain or loss treatment on Schedule
D (Form 1040). For more
information on selling section 1231 property, see chapter 3 of Publication 544.
If you retain a royalty, an overriding royalty, or a net profit interest in a mineral property for the life of the
property, you have made a lease
or a sublease, and any cash you receive for the assignment of other interests in the property is ordinary income subject to
a depletion allowance.
Part of future production sold.
If you own mineral property but sell part of the future production, you generally treat the money you receive from
the buyer at the time of the
sale as a loan from the buyer. Do not include it in your income or take depletion based on it.
When production begins, you include all the proceeds in your income, deduct all the production expenses, and deduct
depletion from that amount to
arrive at your taxable income from the property.
A partnership generally is not a taxable entity. The income, gains, losses, deductions, and credits of a partnership are passed
through to the
partners based on each partner's distributive share of these items. For more information, see Publication 541, Partnerships.
Partner's distributive share.
Your distributive share of partnership income, gains, losses, deductions, or credits is generally based on the partnership
agreement. You must
report your distributive share of these items on your return whether or not they are actually distributed to you. However,
your distributive share of
the partnership losses is limited to the adjusted basis of your partnership interest at the end of the partnership year in
which the losses took
place.
Partnership agreement.
The partnership agreement usually covers the distribution of profits, losses, and other items. However, if the agreement
does not state how a
specific item of gain or loss will be shared, or the allocation stated in the agreement does not have substantial economic
effect, your distributive
share is figured according to your interest in the partnership.
Partnership return.
Although a partnership generally pays no tax, it must file an information return on Form 1065, U.S. Return of Partnership
Income. This shows the
result of the partnership's operations for its tax year and the items that must be passed through to the partners.
Schedule K-1 (Form 1065).
You should receive from each partnership in which you are a member a copy of Schedule K-1 (Form 1065), Partner's Share
of Income, Deductions,
Credits, etc., showing your share of income, deductions, credits, and tax preference items of the partnership for the tax
year. Retain Schedule K-1
for your records. Do not attach it to your Form 1040.
Partner's return.
You generally must report partnership items on your individual return the same way as they are reported on
the partnership return. That is, if the partnership had a capital gain, you report your share on Schedule D (Form 1040). You
report your share of
partnership ordinary income on Schedule E (Form 1040).
Generally, Schedule K-1 (Form 1065) will tell you where to report each item of income on your
individual return.
In general, an S corporation does not pay tax on its income. Instead, the income, losses, deductions, and credits of the corporation
are passed
through to the shareholders based on each shareholder's pro rata share. You must report your share of these items on your return.
Generally, the items passed through to you will increase or decrease the basis of your S corporation stock as appropriate.
S corporation return.
An S corporation must file a return on Form 1120S, U.S. Income Tax Return for an S Corporation. This shows the results
of the corporation's
operations for its tax year and the items of income, losses, deductions, or credits that affect the shareholders' individual
income tax returns.
Schedule K-1 (Form 1120S).
You should receive from the S corporation in which you are a shareholder a copy of Schedule K-1 (Form 1120S), Shareholder's
Share of Income,
Deductions, Credits, etc., showing your share of income, losses, deductions, and credits, of the S corporation for the tax
year. Retain Schedule K-1
for your records. Do not attach it to your Form 1040.
Shareholder's return.
Your distributive share of the items of income, losses, deductions, or credits of the S corporation must be shown
separately on your Form 1040. The
character of these items generally is the same as if you had realized or incurred them personally.
Generally, Schedule K-1 (Form 1120S) will tell you where to report each item of income on your individual return.
Distributions.
Generally, S corporation distributions are a nontaxable return of your basis in the corporation stock. However, in
certain cases, part of the
distributions may be taxable as a dividend, or as a long-term or short-term capital gain, or as both. The corporation's distributions
may be in the
form of cash or property.
More information.
For more information, see the Instructions for Form 1120S.
Sickness and Injury Benefits
Generally, you must report as income any amount you receive for personal injury or sickness through an accident or health
plan that is paid for by
your employer. If both you and your employer pay for the plan, only the amount you receive that is due to your employer's
payments is reported as
income. However, certain payments may not be taxable to you. For information on nontaxable payments, see Military and Government Disability
Pensions and Other Sickness and Injury Benefits, later in this discussion.
Do not report as income any amounts paid to reimburse you for medical expenses you incurred after the plan was established.
Cost paid by you.
If you pay the entire cost of an accident or health plan, do not include any amounts you receive from the plan for
personal injury or sickness 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. See Recoveries under Miscellaneous Income, later.
Cafeteria plans.
Generally, if you are covered by an accident or health insurance plan through a cafeteria plan, and the amount of
the insurance premiums was not
included in your income, you are not considered to have paid the premiums and you must include any benefits you receive in
your income. If the amount
of the premiums was included in your income, you are considered to have paid the premiums and any benefits you receive are
not taxable.
If you retired on disability, you must include in income any disability pension you receive under a plan that is paid for
by your employer. You
must report your taxable disability payments as wages on line 7 of Form 1040 or Form 1040A until you reach minimum retirement
age. Minimum retirement
age generally is the age at which you can first receive a pension or annuity if you are not disabled.
You may be entitled to a tax credit if you were permanently and totally disabled when you retired. For information on this
credit, see Publication
524, Credit for the Elderly or the Disabled.
Beginning on the day after you reach minimum retirement age, payments you receive are taxable as a pension or annuity. Report
the payments on lines
16a and 16b of Form 1040 or on lines 12a and 12b of Form 1040A. For more information on pensions and annuities, see Publication
575.
Retirement and profit-sharing plans.
If you receive payments from a retirement or profit-sharing plan that does not provide for disability retirement,
do not treat the payments as a
disability pension. The payments must be reported as a pension or annuity.
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 tax year you receive it.
Military and Government Disability Pensions
Certain military and government disability pensions are not taxable.
Service-connected disability.
You may be able to exclude from income amounts you receive as a pension, annuity, or similar allowance for personal
injury or sickness resulting
from active service in one of the following government services.
-
The armed forces of any country.
-
The National Oceanic and Atmospheric Administration.
-
The Public Health Service.
-
The Foreign Service.
Conditions for exclusion.
Do not include the disability payments in your income if any of the following conditions apply.
-
You were entitled to receive a disability payment before September 25, 1975.
-
You were a member of a listed government service or its reserve component, or were under a binding written commitment to become
a member, on
September 24, 1975.
-
You receive the disability payments for a combat-related injury. This is a personal injury or sickness that:
-
Results directly from armed conflict,
-
Takes place while you are engaged in extra-hazardous service,
-
Takes place under conditions simulating war, including training exercises such as maneuvers, or
-
Is caused by an instrumentality of war.
-
You would be entitled to receive disability compensation from the Department of Veterans Affairs (VA) if you filed an application
for it.
Your exclusion under this condition is equal to the amount you would be entitled to receive from the VA.
Pension based on years of service.
If you receive a disability pension based on years of service, you generally must include it in your income. However,
if the pension qualifies for
the exclusion for a service-connected disability (discussed earlier), do not include in income the part of your pension that
you would have received
if the pension had been based on a percentage of disability. You must include the rest of your pension in your income.
Retroactive VA determination.
If you retire from the armed services based on years of service and are later given a retroactive service-connected
disability rating by the VA,
your retirement pay for the retroactive period is excluded from income up to the amount of VA disability benefits you would
have been entitled to
receive. You can claim a refund of any tax paid on the excludable amount (subject to the statute of limitations) by filing
an amended return on Form
1040X for each previous year during the retroactive period.
If you receive a lump-sum disability severance payment and are later awarded VA disability benefits, exclude 100%
of the severance benefit from
your income. However, you must include in your income any lump-sum readjustment or other nondisability severance payment you
received on release from
active duty, even if you are later given a retroactive disability rating by the VA.
Terrorist attack or military action.
Do not include in your income disability payments you receive for injuries resulting directly from a terrorist or
military action.
A terrorist action is one that is directed against the United States or any of its allies (including a multinational
force in which the United
States is participating). A military action is one that involves the armed forces of the United States and is a result of
actual or threatened
violence or aggression against the United States or any of its allies, but does not include training exercises.
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. To claim an exclusion for payments made on a per diem or other periodic basis under a long-term care insurance
contract, you must file Form 8853 with your return.
A long-term care insurance contract is an insurance contract that only provides coverage for qualified long-term care services.
The contract must:
-
Be guaranteed renewable,
-
Not provide for a cash surrender value or other money that can be paid, assigned, pledged, or borrowed,
-
Provide that refunds, other than refunds on the death of the insured or complete surrender or cancellation of the contract,
and dividends
under the contract may be used only to reduce future premiums or increase future benefits, and
-
Generally not pay or reimburse expenses incurred for services or items that would be reimbursed under Medicare, except where
Medicare is a
secondary payer or the contract makes per diem or other periodic payments without regard to expenses.
Qualified long-term care services.
Qualified long-term care services are:
-
Necessary diagnostic, preventive, therapeutic, curing, treating, mitigating, rehabilitative services, and maintenance and
personal care
services, and
-
Required by a chronically ill individual and provided pursuant to a plan of care prescribed by a licensed health care practitioner.
Chronically ill individual.
A chronically ill individual is one who has been certified by a licensed health care practitioner within the previous
12 months as one of the
following.
-
An individual who, for at least 90 days, is unable to perform at least two activities of daily living without substantial
assistance due to
loss of functional capacity. Activities of daily living are eating, toileting, transferring, bathing, dressing, and continence.
-
An individual who requires substantial supervision to be protected from threats to health and safety due to severe cognitive
impairment.
Limit on exclusion.
The exclusion for payments made on a per diem or other periodic basis under a long-term care insurance contract is subject to a limit.
The limit applies to the total of these payments and any accelerated death benefits made on a per diem or other periodic basis under a life
insurance contract because the insured is chronically ill. (For more information on accelerated death benefits, see Life Insurance Proceeds
under Miscellaneous Income, later.)
Under this limit, the excludable amount for any period is figured by subtracting any reimbursement received (through
insurance or otherwise) for
the cost of qualified long-term care services during the period from the larger of the following amounts.
See Section C of Form 8853 and its instructions for more information.
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 survivors.
The exemption, however, does
not apply to retirement plan benefits you receive based on your age, length of service, or prior contributions to the plan,
even if you retired
because of an occupational sickness or injury.
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 Other
Income under Miscellaneous Income, later.
Return to work.
If you return to work after qualifying for workers' compensation, salary payments you receive for performing light
duties are taxable as wages.
Disability pension.
If your disability pension is paid under a statute that provides benefits only to employees with service-connected
disabilities, part of it may be
workers' compensation. That part is exempt from tax. The rest of your pension, based on years of service, is taxable as pension
or annuity income. If
you die, the part of your survivors' benefit that is a continuation of the workers' compensation is exempt from tax.
Other Sickness and Injury Benefits
In addition to disability pensions and annuities, you may receive other payments for sickness or injury.
Railroad sick pay.
Payments you receive as sick pay under the Railroad Unemployment Insurance Act are taxable and you must include them
in your income. However, do
not include them in your income if they are for an on-the-job injury.
Black lung benefit payments.
These payments are similar to workers' compensation and generally are not taxable.
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.
Report this income on
line 7 of Form 1040 or Form 1040A or on line 1 of Form 1040EZ. 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
Other Income under Miscellaneous Income, later.
You can deduct the amount you spend to buy back sick leave for an earlier year to be eligible for nontaxable FECA
benefits for that period. It is a
miscellaneous deduction subject to the 2% limit on Schedule A (Form 1040). If you buy back sick leave in the same year you
used it, the amount reduces
your taxable sick leave pay. Do not deduct it separately.
Other compensation.
Many other amounts you receive as compensation for sickness or injury are not taxable. These include the following
amounts.
-
Compensatory damages you receive for physical injury or physical sickness, whether paid in a lump sum or in periodic payments.
See
Court awards and damages under Other Income, later.
-
Benefits you receive under an accident or health insurance policy on which either you paid the premiums or your employer paid
the premiums
but you had to include them in your income.
-
Disability benefits you receive for loss of income or earning capacity as a result of injuries under a no-fault car insurance
policy.
-
Compensation you receive for permanent loss or loss of use of a part or function of your body, or for your permanent disfigurement.
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.
Reimbursement for medical care.
A reimbursement for medical care generally is not taxable. However, it may reduce your medical expense deduction.
If you receive reimbursement for
an expense you deducted in an earlier year, see Recoveries, later.
If you receive an “ advance reimbursement” or “ loan” for future medical expenses from your employer without regard to whether you suffered
a personal injury or sickness or incurred medical expenses, that amount is included in your income, whether or not you incur
uninsured medical
expenses during the year.
Reimbursements received under your employer's plan for expenses incurred before the plan was established are included
in income.
Reimbursements received under your employer's plan of the amount paid for nonprescription medicines
and drugs (such as allergy medicine, pain reliever, and cold medicine) are not included in income. However, reimbursements
of the amount paid for
dietary supplements (such as vitamins) that are merely beneficial to your general health are included in income.
This section discusses various types of income. You may have taxable income from certain transactions even if no money changes
hands. For example,
you may have taxable income if you lend money at a below-market interest rate or have a debt you owe cancelled.
Bartering is an exchange of property or services. You must include in your income, at the time received, the fair market value
of property or
services you receive in bartering. If you exchange services with another person and you both have agreed ahead of time as
to the value of the
services, that value will be accepted as fair market value unless the value can be shown to be otherwise.
Generally, you report this income on Schedule C or Schedule C-EZ (Form 1040). However, if the barter involves an
exchange of something other than services, such as in Example 4 below, you may have to use another form or schedule instead.
Example 1.
You are a self-employed attorney who performs legal services for a client, a small corporation. The corporation gives you
shares of its stock as
payment for your services. You must include the fair market value of the shares in your income on Schedule C or Schedule C-EZ
(Form 1040) in the year
you receive them.
Example 2.
You are a self-employed accountant. You and a house painter are members of a barter club. Members get in touch with each other
directly and bargain
for the value of the services to be performed. In return for accounting services you provided, the house painter painted your
home. You must report as
your income on Schedule C or Schedule C-EZ (Form 1040) the fair market value of the house painting services you received.
The house painter must
include in income the fair market value of the accounting services you provided.
Example 3.
You are self-employed and a member of a barter club. The club uses credit units as a means of exchange. It adds credit units
to your account for
goods or services you provide to members, which you can use to purchase goods or services offered by other members of the
barter club. The club
subtracts credit units from your account when you receive goods or services from other members. You must include in your income
the value of the
credit units that are added to your account, even though you may not actually receive goods or services from other members
until a later tax year.
Example 4.
You own a small apartment building. In return for 6 months rent-free use of an apartment, an artist gives you a work of art
she created. You must
report as rental income on Schedule E (Form 1040) the fair market value of the artwork, and the artist must report as income
on Schedule C or Schedule
C-EZ (Form 1040) the fair rental value of the apartment.
Form 1099-B from barter exchange.
If you exchanged property or services through a barter exchange, Form 1099-B, Proceeds from Broker and Barter Exchange
Transactions, or a similar
statement from the barter exchange should be sent to you by January 31, 2005. It should show the value of cash, property,
services, credits, or scrip
you received from exchanges during 2004. The IRS will also receive a copy of Form 1099-B.
Backup withholding.
The income you receive from bartering generally is not subject to regular income tax withholding. However, backup
withholding will apply in certain
circumstances to ensure that income tax is collected on this income.
Under backup withholding, the barter exchange must withhold, as income tax, 28% of the income if:
-
You do not give the barter exchange your taxpayer identification number (generally a social security number or an employer
identification
number), or
-
The IRS notifies the barter exchange that you gave it an incorrect identification number.
If you join a barter exchange, you must certify under penalties of perjury that your taxpayer identification number is correct
and that you are
not subject to backup withholding. If you do not make this certification, backup withholding may begin immediately. The barter
exchange will give you
a Form W-9, Request for Taxpayer Identification Number and Certification, or a similar form, for you to make this certification.
The barter exchange will withhold tax only up to the amount of any cash paid to you or deposited in your account and
any scrip or credit issued to
you (and converted to cash).
If tax is withheld from your barter income, the barter exchange will report the amount of tax
withheld on Form 1099-B, or similar statement.
Generally, if a debt you owe is canceled or forgiven, other than as a gift or bequest, you must include the canceled amount
in your income. You
have no income from the canceled debt if it is intended as a gift to you. A debt includes any indebtedness for which you are
liable or which attaches
to property you hold.
If the debt is a nonbusiness debt, report the canceled amount on Form 1040, line 21. If it is a business debt, report the
amount on Schedule C or
Schedule C-EZ (Form 1040) (or on Schedule F (Form 1040), Profit or Loss From Farming, if the debt is farm debt and you are
a farmer).
Form 1099-C.
If a Federal Government agency, financial institution, or credit union cancels or forgives a debt you owe of $600
or more, you will receive a Form
1099-C, Cancellation of Debt. The amount of the canceled debt is shown in box 2.
Interest included in canceled debt.
If any interest is forgiven and included in the amount of canceled debt in box 2, the amount of interest also will
be shown in box 3. Whether or
not you must include the interest portion of the canceled debt in your income depends on whether the interest would be deductible
if you paid it. See
Deductible debt under Exceptions, later.
If the interest would not be deductible (such as interest on a personal loan), include in your income the amount from
Form 1099-C, box 2. If the
interest would be deductible (such as on a business loan), include in your income the net amount of the canceled debt (the
amount shown in box 2 less
the interest amount shown in box 3).
Discounted mortgage loan.
If your financial institution offers a discount for the early payment of your mortgage loan, the amount of the discount
is canceled debt. You must
include the canceled amount in your income.
Mortgage relief upon sale or other disposition.
If you are personally liable for a mortgage (recourse debt), and you are relieved of the mortgage when you dispose
of the property, you may realize
gain or loss up to the fair market value of the property. To the extent the mortgage discharge exceeds the fair market value
of the property, it is
income from discharge of indebtedness unless it qualifies for exclusion under Excluded debt, later. Report any income from discharge of
indebtedness on nonbusiness debt that does not qualify for exclusion as other income on Form 1040, line 21.
If you are not personally liable for a mortgage (nonrecourse debt), and you are relieved of the mortgage when
you dispose of the property (such as through foreclosure or repossession), that relief is included in the amount you realize.
You may have a taxable
gain if the amount you realize exceeds your adjusted basis in the property. Report any gain on nonbusiness property as a capital
gain.
See Foreclosures and Repossessions in Publication 544 for more information.
Stockholder debt.
If you are a stockholder in a corporation and the corporation cancels or forgives your debt to it, the canceled debt
is a constructive distribution
that is generally dividend income to you. For more information, see Publication 542.
If you are a stockholder in a corporation and you cancel a debt owed to you by the corporation, you generally do not
realize income. This is
because the canceled debt is considered as a contribution to the capital of the corporation equal to the amount of debt principal
that you canceled.
There are several exceptions to the inclusion of canceled debt in income. These are explained next.
Student loans.
Certain student loans contain a provision that all or part of the debt incurred to attend the qualified educational
institution will be canceled if
you work for a certain period of time in certain professions for any of a broad class of employers.
You do not have income if your student loan is canceled after you agreed to this provision and then performed the
services required. To qualify,
the loan must have been made by:
-
The Federal Government, a state or local government, or an instrumentality, agency, or subdivision thereof,
-
A tax-exempt public benefit corporation that has assumed control of a state, county, or municipal hospital, and whose employees
are
considered public employees under state law, or
-
An educational institution:
-
Under an agreement with an entity described in (1) or (2) that provided the funds to the institution to make the loan, or
-
As part of a program of the institution designed to encourage students to serve in occupations or areas with unmet needs and
under which the
services provided are for or under the direction of a governmental unit or a tax-exempt section 501(c)(3) organization (defined
later).
A loan to refinance a qualified student loan will also qualify if it was made by an educational institution or a tax-exempt
section 501(a)
organization under its program designed as described in (3)(b) above.
An educational institution is an organization with a regular faculty and curriculum and a regularly enrolled body
of students in attendance at the
place where the educational activities are carried on.
A section 501(c)(3) organization is any corporation, community chest, fund, or foundation organized and
operated exclusively for one or more of the following purposes.
-
Charitable.
-
Educational.
-
Fostering national or international amateur sports competition (but only if none of the organization's activities involve
providing athletic
facilities or equipment).
-
Literary.
-
Preventing cruelty to children or animals.
-
Religious.
-
Scientific.
-
Testing for public safety.
Exception.
You do have income if your student loan was made by an educational institution and is canceled because of services
you performed for the
institution or other organization that provided the funds.
Deductible debt.
You do not have income from the cancellation of a debt if your payment of the debt would be deductible. This exception
applies only if you use the
cash method of accounting. For more information, see chapter 5 of Publication 334.
Price reduced after purchase.
Generally, if the seller reduces the amount of debt you owe for property you purchased, you do not have income from
the reduction. The reduction of
the debt is treated as a purchase price adjustment and reduces your basis in the property.
Excluded debt.
Do not include a canceled debt in your gross income in the following situations.
-
The debt is canceled in a bankruptcy case under title 11 of the U.S. Code. See Publication 908, Bankruptcy Tax Guide.
-
The debt is canceled when you are insolvent. However, you cannot exclude any amount of canceled debt that is more than the
amount by which
you are insolvent. See Publication 908.
-
The debt is qualified farm debt and is canceled by a qualified person. See chapter 3 of Publication 225, Farmer's Tax Guide.
-
The debt is qualified real property business debt. See chapter 5 of Publication 334.
-
The cancellation is intended as a gift.
Education Loan Repayment Assistance
Beginning in 2004, education loan repayments made to you by the National Health Service Corps Loan Repayment Program (NHSC
Loan Repayment Program)
or a state education loan repayment program eligible for funds under the Public Health Service Act are not taxable if you
agree to provide primary
health services in health professional shortage areas. For more information, see Publication 970.
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.
Example.
The face amount of the policy is $75,000 and, as beneficiary, you choose to receive 120 monthly installments of $1,000 each.
The excluded part of
each installment is $625 ($75,000 ÷ 120), or $7,500 for an entire year. The rest of each payment, $375 a month (or $4,500
for an entire year),
is interest income to you.
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.
Interest option on insurance.
If an insurance company pays you interest only on proceeds from life insurance left on deposit, the interest you are
paid is taxable.
If your spouse died before October 23, 1986, and you chose to receive only the interest from your insurance proceeds,
the $1,000 interest exclusion
for a surviving spouse does not apply. If you later decide to receive the proceeds from the policy in installments, you can
take the interest
exclusion from the time you begin to receive the installments.
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. In general, your cost (or investment in the contract) is the total of premiums that you paid for the life insurance
policy, less any refunded
premiums, rebates, dividends, or unrepaid loans that were not included in your income.
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 on lines 12a and 12b of Form 1040A.
For information on when the proceeds are excluded from income, see Accelerated Death Benefits, later.
Split-dollar life insurance.
Generally, a split-dollar life insurance arrangement is an arrangement between an owner and a non-owner of a life
insurance contract under which
either party to the arrangement pays all or part of the premiums, and one of the parties paying the premiums is entitled to
recover all or part of
those premiums from the proceeds of the contract. There are two mutually exclusive regimes to tax split-dollar life insurance
arrangements.
-
Under the economic benefit regime, the owner of the life insurance contract is treated as providing current life insurance
protection and
other taxable economic benefits to the non-owner of the contract.
-
Under the loan regime, the non-owner of the life insurance contract is treated as loaning premium payments to the owner of
the
contract.
Only one of these regimes applies to any one policy. For more information, see sections 1.61-22 and 1.7872-15 of the regulations.
Endowment Contract Proceeds
An endowment contract is a policy under which you are paid a specified amount of money on a certain date unless you die before
that date, in which
case, the money is paid to your designated beneficiary. 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, subtract any amount that you previously received under the contract
and excluded from your
income from the total premiums (or other consideration) paid for the contract. 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 amounts paid 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.
Viatical settlement.
This is the sale or assignment of any part of the death benefit under a life insurance contract to a viatical settlement
provider. A viatical
settlement provider is a person 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 and who meets the requirements of section 101(g)(2)(B) of the Internal
Revenue Code.
Exclusion for terminal illness.
Accelerated death benefits are fully excludable if the insured is a terminally ill individual. This is a person who
has been certified by a
physician as having an illness or physical condition that can reasonably be expected to result in death within 24 months from
the date of the
certification.
Exclusion for chronic illness.
If the insured is a chronically ill individual who is not terminally ill, accelerated death benefits paid on the basis
of costs incurred for
qualified long-term care services are fully excludable. Accelerated death benefits paid on a per diem or other periodic basis are
excludable up to a limit. This limit applies to the total of the accelerated death benefits and any periodic payments received
from long-term care
insurance contracts. For information on the limit and the definitions of chronically ill individual, qualified long-term care
services, and long-term
care insurance contracts, see Long-Term Care Insurance Contracts under Sickness and Injury Benefits, earlier.
Exception.
The exclusion does not apply to any amount paid to a person (other than the insured) who has an insurable interest
in the life of the insured
because the insured:
-
Is a director, officer, or employee of the person, or
-
Has a financial interest in the person's business.
Form 8853.
To claim an exclusion for accelerated death benefits made on a per diem or other periodic basis, you must file Form 8853 with your
return. You do not have to file Form 8853 to exclude accelerated death benefits paid on the basis of actual expenses incurred.
A recovery is a return of an amount you deducted or took a credit for in an earlier year. The most
common recoveries are refunds, reimbursements, and rebates of deductions itemized on Schedule A (Form 1040). You also may
have recoveries of
non-itemized deductions (such as payments on previously deducted bad debts) and recoveries of items for which you previously
claimed a tax credit.
Tax benefit rule.
You must include a recovery in your income in the year you receive it up to the amount by which the deduction or credit
you took for the recovered
amount reduced your tax in the earlier year. For this purpose, any increase to an amount carried over to the current year
that resulted from the
deduction or credit is considered to have reduced your tax in the earlier year.
Federal income tax refund.
Refunds of federal income taxes are not included in your income because they are never allowed as a deduction from
income.
State income tax refund.
If you received a state or local income tax refund (or credit or offset) in 2004, you generally must include it in
income if you deducted the tax
in an earlier year. The payer should send Form 1099-G, Certain Government Payments, to you by January 31, 2005. The IRS also
will receive a copy of
the Form 1099-G. Use the worksheet in the 2004 Form 1040 instructions for line 10 to figure the amount (if any) to include
in your income.
Mortgage interest refund.
If you received a refund or credit in 2004 of mortgage interest paid in an earlier year, the amount should be shown
in box 3 of your Form 1098,
Mortgage Interest Statement. Do not subtract the refund amount from the interest you paid in 2004. You may have to include
it in your income under the
rules explained in the following discussions.
Interest on recovery.
Interest on any of the amounts you recover must be reported as interest income in the year received. For example,
report any interest you received
on state or local income tax refunds on Form 1040, line 8a.
Recovery and expense in same year.
If the refund or other recovery and the expense occur in the same year, the recovery reduces the deduction or credit
and is not reported as income.
Recovery for 2 or more years.
If you receive a refund or other recovery that is for amounts you paid in 2 or more separate years, you must allocate,
on a pro rata
basis, the recovered amount between the years in which you paid it. This allocation is necessary to determine the amount of
recovery from any earlier
years and to determine the amount, if any, of your allowable deduction for this item for the current year.
Example.
You paid 2003 estimated state income tax of $4,000 in four equal payments. You made your fourth payment in January 2004. You
had no state income
tax withheld during 2003. In 2004, you received a $400 tax refund based on your 2003 state income tax return. You claimed
itemized deductions each
year on your federal income tax return.
You must allocate the $400 refund between 2003 and 2004, the years in which you paid the tax on which the refund is based.
You paid 75% ($3,000
÷ $4,000) of the estimated tax in 2003, so 75% of the $400 refund, or $300, is for amounts you paid in 2003 and is a recovery
item. If all of
the $300 is a taxable recovery item, you will include $300 on Form 1040, line 10, for 2004, and attach a copy of your computation
showing why that
amount is less than the amount shown on the Form 1099-G you received from the state.
The balance ($100) of the $400 refund is for your January 2004 estimated tax payment. When you figure your deduction for state
and local income
taxes paid during 2004, you will reduce the $1,000 paid in January by $100. Your deduction for state and local income taxes
paid during 2004 will
include the January net amount of $900 ($1,000 - $100), plus any estimated state income taxes paid in 2004 for 2004, and any
state income tax
withheld during 2004.
Deductions not itemized.
If you did not itemize deductions for the year for which you received the recovery of an expense that was deductible
only if you itemized, do not
include any of the recovery amount in your income.
Example.
You claimed the standard deduction on your 2003 federal income tax return. In 2004 you received a refund of your 2003 state
income tax. Do not
report any of the refund as income because you did not itemize deductions for 2003.
Itemized Deduction Recoveries
The following discussion explains how to determine the amount to include in your income from a recovery of an amount deducted
in an earlier year as
an itemized deduction. However, you generally do not need to use this discussion if the recovery is for state or local income
taxes paid in 2003.
Instead, use the worksheet in the 2004 Form 1040 instructions for line 10 to figure the amount (if any) to include in your
income.
You cannot use the Form 1040 worksheet and must use this discussion if any of the following statements is true.
-
The recovery is for a tax year other than 2003.
-
The recovery is for a deducted item other than state or local income taxes, such as real property taxes.
-
Your 2003 taxable income was less than zero.
-
You made your last payment of 2003 state or local estimated tax in 2004.
-
You owed alternative minimum tax for 2003.
-
You could not deduct all your tax credits for 2003 because their total was more than the amount of tax shown on your 2003
Form 1040, line
43.
-
You could be claimed as a dependent by someone else in 2003.
If you also recovered an amount deducted as a non-itemized deduction, figure the amount of that recovery to include in your
income and add it to
your adjusted gross income before applying the rules explained here. See Non-Itemized Deduction Recoveries, later.
Total recovery included in income.
If you recover any amount that you deducted in an earlier year on Schedule A (Form 1040), you generally must include
the full amount of the
recovery in your income in the year you receive it. This rule applies if, for the earlier year, all of the following statements
are true.
-
Your itemized deductions exceeded the standard deduction by at least the amount of the recovery. (If your itemized deductions
did not exceed
the standard deduction by at least the amount of the recovery, see Standard deduction limit, later.)
-
You had taxable income. (If you had no taxable income, see Negative taxable income, later.)
-
Your deduction for the item recovered equals or exceeds the amount recovered. (If your deduction was less than the amount
recovered, see
Recovery limited to deduction, later.)
-
Your itemized deductions were not subject to the limit on itemized deductions. (If your deductions were limited, see Itemized
deductions limited, later.)
-
You had no unused tax credits. (If you had unused tax credits, see Unused tax credits, later.)
-
You were not subject to alternative minimum tax. (If you were subject to alternative minimum tax, see Subject to alternative minimum
tax, later.)
If any of the above statements is not true, see Total recovery not included in income, later.
Where to report.
Enter your state or local income tax refund on Form 1040, line 10, and the total of all other recoveries as other
income on Form 1040, line 21. You
cannot use Form 1040A or Form 1040EZ.
Example.
For 2003, you filed a joint return. Your taxable income was $60,000 and you were not entitled to any tax credits. Your standard
deduction was
$9,500, and you had itemized deductions of $11,000. In 2004, you received the following recoveries for amounts deducted on
your 2003 return:
None of the recoveries were more than the deductions taken for 2003.
Your total recoveries are less than the amount by which your itemized deductions exceeded the standard deduction ($11,000
- $9,500 = $1,500),
so you must include your total recoveries in your income for 2004. Report the state and local income tax refund of $400 on
Form 1040, line 10, and the
balance of your recoveries, $525, on Form 1040, line 21.
Total recovery not included in income.
If one or more of the six statements listed in the preceding discussion is not true, you may be able to exclude at
least part of the recovery from
your income. If statements (4), (5), and (6) are true (your itemized deductions were not limited, you had no unused tax credits,
and you were not
subject to the alternative minimum tax), you can use Worksheet 2 to determine the part of your recovery to include in your
income.
Worksheet 2. Recoveries of Itemized DeductionsKeep for your Records
To determine whether you should complete this worksheet to figure the part of a recovery amount to
include in income on your 2004 Form 1040, see Total recovery not included in income under Itemized Deduction Recoveries. If you
recovered amounts from more than one year, such as a state income tax refund from 2003 and a casualty loss reimbursement from
2002, complete a
separate worksheet for each year. Use information from Schedule A (Form 1040) for the year the expense was deducted.
A recovery is included in income only to the extent of the deduction amount that reduced your tax in the prior year (year
of the deduction). If you
were subject to the alternative minimum tax or your tax credits reduced your tax to zero, see Unused tax credits and Subject to
alternative minimum tax under Itemized Deduction Recoveries. If your recovery was for an itemized deduction that was limited, you
should read Itemized deductions limited under Itemized Deduction Recoveries.
|
|
1.
|
State/local income tax refund or credit
1 |
1.
|
|
|
2.
|
Enter the total of all other Schedule A refunds or reimbursements
(excluding the amount you entered on line 1)
1 |
2.
|
|
|
3.
|
Add lines 1 and 2
|
3.
|
|
|
4.
|
Itemized deductions for the prior year
(for example, line 28 of Schedule A for 2003)
|
4.
|
|
|
|
|
5.
|
Enter any amount previously refunded to you
(do not enter an amount from line 1 or line 2)
|
5.
|
|
|
|
|
6.
|
Subtract line 5 from line 4
|
6.
|
|
|
|
|
7.
|
Standard deduction for the prior year. (The standard deduction amounts for 2003, 2002, and 2001 are shown
in Tables 2, 3, and 4.)
|
7.
|
|
|
|
|
8.
|
Subtract line 7 from line 6. If the result is zero or less, stop here.
The amounts on lines 1 and 2 are not taxable
|
8.
|
|
|
9.
|
Enter the smaller of line 3 or line 8
|
9.
|
|
|
10.
|
Taxable income for prior year
2 (for example, line 41, Form 1040 for 2003)
|
10.
|
|
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|
|
11.
|
Amount to include in income for 2004:
-
If line 10 is zero or more, enter the amount from line 9.
-
If line 10 is a negative amount, add lines 9 and 10 and enter the result
(but not less than zero).
3
|
11.
|
|
| |
If line 11 equals line 3—
Enter the amount from line 1 on line 10, Form 1040.
Enter the amount from line 2 on line 21, Form 1040.
|
| |
If line 11 is less than line 3 and either line 1 or line 2 is zero—
If there is an amount on line 1, enter the amount from line 11 on line 10, Form 1040.
If there is an amount on line 2, enter the amount from line 11 on line 21, Form 1040.
|
| |
If line 11 is less than line 3, and there are amounts on both lines 1 and 2, complete the following
worksheet. |
| |
A.
|
Divide the amount on line 1 by the amount on line 3. Enter the percentage
|
A.
|
|
|
|
| |
B.
|
Multiply the amount on line 11 by the percentage on line A.
Enter the result here and on line 10, Form 1040
|
B.
|
|
| |
C.
|
Subtract the amount on line B from the amount on line 11.
Enter the result here and on line 21, Form 1040
|
C.
|
|
| 1 Do not enter more than the amount deducted for the prior year.
|
| 2 If taxable income is a negative amount, enter that amount in brackets. Do not enter zero unless your taxable income is exactly
zero.
Taxable income will have to be adjusted for any net operating loss carryover. For more information, see Publication 536, Net
Operating Losses (NOLs)
for Individuals, Estates, and Trusts.
|
| 3 For example, $700 + ($400) = $300.
|
Allocating the included part.
If you are not required to include all of your recoveries in your income, and you have both a state income tax refund
and other itemized deduction
recoveries, you must allocate the taxable recoveries between the state tax refund you report on Form 1040, line 10, and the
amount you report as other
income on Form 1040, line 21. If you do not use Worksheet 2, make the allocation as follows.
-
Divide your state income tax refund by the total of all your itemized deduction recoveries.
-
Multiply the amount of taxable recoveries by the percentage in (1). This is the amount you report as a state income tax refund.
-
Subtract the result in (2) above from the amount of taxable recoveries. This is the amount you report as other income.
Example.
In 2004 you recovered $2,500 of your 2003 itemized deductions, but the recoveries you must include in your 2004 income are
only $1,500. Of the
$2,500 you recovered, $500 was due to your state income tax refund. The amount you report as a state tax refund on Form 1040,
line 10, is $300 [($500
÷ $2,500) × $1,500]. The balance of the taxable recoveries, $1,200, is reported as other income on Form 1040, line 21.
Standard deduction limit.
You generally are allowed to claim the standard deduction if you do not itemize your deductions. Only your itemized
deductions that are more than
your standard deduction are subject to the recovery rule (unless you are required to itemize your deductions). If your total
deductions on the earlier
year return were not more than your income for that year, include in your income this year the lesser of:
Standard deduction for earlier years.
To determine if amounts recovered in 2004 must be included in your income, you must know the standard deduction for
your filing status for the year
the deduction was claimed. The standard deduction tables for 2003, 2002, and 2001 are shown in Tables 2, 3, and 4. If you
need the standard deduction
amounts for years before 2001, see the copy of your return for that year.
Example.
You filed a joint return for 2003 with taxable income of $45,000. Your itemized deductions were $10,350. The standard deduction
that you could have
claimed was $9,500. In 2004, you recovered $2,400 of your 2003 itemized deductions. None of the recoveries were more than
the actual deductions for
2003. Include $850 of the recoveries in your 2004 income. This is the smaller of your recoveries ($2,400) or the amount by
which your itemized
deductions were more than the standard deduction ($10,350 - $9,500 = $850).
Negative taxable income.
If your taxable income was a negative amount, reduce the recovery you must otherwise include in your income by the
negative amount.
Example.
The facts are the same as in the previous example except you had a negative taxable income of $200 in 2003. You must include
$650 in your 2004
income, rather than $850.
Recovery limited to deduction.
You do not include in your income any amount of your recovery that is more than the amount you deducted in the earlier
year. The amount you include
in your income is limited to the smaller of:
Example.
During 2003, you paid $1,700 for medical expenses. From this amount you subtracted $1,500, which was 7.5% of your adjusted
gross income. Your
actual medical expense deduction was $200. In 2004, you received a $500 reimbursement from your medical insurance for your
2003 expenses. The only
amount of the $500 reimbursement that must be included in your income for 2004 is $200—the amount actually deducted.
Itemized deductions limited.
You were subject to the limit on itemized deductions in the earlier year if your adjusted gross income (AGI) was more
than a base amount. For
example, this amount was:
-
For 2003, $139,500 ($69,750 if married filing separately),
-
For 2002, $137,300 ($68,650 if married filing separately), and
-
For 2001, $132,950 ($66,475 if married filing separately).
If the limit applied, your itemized deductions were reduced by the smaller of the following amounts.
-
3% of the amount by which your AGI exceeded the base amount.
-
80% of your otherwise allowable deductions other than medical and dental expenses, investment interest expense, nonbusiness
casualty and
theft losses, and gambling losses.
If the amount you recovered was deducted in a year in which your itemized deductions were limited, you must include
it in income up to the
difference between the amount of itemized deductions actually allowed that year and the amount you would have been allowed
(the greater of your
itemized deductions or your standard deduction) if you had figured your deductions using only the net amount of the recovery
item.
To determine the part of the recovery you must include in income, follow the two steps below.
-
Figure the greater of:
-
The standard deduction for the earlier year, or
-
The amount of itemized deductions you would have been allowed for the earlier year (after taking into account the limit on
itemized
deductions) if you had figured them using only the net amount of the recovery item. The net amount is the amount you actually
paid reduced by the
recovery amount.
Note. If you were required to itemize your deductions in the earlier year, use step 1(b) and not step 1(a).
-
Subtract the amount in step 1 from the amount of itemized deductions actually allowed in the earlier year after applying the
limit on
itemized deductions.
The result of step 2 is the amount of the recovery to include in your income for the year you receive the recovery. If your
taxable income for
the earlier year was a negative amount, reduce your recovery by the negative amount.
If you had unused tax credits in the earlier year, see Unused tax credits on page 24.
For more information on this computation, see Revenue Ruling 93-75. This ruling is in Cumulative Bulletin 1993-2.
Example.
Eileen Martin is single. She had an AGI of $1,137,300 and itemized her deductions on her federal income tax return for 2003.
She was not subject to
alternative minimum tax and was not entitled to any credit against income tax. Her only allowable deduction was $40,000 of
state income taxes.
However, Eileen deducted only $10,000 in 2003 because her otherwise allowable deductions of $40,000 were reduced by $30,000.
In 2004, she received a
$5,000 refund of her state income taxes for 2003.
The following shows how Eileen figured the $30,000 reduction and other amounts from the Itemized Deduction Worksheet in the
2003 Schedule A (Form
1040) instructions. These amounts are needed to figure the part of the $5,000 refund that Eileen must include in her income
for 2004.
|
AGI for 2003
|
$1,137,300
|
|
State income taxes paid in 2003
|
$40,000
|
3% reduction (amount on
2003 Itemized Deduction
Worksheet, line 8),
[($1,137,300 - $137,300) × 3%]
|
$30,000
|
80% reduction not applied (amount
on 2003 Itemized
Deduction Worksheet, line 4)
($40,000 × 80%)
|
$32,000
|
2003 deduction (amount on
2003 Itemized Deduction
Worksheet, line 10)
($40,000 - $30,000)
|
$10,000
|
Refund received in 2004 of 2003
state income tax
|
$5,000
|
Net amount of 2003 state income
tax ($40,000 - $5,000)
|
$35,000
|
If Eileen had used the $35,000 net amount of state income tax to figure her itemized deductions for 2003, the deduction allowed
would have been
$7,000. This is her otherwise allowable deduction of $35,000 reduced by $28,000 ($35,000 × 80%). By deducting the full $10,000
paid in 2003, she
derived a tax benefit of $3,000 ($10,000 - $7,000). Therefore, only $3,000 of the $5,000 refund is included in her income
for 2004.
Unused tax credits.
If you recover an item deducted in an earlier year in which you had unused tax credits, you must refigure the earlier
year's tax to determine if
you must include the recovery in your income. To do this, add the amount of the recovery to your earlier year's taxable income
and refigure the tax
and the credits on the recomputed amount. If the recomputed tax, after application of the credits, is more than the actual
tax in the earlier year,
include the recovery in your income up to the amount of the deduction that reduced the tax in the earlier year. For this purpose,
any increase to a
credit carried over to the current year that resulted from deducting the recovered credit in the earlier year is considered
to have reduced your tax
in the earlier year. If the recovery is for an itemized deduction claimed in a year in which the deductions were limited,
see Itemized deductions
limited, earlier.
If your tax, after application of the credits, does not change, you did not have a tax benefit from the deduction.
Do not include the recovery in
your income.
Example.
In 2003, Jean Black filed as head of household and itemized her deductions. Her taxable income was $5,260 and her tax was
$528. She claimed a child
care credit of $1,200. The credit reduced her tax to zero and she had an unused tax credit of $672 ($1,200 - $528). In 2004,
Jean recovered
$1,000 of her itemized deductions. She reduces her 2003 itemized deductions by $1,000 and recomputes that year's tax on taxable
income of $6,260.
However, the child care credit exceeds the recomputed tax of $628. Jean's tax liability for 2003 is not changed by reducing
her deductions by the
recovery. She did not have a tax benefit from the recovered deduction and does not include any of the recovery in her income
for 2004.
Subject to alternative minimum tax.
If you were subject to the alternative minimum tax in the year of the deduction, you will have to recompute your tax
for the earlier year to
determine if the recovery must be included in your income. This will require a recomputation of your regular tax, as shown
in the preceding example,
and a recomputation of your alternative minimum tax. If inclusion of the recovery does not change your total tax, you do not
include the recovery in
your income. However, if your total tax increases by any amount, you received a tax benefit from the deduction and you must
include the recovery in
your income up to the amount of the deduction that reduced your tax in the earlier year.
Non-Itemized Deduction Recoveries
This section discusses recovery of deductions other than those deducted on Schedule A (Form 1040).
Total recovery included in income.
If you recover an amount that you deducted in an earlier year in figuring your adjusted gross income, you must generally
include the full amount of
the recovery in your income in the year received.
Total recovery not included in income.
If any part of the deduction you took for the recovered amount did not reduce your tax, you may be able to exclude
at least part of the recovery
from your income. You must include the recovery in your income only up to the amount of the deduction that reduced your tax
in the year of the
deduction. (See Tax benefit rule, earlier.)
Negative taxable income.
If your taxable income was a negative amount, reduce the recovery by that negative amount. Include this reduced recovery
in your income.
Unused tax credits.
If you recover an item deducted in an earlier year in which you had unused tax credits, you must refigure the earlier
year's tax to determine if
you must include the recovery in your income. To do this, add the amount of the recovery to your earlier year's taxable income
and refigure the tax
and the credits on the recomputed amount. If the recomputed tax, after application of the credits, is more than the actual
tax in the earlier year,
include the recovery in your income up to the amount of the deduction that reduced the tax in the earlier year. For this purpose,
any increase to an
amount carried over to the current year that resulted from deducting the recovered amount in the earlier year is considered
to have reduced your tax
in the earlier year.
If your tax, after application of the credits, does not change, you did not have a tax benefit from the deduction.
Do not include the recovery in
your income.
Amounts Recovered for Credits
If you received a recovery in 2004 for an item for which you claimed a tax credit in an earlier year, you must increase your
2004 tax by the amount
of the recovery, up to the amount by which the credit reduced your tax in the earlier year. You had a recovery if there was
a downward price
adjustment or similar adjustment on the item for which you claimed a credit.
This rule does not apply to the investment credit or the foreign tax credit. Recoveries of
these credits are covered by other provisions of the law. See Publication 514, Foreign Tax Credit for Individuals, or Form
4255, Recapture of
Investment Credit, for details.
Generally, payments made by or for an employer because of an employee's death must be included in income. The following discussions
explain the tax
treatment of certain payments made to survivors. For additional information, see Publication 559.
Lump-sum payments.
Lump-sum payments you receive from a decedent's employer as the surviving spouse or beneficiary may be accrued salary
payments; distributions from
employee profit-sharing, pension, annuity, or stock bonus plans; or other items that should be treated separately for tax
purposes. The tax treatment
of these lump-sum payments depends on the type of payment.
Salary or wages.
Salary or wages received after the death of the employee are usually ordinary income to you.
Qualified employee retirement plans.
Lump-sum distributions from qualified employee retirement plans are subject to special tax treatment. For information
on these distributions, see
Publication 575 (or Publication 721 if you are the survivor of a federal employee or retiree).
Public safety officer killed in the line of duty.
If you are a survivor of a public safety officer who was killed in the line of duty, you may be able to exclude from
income certain amounts you
receive. For this purpose, the term public safety officer includes law enforcement officers, firefighters, chaplains, and
rescue squad and ambulance
crew members. For more information, see Publication 559.
The tax treatment of unemployment benefits you receive depends on the type of program paying the benefits.
Unemployment compensation.
You must include in your income all unemployment compensation you receive. You should receive a Form 1099-G showing
the amount paid to you.
Generally, you enter unemployment compensation on line 19 of Form 1040, line 13 of Form 1040A, or line 3 of Form 1040EZ.
Types of unemployment compensation.
Unemployment compensation generally includes any amount received under an unemployment compensation law of the United
States or of a state. It
includes the following benefits.
-
Benefits paid by a state or the District of Columbia from the Federal Unemployment Trust Fund.
-
State unemployment insurance benefits.
-
Railroad unemployment compensation benefits.
-
Disability payments from a government program paid as a substitute for unemployment compensation. (Amounts received as workers'
compensation
for injuries or illness are not unemployment compensation. See Workers' Compensation under Sickness and Injury Benefits,
earlier.)
-
Trade readjustment allowances under the Trade Act of 1974.
-
Unemployment assistance under the Disaster Relief and Emergency Assistance Act.
Governmental program.
If you contribute to a governmental unemployment compensation program and your contributions are not deductible, amounts
you receive under the
program are not included as unemployment compensation until you recover your contributions.
Repayment of unemployment compensation.
If you repaid in 2004 unemployment compensation you received in 2004, subtract the amount you repaid from the total
amount you received and enter
the difference on line 19 of Form 1040, line 13 of Form 1040A, or line 3 of Form 1040EZ. On the dotted line next to your entry,
enter “ Repaid”
and the amount you repaid. If you repaid unemployment compensation in 2004 that you included in your income in an earlier
year, you can deduct the
amount repaid on Schedule A (Form 1040), line 22, if you itemize deductions. If the amount is more than $3,000, see Repayments, later.
Tax withholding.
You can choose to have federal income tax withheld from your unemployment compensation. To make this choice, complete
Form W-4V, Voluntary
Withholding Request, and give it to the paying office. Tax will be withheld at 10% of your payment.
If you do not choose to have tax withheld from your unemployment compensation, you may be liable
for estimated tax. For more information on estimated tax, see Publication 505, Tax Withholding and Estimated Tax.
Supplemental unemployment benefits.
Benefits received from an employer-financed fund (to which the employees did not contribute) are not unemployment
compensation. They are taxable as
wages and are subject to withholding for income tax. They may be subject to social security and Medicare taxes. For more information,
see
Supplemental Unemployment Benefits in Publication 15-A, section 5, Employer's Supplemental Tax Guide. Report these payments on line 7 of
Form 1040 or Form 1040A or on line 1 of Form 1040EZ.
Repayment of benefits.
You may have to repay some of your supplemental unemployment benefits to qualify for
trade readjustment allowances under the Trade Act of 1974. If you repay supplemental unemployment benefits in the same year
you receive them, reduce
the total benefits by the amount you repay. If you repay the benefits in a later year, you must include the full amount of
the benefits in your income
for the year you received them.
Deduct the repayment in the later year as an adjustment to gross income on Form 1040. (You cannot use Form 1040A or
Form 1040EZ.) Include the
repayment on Form 1040, line 35, and enter “ Sub-Pay TRA” and the amount on the dotted line next to line 35. If the amount you repay in a later
year is more than $3,000, you may be able to take a credit against your tax for the later year instead of deducting the amount
repaid. For information
on this, see Repayments, later.
Private unemployment fund.
Unemployment benefit payments from a private (nonunion) fund to which you voluntarily contribute are taxable only
if the amounts you receive are
more than your total payments into the fund. Report the taxable amount on Form 1040, line 21.
Payments by a union.
Benefits paid to you as an unemployed member of a union from regular union dues are included in your income on Form
1040, line 21. However, if the
unemployment benefits are paid from a special fund to which you contributed, your payments to the fund are not deductible,
and the benefit payments
are includible in your income only to the extent they are more than your contributions.
Guaranteed annual wage.
Payments you receive from your employer during periods of unemployment, under a union agreement that guarantees you
full pay during the year, are
taxable as wages. Include them on line 7 of Form 1040 or Form 1040A or on line 1 of Form 1040EZ.
State employees.
Payments similar to a state's unemployment compensation may be made by the state to its employees who are not covered
by the state's unemployment
compensation law. Although the payments are fully taxable, do not report them as unemployment compensation. Report these payments
on Form 1040, line
21.
Welfare and Other Public Assistance Benefits
Do not include in your income governmental benefit payments from a public welfare fund based upon need, such as payments due
to blindness. Payments
from a state fund for the victims of crime 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. You must include in your income any welfare payments that are compensation
for services or that
are obtained fraudulently.
Work-training program.
Payments you receive from a state welfare agency for taking part in a work-training program are not included in your
income, as long as the
payments (exclusive of extra allowances for transportation or other costs) do not total more than the public welfare benefits
you would have received
otherwise. If the payments are more than the welfare benefits you would have received, the entire amount must be included
in your income as wages.
Persons with disabilities.
If you have a disability, you must include in income compensation you receive for services you perform unless the
compensation is otherwise
excluded. However, you do not include in income the value of goods, services, and cash that you receive, not in return for
your services, but for your
training and rehabilitation because you have a disability. Excludable amounts include payments for transportation and attendant
care, such as
interpreter services for the deaf, reader services for the blind, and services to help mentally retarded persons do their
work.
Disaster relief grants.
Do not include post-disaster grants received under the Disaster Relief and Emergency Assistance Act in your income
if the grant payments are made
to help you meet necessary expenses or serious needs for medical, dental, housing, personal property, transportation, or funeral
expenses. Do not
deduct casualty losses or medical expenses that are specifically reimbursed by these disaster relief grants. Unemployment
assistance payments under
the Act are taxable unemployment compensation. See Unemployment compensation under Unemployment Benefits, earlier.
Disaster relief payments.
You can exclude from income any amount you receive that is a qualified disaster relief payment. A qualified disaster
relief payment is an amount
paid to you:
-
To reimburse or pay reasonable and necessary personal, family, living, or funeral expenses that result from a qualified
disaster,
-
To reimburse or pay reasonable and necessary expenses incurred for the repair or rehabilitation of your home or repair or
replacement of its
contents to the extent it is due to a qualified disaster,
-
By a person engaged in the furnishing or sale of transportation as a common carrier because of the death or personal physical
injuries
incurred as a result of a qualified disaster, or
-
By a federal, state, or local government, or agency, or instrumentality in connection with a qualified disaster in order to
promote the
general welfare.
You can only exclude this amount to the extent any expense it pays for is not paid for by insurance or otherwise. The exclusion
does not apply
if you were a participant or conspirator in a terrorist action or his or her representative.
A qualified disaster is:
-
A disaster which results from a terrorist or military action.
-
A Presidentially declared disaster.
-
A disaster which results from an accident involving a common carrier, or from any other event, which is determined to be catastrophic
by the
Secretary of the Treasury or his or her delegate.
For amounts paid under item (4), a disaster is qualified if it is determined by an applicable federal, state, or local
authority to warrant
assistance from the federal, state, or local government, agency, or instrumentality.
Mortgage assistance payments.
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.
Replacement housing payments.
Replacement housing payments made under the Uniform Relocation Assistance and Real Property Acquisition Policies Act
for Federal and Federally
Assisted Programs are not includible in gross income, but are includible in the basis of the newly acquired property.
Relocation payments and home rehabilitation grants.
A relocation payment under section 105(a)(11) of the Housing and Community Development Act made by a local jurisdiction
to a displaced individual
moving from a flood-damaged residence to another residence is not includible in gross income. Home rehabilitation grants received
by low-income
homeowners in a defined area under the same act are also not includible in gross income.
Indian financing grants.
Nonreimbursable grants under title IV of the Indian Financing Act of 1974 to Indians to expand profit-making Indian-owned
economic enterprises on
or near reservations are not includible in gross income.
Medicare.
Medicare benefits received under title XVIII of the Social Security Act are not includible in the gross income of
the individuals for whom they are
paid. This includes basic (part A (Hospital Insurance Benefits for the Aged)) and supplementary (part B (Supplementary Medical
Insurance Benefits for
the Aged)).
Old-age, survivors, and disability insurance benefits (OASDI).
OASDI payments under section 202 of title II of the Social Security Act are not includible in the gross income of
the individuals for whom they are
paid. This applies to old-age insurance benefits, and insurance benefits for wives, husbands, children, widows, widowers,
mothers and fathers, and
parents, as well as the lump-sum death payment.
Nutrition Program for the Elderly.
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 are
also eligible for food
benefits.
Payments to reduce cost of winter energy.
Payments made by a state to qualified people to reduce their cost of winter energy use are not taxable.
The following brief discussions are arranged in alphabetical order. Income items that are discussed in greater detail in another
publication
include a reference to that publication.
Activity not for profit.
You must include on your return income from an activity from which you do not expect to make a profit. An example
of this type of activity is a
hobby or a farm you operate mostly for recreation and pleasure. Enter this income on Form 1040, line 21. Deductions for expenses
related to the
activity are limited. They cannot total more than the income you report, and can be taken only if you itemize deductions on
Schedule A (Form 1040).
See Not-for-Profit Activities in chapter 1 of Publication 535, Business Expenses, for information on whether an activity is considered
carried on for a profit.
Alaska Permanent Fund dividend.
If you received a payment from Alaska's mineral income fund (Alaska Permanent Fund dividend), report it as income
on line 21 of Form 1040, line 13
of Form 1040A, or line 3 of Form 1040EZ. The state of Alaska sends each recipient a document that shows the amount of the
payment with the check. The
amount is also reported to the IRS.
Alimony.
Include in your income on Form 1040, line 11, any alimony payments you receive. Amounts you receive for child support
are not income to you. For
complete information, see Publication 504, Divorced or Separated Individuals.
Below-market loans.
A below-market loan is a loan on which no interest is charged or on which the interest is charged at a rate below
the applicable federal rate. If
you make a below-market gift or demand loan, you must include the forgone interest (at the federal rate) as interest income
on your return. These
loans are considered a transaction in which you, the lender, are treated as having made:
-
A loan to the borrower in exchange for a note that requires the payment of interest at the applicable federal rate, and
-
An additional payment to the borrower, which the borrower transfers back to you as interest.
Depending on the transaction, the additional payment to the borrower is treated as a:
The borrower may have to report this payment as income, depending on its classification.
For more information on below-market loans, see chapter 1 of Publication 550.
Bribes.
If you receive a bribe, include it in your income.
Campaign contributions.
These contributions are not income to a candidate unless they are diverted to his or her personal
use. To be exempt from tax, the contributions must be spent for campaign purposes or kept in a fund for use in future campaigns.
However, interest
earned on bank deposits, dividends received on contributed securities, and net gains realized on sales of contributed securities
are taxable and must
be reported on Form 1120-POL, U.S. Income Tax Return for Certain Political Organizations. Excess campaign funds transferred
to an office account must
be included in the officeholder's income on Form 1040, line 21, in the year transferred.
Canceled sales contract.
If you sell property (such as land or a residence) under a contract, but the contract is canceled and you return the
buyer's money in the same tax
year as the original sale, you have no income from the sale. If the contract is canceled and you return the buyer's money
in a later tax year, you
must include your gain in your income for the year of the sale. When you return the money and take back the property in the
later year, you treat the
transaction as a purchase that gives you a new basis in the property equal to the funds you return to the buyer.
Special rules apply to the reacquisition of real property where a secured indebtedness (mortgage) to the original
seller is involved. For further information, see Repossession in Publication 537, Installment Sales.
Car pools.
Do not include in your income amounts you receive from the passengers for driving a car in a car pool to and from
work. These amounts are
considered reimbursement for your expenses. However, this rule does not apply if you have developed car pool arrangements
into a profit-making
business of transporting workers for hire.
Cash rebates.
A cash rebate you receive from a dealer or manufacturer of an item you buy is not income, but you must reduce your
basis by the amount of the
rebate.
Example.
You buy a new car for $9,000 cash and receive a $400 rebate check from the manufacturer. The $400 is not income to you. Your
basis in the car is
$8,600. This is your basis on which you figure gain or loss if you sell the car, and depreciation if you use it for business.
Casualty insurance and other reimbursements.
You generally should not report these reimbursements on your return. See Publication 547, Casualties, Disasters, and
Thefts, for more information.
Charitable gift annuities.
If you are the beneficiary of a charitable gift annuity, you must include the yearly annuity or fixed percentage payment
in your income.
The payer will report the types of income you received on Form 1099-R. Report the gross distribution from box 1 on
Form 1040, line 16a, or on Form
1040A, line 12a, and the part taxed as ordinary income (box 2a minus box 3) on Form 1040, line 16b, or on Form 1040A, line
12b. Report the portion
taxed as capital gain (box 3) on Schedule D, line 8.
Child support payments.
You should not report these payments on your return. See Publication 504 for more information.
Court awards and damages.
To determine if settlement amounts you receive by compromise or judgment must be included in your income, you must
consider the item that the
settlement replaces. Include the following as ordinary income.
-
Interest on any award.
-
Compensation for lost wages or lost profits in most cases.
-
Punitive damages. It does not matter if they relate to a physical injury or physical sickness.
-
Amounts received in settlement of pension rights (if you did not contribute to the plan).
-
Damages for:
-
Patent or copyright infringement,
-
Breach of contract, or
-
Interference with business operations.
-
Back pay and damages for emotional distress received to satisfy a claim under Title VII of the Civil Rights Act of 1964.
-
Attorney fees and costs where the underlying recovery is included in gross income.
Do not include in your income compensatory damages for personal physical injury or physical sickness
(whether received in a lump sum or installments).
Emotional distress.
Emotional distress itself is not a physical injury or physical sickness, but damages you receive for emotional distress
due to a physical injury or
sickness are treated as received for the physical injury or sickness. Do not include them in your income.
If the emotional distress is due to a personal injury that is not due to a physical injury or sickness (for example,
unlawful discrimination or
injury to reputation), you must include the damages in your income, except for any damages you receive for medical care due
to that emotional
distress. Emotional distress includes physical symptoms that result from emotional distress, such as headaches, insomnia,
and stomach disorders.
Deduction for costs involved in unlawful discrimination suits.
Beginning after October 22, 2004, you may be able to deduct attorney fees and court costs paid to recover a judgement
or settlement for a claim of
unlawful discrimination under various provisions of federal, state, and local law listed in Internal Revenue Code section
62(e), a claim against the
United States government, or a claim under section 1862(b)(3)(A) of the Social Security Act. You can claim this deduction
as an adjustment to income
on Form 1040, line 35. The following rules apply.
-
The attorney fees and court costs may be paid by you or on your behalf in connection with the claim for unlawful discrimination,
the claim
against the United States government, or the claim under section 1862(b)(3)(A) of the Social Security Act.
-
The deduction you are claiming cannot be more than the amount of the judgement or settlement you are including in income for
the tax
year.
-
You must pay the attorney fees and costs after October 22, 2004.
-
The judgement or settlement to which your attorney fees and court costs apply must occur after October 22, 2004.
Pre-existing agreement.
If you receive damages under a written binding agreement, court decree, or mediation award that was in effect (or
issued on or before) September
13, 1995, do not include in income any of those damages received on account of personal injuries or sickness.
Credit card insurance.
Generally, if you receive benefits under a credit card disability or unemployment insurance plan, the benefits are
taxable to you. These plans make
the minimum monthly payment on your credit card account if you cannot make the payment due to injury, illness, disability,
or unemployment. Report on
Form 1040, line 21, the amount of benefits you received during the year that is more than the amount of the premiums you paid
during the year.
Employment agency fees.
If you get a job through an employment agency, and the fee is paid by your employer, the fee is not includible in
your income if you are not liable
for it. However, if you pay it and your employer reimburses you for it, it is includible in your income.
Energy conservation subsidies.
You can exclude from gross income any subsidy provided, either directly or indirectly, by public utilities for the
purchase or installation of an
energy conservation measure for a dwelling unit.
Energy conservation measure.
This includes installations or modifications that are primarily designed to reduce consumption of electricity or natural
gas, or improve the
management of energy demand.
Dwelling unit.
This includes a house, apartment, condominium, mobile home, boat, or similar property. If a building or structure
contains both dwelling and other
units, any subsidy must be properly allocated.
Estate and trust income.
An estate or trust, unlike a partnership, may have to pay federal
income tax. If you are a beneficiary of an estate or trust, you may be taxed on your share of its income distributed or required
to be distributed to
you. However, there is never a double tax. Estates and trusts file their returns on Form 1041, U.S. Income Tax Return for
Estates and Trusts, and your
share of the income is reported to you on Schedule K-1 (Form 1041), Beneficiary's Share of Income, Deductions, Credits, etc.
Current income required to be distributed.
If you are the beneficiary of an estate or trust that must distribute all of its current income, you must report your
share of the distributable
net income, whether or not you actually received it.
Current income not required to be distributed.
If you are the beneficiary of an estate or trust and the fiduciary has the choice of whether to distribute all or
part of the current income, you
must report:
-
All income that is required to be distributed to you, whether or not it is actually distributed, plus
-
All other amounts actually paid or credited to you,
up to the amount of your share of distributable net income.
How to report.
Treat each item of income the same way that the estate or trust would treat it. For example, if a trust's dividend
income is distributed to you,
you report the distribution as dividend income on your return. The same rule applies to distributions of tax-exempt interest
and capital gains.
The fiduciary of the estate or trust must tell you the type of items making up your share of the estate or trust income
and any credits you are
allowed on your individual income tax return.
Losses.
Losses of estates and trusts generally are not deductible by the beneficiaries.
Grantor trust.
Income earned by a grantor trust is taxable to the grantor, not the beneficiary, if the grantor keeps certain control
over the trust. (The grantor
is the one who transferred property to the trust.) This rule applies if the property (or income from the property) put into
the trust will or may
revert (be returned) to the grantor or the grantor's spouse.
Generally, a trust is a grantor trust if the grantor has a reversionary interest valued (at the date of transfer)
at more than 5% of the value of
the transferred property.
Expenses paid by another.
If your personal expenses are paid for by another person, such as a corporation, the payment may be taxable to you
depending upon your relationship
with that person and the nature of the payment. But if the payment makes up for a loss caused by that person, and only restores
you to the position
you were in before the loss, the payment is not includible in your income.
Fees for services.
Include all fees for your services in your income. Examples of these fees are amounts you receive for services you
perform as:
-
A corporate director,
-
An executor, administrator, or personal representative of an estate,
-
A notary public, or
-
An election precinct official.
If you are not an employee and the fees for your services from the same payer total $600 or
more for the year, you may receive a Form 1099-MISC.
Corporate director.
Corporate director fees are self-employment income. Report these payments on Schedule C or Schedule C-EZ (Form 1040).
Personal representatives.
All personal representatives must include in their gross income fees paid to them from an estate. If paid to a professional
executor or
administrator, self-employment tax also applies to such fees. For a nonprofessional executor or administrator (a person serving
in such capacity in an
isolated instance, such as a friend or relative of the decedent), self-employment tax only applies if a trade or business
is included in the estate's
assets, the executor actively participates in the business, and the fees are related to operation of the business.
The fee is not includible in income if it is waived.
Notary public.
Report payments for these services on Schedule C or Schedule C-EZ (Form 1040). These payments are not subject to self-employment
tax. (See the
separate instructions for Schedule SE (Form 1040) for details.)
Election precinct official.
You should receive a Form W-2 showing payments for services performed as an election official or election worker.
Report these payments on line 7
of Form 1040 or Form 1040A or on line 1 of Form 1040EZ.
Food program payments to daycare providers.
If you operate a daycare service and receive payments under the Child and Adult Care Food Program administered by
the Department of Agriculture
that are not for your services, the payments generally are not included in your income. However, you must include in your
income any part of the
payments you do not use to provide food to individuals eligible for help under the program.
Foreign currency transactions.
If you have a gain on a personal foreign currency transaction because of changes in exchange rates, you do not have
to include that gain in your
income unless it is more than $200. If the gain is more than $200, report it as a capital gain.
Foster-care providers.
Payments you receive from a state, political subdivision, or a qualified foster care placement agency for providing
care to qualified foster
individuals in your home generally are not included in your income. However, you must include in your income payments received
for the care of more
than 5 individuals age 19 or older and certain difficulty-of-care payments.
A qualified foster individual is a person who:
-
Is living in a foster family home, and
-
Was placed there by:
-
An agency of a state or one of its political subdivisions, or
-
A qualified foster care placement agency.
Difficulty-of-care payments.
These are additional payments that are designated by the payer as compensation for providing the additional care that
is required for physically,
mentally, or emotionally handicapped qualified foster individuals. A state must determine that the additional compensation
is needed, and the care for
which the payments are made must be provided in your home.
You must include in your income difficulty-of-care payments received for more than:
Maintaining space in home.
If you are paid to maintain space in your home for emergency foster care, you must include the payment in your income.
Reporting taxable payments.
If you receive payments that you must include in your income, you are in business as a foster-care provider and you
are self-employed. Report the
payments on Schedule C or Schedule C-EZ (Form 1040). See Publication 587, Business Use of Your Home (Including Use by Daycare
Providers), to help you
determine the amount you can deduct for the use of your home.
Found property.
If you find and keep property that does not belong to you that has been lost or abandoned (treasure-trove), it is
taxable to you at its fair market
value in the first year it is your undisputed possession.
Free tour.
If you received a free tour from a travel agency for organizing a group of tourists, you must include its value in
your income. Report the fair
market value of the tour on Form 1040, line 21, if you are not in the trade or business of organizing tours. You cannot deduct
your expenses in
serving as the voluntary leader of the group at the group's request. If you organize tours as a trade or business, report
the tour's value on Schedule
C or Schedule C-EZ (Form 1040).
Gambling winnings.
You must include your gambling winnings in your income on Form 1040, line 21. If you itemize your deductions on Schedule
A (Form 1040), you can
deduct gambling losses you had during the year, but only up to the amount of your winnings.
Lotteries and raffles.
Winnings from lotteries and raffles are gambling winnings. In addition to cash winnings, you must include in your
income the fair market value of
bonds, cars, houses, and other noncash prizes. However, the difference between the fair market value and the cost of an oil
and gas lease obtained
from the government through a lottery is not includible in income.
Installment payments.
Generally, if you win a state lottery prize payable in installments, you must include in your gross income the annual
payments and any amounts you
receive designated as interest on the unpaid installments. If you sell future lottery payments for a lump sum, you must report
the amount you receive
from the sale as ordinary income (Form 1040, line 21) in the year you receive it.
Form W-2G.
You may have received a Form W-2G, Certain Gambling Winnings, showing the amount of your gambling winnings and any
tax taken out of them. Include
the amount from box 1 on Form 1040, line 21. Include the amount shown in box 2 on Form 1040, line 63, as federal income tax
withheld.
Gifts and inheritances.
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 is also taxable to you. If the gift, bequest, or inheritance is the income from
the property, that income
is taxable to you.
Inherited pension or IRA.
If you inherited a pension or an individual retirement arrangement (IRA), you may have to include part of the inherited
amount in your income. See
Survivors and Beneficiaries in Publication 575 if you inherited a pension. See What If You Inherit an IRA in Publication 590,
Individual Retirement Arrangements (IRAs), if you inherited an IRA.
Expected inheritance.
If you sell an interest in an expected inheritance from a living person, include the entire amount you receive in
gross income on Form 1040, line
21.
Bequest for services.
If you receive cash or other property as a bequest for services you performed while the decedent was alive, the value
is taxable compensation.
Historic preservation grants.
Do not include in your income any payment you receive under the National Historic Preservation Act to preserve a historically
significant property.
Hobby losses.
Losses from a hobby are not deductible from other income. A hobby is an activity from which you do not expect to make
a profit. See Activity
not for profit, earlier under Other Income.
If you collect stamps, coins, or other items as a hobby for recreation and pleasure, and you sell any of the items, your gain
is taxable as a
capital gain. However, if you sell items from your collection at a loss, you cannot deduct the loss.
Holocaust victims restitution.
Restitution payments you receive as a Holocaust victim (or the heir of a Holocaust victim) and interest earned on
the payments, including interest
earned on amounts held in certain escrow accounts or funds, are not taxable. You also do not include them in any computations
in which you would
ordinarily add excludable income to your adjusted gross income, such as the computation to determine the taxable part of social
security benefits. If
the payments are made in property, your basis in the property is its fair market value when you receive it.
Excludable restitution payments are payments or distributions made by any country or any other entity because of persecution
of an individual on
the basis of race, religion, physical or mental disability, or sexual orientation by Nazi Germany, any other Axis regime,
or any other Nazi-controlled
or Nazi-allied country, whether the payments are made under a law or as a result of a legal action. They include compensation
or reparation for
property losses resulting from Nazi persecution, including proceeds under insurance policies issued before and during World
War II by European
insurance companies.
Illegal income.
Illegal income, such as money from dealing illegal drugs, must be included in your income on Form 1040, line 21, or
on Schedule C or Schedule C-EZ
(Form 1040) if from your self-employment activity.
Indian fishing rights.
If you are a member of a qualified Indian tribe that has fishing rights secured by treaty, executive order, or an
Act of Congress as of March 17,
1988, do not include in your income amounts you receive from activities related to those fishing rights. The income is not
subject to income tax,
self-employment tax, or employment taxes.
Interest on frozen deposits.
In general, you exclude from your income the amount of interest earned on a frozen deposit. A deposit is frozen if,
at the end of the calendar
year, you cannot withdraw any part of the deposit because:
-
The financial institution is bankrupt or insolvent, or
-
The state where the institution is located has placed limits on withdrawals because other financial institutions in the state
are bankrupt
or insolvent.
Excludable amount.
The amount of interest you exclude from income for the year is the interest that was credited on the frozen deposit
for that tax year minus the sum
of:
-
The net amount withdrawn from the deposit during that year, and
-
The amount that could have been withdrawn at the end of that tax year (not reduced by any penalty for premature withdrawals
of a time
deposit).
The excluded part of the interest is included in your income in the tax year it becomes withdrawable.
Interest on qualified savings bonds.
You may be able to exclude from income the interest from qualified U.S. savings bonds you redeem if you pay qualified
higher educational expenses
in the same year. Qualified higher educational expenses are those you pay for tuition and required fees at an eligible educational
institution for
you, your spouse, or your dependent. A qualified U.S. savings bond is a series EE bond issued after 1989 or a series I bond.
The bond must have been
issued to you when you were 24 years of age or older. For more information on this exclusion, see Education Savings Bond Program in chapter
1 of Publication 550.
Interest on state and local government obligations.
This interest is usually exempt from federal tax. However, you must show the amount of any tax-exempt interest on
your federal income tax return.
For more information, see State or Local Government Obligations in chapter 1 of Publication 550.
Job interview expenses.
If a prospective employer asks you to appear for an interview and either pays you an allowance or reimburses you for
your transportation and other
travel expenses, the amount you receive generally is not taxable. You include in income only the amount you receive that is
more than your actual
expenses.
Jury duty.
Jury duty pay you receive must be included in your income on Form 1040, line 21. If you must give the pay to your
employer because your employer
continues to pay your salary while you serve on the jury, you can deduct the amount turned over to your employer as an adjustment
to income. Include
the amount you repay your employer on Form 1040, line 35. Enter “ Jury Pay” and the amount on the dotted line next to line 35.
Kickbacks.
You must include kickbacks, side commissions, push money, or similar payments you receive in your income on Form 1040,
line 21, or on Schedule C or
Schedule C-EZ (Form 1040) if from your self-employment activity.
Example.
You sell cars and help arrange car insurance for buyers. Insurance brokers pay back part of their commissions to you for referring
customers to
them. You must include the kickbacks in your income.
Manufacturer incentive payments.
You must include as other income on Form 1040, line 21 (or Schedule C or Schedule C-EZ (Form 1040) if you are self-employed)
incentive payments
from a manufacturer that you receive as a salesperson. This is true whether you receive the payment directly from the manufacturer
or through your
employer.
Example.
You sell cars for an automobile dealership and receive incentive payments from the automobile manufacturer every time you
sell a particular model
of car. You report the incentive payments on Form 1040, line 21.
Medical savings accounts (Archer MSAs and Medicare+Choice MSAs).
You generally do not include in income amounts you withdraw from your Archer MSA or Medicare+Choice MSA if you use
the money to pay for qualified
medical expenses. Generally, qualified medical expenses are those you can deduct on Schedule A (Form 1040). For more information
about Archer MSAs or
Medicare+Choice MSAs, see Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans.
Note.
Any reference in this publication to a Medicare+Choice MSA includes a Medicare Advantage MSA.
Moving expense reimbursements.
You generally should not report these benefits on your return. See Publication 521 for more information.
Prizes and awards.
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 Form 1040, line 21. If you refuse
to accept a prize, do
not include its value in your income.
Prizes and awards in goods or services must be included in your income at their fair market value.
Employee awards or bonuses.
Cash awards or bonuses given to you by your employer for good work or suggestions generally must be included in your
income as wages. However,
certain noncash employee achievement awards can be excluded from income. See Bonuses and awards under Miscellaneous Compensation,
earlier.
Prize points.
If you are a salesperson and receive prize points redeemable for merchandise, that are awarded by a distributor or
manufacturer to employees of
dealers, you must include their fair market value in your income. The prize points are taxable in the year they are paid or
made available to you,
rather than in the year you redeem them for merchandise.
Pulitzer, Nobel, and similar prizes.
If you were awarded a prize in recognition of accomplishments in religious, charitable, scientific, artistic, educational,
literary, or civic
fields, you generally must include the value of the prize in your income. However, you do not include this prize in your income
if you meet all of the
following requirements.
-
You were selected without any action on your part to enter the contest or proceeding.
-
You are not required to perform substantial future services as a condition for receiving the prize or award.
-
The prize or award is transferred by the payer directly to a governmental unit or tax-exempt charitable organization as designated
by you.
The following conditions apply to the transfer.
-
You cannot use the prize or award before it is transferred.
-
You should provide the designation before the prize or award is presented to prevent a disqualifying use. The designation
should
contain:
-
The purpose of the designation by making a reference to section 74(b)(3) of the Internal Revenue Code,
-
A description of the prize or award,
-
The name and address of the organization to receive the prize or award,
-
Your name, address, and taxpayer identification number, and
-
Your signature and the date signed.
-
In the case of an unexpected presentation, you must return the prize or award before using it (or spending, depositing, investing
it, etc.,
in the case of money) and then prepare the statement as described in (b).
-
After the transfer, you should receive from the payer a written response stating when and to whom the designated amounts were
transferred.
These rules do not apply to scholarship or fellowship awards. See Scholarships and fellowships, later.
Qualified tuition program (QTP).
A qualified tuition program (also known as a 529 program) is a program set up to allow you to either prepay, or contribute
to an account
established for paying, a student's qualified higher education expenses at an eligible educational institution. A program
can be established and
maintained by a state, an agency or instrumentality of a state, or an eligible educational institution.
The part of a distribution representing the amount paid or contributed to a QTP is not included in income. This is
a return of the investment in
the program.
The beneficiary generally does not include in income any earnings distributed from a QTP established and maintained
by a state (or an agency or
instrumentality of the state) if the total distribution is less than or equal to adjusted qualified higher education expenses.
See Publication 970,
Tax Benefits for Education, for more information.
Railroad retirement annuities.
The following types of payments are treated as pension or annuity income and are taxable under the rules explained
in Publication 575.
Rewards.
If you receive a reward for providing information, include it in your income.
Sale of home.
You may be able to exclude from income all or part of any gain from the sale or exchange of a personal residence.
See Publication 523.
Sale of personal items.
If you sold an item you owned for personal use, such as a car, refrigerator, furniture, stereo, jewelry, or silverware,
your gain is taxable as a
capital gain. Report it on Schedule D (Form 1040). You cannot deduct a loss.
However, if you sold an item you held for investment, such as gold or silver bullion, coins, or gems, any gain is
taxable as a capital gain and any
loss is deductible as a capital loss.
Example.
You sold a painting on an online auction website for $100. You bought the painting for $20 at a garage sale years
ago. Report your $80 gain as a
capital gain on Schedule D (Form 1040).
Scholarships and fellowships.
A candidate for a degree can exclude amounts received as a qualified scholarship or fellowship. A qualified scholarship
or fellowship is any amount
you receive that is for:
-
Tuition and fees to enroll at or attend an educational institution, or
-
Fees, books, supplies, and equipment required for courses at the educational institution.
Amounts used for room and board do not qualify for the exclusion. See Publication 970 for more information on qualified scholarships
and
fellowship grants.
Payment for services.
Generally, you must include in income the part of any scholarship or fellowship that represents payment for past,
present, or future teaching,
research, or other services. This applies even if all candidates for a degree must perform the services to receive the degree.
Do not include in income the part of any scholarship or fellowship 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 information about the rules that apply to a tax-free qualified tuition reduction provided to employees and their
families by an educational
institution, see Publication 970.
VA payments.
Allowances paid by the Department of Veterans Affairs are not included in your income. These allowances are not considered
scholarship or
fellowship grants.
Prizes.
Scholarship prizes won in a contest are not scholarships or fellowships if you do not have to use the prizes for educational
purposes. You must
include these amounts in your income on Form 1040, line 21, whether or not you use the amounts for educational purposes.
Social security and equivalent railroad retirement benefits.
Social security or equivalent railroad retirement benefits, if taxable, must be included in the income of the person
who has the legal right to
receive the benefits. Whether any of your benefits are taxable, and the amount that is taxable, depends on the amount of the
benefits and your other
income.
Social security benefits include any monthly benefit under Title II of the Social
Security Act and any part of a tier I railroad retirement benefit treated as a social security benefit. Social security benefits
do not include any
supplemental security income (SSI) payments.
Form SSA-1099.
If you received social security benefits during the year, you will receive Form SSA-1099, Social Security Benefit
Statement. An IRS Notice 703 will
be enclosed with your Form SSA-1099. This notice includes a worksheet you can use to figure whether any of your benefits are
taxable.
For an explanation of the information found on your Form SSA-1099, see Publication 915.
Form RRB-1099.
If you received equivalent railroad retirement or special guaranty benefits during the year, you will receive Form
RRB-1099, Payments by the
Railroad Retirement Board.
For an explanation of the information found on your Form RRB-1099, see Publication 915.
If you received other railroad retirement benefits, see Railroad retirement annuities, earlier.
Joint return.
If you are married and file a joint return, you and your spouse must combine your incomes and your social security
and equivalent railroad
retirement benefits when figuring whether any of your combined benefits are taxable. Even if your spouse did not receive any
benefits, you must add
your spouse's income to yours when figuring if any of your benefits are taxable.
Taxable amount.
Use the worksheet in the Form 1040 or Form 1040A instruction package to determine the amount of your benefits to include
in your income.
Publication 915 also has worksheets you can use. However, you must use the worksheets in Publication 915 if any of the following
situations apply.
-
You received a lump-sum benefit payment during the year that is for one or more earlier years.
-
You exclude employer-provided adoption benefits or interest from qualified U.S. savings bonds.
-
You take the foreign earned income exclusion, the foreign housing exclusion or deduction, the exclusion of income from U.S.
possessions, or
the exclusion of income from Puerto Rico by bona fide residents of Puerto Rico.
Benefits may affect your IRA deduction.
You must use the special worksheets in appendix B of Publication 590 to figure your taxable benefits and your IRA
deduction if all of the following
conditions apply.
-
You receive social security or equivalent railroad retirement benefits.
-
You have taxable compensation.
-
You contribute to your IRA.
-
You or your spouse is covered by a retirement plan at work.
How to report.
If any of your benefits are taxable, you must use either Form 1040 or Form 1040A to report the taxable part. You cannot
use Form 1040EZ. Report
your net benefits (the amount in box 5 of your Forms SSA-1099 and RRB-1099) on line 20a of Form 1040 or line 14a of Form 1040A.
Report the taxable
part (from the last line of the worksheet) on line 20b of Form 1040 or on line 14b of Form 1040A.
Stolen property.
If you steal property, you must report its fair market value in your income in the year you steal it unless in the
same year, you return it to its
rightful owner.
Transporting school children.
Do not include in your income a school board mileage allowance for taking children to and from school if you are not
in the business of taking
children to school. You cannot deduct expenses for providing this transportation.
Union benefits and dues.
Amounts deducted from your pay for union dues, assessments, contributions, or other payments to a union cannot be
excluded from your income.
You may be able to deduct some of these payments as a miscellaneous deduction subject to the 2% limit if they are
related to your job and if you
itemize deductions on Schedule A (Form 1040). For more information, get Publication 529, Miscellaneous Deductions.
Strike and lockout benefits.
Benefits paid to you by a union as strike or lockout benefits, including both cash and the fair market value of other
property, usually are
included in your income as compensation. You can exclude these benefits from your income only when the facts clearly show
that the union intended them
as gifts to you.
Reimbursed union convention expenses.
If you are a delegate of your local union chapter and you attend the annual convention of the international union,
do not include in your income
amounts you receive from the international union to reimburse you for expenses of traveling away from home to attend the convention.
You cannot deduct
the reimbursed expenses, even if you are reimbursed in a later year. If you are reimbursed for lost salary, you must include
that reimbursement in
your income.
Utility rebates.
If you are a customer of an electric utility company and you participate in the utility's energy conservation program,
you may receive on your
monthly electric bill either:
-
A reduction in the purchase price of electricity furnished to you (rate reduction), or
-
A nonrefundable credit against the purchase price of the electricity.
The amount of the rate reduction or nonrefundable credit is not included in your income.
If you had to repay an amount that you included in your income in an earlier year, you may be able to deduct the amount repaid
from your income for
the year in which you repaid it. Or, if the amount you repaid is more than $3,000, you may be able to take a credit against
your tax for the year in
which you repaid it. Generally, you can claim a deduction or credit only if the repayment qualifies as an expense or loss
incurred in your trade or
business or in a for-profit transaction.
Type of deduction.
The type of deduction you are allowed in the year of repayment depends on the type of income you included in the earlier
year. You generally deduct
the repayment on the same form or schedule on which you previously reported it as income. For example, if you reported it
as self-employment income,
deduct it as a business expense on Schedule C or Schedule C-EZ (Form 1040) or Schedule F (Form 1040). If you reported it as
a capital gain, deduct it
as a capital loss on Schedule D (Form 1040). If you reported it as wages, unemployment compensation, or other nonbusiness
income, deduct it as a
miscellaneous itemized deduction on Schedule A (Form 1040).
If you repaid social security or equivalent railroad retirement benefits, see Publication 915.
Repayment of $3,000 or less.
If the amount you repaid was $3,000 or less, deduct it from your income in the year you repaid it. If you must deduct
it as a miscellaneous
itemized deduction, enter it on Schedule A (Form 1040), line 22.
Repayment over $3,000.
If the amount you repaid was more than $3,000, you can deduct the repayment (as explained earlier under Type of deduction). However, you
can choose instead to take a tax credit for the year of repayment if you included the income under a claim of right. This
means that at the time you
included the income, it appeared that you had an unrestricted right to it. If you qualify for this choice, figure your tax
under both methods and
compare the results. Use the method (deduction or credit) that results in less tax.
Method 1.
Figure your tax for 2004 claiming a deduction for the repaid amount. If you must deduct it as a miscellaneous itemized
deduction, enter it on
Schedule A (Form 1040), line 27.
Method 2.
Figure your tax for 2004 claiming a credit for the repaid amount. Follow these steps.
-
Figure your tax for 2004 without deducting the repaid amount.
-
Refigure your tax from the earlier year without including in income the amount you repaid in 2004.
-
Subtract the tax in (2) from the tax shown on your return for the earlier year. This is the credit.
-
Subtract the answer in (3) from the tax for 2004 figured without the deduction (step 1).
If method 1 results in less tax, deduct the amount repaid. If method 2 results in less tax, claim the credit for the
amount figured in (4) above on
Form 1040, line 69, and enter “ I.R.C. 1341” next to line 69.
Example.
For 2003 you filed a return and reported your income on the cash method. In 2004 you repaid $5,000 included in your 2003 income
under a claim of
right. Your filing status in 2004 and 2003 is single. Your income and tax for both years are as follows:
Your tax under method 1 is $7,981. Your tax under method 2 is $8,481, figured as follows:
You pay less tax using method 1, so you should take a deduction for the repayment in 2004.
Repayment rules do not apply.
This discussion does not apply to:
-
Deductions for bad debts,
-
Deductions from sales to customers, such as returns and allowances, and similar items, or
-
Deductions for legal and other expenses of contesting the repayment.
Year of deduction (or credit).
If you use the cash method, you can take the deduction (or credit, if applicable) for the tax year in
which you actually make the repayment. If you use any other accounting method, you can deduct the repayment or claim a credit
for it only for the tax
year in which it is a proper deduction under your accounting method. For example, if you use an accrual method, you are entitled
to the deduction or
credit in the tax year in which the obligation for the repayment accrues.
You can get help with unresolved tax issues, order free publications and forms, ask tax questions, and get more information
from the IRS in several
ways. By selecting the method that is best for you, you will have quick and easy access to tax help.
Contacting your Taxpayer Advocate.
If you have attempted to deal with an IRS problem unsuccessfully, you should contact your Taxpayer Advocate.
The Taxpayer Advocate independently represents your interests and concerns within the IRS by protecting your rights
and resolving problems that
have not been fixed through normal channels. While Taxpayer Advocates cannot change the tax law or make a technical tax decision,
they can clear up
problems that resulted from previous contacts and ensure that your case is given a complete and impartial review.
To contact your Taxpayer Advocate:
-
Call the Taxpayer Advocate toll free at
1-877-777-4778.
-
Call, write, or fax the Taxpayer Advocate office in your area.
-
Call 1-800-829-4059 if you are a
TTY/TDD user.
-
Visit
www.irs.gov/advocate.
For more information, see Publication 1546, The Taxpayer Advocate Service of the IRS—How To Get Help With Unresolved
Tax Problems.
Free tax services.
To find out what services are available, get Publication 910, IRS Guide to Free Tax Services. It contains a list of
free tax publications and an
index of tax topics. It also describes other free tax information services, including tax education and assistance programs
and a list of TeleTax
topics.
Internet. You can access the IRS website 24 hours a day, 7 days a week, at
www.irs.gov to:
-
E-file your return. Find out about commercial tax preparation and e-file services available free to eligible
taxpayers.
-
Check the status of your 2004 refund. Click on Where's My Refund. Be sure to wait at least 6 weeks from the date you filed your
return (3 weeks if you filed electronically). Have your 2004 tax return available because you will need to know your filing
status and the exact whole
dollar amount of your refund.
-
Download forms, instructions, and publications.
-
Order IRS products online.
-
Research your tax questions online.
-
Search publications online by topic or keyword.
-
View Internal Revenue Bulletins (IRBs) published in the last few years.
-
Figure your withholding allowances using our Form W-4 calculator.
-
Sign up to receive local and national tax news by email.
-
Get information on starting and operating a small business.
Fax. You can get over 100 of the most requested forms and instructions 24 hours a day, 7 days a week, by fax. Just call 703-368-9694
from the telephone connected to your fax machine. When you call, you will hear instructions on how to use the service. The
items you request will be
faxed to you.
For help with transmission problems, call 703-487-4608.
Long-distance charges may apply.
Phone. Many services are available by phone.
-
Ordering forms, instructions, and publications. Call 1-800-829-3676 to order current-year forms, instructions, and publications
and prior-year forms and instructions. You should receive your order within 10 days.
-
Asking tax questions. Call the IRS with your tax questions at 1-800-829-1040.
-
Solving problems. You can get face-to-face help solving tax problems every business day in IRS Taxpayer Assistance Centers. An
employee can explain IRS letters, request adjustments to your account, or help you set up a payment plan. Call your local
Taxpayer Assistance Center
for an appointment. To find the number, go to
www.irs.gov/localcontacts or
look in the phone book under United States Government, Internal Revenue Service.
-
TTY/TDD equipment. If you have access to TTY/TDD equipment, call 1-800-829-4059 to ask tax questions or to order forms and
publications.
-
TeleTax topics. Call 1-800-829-4477 and press 2 to listen to pre-recorded messages covering various tax topics.
-
Refund information. If you would like to check the status of your 2004 refund, call 1-800-829-4477 and press 1 for automated
refund information or call 1-800-829-1954. Be sure to wait at least 6 weeks from the date you filed your return (3 weeks if
you filed electronically).
Have your 2004 tax return available because you will need to know your filing status and the exact whole dollar amount of
your refund.
Evaluating the quality of our telephone services. To ensure that IRS representatives give accurate, courteous, and professional answers,
we use several methods to evaluate the quality of our telephone services. One method is for a second IRS representative to
sometimes listen in on or
record telephone calls. Another is to ask some callers to complete a short survey at the end of the call.
Walk-in. Many products and services are available on a walk-in basis.
-
Products. You can walk in to many post offices, libraries, and IRS offices to pick up certain forms, instructions, and
publications. Some IRS offices, libraries, grocery stores, copy centers, city and county government offices, credit unions,
and office supply stores
have a collection of products available to print from a CD-ROM or photocopy from reproducible proofs. Also, some IRS offices
and libraries have the
Internal Revenue Code, regulations, Internal Revenue Bulletins, and Cumulative Bulletins available for research purposes.
-
Services. You can walk in to your local Taxpayer Assistance Center every business day to ask tax questions or get help with a tax
problem. An employee can explain IRS letters, request adjustments to your account, or help you set up a payment plan. You
can set up an appointment by
calling your local Center and, at the prompt, leaving a message requesting Everyday Tax Solutions help. A representative will
call you back within 2
business days to schedule an in-person appointment at your convenience. To find the number, go to
www.irs.gov/localcontacts or
look in the phone book under United States Government, Internal Revenue Service.
Mail. You can send your order for forms, instructions, and publications to the Distribution Center nearest to you and receive a
response
within 10 business days after your request is received. Use the address that applies to your part of the country.
-
Western part of U.S.:
Western Area Distribution Center
Rancho Cordova, CA 95743-0001
-
Central part of U.S.:
Central Area Distribution Center
P.O. Box 8903
Bloomington, IL 61702-8903
-
Eastern part of U.S. and foreign addresses:
Eastern Area Distribution Center
P.O. Box 85074
Richmond, VA 23261-5074
CD-ROM for tax products. You can order Publication 1796, IRS Federal Tax Products CD-ROM, and obtain:
-
Current-year forms, instructions, and publications.
-
Prior-year forms and instructions.
-
Frequently requested tax forms that may be filled in electronically, printed out for submission, or saved for recordkeeping.
-
Internal Revenue Bulletins.
Buy the CD-ROM from National Technical Information Service (NTIS) at
www.irs.gov/cdorders for $22 (no handling fee) or call 1-877-233-6767 toll free to buy the CD-ROM for $22 (plus a $5 handling fee). The
first release is available in early January and the final release is available in late February.
CD-ROM for small businesses. Publication 3207, The Small Business Resource Guide, CD-ROM 2004, is a must for every small business owner
or any taxpayer about to start a business. This handy, interactive CD contains all the business tax forms, instructions, and
publications needed to
successfully manage a business. In addition, the CD provides other helpful information, such as how to prepare a business
plan, finding financing for
your business, and much more. The design of the CD makes finding information easy and quick and incorporates file formats
and browsers that can be run
on virtually any desktop or laptop computer.
It is available in early April. You can get a free copy by calling 1-800-829-3676 or by visiting
www.irs.gov/smallbiz.
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