Tax on investment income of a child under age 14.   Part of a child's 2004 investment income may be taxed at the parent's tax rate. This may happen if all of the following are true. If all of these statements are true, Form 8615 must be completed and attached to the child's tax return. If any of these statements is not true, Form 8615 is not required and the child's income is taxed at his or her own tax rate.

   However, the parent can choose to include the child's interest and dividends on the parent's return if certain requirements are met. Use Form 8814 for this purpose.

  For more information about the tax on investment income of children and the parents' election, see Publication 929, Tax Rules for Children and Dependents.

Beneficiary of an estate or trust.   Interest, dividends, and other investment income you receive as a beneficiary of an estate or trust is generally taxable income. You should receive a Schedule K-1 (Form 1041), Beneficiary's Share of Income, Deductions, Credits, etc., from the fiduciary. Your copy of Schedule K-1 and its instructions will tell you where to report the income on your Form 1040.

Social security number (SSN).   You must give your name and SSN to any person required by federal tax law to make a return, statement, or other document that relates to you. This includes payers of interest and dividends.

SSN for joint account.   If the funds in a joint account belong to one person, list that person's name first on the account and give that person's SSN to the payer. (For information on who owns the funds in a joint account, see Joint accounts, later.) If the joint account contains combined funds, give the SSN of the person whose name is listed first on the account.

  These rules apply both to joint ownership by a married couple and to joint ownership by other individuals. For example, if you open a joint savings account with your child using funds belonging to the child, list the child's name first on the account and give the child's SSN.

Custodian account for your child.   If your child is the actual owner of an account that is recorded in your name as custodian for the child, give the child's SSN to the payer. For example, you must give your child's SSN to the payer of dividends on stock owned by your child, even though the dividends are paid to you as custodian.

Penalty for failure to supply SSN.   You will be subject to a penalty if, when required, you fail to: The penalty is $50 for each failure up to a maximum penalty of $100,000 for any calendar year.

  You will not be subject to this penalty if you can show that your failure to provide the SSN was due to a reasonable cause and not to willful neglect.

  If you fail to supply an SSN, you may also be subject to backup withholding.

Backup withholding.   Your investment income is generally not subject to regular withholding. However, it may be subject to backup withholding to ensure that income tax is collected on the income. Under backup withholding, the bank, broker, or other payer of interest, original issue discount (OID), dividends, cash patronage dividends, or royalties must withhold, as income tax, a percentage of the amount you are paid. For 2005, the percentage is 28%.

  Backup withholding applies if:

Certification.   For new accounts paying interest or dividends, you must certify under penalties of perjury that your social security number is correct and that you are not subject to backup withholding. Your payer will give you a Form W-9, Request for Taxpayer Identification Number and Certification, or similar form, to make this certification. If you fail to make this certification, backup withholding may begin immediately on your new account or investment.

Underreported interest and dividends.   You will be considered to have underreported your interest and dividends if the IRS has determined for a tax year that:

How to stop backup withholding due to underreporting.   If you have been notified that you underreported interest or dividends, you can request a determination from the IRS to prevent backup withholding from starting or to stop backup withholding once it has begun. You must show that at least one of the following situations applies.

  If the IRS determines that backup withholding should stop, it will provide you with a certification and will notify the payers who were sent notices earlier.

How to stop backup withholding due to an incorrect identification number.   If you have been notified by a payer that you are subject to backup withholding because you have provided an incorrect SSN or employer identification number, you can stop it by following the instructions the payer gives you.

Reporting backup withholding.   If backup withholding is deducted from your interest or dividend income or other reportable payment, the bank or other business must give you an information return for the year (for example, a Form 1099-INT) that indicates the amount withheld. The information return will show any backup withholding as “Federal income tax withheld.”

Nonresident aliens.    Generally, payments made to nonresident aliens are not subject to backup withholding. You can use Form W-8BEN, Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding, to certify exempt status. However, this does not exempt you from the 30% (or lower treaty) withholding rate that may apply to your investment income. For information on the 30% rate, see Publication 519, U.S. Tax Guide for Aliens.

Penalties.   There are civil and criminal penalties for giving false information to avoid backup withholding. The civil penalty is $500. The criminal penalty, upon conviction, is a fine of up to $1,000, or imprisonment of up to 1 year, or both.

Where to report investment income.   Table 1-1 gives an overview of the forms and schedules to use to report some common types of investment income. But, see the rest of this publication for detailed information about reporting investment income.

Joint accounts.   If two or more persons hold property (such as a savings account, bond, or stock) as joint tenants, tenants by the entirety, or tenants in common, each person's share of any interest or dividends from the property is determined by local law.

Income from property given to a child.   Property you give as a parent to your child under the Model Gifts of Securities to Minors Act, the Uniform Gifts to Minors Act, or any similar law, becomes the child's property.

  Income from the property is taxable to the child, except that any part used to satisfy a legal obligation to support the child is taxable to the parent or guardian having that legal obligation.

Savings account with parent as trustee.   Interest income from a savings account opened for a child who is a minor, but placed in the name and subject to the order of the parents as trustees, is taxable to the child if, under the law of the state in which the child resides, both of the following are true.

Accuracy-related penalty.   An accuracy-related penalty of 20% can be charged for underpayments of tax due to negligence or disregard of rules or regulations or substantial understatement of tax. For information on the penalty and any interest that applies, see Penalties in chapter 2.

Accrual method

Below-market loan

Cash method

Demand loan

Forgone interest

Gift loan

Interest

Nominee

Original issue discount

Private activity bond

Term loan

Form 1099-INT.   Interest income is generally reported to you on Form 1099-INT, or a similar statement, by banks, savings and loans, and other payers of interest. This form shows you the interest you received during the year. Keep this form for your records. You do not have to attach it to your tax return.

  Report on your tax return the total amount of interest income that you receive for the tax year.

Interest not reported on Form 1099-INT.   Even if you do not receive Form 1099-INT, you must still report all of your taxable interest income. For example, you may receive distributive shares of interest from partnerships or subchapter S corporations. This interest is reported to you on Schedule K-1 (Form 1065) and Schedule K-1 (Form 1120S).

Nominees.   Generally, if someone receives interest as a nominee for you, that person will give you a Form 1099-INT showing the interest received on your behalf.

  If you receive a Form 1099-INT that includes amounts belonging to another person, see the discussion on nominee distributions, later, under How To Report Interest Income.

Incorrect amount.   If you receive a Form 1099-INT that shows an incorrect amount (or other incorrect information), you should ask the issuer for a corrected form. The new Form 1099-INT you receive will be marked “Corrected.”

Form 1099-OID.   Reportable interest income may also be shown on Form 1099-OID, Original Issue Discount. For more information about amounts shown on this form, see Original Issue Discount (OID), later in this chapter.

Exempt-interest dividends.   Exempt-interest dividends you receive from a regulated investment company (mutual fund) are not included in your taxable income. (However, see Information-reporting requirement, next.) You will receive a notice from the mutual fund telling you the amount of the exempt-interest dividends that you received. Exempt-interest dividends are not shown on Form 1099-DIV or Form 1099-INT.

Information-reporting requirement.   Although exempt-interest dividends are not taxable, you must show them on your tax return if you have to file. This is an information-reporting requirement and does not change the exempt-interest dividends into taxable income. See How To Report Interest Income, later.

Interest on VA dividends.   Interest on insurance dividends that you leave on deposit with the Department of Veterans Affairs (VA) is not taxable. This includes interest paid on dividends on converted United States Government Life Insurance policies and on National Service Life Insurance policies.

Individual retirement arrangements (IRAs).   Interest on a Roth IRA generally is not taxable. Interest on a traditional IRA is tax deferred. You generally do not include it in your income until you make withdrawals from the IRA. See Publication 590 for more information.

Taxable interest includes interest you receive from bank accounts, loans you make to others, and other sources. The following are some sources of taxable interest.

If you make a below-market gift or demand loan, you must report as interest income any forgone interest (defined later) from that loan. The below-market loan rules and exceptions are described in this section. For more information, see section 7872 of the Internal Revenue Code and its regulations.

If you receive a below-market loan, you may be able to deduct the forgone interest as well as any interest that you actually paid, but not if it is personal interest.

A pay-related loan is any below-market loan between an employer and an employee or between an independent contractor and a person for whom the contractor provides services.

A tax avoidance loan is any below-market loan where the avoidance of federal tax is one of the main purposes of the interest arrangement.

These transfers are considered to occur annually, generally on December 31.

This exception does not apply to a term loan described in (2) above that previously has been subject to the below-market loan rules. Those rules will continue to apply even if the outstanding balance is reduced to $10,000 or less.

For a loan described in (6) above, all the facts and circumstances are used to determine if the interest arrangement has a significant effect on the federal tax liability of the lender or borrower. Some factors to be considered are:

If you structure a transaction to meet this exception, and one of the principal purposes of structuring the transaction in that way is the avoidance of federal tax, the loan will be considered a tax-avoidance loan and this exception will not apply.

This section provides tax information on U.S. savings bonds. It explains how to report the interest income on these bonds and how to treat transfers of these bonds.

U.S. savings bonds currently offered to individuals include the following.

For other information on U.S. savings bonds, write to:

For Series HH/H:

For Series EE and I:

Or, on the Internet, visit:
www.publicdebt.treas.gov/sav/sav.htm

If you plan to cash your bonds in the same year that you will pay for higher educational expenses, you may want to use method 1 because you may be able to exclude the interest from your income. To learn how, see Education Savings Bond Program, later.

Treasury bills, notes, and bonds are direct debts (obligations) of the U.S. Government.

For other information on these notes or bonds, write to:

Or, on the Internet, visit:
www. publicdebt.treas.gov

If you sell a bond between interest payment dates, part of the sales price represents interest accrued to the date of sale. You must report that part of the sales price as interest income for the year of sale.

If you buy a bond between interest payment dates, part of the purchase price represents interest accrued before the date of purchase. When that interest is paid to you, treat it as a return of your capital investment, rather than interest income, by reducing your basis in the bond. See Accrued interest on bonds under How To Report Interest Income, later in this chapter, for information on reporting the payment.

Life insurance proceeds paid to you as beneficiary of the insured person are usually not taxable. But if you receive the proceeds in installments, you must usually report part of each installment payment as interest income.

For more information about insurance proceeds received in installments, see Publication 525.

Interest you receive on an obligation issued by a state or local government is generally not taxable. The issuer should be able to tell you whether the interest is taxable. The issuer should also give you a periodic (or year-end) statement showing the tax treatment of the obligation. If you invested in the obligation through a trust, a fund, or other organization, that organization should give you this information.

Even if interest on the obligation is not subject to income tax, you may have to report capital gain or loss when you sell it. Estate, gift, or generation-skipping tax may apply to other dispositions of the obligation.

Market discount

Market discount bond

Original issue discount (OID)

Premium

OID is a form of interest. You generally include OID in your income as it accrues over the term of the debt instrument, whether or not you receive any payments from the issuer.

A debt instrument generally has OID when the instrument is issued for a price that is less than its stated redemption price at maturity. OID is the difference between the stated redemption price at maturity and the issue price.

All debt instruments that pay no interest before maturity are presumed to be issued at a discount. Zero coupon bonds are one example of these instruments.

The OID accrual rules generally do not apply to short-term obligations (those with a fixed maturity date of 1 year or less from date of issue). See Discount on Short-Term Obligations, later.

For information about the sale of a debt instrument with OID, see chapter 4.

A market discount bond is any bond having market discount except:

Market discount arises when the value of a debt obligation decreases after its issue date, generally because of an increase in interest rates. If you buy a bond on the secondary market, it may have market discount.

When you buy a market discount bond, you can choose to accrue the market discount over the period you own the bond and include it in your income currently as interest income. If you do not make this choice, the following rules generally apply.

When you buy a short-term obligation (one with a fixed maturity date of 1 year or less from the date of issue), other than a tax-exempt obligation, you can generally choose to include any discount and interest payable on the obligation in income currently. If you do not make this choice, the following rules generally apply.

Generally, you can elect to treat all interest on a debt instrument acquired during the tax year as OID and include it in income currently. For purposes of this election, interest includes stated interest, acquisition discount, OID, de minimis OID, market discount, de minimis market discount, and unstated interest as adjusted by any amortizable bond premium or acquisition premium. See Regulations section 1.1272-3.

Accrual method

Cash method

Cash method.   Most individual taxpayers use the cash method. If you use this method, you generally report your interest income in the year in which you actually or constructively receive it. However, there are special rules for reporting the discount on certain debt instruments. See U.S. Savings Bonds and Discount on Debt Instruments, earlier.

Constructive receipt.   You constructively receive income when it is credited to your account or made available to you. You do not need to have physical possession of it. For example, you are considered to receive interest, dividends, or other earnings on any deposit or account in a bank, savings and loan, or similar financial institution, or interest on life insurance policy dividends left to accumulate, when they are credited to your account and subject to your withdrawal. This is true even if they are not yet entered in your passbook.

  You constructively receive income on the deposit or account even if you must:

Accrual method.   If you use an accrual method, you report your interest income when you earn it, whether or not you have received it. Interest is earned over the term of the debt instrument.

Coupon bonds.   Interest on coupon bonds is taxable in the year the coupon becomes due and payable. It does not matter when you mail the coupon for payment.

Nominee

Original issue discount (OID)

Form 1040A.   You must complete Schedule 1 (Form 1040A), Part I, if you file Form 1040A and any of the following are true. List each payer's name and the amount of interest income received from each payer on line 1. If you received a Form 1099-INT or Form 1099-OID from a brokerage firm, list the brokerage firm as the payer.

  You cannot use Form 1040A if you must use Form 1040, as described next.

Form 1040.   You must use Form 1040 instead of Form 1040A or Form 1040EZ if:

Schedule B.   You must complete Schedule B (Form 1040), Part I, if you file Form 1040 and any of the following apply. On Part I, line 1, list each payer's name and the amount received from each. If you received a Form 1099-INT or Form 1099-OID from a brokerage firm, list the brokerage firm as the payer.

Reporting tax-exempt interest.    Report the total of your tax-exempt interest (such as interest or accrued OID on certain state and municipal bonds) and exempt-interest dividends from a mutual fund on line 8b of Form 1040A or Form 1040. If you file Form 1040EZ, enter “TEI” and the amount in the space to the left of line 2. Do not add tax-exempt interest in the total on Form 1040EZ, line 2.

  You should not have received a Form 1099-INT for tax-exempt interest. But if you did, you must fill in Schedule 1 (Form 1040A) or Schedule B (Form 1040). See the Schedule 1 or Schedule B instructions for how to report this. Be sure to also show this tax-exempt interest on line 8b.

  

Do not report interest from an individual retirement arrangement (IRA) as tax-exempt interest.

Form 1099-INT.   Your taxable interest income, except for interest from U.S. savings bonds and Treasury obligations, is shown in box 1 of Form 1099-INT. Add this amount to any other taxable interest income you received. You must report all of your taxable interest income even if you do not receive a Form 1099-INT.

1099 INT

  If you forfeited interest income because of the early withdrawal of a time deposit, the deductible amount will be shown on Form 1099-INT, in box 2. See Penalty on early withdrawal of savings, later.

  Box 3 of Form 1099-INT shows the amount of interest income you received from U.S. savings bonds, Treasury bills, Treasury notes, and Treasury bonds. Add the amount shown in box 3 to any other taxable interest income you received, unless part of the amount in box 3 was previously included in your interest income. If part of the amount shown in box 3 was previously included in your interest income, see U.S. savings bond interest previously reported, later. If you redeemed U.S. savings bonds you bought after 1989 and you paid qualified educational expenses, see Interest excluded under the Education Savings Bond Program, later.

  Box 4 (federal income tax withheld) of Form 1099-INT will contain an amount if you were subject to backup withholding. Report the amount from box 4 on Form 1040EZ, line 7, on Form 1040A, line 39, or on Form 1040, line 63.

  Box 5 of Form 1099-INT shows investment expenses you may be able to deduct as an itemized deduction. Chapter 3 discusses investment expenses.

  If there are entries in boxes 6 and 7 of Form 1099-INT, you must file Form 1040. You may be able to take a credit for the amount shown in box 6 (foreign tax paid) unless you deduct this amount on Schedule A of Form 1040 as “Other taxes.” To take the credit, you may have to file Form 1116, Foreign Tax Credit. For more information, see Publication 514, Foreign Tax Credit for Individuals.

Form 1099-OID.   The taxable OID on a discounted obligation for the part of the year you owned it is shown in box 1 of Form 1099-OID. Include this amount in your total taxable interest income. But see Refiguring OID shown on Form 1099-OID under Original Issue Discount (OID), earlier.

  You must report all taxable OID even if you do not receive a Form 1099-OID.

  Box 2 of Form 1099-OID shows any taxable interest on the obligation other than OID. Add this amount to the OID shown in box 1 and include the result in your total taxable income.

  If you forfeited interest or principal on the obligation because of an early withdrawal, the deductible amount will be shown in box 3. See Penalty on early withdrawal of savings, later.

  Box 4 of Form 1099-OID will contain an amount if you were subject to backup withholding. Report the amount from box 4 on Form 1040EZ, line 7, on Form 1040A, line 39, or on Form 1040, line 63.

  Box 7 of Form 1099-OID shows investment expenses you may be able to deduct as an itemized deduction. Chapter 3 discusses investment expenses.

U.S. savings bond interest previously reported.   If you received a Form 1099-INT for U.S. savings bond interest, the form may show interest you do not have to report. See Form 1099-INT for U.S. savings bond interest under U.S. Savings Bonds, earlier.

  On Schedule B (Form 1040), Part I, line 1, or on Schedule 1 (Form 1040A), Part I, line 1, report all the interest shown on your Form 1099-INT. Then follow these steps.

Worksheet for savings bonds distributed from a retirement or profit-sharing plan.   If you cashed a savings bond acquired in a taxable distribution from a retirement or profit-sharing plan (as discussed under U.S. Savings Bonds, earlier), your interest income does not include the interest accrued before the distribution and taxed as a distribution from the plan.

Interest excluded under the Education Savings Bond Program.   Use Form 8815, to figure your interest exclusion when you redeem qualified savings bonds and pay qualified higher educational expenses during the same year.

  For more information on the exclusion and qualified higher educational expenses, see the earlier discussion under Education Savings Bond Program.

  You must show your total interest from qualified savings bonds that you cashed during 2004 on Form 8815, line 6, and on line 1 of either Schedule 1 (Form 1040A) or Schedule B (Form 1040). After completing Form 8815, enter the result from line 14 (Form 8815) on Schedule 1 (Form 1040A), line 3, or Schedule B (Form 1040), line 3.

Interest on seller-financed mortgage.   If an individual buys his or her home from you in a sale that you finance, you must report the buyer's name, address, and social security number on Schedule 1 (Form 1040A), line 1, or Schedule B (Form 1040), line 1. If you do not, you may have to pay a $50 penalty. The buyer may have to pay a $50 penalty if he or she does not give you this information.

  You must also give your name, address, and social security number (or employer identification number) to the buyer. If you do not, you may have to pay a $50 penalty.

Frozen deposits.   Even if you receive a Form 1099-INT for interest on deposits that you could not withdraw at the end of 2004, you must exclude these amounts from your gross income. (See Interest income on frozen deposits under Interest Income, earlier.) Do not include this income on line 8a of Form 1040A or Form 1040. In Schedule 1 (Form 1040A), Part I, or Schedule B (Form 1040), Part I, include the full amount of interest shown on your Form 1099-INT on line 1. Several lines above line 2, put a subtotal of all interest income. Below this subtotal, enter “Frozen Deposits” and show the amount of interest that you are excluding. Subtract this amount from the subtotal and enter the result on line 2.

Accrued interest on bonds.   If you received a Form 1099-INT that reflects accrued interest paid on a bond you bought between interest payment dates, include the full amount shown as interest on the Form 1099-INT on Schedule B (Form 1040), Part I, line 1. Then, below a subtotal of all interest income listed, enter “Accrued Interest” and the amount of accrued interest that you paid to the seller. That amount is taxable to the seller, not you. Subtract that amount from the interest income subtotal. Enter the result on line 2 and also on Form 1040, line 8a.

  For more information, see Bonds Sold Between Interest Dates, earlier.

Nominee distributions.   If you received a Form 1099-INT that includes an amount you received as a nominee for the real owner, report the full amount shown as interest on the Form 1099-INT on Part I, line 1 of Schedule 1 (Form 1040A) or Schedule B (Form 1040). Then, below a subtotal of all interest income listed, enter “Nominee Distribution” and the amount that actually belongs to someone else. Subtract that amount from the interest income subtotal. Enter the result on line 2 and also on line 8a of Form 1040A or 1040.

File Form 1099-INT with the IRS.   If you received interest as a nominee in 2004, you must file a Form 1099-INT for that interest with the IRS. Send Copy A of Form 1099-INT with a Form 1096, Annual Summary and Transmittal of U.S. Information Returns, to your Internal Revenue Service Center by February 28, 2005 (March 31, 2005 if you file Form 1099-INT electronically). Give the actual owner of the interest Copy B of the Form 1099-INT by January 31, 2005. On Form 1099-INT, you should be listed as the “Payer.” Prepare one Form 1099-INT for each other owner and show that person as the “Recipient.” However, you do not have to file Form 1099-INT to show payments for your spouse. For more information about the reporting requirements and the penalties for failure to file (or furnish) certain information returns, see the General Instructions for Forms 1099, 1098, 5498, and W2-G.

  Similar rules apply to OID reported to you as a nominee on Form 1099-OID. You must file a Form 1099-OID with Form 1096 to show the proper distributions of the OID.

Original issue discount (OID) adjustment.   If you are reporting OID in an amount greater or less than the amount shown on Form 1099-OID or other written statement (such as for a REMIC regular interest), include the full amount of OID shown on your Form 1099-OID or other statement on Schedule B (Form 1040), Part I, line 1. If the OID to be reported is less than the amount shown on Form 1099-OID, show the OID you do not have to report below a subtotal of the interest and OID listed. Identify the amount as “OID Adjustment” and subtract it from the subtotal. If the OID to be reported is greater than the amount shown on Form 1099-OID, show the additional OID below the subtotal. Identify the amount as “OID Adjustment” and add it to the subtotal.

Penalty on early withdrawal of savings.    If you withdraw funds from a time-savings or other deferred interest account before maturity, you may be charged a penalty. The Form 1099-INT or similar statement given to you by the financial institution will show the total amount of interest in box 1 and will show the penalty separately in box 2. You must include in income all the interest shown in box 1. You can deduct the penalty on Form 1040, line 33. Deduct the entire penalty even if it is more than your interest income.

Form 1099-DIV.   Most corporations use Form 1099-DIV, Dividends and Distributions, to show you the distributions you received from them during the year. Keep this form with your records. You do not have to attach it to your tax return.

Dividends not reported on Form 1099-DIV.   Even if you do not receive Form 1099-DIV, you must still report all of your taxable dividend income. For example, you may receive distributive shares of dividends from partnerships or subchapter S corporations. These dividends are reported to you on Schedule K-1 (Form 1065) and Schedule K-1 (Form 1120S).

Nominees.   If someone receives distributions as a nominee for you, that person will give you a Form 1099-DIV, which will show distributions received on your behalf.

  If you receive a Form 1099-DIV that includes amounts belonging to another person, see Nominees under How To Report Dividend Income, later, for more information.

Form 1099-MISC.   Certain substitute payments in lieu of dividends or tax-exempt interest that are received by a broker on your behalf must be reported to you on Form 1099-MISC, Miscellaneous Income, or a similar statement. See also Reporting Substitute Payments under Short Sales in chapter 4.

Incorrect amount shown on a Form 1099.   If you receive a Form 1099 that shows an incorrect amount (or other incorrect information), you should ask the issuer for a corrected form. The new Form 1099 you receive will be marked “Corrected.”

Dividends on stock sold.   If stock is sold, exchanged, or otherwise disposed of after a dividend is declared, but before it is paid, the owner of record (usually the payee shown on the dividend check) must include the dividend in income.

Dividends received in January.   If a regulated investment company (mutual fund) or real estate investment trust (REIT) declares a dividend (including any exempt-interest dividend or capital gain distribution) in October, November, or December payable to shareholders of record on a date in one of those months but actually pays the dividend during January of the next calendar year, you are considered to have received the dividend on December 31. You report the dividend in the year it was declared.

Ordinary (taxable) dividends are the most common type of distribution from a corporation. They are paid out of the earnings and profits of a corporation and are ordinary income to you. This means they are not capital gains. You can assume that any dividend you receive on common or preferred stock is an ordinary dividend unless the paying corporation tells you otherwise. Ordinary dividends will be shown in box 1a of the Form 1099-DIV you receive.

Capital gain distributions (also called capital gain dividends) are paid to you or credited to your account by regulated investment companies (commonly called mutual funds) and real estate investment trusts (REITs). They will be shown in box 2a of the Form 1099-DIV you receive from the mutual fund or REIT.

Report capital gain distributions as long-term capital gains, regardless of how long you owned your shares in the mutual fund or REIT. See Capital gain distributions under How To Report Dividend Income, later in this chapter.

A nondividend distribution is a distribution that is not paid out of the earnings and profits of a corporation. You should receive a Form 1099-DIV or other statement from the corporation showing you the nondividend distribution. On Form 1099-DIV, a nondividend distribution will be shown in box 3. If you do not receive such a statement, you report the distribution as an ordinary dividend.

Liquidating distributions, sometimes called liquidating dividends, are distributions you receive during a partial or complete liquidation of a corporation. These distributions are, at least in part, one form of a return of capital. They may be paid in one or more installments. You will receive Form 1099-DIV from the corporation showing you the amount of the liquidating distribution in box 8 or 9.

Any liquidating distribution you receive is not taxable to you until you have recovered the basis of your stock. After the basis of your stock has been reduced to zero, you must report the liquidating distribution as a capital gain. Whether you report the gain as a long-term or short-term capital gain depends on how long you have held the stock. See Holding Period in chapter 4.

Distributions by a corporation of its own stock are commonly known as stock dividends. Stock rights (also known as “stock options”) are distributions by a corporation of rights to acquire the corporation's stock. Generally, stock dividends and stock rights are not taxable to you, and you do not report them on your return.

If you receive taxable stock dividends or stock rights, include their fair market value at the time of the distribution in your income.

For stock issued before October 10, 1990, you include the redemption premium in your income ratably over the period during which the stock cannot be redeemed. For stock issued after October 9, 1990, you include the redemption premium on the basis of its economic accrual over the period during which the stock cannot be redeemed, as if it were original issue discount on a debt instrument. See Original Issue Discount (OID), earlier in this chapter.

The redemption premium is not a constructive distribution, and therefore is not taxable, in the following situations.

You may receive any of the following distributions during the year.

Nominee

Restricted stock

Form 1099-DIV.   If you owned stock on which you received $10 or more in dividends and other distributions, you should receive a Form 1099-DIV. Even if you do not receive a Form 1099-DIV, you must report all of your taxable dividend income.

1099 DIV

  See Form 1099-DIV for more information on how to report dividend income.

Form 1040A.   You must complete Schedule 1 (Form 1040A), Part II, and attach it to your Form 1040A, if: List on line 5 each payer's name and the amount of ordinary dividends you received. If you received a Form 1099-DIV from a brokerage firm, list the brokerage firm as the payer.

  Enter on line 6 the total of the amounts listed on line 5. (However, if you hold stock as a nominee, see Nominees, later.) Also enter this total on Form 1040A, line 9a.

Form 1040.   You must fill in Schedule B, Part II, and attach it to your Form 1040, if: If your ordinary dividends are more than $1,500, you must also complete Schedule B, Part III.

  List on Schedule B, Part II, line 5, each payer's name and the amount of ordinary dividends you received. If your securities are held by a brokerage firm (in “street name”), list the name of the brokerage firm that is shown on Form 1099-DIV as the payer. If your stock is held by a nominee who is the owner of record, and the nominee credited or paid you dividends on the stock, show the name of the nominee and the dividends you received or for which you were credited.

  Enter on line 6 the total of the amounts listed on line 5. (However, if you hold stock as a nominee, see Nominees, later.) Also enter this total on Form 1040, line 9a.

Dividends received on restricted stock.   Restricted stock is stock that you get from your employer for services you perform and that is nontransferable and subject to a substantial risk of forfeiture. You do not have to include the value of the stock in your income when you receive it. However, if you get dividends on restricted stock, you must include them in your income as wages, not dividends. See Restricted Property in Publication 525 for information on restricted stock dividends.

  Your employer should include these dividends in the wages shown on your Form W-2. If you also get a Form 1099-DIV for these dividends, list them on Schedule 1 (Form 1040A), line 5, or Schedule B (Form 1040), line 5, with the other dividends you received. Enter a subtotal of all your dividend income several lines above line 6. Below the subtotal, enter “Dividends on restricted stock reported as wages on Form 1040 (or Form 1040A), line 7,” and enter the amount of the dividends included in your wages on line 7 of Form 1040 or Form 1040A. Subtract this amount from the subtotal and enter the result on line 6.

Election.   You can choose to include the value of restricted stock in gross income as pay for services. If you make this choice, report the dividends on the stock like any other dividends. List them on Part II, line 5, of Schedule 1 or Schedule B, along with your other dividends (if the amount of ordinary dividends received from all sources is more than $1,500). If you receive both a Form 1099-DIV and a Form W-2 showing these dividends, do not include the dividends in your wages reported on line 7 of Form 1040 or Form 1040A. Attach a statement to your Form 1040 or Form 1040A explaining why the amount shown on line 7 of your Form 1040 or Form 1040A is different from the amount shown on your Form W-2.

Independent contractor.   If you received restricted stock for services as an independent contractor, the rules in the previous discussion apply. Generally, you must treat dividends you receive on the stock as income from self-employment.

Qualified dividends.   Report qualified dividends (Form 1099-DIV, box 1b) on line 9b of Form 1040 or Form 1040A. Do not include any of the following on line 9b.

  If you have qualified dividends, you must figure your tax by completing the Qualified Dividends and Capital Gain Tax Worksheet in the Form 1040 or 1040A instructions or the Schedule D Tax Worksheet in the Schedule D instructions, whichever applies. Enter qualified dividends on line 2 of the worksheet.

Investment interest deducted.   If you claim a deduction for investment interest, you may have to reduce the amount of your qualified dividends that are eligible for the 5% or 15% tax rate. Reduce it by the amount of qualified dividends you choose to include in investment income when figuring the limit on your investment interest deduction. This is done on the Qualified Dividends and Capital Gain Tax Worksheet or the Schedule D Tax Worksheet. For more information about the limit on investment interest, see Interest Expenses in chapter 3.

Capital gain distributions.   How to report capital gain distributions depends on whether you have any other capital gains or losses. If you do, report total capital gain distributions (box 2a of Form 1099-DIV) on Schedule D (Form 1040), Part II, line 13. If you do not have any other capital gains or losses, you may be able to report your capital gain distributions directly on Form 1040, line 13, or Form 1040A, line 10. In either case, see Reporting Capital Gains and Losses in chapter 4 for more information.

  The mutual fund or real estate investment trust (REIT) making the distribution should tell you how much of it is: For information about these terms, see Capital Gain Tax Rates in chapter 4.

  Enter on line 11 of the Unrecaptured Section 1250 Gain Worksheet in the Schedule D instructions the part reported to you as unrecaptured section 1250 gain. If you have a gain on qualified small business stock (section 1202 gain), follow the reporting instructions under Section 1202 Exclusion in chapter 4.

Nondividend distributions.   Report nondividend distributions (box 3 of Form 1099-DIV) only after your basis in the stock has been reduced to zero. After the basis of your stock has been reduced to zero, you must show this amount on Schedule D, Part I, line 1, if you held the stock 1 year or less. Show it on Schedule D, Part II, line 8, if you held the stock for more than 1 year. Enter “Nondividend Distribution Exceeding Basis” in column (a) of Schedule D and the name of the company. Report your gain in column (f). Your gain is the amount of the distribution that is more than your basis in the stock.

Nominees.   If you received ordinary dividends as a nominee (that is, the dividends are in your name but actually belong to someone else), include them on line 5 of Schedule 1 (Form 1040A) or Schedule B (Form 1040). Several lines above line 6, put a subtotal of all dividend income listed on line 5. Below this subtotal, enter “Nominee Distribution” and show the amount received as a nominee. Subtract the total of your nominee distributions from the subtotal. Enter the result on line 6.

File Form 1099-DIV with the IRS.   If you received dividends as a nominee in 2004, you must file a Form 1099-DIV for those dividends with the IRS. Send the Form 1099-DIV with a Form 1096, Annual Summary and Transmittal of U.S. Information Returns, to your Internal Revenue Service Center by February 28, 2005. Give the actual owner of the dividends Copy B of the Form 1099-DIV by January 31, 2005. On Form 1099-DIV, you should be listed as the “Payer.” The other owner should be listed as the “Recipient.” You do not, however, have to file a Form 1099-DIV to show payments for your spouse. For more information about the reporting requirements and the penalties for failure to file (or furnish) certain information returns, see the General Instructions for Forms 1099, 1098, 5498, and W-2G.

Liquidating distributions.    If you receive a liquidating distribution on stock, the corporation will give you a Form 1099-DIV showing the amount of the liquidating distribution in boxes 8 and 9.

Stripped preferred stock defined.   Stripped preferred stock is any stock that meets both of the following tests.

Treatment of buyer.   If you buy stripped preferred stock after April 30, 1993, you must include certain amounts in your gross income while you hold the stock. These amounts are ordinary income. They are equal to the amounts you would have included in gross income if the stock were a bond that: Report these amounts as other income on Form 1040, line 21. For information about OID, see Original Issue Discount (OID), earlier.

  This treatment also applies to you if you acquire the stock in such a way (for example, by gift) that your basis in the stock is determined by using a buyer's basis.

Treatment of person stripping stock.   If you strip the rights to one or more dividends from stripped preferred stock, you are treated as having purchased the stock. You are treated as making the purchase on the date you disposed of the dividend rights. Your adjusted basis in the stripped preferred stock is treated as your purchase price. The rules described in Treatment of buyer, earlier, apply to you.

A real estate mortgage investment conduit (REMIC) is an entity that is formed for the purpose of holding a fixed pool of mortgages secured by interests in real property. A REMIC issues regular and residual interests to investors. For tax purposes, a REMIC is generally treated as a partnership with the residual interest holders treated as the partners. The regular interests are treated as debt instruments.

REMIC income or loss is not income or loss from a passive activity.

For more information about the qualifications and the tax treatment that apply to a REMIC and the interests of investors in a REMIC, see sections 860A through 860G of the Internal Revenue Code, and the regulations under those sections.

A collateralized debt obligation (CDO) is a debt instrument, other than a REMIC regular interest, that is secured by a pool of mortgages or other evidence of debt and that has principal payments that are subject to acceleration. (Note: While REMIC regular interests are collateralized debt obligations, they have unique rules that do not apply to CDOs issued before 1987.) CDOs, also known as “pay-through bonds,” are commonly divided into different classes (also called “tranches”).

CDOs can be secured by a pool of mortgages, automobile loans, equipment leases, or credit card receivables.

For more information about the qualifications and the tax treatment that apply to an issuer of a CDO, see section 1272(a)(6) of the Internal Revenue Code and the regulations under that section.

The OID, market discount, and income-reporting rules that apply to bonds and other debt instruments, as described earlier in this chapter under Discount on Debt Instruments, also apply to a CDO.

You must include interest income from your CDO in your gross income under your regular method of accounting. Also include any OID accrued on your CDO during the tax year.

Generally, you report your income from a CDO on Form 1040, line 8a. For more information about reporting these amounts on your return, see How To Report Interest Income, earlier.

A financial asset securitization investment trust (FASIT) is an entity that securitizes debt obligations such as credit card receivables, home equity loans, and automobile loans.

A regular interest in a FASIT is treated as a debt instrument. The rules described under Collateralized Debt Obligations (CDOs), earlier, apply to a regular interest in a FASIT, except that a holder of a regular interest in a FASIT must use an accrual method of accounting to report OID and interest income.

For more information about FASITs, see sections 860H through 860L of the Internal Revenue Code.

Beginning January 1, 2005, the special rules for FASITs are repealed. However, the special rules still apply to any FASIT in existence on October 22, 2004, to the extent that regular interests issued by the FASIT before that date continue to remain outstanding in accordance with the original terms of issuance.

Reporting S corporation income, deductions, and credits.   The S corporation should send you a copy of Schedule K-1 (Form 1120S) showing your share of the S corporation's income, credits, and deductions for the tax year. You must report your distributive share of the S corporation's income, gain, loss, deductions, or credits on the appropriate lines and schedules of your Form 1040.

  For more information about your treatment of S corporation tax items, see Shareholder's Instructions for Schedule K-1 (Form 1120S).

Limit on losses and deductions.   The deduction for your share of losses and deductions shown on Schedule K-1 (Form 1120S) is limited to the adjusted basis of your stock and any debt the corporation owes you. Any loss or deduction not allowed because of this limit is carried over and treated as a loss or deduction in the next tax year.

Passive activity losses.   Rules apply that limit losses from passive activities. Your copy of Schedule K-1 and its instructions will explain the limits and tell you where on your return to report your share of S corporation items from passive activities.

Form 8582.   If you have a passive activity loss from an S corporation, you must complete Form 8582, Passive Activity Loss Limitations, to figure the amount of the allowable loss to enter on your return. See Publication 925 for more information.

Identifying number.    Each club must have an employer identification number (EIN) to use when filing its return. The club's EIN also may have to be given to the payer of dividends or other income from investments recorded in the club's name. To obtain an EIN, first get Form SS-4, Application for Employer Identification Number, from the Internal Revenue Service or your nearest Social Security Administration office. See chapter 5 of this publication for more information about how to get this form.

Investments in name of member.   When an investment is recorded in the name of one club member, this member must give his or her social security number (SSN) to the payer of investment income. (When an investment is held in the names of two or more club members, the SSN of only one member must be given to the payer.) This member is considered as the record owner for the actual owner, the investment club. This member is a “nominee” and must file an information return with the IRS. For example, the nominee member must file Form 1099-DIV for dividend income, showing the club as the owner of the dividend, his or her SSN, and the EIN of the club.

Generally, an investment club is treated as a partnership for federal tax purposes unless it chooses otherwise. In some situations, however, it is taxed as a corporation or a trust.