IRS Releases Publication 17 (2016), Your Federal Income Tax (For Individuals)
Publication 17 (2016)
- Jurisdictions
- LanguageEnglish
What's New
The explanations and examples in this publication reflect the interpretation by the Internal Revenue Service (IRS) of:
• Tax laws enacted by Congress,
• Treasury regulations, and
• Court decisions.
However, the information given does not cover every situation and is not intended to replace the law or change its meaning.
This publication covers some subjects on which a court may have made a decision more favorable to taxpayers than the interpretation by the IRS. Until these differing interpretations are resolved by higher court decisions or in some other way, this publication will continue to present the interpretations by the IRS.
All taxpayers have important rights when working with the IRS. These rights are described in Your Rights as a Taxpayer in the back of this publication.
This section summarizes important tax changes that took effect in 2016. Most of these changes are discussed in more detail throughout this publication.
Future developments. For the latest information about the tax law topics covered in this publication, such as legislation enacted after it was published, go to IRS.gov/pub17.
Due date of return. File your tax return by April 18, 2017. The due date is April 18, instead of April 15, because of the Emancipation Day holiday in the District of Columbia--even if you do not live in the District of Columbia. See chapter 1.
Service at local IRS offices by appointment. Many issues can be resolved conveniently on IRS.gov with no waiting. However, if you need help from an IRS Taxpayer Assistance Center (TAC), you need to call to schedule an appointment. Go to IRS.gov/taclocator to find the location and telephone number of your local TAC.
Delayed refunds for returns claiming certain credits. Due to changes in the law, the IRS can't issue refunds before February 15, 2017, for returns that claim the earned income credit or the additional child tax credit. This delay applies to the entire refund, not just the portion associated with these credits. Although the IRS will begin releasing refunds for returns that claim these credits on February 15, because of the time it generally takes banking or financial systems to process deposits, it is unlikely that your refund will arrive in your bank account or on a debit card before the week of February 27 (assuming your return has no processing issues and you elect direct deposit).
If you filed your return before February 15, you can check Where's My Refund on IRS.gov (IRS.gov/refunds) a few days after February 15 for your projected deposit date. Where's My Refund and the IRS2Go phone app remain the best ways to check the status of any refund.
Delivery services. Eight delivery services have been added to the list of designated private delivery services. For the complete list, see chapter 1.
Cash payment option. There is a new option for taxpayers who want to pay their taxes in cash. For details, see chapter 1.
Educator expenses. You may be able to deduct certain expenses for professional development courses you have taken related to the curriculum you teach or to the students you teach. See chapter 19.
Olympic and Paralympic medals and USOC prize money. If you receive Olympic and Paralympic medals and United States Olympic Committee prize money, the value of the medals and the amount of the prize money may be nontaxable. See the instructions for Form 1040, line 21, for more information.
Child tax credit and additional child tax credit may be disallowed. If you take the child tax credit or the additional child tax credit even though you aren't eligible, you may not be able to take these credits for up to 10 years. For more information, see chapter 34.
American opportunity credit may be disallowed. If you take the American opportunity credit even though you aren't eligible, you may not be able to take this credit for up to 10 years. For more information, see chapter 35.
Health coverage tax credit (HCTC). The HCTC is a tax credit that pays a percentage of health insurance premiums for certain eligible taxpayers and their qualifying family members. The HCTC is a separate tax credit with different eligibility rules than the premium tax credit. You may have received monthly advance payments of the HCTC beginning in July 2016. For information on how to report these payments or on the HCTC generally, see the Instructions for Form 8885.
Get Transcript Online. The Get Transcript Online tool on IRS.gov is available again to get a copy of your tax transcripts and similar documents. To guard against fraud, you will now need to go through a two-step authentication process in order to use the online tool. For more information, go to IRS.gov/transcripts.
Electronic Filing PIN. Electronic Filing PIN, an IRS-generated PIN used to verify your signature on your self-prepared, electronic tax return, is no longer available. To validate your signature, you must use your prior-year adjusted gross income or prior-year self-select PIN. See chapter 1.
Individual taxpayer identification number (ITIN) renewal. If you were assigned an ITIN before January 1, 2013, or if you have an ITIN that you haven't included on a tax return in the last 3 consecutive years, you may need to renew it. For more information, see chapter 1 and the Instructions for Form W-7.
Personal exemption amount increased for certain taxpayers. Your personal exemption is increased to $4,050. But the amount is reduced if your adjusted gross income is more than:
• $155,650 if married filing separately,
• $259,400 if single,
• $285,350 if head of household, or
• $311,300 if married filing jointly or qualifying widow(er).
See chapter 3.
Limit on itemized deductions. You may not be able to deduct all of your itemized deductions if your adjusted gross income is more than:
• $155,650 if married filing separately,
• $259,400 if single,
• $285,350 if head of household, or
• $311,300 if married filing jointly or qualifying widow(er).
See chapter 29.
Standard mileage rates. The 2016 rate for business use of your vehicle is 54 cents a mile. The 2016 rate for use of your vehicle to get medical care or to move is 19 cents a mile.
Adoption credit. The adoption credit and the exclusion for employer-provided adoption benefits have both increased to $13,460 per eligible child in 2016. The amount begins to phase out if you have modified adjusted gross income (MAGI) in excess of $201,920 and is completely phased out if your MAGI is $241,920 or more.
Exemption amount for alternative minimum tax (AMT). The exemption amount for the AMT has increased to $53,900 ($83,800 if married filing jointly or qualifying widow(er); $41,900 if married filing separately).
Standard deduction for head of household filing status. For 2016, the standard deduction for head of household filing status has increased to $9,300. The other standard deduction amounts are unchanged.
Secure access. To combat identity fraud, the IRS has upgraded its identity verification process for certain self-help tools on IRS.gov. To find out what types of information new users will need, go to IRS.gov/secureaccess.
Listed below are important reminders and other items that may help you file your 2016 tax return. Many of these items are explained in more detail later in this publication.
Enter your social security number (SSN). Enter your SSN in the space provided on your tax form. If you filed a joint return for 2015 and are filing a joint return for 2016 with the same spouse, enter your names and SSNs in the same order as on your 2015 return. See chapter 1.
Secure your tax records from identity theft. Identity theft occurs when someone uses your personal information, such as your name, SSN, or other identifying information, without your permission, to commit fraud or other crimes. An identity thief may use your SSN to get a job or may file a tax return using your SSN to receive a refund. For more information about identity theft and how to reduce your risk from it, see Identity Theft in chapter 1.
Taxpayer identification numbers. You must provide the taxpayer identification number for each person for whom you claim certain tax benefits. This applies even if the person was born in 2016. Generally, this number is the person's social security number (SSN). See chapter 1.
Foreign source income. If you are a U.S. citizen with income from sources outside the United States (foreign income), you must report all such income on your tax return unless it is exempt by law or a tax treaty. This is true whether you live inside or outside the United States and whether or not you receive a Form W-2 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 live outside the United States, you may be able to exclude part or all of your foreign earned income. For details, see Pub. 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad.
Foreign financial assets. If you had foreign financial assets in 2016, you may have to file Form 8938 with your return. Check Form 8938 and its instructions or IRS.gov/form8938 for details.
Automatic 6-month extension to file tax return. You can get an automatic 6-month extension of time to file your tax return. See chapter 1.
Include your phone number on your return. To promptly resolve any questions we have in processing your tax return, we would like to be able to call you. Please enter your daytime telephone number on your tax form next to your signature and occupation. If you are filing a joint return, you can enter either your or your spouse's daytime phone number.
Payment of taxes. You can pay your taxes online, by phone, or by check or money order. You can make a direct transfer from your bank account or use a credit or debit card. See chapter 1.
Faster ways to file your return. The IRS offers fast, accurate ways to file your tax return information without filing a paper tax return. You can use IRS e-file (electronic filing). See chapter 1.
Free electronic filing. You may be able to file your 2016 taxes online for free. See chapter 1.
Change of address. If you change your address, notify the IRS. See Change of Address in chapter 1.
Refund on a late filed return. If you were due a refund but you did not file a return, you generally must file your return within 3 years from the date the return was due (including extensions) to get that refund. See chapter 1.
Frivolous tax returns. The IRS has published a list of positions that are identified as frivolous. The penalty for filing a frivolous tax return is $5,000. See chapter 1.
Filing erroneous claim for refund or credit. You may have to pay a penalty if you file an erroneous claim for refund or credit. See chapter 1.
Privacy Act and paperwork reduction information. The IRS Restructuring and Reform Act of 1998, the Privacy Act of 1974, and the Paperwork Reduction Act of 1980 require that when we ask you for information we must first tell you what our legal right is to ask for the information, why we are asking for it, how it will be used, what could happen if we do not receive it, and whether your response is voluntary, required to obtain a benefit, or mandatory under the law. A complete statement on this subject can be found in your tax form instructions.
Preparer e-file mandate. Most paid preparers must e-file returns they prepare and file. Your preparer may make you aware of this requirement and the options available to you.
Treasury Inspector General for Tax Administration. If you want to confidentially report misconduct, waste, fraud, or abuse by an IRS employee, you can call 1-800-366-4484 (call 1-800-877-8339 if you are deaf, hard of hearing, or have a speech disability, and are using TTY/TDD equipment). You can remain anonymous.
Photographs of missing children. The Internal Revenue Service is a proud partner with the National Center for Missing & Exploited Children® (NCMEC). Photographs of missing children selected by the Center may appear in this publication on pages that would otherwise be blank. You can help bring these children home by looking at the photographs and calling 1-800-THE-LOST (1-800-843-5678) if you recognize a child.
This publication covers the general rules for filing a federal income tax return. It supplements the information contained in your tax form instructions. It explains the tax law to make sure you pay only the tax you owe and no more.
How this publication is arranged. This publication closely follows Form 1040, U.S. Individual Income Tax Return. It is divided into six parts which cover different sections of Form 1040. Each part is further divided into chapters which generally discuss one line of the form. Do not worry if you file Form 1040EZ. Anything included on a line of either of these forms is also included on Form 1040.
The table of contents inside the front cover and the index in the back of the publication are useful tools to help you find the information you need.
What is in this publication. The publication begins with the rules for filing a tax return. It explains:
1. Who must file a return,
2. Which tax form to use,
3. When the return is due,
4. How to e-file your return, and
5. Other general information.
It will help you identify which filing status you qualify for, whether you can claim any dependents, and whether the income you receive is taxable. The publication goes on to explain the standard deduction, the kinds of expenses you may be able to deduct, and the various kinds of credits you may be able to take to reduce your tax.
Throughout the publication are examples showing how the tax law applies in typical situations. Also throughout the publication are flowcharts and tables that present tax information in an easy-to-understand manner.
Many of the subjects discussed in this publication are discussed in greater detail in other IRS publications. References to those other publications are provided for your information.
Icons. Small graphic symbols, or icons, are used to draw your attention to special information. See Table 1 for an explanation of each icon used in this publication.
Table 1. Legend of Icons
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Icon Explanation
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[graphic omitted] Items that may cause you particular problems, or
an alert about pending legislation that may be
enacted after this publication goes to print.
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[graphic omitted] An Internet site or an email address.
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[graphic omitted] An address you may need.
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[graphic omitted] Items you should keep in your personal records.
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[graphic omitted] Items you may need to figure or a worksheet you
may need to complete and keep for your records.
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[graphic omitted] An important phone number.
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[graphic omitted] Helpful information you may need.
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What is not covered in this publication. Some material that you may find helpful is not included in this publication but can be found in your tax form instruction booklet. This includes lists of:
• Where to report certain items shown on information documents, and
• Tax Topics you can read at IRS.gov/taxtopics.
If you operate your own business or have other self-employment income, such as from babysitting or selling crafts, see the following publications for more information.
• Pub. 334, Tax Guide for Small Business (For Individuals Who Use Schedule C or C-EZ).
• Pub. 535, Business Expenses.
• Pub. 587, Business Use of Your Home (Including Use by Daycare Providers).
Help from the IRS. There are many ways you can get help from the IRS. These are explained under How To Get Tax Help in the back of this publication.
Comments and suggestions. We welcome your comments about this publication and your suggestions for future editions.
You can send us comments from IRS.gov/forms. Click on "More Information" and then on "Give us feedback."
Or you can write to:
Internal Revenue Service Tax Forms and Publications 1111 Constitution Ave. NW, IR-6526 Washington, DC 20224
We respond to many letters by telephone. Therefore, it would be helpful if you would include your daytime phone number, including the area code, in your correspondence.
Although we cannot respond individually to each comment received, we do appreciate your feedback and will consider your comments as we revise our tax products.
Ordering forms and publications. Visit IRS.gov/forms to download forms and publications. Otherwise, you can go to IRS.gov/orderforms to order current and prior-year forms and instructions. Your order should arrive within 10 business days.
Tax questions. If you have a tax question not answered by this publication, check IRS.gov and How To Get Tax Help at the end of this publication.
IRS mission. Provide America's taxpayers top-quality service by helping them understand and meet their tax responsibilities and enforce the law with integrity and fairness to all.
Part One. The Income Tax Return
The four chapters in this part provide basic information on the tax system. They take you through the first steps of filling out a tax return--such as deciding what your filing status is, how many exemptions you can take, and what form to file. They also discuss recordkeeping requirements, IRS e-file (electronic filing), certain penalties, and the two methods used to pay tax during the year: withholding and estimated tax.
1. Filing Information
What's New
Due date of return. The due date to file your tax return is April 18, 2017. The due date is April 18, instead of April 15, because of the Emancipation Day holiday in the District of Columbia--even if you do not live in the District of Columbia.
Cash payment option. There is a new option for taxpayers whose only option is to pay their taxes in cash. For details see Pay by cash under How To Pay.
Get transcript online. The Get Transcript Online tool on IRS.gov is available again to get a copy of your tax transcript and similar documents. To guard against fraud, you will now need to go through a two-step authentication process in order to use the online tool. For more information, go to IRS.gov/transcript.
Electronic Filing PIN request. Electronic Filing PIN request, an IRS-generated PIN used to verify your signature on your self-prepared, electronic tax return, is no longer available. To validate your signature, you must use your prior-year adjusted gross income or prior-year self-select PIN.
Individual taxpayer identification number (ITIN) renewal. If you were assigned an ITIN before January 1, 2013, or if you have an ITIN that you haven't included on a tax return in the last three consecutive years, you may need to renew it. For more information, see the instructions for Form W-7.
Delivery services. Eight delivery services have been added to the list of designated private delivery services. For the complete list, see Private delivery services, later, under When Do I Have To File.
Who must file. Generally, the amount of income you can receive before you must file a return has been increased. See Table 1-1, Table 1-2, and Table 1-3 for the specific amounts.
Table 1-1. 2016 Filing Requirements for Most Taxpayers
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THEN file a return
IF your filing status AND at the end of 2016 if your gross income
is . . . you were . . .* was at least . . .**
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single under 65 $10,350
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65 or older $11,900
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married filing under 65 $20,700
jointly*** (both spouses)
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65 or older $21,950
(one spouse)
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65 or older $23,200
(both spouses)
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married filing any age $ 4,050
separately
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head of household under 65 $13,350
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65 or older $14,900
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qualifying widow(er) under 65 $16,650
with dependent child ---------------------------------------------
65 or older $17,900
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* If you were born on January 1, 1952, you are considered to be age 65
at the end of 2016. (If your spouse died in 2016 or if you are
preparing a return for someone who died in 2016, see Pub. 501.)
** Gross income means all income you received in the form of money,
goods, property, and services that isn't exempt from tax, including
any income from sources outside the United States or from the sale of
your main home (even if you can exclude part or all of it). Don't
include any social security benefits unless (a) you are married filing
a separate return and you lived with your spouse at any time during
2016 or (b) one-half of your social security benefits plus your other
gross income and any tax-exempt interest is more than $25,000 ($32,000
if married filing jointly). If (a) or (b) applies, see the
instructions for Pub. 915 to figure the taxable
part of social security benefits you must include in gross income.
Gross income includes gains, but not losses, reported on Form 8949
or Schedule D. Gross income from a business means, for example, the
amount on Schedule C, line 7, or Schedule F, line 9. But, in figuring
gross income, don't reduce your income by any losses, including any
loss on Schedule C, line 7, or Schedule F, line 9.
*** If you didn't live with your spouse at the end of 2016 (or on the
date your spouse died) and your gross income was at least $4,050, you
must file a return regardless of your age.
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Table 1-2. 2016 Filing Requirements for Dependents
See chapter 3 to find out if someone can claim you as a dependent.
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If your parents (or someone else) can claim you as a dependent, use
this table to see if you must file a return. (See Table 1-3 for other
situations when you must file.)
In this table, unearned income includes taxable interest, ordinary
dividends, and capital gain distributions. It also includes
unemployment compensation, taxable social security benefits, pensions,
annuities, and distributions of unearned income from a trust. Earned
income includes salaries, wages, tips, professional fees, and taxable
scholarship and fellowship grants. (See Scholarships and fellowships
in chapter 12.) Gross income is the total of your earned and unearned
income.
CAUTION: If your gross income was $4,050 or more, you usually can't
be claimed as a dependent unless you are a qualifying child. For
details, see Exemptions for Dependents, in chapter 3.
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Single dependents -- Were you either age 65 or older or blind?
[ ] No. You must file a return if any of the following apply.
• Your unearned income was more than $1,050.
• Your earned income was more than $6,300.
• Your gross income was more than the larger of:
• $1,050, or
• Your earned income (up to $5,950) plus $350.
[ ] Yes. You must file a return if any of the following apply.
• Your unearned income was more than $2,600 ($4,150 if 65 or
older and blind).
• Your earned income was more than $7,850 ($9,400 if 65 or
older and blind).
• Your gross income was more than the larger of:
• $2,600 ($4,150 if 65 or older and blind), or
• Your earned income (up to $5,950) plus $1,900 ($3,450 if
65 or older and blind).
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Married dependents -- Were you either age 65 or older or blind?
[ ] No. You must file a return if any of the following apply.
• Your unearned income was more than $1,050.
• Your earned income was more than $6,300.
• Your gross income was at least $5 and your spouse files a
separate return and itemizes deductions.
• Your gross income was more than the larger of:
• $1,050, or
• Your earned income (up to $5,950) plus $350.
[ ] Yes. You must file a return if any of the following apply.
• Your unearned income was more than $2,300 ($3,550 if 65 or
older and blind).
• Your earned income was more than $7,550 ($8,800 if 65 or
older and blind).
• Your gross income was at least $5 and your spouse files a
separate return and itemizes deductions.
• Your gross income was more than the larger of:
• $2,300 ($3,550 if 65 or older and blind), or
• Your earned income (up to $5,950) plus $1,600 ($2,850 if
65 or older and blind).
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Table 1-3. Other Situations When You Must File a 2016 Return
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You must file a return if any of the five conditions below apply for
2016.
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1. You owe any special taxes, including any of the following.
a. Alternative minimum tax.
b. Additional tax on a qualified plan, including an individual
retirement arrangement (IRA), or other tax-favored account. But
if you are filing a return only because you owe this tax, you can
file Form 5329 by itself.
c. Household employment taxes. But if you are filing a return only
because you owe this tax, you can file Schedule H by itself.
d. Social security and Medicare tax on tips you didn't report to
your employer or on wages you received from an employer who
didn't withhold these taxes.
e. Recapture of first-time homebuyer credit.
f. Write-in taxes, including uncollected social security and
Medicare or RRTA tax on tips you reported to your employer or on
group-term life insurance and additional taxes on health savings
accounts.
g. Recapture taxes.
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2. You (or your spouse, if filing jointly) received health savings
account, Archer MSA, or Medicare Advantage MSA distributions.
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3. You had net earnings from self-employment of at least $400.
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4. You had wages of $108.28 or more from a church or qualified
church-controlled organization that is exempt from employer
social security and Medicare taxes.
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5. Advance payments of the premium tax credit were made for you,
your spouse, or a dependent who enrolled in coverage through the
Marketplace. You or whoever enrolled you should have received
Form(s) 1095-A showing the amount of the advance payments.
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Reminders
File online. Rather than filing a return on paper, you may be able to file electronically using IRS e-file. For more information, see Why Should I File Electronically, later.
Change of address. If you change your address, you should notify the IRS. You can use Form 8822 to notify the IRS of the change. See Change of Address, later, under What Happens After I File.
Enter your social security number. You must enter your social security number (SSN) in the spaces provided on your tax return. If you file a joint return, enter the SSNs in the same order as the names.
Direct deposit of refund. Instead of getting a paper check, you may be able to have your refund deposited directly into your account at a bank or other financial institution. See Direct Deposit under Refunds, later. If you choose direct deposit of your refund, you may be able to split the refund among two or three accounts.
Pay online or by phone. If you owe additional tax, you may be able to pay online or by phone. See How To Pay, later.
Installment agreement. If you can't pay the full amount due with your return, you may ask to make monthly installment payments. See Installment Agreement, later, under Amount You Owe. You may be able to apply online for a payment agreement if you owe federal tax, interest, and penalties.
Automatic 6-month extension. You can get an automatic 6-month extension to file your tax return if, no later than the date your return is due, you file Form 4868, Application for Automatic Extension of Time To File U.S. Individual Income Tax Return. See Automatic Extension, later.
Service in combat zone. You are allowed extra time to take care of your tax matters if you are a member of the Armed Forces who served in a combat zone, or if you served in the combat zone in support of the Armed Forces. See Individuals Serving in Combat Zone, later, under When Do I Have To File.
Adoption taxpayer identification number. If a child has been placed in your home for purposes of legal adoption and you won't be able to get a social security number for the child in time to file your return, you may be able to get an adoption taxpayer identification number (ATIN). For more information, see Social Security Number (SSN), later.
Taxpayer identification number for aliens. If you or your dependent is a nonresident or resident alien who doesn't have and isn't eligible to get a social security number, file Form W-7, Application for IRS Individual Taxpayer Identification Number, with the IRS. For more information, see Social Security Number (SSN), later.
Frivolous tax submissions. The IRS has published a list of positions that are identified as frivolous. The penalty for filing a frivolous tax return is $5,000. Also, the $5,000 penalty will apply to other specified frivolous submissions. For more information, see Civil Penalties, later.
Introduction
This chapter discusses the following topics.
• Whether you have to file a return.
• Which form to use.
• How to file electronically.
• How to file for free.
• When, how, and where to file your return.
• What happens if you pay too little or too much tax.
• What records you should keep and how long you should keep them.
• How you can change a return you have already filed.
Do I Have To File a Return?
You must file a federal income tax return if you are a citizen or resident of the United States or a resident of Puerto Rico and you meet the filing requirements for any of the following categories that apply to you.
1. Individuals in general. (There are special rules for surviving spouses, executors, administrators, legal representatives, U.S. citizens and residents living outside the United States, residents of Puerto Rico, and individuals with income from U.S. possessions.)
2. Dependents.
3. Certain children under age 19 or full-time students.
4. Self-employed persons.
5. Aliens.
The filing requirements for each category are explained in this chapter.
The filing requirements apply even if you don't owe tax.
TIP: Even if you don't have to file a return, it may be to your advantage to do so. See Who Should File, later.
CAUTION: File only one federal income tax return for the year regardless of how many jobs you had, how many Forms W-2 you received, or how many states you lived in during the year. Don't file more than one original return for the same year, even if you have not gotten your refund or have not heard from the IRS since you filed.
Individuals--In General
If you are a U.S. citizen or resident, whether you must file a return depends on three factors.
1. Your gross income.
2. Your filing status.
3. Your age.
To find out whether you must file, see Table 1-1, Table 1-2, and Table 1-3. Even if no table shows that you must file, you may need to file to get money back. See Who Should File, later.
Gross income. This includes all income you receive in the form of money, goods, property, and services that isn't exempt from tax. It also includes income from sources outside the United States or from the sale of your main home (even if you can exclude all or part of it). Include part of your social security benefits if:
1. You were married, filing a separate return, and you lived with your spouse at any time during 2016; or
2. Half of your social security benefits plus your other gross income and any tax-exempt interest is more than $25,000 ($32,000 if married filing jointly).
If either (1) or (2) applies, see the instructions for Pub. 915, Social Security and Equivalent Railroad Retirement Benefits, to figure the social security benefits you must include in gross income.
Common types of income are discussed in Part Two of this publication.
Community income. If you are married and your permanent home is in a community property state, half of any income described by state law as community income may be considered yours. This affects your federal taxes, including whether you must file if you don't file a joint return with your spouse. See Pub. 555 for more information.
Nevada, Washington, and California domestic partners. A registered domestic partner in Nevada, Washington, or California generally must report half the combined community income of the individual and his or her domestic partner. See Pub. 555.
Self-employed individuals. If you are self-employed, your gross income includes the amount on line 7 of Schedule C (Form 1040), Profit or Loss From Business; line 1 of Schedule C-EZ (Form 1040), Net Profit From Business; and line 9 of Schedule F (Form 1040), Profit or Loss From Farming. See Self-Employed Persons, later, for more information about your filing requirements.
CAUTION: If you don't report all of your self-employment income, your social security benefits may be lower when you retire.
Filing status. Your filing status depends on whether you are single or married and on your family situation. Your filing status is determined on the last day of your tax year, which is December 31 for most taxpayers. See chapter 2 for an explanation of each filing status.
Age. If you are 65 or older at the end of the year, you generally can have a higher amount of gross income than other taxpayers before you must file. See Table 1-1. You are considered 65 on the day before your 65th birthday. For example, if your 65th birthday is on January 1, 2017, you are considered 65 for 2016.
Surviving Spouses, Executors, Administrators, and Legal Representatives
You must file a final return for a decedent (a person who died) if both of the following are true.
• You are the surviving spouse, executor, administrator, or legal representative.
• The decedent met the filing requirements at the date of death.
For more information on rules for filing a decedent's final return, see Pub. 559.
U.S. Citizens and Resident Aliens Living Abroad
To determine whether you must file a return, include in your gross income any income you received abroad, including any income you can exclude under the foreign earned income exclusion. For information on special tax rules that may apply to you, see Pub. 54. It is available online and at most U.S. embassies and consulates. See How To Get Tax Help in the back of this publication.
Residents of Puerto Rico
If you are a U.S. citizen and also a bona fide resident of Puerto Rico, you generally must file a U.S. income tax return for any year in which you meet the income requirements. This is in addition to any legal requirement you may have to file an income tax return with Puerto Rico.
If you are a bona fide resident of Puerto Rico for the entire year, your U.S. gross income doesn't include income from sources within Puerto Rico. It does, however, include any income you received for your services as an employee of the United States or a U.S. agency. If you receive income from Puerto Rican sources that isn't subject to U.S. tax, you must reduce your standard deduction. As a result, the amount of income you must have before you are required to file a U.S. income tax return is lower than the applicable amount in Table 1-1 or Table 1-2. For more information, see Pub. 570.
Individuals With Income From U.S. Possessions
If you had income from Guam, the Commonwealth of the Northern Mariana Islands, American Samoa, or the U.S. Virgin Islands, special rules may apply when determining whether you must file a U.S. federal income tax return. In addition, you may have to file a return with the individual island government. See Pub. 570 for more information.
Dependents
If you are a dependent (one who meets the dependency tests in chapter 3), see Table 1-2 to find out whether you must file a return. You also must file if your situation is described in Table 1-3.
Responsibility of parent. Generally, a child is responsible for filing his or her own tax return and for paying any tax on the return. If a dependent child must file an income tax return but can't file due to age or any other reason, then a parent, guardian, or other legally responsible person must file it for the child. If the child can't sign the return, the parent or guardian must sign the child's name followed by the words "By (your signature), parent for minor child."
Child's earnings. Amounts a child earns by performing services are included in his or her gross income and not the gross income of the parent. This is true even if under local law the child's parent has the right to the earnings and may actually have received them. But if the child doesn't pay the tax due on this income, the parent is liable for the tax.
Certain Children Under Age 19 or Full-Time Students
If a child's only income is interest and dividends (including capital gain distributions and Alaska Permanent Fund dividends), the child was under age 19 at the end of 2016 or was a full-time student under age 24 at the end of 2016, and certain other conditions are met, a parent can elect to include the child's income on the parent's return. If this election is made, the child doesn't have to file a return. See Parent's Election To Report Child's Interest and Dividends in chapter 31.
Self-Employed Persons
You are self-employed if you:
• Carry on a trade or business as a sole proprietor,
• Are an independent contractor,
• Are a member of a partnership, or
• Are in business for yourself in any other way.
Self-employment can include work in addition to your regular full-time business activities, such as certain part-time work you do at home or in addition to your regular job.
You must file a return if your gross income is at least as much as the filing requirement amount for your filing status and age (shown in Table 1-1). Also, you must file Form 1040 and Schedule SE (Form 1040), Self-Employment Tax, if:
1. Your net earnings from self-employment (excluding church employee income) were $400 or more, or
2. You had church employee income of $108.28 or more. (See Table 1-3.)
Use Schedule SE (Form 1040) to figure your self-employment tax. Self-employment tax is comparable to the social security and Medicare tax withheld from an employee's wages. For more information about this tax, see Pub. 334, Tax Guide for Small Business.
Employees of foreign governments or international organizations. If you are a U.S. citizen who works in the United States for an international organization, a foreign government, or a wholly owned instrumentality of a foreign government, and your employer isn't required to withhold social security and Medicare taxes from your wages, you must include your earnings from services performed in the United States when figuring your net earnings from self-employment.
Ministers. You must include income from services you performed as a minister when figuring your net earnings from self-employment, unless you have an exemption from self-employment tax. This also applies to Christian Science practitioners and members of a religious order who have not taken a vow of poverty. For more information, see Pub. 517, Social Security and Other Information for Members of the Clergy and Religious Workers.
Aliens
Your status as an alien (resident, nonresident, or dual-status) determines whether and how you must file an income tax return.
The rules used to determine your alien status are discussed in Pub. 519, U.S. Tax Guide for Aliens.
Resident alien. If you are a resident alien for the entire year, you must file a tax return following the same rules that apply to U.S. citizens. Use the forms discussed in this publication.
Nonresident alien. If you are a nonresident alien, the rules and tax forms that apply to you are different from those that apply to U.S. citizens and resident aliens. See Pub. 519 to find out if U.S. income tax laws apply to you and which forms you should file.
Dual-status taxpayer. If you are a resident alien for part of the tax year and a nonresident alien for the rest of the year, you are a dual-status taxpayer. Different rules apply for each part of the year. For information on dual-status taxpayers, see Pub. 519.
Who Should File
Even if you don't have to file, you should file a federal income tax return to get money back if any of the following conditions apply.
1. You had federal income tax withheld or made estimated tax payments.
2. You qualify for the earned income credit. See chapter 36 for more information.
3. You qualify for the additional child tax credit. See chapter 34 for more information.
4. You qualify for the premium tax credit. See chapter 37 for more information.
5. You qualify for the health coverage tax credit. See chapter 38 for more information.
6. You qualify for the American opportunity credit. See chapter 35 for more information.
7. You qualify for the credit for federal tax on fuels. See chapter 38 for more information.
Which Form Should I Use?
You must use one of three forms to file your return: Form 1040. (But also see Why Should I File Electronically, later.)
TIP: See the discussion under Form 1040 for when you must use that form.
Form 1040EZ
Form 1040EZ is the simplest form to use.
You can use Form 1040EZ if all of the following apply.
1. Your filing status is single or married filing jointly. If you were a nonresident alien at any time in 2016, your filing status must be married filing jointly.
2. You (and your spouse if married filing a joint return) were under age 65 and not blind at the end of 2016. If you were born on January 1, 1952, you are considered to be age 65 at the end of 2016.
3. You don't claim any dependents.
4. Your taxable income is less than $100,000.
5. Your income is only from wages, salaries, tips, unemployment compensation, Alaska Permanent Fund dividends, taxable scholarship and fellowship grants, and taxable interest of $1,500 or less.
6. You don't claim any adjustments to income, such as a deduction for IRA contributions or student loan interest.
7. You don't claim any credits other than the earned income credit.
8. You don't owe any household employment taxes on wages you paid to a household employee.
9. If you earned tips, they are included in boxes 5 and 7 of your Form W-2.
10. You are not a debtor in a chapter 11 bankruptcy case filed after October 16, 2005.
You must meet all of these requirements to use Form 1040EZ. If you don't, you must use Form 1040.
Figuring tax. On Form 1040EZ, you can use only the tax table to figure your income tax. You can find the tax table in the Instructions for Form 1040EZ. You can't use Form 1040EZ to report any other tax.
Form 1040A
If you don't qualify to use Form 1040EZ, you may be able to use Form 1040A.
You can use Form 1040A if all of the following apply.
1. Your income is only from:
a. Wages, salaries, and tips,
b. Interest,
c. Ordinary dividends (including Alaska Permanent Fund dividends),
d. Capital gain distributions,
e. IRA distributions,
f. Pensions and annuities,
g. Unemployment compensation,
h. Taxable social security and railroad retirement benefits, and
i. Taxable scholarship and fellowship grants.
2. Your taxable income is less than $100,000.
3. Your adjustments to income are for only the following items.
a. Educator expenses.
b. IRA deduction.
c. Student loan interest deduction.
d. Tuition and fees.
4. You don't itemize your deductions.
5. You claim only the following tax credits.
a. The credit for child and dependent care expenses. (See chapter 32.)
b. The credit for the elderly or the disabled. (See chapter 33.)
c. The education credits. (See chapter 35.)
d. The retirement savings contributions credit. (See chapter 38.)
e. The child tax credit. (See chapter 34.)
f. The earned income credit. (See chapter 36.)
g. The additional child tax credit. (See chapter 34.)
h. The premium tax credit. (See chapter 37.)
6. You didn't have an alternative minimum tax adjustment on stock you acquired from the exercise of an incentive stock option. (See Pub. 525.)
You can also use Form 1040A if you received employer-provided dependent care benefits or if you owe tax from the recapture of an education credit or the alternative minimum tax.
You must meet all these requirements to use Form 1040A. If you don't, you must use Form 1040.
Form 1040
If you can't use Form 1040A, you must use Form 1040. You can use Form 1040 to report all types of income, deductions, and credits.
You may pay less tax by filing Form 1040 because you can take itemized deductions, some adjustments to income, and credits you can't take on Form 1040EZ.
You must use Form 1040 if any of the following apply.
1. Your taxable income is $100,000 or more.
2. You itemize your deductions on Schedule A.
3. You had income that can't be reported on Form 1040A, including tax-exempt interest from private activity bonds issued after August 7, 1986.
4. You claim any adjustments to gross income other than the adjustments listed earlier under Form 1040A.
5. Your Form W-2, box 12, shows uncollected employee tax (social security and Medicare tax) on tips (see chapter 6) or group-term life insurance (see chapter 5).
6. You received $20 or more in tips in any 1 month and didn't report all of them to your employer. (See chapter 6.)
7. You were a bona fide resident of Puerto Rico and exclude income from sources in Puerto Rico.
8. You claim any credits other than the credits listed earlier under Form 1040A.
9. You owe the excise tax on insider stock compensation from an expatriated corporation.
10. Your Form W-2 shows an amount in box 12 with a code Z.
11. You had a qualified health savings account funding distribution from your IRA.
12. You are an employee and your employer didn't withhold social security and Medicare tax.
13. You have to file other forms with your return to report certain exclusions, taxes, or transactions, such as Form 8959 or Form 8960.
14. You are a debtor in a bankruptcy case filed after October 16, 2005.
15. You must repay the first-time homebuyer credit.
16. You have adjusted gross income of more than $155,650 and must reduce the dollar amount of your exemptions.
17. You received a Form W-2 that incorrectly includes in box 1 amounts that are payments under a Medicaid waiver program, and you can't get a corrected Form W-2.
Why Should I File Electronically?
Electronic Filing
If your adjusted gross income (AGI) is less than a certain amount, you are eligible for Free File, a free tax software service offered by IRS partners, to prepare and e-file your return for free. If your income is over the amount, you are still eligible for Free File Fillable Forms, an electronic version of IRS paper forms. Table 1-4 lists the free ways to electronically file your return.
Table 1-4. Free Ways To e-file
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Use Free File for free tax software and free e-file.
• IRS partners offer name-brand products for free.
• Many taxpayers are eligible for Free File software.
• Everyone is eligible for Free File Fillable Forms, electronic
version of IRS paper forms.
• Free File software and Free File Fillable Forms are available only
at IRS.gov/freefile.
Use VITA/TCE for free tax help from volunteers and free e-file.
• Volunteers prepare your return and e-file it for free.
• Some sites also offer do-it-yourself software.
• You are eligible based either on your income or age.
• Sites are located nationwide. Find one near you by visiting
IRS.gov/vita.
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IRS e-file: IRS e-file uses automation to replace most of the manual steps needed to process paper returns. As a result, the processing of e-file returns is faster and more accurate than the processing of paper returns. However, as with a paper return, you are responsible for making sure your return contains accurate information and is filed on time.
If your return is filed with IRS e-file, you will receive an acknowledgment that your return was received and accepted. If you owe tax, you can e-file and pay electronically. The IRS has processed more than one billion e-filed returns safely and securely. Using e-file doesn't affect your chances of an IRS examination of your return.
Electronic return signatures. To file your return electronically, you must sign the return electronically using a personal identification number (PIN). If you are filing online, you must use a Self-Select PIN. If you are filing electronically using a tax practitioner, you can use a Self-Select PIN or a Practitioner PIN.
Self-Select PIN. The Self-Select PIN method allows you to create your own PIN. If you are married filing jointly, you and your spouse will each need to create a PIN and enter these PINs as your electronic signatures.
A PIN is any combination of five digits you choose except five zeros. If you use a PIN, there is nothing to sign and nothing to mail--not even your Forms W-2.
To verify your identity, you will be prompted to enter your adjusted gross income (AGI) from your originally filed 2015 federal income tax return, if applicable. Don't use your AGI from an amended return (Form 1040X) or a math error correction made by the IRS. AGI is the amount shown on your 2015 Form 1040A, line 22; or Form 1040EZ, line 4. If you don't have your 2015 income tax return, you can request a transcript by using our automated self-service tool. Go to IRS.gov/transcript. (If you filed electronically last year, you may use your prior year PIN to verify your identity instead of your prior year AGI. The prior year PIN is the five-digit PIN you used to electronically sign your 2015 return.) You will also be prompted to enter your date of birth.
CAUTION: You can't use the Self-Select PIN method if you are a first-time filer under age 16 at the end of 2016.
Practitioner PIN. The Practitioner PIN method allows you to authorize your tax practitioner to enter or generate your PIN. The practitioner can provide you with details.
Form 8453. You must send in a paper Form 8453 if you have to attach certain forms or other documents that can't be electronically filed. For details, see Form 8453.
For more details, visit IRS.gov/efile.
Identity Protection PIN. If the IRS gave you an identity protection personal identification number (IP PIN) because you were a victim of identity theft, enter it in the spaces provided on your tax form. If the IRS hasn't given you this type of number, leave these spaces blank. For more information, see the instructions for Form 1040A or Form 1040.
Power of attorney. If an agent is signing your return for you, a power of attorney (POA) must be filed. Attach the POA to Form 8453 and file it using that form's instructions. See Signatures, later, for more information on POAs.
State returns. In most states, you can file an electronic state return simultaneously with your federal return. For more information, check with your local IRS office, state tax agency, tax professional, or the IRS website at IRS.gov/efile.
Refunds. You can have a refund check mailed to you, or you can have your refund deposited directly to your checking or savings account or split among two or three accounts. With e-file, your refund will be issued faster than if you filed on paper.
As with a paper return, you may not get all of your refund if you owe certain past-due amounts, such as federal tax, state income tax, state unemployment compensation debts, child support, spousal support, or certain other federal nontax debts, such as student loans. See Offset against debts under Refunds, later.
Refund inquiries. Information about your return will generally be available within 24 hours after the IRS receives your e-filed return. See Refund Information, later.
Amount you owe. To avoid late-payment penalties and interest, pay your taxes in full by April 18, 2017. The due date is April 18, instead of April 15, because of the Emancipation Day holiday in the District of Columbia--even if you don't live in the District of Columbia. See How To Pay, later, for information on how to pay the amount you owe.
Using Your Personal Computer
You can file your tax return in a fast, easy, and convenient way using your personal computer. A computer with Internet access and tax preparation software are all you need. Best of all, you can e-file from the comfort of your home 24 hours a day, 7 days a week.
IRS approved tax preparation software is available for online use on the Internet, for download from the Internet, and in retail stores.
For information, visit IRS.gov/efile.
Through Employers and Financial Institutions
Some businesses offer free e-file to their employees, members, or customers. Others offer it for a fee. Ask your employer or financial institution if they offer IRS e-file as an employee, member, or customer benefit.
Free Help With Your Return
Free help in preparing your return is available nationwide from IRS-trained volunteers. The Volunteer Income Tax Assistance (VITA) program is designed to help low-to-moderate income taxpayers and the Tax Counseling for the Elderly (TCE) program is designed to assist taxpayers age 60 or older with their tax returns. Many VITA sites offer free electronic filing and all volunteers will let you know about the credits and deductions you may be entitled to claim. To find a site near you, call 1-800-906-9887. Or to find the nearest AARP TaxAide site, visit AARP's website at http://www.aarp.org/taxaide or call 1-888-227-7669. For more information on these programs, go to IRS.gov and enter keyword "VITA" in the search box.
Using a Tax Professional
Many tax professionals electronically file tax returns for their clients. You may personally enter your PIN or complete Form 8879, IRS e-file Signature Authorization, to authorize the tax professional to enter your PIN on your return.
Note. Tax professionals may charge a fee for IRS e-file. Fees can vary depending on the professional and the specific services rendered.
When Do I Have To File?
April 18, 2017, is the due date for filing your 2016 income tax return if you use the calendar year. For a quick view of due dates for filing a return with or without an extension of time to file (discussed later), see Table 1-5.
Table 1-5. When To File Your 2016 Return
For U.S. citizens and residents who file returns on a calendar year.
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For Certain Taxpayers
For Most Taxpayers Outside the U.S.
No extension requested April 18, 2017 June 15, 2017
Automatic extension October 16, 2017 October 16, 2017
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If you use a fiscal year (a year ending on the last day of any month except December, or a 52-53-week year), your income tax return is due by the 15th day of the 4th month after the close of your fiscal year.
When the due date for doing any act for tax purposes--filing a return, paying taxes, etc.--falls on a Saturday, Sunday, or legal holiday, the due date is delayed until the next business day.
Filing paper returns on time. Your paper return is filed on time if it is mailed in an envelope that is properly addressed, has enough postage, and is postmarked by the due date. If you send your return by registered mail, the date of the registration is the postmark date. The registration is evidence that the return was delivered. If you send a return by certified mail and have your receipt postmarked by a postal employee, the date on the receipt is the postmark date. The postmarked certified mail receipt is evidence that the return was delivered.
Private delivery services. If you use a private delivery service designated by the IRS to send your return, the postmark date generally is the date the private delivery service records in its database or marks on the mailing label. The private delivery service can tell you how to get written proof of this date.
The following are designated private delivery services.
• DHL Express 9:00, DHL Express 10:30, DHL Express 12:00, DHL Express Worldwide, DHL Express Envelope, DHL Import Express 10:30, DHL Import Express 12:00, and DHL Import Express Worldwide.
• United Parcel Service (UPS): UPS Next Day Air Early AM, UPS Next Day Air, UPS Next Day Air Saver, UPS 2nd Day Air, UPS 2nd Day Air A.M., UPS Worldwide Express Plus, and UPS Worldwide Express.
• Federal Express (FedEx): FedEx First Overnight, FedEx Priority Overnight, FedEx Standard Overnight, FedEx 2 Day, FedEx International Next Flight Out, FedEx International Priority, FedEx International First, and FedEx International Economy.
For more information, go to IRS.gov and enter "private delivery service" in the search box. The search results will direct you to the IRS mailing address to use if you are using a private delivery service. You will also find any updates to the list of designated private delivery services.
The private delivery service can tell you how to get written proof of the mailing date.
Filing electronic returns on time. If you use IRS e-file, your return is considered filed on time if the authorized electronic return transmitter postmarks the transmission by the due date. An authorized electronic return transmitter is a participant in the IRS e-file program that transmits electronic tax return information directly to the IRS.
The electronic postmark is a record of when the authorized electronic return transmitter received the transmission of your electronically filed return on its host system. The date and time in your time zone controls whether your electronically filed return is timely.
Filing late. If you don't file your return by the due date, you may have to pay a failure-to-file penalty and interest. For more information, see Penalties, later. Also see Interest under Amount You Owe.
If you were due a refund but you didn't file a return, you generally must file within 3 years from the date the return was due (including extensions) to get that refund.
Nonresident alien. If you are a nonresident alien and earn wages subject to U.S. income tax withholding, your 2016 U.S. income tax return (Form 1040NR or Form 1040NR-EZ) is due by:
• April 18, 2017, if you use a calendar year, or
• The 15th day of the 4th month after the end of your fiscal year if you use a fiscal year.
If you don't earn wages subject to U.S. income tax withholding, your return is due by:
• June 15, 2017, if you use a calendar year, or
• The 15th day of the 6th month after the end of your fiscal year, if you use a fiscal year.
See Pub. 519 for more filing information.
Filing for a decedent. If you must file a final income tax return for a taxpayer who died during the year (a decedent), the return is due by the 15th day of the 4th month after the end of the decedent's normal tax year. See Pub. 559.
Extensions of Time To File
You may be able to get an extension of time to file your return. There are three types of situations where you may qualify for an extension:
• Automatic extensions,
• You are outside the United States, or
• You are serving in a combat zone.
Automatic Extension
If you can't file your 2016 return by the due date, you may be able to get an automatic 6-month extension of time to file.
Example. If your return is due on April 18, 2017, you will have until October 16, 2017, to file.
CAUTION: If you don't pay the tax due by the regular due date (generally, April 15), you will owe interest. You may also be charged penalties, discussed later.
How to get the automatic extension. You can get the automatic extension by:
1. Using IRS e-file (electronic filing), or
2. Filing a paper form.
E-file options. There are two ways you can use e-file to get an extension of time to file. Complete Form 4868, to use as a worksheet. If you think you may owe tax when you file your return, use Part II of the form to estimate your balance due. If you e-file Form 4868 to the IRS, don't also send a paper Form 4868.
E-file using your personal computer or a tax professional. You can use a tax software package with your personal computer or a tax professional to file Form 4868 electronically. Free File and Free File Fillable Forms, both available at IRS.gov, allows you to prepare and e-file Form 4868 for free. You will need to provide certain information from your 2015 tax return. If you wish to make a payment by direct transfer from your bank account, see Pay online, under How To Pay, later in this chapter.
E-file and pay by credit or debit card or by direct transfer from your bank account. You can get an extension by paying part or all of your estimate of tax due by using a credit or debit card or by direct transfer from your bank account. You can do this by phone or over the Internet. You don't file Form 4868. See Pay online, under How To Pay, later in this chapter.
Filing a paper Form 4868. You can get an extension of time to file by filing a paper Form 4868. Mail it to the address shown in the form instructions.
If you want to make a payment with the form, make your check or money order payable to "United States Treasury." Write your SSN, daytime phone number, and "2016 Form 4868" on your check or money order.
When to file. You must request the automatic extension by the due date for your return. You can file your return any time before the 6-month extension period ends.
When you file your return. Enter any payment you made related to the extension of time to file on Form 1040EZ or Form 1040A, include that payment in your total payments on Form 1040EZ, line 9, or Form 1040A, line 46. Also enter "Form 4868" and the amount paid in the space to the left of line 9 or line 46.
Individuals Outside the United States
You are allowed an automatic 2-month extension, without filing Form 4868 (until June 15, 2017, if you use the calendar year), to file your 2016 return and pay any federal income tax due if:
1. You are a U.S. citizen or resident, and
2. On the due date of your return:
a. You are living outside the United States and Puerto Rico, and your main place of business or post of duty is outside the United States and Puerto Rico, or
b. You are in military or naval service on duty outside the United States and Puerto Rico.
If you served in a combat zone or qualified hazardous duty area, you may be eligible for a longer extension of time to file. See Individuals Serving in Combat Zone, later, for special rules that apply to you.
Married taxpayers. If you file a joint return, only one spouse has to qualify for this automatic extension. If you and your spouse file separate returns, this automatic extension applies only to the spouse who qualifies.
How to get the extension. To use this automatic extension, you must attach a statement to your return explaining what situation qualified you for the extension. (See the situations listed under (2), earlier.)
Extensions beyond 2 months. If you can't file your return within the automatic 2-month extension period, you may be able to get an additional 4-month extension, for a total of 6 months. File Form 4868 and check the box on line 8.
No further extension. An extension of more than 6 months will generally not be granted. However, if you are outside the United States and meet certain tests, you may be granted a longer extension. For more information, see When To File and Pay in Pub. 54.
Individuals Serving in Combat Zone
The deadline for filing your tax return, paying any tax you may owe, and filing a claim for refund is automatically extended if you serve in a combat zone. This applies to members of the Armed Forces, as well as merchant marines serving aboard vessels under the operational control of the Department of Defense, Red Cross personnel, accredited correspondents, and civilians under the direction of the Armed Forces in support of the Armed Forces.
Combat zone. For purposes of the automatic extension, the term "combat zone" includes the following areas.
1. The Arabian peninsula area, effective January 17, 1991.
2. The Kosovo area, effective March 24, 1999.
3. Afghanistan area, effective September 19, 2001.
See Pub. 3 for more detailed information on the locations comprising each combat zone. The publication also has information about other tax benefits available to military personnel serving in a combat zone.
Extension period. The deadline for filing your return, paying any tax due, and filing a claim for refund is extended for at least 180 days after the later of:
1. The last day you are in a combat zone or the last day the area qualifies as a combat zone, or
2. The last day of any continuous qualified hospitalization for injury from service in the combat zone.
In addition to the 180 days, your deadline is also extended by the number of days you had left to take action with the IRS when you entered the combat zone. For example, you have 3 1/2 months (January 1 - April 15) to file your tax return. Any days left in this period when you entered the combat zone (or the entire 3 1/2 months if you entered it before the beginning of the year) are added to the 180 days. See Extension of Deadlines in Pub. 3 for more information.
The rules on the extension for filing your return also apply when you are deployed outside the United States (away from your permanent duty station) while participating in a designated contingency operation.
How Do I Prepare My Return?
This section explains how to get ready to fill in your tax return and when to report your income and expenses. It also explains how to complete certain sections of the form. You may find Table 1-6 helpful when you prepare your paper return.
Table 1-6. Six Steps for Preparing Your Paper Return
-----------------------------------------
1 -- Get your records together for income
and expenses.
2 -- Get the forms, schedules, and
publications you need.
3 -- Fill in your return.
4 -- Check your return to make sure it is
correct.
5 -- Sign and date your return.
6 -- Attach all required forms and
schedules.
-----------------------------------------
Electronic returns. For information you may find useful in preparing an electronic return, see Why Should I File Electronically, earlier.
Substitute tax forms. You can't use your own version of a tax form unless it meets the requirements explained in Pub. 1167.
Form W-2. If you were an employee, you should receive Form W-2 from your employer. You will need the information from this form to prepare your return. See Form W-2 under Credit for Withholding and Estimated Tax in chapter 4.
Your employer is required to provide or send Form W-2 to you no later than January 31, 2017. If it is mailed, you should allow adequate time to receive it before contacting your employer. If you still don't get the form by February 15, the IRS can help you by requesting the form from your employer. When you request IRS help, be prepared to provide the following information.
• Your name, address (including ZIP code), and phone number.
• Your SSN.
• Your dates of employment.
• Your employer's name, address (including ZIP code), and phone number.
Form 1099. If you received certain types of income, you may receive a Form 1099. For example, if you received taxable interest of $10 or more, the payer is required to provide or send Form 1099 to you no later than January 31, 2017 (or by February 15, 2017, if furnished by a broker). If it is mailed, you should allow adequate time to receive it before contacting the payer. If you still don't get the form by February 15 (or by March 1, 2017, if furnished by a broker), call the IRS for help.
When Do I Report My Income and Expenses?
You must figure your taxable income on the basis of a tax year. A "tax year" is an annual accounting period used for keeping records and reporting income and expenses. You must account for your income and expenses in a way that clearly shows your taxable income. The way you do this is called an accounting method. This section explains which accounting periods and methods you can use.
Accounting Periods
Most individual tax returns cover a calendar year--the 12 months from January 1 through December 31. If you don't use a calendar year, your accounting period is a fiscal year. A regular fiscal year is a 12-month period that ends on the last day of any month except December. A 52-53-week fiscal year varies from 52 to 53 weeks and always ends on the same day of the week.
You choose your accounting period (tax year) when you file your first income tax return. It can't be longer than 12 months.
More information. For more information on accounting periods, including how to change your accounting period, see Pub. 538.
Accounting Methods
Your accounting method is the way you account for your income and expenses. Most taxpayers use either the cash method or an accrual method. You choose a method when you file your first income tax return. If you want to change your accounting method after that, you generally must get IRS approval. Use Form 3115 to request an accounting method change.
Cash method. If you use this method, report all items of income in the year in which you actually or constructively receive them. Generally, you deduct all expenses in the year you actually pay them. This is the method most individual taxpayers use.
Constructive receipt. Generally, you constructively receive income when it is credited to your account or set apart in any way that makes it available to you. You don't need to have physical possession of it. For example, interest credited to your bank account on December 31, 2016, is taxable income to you in 2016 if you could have withdrawn it in 2016 (even if the amount isn't entered in your records or withdrawn until 2017).
Garnisheed wages. If your employer uses your wages to pay your debts, or if your wages are attached or garnisheed, the full amount is constructively received by you. You must include these wages in income for the year you would have received them.
Debts paid for you. If another person cancels or pays your debts (but not as a gift or loan), you have constructively received the amount and generally must include it in your gross income for the year. See Canceled Debts in chapter 12 for more information.
Payment to third party. If a third party is paid income from property you own, you have constructively received the income. It is the same as if you had actually received the income and paid it to the third party.
Payment to an agent. Income an agent receives for you is income you constructively received in the year the agent receives it. If you indicate in a contract that your income is to be paid to another person, you must include the amount in your gross income when the other person receives it.
Check received or available. A valid check that was made available to you before the end of the tax year is constructively received by you in that year. A check that was "made available to you" includes a check you have already received, but not cashed or deposited. It also includes, for example, your last paycheck of the year that your employer made available for you to pick up at the office before the end of the year. It is constructively received by you in that year whether or not you pick it up before the end of the year or wait to receive it by mail after the end of the year.
No constructive receipt. There may be facts to show that you didn't constructively receive income.
Example. Alice Johnson, a teacher, agreed to her school board's condition that, in her absence, she would receive only the difference between her regular salary and the salary of a substitute teacher hired by the school board. Therefore, Alice didn't constructively receive the amount by which her salary was reduced to pay the substitute teacher.
Accrual method. If you use an accrual method, 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.
Income paid in advance. An advance payment of income is generally included in gross income in the year you receive it. Your method of accounting doesn't matter as long as the income is available to you. An advance payment may include rent or interest you receive in advance and pay for services you will perform later.
A limited deferral until the next tax year may be allowed for certain advance payments. See Pub. 538 for specific information.
Additional information. For more information on accounting methods, including how to change your accounting method, see Pub. 538.
Social Security Number (SSN)
You must enter your SSN on your return. If you are married, enter the SSNs for both you and your spouse, whether you file jointly or separately.
If you are filing a joint return, include the SSNs in the same order as the names. Use this same order in submitting other forms and documents to the IRS.
Check that both the name and SSN on your W-2, and 1099 agree with your social security card. If they don't, certain deductions and credits on your Form 1040 may be reduced or disallowed and you may not receive credit for your social security earnings. If your Form W-2 shows an incorrect SSN or name, notify your employer or the form-issuing agent as soon as possible to make sure your earnings are credited to your social security record. If the name or SSN on your social security card is incorrect, call the SSA at 1-800-772-1213.
Name change. If you changed your name because of marriage, divorce, etc., be sure to report the change to your local Social Security Administration (SSA) office before filing your return. This prevents delays in processing your return and issuing refunds. It also safeguards your future social security benefits.
Dependent's SSN. You must provide the SSN of each dependent you claim, regardless of the dependent's age. This requirement applies to all dependents (not just your children) claimed on your tax return.
Exception. If your child was born and died in 2016 and didn't have an SSN, enter "DIED" in column (2) of line 6c (1040A) and include a copy of the child's birth certificate, death certificate, or hospital records. The document must show that the child was born alive.
No SSN. File Form SS-5, Application for a Social Security Card, with your local SSA office to get an SSN for yourself or your dependent. It usually takes about 2 weeks to get an SSN. If you or your dependent isn't eligible for an SSN, see Individual taxpayer identification number (ITIN), later.
If you are a U.S. citizen or resident alien, you must show proof of age, identity, and citizenship or alien status with your Form SS-5. If you are 12 or older and have never been assigned an SSN, you must appear in person with this proof at an SSA office.
Form SS-5 is available at any SSA office, on the Internet at http://www.socialsecurity.gov, or by calling 1-800-772-1213. If you have any questions about which documents you can use as proof of age, identity, or citizenship, contact your SSA office.
If your dependent doesn't have an SSN by the time your return is due, you may want to ask for an extension of time to file, as explained earlier under When Do I Have To File.
If you don't provide a required SSN or if you provide an incorrect SSN, your tax may be increased and any refund may be reduced.
Adoption taxpayer identification number (ATIN). If you are in the process of adopting a child who is a U.S. citizen or resident and can't get an SSN for the child until the adoption is final, you can apply for an ATIN to use instead of an SSN.
File Form W-7A, Application for Taxpayer Identification Number for Pending U.S. Adoptions, with the IRS to get an ATIN if all of the following are true.
• You have a child living with you who was placed in your home for legal adoption.
• You can't get the child's existing SSN even though you have made a reasonable attempt to get it from the birth parents, the placement agency, and other persons.
• You can't get an SSN for the child from the SSA because, for example, the adoption isn't final.
• You are eligible to claim the child as a dependent on your tax return.
After the adoption is final, you must apply for an SSN for the child. You can't continue using the ATIN.
See Form W-7A for more information.
Nonresident alien spouse. If your spouse is a nonresident alien, your spouse must have either an SSN or an ITIN if:
• You file a joint return,
• You file a separate return and claim an exemption for your spouse, or
• Your spouse is filing a separate return.
If your spouse isn't eligible for an SSN, see the following discussion on ITINs.
Individual taxpayer identification number (ITIN). The IRS will issue you an ITIN if you are a nonresident or resident alien and you don't have and aren't eligible to get an SSN. This also applies to an alien spouse or dependent. To apply for an ITIN, file Form W-7 with the IRS. It usually takes about 7 weeks to get an ITIN. Enter the ITIN on your tax return wherever an SSN is requested.
Make sure your ITIN has not expired. ITINs that have not been included on a U.S. federal tax return at least once in the last three consecutive years will expire. In addition, ITINs that were assigned before 2013 will expire according to an annual schedule, regardless of use. Expired ITINs must be renewed in order to avoid delays in processing your return.
TIP: If you are applying for an ITIN for yourself, your spouse, or a dependent in order to file your tax return, attach your completed tax return to your Form W-7. See the Form W-7 instructions for how and where to file.
CAUTION: You can't e-file a return using an ITIN in the calendar year the ITIN is issued; however, you can e-file returns in the following years.
ITIN for tax use only. An ITIN is for federal tax use only. It doesn't entitle you to social security benefits or change your employment or immigration status under U.S. law.
Penalty for not providing social security number. If you don't include your SSN or the SSN of your spouse or dependent as required, you may have to pay a penalty. See the discussion on Penalties, later, for more information.
SSN on correspondence. If you write to the IRS about your tax account, be sure to include your SSN (and the name and SSN of your spouse, if you filed a joint return) in your correspondence. Because your SSN is used to identify your account, this helps the IRS respond to your correspondence promptly.
Presidential Election Campaign Fund
This fund helps pay for Presidential election campaigns. The fund also helps pay for pediatric medical research. If you want $3 to go to this fund, check the box. If you are filing a joint return, your spouse can also have $3 go to the fund. If you check a box, your tax or refund won't change.
Computations
The following information may be useful in making the return easier to complete.
Rounding off dollars. You can round off cents to whole dollars on your return and schedules. 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.
Equal amounts. If you are asked to enter the smaller or larger of two equal amounts, enter that amount.
Negative amounts. If you file a paper return and you need to enter a negative amount, put the amount in parentheses rather than using a minus sign. To combine positive and negative amounts, add all the positive amounts together and then subtract the negative amounts.
Attachments
Depending on the form you file and the items reported on your return, you may have to complete additional schedules and forms and attach them to your paper return.
TIP: You may be able to file a paperless return using IRS e-file. There's nothing to attach or mail, not even your Forms W-2. See Why Should I File Electronically, earlier.
Form W-2. Form W-2 is a statement from your employer of wages and other compensation paid to you and taxes withheld from your pay. You should have a Form W-2 from each employer. If you file a paper return, be sure to attach a copy of Form W-2 in the place indicated on the front page of your return. Attach it to the front page of your paper return, not to any attachments. For more information, see Form W-2 in chapter 4.
Form 1099-R. If you received a Form 1099-R, showing federal income tax withheld, and you file a paper return, attach a copy of that form in the place indicated on the front page of your return.
Form 1040EZ. There are no additional schedules to file with Form 1040EZ.
Form 1040A. If you file a paper return, attach any forms and schedules behind Form 1040A in order of the "Attachment Sequence Number" shown in the upper right corner of the form or schedule. Then arrange all other statements or attachments in the same order as the forms and schedules they relate to and attach them last. Don't attach items unless required to do so.
Form 1040. If you file a paper return, attach any forms and schedules behind Form 1040 in order of the "Attachment Sequence Number" shown in the upper right corner of the form or schedule. Then arrange all other statements or attachments in the same order as the forms and schedules they relate to and attach them last. Don't attach items unless required to do so.
Third Party Designee
You can authorize the IRS to discuss your return with your preparer, a friend, family member, or any other person you choose. If you check the "Yes" box in the Third party designee area of your 2016 tax return and provide the information required, you are authorizing:
1. The IRS to call the designee to answer any questions that arise during the processing of your return, and
2. The designee to:
a. Give information that is missing from your return to the IRS,
b. Call the IRS for information about the processing of your return or the status of your refund or payments,
c. Receive copies of notices or transcripts related to your return, upon request, and
d. Respond to certain IRS notices about math errors, offsets (see Refunds, later), and return preparation.
See your form instructions for more information.
Signatures
You must sign and date your return. If you file a joint return, both you and your spouse must sign the return, even if only one of you had income.
CAUTION: If you file a joint return, both spouses are generally liable for the tax, and the entire tax liability may be assessed against either spouse. See chapter 2.
TIP: If you electronically file your return, you can use an electronic signature to sign your return. See Why Should I File Electronically, earlier.
If you are due a refund, it can't be issued unless you have signed your return.
Enter your occupation. If you file a joint return, enter both your occupation and your spouse's occupation. Entering your daytime phone number may help speed the processing of your return.
When someone can sign for you. You can appoint an agent to sign your return if you are:
1. Unable to sign the return because of disease or injury,
2. Absent from the United States for a continuous period of at least 60 days before the due date for filing your return, or
3. Given permission to do so by the IRS office in your area.
Power of attorney. A return signed by an agent in any of these cases must have a power of attorney (POA) attached that authorizes the agent to sign for you. You can use a POA that states that the agent is granted authority to sign the return, or you can use Form 2848. Part I of Form 2848 must state that the agent is granted authority to sign the return.
Court-appointed, conservator, or other fiduciary. If you are a court-appointed conservator, guardian, or other fiduciary for a mentally or physically incompetent individual who has to file a tax return, sign your name for the individual. File Form 56.
Unable to sign. If the taxpayer is mentally competent but physically unable to sign the return or POA, a valid "signature" is defined under state law. It can be anything that clearly indicates the taxpayer's intent to sign. For example, the taxpayer's "X" with the signatures of two witnesses might be considered a valid signature under a state's law.
Spouse unable to sign. If your spouse is unable to sign for any reason, see Signing a joint return in chapter 2.
Child's return. If a child has to file a tax return but can't sign the return, the child's parent, guardian, or another legally responsible person must sign the child's name, followed by the words "By (your signature), parent for minor child."
Paid Preparer
Generally, anyone you pay to prepare, assist in preparing, or review your tax return must sign it and fill in the other blanks, including their Preparer Tax Identification Number (PTIN), in the paid preparer's area of your return.
Many preparers are required to e-file the tax returns they prepare. They sign these e-filed returns using their tax preparation software. However, you can choose to have your return completed on paper if you prefer. In that case, the paid preparer can sign the paper return manually or use a rubber stamp or mechanical device. The preparer is personally responsible for affixing his or her signature to the return.
If the preparer is self-employed (that is, not employed by any person or business to prepare the return), he or she should check the self-employed box in the Paid Preparer Use Only space on the return.
The preparer must give you a copy of your return in addition to the copy filed with the IRS.
If you prepare your own return, leave this area blank. If another person prepares your return and doesn't charge you, that person shouldn't sign your return.
If you have questions about whether a preparer must sign your return, contact any IRS office.
Refunds
When you complete your return, you will determine if you paid more income tax than you owed. If so, you can get a refund of the amount you overpaid or, if you file Form 1040A, you can choose to apply all or part of the overpayment to your next year's (2017) estimated tax. You can't have your overpayment applied to your 2017 estimated tax if you file Form 1040EZ.
CAUTION: If you choose to have a 2016 overpayment applied to your 2017 estimated tax, you can't change your mind and have any of it refunded to you after the due date (without extensions) of your 2016 return.
Follow the form instructions to complete the entries to claim your refund and/or to apply your overpayment to your 2017 estimated tax.
TIP: If your refund for 2016 is large, you may want to decrease the amount of income tax withheld from your pay in 2017. See chapter 4 for more information.
DIRECT DEPOSIT Simple. Safe. Secure. Instead of getting a paper check, you may be able to have your refund deposited directly into your checking or savings account, including an individual retirement arrangement. Follow the form instructions to request direct deposit. If the direct deposit can't be done, the IRS will send a check instead.
Don't request a deposit of any part of your refund to an account that isn't in your name. Don't allow your tax preparer to deposit any part of your refund into his or her account. The number of direct deposits to a single account or prepaid debit card is limited to three refunds a year. After this limit is exceeded, paper checks will be sent instead. Learn more at IRS.gov/Individuals/Direct-Deposit-Limits.
myRA®. If you already have a myRA® account, you can request a deposit of your refund (or part of it) to your myRA account. A myRA is a starter retirement account offered by the Department of the Treasury. For more information on myRA and to open a myRA account online, visit http://www.myRA.gov.
IRA. You can have your refund (or part of it) directly deposited to a traditional IRA, Roth IRA (including a myRA), or SEP-IRA, but not a SIMPLE IRA. You must establish the IRA at a bank or financial institution before you request direct deposit.
TreasuryDirect®. You can request a deposit of your refund to a TreasuryDirect® online account to buy U.S. Treasury marketable securities and savings bonds. For more information, go to http://www.treasurydirect.gov.
Split refunds. If you choose direct deposit, you may be able to split the refund and have it deposited among two or three accounts or buy up to $5,000 in paper series I savings bonds. Complete Form 8888 and attach it to your return.
Overpayment less than one dollar. If your overpayment is less than one dollar, you won't get a refund unless you ask for it in writing.
Cashing your refund check. Cash your tax refund check soon after you receive it. Checks expire the last business day of the 12th month of issue.
If your check has expired, you can apply to the IRS to have it reissued.
Refund more or less than expected. If you receive a check for a refund you aren't entitled to, or for an overpayment that should have been credited to estimated tax, don't cash the check. Call the IRS.
If you receive a check for more than the refund you claimed, don't cash the check until you receive a notice explaining the difference.
If your refund check is for less than you claimed, it should be accompanied by a notice explaining the difference. Cashing the check doesn't stop you from claiming an additional amount of refund.
If you didn't receive a notice and you have any questions about the amount of your refund, you should wait 2 weeks. If you still haven't received a notice, call the IRS.
Offset against debts. If you are due a refund but haven't paid certain amounts you owe, all or part of your refund may be used to pay all or part of the past-due amount. This includes past-due federal income tax, other federal debts (such as student loans), state income tax, child and spousal support payments, and state unemployment compensation debt. You will be notified if the refund you claimed has been offset against your debts.
Joint return and injured spouse. When a joint return is filed and only one spouse owes a past-due amount, the other spouse can be considered an injured spouse. An injured spouse should file Form 8379, Injured Spouse Allocation, if both of the following apply and the spouse wants a refund of his or her share of the overpayment shown on the joint return.
1. You aren't legally obligated to pay the past-due amount.
2. You made and reported tax payments (such as federal income tax withheld from your wages or estimated tax payments), or claimed a refundable tax credit (see the credits listed under Who Should File, earlier).
Note. If the injured spouse's residence was in a community property state at any time during the tax year, special rules may apply. See the Instructions for Form 8379.
If you haven't filed your joint return and you know that your joint refund will be offset, file Form 8379 with your return. You should receive your refund within 14 weeks from the date the paper return is filed or within 11 weeks from the date the return is filed electronically.
If you filed your joint return and your joint refund was offset, file Form 8379 by itself. When filed after offset, it can take up to 8 weeks to receive your refund. Don't attach the previously filed tax return, but do include copies of all Forms W-2G for both spouses and any Forms 1099 that show income tax withheld. The processing of Form 8379 may be delayed if these forms aren't attached, or if the form is incomplete when filed.
A separate Form 8379 must be filed for each tax year to be considered.
CAUTION: An injured spouse claim is different from an innocent spouse relief request. An injured spouse uses Form 8379 to request the division of the tax overpayment attributed to each spouse. An innocent spouse uses Form 8857, Request for Innocent Spouse Relief, to request relief from joint liability for tax, interest, and penalties on a joint return for items of the other spouse (or former spouse) that were incorrectly reported on the joint return. For information on innocent spouses, see Relief from joint responsibility under Filing a Joint Return in chapter 2.
Amount You Owe
When you complete your return, you will determine if you have paid the full amount of tax that you owe. If you owe additional tax, you should pay it with your return.
TIP: You don't have to pay if the amount you owe is under $1.
If the IRS figures your tax for you, you will receive a bill for any tax that is due. You should pay this bill within 30 days (or by the due date of your return, if later). See Tax Figured by IRS in chapter 30.
CAUTION: If you don't pay your tax when due, you may have to pay a failure-to-pay penalty. See Penalties, later. For more information about your balance due, see Pub. 594.
TIP: If the amount you owe for 2016 is large, you may want to increase the amount of income tax withheld from your pay or make estimated tax payments for 2017. See chapter 4 for more information.
How To Pay
You can pay online, by phone, by mobile device, in cash, or by check or money order. Don't include any estimated tax payment for 2017 in this payment. Instead, make the estimated tax payment separately.
Bad check or payment. The penalty for writing a bad check to the IRS is $25 or 2% of the check, whichever is more. This penalty also applies to other forms of payment if the IRS doesn't receive the funds.
Pay online. Paying online is convenient and secure and helps make sure we get your payments on time.
You can pay online with a direct transfer from your bank account using IRS Direct Pay, the Electronic Federal Tax Payment System, or by debit or credit card.
To pay your taxes online or for more information, go to IRS.gov/payments.
Pay by phone. Paying by phone is another safe and secure method of paying electronically. Use one of the following methods.
• Electronic Federal Tax Payment System (EFTPS).
• Debit or credit card.
To use EFTPS, you must be enrolled either online or have an enrollment form mailed to you. To make a payment using EFTPS call 1-800-555-4477 (English) or 1-800-244-4829 (Español). People who are deaf, hard of hearing, or have a speech disability and have access to TTY/TDD equipment can call 1-800-733-4829. For more information about EFTPS, go to IRS.gov/payments or http://www.eftps.gov.
To pay using a debit or credit card, you can call one of the following service providers. There is a convenience fee charged by these providers that varies by provider, card type, and payment amount.
Link2Gov Corporation 1-888-PAY-1040™ (1-888-729-1040) http://www.PAY1040.com
WorldPay US, Inc. 1-844-PAY-TAX-8™ (1-844-729-8298) http://www.payUSAtax.com
Official Payments 1-888-UPAY-TAX™ (1-888-872-9829) http://www.officialpayments.com
For the latest details on how to pay by phone, go to IRS.gov/payments.
Pay by mobile device. To pay through your mobile device, download the IRS2Go app.
Pay by cash. Cash is a new in-person payment option for individuals provided through retail partners with a maximum of $1,000 per day per transaction. To make a cash payment you must first be registered online at http://www.officialpayments.com.
Pay by check or money order. Make your check or money order payable to "United States Treasury" for the full amount due. Don't send cash. Don't attach the payment to your return. Show your correct name, address, SSN, daytime phone number, and the tax year and form number on the front of your check or money order. If you are filing a joint return, enter the SSN shown first on your tax return.
Estimated tax payments. Don't include any 2017 estimated tax payment in the payment for your 2016 income tax return. See chapter 4 for information on how to pay estimated tax.
Interest
Interest is charged on tax you don't pay by the due date of your return. Interest is charged even if you get an extension of time for filing.
TIP: If the IRS figures your tax for you, to avoid interest for late payment, you must pay the bill within 30 days of the date of the bill or by the due date of your return, whichever is later. For information, see Tax Figured by IRS in chapter 30.
Interest on penalties. Interest is charged on the failure-to-file penalty, the accuracy-related penalty, and the fraud penalty from the due date of the return (including extensions) to the date of payment. Interest on other penalties starts on the date of notice and demand, but isn't charged on penalties paid within 21 calendar days from the date of the notice (or within 10 business days if the notice is for $100,000 or more).
Interest due to IRS error or delay. All or part of any interest you were charged can be forgiven if the interest is due to an unreasonable error or delay by an officer or employee of the IRS in performing a ministerial or managerial act.
A ministerial act is a procedural or mechanical act that occurs during the processing of your case. A managerial act includes personnel transfers and extended personnel training. A decision concerning the proper application of federal tax law isn't a ministerial or managerial act.
The interest can be forgiven only if you aren't responsible in any important way for the error or delay and the IRS has notified you in writing of the deficiency or payment. For more information, see Pub. 556.
Interest and certain penalties may also be suspended for a limited period if you filed your return by the due date (including extensions) and the IRS doesn't provide you with a notice specifically stating your liability and the basis for it before the close of the 36-month period beginning on the later of:
• The date the return is filed, or
• The due date of the return without regard to extensions.
For more information, see Pub. 556.
Installment Agreement
If you can't pay the full amount due with your return, you can ask to make monthly installment payments for the full or a partial amount. However, you will be charged interest and may be charged a late payment penalty on the tax not paid by the date your return is due, even if your request to pay in installments is granted. If your request is granted, you must also pay a fee. To limit the interest and penalty charges, pay as much of the tax as possible with your return. But before requesting an installment agreement, you should consider other less costly alternatives, such as a bank loan or credit card payment.
To apply for an installment agreement online, go to IRS.gov/opa. You can also use Form 9465.
In addition to paying by check or money order, you can use a credit or debit card or direct payment from your bank account to make installment agreement payments. See How To Pay, earlier.
Gift To Reduce Debt Held by the Public
You can make a contribution (gift) to reduce debt held by the public. If you wish to do so, make a separate check payable to "Bureau of the Fiscal Service."
Send your check to:
Bureau of the Fiscal Service ATTN: Department G P.O. Box 2188 Parkersburg, WV 26106-2188
Or, enclose your separate check in the envelope with your income tax return. Don't add this gift to any tax you owe.
For information on making this type of gift online, go to http://www.treasurydirect.gov and click on "How To Make a Contribution to Reduce the Debt."
You may be able to deduct this gift as a charitable contribution on next year's tax return if you itemize your deductions on Schedule A (Form 1040).
Name and Address
After you have completed your return, fill in your name and address in the appropriate area of Form 1040EZ.
CAUTION: You must include your SSN in the correct place on your tax return.
P.O. box. If your post office doesn't deliver mail to your street address and you have a P.O. box, enter your P.O. box number on the line for your present home address instead of your street address.
Foreign address. If your address is outside the United States or its possessions or territories, enter the city name on the appropriate line of your return. Don't enter any other information on that line, but also complete the line listing:
1. Foreign country name,
2. Foreign province/state/county, and
3. Foreign postal code.
Follow the country's practice for entering the postal code and the name of the province, county, or state.
Where Do I File?
After you complete your return, you must send it to the IRS. You can mail it or you may be able to file it electronically. See Why Should I File Electronically, earlier.
Mailing your paper return. Mail your paper return to the address shown in your tax return instructions.
What Happens After I File?
After you send your return to the IRS, you may have some questions. This section discusses concerns you may have about recordkeeping, your refund, and what to do if you move.
What Records Should I Keep?
This part discusses why you should keep records, what kinds of records you should keep, and how long you should keep them.
RECORDS: You must keep records so that you can prepare a complete and accurate income tax return. The law doesn't require any special form of records. However, you should keep all receipts, canceled checks or other proof of payment, and any other records to support any deductions or credits you claim.
If you file a claim for refund, you must be able to prove by your records that you have overpaid your tax.
This part doesn't discuss the records you should keep when operating a business. For information on business records, see Pub. 583, Starting a Business and Keeping Records.
Why Keep Records?
Good records help you:
• Identify sources of income. Your records can identify the sources of your income to help you separate business from nonbusiness income and taxable from nontaxable income.
• Keep track of expenses. You can use your records to identify expenses for which you can claim a deduction. This helps you determine if you can itemize deductions on your tax return.
• Keep track of the basis of property. You need to keep records that show the basis of your property. This includes the original cost or other basis of the property and any improvements you made.
• Prepare tax returns. You need records to prepare your tax return.
• Support items reported on tax returns. The IRS may question an item on your return. Your records will help you explain any item and arrive at the correct tax. If you can't produce the correct documents, you may have to pay additional tax and be subject to penalties.
Kinds of Records to Keep
The IRS doesn't require you to keep your records in a particular way. Keep them in a manner that allows you and the IRS to determine your correct tax.
You can use your checkbook to keep a record of your income and expenses. You also need to keep documents, such as receipts and sales slips, that can help prove a deduction.
In this section you will find guidance about basic records that everyone should keep. The section also provides guidance about specific records you should keep for certain items.
Electronic records. All requirements that apply to hard copy books and records also apply to electronic storage systems that maintain tax books and records. When you replace hard copy books and records, you must maintain the electronic storage systems for as long as they are material to the administration of tax law.
For details on electronic storage system requirements, see Revenue Procedure 97-22, which is on page 9 of Internal Revenue Bulletin 1997-13 at IRS.gov/pub/irs-irbs/irb97-13.pdf.
Copies of tax returns. You should keep copies of your tax returns as part of your tax records. They can help you prepare future tax returns, and you will need them if you file an amended return or are audited. Copies of your returns and other records can be helpful to your survivor or the executor or administrator of your estate.
If necessary, you can request a copy of a return and all attachments (including Form W-2) from the IRS by using Form 4506. There is a charge for a copy of a return. For information on the cost and where to file, see the Instructions for Form 4506.
If you just need information from your return, you can order a transcript in one of the following ways.
• Go to IRS.gov/transcript.
• Call 1-800-908-9946.
• Use Form 4506-T or Form 4506T-EZ.
There is no fee for a transcript. For more information, see Form 4506-T.
Basic Records
Basic records are documents that everybody should keep. These are the records that prove your income and expenses. If you own a home or investments, your basic records should contain documents related to those items.
Income. Your basic records prove the amounts you report as income on your tax return. Your income may include wages, dividends, interest, and partnership or S corporation distributions. Your records also can prove that certain amounts aren't taxable, such as tax-exempt interest.
Note. If you receive a Form W-2, keep Copy C until you begin receiving social security benefits. This will help protect your benefits in case there is a question about your work record or earnings in a particular year.
Expenses. Your basic records prove the expenses for which you claim a deduction (or credit) on your tax return. Your deductions may include alimony, charitable contributions, mortgage interest, and real estate taxes. You also may have child care expenses for which you can claim a credit.
Home. Your basic records should enable you to determine the basis or adjusted basis of your home. You need this information to determine if you have a gain or loss when you sell your home or to figure depreciation if you use part of your home for business purposes or for rent. Your records should show the purchase price, settlement or closing costs, and the cost of any improvements. They also may show any casualty losses deducted and insurance reimbursements for casualty losses.
For detailed information on basis, including which settlement or closing costs are included in the basis of your home, see chapter 13.
When you sell your home, your records should show the sales price and any selling expenses, such as commissions. For information on selling your home, see chapter 15.
Investments. Your basic records should enable you to determine your basis in an investment and whether you have a gain or loss when you sell it. Investments include stocks, bonds, and mutual funds. Your records should show the purchase price, sales price, and commissions. They may also show any reinvested dividends, stock splits and dividends, load charges, and original issue discount (OID).
For information on stocks, bonds, and mutual funds, see chapters 8, 13, 14, and 16.
Proof of Payment
One of your basic records is proof of payment. You should keep these records to support certain amounts shown on your tax return. Proof of payment alone isn't proof that the item claimed on your return is allowable. You also should keep other documents that will help prove that the item is allowable.
Generally, you prove payment with a cash receipt, financial account statement, credit card statement, canceled check, or substitute check. If you make payments in cash, you should get a dated and signed receipt showing the amount and the reason for the payment.
If you make payments using your bank account, you may be able to prove payment with an account statement.
Account statements. You may be able to prove payment with a legible financial account statement prepared by your bank or other financial institution.
Pay statements. You may have deductible expenses withheld from your paycheck, such as union dues or medical insurance premiums. You should keep your year-end or final pay statements as proof of payment of these expenses.
How Long to Keep Records
You must keep your records as long as they may be needed for the administration of any provision of the Internal Revenue Code. Generally, this means you must keep records that support items shown on your return until the period of limitations for that return runs out.
The period of limitations is the period of time in which you can amend your return to claim a credit or refund or the IRS can assess additional tax. Table 1-7 contains the periods of limitations that apply to income tax returns. Unless otherwise stated, the years refer to the period beginning after the return was filed. Returns filed before the due date are treated as being filed on the due date.
Table 1-7. Period of Limitations
-------------------------------------------------
THEN the
IF you . . . period is . . .
-------------------------------------------------
1 File a return and (2), 3 years
(3), and (4) don't apply
to you
-------------------------------------------------
2 Don't report income 6 years
that you should and it is
more than 25% of the
gross income shown on
your return
-------------------------------------------------
3 File a fraudulent return No limit
-------------------------------------------------
4 Don't file a return No limit
-------------------------------------------------
5 File a claim for credit or The later of 3
refund after you filed years or 2
your return years after tax
was paid
-------------------------------------------------
6 File a claim for a loss 7 years
from worthless
securities or bad debt
deduction
-------------------------------------------------
Property. Keep records relating to property until the period of limitations expires for the year in which you dispose of the property in a taxable disposition. You must keep these records to figure your basis for computing gain or loss when you sell or otherwise dispose of the property.
Generally, if you received property in a nontaxable exchange, your basis in that property is the same as the basis of the property you gave up. You must keep the records on the old property, as well as the new property, until the period of limitations expires for the year in which you dispose of the new property in a taxable disposition.
Refund Information
You can go online to check the status of your 2016 refund 24 hours after the IRS receives your e-filed return, or 4 weeks after you mail a paper return. If you filed Form 8379 with your return, allow 14 weeks (11 weeks if you filed electronically) before checking your refund status. Be sure to have a copy of your 2016 tax return handy because you will need to know the filing status, the first SSN shown on the return, and the exact whole-dollar amount of the refund. To check on your refund, do one of the following.
• Go to IRS.gov/refunds.
• Download the free IRS2Go app to your smart phone and use it to check your refund status.
• Call the automated refund hotline at 1-800-829-1954.
Interest on Refunds
If you are due a refund, you may get interest on it. The interest rates are adjusted quarterly.
If the refund is made within 45 days after the due date of your return, no interest will be paid. If you file your return after the due date (including extensions), no interest will be paid if the refund is made within 45 days after the date you filed. If the refund isn't made within this 45-day period, interest will be paid from the due date of the return or from the date you filed, whichever is later.
Accepting a refund check doesn't change your right to claim an additional refund and interest. File your claim within the period of time that applies. See Amended Returns and Claims for Refund, later. If you don't accept a refund check, no more interest will be paid on the overpayment included in the check.
Interest on erroneous refund. All or part of any interest you were charged on an erroneous refund generally will be forgiven. Any interest charged for the period before demand for repayment was made will be forgiven unless:
1. You, or a person related to you, caused the erroneous refund in any way, or
2. The refund is more than $50,000.
For example, if you claimed a refund of $100 on your return, but the IRS made an error and sent you $1,000, you wouldn't be charged interest for the time you held the $900 difference. You must, however, repay the $900 when the IRS asks.
Change of Address
If you have moved, file your return using your new address.
If you move after you filed your return, you should give the IRS clear and concise notification of your change of address. The notification may be written, electronic, or oral. Send written notification to the Internal Revenue Service Center serving your old address. You can use Form 8822, Change of Address. If you are expecting a refund, also notify the post office serving your old address. This will help in forwarding your check to your new address (unless you chose direct deposit of your refund). For more information, see Revenue Procedure 2010-16, 2010-19 I.R.B. 664, available at IRS.gov/irb/2010-19_IRB/ar07.html.
Be sure to include your SSN (and the name and SSN of your spouse, if you filed a joint return) in any correspondence with the IRS.
What If I Made a Mistake?
Errors may delay your refund or result in notices being sent to you. If you discover an error, you can file an amended return or claim for refund.
Amended Returns and Claims for Refund
You should correct your return if, after you have filed it, you find that:
1. You didn't report some income,
2. You claimed deductions or credits you shouldn't have claimed,
3. You didn't claim deductions or credits you could have claimed, or
4. You should have claimed a different filing status. (Once you file a joint return, you can't choose to file separate returns for that year after the due date of the return. However, an executor may be able to make this change for a deceased spouse.)
If you need a copy of your return, see Copies of tax returns under Kinds of Records to Keep, earlier in this chapter.
Form 1040X. Use Form 1040X to correct a return you have already filed. An amended tax return can't be filed electronically.
Completing Form 1040X. On Form 1040X, enter your income, deductions, and credits as you originally reported them on your return, the changes you are making, and the corrected amounts. Then figure the tax on the corrected amount of taxable income and the amount you owe or your refund.
If you owe tax, pay the full amount with Form 1040X. The tax owed won't be subtracted from any amount you had credited to your estimated tax.
If you can't pay the full amount due with your return, you can ask to make monthly installment payments. See Installment Agreement, earlier.
If you overpaid tax, you can have all or part of the overpayment refunded to you, or you can apply all or part of it to your estimated tax. If you choose to get a refund, it will be sent separately from any refund shown on your original return.
Filing Form 1040X. When completing Form 1040X, don't forget to show the year of your original return and explain all changes you made. Be sure to attach any forms or schedules needed to explain your changes. Mail your Form 1040X to the Internal Revenue Service Center serving the area where you now live (as shown in the instructions to the form). However, if you are filing Form 1040X in response to a notice you received from the IRS, mail it to the address shown on the notice.
File a separate form for each tax year involved.
Time for filing a claim for refund. Generally, you must file your claim for a credit or refund 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. Returns filed before the due date (without regard to extensions) are considered filed on the due date (even if the due date was a Saturday, Sunday, or legal holiday). These time periods are suspended while you are financially disabled, discussed later.
If the last day for claiming a credit or refund is a Saturday, Sunday, or legal holiday, you can file the claim on the next business day.
If you don't file a claim within this period, you may not be entitled to a credit or a refund.
Protective claim for refund. Generally, a protective claim is a formal claim or amended return for credit or refund normally based on current litigation or expected changes in tax law or other legislation. You file a protective claim when your right to a refund is contingent on future events and may not be determinable until after the statute of limitations expires. A valid protective claim doesn't have to list a particular dollar amount or demand an immediate refund. However, a valid protective claim must:
• Be in writing and signed,
• Include your name, address, SSN or ITIN, and other contact information,
• Identify and describe the contingencies affecting the claim,
• Clearly alert the IRS to the essential nature of the claim, and
• Identify the specific year(s) for which a refund is sought.
Mail your protective claim for refund to the address listed in the instructions for Form 1040X, under Where To File.
Generally, the IRS will delay action on the protective claim until the contingency is resolved.
Limit on amount of refund. If you file your claim within 3 years after the date you filed your return, the credit or refund can't be more than the part of the tax paid within the 3-year period (plus any extension of time for filing your return) immediately before you filed the claim. This time period is suspended while you are financially disabled, discussed later.
Tax paid. Payments, including estimated tax payments, made before the due date (without regard to extensions) of the original return are considered paid on the due date. For example, income tax withheld during the year is considered paid on the due date of the return, April 15 for most taxpayers.
Example 1. You made estimated tax payments of $500 and got an automatic extension of time to October 15, 2013, to file your 2012 income tax return. When you filed your return on that date, you paid an additional $200 tax. On October 15, 2016, you filed an amended return and claimed a refund of $700. Because you filed your claim within 3 years after you filed your original return, you can get a refund of up to $700, the tax paid within the 3 years plus the 6-month extension period immediately before you filed the claim.
Example 2. The situation is the same as in Example 1, except you filed your return on October 30, 2013, 2 weeks after the extension period ended. You paid an additional $200 on that date. On October 31, 2016, you filed an amended return and claimed a refund of $700. Although you filed your claim within 3 years from the date you filed your original return, the refund was limited to $200, the tax paid within the 3 years plus the 6-month extension period immediately before you filed the claim. The estimated tax of $500 paid before that period can't be refunded or credited.
If you file a claim more than 3 years after you file your return, the credit or refund can't be more than the tax you paid within the 2 years immediately before you file the claim.
Example. You filed your 2012 tax return on April 15, 2013. You paid taxes of $500. On November 5, 2014, after an examination of your 2012 return, you had to pay an additional tax of $200. On May 12, 2016, you file a claim for a refund of $300. However, because you filed your claim more than 3 years after you filed your return, your refund will be limited to the $200 you paid during the 2 years immediately before you filed your claim.
Financially disabled. The time periods for claiming a refund are suspended for the period in which you are financially disabled. For a joint income tax return, only one spouse has to be financially disabled for the time period to be suspended. You are financially disabled if you are unable to manage your financial affairs because of a medically determinable physical or mental impairment which can be expected to result in death or which has lasted or can be expected to last for a continuous period of not less than 12 months. However, you aren't treated as financially disabled during any period your spouse or any other person is authorized to act on your behalf in financial matters.
To claim that you are financially disabled, you must send in the following written statements with your claim for refund.
1. A statement from your qualified physician that includes:
a. The name and a description of your physical or mental impairment,
b. The physician's medical opinion that the impairment prevented you from managing your financial affairs,
c. The physician's medical opinion that the impairment was or can be expected to result in death, or that its duration has lasted, or can be expected to last, at least 12 months,
d. The specific time period (to the best of the physician's knowledge), and
e. The following certification signed by the physician: "I hereby certify that, to the best of my knowledge and belief, the above representations are true, correct, and complete."
2. A statement made by the person signing the claim for credit or refund that no person, including your spouse, was authorized to act on your behalf in financial matters during the period of disability (or the exact dates that a person was authorized to act for you).
Exceptions for special types of refunds. If you file a claim for one of the items in the following list, the dates and limits discussed earlier may not apply. These items, and where to get more information, are as follows.
• Bad debt. See Nonbusiness Bad Debts in chapter 14.
• Worthless security. See Worthless securities in chapter 14.
• Foreign tax paid or accrued. See Pub. 514.
• Net operating loss carryback. See Pub. 536.
• Carryback of certain business tax credits. See Form 3800.
• Claim based on an agreement with the IRS extending the period for assessment of tax.
Processing claims for refund. Claims are usually processed 8-12 weeks after they are filed. Your claim may be accepted as filed, disallowed, or subject to examination. If a claim is examined, the procedures are the same as in the examination of a tax return.
If your claim is disallowed, you will receive an explanation of why it was disallowed.
Taking your claim to court. You can sue for a refund in court, but you must first file a timely claim with the IRS. If the IRS disallows your claim or doesn't act on your claim within 6 months after you file it, you can then take your claim to court. For information on the burden of proof in a court proceeding, see Pub. 556.
The IRS provides a direct method to move your claim to court if:
• You are filing a claim for a credit or refund based solely on contested income tax or on estate tax or gift tax issues considered in your previously examined returns, and
• You want to take your case to court instead of appealing it within the IRS.
When you file your claim with the IRS, you get the direct method by requesting in writing that your claim be immediately rejected. A notice of claim disallowance will be sent to you.
You have 2 years from the date of mailing of the notice of claim disallowance to file a refund suit in the United States District Court having jurisdiction or in the United States Court of Federal Claims.
Interest on refund. If you receive a refund because of your amended return, interest will be paid on it from the due date of your original return or the date you filed your original return, whichever is later, to the date you filed the amended return. However, if the refund isn't made within 45 days after you file the amended return, interest will be paid up to the date the refund is paid.
Reduced refund. Your refund may be reduced by an additional tax liability that has been assessed against you.
Also, your refund may be reduced by amounts you owe for past-due federal tax, state income tax, state unemployment compensation debts, child support, spousal support, or certain other federal nontax debts, such as student loans. If your spouse owes these debts, see Offset against debts, under Refunds, earlier, for the correct refund procedures to follow.
Effect on state tax liability. If your return is changed for any reason, it may affect your state income tax liability. This includes changes made as a result of an examination of your return by the IRS. Contact your state tax agency for more information.
Penalties
The law provides penalties for failure to file returns or pay taxes as required.
Civil Penalties
If you don't file your return and pay your tax by the due date, you may have to pay a penalty. You may also have to pay a penalty if you substantially understate your tax, understate a reportable transaction, file an erroneous claim for refund or credit, file a frivolous tax submission, or fail to supply your SSN or individual taxpayer identification number. If you provide fraudulent information on your return, you may have to pay a civil fraud penalty.
Filing late. If you don't file your return by the due date (including extensions), you may have to pay a failure-to-file penalty. The penalty is usually 5% for each month or part of a month that a return is late, but not more than 25%. The penalty is based on the tax not paid by the due date (without regard to extensions).
Fraud. If your failure to file is due to fraud, the penalty is 15% for each month or part of a month that your return is late, up to a maximum of 75%.
Return over 60 days late. If you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $205 (adjusted for inflation) or 100% of the unpaid tax.
Exception. You won't have to pay the penalty if you show that you failed to file on time because of reasonable cause and not because of willful neglect.
Paying tax late. You will have to pay a failure-to-pay penalty of 1/2 of 1% (0.50%) of your unpaid taxes for each month, or part of a month, after the due date that the tax isn't paid. This penalty doesn't apply during the automatic 6-month extension of time to file period if you paid at least 90% of your actual tax liability on or before the due date of your return and pay the balance when you file the return.
The monthly rate of the failure-to-pay penalty is half the usual rate (0.25% instead of 0.50%) if an installment agreement is in effect for that month. You must have filed your return by the due date (including extensions) to qualify for this reduced penalty.
If a notice of intent to levy is issued, the rate will increase to 1% at the start of the first month beginning at least 10 days after the day that the notice is issued. If a notice and demand for immediate payment is issued, the rate will increase to 1% at the start of the first month beginning after the day that the notice and demand is issued.
This penalty can't be more than 25% of your unpaid tax. You won't have to pay the penalty if you can show that you had a good reason for not paying your tax on time.
Combined penalties. If both the failure-to-file penalty and the failure-to-pay penalty (discussed earlier) apply in any month, the 5% (or 15%) failure-to-file penalty is reduced by the failure-to-pay penalty. However, if you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $205 (adjusted for inflation) or 100% of the unpaid tax.
Accuracy-related penalty. You may have to pay an accuracy-related penalty if you underpay your tax because:
1. You show negligence or disregard of the rules or regulations,
2. You substantially understate your income tax,
3. You claim tax benefits for a transaction that lacks economic substance, or
4. You fail to disclose a foreign financial asset.
The penalty is equal to 20% of the underpayment. The penalty is 40% of any portion of the underpayment that is attributable to an undisclosed noneconomic substance transaction or an undisclosed foreign financial asset transaction. The penalty won't be figured on any part of an underpayment on which the fraud penalty (discussed later) is charged.
Negligence or disregard. The term "negligence" includes a failure to make a reasonable attempt to comply with the tax law or to exercise ordinary and reasonable care in preparing a return. Negligence also includes failure to keep adequate books and records. You won't have to pay a negligence penalty if you have a reasonable basis for a position you took.
The term "disregard" includes any careless, reckless, or intentional disregard.
Adequate disclosure. You can avoid the penalty for disregard of rules or regulations if you adequately disclose on your return a position that has at least a reasonable basis. See Disclosure statement, later.
This exception won't apply to an item that is attributable to a tax shelter. In addition, it won't apply if you fail to keep adequate books and records, or substantiate items properly.
Substantial understatement of income tax. You understate your tax if the tax shown on your return is less than the correct tax. The understatement is substantial if it is more than the larger of 10% of the correct tax or $5,000. However, the amount of the understatement may be reduced to the extent the understatement is due to:
1. Substantial authority, or
2. Adequate disclosure and a reasonable basis.
If an item on your return is attributable to a tax shelter, there is no reduction for an adequate disclosure. However, there is a reduction for a position with substantial authority, but only if you reasonably believed that your tax treatment was more likely than not the proper treatment.
Substantial authority. Whether there is or was substantial authority for the tax treatment of an item depends on the facts and circumstances. Some of the items that may be considered are court opinions, Treasury regulations, revenue rulings, revenue procedures, and notices and announcements issued by the IRS and published in the Internal Revenue Bulletin that involve the same or similar circumstances as yours.
Disclosure statement. To adequately disclose the relevant facts about your tax treatment of an item, use Form 8275. You must also have a reasonable basis for treating the item the way you did.
In cases of substantial understatement only, items that meet the requirements of Revenue Procedure 2016-13 (or later update) are considered adequately disclosed on your return without filing Form 8275.
Use Form 8275-R to disclose items or positions contrary to regulations.
Transaction lacking economic substance. For more information on economic substance, see section 7701(o).
Foreign financial asset. For more information on undisclosed foreign financial assets, see section 6662(j).
Reasonable cause. You won't have to pay a penalty if you show a good reason (reasonable cause) for the way you treated an item. You must also show that you acted in good faith. This doesn't apply to a transaction that lacks economic substance.
Filing erroneous claim for refund or credit. You may have to pay a penalty if you file an erroneous claim for refund or credit. The penalty is equal to 20% of the disallowed amount of the claim, unless you can show a reasonable basis for the way you treated an item. However, any disallowed amount due to a transaction that lacks economic substance won't be treated as having a reasonable basis. The penalty won't be figured on any part of the disallowed amount of the claim that relates to the earned income credit or on which the accuracy-related or fraud penalties are charged.
Frivolous tax submission. You may have to pay a penalty of $5,000 if you file a frivolous tax return or other frivolous submissions. A frivolous tax return is one that doesn't include enough information to figure the correct tax or that contains information clearly showing that the tax you reported is substantially incorrect. For more information on frivolous returns, frivolous submissions, and a list of positions that are identified as frivolous, see Notice 2010-33, 2010-17 I.R.B. 609, available at IRS.gov/irb/2010-17_IRB/ar13.html.
You will have to pay the penalty if you filed this kind of return or submission based on a frivolous position or a desire to delay or interfere with the administration of federal tax laws. This includes altering or striking out the preprinted language above the space provided for your signature.
This penalty is added to any other penalty provided by law.
Fraud. If there is any underpayment of tax on your return due to fraud, a penalty of 75% of the underpayment due to fraud will be added to your tax.
Joint return. The fraud penalty on a joint return doesn't apply to a spouse unless some part of the underpayment is due to the fraud of that spouse.
Failure to supply SSN. If you don't include your SSN or the SSN of another person where required on a return, statement, or other document, you will be subject to a penalty of $50 for each failure. You will also be subject to a penalty of $50 if you don't give your SSN to another person when it is required on a return, statement, or other document.
For example, if you have a bank account that earns interest, you must give your SSN to the bank. The number must be shown on the Form 1099-INT or other statement the bank sends you. If you don't give the bank your SSN, you will be subject to the $50 penalty. (You also may be subject to "backup" withholding of income tax. See chapter 4.)
You won't have to pay the penalty if you are able to show that the failure was due to reasonable cause and not willful neglect.
Criminal Penalties
You may be subject to criminal prosecution (brought to trial) for actions such as:
1. Tax evasion,
2. Willful failure to file a return, supply information, or pay any tax due,
3. Fraud and false statements,
4. Preparing and filing a fraudulent return, or
5. Identity theft.
Identity Theft
Identity theft occurs when someone uses your personal information such as your name, SSN, or other identifying information, without your permission, to commit fraud or other crimes. An identity thief may use your SSN to get a job or may file a tax return using your SSN to receive a refund.
To reduce your risk:
• Protect your SSN,
• Ensure your employer is protecting your SSN, and
• Be careful when choosing a tax preparer.
If your tax records are affected by identity theft and you receive a notice from the IRS, respond right away to the name and phone number printed on the IRS notice or letter.
If your SSN has been lost or stolen or you suspect you are a victim of tax-related identity theft, visit IRS.gov/identitytheft to learn what steps you should take.
For more information, see Pub. 5027.
Victims of identity theft who are experiencing economic harm or a systemic problem, or are seeking help in resolving tax problems that have not been resolved through normal channels, may be eligible for Taxpayer Advocate Service (TAS) assistance. You can reach TAS by calling the National Taxpayer Advocate helpline at 1-877-777-4778 or TTY/TDD at 1-800-829-4059. Deaf or hard-of-hearing individuals can also contact the IRS through relay services such as the Federal Relay Service available at http://www.gsa.gov/fedrelay.
Protect yourself from suspicious emails or phishing schemes. Phishing is the creation and use of email and websites designed to mimic legitimate business emails and websites. The most common form is the act of sending an email to a user falsely claiming to be an established legitimate enterprise in an attempt to scam the user into surrendering private information that will be used for identity theft.
The IRS doesn't initiate contacts with taxpayers via emails. Also, the IRS doesn't request detailed personal information through email or ask taxpayers for the PIN numbers, passwords, or similar secret access information for their credit card, bank, or other financial accounts.
If you receive an unsolicited email claiming to be from the IRS, forward the message to phishing@irs.gov. You may also report misuse of the IRS name, logo, forms or other IRS property to the Treasury Inspector General for Tax Administration toll-free at 1-800-366-4484. You can forward suspicious emails to the Federal Trade Commission at spam@uce.gov or contact them at http://www.ftc.gov/idtheft or 1-877-ID-THEFT (1-877-438-4338).
Go to IRS.gov/idprotection to learn more about identity theft and how to reduce your risk.
2. Filing Status
Introduction
This chapter helps you determine which filing status to use. There are five filing statuses.
• Single.
• Married Filing Jointly.
• Married Filing Separately.
• Head of Household.
• Qualifying Widow(er) With Dependent Child.
TIP: If more than one filing status applies to you, choose the one that will give you the lowest tax.
You must determine your filing status before you can determine whether you must file a tax return (chapter 1), your standard deduction (chapter 20), and your tax (chapter 30). You also use your filing status to determine whether you are eligible to claim certain deductions and credits.
Useful Items
You may want to see:
Publication
• Publication 501 Exemptions, Standard Deduction, and Filing Information
• Publication 519 U.S. Tax Guide for Aliens
• Publication 555 Community Property
Marital Status
In general, your filing status depends on whether you are considered unmarried or married.
Unmarried persons. You are considered unmarried for the whole year if, on the last day of your tax year, you are either:
• Unmarried, or
• Legally separated from your spouse under a divorce or separate maintenance decree. State law governs whether you are married or legally separated under a divorce or separate maintenance decree.
Divorced persons. If you are divorced under a final decree by the last day of the year, you are considered unmarried for the whole year.
Divorce and remarriage. If you obtain a divorce for the sole purpose of filing tax returns as unmarried individuals, and at the time of divorce you intend to and do, in fact, remarry each other in the next tax year, you and your spouse must file as married individuals in both years.
Annulled marriages. If you obtain a court decree of annulment, which holds that no valid marriage ever existed, you are considered unmarried even if you filed joint returns for earlier years. You must file Form 1040X, Amended U.S. Individual Income Tax Return, claiming single or head of household status for all tax years that are affected by the annulment and not closed by the statute of limitations for filing a tax return. Generally, for a credit or refund, you must file Form 1040X within 3 years (including extensions) after the date you filed your original return or within 2 years after the date you paid the tax, whichever is later. If you filed your original return early (for example, March 1) your return is considered filed on the due date (generally April 15). However, if you had an extension to file (for example, until October 15) but you filed earlier and we received it on July 1, your return is considered filed on July 1.
Head of household or qualifying widow(er) with dependent child. If you are considered unmarried, you may be able to file as a head of household or as a qualifying widow(er) with a dependent child. See Head of Household and Qualifying Widow(er) With Dependent Child to see if you qualify.
Married persons. If you are considered married, you and your spouse can file a joint return or separate returns.
Considered married. You are considered married for the whole year if, on the last day of your tax year, you and your spouse meet any one of the following tests.
1. You are married and living together.
2. You are living together in a common law marriage recognized in the state where you now live or in the state where the common law marriage began.
3. You are married and living apart, but not legally separated under a decree of divorce or separate maintenance.
4. You are separated under an interlocutory (not final) decree of divorce.
Same-sex marriage. For federal tax purposes, the marriage of a same-sex couple is treated the same as the marriage of a man to a woman. The term "spouse" in this chapter includes an individual married to a person of the same sex. However, individuals who have entered into a registered domestic partnership, civil union, or other similar relationship that isn't considered a marriage under state law aren't considered married for federal tax purposes. For more details, see Pub. 501.
Spouse died during the year. If your spouse died during the year, you are considered married for the whole year for filing status purposes.
If you didn't remarry before the end of the tax year, you can file a joint return for yourself and your deceased spouse. For the next 2 years, you may be entitled to the special benefits described later under Qualifying Widow(er) With Dependent Child.
If you remarried before the end of the tax year, you can file a joint return with your new spouse. Your deceased spouse's filing status is married filing separately for that year.
Married persons living apart. If you live apart from your spouse and meet certain tests, you may be able to file as head of household even if you aren't divorced or legally separated. If you qualify to file as head of household instead of married filing separately, your standard deduction will be higher. Also, your tax may be lower, and you may be able to claim the earned income credit. See Head of Household, later.
Single
Your filing status is single if you are considered unmarried and you don't qualify for another filing status. To determine your marital status, see Marital Status, earlier.
Widow(er). Your filing status may be single if you were widowed before January 1, 2016, and didn't remarry before the end of 2016. You may, however, be able to use another filing status that will give you a lower tax. See Head of Household and Qualifying Widow(er) With Dependent Child, later, to see if you qualify.
How to file. You can file Form 1040. If you have taxable income of less than $100,000, you may be able to file Form 1040A. If, in addition, you have no dependents, and are under 65 and not blind, and meet other requirements, you can file Form 1040EZ. If you file Form 1040A or Form 1040, show your filing status as single by checking the box on line 1. Use the Single column of the Tax Table or Section A of the Tax Computation Worksheet to figure your tax.
Married Filing Jointly
You can choose married filing jointly as your filing status if you are considered married and both you and your spouse agree to file a joint return. On a joint return, you and your spouse report your combined income and deduct your combined allowable expenses. You can file a joint return even if one of you had no income or deductions.
If you and your spouse decide to file a joint return, your tax may be lower than your combined tax for the other filing statuses. Also, your standard deduction (if you don't itemize deductions) may be higher, and you may qualify for tax benefits that don't apply to other filing statuses.
TIP: If you and your spouse each have income, you may want to figure your tax both on a joint return and on separate returns (using the filing status of married filing separately). You can choose the method that gives the two of you the lower combined tax.
How to file. If you file as married filing jointly, you can use Form 1040. If you and your spouse have taxable income of less than $100,000, you may be able to file Form 1040A. If, in addition, you and your spouse have no dependents, are both under 65 and not blind, and meet other requirements, you can file Form 1040EZ. If you file Form 1040 or Form 1040A, show this filing status by checking the box on line 2. Use the Married filing jointly column of the Tax Table or Section B of the Tax Computation Worksheet to figure your tax.
Spouse died. If your spouse died during the year, you are considered married for the whole year and can choose married filing jointly as your filing status. See Spouse died during the year under Marital Status, earlier, for more information.
If your spouse died in 2017 before filing a 2016 return, you can choose married filing jointly as your filing status on your 2016 return.
Divorced persons. If you are divorced under a final decree by the last day of the year, you are considered unmarried for the whole year and you can't choose married filing jointly as your filing status.
Filing a Joint Return
Both you and your spouse must include all of your income, exemptions, and deductions on your joint return.
Accounting period. Both of you must use the same accounting period, but you can use different accounting methods. See Accounting Periods and Accounting Methods in chapter 1.
Joint responsibility. Both of you may be held responsible, jointly and individually, for the tax and any interest or penalty due on your joint return. This means that if one spouse doesn't pay the tax due, the other may have to. Or, if one spouse doesn't report the correct tax, both spouses may be responsible for any additional taxes assessed by the IRS. One spouse may be held responsible for all the tax due even if all the income was earned by the other spouse.
You may want to file separately if:
• You believe your spouse isn't reporting all of his or her income, or
• You don't want to be responsible for any taxes due if your spouse doesn't have enough tax withheld or doesn't pay enough estimated tax.
Divorced taxpayer. You may be held jointly and individually responsible for any tax, interest, and penalties due on a joint return filed before your divorce. This responsibility may apply even if your divorce decree states that your former spouse will be responsible for any amounts due on previously filed joint returns.
Relief from joint responsibility. In some cases, one spouse may be relieved of joint responsibility for tax, interest, and penalties on a joint return for items of the other spouse that were incorrectly reported on the joint return. You can ask for relief no matter how small the liability.
There are three types of relief available.
1. Innocent spouse relief.
2. Separation of liability (available only to joint filers who are divorced, widowed, legally separated, or haven't lived together for the 12 months ending on the date the election for this relief is filed).
3. Equitable relief.
You must file Form 8857, Request for Innocent Spouse Relief, to request relief from joint responsibility. Pub. 971, Innocent Spouse Relief, explains these kinds of relief and who may qualify for them.
Signing a joint return. For a return to be considered a joint return, both spouses generally must sign the return.
Spouse died before signing. If your spouse died before signing the return, the executor or administrator must sign the return for your spouse. If neither you nor anyone else has yet been appointed as executor or administrator, you can sign the return for your spouse and enter "Filing as surviving spouse" in the area where you sign the return.
Spouse away from home. If your spouse is away from home, you should prepare the return, sign it, and send it to your spouse to sign so that it can be filed on time.
Injury or disease prevents signing. If your spouse can't sign because of disease or injury and tells you to sign for him or her, you can sign your spouse's name in the proper space on the return followed by the words "By (your name), Husband (or Wife)." Be sure to also sign in the space provided for your signature. Attach a dated statement, signed by you, to the return. The statement should include the form number of the return you are filing, the tax year, and the reason your spouse can't sign, and should state that your spouse has agreed to your signing for him or her.
Signing as guardian of spouse. If you are the guardian of your spouse who is mentally incompetent, you can sign the return for your spouse as guardian.
Spouse in combat zone. You can sign a joint return for your spouse if your spouse can't sign because he or she is serving in a combat zone (such as the Persian Gulf Area, Serbia, Montenegro, Albania, or Afghanistan), even if you don't have a power of attorney or other statement. Attach a signed statement to your return explaining that your spouse is serving in a combat zone. For more information on special tax rules for persons who are serving in a combat zone, or who are in missing status as a result of serving in a combat zone, see Pub. 3, Armed Forces' Tax Guide.
Other reasons spouse can't sign. If your spouse can't sign the joint return for any other reason, you can sign for your spouse only if you are given a valid power of attorney (a legal document giving you permission to act for your spouse). Attach the power of attorney (or a copy of it) to your tax return. You can use Form 2848, Power of Attorney and Declaration of Representative.
Nonresident alien or dual-status alien. Generally, a married couple can't file a joint return if either one is a nonresident alien at any time during the tax year. However, if one spouse was a nonresident alien or dual-status alien who was married to a U.S. citizen or resident alien at the end of the year, the spouses can choose to file a joint return. If you do file a joint return, you and your spouse are both treated as U.S. residents for the entire tax year. See chapter 1 of Pub. 519.
Married Filing Separately
You can choose married filing separately as your filing status if you are married. This filing status may benefit you if you want to be responsible only for your own tax or if it results in less tax than filing a joint return.
If you and your spouse don't agree to file a joint return, you must use this filing status unless you qualify for head of household status, discussed later.
You may be able to choose head of household filing status if you are considered unmarried because you live apart from your spouse and meet certain tests (explained later, under Head of Household). This can apply to you even if you aren't divorced or legally separated. If you qualify to file as head of household, instead of as married filing separately, your tax may be lower, you may be able to claim the earned income credit and certain other credits, and your standard deduction will be higher. The head of household filing status allows you to choose the standard deduction even if your spouse chooses to itemize deductions. See Head of Household, later, for more information.
TIP: You will generally pay more combined tax on separate returns than you would on a joint return for the reasons listed under Special Rules, later. However, unless you are required to file separately, you should figure your tax both ways (on a joint return and on separate returns). This way you can make sure you are using the filing status that results in the lowest combined tax. When figuring the combined tax of a married couple, you may want to consider state taxes as well as federal taxes.
How to file. If you file a separate return, you generally report only your own income, exemptions, credits, and deductions. You can claim an exemption for your spouse only if your spouse had no gross income, isn't filing a return, and wasn't the dependent of another person.
You can file Form 1040. If your taxable income is less than $100,000, you may be able to file Form 1040A. Select this filing status by checking the box on line 3 of either form. Enter your spouse's full name and SSN or ITIN in the spaces provided. If your spouse doesn't have and isn't required to have an SSN or ITIN, enter "NRA" in the space for your spouse's SSN. Use the Married filing separately column of the Tax Table or Section C of the Tax Computation Worksheet to figure your tax.
Special Rules
If you choose married filing separately as your filing status, the following special rules apply. Because of these special rules, you usually pay more tax on a separate return than if you use another filing status you qualify for.
1. Your tax rate generally is higher than on a joint return.
2. Your exemption amount for figuring the alternative minimum tax is half that allowed on a joint return.
3. You can't take the credit for child and dependent care expenses in most cases, and the amount you can exclude from income under an employer's dependent care assistance program is limited to $2,500 (instead of $5,000). However, if you are legally separated or living apart from your spouse, you may be able to file a separate return and still take the credit. For more information about these expenses, the credit, and the exclusion, see chapter 32.
4. You can't take the earned income credit.
5. You can't take the exclusion or credit for adoption expenses in most cases.
6. You can't take the education credits (the American opportunity credit and lifetime learning credit), the deduction for student loan interest, or the tuition and fees deduction.
7. You can't exclude any interest income from qualified U.S. savings bonds you used for higher education expenses.
8. If you lived with your spouse at any time during the tax year:
a. You can't claim the credit for the elderly or the disabled, and
b. You must include in income a greater percentage (up to 85%) of any social security or equivalent railroad retirement benefits you received.
9. The following credits and deductions are reduced at income levels half those for a joint return:
a. The child tax credit,
b. The retirement savings contributions credit,
c. The deduction for personal exemptions, and
d. Itemized deductions.
10. Your capital loss deduction limit is $1,500 (instead of $3,000 on a joint return).
11. If your spouse itemizes deductions, you can't claim the standard deduction. If you can claim the standard deduction, your basic standard deduction is half the amount allowed on a joint return.
Adjusted gross income (AGI) limits. If your AGI on a separate return is lower than it would have been on a joint return, you may be able to deduct a larger amount for certain deductions that are limited by AGI, such as medical expenses.
Individual retirement arrangements (IRAs). You may not be able to deduct all or part of your contributions to a traditional IRA if you or your spouse were covered by an employee retirement plan at work during the year. Your deduction is reduced or eliminated if your income is more than a certain amount. This amount is much lower for married individuals who file separately and lived together at any time during the year. For more information, see How Much Can You Deduct in chapter 17.
Rental activity losses. If you actively participated in a passive rental real estate activity that produced a loss, you generally can deduct the loss from your nonpassive income, up to $25,000. This is called a special allowance. However, married persons filing separate returns who lived together at any time during the year can't claim this special allowance. Married persons filing separate returns who lived apart at all times during the year are each allowed a $12,500 maximum special allowance for losses from passive real estate activities. See Limits on Rental Losses in chapter 9.
Community property states. If you live in Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, or Wisconsin and file separately, your income may be considered separate income or community income for income tax purposes. See Pub. 555.
Joint Return After Separate Returns
You can change your filing status from a separate return to a joint return by filing an amended return using Form 1040X.
You generally can change to a joint return any time within 3 years from the due date of the separate return or returns. This doesn't include any extensions. A separate return includes a return filed by you or your spouse claiming married filing separately, single, or head of household filing status.
Separate Returns After Joint Return
Once you file a joint return, you can't choose to file separate returns for that year after the due date of the return.
Exception. A personal representative for a decedent can change from a joint return elected by the surviving spouse to a separate return for the decedent. The personal representative has 1 year from the due date of the return (including extensions) to make the change. See Pub. 559, Survivors, Executors, and Administrators, for more information on filing a return for a decedent.
Head of Household
You may be able to file as head of household if you meet all the following requirements.
1. You are unmarried or "considered unmarried" on the last day of the year. See Marital Status, earlier, and Considered Unmarried, later.
2. You paid more than half the cost of keeping up a home for the year.
3. A qualifying person lived with you in the home for more than half the year (except for temporary absences, such as school). However, if the qualifying person is your dependent parent, he or she doesn't have to live with you. See Special rule for parent, later, under Qualifying Person.
TIP: If you qualify to file as head of household, your tax rate usually will be lower than the rates for single or married filing separately. You will also receive a higher standard deduction than if you file as single or married filing separately.
Kidnapped child. You may be eligible to file as head of household even if the child who is your qualifying person has been kidnapped. For more information, see Pub. 501.
How to file. If you file as head of household, you can use Form 1040. If your taxable income is less than $100,000, you may be able to file Form 1040A. Indicate your choice of this filing status by checking the box on line 4 of either form. Use the Head of a household column of the Tax Table or Section D of the Tax Computation Worksheet to figure your tax.
Considered Unmarried
To qualify for head of household status, you must be either unmarried or considered unmarried on the last day of the year. You are considered unmarried on the last day of the tax year if you meet all the following tests.
1. You file a separate return. A separate return includes a return claiming married filing separately, single, or head of household filing status.
2. You paid more than half the cost of keeping up your home for the tax year.
3. Your spouse didn't live in your home during the last 6 months of the tax year. Your spouse is considered to live in your home even if he or she is temporarily absent due to special circumstances. See Temporary absences, under Qualifying Person, later.
4. Your home was the main home of your child, stepchild, or foster child for more than half the year. (See Home of qualifying person, under Qualifying Person, later, for rules applying to a child's birth, death, or temporary absence during the year.)
5. You must be able to claim an exemption for the child. However, you meet this test if you can't claim the exemption only because the noncustodial parent can claim the child using the rules described in Children of divorced or separated parents (or parents who live apart) under Qualifying Child in chapter 3, or referred to in Support Test for Children of Divorced or Separated Parents (or Parents Who Live Apart) under Qualifying Relative in chapter 3. The general rules for claiming an exemption for a dependent are explained under Exemptions for Dependents in chapter 3.
CAUTION: If you were considered married for part of the year and lived in a community property state (listed earlier under Married Filing Separately), special rules may apply in determining your income and expenses. See Pub. 555 for more information.
Nonresident alien spouse. You are considered unmarried for head of household purposes if your spouse was a nonresident alien at any time during the year and you don't choose to treat your nonresident spouse as a resident alien. However, your spouse isn't a qualifying person for head of household purposes. You must have another qualifying person and meet the other tests to be eligible to file as a head of household.
Choice to treat spouse as resident. You are considered married if you choose to treat your spouse as a resident alien. See Pub. 519.
Keeping Up a Home
To qualify for head of household status, you must pay more than half of the cost of keeping up a home for the year. You can determine whether you paid more than half of the cost of keeping up a home by using Worksheet 2-1.
Worksheet 2-1. Cost of Keeping Up a Home
Keep for Your Records
--------------------------------------------------------
Amount
You Paid Total Cost
--------------------------------------------------------
Property taxes $ $
--------------------------------------------------------
Mortgage interest expense
--------------------------------------------------------
Rent
--------------------------------------------------------
Utility charges
--------------------------------------------------------
Repairs/maintenance
--------------------------------------------------------
Property insurance
--------------------------------------------------------
Food eaten in the home
--------------------------------------------------------
Other household expenses
--------------------------------------------------------
Totals $ $
--------------------------------------------------------
Minus total amount you paid (______)
--------------------------------------------------------
Amount others paid $
--------------------------------------------------------
If the total amount you paid is more than the amount
others paid, you meet the requirement of paying more
than half the cost of keeping up the home.
--------------------------------------------------------
Costs you include. Include in the cost of keeping up a home expenses such as rent, mortgage interest, real estate taxes, insurance on the home, repairs, utilities, and food eaten in the home.
If you used payments you received under Temporary Assistance for Needy Families (TANF) or other public assistance programs to pay part of the cost of keeping up your home, you can't count them as money you paid. However, you must include them in the total cost of keeping up your home to figure if you paid over half the cost.
Costs you don't include. Don't include the costs of clothing, education, medical treatment, vacations, life insurance, or transportation. Also, don't include the rental value of a home you own or the value of your services or those of a member of your household.
Qualifying Person
See Table 2-1 to see who is a qualifying person. Any person not described in Table 2-1 isn't a qualifying person.
Table 2-1. Who Is a Qualifying Person Qualifying You To File as Head of Household?1
Caution. See the text of this chapter for the other requirements you
must meet to claim head of household filing status.
----------------------------------------------------------------------
IF the person THEN that
is your . . . AND . . . person is . . .
----------------------------------------------------------------------
qualifying child (such as he or she is single a qualifying person,
a son, daughter, or whether or not you
grandchild who lived with can claim an
you more than half the exemption for the
year and meets certain person.
other tests)2 -------------------------------------------
he or she is married a qualifying person.
and you can claim an
exemption for him or
her
-------------------------------------------
he or she is married not a qualifying
and you can't claim person.3
an exemption for him
or her
----------------------------------------------------------------------
qualifying relative4 who you can claim an a qualifying person.6
is your father or exemption for him or
mother her5
-------------------------------------------
you can't claim an not a qualifying
exemption for him or person.
her
----------------------------------------------------------------------
qualifying relative4 he or she lived with a qualifying person.
other than your father or you more than half
mother (such as a the year, and he or
grandparent, brother, or she is related to
sister who meets certain you in one of the
tests) ways listed under
Relatives who don't
have to live with
you in chapter 3 and
you can claim an
exemption for him or
her5
-------------------------------------------
he or she didn't not a qualifying
live with you more person.
than half the year
-------------------------------------------
he or she isn't not a qualifying
related to you in person.
one of the ways
listed under
Relatives who don't
have to live with
you in chapter 3 and
is your qualifying
relative only
because he or she
lived with you all
year as a member of
your household
-------------------------------------------
you can't claim an not a qualifying
exemption for him or person.
her
----------------------------------------------------------------------
1 A person can't qualify more than one taxpayer to use the head of
household filing status for the year.
2 The term "qualifying child" is defined in chapter 3. Note. If you
are a noncustodial parent, the term "qualifying child" for head of
household filing status doesn't include a child who is your
qualifying child for exemption purposes only because of the rules
described under Children of divorced or separated parents (or parents
who live apart) under Qualifying Child in chapter 3. If you are the
custodial parent and those rules apply, the child generally is your
qualifying child for head of household filing status even though the
child isn't a qualifying child for whom you can claim an exemption.
3 This person is a qualifying person if the only reason you can't
claim the exemption is that you can be claimed as a dependent on
someone else's return.
4 The term "qualifying relative" is defined in chapter 3.
5 If you can claim an exemption for a person only because of a
multiple support agreement, that person isn't a qualifying person.
See Multiple Support Agreement in chapter 3.
6 See Special rule for parent.
======================================================================
Example 1--child. Your unmarried son lived with you all year and was 18 years old at the end of the year. He didn't provide more than half of his own support and doesn't meet the tests to be a qualifying child of anyone else. As a result, he is your qualifying child (see Qualifying Child in chapter 3) and, because he is single, your qualifying person for you to claim head of household filing status.
Example 2--child who isn't qualifying person. The facts are the same as in Example 1 except your son was 25 years old at the end of the year and his gross income was $5,000. Because he doesn't meet the age test (explained under Qualifying Child in chapter 3), your son isn't your qualifying child. Because he doesn't meet the gross income test (explained later under Qualifying Relative in chapter 3), he isn't your qualifying relative. As a result, he isn't your qualifying person for head of household purposes.
Example 3--girlfriend. Your girlfriend lived with you all year. Even though she may be your qualifying relative if the gross income and support tests (explained in chapter 3) are met, she isn't your qualifying person for head of household purposes because she isn't related to you in one of the ways listed under Relatives who don't have to live with you in chapter 3. See Table 2-1.
Example 4--girlfriend's child. The facts are the same as in Example 3 except your girlfriend's 10-year-old son also lived with you all year. He isn't your qualifying child and, because he is your girlfriend's qualifying child, he isn't your qualifying relative (see Not a Qualifying Child Test in chapter 3). As a result, he isn't your qualifying person for head of household purposes.
Home of qualifying person. Generally, the qualifying person must live with you for more than half of the year.
Special rule for parent. If your qualifying person is your father or mother, you may be eligible to file as head of household even if your father or mother doesn't live with you. However, you must be able to claim an exemption for your father or mother. Also, you must pay more than half the cost of keeping up a home that was the main home for the entire year for your father or mother.
If you pay more than half the cost of keeping your parent in a rest home or home for the elderly, that counts as paying more than half the cost of keeping up your parent's main home.
Death or birth. You may be eligible to file as head of household even if the individual who qualifies you for this filing status is born or dies during the year. If the individual is your qualifying child, the child must have lived with you for more than half the part of the year he or she was alive. If the individual is anyone else, see Pub. 501.
Temporary absences. You and your qualifying person are considered to live together even if one or both of you are temporarily absent from your home due to special circumstances such as illness, education, business, vacation, military service, or detention in a juvenile facility. It must be reasonable to assume the absent person will return to the home after the temporary absence. You must continue to keep up the home during the absence.
Qualifying Widow(er) With Dependent Child
If your spouse died in 2016, you can use married filing jointly as your filing status for 2016 if you otherwise qualify to use that status. The year of death is the last year for which you can file jointly with your deceased spouse. See Married Filing Jointly, earlier.
You may be eligible to use qualifying widow(er) with dependent child as your filing status for 2 years following the year your spouse died. For example, if your spouse died in 2015, and you haven't remarried, you may be able to use this filing status for 2016 and 2017.
This filing status entitles you to use joint return tax rates and the highest standard deduction amount (if you don't itemize deductions). It doesn't entitle you to file a joint return.
How to file. If you file as qualifying widow(er) with dependent child, you can use Form 1040. If you also have taxable income of less than $100,000 and meet certain other conditions, you may be able to file Form 1040A. Check the box on line 5 of either form. Use the Married filing jointly column of the Tax Table or Section B of the Tax Computation Worksheet to figure your tax.
Eligibility rules. You are eligible to file your 2016 return as a qualifying widow(er) with dependent child if you meet all of the following tests.
• You were entitled to file a joint return with your spouse for the year your spouse died. It doesn't matter whether you actually filed a joint return.
• Your spouse died in 2014 or 2015 and you didn't remarry before the end of 2016.
• You have a child or stepchild for whom you can claim an exemption. This doesn't include a foster child.
• This child lived in your home all year, except for temporary absences. See Temporary absences, earlier, under Head of Household. There are also exceptions, described later, for a child who was born or died during the year and for a kidnapped child.
• You paid more than half the cost of keeping up a home for the year. See Keeping Up a Home, earlier, under Head of Household.
Example. John's wife died in 2014. John hasn't remarried. During 2015 and 2016, he continued to keep up a home for himself and his child, who lives with him and for whom he can claim an exemption. For 2014 he was entitled to file a joint return for himself and his deceased wife. For 2015 and 2016, he can file as qualifying widower with a dependent child. After 2016 he can file as head of household if he qualifies.
Death or birth. You may be eligible to file as a qualifying widow(er) with dependent child if the child who qualifies you for this filing status is born or dies during the year. You must have provided more than half of the cost of keeping up a home that was the child's main home during the entire part of the year he or she was alive.
Kidnapped child. You may be eligible to file as a qualifying widow(er) with dependent child even if the child who qualifies you for this filing status has been kidnapped. See Pub. 501.
CAUTION: As mentioned earlier, this filing status is available for only 2 years following the year your spouse died.
3. Personal Exemptions and Dependents
What's New
Exemption amount. The amount you can deduct for each exemption has increased. It was $4,000 for 2015. It is $4,050 for 2016.
Exemption phaseout. You lose at least part of the benefit of your exemptions if your adjusted gross income is more than a certain amount. For 2016, this amount is $155,650 for a married individual filing a separate return; $259,400 for a single individual; $285,350 for a head of household; and $311,300 for married individuals filing jointly or a qualifying widow(er). See Phaseout of Exemptions, later.
Introduction
This chapter discusses the following topics.
• Personal exemptions -- You generally can take one for yourself and, if you are married, one for your spouse.
• Exemptions for dependents -- You generally can take an exemption for each of your dependents. A dependent is your qualifying child or qualifying relative. If you are entitled to claim an exemption for a dependent, that dependent can't claim a personal exemption on his or her own tax return.
• Phaseout of exemptions -- Your deduction is reduced if your adjusted gross income is more than a certain amount.
• Social security number (SSN) requirement for dependents -- You must list the SSN of any dependent for whom you claim an exemption.
Deduction. Exemptions reduce your taxable income. You can deduct $4,050 for each exemption you claim in 2016. But you may lose at least part of the dollar amount of your exemptions if your adjusted gross income is more than a certain amount. See Phaseout of Exemptions, later.
How to claim exemptions. How you claim an exemption on your tax return depends on which form you file.
If you file Form 1040EZ, the exemption amount is combined with the standard deduction amount and entered on line 5.
If you file Form 1040A, complete lines 6a through 6d. The total number of exemptions you can claim is the total in the box on line 6d. Also complete line 26.
If you file Form 1040, complete lines 6a through 6d. The total number of exemptions you can claim is the total in the box on line 6d. Also complete line 42.
Useful Items
You may want to see:
Publication
• Publication 501 Exemptions, Standard Deduction, and Filing Information
Form (and Instructions)
• Form 2120 Multiple Support Declaration
• Form 8332 Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent
Exemptions
There are two types of exemptions you may be able to take:
• Personal exemptions for yourself and your spouse, and
• Exemptions for dependents (dependency exemptions).
While each is worth the same amount ($4,050 for 2016), different rules apply to each type.
Personal Exemptions
You are generally allowed one exemption for yourself. If you are married, you may be allowed one exemption for your spouse. These are called personal exemptions.
Your Own Exemption
You can take one exemption for yourself unless you can be claimed as a dependent by another taxpayer. If another taxpayer is entitled to claim you as a dependent, you can't take an exemption for yourself even if the other taxpayer doesn't actually claim you as a dependent.
Your Spouse's Exemption
Your spouse is never considered your dependent.
Joint return. On a joint return you can claim one exemption for yourself and one for your spouse.
Separate return. If you file a separate return, you can claim an exemption for your spouse only if your spouse:
• Had no gross income,
• Isn't filing a return, and
• Wasn't the dependent of another taxpayer.
This is true even if the other taxpayer doesn't actually claim your spouse as a dependent.
You can claim an exemption for your spouse even if he or she is a nonresident alien. In that case, your spouse:
• Must have no gross income for U.S. tax purposes,
• Must not be filing a return, and
• Must not be the dependent of another taxpayer.
Death of spouse. If your spouse died during the year and you file a joint return for yourself and your deceased spouse, you generally can claim your spouse's exemption under the rules just explained in Joint return. If you file a separate return for the year, you may be able to claim your spouse's exemption under the rules just described in Separate return.
If you remarried during the year, you can't take an exemption for your deceased spouse.
If you are a surviving spouse without gross income and you remarry in the year your spouse died, you can be claimed as an exemption on both the final separate return of your deceased spouse and the separate return of your new spouse for that year. If you file a joint return with your new spouse, you can be claimed as an exemption only on that return.
Divorced or separated spouse. If you obtained a final decree of divorce or separate maintenance during the year, you can't take your former spouse's exemption. This rule applies even if you provided all of your former spouse's support.
Exemptions for Dependents
You are allowed one exemption for each person you can claim as a dependent. You can claim an exemption for a dependent even if your dependent files a return. However, see Joint Return Test, later.
The term "dependent" means:
• A qualifying child, or
• A qualifying relative.
The terms "qualifying child" and "qualifying relative" are defined later.
All the requirements for claiming an exemption for a dependent are summarized in Table 3-1.
Table 3-1. Overview of the Rules for Claiming an Exemption for a Dependent
Caution. This table is only an overview of the rules. For details, see
the rest of this chapter.
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• You can't claim any dependents if you (or your spouse, if filing
jointly) could be claimed as a dependent by another taxpayer.
• You can't claim a married person who files a joint return as a
dependent unless that joint return is filed only to claim a refund
of withheld income tax or estimated tax paid.
• You can't claim a person as a dependent unless that person is a
U.S. citizen, U.S. resident alien, U.S. national, or a resident of
Canada or Mexico.1
• You can't claim a person as a dependent unless that person is your
qualifying child or qualifying relative.
----------------------------------------------------------------------
Tests To Be a Qualifying Tests To Be a Qualifying
Child Relative
----------------------------------------------------------------------
1. The child must be your son, 1. The person can't be your
daughter, stepchild, foster child, qualifying child or the
brother, sister, half brother, half qualifying child of any
sister, stepbrother, stepsister, other taxpayer.
or a descendant of any of them.
2. The person either (a)
2. The child must be (a) under age 19 at must be related to you
the end of the year and younger than in one of the ways
you (or your spouse, if filing listed under Relatives
jointly), (b) under age 24 at the end who don't have to live
of the year, a student, and younger with you, or (b) must
than you (or your spouse, if filing live with you all year as
jointly), or (c) any age if a member of your
permanently and totally disabled. household2 (and your
relationship must not
3. The child must have lived with you violate local law).
for more than half of the year.2
3. The person's gross income
4. The child must not have provided for the year must be less
more than half of his or her own than $4,050.3
support for the year.
4. You must provide more
5. The child must not be filing a joint than half of the person's
return for the year (unless that total support for the
return is filed only to get a refund year.4
of income tax withheld or estimated
tax paid).
If the child meets the rules to be a
qualifying child of more than one
person, only one person can actually
treat the child as a qualifying child.
See Qualifying Child of More Than One
Person to find out which person is the
person entitled to claim the child as a
qualifying child.
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1 There is an exception for certain adopted children.
2 There are exceptions for temporary absences, children who were born
or died during the year, children of divorced or separated parents
(or parents who live apart), and kidnapped children.
3 There is an exception if the person is disabled and has income from
a sheltered workshop.
4 There are exceptions for multiple support agreements, children of
divorced or separated parents (or parents who live apart), and
kidnapped children.
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CAUTION: Dependent not allowed a personal exemption. If you can claim an exemption for your dependent, the dependent can't claim his or her own personal exemption on his or her own tax return. This is true even if you don't claim the dependent's exemption on your return. It is also true if the dependent's exemption on your return is reduced or eliminated under the phaseout rule described under Phaseout of Exemptions, later.
Housekeepers, maids, or servants. If these people work for you, you can't claim exemptions for them.
Child tax credit. You may be entitled to a child tax credit for each qualifying child who was under age 17 at the end of the year if you claimed an exemption for that child. For more information, see chapter 34.
Exceptions
Even if you have a qualifying child or qualifying relative, you can claim an exemption for that person only if these three tests are met.
1. Dependent taxpayer test.
2. Joint return test.
3. Citizen or resident test.
These three tests are explained in detail here.
Dependent Taxpayer Test
If you can be claimed as a dependent by another person, you can't claim anyone else as a dependent. Even if you have a qualifying child or qualifying relative, you can't claim that person as a dependent.
If you are filing a joint return and your spouse can be claimed as a dependent by someone else, you and your spouse can't claim any dependents on your joint return.
Joint Return Test
You generally cannot claim a married person as a dependent if he or she files a joint return.
Exception. You can claim an exemption for a person who files a joint return if that person and his or her spouse file the joint return only to claim a refund of income tax withheld or estimated tax paid.
Example 1--child files joint return. You supported your 18-year-old daughter, and she lived with you all year while her husband was in the Armed Forces. He earned $25,000 for the year. The couple files a joint return. You can't take an exemption for your daughter.
Example 2--child files joint return only as claim for refund of withheld tax. Your 18-year-old son and his 17-year-old wife had $800 of wages from part-time jobs and no other income. They lived with you all year. Neither is required to file a tax return. They don't have a child. Taxes were taken out of their pay so they filed a joint return only to get a refund of the withheld taxes. The exception to the joint return test applies, so you aren't disqualified from claiming an exemption for each of them just because they file a joint return. You can claim exemptions for each of them if all the other tests to do so are met.
Example 3--child files joint return to claim American opportunity credit. The facts are the same as in Example 2 except no taxes were taken out of your son's pay or his wife's pay. However, they file a joint return to claim an American opportunity credit of $124 and get a refund of that amount. Because claiming the American opportunity credit is their reason for filing the return, they aren't filing it only to get a refund of income tax withheld or estimated tax paid. The exception to the joint return test doesn't apply, so you can't claim an exemption for either of them.
Citizen or Resident Test
You generally can't claim a person as a dependent unless that person is a U.S. citizen, U.S. resident alien, U.S. national, or a resident of Canada or Mexico. However, there is an exception for certain adopted children, as explained next.
Exception for adopted child. If you are a U.S. citizen or U.S. national who has legally adopted a child who isn't a U.S. citizen, U.S. resident alien, or U.S. national, this test is met if the child lived with you as a member of your household all year. This exception also applies if the child was lawfully placed with you for legal adoption.
Child's place of residence. Children usually are citizens or residents of the country of their parents.
If you were a U.S. citizen when your child was born, the child may be a U.S. citizen and meet this test even if the other parent was a nonresident alien and the child was born in a foreign country.
Foreign students' place of residence. Foreign students brought to this country under a qualified international education exchange program and placed in American homes for a temporary period generally aren't U.S. residents and don't meet this test. You can't claim an exemption for them. However, if you provided a home for a foreign student, you may be able to take a charitable contribution deduction. See Expenses Paid for Student Living With You in chapter 24.
U.S. national. A U.S. national is an individual who, although not a U.S. citizen, owes his or her allegiance to the United States. U.S. nationals include American Samoans and Northern Mariana Islanders who chose to become U.S. nationals instead of U.S. citizens.
Qualifying Child
Five tests must be met for a child to be your qualifying child. The five tests are:
1. Relationship,
2. Age,
3. Residency,
4. Support, and
5. Joint return.
These tests are explained next.
CAUTION: If a child meets the five tests to be the qualifying child of more than one person, there are rules you must use to determine which person can actually treat the child as a qualifying child. See Qualifying Child of More Than One Person, later.
Relationship Test
To meet this test, a child must be:
• Your son, daughter, stepchild, foster child, or a descendant (for example, your grandchild) of any of them, or
• Your brother, sister, half brother, half sister, stepbrother, stepsister, or a descendant (for example, your niece or nephew) of any of them.
Adopted child. An adopted child is always treated as your own child. The term "adopted child" includes a child who was lawfully placed with you for legal adoption.
Foster child. A foster child is an individual who is placed with you by an authorized placement agency or by judgment, decree, or other order of any court of competent jurisdiction.
Age Test
To meet this test, a child must be:
• Under age 19 at the end of the year and younger than you (or your spouse, if filing jointly),
• A student under age 24 at the end of the year and younger than you (or your spouse, if filing jointly), or
• Permanently and totally disabled at any time during the year, regardless of age.
Example. Your son turned 19 on December 10. Unless he was permanently and totally disabled or a student, he doesn't meet the age test because, at the end of the year, he wasn't under age 19.
Child must be younger than you or spouse. To be your qualifying child, a child who isn't permanently and totally disabled must be younger than you. However, if you are married filing jointly, the child must be younger than you or your spouse but doesn't have to be younger than both of you.
Example 1--child not younger than you or spouse. Your 23-year-old brother, who is a student and unmarried, lives with you and your spouse, who provide more than half of his support. He isn't disabled. Both you and your spouse are 21 years old, and you file a joint return. Your brother isn't your qualifying child because he isn't younger than you or your spouse.
Example 2--child younger than your spouse but not younger than you. The facts are the same as in Example 1 except your spouse is 25 years old. Because your brother is younger than your spouse, and you and your spouse are filing a joint return, your brother is your qualifying child, even though he isn't younger than you.
Student defined. To qualify as a student, your child must be, during some part of each of any 5 calendar months of the year:
1. A full-time student at a school that has a regular teaching staff, course of study, and a regularly enrolled student body at the school, or
2. A student taking a full-time, on-farm training course given by a school described in (1), or by a state, county, or local government agency.
The 5 calendar months don't have to be consecutive.
Full-time student. A full-time student is a student who is enrolled for the number of hours or courses the school considers to be full-time attendance.
School defined. A school can be an elementary school, junior or senior high school, college, university, or technical, trade, or mechanical school. However, an on-the-job training course, correspondence school, or school offering courses only through the Internet doesn't count as a school.
Vocational high school students. Students who work on "co-op" jobs in private industry as a part of a school's regular course of classroom and practical training are considered full-time students.
Permanently and totally disabled. Your child is permanently and totally disabled if both of the following apply.
• He or she can't engage in any substantial gainful activity because of a physical or mental condition.
• A doctor determines the condition has lasted or can be expected to last continuously for at least a year or can lead to death.
Residency Test
To meet this test, your child must have lived with you for more than half the year. There are exceptions for temporary absences, children who were born or died during the year, kidnapped children, and children of divorced or separated parents.
Temporary absences. Your child is considered to have lived with you during periods of time when one of you, or both, are temporarily absent due to special circumstances such as:
• Illness,
• Education,
• Business,
• Vacation,
• Military service, or
• Detention in a juvenile facility.
Death or birth of child. A child who was born or died during the year is treated as having lived with you more than half of the year if your home was the child's home more than half of the time he or she was alive during the year. The same is true if the child lived with you more than half the year except for any required hospital stay following birth.
Child born alive. You may be able to claim an exemption for a child born alive during the year, even if the child lived only for a moment. State or local law must treat the child as having been born alive. There must be proof of a live birth shown by an official document, such as a birth certificate. The child must be your qualifying child or qualifying relative, and all the other tests to claim an exemption for a dependent must be met.
Stillborn child. You can't claim an exemption for a stillborn child.
Kidnapped child. You may be able to treat your child as meeting the residency test even if the child has been kidnapped. See Pub. 501 for details.
Children of divorced or separated parents (or parents who live apart). In most cases, because of the residency test, a child of divorced or separated parents is the qualifying child of the custodial parent. However, the child will be treated as the qualifying child of the noncustodial parent if all four of the following statements are true.
1. The parents:
a. Are divorced or legally separated under a decree of divorce or separate maintenance,
b. Are separated under a written separation agreement, or
c. Lived apart at all times during the last 6 months of the year, whether or not they are or were married.
2. The child received over half of his or her support for the year from the parents.
3. The child is in the custody of one or both parents for more than half of the year.
4. Either of the following statements is true.
a. The custodial parent signs a written declaration, discussed later, that he or she won't claim the child as a dependent for the year, and the noncustodial parent attaches this written declaration to his or her return. (If the decree or agreement went into effect after 1984 and before 2009, see Post-1984 and pre-2009 divorce decree or separation agreement, later. If the decree or agreement went into effect after 2008, see Post-2008 divorce decree or separation agreement, later.)
b. A pre-1985 decree of divorce or separate maintenance or written separation agreement that applies to 2016 states that the noncustodial parent can claim the child as a dependent, the decree or agreement wasn't changed after 1984 to say the noncustodial parent can't claim the child as a dependent, and the noncustodial parent provides at least $600 for the child's support during the year.
• Claim the child as a dependent, and
• Claim the child as a qualifying child for the child tax credit.
However, this doesn't allow the noncustodial parent to claim head of household filing status, the credit for child and dependent care expenses, the exclusion for dependent care benefits, the earned income credit, or the health coverage tax credit. See Applying the tiebreaker rules to divorced or separated parents (or parents who live apart), later.
Example--earned income credit. Even if statements (1) through (4) are all true and the custodial parent signs Form 8332 or a substantially similar statement that he or she will not claim the child as a dependent for 2016, this does not allow the noncustodial parent to claim the child as a qualifying child for the earned income credit. The custodial parent or another taxpayer, if eligible, can claim the child for the earned income credit.
Custodial parent and noncustodial parent. The custodial parent is the parent with whom the child lived for the greater number of nights during the year. The other parent is the noncustodial parent.
If the parents divorced or separated during the year and the child lived with both parents before the separation, the custodial parent is the one with whom the child lived for the greater number of nights during the rest of the year.
A child is treated as living with a parent for a night if the child sleeps:
• At that parent's home, whether or not the parent is present, or
• In the company of the parent, when the child doesn't sleep at a parent's home (for example, the parent and child are on vacation together).
Equal number of nights. If the child lived with each parent for an equal number of nights during the year, the custodial parent is the parent with the higher adjusted gross income (AGI).
December 31. The night of December 31 is treated as part of the year in which it begins. For example, the night of December 31, 2016, is treated as part of 2016.
Emancipated child. If a child is emancipated under state law, the child is treated as not living with either parent. See Examples 5 and 6.
Absences. If a child wasn't with either parent on a particular night (because, for example, the child was staying at a friend's house), the child is treated as living with the parent with whom the child normally would have lived for that night, except for the absence. But if it can't be determined with which parent the child normally would have lived or if the child would not have lived with either parent that night, the child is treated as not living with either parent that night.
Parent works at night. If, due to a parent's nighttime work schedule, a child lives for a greater number of days, but not nights, with the parent who works at night, that parent is treated as the custodial parent. On a school day, the child is treated as living at the primary residence registered with the school.
Example 1--child lived with one parent for a greater number of nights. You and your child's other parent are divorced. In 2016, your child lived with you 210 nights and with the other parent 156 nights. You are the custodial parent.
Example 2--child is away at camp. In 2016, your daughter lives with each parent for alternate weeks. In the summer, she spends 6 weeks at summer camp. During the time she is at camp, she is treated as living with you for 3 weeks and with her other parent, your ex-spouse, for 3 weeks because this is how long she would have lived with each parent if she had not attended summer camp.
Example 3--child lived same number of nights with each parent. Your son lived with you 180 nights during the year and lived the same number of nights with his other parent, your ex-spouse. Your AGI is $40,000. Your ex-spouse's AGI is $25,000. You are treated as your son's custodial parent because you have the higher AGI.
Example 4--child is at parent's home but with other parent. Your son normally lives with you during the week and with his other parent, your ex-spouse, every other weekend. You become ill and are hospitalized. The other parent lives in your home with your son for 10 consecutive days while you are in the hospital. Your son is treated as living with you during this 10-day period because he was living in your home.
Example 5--child emancipated in May. When your son turned age 18 in May 2016, he became emancipated under the law of the state where he lives. As a result, he isn't considered in the custody of his parents for more than half of the year. The special rule for children of divorced or separated parents doesn't apply.
Example 6--child emancipated in August. Your daughter lives with you from January 1, 2016, until May 31, 2016, and lives with her other parent, your ex-spouse, from June 1, 2016, through the end of the year. She turns 18 and is emancipated under state law on August 1, 2016. Because she is treated as not living with either parent beginning on August 1, she is treated as living with you the greater number of nights in 2016. You are the custodial parent.
Written declaration. The custodial parent must use either Form 8332 or a similar statement (containing the same information required by the form) to make the written declaration to release the exemption to the noncustodial parent. The noncustodial parent must attach a copy of the form or statement to his or her tax return.
The exemption can be released for 1 year, for a number of specified years (for example, alternate years), or for all future years, as specified in the declaration.
Post-1984 and pre-2009 divorce decree or separation agreement. If the divorce decree or separation agreement went into effect after 1984 and before 2009, the noncustodial parent may be able to attach certain pages from the decree or agreement instead of Form 8332. The decree or agreement must state all three of the following.
1. The noncustodial parent can claim the child as a dependent without regard to any condition, such as payment of support.
2. The custodial parent won't claim the child as a dependent for the year.
3. The years for which the noncustodial parent, rather than the custodial parent, can claim the child as a dependent.
The noncustodial parent must attach all of the following pages of the decree or agreement to his or her tax return.
• The cover page (write the other parent's social security number on this page).
• The pages that include all of the information identified in items (1) through (3) above.
• The signature page with the other parent's signature and the date of the agreement.
Post-2008 divorce decree or separation agreement. The noncustodial parent can't attach pages from the decree or agreement instead of Form 8332 if the decree or agreement went into effect after 2008. The custodial parent must sign either Form 8332 or a similar statement whose only purpose is to release the custodial parent's claim to an exemption for a child, and the noncustodial parent must attach a copy to his or her return. The form or statement must release the custodial parent's claim to the child without any conditions. For example, the release must not depend on the noncustodial parent paying support.
CAUTION: The noncustodial parent must attach the required information even if it was filed with a return in an earlier year.
Revocation of release of claim to an exemption. The custodial parent can revoke a release of claim to exemption. For the revocation to be effective for 2016, the custodial parent must have given (or made reasonable efforts to give) written notice of the revocation to the noncustodial parent in 2015 or earlier. The custodial parent can use Part III of Form 8332 for this purpose and must attach a copy of the revocation to his or her return for each tax year he or she claims the child as a dependent as a result of the revocation.
Remarried parent. If you remarry, the support provided by your new spouse is treated as provided by you.
Parents who never married. This special rule for divorced or separated parents also applies to parents who never married, and who lived apart at all times during the last 6 months of the year.
Support Test (To Be a Qualifying Child)
To meet this test, the child can't have provided more than half of his or her own support for the year.
This test is different from the support test to be a qualifying relative, which is described later. However, to see what is or isn't support, see Support Test (To Be a Qualifying Relative), later. If you aren't sure whether a child provided more than half of his or her own support, you may find Worksheet 3-1 helpful.
Worksheet 3-1. Worksheet for Determining Support
Keep for Your Records
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Funds Belonging to the Person You Supported
1. Enter the total funds belonging to the person you
supported, including income received (taxable and
nontaxable) and amounts borrowed during the year,
plus the amount in savings and other accounts at the
beginning of the year. Don't include funds provided
by the state; include those amounts on line 23
instead 1. ______
2. Enter the amount on line 1 that was used for the
person's support 2. ______
3. Enter the amount on line 1 that was used for other
purposes 3. ______
4. Enter the total amount in the person's savings and
other accounts at the end of the year 4. ______
5. Add lines 2 through 4. (This amount should equal
line 1.) 5. ______
Expenses for Entire Household (where the person
you supported lived)
6. Lodging (complete line 6a or 6b):
a. Enter the total rent paid 6a. ______
b. Enter the fair rental value of the home. If the
person you supported owned the home, also include
this amount in line 21 6b. ______
7. Enter the total food expenses 7. ______
8. Enter the total amount of utilities (heat, light,
water, etc. not included in line 6a or 6b) 8. ______
9. Enter the total amount of repairs (not included in
line 6a or 6b) 9. ______
10. Enter the total of other expenses. Don't include
expenses of maintaining the home, such as mortgage
interest, real estate taxes, and insurance 10. ______
11. Add lines 6a through 10. These are the total
household expenses 11. ______
12. Enter total number of persons who lived in the
household 12. ______
Expenses for the Person You Supported
13. Divide line 11 by line 12. This is the person's
share of the household expenses 13. ______
14. Enter the person's total clothing expenses 14. ______
15. Enter the person's total education expenses 15. ______
16. Enter the person's total medical and dental expenses
not paid for or reimbursed by insurance 16. ______
17. Enter the person's total travel and recreation
expenses 17. ______
18. Enter the total of the person's other expenses 18. ______
19. Add lines 13 through 18. This is the total cost of
the person's support for the year 19. ______
Did the Person Provide More Than Half of His
or Her Own Support?
20. Multiply line 19 by 50% (0.50) 20. ______
21. Enter the amount from line 2, plus the amount from
line 6b if the person you supported owned the home.
This is the amount the person provided for his or
her own support 21. ______
22. Is line 21 more than line 20?
[ ] No. You meet the support test for this person to be your
qualifying child. If this person also meets the other tests to be
a qualifying child, stop here; don't complete lines 23-26.
Otherwise, go to line 23 and fill out the rest of the worksheet
to determine if this person is your qualifying relative.
[ ] Yes. You don't meet the support test for this person to be
either your qualifying child or your qualifying relative. Stop
here.
Did You Provide More Than Half?
23. Enter the amount others provided for the person's
support. Include amounts provided by state, local,
and other welfare societies or agencies. Don't
include any amounts included on line 1 23. ______
24. Add lines 21 and 23 24. ______
25. Subtract line 24 from line 19. This is the amount
you provided for the person's support 25. ______
26. Is line 25 more than line 20?
[ ] Yes. You meet the support test for this person to be your
qualifying relative.
[ ] No. You don't meet the support test for this person to be
your qualifying relative. You can't claim an exemption for
this person unless you can do so under a multiple support
agreement, the support test for children of divorced or
separated parents, or the special rule for kidnapped children.
See Multiple Support Agreement or Support Test for Children of
Divorced or Separated Parents (or Parents Who Live Apart), or
Kidnapped child under Qualifying Relative.
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Example. You provided $4,000 toward your 16-year-old son's support for the year. He has a part-time job and provided $6,000 to his own support. He provided more than half of his own support for the year. He isn't your qualifying child.
Foster care payments and expenses. Payments you receive for the support of a foster child from a child placement agency are considered support provided by the agency. Similarly, payments you receive for the support of a foster child from a state or county are considered support provided by the state or county.
If you aren't in the trade or business of providing foster care and your unreimbursed out-of-pocket expenses in caring for a foster child were mainly to benefit an organization qualified to receive deductible charitable contributions, the expenses are deductible as charitable contributions but aren't considered support you provided. For more information about the deduction for charitable contributions, see chapter 24. If your unreimbursed expenses aren't deductible as charitable contributions, they may qualify as support you provided.
If you are in the trade or business of providing foster care, your unreimbursed expenses aren't considered support provided by you.
Example 1. Lauren, a foster child, lived with Mr. and Mrs. Smith for the last 3 months of the year. The Smiths cared for Lauren because they wanted to adopt her (although she had not been placed with them for adoption). They didn't care for her as a trade or business or to benefit the agency that placed her in their home. The Smiths' unreimbursed expenses aren't deductible as charitable contributions but are considered support they provided for Lauren.
Example 2. You provided $3,000 toward your 10-year-old foster child's support for the year. The state government provided $4,000, which is considered support provided by the state, not by the child. See Support provided by the state (welfare, food stamps, housing, etc.), later. Your foster child didn't provide more than half of her own support for the year.
Scholarships. A scholarship received by a child who is a student isn't taken into account in determining whether the child provided more than half of his or her own support.
Joint Return Test (To Be a Qualifying Child)
To meet this test, the child can't file a joint return for the year.
Exception. An exception to the joint return test applies if your child and his or her spouse file a joint return only to claim a refund of income tax withheld or estimated tax paid.
Example 1--child files joint return. You supported your 18-year-old daughter, and she lived with you all year while her husband was in the Armed Forces. He earned $25,000 for the year. The couple files a joint return. Because your daughter and her husband file a joint return, she isn't your qualifying child.
Example 2--child files joint return only as a claim for refund of withheld tax. Your 18-year-old son and his 17-year-old wife had $800 of wages from part-time jobs and no other income. They lived with you all year. Neither is required to file a tax return. They don't have a child. Taxes were taken out of their pay so they filed a joint return only to get a refund of the withheld taxes. The exception to the joint return test applies, so your son may be your qualifying child if all the other tests are met.
Example 3--child files joint return to claim American opportunity credit. The facts are the same as in Example 2 except no taxes were taken out of your son's pay or his wife's pay. However, they file a joint return to claim an American opportunity credit of $124 and get a refund of that amount. Because claiming the American opportunity credit is their reason for filing the return, they aren't filing it only to get a refund of income tax withheld or estimated tax paid. The exception to the joint return test doesn't apply, so your son isn't your qualifying child.
Qualifying Child of More Than One Person
TIP: If your qualifying child isn't a qualifying child of anyone else, this topic doesn't apply to you and you don't need to read about it. This is also true if your qualifying child isn't a qualifying child of anyone else except your spouse with whom you plan to file a joint return.
CAUTION: If a child is treated as the qualifying child of the noncustodial parent under the rules for children of divorced or separated parents (or parents who live apart) described earlier, see Applying the tiebreaker rules to divorced or separated parents (or parents who live apart), later.
Sometimes, a child meets the relationship, age, residency, support, and joint return tests to be a qualifying child of more than one person. Although the child is a qualifying child of each of these persons, only one person can actually treat the child as a qualifying child to take all of the following tax benefits (provided the person is eligible for each benefit).
1. The exemption for the child.
2. The child tax credit.
3. Head of household filing status.
4. The credit for child and dependent care expenses.
5. The exclusion from income for dependent care benefits.
6. The earned income credit.
The other person can't take any of these benefits based on this qualifying child. In other words, you and the other person can't agree to divide these benefits between you. The other person can't take any of these tax benefits for a child unless he or she has a different qualifying child.
Tiebreaker rules. To determine which person can treat the child as a qualifying child to claim these six tax benefits, the following tiebreaker rules apply.
• If only one of the persons is the child's parent, the child is treated as the qualifying child of the parent.
• If the parents file a joint return together and can claim the child as a qualifying child, the child is treated as the qualifying child of the parents.
• If the parents don't file a joint return together but both parents claim the child as a qualifying child, the IRS will treat the child as the qualifying child of the parent with whom the child lived for the longer period of time during the year. If the child lived with each parent for the same amount of time, the IRS will treat the child as the qualifying child of the parent who had the higher adjusted gross income (AGI) for the year.
• If no parent can claim the child as a qualifying child, the child is treated as the qualifying child of the person who had the highest AGI for the year.
• If a parent can claim the child as a qualifying child but no parent does so claim the child, the child is treated as the qualifying child of the person who had the highest AGI for the year, but only if that person's AGI is higher than the highest AGI of any of the child's parents who can claim the child. If the child's parents file a joint return with each other, this rule can be applied by dividing the parents' combined AGI equally between the parents. See Example 6.
Subject to these tiebreaker rules, you and the other person may be able to choose which of you claims the child as a qualifying child.
Example 1--child lived with parent and grandparent. You and your 3-year-old daughter Jane lived with your mother all year. You are 25 years old, unmarried, and your AGI is $9,000. Your mother's AGI is $15,000. Jane's father didn't live with you or your daughter. You haven't signed Form 8332 (or a similar statement) to release the child's exemption to the noncustodial parent.
Jane is a qualifying child of both you and your mother because she meets the relationship, age, residency, support, and joint return tests for both you and your mother. However, only one of you can claim her. Jane isn't a qualifying child of anyone else, including her father. You agree to let your mother claim Jane. This means your mother can claim Jane as a qualifying child for all of the six tax benefits listed earlier, if she qualifies for each of those benefits (and if you don't claim Jane as a qualifying child for any of those tax benefits).
Example 2--parent has higher AGI than grandparent. The facts are the same as in Example 1 except your AGI is $18,000. Because your mother's AGI isn't higher than yours, she can't claim Jane. Only you can claim Jane.
Example 3--two persons claim same child. The facts are the same as in Example 1 except that you and your mother both claim Jane as a qualifying child. In this case, you, as the child's parent, will be the only one allowed to claim Jane as a qualifying child. The IRS will disallow your mother's claim to the six tax benefits listed earlier unless she has another qualifying child.
Example 4--qualifying children split between two persons. The facts are the same as in Example 1 except you also have two other young children who are qualifying children of both you and your mother. Only one of you can claim each child. However, if your mother's AGI is higher than yours, you can allow your mother to claim one or more of the children. For example, if you claim one child, your mother can claim the other two.
Example 5--taxpayer who is a qualifying child. The facts are the same as in Example 1 except you are only 18 years old and didn't provide more than half of your own support for the year. This means you are your mother's qualifying child. If she can claim you as a dependent, then you can't claim your daughter as a dependent because of the Dependent Taxpayer Test explained earlier.
Example 6--child lived with both parents and grandparent. The facts are the same as in Example 1 except you are married to your daughter's father. The two of you live together with your daughter and your mother, and have an AGI of $20,000 on a joint return. If you and your husband don't claim your daughter as a qualifying child, your mother can claim her instead. Even though the AGI on your joint return, $20,000, is more than your mother's AGI of $15,000, for this purpose each parent's AGI can be treated as $10,000, so your mother's $15,000 AGI is treated as higher than the highest AGI of any of the child's parents who can claim the child.
Example 7--separated parents. You, your husband, and your 10-year-old son lived together until August 1, 2016, when your husband moved out of the household. In August and September, your son lived with you. For the rest of the year, your son lived with your husband, the boy's father. Your son is a qualifying child of both you and your husband because your son lived with each of you for more than half the year and because he met the relationship, age, support, and joint return tests for both of you. At the end of the year, you and your husband still weren't divorced, legally separated, or separated under a written separation agreement, so the rule for children of divorced or separated parents (or parents who live apart) doesn't apply.
You and your husband will file separate returns. Your husband agrees to let you treat your son as a qualifying child. This means, if your husband doesn't claim your son as a qualifying child, you can claim your son as a qualifying child for the dependency exemption, child tax credit, and exclusion for dependent care benefits (if you qualify for each of those tax benefits). However, you can't claim head of household filing status because you and your husband didn't live apart for the last 6 months of the year. As a result, your filing status is married filing separately, so you can't claim the earned income credit or the credit for child and dependent care expenses.
Example 8--separated parents claim same child. The facts are the same as in Example 7 except that you and your husband both claim your son as a qualifying child. In this case, only your husband will be allowed to treat your son as a qualifying child. This is because, during 2016, the boy lived with him longer than with you. If you claimed an exemption or the child tax credit for your son, the IRS will disallow your claim to both these tax benefits. If you don't have another qualifying child or dependent, the IRS will also disallow your claim to the exclusion for dependent care benefits. In addition, because you and your husband didn't live apart for the last 6 months of the year, your husband can't claim head of household filing status. As a result, his filing status is married filing separately, so he can't claim the earned income credit or the credit for child and dependent care expenses.
Example 9--unmarried parents. You, your 5-year-old son, and your son's father lived together all year. You and your son's father aren't married. Your son is a qualifying child of both you and his father because he meets the relationship, age, residency, support, and joint return tests for both you and his father. Your AGI is $12,000 and your son's father's AGI is $14,000. Your son's father agrees to let you claim the child as a qualifying child. This means you can claim him as a qualifying child for the dependency exemption, child tax credit, head of household filing status, credit for child and dependent care expenses, exclusion for dependent care benefits, and the earned income credit, if you qualify for each of those tax benefits (and if your son's father doesn't claim your son as a qualifying child for any of those tax benefits).
Example 10--unmarried parents claim same child. The facts are the same as in Example 9 except that you and your son's father both claim your son as a qualifying child. In this case, only your son's father will be allowed to treat your son as a qualifying child. This is because his AGI, $14,000, is more than your AGI, $12,000. If you claimed an exemption or the child tax credit for your son, the IRS will disallow your claim to both these tax benefits. If you don't have another qualifying child or dependent, the IRS will also disallow your claim to the earned income credit, head of household filing status, the credit for child and dependent care expenses, and the exclusion for dependent care benefits.
Example 11--child didn't live with a parent. You and your 7-year-old niece, your sister's child, lived with your mother all year. You are 25 years old, and your AGI is $9,300. Your mother's AGI is $15,000. Your niece's parents file jointly, have an AGI of less than $9,000, and don't live with you or their child. Your niece is a qualifying child of both you and your mother because she meets the relationship, age, residency, support, and joint return tests for both you and your mother. However, only your mother can treat her as a qualifying child. This is because your mother's AGI, $15,000, is more than your AGI, $9,300.
Applying the tiebreaker rules to divorced or separated parents (or parents who live apart). If a child is treated as the qualifying child of the noncustodial parent under the rules described earlier for children of divorced or separated parents (or parents who live apart), only the noncustodial parent can claim an exemption and the child tax credit for the child. However, only the custodial parent can claim the credit for child and dependent care expenses or the exclusion for dependent care benefits for the child, and only the custodial parent can treat the child as a dependent for the health coverage tax credit. Also, the noncustodial parent can't claim the child as a qualifying child for head of household filing status or the earned income credit. Instead, the custodial parent, if eligible, or other eligible person can claim the child as a qualifying child for those two benefits. If the child is the qualifying child of more than one person for these benefits, then the tiebreaker rules just explained determine whether the custodial parent or another eligible person can treat the child as a qualifying child.
Example 1. You and your 5-year-old son lived all year with your mother, who paid the entire cost of keeping up the home. Your AGI is $10,000. Your mother's AGI is $25,000. Your son's father didn't live with you or your son.
Under the rules explained earlier for children of divorced or separated parents (or parents who live apart), your son is treated as the qualifying child of his father, who can claim an exemption and the child tax credit for him. Because of this, you can't claim an exemption or the child tax credit for your son. However, those rules don't allow your son's father to claim your son as a qualifying child for head of household filing status, the credit for child and dependent care expenses, the exclusion for dependent care benefits, the earned income credit, or the health coverage tax credit.
You and your mother didn't have any child care expenses or dependent care benefits, so neither of you can claim the credit for child and dependent care expenses or the exclusion for dependent care benefits. Also, neither of you qualifies for the health coverage tax credit. But the boy is a qualifying child of both you and your mother for head of household filing status and the earned income credit because he meets the relationship, age, residency, support, and joint return tests for both you and your mother. (Note: The support test doesn't apply for the earned income credit.) However, you agree to let your mother claim your son. This means she can claim him for head of household filing status and the earned income credit if she qualifies for each and if you don't claim him as a qualifying child for the earned income credit. (You can't claim head of household filing status because your mother paid the entire cost of keeping up the home.)
Example 2. The facts are the same as in Example 1 except your AGI is $25,000 and your mother's AGI is $21,000. Your mother can't claim your son as a qualifying child for any purpose because her AGI isn't higher than yours.
Example 3. The facts are the same as in Example 1 except you and your mother both claim your son as a qualifying child for the earned income credit. Your mother also claims him as a qualifying child for head of household filing status. You, as the child's parent, will be the only one allowed to claim your son as a qualifying child for the earned income credit. The IRS will disallow your mother's claim to the earned income credit and head of household filing status unless she has another qualifying child.
Qualifying Relative
Four tests must be met for a person to be your qualifying relative. The four tests are:
1. Not a qualifying child test,
2. Member of household or relationship test,
3. Gross income test, and
4. Support test.
Age. Unlike a qualifying child, a qualifying relative can be any age. There is no age test for a qualifying relative.
Kidnapped child. You may be able to treat a child as your qualifying relative even if the child has been kidnapped. See Pub. 501 for details.
Not a Qualifying Child Test
A child isn't your qualifying relative if the child is your qualifying child or the qualifying child of any other taxpayer.
Example 1. Your 22-year-old daughter, who is a student, lives with you and meets all the tests to be your qualifying child. She isn't your qualifying relative.
Example 2. Your 2-year-old son lives with your parents and meets all the tests to be their qualifying child. He isn't your qualifying relative.
Example 3. Your son lives with you but isn't your qualifying child because he is 30 years old and doesn't meet the age test. He may be your qualifying relative if the gross income test and the support test are met.
Example 4. Your 13-year-old grandson lived with his mother for 3 months, with his uncle for 4 months, and with you for 5 months during the year. He isn't your qualifying child because he doesn't meet the residency test. He may be your qualifying relative if the gross income test and the support test are met.
Child of person not required to file a return. A child isn't the qualifying child of any other taxpayer and so may qualify as your qualifying relative if the child's parent (or other person for whom the child is defined as a qualifying child) isn't required to file an income tax return and either:
• Doesn't file an income tax return, or
• Files a return only to get a refund of income tax withheld or estimated tax paid.
Example 1--return not required. You support an unrelated friend and her 3-year-old child, who lived with you all year in your home. Your friend has no gross income, isn't required to file a 2016 tax return, and doesn't file a 2016 tax return. Both your friend and her child are your qualifying relatives if the support test is met.
Example 2--return filed to claim refund. The facts are the same as in Example 1 except your friend had wages of $1,500 during the year and had income tax withheld from her wages. She files a return only to get a refund of the income tax withheld and doesn't claim the earned income credit or any other tax credits or deductions. Both your friend and her child are your qualifying relatives if the support test is met.
Example 3--earned income credit claimed. The facts are the same as in Example 2 except your friend had wages of $8,000 during the year and claimed the earned income credit on her return. Your friend's child is the qualifying child of another taxpayer (your friend), so you can't claim your friend's child as your qualifying relative. Also, you can't claim your friend as your qualifying relative because of the gross income test explained later.
Child in Canada or Mexico. You may be able to claim your child as a dependent even if the child lives in Canada or Mexico. If the child doesn't live with you, the child doesn't meet the residency test to be your qualifying child. However, the child may still be your qualifying relative. If the persons the child does live with aren't U.S. citizens and have no U.S. gross income, those persons aren't "taxpayers," so the child isn't the qualifying child of any other taxpayer. If the child isn't the qualifying child of any other taxpayer, the child is your qualifying relative as long as the gross income test and the support test are met.
You can't claim as a dependent a child who lives in a foreign country other than Canada or Mexico, unless the child is a U.S. citizen, U.S. resident alien, or U.S. national. There is an exception for certain adopted children who lived with you all year. See Citizen or Resident Test, earlier.
Example. You provide all the support of your children, ages 6, 8, and 12, who live in Mexico with your mother and have no income. You are single and live in the United States. Your mother isn't a U.S. citizen and has no U.S. income, so she isn't a "taxpayer." Your children aren't your qualifying children because they don't meet the residency test. But since they aren't the qualifying children of any other taxpayer, they are your qualifying relatives and you can claim them as dependents. You may also be able to claim your mother as a dependent if the gross income and support tests are met.
Member of Household or Relationship Test
To meet this test, a person must either:
1. Live with you all year as a member of your household, or
2. Be related to you in one of the ways listed under Relatives who don't have to live with you.
If at any time during the year the person was your spouse, that person can't be your qualifying relative. However, see Personal Exemptions, earlier.
Relatives who don't have to live with you. A person related to you in any of the following ways doesn't have to live with you all year as a member of your household to meet this test.
• Your child, stepchild, foster child, or a descendant of any of them (for example, your grandchild). (A legally adopted child is considered your child.)
• Your brother, sister, half brother, half sister, stepbrother, or stepsister.
• Your father, mother, grandparent, or other direct ancestor, but not foster parent.
• Your stepfather or stepmother.
• A son or daughter of your brother or sister.
• A son or daughter of your half brother or half sister.
• A brother or sister of your father or mother.
• Your son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law.
Any of these relationships that were established by marriage aren't ended by death or divorce.
Example. You and your wife began supporting your wife's father, a widower, in 2010. Your wife died in 2015. Despite your wife's death, your father-in-law continues to meet this test, even if he doesn't live with you. You can claim him as a dependent if all other tests are met, including the gross income test and support test.
Foster child. A foster child is an individual who is placed with you by an authorized placement agency or by judgment, decree, or other order of any court of competent jurisdiction.
Joint return. If you file a joint return, the person can be related to either you or your spouse. Also, the person doesn't need to be related to the spouse who provides support.
For example, your spouse's uncle who receives more than half of his support from you may be your qualifying relative, even though he doesn't live with you. However, if you and your spouse file separate returns, your spouse's uncle can be your qualifying relative only if he lives with you all year as a member of your household.
Temporary absences. A person is considered to live with you as a member of your household during periods of time when one of you, or both, are temporarily absent due to special circumstances such as:
• Illness,
• Education,
• Business,
• Vacation,
• Military service, or
• Detention in a juvenile facility.
If the person is placed in a nursing home for an indefinite period of time to receive constant medical care, the absence may be considered temporary.
Death or birth. A person who died during the year, but lived with you as a member of your household until death, will meet this test. The same is true for a child who was born during the year and lived with you as a member of your household for the rest of the year. The test is also met if a child lived with you as a member of your household except for any required hospital stay following birth.
If your dependent died during the year and you otherwise qualify to claim an exemption for the dependent, you can still claim the exemption.
Example. Your dependent mother died on January 15. She met the tests to be your qualifying relative. The other tests to claim an exemption for a dependent were also met. You can claim an exemption for her on your return.
Local law violated. A person doesn't meet this test if at any time during the year the relationship between you and that person violates local law.
Example. Your girlfriend lived with you as a member of your household all year. However, your relationship with her violated the laws of the state where you live, because she was married to someone else. Therefore, she doesn't meet this test and you can't claim her as a dependent.
Adopted child. An adopted child is always treated as your own child. The term "adopted child" includes a child who was lawfully placed with you for legal adoption.
Cousin. Your cousin meets this test only if he or she lives with you all year as a member of your household. A cousin is a descendant of a brother or sister of your father or mother.
Gross Income Test
To meet this test, a person's gross income for the year must be less than $4,050.
Gross income defined. Gross income is all income in the form of money, property, and services that isn't exempt from tax.
In a manufacturing, merchandising, or mining business, gross income is the total net sales minus the cost of goods sold, plus any miscellaneous income from the business.
Gross receipts from rental property are gross income. Don't deduct taxes, repairs, or other expenses to determine the gross income from rental property.
Gross income includes a partner's share of the gross (not a share of the net) partnership income.
Gross income also includes all taxable unemployment compensation and certain scholarship and fellowship grants. Scholarships received by degree candidates and used for tuition, fees, supplies, books, and equipment required for particular courses generally aren't included in gross income. For more information about scholarships, see chapter 12.
Tax-exempt income, such as certain social security benefits, isn't included in gross income.
Disabled dependent working at sheltered workshop. For purposes of the gross income test, the gross income of an individual who is permanently and totally disabled at any time during the year doesn't include income for services the individual performs at a sheltered workshop. The availability of medical care at the workshop must be the main reason for the individual's presence there. Also, the income must come solely from activities at the workshop that are incident to this medical care.
A "sheltered workshop" is a school that:
• Provides special instruction or training designed to alleviate the disability of the individual, and
• Is operated by certain tax-exempt organizations, or by a state, a U.S. possession, a political subdivision of a state or possession, the United States, or the District of Columbia.
"Permanently and totally disabled" has the same meaning here as under Qualifying Child, earlier.
Support Test (To Be a Qualifying Relative)
To meet this test, you generally must provide more than half of a person's total support during the calendar year.
However, if two or more persons provide support, but no one person provides more than half of a person's total support, see Multiple Support Agreement, later.
How to determine if support test is met. You figure whether you have provided more than half of a person's total support by comparing the amount you contributed to that person's support with the entire amount of support that person received from all sources. This includes support the person provided from his or her own funds.
You may find Worksheet 3-1 helpful in figuring whether you provided more than half of a person's support.
Person's own funds not used for support. A person's own funds aren't support unless they are actually spent for support.
Example. Your mother received $2,400 in social security benefits and $300 in interest. She paid $2,000 for lodging and $400 for recreation. She put $300 in a savings account.
Even though your mother received a total of $2,700 ($2,400 + $300), she spent only $2,400 ($2,000 + $400) for her own support. If you spent more than $2,400 for her support and no other support was received, you have provided more than half of her support.
Child's wages used for own support. You can't include in your contribution to your child's support any support paid for by the child with the child's own wages, even if you paid the wages.
Year support is provided. The year you provide the support is the year you pay for it, even if you do so with borrowed money that you repay in a later year.
If you use a fiscal year to report your income, you must provide more than half of the dependent's support for the calendar year in which your fiscal year begins.
Armed Forces dependency allotments. The part of the allotment contributed by the government and the part taken out of your military pay are both considered provided by you in figuring whether you provide more than half of the support. If your allotment is used to support persons other than those you name, you can take the exemptions for them if they otherwise qualify.
Example. You are in the Armed Forces. You authorize an allotment for your widowed mother that she uses to support herself and her sister. If the allotment provides more than half of each person's support, you can take an exemption for each of them, if they otherwise qualify, even though you authorize the allotment only for your mother.
Tax-exempt military quarters allowances. These allowances are treated the same way as dependency allotments in figuring support. The allotment of pay and the tax-exempt basic allowance for quarters are both considered as provided by you for support.
Tax-exempt income. In figuring a person's total support, include tax-exempt income, savings, and borrowed amounts used to support that person. Tax-exempt income includes certain social security benefits, welfare benefits, nontaxable life insurance proceeds, Armed Forces family allotments, nontaxable pensions, and tax-exempt interest.
Example 1. You provide $4,000 toward your mother's support during the year. She has earned income of $600, nontaxable social security benefits of $4,800, and tax-exempt interest of $200. She uses all these for her support. You can't claim an exemption for your mother because the $4,000 you provide isn't more than half of her total support of $9,600 ($4,000 + $600 + $4,800 + $200).
Example 2. Your niece takes out a student loan of $2,500 and uses it to pay her college tuition. She is personally responsible for the loan. You provide $2,000 toward her total support. You can't claim an exemption for her because you provide less than half of her support.
Social security benefits. If a married couple receives benefits that are paid by one check made out to both of them, half of the total paid is considered to be for the support of each spouse, unless they can show otherwise.
If a child receives social security benefits and uses them toward his or her own support, the benefits are considered as provided by the child.
Support provided by the state (welfare, food stamps, housing, etc.). Benefits provided by the state to a needy person generally are considered support provided by the state. However, payments based on the needs of the recipient won't be considered as used entirely for that person's support if it is shown that part of the payments weren't used for that purpose.
Foster care. Payments you receive for the support of a foster child from a child placement agency are considered support provided by the agency. See Foster care payments and expenses, earlier.
Home for the aged. If you make a lump-sum advance payment to a home for the aged to take care of your relative for life and the payment is based on that person's life expectancy, the amount of support you provide each year is the lump-sum payment divided by the relative's life expectancy. The amount of support you provide also includes any other amounts you provided during the year.
Total Support
To figure if you provided more than half of a person's support, you must first determine the total support provided for that person. Total support includes amounts spent to provide food, lodging, clothing, education, medical and dental care, recreation, transportation, and similar necessities.
Generally, the amount of an item of support is the amount of the expense incurred in providing that item. For lodging, the amount of support is the fair rental value of the lodging.
Expenses not directly related to any one member of a household, such as the cost of food for the household, must be divided among the members of the household.
Example 1. Grace Brown, mother of Mary Miller, lives with Frank and Mary Miller and their two children. Grace gets social security benefits of $2,400, which she spends for clothing, transportation, and recreation. Grace has no other income. Frank and Mary's total food expense for the household is $5,200. They pay Grace's medical and drug expenses of $1,200. The fair rental value of the lodging provided for Grace is $1,800 a year, based on the cost of similar rooming facilities. Figure Grace's total support as follows:
Fair rental value of lodging $1,800
Clothing, transportation, and recreation 2,400
Medical expenses 1,200
Share of food (1/5 of $5,200) 1,040
------
Total support $6,440
======
The support Frank and Mary provide, $4,040 ($1,800 lodging + $1,200 medical expenses + $1,040 food), is more than half of Grace's $6,440 total support.
Example 2. Your parents live with you, your spouse, and your two children in a house you own. The fair rental value of your parents' share of the lodging is $2,000 a year ($1,000 each), which includes furnishings and utilities. Your father receives a nontaxable pension of $4,200, which he spends equally between your mother and himself for items of support such as clothing, transportation, and recreation. Your total food expense for the household is $6,000. Your heat and utility bills amount to $1,200. Your mother has hospital and medical expenses of $600, which you pay during the year. Figure your parents' total support as follows:
Support provided Father Mother
Fair rental value of lodging $1,000 $1,000
Pension spent for their
support 2,100 2,100
Share of food (1/6 of
$6,000) 1,000 1,000
Medical expenses for
mother 600
------ ------
Parents' total support $4,100 $4,700
====== ======
You must apply the support test separately to each parent. You provide $2,000 ($1,000 lodging + $1,000 food) of your father's total support of $4,100 -- less than half. You provide $2,600 to your mother ($1,000 lodging + $1,000 food + $600 medical) -- more than half of her total support of $4,700. You meet the support test for your mother, but not your father. Heat and utility costs are included in the fair rental value of the lodging, so these aren't considered separately.
Lodging. If you provide a person with lodging, you are considered to provide support equal to the fair rental value of the room, apartment, house, or other shelter in which the person lives. Fair rental value includes a reasonable allowance for the use of furniture and appliances, and for heat and other utilities that are provided.
Fair rental value defined. Fair rental value is the amount you could reasonably expect to receive from a stranger for the same kind of lodging. It is used instead of actual expenses such as taxes, interest, depreciation, paint, insurance, utilities, and the cost of furniture and appliances. In some cases, fair rental value may be equal to the rent paid.
If you provide the total lodging, the amount of support you provide is the fair rental value of the room the person uses, or a share of the fair rental value of the entire dwelling if the person has use of your entire home. If you don't provide the total lodging, the total fair rental value must be divided depending on how much of the total lodging you provide. If you provide only a part and the person supplies the rest, the fair rental value must be divided between both of you according to the amount each provides.
Example. Your parents live rent free in a house you own. It has a fair rental value of $5,400 a year furnished, which includes a fair rental value of $3,600 for the house and $1,800 for the furniture. This doesn't include heat and utilities. The house is completely furnished with furniture belonging to your parents. You pay $600 for their utility bills. Utilities aren't usually included in rent for houses in the area where your parents live. Therefore, you consider the total fair rental value of the lodging to be $6,000 ($3,600 fair rental value of the unfurnished house + $1,800 allowance for the furnishings provided by your parents + $600 cost of utilities) of which you are considered to provide $4,200 ($3,600 + $600).
Person living in his or her own home. The total fair rental value of a person's home that he or she owns is considered support contributed by that person.
Living with someone rent free. If you live with a person rent free in his or her home, you must reduce the amount you provide for support of that person by the fair rental value of lodging he or she provides you.
Property. Property provided as support is measured by its fair market value. Fair market value is the price that property would sell for on the open market. It is the price that would be agreed upon between a willing buyer and a willing seller, with neither being required to act, and both having reasonable knowledge of the relevant facts.
Capital expenses. Capital items, such as furniture, appliances, and cars, bought for a person during the year can be included in total support under certain circumstances.
The following examples show when a capital item is or isn't support.
Example 1. You buy a $200 power lawn mower for your 13-year-old child. The child is given the duty of keeping the lawn trimmed. Because the lawn mower benefits all members of the household, don't include the cost of the lawn mower in the support of your child.
Example 2. You buy a $150 television set as a birthday present for your 12-year-old child. The television set is placed in your child's bedroom. You can include the cost of the television set in the support of your child.
Example 3. You pay $5,000 for a car and register it in your name. You and your 17-year-old daughter use the car equally. Because you own the car and don't give it to your daughter but merely let her use it, don't include the cost of the car in your daughter's total support. However, you can include in your daughter's support your out-of-pocket expenses of operating the car for her benefit.
Example 4. Your 17-year-old son, using personal funds, buys a car for $4,500. You provide the rest of your son's support, $4,000. Because the car is bought and owned by your son, the car's fair market value ($4,500) must be included in his support. Your son has provided more than half of his own total support of $8,500 ($4,500 + $4,000), so he isn't your qualifying child. You didn't provide more than half of his total support, so he isn't your qualifying relative. You can't claim an exemption for your son.
Medical insurance premiums. Medical insurance premiums you pay, including premiums for supplementary Medicare coverage, are included in the support you provide.
Medical insurance benefits. Medical insurance benefits, including basic and supplementary Medicare benefits, aren't part of support.
Tuition payments and allowances under the GI Bill. Amounts veterans receive under the GI Bill for tuition payments and allowances while they attend school are included in total support.
Example. During the year, your son receives $2,200 from the government under the GI Bill. He uses this amount for his education. You provide the rest of his support, $2,000. Because GI benefits are included in total support, your son's total support is $4,200 ($2,200 + $2,000). You haven't provided more than half of his support.
Child care expenses. If you pay someone to provide child or dependent care, you can include these payments in the amount you provided for the support of your child or disabled dependent, even if you claim a credit for the payments. For information on the credit, see chapter 32.
Other support items. Other items may be considered as support depending on the facts in each case.
Don't Include in Total Support
The following items aren't included in total support.
1. Federal, state, and local income taxes paid by persons from their own income.
2. Social security and Medicare taxes paid by persons from their own income.
3. Life insurance premiums.
4. Funeral expenses.
5. Scholarships received by your child if your child is a student.
6. Survivors' and Dependents' Educational Assistance payments used for the support of the child who receives them.
Multiple Support Agreement
Sometimes no one provides more than half of the support of a person. Instead, two or more persons, each of whom would be able to take the exemption but for the support test, together provide more than half of the person's support.
When this happens, you can agree that any one of you who individually provides more than 10% of the person's support, but only one, can claim an exemption for that person as a qualifying relative. Each of the others must sign a statement agreeing not to claim the exemption for that year. The person who claims the exemption must keep these signed statements for his or her records. A multiple support declaration identifying each of the others who agreed not to claim the exemption must be attached to the return of the person claiming the exemption. Form 2120 can be used for this purpose.
You can claim an exemption under a multiple support agreement for someone related to you or for someone who lived with you all year as a member of your household.
Example 1. You, your sister, and your two brothers provide the entire support of your mother for the year. You provide 45%, your sister 35%, and your two brothers each provide 10%. Either you or your sister can claim an exemption for your mother. The other must sign a statement agreeing not to take an exemption for your mother. The one who claims the exemption must attach Form 2120, or a similar declaration, to his or her return and must keep the statement signed by the other for his or her records. Because neither brother provides more than 10% of the support, neither can take the exemption and neither has to sign a statement.
Example 2. You and your brother each provide 20% of your mother's support for the year. The remaining 60% of her support is provided equally by two persons who aren't related to her. She doesn't live with them. Because more than half of her support is provided by persons who can't claim an exemption for her, no one can take the exemption.
Example 3. Your father lives with you and receives 25% of his support from social security, 40% from you, 24% from his brother (your uncle), and 11% from a friend. Either you or your uncle can take the exemption for your father if the other signs a statement agreeing not to. The one who takes the exemption must attach Form 2120, or a similar declaration, to his return and must keep for his records the signed statement from the one agreeing not to take the exemption.
Support Test for Children of Divorced or Separated Parents (or Parents Who Live Apart)
In most cases, a child of divorced or separated parents (or parents who live apart) will be a qualifying child of one of the parents. See Children of divorced or separated parents (or parents who live apart) under Qualifying Child, earlier. However, if the child doesn't meet the requirements to be a qualifying child of either parent, the child may be a qualifying relative of one of the parents. If you think this might apply to you, see Pub. 501.
Phaseout of Exemptions
You lose at least part of the benefit of your exemptions if your adjusted gross income (AGI) is above a certain amount. For 2016, the phaseout begins at the following amounts.
AGI Level That Reduces
Filing Status Exemption Amount
Married filing separately $155,650
Single 259,400
Head of household 285,350
Married filing jointly 311,300
Qualifying widow(er) 311,300
You must reduce the dollar amount of your exemptions by 2% for each $2,500, or part of $2,500 ($1,250 if you are married filing separately), that your AGI exceeds the amount shown above for your filing status. If your AGI exceeds the amount shown above by more than $122,500 ($61,250 if married filing separately), the amount of your deduction for exemptions is reduced to zero.
If your AGI exceeds the level for your filing status, use Worksheet 3-2 to figure the amount of your deduction for exemptions.
Worksheet 3-2. Worksheet for Determining the Deduction for Exemptions
Keep for Your Records
----------------------------------------------------------------------
1. Is the amount on Form 1040, line 38, more than the
amount on line 4 below for your filing status?
[ ] No. Stop. Multiply $4,050 by the total number of
exemptions claimed on line 6d of Form 1040 and enter
the result on Form 1040, line 42.
[ ] Yes. Continue.
2. Multiply $4,050 by the total number of exemptions
claimed on line 6d of Form 1040 2. ______
3. Enter the amount from Form 1040, line 38 3. ______
4. Enter the amount shown below for your filing
status:
• Married filing separately -- $155,650 }
}
• Single -- $259,400 }
}
• Head of household -- $285,350 } 4. ______
}
• Married filing jointly or Qualifying }
widow(er) -- $311,300 }
5. Subtract line 4 from line 3. If the result is
more than $122,500 ($61,250 if married filing
separately), stop here. You can't take a
deduction for exemptions 5. ______
6. Divide line 5 by $2,500 ($1,250 if married
filing separately). If the result isn't a
whole number, round it up to the next
higher whole number (for example, increase
.00004 to 1) 6. ______
7. Multiply line 6 by 2% (0.02) and enter the
result as a decimal (rounded to at least
three places) 7. ______
8. Multiply line 2 by line 7 8. ______
9. Deduction for exemptions. Subtract line 8
from line 2. Enter the result here and on
Form 1040, line 42 9. ______
----------------------------------------------------------------------
Social Security Numbers for Dependents
You must show the social security number (SSN) of any dependent for whom you claim an exemption in column (2) of line 6c of your Form 1040 or Form 1040A.
CAUTION: If you don't show the dependent's SSN when required or if you show an incorrect SSN, the exemption may be disallowed.
No SSN. If a person for whom you expect to claim an exemption on your return doesn't have an SSN, either you or that person should apply for an SSN as soon as possible by filing Form SS-5, Application for a Social Security Card, with the Social Security Administration (SSA). You can get Form SS-5 online at http://www.socialsecurity.gov or at your local SSA office.
It usually takes about 2 weeks to get an SSN once the SSA has all the information it needs. If you don't have a required SSN by the filing due date, you can file Form 4868 for an extension of time to file.
Born and died in 2016. If your child was born and died in 2016, and you don't have an SSN for the child, you may attach a copy of the child's birth certificate, death certificate, or hospital records instead. The document must show the child was born alive. If you do this, enter "DIED" in column (2) of line 6c of your Form 1040 or Form 1040A.
Alien or adoptee with no SSN. If your dependent doesn't have and can't get an SSN, you must list the individual taxpayer identification number (ITIN) or adoption taxpayer identification number (ATIN) instead of an SSN.
Taxpayer identification numbers for aliens. If your dependent is a resident or nonresident alien who doesn't have and isn't eligible to get an SSN, your dependent must apply for an individual taxpayer identification number (ITIN). For details on how to apply, see Form W-7, Application for IRS Individual Taxpayer Identification Number.
Taxpayer identification numbers for adoptees. If you have a child who was placed with you by an authorized placement agency, you may be able to claim an exemption for the child. However, if you can't get an SSN or an ITIN for the child, you must get an adoption taxpayer identification number (ATIN) for the child from the IRS. See Form W-7A, Application for Taxpayer Identification Number for Pending U.S. Adoptions, for details.
4. Tax Withholding and Estimated Tax
What's New for 2017
Tax law changes for 2017. When you figure how much income tax you want withheld from your pay and when you figure your estimated tax, consider tax law changes effective in 2017. For more information, see Pub. 505, Tax Withholding and Estimated Tax.
Reminders
Estimated tax safe harbor for higher income taxpayers. If your 2016 adjusted gross income was more than $150,000 ($75,000 if you are married filing a separate return), you must pay the smaller of 90% of your expected tax for 2017 or 110% of the tax shown on your 2016 return to avoid an estimated tax penalty.
Introduction
This chapter discusses how to pay your tax as you earn or receive income during the year. In general, the federal income tax is a pay-as-you-go tax. There are two ways to pay as you go.
• Withholding. If you are an employee, your employer probably withholds income tax from your pay. Tax also may be withheld from certain other income, such as pensions, bonuses, commissions, and gambling winnings. The amount withheld is paid to the IRS in your name.
• Estimated tax. If you don't pay your tax through withholding, or don't pay enough tax that way, you may have to pay estimated tax. People who are in business for themselves generally will have to pay their tax this way. Also, you may have to pay estimated tax if you receive income such as dividends, interest, capital gains, rent, and royalties. Estimated tax is used to pay not only income tax, but self-employment tax and alternative minimum tax as well.
This chapter explains these methods. In addition, it also explains the following.
• Credit for withholding and estimated tax. When you file your 2016 income tax return, take credit for all the income tax withheld from your salary, wages, pensions, etc., and for the estimated tax you paid for 2016. Also take credit for any excess social security or railroad retirement tax withheld (discussed in chapter 38).
• Underpayment penalty. If you didn't pay enough tax during the year, either through withholding or by making estimated tax payments, you may have to pay a penalty. In most cases, the IRS can figure this penalty for you. See Underpayment Penalty for 2016 at the end of this chapter.
Useful Items
You may want to see:
Publication
• Publication 505 Tax Withholding and Estimated Tax
Form (and Instructions)
• Form W-4 Employee's Withholding Allowance Certificate
• Form W-4P Withholding Certificate for Pension or Annuity Payments
• Form W-4S Request for Federal Income Tax Withholding From Sick Pay
• Form W-4V Voluntary Withholding Request
• Form 1040-ES Estimated Tax for Individuals
• Form 2210 Underpayment of Estimated Tax by Individuals, Estates, and Trusts
• Form 2210-F Underpayment of Estimated Tax by Farmers and Fishermen
Tax Withholding for 2017
This section discusses income tax withholding on:
• Salaries and wages,
• Tips,
• Taxable fringe benefits,
• Sick pay,
• Pensions and annuities,
• Gambling winnings,
• Unemployment compensation, and
• Certain federal payments.
This section explains the rules for withholding tax from each of these types of income.
This section also covers backup withholding on interest, dividends, and other payments.
Salaries and Wages
Income tax is withheld from the pay of most employees. Your pay includes your regular pay, bonuses, commissions, and vacation allowances. It also includes reimbursements and other expense allowances paid under a nonaccountable plan. See Supplemental Wages, later, for more information about reimbursements and allowances paid under a nonaccountable plan.
If your income is low enough that you won't have to pay income tax for the year, you may be exempt from withholding. This is explained under Exemption From Withholding, later.
You can ask your employer to withhold income tax from noncash wages and other wages not subject to withholding. If your employer doesn't agree to withhold tax, or if not enough is withheld, you may have to pay estimated tax, as discussed later under Estimated Tax for 2017.
Military retirees. Military retirement pay is treated in the same manner as regular pay for income tax withholding purposes, even though it is treated as a pension or annuity for other tax purposes.
Household workers. If you are a household worker, you can ask your employer to withhold income tax from your pay. A household worker is an employee who performs household work in a private home, local college club, or local fraternity or sorority chapter.
Tax is withheld only if you want it withheld and your employer agrees to withhold it. If you don't have enough income tax withheld, you may have to pay estimated tax, as discussed later under Estimated Tax for 2017.
Farmworkers. Generally, income tax is withheld from your cash wages for work on a farm unless your employer does both of these:
• Pays you cash wages of less than $150 during the year, and
• Has expenditures for agricultural labor totaling less than $2,500 during the year.
Differential wage payments. When employees are on leave from employment for military duty, some employers make up the difference between the military pay and civilian pay. Payments to an employee who is on active duty for a period of more than 30 days will be subject to income tax withholding, but not subject to social security, Medicare, or federal unemployment (FUTA) tax withholding. The wages and withholding will be reported on Form W-2, Wage and Tax Statement.
Determining Amount of Tax Withheld Using Form W-4
The amount of income tax your employer withholds from your regular pay depends on two things.
• The amount you earn in each payroll period.
• The information you give your employer on Form W-4.
Form W-4 includes four types of information that your employer will use to figure your withholding.
• Whether to withhold at the single rate or at the lower married rate.
• How many withholding allowances you claim (each allowance reduces the amount withheld).
• Whether you want an additional amount withheld.
• Whether you are claiming an exemption from withholding in 2017. See Exemption From Withholding, later.
Note. You must specify a filing status and a number of withholding allowances on Form W-4. You can't specify only a dollar amount of withholding.
New Job
When you start a new job, you must fill out Form W-4 and give it to your employer. Your employer should have copies of the form. If you need to change the information later, you must fill out a new form.
If you work only part of the year (for example, you start working after the beginning of the year), too much tax may be withheld. You may be able to avoid overwithholding if your employer agrees to use the part-year method. See Part-Year Method in chapter 1 of Pub. 505 for more information.
Employee also receiving pension income. If you receive pension or annuity income and begin a new job, you will need to file Form W-4 with your new employer. However, you can choose to split your withholding allowances between your pension and job in any manner.
Changing Your Withholding
During the year changes may occur to your marital status, exemptions, adjustments, deductions, or credits you expect to claim on your tax return. When this happens, you may need to give your employer a new Form W-4 to change your withholding status or your number of allowances.
If the changes reduce the number of allowances you are claiming or changes your marital status from married to single, you must give your employer a new Form W-4 within 10 days.
Generally, you can submit a new Form W-4 whenever you wish to change the number of your withholding allowances for any other reason.
Changing your withholding for 2018. If events in 2017 will decrease the number of your withholding allowances for 2018, you must give your employer a new Form W-4 by December 1, 2017. If the event occurs in December 2017, submit a new Form W-4 within 10 days.
Checking Your Withholding
After you have given your employer a Form W-4, you can check to see whether the amount of tax withheld from your pay is too little or too much. If too much or too little tax is being withheld, you should give your employer a new Form W-4 to change your withholding. You should try to have your withholding match your actual tax liability. If not enough tax is withheld, you will owe tax at the end of the year and may have to pay interest and a penalty. If too much tax is withheld, you will lose the use of that money until you get your refund. Always check your withholding if there are personal or financial changes in your life or changes in the law that might change your tax liability.
Note. You can't give your employer a payment to cover withholding on salaries and wages for past pay periods or a payment for estimated tax.
Completing Form W-4 and Worksheets
Form W-4 has worksheets to help you figure how many withholding allowances you can claim. The worksheets are for your own records. Don't give them to your employer.
Multiple jobs. If you have income from more than one job at the same time, complete only one set of Form W-4 worksheets. Then split your allowances between the Forms W-4 for each job. You can't claim the same allowances with more than one employer at the same time. You can claim all your allowances with one employer and none with the other(s), or divide them any other way.
Married individuals. If both you and your spouse are employed and expect to file a joint return, figure your withholding allowances using your combined income, adjustments, deductions, exemptions, and credits. Use only one set of worksheets. You can divide your total allowances any way, but you can't claim an allowance that your spouse also claims.
If you and your spouse expect to file separate returns, figure your allowances using separate worksheets based on your own individual income, adjustments, deductions, exemptions, and credits.
Alternative method of figuring withholding allowances. You don't have to use the Form W-4 worksheets if you use a more accurate method of figuring the number of withholding allowances. For more information, see Alternative method of figuring withholding allowances under Completing Form W-4 and Worksheets in Pub. 505, chapter 1.
Personal Allowances Worksheet. Use the Personal Allowances Worksheet on Form W-4 to figure your withholding allowances based on exemptions and any special allowances that apply.
Deduction and Adjustments Worksheet. Use the Deduction and Adjustments Worksheet on Form W-4 if you plan to itemize your deductions, claim certain credits, or claim adjustments to the income on your 2017 tax return and you want to reduce your withholding. Also, complete this worksheet when you have changes to these items to see if you need to change your withholding.
Two-Earners/Multiple Jobs Worksheet. You may need to complete the Two-Earners/Multiple Jobs Worksheet on Form W-4 if you have more than one job, a working spouse, or are also receiving a pension. Also, on this worksheet you can add any additional withholding necessary to cover any amount you expect to owe other than income tax, such as self-employment tax.
Getting the Right Amount of Tax Withheld
In most situations, the tax withheld from your pay will be close to the tax you figure on your return if you follow these two rules.
• You accurately complete all the Form W-4 worksheets that apply to you.
• You give your employer a new Form W-4 when changes occur.
But because the worksheets and withholding methods don't account for all possible situations, you may not be getting the right amount withheld. This is most likely to happen in the following situations.
• You are married and both you and your spouse work.
• You have more than one job at a time.
• You have nonwage income, such as interest, dividends, alimony, unemployment compensation, or self-employment income.
• You will owe additional amounts with your return, such as self-employment tax.
• Your withholding is based on obsolete Form W-4 information for a substantial part of the year.
• Your earnings are more than the amount shown under Check your withholding in the instructions at the top of page 1 of Form W-4.
• You work only part of the year.
• You change the number of your withholding allowances during the year.
Cumulative wage method. If you change the number of your withholding allowances during the year, too much or too little tax may have been withheld for the period before you made the change. You may be able to compensate for this if your employer agrees to use the cumulative wage withholding method for the rest of the year. You must ask your employer in writing to use this method.
To be eligible, you must have been paid for the same kind of payroll period (weekly, biweekly, etc.) since the beginning of the year.
To make sure you are getting the right amount of tax withheld, get Pub. 505. It will help you compare the total tax to be withheld during the year with the tax you can expect to figure on your return. It also will help you determine how much, if any, additional withholding is needed each payday to avoid owing tax when you file your return. If you don't have enough tax withheld, you may have to pay estimated tax, as explained under Estimated Tax for 2017, later.
TIP: You can use the IRS Withholding Calculator at IRS.gov/w4app, instead of Pub. 505 or the worksheets included with Form W-4, to determine whether you need to have your withholding increased or decreased.
Rules Your Employer Must Follow
It may be helpful for you to know some of the withholding rules your employer must follow. These rules can affect how to fill out your Form W-4 and how to handle problems that may arise.
New Form W-4. When you start a new job, your employer should have you complete a Form W-4. Beginning with your first payday, your employer will use the information you give on the form to figure your withholding.
If you later fill out a new Form W-4, your employer can put it into effect as soon as possible. The deadline for putting it into effect is the start of the first payroll period ending 30 or more days after you turn it in.
No Form W-4. If you don't give your employer a completed Form W-4, your employer must withhold at the highest rate, as if you were single and claimed no withholding allowances.
Repaying withheld tax. If you find you are having too much tax withheld because you didn't claim all the withholding allowances you are entitled to, you should give your employer a new Form W-4. Your employer can't repay any of the tax previously withheld. Instead, claim the full amount withheld when you file your tax return.
However, if your employer has withheld more than the correct amount of tax for the Form W-4 you have in effect, you don't have to fill out a new Form W-4 to have your withholding lowered to the correct amount. Your employer can repay the amount that was withheld incorrectly. If you aren't repaid, your Form W-2 will reflect the full amount actually withheld, which you would claim when you file your tax return.
Exemption From Withholding
If you claim exemption from withholding, your employer won't withhold federal income tax from your wages. The exemption applies only to income tax, not to social security, Medicare, or FUTA tax withholding.
You can claim exemption from withholding for 2017 only if both of the following situations apply.
• For 2016 you had a right to a refund of all federal income tax withheld because you had no tax liability.
• For 2017 you expect a refund of all federal income tax withheld because you expect to have no tax liability.
Students. If you are a student, you aren't automatically exempt. See chapter 1 to find out if you must file a return. If you work only part time or only during the summer, you may qualify for exemption from withholding.
Age 65 or older or blind. If you are 65 or older or blind, use Worksheet 1-3 or 1-4 in chapter 1 of Pub. 505, to help you decide if you qualify for exemption from withholding. Don't use either worksheet if you will itemize deductions, claim exemptions for dependents, or claim tax credits on your 2017 return. Instead, see Itemizing deductions or claiming exemptions or credits in chapter 1 of Pub. 505.
Claiming exemption from withholding. To claim exemption, you must give your employer a Form W-4. Don't complete lines 5 and 6. Enter "Exempt" on line 7.
If you claim exemption, but later your situation changes so that you will have to pay income tax after all, you must file a new Form W-4 within 10 days after the change. If you claim exemption in 2017, but you expect to owe income tax for 2018, you must file a new Form W-4 by December 1, 2017.
Your claim of exempt status may be reviewed by the IRS.
An exemption is good for only 1 year. You must give your employer a new Form W-4 by February 15 each year to continue your exemption.
Supplemental Wages
Supplemental wages include bonuses, commissions, overtime pay, vacation allowances, certain sick pay, and expense allowances under certain plans. The payer can figure withholding on supplemental wages using the same method used for your regular wages. However, if these payments are identified separately from your regular wages, your employer or other payer of supplemental wages can withhold income tax from these wages at a flat rate.
Expense allowances. Reimbursements or other expense allowances paid by your employer under a nonaccountable plan are treated as supplemental wages.
Reimbursements or other expense allowances paid under an accountable plan that are more than your proven expenses are treated as paid under a nonaccountable plan if you don't return the excess payments within a reasonable period of time.
For more information about accountable and nonaccountable expense allowance plans, see Reimbursements in chapter 26.
Penalties
You may have to pay a penalty of $500 if both of the following apply.
• You make statements or claim withholding allowances on your Form W-4 that reduce the amount of tax withheld.
• You have no reasonable basis for those statements or allowances at the time you prepare your Form W-4.
There is also a criminal penalty for willfully supplying false or fraudulent information on your Form W-4 or for willfully failing to supply information that would increase the amount withheld. The penalty upon conviction can be either a fine of up to $1,000 or imprisonment for up to 1 year, or both.
These penalties will apply if you deliberately and knowingly falsify your Form W-4 in an attempt to reduce or eliminate the proper withholding of taxes. A simple error or an honest mistake won't result in one of these penalties. For example, a person who has tried to figure the number of withholding allowances correctly, but claims seven when the proper number is six, won't be charged a W-4 penalty.
Tips
The tips you receive while working on your job are considered part of your pay. You must include your tips on your tax return on the same line as your regular pay. However, tax isn't withheld directly from tip income, as it is from your regular pay. Nevertheless, your employer will take into account the tips you report when figuring how much to withhold from your regular pay.
See chapter 6 for information on reporting your tips to your employer. For more information on the withholding rules for tip income, see Pub. 531, Reporting Tip Income.
How employer figures amount to withhold. The tips you report to your employer are counted as part of your income for the month you report them. Your employer can figure your withholding in either of two ways.
• By withholding at the regular rate on the sum of your pay plus your reported tips.
• By withholding at the regular rate on your pay plus a percentage of your reported tips.
Not enough pay to cover taxes. If your regular pay isn't enough for your employer to withhold all the tax (including income tax and social security and Medicare taxes (or the equivalent railroad retirement tax)) due on your pay plus your tips, you can give your employer money to cover the shortage. See Giving your employer money for taxes in chapter 6.
Allocated tips. Your employer shouldn't withhold income tax, Medicare tax, social security tax, or railroad retirement tax on any allocated tips. Withholding is based only on your pay plus your reported tips. Your employer should refund to you any incorrectly withheld tax. See Allocated Tips in chapter 6 for more information.
Taxable Fringe Benefits
The value of certain noncash fringe benefits you receive from your employer is considered part of your pay. Your employer generally must withhold income tax on these benefits from your regular pay.
For information on fringe benefits, see Fringe Benefits under Employee Compensation in chapter 5.
Although the value of your personal use of an employer-provided car, truck, or other highway motor vehicle is taxable, your employer can choose not to withhold income tax on that amount. Your employer must notify you if this choice is made.
For more information on withholding on taxable fringe benefits, see chapter 1 of Pub. 505.
Sick Pay
Sick pay is a payment to you to replace your regular wages while you are temporarily absent from work due to sickness or personal injury. To qualify as sick pay, it must be paid under a plan to which your employer is a party.
If you receive sick pay from your employer or an agent of your employer, income tax must be withheld. An agent who doesn't pay regular wages to you may choose to withhold income tax at a flat rate.
However, if you receive sick pay from a third party who isn't acting as an agent of your employer, income tax will be withheld only if you choose to have it withheld. See Form W-4S, later.
If you receive payments under a plan in which your employer doesn't participate (such as an accident or health plan where you paid all the premiums), the payments aren't sick pay and usually aren't taxable.
Union agreements. If you receive sick pay under a collective bargaining agreement between your union and your employer, the agreement may determine the amount of income tax withholding. See your union representative or your employer for more information.
Form W-4S. If you choose to have income tax withheld from sick pay paid by a third party, such as an insurance company, you must fill out Form W-4S. Its instructions contain a worksheet you can use to figure the amount you want withheld. They also explain restrictions that may apply.
Give the completed form to the payer of your sick pay. The payer must withhold according to your directions on the form.
Estimated tax. If you don't request withholding on Form W-4S, or if you don't have enough tax withheld, you may have to make estimated tax payments. If you don't pay enough tax, either through estimated tax or withholding, or a combination of both, you may have to pay a penalty. See Underpayment Penalty for 2016 at the end of this chapter.
Pensions and Annuities
Income tax usually will be withheld from your pension or annuity distributions unless you choose not to have it withheld. This rule applies to distributions from:
• A traditional individual retirement arrangement (IRA);
• A life insurance company under an endowment, annuity, or life insurance contract;
• A pension, annuity, or profit-sharing plan;
• A stock bonus plan; and
• Any other plan that defers the time you receive compensation.
The amount withheld depends on whether you receive payments spread out over more than 1 year (periodic payments), within 1 year (nonperiodic payments), or as an eligible rollover distribution (ERD). Income tax withholding from an ERD is mandatory.
More information. For more information on taxation of annuities and distributions (including ERDs) from qualified retirement plans, see chapter 10. For information on IRAs, see chapter 17. For more information on withholding on pensions and annuities, including a discussion of Form W-4P, see Pensions and Annuities in chapter 1 of Pub. 505.
Gambling Winnings
Income tax is withheld at a flat 25% rate from certain kinds of gambling winnings.
Gambling winnings of more than $5,000 from the following sources are subject to income tax withholding.
• Any sweepstakes; wagering pool, including payments made to winners of poker tournaments; or lottery.
• Any other wager, if the proceeds are at least 300 times the amount of the bet.
It doesn't matter whether your winnings are paid in cash, in property, or as an annuity. Winnings not paid in cash are taken into account at their fair market value.
Exception. Gambling winnings from bingo, keno, and slot machines generally aren't subject to income tax withholding. However, you may need to provide the payer with a social security number to avoid withholding. See Backup withholding on gambling winnings in chapter 1 of Pub. 505. If you receive gambling winnings not subject to withholding, you may need to pay estimated tax. See Estimated Tax for 2017, later.
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. See Underpayment Penalty for 2016 at the end of this chapter.
Form W-2G. If a payer withholds income tax from your gambling winnings, you should receive a Form W-2G, Certain Gambling Winnings, showing the amount you won and the amount withheld. Report the tax withheld on line 64 of Form 1040.
Unemployment Compensation
You can choose to have income tax withheld from unemployment compensation. To make this choice, fill out Form W-4V (or a similar form provided by the payer) and give it to the payer.
All unemployment compensation is taxable. If you don't have income tax withheld, you may have to pay estimated tax. See Estimated Tax for 2017, later.
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. For information, see Underpayment Penalty for 2016 at the end of this chapter.
Federal Payments
You can choose to have income tax withheld from certain federal payments you receive. These payments are:
1. Social security benefits,
2. Tier 1 railroad retirement benefits,
3. Commodity credit corporation loans you choose to include in your gross income,
4. Payments under the Agricultural Act of 1949 (7 U.S.C. 1421 et. seq.), as amended, or title II of the Disaster Assistance Act of 1988, that are treated as insurance proceeds and that you receive because:
a. Your crops were destroyed or damaged by drought, flood, or any other natural disaster, or
b. You were unable to plant crops because of a natural disaster described in (a), and
5. Any other payment under federal law as determined by the Secretary.
To make this choice, fill out Form W-4V (or a similar form provided by the payer) and give it to the payer.
If you don't choose to have income tax withheld, you may have to pay estimated tax. See Estimated Tax for 2017, later.
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. For information, see Underpayment Penalty for 2016 at the end of this chapter.
More information. For more information about the tax treatment of social security and railroad retirement benefits, see chapter 11. Get Pub. 225, Farmer's Tax Guide, for information about the tax treatment of commodity credit corporation loans or crop disaster payments.
Backup Withholding
Banks or other businesses that pay you certain kinds of income must file an information return (Form 1099) with the IRS. The information return shows how much you were paid during the year. It also includes your name and taxpayer identification number (TIN). TINs are explained in chapter 1 under Social Security Number (SSN).
These payments generally aren't subject to withholding. However, "backup" withholding is required in certain situations. Backup withholding can apply to most kinds of payments that are reported on Form 1099.
The payer must withhold at a flat 28% rate in the following situations.
• You don't give the payer your TIN in the required manner.
• The IRS notifies the payer that the TIN you gave is incorrect.
• You are required, but fail, to certify that you aren't subject to backup withholding.
• 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 210-day period.
See Backup Withholding in chapter 1 of Pub. 505 for more information.
Penalties. There are civil and criminal penalties for giving false information to avoid backup withholding. The civil penalty is $500. The criminal penalty, upon conviction, is a fine of up to $1,000 or imprisonment of up to 1 year, or both.
Estimated Tax for 2017
Estimated tax is the method used to pay tax on income that isn't subject to withholding. This includes income from self-employment, interest, dividends, alimony, rent, gains from the sale of assets, prizes, and awards. You also may have to pay estimated tax if the amount of income tax being withheld from your salary, pension, or other income isn't enough.
Estimated tax is used to pay both income tax and self-employment tax, as well as other taxes and amounts reported on your tax return. 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. If you don't pay enough by the due date of each payment period (see When To Pay Estimated Tax, later), you may be charged a penalty even if you are due a refund when you file your tax return. For information on when the penalty applies, see Underpayment Penalty for 2016 at the end of this chapter.
Who Doesn't Have To Pay Estimated Tax
If you receive salaries or wages, you can avoid having to pay estimated tax by asking your employer to take more tax out of your earnings. To do this, give a new Form W-4 to your employer. See chapter 1 of Pub. 505.
Estimated tax not required. You don't have to pay estimated tax for 2017 if you meet all three of the following conditions.
• You had no tax liability for 2016.
• You were a U.S. citizen or resident alien for the whole year.
• Your 2016 tax year covered a 12-month period.
You had no tax liability for 2016 if your total tax was zero or you didn't have to file an income tax return. For the definition of "total tax" for 2016, see Pub. 505, chapter 2.
Who Must Pay Estimated Tax
If you owe additional tax for 2016, you may have to pay estimated tax for 2017.
You can use the following general rule as a guide during the year to see if you will have enough withholding, or if you should increase your withholding or make estimated tax payments.
General rule. In most cases, you must pay estimated tax for 2017 if both of the following apply.
1. You expect to owe at least $1,000 in tax for 2017, after subtracting your withholding and refundable credits.
2. You expect your withholding plus your refundable credits to be less than the smaller of:
a. 90% of the tax to be shown on your 2017 tax return, or
b. 100% of the tax shown on your 2016 tax return (but see Special rules for farmers, fishermen, and higher income taxpayers, later). Your 2016 tax return must cover all 12 months.
Special rules for farmers, fishermen, and higher income taxpayers. If at least two-thirds of your gross income for tax year 2016 or 2017 is from farming or fishing, substitute 66 2/3% for 90% in (2a) under the General rule, earlier. If your AGI for 2016 was more than $150,000 ($75,000 if your filing status for 2017 is married filing a separate return), substitute 110% for 100% in (2b) under General rule, earlier. See Figure 4-A and Pub. 505, chapter 2 for more information.
[The following graphic has not been reproduced:
Figure 4-A. Do You Have To Pay Estimated Tax?]
Aliens. Resident and nonresident aliens also may have to pay estimated tax. Resident aliens should follow the rules in this chapter unless noted otherwise. Nonresident aliens should get Form 1040-ES (NR), U.S. Estimated Tax for Nonresident Alien Individuals.
You are an alien if you aren't a citizen or national of the United States. You are a resident alien if you either have a green card or meet the substantial presence test. For more information about the substantial presence test, see Pub. 519, U.S. Tax Guide for Aliens.
Married taxpayers. If you qualify to make joint estimated tax payments, apply the rules discussed here to your joint estimated income.
You and your spouse can make joint estimated tax payments even if you aren't living together.
However, you and your spouse can't make joint estimated tax payments if:
• You are legally separated under a decree of divorce or separate maintenance,
• You and your spouse have different tax years, or
• Either spouse is a nonresident alien (unless that spouse elected to be treated as a resident alien for tax purposes (see chapter 1 of Pub. 519)).
If you don't qualify to make joint estimated tax payments, apply these rules to your separate estimated income. Making joint or separate estimated tax payments won't affect your choice of filing a joint tax return or separate returns for 2017.
2016 separate returns and 2017 joint return. If you plan to file a joint return with your spouse for 2017, but you filed separate returns for 2016, your 2016 tax is the total of the tax shown on your separate returns. You filed a separate return if you filed as single, head of household, or married filing separately.
2016 joint return and 2017 separate returns. If you plan to file a separate return for 2017 but you filed a joint return for 2016, your 2016 tax is your share of the tax on the joint return. You file a separate return if you file as single, head of household, or married filing separately.
To figure your share of the tax on the joint return, first figure the tax both you and your spouse would have paid had you filed separate returns for 2016 using the same filing status as for 2017. Then multiply the tax on the joint return by the following fraction.
The tax you would have paid had
you filed a separate return
-------------------------------
The total tax you and your
spouse would have paid had
you filed separate returns
Example. Joe and Heather filed a joint return for 2016 showing taxable income of $48,500 and a tax of $6,351. Of the $48,500 taxable income, $40,100 was Joe's and the rest was Heather's. For 2017, they plan to file married filing separately. Joe figures his share of the tax on the 2016 joint return as follows.
Tax on $40,100 based on a
separate return $5,803
Tax on $8,400 based on a
separate return 843
------
Total $6,646
Joe's percentage of total
($5,803 ÷ $6,646) 87.3%
Joe's share of tax on joint
return
($6,351 × 87.3%) $5,544
======
How To Figure Estimated Tax
To figure your estimated tax, you must figure your expected adjusted gross income (AGI), taxable income, taxes, deductions, and credits for the year.
When figuring your 2017 estimated tax, it may be helpful to use your income, deductions, and credits for 2016 as a starting point. Use your 2016 federal tax return as a guide. You can use Pub. 505 to figure your estimated tax. Nonresident aliens use Form 1040-ES (NR) and Pub. 505 to figure estimated tax (see chapter 8 of Pub. 519 for more information).
You must make adjustments both for changes in your own situation and for recent changes in the tax law. For a discussion of these changes, visit IRS.gov.
For more complete information on how to figure your estimated tax for 2017, see chapter 2 of Pub. 505.
When To Pay Estimated Tax
For estimated tax purposes, the tax year is divided into four payment periods. Each period has a specific payment due date. If you don't pay enough tax by the due date of each payment period, you may be charged a penalty even if you are due a refund when you file your income tax return. The payment periods and due dates for estimated tax payments are shown next.
For the period: Due date:*
Jan. 1 - March 31 April 18
April 1 - May 31 June 15
June 1 - August 31 Sept. 15
Sept. 1- Dec. 31 Jan. 16, next year
------------------------------------------
* See Saturday, Sunday, holiday rule and
January payment.
==========================================
Saturday, Sunday, holiday rule. If the due date for an estimated tax payment falls on a Saturday, Sunday, or legal holiday, the payment will be on time if you make it on the next day that isn't a Saturday, Sunday, or legal holiday.
January payment. If you file your 2017 Form 1040 or Form 1040A by January 31, 2018, and pay the rest of the tax you owe, you don't need to make the payment due on January 16, 2018.
Fiscal year taxpayers. If your tax year doesn't start on January 1, see the Form 1040-ES instructions for your payment due dates.
When To Start
You don't have to make estimated tax payments until you have income on which you will owe income tax. If you have income subject to estimated tax during the first payment period, you must make your first payment by the due date for the first payment period. You can pay all your estimated tax at that time, or you can pay it in installments. If you choose to pay in installments, make your first payment by the due date for the first payment period. Make your remaining installment payments by the due dates for the later periods.
No income subject to estimated tax during first period. If you don't have income subject to estimated tax until a later payment period, you must make your first payment by the due date for that period. You can pay your entire estimated tax by the due date for that period or you can pay it in installments by the due date for that period and the due dates for the remaining periods. The following chart shows when to make installment payments.
---------------------------------------------------
If you first have
income on
which you must Make a Make later
pay estimated payment installments
tax: by:* by:*
---------------------------------------------------
Before April 1 April 18 June 15
Sept. 15
Jan. 16, next year
---------------------------------------------------
April 1-May 31 June 15 Sept. 15
Jan. 16, next year
---------------------------------------------------
June 1-Aug. 31 Sept. 15 Jan. 16, next year
---------------------------------------------------
After Aug. 31 Jan. 16, (None)
next year
---------------------------------------------------
* See Saturday, Sunday, holiday rule and January
payment.
===================================================
How much to pay to avoid a penalty. To determine how much you should pay by each payment due date, see How To Figure Each Payment, next.
How To Figure Each Payment
You should pay enough estimated tax by the due date of each payment period to avoid a penalty for that period. You can figure your required payment for each period by using either the regular installment method or the annualized income installment method. These methods are described in chapter 2 of Pub. 505. If you don't pay enough during each payment period, you may be charged a penalty even if you are due a refund when you file your tax return.
If the earlier discussion of No income subject to estimated tax during first period or the later discussion of Change in estimated tax applies to you, you may benefit from reading Annualized Income Installment Method in chapter 2 of Pub. 505 for information on how to avoid a penalty.
Underpayment penalty. Under the regular installment method, if your estimated tax payment for any period is less than one-fourth of your estimated tax, you may be charged a penalty for underpayment of estimated tax for that period when you file your tax return. Under the annualized income installment method, your estimated tax payments vary with your income, but the amount required must be paid each period. See chapter 4 of Pub. 505 for more information.
Change in estimated tax. After you make an estimated tax payment, changes in your income, adjustments, deductions, credits, or exemptions may make it necessary for you to refigure your estimated tax. Pay the unpaid balance of your amended estimated tax by the next payment due date after the change or in installments by that date and the due dates for the remaining payment periods.
Estimated Tax Payments Not Required
You don't have to pay estimated tax if your withholding in each payment period is at least as much as:
• One-fourth of your required annual payment, or
• Your required annualized income installment for that period.
You also don't have to pay estimated tax if you will pay enough through withholding to keep the amount you owe with your return under $1,000.
How To Pay Estimated Tax
There are several ways to pay estimated tax.
• Credit an overpayment on your 2016 return to your 2017 estimated tax.
• Pay by direct transfer from your bank account, or pay by debit or credit card using a pay-by-phone system or the Internet.
• Send in your payment (check or money order) with a payment voucher from Form 1040-ES.
Credit an Overpayment
If you show an overpayment of tax after completing your Form 1040A for 2016, you can apply part or all of it to your estimated tax for 2017. On line 77 of Form 1040, or line 49 of Form 1040A, enter the amount you want credited to your estimated tax rather than refunded. Take the amount you have credited into account when figuring your estimated tax payments.
You can't have any of the amount you credited to your estimated tax refunded to you until you file your tax return for the following year. You also can't use that overpayment in any other way.
Pay Online
The IRS offers an electronic payment option that is right for you. Paying online is convenient, secure, and helps make sure we get your payments on time. To pay your taxes online or for more information, go to IRS.gov/payments. You can pay using any of the following methods.
• IRS Direct Pay for online transfers directly from your checking or savings account at no cost to you. Go to IRS.gov/payments.
• Pay by Card to pay by debit or credit card. Go to IRS.gov/payments. A convenience fee is charged by these service providers.
• Electronic Funds Withdrawal(EFW) is an integrated e-file/e-pay option offered when filing your federal taxes electronically using tax preparation software, through a tax professional, or the IRS at IRS.gov/payments.
• Online Payment Agreement if you can't pay in full by the due date of your tax return. You can apply for an online monthly installment agreement at IRS.gov/payments. Once you complete the online process, you will receive immediate notification of whether your agreement has been approved. A convenience fee is charged.
• IRS2GO is the mobile application of the IRS. You can access Direct Pay or Pay By Card by downloading the application.
Pay by Phone
Paying by phone is another safe and secure method of paying electronically. Use one of the following methods (1) call one of the debit or credit card providers or (2) use the Electronic Federal Tax Payment System (EFTPS).
1. Debit or credit card. Call one of our service providers. Each charges a fee that varies by provider, card type, and payment amount.
Link2Gov Corporation 1-888-PAY-1040™ (1-888-729-1040) http://www.PAY1040.com
WorldPay US, Inc. 1-844-PAY-TAX-8™ (1-844-729-8298) http://www.payUSAtax.com
Official Payments Corporation 1-888-UPAY-TAX™ (1-888-872-9829) http://www.officialpayments.com
2. EFTPS. To use EFTPS, you must be enrolled either online or have an enrollment form mailed to you. To make a payment using EFTPS, call 1-800-555-4477 (English) or 1-800-244-4829 (Español). People who are deaf, hard of hearing, or have a speech disability and who have access to TTY/TDD equipment can call 1-800-733-4829. For more information about EFTPS, go to IRS.gov/payments or http://www.eftps.gov.
For the latest details on how to pay by phone, go to IRS.gov/Payments.
Pay by Mobile Device
To pay through your mobile device, download the IRS2Go application.
Pay With Cash
Paying with cash is a new in-person payment option for individuals. This service is provided through retail partners and is limited $1,000 per day per transaction. To make a cash payment, you must first be registered online at http://www.officialpayments.com, our Official Payment provider.
Pay by Check or Money Order Using the Estimated Tax Payment Voucher
Before submitting a payment through the mail using the estimated tax payment voucher, please consider alternative methods. One of our safe, quick, and easy electronic payment options might be right for you.
If you choose to mail in your payment, each payment of estimated tax by check or money order must be accompanied by a payment voucher from Form 1040-ES.
During 2016, if you:
• made at least one estimated tax payment but not by electronic means,
• didn't use software or a paid preparer to prepare or file your return,
then you should receive a copy of the 2017 V.
The enclosed payment vouchers will be preprinted with your name, address, and social security number. Using the preprinted vouchers will speed processing, reduce the chance of error, and help save processing costs.
Use the window envelopes that came with your Form 1040-ES package. If you use your own envelopes, make sure you mail your payment vouchers to the address shown in the Form 1040-ES instructions for the place where you live.
Note. These criteria can change without notice. If you don't receive a V package and you are required to make an estimated tax payment, you should go to IRS.gov/form1040es and print a copy of Form 1040-ES which includes four blank payment vouchers. Complete one of these and make your payment timely to avoid penalties for paying late.
CAUTION: Don't use the address shown in the Form 1040A instructions for your estimated tax payments.
If you didn't pay estimated tax last year, you can order Form 1040-ES from the IRS (see inside back cover of this publication) or download it from IRS.gov. Follow the instructions to make sure you use the vouchers correctly.
Joint estimated tax payments. If you file a joint return and are making joint estimated tax payments, enter the names and social security numbers on the payment voucher in the same order as they will appear on the joint return.
Change of address. You must notify the IRS if you are making estimated tax payments and you changed your address during the year. Complete Form 8822, Change of Address, and mail it to the address shown in the instructions for that form.
Credit for Withholding and Estimated Tax for 2016
When you file your 2016 income tax return, take credit for all the income tax and excess social security or railroad retirement tax withheld from your salary, wages, pensions, etc. Also take credit for the estimated tax you paid for 2016. These credits are subtracted from your total tax. Because these credits are refundable, you should file a return and claim these credits, even if you don't owe tax.
Two or more employers. If you had two or more employers in 2016 and were paid wages of more than $118,500, too much social security or tier 1 railroad retirement tax may have been withheld from your pay. You may be able to claim the excess as a credit against your income tax when you file your return. See Credit for Excess Social Security Tax or Railroad Retirement Tax Withheld in chapter 38.
Withholding
If you had income tax withheld during 2016, you should be sent a statement by January 31, 2017, showing your income and the tax withheld. Depending on the source of your income, you should receive:
• Form W-2, Wage and Tax Statement,
• Form W-2G, Certain Gambling Winnings, or
• A form in the 1099 series.
Forms W-2 and W-2G. If you file a paper return, always file Form W-2 with your income tax return. File Form W-2G with your return only if it shows any federal income tax withheld from your winnings.
You should get at least two copies of each form. If you file a paper return, attach one copy to the front of your federal income tax return. Keep one copy for your records. You also should receive copies to file with your state and local returns.
Form W-2
Your employer is required to provide or send Form W-2 to you no later than January 31, 2017. You should receive a separate Form W-2 from each employer you worked for.
If you stopped working before the end of 2016, your employer could have given you your Form W-2 at any time after you stopped working. However, your employer must provide or send it to you by January 31, 2017.
If you ask for the form, your employer must send it to you within 30 days after receiving your written request or within 30 days after your final wage payment, whichever is later.
If you haven't received your Form W-2 by January 31, you should ask your employer for it. If you don't receive it by February 15, call the IRS.
Form W-2 shows your total pay and other compensation and the income tax, social security tax, and Medicare tax that was withheld during the year. Include the federal income tax withheld (as shown in box 2 of Form W-2) on:
• Line 64 if you file Form 1040,
• Line 40 if you file Form 1040A, or
• Line 7 if you file Form 1040EZ.
In addition, Form W-2 is used to report any taxable sick pay you received and any income tax withheld from your sick pay.
Form W-2G
If you had gambling winnings in 2016, the payer may have withheld income tax. If tax was withheld, the payer will give you a Form W-2G showing the amount you won and the amount of tax withheld.
Report the amounts you won on line 21 of Form 1040. Take credit for the tax withheld on line 64 of Form 1040. If you had gambling winnings, you must use Form 1040; you can't use Form 1040EZ.
The 1099 Series
Most forms in the 1099 series aren't filed with your return. These forms should be furnished to you by January 31, 2017 (or, for Forms 1099-B, 1099-S, and certain Forms 1099-MISC, by February 15, 2017). Unless instructed to file any of these forms with your return, keep them for your records. There are several different forms in this series, including:
• Form 1099-B, Proceeds From Broker and Barter Exchange Transactions;
• Form 1099-DIV, Dividends and Distributions;
• Form 1099-G, Certain Government Payments;
• Form 1099-INT, Interest Income;
• Form 1099-K, Payment Card and Third Party Network Transactions;
• Form 1099-MISC, Miscellaneous Income;
• Form 1099-OID, Original Issue Discount;
• Form 1099-PATR, Taxable Distributions Received From Cooperatives;
• Form 1099-Q, Payments From Qualified Education Programs;
• Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.;
• Form 1099-S, Proceeds From Real Estate Transactions;
• Form RRB-1099, Payments by the Railroad Retirement Board.
If you received the types of income reported on some forms in the 1099 series, you may not be able to use Form 1040EZ. See the instructions to these forms for details.
Form 1099-R. Attach Form 1099-R to your paper return if box 4 shows federal income tax withheld. Include the amount withheld in the total on line 64 of Form 1040A. You can't use Form 1040EZ if you received payments reported on Form 1099-R.
Backup withholding. If you were subject to backup withholding on income you received during 2016, include the amount withheld, as shown on your Form 1099, in the total on line 64 of Form 1040A, or line 7 of Form 1040EZ.
Form Not Correct
If you receive a form with incorrect information on it, you should ask the payer for a corrected form. Call the telephone number or write to the address given for the payer on the form. The corrected Form W-2G or Form 1099 you receive will have an "X" in the "CORRECTED" box at the top of the form. A special form, Form W-2c, Corrected Wage and Tax Statement, is used to correct a Form W-2.
In certain situations, you will receive two forms in place of the original incorrect form. This will happen when your taxpayer identification number is wrong or missing, your name and address are wrong, or you received the wrong type of form (for example, a Form 1099-DIV instead of a Form 1099-INT). One new form you receive will be the same incorrect form or have the same incorrect information, but all money amounts will be zero. This form will have an "X" in the "CORRECTED" box at the top of the form. The second new form should have all the correct information, prepared as though it is the original (the "CORRECTED" box won't be checked).
Form Received After Filing
If you file your return and you later receive a form for income that you didn't include on your return, you should report the income and take credit for any income tax withheld by filing Form 1040X, Amended U.S. Individual Income Tax Return.
Separate Returns
If you are married but file a separate return, you can take credit only for the tax withheld from your own income. Don't include any amount withheld from your spouse's income. However, different rules may apply if you live in a community property state.
Community property states are listed in chapter 2. For more information on these rules, and some exceptions, see Pub. 555, Community Property.
Fiscal Years
If you file your tax return on the basis of a fiscal year (a 12-month period ending on the last day of any month except December), you must follow special rules to determine your credit for federal income tax withholding. For a discussion of how to take credit for withholding on a fiscal year return, see Fiscal Years (FY) in chapter 3 of Pub. 505.
Estimated Tax
Take credit for all your estimated tax payments for 2016 on line 65 of Form 1040 or line 41 of Form 1040A. Include any overpayment from 2015 that you had credited to your 2016 estimated tax. You must use Form 1040 or Form 1040A if you paid estimated tax. You can't use Form 1040EZ.
Name changed. If you changed your name, and you made estimated tax payments using your old name, attach a brief statement to the front of your paper tax return indicating:
• When you made the payments,
• The amount of each payment,
• Your name when you made the payments, and
• Your social security number.
The statement should cover payments you made jointly with your spouse as well as any you made separately.
Be sure to report the change to the Social Security Administration. This prevents delays in processing your return and issuing any refunds.
Separate Returns
If you and your spouse made separate estimated tax payments for 2016 and you file separate returns, you can take credit only for your own payments.
If you made joint estimated tax payments, you must decide how to divide the payments between your returns. One of you can claim all of the estimated tax paid and the other none, or you can divide it in any other way you agree on. If you can't agree, you must divide the payments in proportion to each spouse's individual tax as shown on your separate returns for 2016.
Divorced Taxpayers
If you made joint estimated tax payments for 2016, and you were divorced during the year, either you or your former spouse can claim all of the joint payments, or you each can claim part of them. If you can't agree on how to divide the payments, you must divide them in proportion to each spouse's individual tax as shown on your separate returns for 2016.
If you claim any of the joint payments on your tax return, enter your former spouse's social security number (SSN) in the space provided on the front of Form 1040A. If you divorced and remarried in 2016, enter your present spouse's SSN in that space and write your former spouse's SSN, followed by "DIV," to the left of Form 1040, line 65, or Form 1040A, line 41.
Underpayment Penalty for 2016
If you didn't pay enough tax, either through withholding or by making timely estimated tax payments, you will have an underpayment of estimated tax and you may have to pay a penalty.
Generally, you won't have to pay a penalty for 2016 if any of the following apply.
• The total of your withholding and estimated tax payments was at least as much as your 2015 tax (or 110% of your 2015 tax if your AGI was more than $150,000, $75,000 if your 2016 filing status is married filing separately) and you paid all required estimated tax payments on time;
• The tax balance due on your 2016 return is no more than 10% of your total 2016 tax, and you paid all required estimated tax payments on time;
• Your total 2016 tax minus your withholding and refundable credits is less than $1,000;
• You didn't have a tax liability for 2015 and your 2015 tax year was 12 months; or
• You didn't have any withholding taxes and your current year tax less any household employment taxes is less than $1,000.
See Pub. 505, chapter 4, for a definition of "total tax" for 2015 and 2016.
Farmers and fishermen. Special rules apply if you are a farmer or fisherman. See Farmers and Fishermen in chapter 4 of Pub. 505 for more information.
IRS can figure the penalty for you. If you think you owe the penalty but you don't want to figure it yourself when you file your tax return, you may not have to. Generally, the IRS will figure the penalty for you and send you a bill. However, if you think you are able to lower or eliminate your penalty, you must complete Form 2210 or Form 2210-F and attach it to your paper return. See chapter 4 of Pub. 505.
The eight chapters in this part discuss many kinds of income. They explain which income is and is not taxed. See Part Three for information on gains and losses you report on Form 8949 and Schedule D (Form 1040) and for information on selling your home.
5. Wages, Salaries, and Other Earnings
Reminder
Foreign income. If you're 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's 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. For details, see Pub. 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad.
Introduction
This chapter discusses compensation received for services as an employee, such as wages, salaries, and fringe benefits. The following topics are included.
• Bonuses and awards.
• Special rules for certain employees.
• Sickness and injury benefits.
The chapter explains what income is included and isn't included in the employee's gross income and what's not included.
Useful Items
You may want to see:
Publication
• Publication 525 Taxable and Nontaxable Income
• Publication 554 Tax Guide for Seniors
• Publication 926 Household Employer's Tax Guide
• Publication 3920 Tax Relief for Victims of Terrorist Attacks
Employee Compensation
This section discusses various types of employee compensation including fringe benefits, retirement plan contributions, stock options, and restricted property.
Form W-2. If you're an employee, you should receive a Form W-2 from your employer showing the pay you received for your services. Include your pay on line 7 of Form 1040A, or on line 1 of Form 1040EZ, even if you don't receive a Form W-2.
In some instances your employer isn't required to give you a Form W-2. Your employer isn't required to give you a Form W-2 if you perform household work in your employer's home for less than $2,000 in cash wages during the calendar year and you have no federal income taxes withheld from your wages. Household work is work done in or around an employer's home. Some examples of workers who do household work are:
• Babysitters,
• Caretakers,
• House cleaning workers,
• Domestic workers,
• Drivers,
• Health aides,
• Housekeepers,
• Maids,
• Nannies,
• Private nurses, and
• Yard workers.
See Schedule H (Form 1040), Household Employment Taxes, and its instructions, and Pub. 926, Household Employer's Tax Guide, for more information.
If you performed services, other than as an independent contractor, and your employer didn't withhold social security and Medicare taxes from your pay, you must file Form 8919, Uncollected Social Security and Medicare Tax on Wages, with your Form 1040. See Form 8919 and its instructions for more information on how to calculate unreported wages and taxes and how to include them on your income tax return.
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 aren't an employee, you're probably self-employed and must include payments for your services on Schedule C (Form 1040), Profit or Loss From Business, or Schedule C-EZ (Form 1040), Net Profit From Business. You generally aren't an employee unless you're subject to the will and control of the person who employs you as to what you're to do and how you're to do it.
Babysitting. If you're paid to babysit, even 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're an employee or self-employed person, your income could be subject to self-employment tax. See the instructions for SE (Form 1040) if you're self-employed. Also see Pub. 926, Household Employer's Tax Guide for more information.
Miscellaneous Compensation
This section discusses 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're a cash-method taxpayer, you must include these amounts in your income in the year you receive them.
If you repay unearned commissions or other amounts in the same year you receive them, reduce the amount included in your income by the repayment. If you repay them in a later tax year, you can deduct the repayment as an itemized deduction on your Schedule A (Form 1040), or you may be able to take a credit for that year. See Repayments in chapter 12.
Allowances and reimbursements. If you receive travel, transportation, or other business expense allowances or reimbursements from your employer, see Pub. 521, Moving Expenses.
Back pay awards. If you receive an amount in payment of a settlement or judgment for back pay, you must include the amount of the payment in your income. This includes 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. If you receive a bonus or award (cash, goods, services) from your employer, you must include its value 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's 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. The amount you can exclude is limited to your employer's cost and can't be more than $1,600 for qualified plan awards or $400 for nonqualified 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 the following awards.
• A length-of-service award if you received it for less than 5 years of service or if you received another length-of-service award during the year or the previous 4 years.
• A safety achievement award if you're a manager, administrator, clerical employee, or other professional employee or if more than 10% of eligible employees previously received safety achievement awards during the year.
Example. Ben Green received three employee achievement awards during the year: a nonqualified plan award of a watch valued at $250, two qualified plan awards of a stereo valued at $1,000, and a set of golf clubs valued at $500. Assuming that the requirements for qualified plan awards are otherwise satisfied, each award by itself would be excluded from income. However, because the $1,750 total value of the awards is more than $1,600, Ben must include $150 ($1,750 - $1,600) in his income.
Differential wage payments. This is any payment made to you by an employer for any period during which you're, 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 you would have received from the employer during that period. These payments are treated as wages and are subject to income tax withholding, but not 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. Pub. 516, U.S. Government Civilian Employees Stationed Abroad, explains the tax treatment of allowances, differentials, and other special pay you receive for employment abroad.
Nonqualified deferred compensation plans. Your employer may report to you the total amount of deferrals for the year under a nonqualified deferred compensation plan 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 to the extent vested and not previously included in income are included in your income for the current year. This amount is included in your wages shown on Form W-2, box 1. It's also shown on Form W-2, box 12, using code Z.
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. Don't include that part again in your income. Include the rest of the payment in your income in the year of payment.
If your employer gives you a nonnegotiable unsecured note as payment for your services, payments on the note that are credited toward the principal amount of the note are compensation income when you receive them.
Severance pay. If you receive a severance payment when your employment with your employer ends or is terminated, you must include this amount in your income.
Accrued leave payment. If you're 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 the 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're sick or injured is part of your salary or wages. In addition, you must include in your income sick pay benefits received from any of the following payers.
• A welfare fund.
• A state sickness or disability fund.
• An association of employers or employees.
• An insurance company, if your employer paid for the plan.
However, if you paid the premiums on an accident or health insurance policy yourself, the benefits you receive under the policy aren't taxable. For more information, see Pub. 525.
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 also is 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're a household worker or a farm worker.
Stock appreciation rights. Don't include a stock appreciation right granted by your employer in income until you exercise (use) the right. When you use the right, you're generally 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 your income in the year you use the right.
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're 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.
Accounting period. You must use the same accounting period your employer uses to report your taxable noncash fringe benefits. Your employer has the option to report taxable noncash fringe benefits by using either of the following rules.
• The general rule: benefits are reported for a full calendar year (January 1-December 31).
• The special accounting period rule: benefits provided during the last 2 months of the calendar year (or any shorter period) are treated as paid during the following calendar year. For example, each year your employer reports the value of benefits provided during the last 2 months of the prior year and the first 10 months of the current year.
Your employer 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 (for use of a car, for example).
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, as explained later under Sickness and Injury Benefits.
For information on the items covered in this section, other than Long-term care coverage, see Pub. 969, Health Savings Accounts and Other Tax-Favored Health Plans.
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 offered by your employer must be included in your income. This amount will be reported as wages in box 1 of your Form W-2.
Contributions you make to the plan are discussed in Pub. 502, Medical and Dental Expenses.
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, Archer MSAs and Long-Term Care Insurance Contracts. File the form with your return.
Health flexible spending arrangement (health FSA). If your employer provides a health FSA that qualifies as an accident or health plan, the amount of your salary reduction, and reimbursements of your medical care expenses, in most cases, aren't included in your income.
Note. Health FSAs are subject to a $2,500 limit on salary reduction contributions for plan years beginning after 2012. The $2,500 limit is subject to an inflation adjustment for plan years beginning after 2013. For more information, see Notice 2012-40, 2012-26 I.R.B. 1046, available at IRS.gov/irb/2012-26_IRB/ar09.html.
For tax year 2016, the dollar limitation under section 125(i) on voluntary employee salary reductions for contributions to health flexible spending arrangements is $2,550.
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're 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. See Pub. 969 for the requirements of an HSA.
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. See the Instructions for Form 8839, Qualified Adoption Expenses, for more information.
Adoption benefits are reported by your employer in box 12 of Form W-2 with code T. They also are included as social security and Medicare wages in boxes 3 and 5. However, they aren't included as wages in box 1. To determine the taxable and nontaxable amounts, you must complete Part III of Form 8839. File the form with your return.
De Minimis (Minimal) Benefits
If your employer provides you with a product or service and the cost of it is so small that it would be unreasonable for the employer to account for it, you generally don't include its value in your income. In most cases, don't include in your income the value of discounts at company cafeterias, cab fares home when working overtime, and company picnics.
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 or a cash equivalent, you must include it in your income.
Educational Assistance
You can exclude from your income up to $5,250 of qualified employer-provided educational assistance. For more information, see Pub. 970, Tax Benefits for Education.
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.
For exceptions, see Entire cost excluded, and Entire cost taxed, later.
If your employer provided more than $50,000 of coverage, the amount included in your income is reported as part of your wages in box 1 of your Form W-2. Also, it's 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 (travel insurance, for example) 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's 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 Form 1040, line 62, and follow the instructions there.
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. Use Worksheet 5-1 to figure the amount to include in your income.
Worksheet 5-1. Figuring the Cost of Group-Term Life Insurance To Include in Income
Keep for Your Records
----------------------------------------------
1. Enter the total amount of
your insurance coverage
from your
employer(s) 1. ______
2. Limit on exclusion for
employer-provided
group-term life insurance
coverage 2. 50,000
3. Subtract line 2 from
line 1 3. ______
4. Divide line 3 by $1,000.
Figure to the nearest
tenth 4. ______
5. Go to Table 5-1. Using your
age on the last day of the tax
year, find your age group in
the left column, and enter the
cost from the column on the
right for your age
group 5. ______
6. Multiply line 4 by
line 5 6. ______
7. Enter the number of full
months of coverage at this
cost 7. ______
8. Multiply line 6 by
line 7 8. ______
9. Enter the
premiums you paid
per month 9. ______
10. Enter the number
of months you paid
the premiums 10. ______
11. Multiply line 9 by
line 10 11. ______
12. Subtract line 11 from line 8.
Include this amount in
your income as
wages 12. ______
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Table 5-1. Cost of $1,000 of Group-Term Life Insurance for One Month
Age Cost
Under 25 $0.05
25 through 29 0.06
30 through 34 0.08
35 through 39 0.09
40 through 44 0.10
45 through 49 0.15
50 through 54 0.23
55 through 59 0.43
60 through 64 0.66
65 through 69 1.27
70 and above 2.06
Example. You are 51 years old and work for employers A and B. Both employers provide group-term life insurance coverage for you for the entire year. Your coverage is $35,000 with employer A and $45,000 with employer B. You pay premiums of $4.15 a month under the employer B group plan. You figure the amount to include in your income as shown in Worksheet 5-1. Figuring the Cost of Group-Term Life Insurance to Include in Income--Illustrated next.
Worksheet 5-1. Figuring the Cost of Group-Term Life Insurance to Include in Income -- Illustrated
Keep for Your Records
----------------------------------------------
1. Enter the total amount of
your insurance coverage
from your
employer(s) 1. 80,000
2. Limit on exclusion for
employer-provided
group-term life insurance
coverage 2. 50,000
3. Subtract line 2 from
line 1 3. 30,000
4. Divide line 3 by $1,000.
Figure to the nearest
tenth 4. 30.0
5. Go to Table 5-1. Using your
age on the last day of the tax
year, find your age group in
the left column, and enter the
cost from the column on the
right for your age
group 5. 0.23
6. Multiply line 4 by
line 5 6. 6.90
7. Enter the number of full
months of coverage at this
cost 7. 12
8. Multiply line 6 by
line 7 8. 82.80
9. Enter the
premiums you paid
per month 9. 4.15
10. Enter the number
of months you paid
the premiums 10. 12
11. Multiply line 9 by
line 10 11. 49.80
12. Subtract line 11 from line 8.
Include this amount in
your income as
wages 12. 33.00
----------------------------------------------
Entire cost excluded. You aren't taxed on the cost of group-term life insurance if any of the following circumstances apply.
1. You're permanently and totally disabled and have ended your employment.
2. Your employer is the beneficiary of the policy for the entire period the insurance is in force during the tax year.
3. A charitable organization (defined in chapter 24) 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.)
4. The plan existed on January 1, 1984, and
a. You retired before January 2, 1984, and were covered by the plan when you retired, or
b. You reached age 55 before January 2, 1984, and were employed by the employer or its predecessor in 1983.
• The insurance is provided by your employer through a qualified employees' trust, such as a pension trust or a qualified annuity plan.
• You're a key employee and your employer's plan discriminates in favor of key employees.
Retirement Planning Services
Generally, don't include the value of qualified retirement planning services provided to you and your spouse by your employer's qualified retirement plan. 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.
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.
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, fare-card, voucher, or similar item entitling a person to ride mass transit (whether public or private) free or at a reduced rate or to ride in a commuter highway vehicle operated by a person in the business of transporting persons for compensation.
Qualified parking. This is parking provided to an employee at or near the employer's place of business. It also includes parking provided on or near a location from which the employee commutes to work by mass transit, in a commuter highway vehicle, or by carpool. It 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.
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. See Group-Term Life Insurance, earlier, under Fringe Benefits.
If your employer pays into a nonqualified plan for you, you generally must include the contributions in your income as wages for the tax year in which the contributions are made. However, if your interest in the plan 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's transferable or is no longer subject to a substantial risk of forfeiture.
TIP: For information on distributions from retirement plans, see Pub. 721, Tax Guide to U.S. Civil Service Retirement Benefits, if you're a federal employee or retiree).
Elective deferrals. If you're 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 (discussed later), isn't included in wages subject to income tax at the time contributed. Rather it's subject to income tax when distributed from the plan. However, it's included in wages subject to social security and Medicare taxes at the time contributed.
Elective deferrals include elective contributions to the following retirement plans.
1. Cash or deferred arrangements (section 401(k) plans).
2. The Thrift Savings Plan for federal employees.
3. Salary reduction simplified employee pension plans (SARSEP).
4. Savings incentive match plans for employees (SIMPLE plans).
5. Tax-sheltered annuity plans (section 403(b) plans).
6. Section 501(c)(18)(D) plans.
7. Section 457 plans.
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're to receive written notice of your rights and obligations under the qualified automatic contribution arrangement. The notice must explain:
• 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.
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 2016, in most cases, you shouldn't have deferred more than a total of $18,000 of contributions to the plans listed in (1) through (3) and (5) above. The limit for SIMPLE plans is $12,500. The limit for section 501(c)(18)(D) plans is the lesser of $7,000 or 25% of your compensation. The limit for section 457 plans is the lesser of your includible compensation or $18,000. Amounts deferred under specific plan limits are part of the overall limit on deferrals.
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're included in income at the time contributed.
Excess deferrals. Your employer or plan administrator should apply the proper annual limit when figuring your plan contributions. However, you're responsible for monitoring the total you defer to ensure that the deferrals aren't more than the overall limit.
If you set aside more than the limit, the excess generally must be included in your income for that year, unless you have an excess deferral of a designated Roth contribution. See Pub. 525 for a discussion of the tax treatment of excess deferrals.
Catch-up contributions. You may be allowed catch-up contributions (additional elective deferral) if you're age 50 or older by the end of the tax year.
Stock Options
If you receive a nonstatutory option to buy or sell stock or other property as payment for your services, you usually will have income when you receive the option, when you exercise the option (use it to buy or sell the stock or other property), or when you sell or otherwise dispose of the option. However, if your option is a statutory stock option, you won't have any income until you sell or exchange your stock. Your employer can tell you which kind of option you hold. For more information, see Pub. 525.
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 substantially vested. (Although you can elect to include the value of the property in your income in the year it's transferred to you.) For more information, see Restricted Property in Pub. 525.
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.
Stock you elected to include in income. Dividends you receive on restricted stock you elected to include in your income in the year transferred are treated the same as any other dividends. Report them on your return as dividends. For a discussion of dividends, see chapter 8.
For information on how to treat dividends reported on both your Form 1099-DIV, see Dividends received on restricted stock in Pub. 525.
Special Rules for Certain Employees
This section 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
Generally, if you're 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're a member of a religious organization and you give your outside earnings to the religious organization, you still must include the earnings in your income. However, you may be entitled to a charitable contribution deduction for the amount paid to the organization. See chapter 24.
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 lesser of the following amounts: 1) the amount actually used to provide or rent a home; 2) the fair market rental value of the home (including furnishings, utilities, garage, etc.); 3) the amount officially designated (in advance of payment) as a rental or housing allowance; or 4) an amount that represents reasonable pay for your services. 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're subject to the self-employment tax. For more information, see Pub. 517, Social Security and Other Information for Members of the Clergy and Religious Workers.
Members of Religious Orders
If you're 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're 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're 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.
Example. You're 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're 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're 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're directed to work outside the order, your services aren't an exercise of duties required by the order unless they meet both of the following requirements.
• They're the kind of services that are ordinarily the duties of members of the order.
• They're part of the duties that you must exercise for, or on behalf of, the religious order as its agent.
If you're 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.
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.
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.
Foreign Employer
Special rules apply if you work for a foreign employer.
U.S. citizen. If you're 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're exempt from social security and Medicare employee taxes if you're 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're 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're a citizen of the Philippines (whether or not you're a citizen of the United States).
Your compensation for official services to a foreign government is exempt from federal income tax if all of the following are true.
• You aren't a citizen of the United States or you're a citizen of the Philippines (whether or not you're a citizen of the United States).
• Your work is like the work done by employees of the United States in foreign countries.
• The foreign government gives an equal exemption to employees of the United States in its country.
Waiver of alien status. If you're 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, different rules may apply. See Foreign Employer in Pub. 525.
Employment abroad. For information on the tax treatment of income earned abroad, see Pub. 54.
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. For more information on the tax treatment of military allowances and benefits, see Pub. 3, Armed Forces' Tax Guide.
Differential wage payments. Any payments made to you by an employer during the time you're performing service in the uniformed services are treated as compensation. These wages are subject to income tax withholding and are reported on a Form W-2. See the discussion under Miscellaneous Compensation, earlier.
Military retirement pay. If your retirement pay is based on age or length of service, it's 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. Don't include in your income the amount of any reduction in retirement or retainer pay to provide a survivor annuity for your spouse or children under the Retired Serviceman's Family Protection Plan or the Survivor Benefit Plan.
For more detailed discussion of survivor annuities, see chapter 10.
Disability. If you're retired on disability, see Military and Government Disability Pensions under Sickness and Injury Benefits, later.
Veterans' benefits. Don't 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.
• Education, training, and subsistence allowances.
• Disability compensation and pension payments for disabilities paid either to veterans or their families.
• Grants for homes designed for wheelchair living.
• Grants for motor vehicles for veterans who lost their sight or the use of their limbs.
• Veterans' insurance proceeds and dividends paid either to veterans or their beneficiaries, including the proceeds of a veteran's endowment policy paid before death.
• Interest on insurance dividends you leave on deposit with the VA.
• Benefits under a dependent-care assistance program.
• The death gratuity paid to a survivor of a member of the Armed Forces who died after September 10, 2001.
• Payments made under the compensated work therapy program.
• Any bonus payment by a state or political subdivision because of service in a combat zone.
Volunteers
The tax treatment of amounts you receive as a volunteer worker for the Peace Corps or similar agency is covered in the following discussions.
Peace Corps. Living allowances you receive as a Peace Corps volunteer or volunteer leader for housing, utilities, household supplies, food, and clothing are generally exempt from tax.
Taxable allowances. The following allowances, however, must be included in your income and reported as wages.
• Allowances paid to your spouse and minor children while you're a volunteer leader training in the United States.
• Living allowances designated by the Director of the Peace Corps as basic compensation. These are allowances for personal items such as domestic help, laundry and clothing maintenance, entertainment and recreation, transportation, and other miscellaneous expenses.
• Leave allowances.
• Readjustment allowances or termination payments. These are considered received by you when credited to your account.
Example. Gary Carpenter, a Peace Corps volunteer, gets $175 a month as a readjustment allowance during his period of service, to be paid to him in a lump sum at the end of his tour of duty. Although the allowance isn't available to him until the end of his service, Gary must include it in his income on a monthly basis as it's credited to his account.
Volunteers in Service to America (VISTA). If you're a VISTA volunteer, you must include meal and lodging allowances paid to you in your income as wages.
National Senior Services Corps programs. Don't include in your income amounts you receive for supportive services or reimbursements for out-of-pocket expenses from the following programs.
• Retired Senior Volunteer Program (RSVP).
• Foster Grandparent Program.
• Senior Companion Program.
Service Corps of Retired Executives (SCORE). If you receive amounts for supportive services or reimbursements for out-of-pocket expenses from SCORE, don't include these amounts in gross income.
Volunteer tax counseling. Don't include in your income any reimbursements you receive for transportation, meals, and other expenses you have in training for, or actually providing, volunteer federal income tax counseling for the elderly (TCE).
You can deduct as a charitable contribution your unreimbursed out-of-pocket expenses in taking part in the volunteer income tax assistance (VITA) program. See chapter 24.
Sickness and Injury Benefits
This section discusses sickness and injury benefits including disability pensions, long-term care insurance contracts, workers' compensation, and other 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. Your employer should be able to give you specific details about your pension plan and tell you the amount you paid for your disability pension. In addition to disability pensions and annuities, you may be receiving other payments for sickness and injury.
TIP: Don't 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 a health or accident insurance 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. See Reimbursement in a later year in chapter 21.
Cafeteria plans. In most cases, if you're 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're 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 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're not disabled.
TIP: You may be entitled to a tax credit if you were permanently and totally disabled when you retired. For information on this credit and the definition of permanent and total disability, see chapter 33.
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. The rules for reporting pensions are explained in How To Report in chapter 10.
For information on disability payments from a governmental program provided as a substitute for unemployment compensation, see chapter 12.
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. For more information on pensions, see chapter 10.
Accrued leave payment. If you retire on disability, any lump-sum payment you receive for accrued annual leave is a salary payment. The payment is not a disability payment. Include it in your income in the tax year you receive it.
Military and Government Disability Pensions
Certain military and government disability pensions 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. Don't include the disability payments in your income if any of the following conditions apply.
1. You were entitled to receive a disability payment before September 25, 1975.
2. 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.
3. You receive the disability payments for a combat-related injury. This is a personal injury or sickness that:
a. Results directly from armed conflict,
b. Takes place while you're engaged in extra-hazardous service,
c. Takes place under conditions simulating war, including training exercises such as maneuvers, or
d. Is caused by an instrumentality of war.
4. 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're later given a retroactive disability rating by the VA.
Special period of limitation. In most cases, under the period of limitation, a claim for credit or refund must be filed within 3 years from the time a return was filed or 2 years from the time the tax was paid. However, if you receive a retroactive service-connected disability rating determination, the period of limitation 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.
Terrorist attack or military action. Don't include in your income disability payments you receive for injuries incurred as a direct result of a terrorist attack directed against the United States (or its allies), whether outside or within the United States or from military action. See Pub. 3920, Tax Relief for Victims of Terrorist Attacks, for more information.
Long-Term Care Insurance Contracts
Long-term care insurance contracts in most cases are treated as accident and health insurance contracts. Amounts you receive from them (other than policyholder dividends or premium refunds) in most cases are excludable from income as amounts received for personal injury or sickness. To claim an exclusion for payments made on a per diem or other periodic basis under a long-term care insurance contract, you must file Form 8853 with your return.
A long-term care insurance contract is an insurance contract that only provides coverage for qualified long-term care services. The contract must:
• Be guaranteed renewable;
• Not provide for a cash surrender value or other money that can be paid, assigned, pledged, or borrowed;
• Provide that refunds, other than refunds on the death of the insured or complete surrender or cancellation of the contract, and dividends under the contract, may only be used to reduce future premiums or increase future benefits; and
• In most cases, 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, and rehabilitative services, and maintenance and personal care services; and
• Required by a chronically ill individual and provided pursuant to a plan of care prescribed by a licensed health care practitioner.
Chronically ill individual. A chronically ill individual is one who has been certified by a licensed health care practitioner within the previous 12 months as one of the following.
• An individual who, for at least 90 days, is unable to perform at least two activities of daily living without substantial assistance due to loss of functional capacity. Activities of daily living are eating, toileting, transferring, bathing, dressing, and continence.
• An individual who requires substantial supervision to be protected from threats to health and safety due to severe cognitive impairment.
Limit on exclusion. You generally can exclude from gross income up to $340 a day for 2016. See Limit on exclusion, under Long-Term Care Insurance Contracts, under Sickness and Injury Benefits in Pub. 525 for more information.
Workers' Compensation
Amounts you receive as workers' compensation for an occupational sickness or injury are fully exempt from tax if they're 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.
CAUTION: If part of your workers' compensation reduces your social security or equivalent railroad retirement benefits received, that part is considered social security (or equivalent railroad retirement) benefits and may be taxable. For more information, see Pub. 915, Social Security and Equivalent Railroad Retirement Benefits.
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.
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're for an on-the-job injury.
If you received income because of a disability, see Disability Pensions, earlier.
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're 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 as wages. Also, pay for sick leave while a claim is being processed is taxable and must be included in your income as wages.
CAUTION: 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. See Pub. 554 for more information.
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's 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. Don't deduct it separately.
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 is generally not taxable. However, it may reduce your medical expense deduction. For more information, see chapter 21.
6. Tip Income
Introduction
This chapter is for employees who receive tips.
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.
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.
1. Keep a daily tip record.
2. Report tips to your employer.
3. Report all your tips on your income tax return.
This chapter will explain these three things and show you what to do on your tax return if you haven't done the first two. This chapter will also show you how to treat allocated tips.
For information on special tip programs and agreements, see Pub. 531.
Useful Items
You may want to see:
Publication
• Publication 531 Reporting Tip Income
• Publication 1244 Employee's Daily Record of Tips and Report to Employer
Form (and Instructions)
• Form 4137 Social Security and Medicare Tax on Unreported Tip Income
• Form 4070 Employee's Report of Tips to Employer
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're important for administration of the federal tax law. For information on how long to keep records, see How long to keep records in chapter 1.
If you keep a tip diary, you can use Form 4070A, Employee's Daily Record of Tips. To get Form 4070A, ask your employer for Pub. 1244 or go online to IRS.gov/pub/irs-pdf/p1244.pdf for a copy of Pub. 1244. Pub. 1244 includes a 1-year supply of Form 4070A. Each day, write in the information asked for on the form.
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. See examples below.
Example 1. 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.
Example 2. Good Food Restaurant also 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 his 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. Be sure to 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 (explained later).
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 tips, you can use Form 4070. Fill in the information asked for on the form, sign and date the form, and give it to your employer. To get a 1-year supply of the form, ask your employer for Pub. 1244 or go online to IRS.gov/pub/irs-pdf/p1244.pdf for a copy of Pub. 1244.
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 is 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. Be sure to 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 cannot 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.
Example. You must report your tips received in September 2017 by October 10, 2017.
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, and Additional Medicare taxes or railroad retirement tax you owe on the unreported tips. For information about these taxes, see Reporting social security, Medicare, Additional Medicare, or railroad retirement taxes on tips not reported to your employer under Reporting Tips on Your Tax Return, later. 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 in the following order.
1. All taxes on your regular pay.
2. Social security, Medicare, and Additional Medicare taxes or railroad retirement taxes on your reported tips.
3. Federal, state, and local income taxes on your reported tips.
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. See Pub. 505, Tax Withholding and Estimated Tax, for more information.
CAUTION: Uncollected taxes. You must report on your tax return any social security and Medicare taxes or railroad retirement tax that remained uncollected at the end of 2016. These uncollected taxes will be shown on your 2016 Form W-2. See Reporting uncollected social security, Medicare, or railroad retirement taxes on tips reported to your employer under Reporting Tips on Your Tax Return, later.
Reporting Tips on Your Tax Return
How to report tips. Report your tips with your wages on Form 1040A, line 7; or Form 1040EZ, line 1.
What tips to report. You must report all tips you received in 2016 on your tax return, including both cash tips and noncash tips. Any tips you reported to your employer for 2016 are included in the wages shown on your Form W-2, box 1. Add to the amount in box 1 only the tips you did not report to your employer.
CAUTION: 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, see Reporting social security, Medicare, Additional Medicare, or railroad retirement taxes on tips not reported to your employer, later.
CAUTION: If you didn't keep a daily tip record as required and an amount is shown on your Form W-2, box 8, see Allocated Tips, later.
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 on your Form W-2, box 1.
• Cash and charge tips you received that totaled less than $20 for any month.
• The value of noncash tips, such as tickets, passes, or other items of value.
Example. Ben Smith began working at the Blue Ocean Restaurant (his only employer in 2016) 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 plus $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 1040, 1040NR, 1040-PR, or 1040-SS (not Form 1040EZ or Form 1040A) even if you wouldn't otherwise have to file.
Use Form 4137 to figure social security and Medicare taxes and/or Form 8959 to figure Additional Medicare Tax. Enter the taxes on your return as instructed, and attach the completed Form 4137 and/or Form 8959 to your return.
CAUTION: If you're subject to the Railroad Retirement Tax Act, you cannot 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, 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. For more information, see Giving your employer money for taxes under Reporting Tips to Your Employer, earlier.
If your employer couldn't collect all the social security and Medicare taxes or railroad retirement tax you owe on tips reported for 2016, the uncollected taxes will be shown on your Form W-2, box 12 (codes A and B). You must report these amounts as additional tax on your return. Unlike the uncollected portion of the regular (1.45%) Medicare tax, the uncollected Additional Medicare Tax isn't reported on your Form W-2.
To report these uncollected taxes, you must file Form 1040, 1040NR, 1040-PR, or 1040-SS (not Form 1040A) even if you wouldn't otherwise have to file. You must report these taxes on Form 1040, line 62, or the corresponding line of Form 1040NR, 1040-PR, or 1040-SS (not Form 1040EZ or Form 1040A). See the instructions for these forms for exact reporting information.
Allocated Tips
If your employer allocated tips to you, they're shown separately on your Form W-2, box 8. They aren't included in box 1 with your wages and reported tips. If box 8 is blank, this discussion doesn't apply to you.
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 all tips you received in 2016 on your tax return, including both cash tips and noncash tips. Any tips you reported to your employer for 2016 are included in the wages shown on your Form W-2, box 1. Add to the amount in box 1 only the tips you didn't report to your employer. This should include any allocated tips shown on your Form(s) W-2, box 8, unless you have adequate records to show that you received less tips in the year than the allocated figures.
See What tips to report under Reporting Tips on Your Tax Return, and Keeping a Daily Tip Record, earlier.
How to report allocated tips. Report the amounts shown on your Form(s) W-2, box 1 (wages and tips) and box 8 (allocated tips), as wages on Form 1040, line 7; Form 1040NR, line 8; or Form 1040NR-EZ, line 3. You cannot file Form 1040EZ when you have allocated tips.
Because social security, Medicare, and 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. See Reporting social security, Medicare, Additional Medicare, or railroad retirement taxes on tips not reported to your employer under Reporting Tips on Your Tax Return, earlier.
7. Interest Income
Reminder
Foreign-source income. If you are a U.S. citizen with interest income from sources outside the United States (foreign income), you must report that 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 1099 from the foreign payer.
Introduction
This chapter discusses the following topics.
• Different types of interest income.
• What interest is taxable and what interest is nontaxable.
• When to report interest income.
• How to report interest income on your tax return.
In general, any interest you receive or that is credited to your account and can be withdrawn is taxable income. Exceptions to this rule are discussed later in this chapter.
You may be able to deduct expenses you have in earning this income on Schedule A (Form 1040) if you itemize your deductions. See Money borrowed to invest in certificate of deposit, later, and chapter 28.
Useful Items
You may want to see:
Publication
• Publication 537 Installment Sales
• Publication 550 Investment Income and Expenses
• Publication 1212 Guide to Original Issue Discount (OID) Instruments
Form (and Instructions)
• Schedule A (Form 1040) Itemized Deductions
• Schedule B (Form 1040A or 1040) Interest and Ordinary Dividends
• Form 8615 Tax for Certain Children Who Have Unearned Income
• Form 8814 Parents' Election To Report Child's Interest and Dividends
• Form 8815 Exclusion of Interest From Series EE and I U.S. Savings Bonds Issued After 1989
• Form 8818 Optional Form To Record Redemption of Series EE and I U.S. Savings Bonds Issued After 1989
General Information
A few items of general interest are covered here.
RECORDS: Recordkeeping. You should keep a list showing sources and interest amounts received during the year. Also, keep the forms you receive showing your interest income (Forms 1099-INT, for example) as an important part of your records.
Tax on unearned income of certain children. Part of a child's 2016 unearned income may be taxed at the parent's tax rate. If so, Form 8615, Tax for Certain Children Who Have Unearned Income, must be completed and attached to the child's tax return. If not, Form 8615 is not required and the child's income is taxed at his or her own tax rate.
Some parents can choose to include the child's interest and dividends on the parent's return. If you can, use Form 8814, Parents' Election To Report Child's Interest and Dividends, for this purpose.
For more information about the tax on unearned income of children and the parents' election, see chapter 31.
Beneficiary of an estate or trust. Interest you receive as a beneficiary of an estate or trust is generally taxable income. You should receive a Schedule K-1 (Form 1041), Beneficiary's Share of Income, Deductions, Credits, etc., from the fiduciary. Your copy of Schedule K-1 (Form 1041) and its instructions will tell you where to report the income on your Form 1040.
Social security number (SSN). You must give your name and SSN or individual taxpayer identification number (ITIN) to any person required by federal tax law to make a return, statement, or other document that relates to you. This includes payers of interest. If you do not give your SSN or ITIN to the payer of interest, you may have to pay a penalty.
SSN for joint account. If the funds in a joint account belong to one person, list that person's name first on the account and give that person's SSN to the payer. (For information on who owns the funds in a joint account, see Joint accounts, later.) If the joint account contains combined funds, give the SSN of the person whose name is listed first on the account. This is because only one name and SSN can be shown on Form 1099.
These rules apply both to joint ownership by a married couple and to joint ownership by other individuals. For example, if you open a joint savings account with your child using funds belonging to the child, list the child's name first on the account and give the child's SSN.
Custodian account for your child. If your child is the actual owner of an account that is recorded in your name as custodian for the child, give the child's SSN to the payer. For example, you must give your child's SSN to the payer of interest on an account owned by your child, even though the interest is paid to you as custodian.
Penalty for failure to supply SSN. If you do not give your SSN to the payer of interest, you may have to pay a penalty. See Failure to supply SSN under Penalties in chapter 1. Backup withholding also may apply.
Backup withholding. Your interest income is generally not subject to regular withholding. However, it may be subject to backup withholding to ensure that income tax is collected on the income. Under backup withholding, the payer of interest must withhold, as income tax, on the amount you are paid, applying the appropriate withholding rate.
Backup withholding may also be required if the IRS has determined that you underreported your interest or dividend income. For more information, see Backup Withholding in chapter 4.
Reporting backup withholding. If backup withholding is deducted from your interest income, the payer must give you a Form 1099-INT for the year indicating the amount withheld. The Form 1099-INT will show any backup withholding as "Federal income tax withheld."
Joint accounts. If two or more persons hold property (such as a savings account or bond) as joint tenants, tenants by the entirety, or tenants in common, each person's share of any interest from the property is determined by local law.
Income from property given to a child. Property you give as a parent to your child under the Model Gifts of Securities to Minors Act, the Uniform Gifts to Minors Act, or any similar law becomes the child's property.
Income from the property is taxable to the child, except that any part used to satisfy a legal obligation to support the child is taxable to the parent or guardian having that legal obligation.
Savings account with parent as trustee. Interest income from a savings account opened for a minor child, but placed in the name and subject to the order of the parents as trustees, is taxable to the child if, under the law of the state in which the child resides, both of the following are true.
• The savings account legally belongs to the child.
• The parents are not legally permitted to use any of the funds to support the child.
Form 1099-INT. Interest income is generally reported to you on Form 1099-INT, or a similar statement, by banks, savings and loans, and other payers of interest. This form shows you the interest you received during the year. Keep this form for your records. You do not have to attach it to your tax return.
Report on your tax return the total interest income you receive for the tax year. See the instructions to Form 1099-INT to see whether you need to adjust any of the amounts reported to you.
Interest not reported on Form 1099-INT. Even if you do not receive Form 1099-INT, you must still report all of your interest income. For example, you may receive distributive shares of interest from partnerships or S corporations. This interest is reported to you on Schedule K-1 (Form 1065), Partner's Share of Income, Deduction, Credits, etc., or Schedule K-1 (Form 1120S), Shareholder's Share of Income, Deductions, Credits, etc.
Nominees. Generally, if someone receives interest as a nominee for you, that person must give you a Form 1099-INT showing the interest received on your behalf.
If you receive a Form 1099-INT that includes amounts belonging to another person, see the discussion on nominee distributions under How To Report Interest Income in chapter 1 of Pub. 550, or Schedule B (Form 1040A or 1040) instructions.
Incorrect amount. If you receive a Form 1099-INT that shows an incorrect amount (or other incorrect information), you should ask the issuer for a corrected form. The new Form 1099-INT you receive will be marked "Corrected."
Form 1099-OID. Reportable interest income also may be shown on Form 1099-OID, Original Issue Discount. For more information about amounts shown on this form, see Original Issue Discount (OID), later in this chapter.
Exempt-interest dividends. Exempt-interest dividends you receive from a mutual fund or other regulated investment company, including those received from a qualified fund of funds in any tax year beginning after December 22, 2010, are not included in your taxable income. (However, see Information reporting requirement, next.) Exempt-interest dividends should be shown in box 10 of Form 1099-DIV. You do not reduce your basis for distributions that are exempt-interest dividends.
Information reporting requirement. Although exempt-interest dividends are not taxable, you must show them on your tax return if you have to file. This is an information reporting requirement and does not change the exempt-interest dividends into taxable income.
Note. Exempt-interest dividends paid from specified private activity bonds may be subject to the alternative minimum tax. See Alternative Minimum Tax (AMT) in chapter 30 for more information. Chapter 1 of Pub. 550 contains a discussion on private activity bonds under State or Local Government Obligations.
Interest on VA dividends. Interest on insurance dividends left on deposit with the Department of Veterans Affairs (VA) is not taxable. This includes interest paid on dividends on converted United States Government Life Insurance and on National Service Life Insurance policies.
Individual retirement arrangements (IRAs). Interest on a Roth IRA generally is not taxable. Interest on a traditional IRA is tax deferred. You generally do not include it in your income until you make withdrawals from the IRA. See chapter 17.
Taxable Interest
Taxable interest includes interest you receive from bank accounts, loans you make to others, and other sources. The following are some sources of taxable interest.
Dividends that are actually interest. Certain distributions commonly called dividends are actually interest. You must report as interest so-called "dividends" on deposits or on share accounts in:
• Cooperative banks,
• Credit unions,
• Domestic building and loan associations,
• Domestic savings and loan associations,
• Federal savings and loan associations, and
• Mutual savings banks.
The "dividends" will be shown as interest income on Form 1099-INT.
Money market funds. Money market funds pay dividends and are offered by nonbank financial institutions, such as mutual funds and stock brokerage houses. Generally, amounts you receive from money market funds should be reported as dividends, not as interest.
Certificates of deposit and other deferred interest accounts. If you open any of these accounts, interest may be paid at fixed intervals of 1 year or less during the term of the account. You generally must include this interest in your income when you actually receive it or are entitled to receive it without paying a substantial penalty. The same is true for accounts that mature in 1 year or less and pay interest in a single payment at maturity. If interest is deferred for more than 1 year, see Original Issue Discount (OID), later.
Interest subject to penalty for early withdrawal. If you withdraw funds from a deferred interest account before maturity, you may have to pay a penalty. You must report the total amount of interest paid or credited to your account during the year, without subtracting the penalty. See Penalty on early withdrawal of savings in chapter 1 of Pub. 550 for more information on how to report the interest and deduct the penalty.
Money borrowed to invest in certificate of deposit. The interest you pay on money borrowed from a bank or savings institution to meet the minimum deposit required for a certificate of deposit from the institution and the interest you earn on the certificate are two separate items. You must report the total interest you earn on the certificate in your income. If you itemize deductions, you can deduct the interest you pay as investment interest, up to the amount of your net investment income. See Interest Expenses in chapter 3 of Pub. 550.
Example. You deposited $5,000 with a bank and borrowed $5,000 from the bank to make up the $10,000 minimum deposit required to buy a 6-month certificate of deposit. The certificate earned $575 at maturity in 2016, but you received only $265, which represented the $575 you earned minus $310 interest charged on your $5,000 loan. The bank gives you a Form 1099-INT for 2016 showing the $575 interest you earned. The bank also gives you a statement showing that you paid $310 interest for 2016. You must include the $575 in your income. If you itemize your deductions on Schedule A (Form 1040), you can deduct $310, subject to the net investment income limit.
Gift for opening account. If you receive noncash gifts or services for making deposits or for opening an account in a savings institution, you may have to report the value as interest.
For deposits of less than $5,000, gifts or services valued at more than $10 must be reported as interest. For deposits of $5,000 or more, gifts or services valued at more than $20 must be reported as interest. The value is determined by the cost to the financial institution.
Example. You open a savings account at your local bank and deposit $800. The account earns $20 interest. You also receive a $15 calculator. If no other interest is credited to your account during the year, the Form 1099-INT you receive will show $35 interest for the year. You must report $35 interest income on your tax return.
Interest on insurance dividends. Interest on insurance dividends left on deposit with an insurance company that can be withdrawn annually is taxable to you in the year it is credited to your account. However, if you can withdraw it only on the anniversary date of the policy (or other specified date), the interest is taxable in the year that date occurs.
Prepaid insurance premiums. Any increase in the value of prepaid insurance premiums, advance premiums, or premium deposit funds is interest if it is applied to the payment of premiums due on insurance policies or made available for you to withdraw.
U.S. obligations. Interest on U.S. obligations, such as U.S. Treasury bills, notes, and bonds, issued by any agency or instrumentality of the United States is taxable for federal income tax purposes.
Interest on tax refunds. Interest you receive on tax refunds is taxable income.
Interest on condemnation award. If the condemning authority pays you interest to compensate you for a delay in payment of an award, the interest is taxable.
Installment sale payments. If a contract for the sale or exchange of property provides for deferred payments, it also usually provides for interest payable with the deferred payments. Generally, that interest is taxable when you receive it. If little or no interest is provided for in a deferred payment contract, part of each payment may be treated as interest. See Unstated Interest and Original Issue Discount in Pub. 537, Installment Sales.
Interest on annuity contract. Accumulated interest on an annuity contract you sell before its maturity date is taxable.
Usurious interest. Usurious interest is interest charged at an illegal rate. This is taxable as interest unless state law automatically changes it to a payment on the principal.
Interest income on frozen deposits. Exclude from your gross income interest on frozen deposits. A deposit is frozen if, at the end of the year, you cannot withdraw any part of the deposit because:
• The financial institution is bankrupt or insolvent, or
• The state where the institution is located has placed limits on withdrawals because other financial institutions in the state are bankrupt or insolvent.
The amount of interest you must exclude is the interest that was credited on the frozen deposits minus the sum of:
• The net amount you withdrew from these deposits during the year, and
• The amount you could have withdrawn as of the end of the year (not reduced by any penalty for premature withdrawals of a time deposit).
If you receive a Form 1099-INT for interest income on deposits that were frozen at the end of 2016, see Frozen deposits under How To Report Interest Income in chapter 1 of Pub. 550 for information about reporting this interest income exclusion on your tax return.
The interest you exclude is treated as credited to your account in the following year. You must include it in income in the year you can withdraw it.
Example. $100 of interest was credited on your frozen deposit during the year. You withdrew $80 but could not withdraw any more as of the end of the year. You must include $80 in your income and exclude $20 from your income for the year. You must include the $20 in your income for the year you can withdraw it.
Bonds traded flat. If you buy a bond at a discount when interest has been defaulted or when the interest has accrued but has not been paid, the transaction is described as trading a bond flat. The defaulted or unpaid interest is not income and is not taxable as interest if paid later. When you receive a payment of that interest, it is a return of capital that reduces the remaining cost basis of your bond. Interest that accrues after the date of purchase, however, is taxable interest income for the year it is received or accrued. See Bonds Sold Between Interest Dates, later, for more information.
Below-market loans. In general, a below-market loan is a loan on which no interest is charged or on which interest is charged at a rate below the applicable federal rate. See Below-Market Loans in chapter 1 of Pub. 550 for more information.
U.S. Savings Bonds
This section provides tax information on U.S. savings bonds. It explains how to report the interest income on these bonds and how to treat transfers of these bonds.
For other information on U.S. savings bonds, write to:
For series HH/H: Series HH and Series H Treasury Retail Securities Site P.O. Box 2186 Minneapolis, MN 55480-2186
For series EE and I paper savings bonds: Series EE and Series I Treasury Retail Securities Site P.O. Box 214 Minneapolis, MN 55480-0214
For series EE and I electronic bonds: Series EE and Series I Treasury Retail Securities Site P.O. Box 7015 Minneapolis, MN 55480-7015
Or, on the Internet, visit http://www.treasurydirect.gov/indiv/indiv.htm.
Accrual method taxpayers. If you use an accrual method of accounting, you must report interest on U.S. savings bonds each year as it accrues. You cannot postpone reporting interest until you receive it or until the bonds mature. Accrual methods of accounting are explained in chapter 1 under Accounting Methods.
Cash method taxpayers. If you use the cash method of accounting, as most individual taxpayers do, you generally report the interest on U.S. savings bonds when you receive it. The cash method of accounting is explained in chapter 1 under Accounting Methods. But see Reporting options for cash method taxpayers, later.
Series HH bonds. These bonds were issued at face value. Interest is paid twice a year by direct deposit to your bank account. If you are a cash method taxpayer, you must report interest on these bonds as income in the year you receive it.
Series HH bonds were first offered in 1980 and last offered in August 2004. Before 1980, series H bonds were issued. Series H bonds are treated the same as series HH bonds. If you are a cash method taxpayer, you must report the interest when you receive it.
Series H bonds have a maturity period of 30 years. Series HH bonds mature in 20 years. The last series H bonds matured in 2009.
Series EE and series I bonds. Interest on these bonds is payable when you redeem the bonds. The difference between the purchase price and the redemption value is taxable interest.
Series EE bonds. Series EE bonds were first offered in January 1980 and have a maturity period of 30 years.
Before July 1980, series E bonds were issued. The original 10-year maturity period of series E bonds has been extended to 40 years for bonds issued before December 1965 and 30 years for bonds issued after November 1965. Paper series EE and series E bonds are issued at a discount. The face value is payable to you at maturity. Electronic series EE bonds are issued at their face value. The face value plus accrued interest is payable to you at maturity. As of January 1, 2012, paper savings bonds were no longer sold at financial institutions.
Owners of paper series EE bonds can convert them to electronic bonds. These converted bonds do not retain the denomination listed on the paper certificate but are posted at their purchase price (with accrued interest).
Series I bonds. Series I bonds were first offered in 1998. These are inflation-indexed bonds issued at their face amount with a maturity period of 30 years. The face value plus all accrued interest is payable to you at maturity.
Reporting options for cash method taxpayers. If you use the cash method of reporting income, you can report the interest on series EE, series E, and series I bonds in either of the following ways.
1. Method 1. Postpone reporting the interest until the earlier of the year you cash or dispose of the bonds or the year they mature. (However, see Savings bonds traded, later.)
2. Method 2. Choose to report the increase in redemption value as interest each year.
You must use the same method for all series EE, series E, and series I bonds you own. If you do not choose method 2 by reporting the increase in redemption value as interest each year, you must use method 1.
TIP: If you plan to cash your bonds in the same year you will pay for higher education expenses, you may want to use method 1 because you may be able to exclude the interest from your income. To learn how, see Education Savings Bond Program, later.
Change from method 1. If you want to change your method of reporting the interest from method 1 to method 2, you can do so without permission from the IRS. In the year of change you must report all interest accrued to date and not previously reported for all your bonds.
Once you choose to report the interest each year, you must continue to do so for all series EE, series E, and series I bonds you own and for any you get later, unless you request permission to change, as explained next.
Change from method 2. To change from method 2 to method 1, you must request permission from the IRS. Permission for the change is automatically granted if you send the IRS a statement that meets all the following requirements.
1. You have typed or printed the following number at the top: "131."
2. It includes your name and social security number under "131."
3. It includes the year of change (both the beginning and ending dates).
4. It identifies the savings bonds for which you are requesting this change.
5. It includes your agreement to:
a. Report all interest on any bonds acquired during or after the year of change when the interest is realized upon disposition, redemption, or final maturity, whichever is earliest; and
b. Report all interest on the bonds acquired before the year of change when the interest is realized upon disposition, redemption, or final maturity, whichever is earliest, with the exception of the interest reported in prior tax years.
You can have an automatic extension of 6 months from the due date of your return for the year of change (excluding extensions) to file the statement with an amended return. To get this extension, you must have filed your original return for the year of the change by the due date (including extensions).
By the date you file the original statement with your return, you must also send a signed copy to the address below.
Internal Revenue Service Attention: Automatic Change P.O. Box 7604 Benjamin Franklin Station Washington, DC 20044
If you use a private delivery service, send the signed copy to the address below.
Internal Revenue Service Attention: Automatic Change 1111 Constitution Avenue NW Washington, DC 20224 Room 5336
Instead of filing this statement, you can request permission to change from method 2 to method 1 by filing Form 3115, Application for Change in Accounting Method. In that case, follow the form instructions for an automatic change. No user fee is required.
Co-owners. If a U.S. savings bond is issued in the names of co-owners, such as you and your child or you and your spouse, interest on the bond is generally taxable to the co-owner who bought the bond.
One co-owner's funds used. If you used your funds to buy the bond, you must pay the tax on the interest. This is true even if you let the other co-owner redeem the bond and keep all the proceeds. Under these circumstances, the co-owner who redeemed the bond will receive a Form 1099-INT at the time of redemption and must provide you with another Form 1099-INT showing the amount of interest from the bond taxable to you. The co-owner who redeemed the bond is a "nominee." See Nominee distributions under How To Report Interest Income in chapter 1 of Pub. 550 for more information about how a person who is a nominee reports interest income belonging to another person.
Both co-owners' funds used. If you and the other co-owner each contribute part of the bond's purchase price, the interest is generally taxable to each of you, in proportion to the amount each of you paid.
Community property. If you and your spouse live in a community property state and hold bonds as community property, one-half of the interest is considered received by each of you. If you file separate returns, each of you generally must report one-half of the bond interest. For more information about community property, see Pub. 555.
Table 7-1. These rules are also shown in Table 7-1.
Table 7-1. Who Pays the Tax on U.S. Savings Bond Interest
----------------------------------------------------------------------
THEN the interest must be reported
IF . . . by . . .
----------------------------------------------------------------------
you buy a bond in your name and you.
the name of another person as
co-owners, using only your own
funds
----------------------------------------------------------------------
you buy a bond in the name of the person for whom you bought the
another person, who is the sole bond.
owner of the bond
----------------------------------------------------------------------
you and another person buy a bond both you and the other co-owner,
as co-owners, each contributing in proportion to the amount each
part of the purchase price paid for the bond.
----------------------------------------------------------------------
you and your spouse, who live in a you and your spouse. If you file
community property state, buy a separate returns, both you and
bond that is community property your spouse generally report
one-half of the interest.
----------------------------------------------------------------------
Ownership transferred. If you bought series E, series EE, or series I bonds entirely with your own funds and had them reissued in your co-owner's name or beneficiary's name alone, you must include in your gross income for the year of reissue all interest that you earned on these bonds and have not previously reported. But, if the bonds were reissued in your name alone, you do not have to report the interest accrued at that time.
This same rule applies when bonds (other than bonds held as community property) are transferred between spouses or incident to divorce.
Purchased jointly. If you and a co-owner each contributed funds to buy series E, series EE, or series I bonds jointly and later have the bonds reissued in the co-owner's name alone, you must include in your gross income for the year of reissue your share of all the interest earned on the bonds that you have not previously reported. The former co-owner does not have to include in gross income at the time of reissue his or her share of the interest earned that was not reported before the transfer. This interest, however, as well as all interest earned after the reissue, is income to the former co-owner.
This income-reporting rule also applies when the bonds are reissued in the name of your former co-owner and a new co-owner. But the new co-owner will report only his or her share of the interest earned after the transfer.
If bonds that you and a co-owner bought jointly are reissued to each of you separately in the same proportion as your contribution to the purchase price, neither you nor your co-owner has to report at that time the interest earned before the bonds were reissued.
Example 1. You and your spouse each spent an equal amount to buy a $1,000 series EE savings bond. The bond was issued to you and your spouse as co-owners. You both postpone reporting interest on the bond. You later have the bond reissued as two $500 bonds, one in your name and one in your spouse's name. At that time, neither you nor your spouse has to report the interest earned to the date of reissue.
Example 2. You bought a $1,000 series EE savings bond entirely with your own funds. The bond was issued to you and your spouse as co-owners. You both postpone reporting interest on the bond. You later have the bond reissued as two $500 bonds, one in your name and one in your spouse's name. You must report half the interest earned to the date of reissue.
Transfer to a trust. If you own series E, series EE, or series I bonds and transfer them to a trust, giving up all rights of ownership, you must include in your income for that year the interest earned to the date of transfer if you have not already reported it. However, if you are considered the owner of the trust and if the increase in value both before and after the transfer continues to be taxable to you, you can continue to defer reporting the interest earned each year. You must include the total interest in your income in the year you cash or dispose of the bonds or the year the bonds finally mature, whichever is earlier.
The same rules apply to previously unreported interest on series EE or series E bonds if the transfer to a trust consisted of series HH or series H bonds you acquired in a trade for the series EE or series E bonds. See Savings bonds traded, later.
Decedents. The manner of reporting interest income on series E, series EE, or series I bonds, after the death of the owner (decedent), depends on the accounting and income-reporting methods previously used by the decedent. This is explained in chapter 1 of Pub. 550.
Savings bonds traded. If you postponed reporting the interest on your series EE or series E bonds, you did not recognize taxable income when you traded the bonds for series HH or series H bonds, unless you received cash in the trade. (You cannot trade series I bonds for series HH bonds. After August 31, 2004, you cannot trade any other series of bonds for series HH bonds.) Any cash you received is income up to the amount of the interest earned on the bonds traded. When your series HH or series H bonds mature, or if you dispose of them before maturity, you report as interest the difference between their redemption value and your cost. Your cost is the sum of the amount you paid for the traded series EE or series E bonds plus any amount you had to pay at the time of the trade.
Example. You traded series EE bonds (on which you postponed reporting the interest) for $2,500 in series HH bonds and $223 in cash. You reported the $223 as taxable income on your tax return. At the time of the trade, the series EE bonds had accrued interest of $523 and a redemption value of $2,723. You hold the series HH bonds until maturity, when you receive $2,500. You must report $300 as interest income in the year of maturity. This is the difference between their redemption value, $2,500, and your cost, $2,200 (the amount you paid for the series EE bonds). (It is also the difference between the accrued interest of $523 on the series EE bonds and the $223 cash received on the trade.)
Choice to report interest in year of trade. You could have chosen to treat all of the previously unreported accrued interest on the series EE or series E bonds traded for series HH bonds as income in the year of the trade. If you made this choice, it is treated as a change from method 1. See Change from method 1, earlier.
Form 1099-INT for U.S. savings bonds interest. When you cash a bond, the bank or other payer that redeems it must give you a Form 1099-INT if the interest part of the payment you receive is $10 or more. Box 3 of your Form 1099-INT should show the interest as the difference between the amount you received and the amount paid for the bond. However, your Form 1099-INT may show more interest than you have to include on your income tax return. For example, this may happen if any of the following are true.
• You chose to report the increase in the redemption value of the bond each year. The interest shown on your Form 1099-INT will not be reduced by amounts previously included in income.
• You received the bond from a decedent. The interest shown on your Form 1099-INT will not be reduced by any interest reported by the decedent before death, or on the decedent's final return, or by the estate on the estate's income tax return.
• Ownership of the bond was transferred. The interest shown on your Form 1099-INT will not be reduced by interest that accrued before the transfer.
• You were named as a co-owner, and the other co-owner contributed funds to buy the bond. The interest shown on your Form 1099-INT will not be reduced by the amount you received as nominee for the other co-owner. (See Co-owners, earlier in this chapter, for more information about the reporting requirements.)
• You received the bond in a taxable distribution from a retirement or profit-sharing plan. The interest shown on your Form 1099-INT will not be reduced by the interest portion of the amount taxable as a distribution from the plan and not taxable as interest. (This amount is generally shown on Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., for the year of distribution.)
For more information on including the correct amount of interest on your return, see How To Report Interest Income, later. Pub. 550 includes examples showing how to report these amounts.
TIP: Interest on U.S. savings bonds is exempt from state and local taxes. The Form 1099-INT you receive will indicate the amount that is for U.S. savings bond interest in box 3.
Education Savings Bond Program
You may be able to exclude from income all or part of the interest you receive on the redemption of qualified U.S. savings bonds during the year if you pay qualified higher educational expenses during the same year. This exclusion is known as the Education Savings Bond Program.
You do not qualify for this exclusion if your filing status is married filing separately.
Form 8815. Use Form 8815 to figure your exclusion. Attach the form to your Form 1040 or Form 1040A.
Qualified U.S. savings bonds. A qualified U.S. savings bond is a series EE bond issued after 1989 or a series I bond. The bond must be issued either in your name (sole owner) or in your and your spouse's names (co-owners). You must be at least 24 years old before the bond's issue date. For example, a bond bought by a parent and issued in the name of his or her child under age 24 does not qualify for the exclusion by the parent or child.
CAUTION: The issue date of a bond may be earlier than the date the bond is purchased because the issue date assigned to a bond is the first day of the month in which it is purchased.
Beneficiary. You can designate any individual (including a child) as a beneficiary of the bond.
Verification by IRS. If you claim the exclusion, the IRS will check it by using bond redemption information from the Department of the Treasury.
Qualified expenses. Qualified higher education expenses are tuition and fees required for you, your spouse, or your dependent (for whom you claim an exemption) to attend an eligible educational institution.
Qualified expenses include any contribution you make to a qualified tuition program or to a Coverdell education savings account.
Qualified expenses do not include expenses for room and board or for courses involving sports, games, or hobbies that are not part of a degree or certificate granting program.
Eligible educational institutions. These institutions include most public, private, and nonprofit universities, colleges, and vocational schools that are accredited and eligible to participate in student aid programs run by the U.S. Department of Education.
Reduction for certain benefits. You must reduce your qualified higher education expenses by all of the following tax-free benefits.
1. Tax-free part of scholarships and fellowships (see Scholarships and fellowships in chapter 12).
2. Expenses used to figure the tax-free portion of distributions from a Coverdell ESA.
3. Expenses used to figure the tax-free portion of distributions from a qualified tuition program.
4. Any tax-free payments (other than gifts or inheritances) received for educational expenses, such as:
a. Veterans' educational assistance benefits,
b. Qualified tuition reductions, or
c. Employer-provided educational assistance.
5. Any expense used in figuring the American opportunity and lifetime learning credits.
Amount excludable. If the total proceeds (interest and principal) from the qualified U.S. savings bonds you redeem during the year are not more than your adjusted qualified higher education expenses for the year, you may be able to exclude all of the interest. If the proceeds are more than the expenses, you may be able to exclude only part of the interest.
To determine the excludable amount, multiply the interest part of the proceeds by a fraction. The numerator of the fraction is the qualified higher education expenses you paid during the year. The denominator of the fraction is the total proceeds you received during the year.
Example. In February 2016, Mark and Joan, a married couple, cashed qualified series EE U.S. savings bonds with a total denomination of $10,000 that they bought in April 2000 for $5,000. They received proceeds of $7,828, representing principal of $5,000 and interest of $2,828. In 2016, they paid $4,000 of their daughter's college tuition. They are not claiming an education credit for that amount, and their daughter does not have any tax-free educational assistance. They can exclude $1,445 ($2,828 × ($4,000 ÷ $7,828)) of interest in 2016. They must include the remaining $1,383 ($2,828 - $1,445) interest in gross income.
Modified adjusted gross income limit. The interest exclusion is limited if your modified adjusted gross income (modified AGI) is:
• $77,550 to $92,550 for taxpayers filing single or head of household, and
• $116,300 to $146,300 for married taxpayers filing jointly or for a qualifying widow(er) with dependent child.
You do not qualify for the interest exclusion if your modified AGI is equal to or more than the upper limit for your filing status.
Modified AGI, for purposes of this exclusion, is adjusted gross income (Form 1040, line 37, or Form 1040A, line 21) figured before the interest exclusion, and modified by adding back any:
1. Foreign earned income exclusion,
2. Foreign housing exclusion and deduction,
3. Exclusion of income for bona fide residents of American Samoa,
4. Exclusion for income from Puerto Rico,
5. Exclusion for adoption benefits received under an employer's adoption assistance program,
6. Deduction for tuition and fees,
7. Deduction for student loan interest, and
8. Deduction for domestic production activities.
Use the Line 9 Worksheet in the Form 8815 instructions to figure your modified AGI.
If you have investment interest expense incurred to earn royalties and other investment income, see Education Savings Bond Program in chapter 1 of Pub. 550.
RECORDS: Recordkeeping. If you claim the interest exclusion, you must keep a written record of the qualified U.S. savings bonds you redeem. Your record must include the serial number, issue date, face value, and total redemption proceeds (principal and interest) of each bond. You can use Form 8818 to record this information. You should also keep bills, receipts, canceled checks, or other documentation that shows you paid qualified higher education expenses during the year.
U.S. Treasury Bills, Notes, and Bonds
Treasury bills, notes, and bonds are direct debts (obligations) of the U.S. Government.
Taxation of interest. Interest income from Treasury bills, notes, and bonds is subject to federal income tax but is exempt from all state and local income taxes. You should receive Form 1099-INT showing the interest (in box 3) paid to you for the year.
Payments of principal and interest generally will be credited to your designated checking or savings account by direct deposit through the TreasuryDirect® system.
Treasury bills. These bills generally have a 4-week, 13-week, 26-week, or 52-week maturity period. They are generally issued at a discount in the amount of $100 and multiples of $100. The difference between the discounted price you pay for the bills and the face value you receive at maturity is interest income. Generally, you report this interest income when the bill is paid at maturity. If you paid a premium for a bill (more than the face value), you generally report the premium as a section 171 deduction when the bill is paid at maturity.
Treasury notes and bonds. Treasury notes have maturity periods of more than 1 year, ranging up to 10 years. Maturity periods for Treasury bonds are longer than 10 years. Both generally are issued in denominations of $100 to $1 million and generally pay interest every 6 months. Generally, you report this interest for the year paid. For more information, see U.S. Treasury Bills, Notes, and Bonds in chapter 1 of Pub. 550.
For other information on Treasury notes or bonds, write to:
Treasury Retail Securities Site P.O. Box 7015 Minneapolis, MN 55480-7015
Or, on the Internet, visit http://www.treasurydirect.gov/indiv/indiv.htm.
For information on series EE, series I, and series HH savings bonds, see U.S. Savings Bonds, earlier.
Treasury inflation-protected securities (TIPS). These securities pay interest twice a year at a fixed rate, based on a principal amount adjusted to take into account inflation and deflation. For the tax treatment of these securities, see Inflation-Indexed Debt Instruments under Original Issue Discount (OID) in Pub. 550.
Bonds Sold Between Interest Dates
If you sell a bond between interest payment dates, part of the sales price represents interest accrued to the date of sale. You must report that part of the sales price as interest income for the year of sale.
If you buy a bond between interest payment dates, part of the purchase price represents interest accrued before the date of purchase. When that interest is paid to you, treat it as a nontaxable return of your capital investment, rather than as interest income. See Accrued interest on bonds under How To Report Interest Income in chapter 1 of Pub. 550 for information on reporting the payment.
Insurance
Life insurance proceeds paid to you as beneficiary of the insured person are usually not taxable. But if you receive the proceeds in installments, you must usually report a part of each installment payment as interest income.
For more information about insurance proceeds received in installments, see Pub. 525, Taxable and Nontaxable Income.
Annuity. If you buy an annuity with life insurance proceeds, the annuity payments you receive are taxed as pension and annuity income from a nonqualified plan, not as interest income. See chapter 10 for information on pension and annuity income from nonqualified plans.
State or Local Government Obligations
Interest on a bond used to finance government operations generally is not taxable if the bond is issued by a state, the District of Columbia, a possession of the United States, or any of their political subdivisions.
Bonds issued after 1982 (including tribal economic development bonds issued after February 17, 2009) by an Indian tribal government are treated as issued by a state. Interest on these bonds is generally tax exempt if the bonds are part of an issue of which substantially all proceeds are to be used in the exercise of any essential government function.
For information on federally guaranteed bonds, mortgage revenue bonds, arbitrage bonds, private activity bonds, qualified tax credit bonds, and Build America bonds, see State or Local Government Obligations in chapter 1 of Pub. 550.
Information reporting requirement. If you must file a tax return, you are required to show any tax-exempt interest you received on your return. This is an information reporting requirement only. It does not change tax-exempt interest to taxable interest.
Original Issue Discount (OID)
Original issue discount (OID) is a form of interest. You generally include OID in your income as it accrues over the term of the debt instrument, whether or not you receive any payments from the issuer.
A debt instrument generally has OID when the instrument is issued for a price that is less than its stated redemption price at maturity. OID is the difference between the stated redemption price at maturity and the issue price.
All debt instruments that pay no interest before maturity are presumed to be issued at a discount. Zero coupon bonds are one example of these instruments.
The OID accrual rules generally do not apply to short-term obligations (those with a fixed maturity date of 1 year or less from date of issue). See Discount on Short-Term Obligations in chapter 1 of Pub. 550.
De minimis OID. You can treat the discount as zero if it 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. This small discount is known as "de minimis" OID.
Example 1. You bought a 10-year bond with a stated redemption price at maturity of $1,000, issued at $980 with OID of $20. One-fourth of 1% of $1,000 (stated redemption price) times 10 (the number of full years from the date of original issue to maturity) equals $25. Because the $20 discount is less than $25, the OID is treated as zero. (If you hold the bond at maturity, you will recognize $20 ($1,000 - $980) of capital gain.)
Example 2. The facts are the same as in Example 1, except that the bond was issued at $950. The OID is $50. Because the $50 discount is more than the $25 figured in Example 1, you must include the OID in income as it accrues over the term of the bond.
Debt instrument bought after original issue. If you buy a debt instrument with de minimis OID at a premium, the discount is not includible in income. If you buy a debt instrument with de minimis OID at a discount, the discount is reported under the market discount rules. See Market Discount Bonds in chapter 1 of Pub. 550.
Exceptions to reporting OID as current income. The OID rules discussed in this chapter do not apply to the following debt instruments.
1. Tax-exempt obligations. (However, see Stripped tax-exempt obligations under Stripped Bonds and Coupons in chapter 1 of Pub. 550).
2. U.S. savings bonds.
3. Short-term debt instruments (those with a fixed maturity date of not more than 1 year from the date of issue).
4. Obligations issued by an individual before March 2, 1984.
5. Loans between individuals if all the following are true.
a. The lender is not in the business of lending money.
b. The amount of the loan, plus the amount of any outstanding prior loans between the same individuals, is $10,000 or less.
c. Avoiding any federal tax is not one of the principal purposes of the loan.
In most cases, you must report the entire amount in boxes 1, 2, and 8 of Form 1099-OID as interest income. But see Refiguring OID shown on Form 1099-OID, later in this discussion, for more information.
Form 1099-OID not received. If you had OID for the year but did not receive a Form 1099-OID, you may have to figure the correct amount of OID to report on your return. See Pub. 1212 for details on how to figure the correct OID.
Nominee. If someone else is the holder of record (the registered owner) of an OID instrument belonging to you and receives a Form 1099-OID on your behalf, that person must give you a Form 1099-OID.
Refiguring OID shown on Form 1099-OID. You may need to refigure the OID shown in box 1 or box 8 of Form 1099-OID if either of the following apply.
• You bought the debt instrument after its original issue and paid a premium or an acquisition premium.
• The debt instrument is a stripped bond or a stripped coupon (including certain zero coupon instruments).
For information about figuring the correct amount of OID to include in your income, see Figuring OID on Long-Term Debt Instruments in Form 1099-OID.
Refiguring periodic interest shown on Form 1099-OID. If you disposed of a debt instrument or acquired it from another holder during the year, see Bonds Sold Between Interest Dates, earlier, for information about the treatment of periodic interest that may be shown in box 2 of Form 1099-OID for that instrument.
Certificates of deposit (CDs). If you buy a CD with a maturity of more than 1 year, you must include in income each year a part of the total interest due and report it in the same manner as other OID.
This also applies to similar deposit arrangements with banks, building and loan associations, etc., including:
• Time deposits,
• Bonus plans,
• Savings certificates,
• Deferred income certificates,
• Bonus savings certificates, and
• Growth savings certificates.
Bearer CDs. CDs issued after 1982 generally must be in registered form. Bearer CDs are CDs not in registered form. They are not issued in the depositor's name and are transferable from one individual to another.
Banks must provide the IRS and the person redeeming a bearer CD with a Form 1099-INT.
More information. See chapter 1 of Pub. 550 for more information about OID and related topics, such as market discount bonds.
When To Report Interest Income
When to report your interest income depends on whether you use the cash method or an accrual method to report income.
Cash method. Most individual taxpayers use the cash method. If you use this method, you generally report your interest income in the year in which you actually or constructively receive it. However, there are special rules for reporting the discount on certain debt instruments. See U.S. Savings Bonds and Original Issue Discount (OID), earlier.
Example. On September 1, 2014, you loaned another individual $2,000 at 12%, compounded annually. You are not in the business of lending money. The note stated that principal and interest would be due on August 31, 2016. In 2016, you received $2,508.80 ($2,000 principal and $508.80 interest). If you use the cash method, you must include in income on your 2016 return the $508.80 interest you received in that year.
Constructive receipt. You constructively receive income when it is credited to your account or made available to you. You do not need to have physical possession of it. For example, you are considered to receive interest, dividends, or other earnings on any deposit or account in a bank, savings and loan, or similar financial institution, or interest on life insurance policy dividends left to accumulate, when they are credited to your account and subject to your withdrawal. This is true even if they are not yet entered in your passbook.
You constructively receive income on the deposit or account even if you must:
• Make withdrawals in multiples of even amounts,
• Give a notice to withdraw before making the withdrawal,
• Withdraw all or part of the account to withdraw the earnings, or
• Pay a penalty on early withdrawals, unless the interest you are to receive on an early withdrawal or redemption is substantially less than the interest payable at maturity.
Accrual method. If you use an accrual method, you report your interest income when you earn it, whether or not you have received it. Interest is earned over the term of the debt instrument.
Example. If, in the previous example, you use an accrual method, you must include the interest in your income as you earn it. You would report the interest as follows: 2014, $80; 2015, $249.60; and 2016, $179.20.
Coupon bonds. Interest on bearer bonds with detachable coupons is generally taxable in the year the coupon becomes due and payable. It does not matter when you mail the coupon for payment.
How To Report Interest Income
Generally, you report all your taxable interest income on Form 1040A, line 8a; or Form 1040EZ, line 2.
You cannot use Form 1040EZ if your taxable interest income is more than $1,500. Instead, you must use Form 1040.
Form 1040A. You must complete Schedule B (Form 1040A or 1040), Part I, if you file Form 1040A and any of the following are true.
1. Your taxable interest income is more than $1,500.
2. You are claiming the interest exclusion under the Education Savings Bond Program (discussed earlier).
3. You received interest from a seller-financed mortgage, and the buyer used the property as a home.
4. You received a Form 1099-INT for U.S. savings bond interest that includes amounts you reported in a previous tax year.
5. You received, as a nominee, interest that actually belongs to someone else.
6. You received a Form 1099-INT for interest on frozen deposits.
7. You are reporting OID in an amount less than the amount shown on Form 1099-OID.
8. You received a Form 1099-INT for interest on a bond you bought between interest payment dates.
9. You acquired taxable bonds after 1987 and choose to reduce interest income from the bonds by any amortizable bond premium (see Bond Premium Amortization in chapter 3 of Pub. 550).
List each payer's name and the amount of interest income received from each payer on line 1. If you received a Form 1099-OID from a brokerage firm, list the brokerage firm as the payer.
You cannot use Form 1040A if you must use Form 1040, as described next.
Form 1040. You must use Form 1040 instead of Form 1040EZ if:
1. You forfeited interest income because of the early withdrawal of a time deposit;
2. You acquired taxable bonds after 1987, you choose to reduce interest income from the bonds by any amortizable bond premium, and you are deducting the excess of bond premium amortization for the accrual period over the qualified stated interest for the period (see Bond Premium Amortization in chapter 3 of Pub. 550); or
3. You received tax-exempt interest from private activity bonds issued after August 7, 1986.
Schedule B (Form 1040A or 1040). You must complete Schedule B (Form 1040A or 1040), Part I, if you file Form 1040 and any of the following apply.
1. Your taxable interest income is more than $1,500.
2. You are claiming the interest exclusion under the Education Savings Bond Program (discussed earlier).
3. You received interest from a seller-financed mortgage, and the buyer used the property as a home.
4. You received a Form 1099-INT for U.S. savings bond interest that includes amounts you reported in a previous tax year.
5. You received, as a nominee, interest that actually belongs to someone else.
6. You received a Form 1099-INT for interest on frozen deposits.
7. You received a Form 1099-INT for interest on a bond you bought between interest payment dates.
8. You are reporting OID in an amount less than the amount shown on Form 1099-OID.
9. Statement (2) in the preceding list under Form 1040 is true.
In Part I, line 1, list each payer's name and the amount received from each. If you received a Form 1099-OID from a brokerage firm, list the brokerage firm as the payer.
Reporting tax-exempt interest. Total your tax-exempt interest (such as interest or accrued OID on certain state and municipal bonds, including zero coupon municipal bonds) reported on Form 1099-INT, box 8, and exempt-interest dividends from a mutual fund or other regulated investment company reported on Form 1099-DIV, box 10. Add these amounts to any other tax-exempt interest you received. Report the total on line 8b of Form 1040.
If you file Form 1040EZ, enter "TEI" and the amount in the space to the left of line 2. Do not add tax-exempt interest in the total on Form 1040EZ, line 2.
Form 1099-DIV, box 11, show the tax-exempt interest subject to the alternative minimum tax on Form 6251. These amounts are already included in the amounts on Form 1099-INT, box 8, and Form 1099-DIV, box 10. Do not add the amounts in Form 1099-INT, box 9, and Form 1099-DIV, box 11, to, or subtract them from, the amounts on Form 1099-INT, box 8, and Form 1099-DIV, box 10.
CAUTION: Do not report interest from an individual retirement account (IRA) as tax-exempt interest.
Form 1099-INT. Your taxable interest income, except for interest from U.S. savings bonds and Treasury obligations, is shown in box 1 of Form 1099-INT. Add this amount to any other taxable interest income you received. See the instructions for Form 1099-INT if you have interest from a security acquired at a premium. You must report all of your taxable interest income even if you do not receive a Form 1099-INT. Contact your financial institution if you do not receive a Form 1099-INT by February 15. Your identifying number may be truncated on any paper Form 1099-INT you receive.
If you forfeited interest income because of the early withdrawal of a time deposit, the deductible amount will be shown on Form 1099-INT in box 2. See Penalty on early withdrawal of savings in chapter 1 of Pub. 550.
Box 3 of Form 1099-INT shows the interest income you received from U.S. savings bonds, Treasury bills, Treasury notes, and Treasury bonds. Generally, add the amount shown in box 3 to any other taxable interest income you received. If part of the amount shown in box 3 was previously included in your interest income, see U.S. savings bond interest previously reported, later. If you acquired the security at a premium, see the instructions for Form 1099-INT.
Box 4 of Form 1099-INT will contain an amount if you were subject to backup withholding. Include the amount from box 4 on Form 1040EZ, line 7; Form 1040, line 64 (federal income tax withheld).
Box 5 of Form 1099-INT shows investment expenses you may be able to deduct as an itemized deduction. See chapter 28 for more information about investment expenses.
If there are entries in boxes 6 and 7 of Form 1099-INT, you must file Form 1040. You may be able to take a credit for the amount shown in box 6 unless you deduct this amount on line 8 of Schedule A (Form 1040). To take the credit, you may have to file Form 1116, Foreign Tax Credit. For more information, see Pub. 514, Foreign Tax Credit for Individuals.
U.S. savings bond interest previously reported. If you received a Form 1099-INT for U.S. savings bond interest, the form may show interest you do not have to report. See Form 1099-INT for U.S. savings bonds interest, earlier.
On Schedule B (Form 1040A or 1040), Part I, line 1, report all the interest shown on your Form 1099-INT. Then follow these steps.
1. Several lines above line 2, enter a subtotal of all interest listed on line 1.
2. Below the subtotal, enter "U.S. Savings Bond Interest Previously Reported" and enter amounts previously reported or interest accrued before you received the bond.
3. Subtract these amounts from the subtotal and enter the result on line 2.
More information. For more information about how to report interest income, see chapter 1 of Pub. 550 or the instructions for the form you must file.
8. Dividends and Other Distributions
Reminder
Foreign-source income. If you are a U.S. citizen with dividend income from sources outside the United States (foreign-source income), you must report that 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 1099 from the foreign payer.
Introduction
This chapter discusses the tax treatment of:
• Ordinary dividends,
• Capital gain distributions,
• Nondividend distributions, and
• Other distributions you may receive from a corporation or a mutual fund.
This chapter also explains how to report dividend income on your tax return.
Dividends are distributions of money, stock, or other property paid to you by a corporation or by a mutual fund. You also may receive dividends through a partnership, an estate, a trust, or an association that is taxed as a corporation. However, some amounts you receive that are called dividends are actually interest income. (See Dividends that are actually interest in chapter 7.)
Most distributions are paid in cash (or check). However, distributions can consist of more stock, stock rights, other property, or services.
Useful Items
You may want to see:
Publication
• Publication 514 Foreign Tax Credit for Individuals
• Publication 550 Investment Income and Expenses
Form (and Instructions)
• Schedule B (Form 1040A or 1040) Interest and Ordinary Dividends
General Information
This section discusses general rules for dividend income.
Tax on unearned income of certain children. Part of a child's 2016 unearned income may be taxed at the parent's tax rate. If it is, Form 8615, Tax for Certain Children Who Have Unearned Income, must be completed and attached to the child's tax return. If not, Form 8615 is not required and the child's income is taxed at his or her own tax rate.
Some parents can choose to include the child's interest and dividends on the parent's return if certain requirements are met. Use Form 8814, Parents' Election To Report Child's Interest and Dividends, for this purpose.
For more information about the tax on unearned income of children and the parents' election, see chapter 31.
Beneficiary of an estate or trust. Dividends and other distributions you receive as a beneficiary of an estate or trust are generally taxable income. You should receive a Schedule K-1 (Form 1041), Beneficiary's Share of Income, Deductions, Credits, etc., from the fiduciary. Your copy of Schedule K-1 (Form 1041) and its instructions will tell you where to report the income on your Form 1040.
Social security number (SSN) or individual taxpayer identification number (ITIN). You must give your SSN or ITIN to any person required by federal tax law to make a return, statement, or other document that relates to you. This includes payers of dividends. If you do not give your SSN or ITIN to the payer of dividends, you may have to pay a penalty.
For more information on SSNs and ITINs, see Social Security Number (SSN) in chapter 1.
Backup withholding. Your dividend income is generally not subject to regular withholding. However, it may be subject to backup withholding to ensure that income tax is collected on the income. Under backup withholding, the payer of dividends must withhold, as income tax, on the amount you are paid, applying the appropriate withholding rate.
Backup withholding may also be required if the IRS has determined that you underreported your interest or dividend income. For more information, see Backup Withholding in chapter 4.
Stock certificate in two or more names. If two or more persons hold stock as joint tenants, tenants by the entirety, or tenants in common, each person's share of any dividends from the stock is determined by local law.
Form 1099-DIV. Most corporations and mutual funds use Form 1099-DIV, Dividends and Distributions, to show you the distributions you received from them during the year. Keep this form with your records. You do not have to attach it to your tax return.
Dividends not reported on Form 1099-DIV. Even if you do not receive Form 1099-DIV, you must still report all your taxable dividend income. For example, you may receive distributive shares of dividends from partnerships or S corporations. These dividends are reported to you on Schedule K-1 (Form 1065), Partner's Share of Income, Deductions, Credits, etc., and Schedule K-1 (Form 1120S), Shareholder's Share of Income, Deductions, Credits, etc.
Reporting tax withheld. If tax is withheld from your dividend income, the payer must give you a Form 1099-DIV that indicates the amount withheld.
Nominees. If someone receives distributions as a nominee for you, that person should give you a Form 1099-DIV, which will show distributions received on your behalf.
Form 1099-MISC. Certain substitute payments in lieu of dividends or tax-exempt interest received by a broker on your behalf must be reported to you on Form 1099-MISC, Miscellaneous Income, or a similar statement. See Reporting Substitute Payments under Short Sales in chapter 4 of Pub. 550 for more information about reporting these payments.
Incorrect amount shown on a Form 1099. If you receive a Form 1099 that shows an incorrect amount (or other incorrect information), you should ask the issuer for a corrected form. The new Form 1099 you receive will be marked "Corrected."
Dividends on stock sold. If stock is sold, exchanged, or otherwise disposed of after a dividend is declared but before it is paid, the owner of record (usually the payee shown on the dividend check) must include the dividend in income.
Dividends received in January. If a mutual fund (or other regulated investment company) or real estate investment trust (REIT) declares a dividend (including any exempt-interest dividend or capital gain distribution) in October, November, or December, payable to shareholders of record on a date in one of those months but actually pays the dividend during January of the next calendar year, you are considered to have received the dividend on December 31. You report the dividend in the year it was declared.
Ordinary Dividends
Ordinary (taxable) dividends are the most common type of distribution from a corporation or a mutual fund. They are paid out of earnings and profits and are ordinary income to you. This means they are not capital gains. You can assume that any dividend you receive on common or preferred stock is an ordinary dividend unless the paying corporation or mutual fund tells you otherwise. Ordinary dividends will be shown in box 1a of the Form 1099-DIV you receive.
Qualified Dividends
Qualified dividends are the ordinary dividends subject to the same 0%, 15%, or 20% maximum tax rate that applies to net capital gain. They should be shown in box 1b of the Form 1099-DIV you receive.
The maximum rate of tax on qualified dividends is the following.
• 0% on any amount that otherwise would be taxed at a 10% or 15% rate.
• 15% on any amount that otherwise would be taxed at rates greater than 15% but less than 39.6%.
• 20% on any amount that otherwise would be taxed at a 39.6% rate.
To qualify for the maximum rate, all of the following requirements must be met.
• The dividends must have been paid by a U.S. corporation or a qualified foreign corporation. (See Qualified foreign corporation, later.)
• The dividends are not of the type listed later under Dividends that are not qualified dividends.
• You meet the holding period (discussed next).
Holding period. You must have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date. The ex-dividend date is the first date following the declaration of a dividend on which the buyer of a stock is not entitled to receive the next dividend payment. Instead, the seller will get the dividend.
When counting the number of days you held the stock, include the day you disposed of the stock, but not the day you acquired it. See the examples later.
Exception for preferred stock. In the case of preferred stock, you must have held the stock more than 90 days during the 181-day period that begins 90 days before the ex-dividend date if the dividends are due to periods totaling more than 366 days. If the preferred dividends are due to periods totaling less than 367 days, the holding period in the previous paragraph applies.
Example 1. You bought 5,000 shares of XYZ Corp. common stock on July 9, 2016. XYZ Corp. paid a cash dividend of 10 cents per share. The ex-dividend date was July 16, 2016. Your Form 1099-DIV from XYZ Corp. shows $500 in box 1a (ordinary dividends) and in box 1b (qualified dividends). However, you sold the 5,000 shares on August 12, 2016. You held your shares of XYZ Corp. for only 34 days of the 121-day period (from July 10, 2016, through August 12, 2016). The 121-day period began on May 17, 2016 (60 days before the ex-dividend date), and ended on September 14, 2016. You have no qualified dividends from XYZ Corp. because you held the XYZ stock for less than 61 days.
Example 2. Assume the same facts as in Example 1 except that you bought the stock on July 15, 2016 (the day before the ex-dividend date), and you sold the stock on September 16, 2016. You held the stock for 63 days (from July 16, 2016, through September 16, 2016). The $500 of qualified dividends shown in box 1b of your Form 1099-DIV are all qualified dividends because you held the stock for 61 days of the 121-day period (from July 16, 2016, through September 14, 2016).
Example 3. You bought 10,000 shares of ABC Mutual Fund common stock on July 9, 2016. ABC Mutual Fund paid a cash dividend of 10 cents a share. The ex-dividend date was July 16, 2016. The ABC Mutual Fund advises you that the portion of the dividend eligible to be treated as qualified dividends equals 2 cents per share. Your Form 1099-DIV from ABC Mutual Fund shows total ordinary dividends of $1,000 and qualified dividends of $200. However, you sold the 10,000 shares on August 12, 2016. You have no qualified dividends from ABC Mutual Fund because you held the ABC Mutual Fund stock for less than 61 days.
Holding period reduced where risk of loss is diminished. When determining whether you met the minimum holding period discussed earlier, you cannot count any day during which you meet any of the following conditions.
1. You had an option to sell, were under a contractual obligation to sell, or had made (and not closed) a short sale of substantially identical stock or securities.
2. You were grantor (writer) of an option to buy substantially identical stock or securities.
3. Your risk of loss is diminished by holding one or more other positions in substantially similar or related property.
For information about how to apply condition (3), see Regulations section 1.246-5.
Qualified foreign corporation. A foreign corporation is a qualified foreign corporation if it meets any of the following conditions.
1. The corporation is incorporated in a U.S. possession.
2. The corporation is eligible for the benefits of a comprehensive income tax treaty with the United States that the Treasury Department determines is satisfactory for this purpose and that includes an exchange of information program. For a list of those treaties, see Table 8-1.
3. The corporation does not meet (1) or (2) above, but the stock for which the dividend is paid is readily tradable on an established securities market in the United States. See Readily tradable stock, later.
Table 8-1. Income Tax Treaties
-----------------------------------------
Income tax treaties the United States has
with the following countries satisfy
requirement (2) under Qualified foreign
corporation, earlier.
-----------------------------------------
Australia Indonesia Romania
Austria Ireland Russian
Bangladesh Israel Federation
Barbados Italy Slovak
Belgium Jamaica Republic
Bulgaria Japan Slovenia
Canada Kazakhstan South Africa
China Korea, Spain
Republic of
Cyprus Latvia Sri Lanka
Czech Lithuania Sweden
Republic Luxembourg Switzerland
Denmark Malta Thailand
Egypt Mexico Trinidad and
Estonia Morocco Tobago
Finland Netherlands Tunisia
France New Zealand Turkey
Germany Norway Ukraine
Greece Pakistan United
Hungary Philippines Kingdom
Iceland Poland Venezuela
India Portugal
-----------------------------------------
Exception. A corporation is not a qualified foreign corporation if it is a passive foreign investment company during its tax year in which the dividends are paid or during its previous tax year.
Readily tradable stock. Any stock (such as common, ordinary, or preferred) or an American depositary receipt in respect of that stock is considered to satisfy requirement (3) under Qualified foreign corporation, earlier, if it is listed on a national securities exchange that is registered under section http://www.sec.gov/divisions/marketreg/mrexchanges.shtml.
Dividends that are not qualified dividends. The following dividends are not qualified dividends. They are not qualified dividends even if they are shown in box 1b of Form 1099-DIV.
• Capital gain distributions.
• Dividends paid on deposits with mutual savings banks, cooperative banks, credit unions, U.S. building and loan associations, U.S. savings and loan associations, federal savings and loan associations, and similar financial institutions. (Report these amounts as interest income.)
• Dividends from a corporation that is a tax-exempt organization or farmer's cooperative during the corporation's tax year in which the dividends were paid or during the corporation's previous tax year.
• Dividends paid by a corporation on employer securities held on the date of record by an employee stock ownership plan (ESOP) maintained by that corporation.
• Dividends on any share of stock to the extent you are obligated (whether under a short sale or otherwise) to make related payments for positions in substantially similar or related property.
• Payments in lieu of dividends, but only if you know or have reason to know the payments are not qualified dividends.
• Payments shown in Form 1099-DIV, box 1b, from a foreign corporation to the extent you know or have reason to know the payments are not qualified dividends.
Dividends Used To Buy More Stock
The corporation in which you own stock may have a dividend reinvestment plan. This plan lets you choose to use your dividends to buy (through an agent) more shares of stock in the corporation instead of receiving the dividends in cash. Most mutual funds also permit shareholders to automatically reinvest distributions in more shares in the fund, instead of receiving cash. If you use your dividends to buy more stock at a price equal to its fair market value, you still must report the dividends as income.
If you are a member of a dividend reinvestment plan that lets you buy more stock at a price less than its fair market value, you must report as dividend income the fair market value of the additional stock on the dividend payment date.
You also must report as dividend income any service charge subtracted from your cash dividends before the dividends are used to buy the additional stock. But you may be able to deduct the service charge. See chapter 28 for more information about deducting expenses of producing income.
In some dividend reinvestment plans, you can invest more cash to buy shares of stock at a price less than fair market value. If you choose to do this, you must report as dividend income the difference between the cash you invest and the fair market value of the stock you buy. When figuring this amount, use the fair market value of the stock on the dividend payment date.
Money Market Funds
Report amounts you receive from money market funds as dividend income. Money market funds are a type of mutual fund and should not be confused with bank money market accounts that pay interest.
Capital Gain Distributions
Capital gain distributions (also called capital gain dividends) are paid to you or credited to your account by mutual funds (or other regulated investment companies) and real estate investment trusts (REITs). They will be shown in box 2a of the Form 1099-DIV you receive from the mutual fund or REIT.
Report capital gain distributions as long-term capital gains, regardless of how long you owned your shares in the mutual fund or REIT.
Undistributed capital gains of mutual funds and REITs. Some mutual funds and REITs keep their long-term capital gains and pay tax on them. You must treat your share of these gains as distributions, even though you did not actually receive them. However, they are not included on Form 1099-DIV. Instead, they are reported to you in box 1a of Form 2439.
Report undistributed capital gains (box 1a of Form 2439) as long-term capital gains on Schedule D (Form 1040), line 11, column (h).
The tax paid on these gains by the mutual fund or REIT is shown in box 2 of Form 2439. You take credit for this tax by including it on Form 1040, line 73, and following the instructions there.
Basis adjustment. Increase your basis in your mutual fund, or your interest in a REIT, by the difference between the gain you report and the credit you claim for the tax paid.
Additional information. For more information on the treatment of distributions from mutual funds, see Pub. 550.
Nondividend Distributions
A nondividend distribution is a distribution that is not paid out of the earnings and profits of a corporation or a mutual fund. You should receive a Form 1099-DIV or other statement showing the nondividend distribution. On Form 1099-DIV, a nondividend distribution will be shown in box 3. If you do not receive such a statement, you report the distribution as an ordinary dividend.
Basis adjustment. A nondividend distribution reduces the basis of your stock. It is not taxed until your basis in the stock is fully recovered. This nontaxable portion is also called a return of capital; it is a return of your investment in the stock of the company. If you buy stock in a corporation in different lots at different times, and you cannot definitely identify the shares subject to the nondividend distribution, reduce the basis of your earliest purchases first.
When the basis of your stock has been reduced to zero, report any additional nondividend distribution you receive as a capital gain. Whether you report it as a long-term or short-term capital gain depends on how long you have held the stock. See Holding Period in chapter 14.
Example. You bought stock in 2003 for $100. In 2006, you received a nondividend distribution of $80. You did not include this amount in your income, but you reduced the basis of your stock to $20. You received a nondividend distribution of $30 in 2016. The first $20 of this amount reduced your basis to zero. You report the other $10 as a long-term capital gain for 2016. You must report as a long-term capital gain any nondividend distribution you receive on this stock in later years.
Liquidating Distributions
Liquidating distributions, sometimes called liquidating dividends, are distributions you receive during a partial or complete liquidation of a corporation. These distributions are, at least in part, one form of a return of capital. They may be paid in one or more installments. You will receive Form 1099-DIV from the corporation showing you the amount of the liquidating distribution in box 8 or 9.
For more information on liquidating distributions, see chapter 1 of Pub. 550.
Distributions of Stock and Stock Rights
Distributions by a corporation of its own stock are commonly known as stock dividends. Stock rights (also known as "stock options") are distributions by a corporation of rights to acquire the corporation's stock. Generally, stock dividends and stock rights are not taxable to you, and you do not report them on your return.
Taxable stock dividends and stock rights. Distributions of stock dividends and stock rights are taxable to you if any of the following apply.
1. You or any other shareholder have the choice to receive cash or other property instead of stock or stock rights.
2. The distribution gives cash or other property to some shareholders and an increase in the percentage interest in the corporation's assets or earnings and profits to other shareholders.
3. The distribution is in convertible preferred stock and has the same result as in (2).
4. The distribution gives preferred stock to some common stock shareholders and common stock to other common stock shareholders.
5. The distribution is on preferred stock. (The distribution, however, is not taxable if it is an increase in the conversion ratio of convertible preferred stock made solely to take into account a stock dividend, stock split, or similar event that would otherwise result in reducing the conversion right.)
The term "stock" includes rights to acquire stock, and the term "shareholder" includes a holder of rights or of convertible securities.
If you receive taxable stock dividends or stock rights, include their fair market value at the time of distribution in your income.
Preferred stock redeemable at a premium. If you receive preferred stock having a redemption price higher than its issue price, the difference (the redemption premium) generally is taxable as a constructive distribution of additional stock on the preferred stock. For more information, see chapter 1 of Pub. 550.
Basis. Your basis in stock or stock rights received in a taxable distribution is their fair market value when distributed. If you receive stock or stock rights that are not taxable to you, see Stocks and Bonds under Basis of Investment Property in chapter 4 of Pub. 550 for information on how to figure their basis.
Fractional shares. You may not own enough stock in a corporation to receive a full share of stock if the corporation declares a stock dividend. However, with the approval of the shareholders, the corporation may set up a plan in which fractional shares are not issued but instead are sold, and the cash proceeds are given to the shareholders. Any cash you receive for fractional shares under such a plan is treated as an amount realized on the sale of the fractional shares. Report this transaction on Form 8949, Sales and Other Dispositions of Capital Assets. Enter your gain or loss, the difference between the cash you receive and the basis of the fractional shares sold, in column (h) of Schedule D (Form 1040) in Part I or Part II, whichever is appropriate.
CAUTION: Report these transactions on Form 8949 with the correct box checked.
For more information on Form 8949 and Pub. 550. Also see the Instructions for Form 8949 and the Instructions for Schedule D (Form 1040).
Example. You own one share of common stock that you bought on January 3, 2007, for $100. The corporation declared a common stock dividend of 5% on June 30, 2016. The fair market value of the stock at the time the stock dividend was declared was $200. You were paid $10 for the fractional-share stock dividend under a plan described in the discussion above. You figure your gain or loss as follows:
Fair market value of old stock $200.00
Fair market value of stock dividend (cash
received) +10.00
--------
Fair market value of old stock and stock
dividend $210.00
========
Basis (cost) of old stock after the stock
dividend (($200 ÷ $210) × $100) $95.24
Basis (cost) of stock dividend (($10 ÷ $210) ×
$100) + 4.76
--------
Total $100.00
========
Cash received $10.00
Basis (cost) of stock dividend - 4.76
--------
Gain $5.24
========
Because you had held the share of stock for more than 1 year at the time the stock dividend was declared, your gain on the stock dividend is a long-term capital gain.
Scrip dividends. A corporation that declares a stock dividend may issue you a scrip certificate that entitles you to a fractional share. The certificate is generally nontaxable when you receive it. If you choose to have the corporation sell the certificate for you and give you the proceeds, your gain or loss is the difference between the proceeds and the portion of your basis in the corporation's stock allocated to the certificate.
However, if you receive a scrip certificate that you can choose to redeem for cash instead of stock, the certificate is taxable when you receive it. You must include its fair market value in income on the date you receive it.
Other Distributions
You may receive any of the following distributions during the year.
Exempt-interest dividends. Exempt-interest dividends you receive from a mutual fund or other regulated investment company, including those received from a qualified fund of funds in any tax year beginning after December 22, 2010, are not included in your taxable income. Exempt-interest dividends should be shown in box 10 of Form 1099-DIV.
Information reporting requirement. Although exempt-interest dividends are not taxable, you must show them on your tax return if you have to file a return. This is an information reporting requirement and does not change the exempt-interest dividends to taxable income.
Alternative minimum tax treatment. Exempt-interest dividends paid from specified private activity bonds may be subject to the alternative minimum tax. See Alternative Minimum Tax (AMT) in chapter 30 for more information.
Dividends on insurance policies. Insurance policy dividends the insurer keeps and uses to pay your premiums are not taxable. However, you must report as taxable interest income the interest that is paid or credited on dividends left with the insurance company.
If dividends on an insurance contract (other than a modified endowment contract) are distributed to you, they are a partial return of the premiums you paid. Do not include them in your gross income until they are more than the total of all net premiums you paid for the contract. Report any taxable distributions on insurance policies on Form 1040, line 21.
Dividends on veterans' insurance. Dividends you receive on veterans' insurance policies are not taxable. In addition, interest on dividends left with the Department of Veterans Affairs is not taxable.
Patronage dividends. Generally, patronage dividends you receive in money from a cooperative organization are included in your income.
Do not include in your income patronage dividends you receive on:
• Property bought for your personal use, or
• Capital assets or depreciable property bought for use in your business. But you must reduce the basis (cost) of the items bought. If the dividend is more than the adjusted basis of the assets, you must report the excess as income.
These rules are the same whether the cooperative paying the dividend is a taxable or tax-exempt cooperative.
Alaska Permanent Fund dividends. Do not report these amounts as dividends. Instead, include these amounts on Form 1040, line 21; Form 1040EZ, line 3.
How To Report Dividend Income
Generally, you can use either Form 1040 or Form 1040A to report your dividend income. Report the total of your ordinary dividends on line 9a of Form 1040 or Form 1040A. Report qualified dividends on line 9b of Form 1040 or Form 1040A.
If you receive capital gain distributions, you may be able to use Form 1040A or you may have to use Form 1040. See Exceptions to filing Form 8949 and Schedule D (Form 1040) in chapter 16. If you receive nondividend distributions required to be reported as capital gains, you must use Form 1040. You cannot use Form 1040EZ if you receive any dividend income other than Alaska Permanent Fund dividends.
Form 1099-DIV. If you owned stock on which you received $10 or more in dividends and other distributions, you should receive a Form 1099-DIV. Even if you do not receive Form 1099-DIV, you must report all your dividend income.
See Form 1099-DIV for more information on how to report dividend income.
Form 1040A or 1040. You must complete Schedule B (Form 1040A or 1040), Part II, and attach it to your 1040, if:
• Your ordinary dividends (Form 1099-DIV, box 1a) are more than $1,500; or
• You received, as a nominee, dividends that actually belong to someone else.
If your ordinary dividends are more than $1,500, you must also complete Schedule B (Form 1040A or 1040), Part III.
List on Schedule B (Form 1040A or 1040), Part II, line 5, each payer's name and the ordinary dividends you received. If your securities are held by a brokerage firm (in "street name"), list the name of the brokerage firm shown on Form 1099-DIV as the payer. If your stock is held by a nominee who is the owner of record, and the nominee credited or paid you dividends on the stock, show the name of the nominee and the dividends you received or for which you were credited.
Enter on line 6 the total of the amounts listed on line 5. Also enter this total on line 9a of Form 1040A or 1040.
Qualified dividends. Report qualified dividends (Form 1099-DIV, box 1b) on line 9b of Form 1040A. The amount in box 1b is already included in box 1a. Do not add the amount in box 1b to, or subtract it from, the amount in box 1a.
Do not include any of the following on line 9b.
• Qualified dividends you received as a nominee. See Nominees under How To Report Dividend Income in chapter 1 of Pub. 550.
• Dividends on stock for which you did not meet the holding period. See Holding period, earlier, under Qualified Dividends.
• Dividends on any share of stock to the extent you are obligated (whether under a short sale or otherwise) to make related payments for positions in substantially similar or related property.
• Payments in lieu of dividends, but only if you know or have reason to know the payments are not qualified dividends.
• Payments shown in Form 1099-DIV, box 1b, from a foreign corporation to the extent you know or have reason to know the payments are not qualified dividends.
If you have qualified dividends, you must figure your tax by completing the Qualified Dividends and Capital Gain Tax Worksheet in the 1040A instructions or the Schedule D Tax Worksheet in the Schedule D (Form 1040) instructions, whichever applies. Enter qualified dividends on line 2 of the worksheet.
Investment interest deducted. If you claim a deduction for investment interest, you may have to reduce the amount of your qualified dividends that are eligible for the 0%, 15%, or 20% tax rate. Reduce it by the qualified dividends you choose to include in investment income when figuring the limit on your investment interest deduction. This is done on the Qualified Dividends and Capital Gain Tax Worksheet or the Schedule D Tax Worksheet. For more information about the limit on investment interest, see Investment expenses in chapter 23.
Expenses related to dividend income. You may be able to deduct expenses related to dividend income if you itemize your deductions on Schedule A (Form 1040). See chapter 28 for general information about deducting expenses of producing income.
More information. For more information about how to report dividend income, see chapter 1 of Pub. 550 or the instructions for the form you must file.
9. Rental Income and Expenses
Introduction
This chapter discusses rental income and expenses. It also covers the following topics.
• Personal use of dwelling unit (including vacation home).
• Depreciation.
• Limits on rental losses.
• How to report your rental income and expenses.
If you sell or otherwise dispose of your rental property, see Pub. 544, Sales and Other Dispositions of Assets.
If you have a loss from damage to, or theft of, rental property, see Pub. 547, Casualties, Disasters, and Thefts.
If you rent a condominium or a cooperative apartment, some special rules apply to you even though you receive the same tax treatment as other owners of rental property. See Pub. 527, Residential Rental Property, for more information.
Useful Items
You may want to see:
Publication
• Publication 527 Residential Rental Property
• Publication 534 Depreciating Property Placed in Service Before 1987
• Publication 535 Business Expenses
• Publication 925 Passive Activity and At-Risk Rules
• Publication 946 How To Depreciate Property
Form (and Instructions)
• Form 4562 Depreciation and Amortization
• Form 6251 Alternative Minimum Tax--Individuals
• Form 8582 Passive Activity Loss Limitations
• Schedule E (Form 1040) Supplemental Income and Loss
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. In addition to amounts you receive as normal rent payments, there are other amounts that may be rental income.
When to report. If you are a cash-basis taxpayer, you report rental income on your return for the year you actually or constructively receive it. You are a cash-basis taxpayer if you report income in the year you 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.
For more information about when you constructively receive income, see Accounting Methods in chapter 1.
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. You sign a 10-year lease to rent your property. In the first year, you receive $5,000 for the first year's rent and $5,000 as rent for the last year of the lease. You must include $10,000 in your income in the first year.
Canceling a lease. If your tenant pays you to cancel a lease, the amount you receive is rent. Include the payment in your 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 deduct the expenses if they are deductible rental expenses. See Rental Expenses, later, for more information.
Property or services. If you receive property or services, instead of money, as rent, 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.
Security deposits. Do not 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 does not 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.
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, do not include the rent you receive in your income and do not deduct rental expenses. However, you can deduct on Schedule A (Form 1040) the interest, taxes, and casualty and theft losses that are allowed for nonrental property. See Personal Use of Dwelling Unit (Including Vacation Home), later.
Rental Expenses
This part discusses expenses of renting property that you ordinarily can deduct from your rental income. It includes information on the expenses you can deduct if you rent part of your property, or if you change your property to rental use. Depreciation, which you can also deduct from your rental income, is discussed later.
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. See Personal Use of Dwelling Unit (Including Vacation Home), later.
Part interest. If you own a part interest in rental property, you can deduct expenses that you paid according to your percentage of ownership.
When to deduct. If you are a cash-basis taxpayer, you generally deduct your rental expenses in the year you pay them.
Depreciation. You can begin to depreciate rental property when it is ready and available for rent. See Placed in Service under When Does Depreciation Begin and End in chapter 2 of Pub. 527.
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.
Uncollected rent. If you are a cash-basis taxpayer, do not deduct uncollected rent. Because you have not included it in your income, it is not deductible.
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 cannot 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 is not held out and available for rent while listed for sale, the expenses are not deductible rental expenses.
Repairs and Improvements
Generally, an expense for repairing or maintaining your rental property may be deducted if you are not 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.
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 is not consistent with the intended ordinary use of your property when you began renting the property.
RECORDS: 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.
Other Expenses
Other expenses you can deduct from your rental income include advertising, cleaning and maintenance, utilities, fire and liability insurance, taxes, interest, commissions for the collection of rent, ordinary and necessary travel and transportation, and other expenses, discussed next.
Insurance premiums paid in advance. If you pay an insurance premium for more than one year in advance, you cannot deduct the total premium in the year you pay it. For each year of coverage, you deduct only the part of the premium payment that applies to that year.
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 (Form 1040), Part I. For example, on your 2016 Schedule E, you can deduct fees paid in 2016 to prepare your 2015 Schedule E, Part I. 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 benefits. In most cases, you cannot 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. See Pub. 587, Business Use of Your Home, for information on determining if your home office qualifies as a 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 2016, the standard mileage rate for business use is 54 cents per mile. For more information, see chapter 26.
RECORDS: To deduct car expenses under either method, you must keep records that follow the rules in chapter 26. In addition, you must complete Form 4562, Part V, and attach it to your tax return.
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 cannot 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 cannot deduct the cost of traveling away from home if the primary purpose of the trip was to improve your property. You recover the cost of improvements by taking depreciation. For information on travel expenses, see chapter 26.
RECORDS: To deduct travel expenses, you must keep records that follow the rules in chapter 26.
See Rental Expenses in Pub. 527 for more information.
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 cannot 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.
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 your 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 cannot deduct any part of the cost of the first phone line even if your tenants have unlimited use of it.
You do not 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 if you 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 tenants' use, all of the cost of the second line is deductible as a rental expense. You can deduct depreciation, discussed later, 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 the rental use and the 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 based on (1) the number of rooms in your home, and (2) the square footage of your home.
Not Rented for Profit
If you do not rent your property to make a profit, you can deduct your rental expenses only up to the amount of your rental income. You cannot deduct a loss or carry forward to the next year any rental expenses that are more than your rental income for the year. For more information about the rules for an activity not engaged in for profit, see Not-for-Profit Activities in chapter 1 of Pub. 535.
Where to report. Report your not-for-profit rental income on Form 1040, line 21. For example, 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) if you itemize your deductions.
If you itemize your deductions, 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). You can deduct these expenses only if they, together with certain other miscellaneous itemized deductions, total more than 2% of your adjusted gross income.
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 if you itemize your deductions on Schedule A (Form 1040).
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 does not include 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 is not 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 do not use the room yourself, and you allow only paying customers to use the room. The room is used solely as a hotel, motel, inn, or similar establishment and is not 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 does not apply when determining whether you used the unit as a home.)
• Any day that the unit is available for rent but not actually rented is not a day of rental use.
Example. Your beach cottage was available for rent from June 1 through August 31 (92 days). During that time, 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. 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 was not 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) are not 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. See Dwelling Unit Used as a Home next.
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:
1. 14 days, or
2. 10% of the total days it is rented to others at a fair rental price.
See What is a day of personal use, later.
Fair rental price. A fair rental price for your property generally is the amount of rent that a person who is not related to you would be willing to pay. The rent you charge is not 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.
If a dwelling unit is used for personal purposes on a day it is rented at a fair rental price, do not count that day as a day of rental use in applying (2) just described. Instead, count it as a day of personal use in applying both (1) and (2) just described.
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.
1. You or any other person who has an interest in the unit, unless you rent it to another owner as his or her main home under a shared equity financing agreement (defined later). However, see Days used as a main home before or after renting, later.
2. A member of your family or a member of the family of any other person who owns an interest in the unit, 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.).
3. Anyone under an arrangement that lets you use some other dwelling unit.
4. Anyone at less than a fair rental price.
Main home. If the other person or member of the family in (1) or (2) just described 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 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 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 was not used as a main home by anyone. Your neighbor used the unit for 2 weeks last year; you did not 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 are not 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 does not 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 is not 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 Joshua. Joshua rents his cabin in the mountains to you. You each pay a fair rental price.
You are using your house for personal purposes on the days that Joshua uses it because your house is used by Joshua under an arrangement that allows you to use his house.
Days used for repairs and maintenance. Any day that you spend working substantially full time repairing and maintaining (not improving) your property is not counted as a day of personal use. Do not count such a day as a day of personal use even if family members use the property for recreational purposes on the same day.
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. Do not 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 does not apply when dividing expenses between rental and personal use.
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 those days, the tenant was not able to use the apartment and allowed you to use it even though you did not 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 is not treated as rental activity. See Used as a home but rented less than 15 days, later, for more information.
Limit on deductions. Renting a dwelling unit that is considered a home is not a passive activity. Instead, if your rental expenses are more than your rental income, some or all of the excess expenses cannot be used to offset income from other sources. The excess expenses that cannot 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 do not 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 9-1.
Worksheet 9-1. Worksheet for Figuring Rental Deductions for a Dwelling Unit Used as a Home
Keep for Your Records
----------------------------------------------------------------------
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? (See Dwelling
Unit Used as a Home.)
• 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?
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PART I. Rental Use Percentage
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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. ______
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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
2015 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
2015 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. ______
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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. ______
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Worksheet 9-1 Instructions. Worksheet for Figuring Rental Deductions for a Dwelling Unit Used as a Home
Keep for Your Records
----------------------------------------------------------------------
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. Do not include interest on a loan that did not
benefit the dwelling unit. For example, do not 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 the worksheet.
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. See the Instructions
for Schedule A. However, figure your adjusted gross income
(Form 1040, line 38) without your rental income and
expenses from the dwelling unit. Use line 4b of this
worksheet to deduct the part of the qualified mortgage
insurance premiums not allowed because of the adjusted
gross income limit. Include the rental portion of the
amount from Schedule A, line 13, in the total you enter on
line 2a of the worksheet.
Note. Do not file this Schedule A or use it to figure the
amount to deduct on line 13 of that schedule. Instead,
figure the personal portion on a separate Schedule A. If
you have deducted mortgage interest or qualified mortgage
insurance premiums on the dwelling unit on other forms,
such as Schedule C or F, remember to reduce your Schedule
A deduction by that amount.
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, Casualties and Thefts, treating the
losses as personal losses. If any of the loss is due to a
federally declared disaster, see the Instructions for
Form 4684. On Form 4684, line 17, enter 10% of your
adjusted gross income figured without your rental income and
expenses from the dwelling unit. Enter the rental portion
of the result from Form 4684, line 18, on line 2c of this
worksheet.
Note. Do not file this Form 4684 or use it to figure your
personal losses on Schedule A. Instead, figure the personal
portion on a 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 would not be
deductible on Schedule A because of limits imposed on them,
enter on line 4b of this worksheet the rental portion of
those excess amounts. Do not include interest on a loan that
did not 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 are
not more than the amount on line 4e.*
Line 6a. To find the rental portion of excess casualty and theft
losses, use the Form 4684 you prepared for line 2c of this
worksheet.
A. Enter the amount from Form 4684, line 10 ______
B. Enter the rental portion of line A ______
C. Enter the amount from line 2c of this
worksheet ______
D. Subtract line C from line B. Enter the
result here and on line 6a of this
worksheet ______
Line 6e. You can deduct the amounts on lines 6a, 6b, and 6c as
rental expenses on Schedule E only to the extent they are
not more than the amount on line 6e.*
----------------------------------------------------------------------
* Allocating the limited deduction. If you cannot 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.
======================================================================
Reporting Income and Deductions
Property not used for personal purposes. If you do not use a dwelling unit for personal purposes, see How To Report Rental Income and Expenses, later, for how to report your rental income and expenses.
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. 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 Dividing Expenses. The expenses for personal use are not deductible as rental expenses.
Your deductible rental expenses can be more than your gross rental income; however, see Limits on Rental Losses, later.
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 is not considered to be rental and it should not be reported on Schedule E (Form 1040). You are not required to report the rental income and rental expenses from this activity. The expenses, including qualified mortgage interest, property taxes, and any qualified casualty loss will be reported as normally allowed on Schedule A (Form 1040). See the Instructions for Schedule A (Form 1040) for more information on deducting these expenses.
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 Dividing Expenses. The expenses for personal use are not 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 do not need to use Worksheet 9-1.
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 9-1.
Depreciation
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 cannot 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.
You may have to use Form 4562 to figure and report your depreciation. See How To Report Rental Income and Expenses, later.
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).
Claiming the correct amount of depreciation. You should claim the correct amount of depreciation each tax year. If you did not 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 are not allowed to make the correction on an amended return, you can change your accounting method to claim the correct amount of depreciation. See Claiming the Correct Amount of Depreciation in chapter 2 of Pub. 527 for more information.
Changing your accounting method to deduct unclaimed depreciation. To change your accounting method, you generally must file Form 3115, Application for Change in Accounting Method, to get the consent of the IRS. In some instances, that consent is automatic. For more information, see chapter 1 of Pub. 946.
Land. You cannot depreciate the cost of land because land generally does not wear out, become obsolete, or get used up. The costs of clearing, grading, planting, and landscaping are usually all part of the cost of land and cannot be depreciated.
More information. See Pub. 527 for more information about depreciating rental property and see Pub. 946 for more information about depreciation.
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.
1. At-risk rules. These rules are applied first if there is investment in your rental real estate activity for which you are not at risk. This applies only if the real property was placed in service after 1986.
2. Passive activity limits. Generally, rental real estate activities are considered passive activities and losses are not 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 are not fully at risk.
Losses from holding real property (other than mineral property) placed in service before 1987 are not 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. See Pub. 925 for more information.
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.
Limits on passive activity deductions and credits. Deductions or losses from passive activities are limited. You generally cannot 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.
For a detailed discussion of these rules, see Pub. 925.
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.
Real estate professionals. Rental activities in which you materially participated during the year are not passive activities if, for that year, you were a real estate professional. For a detailed discussion of the requirements, see Pub. 527. For a detailed discussion of material participation, see Pub. 925.
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 Personal Use of Dwelling Unit (Including Vacation Home), earlier.
Exception for Rental Real Estate Activities 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.
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 similar decisions.
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.
More information. See Pub. 925 for more information on the passive loss limits, including information on the treatment of unused disallowed passive losses and credits and the treatment of gains and losses realized on the disposition of a passive activity.
How To Report Rental Income and Expenses
The basic form for reporting residential rental income and expenses is Schedule E (Form 1040). However, do not use that schedule to report a not-for-profit activity. See Not Rented for Profit, earlier.
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, report your rental income and expenses on Schedule C-EZ (Form 1040), Net Profit From Business (Sole Proprietorship). Substantial services do not include the furnishing of heat and light, cleaning of public areas, trash collection, etc. For information, see Pub. 334, Tax Guide for Small Business. You also may have to pay self-employment tax on your rental income using Schedule SE (Form 1040), Self-Employment Tax.
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).
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, will not 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. For more information, see Pub. 527.
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. See the Instructions for Schedule E (Form 1040) for more information.
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 (Form 1040), Part I.
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. See the Instructions for Schedule E (Form 1040).
10. Retirement Plans, Pensions, and Annuities
Reminders
Net Investment Income Tax. For purposes of the Net Investment Income Tax (NIIT), net investment income doesn't include distributions from a qualified retirement plan (for example, 401(a), 403(a), 403(b), 408, 408A, or 457(b) plans). However, these distributions are taken into account when determining the modified adjusted gross income threshold. Distributions from a nonqualified retirement plan are included in net investment income. See Form 8960, Net Investment Income Tax -- Individuals, Estates, and Trusts, and its instructions for more information.
In-plan Roth rollovers. The American Taxpayer Relief Act of 2012 expanded the rules for in-plan Roth rollovers to include more taxpayers. For more information, see Designated Roth accounts discussed later.
Introduction
This chapter discusses the tax treatment of distributions you receive from:
• An employee pension or annuity from a qualified plan,
• A disability retirement, and
• A purchased commercial annuity.
What is not covered in this chapter. The following topics are not discussed in this chapter.
The General Rule. This is the method generally used to determine the tax treatment of pension and annuity income from nonqualified plans (including commercial annuities). For a qualified plan, you generally can't use the General Rule unless your annuity starting date is before November 19, 1996. For more information about the General Rule, see Pub. 939, General Rule for Pensions and Annuities.
Individual retirement arrangements (IRAs). Information on the tax treatment of amounts you receive from an IRA is in chapter 17.
Civil service retirement benefits. If you are retired from the federal government (regular, phased, or disability retirement), see Pub. 721, Tax Guide to U.S. Civil Service Retirement Benefits. Pub. 721 also covers the information that you need if you are the survivor or beneficiary of a federal employee or retiree who died.
Useful Items
You may want to see:
Publication
• Publication 575 Pension and Annuity Income
• Publication 721 Tax Guide to U.S. Civil Service Retirement Benefits
• Publication 939 General Rule for Pensions and Annuities
Form (and Instructions)
• Form W-4P Withholding Certificate for Pension or Annuity Payments
• Form 1099-R Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.
• Form 4972 Tax on Lump-Sum Distributions
• Form 5329 Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts
General Information
Designated Roth accounts. A designated Roth account is a separate account created under a qualified Roth contribution program to which participants may elect to have part or all of their elective deferrals to a 401(k), 403(b), or 457(b) plan designated as Roth contributions. Elective deferrals that are designated as Roth contributions are included in your income. However, qualified distributions aren't included in your income. See Pub. 575 for more information.
In-plan rollovers to designated Roth accounts. If you are a participant in a 401(k), 403(b), or 457(b) plan, your plan may permit you to roll over amounts in those plans to a designated Roth account within the same plan. The rollover of any untaxed amounts must be included in income in the year you receive the distribution. See Pub. 575 for more information.
More than one program. If you receive benefits from more than one program under a single trust or plan of your employer, such as a pension plan and a profit-sharing plan, you may have to figure the taxable part of each pension or annuity contract separately. Your former employer or the plan administrator should be able to tell you if you have more than one pension or annuity contract.
Section 457 deferred compensation plans. If you work for a state or local government or for a tax-exempt organization, you may be able to participate in a section 457 deferred compensation plan. If your plan is an eligible plan, you aren't taxed currently on pay that is deferred under the plan or on any earnings from the plan's investment of the deferred pay. You are generally taxed on amounts deferred in an eligible state or local government plan only when they are distributed from the plan. You are taxed on amounts deferred in an eligible tax-exempt organization plan when they are distributed or otherwise made available to you.
Your 457(b) plan may have a designated Roth account option. If so, you may be able to roll over amounts to the designated Roth account or make contributions. Elective deferrals to a designated Roth account are included in your income. Qualified distributions from a designated Roth account aren't subject to tax.
This chapter covers the tax treatment of benefits under eligible section 457 plans, but it doesn't cover the treatment of deferrals. For information on deferrals under section 457 plans, see Retirement Plan Contributions under Employee Compensation in Pub. 525, Taxable and Nontaxable Income.
For general information on these deferred compensation plans, see Section 457 Deferred Compensation Plans in Pub. 575.
Disability pensions. If you retired on disability, you generally 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 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.
TIP: You may be entitled to a tax credit if you were permanently and totally disabled when you retired. For information on the credit for the elderly or the disabled, see chapter 33.
Beginning on the day after you reach minimum retirement age, payments you receive are taxable as a pension or annuity. Report the payments on Form 1040, lines 16a and 16b, or on Form 1040A, lines 12a and 12b.
TIP: Disability payments for injuries incurred as a direct result of a terrorist attack directed against the United States (or its allies) are not included in income. For more information about payments to survivors of terrorist attacks, see Pub. 3920, Tax Relief for Victims of Terrorist Attacks.
For more information on how to report disability pensions, including military and certain government disability pensions, see chapter 5.
Retired public safety officers. An eligible retired public safety officer can elect to exclude from income distributions of up to $3,000 made directly from a government retirement plan to the provider of accident, health, or long-term disability insurance. See Insurance Premiums for Retired Public Safety Officers in Pub. 575 for more information.
Railroad retirement benefits. Part of any railroad retirement benefits you receive is treated for tax purposes as social security benefits, and part is treated as an employee pension. For information about railroad retirement benefits treated as social security benefits, see Pub. 915, Social Security and Equivalent Railroad Retirement Benefits. For information about railroad retirement benefits treated as an employee pension, see Railroad Retirement Benefits in Pub. 575.
Withholding and estimated tax. The payer of your pension, profit-sharing, stock bonus, annuity, or deferred compensation plan will withhold income tax on the taxable parts of amounts paid to you. You can tell the payer how much to withhold, or not to withhold, by filing Form W-4P. If you choose not to have tax withheld, or you don't have enough tax withheld, you may have to pay estimated tax.
If you receive an eligible rollover distribution, you can't choose not to have tax withheld. Generally, 20% will be withheld, but no tax will be withheld on a direct rollover of an eligible rollover distribution. See Direct rollover option under Rollovers, later.
For more information, see Pensions and Annuities under Tax Withholding for 2017 in chapter 4.
Qualified plans for self-employed individuals. Qualified plans set up by self-employed individuals are sometimes called Keogh or H.R. 10 plans. Qualified plans can be set up by sole proprietors, partnerships (but not a partner), and corporations. They can cover self-employed persons, such as the sole proprietor or partners, as well as regular (common-law) employees.
Distributions from a qualified plan are usually fully taxable because most recipients have no cost basis. If you have an investment (cost) in the plan, however, your pension or annuity payments from a qualified plan are taxed under the Simplified Method. For more information about qualified plans, see Pub. 560, Retirement Plans for Small Business.
Purchased annuities. If you receive pension or annuity payments from a privately purchased annuity contract from a commercial organization, such as an insurance company, you generally must use the General Rule to figure the tax-free part of each annuity payment. For more information about the General Rule, get Pub. 939. Also, see Variable Annuities in Pub. 575 for the special provisions that apply to these annuity contracts.
Loans. If you borrow money from your retirement plan, you must treat the loan as a nonperiodic distribution from the plan unless certain exceptions apply. This treatment also applies to any loan under a contract purchased under your retirement plan, and to the value of any part of your interest in the plan or contract that you pledge or assign. This means that you must include in income all or part of the amount borrowed. Even if you don't have to treat the loan as a nonperiodic distribution, you may not be able to deduct the interest on the loan in some situations. For details, see Loans Treated as Distributions in Pub. 575. For information on the deductibility of interest, see chapter 23.
Tax-free exchange. No gain or loss is recognized on an exchange of an annuity contract for another annuity contract if the insured or annuitant remains the same. However, if an annuity contract is exchanged for a life insurance or endowment contract, any gain due to interest accumulated on the contract is ordinary income. See Transfers of Annuity Contracts in Pub. 575 for more information about exchanges of annuity contracts.
How To Report
If you file Form 1040, report your total annuity on line 16a and the taxable part on line 16b. If your pension or annuity is fully taxable, enter it on line 16b; don't make an entry on line 16a.
If you file Form 1040A, report your total annuity on line 12a and the taxable part on line 12b. If your pension or annuity is fully taxable, enter it on line 12b; don't make an entry on line 12a.
More than one annuity. If you receive more than one annuity and at least one of them is not fully taxable, enter the total amount received from all annuities on Form 1040, line 16a, or Form 1040A, line 12a, and enter the taxable part on Form 1040, line 16b, or Form 1040A, line 12b. If all the annuities you receive are fully taxable, enter the total of all of them on Form 1040, line 16b, or Form 1040A, line 12b.
Joint return. If you file a joint return and you and your spouse each receive one or more pensions or annuities, report the total of the pensions and annuities on Form 1040, line 16a, or Form 1040A, line 12a, and report the taxable part on Form 1040, line 16b, or Form 1040A, line 12b.
Cost (Investment in the Contract)
Before you can figure how much, if any, of a distribution from your pension or annuity plan is taxable, you must determine your cost (your investment in the contract) in the pension or annuity. Your total cost in the plan includes the total premiums, contributions, or other amounts you paid. This includes the amounts your employer contributed that were taxable to you when paid. Cost doesn't include any amounts you deducted or were excluded from your income.
From this total cost, subtract any refunds of premiums, rebates, dividends, unrepaid loans that were not included in your income, or other tax-free amounts that you received by the later of the annuity starting date or the date on which you received your first payment.
Your annuity starting date is the later of the first day of the first period for which you received a payment or the date the plan's obligations became fixed.
Designated Roth accounts. Your cost in these accounts is your designated Roth contributions that were included in your income as wages subject to applicable withholding requirements. Your cost will also include any in-plan Roth rollovers you included in income.
Foreign employment contributions. If you worked in a foreign country and contributions were made to your retirement plan, special rules apply in determining your cost. See Foreign employment contributions under Cost (Investment in the Contract) in Pub. 575.
Taxation of Periodic Payments
Fully taxable payments. Generally, if you didn't pay any part of the cost of your employee pension or annuity and your employer didn't withhold part of the cost from your pay while you worked, the amounts you receive each year are fully taxable. You must report them on your income tax return.
Partly taxable payments. If you paid part of the cost of your pension or annuity, you are not taxed on the part of the pension or annuity you receive that represents a return of your cost. The rest of the amount you receive is generally taxable. You figure the tax-free part of the payment using either the Simplified Method or the General Rule. Your annuity starting date and whether or not your plan is qualified determine which method you must or may use.
If your annuity starting date is after November 18, 1996, and your payments are from a qualified plan, you must use the Simplified Method. Generally, you must use the General Rule if your annuity is paid under a nonqualified plan, and you can't use this method if your annuity is paid under a qualified plan.
If you had more than one partly taxable pension or annuity, figure the tax-free part and the taxable part of each separately.
If your annuity is paid under a qualified plan and your annuity starting date is after July 1, 1986, and before November 19, 1996, you could have chosen to use either the General Rule or the Simplified Method.
Exclusion limit. Your annuity starting date determines the total amount of annuity payments that you can exclude from your taxable income over the years. Once your annuity starting date is determined, it doesn't change. If you calculate the taxable portion of your annuity payments using the simplified method worksheet, the annuity starting date determines the recovery period for your cost. That recovery period begins on your annuity starting date and isn't affected by the date you first complete the worksheet.
Exclusion limited to cost. If your annuity starting date is after 1986, the total amount of annuity income that you can exclude over the years as a recovery of the cost can't exceed your total cost. Any unrecovered cost at your (or the last annuitant's) death is allowed as a miscellaneous itemized deduction on the final return of the decedent. This deduction isn't subject to the 2%-of-adjusted-gross-income limit.
Exclusion not limited to cost. If your annuity starting date is before 1987, you can continue to take your monthly exclusion for as long as you receive your annuity. If you chose a joint and survivor annuity, your survivor can continue to take the survivor's exclusion figured as of the annuity starting date. The total exclusion may be more than your cost.
Simplified Method
Under the Simplified Method, you figure the tax-free part of each annuity payment by dividing your cost by the total number of anticipated monthly payments. For an annuity that is payable for the lives of the annuitants, this number is based on the annuitants' ages on the annuity starting date and is determined from a table. For any other annuity, this number is the number of monthly annuity payments under the contract.
Who must use the Simplified Method. You must use the Simplified Method if your annuity starting date is after November 18, 1996, and you both:
1. Receive pension or annuity payments from a qualified employee plan, qualified employee annuity, or a tax-sheltered annuity (403(b)) plan, and
2. On your annuity starting date, you were either under age 75, or entitled to less than 5 years of guaranteed payments.
Guaranteed payments. Your annuity contract provides guaranteed payments if a minimum number of payments or a minimum amount (for example, the amount of your investment) is payable even if you and any survivor annuitant do not live to receive the minimum. If the minimum amount is less than the total amount of the payments you are to receive, barring death, during the first 5 years after payments begin (figured by ignoring any payment increases), you are entitled to less than 5 years of guaranteed payments.
How to use the Simplified Method. Complete the Simplified Method Worksheet in Pub. 575 to figure your taxable annuity for 2016.
Single-life annuity. If your annuity is payable for your life alone, use Table 1 at the bottom of the worksheet to determine the total number of expected monthly payments. Enter on line 3 the number shown for your age at the annuity starting date.
Multiple-lives annuity. If your annuity is payable for the lives of more than one annuitant, use Table 2 at the bottom of the worksheet to determine the total number of expected monthly payments. Enter on line 3 the number shown for the combined ages of you and the youngest survivor annuitant at the annuity starting date.
However, if your annuity starting date is before 1998, don't use Table 2 and don't combine the annuitants' ages. Instead you must use Table 1 and enter on line 3 the number shown for the primary annuitant's age on the annuity starting date.
RECORDS: Be sure to keep a copy of the completed worksheet; it will help you figure your taxable annuity next year.
Example. Bill Smith, age 65, began receiving retirement benefits in 2016, under a joint and survivor annuity. Bill's annuity starting date is January 1, 2016. The benefits are to be paid for the joint lives of Bill and his wife Kathy, age 65. Bill had contributed $31,000 to a qualified plan and had received no distributions before the annuity starting date. Bill is to receive a retirement benefit of $1,200 a month, and Kathy is to receive a monthly survivor benefit of $600 upon Bill's death.
Bill must use the Simplified Method to figure his taxable annuity because his payments are from a qualified plan and he is under age 75. Because his annuity is payable over the lives of more than one annuitant, he uses his and Kathy's combined ages and Table 2 at the bottom of the worksheet in completing line 3 of the worksheet. His completed worksheet is shown in Worksheet 10-A.
Bill's tax-free monthly amount is $100 ($31,000 ÷ 310) as shown on line 4 of the worksheet. Upon Bill's death, if Bill hasn't recovered the full $31,000 investment, Kathy will also exclude $100 from her $600 monthly payment. The full amount of any annuity payments received after 310 payments are paid must be included in gross income.
If Bill and Kathy die before 310 payments are made, a miscellaneous itemized deduction will be allowed for the unrecovered cost on the final income tax return of the last to die. This deduction isn't subject to the 2%-of-adjusted-gross-income limit.
Worksheet 10-A. Simplified Method Worksheet for Bill Smith
Keep for Your Records
----------------------------------------------------------------------
1. Enter the total pension or annuity payments received
this year. Also, add this amount to the total for
Form 1040A, line 12a 1. 14,400
2. Enter your cost in the plan (contract) at
the annuity starting date plus any death
benefit exclusion*. See Cost (Investment in
the Contract), earlier 2. 31,000
Note: If your annuity starting date was
before this year and you completed this
worksheet last year, skip line 3 and enter
the amount from line 4 of last year's
worksheet on line 4 below (even if the
amount of your pension or annuity has
changed). Otherwise, go to line 3.
3. Enter the appropriate number from Table 1
below. But if your annuity starting date
was after 1997 and the payments are for
your life and that of your beneficiary,
enter the appropriate number from Table 2
below 3. 310
4. Divide line 2 by the number on line 3 4. 100
5. Multiply line 4 by the number of months for
which this year's payments were made. If
your annuity starting date was before 1987,
enter this amount on line 8 below and skip
lines 6, 7, 10, and 11. Otherwise, go to
line 6 5. 1,200
6. Enter any amounts previously recovered tax
free in years after 1986. This is the
amount shown on line 10 of your worksheet
for last year 6. -0-
7. Subtract line 6 from line 2 7. 31,000
8. Enter the smaller of line 5 or line 7 8. 1,200
9. Taxable amount for year. Subtract line 8 from line 1.
Enter the result, but not less than zero. Also, add
this amount to the total for Form 1040, line 16b, or
Form 1040A, line 12b 9. 13,200
Note: If your Form 1099-R shows a larger taxable
amount, use the amount figured on this line instead.
If you are a retired public safety officer, see
Insurance Premiums for Retired Public Safety Officers
in Pub. 575 before entering an amount on your tax
return.
10. Was your annuity starting date before 1987?
[ ] Yes. STOP. Don't complete the rest of this
worksheet.
[x] No. Add lines 6 and 8. This is the amount you have
recovered tax free through 2016. You will need this
number if you need to fill out this worksheet next
year 10. 1,200
11. Balance of cost to be recovered. Subtract line 10 from
line 2. If zero, you won't have to complete this
worksheet next year. The payments you receive next
year will generally be fully taxable 11. 29,800
----------------------------------------------------------------------
TABLE 1 FOR LINE 3 ABOVE
AND your annuity starting date was --
IF the age at before November 19, after November 18,
annuity starting 1996, enter on 1996, enter on
date was . . . line 3 . . . line 3 . . .
---------------- ------------------- ------------------
55 or under 300 360
56-60 260 310
61-65 240 260
66-70 170 210
71 or older 120 160
----------------------------------------------------------------------
TABLE 2 FOR LINE 3 ABOVE
IF the combined
ages at annuity
starting date THEN enter
were . . . on line 3 . . .
--------------- ---------------
110 or under 410
111-120 360
121-130 310
131-140 260
141 or older 210
----------------------------------------------------------------------
* A death benefit exclusion (up to $5,000) applied to certain benefits
received by employees who died before August 21, 1996.
======================================================================
Who must use the General Rule. You must use the General Rule if you receive pension or annuity payments from:
• A nonqualified plan (such as a private annuity, a purchased commercial annuity, or a nonqualified employee plan), or
• A qualified plan if you are age 75 or older on your annuity starting date and your annuity payments are guaranteed for at least 5 years.
Annuity starting before November 19, 1996. If your annuity starting date is after July 1, 1986, and before November 19, 1996, you had to use the General Rule for either circumstance just described. You also had to use it for any fixed-period annuity. If you didn't have to use the General Rule, you could have chosen to use it. If your annuity starting date is before July 2, 1986, you had to use the General Rule unless you could use the Three-Year Rule.
If you had to use the General Rule (or chose to use it), you must continue to use it each year that you recover your cost.
Who can't use the General Rule. You can't use the General Rule if you receive your pension or annuity from a qualified plan and none of the circumstances described in the preceding discussions apply to you. See Who must use the Simplified Method, earlier.
More information. For complete information on using the General Rule, including the actuarial tables you need, see Pub. 939.
Taxation of Nonperiodic Payments
Nonperiodic distributions are also known as amounts not received as an annuity. They include all payments other than periodic payments and corrective distributions. Examples of nonperiodic payments are cash withdrawals, distributions of current earnings, certain loans, and the value of annuity contracts transferred without full and adequate consideration.
Corrective distributions of excess plan contributions. Generally, if the contributions made for you during the year to certain retirement plans exceed certain limits, the excess is taxable to you. To correct an excess, your plan may distribute it to you (along with any income earned on the excess). For information on plan contribution limits and how to report corrective distributions of excess contributions, see Retirement Plan Contributions under Employee Compensation in Pub. 525.
Figuring the taxable amount of nonperiodic payments. How you figure the taxable amount of a nonperiodic distribution depends on whether it is made before the annuity starting date, or on or after the annuity starting date. If it is made before the annuity starting date, its tax treatment also depends on whether it is made under a qualified or nonqualified plan. If it is made under a nonqualified plan, its tax treatment depends on whether it fully discharges the contract, is received under certain life insurance or endowment contracts, or is allocable to an investment you made before August 14, 1982.
Annuity starting date. The annuity starting date is either the first day of the first period for which you receive an annuity payment under the contract or the date on which the obligation under the contract becomes fixed, whichever is later.
Distribution on or after annuity starting date. If you receive a nonperiodic payment from your annuity contract on or after the annuity starting date, you generally must include all of the payment in gross income.
Distribution before annuity starting date. If you receive a nonperiodic distribution before the annuity starting date from a qualified retirement plan, you generally can allocate only part of it to the cost of the contract. You exclude from your gross income the part that you allocate to the cost. You include the remainder in your gross income.
If you receive a nonperiodic distribution before the annuity starting date from a plan other than a qualified retirement plan (nonqualified plan), it is allocated first to earnings (the taxable part) and then to the cost of the contract (the tax-free part). This allocation rule applies, for example, to a commercial annuity contract you bought directly from the issuer.
CAUTION: Distributions from nonqualified plans are subject to the net investment income tax. See the Instructions for Form 8960.
For more information, see Figuring the Taxable Amount under Taxation of Nonperiodic Payments in Pub. 575.
Lump-Sum Distributions
TIP: This section on lump-sum distributions only applies if the plan participant was born before January 2, 1936. If the plan participant was born after January 1, 1936, the taxable amount of this nonperiodic payment is reported as discussed earlier.
A lump-sum distribution is the distribution or payment in one tax year of a plan participant's entire balance from all of the employer's qualified plans of one kind (for example, pension, profit-sharing, or stock bonus plans). A distribution from a nonqualified plan (such as a privately purchased commercial annuity or a section 457 deferred compensation plan of a state or local government or tax-exempt organization) can't qualify as a lump-sum distribution.
The participant's entire balance from a plan doesn't include certain forfeited amounts. It also doesn't include any deductible voluntary employee contributions allowed by the plan after 1981 and before 1987. For more information about distributions that don't qualify as lump-sum distributions, see Distributions that do not qualify under Lump-Sum Distributions in Pub. 575.
If you receive a lump-sum distribution from a qualified employee plan or qualified employee annuity and the plan participant was born before January 2, 1936, you may be able to elect optional methods of figuring the tax on the distribution. The part from active participation in the plan before 1974 may qualify as capital gain subject to a 20% tax rate. The part from participation after 1973 (and any part from participation before 1974 that you don't report as capital gain) is ordinary income. You may be able to use the 10-year tax option, discussed later, to figure tax on the ordinary income part.
Use Form 4972 to figure the separate tax on a lump-sum distribution using the optional methods. The tax figured on Form 4972 is added to the regular tax figured on your other income. This may result in a smaller tax than you would pay by including the taxable amount of the distribution as ordinary income in figuring your regular tax.
How to treat the distribution. If you receive a lump-sum distribution, you may have the following options for how you treat the taxable part.
• Report the part of the distribution from participation before 1974 as a capital gain (if you qualify) and the part from participation after 1973 as ordinary income.
• Report the part of the distribution from participation before 1974 as a capital gain (if you qualify) and use the 10-year tax option to figure the tax on the part from participation after 1973 (if you qualify).
• Use the 10-year tax option to figure the tax on the total taxable amount (if you qualify).
• Roll over all or part of the distribution. See Rollovers, later. No tax is currently due on the part rolled over. Report any part not rolled over as ordinary income.
• Report the entire taxable part of the distribution as ordinary income on your tax return.
The first three options are explained in the following discussions.
Electing optional lump-sum treatment. You can choose to use the 10-year tax option or capital gain treatment only once after 1986 for any plan participant. If you make this choice, you can't use either of these optional treatments for any future distributions for the participant.
Taxable and tax-free parts of the distribution. The taxable part of a lump-sum distribution is the employer's contributions and income earned on your account. You may recover your cost in the lump sum and any net unrealized appreciation (NUA) in employer securities tax free.
Cost. In general, your cost is the total of:
• The plan participant's nondeductible contributions to the plan,
• The plan participant's taxable costs of any life insurance contract distributed,
• Any employer contributions that were taxable to the plan participant, and
• Repayments of any loans that were taxable to the plan participant.
You must reduce this cost by amounts previously distributed tax free.
Net unrealized appreciation (NUA). The NUA in employer securities (box 6 of Form 1099-R) received as part of a lump-sum distribution is generally tax free until you sell or exchange the securities. (For more information, see Distributions of employer securities under Taxation of Nonperiodic Payments in Pub. 575.)
Capital Gain Treatment
Capital gain treatment applies only to the taxable part of a lump-sum distribution resulting from participation in the plan before 1974. The amount treated as capital gain is taxed at a 20% rate. You can elect this treatment only once for any plan participant, and only if the plan participant was born before January 2, 1936.
Complete Part II of Form 4972 to choose the 20% capital gain election. For more information, see Capital Gain Treatment under Lump-Sum Distributions in Pub. 575.
10-Year Tax Option
The 10-year tax option is a special formula used to figure a separate tax on the ordinary income part of a lump-sum distribution. You pay the tax only once, for the year in which you receive the distribution, not over the next 10 years. You can elect this treatment only once for any plan participant, and only if the plan participant was born before January 2, 1936.
The ordinary income part of the distribution is the amount shown in box 2a of the Form 1099-R given to you by the payer, minus the amount, if any, shown in box 3. You also can treat the capital gain part of the distribution (box 3 of Form 1099-R) as ordinary income for the 10-year tax option if you don't choose capital gain treatment for that part.
Complete Part III of Form 4972 to choose the 10-year tax option. You must use the special Tax Rate Schedule shown in the instructions for Part III to figure the tax. Pub. 575 illustrates how to complete Form 4972 to figure the separate tax.
Rollovers
If you withdraw cash or other assets from a qualified retirement plan in an eligible rollover distribution, you can defer tax on the distribution by rolling it over to another qualified retirement plan or a traditional IRA.
For this purpose, the following plans are qualified retirement plans.
• A qualified employee plan.
• A qualified employee annuity.
• A tax-sheltered annuity plan (403(b) plan).
• An eligible state or local government section 457 deferred compensation plan.
Eligible rollover distributions. Generally, an eligible rollover distribution is any distribution of all or any part of the balance to your credit in a qualified retirement plan. For information about exceptions to eligible rollover distributions, see Pub. 575.
Rollover of nontaxable amounts. You may be able to roll over the nontaxable part of a distribution (such as your after-tax contributions) made to another qualified retirement plan that is a qualified employee plan or a 403(b) plan, or to a traditional or Roth IRA. The transfer must be made either through a direct rollover to a qualified plan or 403(b) plan that separately accounts for the taxable and nontaxable parts of the rollover or through a rollover to a traditional or Roth IRA.
If you roll over only part of a distribution that includes both taxable and nontaxable amounts, the amount you roll over is treated as coming first from the taxable part of the distribution.
Any after-tax contributions that you roll over into your traditional IRA become part of your basis (cost) in your IRAs. To recover your basis when you take distributions from your IRA, you must complete Form 8606 for the year of the distribution. For more information, see the Form 8606 instructions.
Direct rollover option. You can choose to have any part or all of an eligible rollover distribution paid directly to another qualified retirement plan that accepts rollover distributions or to a traditional or Roth IRA. If you choose the direct rollover option, or have an automatic rollover, no tax will be withheld from any part of the distribution that is directly paid to the trustee of the other plan.
Payment to you option. If an eligible rollover distribution is paid to you, 20% generally will be withheld for income tax. However, the full amount is treated as distributed to you even though you actually receive only 80%. You generally must include in income any part (including the part withheld) that you don't roll over within 60 days to another qualified retirement plan or to a traditional or Roth IRA. (See Pensions and Annuities under Tax Withholding for 2017 in chapter 4.)
CAUTION: Rolling over more than amount received. If you decide to roll over an amount equal to the distribution before withholding, your contribution to the new plan or IRA must include other money (for example, from savings or amounts borrowed) to replace the amount withheld.
Time for making rollover. You generally must complete the rollover of an eligible rollover distribution paid to you by the 60th day following the day on which you receive the distribution from your employer's plan. (If an amount distributed to you becomes a frozen deposit in a financial institution during the 60-day period after you receive it, the rollover period is extended for the period during which the distribution is in a frozen deposit in a financial institution.)
The IRS may waive the 60-day requirement where the failure to do so would be against equity or good conscience, such as in the event of a casualty, disaster, or other event beyond your reasonable control.
The administrator of a qualified plan must give you a written explanation of your distribution options within a reasonable period of time before making an eligible rollover distribution.
Qualified domestic relations order (QDRO). You may be able to roll over tax free all or part of a distribution from a qualified retirement plan that you receive under a QDRO. If you receive the distribution as an employee's spouse or former spouse (not as a nonspousal beneficiary), the rollover rules apply to you as if you were the employee. You can roll over the distribution from the plan into a traditional IRA or to another eligible retirement plan. See Rollovers in Pub. 575 for more information on benefits received under a QDRO.
Rollover by surviving spouse. You may be able to roll over tax free all or part of a distribution from a qualified retirement plan you receive as the surviving spouse of a deceased employee. The rollover rules apply to you as if you were the employee. You can roll over a distribution into a qualified retirement plan or a traditional or Roth IRA. For a rollover to a Roth IRA, see Rollovers to Roth IRAs, later.
A distribution paid to a beneficiary other than the employee's surviving spouse is generally not an eligible rollover distribution. However, see Rollovers by nonspouse beneficiary next.
Rollovers by nonspouse beneficiary. If you are a designated beneficiary (other than a surviving spouse) of a deceased employee, you may be able to roll over tax free all or a portion of a distribution you receive from an eligible retirement plan of the employee. The distribution must be a direct trustee-to-trustee transfer to your traditional or Roth IRA that was set up to receive the distribution. The transfer will be treated as an eligible rollover distribution and the receiving plan will be treated as an inherited IRA. For information on inherited IRAs, see What if You Inherit an IRA? in chapter 1 of Pub. 590-B, Individual Retirement Arrangements (IRAs).
Retirement bonds. If you redeem retirement bonds purchased under a qualified bond purchase plan, you can roll over the proceeds that exceed your basis tax free into an IRA (as discussed in Pub. 590-A) or a qualified employer plan.
Designated Roth accounts. You can roll over an eligible rollover distribution from a designated Roth account into another designated Roth account or a Roth IRA. If you want to roll over the part of the distribution that is not included in income, you must make a direct rollover of the entire distribution or you can roll over the entire amount (or any portion) to a Roth IRA. For more information on rollovers from designated Roth accounts, see Rollovers in Pub. 575.
In-plan rollovers to designated Roth accounts. If you are a plan participant in a 401(k), 403(b), or 457(b) plan, your plan may permit you to roll over amounts in those plans to a designated Roth account within the same plan. The rollover of any untaxed amounts must be included in income. See Designated Roth accounts under Rollovers in Pub. 575 for more information.
Rollovers to Roth IRAs. You can roll over distributions directly from a qualified retirement plan (other than a designated Roth account) to a Roth IRA.
You must include in your gross income distributions from a qualified retirement plan (other than a designated Roth account) that you would have had to include in income if you hadn't rolled them over into a Roth IRA. You don't include in gross income any part of a distribution from a qualified retirement plan that is a return of contributions to the plan that were taxable to you when paid. In addition, the 10% tax on early distributions doesn't apply.
More information. For more information on the rules for rolling over distributions, see Rollovers in Pub. 575.
Special Additional Taxes
To discourage the use of pension funds for purposes other than normal retirement, the law imposes additional taxes on early distributions of those funds and on failures to withdraw the funds timely. Ordinarily, you won't be subject to these taxes if you roll over all early distributions you receive, as explained earlier, and begin drawing out the funds at a normal retirement age, in reasonable amounts over your life expectancy. These special additional taxes are the taxes on:
• Early distributions, and
• Excess accumulation (not receiving minimum distributions).
These taxes are discussed in the following sections.
If you must pay either of these taxes, report them on Form 5329. However, you don't have to file Form 5329 if you owe only the tax on early distributions and all your Forms 1099-R correctly shows a "1" in box 7. Instead, enter 10% of the taxable part of the distribution on Form 1040, line 59 and write "No" under the heading "Other Taxes" to the left of line 59.
Even if you don't owe any of these taxes, you may have to complete Form 1040. This applies if you meet an exception to the tax on early distributions but box 7 of your Form 1099-R doesn't indicate an exception.
Tax on Early Distributions
Most distributions (both periodic and nonperiodic) from qualified retirement plans and non-qualified annuity contracts made to you before you reach age 59 1/2 are subject to an additional tax of 10%. This tax applies to the part of the distribution that you must include in gross income.
For this purpose, a qualified retirement plan is:
• A qualified employee plan,
• A qualified employee annuity plan,
• A tax-sheltered annuity plan, or
• An eligible state or local government section 457 deferred compensation plan (to the extent that any distribution is attributable to amounts the plan received in a direct transfer or rollover from one of the other plans listed here or an IRA).
5% rate on certain early distributions from deferred annuity contracts. If an early withdrawal from a deferred annuity is otherwise subject to the 10% additional tax, a 5% rate may apply instead. A 5% rate applies to distributions under a written election providing a specific schedule for the distribution of your interest in the contract if, as of March 1, 1986, you had begun receiving payments under the election. On line 4 of Form 5329, multiply the line 3 amount by 5% instead of 10%. Attach an explanation to your return.
Distributions from Roth IRAs allocable to a rollover from an eligible retirement plan within the 5-year period. If, within the 5-year period starting with the first day of your tax year in which you rolled over an amount from an eligible retirement plan to a Roth IRA, you take a distribution from the Roth IRA, you may have to pay the additional 10% tax on early distributions. You generally must pay the 10% additional tax on any amount attributable to the part of the rollover that you had to include in income. The additional tax is figured on Form 5329. For more information, see Form 5329 and its instructions. For information on qualified distributions from Roth IRAs, see Additional Tax on Early Distributions in chapter 2 of Pub. 590-B.
Distributions from designated Roth accounts allocable to in-plan Roth rollovers within the 5-year period. If, within the 5-year period starting with the first day of your tax year in which you rolled over an amount from a 401(k), 403(b), or 457(b) plan to a designated Roth account, you take a distribution from the designated Roth account, you may have to pay the additional 10% tax on early distributions. You generally must pay the 10% additional tax on any amount attributable to the part of the in-plan rollover that you had to include in income. The additional tax is figured on Form 5329. For more information, see Form 5329 and its instructions. For information on qualified distributions from designated Roth accounts, see Designated Roth accounts under Taxation of Periodic Payments in Pub. 575.
Exceptions to tax. Certain early distributions are excepted from the early distribution tax. If the payer knows that an exception applies to your early distribution, distribution code "2," "3," or "4" should be shown in box 7 of your Form 1099-R and you don't have to report the distribution on Form 5329. If an exception applies but distribution code "1" (early distribution, no known exception) is shown in box 7, you must file Form 5329. Enter the taxable amount of the distribution shown in box 2a of your Form 1099-R on line 1 of Form 5329. On line 2, enter the amount that can be excluded and the exception number shown in the Form 5329 instructions.
TIP: If distribution code "1" is incorrectly shown on your Form 1099-R for a distribution received when you were age 59 1/2 or older, include that distribution on Form 5329. Enter exception number "12" on line 2.
General exceptions. The tax doesn't apply to distributions that are:
• Made as part of a series of substantially equal periodic payments (made at least annually) for your life (or life expectancy) or the joint lives (or joint life expectancies) of you and your designated beneficiary (if from a qualified retirement plan, the payments must begin after your separation from service),
• Made because you are totally and permanently disabled. See Exceptions to Tax under Tax on Early Distributions in Pub. 575, or
• Made on or after the death of the plan participant or contract holder.
Additional exceptions for qualified retirement plans. The tax doesn't apply to distributions that are:
• From a qualified retirement plan (other than an IRA) after your separation from service in or after the year you reached age 55 (age 50 for qualified public safety employees),
• From a qualified retirement plan (other than an IRA) to an alternate payee under a qualified domestic relations order,
• From a qualified retirement plan to the extent you have deductible medical expenses that exceed 10% (7.5% if you or your spouse were born before January 2, 1952) of your adjusted gross income, whether or not you itemize your deductions for the year,
• From an employer plan under a written election that provides a specific schedule for distribution of your entire interest if, as of March 1, 1986, you had separated from service and had begun receiving payments under the election,
• From an employee stock ownership plan for dividends on employer securities held by the plan,
• From a qualified retirement plan due to an IRS levy of the plan,
• From elective deferral accounts under 401(k) or 403(b) plans or similar arrangements that are qualified reservist distributions, or
• Phased retirement annuity payments made to federal employees. See Pub. 721 for more information on the phased retirement program.
Qualified public safety employees. If you are a qualified public safety employee, distributions made from a governmental defined benefit pension plan are not subject to the additional tax on early distributions. You are a qualified public safety employee if you provide police protection, firefighting services, or emergency medical services for a state or municipality, and you separated from service in or after the year you attained age 50.
Qualified reservist distributions. A qualified reservist distribution is not subject to the additional tax on early distributions. A qualified reservist distribution is a distribution (a) from elective deferrals under a section 401(k) or 403(b) plan, or a similar arrangement, (b) to an individual ordered or called to active duty (because he or she is a member of a reserve component) for a period of more than 179 days or for an indefinite period, and (c) made during the period beginning on the date of the order or call and ending at the close of the active duty period. You must have been ordered or called to active duty after September 11, 2001. For more information, see Qualified reservist distributions under Special Additional Taxes in Pub. 575.
Additional exceptions for nonqualified annuity contracts. The tax doesn't apply to distributions from:
• A deferred annuity contract to the extent allocable to investment in the contract before August 14, 1982,
• A deferred annuity contract under a qualified personal injury settlement,
• A deferred annuity contract purchased by your employer upon termination of a qualified employee plan or qualified employee annuity plan and held by your employer until your separation from service, or
• An immediate annuity contract (a single premium contract providing substantially equal annuity payments that start within 1 year from the date of purchase and are paid at least annually).
Tax on Excess Accumulation
To make sure that most of your retirement benefits are paid to you during your lifetime, rather than to your beneficiaries after your death, the payments that you receive from qualified retirement plans must begin no later than your required beginning date (defined later). The payments each year can't be less than the required minimum distribution.
Required distributions not made. If the actual distributions to you in any year are less than the minimum required distribution for that year, you are subject to an additional tax. The tax equals 50% of the part of the required minimum distribution that was not distributed.
For this purpose, a qualified retirement plan includes:
• A qualified employee plan,
• A qualified employee annuity plan,
• An eligible section 457 deferred compensation plan, or
• A tax-sheltered annuity plan (403(b) plan) (for benefits accruing after 1986).
Waiver. The tax may be waived if you establish that the shortfall in distributions was due to reasonable error and that reasonable steps are being taken to remedy the shortfall. See the Instructions for Form 5329 for the procedure to follow if you believe you qualify for a waiver of this tax.
State insurer delinquency proceedings. You might not receive the minimum distribution because assets are invested in a contract issued by an insurance company in state insurer delinquency proceedings. If your payments are reduced below the minimum due to these proceedings, you should contact your plan administrator. Under certain conditions, you won't have to pay the 50% excise tax.
Required beginning date. Unless the rule for 5% owners applies, you generally must begin to receive distributions from your qualified retirement plan by April 1 of the year that follows the later of:
• The calendar year in which you reach age 70 1/2, or
• The calendar year in which you retire from employment with the employer maintaining the plan.
However, your plan may require you to begin to receive distributions by April 1 of the year that follows the year in which you reach age 70 1/2, even if you have not retired.
If you reached age 70 1/2 in 2016, you may be required to receive your first distribution by April 1, 2017. Your required distribution then must be made for 2017 by December 31, 2017.
5% owners. If you are a 5% owner, you must begin to receive distributions by April 1 of the year that follows the calendar year in which you reach age 70 1/2.
You are a 5% owner if, for the plan year ending in the calendar year in which you reach age 70 1/2, you own (or are considered to own under section 318 of the Internal Revenue Code) more than 5% of the outstanding stock (or more than 5% of the total voting power of all stock) of the employer, or more than 5% of the capital or profits interest in the employer.
Age 70 1/2. You reach age 70 1/2 on the date that is 6 calendar months after the date of your 70th birthday.
For example, if you are retired and your 70th birthday was on June 30, 2016, you were age 70 1/2 on December 30, 2016. If your 70th birthday was on July 1, 2016, you reached age 70 1/2 on January 1, 2017.
Required distributions. By the required beginning date, as explained earlier, you must either:
• Receive your entire interest in the plan (for a tax-sheltered annuity, your entire benefit accruing after 1986), or
• Begin receiving periodic distributions in annual amounts calculated to distribute your entire interest (for a tax-sheltered annuity, your entire benefit accruing after 1986) over your life or life expectancy or over the joint lives or joint life expectancies of you and a designated beneficiary (or over a shorter period).
Additional information. For more information on this rule, see Tax on Excess Accumulation in Pub. 575.
Form 5329. You must file Form 5329 if you owe tax because you didn't receive a minimum required distribution from your qualified retirement plan.
Survivors and Beneficiaries
Generally, a survivor or beneficiary reports pension or annuity income in the same way the plan participant would have. However, some special rules apply. See Pub. 575 for more information.
Survivors of employees. If you are entitled to receive a survivor annuity on the death of an employee who died, you can exclude part of each annuity payment as a tax-free recovery of the employee's investment in the contract. You must figure the taxable and tax-free parts of your annuity payments using the method that applies as if you were the employee.
Survivors of retirees. If you receive benefits as a survivor under a joint and survivor annuity, include those benefits in income in the same way the retiree would have included them in income. If you receive a survivor annuity because of the death of a retiree who had reported the annuity under the Three-Year Rule and recovered all of the cost tax free, your survivor payments are fully taxable.
If the retiree was reporting the annuity payments under the General Rule, you must apply the same exclusion percentage to your initial survivor annuity payment called for in the contract. The resulting tax-free amount will then remain fixed. Any increases in the survivor annuity are fully taxable.
If the retiree was reporting the annuity payments under the Simplified Method, the part of each payment that is tax free is the same as the tax-free amount figured by the retiree at the annuity starting date. This amount remains fixed even if the annuity payments are increased or decreased. See Simplified Method, earlier.
In any case, if the annuity starting date is after 1986, the total exclusion over the years can't be more than the cost.
Estate tax deduction. If your annuity was a joint and survivor annuity that was included in the decedent's estate, an estate tax may have been paid on it. You can deduct the part of the total estate tax that was based on the annuity. The deceased annuitant must have died after the annuity starting date. (For details, see section 1.691(d)-1 of the regulations.) Deduct it in equal amounts over your remaining life expectancy.
If the decedent died before the annuity starting date of a deferred annuity contract and you receive a death benefit under that contract, the amount you receive (either in a lump sum or as periodic payments) in excess of the decedent's cost is included in your gross income as income in respect of a decedent for which you may be able to claim an estate tax deduction.
You can take the estate tax deduction as an itemized deduction on Schedule A, Form 1040. This deduction isn't subject to the 2%-of-adjusted-gross-income limit on miscellaneous deductions. See Pub. 559, Survivors, Executors, and Administrators, for more information on the estate tax deduction.
11. Social Security and Equivalent Railroad Retirement Benefits
Introduction
This chapter explains the federal income tax rules for social security benefits and equivalent tier 1 railroad retirement benefits. It explains the following topics.
• How to figure whether your benefits are taxable.
• How to use the social security benefits worksheet (with examples).
• How to report your taxable benefits.
• How to treat repayments that are more than the benefits you received during the year.
Social security benefits include monthly retirement, survivor, and disability benefits. They don't include Supplemental Security Income (SSI) payments, which aren't taxable.
Equivalent tier 1 railroad retirement benefits are the part of tier 1 benefits that a railroad employee or beneficiary would have been entitled to receive under the social security system. They are commonly called the social security equivalent benefit (SSEB) portion of tier 1 benefits.
If you received these benefits during 2016, you should have received a Form SSA-1099, Social Security Benefit Statement; or Form RRB-1099, Payments by the Railroad Retirement Board. These forms show the amounts received and repaid, and taxes withheld for the year. You may receive more than one of these forms for the same year. You should add the amounts shown on all the Forms SSA-1099 and Forms RRB-1099 you receive for the year to determine the total amounts received and repaid, and taxes withheld for that year. See the Appendix at the end of Pub. 915 for more information.
Note. When the term "benefits" is used in this chapter, it applies to both social security benefits and the SSEB portion of tier 1 railroad retirement benefits.
my Social Security account. Social Security beneficiaries may quickly and easily obtain various information from the SSA's website with a my Social Security account to:
• Keep track of your earnings and verify them every year;
• Get an estimate of your future benefits if you are still working;
• Get a letter with proof of your benefits if you currently receive them;
• Change your address;
• Start or change your direct deposit;
• Get a replacement Medicare card; and
• Get a replacement Form SSA-1099 for the tax season.
For more information and to set up an account, go to http://www.ssa.gov/myaccount.
What isn't covered in this chapter. This chapter doesn't cover the tax rules for the following railroad retirement benefits.
• Non-social security equivalent benefit (NSSEB) portion of tier 1 benefits.
• Tier 2 benefits.
• Vested dual benefits.
• Supplemental annuity benefits.
For information on these benefits, see Pub. 575, Pension and Annuity Income.
This chapter doesn't cover the tax rules for social security benefits reported on Form SSA-1042S, Social Security Benefit Statement; or Form RRB-1042S, Statement for Nonresident Alien Recipients of: Payments by the Railroad Retirement Board. For information about these benefits, see Pub. 519, U.S. Tax Guide for Aliens; and Pub. 915, Social Security and Equivalent Railroad Retirement Benefits.
This chapter also doesn't cover the tax rules for foreign social security benefits. These benefits are taxable as annuities, unless they are exempt from U.S. tax or treated as a U.S. social security benefit under a tax treaty.
Useful Items
You may want to see:
Publication
• Publication 505 Tax Withholding and Estimated Tax
• Publication 575 Pension and Annuity Income
• Publication 590-A Contributions to Individual Retirement Arrangements (IRAs)
• Publication 915 Social Security and Equivalent Railroad Retirement Benefits
Forms (and Instructions)
• Form 1040-ES Estimated Tax for Individuals
• Form SSA-1099 Social Security Benefit Statement
• Form RRB-1099 Payments by the Railroad Retirement Board
• Form W-4V Voluntary Withholding Request
Are Any of Your Benefits Taxable?
To find out whether any of your benefits may be taxable, compare the base amount for your filing status with the total of:
1. One-half of your benefits; plus
2. All your other income, including tax-exempt interest.
Exclusions. When making this comparison, don't reduce your other income by any exclusions for:
• Interest from qualified U.S. savings bonds,
• Employer-provided adoption benefits,
• Foreign earned income or foreign housing, or
• Income earned by bona fide residents of American Samoa or Puerto Rico.
Children's benefits. The rules in this chapter apply to benefits received by children. See Who is taxed, later.
Figuring total income. To figure the total of one-half of your benefits plus your other income, use Worksheet 11-1 later in this discussion. If the total is more than your base amount, part of your benefits may be taxable.
If you are married and file a joint return for 2016, you and your spouse must combine your incomes and your benefits to figure whether any of your combined benefits are taxable. Even if your spouse didn't receive any benefits, you must add your spouse's income to yours to figure whether any of your benefits are taxable.
TIP: If the only income you received during 2016 was your social security or the SSEB portion of tier 1 railroad retirement benefits, your benefits generally aren't taxable and you probably don't have to file a return. If you have income in addition to your benefits, you may have to file a return even if none of your benefits are taxable.
Base amount. Your base amount is:
• $25,000 if you are single, head of household, or qualifying widow(er);
• $25,000 if you are married filing separately and lived apart from your spouse for all of 2016;
• $32,000 if you are married filing jointly; or
• $-0- if you are married filing separately and lived with your spouse at any time during 2016.
Worksheet 11-1. You can use Worksheet 11-1 to figure the amount of income to compare with your base amount. This is a quick way to check whether some of your benefits may be taxable.
Worksheet 11-1. A Quick Way To Check if Your Benefits May Be Taxable
----------------------------------------------------
Note. If you plan to file a joint income tax return,
include your spouse's amounts, if any, on lines
A, C, and D.
A. Enter the amount from
box 5 of all your Forms
SSA-1099 and RRB-1099.
Include the full amount of
any lump-sum benefit
payments received in 2016,
for 2016 and earlier years.
(If you received more than
one form, combine the
amounts from box 5 and
enter the total.) A. ______
Note. If the amount on line A is zero or less,
stop here; none of your benefits are taxable this
year.
B. Enter one-half of line A B. ______
C. Enter your total income that
is taxable (excluding line A),
such as pensions, wages,
interest, ordinary dividends,
and capital gain
distributions. Don't reduce
your income by any
deductions, exclusions
(listed earlier),
or exemptions C. ______
D. Enter any tax-exempt
interest income such as
interest on municipal
bonds D. ______
E. Add lines B, C, and D
Note. Compare the amount on line E to your
base amount for your filing status. If the
amount on line E equals or is less than the base
amount for your filing status, none of your
benefits are taxable this year. If the amount on
line E is more than your base amount, some of
your benefits may be taxable. You need to
complete Worksheet 1 in Pub. 915 (or the
Social Security Benefits Worksheet in your tax
form instructions). If none of your benefits are
taxable, but you otherwise must file a tax return,
see Benefits not taxable, later, under How To
Report Your Benefits.
----------------------------------------------------
Example. You and your spouse (both over 65) are filing a joint return for 2016 and you both received social security benefits during the year. In January 2017, you received a Form SSA-1099 showing net benefits of $7,500 in box 5. Your spouse received a Form SSA-1099 showing net benefits of $3,500 in box 5. You also received a taxable pension of $22,800 and interest income of $500. You didn't have any tax-exempt interest income. Your benefits aren't taxable for 2016 because your income, as figured in Worksheet 11-1, isn't more than your base amount ($32,000) for married filing jointly.
Even though none of your benefits are taxable, you must file a return for 2016 because your taxable gross income ($23,300) exceeds the minimum filing requirement amount for your filing status.
Filled-in Worksheet 11-1. A Quick Way To Check if Your Benefits May Be Taxable
----------------------------------------------------
Note. If you plan to file a joint income tax return,
include your spouse's amounts, if any, on lines
A, C, or D.
A. Enter the amount from
box 5 of all your Forms
SSA-1099 and RRB-1099.
Include the full amount of
any lump-sum benefit
payments received in 2016,
for 2016 and earlier years.
(If you received more than
one form, combine the
amounts from box 5 and
enter the total.) A. $11,000
Note. If the amount on line A is zero or less,
stop here; none of your benefits are taxable this
year.
B. Enter one-half of line A B. 5,500
C. Enter your total income that
is taxable (excluding line
A), such as pensions,
wages, interest, ordinary
dividends, and capital gain
distributions. Don't reduce
your income by any
deductions, exclusions
(listed earlier),
or exemptions C. 23,300
D. Enter any tax-exempt
interest income such as
interest on municipal
bonds D. -0-
E. Add lines B, C, and D E. $28,800
Note. Compare the amount on line E to your
base amount for your filing status. If the
amount on line E equals or is less than the base
amount for your filing status, none of your
benefits are taxable this year. If the amount on
line E is more than your base amount, some of
your benefits may be taxable. You need to
complete Worksheet 1 in Pub. 915 (or the
Social Security Benefits Worksheet in your tax
form instructions). If none of your benefits are
taxable, but you otherwise must file a tax return,
see Benefits not taxable, later, under How To
Report Your Benefits.
----------------------------------------------------
Who is taxed. Benefits are included in the taxable income (to the extent they are taxable) of the person who has the legal right to receive the benefits. For example, if you and your child receive benefits, but the check for your child is made out in your name, you must use only your part of the benefits to see whether any benefits are taxable to you. One-half of the part that belongs to your child must be added to your child's other income to see whether any of those benefits are taxable to your child.
Repayment of benefits. Any repayment of benefits you made during 2016 must be subtracted from the gross benefits you received in 2016. It doesn't matter whether the repayment was for a benefit you received in 2016 or in an earlier year. If you repaid more than the gross benefits you received in 2016, see Repayments More Than Gross Benefits, later.
Your gross benefits are shown in box 3 of Form SSA-1099 or RRB-1099. Your repayments are shown in box 4. The amount in box 5 shows your net benefits for 2016 (box 3 minus box 4). Use the amount in box 5 to figure whether any of your benefits are taxable.
Tax withholding and estimated tax. You can choose to have federal income tax withheld from your social security benefits and/or the SSEB portion of your tier 1 railroad retirement benefits. If you choose to do this, you must complete a Form W-4V.
If you don't choose to have income tax withheld, you may have to request additional withholding from other income or pay estimated tax during the year. For details, see Pub. 505 or the instructions for Form 1040-ES.
How To Report Your Benefits
If part of your benefits are taxable, you must use Form 1040EZ.
Reporting on Form 1040. Report your net benefits (the total amount from box 5 of all your Forms SSA-1099 and Forms RRB-1099) on line 20a and the taxable part on line 20b. If you are married filing separately and you lived apart from your spouse for all of 2016, also enter "D" to the right of the word "benefits" on line 20a.
Reporting on Form 1040A. Report your net benefits (the total amount from box 5 of all your Forms SSA-1099 and Forms RRB-1099) on line 14a and the taxable part on line 14b. If you are married filing separately and you lived apart from your spouse for all of 2016, also enter "D" to the right of the word "benefits" on line 14a.
Benefits not taxable. If you are filing Form 1040EZ, don't report any benefits on your tax return. If you are filing Form 1040A, report your net benefits (the total amount from box 5 of all your Forms SSA-1099 and Forms RRB-1099) on Form 1040, line 20a; or Form 1040A, line 14a. Enter -0- on Form 1040, line 20b; or Form 1040A, line 14b. If you are married filing separately and you lived apart from your spouse for all of 2016, also enter "D" to the right of the word "benefits" on Form 1040, line 20a; or Form 1040A, line 14a.
How Much Is Taxable?
If part of your benefits are taxable, how much is taxable depends on the total amount of your benefits and other income. Generally, the higher that total amount, the greater the taxable part of your benefits.
Maximum taxable part. Generally, up to 50% of your benefits will be taxable. However, up to 85% of your benefits can be taxable if either of the following situations applies to you.
• The total of one-half of your benefits and all your other income is more than $34,000 ($44,000 if you are married filing jointly).
• You are married filing separately and lived with your spouse at any time during 2016.
Which worksheet to use. A worksheet you can use to figure your taxable benefits is in the instructions for your Form 1040A. You can use either that worksheet or Worksheet 1 in Pub. 915, unless any of the following situations applies to you.
1. You contributed to a traditional individual retirement arrangement (IRA) and you or your spouse is covered by a retirement plan at work. In this situation, you must use the special worksheets in Appendix B of Pub. 590-A to figure both your IRA deduction and your taxable benefits.
2. Situation (1) doesn't apply and you take an exclusion for interest from qualified U.S. savings bonds (Form 8815), for adoption benefits (Form 8839), for foreign earned income or housing (Form 2555-EZ), or for income earned in American Samoa (Form 4563) or Puerto Rico by bona fide residents. In this situation, you must use Worksheet 1 in Pub. 915 to figure your taxable benefits.
3. You received a lump-sum payment for an earlier year. In this situation, also complete Worksheet 2 or 3 and Worksheet 4 in Pub. 915. See Lump-sum election next.
Lump-sum election. You must include the taxable part of a lump-sum (retroactive) payment of benefits received in 2016 in your 2016 income, even if the payment includes benefits for an earlier year.
TIP: This type of lump-sum benefit payment shouldn't be confused with the lump-sum death benefit that both the SSA and RRB pay to many of their beneficiaries. No part of the lump-sum death benefit is subject to tax.
Generally, you use your 2016 income to figure the taxable part of the total benefits received in 2016. However, you may be able to figure the taxable part of a lump-sum payment for an earlier year separately, using your income for the earlier year. You can elect this method if it lowers your taxable benefits.
Making the election. If you received a lump-sum benefit payment in 2016 that includes benefits for one or more earlier years, follow the instructions in Pub. 915 under Lump-Sum Election to see whether making the election will lower your taxable benefits. That discussion also explains how to make the election.
CAUTION: Because the earlier year's taxable benefits are included in your 2016 income, no adjustment is made to the earlier year's return. Don't file an amended return for the earlier year.
Examples
The following are a few examples you can use as a guide to figure the taxable part of your benefits.
Example 1. George White is single and files Form 1040 for 2016. He received the following income in 2016.
Fully taxable pension $18,600
Wages from part-time job 9,400
Taxable interest income 990
-------
Total $28,990
=======
George also received social security benefits during 2016. The Form SSA-1099 he received in January 2017 shows $5,980 in box 5. To figure his taxable benefits, George completes the worksheet shown here.
Filled-in Worksheet 1. Figuring Your Taxable Benefits
------------------------------------------------------------------
1. Enter the total amount from
box 5 of ALL your Forms
SSA-1099 and RRB-1099. Also
enter this amount on Form 1040,
line 20a; or Form 1040A,
line 14a $5,980
2. Enter one-half of line 1 2,990
3. Combine the amounts from:
Form 1040: Lines 7, 8a, 9a, 10
through 14, 15b, 16b, 17 through 19,
and 21.
Form 1040A: Lines 7, 8a, 9a, 10,
11b, 12b, and 13 28,990
4. Enter the amount, if any, from Form 1040
or 1040A, line 8b -0-
5. Enter the total of any exclusions/
adjustments for:
• Adoption benefits (Form 8839,
line 28),
• Foreign earned income or housing
(Form 2555, lines 45 and 50; or
Form 2555-EZ, line 18), and
• Certain income of bona fide
residents of American Samoa
(Form 4563, line 15) or Puerto
Rico -0-
6. Combine lines 2, 3, 4, and 5 31,980
7. Form 1040 filers: Enter the amounts
from Form 1040, lines 23 through 32,
and any write-in adjustments you
entered on the dotted line next to line 36.
Form 1040A filers: Enter the amounts
from Form 1040A, lines 16 and 17 -0-
8. Is the amount on line 7 less than the
amount on line 6?
No. STOP None of your social security
benefits are taxable. Enter -0- on Form 1040,
line 20b; or Form 1040A, line 14b.
Yes. Subtract line 7 from line 6 31,980
9. If you are:
• Married filing jointly, enter $32,000
• Single, head of household,
qualifying widow(er), or married
filing separately and you lived
apart from your spouse for all of
2016, enter $25,000 25,000
Note. If you are married filing separately
and you lived with your spouse at any
time in 2016, skip lines 9 through 16;
multiply line 8 by 85% (0.85) and enter
the result on line 17. Then go to line 18.
10. Is the amount on line 9 less than the
amount on line 8?
No. STOP None of your benefits are
taxable. Enter -0- on Form 1040,
line 20b; or on Form 1040A, line 14b. If
you are married filing separately and
you lived apart from your spouse for all
of 2016, be sure you entered "D" to the
right of the word "benefits" on Form 1040,
line 20a; or on Form 1040A, line 14a.
Yes. Subtract line 9 from line 8 6,980
11. Enter $12,000 if married filing jointly;
$9,000 if single, head of household,
qualifying widow(er), or married filing
separately and you lived apart from
your spouse for all of 2016 9,000
12. Subtract line 11 from line 10. If zero or
less, enter -0- -0-
13. Enter the smaller of line 10
or line 11 6,980
14. Enter one-half of line 13 3,490
15. Enter the smaller of line 2 or line 14 2,990
16. Multiply line 12 by 85% (0.85). If line 12
is zero, enter -0- -0-
17. Add lines 15 and 16 2,990
18. Multiply line 1 by 85% (0.85) 5,083
19. Taxable benefits. Enter the smaller of
line 17 or line 18. Also enter this amount
on Form 1040A,
line 14b $2,990
======
The amount on line 19 of George's worksheet shows that $2,990 of his social security benefits is taxable. On line 20a of his Form 1040, George enters his net benefits of $5,980. On line 20b, he enters his taxable benefits of $2,990.
Example 2. Ray and Alice Hopkins file a joint return on Form 1040A for 2016. Ray is retired and received a fully taxable pension of $15,500. He also received social security benefits, and his Form SSA-1099 for 2016 shows net benefits of $5,600 in box 5. Alice worked during the year and had wages of $14,000. She made a deductible payment to her IRA account of $1,000 and isn't covered by a retirement plan at work. Ray and Alice have two savings accounts with a total of $250 in taxable interest income. They complete Worksheet 1, entering $29,750 ($15,500 + $14,000 + $250) on line 3. They find none of Ray's social security benefits are taxable. On Form 1040A, they enter $5,600 on line 14a and -0- on line 14b.
Filled-in Worksheet 1. Figuring Your Taxable Benefits
------------------------------------------------------------------
1. Enter the total amount from
box 5 of ALL your Forms
SSA-1099 and RRB-1099. Also
enter this amount on Form 1040,
line 20a; or Form 1040A,
line 14a $5,600
2. Enter one-half of line 1 2,800
3. Combine the amounts from:
Form 1040: Lines 7, 8a, 9a,
10 through 14, 15b, 16b, 17
through 19, and 21.
Form 1040A: Lines 7, 8a, 9a,
10, 11b, 12b, and 13 29,750
4. Enter the amount, if any, from
1040A, line 8b -0-
5. Enter the total of any exclusions/
adjustments for:
• Adoption benefits (Form 8839,
line 28),
• Foreign earned income or housing
(Form 2555, lines 45 and 50; or
Form 2555-EZ, line 18), and
• Certain income of bona fide
residents of American Samoa
(Form 4563, line 15) or Puerto
Rico -0-
6. Combine lines 2, 3, 4, and 5 32,550
7. Form 1040 filers: Enter the amounts
from Form 1040, lines 23 through 32,
and any write-in adjustments you
entered on the dotted line next to line 36.
Form 1040A filers: Enter the
amounts from Form 1040A, lines
16 and 17 1,000
8. Is the amount on line 7 less than the
amount on line 6?
No. STOP None of your social security
benefits are taxable. Enter -0- on Form 1040,
line 20b; or Form 1040A, line 14b.
Yes. Subtract line 7 from
line 6 31,550
9. If you are:
• Married filing jointly, enter $32,000
• Single, head of household,
qualifying widow(er), or married
filing separately and you lived
apart from your spouse for all of
2016, enter $25,000 32,000
Note. If you are married filing separately
and you lived with your spouse at any
time in 2016, skip lines 9 through 16;
multiply line 8 by 85% (0.85) and enter
the result on line 17. Then go to line 18.
10. Is the amount on line 9 less than the
amount on line 8?
No. STOP None of your benefits are
taxable. Enter -0- on Form 1040,
line 20b; or on Form 1040A, line 14b. If
you are married filing separately and
you lived apart from your spouse for all
of 2016, be sure you entered "D" to the
right of the word "benefits" on Form 1040,
line 20a; or on >Form 1040A, line 14a.
Yes. Subtract line 9 from line 8 ______
11. Enter $12,000 if married filing jointly;
$9,000 if single, head of household,
qualifying widow(er), or married filing
separately and you lived apart from
your spouse for all of 2016 ______
12. Subtract line 11 from line 10. If zero or
less, enter -0- ______
13. Enter the smaller of line 10
or line 11 ______
14. Enter one-half of line 13 ______
15. Enter the smaller of line 2 or line 14 ______
16. Multiply line 12 by 85% (0.85). If line 12
is zero, enter -0- ______
17. Add lines 15 and 16 ______
18. Multiply line 1 by 85% (0.85) ______
19. Taxable benefits. Enter the smaller of
line 17 or line 18. Also enter this amount
on Form 1040A,
line 14b ======
Example 3. Joe and Betty Johnson file a joint return on Form 1040 for 2016. Joe is a retired railroad worker and in 2016 received the social security equivalent benefit (SSEB) portion of tier 1 railroad retirement benefits. Joe's Form RRB-1099 shows $10,000 in box 5. Betty is a retired government worker and received a fully taxable pension of $38,000. They had $2,300 in taxable interest income plus interest of $200 on a qualified U.S. savings bond. The savings bond interest qualified for the exclusion. They figure their taxable benefits by completing Worksheet 1. Because they have qualified U.S. savings bond interest, they follow the note at the beginning of the worksheet and use the amount from line 2 of their Schedule B (Form 1040A or 1040) on line 3 of the worksheet instead of the amount from line 8a of their Form 1040. On line 3 of the worksheet, they enter $40,500 ($38,000 + $2,500).
Filled-in Worksheet 1. Figuring Your Taxable Benefits
----------------------------------------------------------
Before you begin:
• If you are married filing separately and you lived
apart from your spouse for all of 2016, enter "D"
to the right of the word "benefits" on Form 1040,
line 20a; or Form 1040A, line 14a.
• Don't use this worksheet if you repaid benefits
in 2016 and your total repayments (box 4 of
Forms SSA-1099 and RRB-1099) were more
than your gross benefits for 2016 (box 3 of
Forms SSA-1099 and RRB-1099). None of your
benefits are taxable for 2016. For more
information, see Repayments More Than Gross
Benefits.
• If you are filing Form 8815, Exclusion of Interest
From Series EE and I U.S. Savings Bonds
Issued After 1989, don't include the amount
from line 8a of Form 1040A on
line 3 of this worksheet. Instead, include the
amount from Schedule B (Form 1040A or 1040),
line 2.
----------------------------------------------------------
1. Enter the total amount from
box 5 of ALL your Forms
SSA-1099 and RRB-1099. Also
enter this amount on Form 1040,
line 20a; or Form 1040A,
line 14a $10,000
2. Enter one-half of line 1 5,000
3. Combine the amounts from:
Form 1040: Lines 7, 8a, 9a, 10
through 14, 15b, 16b, 17 through 19,
and 21.
Form 1040A: Lines 7, 8a, 9a, 10,
11b, 12b, and 13 40,500
4. Enter the amount, if any, from Form 1040
or 1040A, line 8b -0-
5. Enter the total of any exclusions/
adjustments for:
• Adoption benefits (Form 8839,
line 28),
• Foreign earned income or housing
(Form 2555, lines 45 and 50; or
Form 2555-EZ, line 18), and
• Certain income of bona fide
residents of American Samoa
(Form 4563, line 15) or Puerto
Rico -0-
6. Combine lines 2, 3, 4, and 5 45,500
7. Form 1040 filers: Enter the amounts
from Form 1040, lines 23 through 32,
and any write-in adjustments you
entered on the dotted line next to line 36.
Form 1040A filers: Enter the amounts
from Form 1040A, lines 16 and 17 -0-
8. Is the amount on line 7 less than the
amount on line 6?
No. STOP None of your social security
benefits are taxable. Enter -0- on Form 1040,
line 20b; or Form 1040A, line 14b.
Yes. Subtract line 7 from line 6 45,500
9. If you are:
• Married filing jointly, enter $32,000
• Single, head of household,
qualifying widow(er), or married
filing separately and you lived
apart from your spouse for all of
2016, enter $25,000 32,000
Note. If you are married filing separately
and you lived with your spouse at any
time in 2016, skip lines 9 through 16;
multiply line 8 by 85% (0.85) and enter
the result on line 17. Then go to line 18.
10. Is the amount on line 9 less than the
amount on line 8?
No. STOP None of your benefits are
taxable. Enter -0- on Form 1040,
line 20b; or on Form 1040A, line 14b. If
you are married filing separately and
you lived apart from your spouse for all
of 2016, be sure you entered "D" to the
right of the word "benefits" on Form 1040,
line 20a; or on Form 1040A,
line 14a.
Yes. Subtract line 9 from line 8 13,500
11. Enter $12,000 if married filing jointly;
$9,000 if single, head of household,
qualifying widow(er), or married filing
separately and you lived apart from
your spouse for all of 2016 12,000
12. Subtract line 11 from line 10. If zero or
less, enter -0- 1,500
13. Enter the smaller of line 10
or line 11 12,000
14. Enter one-half of line 13 6,000
15. Enter the smaller of line 2 or line 14 5,000
16. Multiply line 12 by 85% (0.85). If line 12
is zero, enter -0- 1,275
17. Add lines 15 and 16 6,275
18. Multiply line 1 by 85% (0.85) 8,500
19. Taxable benefits. Enter the smaller of
line 17 or line 18. Also enter this amount
on Form 1040A,
line 14b $6,275
======
More than 50% of Joe's net benefits are taxable because the income on line 8 of the worksheet ($45,500) is more than $44,000. Joe and Betty enter $10,000 on Form 1040, line 20a; and $6,275 on Form 1040, line 20b.
Deductions Related to Your Benefits
You may be entitled to deduct certain amounts related to the benefits you receive.
Disability payments. You may have received disability payments from your employer or an insurance company that you included as income on your tax return in an earlier year. If you received a lump-sum payment from SSA or RRB, and you had to repay the employer or insurance company for the disability payments, you can take an itemized deduction for the part of the payments you included in gross income in the earlier year. If the amount you repay is more than $3,000, you may be able to claim a tax credit instead. Claim the deduction or credit in the same way explained under Repayments More Than Gross Benefits, later.
Legal expenses. You can usually deduct legal expenses that you pay or incur to produce or collect taxable income or in connection with the determination, collection, or refund of any tax.
Legal expenses for collecting the taxable part of your benefits are deductible as a miscellaneous itemized deduction on Schedule A (Form 1040), line 23.
Repayments More Than Gross Benefits
In some situations, your Form SSA-1099 or Form RRB-1099 will show that the total benefits you repaid (box 4) are more than the gross benefits (box 3) you received. If this occurred, your net benefits in box 5 will be a negative figure (a figure in parentheses) and none of your benefits will be taxable. Don't use a worksheet in this case. If you receive more than one form, a negative figure in box 5 of one form is used to offset a positive figure in box 5 of another form for that same year.
If you have any questions about this negative figure, contact your local SSA office or your local RRB field office.
Joint return. If you and your spouse file a joint return, and your Form SSA-1099 or RRB-1099 has a negative figure in box 5, but your spouse's doesn't, subtract the amount in box 5 of your form from the amount in box 5 of your spouse's form. You do this to get your net benefits when figuring if your combined benefits are taxable.
Example. John and Mary file a joint return for 2016. John received Form SSA-1099 showing $3,000 in box 5. Mary also received Form SSA-1099 and the amount in box 5 was ($500). John and Mary will use $2,500 ($3,000 minus $500) as the amount of their net benefits when figuring if any of their combined benefits are taxable.
Repayment of benefits received in an earlier year. If the total amount shown in box 5 of all of your Forms SSA-1099 and RRB-1099 is a negative figure, you can take an itemized deduction for the part of this negative figure that represents benefits you included in gross income in an earlier year.
Deduction $3,000 or less. If this deduction is $3,000 or less, it is subject to the 2%-of-adjusted-gross-income limit that applies to certain miscellaneous itemized deductions. Claim it on Schedule A (Form 1040), line 23.
Deduction more than $3,000. If this deduction is more than $3,000, you should figure your tax two ways.
1. Figure your tax for 2016 with the itemized deduction included on Schedule A, line 28.
2. Figure your tax for 2016 in the following steps.
a. Figure the tax without the itemized deduction included on Schedule A, line 28.
b. For each year after 1983 for which part of the negative figure represents a repayment of benefits, refigure your taxable benefits as if your total benefits for the year were reduced by that part of the negative figure. Then refigure the tax for that year.
c. Subtract the total of the refigured tax amounts in (b) from the total of your actual tax amounts.
d. Subtract the result in (c) from the result in (a).
12. Other Income
Introduction
You must include on your return all items of income you receive in the form of money, property, and services unless the tax law states that you don't include them. Some items, however, are only partly excluded from income. This chapter discusses many kinds of income and explains whether they're taxable or nontaxable.
• Income that's taxable must be reported on your tax return and is subject to tax.
• Income that's nontaxable may have to be shown on your tax return but isn't taxable.
This chapter begins with discussions of the following income items.
• Bartering.
• Canceled debts.
• Sales parties at which you're the host or hostess.
• Life insurance proceeds.
• Partnership income.
• S corporation income.
• Recoveries (including state income tax refunds).
• Rents from personal property.
• Repayments.
• Royalties.
• Unemployment benefits.
• Welfare and other public assistance benefits.
These discussions are followed by brief discussions of other income items.
Useful Items
You may want to see:
Publication
• Publication 525 Taxable and Nontaxable Income
• Publication 544 Sales and Other Dispositions of Assets
• Publication 4681 Canceled Debts, Foreclosures, Repossessions, and Abandonments
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-EZ (Form 1040), Net Profit From Business. However, if the barter involves an exchange of something other than services, such as in Example 3 below, you may have to use another form or schedule instead.
Example 1. You're 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're 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 3. 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), Supplemental Income and Loss, the fair market value of the artwork, and the artist must report as income on Schedule C-EZ (Form 1040) the fair rental value of the apartment.
Form 1099-B from barter exchange. If you exchanged property or services through a barter exchange, Form 1099-B, Proceeds From Broker and Barter Exchange Transactions, or a similar statement from the barter exchange should be sent to you by February 15, 2017. It should show the value of cash, property, services, credits, or scrip you received from exchanges during 2016. The IRS also will receive a copy of Form 1099-B.
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's intended as a gift to you. A debt includes any indebtedness for which you're 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's a business debt, report the amount on Schedule C-EZ (Form 1040) (or on Schedule F (Form 1040), Profit or Loss From Farming, if the debt is farm debt and you're a farmer).
Form 1099-C. If a federal government agency, financial institution, or credit union cancels or forgives a debt you owe of $600 or more, you will receive a Form 1099-C, Cancellation of Debt. The amount of the canceled debt is shown in box 2.
Interest included in canceled debt. If any interest is forgiven and included in the amount of canceled debt in box 2, the amount of interest also will be shown in box 3. Whether or not you must include the interest portion of the canceled debt in your income depends on whether the interest would be deductible when you paid it. See Deductible debt under Exceptions, later.
If the interest wouldn't 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're personally liable for a mortgage (recourse debt), and you're 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. Also, to the extent the mortgage discharge exceeds the fair market value of the property, it's 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.
If you aren't personally liable for a mortgage (nonrecourse debt), and you're 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.
See Pub. 4681 for more information.
Stockholder debt. If you're a stockholder in a corporation and the corporation cancels or forgives your debt to it, the canceled debt is a constructive distribution that's generally dividend income to you. For more information, see Pub. 542, Corporations.
If you're 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:
1. The federal government, a state or local government, or an instrumentality, agency, or subdivision thereof;
2. 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
3. An educational institution:
a. Under an agreement with an entity described in (1) or (2) that provided the funds to the institution to make the loan; or
b. As part of a program of the institution designed to encourage its students to serve in occupations with unmet needs or in areas with unmet needs and under which the services provided by the students (or former students) are for or under the direction of a governmental unit or a tax-exempt organization described in section 501(c)(3).
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's 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. For more information, see chapter 5 of Pub. 334, Tax Guide for Small Business.
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. Don't include a canceled debt in your gross income in the following situations.
• The debt is canceled in a bankruptcy case under title 11 of the U.S. Code. See Pub. 908, Bankruptcy Tax Guide.
• The debt is canceled when you're insolvent. However, you can't exclude any amount of canceled debt that's more than the amount by which you're insolvent. See Pub. 908.
• The debt is qualified farm debt and is canceled by a qualified person. See chapter 3 of Pub. 225, Farmer's Tax Guide.
• The debt is qualified real property business debt. See chapter 5 of Pub. 334.
• The cancellation is intended as a gift.
• The debt is qualified principal residence indebtedness.
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.
For more information about the 50% limit for meal and entertainment expenses, see chapter 26.
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.
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.
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 weren't 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 lines 12a and 12b of Form 1040A.
More information. For more information, see Life Insurance Proceeds in Pub. 525.
Endowment Contract Proceeds
An endowment contract is a policy under which you're paid a specified amount of money on a certain date unless you die before that date, in which case, the money is paid to your designated beneficiary. Endowment proceeds paid in a lump sum to you at maturity are taxable only if the proceeds are more than the cost of the policy. To determine your cost, subtract any amount that you previously received under the contract and excluded from your income from the total premiums (or other consideration) paid for the contract. Include the part of the lump sum payment that's more than your cost in your income.
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's not terminally ill, accelerated death benefits paid on the basis of costs incurred for qualified long-term care services are fully excludable. Accelerated death benefits paid on a per diem or other periodic basis are excludable up to a limit. This limit applies to the total of the accelerated death benefits and any periodic payments received from long-term care insurance contracts. For information on the limit and the definitions of chronically ill individual, qualified long-term care services, and long-term care insurance contracts, see Long-Term Care Insurance Contracts under Sickness and Injury Benefits in Pub. 525.
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, Archer MSAs and Long-Term Care Insurance Contracts, with your return. You don't have to file Form 8853 to exclude accelerated death benefits paid on the basis of actual expenses incurred.
Public Safety Officer Killed or Injured in the Line of Duty
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. See section 101(h).
A public safety officer who'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. See section 104(a)(6).
For this purpose, the term public safety officer includes law enforcement officers, firefighters, chaplains, and rescue squad and ambulance crew members. For more information, see Pub. 559, Survivors, Executors, and Administrators.
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.
Schedule K-1 (Form 1065). Although a partnership generally pays no tax, it must file an information return on Form 1065, U.S. Return of Partnership Income, and send Schedule K-1 (Form 1065) to each partner. In addition, the partnership will send each partner a copy of the Partner's Instructions for Schedule K-1 (Form 1065) to help each partner report his or her share of the partnership's income, deductions, credits, and tax preference items.
RECORDS: Keep Schedule K-1 (Form 1065) for your records. Don't attach it to your Form 1040, unless you're specifically required to do so.
For more information on partnerships, see Pub. 541, Partnerships.
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. For further information on how to make the election and which schedule(s) to file, see the instructions for your individual tax return.
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.
Schedule K-1 (Form 1120S). An S corporation must file a return on Form 1120S, U.S. Income Tax Return for an S Corporation, and send Schedule K-1 (Form 1120S) to each shareholder. In addition, the S corporation will send each shareholder a copy of the Shareholder's Instructions for Schedule K-1 (Form 1120S) to help each shareholder report his or her share of the S corporation's income, losses, credits, and deductions.
RECORDS: Keep Schedule K-1 (Form 1120S) for your records. Don't attach it to your Form 1040, unless you're specifically required to do so.
For more information on S corporations and their shareholders, see the Instructions for Form 1120S.
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 deductions itemized on Schedule A (Form 1040). You also may have recoveries of non-itemized deductions (such as payments on previously deducted bad debts) and recoveries of items for which you previously claimed a tax credit.
Tax benefit rule. You must include a recovery in your income in the year you receive it up to the amount by which the deduction or credit you took for the recovered amount reduced your tax in the earlier year. For this purpose, any increase to an amount carried over to the current year that resulted from the deduction or credit is considered to have reduced your tax in the earlier year. For more information, see Pub. 525.
Federal income tax refund. Refunds of federal income taxes aren't included in your income because they're 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, Certain Government Payments, to you by January 31, 2017. The IRS also will receive a copy of the Form 1099-G. If you file Form 1040, use the State and Local Income Tax Refund Worksheet in the 2016 Form 1040 instructions for line 10 to figure the amount (if any) to include in your income. See Pub. 525 for when you must use another worksheet.
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. For examples, see Pub. 525.
Mortgage interest refund. If you received a refund or credit in 2016 of mortgage interest paid in an earlier year, the amount should be shown in box 4 of your Form 1098, Mortgage Interest Statement. Don't subtract the refund amount from the interest you paid in 2016. You may have to include it in your income under the rules explained in the following discussions.
Interest on recovery. Interest on any of the amounts you recover must be reported as interest income in the year received. For example, report any interest you received on state or local income tax refunds on Form 1040, line 8a.
Recovery and expense in same year. If the refund or other recovery and the expense occur in the same year, the recovery reduces the deduction or credit and isn't reported as income.
Recovery for 2 or more years. If you receive a refund or other recovery that's 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. For information on how to compute the allocation, see Recoveries in Pub. 525.
Itemized Deduction Recoveries
If you recover any amount that you deducted in an earlier year on Schedule A (Form 1040), you generally must include the full amount of the recovery in your income in the year you receive it.
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.
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're required to itemize your deductions). If your total deductions on the earlier year return weren't 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.
Example. For 2015, you filed a joint return. Your taxable income was $60,000 and you weren't entitled to any tax credits. Your standard deduction was $12,600, and you had itemized deductions of $14,200. In 2016, you received the following recoveries for amounts deducted on your 2015 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 2015. The difference between the state and local income tax you deducted and your local general sales tax was more than $400.
Your total recoveries are less than the amount by which your itemized deductions exceeded the standard deduction ($14,200 - 12,600 = $1,600), so you must include your total recoveries in your income for 2016. 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.
Standard deduction for earlier years. To determine if amounts recovered in 2016 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.
Example. You filed a joint return on Form 1040 for 2015 with taxable income of $45,000. Your itemized deductions were $12,850. The standard deduction that you could have claimed was $12,600. In 2016, you recovered $2,100 of your 2015 itemized deductions. None of the recoveries were more than the actual deductions for 2015. Include $250 of the recoveries in your 2016 income. This is the smaller of your recoveries ($2,100) or the amount by which your itemized deductions were more than the standard deduction ($12,850 - $12,600 = $250).
Recovery limited to deduction. You don't include in your income any amount of your recovery that's 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 on Schedule A (Form 1040), or
• The amount recovered.
Example. During 2015 you paid $1,700 for medical expenses. Of this amount, you deducted $200 on your 2015 Schedule A. In 2016, you received a $500 reimbursement from your medical insurance for your 2015 expenses. The only amount of the $500 reimbursement that must be included in your income for 2016 is $200--the amount actually deducted.
Other recoveries. See Recoveries in Pub. 525 if:
• You have recoveries of items other than itemized deductions, or
• You received a recovery for an item for which you claimed a tax credit (other than investment credit or foreign tax credit) in a prior year.
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're involved in the rental activity with continuity and regularity, your rental activity is a business. See Pub. 535, Business Expenses, for details on deducting expenses for both business and not-for-profit activities.
Reporting business income and expenses. If you're in the business of renting personal property, report your income and expenses on Schedule C-EZ (Form 1040). The form instructions have information on how to complete them.
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, and see the instructions there.
If you don't rent personal property for profit, your deductions are limited and you can't report a loss to offset other income. See Activity not for profit under Other Income, later.
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. Generally, you can claim a deduction or credit only if the repayment qualifies as an expense or loss incurred in your trade or business or in a for-profit transaction.
Type of deduction. The type of deduction you're allowed in the year of repayment depends on the type of income you included in the earlier year. You generally deduct the repayment on the same form or schedule on which you previously reported it as income. For example, if you reported it as self-employment income, deduct it as a business expense on Schedule C-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 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).
Repaid social security benefits. If you repaid social security benefits or equivalent railroad retirement benefits, see Repayment of benefits in chapter 11.
Repayment of $3,000 or less. If the amount you repaid was $3,000 or less, deduct it from your income in the year you repaid it. If you must deduct it as a miscellaneous itemized deduction, enter it on Schedule A (Form 1040), line 23.
Repayment over $3,000. If the amount you repaid was more than $3,000, you can deduct the repayment (as explained under Type of deduction, earlier). 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.
CAUTION: 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 2016 claiming a deduction for the repaid amount. If you must deduct it as a miscellaneous itemized deduction, enter it on Schedule A (Form 1040), line 28.
Method 2. Figure your tax for 2016 claiming a credit for the repaid amount. Follow these steps.
1. Figure your tax for 2016 without deducting the repaid amount.
2. Refigure your tax from the earlier year without including in income the amount you repaid in 2016.
3. Subtract the tax in (2) from the tax shown on your return for the earlier year. This is the credit.
4. Subtract the answer in (3) from the tax for 2016 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, line 73, by adding the amount of the credit to any other credits on this line, and see the instructions there.
An example of this computation can be found in Pub. 525.
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 RRTA 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 over collection to support your claim. File a claim for refund using Form 843, Claim for Refund and Request for Abatement.
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, Amended U.S. Individual Income Tax Return, for the prior year in which the wages or compensation were originally received. See Instructions for Form 1040X.
Royalties
Royalties from copyrights, patents, and oil, gas, and mineral properties are taxable as ordinary income.
In most cases, you report royalties in Part I of Schedule E (Form 1040). 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-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 that leases the property from you.
Depletion. If you're the owner of an economic interest in mineral deposits or oil and gas wells, you can recover your investment through the depletion allowance. For information on this subject, see chapter 9 of Pub. 535.
Coal and iron ore. Under certain circumstances, you can treat amounts you receive from the disposal of coal and iron ore as payments from the sale of a capital asset, rather than as royalty income. For information about gain or loss from the sale of coal and iron ore, see Pub. 544, chapter 2.
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 property used in a trade or business under section 1231, not royalty income. Under certain circumstances, the sale is subject to capital gain or loss treatment as explained in Instructions for Schedule D (Form 1040). For more information on selling section 1231 property, see chapter 3 of Pub. 544.
If you retain a royalty, an overriding royalty, or a net profit interest in a mineral property for the life of the property, you have made a lease or a sublease, and any cash you receive for the assignment of other interests in the property is ordinary income subject to a depletion allowance.
Part of future production sold. If you own mineral property but sell part of the future production, in most cases you treat the money you receive from the buyer at the time of the sale as a loan from the buyer. Don't 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.
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 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. See chapter 5 for more information.)
• Trade readjustment allowances under the Trade Act of 1974.
• Unemployment assistance under the Disaster Relief and Emergency Assistance Act.
• 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 2016 unemployment compensation you received in 2016, subtract the amount you repaid from the total amount you received and enter the difference on line 19 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 2016 that you included in income in an earlier year, you can deduct the amount repaid on Schedule A (Form 1040), line 23, if you itemize deductions. If the amount is more than $3,000, see Repayments, earlier.
Tax withholding. You can choose to have federal income tax withheld from your unemployment compensation. To make this choice, complete Form W-4V, Voluntary Withholding Request, and give it to the paying office. Tax will be withheld at 10% of your payment.
CAUTION: 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. For more information on estimated tax, see chapter 4.
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. For more information, see Supplemental Unemployment Benefits in section 5 of Pub. 15-A, Employer's Supplemental Tax Guide. Report these payments on line 7 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 received 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 1040EZ.) Include the repayment on Form 1040, line 36, and see the instructions there. If the amount you repay in a later year is more than $3,000, you may be able to take a credit against your tax for the later year instead of deducting the amount repaid. For more information on this, see Repayments, earlier.
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're 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 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
Don't include in your income governmental benefit payments from a public welfare fund based upon need, such as payments to blind individuals under a state public assistance law. Payments from a state fund for the victims of crime shouldn't be included in the victims' incomes if they're in the nature of welfare payments. Don't 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.
Reemployment Trade Adjustment Assistance (RTAA) payments. RTAA payments received from a state 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.
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. Don't include post-disaster grants received under the Robert T. Stafford 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, child care, or funeral expenses. Don't 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. See Recoveries, earlier. Unemployment assistance payments under the Act are taxable unemployment compensation. See Unemployment compensation under Unemployment Benefits, earlier.
Disaster relief payments. You can exclude from income any amount you receive that's a qualified disaster relief payment. A qualified disaster relief payment is an amount paid to you:
1. To reimburse or pay reasonable and necessary personal, family, living, or funeral expenses that result from a qualified disaster;
2. 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's due to a qualified disaster;
3. 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
4. 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's 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 can exclude from income any amount you receive that's a qualified disaster mitigation payment. Qualified disaster mitigation payments are most 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're 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.
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.
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're 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. See chapter 11, Social Security and Equivalent Railroad Retirement, in this publication and Pub. 915, Social Security and Equivalent Railroad Retirement Benefits, for more information. 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). See Pub. 915 for information on how to make a lump-sum election, which may reduce your tax liability. 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 http://www.socialsecurity.gov.
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're 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 topical 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). See Not-for-Profit Activities in Pub. 535, chapter 1, for information on whether an activity is considered carried on for a profit.
Alaska Permanent Fund dividend. If you received a payment from Alaska's mineral income fund (Alaska Permanent Fund dividend), report it as income on line 21 of Form 1040, line 13 of Form 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 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. Alimony and child support payments are discussed in chapter 18.
Bribes. If you receive a bribe, include it in your income.
Campaign contributions. These contributions aren't income to a candidate unless they're diverted to his or her personal use. To be nontaxable, the contributions must be spent for campaign purposes or kept in a fund for use in future campaigns. However, interest earned on bank deposits, dividends received on contributed securities, and net gains realized on sales of contributed securities are taxable and must be reported on Form 1120-POL, U.S. Income Tax Return for Certain Political Organizations. Excess campaign funds transferred to an office account must be included in the officeholder's income on Form 1040, line 21, in the year transferred.
Car pools. Don't 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're figuring gain or loss from the casualty or theft. See chapter 25 for more information.
Child support payments. You shouldn't report these payments on your return. See chapter 18 for more information.
Court awards and damages. To determine if settlement amounts you receive by compromise or judgment must be included in your income, you must consider the item that the settlement replaces. 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.
1. Interest on any award.
2. Compensation for lost wages or lost profits in most cases.
3. Punitive damages, in most cases. It doesn't matter if they relate to a physical injury or physical sickness.
4. Amounts received in settlement of pension rights (if you didn't contribute to the plan).
5. Damages for:
a. Patent or copyright infringement,
b. Breach of contract, or
c. Interference with business operations.
6. Back pay and damages for emotional distress received to satisfy a claim under title VII of the Civil Rights Act of 1964.
7. Attorney fees and costs (including contingent fees) where the underlying recovery is included in gross income.
Don't 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. Don't 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, employment discrimination or injury to reputation), you must include the damages in your income, except for any damages that aren't more than amounts paid 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.
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's 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's 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're a beneficiary of an estate or trust, you may be taxed on your share of its income distributed or required to be distributed to you. However, there is never a double tax. Estates and trusts file their returns on Form 1041, U.S. Income Tax Return for Estates and Trusts, and your share of the income is reported to you on Schedule K-1 (Form 1041).
Current income required to be distributed. If you're 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're 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's required to be distributed to you, whether or not it's 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're 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.
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.
Nonemployee compensation. 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 a Form 1099-MISC. You may need to report your fees as self-employment income. See Self-Employed Persons, in chapter 1, for a discussion of when you're considered self-employed.
Corporate director. Corporate director fees are self-employment income. Report these payments on 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're the executor of a friend's or relative's estate), report these fees on Form 1040, line 21. If you're in the trade or business of being an executor, report these fees as self-employment income on Schedule C or Schedule C-EZ (Form 1040). The fee isn't includible in income if it's 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-EZ (Form 1040). These payments aren't subject to self-employment tax. See the separate instructions for Schedule SE (Form 1040) for details.
Election precinct official. You should receive a Form W-2 showing payments for services performed as an election official or election worker. Report these payments on line 7 of Form 1040EZ.
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's received for the care of more than 5 qualified foster individuals age 19 years or older.
A qualified foster individual is a person who:
1. Is living in a foster family home, and
2. Was placed there by:
a. An agency of a state or one of its political subdivisions, or
b. A qualified foster care placement agency.
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. See Notice 2014-7 available at IRS.gov/irb/2014-4_IRB/ar06.html and related questions and answers available at IRS.gov/Individuals/Certain-Medicaid-Waiver-Payments-May-Be-Excludable-From-Income for more information.
You must include in your income difficulty-of-care payments to the extent they're received for more than:
• 10 qualified foster individuals under age 19, or
• 5 qualified foster individuals age 19 or older.
Maintaining space in home. If you're 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're in business as a foster care provider, report the payments on Schedule C or Pub. 587, Business Use of Your Home, to help you determine the amount you can deduct for the use of your home.
Found property. If you find and keep property that doesn't belong to you that has been lost or abandoned (treasure trove), it's taxable to you at its fair market value in the first year it's 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-EZ (Form 1040).
Gambling winnings. You must include your gambling winnings in 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're 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.
TIP: If you win a state lottery prize payable in installments, see Pub. 525 for more information.
Form W-2G. You may have received a Form W-2G, Certain Gambling Winnings, showing the amount of your gambling winnings and any tax taken out of them. Include the amount from box 1 on Form 1040, line 21. Include the amount shown in box 4 on Form 1040, line 64, as federal income tax withheld.
Reporting winnings and recordkeeping. For more information on reporting gambling winnings and recordkeeping, see Gambling Losses Up to the Amount of Gambling Winnings in chapter 28.
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. See Survivors and Beneficiaries in Pub. 575, if you inherited a pension. See What if You Inherit an IRA? in Pubs. 590-B, if you inherited an IRA.
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. See Activity not for profit, earlier.
CAUTION: 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. (See chapter 16.) However, if you sell items from your collection at a loss, you can't deduct the loss.
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-EZ (Form 1040) if from your self-employment activity.
Indian fishing rights. If you're 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.
Interest on frozen deposits. In general, you exclude from your income the amount of interest earned on a frozen deposit. See Interest income on frozen deposits in chapter 7.
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 education expenses in the same year. For more information on this exclusion, see Education Savings Bond Program under U.S. Savings Bonds in chapter 7.
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 is generally not taxable. You include in income only the amount you receive that's 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 gave any of your jury duty pay to your employer because your employer continued to pay you while you served jury duty, include the amount you gave your employer as an income adjustment on Form 1040, line 36, and see the instructions there.
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-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.
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), Itemized Deductions. For more information about qualified medical expenses, see chapter 21. For more information about Archer MSAs or Medicare Advantage MSAs, see Pub. 969, Health Savings Accounts and Other Tax-Favored Health Plans.
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. See Bonuses and awards in chapter 5.
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 to 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.
See Pub. 525 for more information about the conditions that apply to the transfer.
Qualified tuition programs (QTPs). A qualified tuition program (also known as a 529 program) is a program set up to allow you to either prepay or contribute to an account established for paying a student's qualified higher education expenses at an eligible educational institution. A program can be established and maintained by a state, an agency or instrumentality of a state, or an eligible educational institution.
The part of a distribution representing the amount paid or contributed to a QTP 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. See Pub. 970 for more information.
Railroad retirement annuities. The following types of payments are treated as pension or annuity income and are taxable under the rules explained in Pub. 575, Pension and Annuity Income.
• 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. See chapter 15.
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 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 gain as a capital gain as explained in 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's for:
• Tuition and fees to enroll at or attend an educational institution; or
• Fees, books, supplies, and equipment required for courses at the educational institution.
Amounts used for room and board don't qualify for the exclusion. See Pub. 970 for more information on qualified scholarships and fellowship grants.
Payment for services. In most cases, you must include in income the part of any scholarship or fellowship that represents payment for past, present, or future teaching, research, or other services. This applies even if all candidates for a degree must perform the services to receive the degree.
For information about the rules that apply to a tax-free qualified tuition reduction provided to employees and their families by an educational institution, see Pub. 970.
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.
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. Don't 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're related to your job and if you itemize deductions on Schedule A (Form 1040). For more information, see Union Dues and Expenses in chapter 28.
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, are usually 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.
Utility rebates. If you're 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.
The four chapters in this part discuss investment gains and losses, including how to figure your basis in property. A gain from selling or trading stocks, bonds, or other investment property generally is taxable. A loss may or may not be deductible. These chapters also discuss gains from selling property you personally use -- including the special rules for selling your home. Nonbusiness casualty and theft losses are discussed in chapter 25 in Part Five.
13. Basis of Property
Introduction
This chapter discusses how to figure your basis in property. It is divided into the following sections.
• Cost basis.
• Adjusted basis.
• Basis other than cost.
Your basis is the amount of your investment in property for tax purposes. Use the basis to figure the gain or loss on the sale, exchange, or other disposition of property. Also use it to figure deductions for depreciation, amortization, depletion, and casualty losses.
If you use property for both business or for production of income purposes, and for personal purposes, you must allocate the basis based on the use. Only the basis allocated to the business or the production of income part of the property can be depreciated.
Your original basis in property is adjusted (increased or decreased) by certain events. For example, if you make improvements to the property, increase your basis. If you take deductions for depreciation or casualty losses, or claim certain credits, reduce your basis.
RECORDS: Keep accurate records of all items that affect the basis of your property. For more information on keeping records, see chapter 1.
Useful Items
You may want to see:
Publication
• Publication 15-B Employer's Tax Guide to Fringe Benefits
• Publication 525 Taxable and Nontaxable Income
• Publication 535 Business Expenses
• Publication 537 Installment Sales
• Publication 544 Sales and Other Dispositions of Assets
• Publication 550 Investment Income and Expenses
• Publication 551 Basis of Assets
• Publication 946 How To Depreciate Property
Cost Basis
The basis of property you buy is usually its cost. The cost is the amount you pay in cash, debt obligations, other property, or services. Your cost also includes amounts you pay for the following items:
• Sales tax,
• Freight,
• Installation and testing,
• Excise taxes,
• Legal and accounting fees (when they must be capitalized),
• Revenue stamps,
• Recording fees, and
• Real estate taxes (if you assume liability for the seller).
In addition, the basis of real estate and business assets may include other items.
Loans with low or no interest. If you buy property on a time-payment plan that charges little or no interest, the basis of your property is your stated purchase price minus any amount considered to be unstated interest. You generally have unstated interest if your interest rate is less than the applicable federal rate.
For more information, see Unstated Interest and Original Issue Discount (OID) in Pub. 537.
Real Property
Real property, also called real estate, is land and generally anything built on, growing on, or attached to land.
If you buy real property, certain fees and other expenses you pay are part of your cost basis in the property.
Lump sum purchase. If you buy buildings and the land on which they stand for a lump sum, allocate the cost basis between the land and the buildings. Allocate the cost basis according to the respective fair market values (FMVs) of the land and buildings at the time of purchase. Figure the basis of each asset by multiplying the lump sum by a fraction. The numerator is the FMV of that asset and the denominator is the FMV of the whole property at the time of purchase.
TIP: If you are not certain of the FMVs of the land and buildings, you can allocate the basis according to their assessed values for real estate tax purposes.
Fair market value (FMV). FMV 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 necessary facts. Sales of similar property on or about the same date may be helpful in figuring the FMV of the property.
Assumption of mortgage. If you buy property and assume (or buy the property subject to) an existing mortgage on the property, your basis includes the amount you pay for the property plus the amount to be paid on the mortgage.
Settlement costs. Your basis includes the settlement fees and closing costs you paid for buying the property. (A fee for buying property is a cost that must be paid even if you buy the property for cash.) Do not include fees and costs for getting a loan on the property in your basis.
The following are some of the settlement fees or closing costs you can include in the basis of your property.
• Abstract fees (abstract of title fees).
• Charges for installing utility services.
• Legal fees (including fees for the title search and preparation of the sales contract and deed).
• Recording fees.
• Survey fees.
• Transfer taxes.
• Owner's 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.
Settlement costs do not include amounts placed in escrow for the future payment of items such as taxes and insurance.
The following are some of the settlement fees and closing costs you cannot include in the basis of property.
• Casualty insurance premiums.
• Rent for occupancy of the property before closing.
• Charges for utilities or other services related to occupancy of the property before closing.
• Charges connected with getting 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.
• Fees for refinancing a mortgage.
Real estate taxes. If you pay real estate taxes the seller owed on real property you bought, and the seller did not reimburse you, treat those taxes as part of your basis. You cannot deduct the taxes as an expense.
If you reimburse the seller for taxes the seller paid for you, you can usually deduct that amount as an expense in the year of purchase. Do not include the amount of real estate taxes you deducted as an expense in the basis of your property. If you did not reimburse the seller, you must reduce your basis by the amount of those taxes.
Points. If you pay points to get a loan (including a mortgage, second mortgage, line of credit, or a home equity loan), do not add the points to the basis of the related property. Generally, you deduct the points over the term of the loan. For more information on how to deduct points, see chapter 23.
Points on home mortgage. Special rules may apply to points you and the seller pay when you get a mortgage to buy your main home. If certain requirements are met, you can deduct the points in full for the year in which they are paid. Reduce the basis of your home by any seller-paid points.
Adjusted Basis
Before figuring gain or loss on a sale, exchange, or other disposition of property or figuring allowable depreciation, depletion, or amortization, you must usually make certain adjustments (increases and decreases) to the cost basis or basis other than cost (discussed later) of the property. The result is the adjusted basis.
Increases to Basis
Increase the basis of any property by all items properly added to a capital account. Examples of items that increase basis are shown in Table 13-1. These include the items discussed below.
Table 13-1. Examples of Adjustments to Basis
----------------------------------------------------------------------
Increases to Basis Decreases to Basis
• Capital improvements: • Exclusion from income of
subsidies for energy
Putting an addition on your home conservation measures
Replacing an entire roof • Casualty or theft loss
deductions and insurance
Paving your driveway reimbursements
Installing central air • Postponed gain from the sale
conditioning of a home
Rewiring your home • Alternative fuel vehicle
refueling property
• Assessments for local improvements: credit (Form 8911)
Water connections • Residential energy credits
(Form 5695)
Extending utility service lines to
the property • Depreciation and section
179 deduction
Sidewalks
• Nontaxable corporate
Roads distributions
• Casualty losses: • Certain canceled debt
excluded from income
Restoring damaged property
• Easements
• Legal fees:
• Adoption tax benefits
Cost of defending and perfecting
a title
Fees for getting a reduction of an
assessment
• Zoning costs
----------------------------------------------------------------------
Improvements. Add to your basis in property the cost of improvements having a useful life of more than 1 year, that increase the value of the property, lengthen its life, or adapt it to a different use. For example, improvements include putting a recreation room in your unfinished basement, adding another bathroom or bedroom, putting up a fence, putting in new plumbing or wiring, installing a new roof, or paving your driveway.
Assessments for local improvements. Add to the basis of property assessments for improvements such as streets and sidewalks if they increase the value of the property assessed. Do not deduct them as taxes. However, you can deduct as taxes assessments for maintenance or repairs, or for meeting interest charges related to the improvements.
Example. Your city changes the street in front of your store into an enclosed pedestrian mall and assesses you and other affected property owners for the cost of the conversion. Add the assessment to your property's basis. In this example, the assessment is a depreciable asset.
Decreases to Basis
Decrease the basis of any property by all items that represent a return of capital for the period during which you held the property. Examples of items that decrease basis are shown in Table 13-1. These include the items discussed below.
Casualty and theft losses. If you have a casualty or theft loss, decrease the basis in your property by any insurance proceeds or other reimbursement and by any deductible loss not covered by insurance.
You must increase your basis in the property by the amount you spend on repairs that restore the property to its pre-casualty condition.
For more information on casualty and theft losses, see chapter 25.
Depreciation and section 179 deduction. Decrease the basis of your qualifying business property by any section 179 deduction you take and the depreciation you deducted, or could have deducted (including any special depreciation allowance), on your tax returns under the method of depreciation you selected.
For more information about depreciation and the section 179 deduction, see Pub. 946 and the Instructions for Form 4562.
Example. You owned a duplex used as rental property that cost you $40,000, of which $35,000 was allocated to the building and $5,000 to the land. You added an improvement to the duplex that cost $10,000. In February last year, the duplex was damaged by fire. Up to that time, you had been allowed depreciation of $23,000. You sold some salvaged material for $1,300 and collected $19,700 from your insurance company. You deducted a casualty loss of $1,000 on your income tax return for last year. You spent $19,000 of the insurance proceeds for restoration of the duplex, which was completed this year. You must use the duplex's adjusted basis after the restoration to determine depreciation for the rest of the property's recovery period. Figure the adjusted basis of the duplex as follows:
Original cost of duplex $35,000
Addition to duplex 10,000
-------
Total cost of duplex $45,000
Minus: Depreciation 23,000
-------
Adjusted basis before casualty $22,000
Minus: Insurance
proceeds $19,700
Deducted casualty
loss 1,000
Salvage
proceeds 1,300 22,000
------- -------
Adjusted basis after casualty $-0-
Add: Cost of restoring duplex 19,000
-------
Adjusted basis after restoration $19,000
=======
Note. Your basis in the land is its original cost of $5,000.
Easements. The amount you receive for granting an easement is generally considered to be proceeds from the sale of an interest in real property. It reduces the basis of the affected part of the property. If the amount received is more than the basis of the part of the property affected by the easement, reduce your basis in that part to zero and treat the excess as a recognized gain.
If the gain is on a capital asset, see chapter 16 for information about how to report it. If the gain is on property used in a trade or business, see Pub. 544 for information about how to report it.
Exclusion of subsidies for energy conservation measures. You can exclude from gross income any subsidy you received from a public utility company for the purchase or installation of an energy conservation measure for a dwelling unit. Reduce the basis of the property for which you received the subsidy by the excluded amount. For more information about this subsidy, see chapter 12.
Postponed gain from sale of home. If you postponed gain from the sale of your main home under rules in effect before May 7, 1997, you must reduce the basis of the home you acquired as a replacement by the amount of the postponed gain. For more information on the rules for the sale of a home, see chapter 15.
Basis Other Than Cost
There are many times when you cannot use cost as basis. In these cases, the fair market value or the adjusted basis of the property can be used. Fair market value (FMV) and adjusted basis were discussed earlier.
Property Received for Services
If you receive property for your services, include the FMV of the property in income. The amount you include in income becomes your basis. If the services were performed for a price agreed on beforehand, it will be accepted as the FMV of the property if there is no evidence to the contrary.
Restricted property. If you receive property for your services and the property is subject to certain restrictions, your basis in the property is its FMV when it becomes substantially vested. However, this rule does not apply if you make an election to include in income the FMV of the property at the time it is transferred to you, less any amount you paid for it. Property is substantially vested when it is transferable or when it is not subject to a substantial risk of forfeiture (you do not have a good chance of losing it). For more information, see Restricted Property in Pub. 525.
Bargain purchases. A bargain purchase is a purchase of an item for less than its FMV. If, as compensation for services, you buy goods or other property at less than FMV, include the difference between the purchase price and the property's FMV in your income. Your basis in the property is its FMV (your purchase price plus the amount you include in income).
If the difference between your purchase price and the FMV is a qualified employee discount, do not include the difference in income. However, your basis in the property is still its FMV. See Employee Discounts in Pub. 15-B.
Taxable Exchanges
A taxable exchange is one in which the gain is taxable or the loss is deductible. A taxable gain or deductible loss also is known as a recognized gain or loss. If you receive property in exchange for other property in a taxable exchange, the basis of the property you receive is usually its FMV at the time of the exchange.
Nontaxable Exchanges
A nontaxable exchange is an exchange in which you are not taxed on any gain and you cannot deduct any loss. If you receive property in a nontaxable exchange, its basis is generally the same as the basis of the property you transferred. See Nontaxable Trades in chapter 14.
Involuntary Conversions
If you receive replacement property as a result of an involuntary conversion, such as a casualty, theft, or condemnation, figure the basis of the replacement property using the basis of the converted property.
Similar or related property. If you receive replacement property similar or related in service or use to the converted property, the replacement property's basis is the same as the converted property's basis on the date of the conversion, with the following adjustments.
1. Decrease the basis by the following.
a. Any loss you recognize on the involuntary conversion.
b. Any money you receive that you do not spend on similar property.
2. Increase the basis by the following.
a. Any gain you recognize on the involuntary conversion.
b. Any cost of acquiring the replacement property.
Example. The state condemned your property. The adjusted basis of the property was $26,000 and the state paid you $31,000 for it. You realized a gain of $5,000 ($31,000 - $26,000). You bought replacement property similar in use to the converted property for $29,000. You recognize a gain of $2,000 ($31,000 - $29,000), the unspent part of the payment from the state. Your unrecognized gain is $3,000, the difference between the $5,000 realized gain and the $2,000 recognized gain. The basis of the replacement property is figured as follows:
Cost of replacement property $29,000
Minus: Gain not recognized 3,000
-------
Basis of replacement property $26,000
=======
Allocating the basis. If you buy more than one piece of replacement property, allocate your basis among the properties based on their respective costs.
Basis for depreciation. Special rules apply in determining and depreciating the basis of MACRS property acquired in an involuntary conversion. For information, see What Is the Basis of Your Depreciable Property? in chapter 1 of Pub. 946.
Like-Kind Exchanges
The exchange of property for the same kind of property is the most common type of nontaxable exchange. To qualify as a like-kind exchange, the property traded and the property received must be both of the following.
• Qualifying property.
• Like-kind property.
The basis of the property you receive is generally the same as the adjusted basis of the property you gave up. If you trade property in a like-kind exchange and also pay money, the basis of the property received is the adjusted basis of the property you gave up increased by the money you paid.
Qualifying property. In a like-kind exchange, you must hold for investment or for productive use in your trade or business both the property you give up and the property you receive.
Like-kind property. There must be an exchange of like-kind property. Like-kind properties are properties of the same nature or character, even if they differ in grade or quality. The exchange of real estate for real estate and personal property for similar personal property are exchanges of like-kind property.
Example. You trade in an old truck used in your business with an adjusted basis of $1,700 for a new one costing $6,800. The dealer allows you $2,000 on the old truck, and you pay $4,800. This is a like-kind exchange. The basis of the new truck is $6,500 (the adjusted basis of the old one, $1,700, plus the amount you paid, $4,800).
If you sell your old truck to a third party for $2,000 instead of trading it in and then buy a new one from the dealer, you have a taxable gain of $300 on the sale (the $2,000 sale price minus the $1,700 adjusted basis). The basis of the new truck is the price you pay the dealer.
Partially nontaxable exchanges. A partially nontaxable exchange is an exchange in which you receive unlike property or money in addition to like-kind property. The basis of the property you receive is the same as the adjusted basis of the property you gave up, with the following adjustments.
1. Decrease the basis by the following amounts.
a. Any money you receive.
b. Any loss you recognize on the exchange.
2. Increase the basis by the following amounts.
a. Any additional costs you incur.
b. Any gain you recognize on the exchange.
Allocation of basis. If you receive like-kind and unlike properties in the exchange, allocate the basis first to the unlike property, other than money, up to its FMV on the date of the exchange. The rest is the basis of the like-kind property.
More information. See Like-Kind Exchanges in chapter 1 of Pub. 544 for more information.
Basis for depreciation. Special rules apply in determining and depreciating the basis of MACRS property acquired in a like-kind exchange. For information, see What Is the Basis of Your Depreciable Property? in chapter 1 of Pub. 946.
Property Transferred From a Spouse
The basis of property transferred to you or transferred in trust for your benefit by your spouse is the same as your spouse's adjusted basis. The same rule applies to a transfer by your former spouse that is incident to divorce. However, for property transferred in trust, adjust your basis for any gain recognized by your spouse or former spouse if the liabilities assumed, plus the liabilities to which the property is subject, are more than the adjusted basis of the property transferred.
If the property transferred to you is a series E, series EE, or series I U.S. savings bond, the transferor must include in income the interest accrued to the date of transfer. Your basis in the bond immediately after the transfer is equal to the transferor's basis increased by the interest income includible in the transferor's income. For more information on these bonds, see chapter 7.
At the time of the transfer, the transferor must give you the records needed to determine the adjusted basis and holding period of the property as of the date of the transfer.
For more information about the transfer of property from a spouse, see chapter 14.
Property Received as a Gift
To figure the basis of property you receive as a gift, you must know its adjusted basis to the donor just before it was given to you, its FMV at the time it was given to you, and any gift tax paid on it.
FMV less than donor's adjusted basis. If the FMV of the property at the time of the gift is less than the donor's adjusted basis, your basis depends on whether you have a gain or a loss when you dispose of the property. Your basis for figuring gain is the same as the donor's adjusted basis plus or minus any required adjustments to basis while you held the property. Your basis for figuring loss is its FMV when you received the gift plus or minus any required adjustments to basis while you held the property. See Adjusted Basis, earlier.
Example. You received an acre of land as a gift. At the time of the gift, the land had an FMV of $8,000. The donor's adjusted basis was $10,000. After you received the property, no events occurred to increase or decrease your basis. If you later sell the property for $12,000, you will have a $2,000 gain because you must use the donor's adjusted basis at the time of the gift ($10,000) as your basis to figure gain. If you sell the property for $7,000, you will have a $1,000 loss because you must use the FMV at the time of the gift ($8,000) as your basis to figure loss.
If the sales price is between $8,000 and $10,000, you have neither gain nor loss.
Business property. If you hold the gift as business property, your basis for figuring any depreciation, depletion, or amortization deductions is the same as the donor's adjusted basis plus or minus any required adjustments to basis while you hold the property.
FMV equal to or greater than donor's adjusted basis. If the FMV of the property is equal to or greater than the donor's adjusted basis, your basis is the donor's adjusted basis at the time you received the gift. Increase your basis by all or part of any gift tax paid, depending on the date of the gift, explained later.
Also, for figuring gain or loss from a sale or other disposition or for figuring depreciation, depletion, or amortization deductions on business property, you must increase or decrease your basis (the donor's adjusted basis) by any required adjustments to basis while you held the property. See Adjusted Basis, earlier.
If you received a gift during the tax year, increase your basis in the gift (the donor's adjusted basis) by the part of the gift tax paid on it due to the net increase in value of the gift. Figure the increase by multiplying the gift tax paid by a fraction. The numerator of the fraction is the net increase in value of the gift and the denominator is the amount of the gift.
The net increase in value of the gift is the FMV of the gift minus the donor's adjusted basis. The amount of the gift is its value for gift tax purposes after reduction by any annual exclusion and marital or charitable deduction that applies to the gift.
Example. In 2016, you received a gift of property from your mother that had an FMV of $50,000. Her adjusted basis was $20,000. The amount of the gift for gift tax purposes was $36,000 ($50,000 minus the $14,000 annual exclusion). She paid a gift tax of $7,320 on the property. Your basis is $26,076, figured as follows:
Fair market value $50,000
Minus: Adjusted basis -20,000
-------
Net increase in value $30,000
=======
Gift tax paid $7,320
Multiplied by ($30,000 ÷ $36,000) × .83
-------
Gift tax due to net increase in value $6,076
Adjusted basis of property to your
mother +20,000
-------
Your basis in the property $26,076
=======
Inherited Property
Your basis in property you inherited from a decedent is generally one of the following:
• The FMV of the property at the date of the decedent's death.
• The FMV on the alternate valuation date if the personal representative for the estate elects to use alternate valuation.
• The value under the special-use valuation method for real property used in farming or a closely held business if elected for estate tax purposes.
• The decedent's adjusted basis in land to the extent of the value excluded from the decedent's taxable estate as a qualified conservation easement.
If a federal estate tax return does not have to be filed, your basis in the inherited property is its appraised value at the date of death for state inheritance or transmission taxes.
For more information, see the instructions to Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return.
Community property. In community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin), married individuals are each usually considered to own half the community property. When either spouse dies, the total value of the community property, even the part belonging to the surviving spouse, generally becomes the basis of the entire property. For this rule to apply, at least half the value of the community property interest must be includible in the decedent's gross estate, whether or not the estate must file a return.
Example. You and your spouse owned community property that had a basis of $80,000. When your spouse died, half the FMV of the community interest was includible in your spouse's estate. The FMV of the community interest was $100,000. The basis of your half of the property after the death of your spouse is $50,000 (half of the $100,000 FMV). The basis of the other half to your spouse's heirs is also $50,000.
For more information about community property, see Pub. 555, Community Property.
Property Changed From Personal to Business or Rental Use
If you hold property for personal use and then change it to business use or use it to produce rent, you can begin to depreciate the property at the time of the change. To do so, you must figure its basis for depreciation at the time of the change. An example of changing property held for personal use to business or rental use would be renting out your former personal residence.
Basis for depreciation. The basis for depreciation is the lesser of the following amounts.
• The FMV of the property on the date of the change.
• Your adjusted basis on the date of the change.
Example. Several years ago, you paid $160,000 to have your house built on a lot that cost $25,000. You paid $20,000 for permanent improvements to the house and claimed a $2,000 casualty loss deduction for damage to the house before changing the property to rental use last year. Because land is not depreciable, you include only the cost of the house when figuring the basis for depreciation.
Your adjusted basis in the house when you changed its use to rental property was $178,000 ($160,000 + $20,000 - $2,000). On the same date, your property had an FMV of $180,000, of which $15,000 was for the land and $165,000 was for the house. The basis for figuring depreciation on the house is its FMV on the date of the change ($165,000) because it is less than your adjusted basis ($178,000).
Sale of property. If you later sell or dispose of property changed to business or rental use, the basis you use will depend on whether you are figuring gain or loss.
Gain. The basis for figuring a gain is your adjusted basis in the property when you sell the property.
Example. Assume the same facts as in the previous example except that you sell the property at a gain after being allowed depreciation deductions of $37,500. Your adjusted basis for figuring gain is $165,500 ($178,000 + $25,000 (land) - $37,500).
Loss. Figure the basis for a loss starting with the smaller of your adjusted basis or the FMV of the property at the time of the change to business or rental use. Then make adjustments (increases and decreases) for the period after the change in the property's use, as discussed earlier under Adjusted Basis.
Example. Assume the same facts as in the previous example, except that you sell the property at a loss after being allowed depreciation deductions of $37,500. In this case, you would start with the FMV on the date of the change to rental use ($180,000), because it is less than the adjusted basis of $203,000 ($178,000 + $25,000 (land)) on that date. Reduce that amount ($180,000) by the depreciation deductions ($37,500). The basis for loss is $142,500 ($180,000 - $37,500).
Stocks and Bonds
The basis of stocks or bonds you buy generally is the purchase price plus any costs of purchase, such as commissions and recording or transfer fees. If you get stocks or bonds other than by purchase, your basis is usually determined by the FMV or the previous owner's adjusted basis, as discussed earlier.
You must adjust the basis of stocks for certain events that occur after purchase. For example, if you receive additional stock from nontaxable stock dividends or stock splits, reduce your basis for each share of stock by dividing the adjusted basis of the old stock by the number of shares of old and new stock. This rule applies only when the additional stock received is identical to the stock held. Also reduce your basis when you receive nontaxable distributions. The nontaxable distributions are a return of capital.
Example. In 2014 you bought 100 shares of XYZ stock for $1,000 or $10 a share. In 2015 you bought 100 shares of XYZ stock for $1,600 or $16 a share. In 2016 XYZ declared a 2-for-1 stock split. You now have 200 shares of stock with a basis of $5 a share and 200 shares with a basis of $8 a share.
Other basis. There are other ways to figure the basis of stocks or bonds depending on how you acquired them. For detailed information, see Stocks and Bonds under Basis of Investment Property in chapter 4 of Pub. 550.
Identifying stocks or bonds sold. If you can adequately identify the shares of stock or the bonds you sold, their basis is the cost or other basis of the particular shares of stocks or bonds. If you buy and sell securities at various times in varying quantities and you cannot adequately identify the shares you sell, the basis of the securities you sell is the basis of the securities you acquired first. For more information about identifying securities you sell, see Stocks and Bonds under Basis of Investment Property in chapter 4 of Pub. 550.
Mutual fund shares. If you sell mutual fund shares you acquired at various times and prices and left on deposit in an account kept by a custodian or agent, you can elect to use an average basis. For more information, see Pub. 550.
Bond premium. If you buy a taxable bond at a premium and elect to amortize the premium, reduce the basis of the bond by the amortized premium you deduct each year. See Bond Premium Amortization in chapter 3 of Pub. 550 for more information. Although you cannot deduct the premium on a tax-exempt bond, you must amortize the premium each year and reduce your basis in the bond by the amortized amount.
Original issue discount (OID) on debt instruments. You must increase your basis in an OID debt instrument by the OID you include in income for that instrument. See Original Issue Discount (OID) in chapter 7 and Pub. 1212, Guide To Original Issue Discount (OID) Instruments.
Tax-exempt obligations. OID on tax-exempt obligations is generally not taxable. However, when you dispose of a tax-exempt obligation issued after September 3, 1982, and acquired after March 1, 1984, you must accrue OID on the obligation to determine its adjusted basis. The accrued OID is added to the basis of the obligation to determine your gain or loss. See chapter 4 of Pub. 550.
14. Sale of Property
Reminder
Foreign income. If you are a U.S. citizen who sells property located outside the United States, you must report all gains and losses from the sale of that property 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 1099 from the payer.
Introduction
This chapter discusses the tax consequences of selling or trading investment property. It explains the following.
• What a sale or trade is.
• Figuring gain or loss.
• Nontaxable trades.
• Related party transactions.
• Capital gains or losses.
• Capital assets and noncapital assets.
• Holding period.
• Rollover of gain from publicly traded securities.
Other property transactions. Certain transfers of property aren't discussed here. They are discussed in other IRS publications. These include the following.
• Sales of a main home, covered in chapter 15.
• Installment sales, covered in Pub. 537.
• Transactions involving business property, covered in Pub. 544.
• Dispositions of an interest in a passive activity, covered in Pub. 925.
Pub. 550, provides a more detailed discussion about sales and trades of investment property. Pub. 550 includes information about the rules covering nonbusiness bad debts, straddles, section 1256 contracts, puts and calls, commodity futures, short sales, and wash sales. It also discusses investment-related expenses.
Useful Items
You may want to see:
Publication
• Publication 550 Investment Income and Expenses
Form (and Instructions)
• Schedule D (Form 1040) Capital Gains and Losses
• Form 8949 Sales and Other Dispositions of Capital Assets
• Form 8824 Like-Kind Exchanges
Sales and Trades
If you sold property such as stocks, bonds, or certain commodities through a broker during the year, you should receive from the broker, a Form 1099-B. You should receive a Form 1099-B for 2016 by February 15, 2017. It will show the gross proceeds from the sale. It may also show your basis. The IRS will also get a copy of Form 1099-B from the broker.
Use Form 1099-B received from your broker to complete Form 8949 and/or Schedule D (Form 1040).
What Is a Sale or Trade?
This section explains what is a sale or trade. It also explains certain transactions and events that are treated as sales or trades.
A sale is generally a transfer of property for money or a mortgage, note, or other promise to pay money.
A trade is a transfer of property for other property or services and may be taxed in the same way as a sale.
Sale and purchase. Ordinarily, a transaction isn't a trade when you voluntarily sell property for cash and immediately buy similar property to replace it. The sale and purchase are two separate transactions. But see Like-kind exchanges under Nontaxable Trades, later.
Redemption of stock. A redemption of stock is treated as a sale or trade and is subject to the capital gain or loss provisions unless the redemption is a dividend or other distribution on stock.
Dividend versus sale or trade. Whether a redemption is treated as a sale, trade, dividend, or other distribution depends on the circumstances in each case. Both direct and indirect ownership of stock will be considered. The redemption is treated as a sale or trade of stock if:
• The redemption isn't essentially equivalent to a dividend (see chapter 8),
• There is a substantially disproportionate redemption of stock,
• There is a complete redemption of all the stock of the corporation owned by the shareholder, or
• The redemption is a distribution in partial liquidation of a corporation.
Redemption or retirement of bonds. A redemption or retirement of bonds or notes at their maturity is generally treated as a sale or trade.
In addition, a significant modification of a bond is treated as a trade of the original bond for a new bond. For details, see Regulations section 1.1001-3.
Surrender of stock. A surrender of stock by a dominant shareholder who retains ownership of more than half of the corporation's voting shares is treated as a contribution to capital rather than as an immediate loss deductible from taxable income. The surrendering shareholder must reallocate his or her basis in the surrendered shares to the shares he or she retains.
Worthless securities. Stocks, stock rights, and bonds (other than those held for sale by a securities dealer) that became completely worthless during the tax year are treated as though they were sold on the last day of the tax year. This affects whether your capital loss is long-term or short-term. See Holding Period, later.
Worthless securities also include securities that you abandon after March 12, 2008. To abandon a security, you must permanently surrender and relinquish all rights in the security and receive no consideration in exchange for it. All the facts and circumstances determine whether the transaction is properly characterized as an abandonment or other type of transaction, such as an actual sale or exchange, contribution to capital, dividend, or gift.
If you are a cash basis taxpayer and make payments on a negotiable promissory note that you issued for stock that became worthless, you can deduct these payments as losses in the years you actually make the payments. Don't deduct them in the year the stock became worthless.
How to report loss. Report worthless securities on Form 8949, Part I or Part II, whichever applies.
CAUTION: Report your worthless securities transactions on Form 8949 with the correct box checked for these transactions. See Form 8949 and the Instructions for Form 8949.
TIP: For more information on Form 8949 and Schedule D (Form 1040), see Reporting Capital Gains and Losses in chapter 16. See also Schedule D (Form 1040), Form 8949, and their separate instructions.
Filing a claim for refund. If you don't claim a loss for a worthless security on your original return for the year it becomes worthless, you can file a claim for a credit or refund due to the loss. You must use Form 1040X, to amend your return for the year the security became worthless. You must file it within 7 years from the date your original return for that year had to be filed, or 2 years from the date you paid the tax, whichever is later. For more information about filing a claim, see Amended Returns and Claims for Refund in chapter 1.
How To Figure Gain or Loss
You figure gain or loss on a sale or trade of property by comparing the amount you realize with the adjusted basis of the property.
Gain. If the amount you realize from a sale or trade is more than the adjusted basis of the property you transfer, the difference is a gain.
Loss. If the adjusted basis of the property you transfer is more than the amount you realize, the difference is a loss.
Adjusted basis. The adjusted basis of property is your original cost or other original basis properly adjusted (increased or decreased) for certain items. See chapter 13 for more information about determining the adjusted basis of property.
Amount realized. The amount you realize from a sale or trade of property is everything you receive for the property minus your expenses of sale (such as redemption fees, sales commissions, sales charges, or exit fees). Amount realized includes the money you receive plus the fair market value of any property or services you receive. If you received a note or other debt instrument for the property, see How To Figure Gain or Loss in chapter 4 of Pub. 550 to figure the amount realized.
If you finance the buyer's purchase of your property and the debt instrument doesn't provide for adequate stated interest, the unstated interest that you must report as ordinary income will reduce the amount realized from the sale. For more information, see Pub. 537.
Fair market value. Fair market value is the price at which the property would change hands between a buyer and a seller, neither being forced to buy or sell and both having reasonable knowledge of all the relevant facts.
Example. You trade A Company stock with an adjusted basis of $7,000 for B Company stock with a fair market value of $10,000, which is your amount realized. Your gain is $3,000 ($10,000 - $7,000).
Debt paid off. A debt against the property, or against you, that is paid off as a part of the transaction, or that is assumed by the buyer, must be included in the amount realized. This is true even if neither you nor the buyer is personally liable for the debt. For example, if you sell or trade property that is subject to a nonrecourse loan, the amount you realize generally includes the full amount of the note assumed by the buyer even if the amount of the note is more than the fair market value of the property.
Example. You sell stock that you had pledged as security for a bank loan of $8,000. Your basis in the stock is $6,000. The buyer pays off your bank loan and pays you $20,000 in cash. The amount realized is $28,000 ($20,000 + $8,000). Your gain is $22,000 ($28,000 - $6,000).
Payment of cash. If you trade property and cash for other property, the amount you realize is the fair market value of the property you receive. Determine your gain or loss by subtracting the cash you pay plus the adjusted basis of the property you trade in from the amount you realize. If the result is a positive number, it is a gain. If the result is a negative number, it is a loss.
No gain or loss. You may have to use a basis for figuring gain that is different from the basis used for figuring loss. In this case, you may have neither a gain nor a loss. See Basis Other Than Cost in chapter 13.
Nontaxable Trades
This section discusses trades that generally don't result in a taxable gain or deductible loss. For more information on nontaxable trades, see chapter 1 of Pub. 544.
Like-kind exchanges. If you trade business or investment property for other business or investment property of a like kind, you don't pay tax on any gain or deduct any loss until you sell or dispose of the property you receive. To be nontaxable, a trade must meet all six of the following conditions.
1. The property must be business or investment property. You must hold both the property you trade and the property you receive for productive use in your trade or business or for investment. Neither property may be property used for personal purposes, such as your home or family car.
2. The property must not be held primarily for sale. The property you trade and the property you receive must not be property you sell to customers, such as merchandise.
3. The property must not be stocks, bonds, notes, choses in action, certificates of trust or beneficial interest, or other securities or evidences of indebtedness or interest, including partnership interests. However, see Special rules for mutual ditch, reservoir, or irrigation company stock, in chapter 4 of Pub. 550 for an exception. Also, you can have a nontaxable trade of corporate stocks under a different rule, as discussed later.
4. There must be a trade of like property. The trade of real estate for real estate, or personal property for similar personal property, is a trade of like property. The trade of an apartment house for a store building, or a panel truck for a pickup truck, is a trade of like property. The trade of a piece of machinery for a store building isn't a trade of like property. Real property located in the United States and real property located outside the United States aren't like property. Also, personal property used predominantly within the United States and personal property used predominantly outside the United States aren't like property.
5. The property to be received must be identified in writing within 45 days after the date you transfer the property given up in the trade.
6. The property to be received must be received by the earlier of:
a. The 180th day after the date on which you transfer the property given up in the trade, or
b. The due date, including extensions, for your tax return for the year in which the transfer of the property given up occurs.
Partly nontaxable exchange. If you receive money or unlike property in addition to like property, and the above six conditions are met, you have a partly nontaxable trade. You are taxed on any gain you realize, but only up to the amount of the money and the fair market value of the unlike property you receive. You can't deduct a loss.
Like property and unlike property transferred. If you give up unlike property in addition to the like property, you must recognize gain or loss on the unlike property you give up. The gain or loss is the difference between the adjusted basis of the unlike property and its fair market value.
Like property and money transferred. If all of the above conditions (1) - (6) are met, you have a nontaxable trade even if you pay money in addition to the like property.
Basis of property received. To figure the basis of the property received, see Nontaxable Exchanges in chapter 13.
How to report. You must report the trade of like property on Form 8824. If you figure a recognized gain or loss on Form 8824, report it on Form 4797, Sales of Business Property, whichever applies. See the instructions for Line 22 in the Instructions for Form 8824.
For information on using Form 4797, see chapter 4 of Pub. 544.
Corporate stocks. The following trades of corporate stocks generally don't result in a taxable gain or a deductible loss.
Corporate reorganizations. In some instances, a company will give you common stock for preferred stock, preferred stock for common stock, or stock in one corporation for stock in another corporation. If this is a result of a merger, recapitalization, transfer to a controlled corporation, bankruptcy, corporate division, corporate acquisition, or other corporate reorganization, you don't recognize gain or loss.
Stock for stock of the same corporation. You can exchange common stock for common stock or preferred stock for preferred stock in the same corporation without having a recognized gain or loss. This is true for a trade between two stockholders as well as a trade between a stockholder and the corporation.
Convertible stocks and bonds. You generally will not have a recognized gain or loss if you convert bonds into stock or preferred stock into common stock of the same corporation according to a conversion privilege in the terms of the bond or the preferred stock certificate.
Property for stock of a controlled corporation. If you transfer property to a corporation solely in exchange for stock in that corporation, and immediately after the trade you are in control of the corporation, you ordinarily will not recognize a gain or loss. This rule applies both to individuals and to groups who transfer property to a corporation. It doesn't apply if the corporation is an investment company.
For this purpose, to be in control of a corporation, you or your group of transferors must own, immediately after the exchange, at least 80% of the total combined voting power of all classes of stock entitled to vote and at least 80% of the outstanding shares of each class of nonvoting stock of the corporation.
If this provision applies to you, you may have to attach to your return a complete statement of all facts pertinent to the exchange. For details, see Regulations section 1.351-3.
Additional information. For more information on trades of stock, see Nontaxable Trades in chapter 4 of Pub. 550.
Insurance policies and annuities. You will not have a recognized gain or loss if the insured or annuitant is the same under both contracts and you trade:
• A life insurance contract for another life insurance contract or for an endowment or annuity contract or for a qualified long-term care insurance contract,
• An endowment contract for another endowment contract that provides for regular payments beginning at a date no later than the beginning date under the old contract or for an annuity contract or for a qualified long-term insurance contract,
• An annuity contract for annuity contract or for a qualified long-term care insurance contract, or
• A qualified long-term care insurance contract for a qualified long-term care insurance contract.
You also may not have to recognize gain or loss on an exchange of a portion of an annuity contract for another annuity contract. See Revenue Ruling 2003-76 and Revenue Procedure 2011-38.
For tax years beginning after 2010, amounts received as an annuity for a period of 10 years or more, or for the lives of one or more individuals, under any portion of an annuity, endowment, or life insurance contract, are treated as a separate contract and are considered partial annuities. A portion of an annuity, endowment, or life insurance contract may be annuitized, provided that the annuitization period is for 10 years or more or for the lives of one or more individuals. The investment in the contract is allocated between the part of the contract from which amounts are received as an annuity and the part of the contract from which amounts aren't received as an annuity.
Exchanges of contracts not included in this list, such as an annuity contract for an endowment contract, or an annuity or endowment contract for a life insurance contract, are taxable.
Demutualization of life insurance companies. If you received stock in exchange for your equity interest as a policyholder or an annuitant, you generally will not have a recognized gain or loss. See Demutualization of Life Insurance Companies in Pub. 550.
U.S. Treasury notes or bonds. You can trade certain issues of U.S. Treasury obligations for other issues designated by the Secretary of the Treasury, with no gain or loss recognized on the trade. See Savings bonds traded in chapter 1 of Pub. 550 for more information.
Transfers Between Spouses
Generally, no gain or loss is recognized on a transfer of property from an individual to (or in trust for the benefit of) a spouse, or if incident to a divorce, a former spouse. This nonrecognition rule doesn't apply in the following situations.
• The recipient spouse or former spouse is a nonresident alien.
• Property is transferred in trust and liability exceeds basis. Gain must be recognized to the extent the amount of the liabilities assumed by the trust, plus any liabilities on the property, exceed the adjusted basis of the property.
For other situations, see Transfers Between Spouses in chapter 4 of Pub. 550.
Any transfer of property to a spouse or former spouse on which gain or loss isn't recognized is treated by the recipient as a gift and isn't considered a sale or exchange. The recipient's basis in the property will be the same as the adjusted basis of the giver immediately before the transfer. This carryover basis rule applies whether the adjusted basis of the transferred property is less than, equal to, or greater than either its fair market value at the time of transfer or any consideration paid by the recipient. This rule applies for purposes of determining loss as well as gain. Any gain recognized on a transfer in trust increases the basis.
A transfer of property is incident to a divorce if the transfer occurs within 1 year after the date on which the marriage ends, or if the transfer is related to the ending of the marriage.
Related Party Transactions
Special rules apply to the sale or trade of property between related parties.
Gain on sale or trade of depreciable property. Your gain from the sale or trade of property to a related party may be ordinary income, rather than capital gain, if the property can be depreciated by the party receiving it. See chapter 3 of Pub. 544 for more information.
Like-kind exchanges. Generally, if you trade business or investment property for other business or investment property of a like kind, no gain or loss is recognized. See Like-kind exchanges, earlier, under Nontaxable Trades.
This rule also applies to trades of property between related parties, defined next under Losses on sales or trades of property. However, if either you or the related party disposes of the like property within 2 years after the trade, you both must report any gain or loss not recognized on the original trade on your return filed for the year in which the later disposition occurs. See Related Party Transactions in chapter 4 of Pub. 550 for exceptions.
Losses on sales or trades of property. You can't deduct a loss on the sale or trade of property, other than a distribution in complete liquidation of a corporation, if the transaction is directly or indirectly between you and the following related parties.
• Members of your family. This includes only your brothers and sisters, half-brothers and half-sisters, spouse, ancestors (parents, grandparents, etc.), and lineal descendants (children, grandchildren, etc.).
• A partnership in which you directly or indirectly own more than 50% of the capital interest or the profits interest.
• A corporation in which you directly or indirectly own more than 50% in value of the outstanding stock. (See Constructive ownership of stock, later.)
• A tax-exempt charitable or educational organization directly or indirectly controlled, in any manner or by any method, by you or by a member of your family, whether or not this control is legally enforceable.
In addition, a loss on the sale or trade of property isn't deductible if the transaction is directly or indirectly between the following related parties.
• A grantor and fiduciary, or the fiduciary and beneficiary, of any trust.
• Fiduciaries of two different trusts, or the fiduciary and beneficiary of two different trusts, if the same person is the grantor of both trusts.
• A trust fiduciary and a corporation of which more than 50% in value of the outstanding stock is directly or indirectly owned by or for the trust, or by or for the grantor of the trust.
• A corporation and a partnership if the same persons own more than 50% in value of the outstanding stock of the corporation and more than 50% of the capital interest, or the profits interest, in the partnership.
• Two S corporations if the same persons own more than 50% in value of the outstanding stock of each corporation.
• Two corporations, one of which is an S corporation, if the same persons own more than 50% in value of the outstanding stock of each corporation.
• An executor and a beneficiary of an estate (except in the case of a sale or trade to satisfy a pecuniary bequest).
• Two corporations that are members of the same controlled group. (Under certain conditions, however, these losses aren't disallowed but must be deferred.)
• Two partnerships if the same persons own, directly or indirectly, more than 50% of the capital interests or the profit interests in both partnerships.
Multiple property sales or trades. If you sell or trade to a related party a number of blocks of stock or pieces of property in a lump sum, you must figure the gain or loss separately for each block of stock or piece of property. The gain on each item may be taxable. However, you can't deduct the loss on any item. Also, you can't reduce gains from the sales of any of these items by losses on the sales of any of the other items.
Indirect transactions. You can't deduct your loss on the sale of stock through your broker if, under a prearranged plan, a related party buys the same stock you had owned. This doesn't apply to a trade between related parties through an exchange that is purely coincidental and isn't prearranged.
Constructive ownership of stock. In determining whether a person directly or indirectly owns any of the outstanding stock of a corporation, the following rules apply.
Rule 1. Stock directly or indirectly owned by or for a corporation, partnership, estate, or trust is considered owned proportionately by or for its shareholders, partners, or beneficiaries.
Rule 2. An individual is considered to own the stock directly or indirectly owned by or for his or her family. Family includes only brothers and sisters, half-brothers and half-sisters, spouse, ancestors, and lineal descendants.
Rule 3. An individual owning, other than by applying rule 2, any stock in a corporation is considered to own the stock directly or indirectly owned by or for his or her partner.
Rule 4. When applying rule 1, 2, or 3, stock constructively owned by a person under rule 1 is treated as actually owned by that person. But stock constructively owned by an individual under rule 2 or rule 3 isn't treated as owned by that individual for again applying either rule 2 or rule 3 to make another person the constructive owner of the stock.
Property received from a related party. If you sell or trade at a gain property you acquired from a related party, you recognize the gain only to the extent it is more than the loss previously disallowed to the related party. This rule applies only if you are the original transferee and you acquired the property by purchase or exchange. This rule doesn't apply if the related party's loss was disallowed because of the wash sale rules described in chapter 4 of Pub. 550 under Wash Sales.
If you sell or trade at a loss property you acquired from a related party, you can't recognize the loss that wasn't allowed to the related party.
Example 1. Your brother sells you stock for $7,600. His cost basis is $10,000. Your brother can't deduct the loss of $2,400. Later, you sell the same stock to an unrelated party for $10,500, realizing a gain of $2,900. Your reportable gain is $500 (the $2,900 gain minus the $2,400 loss not allowed to your brother).
Example 2. If, in Example 1, you sold the stock for $6,900 instead of $10,500, your recognized loss is only $700 (your $7,600 basis minus $6,900). You can't deduct the loss that wasn't allowed to your brother.
Capital Gains and Losses
This section discusses the tax treatment of gains and losses from different types of investment transactions.
Character of gain or loss. You need to classify your gains and losses as either ordinary or capital gains or losses. You then need to classify your capital gains and losses as either short-term or long-term. If you have long-term gains and losses, you must identify your 28% rate gains and losses. If you have a net capital gain, you must also identify any unrecaptured section 1250 gain.
The correct classification and identification helps you figure the limit on capital losses and the correct tax on capital gains. Reporting capital gains and losses is explained in chapter 16.
Capital or Ordinary Gain or Loss
If you have a taxable gain or a deductible loss from a transaction, it may be either a capital gain or loss or an ordinary gain or loss, depending on the circumstances. Generally, a sale or trade of a capital asset (defined next) results in a capital gain or loss. A sale or trade of a noncapital asset generally results in ordinary gain or loss. Depending on the circumstances, a gain or loss on a sale or trade of property used in a trade or business may be treated as either capital or ordinary, as explained in Pub. 544. In some situations, part of your gain or loss may be a capital gain or loss and part may be an ordinary gain or loss.
Capital Assets and Noncapital Assets
For the most part, everything you own and use for personal purposes, pleasure, or investment is a capital asset. Some examples are:
• Stocks or bonds held in your personal account,
• A house owned and used by you and your family,
• Household furnishings,
• A car used for pleasure or commuting,
• Coin or stamp collections,
• Gems and jewelry, and
• Gold, silver, or any other metal.
Any property you own is a capital asset, except the following noncapital assets.
1. Property held mainly for sale to customers or property that will physically become a part of the merchandise for sale to customers. For an exception, see Capital Asset Treatment for Self-Created Musical Works, later.
2. Depreciable property used in your trade or business, even if fully depreciated.
3. Real property used in your trade or business.
4. A copyright, a literary, musical, or artistic composition, a letter or memorandum, or similar property that is:
a. Created by your personal efforts,
b. Prepared or produced for you (in the case of a letter, memorandum, or similar property), or
c. Acquired under circumstances (for example, by gift) entitling you to the basis of the person who created the property or for whom it was prepared or produced.
Accounts or notes receivable acquired in the ordinary course of a trade or business for services rendered or from the sale of property described in (1).
U.S. Government publications that you received from the government free or for less than the normal sales price, or that you acquired under circumstances entitling you to the basis of someone who received the publications free or for less than the normal sales price.
Certain commodities derivative financial instruments held by commodities derivatives dealers.
Hedging transactions, but only if the transaction is clearly identified as a hedging transaction before the close of the day on which it was acquired, originated, or entered into.
Supplies of a type you regularly use or consume in the ordinary course of your trade or business.
Investment Property
Investment property is a capital asset. Any gain or loss from its sale or trade is generally a capital gain or loss.
Gold, silver, stamps, coins, gems, etc. These are capital assets except when they are held for sale by a dealer. Any gain or loss you have from their sale or trade generally is a capital gain or loss.
Stocks, stock rights, and bonds. All of these (including stock received as a dividend) are capital assets except when held for sale by a securities dealer. However, if you own small business stock, see Losses on Section 1244 (Small Business) Stock, later, and Losses on Small Business Investment Company Stock, in chapter 4 of Pub. 550.
Personal Use Property
Property held for personal use only, rather than for investment, is a capital asset, and you must report a gain from its sale as a capital gain. However, you can't deduct a loss from selling personal use property.
Capital Asset Treatment for Self-Created Musical Works
You can elect to treat musical compositions and copyrights in musical works as capital assets when you sell or exchange them if:
• Your personal efforts created the property, or
• You acquired the property under circumstances (for example, by gift) entitling you to the basis of the person who created the property or for whom it was prepared or produced.
You must make a separate election for each musical composition (or copyright in a musical work) sold or exchanged during the tax year. Make the election by the due date (including extensions) of the income tax return for the tax year of the sale or exchange. Make the election on Form 8949 and your Schedule D (Form 1040) by treating the sale or exchange as the sale or exchange of a capital asset, according to Form 8949, Schedule D (Form 1040), and their separate instructions.
You can revoke the election if you have IRS approval. To get IRS approval, you must submit a request for a letter ruling under the appropriate IRS revenue procedure. See, for example, Revenue Procedure 2016-1, available at IRS.gov/irb/2016-01_IRB/ar07.html#d0e1497. Alternatively, you are granted an automatic 6-month extension from the due date of your income tax return (excluding extensions) to revoke the election, provided you timely file your income tax return, and within this 6-month extension period, you file Form 1040X that treats the sale or exchange as the sale or exchange of property that isn't a capital asset.
Discounted Debt Instruments
Treat your gain or loss on the sale, redemption, or retirement of a bond or other debt instrument originally issued at a discount or bought at a discount as capital gain or loss, except as explained in the following discussions.
Short-term government obligations. Treat gains on short-term federal, state, or local government obligations (other than tax-exempt obligations) as ordinary income up to your ratable share of the acquisition discount. This treatment applies to obligations with a fixed maturity date not more than 1 year from the date of issue. Acquisition discount is the stated redemption price at maturity minus your basis in the obligation.
However, don't treat these gains as income to the extent you previously included the discount in income. See Discount on Short-Term Obligations in chapter 1 of Pub. 550.
Short-term nongovernment obligations. Treat gains on short-term nongovernment obligations as ordinary income up to your ratable share of original issue discount (OID). This treatment applies to obligations with a fixed maturity date of not more than 1 year from the date of issue.
However, to the extent you previously included the discount in income, you don't have to include it in income again. See Discount on Short-Term Obligations in chapter 1 of Pub. 550.
Tax-exempt state and local government bonds. If these bonds were originally issued at a discount before September 4, 1982, or you acquired them before March 2, 1984, treat your part of OID as tax-exempt interest. To figure your gain or loss on the sale or trade of these bonds, reduce the amount realized by your part of OID.
If the bonds were issued after September 3, 1982, and acquired after March 1, 1984, increase the adjusted basis by your part of OID to figure gain or loss. For more information on the basis of these bonds, see Discounted Debt Instruments in chapter 4 of Pub. 550.
Any gain from market discount is usually taxable on disposition or redemption of tax-exempt bonds. If you bought the bonds before May 1, 1993, the gain from market discount is capital gain. If you bought the bonds after April 30, 1993, the gain is ordinary income.
You figure the market discount by subtracting the price you paid for the bond from the sum of the original issue price of the bond and the amount of accumulated OID from the date of issue that represented interest to any earlier holders. For more information, see Market Discount Bonds in chapter 1 of Pub. 550.
A loss on the sale or other disposition of a tax-exempt state or local government bond is deductible as a capital loss.
Redeemed before maturity. If a state or local bond issued before June 9, 1980, is redeemed before it matures, the OID isn't taxable to you.
If a state or local bond issued after June 8, 1980, is redeemed before it matures, the part of OID earned while you hold the bond isn't taxable to you. However, you must report the unearned part of OID as a capital gain.
Example. On July 2, 2005, the date of issue, you bought a 20-year, 6% municipal bond for $800. The face amount of the bond was $1,000. The $200 discount was OID. At the time the bond was issued, the issuer had no intention of redeeming it before it matured. The bond was callable at its face amount beginning 10 years after the issue date.
The issuer redeemed the bond at the end of 11 years (July 2, 2016) for its face amount of $1,000 plus accrued annual interest of $60. The OID earned during the time you held the bond, $73, isn't taxable. The $60 accrued annual interest also isn't taxable. However, you must report the unearned part of OID, $127 ($200 - $73 = $127) as a capital gain.
Long-term debt instruments issued after 1954 and before May 28, 1969 (or before July 2, 1982, if a government instrument). If you sell, trade, or redeem for a gain one of these debt instruments, the part of your gain that isn't more than your ratable share of the OID at the time of the sale or redemption is ordinary income. The rest of the gain is capital gain. If, however, there was an intention to call the debt instrument before maturity, all of your gain that isn't more than the entire OID is treated as ordinary income at the time of the sale. This treatment of taxable gain also applies to corporate instruments issued after May 27, 1969, under a written commitment that was binding on May 27, 1969, and at all times thereafter.
Long-term debt instruments issued after May 27, 1969 (or after July 1, 1982, if a government instrument). If you hold one of these debt instruments, you must include a part of OID in your gross income each year you own the instrument. Your basis in that debt instrument is increased by the amount of OID that you have included in your gross income. See Original Issue Discount (OID) in chapter 7 for information about OID that you must report on your tax return.
If you sell or trade the debt instrument before maturity, your gain is a capital gain. However, if at the time the instrument was originally issued there was an intention to call it before its maturity, your gain generally is ordinary income to the extent of the entire OID reduced by any amounts of OID previously includible in your income. In this case, the rest of the gain is capital gain.
Market discount bonds. If the debt instrument has market discount and you chose to include the discount in income as it accrued, increase your basis in the debt instrument by the accrued discount to figure capital gain or loss on its disposition. If you didn't choose to include the discount in income as it accrued, you must report gain as ordinary interest income up to the instrument's accrued market discount. The rest of the gain is capital gain. See Market Discount Bonds in chapter 1 of Pub. 550.
A different rule applies to market discount bonds issued before July 19, 1984, and purchased by you before May 1, 1993. See Market discount bonds under Discounted Debt Instruments in chapter 4 of Pub. 550.
Retirement of debt instrument. Any amount you receive on the retirement of a debt instrument is treated in the same way as if you had sold or traded that instrument.
Notes of individuals. If you hold an obligation of an individual issued with OID after March 1, 1984, you generally must include the OID in your income currently, and your gain or loss on its sale or retirement is generally capital gain or loss. An exception to this treatment applies if the obligation is a loan between individuals and all the following requirements are met.
• The lender isn't in the business of lending money.
• The amount of the loan, plus the amount of any outstanding prior loans, is $10,000 or less.
• Avoiding federal tax isn't one of the principal purposes of the loan.
If the exception applies, or the obligation was issued before March 2, 1984, you don't include the OID in your income currently. When you sell or redeem the obligation, the part of your gain that isn't more than your accrued share of OID at that time is ordinary income. The rest of the gain, if any, is capital gain. Any loss on the sale or redemption is capital loss.
Deposit in Insolvent or Bankrupt Financial Institution
If you lose money you have on deposit in a bank, credit union, or other financial institution that becomes insolvent or bankrupt, you may be able to deduct your loss in one of three ways.
• Ordinary loss.
• Casualty loss.
• Nonbusiness bad debt (short-term capital loss).
For more information, see Deposit in Insolvent or Bankrupt Financial Institution, in chapter 4 of Pub. 550.
Sale of Annuity
The part of any gain on the sale of an annuity contract before its maturity date that is based on interest accumulated on the contract is ordinary income.
Losses on Section 1244 (Small Business) Stock
You can deduct as an ordinary loss, rather than as a capital loss, your loss on the sale, trade, or worthlessness of section 1244 stock. Report an ordinary loss from the sale, exchange, or worthlessness of 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, also report the transaction on Form 8949. See the instructions for Forms 4797 and 8949.
Any gain on section 1244 stock is a capital gain if the stock is a capital asset in your hands. Report the gain on Form 8949. See Losses on Section 1244 (Small Business) Stock in chapter 4 of Pub. 550.
TIP: For more information on Form 8949 and Schedule D (Form 1040), see Reporting Capital Gains and Losses in chapter 16. See also Schedule D (Form 1040), Form 8949, and their separate instructions.
Holding Period
If you sold or traded investment property, you must determine your holding period for the property. Your holding period determines whether any capital gain or loss was a short-term or long-term capital gain or loss.
Long-term or short-term. If you hold investment property more than 1 year, any capital gain or loss is a long-term capital gain or loss. If you hold the property 1 year or less, any capital gain or loss is a short-term capital gain or loss.
To determine how long you held the investment property, begin counting on the date after the day you acquired the property. The day you disposed of the property is part of your holding period.
Example. If you bought investment property on February 5, 2015, and sold it on February 5, 2016, your holding period isn't more than 1 year and you have a short-term capital gain or loss. If you sold it on February 6, 2016, your holding period is more than 1 year and you will have a long-term capital gain or loss.
Securities traded on established market. For securities traded on an established securities market, your holding period begins the day after the trade date you bought the securities, and ends on the trade date you sold them.
CAUTION: Don't confuse the trade date with the settlement date, which is the date by which the stock must be delivered and payment must be made.
Example. You are a cash method, calendar year taxpayer. You sold stock on December 30, 2016. According to the rules of the stock exchange, the sale was closed by delivery of the stock and payment of the sale price in January 2017. Report your gain or loss on your 2016 return, even though you received the payment in 2017. The gain or loss is long-term or short-term depending on whether you held the stock more than 1 year. Your holding period ended on December 30.
U.S. Treasury notes and bonds. The holding period of U.S. Treasury notes and bonds sold at auction on the basis of yield starts the day after the Secretary of the Treasury, through news releases, gives notification of acceptance to successful bidders. The holding period of U.S. Treasury notes and bonds sold through an offering on a subscription basis at a specified yield starts the day after the subscription is submitted.
Automatic investment service. In determining your holding period for shares bought by the bank or other agent, full shares are considered bought first and any fractional shares are considered bought last. Your holding period starts on the day after the bank's purchase date. If a share was bought over more than one purchase date, your holding period for that share is a split holding period. A part of the share is considered to have been bought on each date that stock was bought by the bank with the proceeds of available funds.
Nontaxable trades. If you acquire investment property in a trade for other investment property and your basis for the new property is determined, in whole or in part, by your basis in the old property, your holding period for the new property begins on the day following the date you acquired the old property.
Property received as a gift. If you receive a gift of property and your basis is determined by the donor's adjusted basis, your holding period is considered to have started on the same day the donor's holding period started.
If your basis is determined by the fair market value of the property, your holding period starts on the day after the date of the gift.
Inherited property. Generally, if you inherited investment property, your capital gain or loss on any later disposition of that property is long-term capital gain or loss. This is true regardless of how long you actually held the property.
Real property bought. To figure how long you have held real property bought under an unconditional contract, begin counting on the day after you received title to it or on the day after you took possession of it and assumed the burdens and privileges of ownership, whichever happened first. However, taking delivery or possession of real property under an option agreement isn't enough to start the holding period. The holding period can't start until there is an actual contract of sale. The holding period of the seller can't end before that time.
Real property repossessed. If you sell real property but keep a security interest in it, and then later repossess the property under the terms of the sales contract, your holding period for a later sale includes the period you held the property before the original sale and the period after the repossession. Your holding period doesn't include the time between the original sale and the repossession. That is, it doesn't include the period during which the first buyer held the property. However, the holding period for any improvements made by the first buyer begins at the time of repossession.
Stock dividends. The holding period for stock you received as a taxable stock dividend begins on the date of distribution.
The holding period for new stock you received as a nontaxable stock dividend begins on the same day as the holding period of the old stock. This rule also applies to stock acquired in a "spin-off," which is a distribution of stock or securities in a controlled corporation.
Nontaxable stock rights. Your holding period for nontaxable stock rights begins on the same day as the holding period of the underlying stock. The holding period for stock acquired through the exercise of stock rights begins on the date the right was exercised.
Nonbusiness Bad Debts
If someone owes you money that you can't collect, you have a bad debt. You may be able to deduct the amount owed to you when you figure your tax for the year the debt becomes worthless.
Generally, nonbusiness bad debts are bad debts that didn't come from operating your trade or business, and are deductible as short-term capital losses. To be deductible, nonbusiness bad debts must be totally worthless. You can't deduct a partly worthless nonbusiness debt.
Genuine debt required. A debt must be genuine for you to deduct a loss. A debt is genuine if it arises from a debtor-creditor relationship based on a valid and enforceable obligation to repay a fixed or determinable sum of money.
Basis in bad debt required. To deduct a bad debt, you must have a basis in it--that is, you must have already included the amount in your income or loaned out your cash. For example, you can't claim a bad debt deduction for court-ordered child support not paid to you by your former spouse. If you are a cash method taxpayer (as most individuals are), you generally can't take a bad debt deduction for unpaid salaries, wages, rents, fees, interest, dividends, and similar items.
When deductible. You can take a bad debt deduction only in the year the debt becomes worthless. You don't have to wait until a debt is due to determine whether it is worthless. A debt becomes worthless when there is no longer any chance that the amount owed will be paid.
It isn't necessary to go to court if you can show that a judgment from the court would be uncollectible. You must only show that you have taken reasonable steps to collect the debt. Bankruptcy of your debtor is generally good evidence of the worthlessness of at least a part of an unsecured and unpreferred debt.
How to report bad debts. Deduct nonbusiness bad debts as short-term capital losses on Form 8949.
CAUTION: Make sure you report your bad debt(s) (and any other short-term transactions for which you didn't receive a Form 1099-B) on Form 8949, Part I, with box C checked.
TIP: For more information on Form 8949 and Schedule D (Form 1040), see Reporting Capital Gains and Losses in chapter 16. See also Schedule D (Form 1040), Form 8949, and their separate instructions.
For each bad debt, attach a statement to your return that contains:
• A description of the debt, including the amount, and the date it became due,
• The name of the debtor, and any business or family relationship between you and the debtor,
• The efforts you made to collect the debt, and
• Why you decided the debt was worthless. For example, you could show that the borrower has declared bankruptcy, or that legal action to collect would probably not result in payment of any part of the debt.
Filing a claim for refund. If you don't deduct a bad debt on your original return for the year it becomes worthless, you can file a claim for a credit or refund due to the bad debt. To do this, use Form 1040X to amend your return for the year the debt became worthless. You must file it within 7 years from the date your original return for that year had to be filed, or 2 years from the date you paid the tax, whichever is later. For more information about filing a claim, see Amended Returns and Claims for Refund in chapter 1.
Additional information. For more information, see Nonbusiness Bad Debts in Pub. 550. For information on business bad debts, see chapter 10 of Pub. 535.
Wash Sales
You can't deduct losses from sales or trades of stock or securities in a wash sale.
A wash sale occurs when you sell or trade stock or securities at a loss and within 30 days before or after the sale you:
1. Buy substantially identical stock or securities,
2. Acquire substantially identical stock or securities in a fully taxable trade,
3. Acquire a contract or option to buy substantially identical stock or securities, or
4. Acquire substantially identical stock for your individual retirement account (IRA) or Roth IRA.
If your loss was disallowed because of the wash sale rules, add the disallowed loss to the cost of the new stock or securities (except in (4) above). The result is your basis in the new stock or securities. This adjustment postpones the loss deduction until the disposition of the new stock or securities. Your holding period for the new stock or securities includes the holding period of the stock or securities sold.
For more information, see Wash Sales, in chapter 4 of Pub. 550.
Rollover of Gain From Publicly Traded Securities
You may qualify for a tax-free rollover of certain gains from the sale of publicly traded securities. This means that if you buy certain replacement property and make the choice described in this section, you postpone part or all of your gain.
You postpone the gain by adjusting the basis of the replacement property as described in Basis of replacement property, later. This postpones your gain until the year you dispose of the replacement property.
You qualify to make this choice if you meet all the following tests.
• You sell publicly traded securities at a gain. Publicly traded securities are securities traded on an established securities market.
• Your gain from the sale is a capital gain.
• During the 60-day period beginning on the date of the sale, you buy replacement property. This replacement property must be either common stock of, or a partnership interest in a specialized small business investment company (SSBIC). This is any partnership or corporation licensed by the Small Business Administration under section 301(d) of the Small Business Investment Act of 1958, as in effect on May 13, 1993.
Amount of gain recognized. If you make the choice described in this section, you must recognize gain only up to the following amount.
• The amount realized on the sale, minus
• The cost of any common stock or partnership interest in an SSBIC that you bought during the 60-day period beginning on the date of sale (and didn't previously take into account on an earlier sale of publicly traded securities).
If this amount is less than the amount of your gain, you can postpone the rest of your gain, subject to the limit described next. If this amount is equal to or more than the amount of your gain, you must recognize the full amount of your gain.
Limit on gain postponed. The amount of gain you can postpone each year is limited to the smaller of:
• $50,000 ($25,000 if you are married and file a separate return), or
• $500,000 ($250,000 if you are married and file a separate return), minus the amount of gain you postponed for all earlier years.
Basis of replacement property. You must subtract the amount of postponed gain from the basis of your replacement property.
How to report and postpone gain. See How to report and postpone gain under Rollover of Gain From Publicly Traded Securities in chapter 4 of Pub. 550 for details.
15. Selling Your Home
Reminder
Home sold with undeducted points. If you haven't deducted all the points you paid to secure a mortgage on your old home, you may be able to deduct the remaining points in the year of the sale. See Mortgage ending early under Points in chapter 23.
Introduction
This chapter explains the tax rules that apply when you sell your main home. In most cases, your main home is the one in which you live most of the time.
If you sold your main home in 2016, you may be able to exclude from income any gain up to a limit of $250,000 ($500,000 on a joint return in most cases). See Excluding the Gain, later. Generally, if you can exclude all the gain, you don't need to report the sale on your tax return.
If you have gain that can't be excluded, it's taxable. Report it on Form 8949, Sales and Other Dispositions of Capital Assets, and Schedule D (Form 1040). You may also have to complete Form 4797, Sales of Business Property. See Reporting the Sale, later.
If you have a loss on the sale, you generally cannot deduct it on your return. However, you may need to report it. See Reporting the Sale, later.
The following are main topics in this chapter.
• Figuring gain or loss.
• Basis.
• Excluding the gain.
• Ownership and use tests.
• Reporting the sale.
Other topics include the following.
• Business use or rental of home.
• Recapturing a federal mortgage subsidy.
Useful Items
You may want to see:
Publication
• Publication 523 Selling Your Home
• Publication 530 Tax Information for Homeowners
• Publication 547 Casualties, Disasters, and Thefts
Form (and Instructions)
• Schedule D (Form 1040) Capital Gains and Losses
• Form 982 Reduction of Tax Attributes Due to Discharge of Indebtedness
• Form 8828 Recapture of Federal Mortgage Subsidy
• Form 8949 Sales and Other Dispositions of Capital Assets
Main Home
This section explains the term "main home." Usually, the home you live in most of the time is your main home and can be a:
• House,
• Houseboat,
• Mobile home,
• Cooperative apartment, or
• Condominium.
To exclude gain under the rules of this chapter, you in most cases must have owned and lived in the property as your main home for at least 2 years during the 5-year period ending on the date of sale.
Land. If you sell the land on which your main home is located, but not the house itself, you cannot exclude any gain you have from the sale of the land. However, if you sell vacant land used as part of your main home and that is adjacent to it, you may be able to exclude the gain from the sale under certain circumstances. See Pub. 523 for more information.
Example. You buy a piece of land and move your main home to it. Then you sell the land on which your main home was located. This sale is not considered a sale of your main home, and you cannot exclude any gain on the sale of the land.
More than one home. If you have more than one home, you can exclude gain only from the sale of your main home. You must include in income gain from the sale of any other home. If you have two homes and live in both of them, your main home is ordinarily the one you live in most of the time during the year.
Example 1. You own two homes, one in New York and one in Florida. From 2012 through 2016, you live in the New York home for 7 months and in the Florida residence for 5 months of each year. In the absence of facts and circumstances indicating otherwise, the New York home is your main home. You would be eligible to exclude the gain from the sale of the New York home but not of the Florida home in 2016.
Example 2. You own a house, but you live in another house that you rent. The rented house is your main home.
Example 3. You own two homes, one in Virginia and one in New Hampshire. In 2012 and 2013, you lived in the Virginia home. In 2014 and 2015, you lived in the New Hampshire home. In 2016, you lived again in the Virginia home. Your main home in 2012, 2013, and 2016 is the Virginia home. Your main home in 2014 and 2015 is the New Hampshire home. You would be eligible to exclude gain from the sale of either home (but not both) in 2016.
Property used partly as your main home. If you use only part of the property as your main home, the rules discussed in this publication apply only to the gain or loss on the sale of that part of the property. For details, see Business Use or Rental of Home, later.
Figuring Gain or Loss
To figure the gain or loss on the sale of your main home, you must know the selling price, the amount realized, and the adjusted basis. Subtract the adjusted basis from the amount realized to get your gain or loss.
Selling price
- Selling expenses
---------------------
Amount realized
Amount realized
- Adjusted basis
---------------------
Gain or loss
Selling Price
The selling price is the total amount you receive for your home. It includes money and the fair market value of any other property or any other services you receive and all notes, mortgages, or other debts assumed by the buyer as part of the sale.
Payment by employer. You may have to sell your home because of a job transfer. If your employer pays you for a loss on the sale or for your selling expenses, do not include the payment as part of the selling price. Your employer will include it as wages in box 1 of your Form W-2, and you will include it in your income on Form 1040, line 7.
Option to buy. If you grant an option to buy your home and the option is exercised, add the amount you receive for the option to the selling price of your home. If the option is not exercised, you must report the amount as ordinary income in the year the option expires. Report this amount on Form 1040, line 21.
Form 1099-S. If you received Form 1099-S, Proceeds From Real Estate Transactions, box 2 (Gross proceeds) should show the total amount you received for your home.
However, box 2 will not include the fair market value of any services or property other than cash or notes you received or will receive. Instead, box 4 will be checked to indicate your receipt or expected receipt of these items.
Amount Realized
The amount realized is the selling price minus selling expenses.
Selling expenses. Selling expenses include:
• Commissions,
• Advertising fees,
• Legal fees, and
• Loan charges paid by the seller, such as loan placement fees or "points."
Adjusted Basis
While you owned your home, you may have made adjustments (increases or decreases) to the basis. This adjusted basis must be determined before you can figure gain or loss on the sale of your home. For information on how to figure your home's adjusted basis, see Determining Basis, later.
Amount of Gain or Loss
To figure the amount of gain or loss, compare the amount realized to the adjusted basis.
Gain on sale. If the amount realized is more than the adjusted basis, the difference is a gain and, except for any part you can exclude, in most cases is taxable.
Loss on sale. If the amount realized is less than the adjusted basis, the difference is a loss. A loss on the sale of your main home cannot be deducted.
Jointly owned home. If you and your spouse sell your jointly owned home and file a joint return, you figure your gain or loss as one taxpayer.
Separate returns. If you file separate returns, each of you must figure your own gain or loss according to your ownership interest in the home. Your ownership interest is generally determined by state law.
Joint owners not married. If you and a joint owner other than your spouse sell your jointly owned home, each of you must figure your own gain or loss according to your ownership interest in the home. Each of you applies the rules discussed in this chapter on an individual basis.
Dispositions Other Than Sales
Some special rules apply to other dispositions of your main home.
Foreclosure or repossession. If your home was foreclosed on or repossessed, you have a disposition. See Pub. 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments, to determine if you have ordinary income, gain, or loss.
Abandonment. If you abandon your home, see Pub. 4681 to determine if you have ordinary income, gain, or loss.
Trading (exchanging) homes. If you trade your old home for another home, treat the trade as a sale and a purchase.
Example. You owned and lived in a home with an adjusted basis of $41,000. A real estate dealer accepted your old home as a trade-in and allowed you $50,000 toward a new home priced at $80,000. This is treated as a sale of your old home for $50,000 with a gain of $9,000 ($50,000 - $41,000).
If the dealer had allowed you $27,000 and assumed your unpaid mortgage of $23,000 on your old home, your sales price would still be $50,000 (the $27,000 trade-in allowed plus the $23,000 mortgage assumed).
Transfer to spouse. If you transfer your home to your spouse or you transfer it to your former spouse incident to your divorce, you in most cases have no gain or loss. This is true even if you receive cash or other consideration for the home. As a result, the rules in this chapter do not apply.
More information. If you need more information, see Pub. 523 and Property Settlements in Pub. 504, Divorced or Separated Individuals.
Involuntary conversion. You have a disposition when your home is destroyed or condemned and you receive other property or money in payment, such as insurance or a condemnation award. This is treated as a sale and you may be able to exclude all or part of any gain from the destruction or condemnation of your home, as explained later under Special Situations.
Determining Basis
You need to know your basis in your home to figure any gain or loss when you sell it. Your basis in your home is determined by how you got the home. Generally, your basis is its cost if you bought it or built it. If you got it in some other way (inheritance, gift, etc.), your basis is generally either its fair market value when you received it or the adjusted basis of the previous owner.
While you owned your home, you may have made adjustments (increases or decreases) to your home's basis. The result of these adjustments is your home's adjusted basis, which is used to figure gain or loss on the sale of your home. See Adjusted Basis, later.
You can find more information on basis and adjusted basis in chapter 13 of this publication and in Pub. 523.
Cost As Basis
The cost of property is the amount you paid for it in cash, debt obligations, other property, or services.
Purchase. If you bought your home, your basis is its cost to you. This includes the purchase price and certain settlement or closing costs. In most cases, your purchase price includes your down payment and any debt, such as a first or second mortgage or notes you gave the seller in payment for the home. If you build, or contract to build, a new home, your purchase price can include costs of construction, as discussed in Pub. 523.
Settlement fees or closing costs. When you bought your home, you may have paid settlement fees or closing costs in addition to the contract price of the property. You can include in your basis some of the settlement fees and closing costs you paid for buying the home, but not the fees and costs for getting a mortgage loan. A fee paid for buying the home is any fee you would have had to pay even if you paid cash for the home (that is, without the need for financing).
Chapter 13 lists some of the settlement fees and closing costs that you can include in the basis of property, including your home. It also lists some settlement costs that cannot be included in basis.
Also see Pub. 523 for additional items and a discussion of basis other than cost.
Adjusted Basis
Adjusted basis is your cost or other basis increased or decreased by certain amounts. To figure your adjusted basis, see Pub. 523.
CAUTION: If you are selling a home in which you acquired an interest from a decedent who died in 2010, see Pub. 4895, Tax Treatment of Property Acquired From a Decedent Dying in 2010, to determine your basis.
Increases to basis. These include the following.
• Additions and other improvements that have a useful life of more than 1 year.
• Special assessments for local improvements.
• Amounts you spent after a casualty to restore damaged property.
Improvements. These add to the value of your home, prolong its useful life, or adapt it to new uses. You add the cost of additions and other improvements to the basis of your property.
For example, putting a recreation room or another bathroom in your unfinished basement, putting up a new fence, putting in new plumbing or wiring, putting on a new roof, or paving your unpaved driveway are improvements. An addition to your house, such as a new deck, a sun room, or a new garage, is also an improvement.
Repairs. These maintain your home in good condition but don't add to its value or prolong its life. You don't add their cost to the basis of your property.
Examples of repairs include repainting your house inside or outside, fixing your gutters or floors, repairing leaks or plastering, and replacing broken window panes.
Decreases to basis. These include the following.
• Discharge of qualified principal residence indebtedness that was excluded from income. See Discharges of qualified principal residence indebtedness, later.
• Some or all of the cancellation of debt income that was excluded due to your bankruptcy or insolvency. For details, see Pub. 4681.
• Gain you postponed from the sale of a previous home before May 7, 1997.
• Deductible casualty losses.
• Insurance payments you received or expect to receive for casualty losses.
• Payments you received for granting an easement or right-of-way.
• Depreciation allowed or allowable if you used your home for business or rental purposes.
• Energy-related credits allowed for expenditures made on the residence. (Reduce the increase in basis otherwise allowable for expenditures on the residence by the amount of credit allowed for those expenditures.)
• Adoption credit you claimed for improvements added to the basis of your home.
• Nontaxable payments from an adoption assistance program of your employer you used for improvements you added to the basis of your home.
• Energy conservation subsidy excluded from your gross income because you received it (directly or indirectly) from a public utility after 1992 to buy or install any energy conservation measure. An energy conservation measure is an installation or modification primarily designed either to reduce consumption of electricity or natural gas or to improve the management of energy demand for a home.
• District of Columbia first-time homebuyer credit (allowed on the purchase of a principal residence in the District of Columbia beginning on August 5, 1997 and before January 1, 2012).
• General sales taxes (beginning in 2004) claimed as an itemized deduction on Schedule A (Form 1040) that were imposed on the purchase of personal property, such as a houseboat used as your home or a mobile home.
Discharges of qualified principal residence indebtedness. You may be able to exclude from gross income a discharge of qualified principal residence indebtedness. This exclusion applies to discharges made after 2006 and before 2017. If you choose to exclude this income, you must reduce (but not below zero) the basis of the principal residence by the amount excluded from your gross income.
RECORDS: Recordkeeping. You should keep records to prove your home's adjusted basis. Ordinarily, you must keep records for 3 years after the due date for filing your return for the tax year in which you sold your home. But if you sold a home before May 7, 1997, and postponed tax on any gain, the basis of that home affects the basis of the new home you bought. Keep records proving the basis of both homes as long as they are needed for tax purposes.
The records you should keep include:
• Proof of the home's purchase price and purchase expenses;
• Receipts and other records for all improvements, additions, and other items that affect the home's adjusted basis;
• Any worksheets or other computations you used to figure the adjusted basis of the home you sold, the gain or loss on the sale; the exclusion, and the taxable gain;
• Any Form 982 you filed to report any discharge of qualified principal residence indebtedness;
• Any Form 2119, Sale of Your Home, you filed to postpone gain from the sale of a previous home before May 7, 1997; and
• Any worksheets you used to prepare Form 2119, such as the Adjusted Basis of Home Sold Worksheet or the Capital Improvements Worksheet from the Form 2119 instructions, or other source of computations.
Excluding the Gain
You may qualify to exclude from your income all or part of any gain from the sale of your main home. This means that, if you qualify, you will not have to pay tax on the gain up to the limit described under Maximum Exclusion, next. To qualify, you must meet the ownership and use tests described later.
You can choose not to take the exclusion by including the gain from the sale in your gross income on your tax return for the year of the sale.
See Pub. 523 to figure the amount of your exclusion and your taxable gain, if any.
CAUTION: If you have any taxable gain from the sale of your home, you may have to increase your withholding or make estimated tax payments. See Pub. 505, Tax Withholding and Estimated Tax.
Maximum Exclusion
You can exclude up to $250,000 of the gain (other than gain allocated to periods of nonqualified use) on the sale of your main home if all of the following are true.
• You meet the ownership test.
• You meet the use test.
• During the 2-year period ending on the date of the sale, you did not exclude gain from the sale of another home.
For details on gain allocated to periods of nonqualified use, see Periods of nonqualified use, later.
You may be able to exclude up to $500,000 of the gain (other than gain allocated to periods of nonqualified use) on the sale of your main home if you are married and file a joint return and meet the requirements listed in the discussion of the special rules for joint returns, later, under Married Persons.
Ownership and Use Tests
To claim the exclusion, you must meet the ownership and use tests. This means that during the 5-year period ending on the date of the sale, you must have:
• Owned the home for at least 2 years (the ownership test), and
• Lived in the home as your main home for at least 2 years (the use test).
Exception. If you owned and lived in the property as your main home for less than 2 years, you can still claim an exclusion in some cases. However, the maximum amount you may be able to exclude will be reduced. See Reduced Maximum Exclusion, later.
Example 1--home owned and occupied for at least 2 years. Mya bought and moved into her main home in September 2014. She sold the home at a gain in October 2016. During the 5-year period ending on the date of sale in October 2016, she owned and lived in the home for more than 2 years. She meets the ownership and use tests.
Example 2--ownership test met but use test not met. Ayden bought a home, lived in it for 6 months, moved out, and never occupied the home again. He later sold the home for a gain. He owned the home during the entire 5-year period ending on the date of sale. He meets the ownership test but not the use test. He cannot exclude any part of his gain on the sale unless he qualified for a reduced maximum exclusion (explained later).
Period of Ownership and Use
The required 2 years of ownership and use during the 5-year period ending on the date of the sale do not have to be continuous nor do they both have to occur at the same time.
You meet the tests if you can show that you owned and lived in the property as your main home for either 24 full months or 730 days (365 × 2) during the 5-year period ending on the date of sale.
Temporary absence. Short temporary absences for vacations or other seasonal absences, even if you rent out the property during the absences, are counted as periods of use. The following examples assume that the reduced maximum exclusion (discussed later) doesn't apply to the sales.
Example 1. David Johnson, who is single, bought and moved into his home on February 1, 2014. Each year during 2014 and 2015, David left his home for a 2-month summer vacation. David sold the house on March 1, 2016. Although the total time David used his home is less than 2 years (21 months), he meets the requirement and may exclude gain. The 2-month vacations are short temporary absences and are counted as periods of use in determining whether David used the home for the required 2 years.
Example 2. Professor Paul Beard, who is single, bought and moved into a house on August 19, 2013. He lived in it as his main home continuously until January 5, 2015, when he went abroad for a 1-year sabbatical leave. On February 5, 2016, 1 month after returning from the leave, Paul sold the house at a gain. Because his leave was not a short temporary absence, he cannot include the period of leave to meet the 2-year use test. He cannot exclude any part of his gain, because he didn't use the residence for the required 2 years.
Ownership and use tests met at different times. You can meet the ownership and use tests during different 2-year periods. However, you must meet both tests during the 5-year period ending on the date of the sale.
Example. Beginning in 2005, Helen Jones lived in a rented apartment. The apartment building was later converted to condominiums, and she bought her same apartment on December 2, 2013. In 2014, Helen became ill and on April 14 of that year she moved to her daughter's home. On July 7, 2016, while still living in her daughter's home, she sold her condominium.
Helen can exclude gain on the sale of her condominium because she met the ownership and use tests during the 5-year period from July 8, 2011, to July 7, 2016, the date she sold the condominium. She owned her condominium from December 2, 2013, to July 7, 2016 (more than 2 years). She lived in the property from July 8, 2011 (the beginning of the 5-year period), to April 14, 2014 (more than 2 years).
The time Helen lived in her daughter's home during the 5-year period can be counted toward her period of ownership, and the time she lived in her rented apartment during the 5-year period can be counted toward her period of use.
Cooperative apartment. If you sold stock as a tenant-stockholder in a cooperative housing corporation, the ownership and use tests are met if, during the 5-year period ending on the date of sale, you:
• Owned the stock for at least 2 years, and
• Lived in the house or apartment that the stock entitles you to occupy as your main home for at least 2 years.
Exceptions to Ownership and Use Tests
The following sections contain exceptions to the ownership and use tests for certain taxpayers.
Exception for individuals with a disability. There is an exception to the use test if:
• You become physically or mentally unable to care for yourself, and
• You owned and lived in your home as your main home for a total of at least 1 year during the 5-year period before the sale of your home.
Under this exception, you are considered to live in your home during any time within the 5-year period that you own the home and live in a facility (including a nursing home) licensed by a state or political subdivision to care for persons in your condition.
If you meet this exception to the use test, you still have to meet the 2-out-of-5-year ownership test to claim the exclusion.
Previous home destroyed or condemned. For the ownership and use tests, you add the time you owned and lived in a previous home that was destroyed or condemned to the time you owned and lived in the replacement home on whose sale you wish to exclude gain. This rule applies if any part of the basis of the home you sold depended on the basis of the destroyed or condemned home. Otherwise, you must have owned and lived in the same home for 2 of the 5 years before the sale to qualify for the exclusion.
Members of the uniformed services or Foreign Service, employees of the intelligence community, or employees or volunteers of the Peace Corps. You can choose to have the 5-year test period for ownership and use suspended during any period you or your spouse serve on "qualified official extended duty" as a member of the uniformed services or Foreign Service of the United States, or as an employee of the intelligence community. You can choose to have the 5-year test period for ownership and use suspended during any period you or your spouse serve outside the United States either as an employee of the Peace Corps on "qualified official extended duty" or as an enrolled volunteer or volunteer leader of the Peace Corps. This means that you may be able to meet the 2-year use test even if, because of your service, you did not actually live in your home for at least the required 2 years during the 5-year period ending on the date of sale.
If this helps you qualify to exclude gain, you can choose to have the 5-year test period suspended by filing a return for the year of sale that doesn't include the gain.
For more information about the suspension of the 5-year test period, see Service, Intelligence, and Peace Corps Personnel in Pub. 523.
Married Persons
If you and your spouse file a joint return for the year of sale and one spouse meets the ownership and use tests, you can exclude up to $250,000 of the gain. (But see Special rules for joint returns, next.)
Special rules for joint returns. You can exclude up to $500,000 of the gain on the sale of your main home if all of the following are true.
• You are married and file a joint return for the year.
• Either you or your spouse meets the ownership test.
• Both you and your spouse meet the use test.
• During the 2-year period ending on the date of the sale, neither you nor your spouse excluded gain from the sale of another home.
If either spouse doesn't satisfy all these requirements, the maximum exclusion that can be claimed by the couple is the total of the maximum exclusions that each spouse would qualify for if not married and the amounts were figured separately. For this purpose, each spouse is treated as owning the property during the period that either spouse owned the property.
Example 1--one spouse sells a home. Emily sells her home in June 2016 for a gain of $300,000. She marries Jamie later in the year. She meets the ownership and use tests, but Jamie does not. Emily can exclude up to $250,000 of gain on a separate or joint return for 2016. The $500,000 maximum exclusion for certain joint returns doesn't apply because Jamie does not meet the use test.
Example 2--each spouse sells a home. The facts are the same as in Example 1 except that Jamie also sells a home in 2016 for a gain of $200,000 before he marries Emily. He meets the ownership and use tests on his home, but Emily does not. Emily can exclude $250,000 of gain and Jamie can exclude $200,000 of gain on the respective sales of their individual homes. However, Emily cannot use Jamie's unused exclusion to exclude more than $250,000 of gain. Therefore, Emily and Jamie must recognize $50,000 of gain on the sale of Emily's home. The $500,000 maximum exclusion for certain joint returns doesn't apply because Emily and Jamie do not both meet the use test for the same home.
Sale of main home by surviving spouse. If your spouse died and you did not remarry before the date of sale, you are considered to have owned and lived in the property as your main home during any period of time when your spouse owned and lived in it as a main home.
If you meet all of the following requirements, you may qualify to exclude up to $500,000 of any gain from the sale or exchange of your main home.
• The sale or exchange took place after 2008.
• The sale or exchange took place no more than 2 years after the date of death of your spouse.
• You haven't remarried.
• You and your spouse met the use test at the time of your spouse's death.
• You or your spouse met the ownership test at the time of your spouse's death.
• Neither you nor your spouse excluded gain from the sale of another home during the last 2 years.
Example. Harry owned and used a house as his main home since 2012. Harry and Wilma married on July 1, 2016, and from that date they use Harry's house as their main home. Harry died on August 15, 2016, and Wilma inherited the property. Wilma sold the property on September 2, 2016, at which time she had not remarried. Although Wilma owned and used the house for less than 2 years, Wilma is considered to have satisfied the ownership and use tests because her period of ownership and use includes the period that Harry owned and used the property before death.
Home transferred from spouse. If your home was transferred to you by your spouse (or former spouse if the transfer was incident to divorce), you are considered to have owned it during any period of time when your spouse owned it.
Use of home after divorce. You are considered to have used property as your main home during any period when:
• You owned it, and
• Your spouse or former spouse is allowed to live in it under a divorce or separation instrument and uses it as his or her main home.
Reduced Maximum Exclusion
If you fail to meet the requirements to qualify for the $250,000 or $500,000 exclusion, you may still qualify for a reduced exclusion. This applies to those who:
• Fail to meet the ownership and use tests, or
• Have used the exclusion within 2 years of selling their current home.
In both cases, to qualify for a reduced exclusion, the sale of your main home must be due to one of the following reasons.
• A change in place of employment.
• Health.
• Unforeseen circumstances.
Unforeseen circumstances. The sale of your main home is because of an unforeseen circumstance if your primary reason for the sale is the occurrence of an event that you could not reasonably have anticipated before buying and occupying your main home.
See Pub. 523 for more information.
Business Use or Rental of Home
You may be able to exclude gain from the sale of a home you have used for business or to produce rental income. But you must meet the ownership and use tests.
Periods of nonqualified use. In most cases, gain from the sale or exchange of your main home will not qualify for the exclusion to the extent that the gains are allocated to periods of nonqualified use. Nonqualified use is any period after 2008 during which neither you nor your spouse (or your former spouse) used the property as a main home with the following exceptions.
Exceptions. A period of nonqualified use doesn't include:
1. Any portion of the 5-year period ending on the date of the sale or exchange after the last date you (or your spouse) use the property as a main home;
2. Any period (not to exceed an aggregate period of 10 years) during which you (or your spouse) are serving on qualified official extended duty:
a. As a member of the uniformed services;
b. As a member of the Foreign Service of the United States; or
c. As an employee of the intelligence community; and
3. Any other period of temporary absence (not to exceed an aggregate period of 2 years) due to change of employment, health conditions, or such other unforeseen circumstances as may be specified by the IRS.
The gain resulting from the sale of the property is allocated between qualified and nonqualified use periods based on the amount of time the property was held for qualified and nonqualified use. Gain from the sale or exchange of a main home allocable to periods of qualified use will continue to qualify for the exclusion for the sale of your main home. Gain from the sale or exchange of property allocable to nonqualified use will not qualify for the exclusion.
Calculation. To figure the portion of the gain allocated to the period of nonqualified use, multiply the gain by the following fraction.
Total nonqualified use during the
period of ownership after 2008
---------------------------------------
Total period of ownership
Example 1. On May 24, 2010, Amy, who is unmarried for all years in this example, bought a house. She moved in on that date and lived in it until May 31, 2012, when she moved out of the house and put it up for rent. The house was rented from June 1, 2012, to March 31, 2014. Amy claimed depreciation deductions in 2012 through 2014 totaling $10,000. Amy moved back into the house on April 1, 2014, and lived there until she sold it on January 28, 2016, for a gain of $200,000. During the 5-year period ending on the date of the sale (January 29, 2011-January 28, 2016), Amy owned and lived in the house for more than 2 years as shown in the following table.
Five Year Used as Used as
Period Home Rental
1/29/11 -
5/31/12 16 months
6/1/12 -
3/31/14 22 months
4/1/14 -
1/28/16 21 months
--------- ---------
37 months 22 months
Next, Amy must figure how much of her gain is allocated to nonqualified use and how much is allocated to qualified use. During the period Amy owned the house (2,076 days), her period of nonqualified use was 669 days. Amy divides 669 by 2,076 and obtains a decimal (rounded to at least three decimal places) of 0.322. To figure her gain attributable to the period of nonqualified use, she multiplies $190,000 (the gain not attributable to the $10,000 depreciation deduction) by 0.322. Because the gain attributable to periods of nonqualified use is $61,180, Amy can exclude $128,820 of her gain.
See the worksheet for Taxable Gain on Sale of Home--Completed Example 1 for Amy, later, for how to figure Amy's taxable gain and exclusion.
Worksheet. Taxable Gain on Sale of Home--Completed Example 1 for Amy
----------------------------------------------------------------------
Part 1. Gain or (Loss) on Sale
1. Selling price of home 1. _______
2. Selling expenses (including commissions, advertising
and legal fees, and seller-paid loan charges) 2. _______
3. Subtract line 2 from line 1. This is the amount
realized 3. _______
4. Adjusted basis of home sold. See Pub. 523 4. _______
5. Gain or (loss) on the sale. Subtract line 4 from
line 3. If this is a loss, stop here 5. 200,000
Part 2. Exclusion and Taxable Gain
6. Enter any depreciation allowed or allowable on the
property for periods after May 6, 1997. If none,
enter -0- 6. 10,000
7. Subtract line 6 from line 5. If the result is less
than zero, enter -0- 7. 190,000
8. Aggregate number of days of nonqualified use after
2008. If none, enter -0-. If line 8 is equal to zero,
skip to line 12 and enter the amount from line 7 on
line 12 8. 669
9. Number of days taxpayer owned the property 9. 2,076
10. Divide the amount on line 8 by the amount on line 9.
Enter the result as a decimal (rounded to at least 3
places). Do not enter an amount greater than 1.000 10. 0.322
11. Gain allocated to nonqualified use. (Line 7
multiplied by line 10) 11. 61,180
12. Gain eligible for exclusion. Subtract line 11 from
line 7 12. 128,820
13. If you qualify to exclude gain on the sale, enter
your maximum exclusion.
If you qualify for a reduced maximum exclusion, enter
your reduced maximum exclusion.
If you do not qualify to exclude gain, enter -0-.
See Pub. 523 13. 250,000
14. Exclusion. Enter the smaller of line 12 or line 13 14. 128,820
15. Taxable gain. Subtract line 14 from line 5.
If the amount on line 6 is more than zero, complete
line 16 15. 71,180
16. Enter the smaller of line 6 or line 15. Enter this
amount on line 12 of the Unrecaptured Section 1250
Gain Worksheet in the instructions for
Schedule D (Form 1040) 16. 10,000
----------------------------------------------------------------------
Example 2. William owned and used a house as his main home from 2010 through 2013. On January 1, 2014, he moved to another state. He rented his house from that date until April 29, 2016, when he sold it. During the 5-year period ending on the date of sale (April 30, 2011-April 29, 2016), William owned and lived in the house for more than 2 years. He must report the sale on Form 4797 because it was rental property at the time of sale. Because the period of nonqualified use does not include any part of the 5-year period after the last date William lived in the house, he has no period of nonqualified use. Because he met the ownership and use tests, he can exclude gain up to $250,000. However, he can't exclude the part of the gain equal to the depreciation he claimed or could have claimed for renting the house, as explained next.
Depreciation after May 6, 1997. If you were entitled to take depreciation deductions because you used your home for business purposes or as rental property, you can't exclude the part of your gain equal to any depreciation allowed or allowable as a deduction for periods after May 6, 1997. If you can show by adequate records or other evidence that the depreciation allowed was less than the amount allowable, then you may limit the amount of gain recognized to the depreciation allowed. See Pub. 544 for more information.
Property used partly for business or rental. If you used property partly as a home and partly for business or to produce rental income, see Pub. 523.
Reporting the Sale
Do not report the 2016 sale of your main home on your tax return unless:
• You have a gain and don't qualify to exclude all of it,
• You have a gain and choose not to exclude it, or
• You received Form 1099-S.
If any of these conditions apply, report the entire gain or loss. For details on how to report the gain or loss, see the Instructions for Schedule D (Form 1040) and the Instructions for Form 8949.
If you used the home for business or to produce rental income, you may have to use Form 4797 to report the sale of the business or rental part (or the sale of the entire property if used entirely for business or rental). See Pub. 523 and the Instructions for Form 4797 for additional information.
Installment sale. Some sales are made under arrangements that provide for part or all of the selling price to be paid in a later year. These sales are called "installment sales." If you finance the buyer's purchase of your home yourself instead of having the buyer get a loan or mortgage from a bank, you probably have an installment sale. You may be able to report the part of the gain you cannot exclude on the installment basis.
Use Form 6252, Installment Sale Income, to report the sale. Enter your exclusion on line 15 of Form 6252.
Seller-financed mortgage. If you sell your home and hold a note, mortgage, or other financial agreement, the payments you receive in most cases consist of both interest and principal. You must separately report as interest income the interest you receive as part of each payment. If the buyer of your home uses the property as a main or second home, you must also report the name, address, and social security number (SSN) of the buyer on line 1 of Schedule B (Form 1040A or 1040). The buyer must give you his or her SSN, and you must give the buyer your SSN. Failure to meet these requirements may result in a $50 penalty for each failure. If either you or the buyer does not have and is not eligible to get an SSN, see Social Security Number (SSN) in chapter 1.
More information. For more information on installment sales, see Pub. 537, Installment Sales.
Special Situations
The situations that follow may affect your exclusion.
Sale of home acquired in a like-kind exchange. You can't claim the exclusion if:
• You acquired your home in a like-kind exchange (also known as a section 1031 exchange), or your basis in your home is determined by reference to the basis of the home in the hands of the person who acquired the property in a like-kind exchange (for example, you received the home from that person as a gift), and
• You sold the home during the 5-year period beginning with the date your home was acquired in the like-kind exchange.
Gain from a like-kind exchange is not taxable at the time of the exchange. This means that gain will not be taxed until you sell or otherwise dispose of the property you receive. To defer gain from a like-kind exchange, you must have exchanged business or investment property for business or investment property of a like kind. For more information about like-kind exchanges, see Pub. 544, Sales and Other Dispositions of Assets.
Home relinquished in a like-kind exchange. If you use your main home partly for business or rental purposes and then exchange the home for another property, see Pub. 523.
Expatriates. You can't claim the exclusion if the expatriation tax applies to you. The expatriation tax applies to certain U.S. citizens who have renounced their citizenship (and to certain long-term residents who have ended their residency). For more information about the expatriation tax, see Expatriation Tax in chapter 4 of Pub. 519, U.S. Tax Guide for Aliens.
Home destroyed or condemned. If your home was destroyed or condemned, any gain (for example, because of insurance proceeds you received) qualifies for the exclusion.
Any part of the gain that cannot be excluded (because it's more than the maximum exclusion) can be postponed under the rules explained in:
• Pub. 547, in the case of a home that was destroyed; or
• Pub. 544, chapter 1, in the case of a home that was condemned.
Sale of remainder interest. Subject to the other rules in this chapter, you can choose to exclude gain from the sale of a remainder interest in your home. If you make this choice, you can't choose to exclude gain from your sale of any other interest in the home that you sell separately.
Exception for sales to related persons. You can't exclude gain from the sale of a remainder interest in your home to a related person. Related persons include your brothers, sisters, half-brothers, half-sisters, spouse, ancestors (parents, grandparents, etc.), and lineal descendants (children, grandchildren, etc.). Related persons also include certain corporations, partnerships, trusts, and exempt organizations.
Recapturing (Paying Back) a Federal Mortgage Subsidy
If you financed your home under a federally subsidized program (loans from tax-exempt qualified mortgage bonds or loans with mortgage credit certificates), you may have to recapture all or part of the benefit you received from that program when you sell or otherwise dispose of your home. You recapture the benefit by increasing your federal income tax for the year of the sale. You may have to pay this recapture tax even if you can exclude your gain from income under the rules discussed earlier; that exclusion doesn't affect the recapture tax.
Loans subject to recapture rules. The recapture applies to loans that:
1. Came from the proceeds of qualified mortgage bonds, or
2. Were based on mortgage credit certificates.
The recapture also applies to assumptions of these loans.
When recapture applies. Recapture of the federal mortgage subsidy applies only if you meet both of the following conditions.
• You sell or otherwise dispose of your home at a gain within the first 9 years after the date you close your mortgage loan.
• Your income for the year of disposition is more than that year's adjusted qualifying income for your family size for that year (related to the income requirements a person must meet to qualify for the federally subsidized program).
When recapture does not apply. Recapture does not apply in any of the following situations.
• Your mortgage loan was a qualified home improvement loan (QHIL) of not more than $15,000 used for alterations, repairs, and improvements that protect or improve the basic livability or energy efficiency of your home.
• Your mortgage loan was a QHIL of not more than $150,000 in the case of a QHIL used to repair damage from Hurricane Katrina to homes in the hurricane disaster area; a QHIL funded by a qualified mortgage bond that is a qualified Gulf Opportunity Zone Bond; or a QHIL for an owner-occupied home in the Gulf Opportunity Zone (GO Zone), Rita GO Zone, or Wilma GO Zone. For more information, see Pub. 4492, Information for Taxpayers Affected by Hurricanes Katrina, Rita, and Wilma. Also see Pub. 4492-B, Information for Affected Taxpayers in the Midwestern Disaster Areas.
• The home is disposed of as a result of your death.
• You dispose of the home more than 9 years after the date you closed your mortgage loan.
• You transfer the home to your spouse, or to your former spouse incident to a divorce, where no gain is included in your income.
• You dispose of the home at a loss.
• Your home is destroyed by a casualty, and you replace it on its original site within 2 years after the end of the tax year when the destruction happened. The replacement period is extended for main homes destroyed in a federally declared disaster area, a Midwestern disaster area, the Kansas disaster area, and the Hurricane Katrina disaster area. For more information, see Replacement Period in Pub. 547.
• You refinance your mortgage loan (unless you later meet the conditions listed previously under When recapture applies).
Notice of amounts. At or near the time of settlement of your mortgage loan, you should receive a notice that provides the federally subsidized amount and other information you will need to figure your recapture tax.
How to figure and report the recapture. The recapture tax is figured on Form 8828. If you sell your home and your mortgage is subject to recapture rules, you must file Form 8828 even if you don't owe a recapture tax. Attach Form 8828 to your Form 1040. For more information, see Form 8828 and its instructions.
16. Reporting Gains and Losses
Introduction
This chapter discusses how to report capital gains and losses from sales, exchanges, and other dispositions of investment property on Form 8949 and Schedule D (Form 1040). The discussion includes the following topics.
• How to report short-term gains and losses.
• How to report long-term gains and losses.
• How to figure capital loss carryovers.
• How to figure your tax on a net capital gain.
If you sell or otherwise dispose of property used in a trade or business or for the production of income, see Pub. 544, Sales and Other Dispositions of Assets, before completing Schedule D (Form 1040).
Useful Items
You may want to see:
Publication
• Publication 537 Installment Sales
• Publication 544 Sales and Other Dispositions of Assets
• Publication 550 Investment Income and Expenses
Form (and Instructions)
• Schedule D (Form 1040) Capital Gains and Losses
• Form 4797 Sales of Business Property
• Form 6252 Installment Sale Income
• Form 8582 Passive Activity Loss Limitations
• Form 8949 Sales and Other Dispositions of Capital Assets
Reporting Capital Gains and Losses
Generally, report capital gains and losses on Form 8949. Complete Form 8949 before you complete line 1b, 2, 3, 8b, 9, or 10 of Schedule D (Form 1040).
Use Form 8949 to report:
• The sale or exchange of a capital asset not reported on another form or schedule,
• Gains from involuntary conversions (other than from casualty or theft) of capital assets not held for business or profit, and
• Nonbusiness bad debts, and
• Worthlessness of a security.
Use Schedule D (Form 1040) to report:
• Overall gain or loss from transactions reported on Form 8949;
• Certain transactions you do not have to report on Form 8949;
• Gain from 6252 or Part I of Form 4797;
• Gain or loss from 6781, or 8824;
• Gain or loss from a partnership, S corporation, estate, or trust;
• Capital gain distributions not reported directly on your Form 1040; and
• Capital loss carryover from the previous year to the current year.
On Form 8949, enter all sales and exchanges of capital assets, including stocks, bonds, etc., and real estate (if not reported on 8824, or line 1a or 8a of Schedule D (Form 1040)). Include these transactions even if you did not receive a Form 1099-B or 1099-S for the transaction. Report short-term gains or losses in Part I. Report long-term gains or losses in Part II. Use as many Forms 8949 as you need.
Exceptions to filing Form 8949 and Schedule D (Form 1040). There are certain situations where you may not have to file Form 8949 and/or Schedule D (Form 1040).
Exception 1. You do not have to file Form 8949 or Schedule D (Form 1040) if you have no capital losses and your only capital gains are capital gain distributions from Form(s) 1099-DIV, box 2a. If any Form(s) 1099-DIV you receive have an amount in box 2b (unrecaptured section 1250 gain), box 2c (section 1202 gain), or box 2d (collectibles (28%) gain), you do not qualify for this exception.
If you qualify for this exception, report your capital gain distributions directly on line 13 of Form 1040 (and check the box on line 13). Also use the Qualified Dividends and Capital Gain Tax Worksheet in the Form 1040 instructions to figure your tax. You can report your capital gain distributions on line 10 of Form 1040A, instead of on Form 1040, if you do not have to file Form 1040.
Exception 2. You must file Schedule D (Form 1040), but generally do not have to file Form 8949, if Exception 1 does not apply and your only capital gains and losses are:
• Capital gain distributions;
• A capital loss carryover;
• A gain from 6252 or Part I of Form 4797;
• A gain or loss from 6781, or 8824;
• A gain or loss from a partnership, S corporation, estate, or trust; or
• Gains and losses from transactions for which you received a Form 1099-B that shows the basis was reported to the IRS and for which you do not need to make any adjustments in column (g) of Form 8949 or enter any codes in column (f) of Form 8949.
Installment sales. You cannot use the installment method to report a gain from the sale of stock or securities traded on an established securities market. You must report the entire gain in the year of sale (the year in which the trade date occurs).
Passive activity gains and losses. If you have gains or losses from a passive activity, you may also have to report them on Form 8582. In some cases, the loss may be limited under the passive activity rules. Refer to Form 8582 and its instructions for more information about reporting capital gains and losses from a passive activity.
Form 1099-B transactions. If you sold property, such as stocks, bonds, or certain commodities, through a broker, you should receive Form 1099-B from the broker. Use the Form 1099-B to complete Form 8949 and/or Schedule D (Form 1040).
If you received a Form 1099-B for a transaction, you usually report the transaction on Form 8949. Report the proceeds shown in box 1d of Form 1099-B in column (d) of either Part I or Part II of Form 8949, whichever applies. Include in column (g) any selling expenses or option premiums not reflected in Form 1099-B, box 1d or box 1e. If you include a selling expense in column (g), enter "E" in column (f). Enter the basis shown in box 1e in column (e). If the basis shown on Form 1099-B is not correct, see How To Complete Form 8949, Columns (f) and (g) in the Instructions for Form 8949 for the adjustment you must make. If no basis is shown on Form 1099-B, enter the correct basis of the property in column (e). See the instructions for Form 1099-B, Form 8949, and Schedule D (Form 1040) for more information.
Form 1099-CAP transactions. If a corporation in which you own stock has had a change in control or a substantial change in capital structure, you should receive Form 1099-CAP from the corporation. Use the Form 1099-CAP to fill in Form 8949. If your computations show that you would have a loss because of the change, do not enter any amounts on Form 8949 or Schedule D (Form 1040). You cannot claim a loss on Schedule D (Form 1040) as a result of this transaction.
Report the aggregate amount received shown in box 2 of Form 1099-CAP as the sales price in column (d) of either Part I or Part II of Form 8949, whichever applies.
Form 1099-S transactions. If you sold or traded land (including air rights), a building or similar structure, a condominium unit, or co-op stock, you may receive a Form 1099-S, Proceeds From Real Estate Transactions, showing your proceeds and other important information.
See the Instructions for Form 8949 and the Instructions for Schedule D (Form 1040) for how to report these transactions and include them in Part I or Part II of Form 8949 as appropriate. However, report like-kind exchanges on Form 8824 instead.
See Form 1099-S and the Instructions for Form 1099-S for more information.
Nominees. If you receive gross proceeds as a nominee (that is, the gross proceeds are in your name but actually belong to someone else), see the Instructions for Form 8949 for how to report these amounts on Form 8949.
File Form 1099-B or Form 1099-S with the IRS. If you received gross proceeds as a nominee in 2016, you must file a Form 1099-B or Form 1099-S for those proceeds with the IRS. Send the Form 1099-B or Form 1099-S with a Form 1096, Annual Summary and Transmittal of U.S. Information Returns, to your Internal Revenue Service Center by February 28, 2017 (March 31, 2017, if you file Form 1099-B or Form 1099-S electronically). Give the actual owner of the proceeds Copy B of the Form 1099-B or Form 1099-S by February 15, 2017. On Form 1099-B, you should be listed as the "Payer." The actual owner should be listed as the "Recipient." On Form 1099-S, you should be listed as the "Filer." The actual owner should be listed as the "Transferor." You do not have to file a Form 1099-B or Form 1099-S to show proceeds for your spouse. For more information about the reporting requirements and the penalties for failure to file (or furnish) certain information returns, see the General Instructions for Certain Information Returns. If you are filing electronically, see Pub. 1220.
Sale of property bought at various times. If you sell a block of stock or other property that you bought at various times, report the short-term gain or loss from the sale on one row in Part I of Form 8949, and the long-term gain or loss on one row in Part II of Form 8949. Write "Various" in column (b) for the "Date acquired."
Sale expenses. On Form 8949, include in column (g) any expense of sale, such as broker's fees, commissions, state and local transfer taxes, and option premiums, unless you reported the net sales price in column (d). If you include an expense of sale in column (g), enter "E" in column (f).
For information about adjustments to basis, see chapter 13.
Short-term gains and losses. Capital gain or loss on the sale or trade of investment property held 1 year or less is a short-term capital gain or loss. You report it in Part I of Form 8949.
You combine your share of short-term capital gain or loss from partnerships, S corporations, estates, and trusts, and any short-term capital loss carryover, with your other short-term capital gains and losses to figure your net short-term capital gain or loss on line 7 of Schedule D (Form 1040).
Long-term gains and losses. A capital gain or loss on the sale or trade of investment property held more than 1 year is a long-term capital gain or loss. You report it in Part II of Form 8949.
You report the following in Part II of Schedule D (Form 1040).
• Undistributed long-term capital gains from a mutual fund (or other regulated investment company) or real estate investment trust (REIT).
• Your share of long-term capital gains or losses from partnerships, S corporations, estates, and trusts.
• All capital gain distributions from mutual funds and REITs not reported directly on line 10 of Form 1040.
• Long-term capital loss carryovers.
The result after combining these items with your other long-term capital gains and losses is your net long-term capital gain or loss (Schedule D (Form 1040), line 15).
Total net gain or loss. To figure your total net gain or loss, combine your net short-term capital gain or loss (Schedule D (Form 1040), line 7) with your net long-term capital gain or loss (Schedule D (Form 1040), line 15). Enter the result on Schedule D (Form 1040), Part III, line 16. If your losses are more than your gains, see Capital Losses next. If both lines 15 and 16 of your Schedule D (Form 1040) are gains and your taxable income on your Form 1040 is more than zero, see Capital Gain Tax Rates, later.
Capital Losses
If your capital losses are more than your capital gains, you can claim a capital loss deduction. Report the amount of the deduction on line 13 of Form 1040, in parentheses.
Limit on deduction. Your allowable capital loss deduction, figured on Schedule D (Form 1040), is the lesser of:
• $3,000 ($1,500 if you are married and file a separate return), or
• Your total net loss as shown on line 16 of Schedule D (Form 1040).
You can use your total net loss to reduce your income dollar for dollar, up to the $3,000 limit.
Capital loss carryover. If you have a total net loss on line 16 of Schedule D (Form 1040) that is more than the yearly limit on capital loss deductions, you can carry over the unused part to the next year and treat it as if you had incurred it in that next year. If part of the loss is still unused, you can carry it over to later years until it is completely used up.
When you figure the amount of any capital loss carryover to the next year, you must take the current year's allowable deduction into account, whether or not you claimed it and whether or not you filed a return for the current year.
When you carry over a loss, it remains long term or short term. A long-term capital loss you carry over to the next tax year will reduce that year's long-term capital gains before it reduces that year's short-term capital gains.
Figuring your carryover. The amount of your capital loss carryover is the amount of your total net loss that is more than the lesser of:
1. Your allowable capital loss deduction for the year, or
2. Your taxable income increased by your allowable capital loss deduction for the year and your deduction for personal exemptions.
If your deductions are more than your gross income for the tax year, use your negative taxable income in figuring the amount in item (2).
Complete the Capital Loss Carryover Worksheet in the Instructions for Schedule D or Pub. 550 to determine the part of your capital loss that you can carry over.
Example. Brian and Jackie sold securities in 2016. The sales resulted in a capital loss of $7,000. They had no other capital transactions. Their taxable income was $26,000. On their joint 2016 return, they can deduct $3,000. The unused part of the loss, $4,000 ($7,000 - $3,000), can be carried over to 2017.
If their capital loss had been $2,000, their capital loss deduction would have been $2,000. They would have no carryover.
Use short-term losses first. When you figure your capital loss carryover, use your short-term capital losses first, even if you incurred them after a long-term capital loss. If you have not reached the limit on the capital loss deduction after using the short-term capital losses, use the long-term capital losses until you reach the limit.
Decedent's capital loss. A capital loss sustained by a decedent during his or her last tax year (or carried over to that year from an earlier year) can be deducted only on the final income tax return filed for the decedent. The capital loss limits discussed earlier still apply in this situation. The decedent's estate cannot deduct any of the loss or carry it over to following years.
Joint and separate returns. If you and your spouse once filed separate returns and are now filing a joint return, combine your separate capital loss carryovers. However, if you and your spouse once filed a joint return and are now filing separate returns, any capital loss carryover from the joint return can be deducted only on the return of the spouse who actually had the loss.
Capital Gain Tax Rates
The tax rates that apply to a net capital gain are generally lower than the tax rates that apply to other income. These lower rates are called the maximum capital gain rates.
The term "net capital gain" means the amount by which your net long-term capital gain for the year is more than your net short-term capital loss.
For 2016, the maximum capital gain rates are 0%, 15%, 20%, 25%, and 28%. See Table 16-1 for details.
Table 16-1. What Is Your Maximum Capital Gain Rate?
----------------------------------------------------------------------
THEN your
maximum capital
IF your net capital gain is from . . . gain rate is . . .
----------------------------------------------------------------------
collectibles gain 28%
----------------------------------------------------------------------
eligible gain on qualified small business stock
minus the section 1202 exclusion 28%
----------------------------------------------------------------------
unrecaptured section 1250 gain 25%
----------------------------------------------------------------------
other gain1 and the regular tax rate that would
apply is 39.6% 20%
----------------------------------------------------------------------
other gain1 and the regular tax rate that would
apply is 25%, 28%, 33%, or 35% 15%
----------------------------------------------------------------------
other gain1 and the regular tax rate that would
apply is 10% or 15% 0%
----------------------------------------------------------------------
1 "Other gain" means any gain that is not collectibles gain, gain on
small business stock, or unrecaptured section 1250 gain.
======================================================================
TIP: If you figure your tax using the maximum capital gain rate and the regular tax computation results in a lower tax, the regular tax computation applies.
Example. All of your net capital gain is from selling collectibles, so the capital gain rate would be 28%. If you are otherwise subject to a rate lower than 28%, the 28% rate does not apply.
Investment interest deducted. If you claim a deduction for investment interest, you may have to reduce the amount of your net capital gain that is eligible for the capital gain tax rates. Reduce it by the amount of the net capital gain you choose to include in investment income when figuring the limit on your investment interest deduction. This is done on the Schedule D Tax Worksheet or the Qualified Dividends and Capital Gain Tax Worksheet. For more information about the limit on investment interest, see Interest Expenses in chapter 3 of Pub. 550.
Collectibles gain or loss. This is gain or loss from the sale or trade of a work of art, rug, antique, metal (such as gold, silver, and platinum bullion), gem, stamp, coin, or alcoholic beverage held more than 1 year.
Collectibles gain includes gain from sale of an interest in a partnership, S corporation, or trust due to unrealized appreciation of collectibles.
Gain on qualified small business stock. If you realized a gain from qualified small business stock that you held more than 5 years, you generally can exclude some or all of your gain under section 1202. The eligible gain minus your section 1202 exclusion is a 28% rate gain. See Gains on Qualified Small Business Stock in chapter 4 of Pub. 550.
Unrecaptured section 1250 gain. Generally, this is any part of your capital gain from selling section 1250 property (real property) that is due to depreciation (but not more than your net section 1231 gain), reduced by any net loss in the 28% group. Use the Unrecaptured Section 1250 Gain Worksheet in the Schedule D (Form 1040) instructions to figure your unrecaptured section 1250 gain. For more information about section 1250 property and section 1231 gain, see chapter 3 of Pub. 544.
Tax computation using maximum capital gain rates. Use the Qualified Dividends and Capital Gain Tax Worksheet or the Schedule D Tax Worksheet (whichever applies) to figure your tax if you have qualified dividends or net capital gain. You have net capital gain if Schedule D (Form 1040), lines 15 and 16, are both gains.
Schedule D Tax Worksheet. Use the Schedule D Tax Worksheet in the Schedule D (Form 1040) instructions to figure your tax if:
• You have to file Schedule D (Form 1040); and
• Schedule D (Form 1040), line 18 (28% rate gain) or line 19 (unrecaptured section 1250 gain), is more than zero.
Qualified Dividends and Capital Gain Tax Worksheet. If you do not have to use the Schedule D Tax Worksheet (as explained above) and any of the following apply, use the Qualified Dividends and Capital Gain Tax Worksheet in the instructions for Form 1040A (whichever you file) to figure your tax.
• You received qualified dividends. (See Qualified Dividends in chapter 8.)
• You do not have to file Schedule D (Form 1040) and you received capital gain distributions. (See Exceptions to filing Form 8949 and Schedule D (Form 1040), earlier.)
• Schedule D (Form 1040), lines 15 and 16, are both more than zero.
Alternative minimum tax. These capital gain rates are also used in figuring alternative minimum tax.
Part Four. Adjustments to Income
The three chapters in this part discuss some of the adjustments to income that you can deduct in figuring your adjusted gross income. These chapters cover:
• Contributions you make to traditional individual retirement arrangements (IRAs) -- chapter 17,
• Alimony you pay -- chapter 18, and
• Student loan interest you pay -- chapter 19.
Other adjustments to income are discussed elsewhere. See Table V.
Table V. Other Adjustments to Income
Use this table to find information about other adjustments to income
not covered in this part of the publication.
----------------------------------------------------------------------
IF you are looking for more
information about the deduction
for . . . THEN see . . .
----------------------------------------------------------------------
Certain business expenses of Chapter 26.
reservists, performing artists,
and fee-basis officials
----------------------------------------------------------------------
Contributions to a health savings Pub. 969, Health Savings Accounts
account and Other Tax-Favored Health Plans.
----------------------------------------------------------------------
Moving expenses Pub. 521, Moving Expenses.
----------------------------------------------------------------------
Part of your self-employment tax Chapter 22.
----------------------------------------------------------------------
Self-employed health insurance Chapter 21.
----------------------------------------------------------------------
Payments to self-employed SEP, Pub. 560, Retirement Plans for
SIMPLE, and qualified plans Small Business (SEP, SIMPLE, and
Qualified Plans).
----------------------------------------------------------------------
Penalty on the early withdrawal Chapter 7.
of savings
----------------------------------------------------------------------
Contributions to an Archer MSA Pub. 969.
----------------------------------------------------------------------
Reforestation amortization or Chapters 7 and 8 of Pub. 535,
expense Business Expenses.
----------------------------------------------------------------------
Contributions to Internal Revenue Pub. 525, Taxable and Nontaxable
Code section 501(c)(18)(D) Income.
pension plans
----------------------------------------------------------------------
Expenses from the rental of Chapter 12.
personal property
----------------------------------------------------------------------
Certain required repayments of Chapter 12.
supplemental unemployment
benefits (sub-pay)
----------------------------------------------------------------------
Foreign housing costs Chapter 4 of Pub. 54, Tax Guide for
U.S. Citizens and Resident Aliens
Abroad.
----------------------------------------------------------------------
Jury duty pay given to your Chapter 12.
employer
----------------------------------------------------------------------
Contributions by certain Pub. 517, Social Security and Other
chaplains to Internal Revenue Information for Members of the
Code section 403(b) plans Clergy and Religious Workers.
----------------------------------------------------------------------
Attorney fees and certain costs Pub. 525.
for actions involving certain
unlawful discrimination claims or
awards to whistleblowers
----------------------------------------------------------------------
Domestic production activities Form 8903, Domestic Production
deduction Activities Deduction.
----------------------------------------------------------------------
17. Individual Retirement Arrangements (IRAs)
What's New for 2016
Modified AGI limit for traditional IRA contributions increased. For 2016, if you were covered by a retirement plan at work, your deduction for contributions to a traditional IRA is reduced (phased out) if your modified AGI is:
• More than $98,000 but less than $118,000 for a married couple filing a joint return or a qualifying widow(er),
• More than $61,000 but less than $71,000 for a single individual or head of household, or
• Less than $10,000 for a married individual filing a separate return.
If you either live with your spouse or file a joint return, and your spouse is covered by a retirement plan at work, but you are not, your deduction is phased out if your modified AGI is more than $184,000 but less than $194,000. If your modified AGI is $194,000 or more, you cannot take a deduction for contributions to a traditional IRA. See How Much Can You Deduct, later.
Modified AGI limit for Roth IRA contributions increased. For 2016, your Roth IRA contribution limit is reduced (phased out) in the following situations.
• Your filing status is married filing jointly or qualifying widow(er) and your modified AGI is at least $184,000. You cannot make a Roth IRA contribution if your modified AGI is $194,000 or more.
• Your filing status is single, head of household, or married filing separately and you did not live with your spouse at any time in 2016 and your modified AGI is at least $117,000. You cannot make a Roth IRA contribution if your modified AGI is $132,000 or more.
• Your filing status is married filing separately, you lived with your spouse at any time during the year, and your modified AGI is more than -0-. You cannot make a Roth IRA contribution if your modified AGI is $10,000 or more.
See Can You Contribute to a Roth IRA, later.
Reminders
2017 limits. You can find information about the 2017 contribution and AGI limits in Pub. 590-A. Contributions to both traditional and Roth IRAs. For information on your combined contribution limit if you contribute to both traditional and Roth IRAs, see Roth IRAs and traditional IRAs under How Much Can Be Contributed? in Roth IRAs, later.
Statement of required minimum distribution. If a minimum distribution from your IRA is required, the trustee, custodian, or issuer that held the IRA at the end of the preceding year must either report the amount of the required minimum distribution to you, or offer to calculate it for you. The report or offer must include the date by which the amount must be distributed. The report is due January 31 of the year in which the minimum distribution is required. It can be provided with the year-end fair market value statement that you normally get each year. No report is required for IRAs of owners who have died.
Application of one-rollover-per-year limitation. You can make only one rollover from an IRA to another (or the same) IRA in any 1-year period regardless of the number of IRAs you own. However, you can continue to make unlimited trustee-to-trustee transfers between IRAs because this type of transfer is not considered a rollover. Furthermore, there is no limit on the number of rollovers from a traditional IRA to a Roth IRA (also known as conversions). For more information, see Application of one-rollover limitation, later.
IRA interest. Although interest earned from your IRA is generally not taxed in the year earned, it is not tax-exempt interest. Tax on your traditional IRA is generally deferred until you take a distribution. Do not report this interest on your tax return as tax-exempt interest.
Net Investment Income Tax. For purposes of the Net Investment Income Tax (NIIT), net investment income does not include distributions from a qualified retirement plan including IRAs (for example, 401(a), 403(a), 403(b), 408, 408A, or 457(b) plans). However, these distributions are taken into account when determining the modified adjusted gross income threshold. Distributions from a nonqualified retirement plan are included in net investment income. See Form 8960, Net Investment Income Tax -- Individuals, Estates, and Trusts, and its instructions for more information.
Form 8606. To designate contributions as nondeductible, you must file Form 8606, Nondeductible IRAs.
TIP: The term "50 or older" is used several times in this chapter. It refers to an IRA owner who is age 50 or older by the end of the tax year.
Introduction
An individual retirement arrangement (IRA) is a personal savings plan that gives you tax advantages for setting aside money for your retirement.
This chapter discusses the following topics.
• The rules for a traditional IRA (any IRA that is not a Roth or SIMPLE IRA).
• The Roth IRA, which features nondeductible contributions and tax-free distributions.
Simplified Employee Pensions (SEPs) and Savings Incentive Match Plans for Employees (SIMPLEs) are not discussed in this chapter. For more information on these plans and employees' SEP IRAs and SIMPLE IRAs that are part of these plans, see Pub. 560, Retirement Plans for Small Business.
For information about contributions, deductions, withdrawals, transfers, rollovers, and other transactions, see Pub. 590-B.
Useful Items
You may want to see:
Publication
• Publication 560 Retirement Plans for Small Business
• Publication 590-A Contributions to Individual Retirement Arrangements (IRAs)
• Publication 590-B Distributions from Individual Retirement Arrangements (IRAs)
Form (and Instructions)
• Form 5329 Additional Taxes on Qualified Plans (including IRAs) and Other Tax-Favored Accounts
• Form 8606 Nondeductible IRAs
Traditional IRAs
In this chapter, the original IRA (sometimes called an ordinary or regular IRA) is referred to as a "traditional IRA." A traditional IRA is any IRA that is not a Roth IRA or a SIMPLE IRA.Two advantages of a traditional IRA are:
• You may be able to deduct some or all of your contributions to it, depending on your circumstances, and
• Generally, amounts in your IRA, including earnings and gains, are not taxed until they are distributed.
Who Can Open a Traditional IRA?
You can open and make contributions to a traditional IRA if:
• You (or, if you file a joint return, your spouse) received taxable compensation during the year, and
• You were not age 70 1/2 by the end of the year.
What is compensation? Generally, compensation is what you earn from working. Compensation includes wages, salaries, tips, professional fees, bonuses, and other amounts you receive for providing personal services. The IRS treats as compensation any amount properly shown in box 1 (Wages, tips, other compensation) of Form W-2, Wage and Tax Statement, provided that this amount is reduced by any amount properly shown in box 11 (Nonqualified plans).
Scholarship and fellowship payments are compensation for this purpose only if shown in box 1 of Form W-2.
Compensation also includes commissions and taxable alimony and separate maintenance payments.
Self-employment income. If you are self-employed (a sole proprietor or a partner), compensation is the net earnings from your trade or business (provided your personal services are a material income-producing factor) reduced by the total of:
• The deduction for contributions made on your behalf to retirement plans, and
• The deductible part of your self-employment tax.
Compensation includes earnings from self-employment even if they are not subject to self-employment tax because of your religious beliefs.
Nontaxable combat pay. For IRA purposes, if you were a member of the U.S. Armed Forces, your compensation includes any nontaxable combat pay you receive.
What is not compensation? Compensation does not include any of the following items.
• Earnings and profits from property, such as rental income, interest income, and dividend income.
• Pension or annuity income.
• Deferred compensation received (compensation payments postponed from a past year).
• Income from a partnership for which you do not provide services that are a material income-producing factor.
• Conservation Reserve Program (CRP) payments reported on Schedule SE (Form 1040), line 1b.
• Any amounts (other than combat pay) you exclude from income, such as foreign earned income and housing costs.
When and How Can a Traditional IRA Be Opened?
You can open a traditional IRA at any time. However, the time for making contributions for any year is limited. See When Can Contributions Be Made, later.
You can open different kinds of IRAs with a variety of organizations. You can open an IRA at a bank or other financial institution or with a mutual fund or life insurance company. You can also open an IRA through your stockbroker. Any IRA must meet Internal Revenue Code requirements.
Kinds of traditional IRAs. Your traditional IRA can be an individual retirement account or annuity. It can be part of either a SEP or an employer or employee association trust account.
How Much Can Be Contributed?
There are limits and other rules that affect the amount that can be contributed to a traditional IRA. These limits and other rules are explained below.
Community property laws. Except as discussed later under Kay Bailey Hutchison Spousal IRA limit, each spouse figures his or her limit separately, using his or her own compensation. This is the rule even in states with community property laws.
Brokers' commissions. Brokers' commissions paid in connection with your traditional IRA are subject to the contribution limit.
Trustees' fees. Trustees' administrative fees are not subject to the contribution limit.
Qualified reservist repayments. If you are (or were) a member of a reserve component and you were ordered or called to active duty after September 11, 2001, you may be able to contribute (repay) to an IRA amounts equal to any qualified reservist distributions you received. You can make these repayment contributions even if they would cause your total contributions to the IRA to be more than the general limit on contributions. To be eligible to make these repayment contributions, you must have received a qualified reservist distribution from an IRA or from a section 401(k) or 403(b) plan or similar arrangement.
For more information, see Qualified reservist repayments under How Much Can Be Contributed? in chapter 1 of Pub. 590-A.
CAUTION: Contributions on your behalf to a traditional IRA reduce your limit for contributions to a Roth IRA. (See Roth IRAs, later.)
General limit. For 2016, the most that can be contributed to your traditional IRA generally is the smaller of the following amounts.
• $5,500 ($6,500 if you are 50 or older).
• Your taxable compensation (defined earlier) for the year.
This is the most that can be contributed regardless of whether the contributions are to one or more traditional IRAs or whether all or part of the contributions are nondeductible. (See Nondeductible Contributions, later.) Qualified reservist repayments do not affect this limit.
Example 1. Betty, who is 34 years old and single, earned $24,000 in 2016. Her IRA contributions for 2016 are limited to $5,500.
Example 2. John, an unmarried college student working part time, earned $3,500 in 2016. His IRA contributions for 2016 are limited to $3,500, the amount of his compensation.
Kay Bailey Hutchison Spousal IRA limit. For 2016, if you file a joint return and your taxable compensation is less than that of your spouse, the most that can be contributed for the year to your IRA is the smaller of the following amounts.
1. $5,500 ($6,500 if you are 50 or older).
2. The total compensation includible in the gross income of both you and your spouse for the year, reduced by the following two amounts.
a. Your spouse's IRA contribution for the year to a traditional IRA.
b. Any contribution for the year to a Roth IRA on behalf of your spouse.
When Can Contributions Be Made?
As soon as you open your traditional IRA, contributions can be made to it through your chosen sponsor (trustee or other administrator). Contributions must be in the form of money (cash, check, or money order). Property cannot be contributed.
Contributions must be made by due date. Contributions can be made to your traditional IRA for a year at any time during the year or by the due date for filing your return for that year, not including extensions.
Age 70 1/2 rule. Contributions cannot be made to your traditional IRA for the year in which you reach age 70 1/2 or for any later year.
You attain age 70 1/2 on the date that is 6 calendar months after the 70th anniversary of your birth. If you were born on or before June 30, 1946, you cannot contribute for 2016 or any later year.
Designating year for which contribution is made. If an amount is contributed to your traditional IRA between January 1 and April 18, you should tell the sponsor which year (the current year or the previous year) the contribution is for. If you do not tell the sponsor which year it is for, the sponsor can assume, and report to the IRS, that the contribution is for the current year (the year the sponsor received it).
Filing before a contribution is made. You can file your return claiming a traditional IRA contribution before the contribution is actually made. Generally, the contribution must be made by the due date of your return, not including extensions.
Contributions not required. You do not have to contribute to your traditional IRA for every tax year, even if you can.
How Much Can You Deduct?
Generally, you can deduct the lesser of:
• The contributions to your traditional IRA for the year, or
• The general limit (or the Kay Bailey Hutchison Spousal IRA limit, if it applies).
However, if you or your spouse was covered by an employer retirement plan, you may not be able to deduct this amount. See Limit If Covered by Employer Plan, later.
TIP: You may be able to claim a credit for contributions to your traditional IRA. For more information, see chapter 38.
Trustees' fees. Trustees' administrative fees that are billed separately and paid in connection with your traditional IRA are not deductible as IRA contributions. However, they may be deductible as a miscellaneous itemized deduction on Schedule A (Form 1040). See chapter 28.
Brokers' commissions. Brokers' commissions are part of your IRA contribution and, as such, are deductible subject to the limits.
Full deduction. If neither you nor your spouse was covered for any part of the year by an employer retirement plan, you can take a deduction for total contributions to one or more traditional IRAs of up to the lesser of:
• $5,500 ($6,500 if you are age 50 or older in 2016).
• 100% of your compensation.
This limit is reduced by any contributions made to a 501(c)(18) plan on your behalf.
Kay Bailey Hutchison Spousal IRA. In the case of a married couple with unequal compensation who file a joint return, the deduction for contributions to the traditional IRA of the spouse with less compensation is limited to the lesser of the following amounts.
1. $5,500 ($6,500 if the spouse with the lower compensation is age 50 or older in 2016).
2. The total compensation includible in the gross income of both spouses for the year reduced by the following three amounts.
a. The IRA deduction for the year of the spouse with the greater compensation.
b. Any designated nondeductible contribution for the year made on behalf of the spouse with the greater compensation.
c. Any contributions for the year to a Roth IRA on behalf of the spouse with the greater compensation.
Note. If you were divorced or legally separated (and did not remarry) before the end of the year, you cannot deduct any contributions to your spouse's IRA. After a divorce or legal separation, you can deduct only contributions to your own IRA. Your deductions are subject to the rules for single individuals.
Covered by an employer retirement plan. If you or your spouse was covered by an employer retirement plan at any time during the year for which contributions were made, your deduction may be further limited. This is discussed later under Limit If Covered by Employer Plan. Limits on the amount you can deduct do not affect the amount that can be contributed. See Nondeductible Contributions, later.
Are You Covered by an Employer Plan?
The Form W-2 you receive from your employer has a box used to indicate whether you were covered for the year. The "Retirement plan" box should be checked if you were covered.
Reservists and volunteer firefighters should also see Situations in Which You Are Not Covered by an Employer Plan, later.
If you are not certain whether you were covered by your employer's retirement plan, you should ask your employer.
Federal judges. For purposes of the IRA deduction, federal judges are covered by an employer retirement plan.
For Which Year(s) Are You Covered by an Employer Plan?
Special rules apply to determine the tax years for which you are covered by an employer plan. These rules differ depending on whether the plan is a defined contribution plan or a defined benefit plan.
Tax year. Your tax year is the annual accounting period you use to keep records and report income and expenses on your income tax return. For almost all people, the tax year is the calendar year.
Defined contribution plan. Generally, you are covered by a defined contribution plan for a tax year if amounts are contributed or allocated to your account for the plan year that ends with or within that tax year.
A defined contribution plan is a plan that provides for a separate account for each person covered by the plan. Types of defined contribution plans include profit-sharing plans, stock bonus plans, and money purchase pension plans.
Defined benefit plan. If you are eligible to participate in your employer's defined benefit plan for the plan year that ends within your tax year, you are covered by the plan. This rule applies even if you:
• Declined to participate in the plan,
• Did not make a required contribution, or
• Did not perform the minimum service required to accrue a benefit for the year.
A defined benefit plan is any plan that is not a defined contribution plan. Defined benefit plans include pension plans and annuity plans.
No vested interest. If you accrue a benefit for a plan year, you are covered by that plan even if you have no vested interest in (legal right to) the accrual.
Situations in Which You Are Not Covered by an Employer Plan
Unless you are covered under another employer plan, you are not covered by an employer plan if you are in one of the situations described below.
Social security or railroad retirement. Coverage under social security or railroad retirement is not coverage under an employer retirement plan.
Benefits from a previous employer's plan. If you receive retirement benefits from a previous employer's plan, you are not covered by that plan.
Reservists. If the only reason you participate in a plan is because you are a member of a reserve unit of the armed forces, you may not be covered by the plan. You are not covered by the plan if both of the following conditions are met.
1. The plan you participate in is established for its employees by:
a. The United States,
b. A state or political subdivision of a state, or
c. An instrumentality of either (a) or (b) above.
2. You did not serve more than 90 days on active duty during the year (not counting duty for training).
Volunteer firefighters. If the only reason you participate in a plan is because you are a volunteer firefighter, you may not be covered by the plan. You are not covered by the plan if both of the following conditions are met.
1. The plan you participate in is established for its employees by:
a. The United States,
b. A state or political subdivision of a state, or
c. An instrumentality of either (a) or (b) above.
2. Your accrued retirement benefits at the beginning of the year will not provide more than $1,800 per year at retirement.
Limit If Covered by Employer Plan
If either you or your spouse was covered by an employer retirement plan, you may be entitled to only a partial (reduced) deduction or no deduction at all, depending on your income and your filing status.
Your deduction begins to decrease (phase out) when your income rises above a certain amount and is eliminated altogether when it reaches a higher amount. These amounts vary depending on your filing status.
To determine if your deduction is subject to phaseout, you must determine your modified adjusted gross income (AGI) and your filing status. See Filing status and Modified adjusted gross income (AGI), later. Then use Table 17-1 or 17-2 to determine if the phaseout applies.
Social security recipients. Instead of using Table 17-1 or Table 17-2, use the worksheets in Appendix B of Pub. 590-A if, for the year, all of the following apply.
• You received social security benefits.
• You received taxable compensation.
• Contributions were made to your traditional IRA.
• You or your spouse was covered by an employer retirement plan.
Use those worksheets to figure your IRA deduction, your nondeductible contribution, and the taxable portion, if any, of your social security benefits.
Deduction phaseout. If you are covered by an employer retirement plan and you did not receive any social security retirement benefits, your IRA deduction may be reduced or eliminated depending on your filing status and modified AGI as shown in Table 17-1.
Table 17-1. Effect of Modified AGI1 on Deduction if You Are Covered by Retirement Plan at Work
If you are covered by a retirement plan at work, use this table to
determine if your modified AGI affects the amount of your deduction.
----------------------------------------------------------------------
IF your filing status AND your modified AGI THEN you can take
is . . . is . . . . . .
----------------------------------------------------------------------
single $61,000 or less a full deduction.
----------------------------------------------
or more than $61,000 a partial deduction.
but less than $71,000
----------------------------------------------
head of household $71,000 or more no deduction.
----------------------------------------------------------------------
married filing jointly $98,000 or less a full deduction.
----------------------------------------------
or more than $98,000 a partial deduction.
but less than $118,000
----------------------------------------------
qualifying widow(er) $118,000 or more no deduction.
----------------------------------------------------------------------
married filing less than $10,000 a partial deduction.
separately2 ----------------------------------------------
$10,000 or more no deduction.
----------------------------------------------------------------------
1 Modified AGI (adjusted gross income). See Modified adjusted gross
income (AGI).
2 If you did not live with your spouse at any time during the year,
your filing status is considered Single for this purpose (therefore,
your IRA deduction is determined under the "Single" column).
======================================================================
If your spouse is covered. If you are not covered by an employer retirement plan, but your spouse is, and you did not receive any social security benefits, your IRA deduction may be reduced or eliminated entirely depending on your filing status and modified AGI as shown in Table 17-2.
Table 17-2. Effect of Modified AGI1 on Deduction if You Are NOT Covered by Retirement Plan at Work
If you are not covered by a retirement plan at work, use this table to
determine if your modified AGI affects the amount of your deduction.
----------------------------------------------------------------------
IF your filing status AND your modified AGI THEN you can take
is . . . is . . . . . .
----------------------------------------------------------------------
single, any amount a full deduction.
head of household, or
qualifying widow(er)
----------------------------------------------------------------------
married filing jointly any amount a full deduction.
or separately with a
spouse who is not
covered by a plan at
work
----------------------------------------------------------------------
married filing jointly $184,000 or less a full deduction.
with a spouse who is --------------------------------------------
covered by a plan at more than $184,000 a partial deduction.
work but less than $194,000
--------------------------------------------
$194,000 or more no deduction.
----------------------------------------------------------------------
married filing less than $10,000 a partial deduction.
separately with a spouse --------------------------------------------
who is covered by a plan $10,000 or more no deduction.
at work2
----------------------------------------------------------------------
1 Modified AGI (adjusted gross income). See Modified adjusted gross
income (AGI).
2 You are entitled to the full deduction if you did not live with your
spouse at any time during the year.
======================================================================
Filing status. Your filing status depends primarily on your marital status. For this purpose, you need to know if your filing status is single or head of household, married filing jointly or qualifying widow(er), or married filing separately. If you need more information on filing status, see chapter 2.
Lived apart from spouse. If you did not live with your spouse at any time during the year and you file a separate return, your filing status, for this purpose, is single.
Modified adjusted gross income (AGI). How you figure your modified AGI depends on whether you are filing Form 1040A. If you made contributions to your IRA for 2016 and received a distribution from your IRA in 2016, see Pub. 590-A. You may be able to use Worksheet 17-1 to figure your modified AGI.
CAUTION: Do not assume that your modified AGI is the same as your compensation. Your modified AGI may include income in addition to your compensation (discussed earlier), such as interest, dividends, and income from IRA distributions.
Form 1040. If you file Form 1040, refigure the amount on the page 1 "adjusted gross income" line without taking into account any of the following amounts.
• IRA deduction.
• Student loan interest deduction.
• Tuition and fees deduction.
• Domestic production activities deduction.
• Foreign earned income exclusion.
• Foreign housing exclusion or deduction.
• Exclusion of qualified savings bond interest shown on Form 8815, Exclusion of Interest From Series EE and I U.S. Savings Bonds Issued After 1989.
• Exclusion of employer-provided adoption benefits shown on Form 8839, Qualified Adoption Expenses.
This is your modified AGI.
Form 1040A. If you file Form 1040A, refigure the amount on the page 1 "adjusted gross income" line without taking into account any of the following amounts.
• IRA deduction.
• Student loan interest deduction.
• Tuition and fees deduction.
• Exclusion of qualified savings bond interest shown on Form 8815.
This is your modified AGI.
Both contributions for 2016 and distributions in 2016. If all three of the following apply, any IRA distributions you received in 2016 may be partly tax free and partly taxable.
• You received distributions in 2016 from one or more traditional IRAs.
• You made contributions to a traditional IRA for 2016.
• Some of those contributions may be nondeductible contributions.
If this is your situation, you must figure the taxable part of the traditional IRA distribution before you can figure your modified AGI. To do this, you can use Worksheet 1-1, Figuring the Taxable Part of Your IRA Distribution, in Pub. 590-B.
If at least one of the above does not apply, figure your modified AGI using Worksheet 17-1, later.
How to figure your reduced IRA deduction. You can figure your reduced IRA deduction for either Form 1040A by using the worksheets in chapter 1 of Pub. 590-A. Also, the instructions for Form 1040 and Form 1040A include similar worksheets that you may be able to use instead.
Worksheet 17-1. Figuring Your Modified AGI
Keep for Your Records
Use this worksheet to figure your modified adjusted gross income for
traditional IRA purposes.
----------------------------------------------------------------------
1. Enter your adjusted gross income (AGI) from Form 1040,
line 38, or Form 1040A, line 22, figured without taking
into account the amount from Form 1040, line 32, or
Form 1040A, line 17 1. ______
2. Enter any student loan interest deduction from
Form 1040A, line 18 2. ______
3. Enter any tuition and fees deduction from Form 1040,
line 34, or Form 1040A, line 19 3. ______
4. Enter any domestic production activities deduction from
Form 1040, line 35 4. ______
5. Enter any foreign earned income and/or housing exclusion
from Form 2555-EZ, line 18 5. ______
6. Enter any foreign housing deduction from Form 2555,
line 50 6. ______
7. Enter any excludable savings bond interest from
Form 8815, line 14 7. ______
8. Enter any excluded employer-provided adoption benefits
from Form 8839, line 28 8. ______
9. Add lines 1 through 8. This is your Modified AGI for
traditional IRA purposes 9. ______
----------------------------------------------------------------------
Reporting Deductible Contributions
If you file Form 1040, enter your IRA deduction on line 32 of that form. If you file Form 1040A, enter your IRA deduction on line 17. You cannot deduct IRA contributions on Form 1040EZ.
Nondeductible Contributions
Although your deduction for IRA contributions may be reduced or eliminated, contributions can be made to your IRA up to the general limit or, if it applies, the Kay Bailey Hutchison Spousal IRA limit. The difference between your total permitted contributions and your IRA deduction, if any, is your nondeductible contribution.
Example. Mike is 30 years old and single. In 2016, he was covered by a retirement plan at work. His salary was $67,000. His modified AGI was $80,000. Mike made a $5,500 IRA contribution for 2016. Because he was covered by a retirement plan and his modified AGI was over $71,000, he cannot deduct his $5,500 IRA contribution. He must designate this contribution as a nondeductible contribution by reporting it on Form 8606, as explained next.
Form 8606. To designate contributions as nondeductible, you must file Form 8606.
You do not have to designate a contribution as nondeductible until you file your tax return. When you file, you can even designate otherwise deductible contributions as nondeductible.
You must file Form 8606 to report nondeductible contributions even if you do not have to file a tax return for the year.
CAUTION: A Form 8606 is not used for the year that you make a rollover from a qualified retirement plan to a traditional IRA and the rollover includes nontaxable amounts. In those situations, a Form 8606 is completed for the year you take a distribution from that IRA. See Form 8606 under Distributions Fully or Partly Taxable, later.
Failure to report nondeductible contributions. If you do not report nondeductible contributions, all of the contributions to your traditional IRA will be treated as deductible contributions when withdrawn. All distributions from your IRA will be taxed unless you can show, with satisfactory evidence, that nondeductible contributions were made.
Penalty for overstatement. If you overstate the amount of nondeductible contributions on your Form 8606 for any tax year, you must pay a penalty of $100 for each overstatement, unless it was due to reasonable cause.
Penalty for failure to file Form 8606. You will have to pay a $50 penalty if you do not file a required Form 8606, unless you can prove that the failure was due to reasonable cause.
Tax on earnings on nondeductible contributions. As long as contributions are within the contribution limits, none of the earnings or gains on contributions (deductible or nondeductible) will be taxed until they are distributed. See When Can You Withdraw or Use IRA Assets, later.
Cost basis. You will have a cost basis in your traditional IRA if you made any nondeductible contributions. Your cost basis is the sum of the nondeductible contributions to your IRA minus any withdrawals or distributions of nondeductible contributions.
Inherited IRAs
If you inherit a traditional IRA, you are called a beneficiary. A beneficiary can be any person or entity the owner chooses to receive the benefits of the IRA after he or she dies. Beneficiaries of a traditional IRA must include in their gross income any taxable distributions they receive.
Inherited from spouse. If you inherit a traditional IRA from your spouse, you generally have the following three choices. You can:
1. Treat it as your own IRA by designating yourself as the account owner.
2. Treat it as your own by rolling it over into your IRA, or to the extent it is taxable, into a:
a. Qualified employer plan,
b. Qualified employee annuity plan (section 403(a) plan),
c. Tax-sheltered annuity plan (section 403(b) plan), or
d. Deferred compensation plan of a state or local government (section 457 plan).
3. Treat yourself as the beneficiary rather than treating the IRA as your own.
Treating it as your own. You will be considered to have chosen to treat the IRA as your own if:
• Contributions (including rollover contributions) are made to the inherited IRA, or
• You do not take the required minimum distribution for a year as a beneficiary of the IRA.
You will only be considered to have chosen to treat the IRA as your own if:
• You are the sole beneficiary of the IRA, and
• You have an unlimited right to withdraw amounts from it.
However, if you receive a distribution from your deceased spouse's IRA, you can roll that distribution over into your own IRA within the 60-day time limit, as long as the distribution is not a required distribution, even if you are not the sole beneficiary of your deceased spouse's IRA.
Inherited from someone other than spouse. If you inherit a traditional IRA from anyone other than your deceased spouse, you cannot treat the inherited IRA as your own. This means that you cannot make any contributions to the IRA. It also means you cannot roll over any amounts into or out of the inherited IRA. However, you can make a trustee-to-trustee transfer as long as the IRA into which amounts are being moved is set up and maintained in the name of the deceased IRA owner for the benefit of you as beneficiary.
For more information, see the discussion of inherited IRAs under Rollover From One IRA Into Another, later.
Can You Move Retirement Plan Assets?
You can transfer, tax free, assets (money or property) from other retirement plans (including traditional IRAs) to a traditional IRA. You can make the following kinds of transfers.
• Transfers from one trustee to another.
• Rollovers.
• Transfers incident to a divorce.
Transfers to Roth IRAs. Under certain conditions, you can move assets from a traditional IRA or from a designated Roth account to a Roth IRA. You can also move assets from a qualified retirement plan to a Roth IRA. See Can You Move Amounts Into a Roth IRA? under Roth IRAs, later.
Trustee-to-Trustee Transfer
A transfer of funds in your traditional IRA from one trustee directly to another, either at your request or at the trustee's request, is not a rollover. This includes the situation where the current trustee issues a check to the new trustee but gives it to you to deposit. Because there is no distribution to you, the transfer is tax free. Because it is not a rollover, it is not affected by the 1-year waiting period required between rollovers, discussed later under Rollover From One IRA Into Another. For information about direct transfers to IRAs from retirement plans other than IRAs, see Can You Move Retirement Plan Assets? in chapter 1 and Can You Move Amounts Into a Roth IRA? in chapter 2 of Pub. 590-A.
Rollovers
Generally, a rollover is a tax-free distribution to you of cash or other assets from one retirement plan that you contribute (roll over) to another retirement plan. The contribution to the second retirement plan is called a "rollover contribution."
Note. An amount rolled over tax free from one retirement plan to another is generally includible in income when it is distributed from the second plan.
Kinds of rollovers to a traditional IRA. You can roll over amounts from the following plans into a traditional IRA:
• A traditional IRA,
• An employer's qualified retirement plan for its employees,
• A deferred compensation plan of a state or local government (section 457 plan), or
• A tax-sheltered annuity plan (section 403(b) plan).
Treatment of rollovers. You cannot deduct a rollover contribution, but you must report the rollover distribution on your tax return as discussed later under Reporting rollovers from IRAs and under Reporting rollovers from employer plans.
Kinds of rollovers from a traditional IRA. You may be able to roll over, tax free, a distribution from your traditional IRA into a qualified plan. These plans include the federal Thrift Savings Fund (for federal employees), deferred compensation plans of state or local governments (section 457 plans), and tax-sheltered annuity plans (section 403(b) plans). The part of the distribution that you can roll over is the part that would otherwise be taxable (includible in your income). Qualified plans may, but are not required to, accept such rollovers.
Time limit for making a rollover contribution. You generally must make the rollover contribution by the 60th day after the day you receive the distribution from your traditional IRA or your employer's plan.
The IRS may waive the 60-day requirement where the failure to do so would be against equity or good conscience, such as in the event of a casualty, disaster, or other event beyond your reasonable control. For more information, see Can You Move Retirement Plan Assets? in chapter 1 of Pub. 590-A.
Extension of rollover period. If an amount distributed to you from a traditional IRA or a qualified employer retirement plan is a frozen deposit at any time during the 60-day period allowed for a rollover, special rules extend the rollover period. For more information, see Can You Move Retirement Plan Assets? in chapter 1 of Pub. 590-A.
More information. For more information on rollovers, see Can You Move Retirement Plan Assets? in chapter 1 of Pub. 590-A.
Rollover From One IRA Into Another
You can withdraw, tax free, all or part of the assets from one traditional IRA if you reinvest them within 60 days in the same or another traditional IRA. Because this is a rollover, you cannot deduct the amount that you reinvest in an IRA.
Waiting period between rollovers. Generally, if you make a tax-free rollover of any part of a distribution from a traditional IRA, you cannot, within a 1-year period, make a tax-free rollover of any later distribution from that same IRA. You also cannot make a tax-free rollover of any amount distributed, within the same 1-year period, from the IRA into which you made the tax-free rollover.
The 1-year period begins on the date you receive the IRA distribution, not on the date you roll it over into an IRA. New rules apply to the number of rollovers you can have with your traditional IRAs. See Application of one-rollover limitation, below.
Application of one-rollover limitation. You can make only one rollover from an IRA to another (or the same) IRA in any 1-year period, regardless of the number of IRAs you own. The limit applies by aggregating all of an individual's IRAs, including SEP and SIMPLE IRAs, as well as traditional and Roth IRAs, effectively treating them as one IRA for purposes of the limit. However, trustee-to-trustee transfers between IRAs are not limited and rollovers from traditional IRAs to Roth IRAs (conversions) are not limited.
Example. John has three traditional IRAs, IRA-1, IRA-2, IRA-3. John did not take any distributions from his IRAs in 2016. On January 1, 2017, John took a distribution from IRA-1 and rolled it over into IRA-2 on the same day. For 2017, John cannot rollover any other 2017 IRA distribution, including a rollover distribution involving IRA-3. This would not apply to a trustee-to-trustee transfer or a Roth IRA conversion.
Partial rollovers. If you withdraw assets from a traditional IRA, you can roll over part of the withdrawal tax free and keep the rest of it. The amount you keep will generally be taxable (except for the part that is a return of nondeductible contributions). The amount you keep may be subject to the 10% additional tax on early distributions, discussed later under What Acts Result in Penalties or Additional Taxes?
Required distributions. Amounts that must be distributed during a particular year under the required distribution rules (discussed later) are not eligible for rollover treatment.
Inherited IRAs. If you inherit a traditional IRA from your spouse, you generally can roll it over, or you can choose to make the inherited IRA your own. See Treating it as your own, earlier.
Not inherited from spouse. If you inherit a traditional IRA from someone other than your spouse, you cannot roll it over or allow it to receive a rollover contribution. You must withdraw the IRA assets within a certain period. For more information, see When Must You Withdraw Assets? in chapter 1 of Pub. 590-B.
Reporting rollovers from IRAs. Report any rollover from one traditional IRA to the same or another traditional IRA on lines 15a and 15b, Form 1040A, as follows.
Enter the total amount of the distribution on Form 1040A, line 11a. If the total amount on Form 1040, line 15a, or Form 1040A, line 11a, was rolled over, enter zero on Form 1040, line 15b, or Form 1040A, line 11b. If the total distribution was not rolled over, enter the taxable portion of the part that was not rolled over on Form 1040, line 15b, or Form 1040A, line 11b. Put "Rollover" next to Form 1040, line 15b, or Form 1040A, line 11b. See your tax return instructions.
If you rolled over the distribution into a qualified plan (other than an IRA) or you make the rollover in 2017, attach a statement explaining what you did.
Rollover From Employer's Plan Into an IRA
You can roll over into a traditional IRA all or part of an eligible rollover distribution you receive from your (or your deceased spouse's):
• Employer's qualified pension, profit-sharing, or stock bonus plan;
• Annuity plan;
• Tax-sheltered annuity plan (section 403(b) plan); or
• Governmental deferred compensation plan (section 457 plan).
A qualified plan is one that meets the requirements of the Internal Revenue Code.
Eligible rollover distribution. Generally, an eligible rollover distribution is any distribution of all or part of the balance to your credit in a qualified retirement plan except the following.
1. A required minimum distribution (explained later under When Must You Withdraw IRA Assets? (Required Minimum Distributions)).
2. A hardship distribution.
3. Any of a series of substantially equal periodic distributions paid at least once a year over:
a. Your lifetime or life expectancy,
b. The lifetimes or life expectancies of you and your beneficiary, or
c. A period of 10 years or more.
4. Corrective distributions of excess contributions or excess deferrals, and any income allocable to the excess, or of excess annual additions and any allocable gains.
5. A loan treated as a distribution because it does not satisfy certain requirements either when made or later (such as upon default), unless the participant's accrued benefits are reduced (offset) to repay the loan.
6. Dividends on employer securities.
7. The cost of life insurance coverage.
TIP: Any nontaxable amounts that you roll over into your traditional IRA become part of your basis (cost) in your IRAs. To recover your basis when you take distributions from your IRA, you must complete Form 8606 for the year of the distribution. See Form 8606 under Distributions Fully or Partly Taxable, later.
Rollover by nonspouse beneficiary. A direct transfer from a deceased employee's qualified pension, profit-sharing, or stock bonus plan; annuity plan; tax-sheltered annuity (section 403(b)) plan; or governmental deferred compensation (section Transfers Incident to Divorce If an interest in a traditional IRA is transferred from your spouse or former spouse to you by a divorce or separate maintenance decree or a written document related to such a decree, the interest in the IRA, starting from the date of the transfer, is treated as your IRA. The transfer is tax free. For detailed information, see Can You Move Retirement Plan Assets? in chapter 1 of Pub. 590-A. Converting From Any Traditional IRA to a Roth IRA Allowable conversions. You can withdraw all or part of the assets from a traditional IRA and reinvest them (within 60 days) in a Roth IRA. The amount that you withdraw and timely contribute (convert) to the Roth IRA is called a conversion contribution. If properly (and timely) rolled over, the 10% additional tax on early distributions will not apply. However, a part or all of the conversion contribution from your traditional IRA is included in your gross income. Required distributions. You cannot convert amounts that must be distributed from your traditional IRA for a particular year (including the calendar year in which you reach age 70 1/2) under the required distribution rules (discussed later). Income. You must include in your gross income distributions from a traditional IRA that you would have had to include in income if you had not converted them into a Roth IRA. These amounts are normally included in income on your return for the year that you converted them from a traditional IRA to a Roth IRA. You do not include in gross income any part of a distribution from a traditional IRA that is a return of your basis, as discussed later. You must file Form 8606 to report 2016 conversions from traditional, SEP, or SIMPLE IRAs to a Roth IRA in 2016 (unless you recharacterized the entire amount) and to figure the amount to include in income. If you must include any amount in your gross income, you may have to increase your withholding or make estimated tax payments. See chapter 4. Recharacterizations You may be able to treat a contribution made to one type of IRA as having been made to a different type of IRA. This is called recharacterizing the contribution. See Can You Move Retirement Plan Assets? in chapter 1 of Pub. 590-A for more detailed information. How to recharacterize a contribution. To recharacterize a contribution, you generally must have the contribution transferred from the first IRA (the one to which it was made) to the second IRA in a trustee-to-trustee transfer. If the transfer is made by the due date (including extensions) for your tax return for the year during which the contribution was made, you can elect to treat the contribution as having been originally made to the second IRA instead of to the first IRA. If you recharacterize your contribution, you must do all three of the following. • Report the recharacterization on your tax return for the year during which the contribution was made. • Treat the contribution as having been made to the second IRA on the date that it was actually made to the first IRA. Required notifications. To recharacterize a contribution, you must notify both the trustee of the first IRA (the one to which the contribution was actually made) and the trustee of the second IRA (the one to which the contribution is being moved) that you have elected to treat the contribution as having been made to the second IRA rather than the first. You must make the notifications by the date of the transfer. Only one notification is required if both IRAs are maintained by the same trustee. The notification(s) must include all of the following information. • The date on which the contribution was made to the first IRA and the year for which it was made. • A direction to the trustee of the first IRA to transfer in a trustee-to-trustee transfer the amount of the contribution and any net income (or loss) allocable to the contribution to the trustee of the second IRA. • The name of the trustee of the first IRA and the name of the trustee of the second IRA. • Any additional information needed to make the transfer. When Can You Withdraw or Use IRA Assets? There are rules limiting use of your IRA assets and distributions from it. Violation of the rules generally results in additional taxes in the year of violation. See What Acts Result in Penalties or Additional Taxes, later. Contributions returned before the due date of return. If you made IRA contributions in 2016, you can withdraw them tax free by the due date of your return. If you have an extension of time to file your return, you can withdraw them tax free by the extended due date. You can do this if, for each contribution you withdraw, both of the following conditions apply. • You withdraw any interest or other income earned on the contribution. You can take into account any loss on the contribution while it was in the IRA when calculating the amount that must be withdrawn. If there was a loss, the net income earned on the contribution may be a negative amount.
Earnings includible in income. You must include in income any earnings on the contributions you withdraw. Include the earnings in income for the year in which you made the contributions, not in the year in which you withdraw them.
CAUTION: Generally, except for any part of a withdrawal that is a return of nondeductible contributions (basis), any withdrawal of your contributions after the due date (or extended due date) of your return will be treated as a taxable distribution. Excess contributions can also be recovered tax free as discussed under What Acts Result in Penalties or Additional Taxes?, later.
Early distributions tax. The 10% additional tax on distributions made before you reach age 59 1/2 does not apply to these tax-free withdrawals of your contributions. However, the distribution of interest or other income must be reported on Form 5329 and, unless the distribution qualifies as an exception to the age 59 1/2 rule, it will be subject to this tax.
When Must You Withdraw IRA Assets? (Required Minimum Distributions)
You cannot keep funds in a traditional IRA indefinitely. Eventually they must be distributed. If there are no distributions, or if the distributions are not large enough, you may have to pay a 50% excise tax on the amount not distributed as required. See Excess Accumulations (Insufficient Distributions), later. The requirements for distributing IRA funds differ depending on whether you are the IRA owner or the beneficiary of a decedent's IRA.
Required minimum distribution. The amount that must be distributed each year is referred to as the required minimum distribution.
Distributions not eligible for rollover. Amounts that must be distributed (required minimum distributions) during a particular year are not eligible for rollover treatment.
IRA owners. If you are the owner of a traditional IRA, you must generally start receiving distributions from your IRA by April 1 of the year following the year in which you reach age 70 1/2. April 1 of the year following the year in which you reach age 70 1/2 is referred to as the required beginning date.
Distributions by the required beginning date. You must receive at least a minimum amount for each year starting with the year you reach age 70 1/2 (your 70 1/2 year). If you do not (or did not) receive that minimum amount in your 70 1/2 year, then you must receive distributions for your 70 1/2 year by April 1 of the next year.
If an IRA owner dies after reaching age 70 1/2, but before April 1 of the next year, no minimum distribution is required because death occurred before the required beginning date.
CAUTION: Even if you begin receiving distributions before you attain age 70 1/2, you must begin calculating and receiving required minimum distributions by your required beginning date.
Distributions after the required beginning date. The required minimum distribution for any year after the year you turn 70 1/2 must be made by December 31 of that later year.
Beneficiaries. If you are the beneficiary of a decedent's traditional IRA, the requirements for distributions from that IRA generally depend on whether the IRA owner died before or after the required beginning date for distributions.
More information. For more information, including how to figure your minimum required distribution each year and how to figure your required distribution if you are a beneficiary of a decedent's IRA, see When Must You Withdraw Assets? in chapter 1 of Pub. 590-B.
Are Distributions Taxable?
In general, distributions from a traditional IRA are taxable in the year you receive them.
Exceptions. Exceptions to distributions from traditional IRAs being taxable in the year you receive them are:
• Rollovers,
• Qualified charitable distributions (QCD), discussed later,
• Tax-free withdrawals of contributions, discussed earlier, and
• The return of nondeductible contributions, discussed later under Distributions Fully or Partly Taxable.
CAUTION: Although a conversion of a traditional IRA is considered a rollover for Roth IRA purposes, it is not an exception to the rule that distributions from a traditional IRA are taxable in the year you receive them. Conversion distributions are includible in your gross income subject to this rule and the special rules for conversions explained in Converting From Any Traditional IRA Into a Roth IRA under Can You Move Retirement Plan Assets? in chapter 1 of Pub. 590-A.
Qualified charitable distributions (QCD). A qualified charitable distribution (QCD) is generally a nontaxable distribution made directly by the trustee of your IRA to an organization eligible to receive tax deductible contributions. See Qualified Charitable Distributions in Pub. 590-B for more information.
Ordinary income. Distributions from traditional IRAs that you include in income are taxed as ordinary income.
No special treatment. In figuring your tax, you cannot use the 10-year tax option or capital gain treatment that applies to lump-sum distributions from qualified retirement plans.
Distributions Fully or Partly Taxable
Distributions from your traditional IRA may be fully or partly taxable, depending on whether your IRA includes any nondeductible contributions.
Fully taxable. If only deductible contributions were made to your traditional IRA (or IRAs, if you have more than one), you have no basis in your IRA. Because you have no basis in your IRA, any distributions are fully taxable when received. See Reporting taxable distributions on your return, later.
Partly taxable. If you made nondeductible contributions or rolled over any after-tax amounts to any of your traditional IRAs, you have a cost basis (investment in the contract) equal to the amount of those contributions. These nondeductible contributions are not taxed when they are distributed to you. They are a return of your investment in your IRA.
Only the part of the distribution that represents nondeductible contributions and rolled over after-tax amounts (your cost basis) is tax free. If nondeductible contributions have been made or after-tax amounts have been rolled over to your IRA, distributions consist partly of nondeductible contributions (basis) and partly of deductible contributions, earnings, and gains (if there are any). Until all of your basis has been distributed, each distribution is partly nontaxable and partly taxable.
Form 8606. You must complete Form 8606 and attach it to your return if you receive a distribution from a traditional IRA and have ever made nondeductible contributions or rolled over after-tax amounts to any of your traditional IRAs. Using the form, you will figure the nontaxable distributions for 2016 and your total IRA basis for 2016 and earlier years.
Note. If you are required to file Form 8606, but you are not required to file an income tax return, you still must file Form 8606. Send it to the IRS at the time and place you would otherwise file an income tax return.
Distributions reported on Form 1099-R. If you receive a distribution from your traditional IRA, you will receive Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., or a similar statement. IRA distributions are shown in boxes 1 and 2a of Form 1099-R. The number or letter codes in box 7 tell you what type of distribution you received from your IRA.
Withholding. Federal income tax is withheld from distributions from traditional IRAs unless you choose not to have tax withheld. See chapter 4.
IRA distributions delivered outside the United States. In general, if you are a U.S. citizen or resident alien and your home address is outside the United States or its possessions, you cannot choose exemption from withholding on distributions from your traditional IRA.
Reporting taxable distributions on your return. Report fully taxable distributions, including early distributions, on Form 1040, line 15b, or Form 1040A, line 11b (no entry is required on Form 1040, line 15a, or Form 1040A, line 11a). If only part of the distribution is taxable, enter the total amount on Form 1040, line 15a, or Form 1040A, line 11a, and the taxable part on Form 1040, line 15b, or Form 1040A, line 11b. You cannot report distributions on Form 1040EZ.
What Acts Result in Penalties or Additional Taxes?
The tax advantages of using traditional IRAs for retirement savings can be offset by additional taxes and penalties if you do not follow the rules.
There are additions to the regular tax for using your IRA funds in prohibited transactions. There are also additional taxes for the following activities.
• Investing in collectibles.
• Making excess contributions.
• Taking early distributions.
• Allowing excess amounts to accumulate (failing to take required distributions).
There are penalties for overstating the amount of nondeductible contributions and for failure to file a Form 8606, if required.
Prohibited Transactions
Generally, a prohibited transaction is any improper use of your traditional IRA by you, your beneficiary, or any disqualified person.
Disqualified persons include your fiduciary and members of your family (spouse, ancestor, lineal descendent, and any spouse of a lineal descendent).
The following are examples of prohibited transactions with a traditional IRA.
• Borrowing money from it.
• Selling property to it.
• Using it as security for a loan.
• Buying property for personal use (present or future) with IRA funds.
Effect on an IRA account. Generally, if you or your beneficiary engages in a prohibited transaction in connection with your traditional IRA account at any time during the year, the account stops being an IRA as of the first day of that year.
Effect on you or your beneficiary. If your account stops being an IRA because you or your beneficiary engaged in a prohibited transaction, the account is treated as distributing all its assets to you at their fair market values on the first day of the year. If the total of those values is more than your basis in the IRA, you will have a taxable gain that is includible in your income. For information on figuring your gain and reporting it in income, see Are Distributions Taxable, earlier. The distribution may be subject to additional taxes or penalties.
Taxes on prohibited transactions. If someone other than the owner or beneficiary of a traditional IRA engages in a prohibited transaction, that person may be liable for certain taxes. In general, there is a 15% tax on the amount of the prohibited transaction and a 100% additional tax if the transaction is not corrected.
More information. For more information on prohibited transactions, see What Acts Result in Penalties or Additional Taxes? in chapter 1 of Pub. 590-A.
Investment in Collectibles
If your traditional IRA invests in collectibles, the amount invested is considered distributed to you in the year invested. You may have to pay the 10% additional tax on early distributions, discussed later.
Collectibles. These include:
• Artworks,
• Rugs,
• Antiques,
• Metals,
• Gems,
• Stamps,
• Coins,
• Alcoholic beverages, and
• Certain other tangible personal property.
Exception. Your IRA can invest in one-, one-half-, one-quarter-, or one-tenth-ounce U.S. gold coins, or one-ounce silver coins minted by the Treasury Department. It can also invest in certain platinum coins and certain gold, silver, palladium, and platinum bullion.
Excess Contributions
Generally, an excess contribution is the amount contributed to your traditional IRA(s) for the year that is more than the smaller of:
• The maximum deductible amount for the year. For 2016, this is $5,500 ($6,500 if you are 50 or older), or
• Your taxable compensation for the year.
Tax on excess contributions. In general, if the excess contributions for a year are not withdrawn by the date your return for the year is due (including extensions), you are subject to a 6% tax. You must pay the 6% tax each year on excess amounts that remain in your traditional IRA at the end of your tax year. The tax cannot be more than 6% of the combined value of all your IRAs as of the end of your tax year.
Excess contributions withdrawn by due date of return. You will not have to pay the 6% tax if you withdraw an excess contribution made during a tax year and you also withdraw interest or other income earned on the excess contribution. You must complete your withdrawal by the date your tax return for that year is due, including extensions.
How to treat withdrawn contributions. Do not include in your gross income an excess contribution that you withdraw from your traditional IRA before your tax return is due if both the following conditions are met.
• No deduction was allowed for the excess contribution.
• You withdraw the interest or other income earned on the excess contribution.
You can take into account any loss on the contribution while it was in the IRA when calculating the amount that must be withdrawn. If there was a loss, the net income you must withdraw may be a negative amount.
How to treat withdrawn interest or other income. You must include in your gross income the interest or other income that was earned on the excess contribution. Report it on your return for the year in which the excess contribution was made. Your withdrawal of interest or other income may be subject to an additional 10% tax on early distributions, discussed later.
Excess contributions withdrawn after due date of return. In general, you must include all distributions (withdrawals) from your traditional IRA in your gross income. However, if the following conditions are met, you can withdraw excess contributions from your IRA and not include the amount withdrawn in your gross income.
• Total contributions (other than rollover contributions) for 2016 to your IRA were not more than $5,500 ($6,500 if you are 50 or older).
• You did not take a deduction for the excess contribution being withdrawn.
The withdrawal can take place at any time, even after the due date, including extensions, for filing your tax return for the year.
Excess contribution deducted in an earlier year. If you deducted an excess contribution in an earlier year for which the total contributions were not more than the maximum deductible amount for that year (see the following table), you can still remove the excess from your traditional IRA and not include it in your gross income. To do this, file Form 1040X for that year and do not deduct the excess contribution on the amended return. Generally, you can file an amended return within 3 years after you filed your return, or 2 years from the time the tax was paid, whichever is later.
Contribution
limit if age
50 or older
Contribution at the end of
Year(s) limit the year
----------------------------------------------
2013 through $5,500 $6,500
2015
2008 through $5,000 $6,000
2012
2006 or 2007 $4,000 $5,000
2005 $4,000 $4,500
2002 through $3,000 $3,500
2004
1997 through $2,000 --
2001
before 1997 $2,250 --
Excess due to incorrect rollover information. If an excess contribution in your traditional IRA is the result of a rollover and the excess occurred because the information the plan was required to give you was incorrect, you can withdraw the excess contribution. The limits mentioned above are increased by the amount of the excess that is due to the incorrect information. You will have to amend your return for the year in which the excess occurred to correct the reporting of the rollover amounts in that year. Do not include in your gross income the part of the excess contribution caused by the incorrect information.
Early Distributions
You must include early distributions of taxable amounts from your traditional IRA in your gross income. Early distributions are also subject to an additional 10% tax. See the discussion of Form 5329 under Reporting Additional Taxes, later, to figure and report the tax.
Early distributions defined. Early distributions generally are amounts distributed from your traditional IRA account or annuity before you are age 59 1/2.
Age 59 1/2 rule. Generally, if you are under age 59 1/2, you must pay a 10% additional tax on the distribution of any assets (money or other property) from your traditional IRA. Distributions before you are age 59 1/2 are called early distributions.
The 10% additional tax applies to the part of the distribution that you have to include in gross income. It is in addition to any regular income tax on that amount.
Exceptions. There are several exceptions to the age 59 1/2 rule. Even if you receive a distribution before you are age 59 1/2, you may not have to pay the 10% additional tax if you are in one of the following situations.
• You have unreimbursed medical expenses that are more than 10% (or 7.5% if you or your spouse were born before January 2, 1952) of your adjusted gross income.
• The distributions are not more than the cost of your medical insurance due to a period of unemployment.
• You are totally and permanently disabled.
• You are the beneficiary of a deceased IRA owner.
• You are receiving distributions in the form of an annuity.
• The distributions are not more than your qualified higher education expenses.
• You use the distributions to buy, build, or rebuild a first home.
• The distribution is due to an IRS levy of the qualified plan.
• The distribution is a qualified reservist distribution.
Most of these exceptions are explained under Early Distributions in What Acts Result in Penalties or Additional Taxes? in chapter 1 of Pub. 590-B.
Note. Distributions that are timely and properly rolled over, as discussed earlier, are not subject to either regular income tax or the 10% additional tax. Certain withdrawals of excess contributions after the due date of your return are also tax free and therefore not subject to the 10% additional tax. (See Excess contributions withdrawn after due date of return, earlier.) This also applies to transfers incident to divorce, as discussed earlier.
Receivership distributions. Early distributions (with or without your consent) from savings institutions placed in receivership are subject to this tax unless one of the exceptions listed earlier applies. This is true even if the distribution is from a receiver that is a state agency.
Additional 10% tax. The additional tax on early distributions is 10% of the amount of the early distribution that you must include in your gross income. This tax is in addition to any regular income tax resulting from including the distribution in income.
Nondeductible contributions. The tax on early distributions does not apply to the part of a distribution that represents a return of your nondeductible contributions (basis).
More information. For more information on early distributions, see What Acts Result in Penalties or Additional Taxes? in chapter 1 of Pub. 590-B.
Excess Accumulations (Insufficient Distributions)
You cannot keep amounts in your traditional IRA indefinitely. Generally, you must begin receiving distributions by April 1 of the year following the year in which you reach age 70 1/2. The required minimum distribution for any year after the year in which you reach age 70 1/2 must be made by December 31 of that later year.
Tax on excess. If distributions are less than the required minimum distribution for the year, you may have to pay a 50% excise tax for that year on the amount not distributed as required.
Request to waive the tax. If the excess accumulation is due to reasonable error, and you have taken, or are taking, steps to remedy the insufficient distribution, you can request that the tax be waived. If you believe you qualify for this relief, attach a statement of explanation and complete Form 5329 as instructed under Waiver of tax in the Instructions for Form 5329.
Exemption from tax. If you are unable to take required distributions because you have a traditional IRA invested in a contract issued by an insurance company that is in state insurer delinquency proceedings, the 50% excise tax does not apply if the conditions and requirements of Revenue Procedure 92-10 are satisfied.
More information. For more information on excess accumulations, see What Acts Result in Penalties or Additional Taxes? in chapter 1 of Pub. 590-B.
Reporting Additional Taxes
Generally, you must use Form 5329 to report the tax on excess contributions, early distributions, and excess accumulations. If you must file Form 5329, you cannot use Form 1040A or Form 1040EZ.
Filing a tax return. If you must file an individual income tax return, complete Form 5329 and attach it to your Form 1040. Enter the total additional taxes due on Form 1040, line 59.
Not filing a tax return. If you do not have to file a tax return but do have to pay one of the additional taxes mentioned earlier, file the completed Form 5329 with the IRS at the time and place you would have filed your Form 1040. Be sure to include your address on page 1 and your signature and date on page 2. Enclose, but do not attach, a check or money order payable to the United States Treasury for the tax you owe, as shown on Form 5329. Enter your social security number and "2016 Form 5329" on your check or money order.
Form 5329 not required. You do not have to use Form 5329 if either of the following situations exists.
• Distribution code 1 (early distribution) is correctly shown in box 7 of all your Forms 1099-R. If you do not owe any other additional tax on a distribution, multiply the taxable part of the early distribution by 10% and enter the result on Form 1040, line 59. Put "No" to the left of the line to indicate that you do not have to file Form 5329. However, if you owe this tax and also owe any other additional tax on a distribution, do not enter this 10% additional tax directly on your Form 1040. You must file Form 5329 to report your additional taxes.
• If you rolled over part or all of a distribution from a qualified retirement plan, the part rolled over is not subject to the tax on early distributions.
Roth IRAs
Regardless of your age, you may be able to establish and make nondeductible contributions to a retirement plan called a Roth IRA.
Contributions not reported. You do not report Roth IRA contributions on your return.
What Is a Roth IRA?
A Roth IRA is an individual retirement plan that, except as explained in this chapter, is subject to the rules that apply to a traditional IRA (defined earlier). It can be either an account or an annuity. Individual retirement accounts and annuities are described under How Can a Traditional IRA Be Opened? in chapter 1 of Pub. 590-A.
To be a Roth IRA, the account or annuity must be designated as a Roth IRA when it is opened. A deemed IRA can be a Roth IRA, but neither a SEP IRA nor a SIMPLE IRA can be designated as a Roth IRA.
Unlike a traditional IRA, you cannot deduct contributions to a Roth IRA. But, if you satisfy the requirements, qualified distributions (discussed later) are tax free. Contributions can be made to your Roth IRA after you reach age 70 1/2 and you can leave amounts in your Roth IRA as long as you live.
When Can a Roth IRA Be Opened?
You can open a Roth IRA at any time. However, the time for making contributions for any year is limited. See When Can You Make Contributions?, later, under Can You Contribute to a Roth IRA?
Can You Contribute to a Roth IRA?
Generally, you can contribute to a Roth IRA if you have taxable compensation (defined later) and your modified AGI (defined later) is less than:
• $194,000 for married filing jointly or qualifying widow(er),
• $132,000 for single, head of household, or married filing separately and you did not live with your spouse at any time during the year, or
• $10,000 for married filing separately and you lived with your spouse at any time during the year.
TIP: You may be eligible to claim a credit for contributions to your Roth IRA. For more information, see chapter 38.
Is there an age limit for contributions? Contributions can be made to your Roth IRA regardless of your age.
Can you contribute to a Roth IRA for your spouse? You can contribute to a Roth IRA for your spouse provided the contributions satisfy the Kay Bailey Hutchison Spousal IRA limit (discussed in How Much Can Be Contributed? under Traditional IRAs), you file jointly, and your modified AGI is less than $194,000.
Compensation. Compensation includes wages, salaries, tips, professional fees, bonuses, and other amounts received for providing personal services. It also includes commissions, self-employment income, nontaxable combat pay, military differential pay, and taxable alimony and separate maintenance payments.
Modified AGI. Your modified AGI for Roth IRA purposes is your adjusted gross income (AGI) as shown on your return with some adjustments. Use Worksheet 17-2 below to determine your modified AGI.
Worksheet 17-2. Modified Adjusted Gross Income for Roth IRA Purposes
Keep for Your Records
Use this worksheet to figure your modified adjusted gross income for
Roth IRA purposes.
----------------------------------------------------------------------
1. Enter your adjusted gross income from Form 1040, line
38, or Form 1040A, line 22 1. ______
2. Enter any income resulting from the conversion of an
IRA (other than a Roth IRA) to a Roth IRA (included on
Form 1040A, line 11b) and a
rollover from a qualified retirement plan to a Roth
IRA (included on Form 1040, line 16b, or Form 1040A,
line 12b) 2. ______
3. Subtract line 2 from line 1 3. ______
4. Enter any traditional IRA deduction from Form 1040,
line 32, or Form 1040A, line 17 4. ______
5. Enter any student loan interest deduction from
Form 1040A, line 18 5. ______
6. Enter any tuition and fees deduction from Form 1040,
line 34, or Form 1040A, line 19 6. ______
7. Enter any domestic production activities deduction
from Form 1040, line 35 7. ______
8. Enter any foreign earned income and/or housing
exclusion from Form 2555-EZ,
line 18 8. ______
9. Enter any foreign housing deduction from Form 2555,
line 50 9. ______
10. Enter any excludable savings bond interest from
Form 8815, line 14 10. ______
11. Enter any excluded employer-provided adoption benefits
from Form 8839, line 28 11. ______
12. Add the amounts on lines 3 through 11 12. ______
13. Enter:
• $194,000 if married filing jointly or qualifying
widow(er)
• $10,000 if married filing separately and you lived
with your spouse at any time during the year
• $132,000 for all others 13. ______
Is the amount on line 12 more than the amount on
line 13?
If yes, then see the Note below.
If no, then the amount on line 12 is your modified
AGI for Roth IRA purposes.
Note. If the amount on line 12 is more than the amount on line 13
and you have other income or loss items, such as social security
income or passive activity losses, that are subject to AGI-based
phaseouts, you can refigure your AGI solely for the purpose of
figuring your modified AGI for Roth IRA purposes. (If you receive
social security benefits, use Worksheet 1 in Appendix B of
Pub. 590-A to refigure your AGI.) Then go to line 3 above in this
Worksheet 17-2 to refigure your modified AGI. If you do not have
other income or loss items subject to AGI-based phaseouts, your
modified AGI for Roth IRA purposes is the amount on line 12.
----------------------------------------------------------------------
How Much Can Be Contributed?
The contribution limit for Roth IRAs generally depends on whether contributions are made only to Roth IRAs or to both traditional IRAs and Roth IRAs.
Roth IRAs only. If contributions are made only to Roth IRAs, your contribution limit generally is the lesser of the following amounts.
• $5,500 ($6,500 if you are 50 or older in 2016).
• Your taxable compensation.
However, if your modified AGI is above a certain amount, your contribution limit may be reduced, as explained later under Contribution limit reduced.
Roth IRAs and traditional IRAs. If contributions are made to both Roth IRAs and traditional IRAs established for your benefit, your contribution limit for Roth IRAs generally is the same as your limit would be if contributions were made only to Roth IRAs, but then reduced by all contributions for the year to all IRAs other than Roth IRAs. Employer contributions under a SEP or SIMPLE IRA plan do not affect this limit.
This means that your contribution limit is generally the lesser of the following amounts.
• $5,500 ($6,500 if you are 50 or older in 2016) minus all contributions (other than employer contributions under a SEP or SIMPLE IRA plan) for the year to all IRAs other than Roth IRAs.
• Your taxable compensation minus all contributions (other than employer contributions under a SEP or SIMPLE IRA plan) for the year to all IRAs other than Roth IRAs.
However, if your modified AGI is above a certain amount, your contribution limit may be reduced, as explained next under Contribution limit reduced.
Contribution limit reduced. If your modified AGI is above a certain amount, your contribution limit is gradually reduced. Use Table 17-3 to determine if this reduction applies to you.
Table 17-3. Effect of Modified AGI on Roth IRA Contribution
This table shows whether your contribution to a Roth IRA is affected
by the amount of your modified adjusted gross income (modified AGI).
----------------------------------------------------------------------
IF you have taxable
compensation and AND your modified
your filing status is . . . AGI is . . . THEN . . .
----------------------------------------------------------------------
married filing jointly, or less than $184,000 you can contribute up
qualifying widow(er) to $5,500 ($6,500 if
you are 50 or older
in 2016).
-----------------------------------------
at least $184,000 the amount you can
but less than contribute is reduced
$194,000 as explained under
Contribution limit
reduced in chapter 2
of Pub. 590-A.
-----------------------------------------
$194,000 or more you cannot contribute
to a Roth IRA.
----------------------------------------------------------------------
married filing separately zero (-0-) you can contribute up
and you lived with your to $5,500 ($6,500 if
spouse at any time during you are 50 or older
the year in 2016).
-----------------------------------------
more than zero the amount you can
(-0-) but less contribute is reduced
than $10,000 as explained under
Contribution limit
reduced in chapter 2
of Pub. 590-A.
-----------------------------------------
$10,000 or more you cannot contribute
to a Roth IRA.
----------------------------------------------------------------------
single, less than $117,000 you can contribute up
head of household, or to $5,500 ($6,500 if
married filing separately you are 50 or older
and you did not live with in 2016).
your spouse at any time -----------------------------------------
during the year at least $117,000 the amount you can
but less than contribute is reduced
$132,000 as explained under
Contribution limit
reduced in chapter 2
of Pub. 590-A.
-----------------------------------------
$132,000 or more you cannot contribute
to a Roth IRA.
----------------------------------------------------------------------
Figuring the reduction. If the amount you can contribute to your Roth IRA is reduced, see Worksheet 2-2 under Can You Contribute to a Roth IRA? in chapter 2 of Pub. 590-A for how to figure the reduction.
When Can You Make Contributions?
You can make contributions to a Roth IRA for a year at any time during the year or by the due date of your return for that year (not including extensions).
TIP: You can make contributions for 2016 by the due date (not including extensions) for filing your 2016 tax return.
What if You Contribute Too Much?
A 6% excise tax applies to any excess contribution to a Roth IRA.
Excess contributions. These are the contributions to your Roth IRAs for a year that equal the total of:
1. Amounts contributed for the tax year to your Roth IRAs (other than amounts properly and timely rolled over from a Roth IRA or properly converted from a traditional IRA or rolled over from a qualified retirement plan, as described later) that are more than your contribution limit for the year, plus
2. Any excess contributions for the preceding year, reduced by the total of:
a. Any distributions out of your Roth IRAs for the year, plus
b. Your contribution limit for the year minus your contributions to all your IRAs for the year.
Applying excess contributions. If contributions to your Roth IRA for a year were more than the limit, you can apply the excess contribution in one year to a later year if the contributions for that later year are less than the maximum allowed for that year.
Can You Move Amounts Into a Roth IRA?
You may be able to convert amounts from either a traditional, SEP, or SIMPLE IRA into a Roth IRA. You may be able to roll amounts over from a qualified retirement plan to a Roth IRA. You may be able to recharacterize contributions made to one IRA as having been made directly to a different IRA. You can roll amounts over from a designated Roth account or from one Roth IRA to another Roth IRA.
Conversions
You can convert a traditional IRA to a Roth IRA. The conversion is treated as a rollover, regardless of the conversion method used. Most of the rules for rollovers, described earlier under Rollover From One IRA Into Another under Traditional IRAs, apply to these rollovers. However, the 1-year waiting period does not apply.
Conversion methods. You can convert amounts from a traditional IRA to a Roth IRA in any of the following ways.
• Rollover. You can receive a distribution from a traditional IRA and roll it over (contribute it) to a Roth IRA within 60 days after the distribution.
• Trustee-to-trustee transfer. You can direct the trustee of the traditional IRA to transfer an amount from the traditional IRA to the trustee of the Roth IRA.
• Same trustee transfer. If the trustee of the traditional IRA also maintains the Roth IRA, you can direct the trustee to transfer an amount from the traditional IRA to the Roth IRA.
Same trustee. Conversions made with the same trustee can be made by redesignating the traditional IRA as a Roth IRA, rather than opening a new account or issuing a new contract.
Rollover from a qualified retirement plan into a Roth IRA. You can roll over into a Roth IRA all or part of an eligible rollover distribution you receive from your (or your deceased spouse's):
• Employer's qualified pension, profit-sharing, or stock bonus plan;
• Annuity plan;
• Tax-sheltered annuity plan (section 403(b) plan); or
• Governmental deferred compensation plan (section 457 plan).
Any amount rolled over is subject to the same rules as those for converting a traditional IRA into a Roth IRA. Also, the rollover contribution must meet the rollover requirements that apply to the specific type of retirement plan.
Income. You must include in your gross income distributions from a qualified retirement plan that you would have had to include in income if you had not rolled them over into a Roth IRA. You do not include in gross income any part of a distribution from a qualified retirement plan that is a return of basis (after-tax contributions) to the plan that were taxable to you when paid. These amounts are normally included in income on your return for the year you rolled them over from the employer plan to a Roth IRA.
CAUTION: If you must include any amount in your gross income, you may have to increase your withholding or make estimated tax payments. See Pub. 505, Tax Withholding and Estimated Tax.
For more information, see Rollover From Employer's Plan Into a Roth IRA in chapter 2 of Pub. 590-A.
Converting from a SIMPLE IRA. Generally, you can convert an amount in your SIMPLE IRA to a Roth IRA under the same rules explained earlier under Converting From Any Traditional IRA to a Roth IRA under Traditional IRAs.
However, you cannot convert any amount distributed from the SIMPLE IRA during the 2-year period beginning on the date you first participated in any SIMPLE IRA plan maintained by your employer.
More information. For more detailed information on conversions, see Can You Move Amounts Into a Roth IRA? under chapter 2 in Pub. 590-A.
Rollover From a Roth IRA
You can withdraw, tax free, all or part of the assets from one Roth IRA if you contribute them within 60 days to another Roth IRA. Most of the rules for rollovers, explained earlier under Rollover From One IRA Into Another under Traditional IRAs, apply to these rollovers.
Rollover from designated Roth account. A rollover from a designated Roth account can only be made to another designated Roth account or to a Roth IRA. For more information about designated Roth accounts, see chapter 10.
Are Distributions Taxable?
You do not include in your gross income qualified distributions or distributions that are a return of your regular contributions from your Roth IRA(s). You also do not include distributions from your Roth IRA that you roll over tax free into another Roth IRA. You may have to include part of other distributions in your income. See Ordering rules for distributions, later.
What are qualified distributions? A qualified distribution is any payment or distribution from your Roth IRA that meets the following requirements.
1. It is made after the 5-year period beginning with the first taxable year for which a contribution was made to a Roth IRA set up for your benefit, and
2. The payment or distribution is:
a. Made on or after the date you reach age 59 1/2,
b. Made because you are disabled,
c. Made to a beneficiary or to your estate after your death, or
d. To pay up to $10,000 (lifetime limit) of certain qualified first-time homebuyer amounts. See First home under What Acts Result in Penalties or Additional Taxes? in chapter 1 of Pub. 590-B for more information.
Additional tax on other early distributions. Unless an exception applies, you must pay the 10% additional tax on the taxable part of any distributions that are not qualified distributions. See Pub. 590-B for more information.
Ordering rules for distributions. If you receive a distribution from your Roth IRA that is not a qualified distribution, part of it may be taxable. There is a set order in which contributions (including conversion contributions and rollover contributions from qualified retirement plans) and earnings are considered to be distributed from your Roth IRA. Regular contributions are distributed first. See Ordering Rules for Distributions under Are Distributions Taxable? in chapter 2 of Pub. 590-B for more information.
Must you withdraw or use Roth IRA assets? You are not required to take distributions from your Roth IRA at any age. The minimum distribution rules that apply to traditional IRAs do not apply to Roth IRAs while the owner is alive. However, after the death of a Roth IRA owner, certain minimum distribution rules that apply to traditional IRAs also apply to Roth IRAs.
More information. For more detailed information on Roth IRAs, see chapter 2 of Pub. 590-A and Pub. 590-B.
18. Alimony
Introduction
This chapter discusses the rules that apply if you pay or receive alimony. It covers the following topics.
• What payments are alimony.
• What payments are not alimony, such as child support.
• How to deduct alimony you paid.
• How to report alimony you received as income.
• Whether you must recapture the tax benefits of alimony. Recapture means adding back in your income all or part of a deduction you took in a prior year.
Alimony is a payment to or for a spouse or former spouse under a divorce or separation instrument. It doesn't include voluntary payments that aren't made under a divorce or separation instrument.
Alimony is deductible by the payer, and the recipient must include it in income. Although this chapter is generally written for the payer of the alimony, the recipient can also use the information to determine whether an amount received is alimony.
To be alimony, a payment must meet certain requirements. There are some differences between the requirements that apply to payments under instruments executed after 1984 and to payments under instruments executed before 1985. The general requirements that apply to payments regardless of when the divorce or separation agreement was executed and the specific requirements that apply to post-1984 (and, in certain cases, some pre-1985 instruments) are discussed in this chapter. If you are looking for information on the specific requirements that apply to pre-1985 instruments, get and keep a copy of the 2004 version of Pub. 504. That was the last year the information on pre-1985 instruments was included in Pub. 504.
Use Table 18-1 in this chapter as a guide to determine whether certain payments are considered alimony.
Table 18-1. Alimony Requirements (Instruments Executed After 1984)
----------------------------------------------------------------------
Payments ARE alimony if all of the Payments are NOT alimony if any of
following are true: the following are true:
----------------------------------------------------------------------
Payments are required by a divorce Payments aren't required by a
or separation instrument. divorce or separation instrument.
----------------------------------------------------------------------
Payer and recipient spouse don't Payer and recipient spouse file a
file a joint return with each joint return with each other.
other.
----------------------------------------------------------------------
Payment is in cash (including Payment is:
checks or money orders). • Not in cash,
• A noncash property settlement,
• Spouse's part of community
income, or
• To keep up the payer's
property.
----------------------------------------------------------------------
Payment isn't designated in the Payment is designated in the
instrument as not alimony. instrument as not alimony.
----------------------------------------------------------------------
Spouses legally separated under Spouses legally separated under a
a decree of divorce or separate decree of divorce or separate
maintenance aren't members of the maintenance are members of the
same household. same household.
----------------------------------------------------------------------
Payments aren't required after Payments are required after death
death of the recipient spouse. of the recipient spouse.
----------------------------------------------------------------------
Payment isn't treated as child Payment is treated as child
support. support.
----------------------------------------------------------------------
These payments are deductible by These payments are neither
the payer and includible in income deductible by the payer nor
by the recipient. includible in income by the
recipient.
----------------------------------------------------------------------
Definitions. The following definitions apply throughout this chapter.
Spouse or former spouse. Unless otherwise stated, the term "spouse" includes former spouse.
Divorce or separation instrument. The term "divorce or separation instrument" means:
• A decree of divorce or separate maintenance or a written instrument incident to that decree;
• A written separation agreement; or
• A decree or any type of court order requiring a spouse to make payments for the support or maintenance of the other spouse. This includes a temporary decree, an interlocutory (not final) decree, and a decree of alimony pendente lite (while awaiting action on the final decree or agreement).
Useful Items
You may want to see:
Publication
• Publication 504 Divorced or Separated Individuals
General Rules
The following rules apply to alimony regardless of when the divorce or separation instrument was executed.
Payments not alimony. Not all payments under a divorce or separation instrument are alimony. Alimony doesn't include:
• Child support;
• Noncash property settlements;
• Payments that are your spouse's part of community income, as explained under Community Property in Pub. 504;
• Payments to keep up the payer's property; or
• Use of the payer's property.
Payments to a third party. Cash payments, checks, or money orders to a third party on behalf of your spouse under the terms of your divorce or separation instrument can be alimony, if they otherwise qualify. These include payments for your spouse's medical expenses, housing costs (rent, utilities, etc.), taxes, tuition, etc. The payments are treated as received by your spouse and then paid to the third party.
Life insurance premiums. Alimony includes premiums you must pay under your divorce or separation instrument for insurance on your life to the extent your spouse owns the policy.
Payments for jointly owned home. If your divorce or separation instrument states that you must pay expenses for a home owned by you and your spouse, some of your payments may be alimony.
Mortgage payments. If you must pay all the mortgage payments (principal and interest) on a jointly owned home, and they otherwise qualify as alimony, you can deduct half of the total payments as alimony. If you itemize deductions and the home is a qualified home, you can claim half of the interest in figuring your deductible interest. Your spouse must report half of the payments as alimony received. If your spouse itemizes deductions and the home is a qualified home, he or she can claim half of the interest on the mortgage in figuring deductible interest.
Taxes and insurance. If you must pay all the real estate taxes or insurance on a home held as tenants in common, you can deduct half of these payments as alimony. Your spouse must report half of these payments as alimony received. If you and your spouse itemize deductions, you can each claim half of the real estate taxes and none of the home insurance.
If your home is held as tenants by the entirety or joint tenants, none of your payments for taxes or insurance are alimony. But if you itemize deductions, you can claim all of the real estate taxes and none of the home insurance.
Other payments to a third party. If you made other third-party payments, see Pub. 504 to see whether any part of the payments qualifies as alimony.
Instruments Executed After 1984
The following rules for alimony apply to payments under divorce or separation instruments executed after 1984.
Exception for instruments executed before 1985. There are two situations where the rules for instruments executed after 1984 apply to instruments executed before 1985.
1. A divorce or separation instrument executed before 1985 and then modified after 1984 to specify that the after-1984 rules will apply.
2. A temporary divorce or separation instrument executed before 1985 and incorporated into, or adopted by, a final decree executed after 1984 that:
a. Changes the amount or period of payment, or
b. Adds or deletes any contingency or condition.
Example 1. In November 1984, you and your former spouse executed a written separation agreement. In February 1985, a decree of divorce was substituted for the written separation agreement. The decree of divorce didn't change the terms for the alimony you pay your former spouse. The decree of divorce is treated as executed before 1985. Alimony payments under this decree aren't subject to the rules for payments under instruments executed after 1984.
Example 2. Assume the same facts as in Example 1 except that the decree of divorce changed the amount of the alimony. In this example, the decree of divorce isn't treated as executed before 1985. The alimony payments are subject to the rules for payments under instruments executed after 1984.
Alimony requirements. A payment to or for a spouse under a divorce or separation instrument is alimony if the spouses don't file a joint return with each other and all the following requirements are met.
• The payment is in cash.
• The instrument doesn't designate the payment as not alimony.
• The spouses aren't members of the same household at the time the payments are made. This requirement applies only if the spouses are legally separated under a decree of divorce or separate maintenance.
• There is no liability to make any payment (in cash or property) after the death of the recipient spouse.
• The payment isn't treated as child support.
Each of these requirements is discussed next.
Cash payment requirement. Only cash payments, including checks and money orders, qualify as alimony. The following don't qualify as alimony.
• Transfers of services or property (including a debt instrument of a third party or an annuity contract).
• Execution of a debt instrument by the payer.
• The use of the payer's property.
Payments to a third party. Cash payments to a third party under the terms of your divorce or separation instrument can qualify as cash payments to your spouse. See Payments to a third party under General Rules, earlier.
Also, cash payments made to a third party at the written request of your spouse may qualify as alimony if all the following requirements are met.
• The payments are in lieu of payments of alimony directly to your spouse.
• The written request states that both spouses intend the payments to be treated as alimony.
• You receive the written request from your spouse before you file your return for the year you made the payments.
Payments designated as not alimony. You and your spouse can designate that otherwise qualifying payments aren't alimony. You do this by including a provision in your divorce or separation instrument that states the payments aren't deductible as alimony by you and are excludable from your spouse's income. For this purpose, any instrument (written statement) signed by both of you that makes this designation and that refers to a previous written separation agreement is treated as a written separation agreement (and therefore a divorce or separation instrument). If you are subject to temporary support orders, the designation must be made in the original or a later temporary support order.
Your spouse can exclude the payments from income only if he or she attaches a copy of the instrument designating them as not alimony to his or her return. The copy must be attached each year the designation applies.
Spouses can't be members of the same household. Payments to your spouse while you are members of the same household aren't alimony if you are legally separated under a decree of divorce or separate maintenance. A home you formerly shared is considered one household, even if you physically separate yourselves in the home.
You aren't treated as members of the same household if one of you is preparing to leave the household and does leave no later than 1 month after the date of the payment.
Exception. If you aren't legally separated under a decree of divorce or separate maintenance, a payment under a written separation agreement, support decree, or other court order may qualify as alimony even if you are members of the same household when the payment is made.
Liability for payments after death of recipient spouse. If any part of payments you make must continue to be made for any period after your spouse's death, that part of your payments isn't alimony, whether made before or after the death. If all of the payments would continue, then none of the payments made before or after the death are alimony.
The divorce or separation instrument doesn't have to expressly state that the payments cease upon the death of your spouse if, for example, the liability for continued payments would end under state law.
Example. You must pay your former spouse $10,000 in cash each year for 10 years. Your divorce decree states that the payments will end upon your former spouse's death. You must also pay your former spouse or your former spouse's estate $20,000 in cash each year for 10 years. The death of your spouse wouldn't end these payments under state law.
The $10,000 annual payments may qualify as alimony. The $20,000 annual payments that don't end upon your former spouse's death aren't alimony.
Substitute payments. If you must make any payments in cash or property after your spouse's death as a substitute for continuing otherwise qualifying payments before the death, the otherwise qualifying payments aren't alimony. To the extent that your payments begin, accelerate, or increase because of the death of your spouse, otherwise qualifying payments you made may be treated as payments that weren't alimony. Whether or not such payments will be treated as not alimony depends on all the facts and circumstances.
Example 1. Under your divorce decree, you must pay your former spouse $30,000 annually. The payments will stop at the end of 6 years or upon your former spouse's death, if earlier.
Your former spouse has custody of your minor children. The decree provides that if any child is still a minor at your spouse's death, you must pay $10,000 annually to a trust until the youngest child reaches the age of majority. The trust income and corpus (principal) are to be used for your children's benefit.
These facts indicate that the payments to be made after your former spouse's death are a substitute for $10,000 of the $30,000 annual payments. Of each of the $30,000 annual payments, $10,000 isn't alimony.
Example 2. Under your divorce decree, you must pay your former spouse $30,000 annually. The payments will stop at the end of 15 years or upon your former spouse's death, if earlier. The decree provides that if your former spouse dies before the end of the 15-year period, you must pay the estate the difference between $450,000 ($30,000 × 15) and the total amount paid up to that time. For example, if your spouse dies at the end of the tenth year, you must pay the estate $150,000 ($450,000 - $300,000).
These facts indicate that the lump-sum payment to be made after your former spouse's death is a substitute for the full amount of the $30,000 annual payments. None of the annual payments are alimony. The result would be the same if the payment required at death were to be discounted by an appropriate interest factor to account for the prepayment.
Child support. A payment that is specifically designated as child support or treated as specifically designated as child support under your divorce or separation instrument isn't alimony. The amount of child support may vary over time. Child support payments aren't deductible by the payer and aren't taxable to the recipient.
Specifically designated as child support. A payment will be treated as specifically designated as child support to the extent that the payment is reduced either:
• On the happening of a contingency relating to your child, or
• At a time that can be clearly associated with the contingency.
A payment may be treated as specifically designated as child support even if other separate payments are specifically designated as child support.
Contingency relating to your child. A contingency relates to your child if it depends on any event relating to that child. It doesn't matter whether the event is certain or likely to occur. Events relating to your child include the child's:
• Becoming employed,
• Dying,
• Leaving the household,
• Leaving school,
• Marrying, or
• Reaching a specified age or income level.
Clearly associated with a contingency. Payments that would otherwise qualify as alimony are presumed to be reduced at a time clearly associated with the happening of a contingency relating to your child only in the following situations.
• The payments are to be reduced not more than 6 months before or after the date the child will reach 18, 21, or local age of majority.
• The payments are to be reduced on two or more occasions that occur not more than 1 year before or after a different one of your children reaches a certain age from 18 to 24. This certain age must be the same for each child, but needn't be a whole number of years.
In all other situations, reductions in payments are not treated as clearly associated with the happening of a contingency relating to your child.
Either you or the IRS can overcome the presumption in the two situations above. This is done by showing that the time at which the payments are to be reduced was determined independently of any contingencies relating to your children. For example, if you can show that the period of alimony payments is customary in the local jurisdiction, such as a period equal to half of the duration of the marriage, you can overcome the presumption and may be able to treat the amount as alimony.
How To Deduct Alimony Paid
You can deduct alimony you paid, whether or not you itemize deductions on your return. You must file Form 1040A or Form 1040EZ.
Enter the amount of alimony you paid on Form 1040, line 31a. In the space provided on line 31b, enter the recipient's social security number (SSN) or individual taxpayer identification number (ITIN).
If you paid alimony to more than one person, enter the SSN or ITIN of one of the recipients. Show the SSN or ITIN and amount paid to each additional recipient on an attached statement. Enter your total payments on line 31a.
CAUTION: If you don't provide your spouse's SSN or ITIN, you may have to pay a $50 penalty and your deduction may be disallowed. For more information on SSNs and ITINs, see Social Security Number (SSN) in chapter 1.
How To Report Alimony Received
Report alimony you received as income on Form 1040, line 11, or on Schedule NEC (Form 1040NR), line 12. You can't use Form 1040A or Form 1040EZ.
CAUTION: You must give the person who paid the alimony your SSN or ITIN. If you don't, you may have to pay a $50 penalty.
Recapture Rule
If your alimony payments decrease or end during the first 3 calendar years, you may be subject to the recapture rule. If you are subject to this rule, you have to include in income in the third year part of the alimony payments you previously deducted. Your spouse can deduct in the third year part of the alimony payments he or she previously included in income.
The 3-year period starts with the first calendar year you make a payment qualifying as alimony under a decree of divorce or separate maintenance or a written separation agreement. Don't include any time in which payments were being made under temporary support orders. The second and third years are the next 2 calendar years, whether or not payments are made during those years.
The reasons for a reduction or end of alimony payments that can require a recapture include:
• A change in your divorce or separation instrument,
• A failure to make timely payments,
• A reduction in your ability to provide support, or
• A reduction in your spouse's support needs.
When to apply the recapture rule. You are subject to the recapture rule in the third year if the alimony you pay in the third year decreases by more than $15,000 from the second year or the alimony you pay in the second and third years decreases significantly from the alimony you pay in the first year.
When you figure a decrease in alimony, don't include the following amounts.
• Payments made under a temporary support order.
• Payments required over a period of at least 3 calendar years that vary because they are a fixed part of your income from a business or property, or from compensation for employment or self-employment.
• Payments that decrease because of the death of either spouse or the remarriage of the spouse receiving the payments before the end of the third year.
Figuring the recapture. You can use Worksheet 1 in Pub. 504 to figure recaptured alimony.
Including the recapture in income. If you must include a recaptured amount in income, show it on Form 1040, line 11 ("Alimony received"). Cross out "received" and enter "recapture." On the dotted line next to the amount, enter your spouse's last name and SSN or ITIN.
Deducting the recapture. If you can deduct a recaptured amount, show it on Form 1040, line 31a ("Alimony paid"). Cross out "paid" and enter "recapture." In the space provided, enter your spouse's SSN or ITIN.
19. Education-Related Adjustments
Introduction
This chapter discusses the education-related adjustments you can deduct in figuring your adjusted gross income.
This chapter covers the student loan interest deduction, tuition and fees deduction, and the deduction for educator expenses.
Useful Items
You may want to see:
Publication
• Publication 970 Tax Benefits for Education
What's New
Student loan interest deduction. For 2016, the amount of your student loan interest deduction is gradually reduced (phased out) if your MAGI is between $65,000 and $80,000 ($130,000 and $160,000 if you file a joint return). You can't claim the deduction if your MAGI is $80,000 or more ($160,000 or more if you file a joint return).
Tuition and fees deduction. The tuition and fees deduction was extended to cover qualified education expenses paid in 2015 and 2016.
Form 1098-T requirement. For tax years beginning after June 29, 2015, generally tax year 2016 returns for most taxpayers, the law requires a taxpayer (or a dependent) to have received a Form 1098-T from an eligible educational institution in order to claim the tuition and fees deduction, American opportunity credit, or the lifetime learning credit.
However, for tax year 2016, a taxpayer may claim one of these education benefits if the student does not receive a Form 1098-T because the student's educational institution is not required to send a Form 1098-T to the student under existing rules (for example, if the student is a nonresident alien, has qualified education expenses paid entirely with scholarships, or has qualified education expenses paid under a formal billing arrangement). If a student's educational institution is not required to provide a Form 1098-T to the student, a taxpayer may claim one of these education benefits without a Form 1098-T if the taxpayer otherwise qualifies, can demonstrate that the taxpayer (or a dependent) was enrolled at an eligible educational institution, and can substantiate the payment of qualified tuition and related expenses.
Deduction for educator expenses. The deduction for educator expenses was made permanent for tax years beginning after 2014.
Student Loan Interest Deduction
Generally, personal interest you pay, other than certain mortgage interest, isn't deductible on your tax return. However, if your modified adjusted gross income (MAGI) is less than $80,000 ($160,000 if filing a joint return), there is a special deduction allowed for paying interest on a student loan (also known as an education loan) used for higher education. For most taxpayers, MAGI is the adjusted gross income as figured on their federal income tax return before subtracting any deduction for student loan interest. This deduction can reduce the amount of your income subject to tax by up to $2,500. Table 19-1 summarizes the features of the student loan interest deduction.
Table 19-1. Student Loan Interest Deduction at a Glance
Do not rely on this table alone. Refer to the
text for more details.
------------------------------------------------
Feature Description
------------------------------------------------
Maximum You can reduce your income
benefit subject to tax by up to $2,500.
------------------------------------------------
Loan Your student loan:
qualifications
• must have been taken out
solely to pay qualified
education expenses, and
• can't be from a related
person or made under a
qualified employer plan.
------------------------------------------------
Student The student must be:
qualifications
• you, your spouse, or your
dependent; and
• enrolled at least half-time
in a program leading to a
degree, certificate, or
other recognized
educational credential at
an eligible educational
institution.
------------------------------------------------
Limit on $160,000 if married filing a
modified joint return;
adjusted $80,000 if single, head of
gross income household, or qualifying
(MAGI) widow(er).
------------------------------------------------
Student Loan Interest Defined
Student loan interest is interest you paid during the year on a qualified student loan. It includes both required and voluntary interest payments.
Qualified Student Loan
This is a loan you took out solely to pay qualified education expenses (defined later) that were:
• For you, your spouse, or a person who was your dependent (defined in chapter 3) when you took out the loan;
• Paid or incurred within a reasonable period of time before or after you took out the loan; and
• For education provided during an academic period for an eligible student.
Loans from the following sources aren't qualified student loans.
• A related person.
• A qualified employer plan.
Exceptions. For purposes of the student loan interest deduction, the following are exceptions to the general rules for dependents.
• An individual can be your dependent even if you are the dependent of another taxpayer.
• An individual can be your dependent even if the individual files a joint return with a spouse.
• An individual can be your dependent even if the individual had gross income for the year that was equal to or more than the exemption amount for the year ($4,050 for 2016).
Reasonable period of time. Qualified education expenses are treated as paid or incurred within a reasonable period of time before or after you take out the loan if they are paid with the proceeds of student loans that are part of a federal postsecondary education loan program.
Even if not paid with the proceeds of that type of loan, the expenses are treated as paid or incurred within a reasonable period of time if both of the following requirements are met.
• The expenses relate to a specific academic period.
• The loan proceeds are disbursed within a period that begins 90 days before the start of that academic period and ends 90 days after the end of that academic period.
If neither of the above situations applies, the reasonable period of time is determined based on all the relevant facts and circumstances.
Academic period. An academic period includes a semester, trimester, quarter, or other period of study (such as a summer school session) as reasonably determined by an educational institution. If an educational institution uses credit hours or clock hours and doesn't have academic terms, each payment period can be treated as an academic period.
Eligible student. This is a student who was enrolled at least half-time in a program leading to a degree, certificate, or other recognized educational credential.
Enrolled at least half-time. A student was enrolled at least half-time if the student was taking at least half the normal full-time work load for his or her course of study.
The standard for what is half of the normal full-time work load is determined by each eligible educational institution. However, the standard may not be lower than any of those established by the U.S. Department of Education under the Higher Education Act of 1965.
Related person. You can't deduct interest on a loan you get from a related person. Related persons include:
• Your spouse;
• Your brothers and sisters;
• Your half brothers and half sisters;
• Your ancestors (parents, grandparents, etc.);
• Your lineal descendants (children, grandchildren, etc.); and
• Certain corporations, partnerships, trusts, and exempt organizations.
Qualified employer plan. You can't deduct interest on a loan made under a qualified employer plan or under a contract purchased under such a plan.
Qualified Education Expenses
For purposes of the student loan interest deduction, these expenses are the total costs of attending an eligible educational institution, including graduate school. They include amounts paid for the following items.
• Tuition and fees.
• Room and board.
• Books, supplies, and equipment.
• Other necessary expenses (such as transportation).
The cost of room and board qualifies only to the extent that it isn't more than:
• The allowance for room and board, as determined by the eligible educational institution, that was included in the cost of attendance (for federal financial aid purposes) for a particular academic period and living arrangement of the student; or
• If greater, the actual amount charged if the student is residing in housing owned or operated by the eligible educational institution.
Eligible educational institution. An eligible educational institution is any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the U.S. Department of Education. It includes virtually all accredited public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions.
Certain educational institutions located outside the United States also participate in the U.S. Department of Education's Federal Student Aid (FSA) programs.
For purposes of the student loan interest deduction, an eligible educational institution also includes an institution conducting an internship or residency program leading to a degree or certificate from an institution of higher education, a hospital, or a health care facility that offers postgraduate training.
An educational institution must meet the above criteria only during the academic period(s) for which the student loan was incurred. The deductibility of interest on the loan isn't affected by the institution's subsequent loss of eligibility.
TIP: The educational institution should be able to tell you if it is an eligible educational institution.
Adjustments to qualified education expenses. You must reduce your qualified education expenses by certain tax-free items (such as the tax-free part of scholarships and fellowship grants). See chapter 4 of Pub. 970 for details.
Include as Interest
In addition to simple interest on the loan, if all other requirements are met, the items discussed below can be student loan interest.
Loan origination fee. In general, this is a one-time fee charged by the lender when a loan is made. To be deductible as interest, the fee must be for the use of money rather than for property or services (such as commitment fees or processing costs) provided by the lender. A loan origination fee treated as interest accrues over the life of the loan.
Capitalized interest. This is unpaid interest on a student loan that is added by the lender to the outstanding principal balance of the loan.
Interest on revolving lines of credit. This interest, which includes interest on credit card debt, is student loan interest if the borrower uses the line of credit (credit card) only to pay qualified education expenses. See Qualified Education Expenses, earlier.
Interest on refinanced student loans. This includes interest on both:
• Consolidated loans--loans used to refinance more than one student loan of the same borrower, and
• Collapsed loans--two or more loans of the same borrower that are treated by both the lender and the borrower as one loan.
CAUTION: If you refinance a qualified student loan for more than your original loan and you use the additional amount for any purpose other than qualified education expenses, you can't deduct any interest paid on the refinanced loan.
Do Not Include as Interest
You can't claim a student loan interest deduction for any of the following items.
• Interest you paid on a loan if, under the terms of the loan, you aren't legally obligated to make interest payments.
• Loan origination fees that are payments for property or services provided by the lender, such as commitment fees or processing costs.
• Interest you paid on a loan to the extent payments were made through your participation in the National Health Service Corps Loan Repayment Program (the "NHSC Loan Repayment Program") or certain other loan repayment assistance programs. For more information, see Student Loan Repayment Assistance in chapter 5 of Pub. 970.
Can You Claim the Deduction?
Generally, you can claim the deduction if all of the following requirements are met.
• Your filing status is any filing status except married filing separately.
• No one else is claiming an exemption for you on his or her tax return.
• You are legally obligated to pay interest on a qualified student loan.
• You paid interest on a qualified student loan.
Interest paid by others. If you are the person legally obligated to make interest payments and someone else makes a payment of interest on your behalf, you are treated as receiving the payments from the other person and, in turn, paying the interest. See chapter 4 of Pub. 970 for more information.
No Double Benefit Allowed
You can't deduct as interest on a student loan any amount that is an allowable deduction under any other provision of the tax law (for example, home mortgage interest).
How Much Can You Deduct?
Your student loan interest deduction is generally the smaller of:
• $2,500, or
• The interest you paid during the tax year.
However, the amount determined above is phased out (gradually reduced) if your MAGI is between $65,000 and $80,000 ($130,000 and $160,000 if you file a joint return). You can't take a student loan interest deduction if your MAGI is $80,000 or more ($160,000 or more if you file a joint return). For details on figuring your MAGI, see chapter 4 of Pub. 970.
How Do You Figure the Deduction?
Generally, you figure the deduction using the Student Loan Interest Deduction Worksheet in the Form 1040A instructions. However, if you are filing 2555-EZ, or 4563, or you are excluding income from sources within Puerto Rico, you must complete Worksheet 4-1 in chapter 4 of Pub. 970.
To help you figure your student loan interest deduction, you should receive Form 1098-E, Student Loan Interest Statement. Generally, an institution (such as a bank or governmental agency) that received interest payments of $600 or more during 2016 on one or more qualified student loans must send Form 1098-E (or acceptable substitute) to each borrower by January 31, 2017.
For qualified student loans taken out before September 1, 2004, the institution is required to include on Form 1098-E only payments of stated interest. Other interest payments, such as certain loan origination fees and capitalized interest, may not appear on the form you receive. However, if you pay qualifying interest that isn't included on Form 1098-E, you can also deduct those amounts. For information on allocating payments between interest and principal, see chapter 4 of Pub. 970.
To claim the deduction, enter the allowable amount on Form 1040A, line 18.
Tuition and Fees Deduction
You may be able to deduct qualified education expenses paid during the year for yourself, your spouse, or your dependent(s). You can't claim this deduction if your filing status is married filing separately or if another person can claim an exemption for you as a dependent on his or her tax return. The qualified expenses must be for higher education, as explained later under Qualified Education Expenses.
What is the tax benefit of the tuition and fees deduction? The tuition and fees deduction can reduce the amount of your income subject to tax by up to $4,000.
This deduction is claimed as an adjustment to income. This means you can claim this deduction even if you don't itemize deductions on Schedule A (Form 1040). This deduction may be beneficial to you if you don't qualify for the American opportunity or lifetime learning credit.
TIP: You can choose the education benefit that will give you the lowest tax. You may want to compare the tuition and fees deduction to the education credits. See chapter 35 for more information on the education credits.
Table 19-2 summarizes the features of the tuition and fees deduction.
Table 19-2. Tuition and Fees Deduction at a Glance
Don't rely on this table alone. Refer to the text
for complete details.
-----------------------------------------------------
Question Answer
-----------------------------------------------------
What is the maximum You can reduce your
benefit? income subject to tax by
up to $4,000.
-----------------------------------------------------
What is the limit on $160,000 if married filing a
modified adjusted gross joint return; $80,000 if
income (MAGI)? single, head of household,
or qualifying widow(er).
-----------------------------------------------------
Where is the deduction As an adjustment to
taken? income on Form 1040 or
Form 1040A.
-----------------------------------------------------
For whom must the A student enrolled in an
expenses be paid? eligible educational
institution who is either:
• you,
• your spouse, or
• your dependent for whom
you claim an exemption.
-----------------------------------------------------
What tuition and fees Tuition and fees required
are deductible? for enrollment or
attendance at an eligible
postsecondary educational
institution, but not
including personal, living,
or family expenses, such
as room and board.
-----------------------------------------------------
Can You Claim the Deduction?
The following rules will help you determine if you can claim the tuition and fees deduction.
Who Can Claim the Deduction?
Generally, you can claim the tuition and fees deduction if all three of the following requirements are met.
1. You pay qualified education expenses of higher education.
2. You pay the education expenses for an eligible student.
3. The eligible student is yourself, your spouse, or your dependent for whom you claim an exemption (defined in chapter 3) on your tax return.
The term "qualified education expenses" is defined later under Qualified Education Expenses. "Eligible student" is defined later under Who is an Eligible Student. For more information on claiming the deduction for a dependent, see Who Can Claim a Dependent's Expenses, later.
Who Can't Claim the Deduction?
You can't claim the tuition and fees deduction if any of the following apply.
• Your filing status is married filing separately.
• Another person can claim an exemption for you as a dependent on his or her tax return. You can't take the deduction even if the other person doesn't actually claim that exemption.
• Your MAGI is more than $80,000 ($160,000 if filing a joint return).
• You (or your spouse) were a nonresident alien for any part of 2016 and the nonresident alien didn't elect to be treated as a resident alien for tax purposes. More information on nonresident aliens can be found in Pub. 519.
What Expenses Qualify?
The tuition and fees deduction is based on qualified education expenses you pay for yourself, your spouse, or a dependent for whom you claim an exemption on your tax return. Generally, the deduction is allowed for qualified education expenses paid in 2016 in connection with enrollment at an institution of higher education during 2016 or for an academic period beginning in 2016 or in the first 3 months of 2017.
Academic period. An academic period includes a semester, trimester, quarter, or other period of study (such as a summer school session) as reasonably determined by an educational institution. If an educational institution uses credit hours or clock hours and doesn't have academic terms, each payment period can be treated as an academic period.
Paid with borrowed funds. You can claim a tuition and fees deduction for qualified education expenses paid with the proceeds of a loan. Use the expenses to figure the deduction for the year in which the expenses are paid, not the year in which the loan is repaid. Treat loan disbursements sent directly to the educational institution as paid on the date the institution credits the student's account.
Student withdraws from class(es). You can claim a tuition and fees deduction for qualified education expenses not refunded when a student withdraws.
Qualified Education Expenses
For purposes of the tuition and fees deduction, qualified education expenses are tuition and certain related expenses required for enrollment or attendance at an eligible educational institution.
Eligible educational institution. An eligible educational institution is any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the U.S. Department of Education. It includes virtually all accredited public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions.
An eligible educational institution also includes certain educational institutions located outside the United States that are eligible to participate in a student aid program administered by the U.S. Department of Education.
TIP: The educational institution should be able to tell you if it is an eligible educational institution.
Related expenses. Student activity fees and expenses for course-related books, supplies, and equipment are included in qualified education expenses only if the fees and expenses must be paid to the institution as a condition of enrollment or attendance.
Prepaid expenses. Qualified education expenses paid in 2016 for an academic period that begins in the first 3 months of 2017 can be used in figuring an education credit for 2016 only. See Academic period, earlier.
CAUTION: You can't use any amount you paid in 2015 or 2017 to figure the qualified education expenses you use to figure your 2016 education credit(s).
No Double Benefit Allowed
You can't do any of the following.
• Deduct qualified education expenses you deduct under any other provision of the law, for example, as a business expense.
• Deduct qualified education expenses for a student on your income tax return if you or anyone else claims an American opportunity or lifetime learning credit for that same student in the same year.
• Deduct qualified education expenses that have been used to figure the tax-free portion of a distribution from a Coverdell education savings account (ESA) or a qualified tuition program (QTP). For a QTP, this applies only to the amount of tax-free earnings that were distributed, not to the recovery of contributions to the program. See Coordination with Tuition and Fees Deduction in chapter 8 of Pub. 970.
• Deduct qualified education expenses that have been paid with tax-free interest on U.S. savings bonds (Form 8815). See Figuring the Tax-Free Amount in chapter 10 of Pub. 970.
• Deduct qualified education expenses that have been paid with tax-free educational assistance, such as a scholarship, grant, or assistance provided by an employer. See the following section on Adjustments to Qualified Education Expenses.
Adjustments to Qualified Education Expenses
For each student, reduce the qualified education expenses paid by or on behalf of that student under the following rules. The result is the amount of adjusted qualified education expenses for each student. You must also reduce qualified education expenses by the other amounts referred to in No Double Benefit Allowed, earlier.
Tax-free educational assistance. For tax-free educational assistance received in 2016, reduce the qualified education expenses for each academic period by the amount of tax-free educational assistance allocable to that academic period. See Academic period, earlier.
Some tax-free educational assistance received after 2016 may be treated as a refund of qualified education expenses paid in 2016. This tax-free educational assistance is any tax-free educational assistance received by you or anyone else after 2016 for qualified education expenses paid on behalf of a student in 2016 (or attributable to enrollment at an eligible educational institution during 2016).
If this tax-free educational assistance is received after 2016 but before you file your 2016 income tax return, see Refunds received after 2016 but before your income tax return is filed, later. If this tax-free educational assistance is received after 2016 and after you file your 2016 income tax return, see Refunds received after 2016 and after your income tax return is filed, later.
This tax-free educational assistance includes:
• The tax-free part of scholarships and fellowship grants (see Tax-Free Scholarships and Fellowship Grants in chapter 1 of Pub. 970);
• The tax-free part of Pell grants (see Pell Grants and Other Title IV Need-Based Education Grants in chapter 1 of Pub. 970);
• Employer-provided educational assistance (see chapter 11 of Pub. 970);
• Veterans' educational assistance (see Veterans' Benefits in chapter 1 of Pub. 970); and
• Any other nontaxable (tax-free) payments (other than gifts or inheritances) received as educational assistance.
Generally, any scholarship or fellowship grant is treated as tax free. However, a scholarship or fellowship grant isn't treated as tax free to the extent the student includes it in gross income (the student may or may not be required to file a tax return for the year the scholarship or fellowship grant is received) and either of the following is true.
• The scholarship or fellowship grant (or any part of it) must be applied (by its terms) to expenses (such as room and board) other than qualified education expenses as defined in Qualified education expenses in chapter 1 of Pub. 970.
• The scholarship or fellowship grant (or any part of it) may be applied (by its terms) to expenses (such as room and board) other than qualified education expenses as defined in Qualified education expenses in chapter 1 of Pub. 970.
TIP: You may be able to increase the combined value of an education credit and certain educational assistance if the student includes some or all of the educational assistance in income in the year it is received. For details, see Adjustments to Qualified Education Expenses in chapter 35.
Refunds. A refund of qualified education expenses may reduce adjusted qualified education expenses for the tax year or require repayment (recapture) of a credit claimed in an earlier year. Some tax-free educational assistance received after 2016 may be treated as a refund. See Tax-free educational assistance, earlier.
Refunds received in 2016. For each student, figure the adjusted qualified education expenses for 2016 by adding all the qualified education expenses for 2016 and subtracting any refunds of those expenses received from the eligible educational institution during 2016.
Refunds received after 2016 but before your income tax return is filed. If anyone receives a refund after 2016 of qualified education expenses paid on behalf of a student in 2016 and the refund is paid before you file an income tax return for 2016, the amount of qualified education expenses for 2016 is reduced by the amount of the refund.
Refunds received after 2016 and after your income tax return is filed. If anyone receives a refund after 2016 of qualified education expenses paid on behalf of a student in 2016 and the refund is paid after you file an income tax return for 2016, you may need to repay some or all of the credit. See Credit recapture, later.
Coordination with education savings bonds, Coverdell education savings account, and qualified tuition programs. Reduce your qualified education expenses by any qualified education expenses used to figure the exclusion from gross income of (a) interest received under an education savings bond program, or (b) any distribution from a Coverdell education savings account or qualified tuition program (QTP). For a QTP, this applies only to the amount of tax-free earnings that were distributed, not to the recovery of contributions to the program.
Credit recapture. If any tax-free educational assistance for the qualified education expenses paid in 2016 or any refund of your qualified education expenses paid in 2016 is received after you file your 2016 income tax return, you must recapture (repay) any excess credit. You do this by refiguring the amount of your adjusted qualified education expenses for 2016 by reducing that amount by the amount of the refund or tax-free educational assistance. You then refigure your education credit(s) for 2016 and figure the amount by which your 2016 tax liability would have increased if you had claimed the refigured credit(s). Include that amount as an additional tax for the year the refund or tax-free assistance was received.
Amounts that don't reduce qualified education expenses. Don't reduce qualified education expenses by amounts paid with funds the student receives as:
• Payment for services, such as wages;
• A loan;
• A gift;
• An inheritance; or
• A withdrawal from the student's personal savings.
Don't reduce the qualified education expenses by any scholarship or fellowship grant reported as income on the student's tax return in the following situations.
• The use of the money is restricted, by the terms of the scholarship or fellowship grant, to costs of attendance (such as room and board) other than qualified education expenses as defined in Qualified education expenses in chapter 1 of Pub. 970.
• The use of the money isn't restricted.
Expenses That Don't Qualify
Qualified education expenses don't include amounts paid for:
• Insurance;
• Medical expenses (including student health fees);
• Room and board;
• Transportation; or
• Similar personal, living, or family expenses.
This is true even if the amount must be paid to the institution as a condition of enrollment or attendance.
Sports, games, hobbies, and noncredit courses. Qualified education expenses generally don't include expenses that relate to any course of instruction or other education that involves sports, games or hobbies, or any noncredit course. However, if the course of instruction or other education is part of the student's degree program, these expenses can qualify.
Comprehensive or bundled fees. Some eligible educational institutions combine all of their fees for an academic period into one amount. If you don't receive, or don't have access to, an allocation showing how much you paid for qualified education expenses and how much you paid for personal expenses, such as those listed above, contact the institution. The institution is generally required to make this allocation and provide you with the amount you paid (or were billed) for qualified education expenses on Form 1098-T. See Figuring the Deduction, later, for more information about Form 1098-T.
Who Is an Eligible Student?
For purposes of the tuition and fees deduction, an eligible student is a student who is enrolled in one or more courses at an eligible educational institution (as defined under Qualified Education Expenses, earlier).
Who Can Claim a Dependent's Expenses?
Generally, in order to claim the tuition and fees deduction for qualified education expenses for a dependent, you must:
1. Have paid the expenses, and
2. Claim an exemption for the student as a dependent.
For you to be able to deduct qualified education expenses for your dependent, you must claim an exemption for that individual. You do this by listing your dependent's name and other required information on Form 1040A), line 6c.
Table 19-3. Who Can Claim a Dependent's Expenses
Don't rely on this table alone. Refer to the
text for complete details.
-------------------------------------------------------
IF your
dependent is an
eligible student
and you . . . AND . . . THEN . . .
-------------------------------------------------------
claim an you paid all only you can
exemption for qualified deduct the
your dependent education qualified
expenses for education
your dependent expenses that
you paid. Your
dependent can't
take a deduction.
-------------------------------------------------------
claim an your dependent no one is allowed
exemption for paid all qualified to take a
your dependent education deduction.
expenses
-------------------------------------------------------
don't claim an you paid all no one is allowed
exemption for qualified to take a
your dependent education deduction.
expenses
-------------------------------------------------------
don't claim an your dependent no one is allowed
exemption for paid all qualified to take a
your dependent education deduction.
expenses
-------------------------------------------------------
Expenses paid by dependent. If your dependent pays qualified education expenses, no one can take a tuition and fees deduction for those expenses. Neither you nor your dependent can deduct the expenses. For purposes of the tuition and fees deduction, you aren't treated as paying any expenses actually paid by a dependent for whom you or anyone other than the dependent can claim an exemption. This rule applies even if you don't claim an exemption for your dependent on your tax return.
Expenses paid by you. If you claim an exemption for a dependent who is an eligible student, only you can include any expenses you paid when figuring your tuition and fees deduction.
Expenses paid under divorce decree. Qualified education expenses paid directly to an eligible educational institution for a student under a court-approved divorce decree are treated as paid by the student. Only the student would be eligible to take a tuition and fees deduction for that payment, and then only if no one else could claim an exemption for the student.
Expenses paid by others. Someone other than you, your spouse, or your dependent (such as a relative or former spouse) may make a payment directly to an eligible educational institution to pay for an eligible student's qualified education expenses. In this case, the student is treated as receiving the payment from the other person and, in turn, paying the institution. If you claim, or can claim, an exemption on your tax return for the student, you aren't considered to have paid the expenses and you can't deduct them. If the student isn't a dependent, only the student can deduct payments made directly to the institution for his or her expenses. If the student is your dependent, no one can deduct the payments.
Tuition reduction. When an eligible educational institution provides a reduction in tuition to an employee of the institution (or spouse or dependent child of an employee), the amount of the reduction may or may not be taxable. If it is taxable, the employee is treated as receiving a payment of that amount and, in turn, paying it to the educational institution on behalf of the student. For more information on tuition reductions, see Qualified Tuition Reduction in chapter 1 of Pub 970.
Figuring the Deduction
The maximum tuition and fees deduction in 2016 is $4,000, $2,000, or $0, depending on the amount of your MAGI. See Effect of the Amount of Your Income on the Amount of Your Deduction, later.
Form 1098-T. To help you figure your tuition and fees deduction, the student may receive Form 1098-T. Generally, an eligible educational institution (such as a college or university) must send Form 1098-T (or acceptable substitute) to each enrolled student by January 31, 2017. An institution may choose to report either payments received (box 1), or amounts billed (box 2), for qualified education expenses. However, the amount on Form 1098-T, boxes 1 and 2, might be different from what you paid. When figuring the deduction, use only the amounts you paid in 2016 for qualified education expenses.
In addition, Form 1098-T should give other information for that institution, such as adjustments made for prior years, the amount of scholarships or grants, reimbursements or refunds, and whether the student was enrolled at least half-time or was a graduate student.
The eligible educational institution may ask for a completed Form W-9S or similar statement to obtain the student's name, address, and taxpayer identification number.
Effect of the Amount of Your Income on the Amount of Your Deduction
If your MAGI isn't more than $65,000 ($130,000 if you are married filing jointly), your maximum tuition and fees deduction is $4,000. If your MAGI is larger than $65,000 ($130,000 if you are married filing jointly), but isn't more than $80,000 ($160,000 if you are married filing jointly), your maximum deduction is $2,000. No tuition and fees deduction is allowed if your MAGI is larger than $80,000 ($160,000 if you are married filing jointly).
Modified adjusted gross income (MAGI). For most taxpayers, MAGI is adjusted gross income (AGI) as figured on their federal income tax return before subtracting any deduction for tuition and fees. However, as discussed below, there may be other modifications.
MAGI when using Form 1040A. If you file Form 1040A, your MAGI is the AGI on line 22 of that form, figured without taking into account any amount on line 19 (tuition and fees deduction).
MAGI when using Form 1040. If you file Form 1040, your MAGI is the AGI on line 38 of that form, figured without taking into account any amount on line 34 (tuition and fees deduction) or line 35 (domestic production activities deduction), and modified by adding back any:
1. Foreign earned income exclusion,
2. Foreign housing exclusion,
3. Foreign housing deduction,
4. Exclusion of income by bona fide residents of American Samoa, and
5. Exclusion of income by bona fide residents of Puerto Rico.
Table 19-4 shows how the amount of your MAGI can affect your tuition and fees deduction.
You can use Worksheet 6-1 in chapter 6 of Pub. 970 to figure your MAGI.
Table 19-4. Effect of MAGI on Maximum Tuition and Fees Deduction
-----------------------------------------------------
THEN your
maximum
IF your filing AND your tuition and fees
status is . . . MAGI is . . . deduction is . . .
-----------------------------------------------------
single, head of not more than $4,000.
household, or $65,000
qualifying -----------------------------------
widow(er) more than $2,000.
$65,000 but
not more than
$80,000
-----------------------------------
more than $0.
$80,000
-----------------------------------------------------
married filing not more than $4,000.
joint return $130,000
-----------------------------------
more than $2,000.
$130,000 but
not more than
$160,000
-----------------------------------
more than $0.
$160,000
-----------------------------------------------------
Claiming the Deduction
You claim a tuition and fees deduction by completing Form 8917 and submitting it with your Form 1040A. Enter the deduction on Form 1040, line 34, or Form 1040A, line 19.
Educator Expenses
If you were an eligible educator in 2016, you can deduct up to $250 of qualified expenses you paid in 2016 as an adjustment to gross income on Form 1040, line 23, rather than as a miscellaneous itemized deduction. If you file Form 1040A, you can deduct these expenses on line 16. If you and your spouse are filing jointly and both of you were eligible educators, the maximum deduction is $500. However, neither spouse can deduct more than $250 of his or her qualified expenses.
Eligible educator. An eligible educator is a kindergarten through grade 12 teacher, instructor, counselor, principal, or aide in school for at least 900 hours during a school year.
Qualified expenses. Qualified expenses include ordinary and necessary expenses paid in connection with books, supplies, equipment (including computer equipment, software, and services), and other materials used in the classroom. An ordinary expense is one that is common and accepted in your educational field. A necessary expense is one that is helpful and appropriate for your profession as an educator. An expense doesn't have to be required to be considered necessary.
Note. Beginning in 2016, qualified expenses also include those expenses you incur while participating in professional development courses related to the curriculum in which you provide instruction. It also includes those expenses related to those students for whom you provide that instruction.
Qualified expenses don't include expenses for home schooling or for nonathletic supplies for courses in health or physical education. You must reduce your qualified expenses by the following amounts.
• Excludable U.S. series EE and I savings bond interest from Form 8815.
• Nontaxable qualified state tuition program earnings.
• Nontaxable earnings from Coverdell education savings accounts.
• Any reimbursements you received for those expenses that weren't reported to you on your Form W-2, box 1.
Educator expenses over limit. If you were an educator in 2016 and you had qualified expenses that you can't take as an adjustment to gross income, you can deduct the rest as an itemized deduction subject to the 2% limit.
Part Five. Standard Deduction and Itemized Deductions
After you have figured your adjusted gross income, you are ready to subtract the deductions used to figure taxable income. You can subtract either the standard deduction or itemized deductions. Itemized deductions are deductions for certain expenses that are listed on Schedule A (Form 1040). The 10 chapters in this part discuss the standard deduction, each itemized deduction, and a limit on some of your itemized deductions if your adjusted gross income is more than a certain amount. See chapter 20 for the factors to consider when deciding whether to take the standard deduction or itemized deductions.
20. Standard Deduction
What's New
Standard deduction increased. The standard deduction for some taxpayers who don't itemize their deductions on Schedule A (Form 1040) is higher for 2016 than it was for 2015. The amount depends on your filing status. You can use the 2016 Standard Deduction Tables in this chapter to figure your standard deduction.
Introduction
This chapter discusses the following topics.
• How to figure the amount of your standard deduction.
• The standard deduction for dependents.
• Who should itemize deductions.
Most taxpayers have a choice of either taking a standard deduction or itemizing their deductions. If you have a choice, you can use the method that gives you the lower tax.
The standard deduction is a dollar amount that reduces your taxable income. It is a benefit that eliminates the need for many taxpayers to itemize actual deductions, such as medical expenses, charitable contributions, and taxes, on Schedule A (Form 1040). The standard deduction is higher for taxpayers who:
• Are 65 or older, or
• Are blind.
TIP: You benefit from the standard deduction if your standard deduction is more than the total of your allowable itemized deductions.
Persons not eligible for the standard deduction. Your standard deduction is zero and you should itemize any deductions you have if:
• Your filing status is married filing separately, and your spouse itemizes deductions on his or her return,
• You are filing a tax return for a short tax year because of a change in your annual accounting period, or
• You are a nonresident or dual-status alien during the year. You are considered a dual-status alien if you were both a nonresident and resident alien during the year.
If you are a nonresident alien who is married to a U.S. citizen or resident alien at the end of the year, you can choose to be treated as a U.S. resident. (See Pub. 519, U.S. Tax Guide for Aliens.) If you make this choice, you can take the standard deduction.
CAUTION: If an exemption for you can be claimed on another person's return (such as your parents' return), your standard deduction may be limited. See Standard Deduction for Dependents, later.
Standard Deduction Amount
The standard deduction amount depends on your filing status, whether you are 65 or older or blind, and whether another taxpayer can claim an exemption for you. Generally, the standard deduction amounts are adjusted each year for inflation. The standard deduction amounts for most people are shown in Table 20-1.
Decedent's final return. The standard deduction for a decedent's final tax return is the same as it would have been had the decedent continued to live. However, if the decedent wasn't 65 or older at the time of death, the higher standard deduction for age can't be claimed.
Higher Standard Deduction for Age (65 or Older)
If you are age 65 or older on the last day of the year and don't itemize deductions, you are entitled to a higher standard deduction. You are considered 65 on the day before your 65th birthday. Therefore, you can take a higher standard deduction for 2016 if you were born before January 2, 1952.
Use Table 20-2 to figure the standard deduction amount.
Death of a taxpayer. If you are preparing a return for someone who died in 2016, see Death of taxpayer in Pub. 501 before using Table 20-2 or Table 20-3.
Higher Standard Deduction for Blindness
If you are blind on the last day of the year and you don't itemize deductions, you are entitled to a higher standard deduction.
Not totally blind. If you aren't totally blind, you must get a certified statement from an eye doctor (ophthalmologist or optometrist) that:
• You can't see better than 20/200 in the better eye with glasses or contact lenses, or
• Your field of vision is 20 degrees or less.
If your eye condition isn't likely to improve beyond these limits, the statement should include this fact. Keep the statement in your records.
If your vision can be corrected beyond these limits only by contact lenses that you can wear only briefly because of pain, infection, or ulcers, you can take the higher standard deduction for blindness if you otherwise qualify.
Spouse 65 or Older or Blind
You can take the higher standard deduction if your spouse is age 65 or older or blind and:
• You file a joint return, or
• You file a separate return and can claim an exemption for your spouse because your spouse had no gross income and can't be claimed as a dependent by another taxpayer.
Death of a spouse. If your spouse died in 2016 before reaching age 65, you can't take a higher standard deduction because of your spouse. Even if your spouse was born before January 2, 1952, he or she isn't considered 65 or older at the end of 2016 unless he or she was 65 or older at the time of death.
A person is considered to reach age 65 on the day before his or her 65th birthday.
Example. Your spouse was born on February 14, 1951, and died on February 13, 2016. Your spouse is considered age 65 at the time of death. However, if your spouse died on February 12, 2016, your spouse isn't considered age 65 at the time of death and isn't 65 or older at the end of 2016.
CAUTION: You can't claim the higher standard deduction for an individual other than yourself and your spouse.
Examples
The following examples illustrate how to determine your standard deduction using Tables 20-1 and 20-2.
Example 1. Larry, 46, and Donna, 33, are filing a joint return for 2016. Neither is blind, and neither can be claimed as a dependent. They decide not to itemize their deductions. They use Table 20-1. Their standard deduction is $12,600.
Example 2. The facts are the same as in Example 1 except that Larry is blind at the end of 2016. Larry and Donna use Table 20-2. Their standard deduction is $13,850.
Example 3. Bill and Lisa are filing a joint return for 2016. Both are over age 65. Neither is blind, and neither can be claimed as a dependent. If they don't itemize deductions, they use Table 20-2. Their standard deduction is $15,100.
Standard Deduction for Dependents
The standard deduction for an individual who can be claimed as a dependent on another person's tax return is generally limited to the greater of:
• $1,050, or
• The individual's earned income for the year plus $350 (but not more than the regular standard deduction amount, generally $6,300).
However, if the individual is 65 or older or blind, the standard deduction may be higher.
If you (or your spouse, if filing jointly) can be claimed as a dependent on someone else's return, use Table 20-3 to determine your standard deduction.
Earned income defined. Earned income is salaries, wages, tips, professional fees, and other amounts received as pay for work you actually perform.
For purposes of the standard deduction, earned income also includes any part of a taxable scholarship or fellowship grant. See Scholarships and fellowships in chapter 12 for more information on what qualifies as a scholarship or fellowship grant.
Example 1. Michael is 16 years old and single. His parents can claim an exemption for him on their 2016 tax return. He has interest income of $780 and wages of $150. He has no itemized deductions. Michael uses Table 20-3 to find his standard deduction. He enters $150 (his earned income) on line 1, $500 ($150 + $350) on line 3, $1,050 (the larger of $500 and $1,050) on line 5, and $6,300 on line 6. His standard deduction, on line 7a, is $1,050 (the smaller of $1,050 and $6,300).
Example 2. Joe, a 22-year-old full-time college student, can be claimed as a dependent on his parents' 2016 tax return. Joe is married and files a separate return. His wife doesn't itemize deductions on her separate return. Joe has $1,500 in interest income and wages of $3,800. He has no itemized deductions. Joe finds his standard deduction by using Table 20-3. He enters his earned income, $3,800, on line 1. He adds lines 1 and 2 and enters $4,150 on line 3. On line 5, he enters $4,150, the larger of lines 3 and 4. Because Joe is married filing a separate return, he enters $6,300 on line 6. On line 7a he enters $4,150 as his standard deduction because it is smaller than $6,300, the amount on line 6.
Example 3. Amy, who is single, can be claimed as a dependent on her parents' 2016 tax return. She is 18 years old and blind. She has interest income of $1,300 and wages of $2,900. She has no itemized deductions. Amy uses Table 20-3 to find her standard deduction. She enters her wages of $2,900 on line 1. She adds lines 1 and 2 and enters $3,250 ($2,900 + $350) on line 3. On line 5, she enters $3,250, the larger of lines 3 and 4. Because she is single, Amy enters $6,300 on line 6. She enters $3,250 on line 7a. This is the smaller of the amounts on lines 5 and 6. Because she checked the box in the top part of the worksheet, indicating she is blind, she enters $1,550 on line 7b. She then adds the amounts on lines 7a and 7b and enters her standard deduction of $4,800 on line 7c.
Example 4. Ed is 18 years old and single. His parents can claim an exemption for him on their 2016 tax return. He has wages of $7,000, interest income of $500, and a business loss of $3,000. He has no itemized deductions. Ed uses Table 20-3 to figure his standard deduction. He enters $4,000 ($7,000 - $3,000) on line 1. He adds lines 1 and 2 and enters $4,350 on line 3. On line 5 he enters $4,350, the larger of lines 3 and 4. Because he is single, Ed enters $6,300 on line 6. On line 7a he enters $4,350 as his standard deduction because it is smaller than $6,300, the amount on line 6.
Who Should Itemize
You should itemize deductions if your total deductions are more than the standard deduction amount. Also, you should itemize if you don't qualify for the standard deduction, as discussed earlier under Persons not eligible for the standard deduction.
You should first figure your itemized deductions and compare that amount to your standard deduction to make sure you are using the method that gives you the greater benefit.
CAUTION: You may be subject to a limit on some of your itemized deductions if your adjusted gross income is more than: $259,400 if single ($285,350 if head of household; $311,300 if married filing jointly or qualifying widow(er); or $155,650 if married filing separately). See chapter 29 or the instructions for Schedule A (Form 1040) for more information on figuring the correct amount of your itemized deductions.
When to itemize. You may benefit from itemizing your deductions on Schedule A (Form 1040) if you:
• Don't qualify for the standard deduction, or the amount you can claim is limited,
• Had large uninsured medical and dental expenses during the year,
• Paid interest and taxes on your home,
• Had large unreimbursed employee business expenses or other miscellaneous deductions,
• Had large uninsured casualty or theft losses,
• Made large contributions to qualified charities, or
• Have total itemized deductions that are more than the standard deduction to which you otherwise are entitled.
These deductions are explained in chapters 21-28.
If you decide to itemize your deductions, complete Schedule A and attach it to your Form 1040. Enter the amount from Schedule A, line 29, on Form 1040, line 40.
Electing to itemize for state tax or other purposes. Even if your itemized deductions are less than your standard deduction, you can elect to itemize deductions on your federal return rather than take the standard deduction. You may want to do this if, for example, the tax benefit of itemizing your deductions on your state tax return is greater than the tax benefit you lose on your federal return by not taking the standard deduction. To make this election, you must check the box on line 30 of Schedule A.
Changing your mind. If you don't itemize your deductions and later find that you should have itemized -- or if you itemize your deductions and later find you shouldn't have -- you can change your return by filing Form 1040X, Amended U.S. Individual Income Tax Return. See Amended Returns and Claims for Refund in chapter 1 for more information on amended returns.
Married persons who filed separate returns. You can change methods of taking deductions only if you and your spouse both make the same changes. Both of you must file a consent to assessment for any additional tax either one may owe as a result of the change.
You and your spouse can use the method that gives you the lower total tax, even though one of you may pay more tax than you would have paid by using the other method. You both must use the same method of claiming deductions. If one itemizes deductions, the other should itemize because he or she won't qualify for the standard deduction. See Persons not eligible for the standard deduction, earlier.
2016 Standard Deduction Tables
CAUTION: If you are married filing a separate return and your spouse itemizes deductions, or if you are a dual-status alien, you can't take the standard deduction even if you were born before January 2, 1952, or are blind.
Table 20-1. Standard Deduction Chart for Most People*
----------------------------------------------------------------
Your standard
If your filing status is . . . deduction is:
----------------------------------------------------------------
Single or Married filing separately $6,300
----------------------------------------------------------------
Married filing jointly or Qualifying widow(er)
with dependent child 12,600
----------------------------------------------------------------
Head of household 9,300
----------------------------------------------------------------
* Don't use this chart if you were born before January 2, 1952,
are blind, or if someone else can claim you (or your spouse if
filing jointly) as a dependent. Use Table 20-2 or 20-3 instead.
================================================================
Table 20-2. Standard Deduction Chart for People Born Before January 2, 1952, or Who are Blind*
------------------------------------------------------------------
Check the correct number of boxes below. Then go to
the chart.
You: Born before Blind [ ]
January 2, 1952 [ ]
Your spouse, if claiming Born before Blind [ ]
spouse's exemption: January 2, 1952 [ ]
Total number of boxes checked [ ]
------------------------------------------------------------------
THEN your
AND standard
IF your the number in deduction
filing status is . . . the box above is . . . is . . .
------------------------------------------------------------------
Single 1 $7,850
2 9,400
------------------------------------------------------------------
Married filing jointly 1 $13,850
or Qualifying 2 15,100
widow(er) with 3 16,350
dependent child 4 17,600
------------------------------------------------------------------
Married filing 1 $7,550
separately 2 8,800
3 10,050
4 11,300
------------------------------------------------------------------
Head of household 1 $10,850
2 12,400
------------------------------------------------------------------
* If someone else can claim you (or your spouse if filing jointly)
as a dependent, use Table 20-3 instead.
==================================================================
Table 20-3. Standard Deduction Worksheet for Dependents
Use this worksheet only if someone else can claim you (or your
spouse if filing jointly) as a dependent.
----------------------------------------------------------------------
Check the correct number of boxes below. Then go to the worksheet.
You: Born before Blind [ ]
January 2, 1952 [ ]
Your spouse, if claiming Born before Blind [ ]
spouse's exemption: January 2, 1952 [ ]
Total number of boxes checked [ ]
----------------------------------------------------------------------
1. Enter your earned income (defined below).
If none, enter -0-. 1. __________
----------------------------------------------------------------------
2. Additional amount. 2. $350
----------------------------------------------------------------------
3. Add lines 1 and 2. 3. __________
----------------------------------------------------------------------
4. Minimum standard deduction. 4. $1,050
----------------------------------------------------------------------
5. Enter the larger of line 3 or line 4. 5. __________
----------------------------------------------------------------------
6. Enter the amount shown below for your filing status.
• Single or Married filing separately -- $6,300
• Married filing jointly -- $12,600 6. __________
• Head of household -- $9,300
----------------------------------------------------------------------
7. Standard deduction.
a. Enter the smaller of line 5 or line 6. If
born after January 1, 1952, and not blind,
stop here. This is your standard deduction.
Otherwise, go on to line 7b. 7a. __________
b. If born before January 2, 1952, or blind,
multiply $1,550 ($1,250 if married) by the
number in the box above. 7b. __________
c. Add lines 7a and 7b. This is your standard
deduction for 2016. 7c. __________
----------------------------------------------------------------------
Earned income includes wages, salaries, tips, professional fees, and
other compensation received for personal services you performed. It
also includes any taxable scholarship or fellowship grant.
----------------------------------------------------------------------
21. Medical and Dental Expenses
What's New
Standard mileage rate. The standard mileage rate allowed for operating expenses for a car when you use it for medical reasons is 19 cents per mile. See Transportation under What Medical Expenses Are Includible.
Introduction
This chapter will help you determine the following.
• What medical expenses are.
• What expenses you can include this year.
• How much of the expenses you can deduct.
• Whose medical expenses you can include.
• What medical expenses are includible.
• How to treat reimbursements.
• How to report the deduction on your tax return.
• How to report impairment-related work expenses.
• How to report health insurance costs if you are self-employed.
Useful Items
You may want to see:
Publication
• Publication 502 Medical and Dental Expenses
• Publication 969 Health Savings Accounts and Other Tax-Favored Health Plans
Form (and Instructions)
• Form 1040 U.S. Individual Tax Return
• Schedule A (Form 1040) Itemized Deductions
• Form 8885 Health Coverage Tax Credit
• Form 8962 Premium Tax Credit (PTC)
What Are Medical Expenses?
Medical expenses are the costs of diagnosis, cure, mitigation, treatment, or prevention of disease, and the costs for treatments affecting any part or function of the body. These expenses include payments for legal medical services rendered by physicians, surgeons, dentists, and other medical practitioners. They include the costs of equipment, supplies, and diagnostic devices needed for these purposes.
Medical care expenses must be primarily to alleviate or prevent a physical or mental defect or illness. They don't include expenses that are merely beneficial to general health, such as vitamins or a vacation.
Medical expenses include the premiums you pay for insurance that covers the expenses of medical care, and the amounts you pay for transportation to get medical care. Medical expenses also include amounts paid for qualified long-term care services and limited amounts paid for any qualified long-term care insurance contract.
What Expenses Can You Include This Year?
You can include only the medical and dental expenses you paid this year, regardless of when the services were provided. If you pay medical expenses by check, the day you mail or deliver the check generally is the date of payment. If you use a "pay-by-phone" or "online" account to pay your medical expenses, the date reported on the statement of the financial institution showing when payment was made is the date of payment. If you use a credit card, include medical expenses you charge to your credit card in the year the charge is made, not when you actually pay the amount charged.
Separate returns. If you and your spouse live in a noncommunity property state and file separate returns, each of you can include only the medical expenses each actually paid. Any medical expenses paid out of a joint checking account in which you and your spouse have the same interest are considered to have been paid equally by each of you, unless you can show otherwise.
Community property states. If you and your spouse live in a community property state and file separate returns, or are registered domestic partners in Nevada, Washington, or California, any medical expenses paid out of community funds are divided equally. Each of you should include half the expenses. If medical expenses are paid out of the separate funds of one individual, only the individual who paid the medical expenses can include them. If you live in a community property state, and aren't filing a joint return, see Pub. 555.
How Much of the Expenses Can You Deduct?
Generally, you can deduct on Schedule A (Form 1040) only the amount of your medical and dental expenses that is more than 10% of your adjusted gross income (AGI), found on Form 1040, line 38 (7.5% of your AGI if either you or your spouse was born before January 2, 1952).
Example. You are unmarried and were born after January 2, 1952, and your AGI is $40,000, 10% of which is $4,000. You paid medical expenses of $2,500. You can't deduct any of your medical expenses because they aren't more than 10% of your AGI.
Whose Medical Expenses Can You Include?
You can generally include medical expenses you pay for yourself, as well as those you pay for someone who was your spouse or your dependent either when the services were provided or when you paid for them. There are different rules for decedents and for individuals who are the subject of multiple support agreements. See Support claimed under a multiple support agreement, later.
Spouse
You can include medical expenses you paid for your spouse. To include these expenses, you must have been married either at the time your spouse received the medical services or at the time you paid the medical expenses.
Example 1. Mary received medical treatment before she married Bill. Bill paid for the treatment after they married. Bill can include these expenses in figuring his medical expense deduction even if Bill and Mary file separate returns.
If Mary had paid the expenses, Bill couldn't include Mary's expenses in his separate return. Mary would include the amounts she paid during the year in her separate return. If they filed a joint return, the medical expenses both paid during the year would be used to figure their medical expense deduction.
Example 2. This year, John paid medical expenses for his wife Louise, who died last year. John married Belle this year and they file a joint return. Because John was married to Louise when she received the medical services, he can include those expenses in figuring his medical expense deduction for this year.
Dependent
You can include medical expenses you paid for your dependent. For you to include these expenses, the person must have been your dependent either at the time the medical services were provided or at the time you paid the expenses. A person generally qualifies as your dependent for purposes of the medical expense deduction if both of the following requirements are met.
1. The person was a qualifying child (defined later) or a qualifying relative (defined later); and
2. The person was a U.S. citizen or national, or a resident of the United States, Canada, or Mexico. If your qualifying child was adopted, see Exception for adopted child next.
You can include medical expenses you paid for an individual that would have been your dependent except that:
1. He or she received gross income of $4,050 or more in 2016;
2. He or she filed a joint return for 2016; or
3. You, or your spouse if filing jointly, could be claimed as a dependent on someone else's 2016 return.
Exception for adopted child. If you are a U.S. citizen or U.S. national and your adopted child lived with you as a member of your household for 2016, that child doesn't have to be a U.S. citizen or national or a resident of the United States, Canada, or Mexico.
Qualifying Child
A qualifying child is a child who:
1. Is your son, daughter, stepchild, foster child, brother, sister, stepbrother, stepsister, half brother, half sister, or a descendant of any of them (for example, your grandchild, niece, or nephew);
2. Was:
a. Under age 19 at the end of 2016 and younger than you (or your spouse, if filing jointly);
b. Under age 24 at the end of 2016, a full-time student, and younger than you (or your spouse, if filing jointly); or
c. Any age and permanently and totally disabled;
3. Lived with you for more than half of 2016;
4. Didn't provide over half of his or her own support for 2016; and
5. Didn't file a joint return, or, if he or she did, it was only to claim a refund.
Adopted child. A legally adopted child is treated as your own child. This includes a child lawfully placed with you for legal adoption.
You can include medical expenses that you paid for a child before adoption if the child qualified as your dependent when the medical services were provided or when the expenses were paid.
If you pay back an adoption agency or other persons for medical expenses they paid under an agreement with you, you are treated as having paid those expenses provided you clearly substantiate that the payment is directly attributable to the medical care of the child.
But if you pay the agency or other person for medical care that was provided and paid for before adoption negotiations began, you can't include them as medical expenses.
TIP: You may be able to take an adoption credit for other expenses related to an adoption. See the Instructions for Form 8839, Qualified Adoption Expenses, for more information.
Child of divorced or separated parents. For purposes of the medical and dental expenses deduction, a child of divorced or separated parents can be treated as a dependent of both parents. Each parent can include the medical expenses he or she pays for the child, even if the other parent claims the child's dependency exemption, if:
1. The child is in the custody of one or both parents for more than half the year,
2. The child receives over half of his or her support during the year from his or her parents, and
3. The child's parents:
a. Are divorced or legally separated under a decree of divorce or separate maintenance,
b. Are separated under a written separation agreement, or
c. Live apart at all times during the last 6 months of the year.
Qualifying Relative
A qualifying relative is a person:
1. Who is your:
a. Son, daughter, stepchild, foster child, or a descendant of any of them (for example, your grandchild);
b. Brother, sister, half brother, half sister, or a son or daughter of any of them;
c. Father, mother, or an ancestor or sibling of either of them (for example, your grandmother, grandfather, aunt, or uncle);
d. Stepbrother, stepsister, stepfather, stepmother, son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law; or
e. Any other person (other than your spouse) who lived with you all year as a member of your household if your relationship didn't violate local law;
2. Who wasn't a qualifying child (see Qualifying Child, earlier) of any other person for 2016; and
3. For whom you provided over half of the support in 2016. But see Child of divorced or separated parents, earlier, and Support claimed under a multiple support agreement next.
Support claimed under a multiple support agreement. If you are considered to have provided more than half of a qualifying relative's support under a multiple support agreement, you can include medical expenses you pay for that person. A multiple support agreement is used when two or more people provide more than half of a person's support, but no one alone provides more than half.
Any medical expenses paid by others who joined you in the agreement can't be included as medical expenses by anyone. However, you can include the entire unreimbursed amount you paid for medical expenses.
Example. You and your three brothers each provide one-fourth of your mother's total support. Under a multiple support agreement, you treat your mother as your dependent. You paid all of her medical expenses. Your brothers repaid you for three-fourths of these expenses. In figuring your medical expense deduction, you can include only one-fourth of your mother's medical expenses. Your brothers can't include any part of the expenses. However, if you and your brothers share the nonmedical support items and you separately pay all of your mother's medical expenses, you can include the unreimbursed amount you paid for her medical expenses in your medical expenses.
Decedent
Medical expenses paid before death by the decedent are included in figuring any deduction for medical and dental expenses on the decedent's final income tax return. This includes expenses for the decedent's spouse and dependents as well as for the decedent.
The survivor or personal representative of a decedent can choose to treat certain expenses paid by the decedent's estate for the decedent's medical care as paid by the decedent at the time the medical services were provided. The expenses must be paid within the 1-year period beginning with the day after the date of death. If you are the survivor or personal representative making this choice, you must attach a statement to the decedent's Form 1040 (or the decedent's amended return, Form 1040X) saying that the expenses haven't been and won't be claimed on the estate tax return.
CAUTION: Qualified medical expenses paid before death by the decedent aren't deductible if paid with a tax-free distribution from any Archer MSA, Medicare Advantage MSA, or health savings account.
Amended returns and claims for refund are discussed in chapter 1.
What if you pay medical expenses of a deceased spouse or dependent? If you paid medical expenses for your deceased spouse or dependent, include them as medical expenses on your Schedule A (Form 1040) in the year paid, whether they are paid before or after the decedent's death. The expenses can be included if the person was your spouse or dependent either at the time the medical services were provided or at the time you paid the expenses.
What Medical Expenses Are Includible?
Use Table 21-1, later, as a guide to determine which medical and dental expenses you can include on Schedule A (Form 1040).
This table doesn't include all possible medical expenses. To determine if an expense not listed can be included in figuring your medical expense deduction, see What Are Medical Expenses, earlier.
Table 21-1. Medical and Dental Expenses Checklist. See Pub. 502 for more information about these and other expenses.
----------------------------------------------------------------------
You can include: You can't include:
----------------------------------------------------------------------
• Bandages • Baby sitting and childcare
• Birth control pills prescribed • Bottled water
by your doctor
• Contributions to Archer
• Body scan MSAs (see Pub. 969)
• Braille books • Diaper service
• Breast pump and supplies • Expenses for your general
health (even if following your
• Capital expenses for doctor's advice) such as --
equipment or improvements
to your home needed for -- Health club dues
medical care (see the
worksheet in Pub. 502) -- Household help (even if
recommended by a doctor)
• Diagnostic devices
-- Social activities, such as
• Expenses of an organ donor dancing or swimming lessons
• Eye surgery -- to promote -- Trip for general health
the correct function of the improvement
eye
• Flexible spending account
• Fertility enhancement, reimbursements for medical
certain procedures expenses (if contributions
were on a pre-tax basis)
• Guide dogs or other animals
aiding the blind, deaf, and • Funeral, burial, or cremation
disabled expenses
• Hospital services fees (lab • Health savings account
work, therapy, nursing payments for medical
services, surgery, etc.) expenses
• Lead-based paint removal • Operation, treatment, or
medicine that is illegal under
• Legal abortion federal or state law
• Legal operation to prevent • Life insurance or income
having children such as a protection policies, or
vasectomy or tubal ligation policies providing payment
for loss of life, limb, sight,
• Long-term care contracts, etc.
qualified
• Maternity clothes
• Meals and lodging provided
by a hospital during medical • Medical insurance
treatment included in a car insurance
policy covering all persons
• Medical services fees (from injured in or by your car
doctors, dentists, surgeons,
specialists, and other • Medicine you buy without
medical practitioners) a prescription
• Medicare Part D premiums • Nursing care for a healthy
baby
• Medical and hospital
insurance premiums • Prescription drugs you
brought in (or ordered
• Nursing services shipped) from another
country, in most cases
• Oxygen equipment and
oxygen • Nutritional supplements,
vitamins, herbal
• Part of life-care fee paid to supplements, "natural
retirement home designated medicines," etc., unless
for medical care recommended by a
medical practitioner as a
• Physical examination treatment for a specific
medical condition
• Pregnancy test kit diagnosed by a physician
• Prescription medicines • Surgery for purely
(prescribed by a doctor) and cosmetic reasons
insulin
• Toothpaste, toiletries,
• Psychiatric and cosmetics, etc.
psychological treatment
• Teeth whitening
• Social security tax,
Medicare tax, FUTA, and • Weight-loss expenses not
state employment tax for for the treatment of obesity
worker providing medical or other disease
care (see Wages for nursing
services below)
• Special items (artificial
limbs, false teeth,
eye-glasses, contact lenses,
hearing aids, crutches,
wheelchair, etc.)
• Special education for
mentally or physically
disabled persons
• Stop-smoking programs
• Transportation for needed
medical care
• Treatment at a drug or
alcohol center (includes
meals and lodging provided
by the center)
• Wages for nursing services
• Weight loss, certain
expenses for obesity
----------------------------------------------------------------------
Insurance Premiums
You can include in medical expenses insurance premiums you pay for policies that cover medical care. Medical care policies can provide payment for treatment that includes:
• Hospitalization, surgical services, X-rays;
• Prescription drugs and insulin;
• Dental care;
• Replacement of lost or damaged contact lenses; and
• Long-term care (subject to additional limitations). See Qualified Long-Term Care Insurance Contracts in Pub. 502.
Premium tax credit. When figuring the amount of insurance premiums you can deduct on Schedule A, don't include the amount of net premium tax credit you are claiming on Form 1040.
TIP: If advance payments of the premium tax credit were made, or you think you may be eligible to claim a premium tax credit, fill out Form 8962 before filling out Schedule A. See Pub. 502 for more information on how to figure your deduction.
If you have a policy that provides payments for other than medical care, you can include the premiums for the medical care part of the policy if the charge for the medical part is reasonable. The cost of the medical part must be separately stated in the insurance contract or given to you in a separate statement.
Employer-sponsored health insurance plan. Don't include in your medical and dental expenses any insurance premiums paid by an employer-sponsored health insurance plan unless the premiums are included on your Form W-2. Also, don't include any other medical and dental expenses paid by the plan unless the amount paid is included on your Form W-2.
Example. You are a federal employee participating in the premium conversion plan of the Federal Employee Health Benefits (FEHB) program. Your share of the FEHB premium is paid by making a pre-tax reduction in your salary. Because you are an employee whose insurance premiums are paid with money that is never included in your gross income, you can't deduct the premiums paid with that money.
Long-term care services. Contributions made by your employer to provide coverage for qualified long-term care services under a flexible spending or similar arrangement must be included in your income. This amount will be reported as wages on your Form W-2.
Retired public safety officers. If you are a retired public safety officer, don't include as medical expenses any health or long-term care premiums that you elected to have paid with tax-free distributions from your retirement plan. This applies only to distributions that would otherwise be included in income.
Health reimbursement arrangement (HRA). If you have medical expenses that are reimbursed by a health reimbursement arrangement, you can't include those expenses in your medical expenses. This is because an HRA is funded solely by the employer.
Medicare A. If you are covered under social security (or if you are a government employee who paid Medicare tax), you are enrolled in Medicare A. The payroll tax paid for Medicare A isn't a medical expense.
If you aren't covered under social security (or weren't a government employee who paid Medicare tax), you can voluntarily enroll in Medicare A. In this situation you can include the premiums you paid for Medicare A as a medical expense.
Medicare B. Medicare B is supplemental medical insurance. Premiums you pay for Medicare B are a medical expense. Check the information you received from the Social Security Administration to find out your premium.
Medicare D. Medicare D is a voluntary prescription drug insurance program for persons with Medicare A or B. You can include as a medical expense premiums you pay for Medicare D.
Prepaid insurance premiums. Premiums you pay before you are age 65 for insurance for medical care for yourself, your spouse, or your dependents after you reach age 65 are medical care expenses in the year paid if they are:
• Payable in equal yearly installments, or more often; and
• Payable for at least 10 years, or until you reach age 65 (but not for less than 5 years).
Unused sick leave used to pay premiums. You must include in gross income cash payments you receive at the time of retirement for unused sick leave. You also must include in gross income the value of unused sick leave that, at your option, your employer applies to the cost of your continuing participation in your employer's health plan after you retire. You can include this cost of continuing participation in the health plan as a medical expense.
If you participate in a health plan where your employer automatically applies the value of unused sick leave to the cost of your continuing participation in the health plan (and you don't have the option to receive cash), don't include the value of the unused sick leave in gross income. You can't include this cost of continuing participation in that health plan as a medical expense.
Meals and Lodging
You can include in medical expenses the cost of meals and lodging at a hospital or similar institution if a principal reason for being there is to get medical care. See Nursing home, later.
You may be able to include in medical expenses the cost of lodging not provided in a hospital or similar institution. You can include the cost of such lodging while away from home if all of the following requirements are met.
• The lodging is primarily for and essential to medical care.
• The medical care is provided by a doctor in a licensed hospital or in a medical care facility related to, or the equivalent of, a licensed hospital.
• The lodging isn't lavish or extravagant under the circumstances.
• There is no significant element of personal pleasure, recreation, or vacation in the travel away from home.
The amount you include in medical expenses for lodging can't be more than $50 for each night for each person. You can include lodging for a person traveling with the person receiving the medical care. For example, if a parent is traveling with a sick child, up to $100 per night can be included as a medical expense for lodging. Meals aren't included.
Nursing home. You can include in medical expenses the cost of medical care in a nursing home, home for the aged, or similar institution, for yourself, your spouse, or your dependents. This includes the cost of meals and lodging in the home if a principal reason for being there is to get medical care.
Don't include the cost of meals and lodging if the reason for being in the home is personal. You can, however, include in medical expenses the part of the cost that is for medical or nursing care.
Transportation
Include in medical expenses amounts paid for transportation primarily for, and essential to, medical care. You can include:
• Bus, taxi, train, or plane fares, or ambulance service;
• Transportation expenses of a parent who must go with a child who needs medical care;
• Transportation expenses of a nurse or other person who can give injections, medications, or other treatment required by a patient who is traveling to get medical care and is unable to travel alone; and
• Transportation expenses for regular visits to see a mentally ill dependent, if these visits are recommended as a part of treatment.
Car expenses. You can include out-of-pocket expenses, such as the cost of gas and oil, when you use your car for medical reasons. You can't include depreciation, insurance, general repair, or maintenance expenses.
If you don't want to use your actual expenses for 2016, you can use the standard medical mileage rate of 19 cents per mile.
You can also include parking fees and tolls. You can add these fees and tolls to your medical expenses whether you use actual expenses or use the standard mileage rate.
Example. In 2016, Bill Jones drove 2,800 miles for medical reasons. He spent $450 for gas, $30 for oil, and $100 for tolls and parking. He wants to figure the amount he can include in medical expenses both ways to see which gives him the greater deduction.
He figures the actual expenses first. He adds the $450 for gas, the $30 for oil, and the $100 for tolls and parking for a total of $580.
He then figures the standard mileage amount. He multiplies 2,800 miles by 19 cents a mile for a total of $532. He then adds the $100 tolls and parking for a total of $632.
Bill includes the $632 of car expenses with his other medical expenses for the year because the $632 is more than the $580 he figured using actual expenses.
Transportation expenses you can't include. You can't include in medical expenses the cost of transportation in the following situations.
• Going to and from work, even if your condition requires an unusual means of transportation.
• Travel for purely personal reasons to another city for an operation or other medical care.
• Travel that is merely for the general improvement of one's health.
• The costs of operating a specially equipped car for other than medical reasons.
Disabled Dependent Care Expenses
Some disabled dependent care expenses may qualify as either:
• Medical expenses, or
• Work-related expenses for purposes of taking a credit for dependent care. (See chapter 32 and Pub. 503, Child and Dependent Care Expenses.)
You can choose to apply them either way as long as you don't use the same expenses to claim both a credit and a medical expense deduction.
How Do You Treat Reimbursements?
You can include in medical expenses only those amounts paid during the taxable year for which you received no insurance or other reimbursement.
Insurance Reimbursement
You must reduce your total medical expenses for the year by all reimbursements for medical expenses that you receive from insurance or other sources during the year. This includes payments from Medicare.
Even if a policy provides reimbursement for only certain specific medical expenses, you must use amounts you receive from that policy to reduce your total medical expenses, including those it doesn't reimburse.
Example. You have insurance policies that cover your hospital and doctors' bills but not your nursing bills. The insurance you receive for the hospital and doctors' bills is more than their charges. In figuring your medical deduction, you must reduce the total amount you spent for medical care by the total amount of insurance you received, even if the policies don't cover some of your medical expenses.
Health reimbursement arrangement (HRA). A health reimbursement arrangement is an employer-funded plan that reimburses employees for medical care expenses and allows unused amounts to be carried forward. An HRA is funded solely by the employer and the reimbursements for medical expenses, up to a maximum dollar amount for a coverage period, aren't included in your income.
Other reimbursements. Generally, you don't reduce medical expenses by payments you receive for:
• Permanent loss or loss of use of a member or function of the body (loss of limb, sight, hearing, etc.) or disfigurement to the extent the payment is based on the nature of the injury without regard to the amount of time lost from work; or
• Loss of earnings.
You must, however, reduce your medical expenses by any part of these payments that is designated for medical costs. See How Do You Figure and Report the Deduction on Your Tax Return, later.
For how to treat damages received for personal injury or sickness, see Damages for Personal Injuries, later.
You don't have a medical deduction if you are reimbursed for all of your medical expenses for the year.
Excess reimbursement. If you are reimbursed more than your medical expenses, you may have to include the excess in income. You may want to use Figure 21-A to help you decide if any of your reimbursement is taxable.
[The following graphic has not been reproduced:
Figure 21-A. Is Your Excess Medical Reimbursement Taxable?]
Premiums paid by you. If you pay either the entire premium for your medical insurance or all of the costs of a plan similar to medical insurance and your insurance payments or other reimbursements are more than your total medical expenses for the year, you have an excess reimbursement. Generally, you don't include the excess reimbursement in your gross income.
Premiums paid by you and your employer. If both you and your employer contribute to your medical insurance plan and your employer's contributions aren't included in your gross income, you must include in your gross income the part of your excess reimbursement that is from your employer's contribution.
See Pub. 502 to figure the amount of the excess reimbursement you must include in gross income.
Reimbursement in a later year. If you are reimbursed in a later year for medical expenses you deducted in an earlier year, you generally must report the reimbursement as income up to the amount you previously deducted as medical expenses.
However, don't report as income the amount of reimbursement you received up to the amount of your medical deductions that didn't reduce your tax for the earlier year. For more information about the recovery of an amount that you claimed as an itemized deduction in an earlier year, see Itemized Deduction Recoveries in chapter 12.
Medical expenses not deducted. If you didn't deduct a medical expense in the year you paid it because your medical expenses weren't more than 10% of your AGI (7.5% of your AGI if either you or your spouse was born before January 2, 1952), or because you didn't itemize deductions, don't include the reimbursement up to the amount of the expense in income. However, if the reimbursement is more than the expense, see Excess reimbursement, earlier.
Example. For 2016, you were unmarried, you were born after January 2, 1952, and you had $500 of medical expenses. You can't deduct the $500 because it is less than 10% of your AGI. If, in a later year, you are reimbursed for any of the $500 in medical expenses, you don't include the amount reimbursed in your gross income.
Damages for Personal Injuries
If you receive an amount in settlement of a personal injury suit, part of that award may be for medical expenses that you deducted in an earlier year. If it is, you must include that part in your income in the year you receive it to the extent it reduced your taxable income in the earlier year. See Reimbursement in a Later Year, discussed under How Do You Treat Reimbursements, earlier.
Future medical expenses. If you receive an amount in settlement of a damage suit for personal injuries, part of that award may be for future medical expenses. If it is, you must reduce any future medical expenses for these injuries until the amount you received has been completely used.
How Do You Figure and Report the Deduction on Your Tax Return?
Once you have determined which medical expenses you can include, you figure and report the deduction on your tax return.
What Tax Form Do You Use?
You report your medical expense deduction on Form 1040EZ. If you need more information on itemized deductions or you aren't sure if you can itemize, see chapter 20.
Impairment-Related Work Expenses
If you are a person with a disability, you can take a business deduction for expenses that are necessary for you to be able to work. If you take a business deduction for impairment-related work expenses, they aren't subject to the 10% limit (or 7.5% if either you or your spouse was born before January 2, 1952), that applies to medical expenses.
You have a disability if you have:
• A physical or mental disability (for example, blindness or deafness) that functionally limits your being employed, or
• A physical or mental impairment (for example, a sight or hearing impairment) that substantially limits one or more of your major life activities, such as performing manual tasks, walking, speaking, breathing, learning, or working.
Impairment-related expenses defined. Impairment-related expenses are those ordinary and necessary business expenses that are:
• Necessary for you to do your work satisfactorily,
• For goods and services not required or used, other than incidentally, in your personal activities, and
• Not specifically covered under other income tax laws.
Where to report. If you are self-employed, deduct the business expenses on the appropriate form (Schedule C, C-EZ, E, or F) used to report your business income and expenses.
If you are an employee, complete Form 2106, Employee Business Expenses, or Form 2106-EZ, Unreimbursed Employee Business Expenses. Enter on Schedule A (Form 1040), that part of the amount on Form 2106, or Form 2106-EZ, that is related to your impairment. Enter the amount that is unrelated to your impairment also on Schedule A (Form 1040). Your impairment-related work expenses aren't subject to the 2%-of-adjusted-gross-income limit that applies to other employee business expenses.
Example. You are blind. You must use a reader to do your work. You use the reader both during your regular working hours at your place of work and outside your regular working hours away from your place of work. The reader's services are only for your work. You can deduct your expenses for the reader as business expenses.
Health Insurance Costs for Self-Employed Persons
If you were self-employed and had a net profit for the year, you may be able to deduct, as an adjustment to income, amounts paid for medical and qualified long-term care insurance on behalf of yourself, your spouse, your dependents, and your children who were under age 27 at the end of 2016. For this purpose, you were self-employed if you were a general partner (or a limited partner receiving guaranteed payments) or you received wages from an S corporation in which you were more than a 2% shareholder. The insurance plan must be established under your trade or business and the deduction can't be more than your earned income from that trade or business.
You can't deduct payments for medical insurance for any month in which you were eligible to participate in a health plan subsidized by your employer, your spouse's employer, or an employer of your dependent or your child under age 27 at the end of 2016. You can't deduct payments for a qualified long-term care insurance contract for any month in which you were eligible to participate in a long-term care insurance plan subsidized by your employer or your spouse's employer.
If you qualify to take the deduction, use the Self-Employed Health Insurance Deduction Worksheet in the Form 1040 instructions to figure the amount you can deduct. But if any of the following applies, don't use that worksheet. Instead, use the worksheet in Pub. 535, Business Expenses, to figure your deduction.
• You had more than one source of income subject to self-employment tax.
• You file Form 2555-EZ, Foreign Earned Income Exclusion.
• You are using amounts paid for qualified long-term care insurance to figure the deduction.
Use Pub. 974 instead of the worksheet in the Form 1040 instructions if you, your spouse, or a dependent enrolled in health insurance through the Health Insurance Marketplace and you are claiming the premium tax credit.
Note. When figuring the amount you can deduct for insurance premiums, don't include any advance payments shown on Form 1099-H, Health Coverage Tax Credit (HCTC) Advance Payments. If you are claiming the HCTC, subtract the amount shown on Form 8885, from the total insurance premiums you paid.
Don't include amounts paid for health insurance coverage with retirement plan distributions that were tax free because you are a retired public safety officer.
Where to report. You take this deduction on Form 1040. If you itemize your deductions and don't claim 100% of your self-employed health insurance on Form 1040, you can generally include any remaining premiums with all other medical expenses on Schedule A (Form 1040), subject to the 10% limit (7.5% if either you or your spouse was born before January 2, 1952). See Self-Employed Health Insurance Deduction in Pub. 535 and Medical and Dental Expenses in the Instructions for Schedule A (Form 1040), for more information.
22. Taxes
Introduction
This chapter discusses which taxes you can deduct if you itemize deductions on Schedule A (Form 1040). It also explains which taxes you can deduct on other schedules or forms and which taxes you cannot deduct.
This chapter covers the following topics.
• Income taxes (federal, state, local, and foreign).
• General sales taxes (state and local).
• Real estate taxes (state, local, and foreign).
• Personal property taxes (state and local).
• Taxes and fees you cannot deduct.
Use Table 22-1 as a guide to determine which taxes you can deduct.
The end of the chapter contains a section that explains which forms you use to deduct different types of taxes.
Business taxes. You can deduct certain taxes only if they are ordinary and necessary expenses of your trade or business or of producing income. For information on these taxes, see Pub. 535, Business Expenses.
State or local taxes. These are taxes imposed by the 50 states, U.S. possessions, or any of their political subdivisions (such as a county or city), or by the District of Columbia.
Indian tribal government. An Indian tribal government recognized by the Secretary of the Treasury as performing substantial government functions will be treated as a state for purposes of claiming a deduction for taxes. Income taxes, real estate taxes, and personal property taxes imposed by that Indian tribal government (or by any of its subdivisions that are treated as political subdivisions of a state) are deductible.
General sales taxes. These are taxes imposed at one rate on retail sales of a broad range of classes of items.
Foreign taxes. These are taxes imposed by a foreign country or any of its political subdivisions.
Useful Items
You may want to see:
Publication
• Publication 514 Foreign Tax Credit for Individuals
• Publication 530 Tax Information for Homeowners
Form (and Instructions)
• Schedule A (Form 1040) Itemized Deductions
• Schedule E (Form 1040) Supplemental Income and Loss
• Form 1116 Foreign Tax Credit
Tests To Deduct Any Tax
The following two tests must be met for you to deduct any tax.
• The tax must be imposed on you.
• You must pay the tax during your tax year.
The tax must be imposed on you. In general, you can deduct only taxes imposed on you.
Generally, you can deduct property taxes only if you are an owner of the property. If your spouse owns the property and pays the real estate taxes, the taxes are deductible on your spouse's separate return or on your joint return.
You must pay the tax during your tax year. If you are a cash basis taxpayer, you can deduct only those taxes you actually paid during your tax year. If you pay your taxes by check and the check is honored by your financial institution, the day you mail or deliver the check is the date of payment. If you use a pay-by-phone account (such as a credit card or electronic funds withdrawal), the date reported on the statement of the financial institution showing when payment was made is the date of payment. If you contest a tax liability and are a cash basis taxpayer, you can deduct the tax only in the year you actually pay it (or transfer money or other property to provide for satisfaction of the contested liability). See Pub. 538, Accounting Periods and Methods, for details.
If you use an accrual method of accounting, see Pub. 538 for more information.
Income Taxes
This section discusses the deductibility of state and local income taxes (including employee contributions to state benefit funds) and foreign income taxes.
State and Local Income Taxes
You can deduct state and local income taxes.
Exception. You can't deduct state and local income taxes you pay on income that is exempt from federal income tax, unless the exempt income is interest income. For example, you can't deduct the part of a state's income tax that is on a cost-of-living allowance exempt from federal income tax.
What To Deduct
Your deduction may be for withheld taxes, estimated tax payments, or other tax payments as follows.
Withheld taxes. You can deduct state and local income taxes withheld from your salary in the year they are withheld. Your Form(s) W-2 will show these amounts. Forms W-2G, 1099-MISC may also show state and local income taxes withheld.
Estimated tax payments. You can deduct estimated tax payments you made during the year to a state or local government. However, you must have a reasonable basis for making the estimated tax payments. Any estimated state or local tax payments that aren't made in good faith at the time of payment aren't deductible.
Example. You made an estimated state income tax payment. However, the estimate of your state tax liability shows that you will get a refund of the full amount of your estimated payment. You had no reasonable basis to believe you had any additional liability for state income taxes and you can't deduct the estimated tax payment.
Refund applied to taxes. You can deduct any part of a refund of prior-year state or local income taxes that you chose to have credited to your 2016 estimated state or local income taxes.
Don't reduce your deduction by either of the following items.
• Any state or local income tax refund (or credit) you expect to receive for 2016.
• Any refund of (or credit for) prior-year state and local income taxes you actually received in 2016.
However, part or all of this refund (or credit) may be taxable. See Refund (or credit) of state or local income taxes, later.
Separate federal returns. If you and your spouse file separate state, local, and federal income tax returns, each of you can deduct on your federal return only the amount of your own state and local income tax that you paid during the tax year.
Joint state and local returns. If you and your spouse file joint state and local returns and separate federal returns, each of you can deduct on your separate federal return a part of the total state and local income taxes paid during the tax year. You can deduct only the amount of the total taxes that is proportionate to your gross income compared to the combined gross income of you and your spouse. However, you can't deduct more than the amount you actually paid during the year. You can avoid this calculation if you and your spouse are jointly and individually liable for the full amount of the state and local income taxes. If so, you and your spouse can deduct on your separate federal returns the amount you each actually paid.
Joint federal return. If you file a joint federal return, you can deduct the total of the state and local income taxes both of you paid.
Contributions to state benefit funds. As an employee, you can deduct mandatory contributions to state benefit funds withheld from your wages that provide protection against loss of wages. For example, certain states require employees to make contributions to state funds providing disability or unemployment insurance benefits. Mandatory payments made to the following state benefit funds are deductible as state income taxes on Schedule A (Form 1040), line 5.
• Alaska Unemployment Compensation Fund.
• California Nonoccupational Disability Benefit Fund.
• New Jersey Nonoccupational Disability Benefit Fund.
• New Jersey Unemployment Compensation Fund.
• New York Nonoccupational Disability Benefit Fund.
• Pennsylvania Unemployment Compensation Fund.
• Rhode Island Temporary Disability Benefit Fund.
• Washington State Supplemental Workmen's Compensation Fund.
CAUTION: Employee contributions to private or voluntary disability plans aren't deductible.
Refund (or credit) of state or local income taxes. If you receive a refund of (or credit for) state or local income taxes in a year after the year in which you paid them, you may have to include the refund in income on Form 1040, line 10, in the year you receive it. This includes refunds resulting from taxes that were overwithheld, applied from a prior year return, not figured correctly, or figured again because of an amended return. If you didn't itemize your deductions in the previous year, don't include the refund in income. If you deducted the taxes in the previous year, include all or part of the refund on Form 1040, line 10, in the year you receive the refund. For a discussion of how much to include, see Recoveries in chapter 12.
Foreign Income Taxes
Generally, you can take either a deduction or a credit for income taxes imposed on you by a foreign country or a U.S. possession. However, you can't take a deduction or credit for foreign income taxes paid on income that is exempt from U.S. tax under the foreign earned income exclusion or the foreign housing exclusion. For information on these exclusions, see Pub. 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad. For information on the foreign tax credit, see Pub. 514.
State and Local General Sales Taxes
You can elect to deduct state and local general sales taxes, instead of state and local income taxes, as an itemized deduction on Schedule A (Form 1040), line 5b. You can use either your actual expenses or the state and local sales tax tables to figure your sales tax deduction.
Actual expenses. Generally, you can deduct the actual state and local general sales taxes (including compensating use taxes) if the tax rate was the same as the general sales tax rate. However, sales taxes on food, clothing, medical supplies, and motor vehicles are deductible as a general sales tax even if the tax rate was less than the general sales tax rate. If you paid sales tax on a motor vehicle at a rate higher than the general sales tax rate, you can deduct only the amount of tax that you would have paid at the general sales tax rate on that vehicle. If you use the actual expenses method, you must have receipts to show the general sales taxes paid. Don't include sales taxes paid on items used in your trade or business.
Motor vehicles. For purposes of this section, motor vehicles include cars, motorcycles, motor homes, recreational vehicles, sport utility vehicles, trucks, vans, and off-road vehicles. This also includes sales taxes on a leased motor vehicle, but not on vehicles used in your trade or business.
Optional sales tax tables. Instead of using your actual expenses, you can figure your state and local general sales tax deduction using the state and local sales tax tables in the Instructions for Schedule A (Form 1040). You may also be able to add the state and local general sales taxes paid on certain specified items.
Your applicable table amount is based on the state where you live, your income, and the number of exemptions claimed on your tax return. Your income is your adjusted gross income plus any nontaxable items such as the following.
• Tax-exempt interest.
• Veterans' benefits.
• Nontaxable combat pay.
• Workers' compensation.
• Nontaxable part of social security and railroad retirement benefits.
• Nontaxable part of IRA, pension, or annuity distributions, excluding rollovers.
• Public assistance payments.
If you lived in different states during the same tax year, you must prorate your applicable table amount for each state based on the days you lived in each state. See the Instructions for Schedule A (Form 1040), line 5, for details.
Real Estate Taxes
Deductible real estate taxes are any state, local, or foreign taxes on real property levied for the general public welfare. You can deduct these taxes only if they are assessed uniformly against all property under the jurisdiction of the taxing authority. The proceeds must be for general community or governmental purposes and not be a payment for a special privilege granted or service rendered to you.
Deductible real estate taxes generally don't include taxes charged for local benefits and improvements that increase the value of the property. They also don't include itemized charges for services (such as trash collection) assessed against specific property or certain people, even if the charge is paid to the taxing authority. For more information about taxes and charges that aren't deductible, see Real Estate-Related Items You Can't Deduct, later.
Tenant-shareholders in a cooperative housing corporation. Generally, if you are a tenant-stockholder in a cooperative housing corporation, you can deduct the amount paid to the corporation that represents your share of the real estate taxes the corporation paid or incurred for your dwelling unit. The corporation should provide you with a statement showing your share of the taxes. For more information, see Special Rules for Cooperatives in Pub. 530.
Division of real estate taxes between buyers and sellers. If you bought or sold real estate during the year, the real estate taxes must be divided between the buyer and the seller.
The buyer and the seller must divide the real estate taxes according to the number of days in the real property tax year (the period to which the tax is imposed relates) that each owned the property. The seller is treated as paying the taxes up to, but not including, the date of sale. The buyer is treated as paying the taxes beginning with the date of sale. This applies regardless of the lien dates under local law. Generally, this information is included on the settlement statement provided at the closing.
If you (the seller) can't deduct taxes until they are paid because you use the cash method of accounting, and the buyer of your property is personally liable for the tax, you are considered to have paid your part of the tax at the time of the sale. This lets you deduct the part of the tax to the date of sale even though you didn't actually pay it. However, you must also include the amount of that tax in the selling price of the property. The buyer must include the same amount in his or her cost of the property.
You figure your deduction for taxes on each property bought or sold during the real property tax year as follows.
Worksheet 22-1. Figuring Your Real Estate Tax Deduction
Keep for Your Records
1. Enter the total real estate taxes for the
real property tax year ______
2. Enter the number of days in the real
property tax year that you owned the
property ______
3. Divide line 2 by 365 (for leap years,
divide line 2 by 366) .
4. Multiply line 1 by line 3. This is your
deduction. Enter it on
Schedule A (Form 1040), line 6
======
Note. Repeat steps 1 through 4 for each property you
bought or sold during the real property tax year. Your
total deduction is the sum of the line 4 amounts for
all of the properties.
Real estate taxes for prior years. Don't divide delinquent taxes between the buyer and seller if the taxes are for any real property tax year before the one in which the property is sold. Even if the buyer agrees to pay the delinquent taxes, the buyer can't deduct them. The buyer must add them to the cost of the property. The seller can deduct these taxes paid by the buyer. However, the seller must include them in the selling price.
Examples. The following examples illustrate how real estate taxes are divided between buyer and seller.
Example 1. Dennis and Beth White's real property tax year for both their old home and their new home is the calendar year, with payment due August 1. The tax on their old home, sold on May 7, was $620. The tax on their new home, bought on May 3, was $732. Dennis and Beth are considered to have paid a proportionate share of the real estate taxes on the old home even though they didn't actually pay them to the taxing authority. On the other hand, they can claim only a proportionate share of the taxes they paid on their new property even though they paid the entire amount.
Dennis and Beth owned their old home during the real property tax year for 127 days (January 1 to May 6, the day before the sale). They figure their deduction for taxes on their old home as follows.
Worksheet 22-1. Figuring Your Real Estate Tax Deduction -- Taxes on Old Home
1. Enter the total real estate taxes for the
real property tax year $620
2. Enter the number of days in the real
property tax year that you owned the
property 127
3. Divide line 2 by 365 (for leap years,
divide line 2 by 366) .3470
4. Multiply line 1 by line 3. This is your
deduction. Enter it on Schedule A (Form 1040),
line 6 $215
======
Since the buyers of their old home paid all of the taxes, Dennis and Beth also include the $215 in the selling price of the old home. (The buyers add the $215 to their cost of the home.)
Dennis and Beth owned their new home during the real property tax year for 243 days (May 3 to December 31, including their date of purchase). They figure their deduction for taxes on their new home as follows.
Worksheet 22-1. Figuring Your Real Estate Tax Deduction -- Taxes on New Home
1. Enter the total real estate taxes for the
real property tax year $732
2. Enter the number of days in the real
property tax year that you owned the
property 243
3. Divide line 2 by 365 (for leap years,
divide line 2 by 366) .6639
4. Multiply line 1 by line 3. This is your
deduction. Enter it on Schedule A (Form 1040),
line 6 $486
======
Since Dennis and Beth paid all of the taxes on the new home, they add $246 ($732 paid less $486 deduction) to their cost of the new home. (The sellers add this $246 to their selling price and deduct the $246 as a real estate tax.)
Dennis and Beth's real estate tax deduction for their old and new homes is the sum of $215 and $486, or $701. They will enter this amount on Schedule A (Form 1040), line 6.
Example 2. George and Helen Brown bought a new home on May 3, 2016. Their real property tax year for the new home is the calendar year. Real estate taxes for 2015 were assessed in their state on January 1, 2016. The taxes became due on May 31, 2016, and October 31, 2016.
The Browns agreed to pay all taxes due after the date of purchase. Real estate taxes for 2015 were $680. They paid $340 on May 31, 2016, and $340 on October 31, 2016. These taxes were for the 2015 real property tax year. The Browns cannot deduct them since they didn't own the property until 2016. Instead, they must add $680 to the cost of their new home.
In January 2017, the Browns receive their 2016 property tax statement for $752, which they will pay in 2017. The Browns owned their new home during the 2016 real property tax year for 243 days (May 3 to December 31). They will figure their 2017 deduction for taxes as follows.
Worksheet 22-1. Figuring Your Real Estate Tax Deduction -- Taxes on New Home
1. Enter the total real estate taxes for the
real property tax year $752
2. Enter the number of days in the real
property tax year that you owned the
property 243
3. Divide line 2 by 365 (for leap years,
divide line 2 by 366) .6639
4. Multiply line 1 by line 3. This is your
deduction. Claim it on Schedule A (Form 1040),
line 6 $499
======
The remaining $253 ($752 paid less $499 deduction) of taxes paid in 2017, along with the $680 paid in 2016, is added to the cost of their new home.
Because the taxes up to the date of sale are considered paid by the seller on the date of sale, the seller is entitled to a 2016 tax deduction of $933. This is the sum of the $680 for 2015 and the $253 for the 123 days the seller owned the home in 2016. The seller must also include the $933 in the selling price when he or she figures the gain or loss on the sale. The seller should contact the Browns in January 2017 to find out how much real estate tax is due for 2016.
Form 1099-S. For certain sales or exchanges of real estate, the person responsible for closing the sale (generally the settlement agent) prepares Form 1099-S, Proceeds From Real Estate Transactions, to report certain information to the IRS and to the seller of the property. Box 2 of Form 1099-S is for the gross proceeds from the sale and should include the portion of the seller's real estate tax liability that the buyer will pay after the date of sale. The buyer includes these taxes in the cost basis of the property, and the seller both deducts this amount as a tax paid and includes it in the sales price of the property.
For a real estate transaction that involves a home, any real estate tax the seller paid in advance but that is the liability of the buyer appears on Form 1099-S, box 5. The buyer deducts this amount as a real estate tax, and the seller reduces his or her real estate tax deduction (or includes it in income) by the same amount. See Refund (or rebate), later.
Taxes placed in escrow. If your monthly mortgage payment includes an amount placed in escrow (put in the care of a third party) for real estate taxes, you may not be able to deduct the total amount placed in escrow. You can deduct only the real estate tax that the third party actually paid to the taxing authority. If the third party doesn't notify you of the amount of real estate tax that was paid for you, contact the third party or the taxing authority to find the proper amount to show on your return.
Tenants by the entirety. If you and your spouse held property as tenants by the entirety and you file separate federal returns, each of you can deduct only the taxes each of you paid on the property.
Divorced individuals. If your divorce or separation agreement states that you must pay the real estate taxes for a home owned by you and your spouse, part of your payments may be deductible as alimony and part as real estate taxes. See Taxes and insurance in chapter 18 for more information.
Ministers' and military housing allowances. If you are a minister or a member of the uniformed services and receive a housing allowance that you can exclude from income, you still can deduct all of the real estate taxes you pay on your home.
Refund (or rebate). If you received a refund or rebate in 2016 of real estate taxes you paid in 2016, you must reduce your deduction by the amount refunded to you. If you received a refund or rebate in 2016 of real estate taxes you deducted in an earlier year, you generally must include the refund or rebate in income in the year you receive it. However, the amount you include in income is limited to the amount of the deduction that reduced your tax in the earlier year. For more information, see Recoveries in chapter 12.
Real Estate-Related Items You Can't Deduct
Payments for the following items generally aren't deductible as real estate taxes.
• Taxes for local benefits.
• Itemized charges for services (such as trash and garbage pickup fees).
• Transfer taxes (or stamp taxes).
• Rent increases due to higher real estate taxes.
• Homeowners' association charges.
Taxes for local benefits. Deductible real estate taxes generally don't include taxes charged for local benefits and improvements tending to increase the value of your property. These include assessments for streets, sidewalks, water mains, sewer lines, public parking facilities, and similar improvements. You should increase the basis of your property by the amount of the assessment.
Local benefit taxes are deductible only if they are for maintenance, repair, or interest charges related to those benefits. If only a part of the taxes is for maintenance, repair, or interest, you must be able to show the amount of that part to claim the deduction. If you can't determine what part of the tax is for maintenance, repair, or interest, none of it is deductible.
CAUTION: Taxes for local benefits may be included in your real estate tax bill. If your taxing authority (or mortgage lender) doesn't furnish you a copy of your real estate tax bill, ask for it. You should use the rules above to determine if the local benefit tax is deductible. Contact the taxing authority if you need additional information about a specific charge on your real estate tax bill.
Itemized charges for services. An itemized charge for services assessed against specific property or certain people isn't a tax, even if the charge is paid to the taxing authority. For example, you can't deduct the charge as a real estate tax if it is:
• A unit fee for the delivery of a service (such as a $5 fee charged for every 1,000 gallons of water you use),
• A periodic charge for a residential service (such as a $20 per month or $240 annual fee charged to each homeowner for trash collection), or
• A flat fee charged for a single service provided by your government (such as a $30 charge for mowing your lawn because it was allowed to grow higher than permitted under your local ordinance).
CAUTION: You must look at your real estate tax bill to determine if any nondeductible itemized charges, such as those listed above, are included in the bill. If your taxing authority (or mortgage lender) doesn't furnish you a copy of your real estate tax bill, ask for it.
Exception. Service charges used to maintain or improve services (such as trash collection or police and fire protection) are deductible as real estate taxes if:
• The fees or charges are imposed at a like rate against all property in the taxing jurisdiction,
• The funds collected are not earmarked; instead, they are commingled with general revenue funds, and
• Funds used to maintain or improve services are not limited to or determined by the amount of these fees or charges collected.
Transfer taxes (or stamp taxes). Transfer taxes and similar taxes and charges on the sale of a personal home aren't deductible. If they are paid by the seller, they are expenses of the sale and reduce the amount realized on the sale. If paid by the buyer, they are included in the cost basis of the property.
Rent increase due to higher real estate taxes. If your landlord increases your rent in the form of a tax surcharge because of increased real estate taxes, you can't deduct the increase as taxes.
Homeowners' association charges. These charges aren't deductible because they are imposed by the homeowners' association, rather than the state or local government.
Personal Property Taxes
Personal property tax is deductible if it is a state or local tax that is:
• Charged on personal property,
• Based only on the value of the personal property, and
• Charged on a yearly basis, even if it is collected more or less than once a year.
A tax that meets the above requirements can be considered charged on personal property even if it is for the exercise of a privilege. For example, a yearly tax based on value qualifies as a personal property tax even if it is called a registration fee and is for the privilege of registering motor vehicles or using them on the highways.
If the tax is partly based on value and partly based on other criteria, it may qualify in part.
Example. Your state charges a yearly motor vehicle registration tax of 1% of value plus 50 cents per hundredweight. You paid $32 based on the value ($1,500) and weight (3,400 lbs.) of your car. You can deduct $15 (1% × $1,500) as a personal property tax because it is based on the value. The remaining $17 ($.50 × 34), based on the weight, isn't deductible.
Taxes and Fees You Can't Deduct
Many federal, state, and local government taxes aren't deductible because they don't fall within the categories discussed earlier. Other taxes and fees, such as federal income taxes, aren't deductible because the tax law specifically prohibits a deduction for them. See Table 22-1.
Table 22-1. Which Taxes Can You Deduct?
----------------------------------------------------------------------
Type of Tax You Can Deduct You Can't Deduct
----------------------------------------------------------------------
Fees and Charges Fees and charges that Fees and charges that
are expenses of your aren't expenses of
trade or business or your trade or business
of producing income. or of producing
income, such as fees
for driver's licenses,
car inspections,
parking, or charges
for water bills (see
Taxes and Fees You
Can't Deduct).
Fines and penalties.
----------------------------------------------------------------------
Income Taxes State and local income Federal income taxes.
taxes.
Foreign income taxes.
Employee contributions Employee contributions
to state funds listed to private or
under Contributions to voluntary disability
state benefit funds. plans.
State and local general
sales taxes if you
choose to deduct state
and local income
taxes.
----------------------------------------------------------------------
General Sales Taxes State and local general State and local income
sales taxes, including taxes if you choose
compensating use taxes. to deduct state and
local general sales
taxes.
----------------------------------------------------------------------
Other Taxes Taxes that are expenses Federal excise taxes,
of your trade or such as tax on
business. gasoline, that aren't
expenses of your trade
or business or of
producing income.
Taxes on property Per capita taxes.
producing rent or
royalty income.
Occupational taxes. See
chapter 28.
One-half of
self-employment tax
paid.
----------------------------------------------------------------------
Personal Property State and local personal Customs duties that
Taxes property taxes. aren't expenses of
your trade or business
or of producing
income.
----------------------------------------------------------------------
Real Estate Taxes State and local real Real estate taxes that
estate taxes. are treated as imposed
on someone else (see
Division of real
estate taxes between
buyers and sellers).
Foreign real estate Taxes for local
taxes. benefits (with
exceptions). See Real
Estate-Related Items
You Can't Deduct.
Tenant's share of real Trash and garbage
estate taxes paid by pickup fees (with
cooperative housing exceptions). See Real
corporation. Estate-Related Items
You Can't Deduct.
Rent increase due to
higher real estate
taxes.
Homeowners' association
charges.
----------------------------------------------------------------------
Taxes and fees that are generally not deductible include the following items.
• Employment taxes. This includes social security, Medicare, and railroad retirement taxes withheld from your pay. However, one-half of self-employment tax you pay is deductible. In addition, the social security and other employment taxes you pay on the wages of a household worker may be included in medical expenses that you can deduct or child care expenses that allow you to claim the child and dependent care credit. For more information, see chapters 21 and 32.
• Estate, inheritance, legacy, or succession taxes. However, you can deduct the estate tax attributable to income in respect of a decedent if you, as a beneficiary, must include that income in your gross income. In that case, deduct the estate tax as a miscellaneous deduction that isn't subject to the 2%-of-adjusted-gross-income limit. For more information, see Pub. 559, Survivors, Executors, and Administrators.
• Federal income taxes. This includes income taxes withheld from your pay.
• Fines and penalties. You can't deduct fines and penalties paid to a government for violation of any law, including related amounts forfeited as collateral deposits.
• Gift taxes.
• License fees. You can't deduct license fees for personal purposes (such as marriage, driver's, and dog license fees).
• Per capita taxes. You can't deduct state or local per capita taxes.
Many taxes and fees other than those listed above are also nondeductible, unless they are ordinary and necessary expenses of a business or income producing activity. For other nondeductible items, see Real Estate-Related Items You Can't Deduct, earlier.
Where To Deduct
You deduct taxes on the following schedules.
State and local income taxes. These taxes are deducted on Schedule A (Form 1040), line 5, even if your only source of income is from business, rents, or royalties. Check box a on line 5.
General sales taxes. Sales taxes are deducted on Schedule A (Form 1040), line 5. You must check box b on line 5. If you elect to deduct sales taxes, you can't deduct state and local income taxes on Schedule A (Form 1040), line 5, box a.
Foreign income taxes. Generally, income taxes you pay to a foreign country or U.S. possession can be claimed as an itemized deduction on Schedule A (Form 1040), line 8, or as a credit against your U.S. income tax on Form 1040, line 48. To claim the credit, you may have to complete and attach Form 1116. For more information, see chapter 38, the Form 1040 instructions, or Pub. 514.
Real estate taxes and personal property taxes. Real estate and personal property taxes are deducted on Schedule A (Form 1040), lines 6 and 7, respectively, unless they are paid on property used in your business, in which case they are deducted on Schedule F (Form 1040). Taxes on property that produces rent or royalty income are deducted on Schedule E (Form 1040).
Self-employment tax. Deduct one-half of your self-employment tax on Form 1040, line 27.
Other taxes. All other deductible taxes are deducted on Schedule A (Form 1040), line 8.
23. Interest Expense
Introduction
This chapter discusses what interest expenses you can deduct. Interest is the amount you pay for the use of borrowed money.
The following are types of interest you can deduct as itemized deductions on Schedule A (Form 1040).
• Home mortgage interest, including certain points and mortgage insurance premiums.
• Investment interest.
This chapter explains these deductions. It also explains where to deduct other types of interest and lists some types of interest you can't deduct.
Use Table 23-1 to find out where to get more information on various types of interest, including investment interest.
Useful Items
You may want to see:
Publication
Home Mortgage Interest
Generally, home mortgage interest is any interest you pay on a loan secured by your home (main home or a second home). The loan may be a mortgage to buy your home, a second mortgage, a line of credit, or a home equity loan.
You can deduct home mortgage interest if all the following conditions are met.
• You file Form 1040 and itemize deductions on Schedule A (Form 1040).
• The mortgage is a secured debt on a qualified home in which you have an ownership interest. (Generally, your mortgage is a secured debt if you put your home up as collateral to protect the interest of the lender. The term "qualified home" means your main home or second home. For details, see Pub. 936.)
Both you and the lender must intend that the loan be repaid.
Amount Deductible
In most cases, you can deduct all of your home mortgage interest. How much you can deduct depends on the date of the mortgage, the amount of the mortgage, and how you use the mortgage proceeds.
Fully deductible interest. If all of your mortgages fit into one or more of the following three categories at all times during the year, you can deduct all of the interest on those mortgages. (If any one mortgage fits into more than one category, add the debt that fits in each category to your other debt in the same category.)
The three categories are as follows:
1. Mortgages you took out on or before October 13, 1987 (called grandfathered debt).
2. Mortgages you (or your spouse if married filing a joint return) took out after October 13, 1987, to buy, build, or improve your home (called home acquisition debt), but only if throughout 2016 these mortgages plus any grandfathered debt totaled $1 million or less ($500,000 or less if married filing separately).
3. Mortgages you (or your spouse if married filing a joint return) took out after October 13, 1987, that are home equity debt but that are not home acquisition debt, but only if throughout 2016 these mortgages totaled $100,000 or less ($50,000 or less if married filing separately) and totaled no more than the fair market value of your home reduced by (1) and (2).
The dollar limits for the second and third categories apply to the combined mortgages on your main home and second home.
See Part II of Pub. 936 for more detailed definitions of grandfathered, home acquisition, and home equity debt.
You can use Figure 23-A to check whether your home mortgage interest is fully deductible.
[The following graphic has not been reproduced:
Figure 23-A. Is My Home Mortgage Interest Fully Deductible?]
Limits on deduction. You can't fully deduct interest on a mortgage that doesn't fit into any of the three categories listed earlier. If this applies to you, see Part II of Pub. 936 to figure the amount of interest you can deduct.
Special Situations
This section describes certain items that can be included as home mortgage interest and others that can't. It also describes certain special situations that may affect your deduction.
Late payment charge on mortgage payment. You can deduct as home mortgage interest a late payment charge if it wasn't for a specific service performed in connection with your mortgage loan.
Mortgage prepayment penalty. If you pay off your home mortgage early, you may have to pay a penalty. You can deduct that penalty as home mortgage interest provided the penalty isn't for a specific service performed or cost incurred in connection with your mortgage loan.
Sale of home. If you sell your home, you can deduct your home mortgage interest (subject to any limits that apply) paid up to, but not including, the date of sale.
Example. John and Peggy Harris sold their home on May 7. Through April 30, they made home mortgage interest payments of $1,220. The settlement sheet for the sale of the home showed $50 interest for the 6-day period in May up to, but not including, the date of sale. Their mortgage interest deduction is $1,270 ($1,220 + $50).
Prepaid interest. If you pay interest in advance for a period that goes beyond the end of the tax year, you must spread this interest over the tax years to which it applies. You can deduct in each year only the interest that qualifies as home mortgage interest for that year. However, there is an exception that applies to points, discussed later.
Mortgage interest credit. You may be able to claim a mortgage interest credit if you were issued a mortgage credit certificate (MCC) by a state or local government. Figure the credit on Form 8396, Mortgage Interest Credit. If you take this credit, you must reduce your mortgage interest deduction by the amount of the credit.
For more information on the credit, see chapter 38.
Ministers' and military housing allowance. If you are a minister or a member of the uniformed services and receive a housing allowance that isn't taxable, you can still deduct your home mortgage interest.
Hardest Hit Fund and Emergency Homeowners' Loan Programs. You can use a special method to compute your deduction for mortgage interest and real estate taxes on your main home if you meet the following two conditions.
1. You received assistance under:
a. A State Housing Finance Agency (State HFA) Hardest Hit Fund program in which program payments could be used to pay mortgage interest, or
b. An Emergency Homeowners' Loan Program administered by the Department of Housing and Urban Development (HUD) or a state.
2. You meet the rules to deduct all of the mortgage interest on your loan and all of the real estate taxes on your main home.
If you meet these conditions, then you can deduct all of the payments you actually made during the year to your mortgage servicer, the State HFA, or HUD on the home mortgage (including the amount shown on box 3 of Form 1098-MA, Mortgage Assistance Payments), but not more than the sum of the amounts shown on Form 1098, Mortgage Interest Statement, in box 1 (mortgage interest received from payer(s)/borrower(s)), box 5 (mortgage insurance premiums), and box 10 (real property taxes). However, you aren't required to use this special method to compute your deduction for mortgage interest and real estate taxes on your main home.
Mortgage assistance payments under section 235 of the National Housing Act. If you qualify for mortgage assistance payments for lower-income families under section 235 of the National Housing Act, part or all of the interest on your mortgage may be paid for you. You can't deduct the interest that is paid for you.
No other effect on taxes. Don't include these mortgage assistance payments in your income. Also, don't use these payments to reduce other deductions, such as real estate taxes.
Divorced or separated individuals. If a divorce or separation agreement requires you or your spouse or former spouse to pay home mortgage interest on a home owned by both of you, the payment of interest may be alimony. See the discussion of Payments for jointly-owned home in chapter 18.
Redeemable ground rents. If you make annual or periodic rental payments on a redeemable ground rent, you can deduct them as mortgage interest.
Payments made to end the lease and to buy the lessor's entire interest in the land aren't deductible as mortgage interest. For more information, see Pub. 936.
Nonredeemable ground rents. Payments on a nonredeemable ground rent aren't mortgage interest. You can deduct them as rent if they are a business expense or if they are for rental property.
Reverse mortgages. A reverse mortgage is a loan where the lender pays you (in a lump sum, a monthly advance, a line of credit, or a combination of all three) while you continue to live in your home. With a reverse mortgage, you retain title to your home. Depending on the plan, your reverse mortgage becomes due with interest when you move, sell your home, reach the end of a pre-selected loan period, or die. Because reverse mortgages are considered loan advances and not income, the amount you receive isn't taxable. Any interest (including original issue discount) accrued on a reverse mortgage isn't deductible until the loan is paid in full. Your deduction may be limited because a reverse mortgage loan generally is subject to the limit on Home Equity Debt discussed in Pub. 936.
Rental payments. If you live in a house before final settlement on the purchase, any payments you make for that period are rent and not interest. This is true even if the settlement papers call them interest. You can't deduct these payments as home mortgage interest.
Mortgage proceeds invested in tax-exempt securities. You can't deduct the home mortgage interest on grandfathered debt or home equity debt if you used the proceeds of the mortgage to buy securities or certificates that produce tax-free income. "Grandfathered debt" and "home equity debt" are defined earlier under Amount Deductible.
Refunds of interest. If you receive a refund of interest in the same tax year you paid it, you must reduce your interest expense by the amount refunded to you. If you receive a refund of interest you deducted in an earlier year, you generally must include the refund in income in the year you receive it. However, you need to include it only up to the amount of the deduction that reduced your tax in the earlier year. This is true whether the interest overcharge was refunded to you or was used to reduce the outstanding principal on your mortgage.
If you received a refund of interest you overpaid in an earlier year, you generally will receive a Form 1098, Mortgage Interest Statement, showing the refund in box 4. For information about Form 1098, see Form 1098, Mortgage Interest Statement, later.
For more information on how to treat refunds of interest deducted in earlier years, see Recoveries in chapter 12.
Points
The term "points" is used to describe certain charges paid, or treated as paid, by a borrower to obtain a home mortgage. Points may also be called loan origination fees, maximum loan charges, loan discount, or discount points.
A borrower is treated as paying any points that a home seller pays for the borrower's mortgage. See Points paid by the seller, later.
General Rule
You generally can't deduct the full amount of points in the year paid. Because they are prepaid interest, you generally deduct them ratably over the life (term) of the mortgage. See Deduction Allowed Ratably next.
For exceptions to the general rule, see Deduction Allowed in Year Paid, later.
Deduction Allowed Ratably
If you don't meet the tests listed under Deduction Allowed in Year Paid next, the loan isn't a home improvement loan, or you choose not to deduct your points in full in the year paid, you can deduct the points ratably (equally) over the life of the loan if you meet all the following tests.
1. You use the cash method of accounting. This means you report income in the year you receive it and deduct expenses in the year you pay them. Most individuals use this method.
2. Your loan is secured by a home. (The home doesn't need to be your main home.)
3. Your loan period isn't more than 30 years.
4. If your loan period is more than 10 years, the terms of your loan are the same as other loans offered in your area for the same or longer period.
5. Either your loan amount is $250,000 or less, or the number of points isn't more than:
a. 4, if your loan period is 15 years or less, or
b. 6, if your loan period is more than 15 years.
[The following graphic has not been reproduced:
Figure 23-B. Are My Points Fully Deductible This Year?]
You can fully deduct points in the year paid if you meet all the following tests. (You can use Figure 23-B as a quick guide to see whether your points are fully deductible in the year paid.)
1. Your loan is secured by your main home. (Your main home is the one you ordinarily live in most of the time.)
2. Paying points is an established business practice in the area where the loan was made.
3. The points paid weren't more than the points generally charged in that area.
4. You use the cash method of accounting. This means you report income in the year you receive it and deduct expenses in the year you pay them. (If you want more information about this method, see Accounting Methods in chapter 1.)
5. The points weren't paid in place of amounts that ordinarily are stated separately on the settlement statement, such as appraisal fees, inspection fees, title fees, attorney fees, and property taxes.
6. The funds you provided at or before closing, plus any points the seller paid, were at least as much as the points charged. The funds you provided aren't required to have been applied to the points. They can include a down payment, an escrow deposit, earnest money, and other funds you paid at or before closing for any purpose. You cannot have borrowed these funds from your lender or mortgage broker.
7. You use your loan to buy or build your main home.
8. The points were computed as a percentage of the principal amount of the mortgage.
9. The amount is clearly shown on the settlement statement (such as the Settlement Statement, Form HUD-1) as points charged for the mortgage. The points may be shown as paid from either your funds or the seller's.
Note. If you meet all of these tests, you can choose to either fully deduct the points in the year paid, or deduct them over the life of the loan.
Home improvement loan. You can also fully deduct in the year paid points paid on a loan to improve your main home, if tests (1) through (6) are met.
CAUTION: Second home. You can't fully deduct in the year paid points you pay on loans secured by your second home. You can deduct these points only over the life of the loan.
Refinancing. Generally, points you pay to refinance a mortgage aren't deductible in full in the year you pay them. This is true even if the new mortgage is secured by your main home.
However, if you use part of the refinanced mortgage proceeds to improve your main home and you meet the first 6 tests listed under Deduction Allowed in Year Paid, earlier, you can fully deduct the part of the points related to the improvement in the year you paid them with your own funds. You can deduct the rest of the points over the life of the loan.
Example 1. In 2001, Bill Fields got a mortgage to buy a home. In 2016, Bill refinanced that mortgage with a 15-year $100,000 mortgage loan. The mortgage is secured by his home. To get the new loan, he had to pay three points ($3,000). Two points ($2,000) were for prepaid interest, and one point ($1,000) was charged for services, in place of amounts that ordinarily are stated separately on the settlement statement. Bill paid the points out of his private funds, rather than out of the proceeds of the new loan. The payment of points is an established practice in the area, and the points charged aren't more than the amount generally charged there. Bill's first payment on the new loan was due July 1. He made six payments on the loan in 2016 and is a cash basis taxpayer.
Bill used the funds from the new mortgage to repay his existing mortgage. Although the new mortgage loan was for Bill's continued ownership of his main home, it wasn't for the purchase or improvement of that home. He can't deduct all of the points in 2016. He can deduct two points ($2,000) ratably over the life of the loan. He deducts $67 [($2,000 ÷ 180 months) × 6 payments] of the points in 2016. The other point ($1,000) was a fee for services and isn't deductible.
Example 2. The facts are the same as in Example 1, except that Bill used $25,000 of the loan proceeds to improve his home and $75,000 to repay his existing mortgage. Bill deducts 25% ($25,000 ÷ $100,000) of the points ($2,000) in 2016. His deduction is $500 ($2,000 × 25%).
Bill also deducts the ratable part of the remaining $1,500 ($2,000 - $500) that must be spread over the life of the loan. This is $50 [($1,500 ÷ 180 months) × 6 payments] in 2016. The total amount Bill deducts in 2016 is $550 ($500 + $50).
Special Situations
This section describes certain special situations that may affect your deduction of points.
Original issue discount. If you don't qualify to either deduct the points in the year paid or deduct them ratably over the life of the loan, or if you choose not to use either of these methods, the points reduce the issue price of the loan. This reduction results in original issue discount, which is discussed in chapter 4 of Pub. 535.
Amounts charged for services. Amounts charged by the lender for specific services connected to the loan aren't interest. Examples of these charges are:
• Appraisal fees,
• Notary fees, and
• Preparation costs for the mortgage note or deed of trust.
You can't deduct these amounts as points either in the year paid or over the life of the mortgage.
Points paid by the seller. The term "points" includes loan placement fees that the seller pays to the lender to arrange financing for the buyer.
Treatment by seller. The seller can't deduct these fees as interest. But they are a selling expense that reduces the amount realized by the seller. See chapter 15 for information on selling your home.
Treatment by buyer. The buyer reduces the basis of the home by the amount of the seller-paid points and treats the points as if he or she had paid them. If all the tests under Deduction Allowed in Year Paid, earlier, are met, the buyer can deduct the points in the year paid. If any of those tests aren't met, the buyer deducts the points over the life of the loan.
For information about basis, see chapter 13.
Funds provided are less than points. If you meet all the tests in Deduction Allowed in Year Paid, earlier, except that the funds you provided were less than the points charged to you (test (6)), you can deduct the points in the year paid, up to the amount of funds you provided. In addition, you can deduct any points paid by the seller.
Example 1. When you took out a $100,000 mortgage loan to buy your home in December, you were charged one point ($1,000). You meet all the tests for deducting points in the year paid, except the only funds you provided were a $750 down payment. Of the $1,000 charged for points, you can deduct $750 in the year paid. You spread the remaining $250 over the life of the mortgage.
Example 2. The facts are the same as in Example 1, except that the person who sold you your home also paid one point ($1,000) to help you get your mortgage. In the year paid, you can deduct $1,750 ($750 of the amount you were charged plus the $1,000 paid by the seller). You spread the remaining $250 over the life of the mortgage. You must reduce the basis of your home by the $1,000 paid by the seller.
Excess points. If you meet all the tests in Deduction Allowed in Year Paid, earlier, except that the points paid were more than generally paid in your area (test (3)), you deduct in the year paid only the points that are generally charged. You must spread any additional points over the life of the mortgage.
Mortgage ending early. If you spread your deduction for points over the life of the mortgage, you can deduct any remaining balance in the year the mortgage ends. However, if you refinance the mortgage with the same lender, you can't deduct any remaining balance of spread points. Instead, deduct the remaining balance over the term of the new loan.
A mortgage may end early due to a prepayment, refinancing, foreclosure, or similar event.
Example. Dan paid $3,000 in points in 2005 that he had to spread out over the 15-year life of the mortgage. He deducts $200 points per year. Through 2015, Dan has deducted $2,200 of the points.
Dan prepaid his mortgage in full in 2016. He can deduct the remaining $800 of points in 2016.
Limits on deduction. You can't fully deduct points paid on a mortgage unless the mortgage fits into one of the categories listed earlier under Fully deductible interest. See Pub. 936 for details.
Mortgage Insurance Premiums
You can treat amounts you paid during 2016 for qualified mortgage insurance as home mortgage interest. The insurance must be in connection with home acquisition debt and the insurance contract must have been issued after 2006.
Qualified mortgage insurance. Qualified mortgage insurance is mortgage insurance provided by the Department of Veterans Affairs, the Federal Housing Administration, or the Rural Housing Service, and private mortgage insurance (as defined in section 2 of the Homeowners Protection Act of 1998 as in effect on December 20, 2006).
Mortgage insurance provided by the Department of Veterans Affairs is commonly known as a funding fee. If provided by the Rural Housing Service, it is commonly known as a guarantee fee. These fees can be deducted fully in 2016 if the mortgage insurance contract was issued in 2016. Contact the mortgage insurance issuer to determine the deductible amount if it is not reported in box 5 of Form 1098.
Special rules for prepaid mortgage insurance. Generally, if you paid premiums for qualified mortgage insurance that are allocable to periods after the close of the tax year, such premiums are treated as paid in the period to which they are allocated. You must allocate the premiums over the shorter of the stated term of the mortgage or 84 months, beginning with the month the insurance was obtained. No deduction is allowed for the unamortized balance if the mortgage is satisfied before its term. This paragraph does not apply to qualified mortgage insurance provided by the Department of Veterans Affairs or the Rural Housing Service. See the Example below.
Example. Ryan purchased a home in May of 2015 and financed the home with a 15-year mortgage. Ryan also prepaid all of the $9,240 in private mortgage insurance required at the time of closing in May. Since the $9,240 in private mortgage insurance is allocable to periods after 2015, Ryan must allocate the $9,240 over the shorter of the life of the mortgage or 84 months. Ryan's adjusted gross income (AGI) for 2015 is $76,000. Ryan can deduct $880 ($9,240 ÷ 84 × 8 months) for qualified mortgage insurance premiums in 2015. For 2016, Ryan can deduct $1,320 ($9,240 ÷ 84 × 12 months) if his AGI is $100,000 or less.
In this example, the mortgage insurance premiums are allocated over 84 months, which is shorter than the life of the mortgage of 15 years (180 months).
Limit on deduction. If your adjusted gross income on Form 1040, line 38, is more than $100,000 ($50,000 if your filing status is married filing separately), the amount of your mortgage insurance premiums that are otherwise deductible is reduced and may be eliminated. See Line 13 in the instructions for Schedule A (Form 1040) and complete the Mortgage Insurance Premiums Deduction Worksheet to figure the amount you can deduct. If your adjusted gross income is more than $109,000 ($54,500 if married filing separately), you cannot deduct your mortgage insurance premiums.
Form 1098, Mortgage Interest Statement
If you paid $600 or more of mortgage interest (including certain points and mortgage insurance premiums) during the year on any one mortgage, you generally will receive a Form 1098 or a similar statement from the mortgage holder. You will receive the statement if you pay interest to a person (including a financial institution or a cooperative housing corporation) in the course of that person's trade or business. A governmental unit is a person for purposes of furnishing the statement.
The statement for each year should be sent to you by January 31 of the following year. A copy of this form will also be sent to the IRS.
The statement will show the total interest you paid during the year, any mortgage insurance premiums you paid, and if you purchased a main home during the year, it also will show the deductible points paid during the year, including seller-paid points. However, it shouldn't show any interest that was paid for you by a government agency.
As a general rule, Form 1098 will include only points that you can fully deduct in the year paid. However, certain points not included on Form 1098 also may be deductible, either in the year paid or over the life of the loan. See Points, earlier, to determine whether you can deduct points not shown on Form 1098.
Prepaid interest on Form 1098. If you prepaid interest in 2016 that accrued in full by January 15, 2017, this prepaid interest may be included in box 1 of Form 1098. However, you can't deduct the prepaid amount for January 2017 in 2016. (See Prepaid interest, earlier.) You will have to figure the interest that accrued for 2017 and subtract it from the amount in box 1. You will include the interest for January 2017 with the other interest you pay for 2017. See How To Report, later.
Refunded interest. If you received a refund of mortgage interest you overpaid in an earlier year, you generally will receive a Form 1098 showing the refund in box 4. See Refunds of interest, earlier.
Mortgage insurance premiums. The amount of mortgage insurance premiums you paid during 2016 may be shown in box 5 of Form 1098. See Mortgage Insurance Premiums, earlier.
Investment Interest
This section discusses interest expenses you may be able to deduct as an investor.
If you borrow money to buy property you hold for investment, the interest you pay is investment interest. You can deduct investment interest subject to the limit discussed later. However, you can't deduct interest you incurred to produce tax-exempt income. Nor can you deduct interest expenses on straddles.
Investment interest doesn't include any qualified home mortgage interest or any interest taken into account in computing income or loss from a passive activity.
Investment Property
Property held for investment includes property that produces interest, dividends, annuities, or royalties not derived in the ordinary course of a trade or business. It also includes property that produces gain or loss (not derived in the ordinary course of a trade or business) from the sale or trade of property producing these types of income or held for investment (other than an interest in a passive activity). Investment property also includes an interest in a trade or business activity in which you didn't materially participate (other than a passive activity).
Partners, shareholders, and beneficiaries. To determine your investment interest, combine your share of investment interest from a partnership, S corporation, estate, or trust with your other investment interest.
Allocation of Interest Expense
If you borrow money for business or personal purposes as well as for investment, you must allocate the debt among those purposes. Only the interest expense on the part of the debt used for investment purposes is treated as investment interest. The allocation isn't affected by the use of property that secures the debt.
Limit on Deduction
Generally, your deduction for investment interest expense is limited to the amount of your net investment income.
You can carry over the amount of investment interest that you couldn't deduct because of this limit to the next tax year. The interest carried over is treated as investment interest paid or accrued in that next year.
You can carry over disallowed investment interest to the next tax year even if it's more than your taxable income in the year the interest was paid or accrued.
Net Investment Income
Determine the amount of your net investment income by subtracting your investment expenses (other than interest expense) from your investment income.
Investment income. This generally includes your gross income from property held for investment (such as interest, dividends, annuities, and royalties). Investment income doesn't include Alaska Permanent Fund dividends. It also doesn't include qualified dividends or net capital gain unless you choose to include them.
Choosing to include qualified dividends. Investment income generally doesn't include qualified dividends, discussed in chapter 8. However, you can choose to include all or part of your qualified dividends in investment income.
You make this choice by completing Form 4952, line 4g, according to its instructions.
If you choose to include any amount of your qualified dividends in investment income, you must reduce your qualified dividends that are eligible for the lower capital gains tax rates by the same amount.
Choosing to include net capital gain. Investment income generally doesn't include net capital gain from disposing of investment property (including capital gain distributions from mutual funds). However, you can choose to include all or part of your net capital gain in investment income.
You make this choice by completing Form 4952, line 4g, according to its instructions.
If you choose to include any amount of your net capital gain in investment income, you must reduce your net capital gain that is eligible for the lower capital gains tax rates by the same amount.
TIP: Before making either choice, consider the overall effect on your tax liability. Compare your tax if you make one or both of these choices with your tax if you don't make either choice.
Investment income of child reported on parent's return. Investment income includes the part of your child's interest and dividend income that you choose to report on your return. If the child doesn't have qualified dividends, Alaska Permanent Fund dividends, or capital gain distributions, this is the amount on line 6 of Form 8814, Parents' Election To Report Child's Interest and Dividends.
Child's qualified dividends. If part of the amount you report is your child's qualified dividends, that part (which is reported on Form 1040, line 9b) generally doesn't count as investment income. However, you can choose to include all or part of it in investment income, as explained under Choosing to include qualified dividends, earlier.
Your investment income also includes the amount on Form 8814, line 12 (or, if applicable, the reduced amount figured next under Child's Alaska Permanent Fund dividends).
Child's Alaska Permanent Fund dividends. If part of the amount you report is your child's Alaska Permanent Fund dividends, that part doesn't count as investment income. To figure the amount of your child's income that you can consider your investment income, start with the amount on Form 8814, line 6. Multiply that amount by a percentage that is equal to the Alaska Permanent Fund dividends divided by the total amount on Form 8814, line 4. Subtract the result from the amount on Form 8814, line 12.
Child's capital gain distributions. If part of the amount you report is your child's capital gain distributions, that part (which is reported on Schedule D, line 13, or Form 1040, line 13) generally doesn't count as investment income. However, you can choose to include all or part of it in investment income, as explained in Choosing to include net capital gain, earlier.
Your investment income also includes the amount on Form 8814, line 12 (or, if applicable, the reduced amount figured under Child's Alaska Permanent Fund dividends, earlier).
Investment expenses. Investment expenses are your allowed deductions (other than interest expense) directly connected with the production of investment income. Investment expenses that are included as a miscellaneous itemized deduction on Schedule A (Form 1040) are allowable deductions after applying the 2% limit that applies to miscellaneous itemized deductions. Use the smaller of:
• The investment expenses included on Schedule A (Form 1040), line 23, or
• The amount on Schedule A, line 27.
Losses from passive activities. Income or expenses that you used in computing income or loss from a passive activity aren't included in determining your investment income or investment expenses (including investment interest expense). See Pub. 925, Passive Activity and At-Risk Rules, for information about passive activities.
Form 4952
Use Form 4952, Investment Interest Expense Deduction, to figure your deduction for investment interest.
Exception to use of Form 4952. You don't have to complete Form 4952 or attach it to your return if you meet all of the following tests.
• Your investment interest expense isn't more than your investment income from interest and ordinary dividends minus any qualified dividends.
• You don't have any other deductible investment expenses.
• You have no carryover of investment interest expense from 2015.
If you meet all of these tests, you can deduct all of your investment interest.
More Information
For more information on investment interest, see Interest Expenses in chapter 3 of Pub. 550.
Items You Can't Deduct
Some interest payments aren't deductible. Certain expenses similar to interest also aren't deductible. Nondeductible expenses include the following items.
• Personal interest (discussed later).
• Service charges (however, see Other Expenses (Line 23) in chapter 28).
• Annual fees for credit cards.
• Loan fees.
• Credit investigation fees.
• Interest to purchase or carry tax-exempt securities.
Penalties. You can't deduct fines and penalties paid to a government for violations of law, regardless of their nature.
Personal Interest
Personal interest isn't deductible. Personal interest is any interest that isn't home mortgage interest, investment interest, business interest, or other deductible interest. It includes the following items.
• Interest on car loans (unless you use the car for business).
• Interest on federal, state, or local income tax.
• Finance charges on credit cards, retail installment contracts, and revolving charge accounts incurred for personal expenses.
• Late payment charges by a public utility.
TIP: You may be able to deduct interest you pay on a qualified student loan. For details, see Pub. 970, Tax Benefits for Education.
Allocation of Interest
If you use the proceeds of a loan for more than one purpose (for example, personal and business), you must allocate the interest on the loan to each use. However, you don't have to allocate home mortgage interest if it is fully deductible, regardless of how the funds are used.
You allocate interest (other than fully deductible home mortgage interest) on a loan in the same way as the loan itself is allocated. You do this by tracing disbursements of the debt proceeds to specific uses. For details on how to do this, see chapter 4 of Pub. 535.
How To Report
You must file Form 1040 to deduct any home mortgage interest expense on your tax return. Where you deduct your interest expense generally depends on how you use the loan proceeds. See Table 23-1 for a summary of where to deduct your interest expense.
Table 23-1. Where To Deduct Your Interest Expense
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AND for more
information go
IF you have . . . THEN deduct it on . . . to . . .
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deductible student loan Pub. 970.
interest Form 1040A, line 18
----------------------------------------------------------------------
deductible home mortgage Pub. 936.
interest and points reported line 10
on Form 1098
----------------------------------------------------------------------
deductible home mortgage Pub. 936.
interest not reported on line 11
Form 1098
----------------------------------------------------------------------
deductible points not Pub. 936.
reported on Form 1098 line 12
----------------------------------------------------------------------
deductible mortgage Pub. 936.
insurance premiums line 13
----------------------------------------------------------------------
deductible investment Pub. 550.
interest (other than line 14
incurred to produce rents or
royalties)
----------------------------------------------------------------------
deductible business interest Pub. 535.
(non-farm) C-EZ(Form 1040)
----------------------------------------------------------------------
deductible farm business Pub. 225 and
interest Pub. 535.
----------------------------------------------------------------------
deductible interest incurred Pub. 527 and
to produce rents or Pub. 535.
royalties
----------------------------------------------------------------------
personal interest not deductible.
----------------------------------------------------------------------
Home mortgage interest and points. Deduct the home mortgage interest and points reported to you on Schedule A (Form 1040), line 10. If you paid more deductible interest to the financial institution than the amount shown on Form 1098, show the larger deductible amount on line 10. Attach a statement explaining the difference and print "See attached" next to line 10.
Deduct home mortgage interest that wasn't reported to you on Schedule A (Form 1040), line 11. If you paid home mortgage interest to the person from whom you bought your home, show that person's name, address, and taxpayer identification number (TIN) on the dotted lines next to line 11. The seller must give you this number and you must give the seller your TIN. A Form W-9, Request for Taxpayer Identification Number and Certification, can be used for this purpose. Failure to meet any of these requirements may result in a $50 penalty for each failure. The TIN can be either a social security number, an individual taxpayer identification number (issued by the Internal Revenue Service), or an employer identification number. See Social Security Number (SSN) in chapter 1 for more information about TINs.
If you can take a deduction for points that weren't reported to you on Form 1098, deduct those points on Schedule A (Form 1040), line 12.
Deduct mortgage insurance premiums on Schedule A (Form 1040), line 13.
More than one borrower. 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 a mortgage that was for your home, and the other person received a Form 1098 showing the interest that was paid during the year, attach a statement to your return explaining this. Show how much of the interest each of you paid, and give the name and address of the person who received the form. Deduct your share of the interest on Schedule A (Form 1040), line 11, and print "See attached" next to the line. Also, deduct your share of any qualified mortgage insurance premiums on Schedule A (Form 1040), line 13.
Similarly, if you are the payer of record on a mortgage on which there are other borrowers entitled to a deduction for the interest shown on the Form 1098 you received, deduct only your share of the interest on Schedule A (Form 1040), line 10. You should let each of the other borrowers know what his or her share is.
Mortgage proceeds used for business or investment. If your home mortgage interest deduction is limited, but all or part of the mortgage proceeds were used for business, investment, or other deductible activities, see Table 23-1. It shows where to deduct the part of your excess interest that is for those activities.
Investment interest. Deduct investment interest, subject to certain limits discussed in Pub. 550, on Schedule A (Form 1040), line 14.
Amortization of bond premium. There are various ways to treat the premium you pay to buy taxable bonds. See Bond Premium Amortization in Pub. 550.
Income-producing rental or royalty interest. Deduct interest on a loan for income-producing rental or royalty property that isn't used in your business in Part I of Schedule E (Form 1040).
Example. You rent out part of your home and borrow money to make repairs. You can deduct only the interest payment for the rented part in Part I of Schedule A (Form 1040) if it is deductible home mortgage interest.
24. Contributions
Introduction
This chapter explains how to claim a deduction for your charitable contributions. It discusses the following topics.
• The types of organizations to which you can make deductible charitable contributions.
• The types of contributions you can deduct.
• How much you can deduct.
• What records you must keep.
• How to report your charitable contributions.
A charitable contribution is a donation or gift to, or for the use of, a qualified organization. It is voluntary and is made without getting, or expecting to get, anything of equal value.
Form 1040 required. To deduct a charitable contribution, you must file Form 1040 and itemize deductions on Schedule A. The amount of your deduction may be limited if certain rules and limits explained in this chapter apply to you. The limits are explained in detail in Pub. 526.
Useful Items
You may want to see:
Publication
• Publication 526 Charitable Contributions
• Publication 561 Determining the Value of Donated Property
Form (and Instructions)
• Schedule A (Form 1040) Itemized Deductions
• Form 8283 Noncash Charitable Contributions
Organizations That Qualify To Receive Deductible Contributions
You can deduct your contributions only if you make them to a qualified organization. Most organizations other than churches and governments must apply to the IRS to become a qualified organization.
How to check whether an organization can receive deductible charitable contributions. You can ask any organization whether it is a qualified organization, and most will be able to tell you. Or go to IRS.gov. Click on "Tools" and then on "Exempt Organizations Select Check" (IRS.gov/Charities-&-Non-Profits/Exempt-Organizations-Select-Check). This online tool will enable you to search for qualified organizations.
Types of Qualified Organizations
Generally, only the following types of organizations can be qualified organizations.
1. A community chest, corporation, trust, fund, or foundation organized or created in or under the laws of the United States, any state, the District of Columbia, or any possession of the United States (including Puerto Rico). It must, however, be organized and operated only for charitable, religious, scientific, literary, or educational purposes, or for the prevention of cruelty to children or animals. Certain organizations that foster national or international amateur sports competition also qualify.
2. War veterans' organizations, including posts, auxiliaries, trusts, or foundations, organized in the United States or any of its possessions (including Puerto Rico).
3. Domestic fraternal societies, orders, and associations operating under the lodge system. (Your contribution to this type of organization is deductible only if it is to be used solely for charitable, religious, scientific, literary, or educational purposes, or for the prevention of cruelty to children or animals.)
4. Certain nonprofit cemetery companies or corporations. (Your contribution to this type of organization isn't deductible if it can be used for the care of a specific lot or mausoleum crypt.)
5. The United States or any state, the District of Columbia, a U.S. possession (including Puerto Rico), a political subdivision of a state or U.S. possession, or an Indian tribal government or any of its subdivisions that perform substantial government functions. (Your contribution to this type of organization is only deductible if it is to be used solely for public purposes.)
Examples. The following list gives some examples of qualified organizations.
• Churches, a convention or association of churches, temples, synagogues, mosques, and other religious organizations.
• Most nonprofit charitable organizations such as the American Red Cross and the United Way.
• Most nonprofit educational organizations, including the Boy Scouts of America, Girl Scouts of America, colleges, and museums. This also includes nonprofit daycare centers that provide childcare to the general public if substantially all the childcare is provided to enable parents and guardians to be gainfully employed. However, if your contribution is a substitute for tuition or other enrollment fee, it isn't deductible as a charitable contribution, as explained later under Contributions You Can't Deduct.
• Nonprofit hospitals and medical research organizations.
• Utility company emergency energy programs, if the utility company is an agent for a charitable organization that assists individuals with emergency energy needs.
• Nonprofit volunteer fire companies.
• Nonprofit organizations that develop and maintain public parks and recreation facilities.
• Civil defense organizations.
Certain foreign charitable organizations. Under income tax treaties with Canada, Israel, and Mexico, you may be able to deduct contributions to certain Canadian, Israeli, or Mexican charitable organizations. Generally, you must have income from sources in that country. For additional information on the deduction of contributions to Canadian charities, see Pub. 597, Information on the United States--Canada Income Tax Treaty. If you need more information on how to figure your contribution to Mexican and Israeli charities, see Pub. 526.
Contributions You Can Deduct
Generally, you can deduct contributions of money or property you make to, or for the use of, a qualified organization. A contribution is "for the use of" a qualified organization when it is held in a legally enforceable trust for the qualified organization or in a similar legal arrangement. The contributions must be made to a qualified organization and not set aside for use by a specific person.
If you give property to a qualified organization, you generally can deduct the fair market value of the property at the time of the contribution. See Contributions of Property, later, in this chapter.
Your deduction for charitable contributions generally can't be more than 50% of your adjusted gross income (AGI), but in some cases 20% and 30% limits may apply. See Limits on Deductions, later.
In addition, the total of your charitable contribution deduction and certain other itemized deductions may be limited. See chapter 29.
Table 24-1 gives examples of contributions you can and can't deduct.
Table 24-1. Examples of Charitable Contributions--A Quick Check
----------------------------------------------------------------------
Use the following lists for a quick check of whether you can deduct a
contribution. See the rest of this chapter for more information and
additional rules and limits that may apply.
----------------------------------------------------------------------
Deductible As Not Deductible
Charitable Contributions As Charitable Contributions
Money or property you give to: Money or property you give to:
• Churches, synagogues, temples, • Civic leagues, social and
mosques, and other religious sports clubs, labor unions,
organizations and chambers of commerce
• Federal, state, and local • Foreign organizations
governments, if your contribution (except certain Canadian,
is solely for public purposes Israeli, and Mexican
(for example, a gift to reduce charities)
the public debt or maintain a
public park) • Groups that are run for
personal profit
• Nonprofit schools and hospitals
• Groups whose purpose is to
• The Salvation Army, American Red lobby for law changes
Cross, CARE, Goodwill Industries,
United Way, Boy Scouts of America • Homeowners' associations
Girl Scouts of America, Boys and
Girls Clubs of America, etc. • Individuals
• War veterans' groups • Political groups or
candidates for public
Expenses paid for a student living office
with you, sponsored by a qualified
organization Cost of raffle, bingo, or
lottery tickets
Out-of-pocket expenses when you
serve a qualified organization Dues, fees, or bills paid to
as a volunteer country clubs, lodges,
fraternal orders, or similar
groups
Tuition
Value of your time or services
Value of blood given to a
blood bank
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Contributions From Which You Benefit
If you receive a benefit as a result of making a contribution to a qualified organization, you can deduct only the amount of your contribution that is more than the value of the benefit you receive. Also see Contributions From Which You Benefit under Contributions You Can't Deduct, later.
If you pay more than fair market value to a qualified organization for goods or services, the excess may be a charitable contribution. For the excess amount to qualify, you must pay it with the intent to make a charitable contribution.
Example 1. You pay $65 for a ticket to a dinner dance at a church. Your entire $65 payment goes to the church. The ticket to the dinner dance has a fair market value of $25. When you buy your ticket, you know that its value is less than your payment. To figure the amount of your charitable contribution, subtract the value of the benefit you receive ($25) from your total payment ($65). You can deduct $40 as a contribution to the church.
Example 2. At a fundraising auction conducted by a charity, you pay $600 for a week's stay at a beach house. The amount you pay is no more than the fair rental value. You haven't made a deductible charitable contribution.
Athletic events. If you make a payment to, or for the benefit of, a college or university and, as a result, you receive the right to buy tickets to an athletic event in the athletic stadium of the college or university, you can deduct 80% of the payment as a charitable contribution.
If any part of your payment is for tickets (rather than the right to buy tickets), 100% of that part isn't deductible. Subtract the price of the tickets from your payment. You can deduct 80% of the remaining amount as a charitable contribution.
Example 1. You pay $300 a year for membership in a university's athletic scholarship program. The only benefit of membership is that you have the right to buy one season ticket for a seat in a designated area of the stadium at the university's home football games. You can deduct $240 (80% of $300) as a charitable contribution.
Example 2. The facts are the same as in Example 1 except your $300 payment includes the purchase of one season ticket for the stated ticket price of $120. You must subtract the usual price of a ticket ($120) from your $300 payment. The result is $180. Your deductible charitable contribution is $144 (80% of $180).
Charity benefit events. If you pay a qualified organization more than fair market value for the right to attend a charity ball, banquet, show, sporting event, or other benefit event, you can deduct only the amount that is more than the value of the privileges or other benefits you receive.
If there is an established charge for the event, that charge is the value of your benefit. If there is no established charge, the reasonable value of the right to attend the event is the value of your benefit. Whether you use the tickets or other privileges has no effect on the amount you can deduct. However, if you return the ticket to the qualified organization for resale, you can deduct the entire amount you paid for the ticket.
CAUTION: Even if the ticket or other evidence of payment indicates that the payment is a "contribution," this doesn't mean you can deduct the entire amount. If the ticket shows the price of admission and the amount of the contribution, you can deduct the contribution amount.
Example. You pay $40 to see a special showing of a movie for the benefit of a qualified organization. Printed on the ticket is "Contribution--$40." If the regular price for the movie is $8, your contribution is $32 ($40 payment - $8 regular price).
Membership fees or dues. You may be able to deduct membership fees or dues you pay to a qualified organization. However, you can deduct only the amount that is more than the value of the benefits you receive.
You can't deduct dues, fees, or assessments paid to country clubs and other social organizations. They aren't qualified organizations.
Certain membership benefits can be disregarded. Both you and the organization can disregard the following membership benefits if you receive them in return for an annual payment of $75 or less.
1. Any rights or privileges, other than those discussed under Athletic events, earlier, that you can use frequently while you are a member, such as:
a. Free or discounted admission to the organization's facilities or events,
b. Free or discounted parking,
c. Preferred access to goods or services, and
d. Discounts on the purchase of goods and services.
2. Admission, while you are a member, to events open only to members of the organization, if the organization reasonably projects that the cost per person (excluding any allocated overhead) isn't more than $10.60.
Token items. You don't have to reduce your contribution by the value of any benefit you receive if both of the following are true.
1. You receive only a small item or other benefit of token value.
2. The qualified organization correctly determines that the value of the item or benefit you received isn't substantial and informs you that you can deduct your payment in full.
Written statement. A qualified organization must give you a written statement if you make a payment of more than $75 that is partly a contribution and partly for goods or services. The statement must say that you can deduct only the amount of your payment that is more than the value of the goods or services you received. It must also give you a good faith estimate of the value of those goods or services.
The organization can give you the statement either when it solicits or when it receives the payment from you.
Exception. An organization won't have to give you this statement if one of the following is true.
1. The organization is:
a. A governmental organization described in (5) under Types of Qualified Organizations, earlier; or
b. An organization formed only for religious purposes, and the only benefit you receive is an intangible religious benefit (such as admission to a religious ceremony) that generally isn't sold in commercial transactions outside the donative context.
2. You receive only items whose value isn't substantial as described under Token items, earlier.
3. You receive only membership benefits that can be disregarded, as described under Membership fees or dues, earlier.
Expenses Paid for Student Living With You
You may be able to deduct some expenses of having a student live with you. You can deduct qualifying expenses for a foreign or American student who:
1. Lives in your home under a written agreement between you and a qualified organization as part of a program of the organization to provide educational opportunities for the student,
2. Isn't your relative or dependent, and
3. Is a full-time student in the twelfth or any lower grade at a school in the United States.
TIP: You can deduct up to $50 a month for each full calendar month the student lives with you. Any month when conditions (1) through (3) are met for 15 days or more counts as a full month.
For additional information, see Expenses Paid for Student Living With You in Pub. 526.
Mutual exchange program. You can't deduct the costs of a foreign student living in your home under a mutual exchange program through which your child will live with a family in a foreign country.
Out-of-Pocket Expenses in Giving Services
Although you can't deduct the value of your services given to a qualified organization, you may be able to deduct some amounts you pay in giving services to a qualified organization. The amounts must be:
• Unreimbursed;
• Directly connected with the services;
• Expenses you had only because of the services you gave; and
• Not personal, living, or family expenses.
Table 24-2 contains questions and answers that apply to some individuals who volunteer their services.
Table 24-2. Volunteers' Questions and Answers
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If you volunteer for a qualified organization, the following questions
and answers may apply to you. All of the rules explained in this
chapter also apply. See, in particular, Out-of-Pocket Expenses in
Giving Services.
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Question Answer
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I volunteer 6 hours a week in the No, you can't deduct the value
office of a qualified organization. of your time or services.
The receptionist is paid $10 an hour
for the same work. Can I deduct $60
a week for my time?
The office is 30 miles from my home. Yes, you can deduct the costs
Can I deduct any of my car expenses of gas and oil that are
for these trips? directly related to getting to
and from the place where you
volunteer. If you don't want
to figure your actual costs,
you can deduct 14 cents for
each mile.
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I volunteer as a Red Cross nurse's Yes, you can deduct the cost
aide at a hospital. Can I deduct the of buying and cleaning your
cost of the uniforms I must wear? uniforms if the hospital is a
qualified organization, the
uniforms aren't suitable for
everyday use, and you must
wear them when volunteering.
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I pay a babysitter to watch my No, you can't deduct payments
children while I volunteer for a for childcare expenses as a
qualified organization. Can I deduct charitable contribution, even
these costs? if you would be unable to
volunteer without childcare.
(If you have childcare
expenses so you can work for
pay, see chapter 32.)
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Conventions. If a qualified organization selects you to attend a convention as its representative, you can deduct unreimbursed expenses for travel, including reasonable amounts for meals and lodging, while away from home overnight in connection with the convention. However, see Travel, later.
You can't deduct personal expenses for sightseeing, fishing parties, theater tickets, or nightclubs. You also can't deduct transportation, meals and lodging, and other expenses for your spouse or children.
You can't deduct your travel expenses in attending a church convention if you go only as a member of your church rather than as a chosen representative. You can, however, deduct unreimbursed expenses that are directly connected with giving services for your church during the convention.
Uniforms. You can deduct the cost and upkeep of uniforms that aren't suitable for everyday use and that you must wear while performing donated services for a charitable organization.
Foster parents. You may be able to deduct as a charitable contribution some of the costs of being a foster parent (foster care provider) if you have no profit motive in providing the foster care and aren't, in fact, making a profit. A qualified organization must select the individuals you take into your home for foster care.
You can deduct expenses that meet both of the following requirements.
1. They are unreimbursed out-of-pocket expenses to feed, clothe, and care for the foster child.
2. They are incurred primarily to benefit the qualified organization.
Unreimbursed expenses that you can't deduct as charitable contributions may be considered support provided by you in determining whether you can claim the foster child as a dependent. For details, see chapter 3.
Example. You cared for a foster child because you wanted to adopt her, not to benefit the agency that placed her in your home. Your unreimbursed expenses aren't deductible as charitable contributions.
Car expenses. You can deduct as a charitable contribution any unreimbursed out-of-pocket expenses, such as the cost of gas and oil, that are directly related to the use of your car in giving services to a charitable organization. You can't deduct general repair and maintenance expenses, depreciation, registration fees, or the costs of tires or insurance.
If you don't want to deduct your actual expenses, you can use a standard mileage rate of 14 cents a mile to figure your contribution.
You can deduct parking fees and tolls whether you use your actual expenses or the standard mileage rate.
You must keep reliable written records of your car expenses. For more information, see Car expenses under Records To Keep, later.
Travel. Generally, you can claim a charitable contribution deduction for travel expenses necessarily incurred while you are away from home performing services for a charitable organization only if there is no significant element of personal pleasure, recreation, or vacation in the travel. This applies whether you pay the expenses directly or indirectly. You are paying the expenses indirectly if you make a payment to the charitable organization and the organization pays for your travel expenses.
The deduction for travel expenses won't be denied simply because you enjoy providing services to the charitable organization. Even if you enjoy the trip, you can take a charitable contribution deduction for your travel expenses if you are on duty in a genuine and substantial sense throughout the trip. However, if you have only nominal duties, or if for significant parts of the trip you don't have any duties, you can't deduct your travel expenses.
Example 1. You are a troop leader for a tax-exempt youth group and you take the group on a camping trip. You are responsible for overseeing the setup of the camp and for providing adult supervision for other activities during the entire trip. You participate in the activities of the group and enjoy your time with them. You oversee the breaking of camp and you transport the group home. You can deduct your travel expenses.
Example 2. You sail from one island to another and spend 8 hours a day counting whales and other forms of marine life. The project is sponsored by a charitable organization. In most circumstances, you can't deduct your expenses.
Example 3. You work for several hours each morning on an archaeological dig sponsored by a charitable organization. The rest of the day is free for recreation and sightseeing. You can't take a charitable contribution deduction even though you work very hard during those few hours.
Example 4. You spend the entire day attending a charitable organization's regional meeting as a chosen representative. In the evening you go to the theater. You can claim your travel expenses as charitable contributions, but you can't claim the cost of your evening at the theater.
Daily allowance (per diem). If you provide services for a charitable organization and receive a daily allowance to cover reasonable travel expenses, including meals and lodging while away from home overnight, you must include in income any part of the allowance that is more than your deductible travel expenses. You may be able to deduct any necessary travel expenses that are more than the allowance.
Deductible travel expenses. These include:
• Air, rail, and bus transportation;
• Out-of-pocket expenses for your car;
• Taxi fares or other costs of transportation between the airport or station and your hotel;
• Lodging costs; and
• The cost of meals.
Because these travel expenses aren't business related, they aren't subject to the same limits as business-related expenses. For information on business travel expenses, see Travel Expenses in chapter 26.
Contributions You Can't Deduct
There are some contributions you can't deduct, such as those made to specific individuals and those made to nonqualified organizations. (See Contributions to Individuals and Contributions to Nonqualified Organizations next.) There are others you can deduct only part of, as discussed later under Contributions From Which You Benefit.
Contributions to Individuals
You can't deduct contributions to specific individuals, including the following.
• Contributions to fraternal societies made for the purpose of paying medical or burial expenses of deceased members.
• Contributions to individuals who are needy or worthy. You can't deduct these contributions even if you make them to a qualified organization for the benefit of a specific person. But you can deduct a contribution to a qualified organization that helps needy or worthy individuals if you don't indicate that your contribution is for a specific person.
Example. You can deduct contributions to a qualified organization for flood relief, hurricane relief, or other disaster relief. However, you can't deduct contributions earmarked for relief of a particular individual or family.
• Payments to a member of the clergy that can be spent as he or she wishes, such as for personal expenses.
• Expenses you paid for another person who provided services to a qualified organization.
Example. Your son does missionary work. You pay his expenses. You can't claim a deduction for your son's unreimbursed expenses related to his contribution of services.
• Payments to a hospital that are for a specific patient's care or for services for a specific patient. You can't deduct these payments even if the hospital is operated by a city, a state, or other qualified organization.
Contributions to Nonqualified Organizations
You can't deduct contributions to organizations that aren't qualified to receive tax-deductible contributions, including the following.
1. Certain state bar associations if:
a. The bar isn't a political subdivision of a state;
b. The bar has private, as well as public, purposes, such as promoting the professional interests of members; and
c. Your contribution is unrestricted and can be used for private purposes.
2. Chambers of commerce and other business leagues or organizations (but see chapter 28 about miscellaneous deductions).
3. Civic leagues and associations.
4. Country clubs and other social clubs.
5. Most foreign organizations (other than certain Canadian, Israeli, or Mexican charitable organizations). For details, see Pub. 526.
6. Homeowners' associations.
7. Labor unions (but see chapter 28 about miscellaneous deductions).
8. Political organizations and candidates.
Contributions From Which You Benefit
If you receive or expect to receive a financial or economic benefit as a result of making a contribution to a qualified organization, you can't deduct the part of the contribution that represents the value of the benefit you receive. See Contributions From Which You Benefit under Contributions You Can Deduct, earlier. These contributions include the following.
• Contributions for lobbying. This includes amounts that you earmark for use in, or in connection with, influencing specific legislation.
• Contributions to a retirement home for room, board, maintenance, or admittance. Also, if the amount of your contribution depends on the type or size of apartment you will occupy, it isn't a charitable contribution.
• Costs of raffles, bingo, lottery, etc. You can't deduct as a charitable contribution amounts you pay to buy raffle or lottery tickets or to play bingo or other games of chance. For information on how to report gambling winnings and losses, see Gambling winnings in chapter 12 and Gambling Losses Up to the Amount of Gambling Winnings in chapter 28.
• Dues to fraternal orders and similar groups. However, see Membership fees or dues, earlier, under Contributions You Can Deduct.
• Tuition, or amounts you pay instead of tuition. You can't deduct as a charitable contribution amounts you pay as tuition even if you pay them for children to attend parochial schools or qualifying nonprofit daycare centers. You also can't deduct any fixed amount you must pay in addition to, or instead of, tuition to enroll in a private school, even if it is designated as a "donation."
Value of Time or Services
You can't deduct the value of your time or services, including:
• Blood donations to the American Red Cross or to blood banks, and
• The value of income lost while you work as an unpaid volunteer for a qualified organization.
Personal Expenses
You can't deduct personal, living, or family expenses, such as the following items.
• The cost of meals you eat while you perform services for a qualified organization unless it is necessary for you to be away from home overnight while performing the services.
• Adoption expenses, including fees paid to an adoption agency and the costs of keeping a child in your home before adoption is final (but see Adoption Credit in chapter 38, and the Instructions for Form 8839, Qualified Adoption Expenses). You also may be able to claim an exemption for the child. See Adopted child in chapter 3.
Appraisal Fees
You can't deduct as a charitable contribution any fees you pay to find the fair market value of donated property (but see chapter 28 about miscellaneous deductions).
Contributions of Property
If you contribute property to a qualified organization, the amount of your charitable contribution is generally the fair market value of the property at the time of the contribution. However, if the property has increased in value, you may have to make some adjustments to the amount of your deduction. See Giving Property That Has Increased in Value, later.
For information about the records you must keep and the information you must furnish with your return if you donate property, see Records To Keep and How To Report, later.
Clothing and household items. You can't take a deduction for clothing or household items you donate unless the clothing or household items are in good used condition or better.
Exception. You can take a deduction for a contribution of an item of clothing or household item that isn't in good used condition or better if you deduct more than $500 for it and include a qualified appraisal of it with your return.
Household items. Household items include:
• Furniture and furnishings,
• Electronics,
• Appliances,
• Linens, and
• Other similar items.
Household items don't include:
• Food;
• Paintings, antiques, and other objects of art;
• Jewelry and gems; and
• Collections.
Cars, boats, and airplanes. The following rules apply to any donation of a qualified vehicle.
A qualified vehicle is:
• A car or any motor vehicle manufactured mainly for use on public streets, roads, and highways;
• A boat; or
• An airplane.
Deduction more than $500. If you donate a qualified vehicle with a claimed fair market value of more than $500, you can deduct the smaller of:
• The gross proceeds from the sale of the vehicle by the organization, or
• The vehicle's fair market value on the date of the contribution. If the vehicle's fair market value was more than your cost or other basis, you may have to reduce the fair market value to figure the deductible amount, as described under Giving Property That Has Increased in Value, later.
Form 1098-C. You must attach to your return Copy B of the Form 1098-C, Contributions of Motor Vehicles, Boats, and Airplanes, (or other statement containing the same information as Form 1098-C) you received from the organization. The Form 1098-C (or other statement) will show the gross proceeds from the sale of the vehicle.
If you e-file your return, you must:
• Attach Copy B of Form 1098-C to Form 8453 and mail the forms to the IRS, or
• Include Copy B of Form 1098-C as a PDF attachment if your software program allows it.
If you don't attach Form 1098-C (or other statement), you can't deduct your contribution.
You must get Form 1098-C (or other statement) within 30 days of the sale of the vehicle. But if exception 1 or 2 (described later) applies, you must get Form 1098-C (or other statement) within 30 days of your donation.
Filing deadline approaching and still no Form 1098-C. If the filing deadline is approaching and you still don't have a Form 1098-C, you have two choices.
• Request an automatic 6-month extension of time to file your return. You can get this extension by filing Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return. For more information, see Automatic Extension in chapter 1.
• File the return on time without claiming the deduction for the qualified vehicle. After receiving the Form 1098-C, file an amended return, Form 1040X, claiming the deduction. Attach Copy B of Form 1098-C (or other statement) to the amended return. For more information about amended returns, see Amended Returns and Claims for Refund in chapter 1.
Exceptions. There are two exceptions to the rules just described for deductions of more than $500.
Exception 1--vehicle used or improved by organization. If the qualified organization makes a significant intervening use of or material improvement to the vehicle before transferring it, you generally can deduct the vehicle's fair market value at the time of the contribution. But if the vehicle's fair market value was more than your cost or other basis, you may have to reduce the fair market value to get the deductible amount, as described under Giving Property That Has Increased in Value, later. The Form 1098-C (or other statement) will show whether this exception applies.
Exception 2--vehicle given or sold to needy individual. If the qualified organization will give the vehicle, or sell it for a price well below fair market value, to a needy individual to further the organization's charitable purpose, you generally can deduct the vehicle's fair market value at the time of the contribution. But if the vehicle's fair market value was more than your cost or other basis, you may have to reduce the fair market value to get the deductible amount, as described under Giving Property That Has Increased in Value, later. The Form 1098-C (or other statement) will show whether this exception applies.
This exception doesn't apply if the organization sells the vehicle at auction. In that case, you can't deduct the vehicle's fair market value.
Example. Anita donates a used car to a qualified organization. She bought it 3 years ago for $9,000. A used car guide shows the fair market value for this type of car is $6,000. However, Anita gets a Form 1098-C from the organization showing the car was sold for $2,900. Neither exception 1 nor exception 2 applies. If Anita itemizes her deductions, she can deduct $2,900 for her donation. She must attach Form 1098-C and Form 8283 to her return.
Deduction $500 or less. If the qualified organization sells the vehicle for $500 or less and exceptions 1 and 2 don't apply, you can deduct the smaller of:
• $500, or
• The vehicle's fair market value on the date of the contribution. But if the vehicle's fair market value was more than your cost or other basis, you may have to reduce the fair market value to get the deductible amount, as described under Giving Property That Has Increased in Value, later.
If the vehicle's fair market value is at least $250 but not more than $500, you must have a written statement from the qualified organization acknowledging your donation. The statement must contain the information and meet the tests for an acknowledgment described under Deductions of At Least $250 But Not More Than $500 under Records To Keep, later.
Partial interest in property. Generally, you can't deduct a charitable contribution of less than your entire interest in property.
Right to use property. A contribution of the right to use property is a contribution of less than your entire interest in that property and isn't deductible. For exceptions and more information, see Partial Interest in Property Not in Trust in Pub. 561.
Future interests in tangible personal property. You can't deduct the value of a charitable contribution of a future interest in tangible personal property until all intervening interests in and rights to the actual possession or enjoyment of the property have either expired or been turned over to someone other than yourself, a related person, or a related organization.
Tangible personal property. This is any property, other than land or buildings, that can be seen or touched. It includes furniture, books, jewelry, paintings, and cars.
Future interest. This is any interest that is to begin at some future time, regardless of whether it is designated as a future interest under state law.
Determining Fair Market Value
This section discusses general guidelines for determining the fair market value of various types of donated property. Pub. 561 contains a more complete discussion.
Fair market value is the price at which 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.
Used clothing and household items. The fair market value of used clothing and household goods is usually far less than what you paid for them when they were new.
For used clothing, you should claim as the value the price that buyers of used items actually pay in used clothing stores, such as consignment or thrift shops. See Household Goods in Pub. 561 for information on the valuation of household goods, such as furniture, appliances, and linens.
Example. Dawn Greene donated a coat to a thrift store operated by her church. She paid $300 for the coat 3 years ago. Similar coats in the thrift store sell for $50. The fair market value of the coat is $50. Dawn's donation is limited to $50.
Cars, boats, and airplanes. If you contribute a car, boat, or airplane to a charitable organization, you must determine its fair market value. Certain commercial firms and trade organizations publish used car pricing guides, commonly called "blue books," containing complete dealer sale prices or dealer average prices for recent model years. The guides may be published monthly or seasonally and for different regions of the country. These guides also provide estimates for adjusting for unusual equipment, unusual mileage, and physical condition. The prices aren't "official" and these publications aren't considered an appraisal of any specific donated property. But they do provide clues for making an appraisal and suggest relative prices for comparison with current sales and offerings in your area.
You can also find used car pricing information on the Internet.
Example. You donate a used car in poor condition to a local high school for use by students studying car repair. A used car guide shows the dealer retail value for this type of car in poor condition is $1,600. However, the guide shows the price for a private party sale of the car is only $750. The fair market value of the car is considered to be $750.
Large quantities. If you contribute a large number of the same item, fair market value is the price at which comparable numbers of the item are being sold.
Giving Property That Has Decreased in Value
If you contribute property with a fair market value that is less than your basis in it, your deduction is limited to its fair market value. You can't claim a deduction for the difference between the property's basis and its fair market value.
Giving Property That Has Increased in Value
If you contribute property with a fair market value that is more than your basis in it, you may have to reduce the fair market value by the amount of appreciation (increase in value) when you figure your deduction.
Your basis in property is generally what you paid for it. See chapter 13 if you need more information about basis.
Different rules apply to figuring your deduction, depending on whether the property is:
• Ordinary income property, or
• Capital gain property.
Ordinary income property. Property is ordinary income property if you would have recognized ordinary income or short-term capital gain had you sold it at fair market value on the date it was contributed. Examples of ordinary income property are inventory, works of art created by the donor, manuscripts prepared by the donor, and capital assets (defined in chapter 14) held 1 year or less.
Amount of deduction. The amount you can deduct for a contribution of ordinary income property is its fair market value minus the amount that would be ordinary income or short-term capital gain if you sold the property for its fair market value. Generally, this rule limits the deduction to your basis in the property.
Example. You donate stock you held for 5 months to your church. The fair market value of the stock on the day you donate it is $1,000, but you paid only $800 (your basis). Because the $200 of appreciation would be short-term capital gain if you sold the stock, your deduction is limited to $800 (fair market value minus the appreciation).
Capital gain property. Property is capital gain property if you would have recognized long-term capital gain had you sold it at fair market value on the date of the contribution. It includes capital assets held more than 1 year, as well as certain real property and depreciable property used in your trade or business and, generally, held more than 1 year.
Amount of deduction--general rule. When figuring your deduction for a contribution of capital gain property, you generally can use the fair market value of the property.
Exceptions. However, in certain situations, you must reduce the fair market value by any amount that would have been long-term capital gain if you had sold the property for its fair market value. Generally, this means reducing the fair market value to the property's cost or other basis.
Bargain sales. A bargain sale of property is a sale or exchange for less than the property's fair market value. A bargain sale to a qualified organization is partly a charitable contribution and partly a sale or exchange. A bargain sale may result in a taxable gain.
More information. For more information on donating appreciated property, see Giving Property That Has Increased in Value in Pub. 526.
When To Deduct
You can deduct your contributions only in the year you actually make them in cash or other property (or in a later carryover year, as explained later under Carryovers). This applies whether you use the cash or an accrual method of accounting.
Time of making contribution. Usually, you make a contribution at the time of its unconditional delivery.
Checks. A check you mail to a charity is considered delivered on the date you mail it.
Text message. Contributions made by text message are deductible in the year you send the text message if the contribution is charged to your telephone or wireless account.
Credit card. Contributions charged on your credit card are deductible in the year you make the charge.
Pay-by-phone account. Contributions made through a pay-by-phone account are considered delivered on the date the financial institution pays the amount.
Stock certificate. A properly endorsed stock certificate is considered delivered on the date of mailing or other delivery to the charity or to the charity's agent. However, if you give a stock certificate to your agent or to the issuing corporation for transfer to the name of the charity, your contribution isn't delivered until the date the stock is transferred on the books of the corporation.
Promissory note. If you issue and deliver a promissory note to a charity as a contribution, it isn't a contribution until you make the note payments.
Option. If you grant a charity an option to buy real property at a bargain price, it isn't a contribution until the organization exercises the option.
Borrowed funds. If you contribute borrowed funds, you can deduct the contribution in the year you deliver the funds to the charity, regardless of when you repay the loan.
Limits on Deductions
The amount you can deduct for charitable contributions can't be more than 50% of your AGI. Your deduction may be further limited to 30% or 20% of your AGI, depending on the type of property you give and the type of organization you give it to. If your total contributions for the year are 20% or less of your AGI, these limits don't apply to you. The limits are discussed in detail under Limits on Deductions in Pub. 526.
A higher limit applies to certain qualified conservation contributions. See Pub. 526 for details.
Carryovers
You can carry over any contributions you can't deduct in the current year because they exceed your adjusted-gross-income limits. You may be able to deduct the excess in each of the next 5 years until it is used up, but not beyond that time. For more information, see Carryovers in Pub. 526.
Records To Keep
You must keep records to prove the amount of the contributions you make during the year. The kind of records you must keep depends on the amount of your contributions and whether they are:
• Cash contributions,
• Noncash contributions, or
• Out-of-pocket expenses when donating your services.
Note. An organization generally must give you a written statement if it receives a payment from you that is more than $75 and is partly a contribution and partly for goods or services. (See Contributions From Which You Benefit under Contributions You Can Deduct, earlier.) Keep the statement for your records. It may satisfy all or part of the recordkeeping requirements explained in the following discussions.
Cash Contributions
Cash contributions include those paid by cash, check, electronic funds transfer, debit card, credit card, or payroll deduction.
You can't deduct a cash contribution, regardless of the amount, unless you keep one of the following.
1. A bank record that shows the name of the qualified organization, the date of the contribution, and the amount of the contribution. Bank records may include:
a. A canceled check,
b. A bank or credit union statement, or
c. A credit card statement.
2. A receipt (or a letter or other written communication) from the qualified organization showing the name of the organization, the date of the contribution, and the amount of the contribution.
3. The payroll deduction records described next.
Payroll deductions. If you make a contribution by payroll deduction, you must keep:
1. A pay stub, Form W-2, or other document furnished by your employer that shows the date and amount of the contribution; and
2. A pledge card or other document prepared by or for the qualified organization that shows the name of the organization.
If your employer withheld $250 or more from a single paycheck, see Contributions of $250 or More next.
Contributions of $250 or More
You can claim a deduction for a contribution of $250 or more only if you have an acknowledgment of your contribution from the qualified organization or certain payroll deduction records.
If you made more than one contribution of $250 or more, you must have either a separate acknowledgment for each or one acknowledgment that lists each contribution and the date of each contribution and shows your total contributions.
Amount of contribution. In figuring whether your contribution is $250 or more, don't combine separate contributions. For example, if you gave your church $25 each week, your weekly payments don't have to be combined. Each payment is a separate contribution.
If contributions are made by payroll deduction, the deduction from each paycheck is treated as a separate contribution.
If you made a payment that is partly for goods and services, as described earlier under Contributions From Which You Benefit, your contribution is the amount of the payment that is more than the value of the goods and services.
Acknowledgment. The acknowledgment must meet these tests.
1. It must be written.
2. It must include:
a. The amount of cash you contributed;
b. Whether the qualified organization gave you any goods or services as a result of your contribution (other than certain token items and membership benefits);
c. A description and good faith estimate of the value of any goods or services described in (b) (other than intangible religious benefits); and
d. A statement that the only benefit you received was an intangible religious benefit, if that was the case. The acknowledgment doesn't need to describe or estimate the value of an intangible religious benefit. An intangible religious benefit is a benefit that generally isn't sold in commercial transactions outside a donative (gift) context. An example is admission to a religious ceremony.
3. You must get it on or before the earlier of:
a. The date you file your return for the year you make the contribution; or
b. The due date, including extensions, for filing the return.
Payroll deductions. If you make a contribution by payroll deduction and your employer withholds $250 or more from a single paycheck, you must keep:
1. A pay stub, Form W-2, or other document furnished by your employer that shows the amount withheld as a contribution; and
2. A pledge card or other document prepared by or for the qualified organization that shows the name of the organization and states the organization doesn't provide goods or services in return for any contribution made to it by payroll deduction.
A single pledge card may be kept for all contributions made by payroll deduction regardless of amount as long as it contains all the required information.
If the pay stub, Form W-2, pledge card, or other document doesn't show the date of the contribution, you must have another document that does show the date of the contribution. If the pay stub, Form W-2, pledge card, or other document shows the date of the contribution, you don't need any other records except those just described in (1) and (2).
Noncash Contributions
For a contribution not made in cash, the records you must keep depend on whether your deduction for the contribution is:
1. Less than $250,
2. At least $250 but not more than $500,
3. Over $500 but not more than $5,000, or
4. Over $5,000.
Amount of deduction. In figuring whether your deduction is $500 or more, combine your claimed deductions for all similar items of property donated to any charitable organization during the year.
If you received goods or services in return, as described earlier in Contributions From Which You Benefit, reduce your contribution by the value of those goods or services. If you figure your deduction by reducing the fair market value of the donated property by its appreciation, as described earlier in Giving Property That Has Increased in Value, your contribution is the reduced amount.
Deductions of Less Than $250
If you make any noncash contribution, you must get and keep a receipt from the charitable organization showing:
1. The name of the charitable organization,
2. The date and location of the charitable contribution, and
3. A reasonably detailed description of the property.
A letter or other written communication from the charitable organization acknowledging receipt of the contribution and containing the information in (1), (2), and (3) will serve as a receipt.
You aren't required to have a receipt where it is impractical to get one (for example, if you leave property at a charity's unattended drop site).
Additional records. You must also keep reliable written records for each item of contributed property. Your written records must include the following information.
• The name and address of the organization to which you contributed.
• The date and location of the contribution.
• A description of the property in detail reasonable under the circumstances. For a security, keep the name of the issuer, the type of security, and whether it is regularly traded on a stock exchange or in an over-the-counter market.
• The fair market value of the property at the time of the contribution and how you figured the fair market value. If it was determined by appraisal, keep a signed copy of the appraisal.
• The cost or other basis of the property if you must reduce its fair market value by appreciation. Your records should also include the amount of the reduction and how you figured it.
• The amount you claim as a deduction for the tax year as a result of the contribution if you contribute less than your entire interest in the property during the tax year. Your records must include the amount you claimed as a deduction in any earlier years for contributions of other interests in this property. They must also include the name and address of each organization to which you contributed the other interests, the place where any such tangible property is located or kept, and the name of any person in possession of the property, other than the organization to which you contributed it.
• The terms of any conditions attached to the contribution of property.
Deductions of At Least $250 But Not More Than $500
If you claim a deduction of at least $250 but not more than $500 for a noncash charitable contribution, you must get and keep an acknowledgment of your contribution from the qualified organization. If you made more than one contribution of $250 or more, you must have either a separate acknowledgment for each or one acknowledgment that shows your total contributions.
The acknowledgment must contain the information in items (1) through (3) under Deductions of Less Than $250, earlier, and your written records must include the information listed in that discussion under Additional records.
The acknowledgment must also meet these tests.
1. It must be written.
2. It must include:
a. A description (but not necessarily the value) of any property you contributed,
b. Whether the qualified organization gave you any goods or services as a result of your contribution (other than certain token items and membership benefits), and
c. A description and good faith estimate of the value of any goods or services described in (b). If the only benefit you received was an intangible religious benefit (such as admission to a religious ceremony) that generally isn't sold in a commercial transaction outside the donative context, the acknowledgment must say so and doesn't need to describe or estimate the value of the benefit.
3. You must get it on or before the earlier of:
a. The date you file your return for the year you make the contribution; or
b. The due date, including extensions, for filing the return.
You are required to give additional information if you claim a deduction over $500 for noncash charitable contributions. See Records To Keep in Pub. 526 for more information.
Out-of-Pocket Expenses
If you give services to a qualified organization and have unreimbursed out-of-pocket expenses related to those services, the following two rules apply.
1. You must have adequate records to prove the amount of the expenses.
2. If any of your unreimbursed out-of-pocket expenses, considered separately, are $250 or more (for example, you pay $250 or more for an airline ticket to attend a convention of a qualified organization as a chosen representative), you must get an acknowledgment from the qualified organization that contains:
a. A description of the services you provided;
b. A statement of whether or not the organization provided you any goods or services to reimburse you for the expenses you incurred;
c. A description and a good faith estimate of the value of any goods or services (other than intangible religious benefits) provided to reimburse you; and
d. A statement that the only benefit you received was an intangible religious benefit, if that was the case. The acknowledgment doesn't need to describe or estimate the value of an intangible religious benefit (defined earlier under Acknowledgment).
1. The date you file your return for the year you make the contribution; or
2. The due date, including extensions, for filing the return.
Car expenses. If you claim expenses directly related to use of your car in giving services to a qualified organization, you must keep reliable written records of your expenses. Whether your records are considered reliable depends on all the facts and circumstances. Generally, they may be considered reliable if you made them regularly and at or near the time you had the expenses.
For example, your records might show the name of the organization you were serving and the dates you used your car for a charitable purpose. If you use the standard mileage rate of 14 cents a mile, your records must show the miles you drove your car for the charitable purpose. If you deduct your actual expenses, your records must show the costs of operating the car that are directly related to a charitable purpose.
See Car expenses under Out-of-Pocket Expenses in Giving Services, earlier, for the expenses you can deduct.
How To Report
Report your charitable contributions on Schedule A (Form 1040).
If your total deduction for all noncash contributions for the year is over $500, you must also file Pub. 526 for more information.
25. Nonbusiness Casualty and Theft Losses
Introduction
This chapter explains the tax treatment of personal (not business or investment related) casualty losses, theft losses, and losses on deposits.
The chapter also explains the following topics.
• How to figure the amount of your loss.
• How to treat insurance and other reimbursements you receive.
• The deduction limits.
• When and how to report a casualty or theft.
Forms to file. When you have a casualty or theft, you have to file Form 4684. You will also have to file one or more of the following forms.
• Schedule A (Form 1040), Itemized Deductions.
• Schedule D (Form 1040), Capital Gains and Losses.
Condemnations. For information on condemnations of property, see Involuntary Conversions in chapter 1 of Pub. 544, Sales and Other Dispositions of Assets.
Workbook for casualties and thefts. Pub. 584 is available to help you make a list of your stolen or damaged personal-use property and figure your loss. It includes schedules to help you figure the loss on your home, its contents, and your motor vehicles.
Business or investment-related losses. For information on a casualty or theft loss of business or income-producing property, see Pub. 547.
Useful Items
You may want to see:
Publication
• Publication 544 Sales and Other Dispositions of Assets
• Publication 547 Casualties, Disasters, and Thefts
• Publication 584 Casualty, Disaster, and Theft Loss Workbook (Personal-Use Property)
Form (and Instructions)
• Schedule A (Form 1040) Itemized Deductions
• Schedule D (Form 1040) Capital Gains and Losses
• Form 4684 Casualties and Thefts
Casualty
A casualty is the damage, destruction, or loss of property resulting from an identifiable event that is sudden, unexpected, or unusual.
• A sudden event is one that is swift, not gradual or progressive.
• An unexpected event is one that is ordinarily unanticipated and unintended.
• An unusual event is one that isn't a day-to-day occurrence and that isn't typical of the activity in which you were engaged.
Deductible losses. Deductible casualty losses can result from a number of different causes, including the following.
• Car accidents (but see Nondeductible losses next for exceptions).
• Earthquakes.
• Fires (but see Nondeductible losses next for exceptions).
• Floods.
• Government-ordered demolition or relocation of a home that is unsafe to use because of a disaster as discussed under Disaster Area Losses in Pub. 547.
• Mine cave-ins.
• Shipwrecks.
• Sonic booms.
• Storms, including hurricanes and tornadoes.
• Terrorist attacks.
• Vandalism.
• Volcanic eruptions.
Nondeductible losses. A casualty loss isn't deductible if the damage or destruction is caused by the following.
• Accidentally breaking articles such as glassware or china under normal conditions.
• A family pet (explained below).
• A fire if you willfully set it or pay someone else to set it.
• A car accident if your willful negligence or willful act caused it. The same is true if the willful act or willful negligence of someone acting for you caused the accident.
• Progressive deterioration (explained later).
Family pet. Loss of property due to damage by a family pet isn't deductible as a casualty loss unless the requirements discussed earlier under Casualty are met.
Example. Your antique oriental rug was damaged by your new puppy before it was housebroken. Because the damage wasn't unexpected and unusual, the loss isn't deductible as a casualty loss.
Progressive deterioration. Loss of property due to progressive deterioration isn't deductible as a casualty loss. This is because the damage results from a steadily operating cause or a normal process, rather than from a sudden event. The following are examples of damage due to progressive deterioration.
• The steady weakening of a building due to normal wind and weather conditions.
• The deterioration and damage to a water heater that bursts. However, the rust and water damage to rugs and drapes caused by the bursting of a water heater does qualify as a casualty.
• Most losses of property caused by droughts. To be deductible, a drought-related loss generally must be incurred in a trade or business or in a transaction entered into for profit.
• Termite or moth damage.
• The damage or destruction of trees, shrubs, or other plants by a fungus, disease, insects, worms, or similar pests. However, a sudden destruction due to an unexpected or unusual infestation of beetles or other insects may result in a casualty loss.
Damage from corrosive drywall. Under a special procedure, you may be able to claim a casualty loss deduction for amounts you paid to repair damage to your home and household appliances that resulted from corrosive drywall. For details, see Pub. 547.
Theft
A theft is the taking and removing of money or property with the intent to deprive the owner of it. The taking of property must be illegal under the laws of the state where it occurred and it must have been done with criminal intent. You don't need to show a conviction for theft.
Theft includes the taking of money or property by the following means.
• Blackmail.
• Burglary.
• Embezzlement.
• Extortion.
• Kidnapping for ransom.
• Larceny.
• Robbery.
The taking of money or property through fraud or misrepresentation is theft if it is illegal under state or local law.
Decline in market value of stock. You can't deduct as a theft loss the decline in market value of stock acquired on the open market for investment if the decline is caused by disclosure of accounting fraud or other illegal misconduct by the officers or directors of the corporation that issued the stock. However, you can deduct as a capital loss the loss you sustain when you sell or exchange the stock or the stock becomes completely worthless. You report a capital loss on Schedule D (Form 1040). For more information about stock sales, worthless stock, and capital losses, see chapter 4 of Pub. 550.
Mislaid or lost property. The simple disappearance of money or property isn't a theft. However, an accidental loss or disappearance of property can qualify as a casualty if it results from an identifiable event that is sudden, unexpected, or unusual. Sudden, unexpected, and unusual events are defined earlier.
Example. A car door is accidentally slammed on your hand, breaking the setting of your diamond ring. The diamond falls from the ring and is never found. The loss of the diamond is a casualty.
Losses from Ponzi-type investment schemes. If you had a loss from a Ponzi-type investment scheme, see the following.
• Revenue Ruling 2009-9, 2009-14 I.R.B. 735 (available at IRS.gov/irb/2009-14_IRB/ar07.html).
• Revenue Procedure 2009-20, 2009-14 I.R.B. 749 (available at IRS.gov/irb/2009-14_IRB/ar11.html).
• Revenue Procedure 2011-58, 2011-50 I.R.B. 849 (available at IRS.gov/irb/2011-50_IRB/ar11.html).
If you qualify to use Revenue Procedure 2009-20, as modified by Revenue Procedure 2011-58, and you choose to follow the procedures in the guidance, first fill out Section C of Form 4684 to determine the amount to enter on Section B, line 28. Skip lines 19 to 27. Section C of Form 4684 replaces Appendix A in Revenue Procedure 2009-20. You don't need to complete Appendix A. For more information, see the above revenue ruling and revenue procedures, and the Instructions for Form 4684.
If you choose not to use the procedures in Revenue Procedure 2009-20, you may claim your theft loss by filling out Section B, lines 19 to 39, as appropriate.
Loss on Deposits
A loss on deposits can occur when a bank, credit union, or other financial institution becomes insolvent or bankrupt. If you incurred this type of loss, you can choose one of the following ways to deduct the loss.
• As a casualty loss.
• As an ordinary loss.
• As a nonbusiness bad debt.
Casualty loss or ordinary loss. You can choose to deduct a loss on deposits as a casualty loss or as an ordinary loss for any year in which you can reasonably estimate how much of your deposits you have lost in an insolvent or bankrupt financial institution. The choice is generally made on the return you file for that year and applies to all your losses on deposits for the year in that particular financial institution. If you treat the loss as a casualty or ordinary loss, you can't treat the same amount of the loss as a nonbusiness bad debt when it actually becomes worthless. However, you can take a nonbusiness bad debt deduction for any amount of loss that is more than the estimated amount you deducted as a casualty or ordinary loss. Once you make this choice, you can't change it without permission from the IRS.
If you claim an ordinary loss, report it as a miscellaneous itemized deduction on Schedule A (Form 1040), line 23. The maximum amount you can claim is $20,000 ($10,000 if you are married filing separately) reduced by any expected state insurance proceeds. Your loss is subject to the 2%-of-adjusted-gross-income limit. You can't choose to claim an ordinary loss if any part of the deposit is federally insured.
Nonbusiness bad debt. If you don't choose to deduct the loss as a casualty loss or as an ordinary loss, you must wait until the year the actual loss is determined and deduct the loss as a nonbusiness bad debt in that year.
How to report. The kind of deduction you choose for your loss on deposits determines how you report your loss.
• Casualty loss -- report it on Form 4684 first and then on Schedule A (Form 1040);
• Ordinary loss -- report it on Schedule A (Form 1040) as a miscellaneous itemized deduction; or
• Nonbusiness bad debt -- report it on Form 8949 first and then on Schedule D (Form 1040).
More information. For more information, see Special Treatment for Losses on Deposits in Insolvent or Bankrupt Financial Institutions in the Instructions for Pub. 550.
Proof of Loss
To deduct a casualty or theft loss, you must be able to prove that you had a casualty or theft. You also must be able to support the amount you take as a deduction.
Casualty loss proof. For a casualty loss, your records should show all the following.
• The type of casualty (car accident, fire, storm, etc.) and when it occurred.
• That the loss was a direct result of the casualty.
• That you were the owner of the property or, if you leased the property from someone else, that you were contractually liable to the owner for the damage.
• Whether a claim for reimbursement exists for which there is a reasonable expectation of recovery.
Theft loss proof. For a theft loss, your records should show all the following.
• When you discovered that your property was missing.
• That your property was stolen.
• That you were the owner of the property.
• Whether a claim for reimbursement exists for which there is a reasonable expectation of recovery.
RECORDS: It is important that you have records that will prove your deduction. If you don't have the actual records to support your deduction, you can use other satisfactory evidence to support it.
Figuring a Loss
Figure the amount of your loss using the following steps.
1. Determine your adjusted basis in the property before the casualty or theft.
2. Determine the decrease in fair market value (FMV) of the property as a result of the casualty or theft.
3. From the smaller of the amounts you determined in (1) and (2), subtract any insurance or other reimbursement you received or expect to receive.
For personal-use property and property used in performing services as an employee, apply the deduction limits, discussed later, to determine the amount of your deductible loss.
Gain from reimbursement. If your reimbursement is more than your adjusted basis in the property, you have a gain. This is true even if the decrease in the FMV of the property is smaller than your adjusted basis. If you have a gain, you may have to pay tax on it, or you may be able to postpone reporting the gain. See Pub. 547 for more information on how to treat a gain from a reimbursement for a casualty or theft.
Leased property. If you are liable for casualty damage to property you lease, your loss is the amount you must pay to repair the property minus any insurance or other reimbursement you receive or expect to receive.
Decrease in FMV
FMV is the price for which you could sell your property to a willing buyer when neither of you has to sell or buy and both of you know all the relevant facts.
The decrease in FMV used to figure the amount of a casualty or theft loss is the difference between the property's FMV immediately before and immediately after the casualty or theft.
FMV of stolen property. The FMV of property immediately after a theft is considered to be zero, since you no longer have the property.
Example. Several years ago, you purchased silver dollars at face value for $150. This is your adjusted basis in the property. Your silver dollars were stolen this year. The FMV of the coins was $1,000 just before they were stolen, and insurance didn't cover them. Your theft loss is $150.
Recovered stolen property. Recovered stolen property is your property that was stolen and later returned to you. If you recovered property after you had already taken a theft loss deduction, you must refigure your loss using the smaller of the property's adjusted basis (explained later) or the decrease in FMV from the time just before it was stolen until the time it was recovered. Use this amount to refigure your total loss for the year in which the loss was deducted.
If your refigured loss is less than the loss you deducted, you generally have to report the difference as income in the recovery year. But report the difference only up to the amount of the loss that reduced your tax. For more information on the amount to report, see Recoveries in chapter 12.
Figuring Decrease in FMV--Items To Consider
To figure the decrease in FMV because of a casualty or theft, you generally need a competent appraisal. However, other measures can also be used to establish certain decreases.
Appraisal. An appraisal to determine the difference between the FMV of the property immediately before a casualty or theft and immediately afterward should be made by a competent appraiser. The appraiser must recognize the effects of any general market decline that may occur along with the casualty. This information is needed to limit any deduction to the actual loss resulting from damage to the property.
Several factors are important in evaluating the accuracy of an appraisal, including the following.
• The appraiser's familiarity with your property before and after the casualty or theft.
• The appraiser's knowledge of sales of comparable property in the area.
• The appraiser's knowledge of conditions in the area of the casualty.
• The appraiser's method of appraisal.
TIP: You may be able to use an appraisal that you used to get a federal loan (or a federal loan guarantee) as the result of a federally declared disaster to establish the amount of your disaster loss. For more information on disasters, see Disaster Area Losses in Pub. 547.
Cost of cleaning up or making repairs. The cost of repairing damaged property isn't part of a casualty loss. Neither is the cost of cleaning up after a casualty. But you can use the cost of cleaning up or making repairs after a casualty as a measure of the decrease in FMV if you meet all the following conditions.
• The repairs are actually made.
• The repairs are necessary to bring the property back to its condition before the casualty.
• The amount spent for repairs isn't excessive.
• The repairs take care of the damage only.
• The value of the property after the repairs isn't, due to the repairs, more than the value of the property before the casualty.
Landscaping. The cost of restoring landscaping to its original condition after a casualty may indicate the decrease in FMV. You may be able to measure your loss by what you spend on the following.
• Removing destroyed or damaged trees and shrubs minus any salvage you receive.
• Pruning and other measures taken to preserve damaged trees and shrubs.
• Replanting necessary to restore the property to its approximate value before the casualty.
Car value. Books issued by various automobile organizations that list your car may be useful in figuring the value of your car. You can use the books' retail values and modify them by such factors as mileage and the condition of your car to figure its value. The prices aren't official, but they may be useful in determining value and suggesting relative prices for comparison with current sales and offerings in your area. If your car isn't listed in the books, determine its value from other sources. A dealer's offer for your car as a trade-in on a new car isn't usually a measure of its true value.
Figuring Decrease in FMV--Items Not To Consider
You generally shouldn't consider the following items when attempting to establish the decrease in FMV of your property.
Cost of protection. The cost of protecting your property against a casualty or theft isn't part of a casualty or theft loss. The amount you spend on insurance or to board up your house against a storm isn't part of your loss.
If you make permanent improvements to your property to protect it against a casualty or theft, add the cost of these improvements to your basis in the property. An example would be the cost of a dike to prevent flooding.
Exception. You can't increase your basis in the property by, or deduct as a business expense, any expenditures you made with respect to qualified disaster mitigation payments. See Disaster Area Losses in Pub. 547.
Incidental expenses. Any incidental expenses you have due to a casualty or theft, such as expenses for the treatment of personal injuries, for temporary housing, or for a rental car, aren't part of your casualty or theft loss.
Replacement cost. The cost of replacing stolen or destroyed property isn't part of a casualty or theft loss.
Sentimental value. Don't consider sentimental value when determining your loss. If a family portrait, heirloom, or keepsake is damaged, destroyed, or stolen, you must base your loss on its FMV, as limited by your adjusted basis in the property.
Decline in market value of property in or near casualty area. A decrease in the value of your property because it is in or near an area that suffered a casualty, or that might again suffer a casualty, isn't to be taken into consideration. You have a loss only for actual casualty damage to your property. However, if your home is in a federally declared disaster area, see Disaster Area Losses in Pub. 547.
Costs of photographs and appraisals. Photographs taken after a casualty will be helpful in establishing the condition and value of the property after it was damaged. Photographs showing the condition of the property after it was repaired, restored, or replaced may also be helpful.
Appraisals are used to figure the decrease in FMV because of a casualty or theft. See Appraisal, earlier, under Figuring Decrease in FMV--Items To Consider, for information about appraisals.
The costs of photographs and appraisals used as evidence of the value and condition of property damaged as a result of a casualty aren't a part of the loss. You can claim these costs as a miscellaneous itemized deduction subject to the 2%-of-adjusted-gross-income limit on Schedule A (Form 1040). For information about miscellaneous deductions, see chapter 28.
Adjusted Basis
Adjusted basis is your basis in the property (usually cost) increased or decreased by various events, such as improvements and casualty losses. For more information, see chapter 13.
Insurance and Other Reimbursements
If you receive an insurance payment or other type of reimbursement, you must subtract the reimbursement when you figure your loss. You don't have a casualty or theft loss to the extent you are reimbursed.
If you expect to be reimbursed for part or all of your loss, you must subtract the expected reimbursement when you figure your loss. You must reduce your loss even if you don't receive payment until a later tax year. See Reimbursement Received After Deducting Loss, later.
Failure to file a claim for reimbursement. If your property is covered by insurance, you must file a timely insurance claim for reimbursement of your loss. Otherwise, you can't deduct this loss as a casualty or theft loss. However, this rule doesn't apply to the portion of the loss not covered by insurance (for example, a deductible).
Example. Your car insurance policy includes collision coverage with a $1,000 deductible. Because your insurance doesn't cover the first $1,000 of an auto collision, the $1,000 is deductible (subject to the deduction limits discussed later). This is true even if you don't file an insurance claim, because your insurance policy won't reimburse you for the deductible.
Types of Reimbursements
The most common type of reimbursement is an insurance payment for your stolen or damaged property. Other types of reimbursements are discussed next. Also see the Instructions for Form 4684.
Employer's emergency disaster fund. If you receive money from your employer's emergency disaster fund and you must use that money to rehabilitate or replace property on which you are claiming a casualty loss deduction, you must take that money into consideration in figuring the casualty loss deduction. Take into consideration only the amount you used to replace your destroyed or damaged property.
Example. Your home was extensively damaged by a tornado. Your loss after reimbursement from your insurance company was $10,000. Your employer set up a disaster relief fund for its employees. Employees receiving money from the fund had to use it to rehabilitate or replace their damaged or destroyed property. You received $4,000 from the fund and spent the entire amount on repairs to your home. In figuring your casualty loss, you must reduce your unreimbursed loss ($10,000) by the $4,000 you received from your employer's fund. Your casualty loss before applying the deduction limits discussed later is $6,000.
Cash gifts. If you receive excludable cash gifts as a disaster victim and there are no limits on how you can use the money, you don't reduce your casualty loss by these excludable cash gifts. This applies even if you use the money to pay for repairs to property damaged in the disaster.
Example. Your home was damaged by a hurricane. Relatives and neighbors made cash gifts to you that were excludable from your income. You used part of the cash gifts to pay for repairs to your home. There were no limits or restrictions on how you could use the cash gifts. Because it was an excludable gift, the money you received and used to pay for repairs to your home doesn't reduce your casualty loss on the damaged home.
Insurance payments for living expenses. You don't reduce your casualty loss by insurance payments you receive to cover living expenses in either of the following situations.
• You lose the use of your main home because of a casualty.
• Government authorities don't allow you access to your main home because of a casualty or threat of one.
Inclusion in income. If these insurance payments are more than the temporary increase in your living expenses, you must include the excess in your income. Report this amount on Form 1040, line 21. However, if the casualty occurs in a federally declared disaster area, none of the insurance payments are taxable. See Qualified disaster relief payments under Disaster Area Losses in Pub. 547.
A temporary increase in your living expenses is the difference between the actual living expenses you and your family incurred during the period you couldn't use your home and your normal living expenses for that period. Actual living expenses are the reasonable and necessary expenses incurred because of the loss of your main home. Generally, these expenses include the amounts you pay for the following.
• Rent for suitable housing.
• Transportation.
• Food.
• Utilities.
• Miscellaneous services.
Normal living expenses consist of these same expenses that you would have incurred but didn't because of the casualty or the threat of one.
Example. As a result of a fire, you vacated your apartment for a month and moved to a motel. You normally pay $525 a month for rent. None was charged for the month the apartment was vacated. Your motel rent for this month was $1,200. You normally pay $200 a month for food. Your food expenses for the month you lived in the motel were $400. You received $1,100 from your insurance company to cover your living expenses. You determine the payment you must include in income as follows.
1) Insurance payment for living
expenses $1,100
2) Actual expenses during the month
you are unable to use your home
because of fire 1,600
3) Normal living expenses 725
-----
4) Temporary increase in living
expenses: Subtract line 3
from line 2 875
------
5) Amount of payment includible
in income: Subtract line 4
from line 1 $225
=======
Tax year of inclusion. You include the taxable part of the insurance payment in income for the year you regain the use of your main home or, if later, for the year you receive the taxable part of the insurance payment.
Example. Your main home was destroyed by a tornado in August 2014. You regained use of your home in November 2015. The insurance payments you received in 2014 and 2015 were $1,500 more than the temporary increase in your living expenses during those years. You include this amount in income on your 2015 Form 1040. If, in 2016, you received further payments to cover the living expenses you had in 2014 and 2015, you must include those payments in income on your 2016 Form 1040.
Disaster relief. Food, medical supplies, and other forms of assistance you receive don't reduce your casualty loss unless they are replacements for lost or destroyed property.
TIP: Qualified disaster relief payments you receive for expenses you incurred as a result of a federally declared disaster aren't taxable income to you. For more information, see Disaster Area Losses in Pub. 547.
Disaster unemployment assistance payments are unemployment benefits that are taxable.
Generally, disaster relief grants and qualified disaster mitigation payments made under the Robert T. Stafford Disaster Relief and Emergency Assistance Act or the National Flood Insurance Act (as in effect on April 15, 2005) aren't includible in your income. See Disaster Area Losses in Pub. 547.
Reimbursement Received After Deducting Loss
If you figured your casualty or theft loss using your expected reimbursement, you may have to adjust your tax return for the tax year in which you receive your actual reimbursement. This section explains the adjustment you may have to make.
Actual reimbursement less than expected. If you later receive less reimbursement than you expected, include that difference as a loss with your other losses (if any) on your return for the year in which you can reasonably expect no more reimbursement.
Example. Your personal car had an FMV of $2,000 when it was destroyed in a collision with another car in 2015. The accident was due to the negligence of the other driver. At the end of 2015, there was a reasonable prospect that the owner of the other car would reimburse you in full. You didn't have a deductible loss in 2015.
In January 2016, the court awarded you a judgment of $2,000. However, in July it became apparent that you will be unable to collect any amount from the other driver. You can deduct the loss in 2016 subject to the deduction limits discussed later.
Actual reimbursement more than expected. If you later receive more reimbursement than you expected after you claimed a deduction for the loss, you may have to include the extra reimbursement in your income for the year you receive it. However, if any part of the original deduction didn't reduce your tax for the earlier year, don't include that part of the reimbursement in your income. You don't refigure your tax for the year you claimed the deduction. For more information, see Recoveries in chapter 12.
CAUTION: If the total of all the reimbursements you receive is more than your adjusted basis in the destroyed or stolen property, you will have a gain on the casualty or theft. If you have already taken a deduction for a loss and you receive the reimbursement in a later year, you may have to include the gain in your income for the later year. Include the gain as ordinary income up to the amount of your deduction that reduced your tax for the earlier year. See Figuring a Gain in Pub. 547 for more information on how to treat a gain from the reimbursement of a casualty or theft.
Actual reimbursement same as expected. If you receive exactly the reimbursement you expected to receive, you don't have to include any of the reimbursement in your income and you can't deduct any additional loss.
Example. In December 2016, you had a collision while driving your personal car. Repairs to the car cost $950. You had $100 deductible collision insurance. Your insurance company agreed to reimburse you for the rest of the damage. Because you expected a reimbursement from the insurance company, you didn't have a casualty loss deduction in 2016.
Due to the $100 rule (discussed later under Deduction Limits), you can't deduct the $100 you paid as the deductible. When you receive the $850 from the insurance company in 2017, don't report it as income.
Single Casualty on Multiple Properties
Personal property. Personal property is any property that isn't real property. If your personal property is stolen or is damaged or destroyed by a casualty, you must figure your loss separately for each item of property. Then combine these separate losses to figure the total loss from that casualty or theft.
Example. A fire in your home destroyed an upholstered chair, an oriental rug, and an antique table. You didn't have fire insurance to cover your loss. (This was the only casualty or theft you had during the year.) You paid $750 for the chair and you established that it had an FMV of $500 just before the fire. The rug cost $3,000 and had an FMV of $2,500 just before the fire. You bought the table at an auction for $100 before discovering it was an antique. It had been appraised at $900 before the fire. You figure your loss on each of these items as follows.
Chair Rug Table
1) Basis (cost) $750 $3,000 $100
===== ====== ======
2) FMV before fire $500 $2,500 $900
3) FMV after fire -0- -0- -0-
----- ------ ------
4) Decrease in FMV $500 $2,500 $900
===== ====== ======
5) Loss (smaller of (1) or
(4)) $500 $2,500 $100
===== ====== ======
6) Total loss $3,100
======
Real property. In figuring a casualty loss on personal-use real property, treat the entire property (including any improvements, such as buildings, trees, and shrubs) as one item. Figure the loss using the smaller of the adjusted basis or the decrease in FMV of the entire property.
Example. You bought your home a few years ago. You paid $160,000 ($20,000 for the land and $140,000 for the house). You also spent $2,000 for landscaping. This year a fire destroyed your home. The fire also damaged the shrubbery and trees in your yard. The fire was your only casualty or theft loss this year. Competent appraisers valued the property as a whole at $200,000 before the fire, but only $30,000 after the fire. (The loss to your household furnishings isn't shown in this example. It would be figured separately on each item, as explained earlier under Personal property.) Shortly after the fire, the insurance company paid you $155,000 for the loss. You figure your casualty loss as follows.
1) Adjusted basis of the entire property
(land, building, and landscaping) $162,000
========
2) FMV of entire property before
fire $200,000
3) FMV of entire property after fire 30,000
--------
4) Decrease in FMV of entire
property $170,000
========
5) Loss (smaller of (1) or (4)) $162,000
6) Subtract insurance 155,000
--------
7) Amount of loss after
reimbursement $7,000
========
Deduction Limits
After you have figured your casualty or theft loss, you must figure how much of the loss you can deduct. If the loss was to property for your personal use or your family's use, there are two limits on the amount you can deduct for your casualty or theft loss.
1. You must reduce each casualty or theft loss by $100 ($100 rule).
2. You must further reduce the total of all your casualty or theft losses by 10% of your adjusted gross income (AGI) (10% rule).
You make these reductions on Form 4684.
These rules are explained next and Table 25-1 summarizes how to apply the $100 rule and the 10% rule in various situations. For more detailed explanations and examples, see Pub. 547.
Table 25-1. How To Apply the Deduction Limits for Personal-Use Property
----------------------------------------------------------------------
$100 Rule 10% Rule
----------------------------------------------------------------------
General Application You must reduce each You must reduce your
casualty or theft loss total casualty or
by $100 when figuring theft loss by 10% of
your deduction. Apply your AGI. Apply this
this rule after you rule after you
have figured the reduce each loss by
amount of your $100 ($100 rule).
loss.
----------------------------------------------------------------------
Single Event Apply this rule only Apply this rule only
once, even if many once, even if many
pieces of property are pieces of property
affected. are affected.
----------------------------------------------------------------------
More Than One Event Apply to the loss from Apply to the total
each event. of all your losses
from all events.
----------------------------------------------------------------------
More Than One Person -- Apply separately to Apply separately to
With Loss From the Same each person. each person.
Event (other than a
married couple filing
jointly)
----------------------------------------------------------------------
Married Filing Apply as if you were Apply as if you were
Couple -- Jointly one person. one person.
With Loss -----------------------------------------------------------
From the Filing Apply separately to Apply separately to
Same Separately each spouse. each spouse.
Event
----------------------------------------------------------------------
More Than One Owner Apply separately to Apply separately to
(other than a married each owner of jointly each owner of
couple filing jointly) owned property. jointly owned
property.
----------------------------------------------------------------------
Property used partly for business and partly for personal purposes. When property is used partly for personal purposes and partly for business or income-producing purposes, the casualty or theft loss deduction must be figured separately for the personal-use part and for the business or income-producing part. You must figure each loss separately because the $100 rule and the 10% rule apply only to the loss on the personal-use part of the property.
$100 Rule
After you have figured your casualty or theft loss on personal-use property, you must reduce that loss by $100. This reduction applies to each total casualty or theft loss. It doesn't matter how many pieces of property are involved in an event. Only a single $100 reduction applies.
Example. A hailstorm damages your home and your car. Determine the amount of loss, as discussed earlier, for each of these items. Since the losses are due to a single event, you combine the losses and reduce the combined amount by $100.
Single event. Generally, events closely related in origin cause a single casualty. It is a single casualty when the damage is from two or more closely related causes, such as wind and flood damage caused by the same storm.
10% Rule
You must reduce the total of all your casualty or theft losses on personal-use property by 10% of your AGI. Apply this rule after you reduce each loss by $100. For more information, see the Form 4684 instructions. If you have both gains and losses from casualties or thefts, see Gains and losses, later.
Example 1. In June, you discovered that your house had been burglarized. Your loss after insurance reimbursement was $2,000. Your AGI for the year you discovered the theft is $29,500. You first apply the $100 rule and then the 10% rule. Figure your theft loss deduction as follows.
1) Loss after insurance $2,000
2) Subtract $100 100
------
3) Loss after $100 rule $1,900
4) Subtract 10% × $29,500 AGI 2,950
------
5) Theft loss deduction -0-
======
You don't have a theft loss deduction because your loss after you apply the $100 rule ($1,900) is less than 10% of your AGI ($2,950).
Example 2. In March, you had a car accident that totally destroyed your car. You didn't have collision insurance on your car, so you didn't receive any insurance reimbursement. Your loss on the car was $1,800. In November, a fire damaged your basement and totally destroyed the furniture, washer, dryer, and other items stored there. Your loss on the basement items after reimbursement was $2,100. Your AGI for the year that the accident and fire occurred is $25,000. You figure your casualty loss deduction as follows.
Car Basement
1) Loss $1,800 $2,100
2) Subtract $100 per
incident 100 100
------ ---------
3) Loss after $100 rule $1,700 $2,000
====== =========
4) Total loss $3,700
5) Subtract 10% × $25,000 AGI 2,500
---------
6) Casualty loss deduction $1,200
=========
Gains and losses. If you had both gains and losses from casualties or thefts to personal-use property, you must compare your total gains to your total losses. Do this after you have reduced each loss by any reimbursements and by $100, but before you have reduced the losses by 10% of your AGI.
CAUTION: Casualty or theft gains don't include gains you choose to postpone. See Pub. 547 for information on the postponement of gain.
Losses more than gains. If your losses are more than your recognized gains, subtract your gains from your losses and reduce the result by 10% of your AGI. The rest, if any, is your deductible loss from personal-use property.
Gains more than losses. If your recognized gains are more than your losses, subtract your losses from your gains. The difference is treated as capital gain and must be reported on Schedule D (Form 1040). The 10% rule doesn't apply to your gains.
When To Report Gains and Losses
Gains. If you receive an insurance or other reimbursement that is more than your adjusted basis in the destroyed or stolen property, you have a gain from the casualty or theft. You must include this gain in your income in the year you receive the reimbursement, unless you choose to postpone reporting the gain as explained in Pub. 547.
Losses. Generally, you can deduct a casualty loss that isn't reimbursable only in the tax year in which the casualty occurred. This is true even if you don't repair or replace the damaged property until a later year.
You can deduct theft losses that aren't reimbursable only in the year you discover your property was stolen.
If you aren't sure whether part of your casualty or theft loss will be reimbursed, don't deduct that part until the tax year when you become reasonably certain that it won't be reimbursed.
If you have a loss, see Table 25-2.
Table 25-2. When To Deduct a Loss
----------------------------------------------------------------------
IF you have a loss . . . THEN deduct it in the year . . .
----------------------------------------------------------------------
from a casualty, the loss occurred.
----------------------------------------------------------------------
in a federally declared disaster the disaster occurred or the year
area, immediately before the disaster.
----------------------------------------------------------------------
from a theft, the theft was discovered.
----------------------------------------------------------------------
on a deposit treated as a:
----------------------------------------------------------------------
• casualty or any ordinary loss, a reasonable estimate can be made.
----------------------------------------------------------------------
• bad debt, deposits are totally worthless.
----------------------------------------------------------------------
Loss on deposits. If your loss is a loss on deposits in an insolvent or bankrupt financial institution, see Loss on Deposits, earlier.
Disaster Area Loss
You generally must deduct a casualty loss in the year it occurred. However, if you have a casualty loss from a federally declared disaster that occurred in an area warranting public or individual assistance (or both), you can choose to deduct the loss on your tax return or amended return for either of the following years.
• The year the disaster occurred.
• The year immediately preceding the year the disaster occurred.
Gains. Special rules apply if you choose to postpone reporting gain on property damaged or destroyed in a federally declared disaster area. For those special rules, see Pub. 547.
Postponed tax deadlines. The IRS may postpone for up to 1 year certain tax deadlines of taxpayers who are affected by a federally declared disaster. The tax deadlines the IRS may postpone include those for filing income and employment tax returns, paying income and employment taxes, and making contributions to a traditional IRA or Roth IRA.
If any tax deadline is postponed, the IRS will publicize the postponement in your area by publishing a news release, revenue ruling, revenue procedure, notice, announcement, or other guidance in the Internal Revenue Bulletin (IRB). Go to IRS.gov/uac/Tax-Relief-in-Disaster-Situations to find out if a tax deadline has been postponed for your area.
Who is eligible. If the IRS postpones a tax deadline, the following taxpayers are eligible for the postponement.
• Any individual whose main home is located in a covered disaster area (defined next).
• Any business entity or sole proprietor whose principal place of business is located in a covered disaster area.
• Any individual who is a relief worker affiliated with a recognized government or philanthropic organization who is assisting in a covered disaster area.
• Any individual, business entity, or sole proprietorship whose records are needed to meet a postponed tax deadline, provided those records are maintained in a covered disaster area. The main home or principal place of business doesn't have to be located in the covered disaster area.
• Any estate or trust that has tax records necessary to meet a postponed tax deadline, provided those records are maintained in a covered disaster area.
• The spouse on a joint return with a taxpayer who is eligible for postponements.
• Any individual, business entity, or sole proprietorship not located in a covered disaster area, but whose records necessary to meet a postponed tax deadline are located in the covered disaster area.
• Any individual visiting the covered disaster area who was killed or injured as a result of the disaster.
• Any other person determined by the IRS to be affected by a federally declared disaster.
Covered disaster area. This is an area of a federally declared disaster in which the IRS has decided to postpone tax deadlines for up to 1 year.
Abatement of interest and penalties. The IRS may abate the interest and penalties on underpaid income tax for the length of any postponement of tax deadlines.
More information. For more information, see Disaster Area Losses in Pub. 547.
How To Report Gains and Losses
Use Form 4684 to report a gain or a deductible loss from a casualty or theft. If you have more than one casualty or theft, use a separate Form 4684 to determine your gain or loss for each event. Combine the gains and losses on one Form 4684. Follow the form instructions as to which lines to fill out. In addition, you must use the appropriate schedule to report a gain or loss. The schedule you use depends on whether you have a gain or loss.
If you have a: Report it on:
Gain Schedule D (Form 1040)
Loss Schedule A (Form 1040)
Adjustments to basis. If you have a casualty or theft loss, you must decrease your basis in the property by any insurance or other reimbursement you receive, and by any deductible loss. If you make either of the basis adjustments described above, amounts you spend on repairs to restore your property to its pre-casualty condition increase your adjusted basis. See Adjusted Basis in chapter 13 for more information.
Net operating loss (NOL). If your casualty or theft loss deduction causes your deductions for the year to be more than your income for the year, you may have an NOL. You can use an NOL to lower your tax in an earlier year, allowing you to get a refund for tax you have already paid. Or, you can use it to lower your tax in a later year. You don't have to be in business to have an NOL from a casualty or theft loss. For more information, see Pub. 536.
26. Car Expenses and Other Employee Business Expenses
What's New
Standard mileage rate. For 2016, the standard mileage rate for the cost of operating your car for business use is 54 cents (0.54) per mile.
Car expenses and use of the standard mileage rate are explained under Transportation Expenses, later.
Depreciation limits on cars, trucks, and vans. For 2016, the first-year limit on the total depreciation deduction for cars remains at $11,160 ($3,160 if you elect not to claim the special depreciation allowance). For trucks and vans, the first-year limit is $11,460 ($3,560 if you elect not to claim the special depreciation allowance).
Special depreciation allowance. For 2016, the special ("bonus") depreciation allowance on qualified property (including cars, trucks, and vans) remains at 50%. The special depreciation allowance is explained in chapter 4 of Pub 463.
Introduction
You may be able to deduct the ordinary and necessary business-related expenses you have for:
• Travel,
• Entertainment,
• Gifts, or
• Transportation.
An ordinary expense is one that is common and accepted in your trade or business. A necessary expense is one that is helpful and appropriate for your business. An expense does not have to be required to be considered necessary.
This chapter explains the following.
• What expenses are deductible.
• How to report your expenses on your return.
• What records you need to prove your expenses.
• How to treat any expense reimbursements you may receive.
Who does not need to use this chapter. If you are an employee, you won't need to read this chapter if all of the following are true.
• You fully accounted to your employer for your work-related expenses.
• You received full reimbursement for your expenses.
• Your employer required you to return any excess reimbursement and you did so.
• There is no amount shown with a code L in box 12 of your Form W-2, Wage and Tax Statement.
If you meet all of these conditions, there is no need to show the expenses or the reimbursements on your return. See Reimbursements, later, if you would like more information on reimbursements and accounting to your employer.
TIP: If you meet these conditions and your employer included reimbursements on your Form W-2 in error, ask your employer for a corrected Form W-2.
Useful Items
You may want to see:
Publication
• Publication 535 Business Expenses
Form (and Instructions)
• Schedule A (Form 1040) Itemized Deductions
• Schedule C (Form 1040) Profit or Loss From Business
• Schedule C-EZ (Form 1040) Net Profit From Business
• Schedule F (Form 1040) Profit or Loss From Farming
• Form 2106 Employee Business Expenses
• Form 2106-EZ Unreimbursed Employee Business Expenses
Travel Expenses
If you temporarily travel away from your tax home, you can use this section to determine if you have deductible travel expenses. This section discusses:
• Traveling away from home,
• Tax home,
• Temporary assignment or job, and
• What travel expenses are deductible.
It also discusses the standard meal allowance, rules for travel inside and outside the United States, and deductible convention expenses.
Travel expenses defined. For tax purposes, travel expenses are the ordinary and necessary expenses (defined earlier) of traveling away from home for your business, profession, or job.
You will find examples of deductible travel expenses in Table 26-1.
Table 26-1. Travel Expenses You Can Deduct
This chart summarizes expenses you can deduct when you travel away
from home for business purposes.
----------------------------------------------------------------------
IF you have
expenses for . . . THEN you can deduct the cost of . . .
----------------------------------------------------------------------
transportation travel by airplane, train, bus, or car between
your home and your business destination. If you
were provided with a ticket or you are riding free
as a result of a frequent traveler or similar
program, your cost is zero. If you travel by ship,
see Luxury Water Travel and Cruise Ships (under
Conventions) in Pub. 463 for additional rules and
limits.
----------------------------------------------------------------------
taxi, commuter fares for these and other types of transportation
bus, and airport that take you between:
limousine
• The airport or station and your hotel, and
• The hotel and the work location of your
customers or clients, your business meeting
place, or your temporary work location.
----------------------------------------------------------------------
baggage and sending baggage and sample or display material
shipping between your regular and temporary work locations.
----------------------------------------------------------------------
car operating and maintaining your car when traveling
away from home on business. You can deduct actual
expenses or the standard mileage rate as well as
business-related tolls and parking. If you rent a
car while away from home on business, you can
deduct only the business-use portion of the
expenses.
----------------------------------------------------------------------
lodging and meals your lodging and meals if your business trip is
overnight or long enough that you need to stop for
sleep or rest to properly perform your duties.
Meals include amounts spent for food, beverages,
taxes, and related tips. See Meals and Incidental
Expenses for additional rules and limits.
----------------------------------------------------------------------
cleaning dry cleaning and laundry.
----------------------------------------------------------------------
telephone business calls while on your business trip. This
includes business communication by fax machine
or other communication devices.
----------------------------------------------------------------------
tips tips you pay for any expenses in this chart.
----------------------------------------------------------------------
other other similar ordinary and necessary expenses
related to your business travel. These expenses
might include transportation to or from a business
meal, public stenographer's fees, computer rental
fees, and operating and maintaining a house
trailer.
----------------------------------------------------------------------
Traveling Away From Home
You are traveling away from home if:
• Your duties require you to be away from the general area of your Tax Home (defined later) substantially longer than an ordinary day's work, and
• You need to sleep or rest to meet the demands of your work while away from home.
This rest requirement is not satisfied by merely napping in your car. You don't have to be away from your tax home for a whole day or from dusk to dawn as long as your relief from duty is long enough to get necessary sleep or rest.
Example 1. You are a railroad conductor. You leave your home terminal on a regularly scheduled round-trip run between two cities and return home 16 hours later. During the run, you have 6 hours off at your turnaround point where you eat two meals and rent a hotel room to get necessary sleep before starting the return trip. You are considered to be away from home.
Example 2. You are a truck driver. You leave your terminal and return to it later the same day. You get an hour off at your turnaround point to eat. Because you are not off to get necessary sleep and the brief time off isn't an adequate rest period, you are not traveling away from home.
Members of the Armed Forces. If you are a member of the U.S. Armed Forces on a permanent duty assignment overseas, you are not traveling away from home. You cannot deduct your expenses for meals and lodging. You cannot deduct these expenses even if you have to maintain a home in the United States for your family members who are not allowed to accompany you overseas. If you are transferred from one permanent duty station to another, you may have deductible moving expenses, which are explained in Pub. 521, Moving Expenses.
A naval officer assigned to permanent duty aboard a ship that has regular eating and living facilities has a tax home aboard ship for travel expense purposes.
Tax Home
To determine whether you are traveling away from home, you must first determine the location of your tax home.
Generally, your tax home is your regular place of business or post of duty, regardless of where you maintain your family home. It includes the entire city or general area in which your business or work is located.
If you have more than one regular place of business, your tax home is your main place of business. See Main place of business or work, later.
If you don't have a regular or a main place of business because of the nature of your work, then your tax home may be the place where you regularly live. See No main place of business or work, later.
If you don't have a regular or a main place of business or post of duty and there is no place where you regularly live, you are considered an itinerant (a transient) and your tax home is wherever you work. As an itinerant, you cannot claim a travel expense deduction because you are never considered to be traveling away from home.
Main place of business or work. If you have more than one place of business or work, consider the following when determining which one is your main place of business or work.
• The total time you ordinarily spend in each place.
• The level of your business activity in each place.
• Whether your income from each place is significant or insignificant.
Example. You live in Cincinnati where you have a seasonal job for 8 months each year and earn $40,000. You work the other 4 months in Miami, also at a seasonal job, and earn $15,000. Cincinnati is your main place of work because you spend most of your time there and earn most of your income there.
No main place of business or work. You may have a tax home even if you don't have a regular or main place of business or work. Your tax home may be the home where you regularly live.
Factors used to determine tax home. If you don't have a regular or main place of business or work, use the following three factors to determine where your tax home is.
1. You perform part of your business in the area of your main home and use that home for lodging while doing business in the area.
2. You have living expenses at your main home that you duplicate because your business requires you to be away from that home.
3. You haven't abandoned the area in which both your historical place of lodging and your claimed main home are located; you have a member or members of your family living at your main home; or you often use that home for lodging.
If you satisfy all three factors, your tax home is the home where you regularly live. If you satisfy only two factors, you may have a tax home depending on all the facts and circumstances. If you satisfy only one factor, you are an itinerant; your tax home is wherever you work and you cannot deduct travel expenses.
Example. You are single and live in Boston in an apartment you rent. You have worked for your employer in Boston for a number of years. Your employer enrolls you in a 12-month executive training program. You don't expect to return to work in Boston after you complete your training.
During your training, you don't do any work in Boston. Instead, you receive classroom and on-the-job training throughout the United States. You keep your apartment in Boston and return to it frequently. You use your apartment to conduct your personal business. You also keep up your community contacts in Boston. When you complete your training, you are transferred to Los Angeles.
You don't satisfy factor (1) because you did not work in Boston. You satisfy factor (2) because you had duplicate living expenses. You also satisfy factor (3) because you did not abandon your apartment in Boston as your main home, you kept your community contacts, and you frequently returned to live in your apartment. Therefore, you have a tax home in Boston.
Tax home different from family home. If you (and your family) don't live at your tax home (defined earlier), you cannot deduct the cost of traveling between your tax home and your family home. You also cannot deduct the cost of meals and lodging while at your tax home. See Example 1.
If you are working temporarily in the same city where you and your family live, you may be considered as traveling away from home. See Example 2.
Example 1. You are a truck driver and you and your family live in Tucson. You are employed by a trucking firm that has its terminal in Phoenix. At the end of your long runs, you return to your home terminal in Phoenix and spend one night there before returning home. You cannot deduct any expenses you have for meals and lodging in Phoenix or the cost of traveling from Phoenix to Tucson. This is because Phoenix is your tax home.
Example 2. Your family home is in Pittsburgh, where you work 12 weeks a year. The rest of the year you work for the same employer in Baltimore. In Baltimore, you eat in restaurants and sleep in a rooming house. Your salary is the same whether you are in Pittsburgh or Baltimore.
Because you spend most of your working time and earn most of your salary in Baltimore, that city is your tax home. You cannot deduct any expenses you have for meals and lodging there. However, when you return to work in Pittsburgh, you are away from your tax home even though you stay at your family home. You can deduct the cost of your round trip between Baltimore and Pittsburgh. You can also deduct your part of your family's living expenses for meals and lodging while you are living and working in Pittsburgh.
Temporary Assignment or Job
You may regularly work at your tax home and also work at another location. It may not be practical to return to your tax home from this other location at the end of each work day.
Temporary assignment vs. indefinite assignment. If your assignment or job away from your main place of work is temporary, your tax home does not change. You are considered to be away from home for the whole period you are away from your main place of work. You can deduct your travel expenses if they otherwise qualify for deduction. Generally, a temporary assignment in a single location is one that is realistically expected to last (and does in fact last) for 1 year or less.
However, if your assignment or job is indefinite, the location of the assignment or job becomes your new tax home and you cannot deduct your travel expenses while there. An assignment or job in a single location is considered indefinite if it is realistically expected to last for more than 1 year, whether or not it actually lasts for more than 1 year.
If your assignment is indefinite, you must include in your income any amounts you receive from your employer for living expenses, even if they are called travel allowances and you account to your employer for them. You may be able to deduct the cost of relocating to your new tax home as a moving expense. See Pub. 521 for more information.
Exception for federal crime investigations or prosecutions. If you are a federal employee participating in a federal crime investigation or prosecution, you are not subject to the 1-year rule. This means you may be able to deduct travel expenses even if you are away from your tax home for more than 1 year, provided you meet the other requirements for deductibility.
For you to qualify, the Attorney General (or his or her designee) must certify that you are traveling:
• For the federal government,
• In a temporary duty status, and
• To investigate or prosecute, or provide support services for the investigation or prosecution of a federal crime.
Determining temporary or indefinite. You must determine whether your assignment is temporary or indefinite when you start work. If you expect an assignment or job to last for 1 year or less, it is temporary unless there are facts and circumstances that indicate otherwise. An assignment or job that is initially temporary may become indefinite due to changed circumstances. A series of assignments to the same location, all for short periods but that together cover a long period, may be considered an indefinite assignment.
Going home on days off. If you go back to your tax home from a temporary assignment on your days off, you are not considered away from home while you are in your hometown. You cannot deduct the cost of your meals and lodging there. However, you can deduct your travel expenses, including meals and lodging, while traveling between your temporary place of work and your tax home. You can claim these expenses up to the amount it would have cost you to stay at your temporary place of work.
If you keep your hotel room during your visit home, you can deduct the cost of your hotel room. In addition, you can deduct your expenses of returning home up to the amount you would have spent for meals had you stayed at your temporary place of work.
Probationary work period. If you take a job that requires you to move, with the understanding that you will keep the job if your work is satisfactory during a probationary period, the job is indefinite. You cannot deduct any of your expenses for meals and lodging during the probationary period.
What Travel Expenses Are Deductible?
Once you have determined that you are traveling away from your tax home, you can determine what travel expenses are deductible.
You can deduct ordinary and necessary expenses you have when you travel away from home on business. The type of expense you can deduct depends on the facts and your circumstances.
Table 26-1 summarizes travel expenses you may be able to deduct. You may have other deductible travel expenses that are not covered there, depending on the facts and your circumstances.
RECORDS: When you travel away from home on business, you should keep records of all the expenses you have and any advances you receive from your employer. You can use a log, diary, notebook, or any other written record to keep track of your expenses. The types of expenses you need to record, along with supporting documentation, are described in Table 26-2, later.
Table 26-2. How To Prove Certain Business Expenses
----------------------------------------------------------------------
THEN you must keep records that show details of the
following elements . . .
-----------------------------------------------------
IF you have
expenses Place or
for . . . Amount Time Description
----------------------------------------------------------------------
Travel Cost of each Dates you left Destination or
separate expense and returned area of your
for travel, lodging, for each trip travel (name
and meals. and number of of city, town,
Incidental expenses days spent on or other
may be totaled in business. designation).
reasonable categories
such as taxis, fees
and tips, etc.
----------------------------------------------------------------------
Entertainment Cost of each separate Date of Name and
expense. Incidental entertainment. address or
expenses such as (Also see location of
taxis, telephones, Business place of
etc., may be totaled Purpose.) entertainment.
on a daily basis. Type of
entertainment
if not
otherwise
apparent.
(Also see
Business
Purpose.)
----------------------------------------------------------------------
Gifts Cost of the gift. Date of the Description of
gift. the gift.
----------------------------------------------------------------------
Transportation Cost of each separate Date of the Your business
expense. For car expense. For destination.
expenses, the cost of car expenses,
the car and any the date of
improvements, the the use of the
date you started car.
using it for
business, the
mileage for each
business use, and the
total miles for
the year.
----------------------------------------------------------------------
[Table Continued]
------------------------------------------------------------
IF you have
expenses Business Purpose and
for . . . Business Relationship
------------------------------------------------------------
Travel Purpose: Business purpose for the
expense or the business benefit gained or
expected to be gained.
Relationship: N/A
------------------------------------------------------------
Entertainment Purpose: Business purpose for the
--------------- expense or the business benefit gained or
Gifts expected to be gained. For entertainment,
the nature of the business discussion or
activity. If the entertainment was directly
before or after a business discussion: the
date, place, nature, and duration of the
business discussion, and the identities of
the persons who took part in both the
business discussion and the
entertainment activity.
Relationship: Occupations or other
information (such as names, titles, or
other designations) about the recipients
that shows their business relationship to
you. For entertainment, you must also
prove that you or your employee was
present if the entertainment was a
business meal.
------------------------------------------------------------
Transportation Purpose: Business purpose for the
expense.
Relationship: N/A
------------------------------------------------------------
Separating costs. If you have one expense that includes the costs of meals, entertainment, and other services (such as lodging or transportation), you must allocate that expense between the cost of meals and entertainment and the cost of other services. You must have a reasonable basis for making this allocation. For example, you must allocate your expenses if a hotel includes one or more meals in its room charge.
Travel expenses for another individual. If a spouse, dependent, or other individual goes with you (or your employee) on a business trip or to a business convention, you generally cannot deduct his or her travel expenses.
Employee. You can deduct the travel expenses of someone who goes with you if that person:
1. Is your employee,
2. Has a bona fide business purpose for the travel, and
3. Would otherwise be allowed to deduct the travel expenses.
Business associate. If a business associate travels with you and meets the conditions in (2) and (3) above, you can deduct the travel expenses you have for that person. A business associate is someone with whom you could reasonably expect to engage or deal in the active conduct of your business. A business associate can be a current or prospective (likely to become) customer, client, supplier, employee, agent, partner, or professional advisor.
Bona fide business purpose. A bona fide business purpose exists if you can prove a real business purpose for the individual's presence. Incidental services, such as typing notes or assisting in entertaining customers, are not enough to make the expenses deductible.
Example. Jerry drives to Chicago on business and takes his wife, Linda, with him. Linda isn't Jerry's employee. Linda occasionally types notes, performs similar services, and accompanies Jerry to luncheons and dinners. The performance of these services does not establish that her presence on the trip is necessary to the conduct of Jerry's business. Her expenses are not deductible.
Jerry pays $199 a day for a double room. A single room costs $149 a day. He can deduct the total cost of driving his car to and from Chicago, but only $149 a day for his hotel room. If he uses public transportation, he can deduct only his fare.
Meals and Incidental Expenses
You can deduct the cost of meals in either of the following situations.
• It is necessary for you to stop for substantial sleep or rest to properly perform your duties while traveling away from home on business.
• The meal is business-related entertainment.
Business-related entertainment is discussed under Entertainment Expenses, later. The following discussion deals only with meals (and incidental expenses) that are not business-related entertainment.
Lavish or extravagant. You cannot deduct expenses for meals that are lavish or extravagant. An expense isn't considered lavish or extravagant if it is reasonable based on the facts and circumstances. Expenses won't be disallowed merely because they are more than a fixed dollar amount or take place at deluxe restaurants, hotels, nightclubs, or resorts.
50% limit on meals. You can figure your meal expenses using either of the following methods.
• Actual cost.
• The standard meal allowance.
Both of these methods are explained below. But, regardless of the method you use, you generally can deduct only 50% of the unreimbursed cost of your meals.
If you are reimbursed for the cost of your meals, how you apply the 50% limit depends on whether your employer's reimbursement plan was accountable or nonaccountable. If you are not reimbursed, the 50% limit applies whether the unreimbursed meal expense is for business travel or business entertainment. The 50% limit is explained later under Entertainment Expenses. Accountable and nonaccountable plans are discussed later under Reimbursements.
Actual cost. You can use the actual cost of your meals to figure the amount of your expense before reimbursement and application of the 50% deduction limit. If you use this method, you must keep records of your actual cost.
Standard meal allowance. Generally, you can use the "standard meal allowance" method as an alternative to the actual cost method. It allows you to use a set amount for your daily meals and incidental expenses (M&IE), instead of keeping records of your actual costs. The set amount varies depending on where and when you travel. In this chapter, "standard meal allowance" refers to the federal rate for M&IE, discussed later under Amount of standard meal allowance. If you use the standard meal allowance, you still must keep records to prove the time, place, and business purpose of your travel. See Recordkeeping, later.
Incidental expenses. The term "incidental expenses" means fees and tips given to porters, baggage carriers, hotel staff, and staff on ships. Incidental expenses don't include expenses for laundry, cleaning and pressing of clothing, lodging taxes, costs of telegrams or telephone calls, transportation between places of lodging or business and places where meals are taken, or the mailing cost of filing travel vouchers and paying employer-sponsored charge card billings.
Incidental expenses only method. You can use an optional method (instead of actual cost) for deducting incidental expenses only. The amount of the deduction is $5 a day. You can use this method only if you did not pay or incur any meal expenses. You cannot use this method on any day that you use the standard meal allowance.
CAUTION: Federal employees should refer to the Federal Travel Regulations at http://www.gsa.gov. Find "What GSA Offers" and click on "Regulations: FMR, FTR, & FAR" for Federal Travel Regulation (FTR) for changes affecting claims for reimbursement.
50% limit may apply. If you use the standard meal allowance method for meal expenses and you are not reimbursed or you are reimbursed under a nonaccountable plan, you can generally deduct only 50% of the standard meal allowance. If you are reimbursed under an accountable plan and you are deducting amounts that are more than your reimbursements, you can deduct only 50% of the excess amount. The 50% limit is explained later under Entertainment Expenses. Accountable and nonaccountable plans are discussed later under Reimbursements.
CAUTION: There is no optional standard lodging amount similar to the standard meal allowance. Your allowable lodging expense deduction is your actual cost.
Who can use the standard meal allowance. You can use the standard meal allowance whether you are an employee or self-employed, and whether or not you are reimbursed for your traveling expenses.
Use of the standard meal allowance for other travel. You can use the standard meal allowance to figure your meal expenses when you travel in connection with investment and other income-producing property. You can also use it to figure your meal expenses when you travel for qualifying educational purposes. You cannot use the standard meal allowance to figure the cost of your meals when you travel for medical or charitable purposes.
Amount of standard meal allowance. The standard meal allowance is the federal M&IE rate. For travel in 2016, the rate for most small localities in the United States is $51 a day.
Most major cities and many other localities in the United States are designated as high-cost areas, qualifying for higher standard meal allowances. You can find this information (organized by year and location) on the Internet at http://www.gsa.gov/perdiem.
If you travel to more than one location in one day, use the rate in effect for the area where you stop for sleep or rest. If you work in the transportation industry, however, see Special rate for transportation workers, later.
Standard meal allowance for areas outside the continental United States. The standard meal allowance rates above don't apply to travel in Alaska, Hawaii, or any other location outside the continental United States. The Department of Defense establishes per diem rates for Alaska, Hawaii, Puerto Rico, American Samoa, Guam, Midway, the Northern Mariana Islands, the U.S. Virgin Islands, Wake Island, and other non-foreign areas outside the continental United States. The Department of State establishes per diem rates for all other foreign areas.
You can access per diem rates for non-foreign areas outside the continental United States at http://www.defensetravel.dod.mil/site/perdiemCalc.cfm. You can access all other foreign per diem rates at http://www.state.gov/travel/. Click on "Travel Per Diem Allowances for Foreign Areas" under "Foreign Per Diem Rates," to obtain the latest foreign per diem rates.
Special rate for transportation workers. You can use a special standard meal allowance if you work in the transportation industry. You are in the transportation industry if your work:
• Directly involves moving people or goods by airplane, barge, bus, ship, train, or truck; and
• Regularly requires you to travel away from home and, during any single trip, usually involves travel to areas eligible for different standard meal allowance rates.
If this applies to you, the standard daily meal allowance for 2016 is $63 a day ($68 for travel outside the continental United States). To determine which rate you should use, see Transition Rules in
• Method 1: You can claim 3/4 of the standard meal allowance.
• Method 2: You can prorate using any method that you consistently apply and that is in accordance with reasonable business practice.
Example. Jen is employed in New Orleans as a convention planner. In March, her employer sent her on a 3-day trip to Washington, DC, to attend a planning seminar. She left her home in New Orleans at 10 a.m. on Wednesday and arrived in Washington, DC, at 5:30 p.m. After spending two nights there, she flew back to New Orleans on Friday and arrived back home at 8:00 p.m. Jen's employer gave her a flat amount to cover her expenses and included it with her wages.
Under Method 1, Jen can claim 2 1/2 days of the standard meal allowance for Washington, DC: 3/4 of the daily rate for Wednesday and Friday (the days she departed and returned), and the full daily rate for Thursday.
Under Method 2, Jen could also use any method that she applies consistently and that is in accordance with reasonable business practice. For example, she could claim 3 days of the standard meal allowance even though a federal employee would have to use Method 1 and be limited to only 2 1/2 days.
Travel in the United States
The following discussion applies to travel in the United States. For this purpose, the United States includes only the 50 states and the District of Columbia. The treatment of your travel expenses depends on how much of your trip was business related and on how much of your trip occurred within the United States. See Part of Trip Outside the United States, later.
Trip Primarily for Business
You can deduct all your travel expenses if your trip was entirely business related. If your trip was primarily for business and, while at your business destination, you extended your stay for a vacation, made a personal side trip, or had other personal activities, you can deduct your business-related travel expenses. These expenses include the travel costs of getting to and from your business destination and any business-related expenses at your business destination.
Example. You work in Atlanta and take a business trip to New Orleans in May. Your business travel totals 900 miles round trip. On your way home, you stop in Mobile to visit your parents. You spend $2,165 for the 9 days you are away from home for travel, meals, lodging, and other travel expenses. If you hadn't stopped in Mobile, you would've been gone only 6 days, and your total cost would have been $1,602. You can deduct $1,602 for your trip, including the cost of round-trip transportation to and from New Orleans. The deduction for your meals is subject to the 50% limit on meals mentioned earlier.
Trip Primarily for Personal Reasons
If your trip was primarily for personal reasons, such as a vacation, the entire cost of the trip is a nondeductible personal expense. However, you can deduct any expenses you have while at your destination that are directly related to your business.
A trip to a resort or on a cruise ship may be a vacation even if the promoter advertises that it is primarily for business. The scheduling of incidental business activities during a trip, such as viewing videotapes or attending lectures dealing with general subjects, won't change what is really a vacation into a business trip.
Part of Trip Outside the United States
If part of your trip is outside the United States, use the rules described later under Travel Outside the United States for that part of the trip. For the part of your trip that is inside the United States, use the rules for travel in the United States. Travel outside the United States does not include travel from one point in the United States to another point in the United States. The following discussion can help you determine whether your trip was entirely within the United States.
Public transportation. If you travel by public transportation, any place in the United States where that vehicle makes a scheduled stop is a point in the United States. Once the vehicle leaves the last scheduled stop in the United States on its way to a point outside the United States, you apply the rules under Travel Outside the United States.
Example. You fly from New York to Puerto Rico with a scheduled stop in Miami. You return to New York nonstop. The flight from New York to Miami is in the United States, so only the flight from Miami to Puerto Rico is outside the United States. Because there are no scheduled stops between Puerto Rico and New York, all of the return trip is outside the United States.
Private car. Travel by private car in the United States is travel between points in the United States, even when you are on your way to a destination outside the United States.
Example. You travel by car from Denver to Mexico City and return. Your travel from Denver to the border and from the border back to Denver is travel in the United States, and the rules in this section apply. The rules under Travel Outside the United States apply to your trip from the border to Mexico City and back to the border.
Travel Outside the United States
If any part of your business travel is outside the United States, some of your deductions for the cost of getting to and from your destination may be limited. For this purpose, the United States includes only the 50 states and the District of Columbia.
How much of your travel expenses you can deduct depends in part upon how much of your trip outside the United States was business related.
See chapter 1 of • Are not related to your employer, or • Are not a managing executive.
"Related to your employer" is defined later in this chapter under Per Diem and Car Allowances.
A "managing executive" is an employee who has the authority and responsibility, without being subject to the veto of another, to decide on the need for the business travel.
A self-employed person generally has substantial control over arranging business trips.
Exception 2--Outside United States no more than a week. Your trip is considered entirely for business if you were outside the United States for a week or less, combining business and nonbusiness activities. One week means 7 consecutive days. In counting the days, don't count the day you leave the United States, but do count the day you return to the United States.
Exception 3--Less than 25% of time on personal activities. Your trip is considered entirely for business if:
• You were outside the United States for more than a week, and
• You spent less than 25% of the total time you were outside the United States on nonbusiness activities.
For this purpose, count both the day your trip began and the day it ended.
Exception 4--Vacation not a major consideration. Your trip is considered entirely for business if you can establish that a personal vacation was not a major consideration, even if you have substantial control over arranging the trip.
Travel Primarily for Business
If you travel outside the United States primarily for business but spend some of your time on nonbusiness activities, you generally cannot deduct all of your travel expenses. You only can deduct the business portion of your cost of getting to and from your destination. You must allocate the costs between your business and nonbusiness activities to determine your deductible amount. These travel allocation rules are discussed in chapter 1 of Pub. 463 for information on conventions held outside the North American area.
Entertainment Expenses
You may be able to deduct business-related entertainment expenses you have for entertaining a client, customer, or employee.
You can deduct entertainment expenses only if they are both ordinary and necessary (defined earlier in the Introduction) and meet one of the following tests.
• Directly related test.
• Associated test.
Both of these tests are explained in chapter 2 of Individuals subject to "hours of service" limits, later.)
The 50% limit applies to employees or their employers, and to self-employed persons (including independent contractors) or their clients, depending on whether the expenses are reimbursed.
[The following graphic has not been reproduced:
Figure 26-A. Does the 50% Limit Apply to Your Expenses?]
Figure 26-A summarizes the general rules explained in this section.
The 50% limit applies to business meals or entertainment expenses you have while:
• Traveling away from home (whether eating alone or with others) on business;
• Entertaining customers at your place of business, a restaurant, or other location; or
• Attending a business convention or reception, business meeting, or business luncheon at a club.
Included expenses. Expenses subject to the 50% limit include:
• Taxes and tips relating to a business meal or entertainment activity,
• Cover charges for admission to a nightclub,
• Rent paid for a room in which you hold a dinner or cocktail party, and
• Amounts paid for parking at a sports arena.
However, the cost of transportation to and from a business meal or a business-related entertainment activity isn't subject to the 50% limit.
Application of 50% limit. The 50% limit on meal and entertainment expenses applies if the expense is otherwise deductible and isn't covered by one of the exceptions discussed later in this section.
The 50% limit also applies to certain meal and entertainment expenses that are not business related. It applies to meal and entertainment expenses incurred for the production of income, including rental or royalty income. It also applies to the cost of meals included in deductible educational expenses.
When to apply the 50% limit. You apply the 50% limit after determining the amount that would otherwise qualify for a deduction. You first have to determine the amount of meal and entertainment expenses that would be deductible under the other rules discussed in this chapter.
Example 1. You spend $200 for a business-related meal. If $110 of that amount isn't allowable because it is lavish and extravagant, the remaining $90 is subject to the 50% limit. Your deduction cannot be more than $45 (0.50 × $90).
Example 2. You purchase two tickets to a concert and give them to a client. You purchased the tickets through a ticket agent. You paid $200 for the two tickets, which had a face value of $80 each ($160 total). Your deduction cannot be more than $80 (0.50 × $160).
Exceptions to the 50% Limit
Generally, business-related meal and entertainment expenses are subject to the 50% limit. Figure 26-A can help you determine if the 50% limit applies to you.
Your meal or entertainment expense isn't subject to the 50% limit if the expense meets one of the following exceptions.
Employee's reimbursed expenses. If you are an employee, you are not subject to the 50% limit on expenses for which your employer reimburses you under an accountable plan. Accountable plans are discussed later under Reimbursements.
Individuals subject to "hours of service" limits. You can deduct a higher percentage of your meal expenses while traveling away from your tax home if the meals take place during or incident to any period subject to the Department of Transportation's "hours of service" limits. The percentage is 80%.
Individuals subject to the Department of Transportation's "hours of service" limits include the following persons.
• Certain air transportation workers (such as pilots, crew, dispatchers, mechanics, and control tower operators) who are under Federal Aviation Administration regulations.
• Interstate truck operators and bus drivers who are under Department of Transportation regulations.
• Certain railroad employees (such as engineers, conductors, train crews, dispatchers, and control operations personnel) who are under Federal Railroad Administration regulations.
• Certain merchant mariners who are under Coast Guard regulations.
Other exceptions. There are also exceptions for the self-employed, advertising expenses, selling meals or entertainment, and charitable sports events. These are discussed in
• Business,
• Pleasure,
• Recreation, or
• Other social purpose.
This rule applies to any membership organization if one of its principal purposes is either:
• To conduct entertainment activities for members or their guests, or
• To provide members or their guests with access to entertainment facilities.
The purposes and activities of a club, not its name, will determine whether or not you can deduct the dues. You cannot deduct dues paid to:
• Country clubs,
• Golf and athletic clubs,
• Airline clubs,
• Hotel clubs, and
• Clubs operated to provide meals under circumstances generally considered to be conducive to business discussions.
Entertainment facilities. Generally, you cannot deduct any expense for the use of an entertainment facility. This includes expenses for depreciation and operating costs such as rent, utilities, maintenance, and protection.
An entertainment facility is any property you own, rent, or use for entertainment. Examples include a yacht, hunting lodge, fishing camp, swimming pool, tennis court, bowling alley, car, airplane, apartment, hotel suite, or home in a vacation resort.
Out-of-pocket expenses. You can deduct out-of-pocket expenses, such as for food and beverages, catering, gas, and fishing bait, that you provided during entertainment at a facility. These are not expenses for the use of an entertainment facility. However, these expenses are subject to the directly-related and associated tests and to the 50% Limit discussed earlier.
Additional information. For more information on entertainment expenses, including discussions of the directly-related and associated tests, see chapter 2 of b. Is one of a number of identical items you widely distribute. Examples include pens, desk sets, and plastic bags and cases.
Gift or entertainment. Any item that might be considered either a gift or entertainment generally will be considered entertainment. However, if you give a customer packaged food or beverages you intend the customer to use at a later date, treat it as a gift.
If you give a customer tickets to a theater performance or sporting event and you don't go with the customer to the performance or event, you have a choice. You can treat the cost of the tickets as either a gift expense or an entertainment expense, whichever is to your advantage.
If you go with the customer to the event, you must treat the cost of the tickets as an entertainment expense. You cannot choose, in this case, to treat the cost of the tickets as a gift expense.
Transportation Expenses
This section discusses expenses you can deduct for business transportation when you are not traveling away from home as defined earlier under Travel Expenses. These expenses include the cost of transportation by air, rail, bus, taxi, etc., and the cost of driving and maintaining your car.
Transportation expenses include the ordinary and necessary costs of all of the following.
• Getting from one workplace to another in the course of your business or profession when you are traveling within the area of your tax home. (Tax home is defined earlier under Travel Expenses.)
• Visiting clients or customers.
• Going to a business meeting away from your regular workplace.
• Getting from your home to a temporary workplace when you have one or more regular places of work. These temporary workplaces can be either within the area of your tax home or outside that area.
Transportation expenses don't include expenses you have while traveling away from home overnight. Those expenses are travel expenses, discussed earlier. However, if you use your car while traveling away from home overnight, use the rules in this section to figure your car expense deduction. See Car Expenses, later.
Illustration of transportation expenses. Figure 26-B illustrates the rules for when you can deduct transportation expenses when you have a regular or main job away from your home. You may want to refer to it when deciding whether you can deduct your transportation expenses. Daily transportation expenses you incur while traveling from home to one or more regular places of business are generally nondeductible commuting expenses. However, there are many exceptions for deducting transportation expenses, like whether your work location is temporary (inside or outside the metropolitan area), traveling for same trade or business, or if you have a home office.
Temporary work location. If you have one or more regular work locations away from your home and you commute to a temporary work location in the same trade or business, you can deduct the expenses of the daily round-trip transportation between your home and the temporary location, regardless of distance.
If your employment at a work location is realistically expected to last (and does in fact last) for 1 year or less, the employment is temporary unless there are facts and circumstances that would indicate otherwise.
If your employment at a work location is realistically expected to last for more than 1 year or if there is no realistic expectation that the employment will last for 1 year or less, the employment isn't temporary, regardless of whether it actually lasts for more than 1 year.
If employment at a work location initially is realistically expected to last for 1 year or less, but at some later date the employment is realistically expected to last more than 1 year, that employment will be treated as temporary (unless there are facts and circumstances that would indicate otherwise) until your expectation changes. It won't be treated as temporary after the date you determine it will last more than 1 year.
If the temporary work location is beyond the general area of your regular place of work and you stay overnight, you are traveling away from home. You may have deductible travel expenses as discussed earlier in this chapter.
No regular place of work. If you have no regular place of work but ordinarily work in the metropolitan area where you live, you can deduct daily transportation costs between home and a temporary work site outside that metropolitan area.
Generally, a metropolitan area includes the area within the city limits and the suburbs that are considered part of that metropolitan area.
You cannot deduct daily transportation costs between your home and temporary work sites within your metropolitan area. These are nondeductible commuting expenses.
Two places of work. If you work at two places in one day, whether or not for the same employer, you can deduct the expense of getting from one workplace to the other. However, if for some personal reason you don't go directly from one location to the other, you cannot deduct more than the amount it would have cost you to go directly from the first location to the second.
Transportation expenses you have in going between home and a part-time job on a day off from your main job are commuting expenses. You cannot deduct them.
Armed Forces reservists. A meeting of an Armed Forces reserve unit is a second place of business if the meeting is held on a day on which you work at your regular job. You can deduct the expense of getting from one workplace to the other as just discussed under Two places of work, earlier.
You usually cannot deduct the expense if the reserve meeting is held on a day on which you don't work at your regular job. In this case, your transportation generally is a nondeductible commuting expense. However, you can deduct your transportation expenses if the location of the meeting is temporary and you have one or more regular places of work.
If you ordinarily work in a particular metropolitan area but not at any specific location and the reserve meeting is held at a temporary location outside that metropolitan area, you can deduct your transportation expenses.
If you travel away from home overnight to attend a guard or reserve meeting, you can deduct your travel expenses. These expenses are discussed earlier under Travel Expenses.
If you travel more than 100 miles away from home in connection with your performance of services as a member of the reserves, you may be able to deduct some of your reserve-related travel costs as an adjustment to income rather than as an itemized deduction. See Armed Forces reservists traveling more than 100 miles from home under Special Rules, later.
[The following graphic has not been reproduced:
Figure 26-B. When Are Transportation Expenses Deductible?]
Commuting expenses. You cannot deduct the costs of taking a bus, trolley, subway, or taxi, or of driving a car between your home and your main or regular place of work. These costs are personal commuting expenses. You cannot deduct commuting expenses no matter how far your home is from your regular place of work. You cannot deduct commuting expenses even if you work during the commuting trip.
Example. You sometimes use your cell phone to make business calls while commuting to and from work. Sometimes business associates ride with you to and from work, and you have a business discussion in the car. These activities don't change the trip from personal to business. You cannot deduct your commuting expenses.
Parking fees. Fees you pay to park your car at your place of business are nondeductible commuting expenses. You can, however, deduct business-related parking fees when visiting a customer or client.
Advertising display on car. Putting display material that advertises your business on your car does not change the use of your car from personal use to business use. If you use this car for commuting or other personal uses, you still cannot deduct your expenses for those uses.
Car pools. You cannot deduct the cost of using your car in a nonprofit car pool. Do not include payments you receive from the passengers in your income. These payments are considered reimbursements of your expenses. However, if you operate a car pool for a profit, you must include payments from passengers in your income. You can then deduct your car expenses (using the rules in this chapter).
Hauling tools or instruments. Hauling tools or instruments in your car while commuting to and from work does not make your car expenses deductible. However, you can deduct any additional costs you have for hauling tools or instruments (such as for renting a trailer you tow with your car).
Union members' trips from a union hall. If you get your work assignments at a union hall and then go to your place of work, the costs of getting from the union hall to your place of work are nondeductible commuting expenses. Although you need the union to get your work assignments, you are employed where you work, not where the union hall is located.
Office in the home. If you have an office in your home that qualifies as a principal place of business, you can deduct your daily transportation costs between your home and another work location in the same trade or business. (See chapter 28 for information on determining if your home office qualifies as a principal place of business.)
Examples of deductible transportation. The following examples show when you can deduct transportation expenses based on the location of your work and your home.
Example 1. You regularly work in an office in the city where you live. Your employer sends you to a 1-week training session at a different office in the same city. You travel directly from your home to the training location and return each day. You can deduct the cost of your daily round-trip transportation between your home and the training location.
Example 2. Your principal place of business is in your home. You can deduct the cost of round-trip transportation between your qualifying home office and your client's or customer's place of business.
Example 3. You have no regular office, and you don't have an office in your home. In this case, the location of your first business contact inside the metropolitan area is considered your office. Transportation expenses between your home and this first contact are nondeductible commuting expenses. Transportation expenses between your last business contact and your home are also nondeductible commuting expenses. While you cannot deduct the costs of these first and last trips, you can deduct the costs of going from one client or customer to another. With no regular or home office, the costs of travel between two or more business contacts in a metropolitan area are deductible while the costs of travel between the home to (and from) business contacts are not deductible.
Car Expenses
If you use your car for business purposes, you may be able to deduct car expenses. You generally can use one of the following two methods to figure your deductible expenses.
• Standard Mileage Rate.
• Actual Car Expenses.
If you use actual car expenses to figure your deduction for a car you lease, there are rules that affect the amount of your lease payments you can deduct. See Leasing a car under Actual Car Expenses, later.
In this chapter, the term "car" includes a van, pickup, or panel truck.
Rural mail carriers. If you are a rural mail carrier, you may be able to treat the amount of qualified reimbursement you received as the amount of your allowable expense. Because the qualified reimbursement is treated as paid under an accountable plan, your employer shouldn't include the amount of reimbursement in your income.
If your vehicle expenses are more than the amount of your reimbursement, you can deduct the unreimbursed expenses as an itemized deduction on Schedule A (Form 1040). You must complete Form 1040.
A "qualified reimbursement" is the reimbursement you receive that meets both of the following conditions.
• It is given as an equipment maintenance allowance (EMA) to employees of the U.S. Postal Service.
• It is at the rate contained in the 1991 collective bargaining agreement. Any later agreement cannot increase the qualified reimbursement amount by more than the rate of inflation.
See your employer for information on your reimbursement.
CAUTION: If you are a rural mail carrier and received a qualified reimbursement, you cannot use the standard mileage rate.
Standard Mileage Rate
You may be able to use the standard mileage rate to figure the deductible costs of operating your car for business purposes. For 2016, the standard mileage rate for business use is 54 cents (0.54) per mile.
CAUTION: If you use the standard mileage rate for a year, you cannot deduct your actual car expenses for that year, but see Parking fees and tolls, later.
You generally can use the standard mileage rate whether or not you are reimbursed and whether or not any reimbursement is more or less than the amount figured using the standard mileage rate. See Reimbursements under How To Report, later.
Choosing the standard mileage rate. If you want to use the standard mileage rate for a car you own, you must choose to use it in the first year the car is available for use in your business. Then in later years, you can choose to use either the standard mileage rate or actual expenses.
If you want to use the standard mileage rate for a car you lease, you must use it for the entire lease period.
You must make the choice to use the standard mileage rate by the due date (including extensions) of your return. You cannot revoke the choice. However, in a later year, you can switch from the standard mileage rate to the actual expenses method. If you change to the actual expenses method in a later year, but before your car is fully depreciated, you have to estimate the remaining useful life of the car and use straight line depreciation.
Example. Larry is an employee who occasionally uses his own car for business purposes. He purchased the car in 2014, but he did not claim any unreimbursed employee expenses on his 2014 tax return. Because Larry did not use the standard mileage rate the first year the car was available for business use, he cannot use the standard mileage rate in 2016 to claim unreimbursed employee business expenses.
For more information about depreciation included in the standard mileage rate, see the exception in Methods of depreciation under Depreciation Deduction in chapter 4 of • Claimed a depreciation deduction for the car using any method other than straight line depreciation, • Claimed a section 179 deduction on the car, • Claimed the special depreciation allowance on the car, • Claimed actual car expenses after 1997 for a car you leased, or • Are a rural mail carrier who received a qualified reimbursement. (See Rural mail carriers, earlier.)