In general, distributions from a traditional IRA are taxable in the year you receive them. A traditional IRA is any IRA that is not a Roth or SIMPLE IRA. Exceptions to the general rule are rollovers, tax-free withdrawals of contributions, and the return of nondeductible contributions discussed in Publication 590.

Generally, if you did not pay any part of the cost of your employee pension or annuity, and your employer did not withhold part of the cost of the contract from your pay while you worked, the amounts you receive each year are fully taxable.

If you have a cost to recover from your pension or annuity plan (see Cost, later), you can exclude part of each annuity payment from income as a recovery of your cost. This tax-free part of the payment is figured when your annuity starts and remains the same each year, even if the amount of the payment changes. The rest of each payment is taxable.

You figure the tax-free part of the payment using one of the following methods.

You determine which method to use when you first begin receiving your annuity, and you continue using it each year that you recover part of your cost.

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

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

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

  

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

How to use the Simplified Method.   Complete the Simplified Method Worksheet in the Form 1040 or Form 1040A instructions or in Publication 575 to figure your taxable annuity for 2004. If the annuity is payable only over your life, use your age on your annuity starting date to complete line 3 of the worksheet. If your annuity is payable over your life and the lives of other individuals, use your combined ages on the annuity starting date. However, if your annuity starting date is before 1998, use the primary annuitant's age on the annuity starting date. If the annuity does not depend on anyone's life expectancy, use the total number of monthly annuity payments under the contract.

  

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

Example.

Dale Stanford, age 65, began receiving retirement benefits in 2004, under a joint and survivor annuity. Dale's annuity starting date is January 1, 2004. The benefits are to be paid over the joint lives of Dale and his wife, Kathy, age 65. Dale had contributed $31,000 to a qualified plan and had received no distributions before the annuity starting date. Dale is to receive a retirement benefit of $1,200 a month, and Kathy is to receive a monthly survivor benefit of $600 upon Dale's death.

Dale must use the Simplified Method to figure his taxable annuity because his payments are from a qualified plan and he is under age 75. See his illustrated completed Simplified Method Worksheet from Publication 575, later.

His annuity is payable over the lives of more than one annuitant, so Dale uses his and Kathy's combined ages and Table 2 at the bottom of the worksheet in completing line 3 of the worksheet. Dale's tax-free monthly amount is $100 ($31,000 ÷ 310 as shown on line 4 of the worksheet). Upon Dale's death, if Dale has not recovered the full $31,000 investment, Kathy will also exclude $100 from her $600 monthly payment. The full amount of any annuity payments received after 310 payments are paid must be included in gross income.

If Dale and Kathy die before 310 payments are made, a miscellaneous itemized deduction will be allowed for the unrecovered cost on the final income tax return of the last to die. This deduction is not subject to the 2%-of-adjusted-gross-income limit.

  

Filled-In Worksheet 2-A. Simplified Method Worksheet for Dale StanfordKeep for your records

1.	Enter the total pension or annuity payments received this year. Also, add this amount to the total for Form 1040, line 16a, or Form 1040A, line 12a				1.	$ 14,400
2.	Enter your cost in the plan (contract) at the annuity starting date				2.	31,000
	Note. If your annuity starting date was before this year and you completed this worksheet last year, skip line 3 and enter the amount from line 4 of last year's worksheet on line 4 below. Otherwise, go to line 3.
3.	Enter the appropriate number from Table 1 below. But if your annuity starting date was after 1997 and the payments are for your life and that of your beneficiary, enter the appropriate number from Table 2 below				3.	310
4.	Divide line 2 by the number on line 3				4.	100
5.	Multiply line 4 by the number of months for which this year's payments were made. If your annuity starting date was before 1987, enter this amount on line 8 below and skip lines 6, 7, 10, and 11. Otherwise go to line 6				5.	1,200
6.	Enter any amount previously recovered tax free in years after 1986				6.	0
7.	Subtract line 6 from line 2				7.	31,000
8.	Enter the smaller of line 5 or line 7				8.	1,200
9.	Taxable amount for year. Subtract line 8 from line 1. Enter the result, but not less than zero. Also, add this amount to the total for Form 1040, line 16b, or Form 1040A, line 12b. Note. If your Form 1099-R shows a larger taxable amount, use the amount on this line instead				9.	$ 13,200
10.	Add lines 6 and 8				10.	1,200
11.	Balance of cost to be recovered. Subtract line 10 from line 2				11.	$29,800
Table 1 for Line 3 Above
	IF the age at annuity starting date was		AND your annuity starting date was—
			before November 19, 1996, enter on line 3	after November 18, 1996, enter on line 3
	55 or under		300	360
	56–60		260	310
	61–65		240	260
	66–70		170	210
	71 or over		120	160
Table 2 for Line 3 Above
	IF the combined ages at annuity starting date were		THEN enter on line 3
	110 or under		410
	111–120		360
	121–130		310
	131–140		260
	141 or over		210

Nonperiodic Distributions

If you receive a nonperiodic distribution from your retirement plan, you may be able to exclude all or part of it from your income as a recovery of your cost. Nonperiodic distributions include cash withdrawals, distributions of current earnings, and certain loans. For information on how to figure the taxable amount of a nonperiodic distribution, see Taxation of Nonperiodic Payments in Publication 575.

The taxable part of a nonperiodic distribution may be subject to an additional 10% tax. See Tax on Early Distributions, later.

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

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

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

To find out whether any of your benefits are taxable, compare the base amount for your filing status to the total of:

When making this comparison, do not reduce your other income by any exclusions for:

If you are married and file a joint return for 2004, you and your spouse must combine your incomes and your benefits to figure 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 to figure whether any of your benefits are taxable.

If part of your benefits are taxable, you must use Form 1040 or Form 1040A. You cannot use Form 1040EZ.

If part of your benefits are taxable, how much is taxable depends on the total amount of your benefits and other income. Generally, the higher that total amount, the greater the taxable part of your benefits.

You must include the taxable part of a lump-sum (retroactive) payment of benefits received in 2004 in your 2004 income, even if the payment includes benefits for an earlier year.

Generally, you use your 2004 income to figure the taxable part of the total benefits received in 2004. However, you may be able to figure the taxable part of a lump-sum payment for an earlier year separately, using your income for the earlier year. You can elect this method if it lowers your taxable benefits. See Publication 915 for more information.

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

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

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.

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. See Exception, later. For a chronically ill individual, the payments must be for costs incurred for qualified long-term care services or made on a periodic basis without regard to the costs.

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

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

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

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

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

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

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

Do not report the 2004 sale of your main home on your tax return unless:

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