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2018 Taxability of Wages, Salaries and Other Income |
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In this tax subject, we will review the taxability of wages, salaries and other income. These items include earned income, statutory employees and tip income. We will also look at the tax treatment interest income both taxable and nontaxable, dividends and other distributions from mutual funds, corporations and other entities. We will look closely at qualified dividends. In addition, we will review the tax treatment of rental income and expenses, why rental income can be considered passive income and what needs to happen in order for rental income to be considered nonpassive income for tax purposes. Furthermore, this review of rental income will include depreciation, vacation homes, not-for-profit rental and even the renting of personal property. We will discuss the tax treatment of professional real estate agents, also. Once you complete this 2018 Taxability of Wages, Salaries and Other Income course, you will have satisfied 8 hours of continuing education which satisfies 8 hours of tax law towards your total continuing education required hours.
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Wages and salaries Wages and Salaries All wages, salaries and tips you received for performing services as an employee of an employer must be included in your gross income. Amounts withheld for taxes, including but not limited to income tax, social security and Medicare taxes, are considered "received" and must be included in gross income in the year they're withheld. Generally, your employer's contribution to a qualified pension plan for you isn't included in gross income at the time it's contributed. Additionally, while amounts withheld under certain salary reduction agreements with your employer are generally excluded from gross income, such amounts may have to be included in wages subject to social security and Medicare taxes in the year they're withheld. Your employer should provide you a Form W-2, Wage and Tax Statement, showing your total income and withholding. You must include all income and withholding from all Forms W-2 you receive on your tax return, and if filing jointly, you must also include all income and withholding from your spouse's Forms W-2. Other income you need to consider and include on your tax return is self-employment income, business income, and tips. With these you should also know how to treat excess social secuirity or railroad tax withholding and must know what to do if you have any excess social security and RRTA tax withheld. If you receive a Form W-2 after you've filed your return, you must file an amended tax return to include the income that you forgot to include. You should probably not wait for the IRS to send you a notice that you forgot to include the extra income because by that time, you will be responsible for certain penalties and interest.Achieving a Better Life Experience (ABLE) account. This is a new type of savings account for individuals with disabilities and their families. Distributions are tax-free if used to pay the beneficiary's qualified disability expenses. Public safety officers. A spouse, former spouse, and child of a public safety officer killed in the line of duty can exclude from gross income survivor benefits received from a governmental section 401(a) plan attributable to the officer's service. A public safety officer that's permanently and totally disabled or killed in the line of duty and a surviving spouse or child can exclude from income death or disability benefits received from the federal Bureau of Justice Assistance or death benefits paid by a state program. Certain amounts received by wrongfully incarcerated individuals. Certain amounts you receive due to a wrongful incarceration may be excluded from gross income. Qualified Medicaid waiver payments. Certain payments you receive for providing care to an eligible individual in your home under a state's Medicaid waiver program aren’t included in your income. These payments may be excluded from your income whether or not you are related to the eligible individual receiving care. Terrorist attacks. You can exclude from income certain disaster assistance, disability, and death payments received as a result of a terrorist or military action. Qualified settlement income. If you are a qualified taxpayer, you can contribute all or part of your qualified settlement income, up to $100,000, to an eligible retirement plan, including an IRA. Contributions to eligible retirement plans, other than a Roth IRA or a designated Roth contribution, reduce the qualified settlement income that you must include in income. Foreign income. If you are a U.S. citizen or resident alien, you must report income from sources outside the United States (foreign income) on your tax return unless it is exempt by U.S. law. This is true whether you reside inside or outside the United States and whether or not you receive a Form W-2, Wage and Tax Statement, or Form 1099 from the foreign payer. This applies to earned income (such as wages and tips) as well as unearned income (such as interest, dividends, capital gains, pensions, rents, and royalties). If you reside outside the United States, you may be able to exclude part or all of your foreign source earned income. Olympic and Paralympic medals and United States Olympic Committee (USOC) prize money. If you receive Olympic and Paralympic medals and USOC prize money, the value of the medals and the amount of the prize money may be non-taxable. You can receive income in the form of money, property, or services. Th ere are many kinds of income and you must know whether they are taxable or nontaxable. This includes employee wages and fringe benefits, and income from bartering, partnerships, S corporations, and royalties. You also know what to do with income from disability pensions, life insurance proceeds, and welfare and other public assistance benefits.In most cases, an amount included in your income is taxable unless it is specifically exempted by law. Income that is taxable must be reported on your return and is subject to tax. Income that is nontaxable may have to be shown on your tax return but isn’t taxable. Constructively received income. You are generally taxed on income that is available to you, regardless of whether it is actually in your possession. For example, a valid check that you received or that was made available to you before the end of the tax year is considered income constructively received in that year, even if you don’t cash the check or deposit it to your account until the next year. Furthermore, if the postal service tries to deliver a check to you on the last day of the tax year but you aren’t at home to receive it, you must include the amount in your income for that tax year. If the check was mailed so that it couldn’t possibly reach you until after the end of the tax year, and you otherwise couldn’t get the funds before the end of the year, you include the amount in your income for the next tax year.Assignment of income. Income received by an agent for you is income you constructively received in the year the agent received it. If you agree by contract that a third party is to receive income for you, you must include the amount in your income when the third party receives it. For example, you and your employer agree that part of your salary is to be paid directly to one of your creditors. You must include that amount in your income when your creditor receives it.Prepaid income. In most cases, prepaid income, such as compensation for future services, is included in your income in the year you receive it. However, if you use an accrual method of accounting, you can defer prepaid income you receive for services to be performed before the end of the next tax year. In this case, you include the payment in your income as you earn it by performing the services. Employee Compensation In most cases, 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 from your employer or former employer showing the pay you received for your services. Include all your pay on line 7 of Form 1040 or Form 1040A or on line 1 of Form 1040EZ, even if you don’t receive Form W-2, or you receive a Form W-2 that doesn’t include all pay that should be included on the Form W-2. If you performed services, other than as an independent contractor, and your employer didn’t withhold social security and Medicare taxes from your pay and for this you must file Form 8919, with your Form 1040. These wages must be included on line 7 of Form 1040.Childcare providers. If you provide childcare, 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. How do you determine if you are or not an employee? 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.Babysitting. If you babysit for relatives or neighborhood children, whether on a regular basis or only periodically, the rules for childcare providers apply to you. Employment tax. Whether you are an employee or self-employed person, your income could be subject to self-employment tax. Bankruptcy. If you filed for bankruptcy under Chapter 11 of the Bankruptcy Code, you must allocate your wages and withheld income tax. Your W-2 will show your total wages and withheld income tax for the year. On your tax return, you report the wages and withheld income tax for the period before you filed for bankruptcy. Your bankruptcy estate reports the wages and withheld income tax for the period after you filed for bankruptcy. If you receive other information returns (such as Form 1099-DIV, or 1099-INT) that report gross income to you, rather than to the bankruptcy estate, you must allocate that income. The only exception is for purposes of figuring your self-employment tax, if you are self-employed. For that purpose, you must take into account all your self-employment income for the year from services performed both before and after the beginning of the case. You must file a statement with your income tax return stating you filed a Chapter 11 bankruptcy case. The statement must show the allocation and describe the method used to make the allocation. Miscellaneous Compensation Th ere are a plethora of different types of employee compensation.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. Allowances and reimbursements. If you receive travel, transportation, or other business expense allowances or reimbursements from your employer, these may be taxable or nontaxable depending on your situation. This is also true if you are reimbursed for 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 isn’t 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 can’t be more than $1,600 ($400 for awards that aren’t 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 don’t create a significant likelihood of it being disguised pay. However, the exclusion doesn’t apply to 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. In addition, the exclusion doesn’t apply to 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. For 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 incomee.Differential wage payments. A differential wage payment is any payment made by an employer to an individual for any period during which the individual is, for a period of more than 30 days, an active duty member of the uniformed services and represents all or a portion of the wages the individual would have received from the employer for that period. These payments are treated as wages and are subject to income tax withholding, but are not subject to FICA or FUTA taxes. The payments are reported as wages on Form W-2. Government cost-of-living allowances. Most payments received by U.S. Government civilian employees for working abroad are taxable. However, certain cost-of-living allowances are tax free. Get familiarized with the tax treatment of allowances, differentials, and other special pay received for employment abroad. Nonqualified deferred compensation plans. Your employer will report to you the total amount of deferrals for the year under a nonqualified deferred compensation plan. This amount is shown on Form W-2, box 12, using code Y. This amount isn’t included in your income. However, if at any time during the tax year, the plan fails to meet certain requirements, or isn’t operated under those requirements, all amounts deferred under the plan for the tax year and all preceding tax years are included in your income for the current year. This amount is included in your wages shown on Form W-2, box 1. It is also shown on Form W-2, box 12, using code Z. Nonqualified deferred compensation plans of nonqualified entities. In most cases, any compensation deferred under a nonqualified deferred compensation plan of a nonqualified entity is included in gross income when there is no substantial risk of forfeiture of the rights to such compensation. For this purpose, a nonqualified entity is a a foreign corporation unless substantially all of its income is:
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. On the other hand, 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. You must include in income amounts you receive as severance pay and any payment for the cancellation of your employment contract. Severance payments are subject to social security and Medicare taxes, income tax withholding, and FUTA tax. Severance payments are wages subject to social security and Medicare taxes. There are special rules for various types of services and payments and severance payments are also subject to income tax withholding and FUTA tax.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%-of-adjusted-gross-income (AGI) 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
However, if you paid the premiums on an accident or health insurance policy, the benefits you receive under the policy aren’t taxable. 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 aren’t 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. Virtual currency. If your employer gives you virtual currency (such as Bitcoin) as payment for your services, you must include the fair market value of the currency in your income. The fair market value of virtual currency paid as wages is subject to federal income tax withholding, Federal Insurance Contribution Act (FICA) tax, and Federal Unemployment Tax Act (FUTA) tax and must be reported on Form W-2. Virtual currency is considered property by the IRS and like property is how virtual currency is treated for federal tax purposes.Fringe Benefits 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. You must know the steps in the valuation of fringe benefits and must arrive at the correct determination of 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. It is important to note that you don’t 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 also can 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 The general rule is that benefits be reported for a full calendar year which is usually from January 1 through December 31.The special accounting period rule The special accounting period rule is used when benefits are 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 doesn’t 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 such as for the use of a company car.Form W-2. Your employer must include all taxable fringe benefits in box 1 of Form W-2 as wages, tips and other compensation and, if applicable, in boxes 3 and 5 as social security and Medicare wages. Although not required, your employer may include the total value of fringe benefits in box 14 or on a separate statement. However, if your employer provided you with a vehicle and included 100% of its annual lease value in your income, the employer must separately report this value to you in box 14 or on a separate statement. Accident or Health Plan In most cases, the value of accident or health plan coverage provided to you by your employer isn’t included in your income. Benefits you receive from the plan may be taxable, under sickness and injury benefits .Long-term care coverage. Contributions by your employer to provide coverage for long-term care services generally aren’t 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 aren’t 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 and must file this 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, in most cases, aren’t included in your income. For 2017, health FSAs are subject to a $2,600 limit (as indexed for inflation) on a salary reduction contribution.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 generally aren’t included in your income. Health savings account (HSA). If you are an eligible individual, you and any other person, including your employer or a family member, can make contributions to your HSA. Contributions, other than employer contributions, are deductible on your return whether or not you itemize deductions. Contributions made by your employer aren’t included in your income. Distributions from your HSA that are used to pay qualified medical expenses aren’t included in your income. Distributions not used for qualified medical expenses are included in your income. Contributions by a partnership to a bona fide partner's HSA aren’t contributions by an employer. The contributions are treated as a distribution of money and aren’t included in the partner's gross income. Contributions by a partnership to a partner's HSA for services rendered are treated as guaranteed payments that are includible in the partner's gross income. In both situations, the partner can deduct the contribution made to the partner's HSA. Contributions by an S corporation to a 2% shareholder-employee's HSA for services rendered are treated as guaranteed payments and are includible in the shareholder-employee's gross income. The shareholder-employee can deduct the contribution made to the shareholder-employee's HSA. Qualified HSA funding distribution. You can make a one-time distribution from your individual retirement account (IRA) to an HSA and you generally won’t include any of the distribution in your income. Adoption Assistance 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. 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 aren’t included as wages in box 1. You must determine the taxable and nontaxable amounts by completing Part III of Form 8839. You must file the form with your return.Athletic Facilities 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 isn’t 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.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 isn’t included in your income. In most cases, the value of benefits such as discounts at company cafeterias, cab fares home when working overtime, and company picnics aren’t included in your income. Holiday gifts. If your employer gives you a turkey, ham, or other item of nominal value at Christmas or other holidays, don’t 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. Dependent Care Benefits 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. If you want to claim an exclusion, you must complete Part III of Form 2441.Educational Assistance You can exclude from your income up to $5,250 of qualified employer-provided educational assistance. Employee Discounts 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 doesn’t 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 20%.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 and you need to ask the employer for this percentage.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%-of-AGI limit). Qualified retirement planning services paid for you by your employer may be excluded from your income. Group-Term Life Insurance In most cases, the cost of up to $50,000 of group-term life insurance coverage provided to you by your employer (or former employer) isn’t 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. There are exceptions to this rule where you may be able to have entire cost excluded. You must be careful to follow the guidelines carefully because it may be the entire cost will be taxed.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. Also, it is 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 doesn't provide general death benefits (for example, travel insurance) isn’t group-term life insurance. Former employer. If your former employer provided 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 on line 62, Form 1040, and follow the instructions for line 62. Two or more employers. Your exclusion for employer-provided group-term life insurance coverage can’t 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 won’t 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. If you pay any part of the cost of the insurance, your entire payment reduces, dollar for dollar, the amount you otherwise would include in your income. However, you can’t reduce the amount to include in your income by
Entire cost excluded. You aren't taxed on the cost of group-term life insurance if ou are permanently and totally disabled and have ended your employment. In addition, you aren't taxed on the cost of group-term life insurance if your employer is the beneficiary of the policy for the entire period the insurance is in force during the tax year. Furthermore, you aren't taxed on the cost of group-term life insurance if 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 aren't entitled to a deduction for a charitable contribution for naming a charitable organization as the beneficiary of your policy.)You are also not taxed on the cost of group-term life insurance if he plan existed on January 1, 1984, and
Entire cost taxed. You are taxed on the entire cost of group-term life insurance if the insurance is provided by your employer through a qualified employees' trust, such as a pension trust or a qualified annuity plan or if you are a key employee and your employer's plan discriminates in favor of key employees.Meals and Lodging You don't include in your income the value of meals provided to you and your family by your employer at no charge if the meals are furnished on the business premises of your employer, and the meals are urnished for the convenience of your employer. In the same manner, you don't include in your income the value lodging provided to you and your family by your employer at no charge if the lodging is furnished on the business premises of your employer, furnished for the convenience of your employer, and the lodging is a condition of your employment. The lodging is a condition of your employment if you must accept it in order to be able to properly perform your duties.You also don't include in your income the value of meals or meal money that qualifies as a minimal fringe benefit. Faculty lodging. If you are an employee of an educational institution or an academic health center and you are provided with lodging that doesn't meet the three conditions given earlier, 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 certain conditions. First, its principal purpose or function is to provide medical or hospital care or medical education or research. Second, it receives payments for graduate medical education under the Social Security Act. Additionally, 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. For 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 $200,000. The average rent paid for comparable university lodging by persons other than employees or students is $14,000 a year. Carl pays an annual rent of $11,000. Carl doesn't include in his income any rental value because the rent he pays equals at least 5% of the appraised value of the house (5% × $200,000 = $10,000). If Carl paid annual rent of only $8,000, he would have to include $2,000 in his income ($10,000 − $8,000).Moving Expense Reimbursements In most cases, 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 isn't included in your income. No-Additional-Cost Services The value of services you receive from your employer for free, at cost, or for a reduced price isn't 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).In most cases, no-additional-cost services are excess capacity services, such as airline, bus, or train tickets, hotel rooms, and telephone services. For 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 isn't included in your income. However, the value of the hotel room is included in your income because you don't 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 aren't 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 can't exclude the value of any tax preparation, accounting, legal, or brokerage services provided by your employer. You also can't exclude any financial counseling fees paid by your employer.Transportation 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 transportation in a commuter highway vehicle (such as a van) between your home and work place, a transit pass, qualified parking, or qualified bicycle commuting reimbursement.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 isn't readily available for direct distribution to you. Exclusion limit. The exclusion for commuter vehicle transportation and transit pass fringe benefits can't be more than $255 a month. The exclusion for the qualified parking fringe benefit can't be more than $255 a month. The exclusion for qualified bicycle commuting in a calendar year is $20 multiplied by the number of qualified bicycle commuting months that year. You can't exclude from your income any qualified bicycle commuting reimbursement if you can choose between reimbursement and compensation that is otherwise includible in your income. However, 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 workplace, 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. Qualified parking 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 doesn't include parking at or near the employee's home. Qualified bicycle commuting. This is reimbursement based on the number of qualified bicycle commuting months for the year. A qualified bicycle commuting month is any month you use the bicycle regularly for a substantial portion of the travel between your home and place of employment and you don't receive any of the other qualified transportation fringe benefits. The reimbursement can be for expenses you incurred during the year for the purchase of a bicycle and bicycle improvements, repair, and storage. Tuition Reduction 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. Furthermore, this is the amount of a reduction in tuition 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. This is also the amount of a reduction in tuition 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.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 isn't included in your income. For example, you work as an engineer and your employer provides you with a subscription to an engineering trade magazine. The cost of the subscription isn't 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. There is an exception, however.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. However, 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 various 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 your perceived value of the benefit, or the amount your employer paid for the benefit.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 can't 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 can't use a different special rule to value that benefit. You always can use the general valuation rule 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
Retirement Plan Contributions Your employer's contributions to a qualified retirement plan for you aren't 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. 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 isn't 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 don't 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. Other rules qualifying factors may apply if you are a federal employee or retiree.Elective Deferrals 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. An elective deferral, other than a designated Roth contribution isn't 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
Qualified automatic contribution arrangements. Under a qualified automatic contribution arrangement, your employer can treat you as having elected to have a part of your compensation contributed to a section 401(k) plan. You are to receive written notice of your rights and obligations under the qualified automatic contribution arrangement. The notice must explai n your rights to elect not to have elective contributions made, or to have contributions made at a different percentage, and how contributions made will be invested in the absence of any investment decision by you. Furthermore, you must be given a reasonable period of time after receipt of the notice and before the first elective contribution is made to make an election with respect to the contributions.Overall limit on deferrals. For 2017, in most cases, you shouldn't have deferred more than a total of $18,000 of contributions to the plans listed. Amounts deferred under specific plan limits are part of the overall limit on deferrals. 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 aren't 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. Limit for deferrals under SIMPLE plans. If you are a participant in a SIMPLE plan, you generally shouldn't have deferred more than $12,500 in 2017. Amounts you defer under a SIMPLE plan count toward the overall limit ($18,000 for 2017) and may affect the amount you can defer under other elective deferral plans. 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 2017 generally is $18,000. 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 $3,000, $15,000, reduced by the sum of the additional pre-tax elective deferrals made in earlier years because of this rule, plus the aggregate amount of designated Roth contributions permitted for prior tax years because of this rule, or $5,000 times the number of your years of service for the organization, minus the total elective deferrals made by your employer on your behalf for earlier years. If you qualify for the 15-year rule, your elective deferrals under this limit can be as high as $21,000 for 2017.Limit for deferral under section 501(c)(18) plans. If you are a participant in a section 501(c)(18) plan (a trust created before June 25, 1959, funded only by employee contributions), you should have deferred no more than the lesser of $7,000 or 25% of your compensation. Amounts you defer under a section 501(c)(18) plan count toward the overall limit ($18,000 in 2017) 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 $18,000 in 2017. However, if you are within 3 years of normal retirement age, you may be allowed an increased limit if the plan allows it. Includible compensation. This is the pay you received for the year from the employer who maintained the section 457 plan. In most cases, it includes
Instead of using the amounts listed earlier to determine your includible compensation, your employer can use
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 annual limit ($36,000 for 2017), or the basic annual limit plus the amount of the basic limit not used in prior years (only allowed if not using age 50 or over catch-up contributions).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 $18,000, plus $6,000. However, if you are within 3 years of retirement age and your plan provides the increased limit, that limit may be higher.Designated Roth contributions. Employers with section 401(k) and section 403(b) plans can create qualified Roth contribution programs so that you may elect to have part or all of your elective deferrals to the plan designated as after-tax Roth contributions. Designated Roth contributions are treated as elective deferrals, except that they are included in income. Your retirement plan must maintain separate accounts and recordkeeping for the designated Roth contributions. Qualified distributions from a Roth plan aren't included in income. In most cases, a distribution made before the end of the 5-tax-year period beginning with the first tax year for which you made a designated Roth contribution to the plan isn't a qualified distribution. Reporting by employer. Your employer generally shouldn't 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 shouldn't 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 36. Enter the amount and "501(c)(18)(D)" on the dotted line next to line 36. Designated Roth contributions. These contributions are elective deferrals but are included in your wages in box 1 of Form W-2. Designated Roth contributions to a section 401(k) plan are reported using code AA in box 12, or, for section 403(b) plans, code BB in box 12. 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 then must pay you the amount of the excess, along with any income earned on that amount, by April 18 of the following year. You must include the excess deferral in your income for the year of the deferral unless you have an excess deferral of a designated Roth contribution. 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 don't take out the excess amount, you can't 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 18 of the following year, don't 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 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 2017. If the distribution was for a 2017 excess deferral, your Form 1099-R should have the code 8 in box 7. Add the excess deferral amount to your wages on your 2017 tax return. However, if the distribution was for a 2017 excess deferral to a designated Roth account, your Form 1099-R should have code B in box 7. Do not add this amount to your wages on your 2017 return.Moreover, if the distribution was for a 2016 excess deferral, your Form 1099-R should have the code P in box 7. If you didn't add the excess deferral amount to your wages on your 2016 tax return, you must file an amended return on Form 1040X. If you didn't receive the distribution by April 18, 2017, you also must add it to your wages on your 2017 tax return. What's more, 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 2017 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." It must be noted that even though a corrective distribution of excess deferrals is reported on Form 1099-R, it isn't otherwise treated as a distribution from the plan. It can't be rolled over into another plan, and it isn't subject to the additional tax on early distributions.Excess Contributions 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 can't use Form 1040A or Form 1040EZ to report excess contribution amounts. However, if you receive a corrective distribution of excess contributions (and allocable income), it is included in your income in the year of the distribution. The allocable income is the amount of gain or loss through the end of the plan year for which the contribution was made that is allocable to the excess contributions. You should receive a Form 1099-R for the year the excess contributions are distributed to you. Add the distribution to your wages for that year. Even though a corrective distribution of excess contributions is reported on Form 1099-R, it isn't otherwise treated as a distribution from the plan. It can't be rolled over into another plan, and it isn't subject to the additional tax on early distributions. Excess Annual Additions The amount contributed in 2017 to a defined contribution plan is generally limited to the lesser of 100% of your compensation or $54,000. 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. Secondly, 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 isn't 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 isn't otherwise treated as a distribution from the plan. It can't be rolled over into another plan, and it isn't subject to the additional tax on early distributions. Stock Options If you receive an option to buy or sell stock or other property as payment for your services, you may have income when you receive the option (the grant), 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 or property acquired through exercise of the option. The timing, type, and amount of income inclusion depend on whether you receive a nonstatutory stock option or a statutory stock option. Your employer can tell you which kind of option you hold. Nonstatutory Stock Options Nostatutory stock options are grant of options, obtions with readily determinable value, and options without readily determinable value. Grant of option. If you are granted a nonstatutory stock option, you may have income when you receive the 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 isn't traded on an established market can be readily determined only if you can transfer the option, you can exercise the option immediately in full. The option or the property subject to the option isn't 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. Option with readily determinable value. If you receive a nonstatutory stock option that has a readily determinable fair market value at the time it is granted to you, the option is treated like other property received as compensation. However, the rule described in that discussion for choosing to include the value of property in your income for the year of the transfer doesn't apply to a nonstatutory option. Option without readily determinable value. If the fair market value of the option isn't readily determinable at the time it is granted to you (even if it is determined later), you don't have income until you exercise or transfer the option. Exercise or transfer of option. When you exercise a nonstatutory stock option, the amount to include in your income depends on whether the option had a readily determinable value. Option with readily determinable value. When you exercise a nonstatutory stock option that had a readily determinable value at the time the option was granted, you don't have to include any amount in income. Option without readily determinable value. When you exercise a nonstatutory stock option that didn't have a readily determinable value at the time the option was granted, 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. If it isn't substantially vested at the time you exercise this nonstatutory stock option (so that you may have to give the stock back), you don't have to include any amount in income. You include the difference in income when the option becomes substantially vested. On the other hand, your property can be restricted property.Transfer in arm's-length transaction. If you transfer a nonstatutory stock option without a readily determinable value 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. Transfer in non-arm's-length transaction. If you transfer a nonstatutory stock option without a readily determinable value in a non-arm's-length transaction (for example, a gift), the option isn't treated as exercised or closed at that time. You must include in your income, as compensation, any money or property received. When the transferee exercises the option, you must include in your income, as compensation, the excess of the fair market value of the stock acquired by the transferee over the sum of the exercise price paid and any amount you included in income at the time you transferred the option. At the time of the exercise, the transferee recognizes no income and has a basis in the stock acquired equal to the fair market value of the stock. Any transfer of this kind of option to a related person is treated as a non-arm's-length transaction.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. Your employer reports on your Form W2. If you have income from the exercise of nonstatutory stock options, your employer should report the amount to you on Form W-2, box 12, code V. The employer should show the spread (that is, the fair market value of stock over the exercise price of options granted to you for that stock) from your exercise of the nonstatutory stock options. Your employer should include this amount in boxes 1, 3 (up to the social security wage base), and 5. Your employer should include this amount in box 14 if it is a railroad employer. Nevertheless, 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, in box 3. Sale of the stock. There are no special income rules for the sale of stock acquired through the exercise of a nonstatutory stock option. Report the sale on Schedule D (Form 1040), for the year of the sale. You may receive a Form 1099-B, reporting the sales proceeds. Your basis in the property you acquire under the option is the amount you pay for it plus any amount you included in income upon grant or exercise of the option. Your holding period begins as of the date you acquired the option, if it had a readily determinable value, or as of the date you exercised or transferred the option, if it had no readily determinable value. For options granted on or after January 1, 2014, the basis information reported to you on Form 1099-B won't reflect any amount you included in income upon grant or exercise of the option. For options granted before January 1, 2014, any basis information reported to you on Form 1099-B may or may not reflect any amount you included in income upon grant or exercise; therefore, the basis may need to be adjusted. In fact, i t is your responsibility to make any appropriate adjustments to the basis information reported on Form 1099-B by completing Form 8949.Statutory Stock Options There are two kinds of statutory stock options. There are the incentive stock options (ISOs), and options granted under employee stock purchase plans.For either kind of option, you must be an employee of the company granting the option, or a related company, at all times during the period beginning on the date the option is granted and ending 3 months before the date 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. However, if you don't meet the employment requirements, or you receive a transferable option, your option is a nonstatutory stock option.Grant of option. If you receive a statutory stock option, don't include any amount in your income when the option is granted. Exercise of option. If you exercise a statutory stock option, don't include any amount in income when you exercise the option. 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 line 14 of Form 6251. 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. 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. For example, your employer, M Company, granted you an incentive stock option on April 8, 2016, to buy 100 shares of M Company at $9 a share, its fair market value at the time. You exercised the option on January 7, 2017, when the stock was selling on the open market for $14 a share. On January 27, 2017, when the stock was selling on the open market for $16 a share, your rights to the stock first became transferable. You include $700 ($1,600 value when your rights first became transferable minus $900 option price) as an adjustment on Form 6251, line 14.If you exercise an ISO during 2017, you should receive Form 3921, or a statement, from the corporation for each transfer made during 2017. The corporation must send or provide you with the form by February 1, 2018. Keep this information for your records. Sale of the stock. 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) 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 don't satisfy the holding period requirement. Your employer or former employer should report the ordinary income to you as wages in box 1 of Form W-2, and you must report this ordinary income amount on Form 1040, line 7. If your employer or former employer doesn't provide you with a Form W-2, or if the Form W-2 doesn't include the ordinary income in box 1, you still must report the ordinary income as wages on Form 1040, line 7, for the year of the sale or other disposition of the stock. For options granted on or after January 1, 2014, the basis information reported to you on Form 1099-B won't reflect any amount you included in income upon grant or exercise of the option. For options granted before January 1, 2014, any basis information reported to you on Form 1099-B may or may not reflect any amount you included in income upon grant or exercise; therefore, the basis may need to be adjusted. Remember, it is your responsibility to make any appropriate adjustments to the basis information reported on Form 1099-B by completing Form 8949.Holding period requirement. You satisfy the holding period requirement if you don't sell the stock until the end of the later of the 1-year period after the stock was transferred to you or the 2-year period after the option was granted. However, you are considered to satisfy the holding period requirement if you sold the stock to comply with conflict-of-interest requirements. Your holding period for the property you acquire when you exercise an option begins on the day after you exercise the option.Incentive stock options (ISOs). If you sell stock acquired by exercising an ISO, you need to determine if you satisfied the holding period requirement. Holding period requirement satisfied. If you sell stock acquired by exercising an ISO and satisfy the holding period requirement, your gain or loss from the sale is capital gain or loss. Report the sale on Schedule D (Form 1040). The basis of your stock is the amount you paid for the stock.Holding period requirement not satisfied. If you sell stock acquired by exercising an ISO, don't satisfy the holding period requirement, and 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 don't have any ordinary income. Your employer or former employer should report the ordinary income to you as wages in box 1 of Form W-2, and you must report this ordinary income amount on Form 1040, line 7. If your employer or former employer doesn't provide you with a Form W-2, or if the Form W-2 doesn't include the ordinary income in box 1, you still must report the ordinary income as wages on Form 1040, line 7, for the year of the sale or other disposition of the stock. Report the capital gain or loss on Schedule D (Form 1040). In determining capital gain or loss, your basis is the amount you paid when you exercised the option plus the amount reported as wages. For example, your employer, X Corporation, granted you an ISO on March 12, 2015, 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 7, 2016, when the stock was selling on the open market for $12 a share. On January 27, 2017, 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 2017, 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:× 100 shares) $ 1,500 Purchase price ($10 × 100 shares) − 1,000Gain $ 500 Amount reported as wages [($12 × 100 shares) − $1,000] − 200Amount reported as capital gain $ 300
Employee stock purchase plan. If you sold stock acquired by exercising an option granted under an employee stock purchase plan, you need to determine if you satisfied the holding period requirement. Holding period requirement satisfied. If you sold stock acquired by exercising an option granted under an employee stock purchase plan, and you satisfy the holding period requirement, determine your ordinary income as follows. Your basis is equal to the option price at the time you exercised your option and acquired the stock. The timing and amount of pay period deductions don't affect your basis.For example, XYZ Company has an employee stock purchase plan. The option price is the lower of the stock price at the time the option is granted or at the time the option is exercised. The value of the stock when the option was granted was $25. XYZ deducts $5 from A's pay every week for 48 weeks (total = $240 ($5 × 48)). The value of the stock when the option is exercised is $20. A receives 12 shares of XYZ stock ($240 ÷ $20). A's holding period for all 12 shares begins the day after the option is exercised, even though the money used to purchase the shares was deducted from A's pay on 48 separate days. A's basis in each share is $20. 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 excess of the fair market value of the share at the time the option was granted over the option price, or the excess of the fair market value of the share at the time of the disposition or death over the amount paid for the share under the option. For this purpose, if the option price wasn't 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 don't have any ordinary income.For 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: − 2,000 Gain $ 1,000 Amount reported as wages [($22 × 100 shares) − $2,000] − 200Amount reported as capital gain $ 800 Holding period requirement not satisfied. If you don't satisfy 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 isn't 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. For 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 didn't satisfy the holding period requirement, so you must report $300 as wages and $700 as capital gain, figured as follows: − 2,000 Gain $1,000 Amount reported as wages [($23 × 100 shares) − $2,000] − 300Amount reported as capital gain [$3,000 – ($2,000 + $300)] $700
Moreover, if you sold stock in 2016 that you acquired by exercising an option granted at a discount under an employee stock purchase plan, you should receive Form 3922, from the corporation. The corporation must send or provide you with the form by February 1, 2017. Keep this information for your records. Restricted Property In most cases, 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 don't 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, 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. Your holding period for this property begins when the property becomes substantially vested. For 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 isn't substantially vested when it is transferred, so you don't 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 it is transferable, or it isn't subject to a substantial risk of forfeiture. (You don't have a good chance of losing it.)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 isn't required to give up the property, or its value, if the substantial risk of forfeiture occurs. Substantial risk of forfeiture. Generally, a substantial risk of forfeiture exists only if rights in property that are transferred are conditioned, directly or indirectly, on the future performance (or refraining from performance) of substantial services by any person, or on the occurrence of a condition related to a purpose of the transfer if the possibility of forfeiture is substantial. For 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 don't 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 don't apply and, generally, any later appreciation in value isn't 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 can't 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. However, you can't 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. Mail your statement to the address listed for your state under "Are requesting a refund or are not enclosing a check or money order..." given in Where Do You File in the Instructions for Form 1040 and the Instructions for Form 1040A. You 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. Furthermore, 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
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 also are reported on a Form 1099-DIV, you should list them on Schedule B (Form 1040A or 1040), 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 didn't choose to include in your income in the year transferred and that isn't 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 isn't 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 isn't considered an arm's-length transaction. If you sell the property in a transaction that isn't 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. For example, in 2014, you paid your employer $50 for a share of stock that had a fair market value of $100 and was subject to forfeiture until 2017. In 2016, 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 2017, when the stock had a fair market value of $120, it became substantially vested. For 2016, you must report additional compensation of $60, figured as follows: − 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. 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. Clergy 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 isn't 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. 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. Housing Special rules for housing apply to members of the clergy. Under these rules, you don't 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 can't 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), if you are subject to the self-employment tax. 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, don't 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 aren't included in your income. for 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 aren't included in your income. Services performed outside the order. If you are directed to work outside the order, your services aren't an exercise of duties required by the order unless they are the kind of services that are ordinarily the duties of members of the order and 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 won't 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. For example, 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. Moreover, 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. To illutrate further, 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 doesn't make him an agent of the religious order. The psychological services provided by Gene aren't 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. Foreign Employer 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 aren't 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 aren't 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 you aren't 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 and 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 isn't exempt under this rule. However, it may be exempt under a treaty or agreement. Nonwage income. This exemption applies only to employees' wages, salaries, and fees. Pensions and other income, such as investment income, don't qualify for this exemption. Military 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 aren't taxed. Differential wage payments. Any payments made to you by an employer during the time you are performing service in the uniformed services are treated as compensation. These wages are subject to income tax withholding and are reported on Form W-2. 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. Qualified reservist distribution (QRD). If you received a QRD of all or part of the balance in your health flexible spending account because you are a reservist and you have been ordered or called to active duty for a period of 180 days or more, the QRD is treated as wages and is reportable on Form W-2. 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 aren't taxable.
Please note that if, in a previous year, you received a bonus payment by a state or political subdivision because of service in a combat zone that you included in your income, you can file a claim for refund of the taxes on that income. Use Form 1040X to file the claim. File a separate form for each tax year involved. In most cases, you must file your claim within 3 years after the date you filed your original return or within 2 years after the date you paid the tax, whichever is later. Volunteers The tax treatment of amounts you receive as a volunteer vary. Some of these amounts are tax exempt and some can be taxable.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. Allowances paid to your spouse and minor children while you are a volunteer leader training in the United States must be included in your income and reported as wages. In addition, living allowances designated by the Director of the Peace Corps as basic compensation must be included in your income and reported as wages.These are allowances for personal items such as domestic help, laundry and clothing maintenance, entertainment and recreation, transportation, and other miscellaneous expenses.Leave allowances must be included in your income and reported as wages. Readjustment allowances or termination payments. These are considered received by you when credited to your account. For 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 isn't 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
Service Corps of Retired Executives (SCORE). If you receive amounts for supportive services or reimbursements for out-of-pocket expenses from SCORE, don't 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 also 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 You must know the treatment of income from certain rents and royalties, and from interests in partnerships and S corporations. Please note that you may be subject to the Net Investment Income Tax (NIIT). The NIIT is a 3.8% tax on the lesser of net investment income or the excess of your modified adjusted gross income (MAGI) over a threshold amount. In addition, income from sales at auctions, including online auctions, may be business income.Rents From Personal Property If you rent out personal property, such as equipment or vehicles, how you report your income and expenses is in most cases determined by whether or not the rental activity is a business, and whether or not the rental activity is conducted for profit. In most cases, 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.Reporting business income and expenses. If you are in the business of renting personal property, report your income and expenses on Schedule C (Form 1040) or Schedule C-EZ (Form 1040). Reporting nonbusiness income. If you aren't 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 36. Also, enter the amount and "PPR" on the dotted line next to line 36. However, if you don't rent personal property for profit, your deductions are limited and you can't report a loss to offset other income.Royalties Royalties from copyrights, patents, and oil, gas, and mineral properties are taxable as ordinary income. In most cases you report royalties on 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 (Form 1040) 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. 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. 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 as explained in the Instructions for Schedule D (Form 1040). al 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, in most cases you 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. Partnership Income A partnership generally isn't 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. Partner's distributive share. Your distributive share of partnership income, gains, losses, deductions, or credits generally is based on the partnership agreement. You must report your distributive share of these items on your return whether or not they actually are 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 doesn't state how a specific item of gain or loss will be shared, or the allocation stated in the agreement doesn't 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. 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), showing your share of income, deductions, credits, and tax preference items of the partnership for the tax year. Keep Schedule K-1 for your records. Do not attach it to your Form 1040, unless you are specifically required to do so. 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 as explained in the Instructions for Schedule D (Form 1040). You report your share of partnership ordinary income on Schedule E (Form 1040). In many cases, Schedule K-1 (Form 1065) will tell you where to report an item of income on your individual return. Qualified joint venture. If you and your spouse each materially participate as the only members of a jointly owned and operated business, and you file a joint return for the tax year, you can make a joint election to be treated as a qualified joint venture instead of a partnership. To make this election, you must divide all items of income, gain, loss, deduction, and credit attributable to the business between you and your spouse in accordance with your respective interests in the venture. S Corporation Income In most cases, an S corporation doesn't 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. In most cases, 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. 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 a copy of Schedule K-1 (Form 1120S) from any S corporation in which you are a shareholder. Schedule K-1 shows your share of income, losses, deductions, and credits for the tax year. Keep Schedule K-1 for your records. Do not attach it to your Form 1040, unless you are specifically required to do so. 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. In many cases, Schedule K-1 (Form 1120S) will tell you where to report an item of income on your individual return. Distributions. In most cases, 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. Sickness and Injury Benefits In most cases, 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. 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, don't 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. Cafeteria plans. In most cases, if you are covered by an accident or health insurance plan through a cafeteria plan, and the amount of the insurance premiums wasn't included in your income, you aren't 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 aren't taxable. Disability Pensions 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 aren't disabled. You may be entitled to a tax credit if you were permanently and totally disabled when you retired. 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. Terrorist attacks. Do not include in your income disability payments you receive for injuries incurred as a direct result of terrorist attacks directed against the United States (or its allies), whether outside or within the United States. However, you must include in your income any amounts that you received that you would have received in retirement had you not become disabled as a result of a terrorist attack. Contact the company or agency making these payments if it incorrectly reports your payments as taxable income to the IRS on Form W-2, or on Form 1099-R, to request that it re-issue the form to report some or all of these payments as nontaxable income in box 12 (under code J) on Form W-2 or in box 1 but not in box 2a on Form 1099-R. If income taxes are being incorrectly withheld from these payments, you may also submit Form W-4, to the company or agency to stop the withholding of income taxes from payments reported on Form W-2 or you may submit Form W-4P, to stop the withholding of income taxes from payments reported on Form 1099-R. Disability payments you receive for injuries not incurred as a direct result of a terrorist attack or for illnesses or diseases not resulting from an injury incurred as a direct result of a terrorist attack can't be excluded from your income under this provision but may be excludable for other reasons. Retirement and profit-sharing plans. If you receive payments from a retirement or profit-sharing plan that doesn't provide for disability retirement, don't 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 isn't 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 aren't 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, in most cases you must include it in your income. However, if the pension qualifies for the exclusion for a service-connected disability (discussed earlier), don't 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. You must include with each Form 1040X a copy of the official VA Determination letter granting the retroactive benefit. The letter must show the amount withheld and the effective date of the benefit. 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. Special statute of limitations. In most cases, under the statute of limitations a claim for credit or refund must be filed within 3 years from the time a return was filed. However, if you receive a retroactive service-connected disability rating determination, the statute of limitations is extended by a 1-year period beginning on the date of the determination. This 1-year extended period applies to claims for credit or refund filed after June 17, 2008, and doesn't apply to any tax year that began more than 5 years before the date of the determination. Example. You retired in 2011 and receive a pension based on your years of service. On August 3, 2017, you receive a determination of service-connected disability retroactive to 2011. Generally, you could claim a refund for the taxes paid on your pension for 2014, 2015, and 2016. However, under the special limitation period, you can also file a claim for 2013 as long as you file the claim by August 3, 2018. You can't file a claim for 2011 and 2012 because those tax years began more than 5 years before the determination. 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. However, you must include in your income any amounts that you received that you would have received in retirement had you not become disabled as a result of a terrorist or military action. Disability payments you receive for injuries not incurred as a direct result of a terrorist or military action or for illnesses or diseases not resulting from an injury incurred as a direct result of a terrorist or military action may be excludable from income for other reasons. 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 doesn't include training exercises. Long-Term Care Insurance Contracts In most cases, long-term care insurance contracts are treated as accident and health insurance contracts. Amounts you receive from them (other than policyholder dividends or premium refunds) are excludable in most cases 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 In most cases, you do 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 a 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. 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. The cost of qualified long-term care services during the period. The dollar amount for the period ($360 per day for any period in 2017). Workers' Compensation Amounts you receive as workers' compensation for an occupational sickness or injury are fully exempt from tax if they are paid under a workers' compensation act or a statute in the nature of a workers' compensation act. The exemption also applies to your survivors. The exemption, however, doesn't 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. 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, don't 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 aren't taxable in most cases. Federal Employees' Compensation Act (FECA). Payments received under this Act for personal injury or sickness, including payments to beneficiaries in case of death, aren't 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. 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%-of-AGI 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. Qualified Indian health care benefit. For benefits and coverage provided after March 23, 2010, the value of any qualified Indian health care benefit isn't taxable. These benefits include any health service or benefits provided by the Indian Health Service, amounts to reimburse medical care expenses provided by an Indian tribe, coverage under accident or health insurance, and any other medical care provided by an Indian tribe. Other compensation. Many other amounts you receive as compensation for sickness or injury aren't 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. 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 aren't 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 isn't taxable. However, it may reduce your medical expense deduction. If you receive reimbursement for an expense you deducted in an earlier year, you may be required to report it as taxable income.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. Amounts you receive under a reimbursement plan that provides for the payment of unused reimbursement amounts in cash or other benefits are included in your income. Miscellaneous 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 canceled. Bartering 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 on 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 (Form 1040) or Schedule C-EZ (Form 1040). However, if the barter involves an exchange of something other than services, such as in Example 4 , later, 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 (Form 1040) 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 contact 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 (Form 1040) 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 (Form 1040) 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, or a similar statement from the barter exchange should be sent to you by February 15, 2018. It should show the value of cash, property, services, credits, or scrip you received from exchanges during 2017. The IRS also will receive a copy of Form 1099-B. Backup withholding. In most cases the income you receive from bartering isn't 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 don't 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 aren't subject to backup withholding. If you don't make this certification, backup withholding may begin immediately. The barter exchange will give you a Form W-9, 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. Canceled Debts In most cases, 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 (Form 1040) or Schedule C-EZ (Form 1040) (or on Schedule F (Form 1040), if the debt is farm debt and you are a farmer). Starting in 2014 you must include the income you elected to defer in 2009 or 2010 from a cancellation, reacquisition, or modification of a business debt. 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 may receive a Form 1099-C. Form 1099-C, box 2 shows the amount of debt either actually or deemed discharged. If you don't agree with the amount reported in box 2, contact your creditor. 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. 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 doesn't qualify for exclusion as other income on Form 1040, line 21. You may be able to exclude part of the mortgage relief on your principal residence. If you aren't personally liable for a mortgage (nonrecourse debt), and you are relieved of the mortgage when you dispose of the property (such as through foreclosure), 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. 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. If you are a stockholder in a corporation and you cancel a debt owed to you by the corporation, you generally don't 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. Repayment of canceled debt. If you included a canceled amount in your income and later pay the debt, you may be able to file a claim for refund for the year the amount was included in income. You can file a claim on Form 1040X if the statute of limitations for filing a claim is still open. The statute of limitations generally doesn't end until 3 years after the due date of your original return. Exceptions 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 don't 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 also will 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) earlier. 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. Education loan repayment assistance. Education loan repayments made to you by the National Health Service Corps Loan Repayment Program (NHSC Loan Repayment Program), a state education loan repayment program eligible for funds under the Public Health Service Act, or any other state loan repayment or loan forgiveness program that is intended to provide for the increased availability of health services in underserved or health professional shortage areas aren't taxable. Deductible debt. You don't 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. Price reduced after purchase. In most cases, if the seller reduces the amount of debt you owe for property you purchased, you don't 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. The debt is canceled when you are insolvent. However, you can't exclude any amount of canceled debt that is more than the amount by which you are insolvent. The debt is qualified farm debt and is canceled by a qualified person. The debt is qualified real property business debt. The cancellation is intended as a gift. The debt is qualified principal residence indebtedness. Qualified principal residence indebtedness (QPRI). This is debt secured by your principal residence that you took out to buy, build, or substantially improve your principal residence. QPRI can't be more than the cost of your principal residence plus improvements. You must reduce the basis of your principal residence by the amount excluded from gross income. To claim the exclusion, you must file Form 982 with your tax return. Principal residence. Your principal residence is the home where you ordinarily live most of the time. You can have only one principal residence at any one time. Amount eligible for exclusion. The maximum amount you can treat as QPRI is $2 million ($1 million if married filing separately). You can't exclude debt canceled because of services performed for the lender or on account of any other factor not directly related to a decline in the value of your residence or to your financial condition. Limitation. If only part of a loan is QPRI, the exclusion applies only to the extent the canceled amount is more than the amount of the loan immediately before the cancellation that isn't QPRI. Example. Your principal residence is secured by a debt of $1 million, of which $800,000 is QPRI. Your residence is sold for $700,000 and $300,000 of debt is canceled. Only $100,000 of the canceled debt may be excluded from income (the $300,000 that was discharged minus the $200,000 of nonqualified debt). Host or Hostess If you host a party or event at which sales are made, any gift or gratuity you receive for giving the event is a payment for helping a direct seller make sales. You must report this item as income at its fair market value. Your out-of-pocket party expenses are subject to the 50% limit for meal and entertainment expenses. These expenses are deductible as miscellaneous itemized deductions subject to the 2%-of-AGI limit on Schedule A (Form 1040), but only up to the amount of income you receive for giving the party.
Life Insurance Proceeds Life insurance proceeds paid to you because of the death of the insured person aren't 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. However, interest income received as a result of life insurance proceeds may be taxable. 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 isn't 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. Employer-owned life insurance contract. If you are the policyholder of an employer-owned life insurance contract, you must include in income any life insurance proceeds received that are more than the premiums and any other amounts you paid on the policy. You are subject to this rule if you have a trade or business, you own a life insurance contract on the life of your employee, and you (or a related person) are a beneficiary under the contract. However, you may exclude the full amount of the life insurance proceeds if the following apply. Before the policy is issued, you provide written notice about the insurance to the employee and the employee provides written consent to be insured. Either: The employee was your employee within the 12-month period before death, or, at the time the contract was issued, was a director or highly compensated employee, or The amount is paid to the family or designated beneficiary of the employee. 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 doesn't 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 most cases, 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. Split-dollar life insurance. In most cases, 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 rules to tax split-dollar life insurance arrangements. Under the economic benefit rule, the owner of the life insurance contract is treated as providing current life insurance protection and other taxable economic benefits to the nonowner of the contract. Under the loan rule, the nonowner 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. 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 (investment in the contract) 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 Pub. 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 isn't 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. Exception. The exclusion doesn't 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 don't have to file Form 8853 to exclude accelerated death benefits paid on the basis of actual expenses incurred. Recoveries 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 itemized deductions. You also may have recoveries of nonitemized 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 aren't included in your income because they are never allowed as a deduction from income. State tax refund. If you received a state or local income tax refund (or credit or offset) in 2016, you generally must include it in income if you deducted the tax in an earlier year. The payer should send Form 1099-G to you by February 1, 2017. The IRS also will receive a copy of the Form 1099-G. If you file Form 1040, use the worksheet in the 2016 Form 1040 instructions for line 10 to figure the amount (if any) to include in your income. If you could choose to deduct for a tax year either: State and local income taxes, or State and local general sales taxes, then the maximum refund that you may have to include in income is limited to the excess of the tax you chose to deduct for that year over the tax you didn't choose to deduct for that year. Example 1. For 2016 you can choose an $11,000 state income tax deduction or a $10,000 state general sales tax deduction. You choose to deduct the state income tax. In 2017 you receive a $2,500 state income tax refund. The maximum refund that you may have to include in income is $1,000, since you could have deducted $10,000 in state general sales tax. Example 2. For 2016 you can choose an $11,500 state general sales tax deduction based on actual expenses or an $11,200 state income tax deduction. You choose to deduct the general sales tax deduction. In 2017 you return an item you had purchased and receive a $500 sales tax refund. In 2017 you also receive a $1,500 state income tax refund. The maximum refund that you may have to include in income is $500, since it is less than the excess of the tax deducted ($11,500) over the tax you didn't choose to deduct ($11,200 − $1,500 = $9,700). Since you didn't choose to deduct the state income tax, you don't include the state income tax refund in income.Mortgage interest refund. If you received a refund or credit in 2017 of mortgage interest paid in an earlier year, the amount should be shown in box 3 of your Form 1098. Do not subtract the refund amount from the interest you paid in 2017. 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 or Form 1040NR, line 9a. 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 isn't 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 2016 estimated state income tax of $4,000 in four equal payments. You made your fourth payment in January 2017. You had no state income tax withheld during 2016. In 2017, you received a $400 tax refund based on your 2016 state income tax return. You claimed itemized deductions each year on Schedule A (Form 1040). You must allocate the $400 refund between 2016 and 2017, 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 2016, so 75% of the $400 refund, or $300, is for amounts you paid in 2016 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 2017, 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 2017 estimated tax payment. When you figure your deduction for state and local income taxes paid during 2017, you will reduce the $1,000 paid in January by $100. Your deduction for state and local income taxes paid during 2017 will include the January net amount of $900 ($1,000 − $100), plus any estimated state income taxes paid in 2017 for 2017, and any state income tax withheld during 2017.Joint state or local income tax return. If you filed a joint state or local income tax return in an earlier year and you aren't filing a joint Form 1040 with the same person for 2017, any refund of a deduction claimed on that state or local income tax return must be allocated to the person that paid the expense. If both persons paid a portion of the expense, allocate the refund based on your individual portion. For example, if you paid 25% of the expense, then you would use 25% of the refund to figure if you must include any portion of the refund in your income. Registered domestic partners (RDPs) domiciled in community property states.
Deductions not itemized. If you didn't itemize deductions for the year for which you received the recovery of an expense that was deductible only if you itemized, don't include any of the recovery amount in your income. Example. You claimed the standard deduction on your 2016 federal income tax return. In 2017 you received a refund of your 2016 state income tax. Do not report any of the refund as income because you didn't itemize deductions for 2016. 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 don't need to use this discussion if you file Form 1040 and the recovery is for state or local income taxes paid in 2016. Instead, use the worksheet in the 2017 Form 1040 instructions for line 10 to figure the amount (if any) to include in your income. You can't use the Form 1040 worksheet and must use this discussion if you are a nonresident alien (discussed later) or any of the following statements are true. You received a refund in 2017 that is for a tax year other than 2016. You received a refund other than an income tax refund, such as a general sales tax or real property tax refund, in 2017 of an amount deducted or credit claimed in an earlier year. The amount on your 2016 Form 1040, line 42 was more than the amount on your 2016 Form 1040, line 41. You had taxable income on your 2016 Form 1040, line 43, but no tax on your Form 1040, line 44, because of the 0% tax rate on net capital gain and qualified dividends in certain situations. Your 2016 state and local income tax refund is more than your 2016 state and local income tax deduction minus the amount you could have deducted as your 2016 state and local general sales taxes. You made your last payment of 2016 estimated state or local income tax in 2017. You owed alternative minimum tax in 2016. You couldn't use the full amount of credits you were entitled to in 2016 because the total credits were more than the amount shown on your 2016 Form 1040, line 47. You could be claimed as a dependent by someone else in 2016. You received a refund because of a jointly-filed state or local income tax return, but you aren't filing a joint 2017 Form 1040 with the same person. If you also recovered an amount deducted as a nonitemized 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. Nonresident aliens. If you are a nonresident alien and file Form 1040NR or 1040NR-EZ, you can't claim the standard deduction. If you recover an itemized deduction that you claimed in an earlier year, you generally must include the full amount of the recovery in your income in the year you receive it. However, if you had no taxable income in that earlier year, you should complete the worksheets to determine the amount you must include in income.Capital gains. If you determined your tax in the earlier year by using the Schedule D Tax Worksheet, or the Qualified Dividends and Capital Gain Tax Worksheet, and you receive a refund in 2017 of a deduction claimed in that year, you will have to recompute your tax for the earlier year to determine if the recovery must be included in your income. If inclusion of the recovery doesn't change your total tax, you don't include the recovery in income. However, if your total tax increases by any amount, you must include the recovery in your income up to the amount of the deduction that reduced your tax in the earlier year. Total recovery included in income. If you recover any itemized deduction that you claimed in an earlier year, 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. You had taxable income. Your deduction for the item recovered equals or exceeds the amount recovered. Your itemized deductions were not subject to the limit on itemized deductions. You had no unused tax credits. You were not subject to alternative minimum tax.
State tax refund. In addition to the previous six items, you must include in your income the full amount of a refund of state or local income tax or general sales tax if the excess of the tax you deducted over the tax you didn't deduct is more than the refund of the tax deducted.
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 can't use Form 1040A or Form 1040EZ. If you file Form 1040NR, enter your state or local income tax refund on line 11 and the total of all other recoveries on line 21. If you file Form 1040NR-EZ, enter your state or local income tax refund on line 4. Example. For 2016, you filed a joint return on Form 1040. Your taxable income was $60,000 and you were not entitled to any tax credits. Your standard deduction was $12,700, and you had itemized deductions of $14,000. In 2017, you received the following recoveries for amounts deducted on your 2016 return: Medical expenses $200 State and local income tax refund 400 Refund of mortgage interest 325 Total recoveries $925 None of the recoveries were more than the deductions taken for 2016. The difference between the state and local income tax you deducted and your local general sales tax you could have deducted was more than $400. Your total recoveries are less than the amount by which your itemized deductions exceeded the standard deduction ($14,000 − $12,700 = $1,300), so you must include your total recoveries in your income for 2017. 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 Total recovery included in income , isn't true, you may be able to exclude at least part of the recovery from your income. You may be able to use Worksheet 2 , later, to determine the part of your recovery to include in your income. You also can use Worksheet 2 to determine the part of a State tax refund (discussed earlier) to include in income. Allocating the included part. If you aren't 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 income tax refund you report on Form 1040, line 10 (Form 1040NR, line 11), and the amount you report as other income on Form 1040, line 21 (Form 1040NR, line 21). If you don't 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 2017 you recovered $2,500 of your 2016 itemized deductions claimed on Schedule A (Form 1040), but the recoveries you must include in your 2017 income are only $1,500. Of the $2,500 you recovered, $500 was due to your state income tax refund. Your state income tax was more than your state general sales tax by $600. 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 don't 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: Your recoveries, or The amount by which your itemized deductions exceeded the standard deduction. Standard deduction for earlier years. To determine if amounts recovered in the current year must be included in your income, you must know the standard deduction for your filing status for the year the deduction was claimed. Look in the instructions for your tax return from prior years to locate the standard deduction for the filing status for that prior year. If you filed Form 1040NR or 1040NR-EZ, you couldn't claim the standard deduction. Example. You filed a joint return on Form 1040 for 2016 with taxable income of $45,000. Your itemized deductions were $12,950. The standard deduction that you could have claimed was $12,700. In 2017, you recovered $2,100 of your 2016 itemized deductions. None of the recoveries were more than the actual deductions for 2016. Include $250 of the recoveries in your 2017 income. This is the smaller of your recoveries ($2,100) or the amount by which your itemized deductions were more than the standard deduction ($12,950 − $12,700 = $250).Negative taxable income. If your taxable income for the prior year ( Worksheet 2 , line 10) was a negative amount, the recovery you must include in income is reduced by that amount. You have a negative taxable income for 2016 if your: Form 1040, line 42 was more than line 41, Form 1040NR, line 40 was more than line 39, or Form 1040NR-EZ, line 13 was more than line 12. Example. The facts are the same as in the previous example except line 42 was $200 more than line 41 on your 2016 Form 1040 giving you a negative taxable income of $200. You must include $50 in your 2017 income, rather than $250. Recovery limited to deduction. You don't 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: The amount deducted, or The amount recovered. Example. For 2016, you paid $1,700 for medical expenses. Because of the limit on deducting medical expenses, you deducted only $200 as an itemized deduction. In 2017, you received a $500 reimbursement from your medical insurance for your 2016 expenses. The only amount of the $500 reimbursement that must be included in your income for 2017 is $200 - the amount actually deducted. Itemized deductions limited. 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. For example, your itemized deductions were reduced for 2016 if your adjusted gross income was over the following amount: $311,300 in the case of a joint return or a surviving spouse, $285,350 in the case of a head of household, $259,400 in the case of an individual who isn't married and who isn't a surviving spouse or head of household, and $155,650 in the case of a married individual filing a separate return. 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.
Recoveries of Itemized Deductions If you recovered amounts from more than 1 year, such as a state income tax refund from 2016 and a casualty loss reimbursement from 2015, complete a separate worksheet for each year. Use information from your tax return 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 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 credit1 1. 2. Enter the total of all other Schedule A refunds or reimbursements (excluding the amount you entered on line 1)2 2. 3. Add lines 1 and 2 3. 4. Itemized deductions for the prior year. For 2016, Form 1040, Schedule A, line 29 Form 1040NR, Schedule A, line 15 Form 1040NR-EZ, line 11 4. 5. Enter any amount previously refunded to you (don't 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. 3 If you filed Form 1040NR or 1040NR-EZ, enter -0- 7. 8. Subtract line 7 from line 6. If the result is zero or less, stop here. The amounts on lines 1 and 2 aren't taxable 8. 9. Enter the smaller of line 3 or line 8 9. 10. Taxable income for prior year4 (2016 Form 1040, line 43; 2016 Form 1040NR, line 41; 2016 Form 1040NR-EZ, line 14) 10. 11. Amount to include in income for 2017: 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)5 11. If line 11 equals line 3 —Enter the amount from line 1 on Form 1040, line 10; Form 1040NR, line 11; Form 1040NR-EZ, line 4. Enter the amount from line 2 on Form 1040, line 21; Form 1040NR, line 21. 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 Form 1040, line 10; Form 1040NR, line 11; Form 1040NR-EZ, line 4. If there is an amount on line 2, enter the amount from line 11 on Form 1040, line 21; Form 1040NR, line 21. 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 Form 1040, line 10; Form 1040NR, line 11 B. C. Subtract the amount on line B from the amount on line 11. Enter the result here and on Form 1040, line 21; Form 1040NR, line 21 C. 1 Do not enter more than the amount deducted for the prior year. Do not enter more than the excess of your state and local income tax deduction over your state and local general sales taxes you could have deducted. 2 Do not enter more than the amount deducted for the prior year. If you deducted state and local general sales taxes and received a refund of those taxes, include the amount on line 2, but don't enter more than the excess of your sales tax deduction over your state and local income tax you could have deducted. 3 See the instructions for prior year forms at IRS.gov for prior year standard deduction. 4 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. 5 For example, $700 + ($400) = $300. 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 amount in the earlier year is considered to have reduced your tax in the earlier year. If your tax, after application of the credits, doesn't change, you didn't have a tax benefit from the deduction. Do not include the recovery in your income. Example. In 2016, Jean Black filed as head of household and itemized her deductions on Schedule A (Form 1040). 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 2017, Jean recovered $1,000 of her itemized deductions. She reduces her 2016 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 2016 isn't changed by reducing her deductions by the recovery. She didn't have a tax benefit from the recovered deduction and doesn't include any of the recovery in her income for 2017.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 doesn't change your total tax, you don't 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. NonItemized Deduction Recoveries This section discusses recovery of deductions other than itemized deductions. Total recovery included in income. If you recover an amount that you deducted in an earlier year when you were figuring your adjusted gross income, you generally must 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 didn't 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. Negative taxable income. If your taxable income for the prior year was a negative amount, the recovery you must include in income is reduced by that amount. You have a negative taxable income for 2016 if your: Form 1040, line 42 was more than line 41, Form 1040NR, line 40 was more than line 39, or Form 1040NR-EZ, line 13 was more than line 12. If you had a net operating loss (NOL) in a prior year, you will have to adjust your taxable income for any NOL carryover. 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 amount in the earlier year is considered to have reduced your tax in the earlier year. If your tax, after application of the credits, doesn't change, you didn't have a tax benefit from the deduction. Do not include the recovery in your income. Capital gains. If you determined your tax in the earlier year by using the Schedule D Tax Worksheet, or the Qualified Dividends and Capital Gain Tax Worksheet, and you receive a refund in 2017 of a deduction claimed in that year, you will have to recompute your tax for the earlier year to determine if the recovery must be included in your income. If inclusion of the recovery doesn't change your total tax, you don't include the recovery in income. However, if your total tax increases by any amount, you must include the recovery in your income up to the amount of the deduction that reduced your tax in the earlier year. Amounts Recovered for Credits If you received a recovery in 2017 for an item for which you claimed a tax credit in an earlier year, you must increase your 2017 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 doesn't apply to the investment credit or the foreign tax credit. Recoveries of these credits are covered by other provisions of the law. Survivor Benefits In most cases, 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. 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. 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 can exclude from income any amount received as a survivor annuity on account of the death of a public safety officer killed in the line of duty. For this purpose, the term public safety officer includes law enforcement officers, firefighters, chaplains, and rescue squad and ambulance crew members. Unemployment Benefits The tax treatment of unemployment benefits you receive depends on the type of program paying the benefits. Unemployment compensation. You must include in income all unemployment compensation you receive. You should receive a Form 1099-G showing in box 1 the total unemployment compensation paid to you. In most cases, 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 aren't unemployment compensation. Trade readjustment allowances under the Trade Act of 1974. Unemployment assistance under the Disaster Relief and Emergency Assistance Act of 1974. Unemployment assistance under the Airline Deregulation Act of 1978 Program. Governmental program. If you contribute to a governmental unemployment compensation program and your contributions aren't deductible, amounts you receive under the program aren't included as unemployment compensation until you recover your contributions. If you deducted all of your contributions to the program, the entire amount you receive under the program is included in your income. Repayment of unemployment compensation. If you repaid in 2017 unemployment compensation you received in 2017, 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 2017 that you included in your income in an earlier year, you can deduct the amount repaid on Schedule A (Form 1040), line 23, if you itemize deductions. Tax withholding. You can choose to have federal income tax withheld from your unemployment compensation. To make this choice, complete Form W-4V, and give it to the paying office. Tax will be withheld at 10% of your payment. If you don't choose to have tax withheld from your unemployment compensation, you may be liable for estimated tax. If you don't pay enough tax, either through withholding or estimated tax, or a combination of both, you may have to pay a penalty. Supplemental unemployment benefits. Benefits received from an employer-financed fund (to which the employees didn't contribute) aren't 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. 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 can't use Form 1040A or Form 1040EZ.) Include the repayment on Form 1040, line 36, and enter "Sub-Pay TRA" and the amount on the dotted line next to line 36. 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. 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 you contribute to a special union fund and your payments to the fund aren't deductible, the unemployment benefits you receive from the fund 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 aren't covered by the state's unemployment compensation law. Although the payments are fully taxable, don't 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 shouldn't 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 aren't included in your income, as long as the payments (exclusive of extra allowances for transportation or other costs) don't 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. Reemployment Trade Adjustment Assistance (RTAA) payments. Payments you receive from a state agency under the Reemployment Trade Adjustment Assistance (RTAA) must be included in your income. The state must send you Form 1099-G to advise you of the amount you should include in income. The amount should be reported on Form 1040, line 21 or Form 1040NR, line 21. 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 don't 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 individuals with an intellectual disability 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. If you have deducted a casualty loss for the loss of your personal residence and you later receive a disaster relief grant for the loss of the same residence, you may have to include part or all of the grant in your taxable income. Unemployment assistance payments under the Act are taxable unemployment compensation. 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 exclude this amount only to the extent any expense it pays for isn't paid for by insurance or otherwise. The exclusion doesn't apply if you were a participant or conspirator in a terrorist action or a representative of one. A qualified disaster is: A disaster which results from a terrorist or military action; A federally declared disaster; or 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. Disaster mitigation payments. You also can exclude from income any amount you receive that is a qualified disaster mitigation payment. Qualified disaster mitigation payments are commonly paid to you in the period immediately following damage to property as a result of a natural disaster. However, disaster mitigation payments are used to mitigate (reduce the severity of) potential damage from future natural disasters. They are paid to you through state and local governments based on the provisions of the Robert T. Stafford Disaster Relief and Emergency Assistance Act or the National Flood Insurance Act. You can't increase the basis or adjusted basis of your property for improvements made with nontaxable disaster mitigation payments. Home Affordable Modification Program (HAMP). If you benefit from Pay-for-Performance Success Payments under HAMP, the payments aren't taxable. Hardest Hit Fund and Emergency Homeowners' Loan Program. If you receive or benefit from payments made under: A State Housing Finance agency (State HFA) Hardest Hit Fund program in which program payments can be used to pay mortgage interest, or An Emergency Homeowners' Loan Program (EHLP) administered by the Department of Housing and Urban Development (HUD) or a state. The payments aren't included in gross income and aren't taxable. Mortgage assistance payments under section 235 of the National Housing Act. Payments made under section 235 of the National Housing Act for mortgage assistance aren't included in the homeowner's income. Interest paid for the homeowner under the mortgage assistance program can't 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 aren't 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 isn't 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 aren't includible in gross income. Indian general welfare benefit. Gross income doesn't include the value of any Indian general welfare benefit. "Indian general welfare benefit" includes any payment made or services provided to or on behalf of a member of an Indian tribe (or any spouse or dependent of that member) under an Indian tribal government program, but only if: The program is administered under specified guidelines and doesn't discriminate in favor of members of the governing body of the tribe, and The benefits provided under the program (a) are available to any tribal member who meets guidelines, (b) are for the promotion of general welfare, (c) aren't lavish or extravagant, and (d) aren't compensation for services. Any items of cultural significance, reimbursement of costs, or cash honorarium for participation in cultural or ceremonial activities for the transmission of tribal culture aren't treated as compensation for services. Note. The above exclusion was enacted by the Tribal General Welfare Exclusion Act of 2014, September 26, 2014. The exclusion applies to tax years for which the period of limitation on refund or credit under section 6511 has not expired (generally, within 3 years from the time the return was filed or 2 years from the time the tax was paid, whichever expires later). Additionally, a claim for the above exclusion will be allowed if made within 1 year of the enactment of the exclusion. Note. The enactment of the above exclusion generally codifies the exclusion afforded under Revenue Procedure 2014-35, June 4, 2014. Medicare. Medicare benefits received under Title XVIII of the Social Security Act aren't 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)). Social security benefits (including lump-sum payments attributable to prior years), Supplemental security income benefits, and Lump-sum death benefits. The Social Security Administration (SSA) provides benefits such as old-age benefits, benefits to disabled workers, and benefits to spouses and dependents. These benefits may be subject to federal income tax depending on your filing status and other income. An individual originally denied benefits, but later approved, may receive a lump-sum payment for the period when benefits were denied (which may be prior years). There are also other types of benefits paid by the SSA. However, Supplemental Security Income (SSI) benefits and lump-sum death benefits (one-time payment to spouse and children of deceased) aren't subject to federal income tax. For more information on these benefits, go to www.socialsecurity.gov.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.
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. 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 didn't 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. Pub. 915 also has worksheets you can use. However, you must use the worksheets in Pub. 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 American Samoa, 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 Pubs. 590-A and 590-B 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 can't use Form 1040EZ. Report your net benefits (as shown on your Forms SSA-1099 and RRB-1099) on line 20a of Form 1040 or line 14a of Form 1040A. Report the taxable part on line 20b of Form 1040 or on line 14b of Form 1040A. Nutrition Program for the Elderly. Food benefits you receive under the Nutrition Program for the Elderly aren't 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 aren't taxable. Other Income The following brief discussions are arranged in alphabetical order. Other income items briefly discussed below are referenced to publications which provide more information. Activity not for profit. You must include on your return income from an activity from which you don't 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 can't total more than the income you report and can be taken only if you itemize deductions on Schedule A (Form 1040). 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 also is 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 aren't income to you. 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: Gift, Dividend, Contribution to capital, Payment of compensation, or Another type of payment. The borrower may have to report this payment as income, depending on its classification.
Bribes. If you receive a bribe, include it in your income. Campaign contributions. These contributions aren't 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. 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. 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 doesn't 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 isn't income, but you must reduce your basis by the amount of the rebate. Example. You buy a new car for $24,000 cash and receive a $2,000 rebate check from the manufacturer. The $2,000 isn't income to you. Your basis in the car is $22,000. This is the 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 shouldn't report these reimbursements on your return unless you are figuring gain or loss from the casualty or theft. 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 as explained in the Instructions for Schedule D (Form 1040). Child support payments. You shouldn't report these payments on your return. 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. The character of the income as ordinary income or capital gain depends on the nature of the underlying claim. Include the following as ordinary income. Interest on any award. Compensation for lost wages or lost profits in most cases. Punitive damages, in most cases. It doesn't matter if they relate to a physical injury or physical sickness. Amounts received in settlement of pension rights (if you didn't 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 (including contingent fees) 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 isn't 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 isn't 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. You may be able to deduct attorney fees and court costs paid to recover a judgment 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 36. 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 can't be more than the amount of the judgment or settlement you are including in income for the tax year. The judgment 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, don't include in income any of those damages received on account of personal injuries or sickness. Credit card insurance. In most cases, 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 can't 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. Down payment assistance. If you purchase a home and receive assistance from a nonprofit corporation to make the down payment, that assistance isn't included in your income. If the corporation qualifies as a tax-exempt charitable organization, the assistance is treated as a gift and is included in your basis of the house. If the corporation doesn't qualify, the assistance is treated as a rebate or reduction of the purchase price and isn't included in your basis. Employment agency fees. If you get a job through an employment agency, and the fee is paid by your employer, the fee isn't includible in your income if you aren't 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, and your share of the income is reported to you on Schedule K-1 (Form 1041). 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 aren't 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 isn't includible in your income. Exxon Valdez settlement income. Include in your income on Form 1040, line 21, or Form 1040NR, line 21, any qualified settlement income you receive as a qualified taxpayer. Qualified settlement income is any interest and punitive damage awards that are: Otherwise includible in taxable income, and Received in connection with the civil action In re Exxon Valdez, No. 89-095-CV (HRH) (Consolidated) (D. Alaska). You are a qualified taxpayer if you were a plaintiff in the civil action mentioned earlier or you were a beneficiary of the estate of your spouse or a close relative who was such a plaintiff and from whom you acquired the right to receive qualified settlement income. The income can be received as a lump sum or as periodic payments. You will receive a Form 1099-MISC showing the gross amount of the settlement income paid to you in the tax year. Contributions to eligible retirement plan. If you are a qualified taxpayer, you can contribute all or part of your qualified settlement income, up to $100,000, to an eligible retirement plan, including an IRA. Contributions to eligible retirement plans, other than a Roth IRA or a designated Roth contribution, reduce the qualified settlement income that you must include in income. Legal expenses. You may be able to deduct attorney fees and court costs paid in connection with the civil action. Depending on the facts and circumstances, these expenses are either claimed on Schedule A (Form 1040) or Form 1040NR (Schedule A), or deducted in figuring the income you report on Form 1040, line 21, or Form 1040NR, line 21. If the qualified settlement income was received in connection with your trade or business (other than as an employee), you can reduce the taxable amount of qualified settlement income by these expenses. In all other situations, you can only claim these expenses as a miscellaneous itemized deduction subject to the 2%-of-adjusted-gross-income limit on Schedule A (Form 1040), line 23, or Schedule A (Form 1040NR), line 9. For example, an employee or the surviving spouse or beneficiary of a deceased plaintiff would claim the expenses as a miscellaneous itemized deduction subject to the 2% limit. Statement. If you report on Form 1040, line 21, or Form 1040NR, line 21, qualified settlement income that is less than the gross amount shown on the Form 1099-MISC, you must attach a statement to your tax return. The statement must identify and show the gross amount of the qualified settlement income, the reductions for the amount contributed to an eligible retirement plan or allowable as legal expenses not reported as a miscellaneous itemized deduction, and the net amount. Income averaging. For purposes of the income averaging rules that apply to an individual engaged in a farming or fishing business, qualified settlement income is treated as attributable to a fishing business for the tax year in which it is received. 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 manager of a trade or business you operated before declaring Chapter 11 bankruptcy, A notary public, or An election precinct official. If you aren't an employee and the fees for your services from a single payer in the course of the payer's trade or business total $600 or more for the year, the payer should send you Form 1099-MISC. Corporate director. Corporate director fees are self-employment income. Report these payments on Schedule C (Form 1040) 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 you aren't in the trade or business of being an executor (for instance, you are the executor of a friend's or relative's estate), report these fees on Form 1040, line 21. If you are in the trade or business of being an executor, report these fees as self-employment income on Schedule C (Form 1040) or Schedule C-EZ (Form 1040). The fee isn't includible in income if it is waived. Manager of trade or business for bankruptcy estate. Include in your income all payments received from your bankruptcy estate for managing or operating a trade or business that you operated before you filed for bankruptcy. Report this income on Form 1040, line 21. Notary public. Report payments for these services on Schedule C (Form 1040) or Schedule C-EZ (Form 1040). These payments aren't subject to self-employment tax. 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 aren't for your services, the payments aren't included in your income in most cases. However, you must include in your income any part of the payments you don't 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 don't 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. Generally, payment you receive from a state, political subdivision, or a qualified foster care placement agency for caring for a qualified foster individual in your home is excluded from your income. However, you must include in your income payment to the extent it is received for the care of more than 5 qualified foster individuals age 19 years or older. 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 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 the foster care provider's home in which the qualified foster individual was placed. Certain Medicaid waiver payments are treated as difficulty-of-care payments when received by an individual care provider for caring for an eligible individual (whether related or unrelated) living in the provider's home. S You must include in your income difficulty-of-care payments to the extent they are received for more than: 10 qualified foster individuals under age 19, or Five qualified foster individuals age 19 or older. 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 and you are in business as a foster-care provider, report the payments on Schedule C (Form 1040) or Schedule C-EZ (Form 1040). Found property. If you find and keep property that doesn't 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 aren't in the trade or business of organizing tours. You can't 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 (Form 1040) 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. If you are in the trade or business of gambling, use Schedule C. 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 isn't 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, 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 4 on Form 1040, line 64, as federal income tax withheld. Gifts and inheritances. In most cases, property you receive as a gift, bequest, or inheritance isn't 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. 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. Gulf oil spill. If you received payments for lost wages or income, property damage, or physical injury due to the Gulf oil spill, the payment may be taxable. Lost wages or income. Payments you received for lost wages, lost business income, or lost profits are taxable. Property damage. Payments you received for property damage aren't taxable if the payments aren't more than your adjusted basis in the property. If the payments are more than your adjusted basis, you will realize a gain. If the damage was due to an involuntary conversion, you may defer the tax on the gain if you purchase qualified replacement property. If the payments (including insurance proceeds) you received, or expect to receive, are less than your adjusted basis, you may be able to claim a casualty deduction. Physical injury. Payments you received for personal physical injuries or physical sickness aren't taxable. This includes payments for emotional distress that is attributable to personal physical injuries or physical sickness. Payments for emotional distress that aren't attributable to personal physical injuries or physical sickness are taxable. 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 aren't deductible from other income. A hobby is an activity from which you don't expect to make a profit. 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 can't 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 aren't taxable. Excludable interest is earned by escrow accounts or settlement funds established for holding funds prior to the settlement. You also don't include the restitution payments and interest the funds earned prior to disbursement in any computations in which you ordinarily would 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 activities. Income from illegal activities, such as money from dealing illegal drugs, must be included in your income on Form 1040, line 21, or on Schedule C (Form 1040) 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, don't include in your income amounts you receive from activities related to those fishing rights. The income isn't subject to income tax, self-employment tax, or employment taxes. Indian money account litigation settlement. Amounts received by an individual Indian as a lump sum or periodic payment pursuant to the Class Action Settlement Agreement dated December 7, 2009, aren't included in gross income. This amount won't be used to figure adjusted gross income (AGI) or modified AGI in applying any Internal Revenue Code provision that takes into account excludable income. 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 can't 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. 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. 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 isn't taxable in most cases. 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. Enter the amount you repay your employer on Form 1040, line 36. Enter "Jury Pay" and the amount on the dotted line next to line 36. 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 (Form 1040) 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 (Form 1040) 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 Advantage MSAs). In most cases, you don't include in income amounts you withdraw from your Archer MSA or Medicare Advantage 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). Moving expense reimbursements. You generally shouldn't report these benefits on your return. 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, don't 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. 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 don't 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 aren't 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 can't 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, or 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 don't apply to scholarship or fellowship awards. Qualified tuition program (QTP). A QTP (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 isn't included in income. This is a return of the investment in the program. In most cases, the beneficiary doesn't include in income any earnings distributed from a QTP if the total distribution is less than or equal to adjusted qualified higher education expenses. Railroad retirement annuities. Tier 1 railroad retirement benefits that are more than the social security equivalent benefit. Tier 2 benefits. Vested dual benefits. 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 your main home. 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 as explained in the Instructions for Schedule D (Form 1040). You can't 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 as explained in the Instructions for 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 required to enroll at or attend an eligible educational institution, or Course-related expenses, such as fees, books, and equipment that are required for courses at the eligible educational institution. These items must be required of all students in your course of instruction. Amounts used for room and board don't qualify for the exclusion. Payment for services. Generally, you can't exclude from your gross income the part of any scholarship or fellowship that represents payment for teaching, research, or other services required as a condition for receiving the scholarship. This applies even if all candidates for a degree must perform the services to receive the degree. Exceptions. You don't have to include in income the part of any scholarship or fellowship that represents payment for teaching, research, or other services if you receive the amount under: The National Health Services Corps Scholarship Program, or The Armed Forces Health Professions Scholarship and Financial Assistance Program.
VA payments. Allowances paid by the Department of Veterans Affairs aren't included in your income. These allowances aren't considered scholarship or fellowship grants. Prizes. Scholarship prizes won in a contest aren't scholarships or fellowships if you don't 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. Smallpox vaccine injuries. If you are an eligible individual who receives benefits under the Smallpox Emergency Personnel Protection Act of 2003 for a covered injury resulting from a covered countermeasure, you can exclude the payment from your income (to the extent it isn't allowed as a medical and dental expense deduction on Schedule A (Form 1040)). Eligible individuals include health care workers, emergency personnel, and first responders in a smallpox emergency who have received a smallpox vaccination. 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 aren't in the business of taking children to school. You can't 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 can't be excluded from your income. You may be able to deduct some of these payments as a miscellaneous deduction subject to the 2%-of-AGI limit if they are related to your job and if you itemize deductions on Schedule A (Form 1040). 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, don't 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 can't 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 isn't included in your income. Whistleblower's award. If you receive a whistleblower's award from the Internal Revenue Service, you must include it in your income. Any deduction allowed for attorney fees and court costs paid by you, or on your behalf, in connection with the award are deducted as an adjustment to income, but can't be more than the amount included in income for the tax year. Repayments 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. In most cases, 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. In most cases, you 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 (Form 1040) 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 as explained in the Instructions for 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).
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. 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. When determining whether the amount you repaid was more or less than $3,000, consider the total amount being repaid on the return. Each instance of repayment isn't considered separately. Method 1. Figure your tax for the year of repayment claiming a deduction for the repaid amount. Method 2. Figure your tax for the year of repayment claiming a credit for the repaid amount. Follow these steps. Figure your tax for the year of repayment without deducting the repaid amount. Refigure your tax from the earlier year without including in income the amount you repaid in the year of repayment. 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 the year of repayment 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 figured in (3) above on Form 1040. (If the year of repayment is 2016, and you are taking the credit, enter the credit on Form 1040, line 73.) Example. For 2016 you filed a return and reported your income on the cash method. In 2017 you repaid $5,000 included in your 2016 income under a claim of right. Your filing status in 2017 and 2015 is single. Your income and tax for both years are as follows: 2016 With Income Without Income Taxable Income $15,000 $10,000 Tax $ 1,790 $ 1,040 2017 Without Deduction With Deduction Taxable Income $49,950 $44,950 Tax $ 8,233 $ 6,983 Your tax under method 1 is $6,983. Your tax under method 2 is $7,483, figured as follows: Tax previously determined for 2016 $1,790 Less: Tax as refigured − 1,040Decrease in 2016 tax $ 750 Regular tax liability for 2017 $8,233 Less: Decrease in 2016 tax − 750Refigured tax for 2017 $7,483 You pay less tax using method 1, so you should take a deduction for the repayment in 2017. Repaid wages subject to social security and Medicare taxes. If you had to repay an amount that you included in your wages or compensation in an earlier year on which social security, Medicare, or tier 1 Railroad Retirement Tax Act taxes were paid, ask your employer to refund the excess amount to you. If the employer refuses to refund the taxes, ask for a statement indicating the amount of the overcollection to support your claim. File a claim for refund using Form 843. Repaid wages subject to Additional Medicare Tax. Employers can't make an adjustment or file a claim for refund for Additional Medicare Tax withholding when there is a repayment of wages received by an employee in a prior year because the employee determines liability for Additional Medicare Tax on the employee's income tax return for the prior year. If you had to repay an amount that you included in your wages or compensation in an earlier year, and on which Additional Medicare Tax was paid, you may be able to recover the Additional Medicare Tax paid on the amount. To recover Additional Medicare Tax on the repaid wages or compensation, you must file Form 1040X for the prior year in which the wages or compensation were originally received. Repayment rules do not apply. This discussion doesn't apply to: Deductions for bad debts; Deductions for theft losses due to criminal fraud or embezzlement in a transaction entered into for profit; 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.
References: https://www.irs.gov/taxtopics/tc401 https://www.irs.gov/publications/p525
Earned income Earned income includes all the taxable income and wages you get from working or from certain disability payments. There are two ways to get earned income: You work for someone who pays you or you own or run a business or farmTaxable earned income includes: Wages, salaries, tips, and other taxable employee pay; Union strike benefits; Long-term disability benefits received prior to minimum retirement age; Net earnings from self-employment if: You own or operate a business or a farm or You are a minister or member of a religious order You are a statutory employee and have income. Nontaxable Combat Pay election. You can elect to have your nontaxable combat pay included in earned income for EITC. The amount of your nontaxable combat pay should be shown on your Form W-2, in box 12, with code Q. Electing to include nontaxable combat pay in earned income may increase or decrease your EITC. Examples of Income that are Not Earned Income: Pay received for work while an inmate in a penal institution Interest and dividends Retirement income Social security Unemployment benefits Alimony Child support. References: https://www.irs.gov/credits-deductions/individuals/earned-income-tax-credit/earned-income
Statutory Employees If workers are independent contractors under the common law rules, such workers may nevertheless be treated as employees by statute (statutory employees) for certain employment tax purposes if they fall within any one of the following four categories and meet the three conditions described under Social Security and Medicare taxes, below. A driver who distributes beverages (other than milk) or meat, vegetable, fruit, or bakery products; or who picks up and delivers laundry or dry cleaning, if the driver is your agent or is paid on commission. A full-time life insurance sales agent whose principal business activity is selling life insurance or annuity contracts, or both, primarily for one life insurance company. An individual who works at home on materials or goods that you supply and that must be returned to you or to a person you name, if you also furnish specifications for the work to be done. A full-time traveling or city salesperson who works on your behalf and turns in orders to you from wholesalers, retailers, contractors, or operators of hotels, restaurants, or other similar establishments. The goods sold must be merchandise for resale or supplies for use in the buyer’s business operation. The work performed for you must be the salesperson's principal business activity. Social Security and Medicare Taxes Withhold Social Security and Medicare taxes from the wages of statutory employees if all three of the following conditions apply. The service contract states or implies that substantially all the services are to be performed personally by them. They do not have a substantial investment in the equipment and property used to perform the services (other than an investment in transportation facilities). The services are performed on a continuing basis for the same payer. It is critical that business owners correctly determine whether the individuals providing services are employees or independent contractors. Generally, you must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee. You do not generally have to withhold or pay any taxes on payments to independent contractors. Select the Scenario that Applies to You: I am an independent contractor or in business for myself If you are a business owner or contractor who provides services to other businesses, then you are generally considered self-employed. I hire or contract with individuals to provide services to my business If you are a business owner hiring or contracting with other individuals to provide services, you must determine whether the individuals providing services are employees or independent contractors. Follow the rest of this page to find out more about this topic and what your responsibilities are. Determining Whether the Individuals Providing Services are Employees or Independent Contractors Before you can determine how to treat payments you make for services, you must first know the business relationship that exists between you and the person performing the services. The person performing the services may be - An independent contractor An employee (common-law employee) A statutory employee A statutory nonemployee A government worker In determining whether the person providing service is an employee or an independent contractor, all information that provides evidence of the degree of control and independence must be considered. Common Law Rules Facts that provide evidence of the degree of control and independence fall into three categories: Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job? Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.) Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business? Businesses must weigh all these factors when determining whether a worker is an employee or independent contractor. Some factors may indicate that the worker is an employee, while other factors indicate that the worker is an independent contractor. There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor, and no one factor stands alone in making this determination. Also, factors which are relevant in one situation may not be relevant in another. The keys are to look at the entire relationship, consider the degree or extent of the right to direct and control, and finally, to document each of the factors used in coming up with the determination. Form SS-8 If, after reviewing the three categories of evidence, it is still unclear whether a worker is an employee or an independent contractor, Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding can be filed with the IRS. The form may be filed by either the business or the worker. The IRS will review the facts and circumstances and officially determine the worker’s status. Be aware that it can take at least six months to get a determination, but a business that continually hires the same types of workers to perform particular services may want to consider filing the Form SS-8. Employment Tax Obligations Once a determination is made (whether by the business or by the IRS), the next step is filing the appropriate forms and paying the associated taxes. Misclassification of Employees You must determine the classification of your employees from the start. If you don't, it will cost you more eventually if you get challenged or if later realize that you have misclassified your employee. Consequences of Treating an Employee as an Independent Contractor If you classify an employee as an independent contractor and you have no reasonable basis for doing so, you may be held liable for employment taxes for that worker (the relief provisions, discussed below, will not apply). Relief Provisions If you have a reasonable basis for not treating a worker as an employee, you may be relieved from having to pay employment taxes for that worker. To get this relief, you must file all required federal information returns on a basis consistent with your treatment of the worker. You (or your predecessor) must not have treated any worker holding a substantially similar position as an employee for any periods beginning after 1977. Misclassified Workers Can File Social Security Tax Form Workers who believe they have been improperly classified as independent contractors by an employer can use Form 8919, Uncollected Social Security and Medicare Tax on Wages to figure and report the employee’s share of uncollected Social Security and Medicare taxes due on their compensation. Voluntary Classification Settlement Program The Voluntary Classification Settlement Program (VCSP) is a new optional program that provides taxpayers with an opportunity to reclassify their workers as employees for future tax periods for employment tax purposes with partial relief from federal employment taxes for eligible taxpayers that agree to prospectively treat their workers (or a class or group of workers) as employees. To participate in this new voluntary program, the taxpayer must meet certain eligibility requirements, apply to participate in the VCSP by filing Form 8952, Application for Voluntary Classification Settlement Program, and enter into a closing agreement with the IRS. Find out the difference between employees and contractors.
For Employers: Independent Contractor (Self-Employed) or Employee? It is critical that you, the employer, correctly determine whether the individuals providing services are employees or independent contractors. Generally, you must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee. You do not generally have to withhold or pay any taxes on payments to independent contractors. For Charities & Non-profits: Independent Contractors vs. Employees Description of the types of relationships between workers and exempt organizations for which services are provided. For Government Agencies: Tax Withholding for Government Workers In most cases, individuals who serve as public officials are government employees. However, there are special rules that apply to determine whether certain groups of government workers are employees, and additional rules that create exceptions to general rules for income tax, social security and Medicare tax withholding.
References: https://www.irs.gov/businesses/small-businesses-self-employed/statutory-employees https://www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-self-employed-or-employee https://www.irs.gov/businesses/small-businesses-self-employed/know-who-youre-hiring-independent-contractor-self-employed-vs-employee
Tip Income All tips you receive are income and are subject to federal income tax. You must include in gross income all tips you receive directly, charged tips paid to you by your employer, and your share of any tips you receive under a tip-splitting or tip-pooling arrangement. For 2017, the maximum wages and tips subject to social security tax is increased to $127,200. The social security tax rate an employee must pay on tips remains at 6.2% (0.062). Additional Medicare Tax. A 0.9% Additional Medicare Tax applies to Medicare wages, Railroad Retirement Tax Act (RRTA) compensation, and self-employment income that are more than:
An employer is required to withhold Additional Medicare Tax on any Medicare wages or RRTA compensation it pays to an employee in excess of $200,000 in a calendar year without regard to the employee's filing status. The value of noncash tips, such as tickets, passes, or other items of value, is also income and subject to tax. Reporting your tip income correctly isn’t difficult. You must do three things.
Keeping a Daily Tip Record Why keep a daily tip record? You must keep a daily tip record so you can: Report your tips accurately to your employer, report your tips accurately on your tax return, and prove your tip income if your return is ever questioned. How to keep a daily tip record? There are two ways to keep a daily tip record. You can either write information about your tips in a tip diary; or keep copies of documents that show your tips, such as restaurant bills and credit or debit card charge slips. You should keep your daily tip record with your tax or other personal records. You must keep your records for as long as they are important for administration of the federal tax law. To help you keep a record or diary of your tips, you can use Form 4070A, Employee's Daily Record of Tips. In addition to the information asked for on Form 4070A, you also need to keep a record of the date and value of any noncash tips you get, such as tickets, passes, or other items of value. Although you don't report these tips to your employer, you must report them on your tax return. If you don't use Form 4070A, start your records by writing your name, your employer's name, and the name of the business (if it's different from your employer's name). Then, each workday, write the date and the following information. Cash tips you get directly from customers or from other employees. Tips from credit and debit card charge customers that your employer pays you. The value of any noncash tips you get, such as tickets, passes, or other items of value. The amount of tips you paid out to other employees through tip pools or tip splitting, or other arrangements, and the names of the employees to whom you paid the tips. Electronic tip record. You can use an electronic system provided by your employer to record your daily tips. If you do, you must receive and keep a paper copy of this record. Service charges. Don't write in your tip diary the amount of any service charge that your employer adds to a customer's bill and then pays to you and treats as wages. This is part of your wages, not a tip. The following factors determine if you have a tip or service charge. The payment is made free from compulsion. The customer has the right to determine the amount of payment. The payment isn't subject to negotiation or dictated by employer policy. The customer generally has the right to determine who receives the payment. For example, Good Food Restaurant adds an 18% charge to the bill for parties of 6 or more customers. Jane's bill for food and beverages for her party of 8 includes an amount on the tip line equal to 18% of the charges for food and beverages, and the total includes this amount. Because Jane didn’t have an unrestricted right to determine the amount on the "tip line," the 18% charge is considered a service charge. Don't include the 18% charge in your tip diary. Service charges that are paid to you are considered wages, not tips. On the other hand, if Good Food Restaurant includes sample calculations of tip amounts at the bottom of its bills for food and beverages provided to customers. David's bill includes a blank "tip line," with sample tip calculations of 15%, 18%, and 20% of the charges for food and beverages at the bottom of the bill beneath the signature line. Because David is free to enter any amount on the "tip line" or leave it blank, any amount he includes is considered a tip. Include this amount in your tip diary. Reporting Tips to Your Employer Why report tips to your employer? You must report tips to your employer so that your employer can withhold federal income tax and social security, Medicare, Additional Medicare*, or railroad retirement taxes; your employer can report the correct amount of your earnings to the Social Security Administration or Railroad Retirement Board (which affects your benefits when you retire or if you become disabled, or your family's benefits if you die); and you can avoid the penalty for not reporting tips to your employer. What tips to report. Report to your employer only cash, check, and debit and credit card tips you receive. If your total tips for any 1 month from any one job are less than $20, don't report the tips for that month to that employer. If you participate in a tip-splitting or tip-pooling arrangement, report only the tips you receive and retain. Don't report to your employer any portion of the tips you receive that you pass on to other employees. However, you must report tips you receive from other employees. Don't report the value of any noncash tips, such as tickets or passes, to your employer. You don't pay social security, Medicare, Additional Medicare, or railroad retirement taxes on these tips. How to report. If your employer doesn't give you any other way to report your tips, you can use Form 4070, Employee's Report of Tips to Employer. Fill in the information asked for on the form, sign and date the form, and give it to your employer. If you don't use Form 4070, give your employer a statement with the following information. Your name, address, and social security number. Your employer's name, address, and business name (if it's different from your employer's name). The month (or the dates of any shorter period) in which you received tips. The total tips required to be reported for that period. You must sign and date the statement. Keep a copy with your tax or other personal records. Your employer may require you to report your tips more than once a month. However, the statement can't cover a period of more than 1 calendar month. Electronic tip statement. Your employer can have you furnish your tip statements electronically. When to report. Give your report for each month to your employer by the 10th of the next month. If the 10th falls on a Saturday, Sunday, or legal holiday, give your employer the report by the next day that isn’t a Saturday, Sunday, or legal holiday. For example, you must report your tips received in October 2018 by November 13, 2018. November 10 is a Saturday. November 12 is a legal holiday (Veteran’s Day). November 13 is the next day that isn’t a Saturday, Sunday, or legal holiday. To illustrate further, you must report your tips received in September 2018 by October 10, 2018. Final report. If your employment ends during the month, you can report your tips when your employment ends. Penalty for not reporting tips. If you don't report tips to your employer as required, you may be subject to a penalty equal to 50% of the social security, Medicare, Additional Medicare, or railroad retirement taxes you owe on the unreported tips. The penalty amount is in addition to the taxes you owe. You can avoid this penalty if you can show reasonable cause for not reporting the tips to your employer. To do so, attach a statement to your return explaining why you didn’t report them. Giving your employer money for taxes. Your regular pay may not be enough for your employer to withhold all the taxes you owe on your regular pay plus your reported tips. If this happens, you can give your employer money until the close of the calendar year to pay the rest of the taxes. If you don't give your employer enough money, your employer will apply your regular pay and any money you give to the taxes, in the following order.
Any taxes that remain unpaid can be collected by your employer from your next paycheck. If withholding taxes remain uncollected at the end of the year, you may be subject to a penalty for underpayment of estimated taxes. Uncollected taxes. You must report on your tax return any social security and Medicare taxes, or railroad retirement taxes that remained uncollected at the end of 2017. These uncollected taxes will be shown on your 2017 Form W-2. A 0.9% Additional Medicare Tax applies to Medicare wages, Railroad Retirement Tax Act (RRTA) compensation, and self-employment income that are more than:
An employer is required to withhold Additional Medicare Tax on any Medicare wages or RRTA compensation it pays to an employee in excess of $200,000 in a calendar year without regard to the employee's filing status. Tip Rate Determination and Education Program Your employer may participate in the Tip Rate Determination and Education Program. The program was developed to help employees and employers understand and meet their tip reporting responsibilities. There are two agreements under the program: the Tip Rate Determination Agreement (TRDA) and the Tip Reporting Alternative Commitment (TRAC). If you are employed in the gaming industry, your employer may participate in the Gaming Industry Tip Compliance Agreement Program. Your employer can provide you with a copy of any applicable agreement. Reporting Tips on Your Tax Return You must know how to report tips, what tips to report, and when to report them on your tax return. How to report tips. Report your tips with your wages on Form 1040, line 7; Form 1040A, line 7; Form 1040EZ, line 1; Form 1040NR, line 8; or Form 1040NR-EZ, line 3. What tips to report. Generally, you must report all tips you received in 2017 on your tax return including both cash tips and noncash tips. Any tips you reported to your employer as required in 2017 are included in the wages shown in box 1 of your Form W-2. Add to the amount in box 1 only the tips you did not report to your employer. However, any tips you received in 2017 that you reported to your employer as required after 2017 but before January 10, 2018, are not included in the wages shown in box 1 of your 2017 Form W-2. Don't include the amount of these tips on your 2017 tax return. Instead, include them on your 2018 tax return. Tips you received in 2016 that you reported to your employer as required after 2016 but before January 10, 2017, are included in the wages shown in box 1 of your 2017 Form W-2. Although these tips were received in 2016, you must report them on your 2017 tax return. If you participate in a tip-splitting or tip-pooling arrangement, report only the tips you receive and retain. Don't report on your income tax return any portion of the tips you receive that you pass on to other employees. However, you must report tips you receive from other employees. If you received $20 or more in cash and charge tips in a month and didn’t report all of those tips to your employer, then you must file an additional form to report social security, Medicare, Additional Medicare, or railroad retirement taxes on tips not reported to your employer. If you didn’t keep a daily tip record as required and an amount is shown in box 8 of your Form W-2, you must also file an additional form to report these allocated tips on your tax return. If you kept a daily tip record and reported tips to your employer as required under the rules explained earlier, add the following tips to the amount in box 1 of your Form W-2.
For example, Ben Smith began working at the Blue Ocean Restaurant (his only employer in 2017) on June 30 and received $10,000 in wages during the year. Ben kept a daily tip record showing that his tips for June were $18 and his tips for the rest of the year totaled $7,000. He wasn’t required to report his June tips to his employer, but he reported all of the rest of his tips to his employer as required. Ben's Form W-2 from Blue Ocean Restaurant shows $17,000 ($10,000 wages + $7,000 reported tips) in box 1. He adds the $18 unreported tips to that amount and reports $17,018 as wages on his tax return.
Reporting social security, Medicare, Additional Medicare, or railroad retirement taxes on tips not reported to your employer. If you received $20 or more in cash and charge tips in a month from any one job and didn’t report all of those tips to your employer, you must report the social security, Medicare, and Additional Medicare taxes on the unreported tips as additional tax on your return. To report these taxes, you must file Form 1040, Form 1040NR, Form 1040-PR, or Form 1040-SS (not Form 1040A, Form 1040EZ, or Form 1040NR-EZ) even if you won’t otherwise have to file. You must use Form 4137, Social Security and Medicare Tax on Unreported Tip Income, to figure social security and Medicare taxes and/or Form 8959, Additional Medicare Tax, to figure Additional Medicare Tax. Enter the tax(es) on your return as instructed, and attach the completed Form 4137 and/or Form 8959 to your return. If you’re subject to the Railroad Retirement Tax Act, you can't use Form 4137 to pay railroad retirement tax on unreported tips. To get railroad retirement credit, you must report tips to your employer.
Reporting uncollected social security, Medicare, Additional Medicare, or railroad retirement taxes on tips reported to your employer. You may have uncollected taxes if your regular pay wasn’t enough for your employer to withhold all the taxes you owe and you didn’t give your employer enough money to pay the rest of the taxes. If your employer couldn’t collect all the social security and Medicare, and Additional Medicare taxes, or railroad retirement taxes you owe on tips reported for 2017, the uncollected taxes will be shown in box 12 of your Form W-2 (codes A and B). You must report these amounts as additional tax on your return. If you worked in the U.S. possessions and received Form W-2AS, Form W-2CM, Form W-2GU, or Form W-2VI, any uncollected taxes on tips will be shown in box 12 with codes A and B. If you received Form 499R-2/W-2PR, any uncollected taxes will be shown in boxes 22 and 23. Unlike the uncollected portion of the regular (1.45%) Medicare tax, the uncollected Additional Medicare Tax isn't reported on Form W-2. To report these uncollected taxes, you must file Form 1040NR, Form 1040-PR, or Form 1040-SS (not Form 1040A, Form 1040EZ, or Form 1040NR-EZ) even if you wouldn’t otherwise have to file. You can report these taxes on Form 1040, in the space next to line 62, or the corresponding line of Form 1040NR, Form 1040-PR, or Form 1040-SS (not Form 1040A, Form 1040EZ, or Form 1040NR-EZ). Self-employed persons. If you receive tips as a self-employed person, you should report these tips as income on Schedule C or C-EZ. Allocated Tips If your employer allocated tips to you, they’re shown separately in box 8 of your Form W-2. They’re not included in box 1 with your wages and reported tips. If box 8 is blank, then you don't need to worry about allocated tips because this means that your employer did not report any. What are allocated tips? These are tips that your employer assigned to you in addition to the tips you reported to your employer for the year. Your employer will have done this only if you worked in an establishment (restaurant, cocktail lounge, or similar business) that must allocate tips to employees, and the tips you reported to your employer were less than your share of 8% of food and drink sales. No income, social security, Medicare, Additional Medicare, or railroad retirement taxes are withheld on allocated tips. How were your allocated tips figured? The tips allocated to you are your share of an amount figured by subtracting the reported tips of all employees from 8% (or an approved lower rate) of food and drink sales (other than carryout sales and sales with a service charge of 10% or more). Your share of that amount was figured using either a method provided by an employer-employee agreement or a method provided by IRS regulations based on employees' sales or hours worked. For information about the exact allocation method used, ask your employer. Must you report your allocated tips on your tax return? You must report tips you received in 2017 (including both cash and noncash tips) on your tax return as explained in What tips to report , earlier. Any tips you reported to your employer in 2017 as required (explained under Reporting Tips to Your Employer , earlier) are included in the wages shown in box 1 of your Form W-2. Add to the amount in box 1 only the tips you didn’t report to your employer as required. This should include any allocated tips shown in box 8 on your Form(s) W-2, unless you have adequate records to show that you received less tips in the year than the allocated amount. How to report allocated tips? If you received any tips in 2017 that you didn’t report to your employer as required (including allocated tips that you are required to report on your tax return), add these tips to the amount in box 1 of your Form(s) W-2 and report this amount as wages on Form 1040, line 7; Form 1040NR, line 8; or Form 1040NR-EZ, line 3. You can't file Form 1040A or Form 1040EZ. Because social security, Medicare, or Additional Medicare taxes weren’t withheld from the allocated tips, you must report those taxes as additional tax on your return. Complete Form 4137 and include the allocated tips on line 1 of the form. How to request an approved lower rate. Your employer can use a tip rate lower than 8% (but not lower than 2%) to figure allocated tips only if the IRS approves the lower rate. Either the employer or the employees can request approval of a lower rate by filing a petition with the IRS. The petition must include specific information about the establishment that will justify the lower rate. A user fee must be paid with the petition. An employee petition can be filed only with the consent of a majority of the directly tipped employees (waiters, bartenders, and others who receive tips directly from customers). The petition must state the total number of directly tipped employees and the number of employees consenting to the petition. Employees filing the petition must promptly notify the employer, and the employer must promptly give the IRS a copy of all Forms 8027, Employer's Annual Information Return of Tip Income and Allocated Tips, filed for the establishment for the previous 3 years.
Interest Income (e.g., taxable and nontaxable), OIDS, and backup withholding Interest Received Most interest that you receive or that is credited to an account that you can withdraw without penalty is taxable income in the year it becomes available to you. However, some interest you receive may be tax-exempt. You should receive Copy B of Form 1099-INT or Form 1099-OID, reporting payments of interest of $10 or more. You should receive Copy B of Form 1099-INT or Form 1099-OID reporting payments of tax-exempt interest of $10 or more. You may receive these forms as part of a composite statement from a broker. You must report all taxable and tax-exempt interest on your federal income tax return, even if you don't receive a Form 1099-INT or Form 1099-OID. You must give the payer of interest income your correct taxpayer identification number; otherwise, you may be subject to a penalty and backup withholding. Refer to Topic No. 307 for information on backup withholding. Examples of Taxable Interest Interest on bank accounts, money market accounts, certificates of deposit, corporate bonds and deposited insurance dividends - Be aware that certain distributions, commonly referred to as dividends, are actually taxable interest. They include dividends on deposits or on share accounts in cooperative banks, credit unions, domestic building and loan associations, domestic federal savings and loan associations, and mutual savings banks. Interest income from Treasury bills, notes and bonds - This interest is subject to federal income tax, but is exempt from all state and local income taxes. Savings Bond interest - You can elect to include the interest in income each year, but you generally won't include interest on Series EE and Series I U.S. Savings Bonds until the earlier of when the bonds mature or when they're redeemed or disposed of. Other interest - Other interest paid to you by a business will be reported to you on Form 1099-INT if it is $600 or more. Examples include interest received with damages or delayed death benefits. Examples of Nontaxable or Excludable Interest Interest redeemed from Series EE and Series I bonds issued after 1989 may be excluded from income when used to pay for qualified higher educational expenses during the year and you meet the other requirements for the Educational Savings Bond Program. Figure the amount of excludable interest on Form 8815, Exclusion of Interest From Series EE and I U.S. Savings Bonds Issued After 1989, and show it on Form 1040A or 1040, Schedule B, Interest and Ordinary Dividends. Refer to Publication 550, Investment Income and Expenses, for detailed information. Interest on some bonds used to finance government operations and issued by a state, the District of Columbia, or a U.S. possession is reportable but not taxable at the federal level. Reporting tax-exempt interest received during the tax year is an information-reporting requirement only and doesn't convert tax-exempt interest into taxable interest. Interest on insurance dividends left on deposit with the U.S. Department of Veterans Affairs is nontaxable interest and not reportable. Original Issue Discount Instruments If a taxable bond, note or other debt instrument was originally issued at a discount, part of the original issue discount may have to be included in income each year as interest, even if no payment is received during the year. You should receive a Form 1099-OID, Original Issue Discount, or a similar statement from each payer of taxable original issue discount of $10 or more, showing the amount you should report in income. For a tax-exempt bond acquired on or after January 1, 2017, you should receive a Form 1099-OID, or a similar statement, of tax-exempt OID that is reportable as tax-exempt interest. Nominee Recipient There are times when you may receive a Form 1099 for interest in your name that actually belongs to someone else. In this case, the IRS considers you a nominee recipient. If you received a Form 1099-INT or Form 1099-OID that includes an amount you received as a nominee for the real owner: You must then prepare a Form 1099-INT or Form 1099-OID for the interest (or OID) that's not yours unless that interest (or OID) belongs to your spouse. Send Copy A of the 1099-INT or Form 1099-OID and a completed Form 1096, Annual Summary and Transmittal of U.S. Information Returns, to the Internal Revenue Service and give Copy B to the actual owner. For more information on these requirements, refer to the Form 1099-INT and 1099-OID Instructions. In this reading material you will learn how brokers and other middlemen identify publicly offered original issue discount (OID) debt instruments they may hold as nominees for the true owners, so they can file Forms 1099-OID or Forms 1099-INT as required. You will also learn how owners of publicly offered OID debt instruments determine how much OID to report on their income tax returns. The list of publicly offered OID debt instruments (OID list) is on the IRS website. The original issue discount tables, Sections I-A through III-F, are only available on the IRS website at IRS.gov/pub1212 by clicking the link under Recent Developments. The tables are posted to the website in late November or early December of each year. The information on these lists comes from the issuers of the debt instruments and from financial publications and is updated annually. Brokers and other middlemen can rely on this list to determine, for information reporting purposes, whether a debt instrument was issued at a discount and the OID to be reported on information returns. However, because the information in the list has generally not been verified by the IRS as correct, the following tax matters are subject to change upon examination by the IRS. The OID reported by owners of a debt instrument on their income tax returns. The issuer's classification of an instrument as debt for federal income tax purposes. The adjusted basis of a debt instrument. Instructions for issuers of OID debt instruments. In general, issuers of publicly offered OID debt instruments must, within 30 days after the issue date, report information about the instruments to the IRS on Form 8281, Information Return for Publicly Offered Original Issue Discount Instruments. In addition, Form 8281 must be filed for a debt instrument that is part of an issue the offering of which is registered with the Securities and Exchange Commission after the issue date of the debt instrument and such registration occurs on or after January 1, 2014. REMIC and CDO information reporting requirements. Brokers and other middlemen must follow special information reporting requirements for real estate mortgage investment conduit (REMIC) regular interests, and collateralized debt obligations (CDO) interests. Original issue discount (OID). OID is a form of interest. It is the excess of a debt instrument's stated redemption price at maturity over its issue price (acquisition price for a stripped bond or coupon). Zero coupon bonds and debt instruments that pay no stated interest until maturity are examples of debt instruments that have OID. Accrual period. An accrual period is an interval of time used to measure OID. The length of an accrual period can be 6 months, a year, or some other period no longer than one year, depending on when the debt instrument was issued. Acquisition premium. Acquisition premium is the excess of a debt instrument's adjusted basis immediately after purchase, including purchase at original issue, over the debt instrument's adjusted issue price at that time. A debt instrument does not have acquisition premium, however, if the debt instrument was purchased at a premium. Adjusted issue price. The adjusted issue price of a debt instrument at the beginning of an accrual period is used to figure the OID allocable to that period. In general, the adjusted issue price at the beginning of the debt instrument's first accrual period is its issue price. The adjusted issue price at the beginning of any subsequent accrual period is the sum of the issue price and all the OID includible in income before that accrual period minus any payment previously made on the debt instrument, other than a payment of qualified stated interest. Debt instrument. The term "debt instrument" means any instrument or contractual arrangement that constitutes indebtedness under general principles of federal income tax law (including, for example, a bond, debenture, note, certificate, or other evidence of indebtedness). It generally does not include an annuity contract. Issue price. For debt instruments listed in Section I-A and Section I-B, the issue price generally is the initial offering price to the public (excluding bond houses and brokers) at which a substantial amount of these instruments was sold. Market discount. A debt instrument generally is acquired with market discount if its stated redemption price at maturity is greater than its basis immediately after its acquisition. Market discount arises when a debt instrument purchased in the secondary market has decreased in value since its issue date, generally because of an increase in interest rates. An OID debt instrument has market discount if your adjusted basis in the debt instrument immediately after you acquired it (usually its purchase price) was less than the debt instrument's issue price plus the total OID that accrued before you acquired it. The market discount is the difference between the issue price plus accrued OID and your adjusted basis. Premium. A debt instrument is purchased at a premium if its adjusted basis immediately after purchase is greater than the total of all amounts payable on the debt instrument after the purchase date, other than qualified stated interest. The premium is the excess of the adjusted basis over the payable amounts. Qualified stated interest. In general, qualified stated interest is stated interest that is unconditionally payable in cash or property (other than debt instruments of the issuer) at least annually over the term of the debt instrument at a single fixed rate. Stated redemption price at maturity. A debt instrument's stated redemption price at maturity is the sum of all amounts (principal and interest) payable on the debt instrument other than qualified stated interest. Yield to maturity (YTM). In general, the YTM is the discount rate that, when used in figuring the present value of all principal and interest payments, produces an amount equal to the issue price of the debt instrument. The YTM is generally shown on the face of the debt instrument or in the literature you receive from your broker. If you do not have this information, consult your broker, tax advisor, or the issuer. Debt Instruments on the OID List The OID list on the IRS website can be used by brokers and other middlemen to prepare information returns. If you own a listed debt instrument, you generally should not rely on the information in the OID list to determine (or compare) the OID to be reported on your tax return. The OID amounts listed are figured without reference to the price or date at which you acquired the debt instrument. Information for Brokers and Other Middlemen The following discussions contain specific instructions for brokers and middlemen who hold or redeem a debt instrument for the owner. In general, you must file a Form 1099 for the debt instrument if the interest or OID to be included in the owner's income for a calendar year totals $10 or more. You also must file a Form 1099 if you were required to deduct and withhold tax, even if the interest or OID is less than $10. If you must file a Form 1099, furnish a copy to the owner of the debt instrument by January 31 in the year it is due. File all your Forms 1099 with the IRS, accompanied by Form 1096, by February 28 in the year it is due (March 31 if you file electronically). Electronic payee statements. You can issue Form 1099-OID electronically with the consent of the recipient. Short-Term Obligations Redeemed at Maturity If you redeem a short-term discount obligation for the owner at maturity, you must report the discount as interest on Form 1099-INT. To figure the discount, use the purchase price shown on the owner's copy of the purchase confirmation receipt or similar record, or the price shown in your transaction records. If the owner's purchase price cannot be determined, figure the discount as if the owner had purchased the obligation at its original issue price. A special rule is used to determine the original issue price for information reporting on U.S. Treasury bills (T-bills) listed in Section III-A. Under this rule, you treat as the original issue price of the T-bill the noncompetitive (weighted average of accepted auction bids) discount price for the longest-maturity T-bill maturing on the same date as the T-bill being redeemed. This noncompetitive discount price is the issue price (expressed as a percent of principal) shown in Section III-A. A similar rule is used to figure the discount on short-term discount obligations issued by the organizations listed in Section III-B through Section III-F. Example 1. There are 13-week and 26-week T-bills maturing on the same date as the T-bill being redeemed. The price actually paid by the owner cannot be established by owner or middleman records. You treat as the issue price of the T-bill the noncompetitive discount price (expressed as a percent of principal) shown in Section III-A for a 26-week bill maturing on the same date as the T-bill redeemed. The interest you report on Form 1099-INT is the OID (per $1,000 of principal) shown in Section III-A for that obligation. Long-Term Debt Instruments If you hold a long-term OID debt instrument as a nominee for the true owner, you generally must file Form 1099-OID. For this purpose, you can rely on Section I of the OID list to determine the following information. Whether a debt instrument has OID. The OID to be reported on the Form 1099-OID. In general, you must report OID on publicly offered, long-term debt instruments listed in Section I. You also can report OID on other long-term debt instruments. Form 1099-OID. On Form 1099-OID for a calendar year show the following information. Box 1. The OID for the actual dates the owner held the debt instruments during a calendar year. You may report a net amount of OID that reflects the offset of OID by the amount of acquisition premium amortization for the year. If you do so, leave box 6 blank. Box 2. The qualified stated interest paid or credited during the calendar year. Interest reported here is not reported on Form 1099-INT. The qualified stated interest on Treasury inflation-protected securities may be reported on Form 1099-INT in box 3 instead. Box 3. Any interest or principal forfeited because of an early withdrawal that the owner can deduct from gross income. Do not reduce the amounts in boxes 1 and 2 by the forfeiture. Box 4. Any backup withholding for this debt instrument. Box 5. For a covered security acquired with market discount, enter the amount of market discount that accrued during the period the holder owned the debt instrument provided the holder notified you of an election made under section 1278(b) to include market discount in income as it accrued. Follow the instructions in Regulations section 1.6045-1(n) to determine the accruals of market discount. Box 6. For a covered security acquired with acquisition premium, enter the amount of acquisition premium amortization for the period the holder owned the debt instrument. If a net amount of OID is reported in box 1, box 8, or box 11 as applicable, leave this box blank. Follow the instructions in Regulations section 1.6045-1(n) to determine the amortization of acquisition premium. Box 7. The CUSIP number, if any. If there is no CUSIP number, give a description of the debt instrument, including the abbreviation for the stock exchange, the abbreviation used by the stock exchange for the issuer, the coupon rate, and the year of maturity (for example, NYSE XYZ 12.50 2006). If the issuer of the debt instrument is other than the payer, show the name of the issuer in this box. Box 8. The OID on a U.S. Treasury obligation for the part of the year the owner held the debt instrument. You may report a net amount of OID that reflects the offset of OID by the amount of acquisition premium amortization for the year. If you do so, leave box 6 blank. Box 9. Investment expenses passed on to holders of a single-class REMIC. Box 10. For a taxable covered security acquired at a premium, enter the amount of bond premium amortization allocable to the interest paid during the tax year, unless you were notified in writing that the holder did not want to amortize bond premium under section 171. If you are required to report bond premium amortization and you reported a net amount of interest in box 2, leave this box blank.Box 11. Use to report any Tax-exempt OID. Boxes 12-14. Use to report any state income tax withheld for this debt instrument. Figuring OID. You can determine the OID on a long-term debt instrument by using either of the following. Section I of the OID list. The income tax regulations. Using Section I. If the owner held the debt instrument for the entire calendar year, report the OID shown in Section I for the calendar year. Because OID is listed for each $1,000 of stated redemption price at maturity, you must adjust the listed amount to reflect the debt instrument's actual stated redemption price at maturity. For example, if the debt instrument's stated redemption price at maturity is $500, report one-half the listed OID. If the owner held the debt instrument for less than the entire calendar year, figure the OID to report as follows. Look up the daily OID for the first accrual period in the calendar year during which the owner held the debt instrument. Multiply the daily OID by the number of days the owner held the debt instrument during that accrual period. Repeat steps (1) and (2) for any remaining accrual periods for the year during which the owner held the debt instrument. Add the results in steps (2) and (3) to determine the owner's OID per $1,000 of stated redemption price at maturity. If necessary, adjust the OID in (4) to reflect the debt instrument's stated redemption price at maturity. Report the result on Form 1099-OID in box 1. Using the income tax regulations. Instead of using Section I to figure OID, you can use the regulations under sections 1272 through 1275 of the Internal Revenue Code. For example, under the regulations, you can use monthly accrual periods in figuring OID for a debt instrument issued after April 3, 1994, that provides for monthly payments. (If you use Section I-B, the OID is figured using 6-month accrual periods.)
Certificates of Deposit If you hold a bank certificate of deposit (CD) as a nominee, you must determine whether the CD has OID and any OID includible in the income of the owner. You must file an information return showing the reportable interest and OID, if any, on the CD. These rules apply whether or not you sold the CD to the owner. Report OID on a CD in the same way as OID on other debt instruments. Bearer Bonds and Coupons If a coupon from a bearer bond is presented to you for collection before the bond matures, you generally must report the interest on Form 1099-INT. However, do not report the interest if either of the following apply. You hold the bond as a nominee for the true owner. The payee is a foreign person. Because you cannot assume the presenter of the coupon also owns the bond, you should not report OID on the bond on Form 1099-OID. The coupon may have been "stripped" (separated) from the bond and separately purchased. However, if a long-term bearer bond on the OID list is presented to you for redemption upon call or maturity, you should prepare a Form 1099-OID showing the OID for that calendar year, as well as any coupon interest payments collected at the time of redemption. Backup Withholding If you report OID on Form 1099-OID or interest on Form 1099-INT for a calendar year, you may be required to apply backup withholding to the reportable payment at a rate of 28%. The backup withholding is deducted at the time a cash payment is made. Backup withholding generally applies to reportable interest and OID in the following situations. The payee does not give you a taxpayer identification number (TIN). The IRS notifies you that the payee gave an incorrect TIN. The IRS notifies you that the payee is subject to backup withholding due to payee underreporting. For debt instruments acquired after 1983: The payee does not certify, under penalties of perjury, that he or she is not subject to backup withholding under (3), or The payee does not certify, under penalties of perjury, that the TIN given is correct. However, for short-term discount obligations (other than government obligations), bearer bonds and coupons, and U.S. savings bonds, backup withholding applies to reportable interest and OID only if the payee does not give you a TIN or gives you an obviously incorrect number for a TIN. Short-term obligations. Backup withholding applies to the payment of OID that is includible in the holder’s gross income, to the extent it is in cash. However, backup withholding applies to any interest payable before maturity when the interest is paid or credited. If the owner of a short-term obligation at maturity is not the original owner and can establish the purchase price of the obligation, the amount subject to backup withholding must be determined by treating the purchase price as the issue price. However, you can choose to disregard that price if it would require significant manual intervention in the computer or recordkeeping system used for the obligation. If the purchase price of a listed obligation is not established or is disregarded, you must use the issue price shown in Section III. Long-term obligations. If no cash payments are made on a long-term obligation before maturity, backup withholding applies only at maturity. The amount subject to backup withholding is the OID includible in the owner's gross income for the calendar year when the obligation matures. The amount to be withheld is limited to the cash paid. Registered long-term obligations with cash payments. If a registered long-term obligation has cash payments before maturity, backup withholding applies when a cash payment is made. The amount subject to backup withholding is the total of the qualified stated interest (defined earlier under Definitions) and OID includible in the owner's gross income for the calendar year when the payment is made. If more than one cash payment is made during the year, the OID subject to withholding for the year must be allocated among the expected cash payments in the ratio that each bears to the total of the expected cash payments. For any payment, the required withholding is limited to the cash paid. Payee not the original owner. If the payee is not the original owner of the obligation, the OID subject to backup withholding is the OID includible in the gross income of all owners during the calendar year (without regard to any amount paid by the new owner at the time of transfer). The amount subject to backup withholding at maturity of a listed obligation must be determined using the issue price shown in Section I. Bearer long-term obligations with cash payments. If a bearer long-term obligation has cash payments before maturity, backup withholding applies when the cash payments are made. For payments before maturity, the amount subject to withholding is the qualified stated interest (defined earlier under Definitions) includible in the owner's gross income for the calendar year. For a payment at maturity, the amount subject to withholding is only the total of any qualified stated interest paid at maturity and the OID includible in the owner's gross income for the calendar year when the obligation matures. The required withholding at maturity is limited to the cash paid. Sales and redemptions. If you report the gross proceeds from a sale, exchange, or redemption of a debt instrument on Form 1099-B for a calendar year, you may be required to withhold 28% of the amount reported. Backup withholding applies in the following situations. The payee does not give you a TIN. The IRS notifies you that the payee gave an incorrect TIN. For debt instruments held in an account opened after 1983, the payee does not certify, under penalties of perjury, that the TIN given is correct. Payments outside the United States to U.S. person. The requirements for backup withholding and information reporting apply to payments of OID and interest made outside the United States to a U.S. person, or a foreign person at least 50% of whose income for the preceding 3-year period is effectively connected with the conduct of a U.S. trade or business. Payments to foreign person. The following discussions explain the rules for backup withholding and information reporting on payments to foreign persons. U.S.-source amount. Backup withholding and information reporting are not required for payments of U.S.-source OID, interest, or proceeds from a sale or redemption of an OID instrument if the payee has given you proof (generally the appropriate Form W-8 or an acceptable substitute) that the payee is a foreign person. A U.S. resident is not a foreign person. For proof of the payee's foreign status, you can rely on the appropriate Form W-8 or on documentary evidence for payments made outside the United States to an offshore account or, in case of broker proceeds, a sale effected outside the United States. Receipt of the appropriate Form W-8 does not relieve you from information reporting and backup withholding if you actually know the payee is a U.S. person. A 28% withholding tax may apply to payments of U.S.-source OID or interest to foreign persons.Foreign-source amount. Backup withholding and information reporting are not required for payments of foreign-source OID and interest paid and received outside the U.S. However, if the payments are made inside the United States, the requirements for backup withholding and information reporting will apply unless the payee has given you the appropriate Form W-8 or acceptable substitute as proof that the payee is a foreign person. Owners of OID Debt Instruments Here you will see the income tax rules for figuring and reporting OID on long-term debt instruments. It also includes a similar discussion for stripped bonds and coupons, such as zero coupon bonds available through the Department of the Treasury's STRIPS program and government-sponsored enterprises such as the Resolution Funding Corporation. However, the information provided does not cover every situation. Including OID in income. Generally, you include OID in income as it accrues each year, whether or not you receive any payments from the debt instrument issuer. Exceptions. The rules for including OID in income as it accrues generally do not apply to the following debt instruments. U.S. savings bonds. Tax-exempt obligations. Obligations issued by individuals before March 2, 1984. Loans of $10,000 or less between individuals who are not in the business of lending money. (The dollar limit includes outstanding prior loans by the lender to the borrower.) This exception does not apply if a principal purpose of the loan is to avoid any federal tax. De minimis rule. You can treat OID as zero if the total OID on a debt instrument is less than one-fourth of 1% (.0025) of the stated redemption price at maturity multiplied by the number of full years from the date of original issue to maturity. Debt instruments with de minimis OID are not listed in this publication. There are special rules to determine the de minimis amount in the case of debt instruments that provide for more than one payment of principal. Also, the de minimis rules generally do not apply to tax-exempt obligations. Example 2. You bought at issuance a 10-year debt instrument with a stated redemption price at maturity of $1,000, issued at $980 with OID of $20. One-fourth of 1% of $1,000 (the stated redemption price) times 10 (the number of full years from the date of original issue to maturity) equals $25. Under the de minimis rule, you can treat the OID as zero because the $20 discount is less than $25. Example 3. Assume the same facts as Example 2, except the debt instrument was issued at $950. You must report part of the $50 OID each year because it is more than $25. Choice to report all interest as OID. Generally, you can choose to treat all interest on a debt instrument acquired after April 3, 1994, as OID and include it in gross income by using the constant yield method. For this choice, 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. Purchase after date of original issue. A debt instrument you purchased after the date of original issue may have premium, acquisition premium, or market discount. If your debt instrument has premium or acquisition premium, the OID reported to you on Form 1099-OID may have to be adjusted. The following rules generally do not apply to contingent payment debt instruments. Adjustment for premium. If your debt instrument (other than an inflation-indexed debt instrument) has premium, do not report any OID as ordinary income. Your adjustment is the total OID shown on your Form 1099-OID. Adjustment for acquisition premium. If your debt instrument has acquisition premium, reduce the OID you report. Your adjustment is the difference between the OID shown on your Form 1099-OID and the reduced OID amount figured using the rules explained later under Figuring OID on Long-Term Debt Instruments. If your debt instrument is a covered security under Regulations section 1.6045-1(a)(15), your broker may either report the acquisition premium amortization adjustment amount in box 6 or may report a net amount of OID in box 1 or box 8, as applicable, that reflects the adjustment of OID by the amortized acquisition premium. In general, your broker will use the rules in Regulations section 1.1272‐2(b)(4) to determine the amortization of acquisition premium. Market discount. If your debt instrument has market discount that you choose to include in income currently and if the debt instrument is a covered security under Regulations section 1.6045‐1(a)(15), the market discount includible in income is reported in box 5 of Form 1099‐OID. Unless you notify your broker in writing that you have not elected to use a constant yield method under section 1276(b) to determine accruals of market discount, your broker will use a constant yield method to determine accruals of market discount rather than a ratable method. If you choose to use the constant yield method to figure accrued market discount The constant yield method of figuring accrued OID, explained in those discussions under Constant yield method, is also used to figure accrued market discount. Sale, exchange, or redemption. Generally, you treat your gain or loss from the sale, exchange, or redemption of an OID debt instrument as a capital gain or loss if you held the debt instrument as a capital asset. If you sold the debt instrument through a broker, you should receive Form 1099-B or an equivalent statement from the broker. Use the Form 1099-B or other statement and your brokerage statements to complete Form 8949, and Schedule D (Form 1040). Your gain or loss is the difference between the amount you realized on the sale, exchange, or redemption and your basis in the debt instrument. Your basis, generally, is your cost increased by the OID you have included in income each year you held it. In general, to determine your gain or loss on a tax-exempt bond, figure your basis in the bond by adding to your cost the OID you would have included in income if the bond had been taxable. For a covered security, your broker will report the adjusted basis of the debt instrument to you on Form 1099-B. Example 4. Larry, a calendar year taxpayer, bought a corporate debt instrument at original issue for $86,235.00 on November 1 of Year 1. The 15-year debt instrument matures on October 31 of Year 16 at a stated redemption price of $100,000. The debt instrument provides for semiannual payments of interest at 10%. Assume the debt instrument is a capital asset in Larry's hands. The debt instrument has $13,765.00 of OID ($100,000 stated redemption price at maturity minus $86,235.00 issue price). Larry sold the debt instrument for $90,000 on November 1 of Year 4. Including the OID he will report for the period he held the debt instrument in Year 4, Larry has included $4,556.00 of OID in income and has increased his basis by that amount to $90,791.00. Larry has realized a loss of $791.00. All of Larry's loss is capital loss. Form 1099-OID The issuer of the debt instrument (or your broker, if you purchased or held the debt instrument through a broker) should give you a copy of Form 1099-OID or a similar statement if the accrued OID for the calendar year is $10 or more and the term of the debt instrument is more than 1 year. Form 1099-OID shows all OID income in box 1 except OID on a U.S. Treasury obligation, which is shown in box 8. It also shows, in box 2, any qualified stated interest you must include in income. (However, any qualified stated interest on Treasury inflation-protected securities can be reported on Form 1099-INT in box 3.) For a taxable covered security, Form 1099-OID may show accrued market discount in box 5, acquisition premium in box 6, or premium in box 10. For a taxable covered security with acquisition premium, box 1 or box 8, as applicable, may show a net amount of OID that reflects the offset of OID by the amount of acquisition premium amortization for the year. If so, box 6 will be blank. For a covered security with bond premium, box 2 may show a net amount of qualified stated interest that reflects the offset of interest income by the amount of premium amortization for the year. If so, box 10 will be blank. A copy of Form 1099-OID will be sent to the IRS. Do not attach your copy to your tax return. Keep it for your records. If you are required to file a tax return and you receive Form 1099-OID showing taxable amounts, you must report these amounts on your return. A 20% accuracy-related penalty may be charged for underpayment of tax due to either negligence or disregard of rules and regulations or substantial understatement of tax. Form 1099-OID not received. If you held an OID debt instrument for a calendar year but did not receive a Form 1099-OID, refer to the discussions under Figuring OID on Long-Term Debt Instruments, later, for information on the OID you must report. Refiguring OID. You may need to refigure the OID shown on Form 1099-OID, in box 1 or box 8, to determine the proper amount to include in income if one of the following applies. You bought the debt instrument at a premium or at an acquisition premium. However, if you bought a covered security at an acquisition premium, you may not have to refigure the OID if your broker reported a net adjusted amount of OID in box 1 or box 8, as applicable, that reflects the adjustment of the OID by the amortized acquisition premium. The debt instrument is a stripped bond or coupon (including zero coupon bonds backed by U.S. Treasury securities). The debt instrument is a contingent payment or inflation-indexed debt instrument.
Refiguring interest. If you disposed of a debt instrument or acquired it from another holder between interest dates, about refiguring the interest shown on Form 1099-OID in box 2. Nominee. If you are the holder of an OID debt instrument and you receive a Form 1099-OID that shows your taxpayer identification number and includes amounts belonging to another person, you are considered a "nominee." You must file another Form 1099-OID for each actual owner, showing the OID for the owner. Show the owner of the debt instrument as the "recipient" and you as the "payer." Complete Form 1099-OID and Form 1096 and file the forms with the Internal Revenue Service Center for your area. You must also give a copy of the Form 1099-OID to the actual owner. However, you are not required to file a nominee return to show amounts belonging to your spouse. How To Report OID Generally, you report your taxable interest and OID income on the interest line of Form 1040EZ, Form 1040A, or Form 1040. Form 1040 or Form 1040A required. You must use Form 1040 or Form 1040A (you cannot use Form 1040EZ) under either of the following conditions. You received a Form 1099-OID as a nominee for the actual owner. Your total interest and OID income for the year was more than $1,500. You are reporting more or less OID than the amount shown on Form 1099-OID, other than because you are a nominee. For example, you paid a premium or an acquisition premium when you purchased the debt instrument and you will report less OID than shown on Form 1099-OID in box 1 or box 8. Form 1040 required. You must use Form 1040 if you were charged an early withdrawal penalty. Where to report. List each payer's name (if a brokerage firm gave you a Form 1099, list the brokerage firm as the payer) and the amount received from each payer on Form 1040A, Schedule B, Part I, line 1, or Form 1040, Schedule B, line 1. Include all OID and periodic interest shown on any Form 1099-OID, boxes 1, 2, and 8, you received for the tax year. Also include any other OID and interest income for which you did not receive a Form 1099. Showing an OID adjustment. If you use Form 1040 to report more or less OID than shown in box 1 or box 8 on Form 1099-OID, list the full OID on Schedule B, Part I, line 1, and follow the instructions under 1 or 2, next. If you use Form 1040A to report the OID shown on a Form 1099-OID you received as a nominee for the actual owner, list the full OID on Schedule B, Part I, line 1 and follow the instructions under 1, or 2 next. If the OID, as adjusted, is less than the amount shown on Form 1099-OID, show the adjustment as follows. Under your last entry on line 1, subtotal all interest and OID income listed on line 1. Below the subtotal, write "Nominee Distribution" or "OID Adjustment" and show the OID you are not required to report. Subtract that OID from the subtotal and enter the result on line 2. If the OID, as adjusted, is more than the amount shown on Form 1099-OID, show the adjustment as follows. Under your last entry on line 1, subtotal all interest and OID income listed on line 1. Below the subtotal, write "OID Adjustment" and show the additional OID. Add that OID to the subtotal and enter the result on line 2. Figuring OID on Long-Term Debt Instruments How you figure the OID on a long-term debt instrument depends on the date it was issued. It also may depend on the type of the debt instrument. There are different rules for each of the following debt instruments. Debt instruments issued after July 1, 1982, and before 1985. Debt instruments issued after 1984 (other than debt instruments described in (5) and (6)). Contingent payment debt instruments issued after August 12, 1996. Inflation-indexed debt instruments (including Treasury inflation-protected securities) issued after January 5, 1997. Zero coupon bonds. A zero-coupon bond is a debt security which does not pay interest (a coupon) but is traded at a deep discount, rendering profit maturity when the bond is redeemed for its full face value. You must follow certain rules for figuring OID on zero coupon bonds backed by U.S. Treasury securities. Form 1099-OID. You should receive a Form 1099-OID showing OID for the part of the year you held the debt instrument. However, if you paid an acquisition premium, you may need to refigure the OID to report on your tax return. If your debt instrument is a covered security under Regulations section 1.6045-1(a)(15), you may not have to refigure the OID if your broker reported a net adjusted amount of OID in box 1 or box 8, as applicable, that reflects the adjustment of OID by the amortized acquisition premium. Form 1099-OID not received. The OID listed is for each $1,000 of redemption price. You must adjust the listed amount if your debt instrument has a different principal amount. For example, if you have a debt instrument with a $500 principal amount, use one-half the listed amount to figure your OID. If you held the debt instrument the entire year, use the OID shown in Section I-A for a calendar year. (If your debt instrument is not listed in Section I-A, consult the issuer for information about the issue price and the OID that accrued for that year.) If you did not hold the debt instrument the entire year, figure your OID using the following method. Divide the OID shown by 12. Multiply the result in (1) by the number of complete and partial months (for example, 6 ½ months) you held the debt instrument during a calendar year. This is the OID to include in income unless you paid an acquisition premium. The reduction for acquisition premium is discussed next.Reduction for acquisition premium. If you bought the debt instrument at an acquisition premium, figure the OID to include in income as follows. Divide the total OID on the debt instrument by the number of complete months, and any part of a month, from the date of original issue to the maturity date. This is the monthly OID. Subtract from your cost the issue price and the accumulated OID from the date of issue to the date of purchase. (If the result is zero or less, stop here. You did not pay an acquisition premium.) Divide the amount figured in (2) by the number of complete months, and any part of a month, from the date of your purchase to the maturity date. Subtract the amount figured in (3) from the amount figured in (1). This is the OID to include in income for each month you hold the debt instrument during the year. Transfers during the month. If you buy or sell a debt instrument on any day other than the same day of the month as the date of original issue, the ratable monthly portion of OID for the month of sale is divided between the seller and the buyer according to the number of days each held the debt instrument. Your holding period for this purpose begins the day you acquire the debt instrument and ends the day before you dispose of it. Debt Instruments Issued After July 1, 1982, and Before 1985 If you hold these debt instruments as capital assets, you must include part of the OID in income each year you own the debt instruments and increase your basis by the amount included. Form 1099-OID. You should receive a Form 1099-OID showing OID for the part of the year you held the debt instrument. However, if you paid an acquisition premium, you may need to refigure the OID to report on your tax return. Form 1099-OID not received. The OID listed is for each $1,000 of redemption price. You must adjust the listed amount if your debt instrument has a different principal amount. For example, if you have a debt instrument with a $500 principal amount, use one-half the listed amount to figure your OID. If you held the debt instrument the entire year, use the OID shown in Section I-A. (If your instrument is not listed in Section I-A, consult the issuer for information about the issue price, the yield to maturity, and the OID that accrued for that year.) If you did not hold the debt instrument the entire year, figure your OID using either of the following methods. Method 1. Divide the total OID for a calendar year by 365 (366 for leap years). Multiply the result in (1) by the number of days you held the debt instrument during that particular year.
This computation is an approximation and may result in a slightly higher OID than Method 2. Method 2. Look up the daily OID for the first accrual period you held the debt instrument during a calendar year. Multiply the daily OID by the number of days you held the debt instrument during that accrual period. If you held the debt instrument for part of both accrual periods, repeat (1) and (2) for the second accrual period. Add the results of (2) and (3). This is the OID to include in income, unless you paid an acquisition premium. (The reduction for acquisition premium is discussed later.) Constant yield method. This discussion shows how to figure OID on debt instruments issued after July 1, 1982, and before 1985, using a constant yield method. OID is allocated over the life of the debt instrument through adjustments to the issue price for each accrual period. Figure the OID allocable to any accrual period as follows. Multiply the adjusted issue price at the beginning of the accrual period by the debt instrument's yield to maturity. Subtract from the result in (1) any qualified stated interest allocable to the accrual period. Accrual period. An accrual period for any OID debt instrument issued after July 1, 1982, and before 1985 is each year period beginning on the date of the issue of the obligation and each anniversary thereafter, or the shorter period to maturity for the last accrual period. Your tax year will usually include parts of two accrual periods. Daily OID. The OID for any accrual period is allocated equally to each day in the accrual period. You must include in income the sum of the OID amounts for each day you hold the debt instrument during the year. If your tax year includes parts of two or more accrual periods, you must include the proper daily OID amounts for each accrual period. Figuring daily OID. The daily OID for the initial accrual period is figured using the following formula. (ip × ytm) − qsip ip = issue price ytm = yield to maturity qsi = qualified stated interest p = number of days in accrual period The daily OID for subsequent accrual periods is figured the same way except the adjusted issue price at the beginning of each period is used in the formula instead of the issue price. Reduction for acquisition premium on debt instruments purchased before July 19, 1984. If you bought the debt instrument at an acquisition premium before July 19, 1984, figure the OID includible in income by reducing the daily OID by the daily acquisition premium. Figure the daily acquisition premium by dividing the total acquisition premium by the number of days in the period beginning on your purchase date and ending on the day before the date of maturity. Reduction for acquisition premium on debt instruments purchased after July 18, 1984. If you bought the debt instrument at an acquisition premium after July 18, 1984, figure the OID includible in income by reducing the daily OID by the daily acquisition premium. However, the method of figuring the daily acquisition premium is different from the method described in the preceding discussion. To figure the daily acquisition premium under this method, multiply the daily OID by the following fraction. The numerator is the acquisition premium. The denominator is the total OID remaining for the debt instrument after your purchase date. Section I-A is available at IRS.gov/pub1212 and clicking the link under Recent Developments. Using Section I-A to figure accumulated OID. If you bought your corporate debt instrument in a calendar year or the subsequent year, you can figure the accumulated OID to the date of purchase by adding the following amounts. The amount from the "Total OID to January 1, YYYY" column for your debt instrument. The OID from January 1 of a calendar year to the date of purchase, figured as follows. Multiply the daily OID for the first accrual period in the calendar year by the number of days from January 1 to the date of purchase, or the end of the accrual period if the debt instrument was purchased in the second or third accrual period. Multiply the daily OID for each subsequent accrual period by the number of days in the period to the date of purchase or the end of the accrual period, whichever applies. Add the amounts figured in (2a) and (2b). Debt Instruments Issued After 1984 If you hold debt instruments issued after 1984, you must report part of the OID in gross income each year that you own the debt instruments. You must include the OID in gross income whether or not you hold the debt instrument as a capital asset. Your basis in the debt instrument is increased by the OID you include in income. Form 1099-OID. You should receive a Form 1099-OID showing OID for the part of a calendar year you held the debt instrument. However, if you paid an acquisition premium, you may need to refigure the OID to report on your tax return. If your taxable debt instrument is a covered security, your broker will calculate the amortization of acquisition premium for you. Your broker may report either a gross amount of OID in box 1 or box 8, as applicable, and the acquisition premium amortization in box 6, or may report a net amount of OID that reflects the offset of OID by the amount of acquisition premium amortization for the year in box 1 or box 8, as applicable. In general, your broker will use the rules in Regulations section 1.1272 ‐2(b)(4) to determine the amortization of acquisition premium. However, you may use a constant yield method to amortize acquisition premium if you make an election under Regulations section 1.1272‐3.You may also need to refigure the OID for a contingent payment or inflation-indexed debt instrument on which the amount reported on Form 1099-OID is inaccurate. Form 1099-OID not received. The OID listed is for each $1,000 of redemption price. You must adjust the listed amount if your debt instrument has a different principal amount. For example, if you have a debt instrument with a $500 principal amount, use one-half the listed amount to figure your OID. Use the OID shown in Section I-B for a calendar year if you held the debt instrument the entire year. (If your debt instrument is not listed in Section I-B, consult the issuer for information about the issue price, the yield to maturity, and the OID that accrued for that year.) If you did not hold the debt instrument the entire year, figure your OID as follows. Look up the daily OID for the first accrual period in which you held the debt instrument during a calendar year. Multiply the daily OID by the number of days you held the debt instrument during that accrual period. Repeat (1) and (2) for any remaining accrual periods in which you held the debt instrument. Add the results of (2) and (3). This is the OID to include in income for that year, unless you paid an acquisition premium. (The reduction for acquisition premium is discussed later.) Tax-exempt bond. If you own a tax-exempt bond, figure your basis in the bond by adding to your cost the OID you would have included in income if the bond had been taxable. You need to make this adjustment to determine if you have a gain or loss on a later disposition of the bond. In general, use the rules that follow to determine your OID. If your tax-exempt bond is a covered security under Regulations section 1.6045-1(a)(15), your broker will make this adjustment to your basis and will report the adjusted basis on Form 1099-B. Constant yield method. This discussion shows how to figure OID on debt instruments issued after 1984 using a constant yield method. (The special rules that apply to contingent payment debt instruments and inflation-indexed debt instruments are explained later.) OID is allocated over the life of the debt instrument through adjustments to the issue price for each accrual period. Figure the OID allocable to any accrual period as follows. Multiply the adjusted issue price at the beginning of the accrual period by a fraction. The numerator of the fraction is the debt instrument's yield to maturity and the denominator is the number of accrual periods per year. The yield must be stated appropriately taking into account the length of the particular accrual period. Subtract from the result in (1) any qualified stated interest allocable to the accrual period. Accrual period. For debt instruments issued after 1984 and before April 4, 1994, an accrual period is each 6-month period that ends on the day that corresponds to the stated maturity date of the debt instrument or the date 6 months before that date. For example, a debt instrument maturing on March 31 has accrual periods that end on September 30 and March 31 of each calendar year. Any short period is included as the first accrual period. For debt instruments issued after April 3, 1994, accrual periods may be of any length and may vary in length over the term of the debt instrument, as long as each accrual period is no longer than 1 year and all payments are made on the first or last day of an accrual period. However, the OID listed for these debt instruments in Section I-B has been figured using 6-month accrual periods. Daily OID. The OID for any accrual period is allocated equally to each day in the accrual period. Figure the amount to include in income by adding the OID for each day you hold the debt instrument during the year. Since your tax year will usually include parts of two or more accrual periods, you must include the proper daily OID for each accrual period. If your debt instrument has 6-month accrual periods, your tax year will usually include one full 6-month accrual period and parts of two other 6-month periods. Figuring daily OID. The daily OID for the initial accrual period is figured using the following formula. (ip × ytm/n) − qsip ip = issue price ytm = yield to maturity n = number of accrual periods in 1 year qsi = qualified stated interest p = number of days in accrual period The daily OID for subsequent accrual periods is figured the same way except the adjusted issue price at the beginning of each period is used in the formula instead of the issue price. Example 5. On January 1 of Year 1, you bought a 15-year, 10% debt instrument of A Corporation at original issue for $86,235.17. According to the prospectus, the debt instrument matures on December 31 of Year 15 at a stated redemption price of $100,000. The yield to maturity is 12%, compounded semiannually. The debt instrument provides for qualified stated interest payments of $5,000 on June 30 and December 31 of each calendar year. The accrual periods are the 6-month periods ending on each of these dates. The number of days for the first accrual period (January 1 through June 30) is 181 days (182 for leap years). The daily OID for the first accrual period is figured as follows. ($86,235.17 x .12/2) – $5,000181 days = $174.11020 = $.96193 181 The adjusted issue price at the beginning of the second accrual period is the issue price plus the OID previously includible in income ($86,235.17 + $174.11), or $86,409.28. The number of days for the second accrual period (July 1 through December 31) is 184 days. The daily OID for the second accrual period is figured as follows. ($86,409.28 x .12/2) – $5,000 184 days = $184.55681 = $1.00303 184 Since the first and second accrual periods coincide exactly with your tax year, you include in income for Year 1 the OID allocable to the first two accrual periods, $174.11 ($.95665 × 182 days) plus $184.56 ($1.00303 × 184 days), or $358.67. Add the OID to the $10,000 interest you report on your income tax return for Year 1.Example 6. Assume the same facts as in Example 5, except that you bought the debt instrument at original issue on May 1 of Year 1, with a maturity date of April 30, Year 16. Also, the interest payment dates are October 31 and April 30 of each calendar year. The accrual periods are the 6-month periods ending on each of these dates. The number of days for the first accrual period (May 1 through October 31) is 184 days. The daily OID for the first accrual period is figured as follows. ($86,235.17 x .12/2) – $5,000184 days = $174.11020 = $.94625 184 The number of days for the second accrual period (November 1 through April 30) is 181 days (182 for leap years). The daily OID for the second accrual period is figured as follows. ($86,409.28 x .12/2) – $5,000 181 days = $184.55681 = $1.01965 181 If you hold the debt instrument through the end of Year 1, you must include $236.31 of OID in income. This is $174.11 ($.94625 × 184 days) for the period May 1 through October 31 plus $62.20 ($1.01965 × 61 days) for the period November 1 through December 31. The OID is added to the $5,000 interest income paid on October 31 of Year 1. Your basis in the debt instrument is increased by the OID you include in income. On January 1 of Year 2, your basis in the A Corporation debt instrument is $86,471.48 ($86,235.17 + $236.31).Short first accrual period. You may have to make adjustments if a debt instrument has a short first accrual period. For example, a debt instrument with 6-month accrual periods that is issued on February 15 and matures on October 31 has a short first accrual period that ends April 30. (The remaining accrual periods begin on May 1 and November 1.) For this short period, figure the daily OID as described earlier, but adjust the yield for the length of the short accrual period. You may use any reasonable compounding method in determining OID for a short period. Examples of reasonable compounding methods include continuous compounding and monthly compounding (that is, simple interest within a month). Consult your tax advisor for more information about making this computation. The OID for the final accrual period is the difference between the amount payable at maturity (other than a payment of qualified stated interest) and the adjusted issue price at the beginning of the final accrual period. Reduction for acquisition premium. If you bought the debt instrument at an acquisition premium, unless you made the constant yield election under Regulations section 1.1272 ‐3, figure the OID includible in income by reducing the daily OID by the daily acquisition premium. To figure the daily acquisition premium, multiply the daily OID by the following fraction.The numerator is the acquisition premium. The denominator is the total OID remaining for the debt instrument after your purchase date. Example 7. Assume the same facts as in Example 6, except that you bought the debt instrument on November 1 of Year 1 for $87,000, after its original issue on May 1 of Year 1. The adjusted issue price on November 1 of Year 1 is $86,409.28 ($86,235.17 + $174.11). In this case, you paid an acquisition premium of $590.72 ($87,000 − $86,409.28). The daily OID for the accrual period November 1 through April 30, reduced for the acquisition premium, is figured as follows.1) Daily OID on date of purchase (2nd accrual period) $1.01965* 2) Acquisition premium $590.72 3) Total OID remaining after purchase date ($13,764.83 − $174.11) $13,590.724) Line 2 ÷ line 3 .04346 5) Line 1 × line 4 .04432 6) Daily OID reduced for the acquisition premium. Line 1 − line 5 $0.97533* As shown in Example 6. The total OID to include in income for Year 1 is $59.50 ($.97533 × 61 days). Contingent Payment Debt Instruments This discussion shows how to figure OID on a contingent payment debt instrument issued after August 12, 1996, that was issued for cash or publicly traded property. In general, a contingent payment debt instrument provides for one or more payments that are contingent as to timing or amount. If you hold a contingent payment bond, you must report OID as it accrues each year. Contingent payment debt instruments acquired on or after January 1, 2016, are "covered securities." Dispositions of covered and noncovered securities must be reported on Form 8949, Sales and Other Dispositions of Capital Assets. The gain or loss on these securities subject to the noncontingent bond method will be adjusted by any amounts shown in column (g) with a corresponding code O in column (f). In general, the gain from the sale of these securities will be ordinary and losses will be ordinary to the extent of prior year OID inclusions. Because the actual payments on a contingent payment debt instrument cannot be known in advance, issuers and holders cannot use the constant yield method (discussed earlier under Debt Instruments Issued After 1984) without making certain assumptions about the payments on the debt instrument. To figure OID accruals on contingent payment debt instruments, holders and issuers must use the noncontingent bond method. Noncontingent bond method. Under this method, the issuer must compute a comparable yield for the debt instrument and, based on this yield, construct a projected payment schedule for the instrument, which includes a projected fixed amount for each contingent payment. In general, holders and issuers accrue OID on this projected payment schedule using the constant yield method that applies to fixed payment debt instruments. When a contingent payment differs from the projected fixed amount, the holders and issuers make adjustments to their OID accruals. If the actual contingent payment is larger than expected, both the issuer and the holder increase their OID accruals. If the actual contingent payment is smaller than expected, holders and issuers generally decrease their OID accruals. Form 1099-OID. The amount shown on Form 1099-OID in box 1 you receive for a contingent payment debt instrument may not be the correct amount to include in income. For example, the amount may not be correct if the contingent payment was different from the projected amount. If the amount in box 1 is not correct, you must figure the OID to report on your return under the following rules. Figuring OID. To figure OID on a contingent payment debt instrument, you need to know the "comparable yield" and "projected payment schedule" of the debt instrument. The issuer must make these available to you. Comparable yield. The comparable yield generally is the yield at which the issuer would issue a fixed rate debt instrument with terms and conditions similar to those of the contingent payment debt instrument. The comparable yield is determined as of the debt instrument's issue date. Projected payment schedule. The projected payment schedule for a contingent payment debt instrument includes all fixed payments due under the instrument and a projected fixed amount for each contingent payment. The projected payment schedule is created by the issuer as of the debt instrument's issue date. It is used to determine the issuer's and holder's interest accruals and adjustments. Steps for figuring OID. Figure the OID on a contingent payment debt instrument in two steps. Figure the OID using the constant yield method (discussed earlier under Debt Instruments Issued After 1984 ) that applies to fixed payment debt instruments. Use the comparable yield as the yield to maturity. In general, use the projected payment schedule to determine the instrument's adjusted issue price at the beginning of each accrual period (other than the initial period). Do not treat any amount payable as qualified stated interest. Adjust the OID in (1) to account for actual contingent payments. If the contingent payment is greater than the projected fixed amount, you have a positive adjustment. If the contingent payment is less than the projected fixed amount, you have a negative adjustment. Net positive adjustment. A net positive adjustment exists for a tax year when the total of any positive adjustments described in (2) above for the tax year is more than the total of any negative adjustments for the tax year. Treat a net positive adjustment as additional OID for the tax year. Net negative adjustment. A net negative adjustment exists for a tax year when the total of any negative adjustments described in (2) above for the tax year is more than the total of any positive adjustments for the tax year. Use a net negative adjustment to offset OID on the debt instrument for the tax year. If the net negative adjustment is more than the OID on the debt instrument for the tax year, you can claim the difference as an ordinary loss. However, the amount you can claim as an ordinary loss is limited to the OID on the debt instrument you included in income in prior tax years. You must carry forward any net negative adjustment that is more than the total OID for the tax year and prior tax years and treat it as a negative adjustment in the next tax year. Basis adjustments. In general, increase your basis in a contingent payment debt instrument by the OID included in income. Your basis, however, is not affected by any negative or positive adjustments. Decrease your basis by any noncontingent payment received and the projected contingent payment scheduled to be received. Treatment of gain or loss on sale or exchange. If you sell a contingent payment debt instrument at a gain, your gain is ordinary income (interest income), even if you hold the debt instrument as a capital asset. If you sell a contingent payment debt instrument at a loss, your loss is an ordinary loss to the extent of your prior OID accruals on the debt instrument. If the debt instrument is a capital asset, treat any loss that is more than your prior OID accruals as a capital loss. Premium, acquisition premium, and market discount. The rules for accruing premium, acquisition premium, and market discount do not apply to a contingent payment debt instrument. Inflation-Indexed Debt Instruments This discussion shows how you figure OID on certain inflation-indexed debt instruments issued after January 5, 1997. An inflation-indexed debt instrument is generally a debt instrument on which the payments are adjusted for inflation and deflation (such as Treasury inflation-protected securities (TIPS)). In general, if you hold an inflation-indexed debt instrument, you must report as OID any increase in the inflation-adjusted principal amount of the debt instrument that occurs while you held the debt instrument during the tax year. You must include the OID in gross income whether or not you hold the debt instrument as a capital asset. Your basis in the debt instrument is increased by the OID you include in income. Inflation-indexed debt instruments acquired on or after January 1, 2016, are "covered securities." Dispositions of covered and noncovered securities must be reported on Form 8949, Sales and Other Dispositions of Capital Assets. Inflation-adjusted principal amount. For any date, the inflation-adjusted principal amount of an inflation-indexed debt instrument is the debt instrument's outstanding principal amount multiplied by the index ratio for that date. (For TIPS, multiply the par value by the index ratio for that date.) For this purpose, determine the outstanding principal amount as if there were no inflation or deflation over the term of the debt instrument. Index ratio. This is a fraction, the numerator of which is the value of the reference index for the date and the denominator of which is the value of the reference index for the debt instrument's issue date. A qualified reference index measures inflation and deflation over the term of a debt instrument. Its value is reset each month to a current value of a single qualified inflation index (for example, the nonseasonally adjusted U.S. City Average All Items Consumer Price Index for All Urban Consumers (CPI-U), published by the Department of Labor). The value of the index for any date between reset dates is determined through straight-line interpolation. The daily index ratios for Treasury inflation-protected securities are available on the Internet at http://www.treasurydirect.gov/instit/annceresult/tipscpi/tipscpi.htm.Form 1099-OID. The amount shown in box 8 of the Form 1099-OID you receive for an inflation-indexed debt instrument may not be the correct amount to include in income. For example, the amount may not be correct if you bought the debt instrument other than at original issue or sold it during the year. If the amount shown in box 8 is not correct, you must figure the OID to report on your return under the following rules. Figuring OID. Figure the OID on an inflation-indexed debt instrument using one of the following methods. The coupon bond method, described in the following discussion, applies if the debt instrument is issued at par (as determined under Regulations section 1.1275-7(d)(2)(i)), all stated interest payable on the debt instrument is qualified stated interest, and the coupons have not been stripped from the debt instrument. This method applies to TIPS, including TIPS issued with more than a de minimis amount of premium (see Regulations section 1.1275-7). The discount bond method applies to any inflation-indexed debt instrument that does not qualify for the coupon bond method, such as a stripped debt instrument. This method is described in Regulations section 1.1275-7(e). Under the coupon bond method, figure the OID you must report for the tax year as follows. Debt instrument held at the end of the tax year. If you held the debt instrument at the end of the tax year, figure your OID for the year using the following steps. Add the inflation-adjusted principal amount for the day after the last day of the tax year and any principal payments you received during the year. (For TIPS, multiply the par value by the index ratio for the day after the last day of the tax year, and add any principal payments received.) Subtract from (1) above the inflation-adjusted principal amount for the first day on which you held the debt instrument during the tax year. (For TIPS, subtract from (1) above the product of the par value times the index ratio for the first day held during the tax year.) Interest is reported separately, as discussed later under Stated interest. Debt instrument sold or retired during the tax year. If you sold the debt instrument during the tax year, or if it was retired, figure your OID for the year using the following steps. Add the inflation-adjusted principal amount for the last day on which you held the debt instrument during the tax year and any principal payments you received during the year. (For TIPS, multiply the par value by the index ratio for the sale or retirement date, and add any principal payments received.) Subtract from (1) above the inflation-adjusted principal amount for the first day on which you held the debt instrument during the tax year. (For TIPS, subtract from (1) above the product of the par value times the index ratio for the first day held during the tax year.) Interest is reported separately, as discussed later under Stated interest. Example 8. On February 6 of Year 9, you bought an old 10-year, 3.375% inflation-indexed debt instrument (maturing January 15 of Year 11) for $9,831. The stated principal (par value) amount is $10,000 and the inflation-adjusted principal amount for February 6 of Year 9 is $12,047.50 ($10,000 par value times 1.20475 index ratio). You held the debt instrument until August 29 of Year 9 when the inflation-adjusted principal amount was $12,275.70 ($10,000 par value times 1.22757 index ratio). Your OID for Year 9 is $228.20 ($12,275.70 − $12,047.50). Your basis in the debt instrument on August 29 of Year 9 was $10,059.20 ($9,831 cost + $228.20 OID) for Year 9.Stated interest. Under the coupon bond method, you report any stated interest on the debt instrument under your regular method of accounting. For example, if you use the cash method, you generally include in income for the tax year any interest payments received on the debt instrument during the year. Deflation adjustments. If your calculation to figure OID on an inflation-indexed debt instrument produces a negative number, you do not have any OID. Instead, you have a deflation adjustment. A deflation adjustment generally is used to offset interest income from the debt instrument for the tax year. Show this offset as an adjustment on your Form 1040, Schedule B, in the same way you would show an OID adjustment. You decrease your basis in the debt instrument by the deflation adjustment used to offset interest income. Example 9. Assume the same facts as in Example 8, except that you bought the debt instrument for $9,831 on January 6 of Year 9, when the inflation-adjusted principal amount was $12,050.10, and sold the debt instrument on March 1 of Year 9, when the inflation-adjusted principal amount was $12,011.20. Because the OID calculation for Year 9 ($12,011.20 − $12,050.10) produces a negative number (negative $38.90), you have a deflation adjustment. You use this deflation adjustment to offset the stated interest reported to you on the debt instrument.Your basis in the debt instrument on March 1 of Year 9 is $9,792.10 ($9,831 cost − $38.90 deflation adjustment) for Year 9.Premium on inflation-indexed debt instruments. In general, any premium on an inflation-indexed debt instrument is determined as of the date you acquire the debt instrument by assuming there will be no further inflation or deflation over the remaining term of the debt instrument. You allocate any premium over the remaining term of the debt instrument by making the same assumption. In general, the premium allocable to a tax year offsets the interest otherwise includible in income for the year. If the premium allocable to the year is more than that interest, the difference generally offsets the OID on the debt instrument for the year. See Regulations section 1.1275-7 for an example applying the coupon bond method to a TIPS issued with more than a de minimis amount of premium. Figuring OID on Stripped Bonds and Coupons If you strip one or more coupons from a bond and then sell or otherwise dispose of the bond or the stripped coupons, they are treated as separate debt instruments issued with OID. The holder of a stripped bond has the right to receive the principal (redemption price) payment. The holder of a stripped coupon has the right to receive an interest payment on the bond. The rule requiring the holder of a debt instrument issued with OID to include the OID in gross income as it accrues applies to stripped bonds and coupons acquired after July 1, 1982. See Debt Instruments and Coupons Purchased After July 1, 1982, and Before 1985 or Debt Instruments and Coupons Purchased After 1984, later, for information about figuring the OID to report. Stripped bonds and coupons include the following instruments. Zero coupon bonds available through the Department of the Treasury's STRIPS program and government-sponsored enterprises such as the Resolution Funding Corporation and the Financing Corporation. Debt instruments backed by U.S. Treasury securities that represent ownership interests in those securities. Examples include obligations backed by U.S. Treasury bonds that are offered primarily by brokerage firms (variously called CATS, TIGRs, etc.). Seller of stripped bonds or coupons. If you strip coupons from a bond and sell the bond or coupons, include in income the interest that accrued while you held the bond before the date of sale to the extent the interest was not previously included in your income. For an obligation acquired after October 22, 1986, you must also include the market discount that accrued before the date of sale of the stripped bond (or coupon) to the extent the discount was not previously included in your income. Add the interest and market discount you include in income to the basis of the bond and coupons. This adjusted basis is then allocated between the items you keep and the items you sell, based on the fair market value of the items. The difference between the sale price of the bond (or coupon) and the allocated basis of the bond (or coupon) is the gain or loss from the sale. Treat any item you keep as an OID bond originally issued and purchased by you on the sale date of the other items. If you keep the bond, treat the excess of the redemption price of the bond over the basis of the bond as OID. If you keep the coupons, treat the excess of the amount payable on the coupons over the basis of the coupons as OID. Purchaser of stripped bonds or coupons. If you purchase a stripped bond or coupon, treat it as if it were originally issued on the date of purchase. If you purchase the stripped bond, treat as OID any excess of the stated redemption price at maturity over your purchase price. If you purchase the stripped coupon, treat as OID any excess of the amount payable on the due date of the coupon over your purchase price. Form 1099-OID The amount shown in box 8 of the Form 1099-OID you receive for a stripped bond or coupon may not be the proper amount to include in income. If not, you must figure the OID to report on your return under the rules that follow. Tax-Exempt Bonds and Coupons The OID on a stripped tax-exempt bond, or on a stripped coupon from such a bond, is generally not taxable. However, if you acquired the stripped bond or coupon after October 22, 1986, you must accrue OID on it to determine its basis when you dispose of it. How you figure accrued OID and whether any OID is taxable depend on the date you bought (or are treated as having bought) the stripped bond or coupon. Acquired before June 11, 1987. None of the OID on bonds or coupons acquired before this date is taxable. The accrued OID is added to the basis of the bond or coupon. The accrued OID is the amount that produces a yield to maturity (YTM), based on your purchase date and purchase price, equal to the lower of the following rates. The coupon rate on the bond before the separation of coupons. (However, if you can establish the YTM of the bond (with all coupons attached) at the time of its original issue, you can use that YTM instead.) The YTM of the stripped bond or coupon. Increase your basis in the stripped tax-exempt bond or coupon by the interest that accrued but was neither paid nor previously reflected in your basis before the date you sold the bond or coupon. Acquired after June 10, 1987. Part of the OID on bonds or coupons acquired after this date may be taxable. Figure the taxable part in three steps. Step 1. Figure OID as if all taxable. First figure the OID following the rules in this section as if all the OID were taxable. Use the yield to maturity (YTM) based on the date you obtained the stripped bond or coupon. Step 2. Determine nontaxable part. Find the issue price that would produce a YTM as of the purchase date equal to the lower of the following rates. The coupon rate on the bond from which the coupons were separated. (However, you can use the original YTM instead.) The YTM based on the purchase price of the stripped coupon or bond. Subtract this issue price from the stated redemption price of the bond at maturity (or, in the case of a coupon, the amount payable on the due date of the coupon). The result is the part of the OID treated as OID on a stripped tax-exempt bond or coupon. Step 3. Determine taxable part. The taxable part of OID is the OID determined in Step 1 minus the nontaxable part determined in Step 2. Exception. None of the OID on your stripped tax-exempt bond or coupon is taxable if you bought it from a person who held it for sale on June 10, 1987, in the ordinary course of that person's trade or business. Basis adjustment. Increase the basis of your stripped tax-exempt bond or coupon by the taxable and nontaxable accrued OID. If you own a tax-exempt bond from which one or more coupons have been stripped, increase your basis in it by the sum of the interest accrued but not paid before you dispose of it (and not previously reflected in basis) and any accrued market discount to the extent not previously included in your income. Example 10. Assume that a tax-exempt bond with a face amount of $100 due January 1 of Year 4 and a coupon rate of 10% (compounded semiannually) was issued for $100 on January 1 of Year 1. On January 1 of Year 2 the bond was stripped and you bought the right to receive the principal amount for $79.21. The stripped bond is treated as if it was originally issued on January 1 of Year 2 with OID of $20.79 ($100.00 − $79.21). This reflects a YTM at the time of the strip of 12% (compounded semiannually). The tax-exempt part of OID on the stripped bond is limited to $17.73. This is the difference between the redemption price ($100) and the issue price that would produce a YTM of 10% ($82.27). This part of the OID is treated as OID on a tax-exempt obligation.The OID on the stripped bond that is more than the tax-exempt part is $3.06. This is the excess of the total OID ($20.79) over the tax-exempt part ($17.73). This part of the OID ($3.06) is treated as OID on an obligation that is not tax exempt. The total OID allocable to the accrual period ending June 30 of Year 2 is $4.75 (6% × $79.21). Of this, $4.11 (5% × $82.27) is treated as OID on a tax-exempt obligation and $0.64 ($4.75 − $4.11) is treated as OID on an obligation that is not tax exempt. Your basis in the debt instrument as of June 30 of Year 2 is increased to $83.96 ($79.21 issue price + accrued OID of $4.75).Debt Instruments and Coupons Purchased After July 1, 1982, and Before 1985 If you purchased a stripped bond or coupon after July 1, 1982, and before 1985, and you held that debt instrument as a capital asset during any part of a calendar year, you must figure the OID to be included in income using a constant yield method. Under this method, OID is allocated over the time you hold the debt instrument by adjusting the acquisition price for each accrual period. The OID for the accrual period is figured by multiplying the adjusted acquisition price at the beginning of the period by the yield to maturity. Adjusted acquisition price. The adjusted acquisition price of a stripped bond or coupon at the beginning of the first accrual period is its purchase (or acquisition) price. The adjusted acquisition price at the beginning of any subsequent accrual period is the sum of the acquisition price and all of the OID includible in income before that accrual period. Accrual period. An accrual period for any stripped bond or coupon acquired before 1985 is each year period beginning on the date of the purchase of the obligation and each anniversary thereafter, or the shorter period to maturity for the last accrual period. Yield to maturity (YTM). In general, the YTM of a stripped bond or coupon is the discount rate that, when used in figuring the present value of all principal and interest payments, produces an amount equal to the acquisition price of the debt instrument or coupon. Figuring YTM. If you purchased a stripped bond or coupon after July 1, 1982, but before 1985, and the period from your purchase date to the day the debt instrument matures can be divided exactly into full 1-year periods without including a shorter period, then the YTM can be figured by applying the following formula. Calculation Please click here for the text description of the image. srp = stated redemption price at maturity ap = acquisition price m = number of full accrual periods from purchase to maturity If the debt instrument is a stripped coupon, the stated redemption price is the amount payable on the due date of the coupon. If the period between your purchase date and the maturity date (or due date) of the debt instrument does not divide into an exact number of full 1-year periods, so that a period shorter than 1 year must be included, consult your broker or your tax advisor for information about figuring the YTM. Daily OID. The OID for any accrual period is allocated equally to each day in the accrual period. You figure the amount to include in income by adding the daily OID amounts for each day you hold the debt instrument during the year. If your tax year includes parts of more than one accrual period (which will be the case unless the accrual period coincides with your tax year), you must include the proper daily OID amounts for each of the two accrual periods. The daily OID for the initial accrual period is figured by applying the following formula. (ap × ytm) p ap = acquisition price ytm = yield to maturity p = number of days in accrual period The daily OID for subsequent accrual periods is figured in the same way except the adjusted acquisition price at the beginning of each period is used in the formula instead of the acquisition price. Debt Instruments and Coupons Purchased After 1984 If you purchased a stripped bond or coupon (other than a stripped inflation-indexed debt instrument) after 1984, and you held that debt instrument during any part of a calendar year, you must figure the OID to be included in income using a constant yield method. Under this method, OID is allocated over the time you hold the debt instrument by adjusting the acquisition price for each accrual period. The OID for the accrual period is figured by multiplying the adjusted acquisition price at the beginning of the period by a fraction. The numerator of the fraction is the debt instrument's yield to maturity and the denominator is the number of accrual periods per year. If the stripped bond or coupon is an inflation-indexed instrument, you must figure the OID to be included in income using the discount bond method described in Regulations section 1.1275-7(e). Adjusted acquisition price. The adjusted acquisition price of a stripped bond or coupon at the beginning of the first accrual period is its purchase (or acquisition) price. The adjusted acquisition price at the beginning of any subsequent accrual period is the sum of the acquisition price and all of the OID includible in income before that accrual period. Accrual period. For a stripped bond or coupon acquired after 1984 and before April 4, 1994, an accrual period is each 6-month period that ends on the day that corresponds to the stated maturity date of the stripped bond (or payment date of a stripped coupon) or the date 6 months before that date. For example, a stripped bond that has a maturity date (or a stripped coupon that has a payment date) of March 31 has accrual periods that end on September 30 and March 31 of each calendar year. Any short period is included as the first accrual period. For a stripped bond or coupon acquired after April 3, 1994, accrual periods may be of any length and may vary in length over the term of the debt instrument, as long as each accrual period is no longer than 1 year and all payments are made on the first or last day of an accrual period. Yield to maturity (YTM). In general, the YTM of a stripped bond or coupon is the discount rate that, when used in figuring the present value of all principal and interest payments, produces an amount equal to the acquisition price. Figuring YTM. How you figure the YTM for a stripped debt instrument or coupon purchased after 1984 depends on whether you have equal accrual periods or a short initial accrual period. 1. Equal accrual periods. If the period from the date you purchased a stripped bond or coupon to the maturity date can be divided evenly into full accrual periods without including a shorter period, you can figure the YTM by using the following formula. Calculation Please click here for the text description of the image. n = number of accrual periods in 1 year srp = stated redemption price at maturity ap = acquisition price m = number of full accrual periods from purchase to maturity If the debt instrument is a stripped coupon, the stated redemption price is the amount payable on the due date of the coupon. Example 11. On May 15 of Year 1, you bought a coupon stripped from a U.S. Treasury bond through the Department of the Treasury's STRIPS program for $38,000. An amount of $100,000 is payable on the coupon's due date, November 14 of Year 13. There are exactly 25 6-month periods between the purchase date, May 15 of Year 1, and the coupon's due date, November 14 of Year 13. The YTM on this stripped coupon is figured as follows. Calculation Please click here for the text description of the image. Use 7.892% YTM to figure the OID for each accrual period or partial accrual period for which you must report OID. 2. Short initial accrual period. If the period from the date you purchased a stripped bond or coupon to the date of its maturity cannot be divided evenly into full accrual periods, so that a shorter period must be included, you can figure the YTM by using the following formula (the exact method). Calculation Please click here for the text description of the image. n = number of accrual periods in 1 year srp = stated redemption price at maturity ap = acquisition price r = number of days from purchase to end of short accrual period s = number of days in accrual period ending on last day of short accrual period m = number of full accrual periods from purchase to maturity Example 12. On May 30 of Year 1, you bought a coupon stripped from a U.S. Treasury bond through the Department of the Treasury's STRIPS program for $60,000. $100,000 is payable on the coupon's due date, August 11 of Year 7. You decide to figure OID using 6-month accrual periods. There are 12 full 6-month accrual periods and a 74-day short initial accrual period from the purchase date to the coupon's due date. The YTM on this stripped coupon is figured as follows. Calculation Please click here for the text description of the image. Use 8.406% YTM to figure the OID for each accrual period or partial accrual period for which you must report OID. Daily OID. The OID for any accrual period is allocated equally to each day in the accrual period. You must include in income the sum of the daily OID amounts for each day you hold the debt instrument during the year. Since your tax year will usually include parts of two or more accrual periods, you must include the proper daily OID amounts for each accrual period. Figuring daily OID. For the initial accrual period of a stripped bond or coupon acquired after 1984, figure the daily OID using Formula 1, next, if there are equal accrual periods. Use Formula 2 if there is a short initial accrual period. For subsequent accrual periods, figure the daily OID using Formula 1 (whether or not there was a short initial accrual period), but use the adjusted acquisition price in the formula instead of the acquisition price. Formula 1. ap × ytm / n p Formula 2. r s ap x (1 + ytm /n) − apr ap = acquisition price ytm = yield to maturity n = number of accrual periods in 1 year p = number of days in accrual period r = number of days from purchase to end of short accrual period s = number of days in accrual period ending on last day of short accrual period The rules for figuring OID on these debt instruments are similar to those illustrated in Example 5 and Example 6, earlier, under Debt Instruments Issued After 1984. Example 13. Assume the same facts as in Example 12, and that you held the coupon for the rest of Year 1. For the short initial accrual period from May 30 through August 11, the daily OID is figured using Formula 2, as follows. 74 181 $60,000 × (1 + .08406/2) − $60,00074 = $1,018.48 = $13.76327 74 The OID for this period is $1,018.48 ($13.76327 × 74 days). For the second accrual period from August 12 of Year 1 through February 11 of Year 2, the adjusted acquisition price is $61,018.48. This is the original $60,000 acquisition price plus $1,018.48 OID for the short initial accrual period. The daily OID is figured using Formula 1, as follows. $61,018.48 × (.08406/2) 184 = $2,564.60671 = $13.93808 184 The OID for the part of this period included in Year 1 (August 12 – December 31) is $1,979.21 ($13.93808 × 142 days).The OID to be reported on your income tax return for Year 1 is $2,997.69 ($1,018.48 + $1,979.21). Final accrual period. The OID for the final accrual period for a stripped bond or coupon is the amount payable at maturity of the stripped bond (or interest payable on the stripped coupon) minus the adjusted acquisition price at the beginning of the final accrual period. The daily OID for the final accrual period is figured by dividing the OID for the period by the number of days in the period. Topic Number 307 - Backup Withholding When it applies, backup withholding requires a payer to withhold tax from payments not otherwise subject to withholding. You may be subject to backup withholding if you fail to provide a correct taxpayer identification number (TIN) when required or if you fail to report interest, dividend, or patronage dividend income. Banks or other businesses that make certain types of payments to you must file an information return with the IRS on Form 1099 showing payments that you received during the year. A Form 1099 includes your name and TIN such as a social security number (SSN), employer identification number (EIN), or individual taxpayer identification number (ITIN). The Form 1099 will also report any amounts withheld under the backup withholding rules. Payments subject to backup withholding: Backup withholding can apply to most kinds of payments reported on Form 1099, including: Interest payments (Form 1099-INT); Dividends (Form 1099-DIV); Patronage dividends, but only if at least half of the payment is in money (Form 1099-PATR); Rents, profits, or other income (Form 1099-MISC); Commissions, fees, or other payments for work performed as an independent contractor (Form 1099-MISC); Payments by brokers and barter exchange transactions (Form 1099-B); Payments by fishing boat operators, but only the part that's in money and that represents a share of the proceeds of the catch (Form 1099-MISC); Payment Card and Third-Party Network Transactions (Form 1099-K); and Royalty payments - Form 1099-MISCBackup withholding also may apply to gambling winnings (Form W-2G) on winnings that aren't subject to regular gambling withholding. Withholding rules When you open a new account, make an investment, or begin to receive payments reportable on Form 1099, you must provide your TIN. For certain types of payments, you must provide the TIN in writing and certify under penalties of perjury that it's correct. In those cases, the bank or business will give you Form W-9, Request for Taxpayer Identification Number and Certification, or a similar form. If your account or investment will earn interest or dividends, you must also certify that you're not subject to backup withholding due to previous underreporting of interest and dividends. You may be subject to backup withholding and the payer must withhold at a flat 24% rate when: You don't give the payer your TIN in the required manner. The IRS notifies the payer that the TIN you gave is incorrect. The IRS notifies the payer to start withholding on interest or dividends because you have underreported interest or dividends on your income tax return. The IRS will do this only after it has mailed you four notices over at least a 120-day period. You fail to certify that you're not subject to backup withholding for underreporting of interest and dividends. How to prevent or stop backup withholding: To stop backup withholding, you'll need to correct the reason you became subject to backup withholding in the first place. This can include providing the correct TIN to the payer, resolving the underreported income and paying the amount owed, or filing the missing return(s), as appropriate. If you receive a notice from a payer notifying you that the TIN you gave is incorrect, you can usually prevent backup withholding from starting or stop it once it has begun by giving the payer your correct name and TIN and certifying that the TIN you give is correct. If you receive a second notice from that payer, you'll need to provide them with a copy of your social security card that shows your correct name and SSN. Credit for backup withholding: If your 1099 shows an amount withheld under the backup withholding rules, report the amount as Federal income tax withheld on your income tax return for the year you received the income. If you operate as a partnership or subchapter S corporation, any backup withholding can only be claimed by the partners and shareholders. Partners and shareholders should report their respective shares of the withheld amounts on their individual income tax returns. The amounts aren't refundable to the partnership or subchapter S corporation.
References: https://www.irs.gov/taxtopics/tc403 https://www.irs.gov/publications/p1212 https://www.irs.gov/taxtopics/tc307
Dividends Dividends are distributions of property a corporation may pay you if you own stock in that corporation. Corporations pay most dividends in cash. However, they may also pay them as stock of another corporation or as any other property. You also may receive distributions through your interest in a partnership, an estate, a trust, a subchapter S corporation, or from an association that's taxable as a corporation. A shareholder of a corporation may be deemed to receive a dividend if the corporation pays the debt of its shareholder, the shareholder receives services from the corporation, or the shareholder is allowed the use of the corporation's property. Additionally, a shareholder that provides services to a corporation may be deemed to receive a dividend if the corporation pays the shareholder service-provider in excess of what it would pay a third party for the same services. A shareholder may also receive distributions such as additional stock or stock rights in the distributing corporation; such distributions may or may not qualify as dividends. Form 1099-DIV You should receive a Form 1099-DIV, Dividends and Distributions, from each payer for distributions of at least $10. If you're a partner in a partnership or a beneficiary of an estate or trust, you may be required to report your share of any dividends received by the entity, whether or not the dividend is paid out to you. Your share of the entity's dividends is generally reported to you on a Schedule K-1. Dividends are the most common type of distribution from a corporation. They're paid out of the earnings and profits of the corporation. Dividends can be classified either as ordinary or qualified. Whereas ordinary dividends are taxable as ordinary income, qualified dividends that meet certain requirements are taxed at lower capital gain rates. The payer of the dividend is required to correctly identify each type and amount of dividend for you when reporting them on your Form 1099-DIV for tax purposes. Return of Capital Distributions that qualify as a return of capital aren't dividends. A return of capital is a return of some or all of your investment in the stock of the company. A return of capital reduces the adjusted cost basis of your stock. For information on basis of assets, refer to Topic No. 703. A distribution generally qualifies as a return of capital if the corporation making the distribution doesn't have any accumulated or current year earnings and profits. Once the adjusted cost basis of your stock has been reduced to zero, any further nondividend distribution is a taxable capital gain that you report on Form 8949, Sales and Other Dispositions of Capital Assets, and Form 1040, Schedule D, Capital Gains and Losses. Capital Gain Distributions Regulated investment companies (RICs) (mutual funds, exchange traded funds, money market funds, etc.) and real estate investment trusts (REITs) may pay capital gain distributions. Capital gain distributions are always reported as long-term capital gains. You must also report any undistributed capital gain that RICs or REITs have designated to you in a written notice. They report these undistributed capital gains to you on Form 2439, Notice to Shareholder of Undistributed Long-Term Capital Gains. For information on how to report qualifying dividends and capital gain distributions, refer to the Form 1040 Instructions or Form 1040A Instructions. Additional Considerations Form 1099-DIV should break down the distribution into the various categories. If it doesn't, contact the payer. You must give your correct social security number to the payer of your dividend income. If you don't, you may be subject to a penalty and/or backup withholding. For more information on backup withholding, refer to Topic No. 307. If you receive over $1,500 of taxable ordinary dividends, you must report these dividends on Form 1040A or 1040, Schedule B, Interest and Ordinary Dividends. If you receive dividends in significant amounts, you may have to pay estimated tax to avoid a penalty. Basis of Assets Basis is generally the amount of your capital investment in property for tax purposes. Use your basis to figure depreciation, amortization, depletion, casualty losses, and any gain or loss on the sale, exchange, or other disposition of the property. In most situations, the basis of an asset is its cost to you. The cost is the amount you pay for it in cash, debt obligations, and other property or services. Cost includes sales tax and other expenses connected with the purchase. Your basis in some assets isn't determined by the cost to you. If you acquire property other than through a purchase (such as a gift or an inheritance), refer to Publication 551, Basis of Assets, for more information. If you acquired your property from an individual who died in 2010, special rules may apply to your calculation of basis. If you buy stocks or bonds, your basis is the purchase price plus any additional costs such as commissions and recording or transfer fees. If you have stocks or bonds that you didn't purchase, you may have to determine your basis by the fair market value of the stocks and bonds on the date of transfer or the basis of the previous owner. Refer to Publication 550, Investment Income and Expenses, for more information. Before figuring gain or loss on a sale, exchange, or other disposition of property, or before figuring allowable depreciation, you must determine your adjusted basis in that property. Certain events that occur during the period of your ownership may increase or decrease your basis, resulting in an "adjusted basis." Increase your basis by items such as the cost of improvements that add to the value of the property, and decrease it by items such as allowable depreciation and insurance reimbursements for casualty and theft losses.
instructions for Schedule D Capital Gains and Losses Use Schedule D:
Rollover of empowerment zone assets. The election to rollover gain from an empowerment zone asset is no longer available. Other Forms You May Have To File Use Form 8949 to report the sale or exchange of a capital asset (defined later) not reported on another form or schedule. Complete all necessary pages of Form 8949 before you complete line 1b, 2, 3, 8b, 9, or 10 of Schedule D. Use Form 4797 to report the following. The sale or exchange of: Real property used in your trade or business; Depreciable and amortizable tangible property used in your trade or business; Oil, gas, geothermal, or other mineral property; and Section 126 property. The involuntary conversion (other than from casualty or theft) of property used in a trade or business and capital assets held more than 1 year for business or profit. The disposition of noncapital assets other than inventory or property held primarily for sale to customers in the ordinary course of your trade or business. Ordinary loss on the sale, exchange, or worthlessness of small business investment company (section 1242) stock. Ordinary loss on the sale, exchange, or worthlessness of small business (section 1244) stock. Ordinary gain or loss on securities or commodities held in connection with your trading business, if you previously made a mark-to-market election. Use Form 4684 to report involuntary conversions of property due to casualty or theft. Use Form 6781 to report gains and losses from section 1256 contracts and straddles. Use Form 8824 to report like-kind exchanges. A like-kind exchange occurs when you exchange business or investment property for property of a like kind. Use Form 8960 to figure any net investment income tax relating to gains and losses reported on Schedule D, including gains and losses from a securities trading activity. Capital Asset Most property you own and use for personal purposes or investment is a capital asset. For example, your house, furniture, car, stocks, and bonds are capital assets. A capital asset is any property owned by you except the following. Stock in trade or other property included in inventory or held mainly for sale to customers. Accounts or notes receivable: For services rendered in the ordinary course of your trade or business, For services rendered as an employee, or From the sale of stock in trade or other property included in inventory or held mainly for sale to customers. Depreciable property used in your trade or business, even if it is fully depreciated. Real estate used in your trade or business. A copyright; a literary, musical, or artistic composition; a letter or memorandum; or similar property that is: Created by your personal efforts; Prepared or produced for you (in the case of a letter, memorandum, or similar property); or Received under circumstances (such as by gift) that entitle you to the basis of the person who created the property or for whom the property was prepared or produced.
A U.S. Government publication, including the Congressional Record, that you received from the government for less than the normal sales price, or that you received under circumstances that entitle you to the basis of someone who received the publication for less than the normal sales price. Certain commodities derivative financial instruments held by a dealer and connected to the dealer's activities as a dealer. Certain hedging transactions entered into in the normal course of your trade or business. Supplies regularly used in your trade or business. You can elect to treat as capital assets certain musical compositions or copyrights you sold or exchanged. Basis and Recordkeeping Basis is the amount of your investment in property for tax purposes. The basis of property you buy is usually its cost. There are special rules for certain kinds of property, such as inherited property. You need to know your basis to figure any gain or loss on the sale or other disposition of the property. You must keep accurate records that show the basis and, if applicable, adjusted basis of your property. Your records should show the purchase price, including commissions; increases to basis, such as the cost of improvements; and decreases to basis, such as depreciation, nondividend distributions on stock, and stock splits. If you received a Schedule A to Form 8971 from an executor of an estate or other person required to file an estate tax return, you may be required to report a basis consistent with the estate tax value of the property. Expenses (Including Capital Gains and Losses). Short- or Long-Term Gain or Loss Report short-term gains or losses in Part I. Report long-term gains or losses in Part II. The holding period for short-term capital gains and losses is 1 year or less. The holding period for long-term capital gains and losses is more than 1 year. Capital Gain Distributions These distributions are paid by a mutual fund (or other regulated investment company) or real estate investment trust from its net realized long-term capital gains. Distributions of net realized short-term capital gains aren't treated as capital gains. Instead, they are included on Form 1099-DIV as ordinary dividends. Enter on Schedule D, line 13, the total capital gain distributions paid to you during the year, regardless of how long you held your investment. This amount is shown in box 2a of Form 1099-DIV. If there is an amount in box 2b, include that amount on line 11 of the Unrecaptured Section 1250 Gain Worksheet in these instructions if you complete line 19 of Schedule D.
If there is an amount in box 2d, include that amount on line 4 of the 28% Rate Gain Worksheet in these instructions if you complete line 18 of Schedule D. If you received capital gain distributions as a nominee (that is, they were paid to you but actually belong to someone else), report on Schedule D, line 13, only the amount that belongs to you. Attach a statement showing the full amount you received and the amount you received as a nominee. Sale of Your Home You may not need to report the sale or exchange of your main home. If you must report it, complete Form 8949 before Schedule D. Report the sale or exchange of your main home on Form 8949 if: You can't exclude all of your gain from income, or You received a Form 1099-S for the sale or exchange. Any gain you can't exclude is taxable. Generally, if you meet the following two tests, you can exclude up to $250,000 of gain. If both you and your spouse meet these tests and you file a joint return, you can exclude up to $500,000 of gain (but only one spouse needs to meet the ownership requirement in Test 1). Test 1. During the 5-year period ending on the date you sold or exchanged your home, you owned it for 2 years or more (the ownership requirement) and lived in it as your main home for 2 years or more (the use requirement). Test 2. You haven't excluded gain on the sale or exchange of another main home during the 2-year period ending on the date of the sale or exchange of your home. Reduced exclusion. Even if you don't meet one or both of the above two tests, you still can claim an exclusion if you sold or exchanged the home because of a change in place of employment, health, or certain unforeseen circumstances. In this case, the maximum amount of gain you can exclude is reduced. Sale of home by surviving spouse. If your spouse died before the sale or exchange, you can still exclude up to $500,000 of gain if: The sale or exchange is no later than 2 years after your spouse's death; Just before your spouse's death, both spouses met the use requirement of Test 1, at least one spouse met the ownership requirement of Test 1, and both spouses met Test 2; and You didn't remarry before the sale or exchange. Exceptions to Test 1. You can choose to have the 5-year test period for ownership and use in Test 1 suspended during any period you or your spouse serve outside the United States as a Peace Corps volunteer or serve on qualified official extended duty as a member of the uniformed services or Foreign Service of the United States, as an employee of the intelligence community, or outside the United States as an employee of the Peace Corps. This means you may be able to meet Test 1 even if, because of your service, you didn't actually use the home as your main home for at least the required 2 years during the 5-year period ending on the date of sale. The 5-year period can't be extended for more than 10 years. Example. Tamara buys a house in Virginia in 2005 that she uses as her main home for 3 years. For 8 years, from 2008 through 2016, Tamara serves on qualified official extended duty as a member of the uniformed services in Kuwait. In 2017, Tamara sells the house. Tamara didn't use the house as her main home for 2 of the 5 years before the sale. To meet Test 1, Tamara elects to suspend the 5-year test period during her 8-year period of uniformed service in Kuwait. Because that 8-year period won't be counted in determining if she used the house as her main home for 2 of the 5 years before the sale, she meets the ownership and use requirements of Test 1. Qualified extended duty. You are on qualified extended duty if: You are called or ordered to active duty for an indefinite period or for a period of more than 90 days, and You are serving at a duty station at least 50 miles from your main home, or you are living in government quarters under government orders. Sale of home acquired in a like-kind exchange. You can't exclude any gain if: You acquired your home in a like-kind exchange in which all or part of the gain wasn't recognized, and You sold or exchanged the home during the 5-year period beginning on the date you acquired it. How to report the sale of your main home. If you have to report the sale or exchange, report it on Form 8949. If the gain or loss is short term, report it in Part I of Form 8949 with box C checked. If the gain or loss is long term, report it in Part II of Form 8949 with box F checked. If you had a gain and can exclude part or all of it, enter "H" in column (f) of Form 8949. Enter the exclusion as a negative number (in parentheses) in column (g) of Form 8949. If you had a loss but have to report the sale or exchange because you got a Form 1099-S, how to figure and report any taxable gain if: You (or your spouse if married) used any part of the home for business or rental purposes after May 6, 1997, or There was a period of time after 2008 when the home wasn't your main home. Partnership Interests A sale or other disposition of an interest in a partnership may result in ordinary income, collectibles gain (28% rate gain), or unrecaptured section 1250 gain. Capital Assets Held for Personal Use Generally, gain from the sale or exchange of a capital asset held for personal use is a capital gain. Report it on Form 8949 with box C checked (if the transaction is short term) or box F checked (if the transaction is long term). However, if you converted depreciable property to personal use, all or part of the gain on the sale or exchange of that property may have to be recaptured as ordinary income. Use Part III of Form 4797 to figure the amount of ordinary income recapture. The recapture amount is included on line 31 (and line 13) of Form 4797. Don't enter any gain from this property on line 32 of Form 4797. If you aren't completing Part III for any other properties, enter "N/A" on line 32. If the total gain is more than the recapture amount, enter "From Form 4797" in column (a) of Part I of Form 8949 (if the transaction is short term) or Part II of Form 8949 (if the transaction is long term), and skip columns (b) and (c). In column (d) of Form 8949, enter the excess of the total gain over the recapture amount. Leave columns (e) through (g) blank. Complete column (h). Be sure to check box C at the top of Part I or box F at the top of Part II of this Form 8949 (depending on how long you held the asset). Loss from the sale or exchange of a capital asset held for personal use isn't deductible. But if you had a loss from the sale or exchange of real estate held for personal use for which you received a Form 1099-S, you must report the transaction on Form 8949 even though the loss isn't deductible. Example. You have a loss on the sale of a vacation home that isn't your main home and you received a Form 1099-S for the transaction. Report the transaction in Part I or Part II of Form 8949, depending on how long you owned the home. Complete all columns. Because the loss isn't deductible, enter "L" in column (f). Enter the difference between column (d) and column (e) as a positive amount in column (g). Then complete column (h). (For example, if you entered $5,000 in column (d) and $6,000 in column (e), enter $1,000 in column (g). Then enter -0- ($5,000 − $6,000 + $1,000) in column (h). Be sure to check box C at the top of Part I or box F at the top of Part II of this Form 8949 (depending on how long you owned the home).)Capital Losses You can deduct capital losses up to the amount of your capital gains plus $3,000 ($1,500 if married filing separately). You may be able to use capital losses that exceed this limit in future years. For details, see the instructions for line 21. Be sure to report all of your capital gains and losses even if you can't use all of your losses in 2017. Nondeductible Losses Don't deduct a loss from a sale or exchange between certain related parties. This includes a direct or indirect sale or exchange of property between any of the following. Members of a family. A corporation and an individual who directly (or indirectly) owns more than 50% of the corporation's stock (unless the loss is from a distribution in complete liquidation of a corporation). A grantor and a fiduciary of a trust. A fiduciary and a beneficiary of the same trust. A fiduciary of a trust and a fiduciary (or beneficiary) of another trust if both trusts were created by the same grantor. An executor of an estate and a beneficiary of that estate, unless the sale or exchange was to satisfy a pecuniary bequest (that is, a bequest of a sum of money). An individual and a tax-exempt organization controlled directly (or indirectly) by the individual or the individual's family. Report a transaction that results in a nondeductible loss in Part I or Part II of Form 8949 (depending on how long you held the property). Unless you received a Form 1099-B for the sale or exchange, check box C at the top of Part I or box F at the top of Part II of this Form 8949 (depending on how long you owned the property). Complete all columns. Because the loss isn't deductible, enter "L" in column (f). Enter the amount of the nondeductible loss as a positive number in column (g). Complete column (h). Example 1. You sold land you held as an investment for 5 years to your brother for $10,000. Your basis was $15,000. On Part II of Form 8949, check box F at the top. Enter $10,000 on Form 8949, Part II, column (d). Enter $15,000 in column (e). Because the loss isn't deductible, enter "L" in column (f) and $5,000 (the difference between $10,000 and $15,000) in column (g). In column (h), enter -0- ($10,000 − $15,000 + $5,000). If this is your only transaction on this Form 8949, enter $10,000 on Schedule D, line 10, column (d). Enter $15,000 in column (e) and $5,000 in column (g). In column (h), enter -0- ($10,000 − $15,000 + $5,000). Example 2. You received a Form 1099-B showing proceeds (sales price) of $1,000 and basis of $5,000. Box 7 on Form 1099-B is checked, indicating that your loss of $4,000 ($1,000 − $5,000) isn't allowed. On the top of Form 8949, check box A or box B in Part I or box D or box E in Part II (whichever applies). Enter $1,000 in column (d) and $5,000 in column (e). Because the loss isn't deductible, enter "L" in column (f) and $4,000 (the difference between $1,000 and $5,000) in column (g). In column (h), enter -0- ($1,000 − $5,000 + $4,000). At-risk rules. If you disposed of (a) an asset used in an activity to which the at-risk rules apply or (b) any part of your interest in an activity to which the at-risk rules apply, and you have amounts in the activity for which you aren't at risk, see Form 6198. Passive activity rules. If the loss is allowable under the at-risk rules, it may be subject to the passive activity rules. See Form 8582 for details on reporting capital gains and losses from a passive activity. Items for Special Treatment Transactions by a securities dealer. See section 475 and Revenue Ruling 97-39, which begins on page 4 of Internal Revenue Bulletin 1997-39 at IRS.gov/pub/irs-irbs/irb97-39. Bonds and other debt instruments. Certain real estate subdivided for sale that may be considered a capital asset. Gain on the sale of depreciable property to a more than 50%-owned entity or to a trust of which you are a beneficiary. Gain on the disposition of stock in domestic international sales corporations. . Gain on the sale or exchange of stock in certain foreign corporations. Transfer of property to a partnership that would be treated as an investment company if it were incorporated. Sales of stock received under a qualified public utility dividend reinvestment plan. Transfer of appreciated property to a political organization. Transfer of property by a U.S. person to a foreign estate or trust. If you give up your U.S. citizenship, you may be treated as having sold all your property for its fair market value on the day before you gave up your citizenship. This also applies to long-term U.S. residents who cease to be lawful permanent residents. For details, exceptions, and rules for reporting these deemed sales, In general, no gain or loss is recognized on the transfer of property from an individual to a spouse or a former spouse if the transfer is incident to a divorce. Amounts received on the retirement of a debt instrument generally are treated as received in exchange for the debt instrument. Any loss on the disposition of converted wetland or highly erodible cropland that is first used for farming after March 1, 1986, is reported as a long-term capital loss on Form 8949, but any gain is reported as ordinary income on Form 4797. If qualified dividends that you reported on Form 1040, line 9b, or Form 1040NR, line 10b, include extraordinary dividends, any loss on the sale or exchange of the stock is a long-term capital loss to the extent of the extraordinary dividends. An extraordinary dividend is a dividend that equals or exceeds 10% (5% in the case of preferred stock) of your basis in the stock. Amounts received by shareholders in corporate liquidations. Cash received in lieu of fractional shares of stock as a result of a stock split or stock dividend. Load charges to acquire stock in a regulated investment company (including a mutual fund), which may not be taken into account in determining gain or loss on certain dispositions of the stock if reinvestment rights were exercised. The sale or exchange of S corporation stock or an interest in a partnership or trust held for more than 1 year, which may result in collectibles gain (28% rate gain). Gain or loss on the disposition of securities futures contracts. Gain on the constructive sale of certain appreciated financial positions. Certain constructive ownership transactions. Gain in excess of the gain you would have recognized if you had held a financial asset directly during the term of a derivative contract must be treated as ordinary income. If any portion of the constructive ownership transaction was open in any prior year, you may have to pay interest. including how to figure the interest. Include the interest as an additional tax on Form 1040, line 62. Check box c and in the space next to that box, enter "Section 1260(b) interest" and the amount of the interest. If you are filing Form 1040NR, include the interest as an additional tax on line 60. Check box b and, in the space next to that box, enter "Section 1260(b) interest" and the amount of the interest. This interest isn't deductible. Gain or loss from the disposition of stock or other securities in an investment club. Certain virtual currencies, such as Bitcoin. Market Discount Bonds In general, a capital gain from the disposition of a market discount bond is treated as interest income to the extent of accrued market discount as of the date of disposition. Contingent Payment Debt Instruments Any gain recognized on the sale, exchange, or retirement of a taxable contingent payment debt instrument subject to the noncontingent bond method is treated as interest income rather than as capital gain, even if you hold the debt instrument as a capital asset. If you sell a taxable contingent payment debt instrument subject to the noncontingent bond method at a loss, your loss is an ordinary loss to the extent of your prior original issue discount (OID) inclusions on the debt instrument. If the debt instrument is a capital asset, treat any loss that is more than your prior OID inclusions as a capital loss. If you received a Form 1099-B (or substitute statement) reporting the sale of a taxable contingent payment debt instrument subject to the noncontingent bond method and the Ordinary box in box 2 is checked, an adjustment may be required. Report the transaction on Form 8949 and complete the form’s Worksheet for Contingent Payment Debt Instrument Adjustment in Column (g) to figure the adjustment to enter in column (g) of Form 8949.
Wash Sales A wash sale occurs when you sell or otherwise dispose of stock or securities (including a contract or option to acquire or sell stock or securities) at a loss and, within 30 days before or after the sale or disposition, you: Buy substantially identical stock or securities, Acquire substantially identical stock or securities in a fully taxable trade, Enter into a contract or option to acquire substantially identical stock or securities, or Acquire substantially identical stock or securities for your individual retirement arrangement (IRA) or Roth IRA. You can't deduct losses from wash sales unless the loss was incurred in the ordinary course of your business as a dealer in stock or securities. The basis of the substantially identical property (or contract or option to acquire such property) is its cost increased by the disallowed loss (except in the case of (4) above). These wash sale rules don't apply to a redemption of shares in a floating-NAV (net asset value) money market fund. If you received a Form 1099-B (or substitute statement), box 1g of that form generally will show whether there was any nondeductible wash sale loss and its amount if: The stock or securities sold were covered securities (defined in the Instructions for Form 8949, column (e)), and The substantially identical stock or securities you bought had the same CUSIP number as the stock or securities you sold and were bought in the same account as the stock or securities you sold. (CUSIP numbers are security identification numbers.) However, you can't deduct a loss from a wash sale even if it isn't reported on Form 1099-B (or substitute statement). Report a wash sale transaction in Part I or Part II (depending on how long you owned the stock or securities) of Form 8949 with the appropriate box checked. Complete all columns. Enter "W" in column (f). Enter as a positive number in column (g) the amount of the loss not allowed. Traders in Securities You are a trader in securities if you are engaged in the business of buying and selling securities for your own account. To be engaged in business as a trader in securities, all of the following statements must be true. You must seek to profit from daily market movements in the prices of securities and not from dividends, interest, or capital appreciation. Your activity must be substantial. You must carry on the activity with continuity and regularity. The following facts and circumstances should be considered in determining if your activity is a business. Typical holding periods for securities bought and sold. The frequency and dollar amount of your trades during the year. The extent to which you pursue the activity to produce income for a livelihood. The amount of time you devote to the activity. You are considered an investor, and not a trader, if your activity doesn't meet the above definition of a business. It doesn't matter whether you call yourself a trader or a "day trader." Like an investor, a trader generally must report each sale of securities (taking into account commissions and any other costs of acquiring or disposing of the securities) on Form 8949 unless one of the exceptions described in the instructions to Form 8949 applies. However, if a trader previously made the mark-to-market election (explained below), each transaction is reported in Part II of Form 4797 instead of on Form 8949. Regardless of whether a trader reports his or her gains and losses on Form 8949 or Form 4797, the gain or loss from the disposition of securities isn't taken into account when figuring net earnings from self-employment on Schedule SE. The limitation on investment interest expense that applies to investors doesn't apply to interest paid or incurred in a trading business. A trader reports interest expense and other expenses (excluding commissions and other costs of acquiring or disposing of securities) from a trading business on Schedule C (instead of Schedule A). A trader also may hold securities for investment. The rules for investors generally will apply to those securities. Allocate interest and other expenses between your trading business and your investment securities. Mark-To-Market Election for Traders A trader may make an election under section 475(f) to report all gains and losses from securities held in connection with a trading business as ordinary income (or loss), including those from securities held at the end of the year. Securities held at the end of the year are "marked-to-market" by treating them as if they were sold (and reacquired) for fair market value on the last business day of the year. Generally, the election must be made by the due date (not including extensions) of the tax return for the year prior to the year for which the election becomes effective. To be effective for 2017, the election must have been made by the due date of your 2016 return (not counting extensions), April 18, 2017, for most people. The due date for the 2017 election was April 18, instead of April 15, because of the Emancipation Day holiday in the District of Columbia (even if you didn’t live in the District of Columbia). Starting with the year the election becomes effective, a trader reports all gains and losses from securities held in connection with the trading business, including securities held at the end of the year, in Part II of Form 4797. If you previously made the election, If you hold securities for investment, you must identify them as such in your records on the day you acquired them (for example, by holding the securities in a separate brokerage account). Securities that you hold for investment aren't marked-to-market. Short Sales A short sale is a contract to sell property you borrowed for delivery to a buyer. At a later date, you either buy substantially identical property and deliver it to the lender or deliver property that you held but didn't want to transfer at the time of the sale. Example. You think the value of XYZ stock will drop. You borrow 10 shares from your broker and sell them for $100. This is a short sale. You later buy 10 shares for $80 and deliver them to your broker to close the short sale. Your gain is $20 ($100 − $80).Holding period. Usually, your holding period is the amount of time you actually held the property eventually delivered to the broker or lender to close the short sale. However, your gain when closing a short sale is short term if you (a) held substantially identical property for 1 year or less on the date of the short sale, or (b) acquired property substantially identical to the property sold short after the short sale but on or before the date you close the short sale. If you held substantially identical property for more than 1 year on the date of a short sale, any loss realized on the short sale is a long-term capital loss, even if the property used to close the short sale was held 1 year or less. Reporting a short sale. Report any short sale on Form 8949 in the year it closes. If a short sale closed in 2017 but you didn't get a 2017 Form 1099-B (or substitute statement) for it because you entered into it before 2011, report it on Form 8949 in Part I with box C checked or Part II with box F checked (whichever applies). In column (a), enter (for example) "100 sh. XYZ Co.—2010 short sale closed." Fill in the other columns according to their instructions. Report the short sale the same way if you received a 2017 Form 1099-B (or substitute statement) that doesn't show proceeds (sales price). Gain or Loss From Options Report on Form 8949 gain or loss from the closing or expiration of an option that isn't a section 1256 contract but is a capital asset in your hands. If an option you purchased expired, enter the expiration date in column (c) and enter "EXPIRED" in column (d). If an option that was granted (written) expired, enter the expiration date in column (b) and enter "EXPIRED" in column (e). Fill in the other columns according to their instructions. If a call option you sold after 2013 was exercised, the option premium you received will be reflected in the proceeds shown in box 1d of the Form 1099-B (or substitute statement) you received. If you sold the call option before 2014, the option premium you received may not be reflected on Form 1099-B. If it isn't, enter the premium as a positive number in column (g) of Form 8949. Enter "E" in column (f). Example. For $10 in 2013, you sold Joe an option to buy one share of XYZ stock for $80. Joe later exercised the option. The Form 1099-B you get shows the proceeds to be $80. Enter $80 in column (d) of Form 8949. Enter "E" in column (f) and $10 in column (g). Complete the other columns according to the instructions. NAV Method for Money Market Funds If you have a capital gain or loss determined under the net asset value (NAV) method with respect to shares in a NAV money market fund, report the capital gain or loss on Form 8949, Part I, with box C checked. Enter the name of each fund followed by “(NAV)” in column (a). Enter the net gain or loss in column (h). Leave all other columns blank. Undistributed Capital Gains Include on Schedule D, line 11, the amount from box 1a of Form 2439. This represents your share of the undistributed long-term capital gains of the regulated investment company (including a mutual fund) or real estate investment trust. If there is an amount in box 1b, include that amount on line 11 of the Unrecaptured Section 1250 Gain Worksheet if you complete line 19 of Schedule D.
If there is an amount in box 1d, include that amount on line 4 of the 28% Rate Gain Worksheet if you complete line 18 of Schedule D. Include on Form 1040, line 73, or Form 1040NR, line 69, the tax paid as shown in box 2 of Form 2439. Also check the box for Form 2439. Add to the basis of your stock the excess of the amount included in income over the amount of the credit for the tax paid. S Installment Sales If you sold property (other than publicly traded stocks or securities) at a gain and you will receive a payment in a tax year after the year of sale, you generally must report the sale on the installment method unless you elect not to. Use Form 6252 to report the sale on the installment method. Also use Form 6252 to report any payment received in 2017 from a sale made in an earlier year that you reported on the installment method. To elect out of the installment method, report the full amount of the gain on Form 8949 on a timely filed return (including extensions) for the year of the sale. If your original return was filed on time, you can make the election on an amended return filed no later than 6 months after the due date of your return (excluding extensions). Write "Filed pursuant to section 301.9100-2" at the top of the amended return. Demutualization of Life Insurance Companies Demutualization of a life insurance company occurs when a mutual life insurance company changes to a stock company. If you were a policyholder or annuitant of the mutual company, you may have received either stock in the stock company or cash in exchange for your equity interest in the mutual company. If the demutualization transaction qualifies as a tax-free reorganization, no gain or loss is recognized on the exchange of your equity interest in the mutual company for stock. The company can advise you if the transaction is a tax-free reorganization. Your holding period for the new stock includes the period you held an equity interest in the mutual company. If you received cash in exchange for your equity interest, you must recognize any capital gain. If you held the equity interest for more than 1 year, report the gain as a long-term capital gain in Part II of Form 8949. If you held the equity interest for 1 year or less, report the gain as a short-term capital gain in Part I of Form 8949. Be sure the appropriate box is checked at the top of Form 8949. If the demutualization transaction doesn't qualify as a tax-free reorganization, you must recognize a capital gain or loss. If you held the equity interest for more than 1 year, report the gain or loss as a long-term capital gain or loss in Part II of Form 8949. If you held the equity interest for 1 year or less, report the gain or loss as a short-term capital gain or loss in Part I of Form 8949. Be sure the appropriate box is checked at the top of Form 8949. Your holding period for the new stock begins on the day after you received the stock. Small Business (Section 1244) Stock Report an ordinary loss from the sale, exchange, or worthlessness of small business (section 1244) stock on Form 4797. However, if the total loss is more than the maximum amount that can be treated as an ordinary loss for the year ($50,000 or, on a joint return, $100,000), also report the transaction on Form 8949 as follows. In column (a), enter "Capital portion of section 1244 stock loss." Complete columns (b) and (c) as you normally would. In column (d), enter the entire sales price of the stock sold. In column (e), enter the entire basis of the stock sold. Enter "S" in column (f). See the instructions for Form 8949, columns (f), (g), and (h). In column (g), enter the loss you claimed on Form 4797 for this transaction. Enter it as a positive number. Complete column (h) according to its instructions. Report the transaction in Part I or Part II of Form 8949 (depending on how long you held the stock) with the appropriate box checked. Example. You sold section 1244 stock for $1,000. Your basis was $60,000. You had held the stock for 3 years. You can claim $50,000 of your loss as an ordinary loss on Form 4797. To claim the rest of the loss on Form 8949, check the appropriate box at the top. Enter $1,000 on Form 8949, Part II, column (d). Enter $60,000 in column (e). Enter "S" in column (f) and $50,000 (the ordinary loss claimed on Form 4797) in column (g). In column (h), enter ($9,000) ($1,000 − $60,000 + $50,000). Put it in parentheses to show it is a negative amount.Exclusion of Gain on Qualified Small Business (QSB) Stock Section 1202 allows you to exclude a portion of the eligible gain on the sale or exchange of QSB stock. The section 1202 exclusion applies only to QSB stock held for more than 5 years. If you acquired the QSB stock on or before February 17, 2009, you can exclude up to 50% of the qualified gain. However, you can exclude up to 60% of the qualified gain on certain empowerment zone business stock. If you acquired the QSB stock after February 17, 2009, and before September 28, 2010, you can exclude up to 75% of the qualified gain. If you acquired the QSB stock after September 27, 2010, you can exclude up to 100% of the qualified gain. To be QSB stock, the stock must meet all of the following tests. It must be stock in a C corporation (that is, not S corporation stock). It must have been originally issued after August 10, 1993. As of the date the stock was issued, the corporation was a domestic C corporation with total gross assets of $50 million or less (a) at all times after August 9, 1993, and before the stock was issued, and (b) immediately after the stock was issued. Gross assets include those of any predecessor of the corporation. All corporations that are members of the same parent-subsidiary controlled group are treated as one corporation. You must have acquired the stock at its original issue (either directly or through an underwriter), either in exchange for money or other property (other than stock) or as pay for services (other than as an underwriter) to the corporation. In certain cases, you may meet this test if you acquired the stock from another person who met the test (such as by gift or inheritance) or through a conversion or exchange of QSB stock you held. During substantially all the time you held the stock: The corporation was a C corporation, At least 80% of the value of the corporation's assets were used in the active conduct of one or more qualified businesses (defined next), and The corporation wasn't a foreign corporation, DISC, former DISC, regulated investment company, real estate investment trust, REMIC, FASIT, cooperative, or a corporation that has made (or that has a subsidiary that has made) a section 936 election. SSBIC. A specialized small business investment company (SSBIC) is treated as having met test 5b. Definition of qualified business. A qualified business is any business that isn't one of the following. A business involving services performed in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, or brokerage services. A business whose principal asset is the reputation or skill of one or more employees. A banking, insurance, financing, leasing, investing, or similar business. A farming business (including the raising or harvesting of trees). A business involving the production of products for which percentage depletion can be claimed. A business of operating a hotel, motel, restaurant, or similar business. For more details about limits and additional requirements that may apply, Acquisition date of stock acquired after February 17, 2009. When you are determining whether your exclusion is limited to 50%, 75%, or 100% of the gain from QSB stock, your acquisition date is considered to be the first day you held the stock (determined after applying the holding period rules in section 1223). Empowerment Zone Business Stock You generally can exclude up to 60% of your gain from the sale or exchange of QSB stock held for more than 5 years if you meet the following additional requirements. The stock you sold or exchanged was stock in a corporation that qualified as an empowerment zone business during substantially all of the time you held the stock. You acquired the stock after December 21, 2000, and before February 18, 2009. Requirement 1 will still be met if the corporation ceased to qualify after the 5-year period that began on the date you acquired the stock. However, the gain that qualifies for the 60% exclusion can't be more than the gain you would have had if you had sold the stock on the date the corporation ceased to qualify. Stock acquired after February 17, 2009. You can exclude up to 75% of your gain if you acquired the stock after February 17, 2009, and before September 28, 2010. You can exclude up to 100% of your gain if you acquired the stock after September 27, 2010. Pass-Through Entities If you held an interest in a pass-through entity (a partnership, S corporation, common trust fund, or mutual fund or other regulated investment company) that sold QSB stock, to qualify for the exclusion you must have held the interest on the date the pass-through entity acquired the QSB stock and at all times thereafter until the stock was sold. How To Report Report the sale or exchange of the QSB stock on Form 8949, Part II, with the appropriate box checked, as you would if you weren't taking the exclusion. Then enter "Q" in column (f) and enter the amount of the excluded gain as a negative number in column (g). Put it in parentheses to show it is negative. See the instructions for Form 8949, columns (f), (g), and (h). Complete all remaining columns. If you are completing line 18 of Schedule D, enter as a positive number the amount of your allowable exclusion on line 2 of the 28% Rate Gain Worksheet; if you excluded 60% of the gain, enter 2/3 of the exclusion; if you excluded 75% of the gain, enter 1/3 of the exclusion; if you excluded 100% of the gain, don't enter an amount. Gain from Form 1099-DIV. If you received a Form 1099-DIV with a gain in box 2c, part or all of that gain (which is also included in box 2a) may be eligible for the section 1202 exclusion. Report the total gain (box 2a) on Schedule D, line 13. In column (a) of Form 8949, Part II, enter the name of the corporation whose stock was sold. In column (f), enter "Q" and in column (g) enter the amount of the excluded gain as a negative number. See the instructions for Form 8949, columns (f), (g), and (h). If you are completing line 18 of Schedule D, enter as a positive number the amount of your allowable exclusion on line 2 of the 28% Rate Gain Worksheet; if you excluded 60% of the gain, enter 2/3 of the exclusion; if you excluded 75% of the gain, enter 1/3 of the exclusion; if you excluded 100% of the gain, don't enter an amount. Gain from Form 2439. If you received a Form 2439 with a gain in box 1c, part or all of that gain (which is also included in box 1a) may be eligible for the section 1202 exclusion. Report the total gain (box 1a) on Schedule D, line 11. In column (a) of Form 8949, Part II, enter the name of the corporation whose stock was sold. In column (f), enter "Q" and in column (g) enter the amount of the excluded gain as a negative number. See the instructions for Form 8949, columns (f), (g), and (h). If you are completing line 18 of Schedule D, enter as a positive number the amount of your allowable exclusion on line 2 of the 28% Rate Gain Worksheet; if you excluded 60% of the gain, enter 2/3 of the exclusion; if you excluded 75% of the gain, enter 1/3 of the exclusion; if you excluded 100% of the gain, don't enter an amount. Gain from an installment sale of QSB stock. If all payments aren't received in the year of sale, a sale of QSB stock that isn't traded on an established securities market generally is treated as an installment sale and is reported on Form 6252. Report the long-term gain from Form 6252 on Schedule D, line 11. Figure the allowable section 1202 exclusion for the year by multiplying the total amount of the exclusion by a fraction, the numerator of which is the amount of eligible gain to be recognized for the tax year and the denominator of which is the total amount of eligible gain. In column (a) of Form 8949, Part II, enter the name of the corporation whose stock was sold. In column (f), enter "Q" and in column (g) enter the amount of the allowable exclusion for the year as a negative number. See the instructions for Form 8949, columns (f), (g), and (h). If you are completing line 18 of Schedule D, enter as a positive number the amount of your allowable exclusion for the year on line 2 of the 28% Rate Gain Worksheet; if you excluded 60% of the gain, enter 2/3 of the allowable exclusion for the year; if you excluded 75% of the gain, enter 1/3 of the allowable exclusion for the year; if you excluded 100% of the gain, don't enter an amount. Alternative minimum tax. If you qualify for the 50%, 60%, or 75% exclusion, enter 7% of your allowable exclusion for the year on line 13 of Form 6251. If you qualify for the 100% exclusion, leave line 13 of Form 6251 blank. Rollover of Gain From QSB Stock If you sold QSB stock (defined earlier) that you held for more than 6 months, you can elect to postpone gain if you buy other QSB stock during the 60-day period that began on the date of the sale. A pass-through entity also can make the election to postpone gain. The benefit of the postponed gain applies to your share of the entity's postponed gain if you held an interest in the entity for the entire period the entity held the QSB stock. If a pass-through entity sold QSB stock held for more than 6 months and you held an interest in the entity for the entire period the entity held the stock, you also can elect to postpone gain if you, rather than the pass-through entity, buy the replacement QSB stock within the 60-day period. If you were a partner in a partnership that sold or bought QSB stock, see box 11 of the Schedule K-1 (Form 1065) sent to you by the partnership and Regulations section 1.1045-1. You must recognize gain to the extent the sale proceeds are more than the cost of the replacement stock. Reduce the basis of the replacement stock by any postponed gain. You must make the election no later than the due date (including extensions) for filing your tax return for the tax year in which the QSB stock was sold. If your original return was filed on time, you can make the election on an amended return filed no later than 6 months after the due date of your return (excluding extensions). Write "Filed pursuant to section 301.9100-2" at the top of the amended return. To make the election, report the sale in Part I or Part II (depending on how long you, or the pass-through entity, if applicable, owned the stock) of Form 8949 as you would if you weren't making the election. Then enter "R" in column (f). Enter the amount of the postponed gain as a negative number in column (g). Put it in parentheses to show it is negative. Exclusion of Gain From DC Zone Assets If you sold or exchanged a District of Columbia Enterprise Zone (DC Zone) asset that you acquired after 1997 and before 2012 and held for more than 5 years, you may be able to exclude the amount of qualified capital gain that you would otherwise include in income. The exclusion applies to an interest in, or property of, certain businesses operating in the District of Columbia. DC Zone asset. A DC Zone asset is any of the following. DC Zone business stock. DC Zone partnership interest. DC Zone business property. Qualified capital gain. Qualified capital gain is any gain recognized on the sale or exchange of a DC Zone asset that is a capital asset or property used in a trade or business. It doesn't include any of the following gains. Gain attributable to periods after December 31, 2016. Gain treated as ordinary income under section 1245. Section 1250 gain figured as if section 1250 applied to all depreciation rather than the additional depreciation. Gain attributable to real property, or an intangible asset, that isn't an integral part of a DC Zone business. Gain from a related-party transaction.
How to report. Report the sale or exchange of DC Zone business stock or a DC Zone partnership interest on Form 8949, Part II, as you would if you weren't taking the exclusion. Then enter "X" in column (f). Enter the amount of the exclusion as a negative number in column (g). Put it in parentheses to show it is negative. See the instructions for Form 8949, columns (f), (g), and (h). Complete all remaining columns. Report the sale or exchange of DC Zone business property on Form 4797. Exclusion of Gain From Qualified Community Assets If you sold or exchanged a qualified community asset that you acquired after 2001 and before 2010 and held for more than 5 years, you may be able to exclude the qualified capital gain that you would otherwise include in income. The exclusion applies to an interest in, or property of, certain renewal community businesses. Qualified community asset. A qualified community asset is any of the following. Qualified community stock. Qualified community partnership interest. Qualified community business property. Qualified capital gain. Qualified capital gain is any gain recognized on the sale or exchange of a qualified community asset but doesn't include any of the following. Gain attributable to periods after December 31, 2014. Gain treated as ordinary income under section 1245. Section 1250 gain figured as if section 1250 applied to all depreciation rather than the additional depreciation. Gain attributable to real property, or an intangible asset, that isn't an integral part of a renewal community business. Gain from a related-party transaction.
How to report. Report the sale or exchange of qualified community stock or a qualified community partnership interest on Form 8949, Part II, with the appropriate box checked, as you would if you weren't taking the exclusion. Then enter "X" in column (f) and enter the amount of the exclusion as a negative number in column (g). Put it in parentheses to show it is negative. Report the sale or exchange of qualified community business property on Form 4797. Rollover of Gain From Publicly Traded Securities You can postpone all or part of any gain from the sale of publicly traded securities by buying common stock or a partnership interest in a specialized small business investment company during the 60-day period that began on the date of the sale. Rollover of Gain From Stock Sold to ESOPs or Certain Cooperatives You can postpone all or part of any gain from the sale of qualified securities, held for at least 3 years, to an employee stock ownership plan (ESOP) or eligible worker-owned cooperative, if you buy qualified replacement property. Specific Instructions Rounding Off to Whole Dollars You can round off cents to whole dollars on your Schedule D. If you do round to whole dollars, you must round all amounts. To round, drop amounts under 50 cents and increase amounts from 50 to 99 cents to the next dollar. For example, $1.39 becomes $1 and $2.50 becomes $3. If you have to add two or more amounts to figure the amount to enter on a line, include cents when adding the amounts and round off only the total. Capital Loss Carryover Worksheet—Lines 6 and 14 Use this worksheet to figure your capital loss carryovers from 2016 to 2017 if your 2016 Schedule D, line 21, is a loss and (a) that loss is a smaller loss than the loss on your 2016 Schedule D, line 16, or (b) the amount on your 2016 Form 1040, line 41 (or your 2016 Form 1040NR, line 39, if applicable) is less than zero. Otherwise, you don't have any carryovers. If you and your spouse once filed a joint return and are filing separate returns for 2017, any capital loss carryover from the joint return can be deducted only on the return of the spouse who actually had the loss.
1. Enter the amount from your 2016 Form 1040, line 41, or your 2016 Form 1040NR, line 39. If a loss, enclose the amount in parentheses 1. 2. Enter the loss from your 2016 Schedule D, line 21, as a positive amount 2. 3. Combine lines 1 and 2. If zero or less, enter -0- 3. 4. Enter the smaller of line 2 or line 3 4. If line 7 of your 2016 Schedule D is a loss, go to line 5; otherwise, enter -0- on line 5 and go to line 9. 5. Enter the loss from your 2016 Schedule D, line 7, as a positive amount 5. 6. Enter any gain from your 2016 Schedule D, line 15. If a loss, enter -0- 6. 7. Add lines 4 and 6 7. 8. Short-term capital loss carryover for 2017. Subtract line 7 from line 5. If zero or less, enter -0-. If more than zero, also enter this amount on Schedule D, line 6 8. If line 15 of your 2016 Schedule D is a loss, go to line 9; otherwise, skip lines 9 through 13. 9. Enter the loss from your 2016 Schedule D, line 15, as a positive amount 9. 10. Enter any gain from your 2016 Schedule D, line 7. If a loss, enter -0- 10. 11. Subtract line 5 from line 4. If zero or less, enter -0- 11. 12. Add lines 10 and 11 12. 13. Long-term capital loss carryover for 2017. Subtract line 12 from line 9. If zero or less, enter -0-. If more than zero, also enter this amount on Schedule D, line 14 13. Lines 1a and 8a— Transactions Not Reported on Form 8949 You can report on line 1a (for short-term transactions) or line 8a (for long-term transactions) the aggregate totals from any transactions (except sales of collectibles) for which: You received a Form 1099-B (or substitute statement) that shows basis was reported to the IRS and doesn't show any adjustments in box 1f or 1g, The Ordinary box in box 2 isn’t checked, and You don't need to make any adjustments to the basis or type of gain or loss reported on Form 1099-B (or substitute statement), or to your gain or loss.
If you choose to report these transactions on lines 1a and 8a, don't report them on Form 8949. You don't need to attach a statement to explain the entries on lines 1a and 8a and, if you e-file your return, you don't need to file Form 8453. Figure gain or loss on each line. Subtract the cost or other basis in column (e) from the proceeds (sales price) in column (d). Enter the gain or loss in column (h). Enter negative amounts in parentheses. Example 1 — basis reported to the IRS. You received a Form 1099-B reporting the sale of stock you held for 3 years. It shows proceeds (in box 1d) of $6,000 and cost or other basis (in box 1e) of $2,000. Box 3 is checked, meaning that basis was reported to the IRS. You don't need to make any adjustments to the amounts reported on Form 1099-B or enter any codes. This was your only 2017 transaction. Instead of reporting this transaction on Form 8949, you can enter $6,000 on Schedule D, line 8a, column (d), $2,000 in column (e), and $4,000 ($6,000 − $2,000) in column (h). If you had a second transaction that was the same except that the proceeds were $5,000 and the basis was $3,000, combine the two transactions. Enter $11,000 ($6,000 + $5,000) on Schedule D, line 8a, column (d), $5,000 ($2,000 + $3,000) in column (e), and $6,000 ($11,000 − $5,000) in column (h). Example 2 — basis not reported to the IRS. You received a Form 1099-B showing proceeds (in box 1d) of $6,000 and cost or other basis (in box 1e) of $2,000. Box 3 isn't checked, meaning that basis wasn't reported to the IRS. Don't report this transaction on line 1a or line 8a. Instead, report the transaction on Form 8949. Complete all necessary pages of Form 8949 before completing line 1b, 2, 3, 8b, 9, or 10 of Schedule D. Example 3 — adjustment. You received a Form 1099-B showing proceeds (in box 1d) of $6,000 and cost or other basis (in box 1e) of $2,000. Box 3 is checked, meaning that basis was reported to the IRS. However, the basis shown in box 1e is incorrect. Don't report this transaction on line 1a or line 8a. Instead, report the transaction on Form 8949. Lines 1b, 2, 3, 8b, 9, and 10, Column (h)—Transactions Reported on Form 8949 Figure gain or loss on each line. First, subtract the cost or other basis in column (e) from the proceeds (sales price) in column (d). Then combine the result with any adjustments in column (g). Enter the gain or loss in column (h). Enter negative amounts in parentheses. Example 1 — gain. Column (d) is $6,000 and column (e) is $2,000. Enter $4,000 in column (h). Example 2 — loss. Column (d) is $6,000 and column (e) is $8,000. Enter ($2,000) in column (h). Example 3 — adjustment. Column (d) is $6,000, column (e) is $2,000, and column (g) is ($1,000). Enter $3,000 ($6,000 − $2,000 − $1,000) in column (h). Line 13
Line 18 If you checked "Yes" on line 17, complete the 28% Rate Gain Worksheet in these instructions if either of the following apply for 2017. You reported in Part II of Form 8949 a section 1202 exclusion from the eligible gain on qualified small business stock You reported in Part II of Form 8949 a collectibles gain or (loss). A collectibles gain or (loss) is any long-term gain or deductible long-term loss from the sale or exchange of a collectible that is a capital asset. Collectibles include works of art, rugs, antiques, metals (such as gold, silver, and platinum bullion), gems, stamps, coins, alcoholic beverages, and certain other tangible property. Include on the worksheet any gain (but not loss) from the sale or exchange of an interest in a partnership, S corporation, or trust held for more than 1 year and attributable to unrealized appreciation of collectibles. Also, attach the statement required under Regulations section 1.1(h)-1(e). 28% Rate Gain Worksheet—Line 18 1. Enter the total of all collectibles gain or (loss) from items you reported on Form 8949, Part II 1. 2. Enter as a positive number the total of: Any section 1202 exclusion you reported in column (g) of Form 8949, Part II, with code "Q" in column (f), that is 50% of the gain; 2/3 of any section 1202 exclusion you reported in column (g) of Form 8949, Part II, with code "Q" in column (f), that is 60% of the gain; and 1/3 of any section 1202 exclusion you reported in column (g) of Form 8949, Part II, with code "Q" in column (f), that is 75% of the gain. Don’t make an entry for any section 1202 exclusion that is 100% of the gain. 2. 3. Enter the total of all collectibles gain or (loss) from Form 4684, line 4 (but only if Form 4684, line 15, is more than zero); Form 6252; Form 6781, Part II; and Form 8824 3. 4. Enter the total of any collectibles gain reported to you on: Form 1099-DIV, box 2d; Form 2439, box 1d; and Schedule K-1 from a partnership, S corporation, estate, or trust. 4. 5. Enter your long-term capital loss carryovers from Schedule D, line 14, and Schedule K-1 (Form 1041), box 11, code C 5. ( ) 6. If Schedule D, line 7, is a (loss), enter that (loss) here. Otherwise, enter -0- 6. ( ) 7. Combine lines 1 through 6. If zero or less, enter -0-. If more than zero, also enter this amount on Schedule D, line 18 7. Line 19 If you checked "Yes" on line 17, complete the Unrecaptured Section 1250 Gain Worksheet in these instructions if any of the following apply for 2017. You sold or otherwise disposed of section 1250 property (generally, real property that you depreciated) held more than 1 year. You received installment payments for section 1250 property held more than 1 year for which you are reporting gain on the installment method. You received a Schedule K-1 from an estate or trust, partnership, or S corporation that shows "unrecaptured section 1250 gain." You received a Form 1099-DIV or Form 2439 from a real estate investment trust or regulated investment company (including a mutual fund) that reports "unrecaptured section 1250 gain." You reported a long-term capital gain from the sale or exchange of an interest in a partnership that owned section 1250 property. Instructions for the Unrecaptured Section 1250 Gain Worksheet Lines 1 through 3. If you had more than one property described on line 1, complete lines 1 through 3 for each property on a separate worksheet. Enter the total of the line 3 amounts for all properties on line 3 and go to line 4. Line 4. To figure the amount to enter on line 4, follow the steps below for each installment sale of trade or business property held more than 1 year. Step 1. Figure the smaller of (a) the depreciation allowed or allowable, or (b) the total gain for the sale. This is the smaller of line 22 or line 24 of your 2017 Form 4797 (or the comparable lines of Form 4797 for the year of sale) for the property. Step 2. Reduce the amount figured in Step 1 by any section 1250 ordinary income recapture for the sale. This is the amount from line 26g of your 2017 Form 4797 (or the comparable line of Form 4797 for the year of sale) for the property. The result is your total unrecaptured section 1250 gain that must be allocated to the installment payments received from the sale. Step 3. Generally, the entire amount of gain from the sale of trade or business property included in each installment payment is treated as unrecaptured section 1250 gain until the total unrecaptured section 1250 gain figured in Step 2 has been used in full. Figure the amount of gain treated as unrecaptured section 1250 gain for installment payments received in 2017 as the smaller of (a) the amount from line 26 or line 37 of your 2017 Form 6252, whichever applies, or (b) the amount of unrecaptured section 1250 gain remaining to be reported. This amount is generally the total unrecaptured section 1250 gain for the sale reduced by all gain reported in prior years (excluding section 1250 ordinary income recapture). However, if you chose not to treat all of the gain from payments received after May 6, 1997, and before August 24, 1999, as unrecaptured section 1250 gain, use only the amount you chose to treat as unrecaptured section 1250 gain for those payments to reduce the total unrecaptured section 1250 gain remaining to be reported for the sale. Include this amount on line 4. Unrecaptured Section 1250 Gain Worksheet—Line 19 If you aren't reporting a gain on Form 4797, line 7, skip lines 1 through 9 and go to line 10. 1. If you have a section 1250 property in Part III of Form 4797 for which you made an entry in Part I of Form 4797 (but not on Form 6252), enter the smaller of line 22 or line 24 of Form 4797 for that property. If you didn't have any such property, go to line 4. If you had more than one such property, see instructions 1. 2. Enter the amount from Form 4797, line 26g, for the property for which you made an entry on line 1 2. 3. Subtract line 2 from line 1 3. 4. Enter the total unrecaptured section 1250 gain included on line 26 or line 37 of Form(s) 6252 from installment sales of trade or business property held more than 1 year 4. 5. Enter the total of any amounts reported to you on a Schedule K-1 from a partnership or an S corporation as "unrecaptured section 1250 gain" 5. 6. Add lines 3 through 5 6. 7. Enter the smaller of line 6 or the gain from Form 4797, line 7 7. 8. Enter the amount, if any, from Form 4797, line 8 8. 9. Subtract line 8 from line 7. If zero or less, enter -0- 9. 10. Enter the amount of any gain from the sale or exchange of an interest in a partnership attributable to unrecaptured section 1250 gain 10. 11. Enter the total of any amounts reported to you as "unrecaptured section 1250 gain" on a Schedule K-1, Form 1099-DIV, or Form 2439 from an estate, trust, real estate investment trust, or mutual fund (or other regulated investment company) or in connection with a Form 1099-R 11. 12. Enter the total of any unrecaptured section 1250 gain from sales (including installment sales) or other dispositions of section 1250 property held more than 1 year for which you didn't make an entry in Part I of Form 4797 for the year of sale 12. 13. Add lines 9 through 12 13. 14. If you had any section 1202 gain or collectibles gain or (loss), enter the total of lines 1 through 4 of the 28% Rate Gain Worksheet. Otherwise, enter -0- 14. 15. Enter the (loss), if any, from Schedule D, line 7. If Schedule D, line 7, is zero or a gain, enter -0- 15. ( ) 16. Enter your long-term capital loss carryovers from Schedule D, line 14, and Schedule K-1 (Form 1041), box 11, code C* 16. ( ) 17. Combine lines 14 through 16. If the result is a (loss), enter it as a positive amount. If the result is zero or a gain, enter -0- 17. 18. Unrecaptured section 1250 gain. Subtract line 17 from line 13. If zero or less, enter -0-. If more than zero, enter the result here and on Schedule D, line 19 18. *If you are filing Form 2555 or 2555-EZ (relating to foreign earned income), Line 10. Include on line 10 your share of the partnership's unrecaptured section 1250 gain that would result if the partnership had transferred all of its section 1250 property in a fully taxable transaction immediately before you sold or exchanged your interest in that partnership. If you recognized less than all of the realized gain, the partnership will be treated as having transferred only a proportionate amount of each section 1250 property. For details, see Regulations section 1.1(h)-1. Also attach the statement required under Regulations section 1.1(h)-1(e). Line 12. An example of an amount to include on line 12 is unrecaptured section 1250 gain from the sale of a vacation home you previously used as a rental property but converted to personal use prior to the sale. To figure the amount to enter on line 12, follow the applicable instructions below. Installment sales. To figure the amount to include on line 12, follow the steps below for each installment sale of property held more than 1 year for which you didn't make an entry in Part I of your Form 4797 for the year of sale. Step 1. Figure the smaller of (a) the depreciation allowed or allowable, or (b) the total gain for the sale. This is the smaller of line 22 or line 24 of your 2017 Form 4797 (or the comparable lines of Form 4797 for the year of sale) for the property. Step 2. Reduce the amount figured in step 1 by any section 1250 ordinary income recapture for the sale. This is the amount from line 26g of your 2017 Form 4797 (or the comparable line of Form 4797 for the year of sale) for the property. The result is your total unrecaptured section 1250 gain that must be allocated to the installment payments received from the sale. Step 3. Generally, the amount of capital gain on each installment payment is treated as unrecaptured section 1250 gain until the total unrecaptured section 1250 gain figured in step 2 has been used in full. Figure the amount of gain treated as unrecaptured section 1250 gain for installment payments received in 2017 as the smaller of (a) the amount from line 26 or line 37 of your 2017 Form 6252, whichever applies, or (b) the amount of unrecaptured section 1250 gain remaining to be reported. This amount is generally the total unrecaptured section 1250 gain for the sale reduced by all gain reported in prior years (excluding section 1250 ordinary income recapture). However, if you chose not to treat all of the gain from payments received after May 6, 1997, and before August 24, 1999, as unrecaptured section 1250 gain, use only the amount you chose to treat as unrecaptured section 1250 gain for those payments to reduce the total unrecaptured section 1250 gain remaining to be reported for the sale. Include this amount on line 12. Other sales or dispositions of section 1250 property. For each sale of property held more than 1 year (for which you didn't make an entry in Part I of Form 4797), figure the smaller of (a) the depreciation allowed or allowable, or (b) the total gain for the sale. This is the smaller of line 22 or line 24 of Form 4797 for the property. Next, reduce that amount by any section 1250 ordinary income recapture for the sale. This is the amount from line 26g of Form 4797 for the property. The result is the total unrecaptured section 1250 gain for the sale. Include this amount on line 12. Line 21 You have a capital loss carryover from 2017 to 2018 if you have a loss on line 16 and either: That loss is more than the loss on line 21, or The amount on Form 1040, line 41 (or Form 1040NR, line 39, if applicable), is less than zero. To figure any capital loss carryover to 2018, you will use the Capital Loss Carryover Worksheet in the 2018 Instructions for Schedule D. If you want to figure your carryover to 2018 now, You will need a copy of your 2017 Form 1040 and Schedule D to figure your capital loss carryover to 2018. Schedule D Tax Worksheet Complete this worksheet only if line 18 or line 19 of Schedule D is more than zero and lines 15 and 16 of Schedule D are gains. Otherwise, complete the Qualified Dividends and Capital Gain Tax Worksheet in the instructions for Form 1040, line 44 (or in the instructions for Form 1040NR, line 42) to figure your tax. Before completing this worksheet, complete Form 1040 through line 43 (or Form 1040NR through line 41). Exception: Don’t use the Qualified Dividends and Capital Gain Tax Worksheet or this worksheet to figure your tax if: Line 15 or line 16 of Schedule D is zero or less and you have no qualified dividends on Form 1040, line 9b (or Form 1040NR, line 10b); or Form 1040, line 43 (or Form 1040NR, line 41) is zero or less.
1. Enter your taxable income from Form 1040, line 43 (or Form 1040NR, line 41). (However, if you are filing Form 2555 or 2555-EZ (relating to foreign earned income), enter instead the amount from line 3 of the Foreign Earned Income Tax Worksheet in the instructions for Form 1040, line 44) 1. 2. Enter your qualified dividends from Form 1040, line 9b (or Form 1040NR, line 10b) 2. 3. Enter the amount from Form 4952 (used to figure investment interest expense deduction), line 4g 3. 4. Enter the amount from Form 4952, line 4e* 4. 5. Subtract line 4 from line 3. If zero or less, enter -0- 5. 6. Subtract line 5 from line 2. If zero or less, enter -0-** 6. 7. Enter the smaller of line 15 or line 16 of Schedule D 7. 8. Enter the smaller of line 3 or line 4 8. 9. Subtract line 8 from line 7. If zero or less, enter -0-** 9. 10. Add lines 6 and 9 10. 11. Add lines 18 and 19 of Schedule D** 11. 12. Enter the smaller of line 9 or line 11 12. 13. Subtract line 12 from line 10 13. 14. Subtract line 13 from line 1. If zero or less, enter -0- 14. 15. Enter: • $37,950 if single or married filing separately; • $75,900 if married filing jointly or qualifying widow(er); or • $50,800 if head of household 15. 16. Enter the smaller of line 1 or line 15 16. 17. Enter the smaller of line 14 or line 16 17. 18. Subtract line 10 from line 1. If zero or less, enter -0- 18. 19. Enter the larger of line 17 or line 18 19. 20. Subtract line 17 from line 16. This amount is taxed at 0%. 20. If lines 1 and 16 are the same, skip lines 21 through 41 and go to line 42. Otherwise, go to line 21. 21. Enter the smaller of line 1 or line 13 21. 22. Enter the amount from line 20 (if line 20 is blank, enter -0-) 22. 23. Subtract line 22 from line 21. If zero or less, enter -0- 23. 24. Enter: • $418,400 if single; • $235,350 if married filing separately; • $470,700 if married filing jointly or qualifying widow(er); or • $444,550 if head of household 24. 25. Enter the smaller of line 1 or line 24 25. 26. Add lines 19 and 20 26. 27. Subtract line 26 from line 25. If zero or less, enter -0- 27. 28. Enter the smaller of line 23 or line 27 28. 29. Multiply line 28 by 15% (0.15) 29. 30. Add lines 22 and 28 30. If lines 1 and 30 are the same, skip lines 31 through 41 and go to line 42. Otherwise, go to line 31. Schedule D Tax Worksheet—Continued 31. Subtract line 30 from line 21 31. 32. Multiply line 31 by 20% (0.20) 32. If Schedule D, line 19, is zero or blank, skip lines 33 through 38 and go to line 39. Otherwise, go to line 33. 33. Enter the smaller of line 9 above or Schedule D, line 19 33. 34. Add lines 10 and 19 34. 35. Enter the amount from line 1 above 35. 36. Subtract line 35 from line 34. If zero or less, enter -0- 36. 37. Subtract line 36 from line 33. If zero or less, enter -0- 37. 38. Multiply line 37 by 25% (0.25) 38. If Schedule D, line 18, is zero or blank, skip lines 39 through 41 and go to line 42. Otherwise, go to line 39. 39. Add lines 19, 20, 28, 31, and 37 39. 40. Subtract line 39 from line 1 40. 41. Multiply line 40 by 28% (0.28) 41. 42. Figure the tax on the amount on line 19. If the amount on line 19 is less than $100,000, use the Tax Table to figure the tax. If the amount on line 19 is $100,000 or more, use the Tax Computation Worksheet 42. 43. Add lines 29, 32, 38, 41, and 42 43. 44. Figure the tax on the amount on line 1. If the amount on line 1 is less than $100,000, use the Tax Table to figure the tax. If the amount on line 1 is $100,000 or more, use the Tax Computation Worksheet 44. 45. Tax on all taxable income (including capital gains and qualified dividends). Enter the smaller of line 43 or line 44. Also include this amount on Form 1040, line 44 (or Form 1040NR, line 42). (If you are filing Form 2555 or 2555-EZ, don't enter this amount on Form 1040, line 44. Instead, enter it on line 4 of the Foreign Earned Income Tax Worksheet in the Form 1040 instructions) 45. *If applicable, enter instead the smaller amount you entered on the dotted line next to line 4e of Form 4952.
References: https://www.irs.gov/taxtopics/tc404 https://www.irs.gov/taxtopics/tc703 https://www.irs.gov/pub/irs-pdf/i1040sd.pdf https://www.irs.gov/pub/irs-prior/p4895--2011.pdfhttps://www.irs.gov/instructions/i1040sd
Report capital gains from mutual funds A mutual fund is a regulated investment company that pools funds of investors allowing them to take advantage of a diversity of investments and professional asset management. You own shares in the mutual fund but the fund owns capital assets, such as shares of stock, corporate bonds, government obligations, etc. One of the ways the fund makes money for you is to sell these assets at a gain. If the mutual fund held the capital asset for more than one year, the nature of the income is capital gain, and the mutual fund passes it on to you as a capital gain distribution. Form 1099-DIV, Dividends and Distributions, distinguishes this from other types of income, such as ordinary dividends. Consider capital gain distributions as long-term capital gains no matter how long you've owned shares in the mutual fund. Report the amount shown in box 2a of Form 1099-DIV on line 13 of Schedule D (Form 1040), Capital Gains and Losses. If you have no requirement to use Schedule D (Form 1040), report this amount on line 13 of Form 1040, U.S. Individual Income Tax Return, and check the box, or on line 10 of Form 1040A, U.S. Individual Income Tax Return. References:
Form of Business When beginning a business, you must decide what form of business entity to establish. Your form of business determines which income tax return form you have to file. The most common forms of business are the sole proprietorship, partnership, corporation, and S corporation. A Limited Liability Company (LLC) is a business structure allowed by state statute. Legal and tax considerations enter into selecting a business structure. Sole Proprietorships Partnerships Corporations S Corporations Limited Liability Company (LLC)
F orming a corporationIn forming a corporation, prospective shareholders exchange money, property, or both, for the corporation's capital stock. A corporation generally takes the same deductions as a sole proprietorship to figure its taxable income. A corporation can also take special deductions. For federal income tax purposes, a C corporation is recognized as a separate taxpaying entity. A corporation conducts business, realizes net income or loss, pays taxes and distributes profits to shareholders. The profit of a corporation is taxed to the corporation when earned, and then is taxed to the shareholders when distributed as dividends. This creates a double tax. The corporation does not get a tax deduction when it distributes dividends to shareholders. Shareholders cannot deduct any loss of the corporation. If you are a C corporation, use the information in the chart below to help you determine some of the forms you may be required to file. Corporations that have assets of $10 million or more and file at least 250 returns annually are required to electronically file their Forms 1120 and 1120S for tax years ending on or after December 31, 2007.
References: https://www.irs.gov/businesses/small-businesses-self-employed/business-structures https://www.irs.gov/businesses/small-businesses-self-employed/forming-a-corporation
Dividends Dividends are distributions of property a corporation may pay you if you own stock in that corporation. Corporations pay most dividends in cash. However, they may also pay them as stock of another corporation or as any other property. You also may receive distributions through your interest in a partnership, an estate, a trust, a subchapter S corporation, or from an association that's taxable as a corporation. A shareholder of a corporation may be deemed to receive a dividend if the corporation pays the debt of its shareholder, the shareholder receives services from the corporation, or the shareholder is allowed the use of the corporation's property. Additionally, a shareholder that provides services to a corporation may be deemed to receive a dividend if the corporation pays the shareholder service-provider in excess of what it would pay a third party for the same services. A shareholder may also receive distributions such as additional stock or stock rights in the distributing corporation; such distributions may or may not qualify as dividends. Form 1099-DIV You should receive a Form 1099-DIV, Dividends and Distributions, from each payer for distributions of at least $10. If you're a partner in a partnership or a beneficiary of an estate or trust, you may be required to report your share of any dividends received by the entity, whether or not the dividend is paid out to you. Your share of the entity's dividends is generally reported to you on a Schedule K-1. Dividends are the most common type of distribution from a corporation. They're paid out of the earnings and profits of the corporation. Dividends can be classified either as ordinary or qualified. Whereas ordinary dividends are taxable as ordinary income, qualified dividends that meet certain requirements are taxed at lower capital gain rates. The payer of the dividend is required to correctly identify each type and amount of dividend for you when reporting them on your Form 1099-DIV for tax purposes. Return of Capital Distributions that qualify as a return of capital aren't dividends. A return of capital is a return of some or all of your investment in the stock of the company. A return of capital reduces the adjusted cost basis of your stock. For information on basis of assets, refer to Topic No. 703. A distribution generally qualifies as a return of capital if the corporation making the distribution doesn't have any accumulated or current year earnings and profits. Once the adjusted cost basis of your stock has been reduced to zero, any further nondividend distribution is a taxable capital gain that you report on Form 8949, Sales and Other Dispositions of Capital Assets, and Form 1040, Schedule D, Capital Gains and Losses. Capital Gain Distributions Regulated investment companies (RICs) (mutual funds, exchange traded funds, money market funds, etc.) and real estate investment trusts (REITs) may pay capital gain distributions. Capital gain distributions are always reported as long-term capital gains. You must also report any undistributed capital gain that RICs or REITs have designated to you in a written notice. They report these undistributed capital gains to you on Form 2439, Notice to Shareholder of Undistributed Long-Term Capital Gains. For information on how to report qualifying dividends and capital gain distributions, refer to the Form 1040 Instructions or Form 1040A Instructions. Additional Considerations Form 1099-DIV should break down the distribution into the various categories. If it doesn't, contact the payer. You must give your correct social security number to the payer of your dividend income. If you don't, you may be subject to a penalty and/or backup withholding. For more information on backup withholding, refer to Topic No. 307. If you receive over $1,500 of taxable ordinary dividends, you must report these dividends on Form 1040A or 1040, Schedule B, Interest and Ordinary Dividends. If you receive dividends in significant amounts, you may have to pay estimated tax to avoid a penalty. For more information, see Estimated Taxes or visit Am I Required to Make Estimated Tax Payments for 2018? References: https://www.irs.gov/taxtopics/tc404
Rental Income and Expenses Cash or the fair market value of property or services you receive for the use of real estate or personal property is taxable to you as rental income. In general, you can deduct expenses of renting property from your rental income. Real Estate Rentals You can generally use Form 1040, Schedule E, Supplemental Income and Loss, to report income and expenses related to real estate rentals. If you provide substantial services that are primarily for your tenant's convenience, report your income and expenses on Form 1040, Schedule C, Profit or Loss From Business (Sole Proprietorship). Personal Property Rentals Report income and expenses related to personal property rentals on Form 1040, Schedule C or Form 1040, Schedule C-EZ, Net Profit From Business (Sole Proprietorship), if you're in the business of renting personal property. Report income on line 21 and expenses on line 36 of Form 1040, if you're not in the business of renting personal property. Rental Income Most individuals operate on a cash basis, which means they count their rental income as income when they actually or constructively receive it, and deduct their expenses when they pay them. Rental income includes: Amounts paid to cancel a lease – If a tenant pays you to cancel a lease, this money is also rental income and is reported in the year you receive it.Advance rent – Generally, you include any advance rent paid in income in the year you receive it regardless of the period covered or the method of accounting you use. Expenses paid by a tenant – If your tenant pays any of your expenses, those payments are rental income. You may also deduct the expenses if they're considered deductible expenses. Security deposits – Don't include a security deposit in your income if you may be required to return it to the tenant at the end of the lease. If you keep part or all of the security deposit because the tenant breaks the lease by vacating the property early, include the amount you keep in your income in that year. If you keep part or all of the security deposit because the tenant damaged the property and you must make repairs, include the amount you keep in that year if your practice is to deduct the cost of repairs as expenses. To the extent the security deposit reimburses those expenses, don't include the amount in income if your practice isn't to deduct the cost of repairs as expenses. If a security deposit amount is to be used as the tenant's final month's rent, it is advance rent that you include as income when you receive it, rather than when you apply it to the last month's rent. Rental Expenses Examples of expenses that you may deduct from your total rental income include: Depreciation – Allowances for exhaustion, wear and tear (including obsolescence) of property. You begin to depreciate your rental property when you place it in service. You can recover some or all of your original acquisition cost and the cost of improvements by using Form 4562, Depreciation and Amortization, (to report depreciation) beginning in the year your rental property is first placed in service, and beginning in any year you make improvements or add furnishings. Repair Costs – Expenses to keep your property in good working condition but that don't add to the value of the property. Operating Expenses – Other expenses necessary for the operation of the rental property, such as the salaries of employees or fees charged by independent contractors (groundkeepers, bookkeepers, accountants, attorneys, etc.) for services provided. If you're a cash basis taxpayer, you can't deduct uncollected rents as an expense because you haven't included those rents in income. Repair costs, such as materials, are usually deductible. For information about repairs and improvements, and depreciation of most rental property, refer to Publication 527, Residential Rental Property (Including Rental of Vacation Homes). Personal Use There are special rules relating to the rental of real property that you also use as your main home or your vacation home. Limitations If you don't use the rental property as a home and you're renting to make a profit, your deductible rental expenses can be more than your gross rental income, subject to certain limits. Net Investment Income Tax If you have a rental profit, you may be subject to the Net Investment Income Tax (NIIT).
Residential Rental Property (Including Rental of Vacation Homes)
Net Investment Income Tax (NIIT). You may be subject to the Net Investment Income Tax (NIIT). NIIT is a 3.8% tax on the lesser of net investment income or the excess of modified adjusted gross income (MAGI) over the threshold amount. Net investment income may include rental income and other income from passive activities. Use Form 8960 to figure this tax. Residential Rental Property Do you own a second house that you rent out all the time? Do you own a vacation home that you rent out when you or your family isn't using it? Rental Income In most cases, you must include in your gross income all amounts you receive as rent. Rental income is any payment you receive for the use or occupation of property. It isn’t limited to amounts you receive as normal rental payments. When To Report When you report rental income on your tax return generally depends on whether you are a cash or an accrual basis taxpayer. Most individual taxpayers use the cash method. Cash method. You are a cash basis taxpayer if you report income on your return in the year you actually or constructively receive it, regardless of when it was earned. You constructively receive income when it is made available to you, for example, by being credited to your bank account. Accrual method. If you are an accrual basis taxpayer, you generally report income when you earn it, rather than when you receive it. You generally deduct your expenses when you incur them, rather than when you pay them. Types of Income The following are common types of rental income. Advance rent. Advance rent is any amount you receive before the period that it covers. Include advance rent in your rental income in the year you receive it regardless of the period covered or the method of accounting you use. Example. On March 18, 2017, you signed a 10-year lease to rent your property. During 2017, you received $9,600 for the first year's rent and $9,600 as rent for the last year of the lease. You must include $19,200 in your rental income in 2017. Canceling a lease. If your tenant pays you to cancel a lease, the amount you receive is rent. Include the payment in your rental income in the year you receive it regardless of your method of accounting. Expenses paid by tenant. If your tenant pays any of your expenses, those payments are rental income. Because you must include this amount in income, you can also deduct the expenses if they are deductible rental expenses. Example 1. Your tenant pays the water and sewage bill for your rental property and deducts the amount from the normal rent payment. Under the terms of the lease, your tenant doesn’t have to pay this bill. Include the utility bill paid by the tenant and any amount received as a rent payment in your rental income. You can deduct the utility payment made by your tenant as a rental expense. Example 2. While you are out of town, the furnace in your rental property stops working. Your tenant pays for the necessary repairs and deducts the repair bill from the rent payment. Include the repair bill paid by the tenant and any amount received as a rent payment in your rental income. You can deduct the repair payment made by your tenant as a rental expense. Property or services. If you receive property or services as rent, instead of money, include the fair market value of the property or services in your rental income. If the services are provided at an agreed upon or specified price, that price is the fair market value unless there is evidence to the contrary. Example. Your tenant is a house painter. He offers to paint your rental property instead of paying 2 months rent. You accept his offer. Include in your rental income the amount the tenant would have paid for 2 months rent. You can deduct that same amount as a rental expense for painting your property. Security deposits. Don’t include a security deposit in your income when you receive it if you plan to return it to your tenant at the end of the lease. But if you keep part or all of the security deposit during any year because your tenant doesn’t live up to the terms of the lease, include the amount you keep in your income in that year. If an amount called a security deposit is to be used as a final payment of rent, it is advance rent. Include it in your income when you receive it. Other Sources of Rental Income Lease with option to buy. If the rental agreement gives your tenant the right to buy your rental property, the payments you receive under the agreement are generally rental income. If your tenant exercises the right to buy the property, the payments you receive for the period after the date of sale are considered part of the selling price. Part interest. If you own a part interest in rental property, you must report your part of the rental income from the property. Rental of property also used as your home. If you rent property that you also use as your home and you rent it less than 15 days during the tax year, don’t include the rent you receive in your income and don’t deduct rental expenses. However, you can deduct on Schedule A (Form 1040), Itemized Deductions, the interest, taxes, and casualty and theft losses that are allowed for nonrental property. Rental Expenses In most cases, the expenses of renting your property, such as maintenance, insurance, taxes, and interest, can be deducted from your rental income. Personal use of rental property. If you sometimes use your rental property for personal purposes, you must divide your expenses between rental and personal use. Also, your rental expense deductions may be limited. Part interest. If you own a part interest in rental property, you can deduct expenses you paid according to your percentage of ownership. Example. Roger owns a one-half undivided interest in a rental house. Last year he paid $968 for necessary repairs on the property. Roger can deduct $484 (50% × $968) as a rental expense. He is entitled to reimbursement for the remaining half from the co-owner.When To Deduct You generally deduct your rental expenses in the year you pay them. Types of Expenses Listed below are the most common rental expenses. Advertising. Auto and travel expenses. Cleaning and maintenance. Commissions. Depreciation. Insurance. Interest (other). Legal and other professional fees. Local transportation expenses. Management fees. Mortgage interest paid to banks, etc. Points. Rental payments. Repairs. Taxes. Utilities. Some of these expenses, as well as other less common ones, are discussed below. Depreciation. Depreciation is a capital expense. It is the mechanism for recovering your cost in an income-producing property and must be taken over the expected life of the property. You can begin to depreciate rental property when it is ready and available for rent. Insurance premiums paid in advance. If you pay an insurance premium for more than one year in advance, you can’t deduct the total premium in the year you pay it. For each year of coverage, you can deduct only the part of the premium payment that applies to that year. Interest expense. You can deduct mortgage interest you pay on your rental property. When you refinance a rental property for more than the previous outstanding balance, the portion of the interest allocable to loan proceeds not related to rental use generally can’t be deducted as a rental expense. Chapter 4 of Pub. 535 explains mortgage interest in detail. Expenses paid to obtain a mortgage. Certain expenses you pay to obtain a mortgage on your rental property can’t be deducted as interest. These expenses, which include mortgage commissions, abstract fees, and recording fees, are capital expenses that are part of your basis in the property. Form 1098, Mortgage Interest Statement. If you paid $600 or more of mortgage interest on your rental property to any one person, you should receive a Form 1098 or similar statement showing the interest you paid for the year. If you and at least one other person (other than your spouse if you file a joint return) were liable for, and paid interest on, the mortgage, and the other person received the Form 1098, report your share of the interest on Schedule E (Form 1040), line 13. Attach a statement to your return showing the name and address of the other person. On the dotted line next to line 13, enter "See attached." Legal and other professional fees. You can deduct, as a rental expense, legal and other professional expenses such as tax return preparation fees you paid to prepare Schedule E, Part I. For example, on your 2017 Schedule E you can deduct fees paid in 2017 to prepare Part I of your 2016 Schedule E. You can also deduct, as a rental expense, any expense (other than federal taxes and penalties) you paid to resolve a tax underpayment related to your rental activities. Local benefit taxes. In most cases, you can’t deduct charges for local benefits that increase the value of your property, such as charges for putting in streets, sidewalks, or water and sewer systems. These charges are nondepreciable capital expenditures and must be added to the basis of your property. However, you can deduct local benefit taxes that are for maintaining, repairing, or paying interest charges for the benefits. Local transportation expenses. You may be able to deduct your ordinary and necessary local transportation expenses if you incur them to collect rental income or to manage, conserve, or maintain your rental property. However, transportation expenses incurred to travel between your home and a rental property generally constitute nondeductible commuting costs unless you use your home as your principal place of business. Generally, if you use your personal car, pickup truck, or light van for rental activities, you can deduct the expenses using one of two methods: actual expenses or the standard mileage rate. For 2017, the standard mileage rate for business use is 53.5 cents per mile. To deduct car expenses under either method, you must keep records that follow the rules. In addition, you must complete Form 4562, Part V, and attach it to your tax return. Pre-rental expenses. You can deduct your ordinary and necessary expenses for managing, conserving, or maintaining rental property from the time you make it available for rent. Rental of equipment. You can deduct the rent you pay for equipment that you use for rental purposes. However, in some cases, lease contracts are actually purchase contracts. If so, you can’t deduct these payments. You can recover the cost of purchased equipment through depreciation. Rental of property. You can deduct the rent you pay for property that you use for rental purposes. If you buy a leasehold for rental purposes, you can deduct an equal part of the cost each year over the term of the lease. Travel expenses. You can deduct the ordinary and necessary expenses of traveling away from home if the primary purpose of the trip is to collect rental income or to manage, conserve, or maintain your rental property. You must properly allocate your expenses between rental and nonrental activities. You can’t deduct the cost of traveling away from home if the primary purpose of the trip is to improve the property. The cost of improvements is recovered by taking depreciation. Uncollected rent. If you are a cash basis taxpayer, don’t deduct uncollected rent. Because you haven’t included it in your income, it’s not deductible. If you use an accrual method, report income when you earn it. If you are unable to collect the rent, you may be able to deduct it as a business bad debt. Vacant rental property. If you hold property for rental purposes, you may be able to deduct your ordinary and necessary expenses (including depreciation) for managing, conserving, or maintaining the property while the property is vacant. However, you can’t deduct any loss of rental income for the period the property is vacant. Vacant while listed for sale. If you sell property you held for rental purposes, you can deduct the ordinary and necessary expenses for managing, conserving, or maintaining the property until it is sold. If the property isn’t held out and available for rent while listed for sale, the expenses aren’t deductible rental expenses. Points The term "points" is often used to describe some of the charges paid, or treated as paid, by a borrower to take out a loan or a mortgage. These charges are also called loan origination fees, maximum loan charges, or premium charges. Any of these charges (points) that are solely for the use of money are interest. Because points are prepaid interest, you generally can’t deduct the full amount in the year paid, but must deduct the interest over the term of the loan. The method used to figure the amount of points you can deduct each year follows the original issue discount (OID) rules. In this case, points are equivalent to OID, which is the difference between: The amount borrowed (redemption price at maturity, or principal); and The proceeds (issue price). The first step is to determine whether your total OID (which you may have on bonds or other investments in addition to the mortgage loan), including the OID resulting from the points, is insignificant or de minimis. If the OID isn’t de minimis, you must use the constant-yield method to figure how much you can deduct. De minimis OID. The OID is de minimis if it is less than one-fourth of 1% (0.0025) of the stated redemption price at maturity (principal amount of the loan) multiplied by the number of full years from the date of original issue to maturity (term of the loan). If the OID is de minimis, you can choose one of the following ways to figure the amount of points you can deduct each year. On a constant-yield basis over the term of the loan. On a straight line basis over the term of the loan. In proportion to stated interest payments. In its entirety at maturity of the loan. You make this choice by deducting the OID (points) in a manner consistent with the method chosen on your timely filed tax return for the tax year in which the loan is issued. Example. Carol took out a $100,000 mortgage loan on January 1, 2017, to buy a house she will use as a rental during 2017. The loan is to be repaid over 30 years. During 2017, Carol paid $10,000 of mortgage interest (stated interest) to the lender. When the loan was made, she paid $1,500 in points to the lender. The points reduced the principal amount of the loan from $100,000 to $98,500, resulting in $1,500 of OID. Carol determines that the points (OID) she paid are de minimis based on the following computation. Redemption price at maturity (principal amount of the loan) $100,000 Multiplied by: The term of the loan in complete years × 30 Multiplied by × 0.0025 De minimis amount $ 7,500 The points (OID) she paid ($1,500) are less than the de minimis amount ($7,500). Therefore, Carol has de minimis OID and she can choose one of the four ways discussed earlier to figure the amount she can deduct each year. Under the straight line method, she can deduct $50 each year for 30 years. Constant-yield method. If the OID isn’t de minimis, you must use the constant-yield method to figure how much you can deduct each year. You figure your deduction for the first year in the following manner. Determine the issue price of the loan. If you paid points on the loan, the issue price generally is the difference between the principal and the points. Multiply the result in (1) by the yield to maturity (defined later). Subtract any qualified stated interest payments (defined later) from the result in (2). This is the OID you can deduct in the first year. Yield to maturity (YTM). This rate is generally shown in the literature you receive from your lender. If you don’t have this information, consult your lender or tax advisor. In general, the YTM is the discount rate that, when used in computing the present value of all principal and interest payments, produces an amount equal to the principal amount of the loan. Qualified stated interest (QSI). In general, this is the stated interest that is unconditionally payable in cash or property (other than another loan of the issuer) at least annually over the term of the loan at a fixed rate. Example —Year 1.The facts are the same as in the previous example. The yield to maturity on Carol's loan is 10.2467%, compounded annually. She figured the amount of points (OID) she could deduct in 2017 as follows. Principal amount of the loan $100,000 Minus: Points (OID) – 1,500 Issue price of the loan $ 98,500 Multiplied by: YTM × 0.102467Total 10,093 Minus: QSI – 10,000Points (OID) deductible in 2017 $ 93 To figure your deduction in any subsequent year, you start with the adjusted issue price. To get the adjusted issue price, add to the issue price figured in Year 1 any OID previously deducted. Then follow steps (2) and (3), earlier. Example—Year 2. Carol figured the deduction for 2018 as follows. Issue price $98,500 Plus: Points (OID) deducted in 2017 + 93 Adjusted issue price $98,593 Multiplied by: YTM × 0.102467Total 10,103 Minus: QSI – 10,000Points (OID) deductible in 2018 $ 103 Loan or mortgage ends. If your loan or mortgage ends, you may be able to deduct any remaining points (OID) in the tax year in which the loan or mortgage ends. A loan or mortgage may end due to a refinancing, prepayment, foreclosure, or similar event. However, if the refinancing is with the same lender, the remaining points (OID) generally aren’t deductible in the year in which the refinancing occurs, but may be deductible over the term of the new mortgage or loan. Points when loan refinance is more than the previous outstanding balance. When you refinance a rental property for more than the previous outstanding balance, the portion of the points allocable to loan proceeds not related to rental use generally can’t be deducted as a rental expense. Example. Charles refinanced a loan with a balance of $100,000. The amount of the new loan was $120,000. Charles used the additional $20,000 to purchase a car. The points allocable to the $20,000 would be treated as nondeductible personal interest. Repairs and Improvements Generally, an expense for repairing or maintaining your rental property may be deducted if you aren’t required to capitalize the expense. Improvements. You must capitalize any expense you pay to improve your rental property. An expense is for an improvement if it results in a betterment to your property, restores your property, or adapts your property to a new or different use. Table 1-1 shows examples of many improvements. Betterments. Expenses that may result in a betterment to your property include expenses for fixing a pre-existing defect or condition, enlarging or expanding your property, or increasing the capacity, strength, or quality of your property. Restoration. Expenses that may be for restoration include expenses for replacing a substantial structural part of your property, repairing damage to your property after you properly adjusted the basis of your property as a result of a casualty loss, or rebuilding your property to a like-new condition. Adaptation. Expenses that may be for adaptation include expenses for altering your property to a use that isn’t consistent with the intended ordinary use of your property when you began renting the property. De minimis safe harbor for tangible property. If you elect this de minimis safe harbor for your rental activity for the taxable year, you aren’t required to capitalize the de minimis costs of acquiring or producing certain real and tangible personal property and may deduct these amounts as rental expenses on line 19 of Schedule E. Safe harbor for routine maintenance. If you determine that your cost was for an improvement to a building or equipment, you may still be able to deduct your cost under the routine maintenance safe harbor. Separate the costs of repairs and improvements, and keep accurate records. You will need to know the cost of improvements when you sell or depreciate your property. The expenses you capitalize for improving your property can generally be depreciated as if the improvement were separate property. Table 1-1. Examples of Improvements Additions Bedroom Bathroom Deck Garage Porch Patio Lawn & Grounds Landscaping Driveway Walkway Fence Retaining wall Sprinkler system Swimming pool Miscellaneous Storm windows, doors New roof Central vacuum Wiring upgrades Satellite dish Security system Heating & Air Conditioning Heating system Central air conditioning Furnace Duct work Central humidifier Filtration system Plumbing Septic system Water heater Soft water system Filtration system Interior Improvements Built-in appliances Kitchen modernization Flooring Wall-to-wall carpeting Insulation Attic Walls, floor Pipes, duct work 2. Depreciation of Rental Property You recover the cost of income-producing property through yearly tax deductions. You do this by depreciating the property; that is, by deducting some of the cost each year on your tax return. Three factors determine how much depreciation you can deduct each year: (1) your basis in the property, (2) the recovery period for the property, and (3) the depreciation method used. You can’t simply deduct your mortgage or principal payments, or the cost of furniture, fixtures, and equipment, as an expense. You can deduct depreciation only on the part of your property used for rental purposes. Depreciation reduces your basis for figuring gain or loss on a later sale or exchange. Section 179 deduction. The section 179 deduction is a means of recovering part or all of the cost of certain qualifying property in the year you place the property in service. This deduction isn’t allowed for property used in connection with residential rental property. Alternative minimum tax (AMT). If you use accelerated depreciation, you may be subject to the AMT. Accelerated depreciation allows you to deduct more depreciation earlier in the recovery period than you could deduct using a straight line method (same deduction each year). The prescribed depreciation methods for rental real estate aren’t accelerated, so the depreciation deduction isn’t adjusted for the AMT. However, accelerated methods are generally used for other property connected with rental activities (for example, appliances and wall-to-wall carpeting).
The Basics The following section discusses the information you will need to have about the rental property and the decisions to be made before figuring your depreciation deduction. What Rental Property Can Be Depreciated? You can depreciate your property if it meets all the following requirements. You own the property. You use the property in your business or income-producing activity (such as rental property). The property has a determinable useful life. The property is expected to last more than one year. Property you own. To claim depreciation, you usually must be the owner of the property. You are considered to be the owner of property even if it is subject to a debt. Rented property. Generally, if you pay rent for property, you can’t depreciate that property. Usually, only the owner can depreciate it. However, if you make permanent improvements to leased property, you may be able to depreciate the improvements. Cooperative apartments. If you are a tenant-stockholder in a cooperative housing corporation and rent your cooperative apartment to others, you can depreciate your stock in the corporation. Property having a determinable useful life. To be depreciable, your property must have a determinable useful life. This means that it must be something that wears out, decays, gets used up, becomes obsolete, or loses its value from natural causes. What Rental Property Can’t Be Depreciated? Certain property can’t be depreciated. This includes land and certain excepted property. Land. You can’t depreciate the cost of land because land generally doesn’t wear out, become obsolete, or get used up. But if it does, the loss is accounted for upon disposition. The costs of clearing, grading, planting, and landscaping are usually all part of the cost of land and can’t be depreciated. You may, however, be able to depreciate certain land preparation costs if the costs are so closely associated with other depreciable property that you can determine a life for them along with the life of the associated property. Example. You built a new house to use as a rental and paid for grading, clearing, seeding, and planting bushes and trees. Some of the bushes and trees were planted right next to the house, while others were planted around the outer border of the lot. If you replace the house, you would have to destroy the bushes and trees right next to it. These bushes and trees are closely associated with the house, so they have a determinable useful life. Therefore, you can depreciate them. Add your other land preparation costs to the basis of your land because they have no determinable life and you can’t depreciate them. Excepted property. Even if the property meets all the requirements listed earlier under What Rental Property Can Be Depreciated , you can’t depreciate the following property. Property placed in service and disposed of (or taken out of business use) in the same year. Equipment used to build capital improvements. You must add otherwise allowable depreciation on the equipment during the period of construction to the basis of your improvements. When Does Depreciation Begin and End? You begin to depreciate your rental property when you place it in service for the production of income. You stop depreciating it either when you have fully recovered your cost or other basis, or when you retire it from service, whichever happens first. Placed in Service You place property in service in a rental activity when it is ready and available for a specific use in that activity. Even if you aren’t using the property, it is in service when it is ready and available for its specific use. Example 1. On November 22 of last year, you purchased a dishwasher for your rental property. The appliance was delivered on December 7, but wasn’t installed and ready for use until January 3 of this year. Because the dishwasher wasn’t ready for use last year, it isn’t considered placed in service until this year. If the appliance had been installed and ready for use when it was delivered in December of last year, it would have been considered placed in service in December, even if it wasn’t actually used until this year. Example 2. On April 6, you purchased a house to use as residential rental property. You made extensive repairs to the house and had it ready for rent on July 5. You began to advertise the house for rent in July and actually rented it beginning September 1. The house is considered placed in service in July when it was ready and available for rent. You can begin to depreciate the house in July. Example 3. You moved from your home in July. During August and September you made several repairs to the house. On October 1, you listed the property for rent with a real estate company, which rented it on December 1. The property is considered placed in service on October 1, the date when it was available for rent. Conversion to business use. If you place property in service in a personal activity, you can’t claim depreciation. However, if you change the property's use to business or the production of income, you can begin to depreciate it at the time of the change. You place the property in service for business or income-producing use on the date of the change. Example. You bought a house and used it as your personal home several years before you converted it to rental property. Although its specific use was personal and no depreciation was allowable, you placed the home in service when you began using it as your home. You can begin to claim depreciation in the year you converted it to rental property because at that time its use changed to the production of income. Idle Property Continue to claim a deduction for depreciation on property used in your rental activity even if it is temporarily idle (not in use). For example, if you must make repairs after a tenant moves out, you still depreciate the rental property during the time it isn’t available for rent. Cost or Other Basis Fully Recovered You must stop depreciating property when the total of your yearly depreciation deductions equals your cost or other basis of your property. For this purpose, your yearly depreciation deductions include any depreciation that you were allowed to claim, even if you didn’t claim it. Retired From Service You stop depreciating property when you retire it from service, even if you haven’t fully recovered its cost or other basis. You retire property from service when you permanently withdraw it from use in a trade or business or from use in the production of income because of any of the following events. You sell or exchange the property. You convert the property to personal use. You abandon the property. The property is destroyed. Depreciation Methods Generally, you must use the Modified Accelerated Cost Recovery System (MACRS) to depreciate residential rental property placed in service after 1986. If you placed rental property in service before 1987, you are using one of the following methods. Accelerated Cost Recovery System (ACRS) for property placed in service after 1980 but before 1987. Straight line or declining balance method over the useful life of property placed in service before 1981.
Rental property placed in service before 2017. Continue to use the same method of figuring depreciation that you used in the past. Use of real property changed. Generally, you must use MACRS to depreciate real property that you acquired for personal use before 1987 and changed to business or income-producing use after 1986. This includes your residence that you changed to rental use. Improvements made after 1986. Treat an improvement made after 1986 to property you placed in service before 1987 as separate depreciable property. As a result, you can depreciate that improvement as separate property under MACRS if it is the type of property that otherwise qualifies for MACRS depreciation. Basis of Depreciable Property The basis of property used in a rental activity is generally its adjusted basis when you place it in service in that activity. This is its cost or other basis when you acquired it, adjusted for certain items occurring before you place it in service in the rental activity. If you depreciate your property under MACRS, you may also have to reduce your basis by certain deductions and credits with respect to the property. If you used the property for personal purposes before changing it to rental use, its basis for depreciation is the lesser of its adjusted basis or its fair market value when you change it to rental use. Cost Basis The basis of property you buy is usually its cost. The cost is the amount you pay for it in cash, in debt obligation, in other property, or in services. Your cost also includes amounts you pay for: Sales tax charged on the purchase , Freight charges to obtain the property, and Installation and testing charges. Exception. If you deducted state and local general sales taxes as an itemized deduction on Schedule A (Form 1040), don’t include those sales taxes as part of your cost basis. Such taxes were deductible before 1987 and after 2003. Loans with low or no interest. If you buy property on any payment plan that charges little or no interest, the basis of your property is your stated purchase price, less the amount considered to be unstated interest. Real property. If you buy real property, such as a building and land, certain fees and other expenses you pay are part of your cost basis in the property. Real estate taxes. If you buy real property and agree to pay real estate taxes on it that were owed by the seller and the seller doesn’t reimburse you, the taxes you pay are treated as part of your basis in the property. You can’t deduct them as taxes paid. If you reimburse the seller for real estate taxes the seller paid for you, you can usually deduct that amount. Don’t include that amount in your basis in the property. Settlement fees and other costs. The following settlement fees and closing costs for buying the property are part of your basis in the property. Abstract fees. Charges for installing utility services. Legal fees. Recording fees. Surveys. Transfer taxes. Title insurance. Any amounts the seller owes that you agree to pay, such as back taxes or interest, recording or mortgage fees, charges for improvements or repairs, and sales commissions. The following are settlement fees and closing costs you can’t include in your basis in the property. Fire insurance premiums. Rent or other charges relating to occupancy of the property before closing. Charges connected with getting or refinancing a loan, such as: Points (discount points, loan origination fees), Mortgage insurance premiums, Loan assumption fees, Cost of a credit report, and Fees for an appraisal required by a lender. Also, don’t include amounts placed in escrow for the future payment of items such as taxes and insurance. Assumption of a mortgage. If you buy property and become liable for an existing mortgage on the property, your basis is the amount you pay for the property plus the amount remaining to be paid on the mortgage. Example. You buy a building for $60,000 cash and assume a mortgage of $240,000 on it. Your basis is $300,000. Separating cost of land and buildings. If you buy buildings and your cost includes the cost of the land on which they stand, you must divide the cost between the land and the buildings to figure the basis for depreciation of the buildings. The part of the cost that you allocate to each asset is the ratio of the fair market value of that asset to the fair market value of the whole property at the time you buy it. If you aren’t certain of the fair market values of the land and the buildings, you can divide the cost between them based on their assessed values for real estate tax purposes. Example. You buy a house and land for $200,000. The purchase contract doesn’t specify how much of the purchase price is for the house and how much is for the land. The latest real estate tax assessment on the property was based on an assessed value of $160,000, of which $136,000 was for the house and $24,000 was for the land. You can allocate 85% ($136,000 ÷ $160,000) of the purchase price to the house and 15% ($24,000 ÷ $160,000) of the purchase price to the land.Your basis in the house is $170,000 (85% of $200,000) and your basis in the land is $30,000 (15% of $200,000). Basis Other Than Cost You can’t use cost as a basis for property that you received: In return for services you performed; In an exchange for other property; As a gift; From your spouse, or from your former spouse as the result of a divorce; or As an inheritance.
Adjusted Basis To figure your property's basis for depreciation, you may have to make certain adjustments (increases and decreases) to the basis of the property for events occurring between the time you acquired the property and the time you placed it in service for business or the production of income. The result of these adjustments to the basis is the adjusted basis. Increases to basis. You must increase the basis of any property by the cost of all items properly added to a capital account. These include the following. The cost of any additions or improvements made before placing your property into service as a rental that have a useful life of more than 1 year. Amounts spent after a casualty to restore the damaged property. The cost of extending utility service lines to the property. Legal fees, such as the cost of defending and perfecting title, or settling zoning issues. Additions or improvements. Add to the basis of your property the amount an addition or improvement actually cost you, including any amount you borrowed to make the addition or improvement. This includes all direct costs, such as material and labor, but doesn’t include your own labor. It also includes all expenses related to the addition or improvement. For example, if you had an architect draw up plans for remodeling your property, the architect's fee is a part of the cost of the remodeling. Or, if you had your lot surveyed to put up a fence, the cost of the survey is a part of the cost of the fence. Keep separate accounts for depreciable additions or improvements made after you place the property in service in your rental activity. The cost of landscaping improvements is usually treated as an addition to the basis of the land, which isn’t depreciable. Assessments for local improvements. Assessments for items which tend to increase the value of property, such as streets and sidewalks, must be added to the basis of the property. For example, if your city installs curbing on the street in front of your house, and assesses you and your neighbors for its cost, you must add the assessment to the basis of your property. Also add the cost of legal fees paid to obtain a decrease in an assessment levied against property to pay for local improvements. You can’t deduct these items as taxes or depreciate them. However, you can deduct assessments for the purpose of maintenance or repairs or for the purpose of meeting interest charges related to the improvements. Don’t add them to your basis in the property. Deducting vs. capitalizing costs. Don’t add to your basis costs you can deduct as current expenses. However, there are certain costs you can choose either to deduct or to capitalize. If you capitalize these costs, include them in your basis. If you deduct them, don’t include them in your basis. The costs you may choose to deduct or capitalize include carrying charges, such as interest and taxes, that you must pay to own property. Decreases to basis. You must decrease the basis of your property by any items that represent a return of your cost. These include the following. Insurance or other payment you receive as the result of a casualty or theft loss. Casualty loss not covered by insurance for which you took a deduction. Amount(s) you receive for granting an easement. Residential energy credits you were allowed before 1986 or after 2005 if you added the cost of the energy items to the basis of your home. Exclusion from income of subsidies for energy conservation measures. Special depreciation allowance claimed on qualified property. Depreciation you deducted or could have deducted on your tax returns under the method of depreciation you chose. If your rental property was previously used as your main home, you must also decrease the basis by the following. Gain you postponed from the sale of your main home before May 7, 1997, if the replacement home was converted to your rental property. District of Columbia first-time homebuyer credit allowed on the purchase of your main home after August 4, 1997, and before January 1, 2012. Amount of qualified principal residence indebtedness discharged on or after January 1, 2007. Special Depreciation Allowance For 2017, some properties used in connection with residential real property activities may qualify for a special depreciation allowance. This allowance is figured before you figure your regular depreciation deduction. If you qualify for, but choose not to take, a special depreciation allowance, you must attach a statement to your return. The details of this election are in Pub. 946, chapter 3, and the instructions for Form 4562, line 14. MACRS Depreciation Most business and investment property placed in service after 1986 is depreciated using MACRS. This section explains how to determine which MACRS depreciation system applies to your property. It also discusses other information you need to know before you can figure depreciation under MACRS. This information includes the property's: Recovery class, Applicable recovery period, Convention, Placed-in-service date, Basis for depreciation, and Depreciation method. Depreciation Systems MACRS consists of two systems that determine how you depreciate your property —the General Depreciation System (GDS) and the Alternative Depreciation System (ADS). You must use GDS unless you are specifically required by law to use ADS or you elect to use ADS.Excluded Property You can’t use MACRS for certain personal property (such as furniture or appliances) placed in service in your rental property in 2017 if it had been previously placed in service before 1987, when MACRS became effective. In most cases, personal property is excluded from MACRS if you (or a person related to you) owned or used it in 1986 or if your tenant is a person (or someone related to the person) who owned or used it in 1986. However, the property isn’t excluded if your 2017 deduction under MACRS (using a half-year convention) is less than the deduction you would have under ACRS. Electing ADS If you choose, you can use the ADS method for most property. Under ADS, you use the straight line method of depreciation. The election of ADS for one item in a class of property generally applies to all property in that class placed in service during the tax year of the election. However, the election applies on a property-by-property basis for residential rental property and nonresidential real property. If you choose to use ADS for your residential rental property, the election must be made in the first year the property is placed in service. Once you make this election, you can never revoke it. For property placed in service during 2017, you make the election to use ADS by entering the depreciation on Form 4562, Part III, Section C, line 20c. Property Classes Under GDS Each item of property that can be depreciated under MACRS is assigned to a property class, determined by its class life. The property class generally determines the depreciation method, recovery period, and convention. The property classes under GDS are: 3-year property, 5-year property, 7-year property, 10-year property, 15-year property, 20-year property, Nonresidential real property, and Residential rental property. Under MACRS, property that you placed in service during 2017 in your rental activities generally falls into one of the following classes. 5-year property. This class includes computers and peripheral equipment, office machinery (typewriters, calculators, copiers, etc.), automobiles, and light trucks. This class also includes appliances, carpeting, and furniture used in a residential rental real estate activity. Depreciation is limited on automobiles and other property used for transportation; computers and related peripheral equipment; and property of a type generally used for entertainment, recreation, or amusement. 7-year property. This class includes office furniture and equipment (desks, file cabinets, and similar items). This class also includes any property that doesn’t have a class life and that hasn’t been designated by law as being in any other class. 15-year property. This class includes roads, fences, and shrubbery (if depreciable). Residential rental property. This class includes any real property that is a rental building or structure (including a mobile home) for which 80% or more of the gross rental income for the tax year is from dwelling units. It doesn’t include a unit in a hotel, motel, inn, or other establishment where more than half of the units are used on a transient basis. If you live in any part of the building or structure, the gross rental income includes the fair rental value of the part you live in. The other property classes don’t generally apply to property used in rental activities. These classes aren’t discussed in this publication. Recovery Periods Under GDS The recovery period of property is the number of years over which you recover its cost or other basis. The recovery periods are generally longer under ADS than GDS. The recovery period of property depends on its property class. Under GDS, the recovery period of an asset is generally the same as its property class.
Qualified Indian reservation property. Shorter recovery periods are provided under MACRS for qualified Indian reservation property placed in service on Indian reservations. Additions or improvements to property. Treat additions or improvements you make to your depreciable rental property as separate property items for depreciation purposes. The property class and recovery period of the addition or improvement is the one that would apply to the original property if you had placed it in service at the same time as the addition or improvement. The recovery period for an addition or improvement to property begins on the later of: The date the addition or improvement is placed in service, or The date the property to which the addition or improvement was made is placed in service. Example. You own a residential rental house that you have been renting since 1986 and depreciating under ACRS. You built an addition onto the house and placed it in service in 2017. You must use MACRS for the addition. Under GDS, the addition is depreciated as residential rental property over 27.5 years. Table 2-1. MACRS Recovery Periods for Property Used in Rental Activities MACRS Recovery Period Type of Property General Depreciation System Alternative Depreciation System Computers and their peripheral equipment 5 years 5 years Office machinery, such as: Typewriters Calculators Copiers 5 years 6 years Automobiles 5 years 5 years Light trucks 5 years 5 years Appliances, such as: Stoves Refrigerators 5 years 9 years Carpets 5 years 9 years Furniture used in rental property 5 years 9 years Office furniture and equipment, such as: Desks Files 7 years 10 years Any property that doesn’t have a class life and that hasn’t been designated by law as being in any other class 7 years 12 years Roads 15 years 20 years Shrubbery 15 years 20 years Fences 15 years 20 years Residential rental property (buildings or structures) and structural components such as furnaces, waterpipes, venting, etc. 27.5 years 40 years Additions and improvements, such as a new roof The same recovery period as that of the property to which the addition or improvement is made, determined as if the property were placed in service at the same time as the addition or improvement. Conventions A convention is a method established under MACRS to set the beginning and end of the recovery period. The convention you use determines the number of months for which you can claim depreciation in the year you place property in service and in the year you dispose of the property. Mid-month convention. A mid-month convention is used for all residential rental property and nonresidential real property. Under this convention, you treat all property placed in service, or disposed of, during any month as placed in service, or disposed of, at the midpoint of that month. Mid-quarter convention. A mid-quarter convention must be used if the mid-month convention doesn’t apply and the total depreciable basis of MACRS property placed in service in the last 3 months of a tax year (excluding nonresidential real property, residential rental property, and property placed in service and disposed of in the same year) is more than 40% of the total basis of all such property you place in service during the year. Under this convention, you treat all property placed in service, or disposed of, during any quarter of a tax year as placed in service, or disposed of, at the midpoint of the quarter. Example. During the tax year, Tom purchased the following items to use in his rental property. He elects not to claim the special depreciation allowance discussed earlier. A dishwasher for $400 that he placed in service in January. Used furniture for $100 that he placed in service in September. A refrigerator for $800 that he placed in service in October. Tom uses the calendar year as his tax year. The total basis of all property placed in service that year is $1,300. The $800 basis of the refrigerator placed in service during the last 3 months of his tax year exceeds $520 (40% × $1,300). Tom must use the mid-quarter convention instead of the half-year convention for all three items.Half-year convention. The half-year convention is used if neither the mid-quarter convention nor the mid-month convention applies. Under this convention, you treat all property placed in service, or disposed of, during a tax year as placed in service, or disposed of, at the midpoint of that tax year. If this convention applies, you deduct a half year of depreciation for the first year and the last year that you depreciate the property. You deduct a full year of depreciation for any other year during the recovery period. Figuring Your Depreciation Deduction You can figure your MACRS depreciation deduction in one of two ways. The deduction is substantially the same both ways. You can figure the deduction using either: The depreciation method and convention that apply over the recovery period of the property, or The percentage from the MACRS percentage tables.
Residential rental property. You must use the straight line method and a mid-month convention for residential rental property. In the first year that you claim depreciation for residential rental property, you can claim depreciation only for the number of months the property is in use. Use the mid-month convention (explained under Conventions , earlier). 5-, 7-, or 15-year property. For property in the 5- or 7-year class, use the 200% declining balance method and a half-year convention. However, in limited cases you must use the mid-quarter convention, if it applies. For property in the 15-year class, use the 150% declining balance method and a half-year convention. You can also choose to use the 150% declining balance method for property in the 5- or 7-year class. The choice to use the 150% method for one item in a class of property applies to all property in that class that is placed in service during the tax year of the election. You make this election on Form 4562. In Part III, column (f), enter "150 DB." Once you make this election, you can’t change to another method. If you use either the 200% or 150% declining balance method, figure your deduction using the straight line method in the first tax year that the straight line method gives you an equal or larger deduction. You can also choose to use the straight line method with a half-year or mid-quarter convention for 5-, 7-, or 15-year property. The choice to use the straight line method for one item in a class of property applies to all property in that class that is placed in service during the tax year of the election. You elect the straight line method on Form 4562. In Part III, column (f), enter "S/L." Once you make this election, you can’t change to another method. MACRS Percentage Tables You can use the percentages in Table 2-2 to compute annual depreciation under MACRS. The tables show the percentages for the first few years or until the change to the straight line method is made. See Appendix A of Pub. 946 for complete tables. The percentages in Tables 2-2a, 2-2b, and 2-2c make the change from declining balance to straight line in the year that straight line will give a larger deduction. If you elect to use the straight line method for 5-, 7-, or 15-year property, or the 150% declining balance method for 5- or 7-year property, use the tables in Appendix A of Pub. 946. How to use the percentage tables. You must apply the table rates to your property's unadjusted basis (defined below) each year of the recovery period. Once you begin using a percentage table to figure depreciation, you must continue to use it for the entire recovery period unless there is an adjustment to the basis of your property for a reason other than: Depreciation allowed or allowable, or An addition or improvement that is depreciated as a separate item of property. If there is an adjustment for any reason other than (1) or (2), for example, because of a deductible casualty loss, you can no longer use the table. Unadjusted basis. This is the same basis you would use to figure gain on a sale, but without reducing your original basis by any MACRS depreciation taken in earlier years. However, you do reduce your original basis by other amounts claimed on the property, including: Any amortization, Any section 179 deduction, and Any special depreciation allowance.
Table 2-2 Please click here for the text description of the image. Tables 2-2a, 2-2b, and 2-2c. The percentages in these tables take into account the half-year and mid-quarter conventions. Use Table 2-2a for 5-year property, Table 2-2b for 7-year property, and Table 2-2c for 15-year property. Use the percentage in the second column (half-year convention) unless you are required to use the mid-quarter convention (explained earlier). If you must use the mid-quarter convention, use the column that corresponds to the calendar year quarter in which you placed the property in service. Example 1. You purchased a stove and refrigerator and placed them in service in June. Your basis in the stove is $600 and your basis in the refrigerator is $1,000. Both are 5-year property. Using the half-year convention column in Table 2-2a, the depreciation percentage for Year 1 is 20%. For that year your depreciation deduction is $120 ($600 × 0.20) for the stove and $200 ($1,000 × 0.20) for the refrigerator. For Year 2, the depreciation percentage is 32%. That year's depreciation deduction will be $192 ($600 × 0.32) for the stove and $320 ($1,000 × 0.32) for the refrigerator. Example 2. Assume the same facts as in Example 1, except you buy the refrigerator in October instead of June. Since the refrigerator was placed in service in the last 3 months of the tax year, and its basis ($1,000) is more than 40% of the total basis of all property placed in service during the year ($1,600 × 0.40 = $640), you are required to use the mid-quarter convention to figure depreciation on both the stove and refrigerator. Because you placed the refrigerator in service in October, you use the fourth quarter column of Table 2-2a and find the depreciation percentage for Year 1 is 5%. Your depreciation deduction for the refrigerator is $50 ($1,000 x 0.05). Because you placed the stove in service in June, you use the second quarter column of Table 2-2a and find the depreciation percentage for Year 1 is 25%. For that year, your depreciation deduction for the stove is $150 ($600 x 0.25). Table 2-2d. Use this table when you are using the GDS 27.5 year option for residential rental property. Find the row for the month that you placed the property in service. Use the percentages listed for that month to figure your depreciation deduction. The mid-month convention is taken into account in the percentages shown in the table. Continue to use the same row (month) under the column for the appropriate year. Example. You purchased a single family rental house for $185,000 and placed it in service on February 8. The sales contract showed that the building cost $160,000 and the land cost $25,000. Your basis for depreciation is its original cost, $160,000. This is the first year of service for your residential rental property and you decide to use GDS which has a recovery period of 27.5 years. Using Table 2-2d, you find that the percentage for property placed in service in February of Year 1 is 3.182%. That year's depreciation deduction is $5,091 ($160,000 x 0.03182). Figuring MACRS Depreciation Under ADS Table 2-1, earlier, shows the ADS recovery periods for property used in rental activities. See Appendix B in Pub. 946 for other property. If your property isn’t listed in Appendix B, it is considered to have no class life. Under ADS, personal property with no class life is depreciated using a recovery period of 12 years. Use the mid-month convention for residential rental property and nonresidential real property. For all other property, use the half-year or mid-quarter convention, as appropriate. See Pub. 946 for ADS depreciation tables. Claiming the Correct Amount of Depreciation You should claim the correct amount of depreciation each tax year. If you didn’t claim all the depreciation you were entitled to deduct, you must still reduce your basis in the property by the full amount of depreciation that you could have deducted. If you deducted an incorrect amount of depreciation for property in any year, you may be able to make a correction by filing Form 1040X, Amended U.S. Individual Income Tax Return. If you aren’t allowed to make the correction on an amended return, you can change your accounting method to claim the correct amount of depreciation. Filing an amended return. You can file an amended return to correct the amount of depreciation claimed for any property in any of the following situations. You claimed the incorrect amount because of a mathematical error made in any year. You claimed the incorrect amount because of a posting error made in any year. You haven’t adopted a method of accounting for property placed in service by you in tax years ending after December 29, 2003. You claimed the incorrect amount on property placed in service by you in tax years ending before December 30, 2003. Generally, you adopt a method of accounting for depreciation by using a permissible method of determining depreciation when you file your first tax return for the property used in your rental activity. This also occurs when you use the same impermissible method of determining depreciation (for example, using the wrong MACRS recovery period) in two or more consecutively filed tax returns. If an amended return is allowed, you must file it by the later of the following dates. 3 years from the date you filed your original return for the year in which you didn’t deduct the correct amount. A return filed before an unextended due date is considered filed on that due date. 2 years from the time you paid your tax for that year. Changing your accounting method. To change your accounting method, you generally must file Form 3115 to get the consent of the IRS. In some instances, that consent is automatic. F Reporting Rental Income, Expenses, and Losses Figuring the net income or loss for a residential rental activity may involve more than just listing the income and deductions on Schedule E (Form 1040). There are activities that don’t qualify to use Schedule E, such as when the activity isn’t engaged in to make a profit or when you provide substantial services in conjunction with the property. There are also the limitations that may need to be applied if you have a net loss on Schedule E. There are two: (1) the limitation based on the amount of investment you have at risk in your rental activity, and (2) the special limits imposed on passive activities. You may also have a gain or loss related to your rental property from a casualty or theft. This is considered separately from the income and expense information you report on Schedule E. Which Forms To Use The basic form for reporting residential rental income and expenses is Schedule E (Form 1040). However, don’t use that schedule to report a not-for-profit activity. There are also other rental situations in which forms other than Schedule E would be used. Schedule E (Form 1040) If you rent buildings, rooms, or apartments, and provide basic services such as heat and light, trash collection, etc., you normally report your rental income and expenses on Schedule E, Part I. List your total income, expenses, and depreciation for each rental property. Be sure to enter the number of fair rental and personal use days on line 2. If you have more than three rental or royalty properties, complete and attach as many Schedules E as are needed to list the properties. Complete lines 1 and 2 for each property. However, fill in lines 23a through 26 on only one Schedule E. On Schedule E, page 1, line 18, enter the depreciation you are claiming for each property. To find out if you need to attach Form 4562, see Form 4562 . If you have a loss from your rental real estate activity, you also may need to complete one or both of the following forms. Form 6198, At-Risk Limitations. Form 8582, Passive Activity Loss Limitations. Page 2 of Schedule E is used to report income or loss from partnerships, S corporations, estates, trusts, and real estate mortgage investment conduits. If you need to use page 2 of Schedule E, be sure to use page 2 of the same Schedule E you used to enter your rental activity on page 1. Also, include the amount from line 26 (Part I) in the "Total income or (loss)" on line 41 (Part V). Form 4562. You must complete and attach Form 4562 for rental activities only if you are claiming: Depreciation, including the special depreciation allowance, on property placed in service during 2017; Depreciation on listed property (such as a car), regardless of when it was placed in service; or Any other car expenses, including the standard mileage rate or lease expenses. Otherwise, figure your depreciation on your own worksheet. You don’t have to attach these computations to your return, but you should keep them in your records for future reference. Schedule C (Form 1040), Profit or Loss From Business Generally, Schedule C is used when you provide substantial services in conjunction with the property or the rental is part of a trade or business as a real estate dealer. Providing substantial services. If you provide substantial services that are primarily for your tenant's convenience, such as regular cleaning, changing linen, or maid service, you report your rental income and expenses on Schedule C (Form 1040), Profit or Loss From Business, or Schedule C-EZ (Form 1040), Net Profit From Business. Use Form 1065, U.S. Return of Partnership Income, if your rental activity is a partnership (including a partnership with your spouse unless it is a qualified joint venture). Substantial services don’t include the furnishing of heat and light, cleaning of public areas, trash collection, etc. Also, you may have to pay self-employment tax on your rental income using Schedule SE (Form 1040), Self-Employment Tax. For a discussion of "substantial services," Qualified Joint Venture If you and your spouse each materially participate as the only members of a jointly owned and operated real estate business, and you file a joint return for the tax year, you can make a joint election to be treated as a qualified joint venture instead of a partnership. This election, in most cases, won’t increase the total tax owed on the joint return, but it does give each of you credit for social security earnings on which retirement benefits are based and for Medicare coverage if your rental income is subject to self-employment tax. If you make this election, you must report rental real estate income on Schedule E (or Schedule C if you provide substantial services). You won’t be required to file Form 1065 for any year the election is in effect. Rental real estate income generally isn’t included in net earnings from self-employment subject to self-employment tax and generally is subject to the passive activity limits. If you and your spouse filed a Form 1065 for the year prior to the election, the partnership terminates at the end of the tax year immediately preceding the year the election takes effect. For more information on qualified joint ventures, go to IRS.gov and enter "qualified joint venture" (with the quotation marks) in the search box. Limits on Rental Losses If you have a loss from your rental real estate activity, two sets of rules may limit the amount of loss you can deduct. You must consider these rules in the order shown below. Both are discussed in this section. At-risk rules. These rules are applied first if there is investment in your rental real estate activity for which you aren’t at risk. This applies only if the real property was placed in service after 1986. Passive activity limits. Generally, rental real estate activities are considered passive activities and losses aren’t deductible unless you have income from other passive activities to offset them. However, there are exceptions. At-Risk Rules You may be subject to the at-risk rules if you have: A loss from an activity carried on as a trade or business or for the production of income, and Amounts invested in the activity for which you aren’t fully at risk. Losses from holding real property (other than mineral property) placed in service before 1987 aren’t subject to the at-risk rules. In most cases, any loss from an activity subject to the at-risk rules is allowed only to the extent of the total amount you have at risk in the activity at the end of the tax year. You are considered at risk in an activity to the extent of cash and the adjusted basis of other property you contributed to the activity and certain amounts borrowed for use in the activity. Any loss that is disallowed because of the at-risk limits is treated as a deduction from the same activity in the next tax year. Form 6198. If you are subject to the at-risk rules, file Form 6198 with your tax return. Passive Activity Limits In most cases, all rental real estate activities (except those of certain real estate professionals, discussed later) are passive activities. For this purpose, a rental activity is an activity from which you receive income mainly for the use of tangible property, rather than for services. Deductions or losses from passive activities are limited. You generally can’t offset income, other than passive income, with losses from passive activities. Nor can you offset taxes on income, other than passive income, with credits resulting from passive activities. Any excess loss or credit is carried forward to the next tax year. Exceptions to the rules for figuring passive activity limits for personal use of a dwelling unit and for rental real estate with active participation are discussed later. Real estate professionals. If you are a real estate professional, complete line 43 of Schedule E. You qualify as a real estate professional for the tax year if you meet both of the following requirements. More than half of the personal services you perform in all trades or businesses during the tax year are performed in real property trades or businesses in which you materially participate. You perform more than 750 hours of services during the tax year in real property trades or businesses in which you materially participate. If you qualify as a real estate professional, rental real estate activities in which you materially participated aren’t passive activities. For purposes of determining whether you materially participated in your rental real estate activities, each interest in rental real estate is a separate activity unless you elect to treat all your interests in rental real estate as one activity. Don’t count personal services you perform as an employee in real property trades or businesses unless you are a 5% owner of your employer. You are a 5% owner if you own (or are considered to own) more than 5% of your employer's outstanding stock, or capital or profits interest. Don’t count your spouse's personal services to determine whether you met the requirements listed earlier to qualify as a real estate professional. However, you can count your spouse's participation in an activity in determining if you materially participated. Real property trades or businesses. A real property trade or business is a trade or business that does any of the following with real property. Develops or redevelops it. Constructs or reconstructs it. Acquires it. Converts it. Rents or leases it. Operates or manages it. Brokers it. Choice to treat all interests as one activity. If you were a real estate professional and had more than one rental real estate interest during the year, you can choose to treat all the interests as one activity. You can make this choice for any year that you qualify as a real estate professional. If you forgo making the choice for one year, you can still make it for a later year. If you make the choice, it is binding for the tax year you make it and for any later year that you are a real estate professional. This is true even if you aren’t a real estate professional in any intervening year. (For that year, the exception for real estate professionals won’t apply in determining whether your activity is subject to the passive activity rules.)
Material participation. Generally, you materially participated in an activity for the tax year if you were involved in its operations on a regular, continuous, and substantial basis during the year. Participating spouse. If you are married, determine whether you materially participated in an activity by also counting any participation in the activity by your spouse during the year. Do this even if your spouse owns no interest in the activity or files a separate return for the year. Form 8582. You may have to complete Form 8582 to figure the amount of any passive activity loss for the current tax year for all activities and the amount of the passive activity loss allowed on your tax return. If you are required to complete Form 8582 and are also subject to the at-risk rules, include the amount from Form 6198, line 21 (deductible loss) in column (b) of Form 8582, Worksheet 1 or 3, as required. Exception for Personal Use of Dwelling Unit If you used the rental property as a home during the year, any income, deductions, gain, or loss allocable to such use shall not be taken into account for purposes of the passive activity loss limitation. Instead, follow the rules explained in chapter 5, Personal Use of Dwelling Unit (Including Vacation Home). Exception for Rental Real Estate With Active Participation If you or your spouse actively participated in a passive rental real estate activity, you may be able to deduct up to $25,000 of loss from the activity from your nonpassive income. This special allowance is an exception to the general rule disallowing losses in excess of income from passive activities. Similarly, you may be able to offset credits from the activity against the tax on up to $25,000 of nonpassive income after taking into account any losses allowed under this exception. Example. Jane is single and has $40,000 in wages, $2,000 of passive income from a limited partnership, and $3,500 of passive loss from a rental real estate activity in which she actively participated. $2,000 of Jane's $3,500 loss offsets her passive income. The remaining $1,500 loss can be deducted from her $40,000 wages. The special allowance isn’t available if you were married, lived with your spouse at any time during the year, and are filing a separate return. Active participation. You actively participated in a rental real estate activity if you (and your spouse) owned at least 10% of the rental property and you made management decisions or arranged for others to provide services (such as repairs) in a significant and bona fide sense. Management decisions that may count as active participation include approving new tenants, deciding on rental terms, approving expenditures, and other similar decisions. Example. Mike is single and had the following income and losses during the tax year: Salary $42,300 Dividends 300 Interest 1,400 Rental loss (4,000) The rental loss was from the rental of a house Mike owned. Mike had advertised and rented the house to the current tenant himself. He also collected the rents, which usually came by mail. All repairs were either made or contracted out by Mike. Although the rental loss is from a passive activity, because Mike actively participated in the rental property management he can use the entire $4,000 loss to offset his other income. Maximum special allowance. The maximum special allowance is: $25,000 for single individuals and married individuals filing a joint return for the tax year, $12,500 for married individuals who file separate returns for the tax year and lived apart from their spouses at all times during the tax year, and $25,000 for a qualifying estate reduced by the special allowance for which the surviving spouse qualified. If your modified adjusted gross income (MAGI) is $100,000 or less ($50,000 or less if married filing separately), you can deduct your loss up to the amount specified above. If your MAGI is more than $100,000 (more than $50,000 if married filing separately), your special allowance is limited to 50% of the difference between $150,000 ($75,000 if married filing separately) and your MAGI. Generally, if your MAGI is $150,000 or more ($75,000 or more if you are married filing separately), there is no special allowance. Modified adjusted gross income (MAGI). This is your adjusted gross income from Form 1040, U.S. Individual Income Tax Return, line 38, or Form 1040NR, U.S. Nonresident Alien Income Tax Return, line 37, figured without taking into account: The taxable amount of social security or equivalent tier 1 railroad retirement benefits, The deductible contributions to traditional individual retirement accounts (IRAs) and section 501(c)(18) pension plans, The exclusion from income of interest from Series EE and I U.S. savings bonds used to pay higher educational expenses, The exclusion of amounts received under an employer's adoption assistance program, Any passive activity income or loss included on Form 8582, Any rental real estate loss allowed to real estate professionals, Any overall loss from a publicly traded partnership The deduction allowed for one-half of self-employment tax, The deduction allowed for interest paid on student loans, The deduction for qualified tuition and related fees, and The domestic production activities deduction Form 8582 not required. Don’t complete Form 8582 if you meet all of the following conditions. Your only passive activities were rental real estate activities in which you actively participated. Your overall net loss from these activities is $25,000 or less ($12,500 or less if married filing separately and you lived apart from your spouse all year). If married filing separately, you lived apart from your spouse all year. You have no prior year unallowed losses from these (or any other passive) activities. You have no current or prior year unallowed credits from passive activities. Your MAGI is $100,000 or less ($50,000 or less if married filing separately and you lived apart from your spouse all year). You don’t hold any interest in a rental real estate activity as a limited partner or as a beneficiary of an estate or a trust. If you meet all of the conditions listed above, your rental real estate activities aren’t limited by the passive activity rules and you don’t have to complete Form 8582. On lines 23a through 23e of your Schedule E, enter the applicable amounts. Casualties and Thefts As a result of a casualty or theft, you may have a loss related to your rental property. You may be able to deduct the loss on your income tax return. Casualty. This is the damage, destruction, or loss of property resulting from an identifiable event that is sudden, unexpected, or unusual. Such events include a storm, fire, or earthquake. Theft. This is defined as the unlawful taking and removing of your money or property with the intent to deprive you of it. Gain from casualty or theft. It is also possible to have a gain from a casualty or theft if you receive money, including insurance, that is more than your adjusted basis in the property. Generally, you must report this gain. However, under certain circumstances, you may defer paying tax by choosing to postpone reporting the gain. To do this, you generally must buy replacement property within 2 years after the close of the first tax year in which any part of your gain is realized. In certain circumstances, the replacement period can be greater than 2 years; The cost of the replacement property must be equal to or more than the net insurance or other payment you received.How to report. If you had a casualty or theft that involved property used in your rental activity, figure the net gain or loss in Section B of Form 4684, Casualties and Thefts. Follow the Instructions for Form 4684 for where to carry your net gain or loss. Example In February 2012, Marie bought a rental house for $135,000 (house $120,000 and land $15,000) and immediately began renting it out. In 2017, she rented it all 12 months for a monthly rental fee of $1,125. In addition to her rental income of $13,500 (12 x $1,125), Marie had the following expenses. Mortgage interest $8,000 Fire insurance (1-year policy) 250 Miscellaneous repairs 400 Real estate taxes imposed and paid 500 Maintenance 200 Marie depreciates the residential rental property under MACRS GDS. This means using the straight line method over a recovery period of 27.5 years. She uses Table 2-2d to find her depreciation percentage. Because she placed the property in service in February 2012, she continues to use that row of Table 2-2d. For year 6, the rate is 3.636%. Marie figures her net rental income or loss for the house as follows: Total rental income received ($1,125 × 12) $13,500 Minus: Expenses Mortgage interest $8,000 Fire insurance 250 Miscellaneous repairs 400 Real estate taxes 500 Maintenance 200 Total expenses 9,350 Balance $4,150 Minus: Depreciation ($120,000 x 3.636%) 4,363 Net rental (loss) for house ($213) Marie had a net loss for the year. Because she actively participated in her passive rental real estate activity and her loss was less than $25,000, she can deduct the loss on her return. Marie also meets all of the requirements for not having to file Form 8582. She uses Schedule E, Part I, to report her rental income and expenses. She enters her income, expenses, and depreciation for the house in the column for Property A and enters her loss on line 22. Form 4562 isn’t required. Condominiums A condominium is most often a dwelling unit in a multi-unit building, but can also take other forms, such as a townhouse or garden apartment. If you own a condominium, you also own a share of the common elements, such as land, lobbies, elevators, and service areas. You and the other condominium owners may pay dues or assessments to a special corporation that is organized to take care of the common elements. Special rules apply if you rent your condominium to others. You can deduct as rental expenses all the expenses discussed in chapters 1 and 2. In addition, you can deduct any dues or assessments paid for maintenance of the common elements. You can’t deduct special assessments you pay to a condominium management corporation for improvements. However, you may be able to recover your share of the cost of any improvement by taking depreciation. Cooperatives If you live in a cooperative, you don’t own your apartment. Instead, a corporation owns the apartments and you are a tenant-stockholder in the cooperative housing corporation. If you rent your apartment to others, you usually can deduct, as a rental expense, all the maintenance fees you pay to the cooperative housing corporation. In addition to the maintenance fees paid to the cooperative housing corporation, you can deduct your direct payments for repairs, upkeep, and other rental expenses, including interest paid on a loan used to buy your stock in the corporation. Depreciation You will be depreciating your stock in the corporation rather than the apartment itself. Figure your depreciation deduction as follows. Multiply your cost per share by the total number of outstanding shares. Add to the amount figured in (a) any mortgage debt on the property on the date you bought the stock. Subtract from the amount figured in (b) any mortgage debt that isn’t for the depreciable real property, such as the part for the land. Subtract from the amount figured in (1) any depreciation for space owned by the corporation that can be rented but can’t be lived in by tenant-stockholders. Divide the number of your shares of stock by the total number of shares outstanding, including any shares held by the corporation. Multiply the result of (2) by the percentage you figured in (3). This is your depreciation on the stock. Your depreciation deduction for the year can’t be more than the part of your adjusted basis (defined in chapter 2) in the stock of the corporation that is allocable to your rental property. Payments added to capital account. Payments earmarked for a capital asset or improvement, or otherwise charged to the corporation's capital account are added to the basis of your stock in the corporation. For example, you can’t deduct a payment used to pave a community parking lot, install a new roof, or pay the principal of the corporation's mortgage. Treat as a capital cost the amount you were assessed for capital items. This can’t be more than the amount by which your payments to the corporation exceeded your share of the corporation's mortgage interest and real estate taxes. Your share of interest and taxes is the amount the corporation elected to allocate to you, if it reasonably reflects those expenses for your apartment. Otherwise, figure your share in the following manner. Divide the number of your shares of stock by the total number of shares outstanding, including any shares held by the corporation. Multiply the corporation's deductible interest by the number you figured in (1). This is your share of the interest. Multiply the corporation's deductible taxes by the number you figured in (1). This is your share of the taxes. Property Changed to Rental Use If you change your home or other property (or a part of it) to rental use at any time other than the beginning of your tax year, you must divide yearly expenses, such as taxes and insurance, between rental use and personal use. You can deduct as rental expenses only the part of the expense that is for the part of the year the property was used or held for rental purposes. You can’t deduct depreciation or insurance for the part of the year the property was held for personal use. However, you can include the home mortgage interest, qualified mortgage insurance premiums, and real estate tax expenses for the part of the year the property was held for personal use as an itemized deduction on Schedule A (Form 1040). Example. Your tax year is the calendar year. You moved from your home in May and started renting it out on June 1. You can deduct as rental expenses seven-twelfths of your yearly expenses, such as taxes and insurance. Starting with June, you can deduct as rental expenses the amounts you pay for items generally billed monthly, such as utilities. When figuring depreciation, treat the property as placed in service on June 1. Basis of Property Changed to Rental Use When you change property you held for personal use to rental use (for example, you rent your former home), the basis for depreciation will be the lesser of fair market value or adjusted basis on the date of conversion. Fair market value. This is the price at which the property would change hands between a willing buyer and a willing seller, neither having to buy or sell, and both having reasonable knowledge of all the relevant facts. Sales of similar property, on or about the same date, may be helpful in figuring the fair market value of the property. Figuring the basis. The basis for depreciation is the lesser of: The fair market value of the property on the date you changed it to rental use; or Your adjusted basis on the date of the change —that is, your original cost or other basis of the property, plus the cost of permanent additions or improvements since you acquired it, minus deductions for any casualty or theft losses claimed on earlier years' income tax returns and other decreases to basis.Example. You originally built a house for $140,000 on a lot that cost you $14,000, which you used as your home for many years. Before changing the property to rental use this year, you added $28,000 of permanent improvements to the house and claimed a $3,500 casualty loss deduction for damage to the house. Part of the improvements qualified for a $500 residential energy credit, which you claimed on a prior year tax return. Because land isn’t depreciable, you can only include the cost of the house when figuring the basis for depreciation. The adjusted basis of the house at the time of the change in its use was $164,000 ($140,000 + $28,000 − $3,500 − $500).On the date of the change in use, your property had a fair market value of $168,000, of which $21,000 was for the land and $147,000 was for the house. The basis for depreciation on the house is the fair market value on the date of the change ($147,000) because it is less than your adjusted basis ($164,000). Cooperatives If you change your cooperative apartment to rental use, figure your allowable depreciation as explained earlier. (Depreciation methods are discussed in chapter 2 of this publication and Pub. 946.) The basis of all the depreciable real property owned by the cooperative housing corporation is the smaller of the following amounts. The fair market value of the property on the date you change your apartment to rental use. This is considered to be the same as the corporation's adjusted basis minus straight line depreciation, unless this value is unrealistic. The corporation's adjusted basis in the property on that date. Don’t subtract depreciation when figuring the corporation's adjusted basis. If you bought the stock after its first offering, the corporation's adjusted basis in the property is the amount figured in (1) under Depreciation (under Cooperatives, near the beginning of this chapter). The fair market value of the property is considered to be the same as the corporation's adjusted basis figured in this way minus straight line depreciation, unless the value is unrealistic. Figuring the Depreciation Deduction To figure the deduction, use the depreciation system in effect when you convert your residence to rental use. Generally, that will be MACRS for any conversion after 1986. Treat the property as placed in service on the conversion date. Example. Your converted residence was available for rent on August 1. Using Table 2-2d, the percentage for Year 1 beginning in August is 1.364% and the depreciation deduction for Year 1 is $2,005 ($147,000 × 0.01364). Renting Part of Property If you rent part of your property, you must divide certain expenses between the part of the property used for rental purposes and the part of the property used for personal purposes, as though you actually had two separate pieces of property. You can deduct the expenses related to the part of the property used for rental purposes, such as home mortgage interest, qualified mortgage insurance premiums, and real estate taxes, as rental expenses on Schedule E (Form 1040). You can also deduct as rental expenses a portion of other expenses that normally are nondeductible personal expenses, such as expenses for electricity or painting the outside of the house. There is no change in the types of expenses deductible for the personal-use part of your property. Generally, these expenses may be deducted only if you itemize your deductions on Schedule A (Form 1040). You can’t deduct any part of the cost of the first phone line even if your tenants have unlimited use of it. You don’t have to divide the expenses that belong only to the rental part of your property. For example, if you paint a room that you rent or pay premiums for liability insurance in connection with renting a room in your home, your entire cost is a rental expense. If you install a second phone line strictly for your tenant's use, all the cost of the second line is deductible as a rental expense. You can deduct depreciation on the part of the house used for rental purposes as well as on the furniture and equipment you use for rental purposes. How to divide expenses. If an expense is for both rental use and personal use, such as mortgage interest or heat for the entire house, you must divide the expense between rental use and personal use. You can use any reasonable method for dividing the expense. It may be reasonable to divide the cost of some items (for example, water) based on the number of people using them. The two most common methods for dividing an expense are (1) the number of rooms in your home, and (2) the square footage of your home. Example. You rent a room in your house. The room is 12 × 15 feet, or 180 square feet. Your entire house has 1,800 square feet of floor space. You can deduct as a rental expense 10% of any expense that must be divided between rental use and personal use. If your heating bill for the year for the entire house was $600, $60 ($600 × 0.10) is a rental expense. The balance, $540, is a personal expense that you can’t deduct. Duplex. A common situation is the duplex where you live in one unit and rent out the other. Certain expenses apply to the entire property, such as mortgage interest and real estate taxes, and must be split to determine rental and personal expenses. Example. You own a duplex and live in one half, renting the other half. Both units are approximately the same size. Last year, you paid a total of $10,000 mortgage interest and $2,000 real estate taxes for the entire property. You can deduct $5,000 mortgage interest and $1,000 real estate taxes on Schedule E (Form 1040). If you itemize your deductions, you can deduct the other $5,000 mortgage interest and $1,000 real estate taxes on Schedule A (Form 1040). Not Rented for Profit If you don’t rent your property to make a profit, you can deduct your rental expenses only up to the amount of your rental income. You can’t deduct a loss or carry forward to the next year any rental expenses that are more than your rental income for the year. Where to report. Report your not-for-profit rental income on Form 1040 or 1040NR, line 21. If you are filing Form 1040 and you itemize your deductions, you can include your mortgage interest and any qualified mortgage insurance premiums (if you use the property as your main home or second home), real estate taxes, and casualty losses on the appropriate lines of Schedule A (Form 1040). Claim your other rental expenses, subject to the rules explained in chapter 1 of Pub. 535, as miscellaneous itemized deductions on Schedule A (Form 1040), line 23, or Schedule A (Form 1040NR), line 9. You can deduct these expenses only if they, together with certain other miscellaneous itemized deductions, total more than 2% of your adjusted gross income. Presumption of profit. If your rental income is more than your rental expenses for at least 3 years out of a period of 5 consecutive years, you are presumed to be renting your property to make a profit. Postponing decision. If you are starting your rental activity and don’t have 3 years showing a profit, you can elect to have the presumption made after you have the 5 years of experience required by the test. You may choose to postpone the decision of whether the rental is for profit by filing Form 5213. You must file Form 5213 within 3 years after the due date of your return (determined without extensions) for the year in which you first carried on the activity or, if earlier, within 60 days after receiving written notice from the Internal Revenue Service proposing to disallow deductions attributable to the activity. Example —Property Changed to Rental UseIn January, Eileen bought a condominium apartment to live in. Instead of selling the house she had been living in, she decided to change it to rental property. Eileen selected a tenant and started renting the house on February 1. Eileen charges $750 a month for rent and collects it herself. Eileen also received a $750 security deposit from her tenant. Because she plans to return it to her tenant at the end of the lease, she doesn’t include it in her income. Her rental expenses for the year are as follows. Mortgage interest $1,800 Fire insurance (1-year policy) 100 Miscellaneous repairs (after renting) 297 Real estate taxes imposed and paid 1,200 Eileen must divide the real estate taxes, mortgage interest, and fire insurance between the personal use of the property and the rental use of the property. She can deduct eleven-twelfths of these expenses as rental expenses. She can include the balance of the allowable taxes and mortgage interest on Schedule A (Form 1040) if she itemizes. She can’t deduct the balance of the fire insurance because it is a personal expense. Eileen bought this house in 1984 for $35,000. Her property tax was based on assessed values of $10,000 for the land and $25,000 for the house. Before changing it to rental property, Eileen added several improvements to the house. She figures her adjusted basis as follows. Improvements Cost House $25,000 Remodeled kitchen 4,200 Recreation room 5,800 New roof 1,600 Patio and deck 2,400 Adjusted basis $39,000 On February 1, when Eileen changed her house to rental property, the property had a fair market value of $152,000. Of this amount, $35,000 was for the land and $117,000 was for the house. Because Eileen's adjusted basis is less than the fair market value on the date of the change, Eileen uses $39,000 as her basis for depreciation. As specified for residential rental property, Eileen must use the straight line method of depreciation over the GDS or ADS recovery period. She chooses the GDS recovery period of 27.5 years. She uses Table 2-2d to find her depreciation percentage. Since she placed the property in service in February, the percentage is 3.182%. On April 1, Eileen bought a new dishwasher for the rental property at a cost of $425. The dishwasher is personal property used in a rental real estate activity, which has a 5-year recovery period. She uses Table 2-2a to find the percentage for Year 1 under "Half-year convention" (20%) to figure her depreciation deduction. On May 1, Eileen paid $4,000 to have a furnace installed in the house. The furnace is residential rental property. Because she placed the property in service in May, the percentage from Table 2-2d is 2.273%. Eileen figures her net rental income or loss for the house as follows. Total rental income received ($750 × 11) $8,250Minus: Expenses Mortgage interest ($1,800 × 11/12) $1,650 Fire insurance ($100 × 11/12) 92 Miscellaneous repairs 297 Real estate taxes ($1,200 × 11/12) 1,100 Total expenses 3,139 Balance $5,111 Minus: Depreciation House ($39,000 × 0.03182) $1,241 Dishwasher ($425 × 0.20) 85 Furnace ($4,000 × 0.02273) 91 Total depreciation 1,417 Net rental income for house $3,694 Eileen uses Schedule E, Part I, to report her rental income and expenses. She enters her income, expenses, and depreciation for the house in the column for Property A. Since all property was placed in service this year, Eileen must use Form 4562 to figure the depreciation. Personal Use of Dwelling Unit (Including Vacation Home) If you have any personal use of a dwelling unit (including a vacation home) that you rent, you must divide your expenses between rental use and personal use. In general, your rental expenses will be no more than your total expenses multiplied by a fraction; the denominator of which is the total number of days the dwelling unit is used and the numerator of which is the total number of days actually rented at a fair rental price. Only your rental expenses may be deducted on Schedule E (Form 1040). Some of your personal expenses may be deductible on Schedule A (Form 1040) if you itemize your deductions. You must also determine if the dwelling unit is considered a home. The amount of rental expenses that you can deduct may be limited if the dwelling unit is considered a home. Whether a dwelling unit is considered a home depends on how many days during the year are considered to be days of personal use. There is a special rule if you used the dwelling unit as a home and you rented it for less than 15 days during the year. Dwelling unit. A dwelling unit includes a house, apartment, condominium, mobile home, boat, vacation home, or similar property. It also includes all structures or other property belonging to the dwelling unit. A dwelling unit has basic living accommodations, such as sleeping space, a toilet, and cooking facilities. A dwelling unit doesn’t include property (or part of the property) used solely as a hotel, motel, inn, or similar establishment. Property is used solely as a hotel, motel, inn, or similar establishment if it is regularly available for occupancy by paying customers and isn’t used by an owner as a home during the year. Example. You rent a room in your home that is always available for short-term occupancy by paying customers. You don’t use the room yourself and you allow only paying customers to use the room. This room is used solely as a hotel, motel, inn, or similar establishment and isn’t a dwelling unit. Dividing Expenses If you use a dwelling unit for both rental and personal purposes, divide your expenses between the rental use and the personal use based on the number of days used for each purpose. When dividing your expenses, follow these rules. Any day that the unit is rented at a fair rental price is a day of rental use even if you used the unit for personal purposes that day. (This rule doesn’t apply when determining whether you used the unit as a home.) Any day that the unit is available for rent but not actually rented isn’t a day of rental use. Fair rental price. A fair rental price for your property generally is the amount of rent that a person who isn’t related to you would be willing to pay. The rent you charge isn’t a fair rental price if it is substantially less than the rents charged for other properties that are similar to your property in your area. Ask yourself the following questions when comparing another property with yours. Is it used for the same purpose? Is it approximately the same size? Is it in approximately the same condition? Does it have similar furnishings? Is it in a similar location? If any of the answers are no, the properties probably aren’t similar. Example. Your beach cottage was available for rent from June 1 through August 31 (92 days). Except for the first week in August (7 days), when you were unable to find a renter, you rented the cottage at a fair rental price during that time. The person who rented the cottage for July allowed you to use it over the weekend (2 days) without any reduction in or refund of rent. Your family also used the cottage during the last 2 weeks of May (14 days). The cottage wasn’t used at all before May 17 or after August 31. You figure the part of the cottage expenses to treat as rental expenses as follows. The cottage was used for rental a total of 85 days (92 − 7). The days it was available for rent but not rented (7 days) aren’t days of rental use. The July weekend (2 days) you used it is rental use because you received a fair rental price for the weekend.You used the cottage for personal purposes for 14 days (the last 2 weeks in May). The total use of the cottage was 99 days (14 days personal use + 85 days rental use). Your rental expenses are 85/99 (86%) of the cottage expenses. Note. When determining whether you used the cottage as a home, the July weekend (2 days) you used it is considered personal use even though you received a fair rental price for the weekend. Therefore, you had 16 days of personal use and 83 days of rental use for this purpose. Because you used the cottage for personal purposes more than 14 days and more than 10% of the days of rental use (8 days), you used it as a home. If you have a net loss, you may not be able to deduct all of the rental expenses. Dwelling Unit Used as a Home If you use a dwelling unit for both rental and personal purposes, the tax treatment of the rental expenses you figured earlier under Dividing Expenses and rental income depends on whether you are considered to be using the dwelling unit as a home. You use a dwelling unit as a home during the tax year if you use it for personal purposes more than the greater of: 14 days, or 10% of the total days it is rented to others at a fair rental price.
If a dwelling unit is used for personal purposes on a day it is rented at a fair rental price (discussed earlier), don’t count that day as a day of rental use in applying (2) above. Instead, count it as a day of personal use in applying both (1) and (2) above. What is a day of personal use? A day of personal use of a dwelling unit is any day that the unit is used by any of the following persons. You or any other person who owns an interest in it, unless you rent it to another owner as his or her main home under a shared equity financing agreement (defined later). A member of your family or a member of the family of any other person who owns an interest in it, unless the family member uses the dwelling unit as his or her main home and pays a fair rental price. Family includes only your spouse, brothers and sisters, half brothers and half sisters, ancestors (parents, grandparents, etc.), and lineal descendants (children, grandchildren, etc.). Anyone under an arrangement that lets you use some other dwelling unit. Anyone at less than a fair rental price. Main home. If the other person or member of the family in (1) or (2) has more than one home, his or her main home is ordinarily the one he or she lived in most of the time. Shared equity financing agreement. This is an agreement under which two or more persons acquire undivided interests for more than 50 years in an entire dwelling unit, including the land, and one or more of the co-owners is entitled to occupy the unit as his or her main home upon payment of rent to the other co-owner or owners. Donation of use of the property. You use a dwelling unit for personal purposes if: You donate the use of the unit to a charitable organization, The organization sells the use of the unit at a fundraising event, and The "purchaser" uses the unit. Examples. The following examples show how to determine if you have days of personal use. Example 1. You and your neighbor are co-owners of a condominium at the beach. Last year, you rented the unit to vacationers whenever possible. The unit wasn’t used as a main home by anyone. Your neighbor used the unit for 2 weeks last year; you didn’t use it at all. Because your neighbor has an interest in the unit, both of you are considered to have used the unit for personal purposes during those 2 weeks. Example 2. You and your neighbors are co-owners of a house under a shared equity financing agreement. Your neighbors live in the house and pay you a fair rental price. Even though your neighbors have an interest in the house, the days your neighbors live there aren’t counted as days of personal use by you. This is because your neighbors rent the house as their main home under a shared equity financing agreement. Example 3. You own a rental property that you rent to your son. Your son doesn’t own any interest in this property. He uses it as his main home and pays you a fair rental price. Your son's use of the property isn’t personal use by you because your son is using it as his main home, he owns no interest in the property, and he is paying you a fair rental price. Example 4. You rent your beach house to Rosa. Rosa rents her cabin in the mountains to you. You each pay a fair rental price. You are using your beach house for personal purposes on the days that Rosa uses it because your house is used by Rosa under an arrangement that allows you to use her cabin. Example 5. You rent an apartment to your mother at less than a fair rental price. You are using the apartment for personal purposes on the days that your mother rents it because you rent it for less than a fair rental price. Days used for repairs and maintenance. Any day that you spend working substantially full time repairing and maintaining (not improving) your property isn’t counted as a day of personal use. Don’t count such a day as a day of personal use even if family members use the property for recreational purposes on the same day. Example. Corey owns a cabin in the mountains that he rents for most of the year. He spends a week at the cabin with family members. Corey works on maintenance of the cabin 3 or 4 hours each day during the week and spends the rest of the time fishing, hiking, and relaxing. Corey's family members, however, work substantially full time on the cabin each day during the week. The main purpose of being at the cabin that week is to do maintenance work. Therefore, the use of the cabin during the week by Corey and his family won’t be considered personal use by Corey. Days used as a main home before or after renting. For purposes of determining whether a dwelling unit was used as a home, you may not have to count days you used the property as your main home before or after renting it or offering it for rent as days of personal use. Don’t count them as days of personal use if: You rented or tried to rent the property for 12 or more consecutive months. You rented or tried to rent the property for a period of less than 12 consecutive months and the period ended because you sold or exchanged the property. However, this special rule doesn’t apply when dividing expenses between rental and personal use. Example 1. On February 29, 2016, you moved out of the house you had lived in for 6 years because you accepted a job in another town. You rented your house at a fair rental price from March 15, 2016, to May 14, 2017 (14 months). On June 1, 2017, you moved back into your old house. The days you used the house as your main home from January 1 to February 29, 2016, and from June 1 to December 31, 2017, aren’t counted as days of personal use. Therefore, you would use the rules in chapter 1 when figuring your rental income and expenses. Example 2. On January 31, you moved out of the condominium where you had lived for 3 years. You offered it for rent at a fair rental price beginning on February 1. You were unable to rent it until April. On September 15, you sold the condominium. The days you used the condominium as your main home from January 1 to January 31 aren’t counted as days of personal use when determining whether you used it as a home. Examples. The following examples show how to determine whether you used your rental property as a home. Example 1. You converted the basement of your home into an apartment with a bedroom, a bathroom, and a small kitchen. You rented the basement apartment at a fair rental price to college students during the regular school year. You rented to them on a 9-month lease (273 days). You figured 10% of the total days rented to others at a fair rental price is 27 days. During June (30 days), your brothers stayed with you and lived in the basement apartment rent free. Your basement apartment was used as a home because you used it for personal purposes for 30 days. Rent-free use by your brothers is considered personal use. Your personal use (30 days) is more than the greater of 14 days or 10% of the total days it was rented (27 days). Example 2. You rented the guest bedroom in your home at a fair rental price during the local college's homecoming, commencement, and football weekends (a total of 27 days). Your sister-in-law stayed in the room, rent free, for the last 3 weeks (21 days) in July. You figured 10% of the total days rented to others at a fair rental price is 3 days. The room was used as a home because you used it for personal purposes for 21 days. That is more than the greater of 14 days or 10% of the 27 days it was rented (3 days). Example 3. You own a condominium apartment in a resort area. You rented it at a fair rental price for a total of 170 days during the year. For 12 of these days, the tenant wasn’t able to use the apartment and allowed you to use it even though you didn’t refund any of the rent. Your family actually used the apartment for 10 of those days. Therefore, the apartment is treated as having been rented for 160 (170 – 10) days. You figured 10% of the total days rented to others at a fair rental price is 16 days. Your family also used the apartment for 7 other days during the year.You used the apartment as a home because you used it for personal purposes for 17 days. That is more than the greater of 14 days or 10% of the 160 days it was rented (16 days). Minimal rental use. If you use the dwelling unit as a home and you rent it less than 15 days during the year, that period isn’t treated as rental activity. Limit on deductions. Renting a dwelling unit that is considered a home isn’t a passive activity. Instead, if your rental expenses are more than your rental income, some or all of the excess expenses can’t be used to offset income from other sources. The excess expenses that can’t be used to offset income from other sources are carried forward to the next year and treated as rental expenses for the same property. Any expenses carried forward to the next year will be subject to any limits that apply for that year. This limitation will apply to expenses carried forward to another year even if you don’t use the property as your home for that subsequent year. To figure your deductible rental expenses for this year and any carryover to next year, use Worksheet 5-1. Reporting Income and Deductions Property not used for personal purposes.
Property used for personal purposes. If you do use a dwelling unit for personal purposes, then how you report your rental income and expenses depends on whether you used the dwelling unit as a home. Not used as a home. If you use a dwelling unit for personal purposes, but not as a home, report all the rental income in your income. Because you used the dwelling unit for personal purposes, you must divide your expenses between the rental use and the personal use as described earlier in this chapter under Dividing Expenses . The expenses for personal use aren’t deductible as rental expenses. Your deductible rental expenses can be more than your gross rental income; Used as a home but rented less than 15 days. If you use a dwelling unit as a home and you rent it less than 15 days during the year, its primary function isn’t considered to be rental and it shouldn’t be reported on Schedule E (Form 1040). You aren’t required to report the rental income and rental expenses from this activity. The expenses, including mortgage interest, property taxes, and any qualified casualty loss will be reported as normally allowed on Schedule A (Form 1040). Used as a home and rented 15 days or more. If you use a dwelling unit as a home and rent it 15 days or more during the year, include all your rental income in your income. Since you used the dwelling unit for personal purposes, you must divide your expenses between the rental use and the personal use as described earlier in this chapter under Dividing Expenses . The expenses for personal use aren’t deductible as rental expenses. If you had a net profit from renting the dwelling unit for the year (that is, if your rental income is more than the total of your rental expenses, including depreciation), deduct all of your rental expenses. You don’t need to use Worksheet 5-1. However, if you had a net loss from renting the dwelling unit for the year, your deduction for certain rental expenses is limited. To figure your deductible rental expenses and any carryover to next year, use Worksheet 5-1. Worksheet 5-1. Worksheet for Figuring Rental Deductions for a Dwelling Unit Used as a Home Use this worksheet only if you answer "yes" to all of the following questions. Did you use the dwelling unit as a home this year? Did you rent the dwelling unit at a fair rental price 15 days or more this year? Is the total of your rental expenses and depreciation more than your rental income? PART I. Rental Use Percentage A. Total days available for rent at fair rental price A. B. Total days available for rent (line A) but not rented B. C. Total days of rental use. Subtract line B from line A C. D. Total days of personal use (including days rented at less than fair rental price) D. E. Total days of rental and personal use. Add lines C and D E. F. Percentage of expenses allowed for rental. Divide line C by line E F. . PART II. Allowable Rental Expenses 1. Enter rents received 1. 2a. Enter the rental portion of deductible home mortgage interest and qualified mortgage insurance premiums. See instructions 2a. b. Enter the rental portion of real estate taxes b. c. Enter the rental portion of deductible casualty and theft losses. See instructions c. d. Enter direct rental expenses. See instructions d. e. Fully deductible rental expenses. Add lines 2a–2d. Enter here and on the appropriate lines on Schedule E. See instructions 2e. 3. Subtract line 2e from line 1. If zero or less, enter -0- 3. 4a. Enter the rental portion of expenses directly related to operating or maintaining the dwelling unit (such as repairs, insurance, and utilities) 4a. b. Enter the rental portion of excess mortgage interest and qualified mortgage insurance premiums. See instructions b. c. Carryover of operating expenses from 2016 worksheet c. d. Add lines 4a–4c d. e. Allowable expenses. Enter the smaller of line 3 or line 4d. See instructions 4e. 5. Subtract line 4e from line 3. If zero or less, enter -0- 5. 6a. Enter the rental portion of excess casualty and theft losses. See instructions 6a. b. Enter the rental portion of depreciation of the dwelling unit b. c. Carryover of excess casualty and theft losses and depreciation from 2016 worksheet c. d. Add lines 6a–6c d. e. Allowable excess casualty and theft losses and depreciation. Enter the smaller of line 5 or line 6d. See instructions 6e. PART III. Carryover of Unallowed Expenses to Next Year 7a. Operating expenses to be carried over to next year. Subtract line 4e from line 4d 7a. b. Excess casualty and theft losses and depreciation to be carried over to next year. Subtract line 6e from line 6d b. Worksheet 5-1 Instructions. Worksheet for Figuring Rental Deductions for a Dwelling Unit Used as a Home Caution. Use the percentage determined in Part I, line F, to figure the rental portions to enter on lines 2a–2c, 4a–4b, and 6a–6b of Part II. Line 2a. Figure the mortgage interest on the dwelling unit that you could deduct on Schedule A as if you had not rented the unit. Don’t include interest on a loan that didn’t benefit the dwelling unit. For example, don’t include interest on a home equity loan used to pay off credit cards or other personal loans, buy a car, or pay college tuition. Include interest on a loan used to buy, build, or improve the dwelling unit, or to refinance such a loan. Include the rental portion of this interest in the total you enter on line 2a of this Worksheet 5-1. Figure the qualified mortgage insurance premiums on the dwelling unit that you could deduct on line 13 of Schedule A as if you had not rented the unit. To do this, complete Schedule A, line 13, as a worksheet in accordance with the Instructions for Schedule A. Your deductible mortgage insurance premiums are subject to a limit based on your adjusted gross income (Form 1040, line 38). When figuring your adjusted gross income for this worksheet version of Schedule A, line 13, exclude the rental income and expenses from the dwelling unit. Include the rental portion of the amount from the worksheet version of Schedule A, line 13, on line 2a of this Worksheet 5-1. Don’t file this worksheet version of Schedule A, line 13, or use it to figure the amount of qualified mortgage insurance premiums you can deduct as an itemized deduction on Schedule A; instead keep it for your records. Note. If you itemize your deductions on Schedule A, be sure to claim only the personal portion of your deductible mortgage interest and qualified mortgage insurance premiums on Schedule A. The personal portion of mortgage interest and mortgage insurance premiums on the dwelling unit doesn’t include the rental portion you reported on line 2a of this Worksheet 5-1 or any portion that you deducted on other forms, such as Schedule C or F. Line 2c. Figure the casualty and theft losses related to the dwelling unit that you could deduct on Schedule A as if you had not rented the dwelling unit. To do this, complete Section A of Form 4684 as a worksheet. When completing line 17 of this worksheet version of Form 4684, enter 10% of your adjusted gross income figured without your rental income and expenses from the dwelling unit. Enter the rental portion of the amounts on lines 15 and 18 of your worksheet version of Form 4684 on line 2c of this Worksheet 5-1. Don’t file this worksheet version of Form 4684; instead, keep it for your records. You will complete a separate Form 4684 to attach to your return. Note. To figure the casualty and theft losses that you can include in your itemized deductions on Schedule A or the qualified disaster losses by which you may be able to increase your standard deduction, complete Section A on the separate Form 4684 using the personal portion of your casualty losses. You will report casualty and theft losses attributable to your rental activity in Section B of that separate Form 4684. Line 2d. Enter the total of your rental expenses that are directly related only to the rental activity. These include interest on loans used for rental activities other than to buy, build, or improve the dwelling unit. Also include rental agency fees, advertising, office supplies, and depreciation on office equipment used in your rental activity. Line 2e. You can deduct the amounts on lines 2a, 2b, 2c, and 2d as rental expenses on Schedule E even if your rental expenses are more than your rental income. Enter the amounts on lines 2a, 2b, 2c, and 2d on the appropriate lines of Schedule E. Line 4b. On line 2a, you entered the rental portion of the mortgage interest and qualified mortgage insurance premiums you could deduct on Schedule A if you had not rented the dwelling unit. If you had additional mortgage interest and qualified mortgage insurance premiums that wouldn’t be deductible on Schedule A because of limits imposed on them, enter on line 4b of this Worksheet 5-1 the rental portion of those excess amounts. Don’t include interest on a loan that didn’t benefit the dwelling unit (as explained in the line 2a instructions). Line 4e. You can deduct the amounts on lines 4a, 4b, and 4c as rental expenses on Schedule E only to the extent they aren’t more than the amount on line 4e.* Line 6a. To find the rental portion of excess casualty and theft losses, use the worksheet version of Form 4684 (Section A) from the line 2c instructions. A. Enter the amount from the worksheet version of Form 4684, line 10 B. Enter the rental portion of line A C. Enter the amount from line 2c of this Worksheet 5-1 D. Subtract line C from line B. Enter the result here and on line 6a of this Worksheet 5-1 Line 6e. You can deduct the amounts on lines 6a, 6b, and 6c as rental expenses on Schedule E only to the extent they aren’t more than the amount on line 6e.* *Allocating the limited deduction. If you can’t deduct all of the amount on line 4d or 6d this year, you can allocate the allowable deduction in any way you wish among the expenses included on line 4d or 6d. Enter the amount you allocate to each expense on the appropriate line of Schedule E, Part I. Topic Number 415 - Renting Residential and Vacation PropertyIf you receive rental income for the use of a dwelling unit, such as a house or an apartment, you may deduct certain expenses. These expenses, which may include mortgage interest, real estate taxes, casualty losses, maintenance, utilities, insurance, and depreciation, will reduce the amount of rental income that's subject to tax. You'll generally report such income and expenses on Form 1040, Schedule E, Supplemental Income and Loss. If you're renting to make a profit and don't use the dwelling unit as a residence, then your deductible rental expenses may be more than your gross rental income. Your rental losses, however, generally will be limited by the "at-risk" rules and/or the passive activity loss rules. For information on these limits, refer to Publication 925, Passive Activities and At-Risk Rules. Rental Property / Personal Use If you rent a dwelling unit to others that you also use as a residence, limitations may apply to the rental expenses you can deduct. You're considered to use a dwelling unit as a residence if you use it for personal purposes during the tax year for more than the greater of: 14 days, or 10% of the total days you rent it to others at a fair rental price.It's possible that you'll use more than one dwelling unit as a residence during the year. For example, if you live in your main home for 11 months, your home is a dwelling unit used as a residence. If you live in your vacation home for the other 30 days of the year, your vacation home is also a dwelling unit used as a residence unless you rent your vacation home to others at a fair rental value for 300 or more days during the year in this example. A day of personal use of a dwelling unit is any day that it's used by: You or any other person who has an interest in it, unless you rent your interest to another owner as his or her main home and the other owner pays a fair rental price under a shared equity financing agreement A member of your family or of a family of any other person who has an interest in it, unless the family member uses it as his or her main home and pays a fair rental price Anyone under an agreement that lets you use some other dwelling unit Anyone at less than fair rental priceMinimal Rental Use There's a special rule if you use a dwelling unit as a residence and rent it for fewer than 15 days. In this case, don't report any of the rental income and don't deduct any expenses as rental expenses. Dividing Expenses between Rental and Personal Use If you use the dwelling unit for both rental and personal purposes, you generally must divide your total expenses between the rental use and the personal use based on the number of days used for each purpose. You won't be able to deduct your rental expense in excess of the gross rental income limitation (your gross rental income less the rental portion of mortgage interest, real estate taxes, and casualty losses, and rental expenses like realtors' fees and advertising costs). However, you may be able to carry forward some of these rental expenses to the next year, subject to the gross rental income limitation for that year. If you itemize your deductions on Form 1040, Schedule A, Itemized Deductions, you may still be able to deduct your personal portion of mortgage interest, property taxes, and casualty losses on that schedule. Business Use of Home Another special rule applies if you rent part of your home to your employer and provide services for your employer in that rented space. In this case, report the rental income. You can deduct mortgage interest, qualified mortgage insurance premiums, real estate taxes, and personal casualty losses for the rented part, subject to any limitations, but don't deduct any business expenses. For information on these limits, refer to Publication 587, Business Use of Your Home (Including Use by Daycare Providers). Net Investment Income Tax If you have a rental income, you may be subject to the Net Investment Income Tax (NIIT). For more information, refer to Topic No. 559.
Passive Activities – Losses and Credits Generally, losses from passive activities that exceed the income from passive activities are disallowed for the current year. You can carry forward disallowed passive losses to the next taxable year. A similar rule applies to credits from passive activities. Material and Active Participation Passive activities include trade or business activities in which you don't materially participate. You materially participate in an activity if you're involved in the operation of the activity on a regular, continuous, and substantial basis. In general, rental activities, including rental real estate activities, are also passive activities even if you do materially participate. However, rental real estate activities in which you materially participate aren't passive activities if you qualify as a real estate professional. Additionally, there's a limited exception for rental real estate activities in which you actively participate. The rules for active participation are different from those for material participation. You can find guidelines for determining material participation, the rules for determining who's a real estate professional and what's active participation, and the special rules that apply to the income and losses from a passive activity held through a publicly traded partnership (PTP) in Publication 925, Passive Activity and At-Risk Rules. Disposition of Entire Interest Generally, you may deduct in full any previously disallowed passive activity loss in the year you dispose of your entire interest in the activity. In contrast, you may not claim unused passive activity credits merely because you disposed of your entire interest in the activity. However, you may elect to increase the basis of the credit property in an amount equal to the portion of the unused credit that previously reduced the basis of the credit property. Forms 8582 and 8582-CR Use Form 8582, Passive Activity Loss Limitations, to summarize income and losses from passive activities and to compute the deductible losses. Use Form 8582-CR, Passive Activity Credit Limitations, to summarize the credits from passive activities and to compute the allowed passive activity credit. You may also use Form 8582-CR to make an election to increase the basis of credit property when you dispose of the property.
Net Investment Income Tax A 3.8 percent Net Investment Income Tax (NIIT) applies to individuals, estates, and trusts that have net investment income above applicable threshold amounts. Individuals In the case of an individual, the NIIT is 3.8 percent on the lesser of: the net investment income, or the excess of modified adjusted gross income over the following threshold amounts: $250,000 for married filing jointly or qualifying widow(er) $125,000 for married filing separately $200,000 in all other cases Estates & Trusts In the case of an estate or trust, the NIIT is 3.8 percent on the lesser of: (A) the undistributed net investment income, or (B) the excess (if any) of: the adjusted gross income over the dollar amount at which the highest tax bracket begins for an estate or trust for the tax year. (For estates and trusts, the 2017 threshold is $12,500) Definition of Net Investment Income and Modified Adjusted Gross Income In general, net investment income for purpose of this tax, includes, but isn't limited to: interest, dividends, certain annuities, royalties, and rents (unless derived in a trade or business in which the NIIT doesn't apply), income derived in a trade or business which is a passive activity or trading in financial instruments or commodities, and net gains from the disposition of property (to the extent taken into account in computing taxable income), other than property held in a trade or business to which NIIT doesn't apply. The NIIT applies to income from a trade or business that is (1) a passive activity, as determined under § 469, of the taxpayer; or (2) trading in financial instruments or commodities, as determined under § 475(e)(2).The NIIT doesn't apply to certain types of income that taxpayers can exclude for regular income tax purposes such as tax-exempt state or municipal bond interest, Veterans Administration benefits, or gain from the sale of a principal residence on that portion that's excluded for income tax purposes. Modified adjusted gross income (MAGI), for purposes of the NIIT, is generally defined as adjusted gross income (AGI) for regular income tax purposes increased by the foreign earned income exclusion (but also adjusted for certain deductions related to the foreign earned income). For individual taxpayers who haven't excluded any foreign earned income, their MAGI is generally the same as their regular AGI. Reporting NIIT Compute the tax on Form 8960, Net Investment Income Tax —Individuals, Estates, and Trusts.Individuals report this tax on Form 1040, U.S. Individual Income Tax Return; Estates and trusts report this tax on Form 1041, U.S. Income Tax Return for Estates and Trusts. Tax Withholding and Estimated Tax Taxpayers may need to increase their income tax withholding or estimated taxes to take into account any additional tax liability associated with the NIIT in order to avoid certain penalties. The IRS Withholding Calculator can be used to help determine necessary changes in withholding by your employer, or see our Estimated Taxes page for resources to help you recalculate those payments.
References: https://www.irs.gov/taxtopics/tc414 https://www.irs.gov/publications/p527 https://www.irs.gov/taxtopics/tc415 https://www.irs.gov/taxtopics/tc425 https://www.irs.gov/taxtopics/tc559
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References: https://www.irs.gov/publications/p531
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100,212 current word count |
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Word count words 72,000/50/180=8 hours |
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38 topics / 72,000 = 1,895 words per topic |
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This entire part 1 and part 2 contains 190,744 words and after adjustments is should contain only 144,000 words & split to 72,000 each |
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