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Publication 17 Your Federal Catalog Number 10311G Income Tax Department of the For Individuals For use in Treasury preparing Internal Revenue Service 2003 Returns Get forms and other information faster and easier by: Internet • www.irs.gov or FTP • ftp.irs.gov FAX • 703–368–9694 (from your fax machine) Your Federal Income Tax Department of the For Individuals Treasury Internal Revenue Contents Service Important Changes for 2003 . . . . . . . . . . . . . . 1 Part Five. Standard Deduction and Itemized Deductions Important Changes for 2004 . . . . . . . . . . . . . . 2 22 Standard Deduction . . . . . . . . . . . . . . . . 151 23 Medical and Dental Expenses . . . . . . . . . 154 Important Reminders . . . . . . . . . . . . . . . . . . . 2 24 Taxes . . . . . . . . . . . . . . . . . . . . . . . . . 160 25 Interest Expense . . . . . . . . . . . . . . . . . . 164 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . 4 26 Contributions . . . . . . . . . . . . . . . . . . . . 171 Part One. The Income Tax Return 27 Nonbusiness Casualty and Theft 1 Filing Information . . . . . . . . . . . . . . . . . . 7 Losses . . . . . . . . . . . . . . . . . . . . . . . . 179 2 Filing Status . . . . . . . . . . . . . . . . . . . . . 23 28 Car Expenses and Other Employee 3 Personal Exemptions and Dependents . . . 28 Business Expenses . . . . . . . . . . . . . . . 185 4 Decedents . . . . . . . . . . . . . . . . . . . . . . 37 29 Tax Benefits for Work-Related 5 Tax Withholding and Estimated Tax . . . . . 42 Education . . . . . . . . . . . . . . . . . . . . . . 204 30 Miscellaneous Deductions . . . . . . . . . . . 209 Part Two. Income 31 Limit on Itemized Deductions . . . . . . . . . 215 6 Wages, Salaries, and Other Earnings . . . . 50 7 Tip Income . . . . . . . . . . . . . . . . . . . . . . 58 Part Six. Figuring Your Taxes and Credits 8 Interest Income . . . . . . . . . . . . . . . . . . . 60 32 How To Figure Your Tax . . . . . . . . . . . . 217 9 Dividends and Other Corporate 33 Tax on Investment Income of Certain Distributions . . . . . . . . . . . . . . . . . . . . 68 Minor Children . . . . . . . . . . . . . . . . . . . 220 10 Rental Income and Expenses . . . . . . . . . 73 34 Child and Dependent Care Credit . . . . . . . 227 11 Retirement Plans, Pensions, and 35 Credit for the Elderly or the Disabled . . . . 237 Annuities . . . . . . . . . . . . . . . . . . . . . . 83 36 Child Tax Credit . . . . . . . . . . . . . . . . . . 244 12 Social Security and Equivalent 37 Education Credits . . . . . . . . . . . . . . . . . 248 Railroad Retirement Benefits . . . . . . . . . 89 38 Earned Income Credit . . . . . . . . . . . . . . 254 13 Other Income . . . . . . . . . . . . . . . . . . . . 93 39 Other Credits . . . . . . . . . . . . . . . . . . . . 267 Part Three. Gains and Losses 2003 Tax Table . . . . . . . . . . . . . . . . . . . . . . . . 271 14 Basis of Property . . . . . . . . . . . . . . . . . 101 2003 Tax Rate Schedules . . . . . . . . . . . . . . . . 283 15 Sale of Property . . . . . . . . . . . . . . . . . . 106 16 Selling Your Home . . . . . . . . . . . . . . . . 112 Your Rights as a Taxpayer . . . . . . . . . . . . . . . 284 17 Reporting Gains and Losses . . . . . . . . . . 117 How To Get Tax Help . . . . . . . . . . . . . . . . . . . 285 Part Four. Adjustments to Income 18 Individual Retirement Arrangements Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 287 (IRAs) . . . . . . . . . . . . . . . . . . . . . . . . 125 19 Moving Expenses . . . . . . . . . . . . . . . . . 138 Order Blank 20 Alimony . . . . . . . . . . . . . . . . . . . . . . . . 143 (Inside back cover) 21 Education-Related Adjustments . . . . . . . . 146 All material in this The explanations and examples in this publication reflect This publication covers some subjects on which a publication may be the interpretation by the Internal Revenue Service (IRS) court may have made a decision more favorable to tax- reprinted freely. A of: payers than the interpretation by the IRS. Until these citation to Your Federal differing interpretations are resolved by higher court deci- Income Tax (2003) • Tax laws enacted by Congress, sions or in some other way, this publication will continue would be appropriate. • Treasury regulations, and to present the interpretations by the IRS. All taxpayers have important rights when working with • Court decisions. the IRS. These rights are described in Your Rights as a Taxpayer in the back of this publication. However, the information given does not cover every situation and is not intended to replace the law or change its meaning. Important Changes for 2003 This section summarizes important see Capital Gain Tax Rates in Credit in chapter 39 and Publica- gross income is more than tax changes that took effect in chapter 17. tion 968, Tax Benefits for Adoption. $139,500 ($69,750 if you are mar- 2003. Most of these changes are ried filing separately). See chapter discussed in more detail through- Dividends taxed at capital gain Retirement savings plans. The rates. After December 31, 2002, following paragraphs highlight 31. out this publication. Changes are also discussed in qualified dividend income is taxed changes that affect individual re- Social security and Medicare Publication 553, Highlights of 2003 at the new capital gain rates. See tirement arrangements (IRAs) and taxes. The maximum wages sub- Tax Changes. Qualified Dividend Income in pension plans. ject to social security tax (6.2%) Chapter 9. Traditional IRA income limits. increased to $87,000. All wages Tax rates changes. The follow- If you have a traditional IRA and are subject to Medicare tax ing items highlight the changes to Standard mileage rates. The are covered by a retirement plan at standard mileage rate for the cost (1.45%). the tax rates. The 2003 tax tables work, the amount of income you and tax rate schedules are in- of operating your car decreased to can have and not be affected by the Military Family Tax Relief Act of cluded near the back of this publi- 36 cents a mile for all business deduction phaseout increases. The 2003. This legislation made the cation. miles driven. See chapter 28. amounts vary depending on filing following changes. See Publication The standard mileage rate al- status. See chapter 18. • The 10% tax rate bracket for lowed for use of your car for medi- Deemed IRAs. A qualified 553 for more information. most filing statuses is ex- panded. cal reasons decreased to 12 cents employer plan (retirement plan) • The 5-year period that can a mile. See chapter 23. can maintain a separate account or qualify you to exclude the • The 15% tax rate bracket for The standard mileage rate al- annuity under the plan (a deemed gain from the sale of a your married taxpayers filing jointly lowed for use of your car for deter- IRA) to receive voluntary employee mining moving expenses contributions. An employee's ac- main home can be sus- and qualifying widow(er) is expanded. decreased to 12 cents a mile. See count can be treated as a tradi- pended by certain members chapter 19. tional IRA or a Roth IRA. of the uniformed services or • The 27%, 30%, 35%, and Limit on elective deferrals. Foreign Service while on offi- 38.6% tax rates are reduced Lifetime learning credit. The The maximum amount of elective cial extended duty. to 25%, 28%, 33%, and 35%, amount of qualified tuition and re- deferrals under a salary reduction respectively. lated expenses you may take into agreement that could be contrib- • The tax-free treatment of the account in figuring your lifetime uted to a qualified plan increased to death gratuity paid to survi- Child tax credits increased. learning credit increased from $12,000 ($14,000 If you were age vors of U.S. military members You may be able to take credits of $5,000 to $10,000. The credit 50 or over). However, for SIMPLE for deaths occurring after up to $1,000 for each qualifying equals 20% of these qualified ex- plans, the amount increased to September 10, 2001, in- child. But you must reduce your penses, with the maximum credit $8,000 ($9,000 if you were age 50 creased from $3,000 to credits by any advance child tax being $2,000. See chapter 37. or over). $12,000. credit payment you received in 2003. See chapter 36. Child and dependent care credit. Self-employed health insurance • Amounts received as a quali- The following changes apply to the deduction. You can deduct fying military base realign- A d va nce c hild ta x cr edi t child and dependent care credit. 100% of your self-employed health ment and closure fringe payment. You must reduce your insurance premiums as an adjust- 2003 child tax credits by any ad- • The credit can be as much as ment to income. benefit are now excluded vance child tax credit payment you 35% (previously 30%) of your from taxable income. received in 2003. The amount of qualified expenses. Health coverage tax credit. • The rules for filing a return your advance payment is shown on • The maximum adjusted gross Certain older workers can claim a that apply to members of the Notice 1319. This notice was income amount that qualifies credit for amounts they pay for armed forces in a combat mailed to you in 2003. If you do not for the highest rate increased health insurance premiums. For more information, see Health Cov- zone are extended to include have this notice, you can check the to $15,000 (previously erage Tax Credit in chapter 39. members of the armed forces amount of your advance payment $10,000). on the IRS website at www.irs.gov in a designated contingency or call us at 1 – 800 – 829 – 1040. • The limit on the amount of Certain amounts increased. operation. qualifying expenses in- Some tax items that are indexed for If you received an advance pay- creased to $3,000 for one inflation increased for 2003. • Qualified military benefits in- ment but did not have a qualifying clude benefits under qualifying individual and Earned income credit (EIC). child for 2003, you do not have to dependent-care assistance $6,000 for two or more quali- The maximum amount of income pay back the amount you received. fying individuals. you can earn and still get the programs. Do not enter the amount of your earned income credit increased. advance payment on your return. If • The amount of income that is The amount depends on your filing • The additional tax on distribu- you filed a joint return for 2002, but treated as having been tions from a Coverdell educa- status and number of children. The for 2003 you are not filing a joint earned by a spouse who is tion savings account or a maximum amount of investment in- return (or a joint return with the either a full-time student or qualified tuition plan, does not come you can have and still be same spouse), you are considered not able to care for himself or apply to a distribution made eligible for the credit has increased to have received one-half of the herself increased to $250 a to $2,600. See chapter 38. on account of attendance at a advance payment. month if there is one qualify- Standard deduction. The military academy. ing individual and $500 a standard deduction for taxpayers Married filing joint standard month if there are two or who do not itemize deductions on • Reserve component mem- deduction. The standard deduc- more qualifying individuals. Schedule A (Form 1040) has in- bers can claim an tion for married taxpayers filing a See chapter 34. creased. The amount depends on above-the-line deduction for joint return has increased. See chapter 22. your filing status. See chapter 22. overnight travel expenses Tax benefits for adoption. Sub- Exemption amount. You are such as transportation, lodg- New capital gain rates. For ject to the income and tax liability allowed a $3,050 deduction for ing, and meals. See chapter gains after May 5, 2003, the 10% limits, the adoption credit and the each exemption to which you are 28. capital gain rate is reduced to 5% exclusion from income of benefits entitled. However, your exemption and the 20% capital gain rate is under an adoption assistance pro- amount could be phased out if you • Income tax relief is granted to reduced to 15%. In addition, the 8% gram for the adoption of a child with have high income. See chapter 3. families of astronauts who die capital gain rate for qualified 5-year special needs is $10,160 regard- Limit on itemized deduction. in the line of duty. gain does not apply to gains after less of the amount of qualified Some of your itemized deductions that date. For more information, adoption expenses. See Adoption may be limited if your adjusted ■ Important Changes for 2004 This section summarizes the im- • 14 cents a mile for the use of work, the amount of income you Tuition and fees deduction. Be- portant changes that take effect in your car for medical reasons, can have and not be affected by the ginning in 2004, the amount of 2004 that could affect your esti- and deduction phaseout increases. The qualified education expenses you can take into account in figuring mated tax payments for 2004. • 14 cents a mile for the use of amounts vary depending on filing your tuition and fees deduction var- More information on these and your car for determining mov- status. Limit on elective deferrals. ies depending on your modified ad- other changes can be found in Pub- ing expenses. The maximum amount of elective justed gross income. The tuition lication 553. and fees deduction is explained in Retirement savings plans. The deferrals under a salary reduction Standard mileage rates. For tax chapter 21. following paragraphs highlight agreement that can be contributed years beginning in 2004, the stan- changes that affect individual re- to a qualified plan increases to dard mileage rate for the cost of tirement arrangements (IRAs) and $13,000 ($16,000 if you are age 50 operating your car increases to: pension plans. or over). However, for SIMPLE Traditional IRA income limits. plans, the amount increases to • 37.5 cents a mile for all busi- If you have a traditional IRA and $9,000 ($10,500 if you are age 50 ■ ness miles driven, are covered by a retirement plan at or over). Important Reminders Listed below are important remind- • The September 11, 2001 ter- formation and Publication 596, Spouse covered by plan. ers and other items that may help rorist attacks. Earned Income Credit (EIC). Even if your spouse is covered by you file your 2003 tax return. Many an employer-sponsored retirement • The terrorist attacks involving Payments received by Holo- of these items are explained in plan, you may be able to deduct anthrax occurring after Sep- caust victims. Restitution pay- more detail later in this publication. contributions to your traditional IRA tember 10, 2001, and before ments received after 1999 (and if you are not covered by an em- Write in your social security January 2, 2002. certain interest earned on the pay- ployer plan. number. To protect your privacy, ments) are not taxable and do not Roth IRA. You may be able to social security numbers (SSNs) are The Act also exempts from fed- affect the taxability of certain bene- establish a Roth IRA. In this type of not printed on the peel-off label that eral income tax certain amounts re- fits, such as social security bene- IRA, contributions are not deducti- comes in the mail with your tax in- ceived by survivors. fits. For more details, see chapter ble but earnings grow tax free and struction booklet. This means you For more information, see Pub- 13. qualified withdrawals are not tax- must enter your SSN in the space lication 3920, Tax Relief for Victims able. You may also be able to con- provided on your tax form. If you of Terrorist Attacks. Advance earned income credit. vert a traditional IRA to a Roth IRA, filed a joint return for 2002 and are If a qualifying child lives with you but you must include all or part of Benefits for public safety filing a joint return for 2003 with the and you expect to qualify for the the taxable converted amount in in- officer's survivors. A survivor same spouse, enter your names earned income credit in 2004, you come. annuity received by the spouse, and SSNs in the same order as on may be able to get part of the credit former spouse, or child of a public your 2002 return. See chapter 1. paid to you in advance throughout Retirement savings contribu- safety officer killed in the line of tions credit. If you contribute to Taxpayer identification duty will generally be excluded the year (by your employer) instead an individual retirement arrange- numbers. You must provide the from the recipient's income regard- of waiting until you file your tax re- ment (IRA) or to a retirement plan taxpayer identification number for less of the date of the officer's turn. See chapter 38. sponsored by your employer, you each person for whom you claim death. The provision applies to a Sale of your home. Generally, may qualify for a tax credit. See certain tax benefits. This applies chaplain killed in the line of duty you will only need to report the sale Retirement Savings Contributions even if the person was born in after September 10, 2001. The of your home if your gain is more Credit in chapter 39. 2003. Generally, this number is the chaplain must have been respond- person's social security number ing to a fire, rescue, or emergency than $250,000 ($500,000 if married Foreign source income. If you (SSN). See chapter 1. as a member or employee of a fire filing a joint return). See chapter 16. are a U.S. citizen with income from or police department. See chapter sources outside the United States Reporting interest and 13. Retirement planning services. (foreign income), you must report dividends. If you have interest or If your employer has a qualified re- all such income on your tax return dividend income of more than Parent of a kidnapped child. tirement plan, qualified retirement unless it is exempt by U.S. law. $1,500, you have to file Schedule 1 The parent of a child who is pre- planning services provided for you This is true whether you reside in- (Form 1040A) or Schedule B (Form sumed by law enforcement authori- (or your spouse) by your employer side or outside the United States 1040) with your tax return. Also, ties to have been kidnapped by are not included in your income. and whether or not you receive a you cannot file Form 1040EZ if you someone who is not a family mem- For more information see, Retire- Form W – 2 or 1099 from the for- have more than $1,500 of taxable ber may be able to take the child ment Planning Services under eign payer. This applies to earned interest income. into account in determining his or Fringe Benefits in chapter 6. income (such as wages and tips) her eligibility for the following. as well as unearned income (such Tax relief for victims of terrorist Individual retirement arrange- attacks. Under the Victims of • Head of household or qualify- as interest, dividends, capital ments (IRAs). The following ing widow(er) with dependent gains, pensions, rents and royal- Terrorism Tax Relief Act of 2001, paragraphs highlight important re- child filing status. ties). the federal income tax liability of minders that relate to IRAs. See If you reside outside the United those killed in the following attacks • Exemption for dependents. chapter 18 for details. States, you may be able to exclude is forgiven for certain tax years. • Child tax credit. IRA for spouse. A married part or all of your foreign source • The April 19, 1995, terrorist couple filing a joint return can con- earned income. For details, see attack on the Alfred P. Murrah • Earned income credit. tribute up to the maximum amount Publication 54, Tax Guide for U.S. Federal Building (Oklahoma See Publication 501, Exemptions, each to their IRAs, even if one Citizens and Resident Aliens City). Standard Deduction, and Filing In- spouse had little or no income. Abroad. Page 2 Child tax credit. You may be to authorize the IRS to discuss your please use it. Otherwise, see the nue Service has expanded cus- able to claim a tax credit for each of return with a friend, family member, last page of this publication for a list tomer service for taxpayers. your qualifying children under age or any other person you choose. of IRS addresses. Through the agency's Everyday 17 at the end of the year. This This allows the IRS to call the per- Tax Solutions service, you can set credit can be as much as $1,000 for son you identified as your designee Private delivery services. You up a personal appointment at the each qualifying child. See chapter to answer any questions that may may be able to use a designated most convenient Taxpayer Assis- 36. arise during the processing of your private delivery service to mail your tax returns and payments. See tance Center, on the most conve- return. It also allows your designee Health insurance credit. If you chapter 1 for more information. nient business day. See How To to perform certain actions. See are an eligible individual, you can Get Tax Help in the back of this your income tax package for de- claim a tax credit equal to 65% of Refund on a late filed return. If publication. tails. the amount you pay for qualified you were due a refund but you did not file a return, you generally must Treasury Inspector General for health insurance coverage. See Payment of taxes. Make your chapter 39. check or money order payable to file your return within 3 years from Tax Administration. If you want "United States Treasury." You can the date the return was due (includ- to confidentially report misconduct, Joint return responsibility. pay your taxes by credit card or, if ing extensions) to get that refund. waste, fraud, or abuse by an IRS Generally, both spouses are re- you file electronically, by electronic See chapter 1 for more information. employee, you can call sponsible for the tax and any inter- funds withdrawal. See chapter 1. 1 – 800 – 366 – 4484 (1 – 800 – 877 – est or penalties on a joint tax return. Privacy Act and paperwork re- 8339 for TTY/TDD users). You can In some cases, one spouse may be Faster ways to file your return. duction information. The IRS remain anonymous. relieved of that responsibility for The IRS offers fast, accurate ways Restructuring and Reform Act of items of the other spouse that were to file your tax return information 1998, the Privacy Act of 1974, and Photographs of missing incorrectly reported on the joint re- without filing a paper tax return. the Paperwork Reduction Act of children. The Internal Revenue turn. For details, see Joint respon- You can use IRS e-file (electronic 1980 require that when we ask you Service is a proud partner with the sibility in chapter 2. filing). For details, see chapter 1. for information we must first tell you National Center for Missing and what our legal right is to ask for the Exploited Children. Photographs of Include your phone number on Free electronic filing. You may information, why we are asking for missing children selected by the your return. To promptly resolve be able to file your 2003 taxes on- it, how it will be used, what could Center may appear in this publica- any questions we have in process- line for free thanks to an electronic happen if we do not receive it, and ing your tax return, we would like to filing agreement. See chapter 1. whether your response is volun- tion on pages that would otherwise be able to call you. Please enter tary, required to obtain a benefit, or be blank. You can help bring these your daytime telephone number on Mailing your return. If you are mandatory under the law. A com- children home by looking at the your tax form next to your signa- filing a paper return, you may be plete statement on this subject can photographs and calling ture. mailing your return to a different be found in your tax form instruc- 1 – 8 0 0 – T H E – L O S T address because the IRS has tion booklet. (1 – 800 – 843 – 5678) if you recog- Third party designee. You can changed the filing location for sev- nize a child. check the "Yes" box in the "Third eral areas. If you received an en- Customer service for taxpayers ■ Party Designee" area of your return velope with your tax package, expanded. The Internal Reve- Page 3 Introduction This publication covers the general 5) Other general information. rules for filing a federal income tax • Where to report certain items • Tax questions. Visit It will help you identify which filing shown on information docu- www.irs.gov or call return. It supplements the informa- status you qualify for, whether you ments, and 1 – 800 – 829 – 1040. tion contained in your tax form in- struction booklet. It explains the tax can claim any dependents, and • Recorded tax information top- • Forms and publications. Visit law to make sure you pay only the whether the income you receive is www.irs.gov to download ics (TeleTax). tax you owe and no more. taxable. The publication goes on to them, call explain the standard deduction, the If you operate your own business 1 – 800 – 829 – 3676, or write How this publication is ar- kinds of expenses you may be able or have other self-employment in- to one of the three addresses ranged. This publication closely to deduct, and the various kinds of come, such as from babysitting or shown on page 285. follows Form 1040, U.S. Individual credits you may be able to take to selling crafts, see the following Income Tax Return. It is divided reduce your tax. publications for more information. Comments and suggestions. into six parts which cover different Throughout the publication are We welcome your comments about sections of Form 1040. Each part is examples showing how the tax law • Publication 334, Tax Guide this publication and your sugges- further divided into chapters which applies in typical situations. Sam- for Small Business (For Indi- tions for future editions. generally discuss one line of the ple forms and schedules show you viduals Who Use Schedule C You can email us at form. how to report certain items on your or C – EZ). *email@example.com. Please put Figure 1, Finding Form 1040 In- return. Also throughout the publica- • Publication 533, Self-Employ- "Publications Comment" on the formation in Publication 17, begin- tion are flowcharts and tables that subject line. ment Tax. ning on the next page shows you present tax information in an You can write to us at the fol- line-by-line where the items found easy-to-understand manner. • Publication 535, Business Ex- lowing address: on Form 1040 are discussed in this penses. publication. Do not worry if you file Many of the subjects discussed Form 1040A or Form 1040EZ. Any- in this publication are discussed in • Publication 587, Business Internal Revenue Service Use of Your Home (Including Individual Forms and thing included on a line of either of greater detail in other IRS publica- Use by Daycare Providers). Publications Branch these forms is also included on tions. References to those other SE:W:CAR:MP:T:I Form 1040. publications are provided for your • Publication 911, Direct Sell- 1111 Constitution Ave. NW The table of contents inside the information. ers. Washington, DC 20224 front cover and the index in the Icons. Small graphic symbols, back of the publication are also We respond to many letters by or icons, are used to draw your IRS mission. Provide America's useful tools to help you find the telephone. Therefore, it would be attention to special information. taxpayers top quality service by information you need. helpful if you would include your See Table 1, Legend of Icons, be- helping them understand and meet low, for an explanation of each icon daytime phone number, including their tax responsibilities and by ap- What is in this publication. The the area code, in your correspond- used in this publication. plying the tax law with integrity and publication begins with the rules for ence. fairness to all. filing a tax return. It explains: What is not covered in this publi- 1) Who must file a return, cation. Some material that you Help from the IRS. There are 2) Which tax form to use, may find helpful is not included in many ways you can get help from this publication but can be found in the IRS. These are explained 3) When the return is due, your tax form instruction booklet. under How To Get Tax Help in the 4) How to e-file your return, and This includes lists of: back of this publication. Table 1. Legend of Icons Icon Explanation Items that may cause you particular problems, or an alert about pending legislation that may be enacted after ! CAUTION this publication goes to print. An Internet site or an email address. An address you may need. RECORDS Items you should keep in your personal records. Items you may need to figure or a worksheet you may need to complete. An important phone number. TIP Helpful information you may need. ■ Page 4 Figure 1—Finding Form 1040 Information in Publication 17 Questions about what to put on a line? Help is on the page number in the circle. 1040 Department of the Treasury—Internal Revenue Service 2003 Form U.S. Individual Income Tax Return (99) IRS Use Only—Do not write or staple in this space. For the year Jan. 1–Dec. 31, 2003, or other tax year beginning , 2003, ending , 20 OMB No. 1545-0074 Label Your first name and initial Last name Your social security number (See L 18 15 A instructions B If a joint return, spouse's first name and initial Last name Spouse's social security number on page 19.) Use the IRS E L FOR REFERENCE ONLY—DO NOT FILE Home address (number and street). If you have a P.O. box, see page 19. Apt. no. label. H Important! Otherwise, E please print R You must enter E City, town or post office, state, and ZIP code. If you have a foreign address, see page 19. or type. your SSN(s) above. Presidential You Spouse Election Campaign Note. Checking "Yes" will not change your tax or reduce your refund. 16 (See page 19.) Do you, or your spouse if filing a joint return, want $3 to go to this fund? Yes No Yes No 1 Single 4 Head of household (with qualifying person). (See page 20.) If Filing Status 2 Married filing jointly (even if only one had income) the qualifying person is a child but not your dependent, enter Check only 3 Married filing separately. Enter spouse's SSN above this child's name here. one box. 23 and full name here. 5 Qualifying widow(er) with dependent child. (See page 20.) 6a Yourself. If your parent (or someone else) can claim you as a dependent on his or her tax No. of boxes checked on Exemptions return, do not check box 6a 6a and 6b 28 b Spouse No. of children c Dependents: (3) Dependent's (4) if qualifying on 6c who: (2) Dependent's social security number relationship to child for child tax ● lived with you (1) First name Last name you credit (see page 21) ● did not live with 28 you due to divorce If more than five or separation dependents, (see page 21) see page 21. Dependents on 6c not entered above Add numbers on lines d Total number of exemptions claimed above 7 Wages, salaries, tips, etc. Attach Form(s) W-2 7 50 Income 8a Taxable interest. Attach Schedule B if required 8a 60 b Tax-exempt interest. Do not include on line 8a 8b 60 Attach Forms W-2 and 9a Ordinary dividends. Attach Schedule B if required 9a 68 W-2G here. 9b 69 b Qualified dividends (see page 23) Also attach 95 Form(s) 1099-R 10 Taxable refunds, credits, or offsets of state and local income taxes (see page 23) 10 if tax was 11 Alimony received 11 143 withheld. 12 8 12 Business income or (loss). Attach Schedule C or C-EZ 13a Capital gain or (loss). Attach Schedule D if required. If not required, check here 13a 117 b If box on 13a is checked, enter post-May 5 capital gain distributions 13b 117 If you did not 14 Other gains or (losses). Attach Form 4797 14 107 get a W-2, 15a IRA distributions 15a 125 b Taxable amount (see page 25) 15b see page 22. 16a Pensions and annuities 16a 83 b Taxable amount (see page 25) 16b Enclose, but do 17 Rental real estate, royalties, partnerships, S corporations, trusts, etc. Attach Schedule E 17 73 not attach, any 18 Farm income or (loss). Attach Schedule F 18 8 payment. Also, 19 Unemployment compensation 19 96 please use Form 1040-V. 20a Social security benefits 20a b Taxable amount (see page 27) 20b 89 21 Other income. List type and amount (see page 27) 21 93 22 Add the amounts in the far right column for lines 7 through 21. This is your total income 22 23 Educator expenses (see page 29) 23 146 Adjusted 24 IRA deduction (see page 29) 24 125 Gross 25 Student loan interest deduction (see page 31) 25 146 Income 26 Tuition and fees deduction (see page 32) 26 148 27 Moving expenses. Attach Form 3903 27 138 28 One-half of self-employment tax. Attach Schedule SE 28 124 29 Self-employed health insurance deduction (see page 33) 29 124 30 Self-employed SEP, SIMPLE, and qualified plans 30 124 31 Penalty on early withdrawal of savings 31 67 32a Alimony paid b Recipient's SSN 32a 143 33 Add lines 23 through 32a 33 34 Subtract line 33 from line 22. This is your adjusted gross income 34 For Disclosure, Privacy Act, and Paperwork Reduction Act Notice, see page 77. Cat. No. 11320B Form 1040 (2003) Page 5 Figure 1—Finding Form 1040 Information in Publication 17, continued Questions about what to put on a line? Help is on the page number in the circle. Form 1040 (2003) Page 2 35 Amount from line 34 (adjusted gross income) 35 Tax and 36a Check You were born before January 2, 1939, Blind. Total boxes Credits if: Spouse was born before January 2, 1939, Blind. checked 36a Standard Deduction b If you are married filing separately and your spouse itemizes deductions, or for— you were a dual-status alien, see page 34 and check here 36b ● People who 37 Itemized deductions (from Schedule A) or your standard deduction (see left margin) 37 150 checked any 38 box on line 38 Subtract line 37 from line 35 36a or 36b or 39 If line 35 is $104,625 or less, multiply $3,050 by the total number of exemptions claimed on who can be claimed as a line 6d. If line 35 is over $104,625, see the worksheet on page 35 39 dependent, 40 Taxable income. Subtract line 39 from line 38. If line 39 is more than line 38, enter -0- 40 see page 34. 41 Tax (see page 36). Check if any tax is from: a Form(s) 8814 b Form 4972 41 217 ● All others: 218 42 Alternative minimum tax (see page 38). Attach Form 6251 42 Single or 43 Married filing 43 Add lines 41 and 42 separately, 44 Foreign tax credit. Attach Form 1116 if required 44 268 $4,750 45 Credit for child and dependent care expenses. Attach Form 2441 45 227 Married filing 237 jointly or 46 Credit for the elderly or the disabled. Attach Schedule R 46 Qualifying 47 Education credits. Attach Form 8863 47 248 widow(er), 268 $9,500 48 Retirement savings contributions credit. Attach Form 8880 48 49 Child tax credit (see page 40) 49 244 Head of household, 50 Adoption credit. Attach Form 8839 50 267 $7,000 51 268 51 Credits from: a Form 8396 b Form 8859 52 Other credits. Check applicable box(es): a Form 3800 b Form 8801 c Specify 52 269 53 Add lines 44 through 52. These are your total credits 53 54 Subtract line 53 from line 43. If line 53 is more than line 43, enter -0- 54 55 Self-employment tax. Attach Schedule SE 55 9 Other 56 59 56 Social security and Medicare tax on tip income not reported to employer. Attach Form 4137 Taxes 57 133 57 Tax on qualified plans, including IRAs, and other tax-favored accounts. Attach Form 5329 if required 58 Advance earned income credit payments from Form(s) W-2 58 262 59 Household employment taxes. Attach Schedule H 59 233 60 Add lines 54 through 59. This is your total tax 60 217 Payments 61 Federal income tax withheld from Forms W-2 and 1099 61 42 62 2003 estimated tax payments and amount applied from 2002 return 62 42 If you have a 63 Earned income credit (EIC) 63 254 qualifying 64 Excess social security and tier 1 RRTA tax withheld (see page 56) 64 269 child, attach Schedule EIC. 65 Additional child tax credit. Attach Form 8812 65 245 66 Amount paid with request for extension to file (see page 56) 66 13 67 Other payments from: a Form 2439 b Form 4136 c Form 8885 67 70 68 Add lines 61 through 67. These are your total payments 68 69 If line 68 is more than line 60, subtract line 60 from line 68. This is the amount you overpaid 69 Refund Direct deposit? 70a Amount of line 69 you want refunded to you 70a 16 See page 56 b Routing number c Type: Checking Savings and fill in 70b, d Account number 70c, and 70d. 71 Amount of line 69 you want applied to your 2004 estimated tax 71 47 Amount 72 Amount you owe. Subtract line 68 from line 60. For details on how to pay, see page 57 72 17 You Owe 73 Estimated tax penalty (see page 58) 73 49 Do you want to allow another person to discuss this return with the IRS (see page 58)? Yes. Complete the following. No Third Party Designee's Phone Personal identification Designee name 16 no. ( ) number (PIN) Under penalties of perjury, I declare that I have examined this return and accompanying schedules and statements, and to the best of my knowledge and Sign belief, they are true, correct, and complete. Declaration of preparer (other than taxpayer) is based on all information of which preparer has any knowledge. Here Your signature Date Your occupation Daytime phone number Joint return? 16 See page 20. ( ) Keep a copy Spouse's signature. If a joint return, both must sign. Date Spouse's occupation for your records. Date Preparer's SSN or PTIN Preparer's Paid signature 16 Check if self-employed Preparer's Firm's name (or EIN Use Only yours if self-employed), address, and ZIP code Phone no. ( ) Form 1040 (2003) Page 6 Part One. The Income Tax The five 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 Return 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. make monthly installment payments. See In- stallment Agreement, later, under Amount You Do I Have To 1. Owe. File a Return? Service in combat zone. You are allowed ex- tra time to take care of your tax matters if you are You must file a federal income tax return if you Filing a member of the Armed Forces who served in a combat zone, or if you served in the combat are a citizen or resident of the United States or a zone in support of the Armed Forces. See Indi- resident of Puerto Rico and you meet the filing Information viduals Serving in Combat Zone, later, under When Do I Have To File. requirements for any of the following categories that apply to you. Adoption taxpayer identification number. If 1) Individuals in general. (There are special Important Changes a child has been placed in your home for pur- rules for surviving spouses, executors, ad- poses of legal adoption and you will not be able ministrators, legal representatives, U.S. Who must file. Generally, the amount of in- to get a social security number for the child in citizens and residents living outside the come you can receive before you must file a time to file your return, you may be able to get an United States, residents of Puerto Rico, return has been increased. See Table 1 – 1, Ta- adoption taxpayer identification number (ATIN). and individuals with income from U.S. pos- ble 1 – 2, and Table 1 – 3 for the specific For more information, see Social Security Num- sessions.) amounts. ber, later. 2) Dependents. Mailing your return. You may be mailing your Taxpayer identification number for aliens. 3) Children under age 14. return to a different address this year because If you or your dependent is a nonresident or resident alien who does not have and is not 4) Self-employed persons. the IRS has changed the filing location for sev- eral areas. If you received an envelope with your eligible to get a social security number, file Form 5) Aliens. tax package, please use it. Otherwise, see W – 7, Application for IRS Individual Taxpayer Identification Number, with the IRS. For more The filing requirements for each category are Where Do I File, later in this chapter. information, see Social Security Number, later. explained in this chapter. The filing requirements apply even if you do Third party designee. You can allow the IRS not owe tax. to discuss your tax return with a friend, family Important Reminders member, or any other person you choose by TIP Even if you do not have to file a return, it may be to your advantage to do so. checking the "Yes" box in the Third party desig- nee area of your return. For more information, See Who Should File, later. Alternative filing methods. Rather than filing a return on paper, you may be able to file elec- see Third Party Designee, later. File only one federal income tax return tronically using IRS e-file. Create your own per- sonal identification number (PIN) and file a ! for the year regardless of how many CAUTION jobs you had, how many Forms W – 2 completely paperless tax return. For more infor- you received, or how many states you lived in mation, see Does My Return Have To Be on Introduction during the year. Paper, later. This chapter discusses: Change of address. If you change your ad- • Whether you have to file a return, Individuals—In General dress, you should notify the IRS. See Change of Address, later, under What Happens After I File. • Which form to use, If you are a U.S. citizen or resident, whether you Write in your social security number. You • How to file electronically, must file a return depends on three factors: must write your social security number (SSN) in • When, how, and where to file your return, 1) Your gross income, the spaces provided on your tax return. If you file a joint return, write the SSNs in the same order • What happens if you pay too little or too 2) Your filing status, and as the names. much tax, 3) Your age. • What records you should keep and how Direct Deposit of refund. Instead of getting a long you should keep them, and To find out whether you must file, see Table paper check, you may be able to have your 1 – 1, Table 1 – 2, and Table 1 – 3. Even if no refund deposited directly into your account at a • How you can change a return you have table shows that you must file, you may need to bank or other financial institution. See Direct already filed. file to get money back. (See Who Should File, Deposit under Refunds, later. later.) Alternative payment methods. If you owe additional tax, you may be able to pay electroni- Gross income. This includes all income you cally. See How To Pay, later. receive in the form of money, goods, property, and services that is not exempt from tax. It also Installment agreement. If you cannot pay the includes income from sources outside the full amount due with your return, you may ask to United States (even if you may exclude all or Chapter 1 Filing Information Page 7 part of it). Common types of income are dis- This is in addition to any legal requirement you file a U.S. federal income tax return. In addition, cussed in Part Two of this publication. may have to file an income tax return for Puerto you may have to file a return with the individual Rico. island government. See Publication 570 for Community income. If you are married and If you are a resident of Puerto Rico for the more information. your permanent home is in a community prop- erty state, half of any income described by state entire year, gross income does not include in- law as community income may be considered come from sources within Puerto Rico, except Dependents yours. This affects your federal taxes, including for amounts received as an employee of the whether you must file if you do not file a joint United States or a U.S. agency. If you receive If you are a dependent (one who meets the return with your spouse. See Publication 555, income from Puerto Rican sources that is not dependency tests in chapter 3), see Table 1 – 2 Community Property, for more information. subject to U.S. tax, you must reduce your stan- to find whether you must file a return. You also dard deduction. As a result, the amount of in- must file if your situation is described in Table Self-employed individuals. If you are come you must have before you are required to 1 – 3. self-employed, your gross income includes the file a U.S. income tax return is lower than the amount on line 7 of Schedule C (Form 1040), applicable amount in Table 1 – 1 or Table 1 – 2. Profit or Loss From Business, line 1 of Schedule Responsibility of parent. Generally, a child For more information, see U.S. taxation and its is responsible for filing his or her own tax return C – EZ (Form 1040), Net Profit From Business, discussion, Standard deduction, under The and line 11 of Schedule F (Form 1040), Profit or and for paying any tax on the return. But if a Commonwealth of Puerto Rico in Publication dependent child who must file an income tax Loss From Farming. See Self-Employed Per- 570, Tax Guide for Individuals With Income sons, later, for more information about your filing return cannot file it for any reason, such as age, From U.S. Possessions. requirements. then a parent, guardian, or other legally respon- sible person must file it for the child. If the child If you do not report all of your self-em- cannot sign the return, the parent or guardian ! ployment income, your social security Individuals With Income From must sign the child's name followed by the CAUTION benefits may be lower when you retire. U.S. Possessions words "By (your signature), parent for minor child." Filing status. Your filing status depends on If you had income from Guam, the Common- whether you are single or married and on your wealth of the Northern Mariana Islands, Ameri- Child's earnings. Amounts a child earns by family situation. Your filing status is determined can Samoa, or the Virgin Islands, special rules performing services are his or her gross income. on the last day of your tax year, which is Decem- may apply when determining whether you must This is true even if under local law the child's ber 31 for most taxpayers. See chapter 2 for an explanation of each filing status. Table 1 – 1. 2003 Filing Requirements for Most Taxpayers Age. If you are 65 or older at the end of the year, you generally can have a higher amount of To use this table, first find your marital status at the end of 2003. Then, read across the line gross income than other taxpayers before you that shows your filing status and age at the end of 2003. You must file a return if your gross must file. See Table 1 – 1. You are considered income was at least the amount shown in the last column. Gross income means all income you received in the form of money, goods, property, and 65 on the day before your 65th birthday. For services that is not exempt from tax, including any income from sources outside the United example, if your 65th birthday is on January 1, States (even if you may exclude part or all of it). 2004, you are considered 65 for 2003. When using this table, do not include social security benefits as gross income unless you are married filing a separate return and lived with your spouse at any time in 2003. (If you must include the benefits, see chapter 12 for the amount to include.) Surviving Spouses, Also, see Table 1 – 2 and Table 1 – 3 for other situations when you must file a return. Executors, Administrators, Marital Status Filing Status Age* Gross Income and Legal Representatives under 65 $ 7,800 You must file a final return for a decedent (a Single Single (including divorced 65 or older $ 8,950 person who died) if both of the following are and legally separated) Head of under 65 $10,050 true. household 65 or older $11,200 • You are the surviving spouse, executor, administrator, or legal representative. Married, with a child in your home, living apart from your Head of under 65 $10,050 • The decedent met the filing requirements spouse during the last household 65 or older $11,200 at the date of death. 6 months of 2003 For more information on rules for filing a under 65 decedent's final return, see chapter 4. (both spouses) $15,600 Married, living with your Married, 65 or older spouse at the end of 2003 joint return (one spouse) $16,550 (or on the date your spouse 65 or older U.S. Citizens and Residents Living (both spouses) $17,500 died) Outside the United States Married, any age $ 3,050 If you are a U.S. citizen or resident living outside separate return the United States, you must file a return if you Married, not living with your meet the filing requirements. For information on Married, joint or spouse at end of 2003 (or on any age $ 3,050 special tax rules that may apply to you, get separate return the date your spouse died) Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad. It is available at most under 65 $ 7,800 Single U.S. embassies and consulates. Also see How 65 or older $ 8,950 To Get Tax Help in the back of this publication. Widowed before 2003 and Head of under 65 $10,050 not remarried in 2003 household 65 or older $11,200 Residents of Puerto Rico Qualifying under 65 $12,550 widow(er) with Generally, if you are a U.S. citizen and a resi- 65 or older $13,500 dependent child dent of Puerto Rico, you must file a U.S. income *If your 65th birthday is on January 1, 2004, you are considered to be age 65 at the end of 2003. tax return if you meet the filing requirements. Page 8 Chapter 1 Filing Information Table 1 –2. 2003 Filing Requirements for Dependents Use Schedule SE (Form 1040) to figure your self-employment tax. Self-employment tax is See chapter 3 to find out if someone can claim you as a dependent. comparable to the social security and Medicare If your parents (or someone else) can claim you as a dependent, and any of the situations tax withheld from an employee's wages. For below apply to you, you must file a return. (See Table 1 – 3 for other situations when you must more information about this tax, get Publication file.) 533, Self-Employment Tax. In this table, earned income includes salaries, wages, tips, and professional fees. It also includes taxable scholarship and fellowship grants. (See Scholarship and Fellowship Grants in Employees of foreign governments or in- chapter 13.) Unearned income includes investment-type income such as interest, dividends, ternational organizations. If you are a U.S. and capital gains. It also includes unemployment compensation, taxable social security citizen who works in the United States for an benefits, pensions, annuities, and distributions of unearned income from a trust. Gross income international organization, a foreign govern- is the total of your earned and unearned income. ment, or a wholly owned instrumentality of a Caution: If your gross income was $3,050 or more, you generally cannot be claimed as a foreign government, and your employer is not dependent unless you were under age 19 or a full-time student under age 24. For details, see required to withhold social security and Medi- Gross Income Test in chapter 3. care taxes from your wages, you must include your earnings from services performed in the Single dependents — Were you either age 65 or older or blind? United States when figuring your net earnings ❏ No. You must file a return if any of the following apply. from self-employment. • Your unearned income was more than $750. Ministers. You must include income from • Your earned income was more than $4,750. services you performed as a minister when fig- • Your gross income was more than the larger of: uring your net earnings from self-employment, • $750, or unless you have an exemption from self-em- • Your earned income (up to $4,500) plus $250. ployment tax. This also applies to Christian Sci- ❏ Yes. You must file a return if any of the following apply. ence practitioners and members of a religious • Your unearned income was more than $1,900 ($3,050 if 65 or older and blind). order who have not taken a vow of poverty. For • Your earned income was more then $5,900 ($7,050 if 65 or older and blind). more information, get Publication 517, Social • Your gross income was more than $1,150 ($2,300 if 65 or older and blind) Security and Other Information for Members of plus the larger of: the Clergy and Religious Workers. • $750, or • Your earned income (up to $4,500) plus $250. Aliens Married dependents — Were you either age 65 or older or blind? Your status as an alien — resident, nonresident, ❏ No. You must file a return if any of the following apply. or dual-status — determines whether and how • Your unearned income was more than $750. you must file an income tax return. • Your earned income was more than $4,750. The rules used to determine your alien status • Your gross income was at least $5 and your spouse files a separate return and are discussed in Publication 519, U.S. Tax itemizes deductions. Guide for Aliens. • Your gross income was more than the larger of: • $750, or Resident alien. If you are a resident alien for • Your earned income (up to $4,500) plus $250. the entire year, you must file a tax return follow- ing the same rules that apply to U.S. citizens. ❏ Yes. You must file a return if any of the following apply. Use the forms discussed in this publication. • Your unearned income was more than $1,700 ($2,650 if 65 or older and blind). • Your earned income was more than $5,700 ($6,650 if 65 or older and blind). Nonresident alien. If you are a nonresident • Your gross income was at least $5 and your spouse files a separate return and alien, the rules and tax forms that apply to you itemizes deductions. are different from those that apply to U.S. citi- • Your gross income was more than $950 ($1,900 if 65 or older and blind) zens and resident aliens. See Publication 519 to plus the larger of: find out if U.S. income tax laws apply to you and • $750, or which forms you should file. • Your earned income (up to $4,500) plus $250. Dual-status taxpayer. If you are a resident alien for part of the tax year and a nonresident parents have the right to the earnings and may • Are an independent contractor, alien for the rest of the year, you are a dual-sta- actually have received them. If the child does not • Are a member of a partnership, or tus taxpayer. Different rules apply for each part pay the tax due on this income, the parent is of the year. For information on dual-status tax- liable for the tax. • Are in business for yourself in any other payers, see Publication 519. way. Children Under Age 14 Self-employment can include work in addition Who Should File If a child's only income is interest and dividends to your regular full-time business activities, such as certain part-time work you do at home or in Even if you do not have to file, you should file a (including Alaska Permanent Fund dividends) federal income tax return to get money back if and certain other conditions are met, a parent addition to your regular job. any of the following conditions apply. can elect to include the child's income on the You must file a return if your gross income is parent's return. If this election is made, the child at least as much as the filing requirement 1) You had federal income tax withheld from does not have to file a return. See Parent's amount for your filing status and age (shown in your pay. Election To Report Child's Interest and Divi- Table 1 – 1). Also, you must file Form 1040 and 2) You qualify for the earned income credit. dends in chapter 33. Schedule SE (Form 1040), Self-Employment See chapter 38 for more information. Tax, if: 3) You qualify for the additional child tax Self-Employed Persons 1) Your net earnings from self-employment credit. See chapter 36 for more informa- You are self-employed if you: (excluding church employee income) were tion. $400 or more, or 4) You qualify for the health coverage tax • Carry on a trade or business as a sole 2) You had church employee income of credit. See chapter 39 for more informa- proprietor, $108.28 or more. (See Table 1 – 3.) tion. Chapter 1 Filing Information Page 9 Table 1 – 3. Other Situations When You Must File a 2003 Return If any of the four conditions listed below apply, you must file a return, even if your income is less than the amount shown in Table 1 – 1 or Table 1 – 2. 1. You owe any special taxes, such as: • Social security or Medicare tax on tips you did not report to your employer. (See chapter 7.) • Uncollected social security, Medicare, or railroad retirement tax on tips you reported to your employer. (See chapter 7.) • Uncollected social security, Medicare, or railroad retirement tax on your group-term life insurance. This amount should be shown in box 12 of your Form W-2. • Alternative minimum tax. (See chapter 32.) • Tax on a qualified retirement plan, including an individual retirement arrangement (IRA). (See chapter 18.) • Tax on an Archer MSA. (See Publication 969, Medical Savings Accounts (MSAs).) • Tax on a Coverdell ESA or qualified tuition program. (See Publication 970, Tax Benefits for Education.) • Recapture of an investment credit or a low-income housing credit. (See the instructions for Form 4255, Recapture of Investment Credit, or Form 8611, Recapture of Low-Income Housing Credit.) • Recapture tax on the disposition of a home purchased with a federally-subsidized mortgage. (See chapter 16.) • Recapture of the qualified electric vehicle credit. (See chapter 39.) • Recapture of an education credit. (See chapter 37.) • Recapture of the Indian employment credit. (See the instructions for Form 8845, Indian Employment Credit.) • Recapture of the new markets credit. (See Form 8874, New Markets Credit.) 2. You received any advance earned income credit (EIC) payments from your employer. This amount should be shown in box 9 of your Form W – 2. (See chapter 38.) 3. You had net earnings from self-employment of at least $400. (See Self-Employed Persons earlier in this chapter.) 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. (See Publication 533.) 9) You do not owe any household employ- c) Advance earned income credit (EIC) ment taxes on wages you paid to a house- payments, if you received any. (See Which Form hold employee. chapter 38.) Should I Use? You must meet all of these requirements to use Form 1040EZ. If you do not, you must use d) Recapture of an education credit. (See chapter 37.) You must use one of three forms to file your Form 1040A or Form 1040. e) Form 8615, Tax for Children Under Age return: Form 1040EZ, Form 1040A, or Form 14 With Investment Income of More Figuring tax. On Form 1040EZ, you can use 1040. (But also see Does My Return Have To Be Than $1,500. only the tax table to figure your tax. You cannot on Paper, later.) use Form 1040EZ to report any other tax. f) Qualified Dividends and Capital Gain Tax Worksheet. Form 1040EZ Form 1040A 6) You claim only the following tax credits. Form 1040EZ is the simplest form to use. If you do not qualify to use Form 1040EZ, you may be able to use Form 1040A. a) The credit for child and dependent care You can use Form 1040EZ if all of the follow- expenses. (See chapter 34.) ing apply. You can use Form 1040A if all of the follow- b) The credit for the elderly or the dis- ing apply. abled. (See chapter 35.) 1) Your filing status is single or married filing 1) Your income is only from wages, salaries, jointly. If you were a nonresident alien at c) The child tax credit. (See chapter 36.) tips, IRA distributions, pensions and annui- any time in 2003, your filing status must be ties, taxable social security and railroad d) The additional child tax credit. (See married filing jointly. retirement benefits, taxable scholarship chapter 36.) 2) You (and your spouse if married filing a and fellowship grants, interest, ordinary e) The education credits. (See chapter joint return) were under age 65 and not dividends (including Alaska Permanent 37.) blind at the end of 2003. If you were born Fund dividends), capital gain distributions, and unemployment compensation. f) The retirement savings contributions on January 1, 1939, you are considered to credit. (See chapter 39.) be age 65 at the end of 2003. 2) Your taxable income is less than $50,000. g) The earned income credit. (See chapter 3) You do not claim any dependents. 3) Your adjustments to income are for only 38.) the following items. 4) Your taxable income is less than $50,000. h) The adoption credit. (See chapter 39.) 5) Your income is only from wages, salaries, a) Educator expenses. tips, unemployment compensation, Alaska b) IRA deduction. You must meet all of the above requirements Permanent Fund dividends, taxable schol- to use Form 1040A. If you do not, you must use c) Student loan interest deduction. Form 1040. arship and fellowship grants, and taxable interest of $1,500 or less. d) Tuition and fees deduction. If you meet the above requirements, you can 6) You did not receive any advance earned use Form 1040A even if you received 4) You do not itemize your deductions. employer-provided adoption benefits or depen- income credit (EIC) payments. 5) Your taxes are from only the following dent care benefits. 7) You do not claim any adjustments to in- items. If you receive a capital gain distribution come, such as a deduction for IRA contri- butions or student loan interest. a) Tax Table. ! that includes qualified 5-year gain, un- CAUTION recaptured section 1250 gain, section 8) You do not claim any credits other than the b) Alternative minimum tax. (See chapter 1202 gain, or collectibles (28%) gain, you can- earned income credit. 32.) not use Form 1040A. You must use Form 1040. Page 10 Chapter 1 Filing Information contains accurate information and is filed on Form 8453, U.S. Individual Income Tax Declara- Form 1040 time. tion for an IRS e-file Return, or Form 8453 – OL, If you cannot use Form 1040EZ or Form 1040A, Using e-file does not affect your chances of U.S. Individual Income Tax Declaration for an you must use Form 1040. You can use Form an IRS examination of your return. IRS e-file Online Return, whichever applies. 1040 to report all types of income, deductions, State returns. In most states, you can file an Electronic signatures. Create your own per- and credits. electronic state return simultaneously with your sonal identification number (PIN) and use a tax You may have received Form 1040A or Form professional or file your own paperless return federal return. For more information, check with 1040EZ in the mail because of the return you electronically. If you are married filing jointly, you your local IRS office, state tax agency, tax pro- filed last year. If your situation has changed this and your spouse will each need to create a PIN fessional, or the IRS web site at www.irs.gov/ year, it may be to your advantage to file Form and enter these PINs as your electronic signa- efile. 1040 instead. You may pay less tax by filing tures. Refunds. You can have a refund check mailed Form 1040 because you can take itemized de- A PIN is any combination of five numbers to you, or you can have your refund deposited ductions, some adjustments to income, and you choose, except five zeros. If you use a PIN, directly to your checking or savings account. credits you cannot take on Form 1040A or Form there is nothing to sign and nothing to mail — not With e-file, your refund will be issued in half 1040EZ. even your Forms W – 2. the time as when filing on paper. If you choose To verify your identity, you will be asked to Direct Deposit, you can receive your refund in as You must use Form 1040 if any of the follow- enter your adjusted gross income (AGI) from ing apply. . few as 10 days. your originally filed 2002 income tax return, if applicable. Do not use your AGI from an Offset against debts. As with a paper re- 1) Your taxable income is $50,000 or more. turn, you may not get all of your refund if you amended return (Form 1040X). AGI is the 2) You itemize your deductions. amount shown on your 2002 Form 1040, line 35; owe certain past-due amounts, such as federal Form 1040A, line 21; Form 1040EZ, line 4; and tax, state tax, a student loan, or child support. 3) You had income that cannot be reported See Offset against debts under Refunds, later. on the TeleFile Tax Record, line I. If you do not on Form 1040EZ or Form 1040A. have your 2002 income tax return, call the IRS at Refund inquiries. If you do not receive your 4) You claim any adjustments to gross in- 1 – 800 – 829 – 1040 to get a free transcript of refund within 3 weeks after your come other than the adjustments listed your account. You will also be asked to enter electronically-filed return was accepted by IRS, earlier under Form 1040A. your date of birth (DOB). Make sure your DOB is see Past-Due Refund later. accurate and matches the information on record 5) Your Form W – 2, box 12, shows uncol- Balance due. If you owe tax, you must pay it with the Social Security Administration by lected employee tax (social security and by April 15, 2004, to avoid late-payment penal- checking your annual Social Security State- Medicare tax) on tips (see chapter 7) or ties and interest. You can make your payment ment. group-term life insurance (see chapter 6). electronically by credit card or by scheduling an You cannot sign your return electroni- electronic funds withdrawal from your checking 6) You received $20 or more in tips in any one month and did not report all of them to ! cally if you are a first-time filer under or savings account. CAUTION age 16 at the end of 2003, or if you are See How To Pay, later, for information on your employer. (See chapter 7.) filing Form 3115, 5713, 8283 (if completing how to pay the balance due. 7) You claim any credits other than the cred- Section B), 8332, or 8609. its listed earlier under Form 1040A. For more details on the Self-Select PIN 8) You have to file other forms with your re- method, visit www.irs.gov/efile and click on Using an Authorized IRS e-file turn to report certain exclusions, taxes, or "IRS e-file for Individual Taxpayers." Provider transactions. Forms 8453 and 8453 – OL. Your return is not complete without your signature. If you are not Many tax professionals electronically eligible or choose not to sign your return elec- file tax returns for their clients. As a tronically, you must complete, sign, and file taxpayer, you have two options. Does My Return Have Table 1 – 4. Benefits of IRS e-file To Be on Paper? Free File • At least 60 percent of taxpayers — or 78 million — are eligible to use free Options! commercial online tax preparation software to e-file. You may be able to file a paperless return using IRS e-file (electronic filing). It's so easy, 53 mil- • Visit www.irs.gov/efile to see if you qualify and to access these free lion taxpayers preferred e-file over filing a paper services offered by the tax software industry (not the IRS). tax return last year. Fast! Easy! • Get your refund in half the time as paper filers do, even faster and safer This section explains how to e-file: Convenient! with Direct Deposit — in as few as 10 days. • Using an Authorized IRS e-file Provider, • Sign electronically and file a completely paperless return. • Using your personal computer, or • Receive an electronic proof of receipt within 48 hours that the IRS received your return. • Using a telephone (TeleFile). • If you owe, you can e-file and authorize an electronic funds withdrawal or pay by credit card. If you e-file before April 15, 2004, you can schedule an IRS e-file electronic funds withdrawal from your checking or savings account as late as April 15, 2004. • Prepare and file your federal and state returns together and save time. Accurate! • IRS computers quickly and automatically check for errors or other missing Secure! information. Table 1 – 4 lists the benefits of IRS e-file. IRS • The error rate for e-filed returns is less than 1 percent. e-file uses automation to replace most of the • The chance of being audited does not differ whether you e-file or file a manual steps needed to process paper returns. paper tax return. As a result, the processing of e-file returns is faster and more accurate than the processing of • Your bank account information is safeguarded along with other tax return paper returns. However, as with a paper return, information. The IRS does not have access to credit card numbers. you are responsible for making sure your return Chapter 1 Filing Information Page 11 1) You can prepare your return, take it to an gram is designed to help low-income taxpayers • DHL Worldwide Express (DHL): DHL Authorized IRS e-file Provider, and have and the Tax Counseling for the Elderly (TCE) "Same Day" Service and DHL USA Over- the provider transmit it electronically to the program is designed to assist taxpayers age 60 night. IRS. or older with their tax returns. Some locations • Federal Express (FedEx): FedEx Priority 2) You can have a tax professional prepare offer free electronic filing and all volunteers will Overnight, FedEx Standard Overnight, your return and transmit it for you let you know about the credits and deductions FedEx 2Day, FedEx International Priority, electronically. you may be entitled to claim. To find a site near and FedEx International First. you, call 1 – 800 – 829 – 1040. Or to find the near- You may personally enter your self-selected est AARP TaxAide site, visit AARP's website at • United Parcel Service (UPS): UPS Next PIN or complete Form 8879, IRS e-file Signa- Day Air, UPS Next Day Air Saver, UPS www.aarp.org/taxaide or call ture Authorization, to authorize the provider to 2nd Day Air, UPS 2nd Day Air A.M., UPS 1 – 888 – 227 – 7669. enter your self-selected PIN on your return. Worldwide Express Plus, and UPS World- Note. Tax professionals may charge a fee wide Express. for IRS e-file. Fees may vary depending on the professional and the specific services rendered. When Do I Private delivery services cannot deliver ! items to P.O. boxes. You must use the Using Your Personal Computer Have To File? CAUTION U.S. Postal Service to mail any item to an IRS P.O. box address. April 15, 2004, is the due date for filing your You can file your tax return in a fast, Electronically filed returns. If you use IRS 2003 income tax return if you use the calendar easy, convenient way using your per- e-file, your return is considered filed on time if year. For a quick view of due dates for filing a sonal computer. A computer with a the authorized electronic return transmitter post- return with or without an extension of time to file modem or Internet access and tax preparation marks the transmission by the due date. An (discussed later), see Table 1 – 5. software are all you need. You can e-file from authorized electronic return transmitter is a par- the comfort of your home 24 hours a day, 7 days If you use a fiscal year (a year ending on the last day of any month except December, or a ticipant in the IRS e-file program that transmits a week. Best of all, you may qualify for Free File. electronic tax return information directly to the 52 – 53 week year), your income tax return is If you do not qualify for the Free File options, IRS. due by the 15th day of the 4th month after the visit our Partners Page for partners that offer The electronic postmark is a record of when close of your fiscal year. other free or low-cost filing options. the authorized electronic return transmitter re- When the due date for doing any act for tax IRS approved tax preparation software is ceived the transmission of your electronically available for online use on the Internet, for purposes — filing a return, paying taxes, etc. — filed return on its host system. The date and time download from the Internet, and in retail stores. falls on a Saturday, Sunday, or legal holiday, the in your time zone controls whether your elec- due date is delayed until the next business day. For information on Free File, Partners Page, tronically filed return is timely. and tax preparation software, visit our website at www.irs.gov/efile. Filing on time. Your paper return is filed on Filing late. If you do not file your return by the time if it is mailed in an envelope that is properly due date, you may have to pay a failure-to-file addressed, has enough postage, and is post- penalty and interest. For more information, see Using a Telephone (TeleFile) marked by the due date. If you send your return Penalties, later. Also see Interest under Amount by registered mail, the date of the registration is You Owe. the postmark date. The registration is evidence If you were due a refund but you did not file a For millions of eligible taxpayers, that the return was delivered. If you send a return, you generally must file within 3 years TeleFile is the easiest way to file. return by certified mail and have your receipt Your Easiest Way from the date the return was due (including ex- TeleFile allows you to file your simple To File postmarked by a postal employee, the date on tensions) to get that refund. federal tax return using a touch-tone telephone. the receipt is the postmark date. The post- Only taxpayers who met the qualifications for marked certified mail receipt is evidence that the Nonresident alien. If you are a nonresident Form 1040EZ in the prior year are eligible to return was delivered. alien and earn wages subject to U.S. income tax receive the TeleFile tax package for the current withholding, your 2003 U.S. income tax return year. A TeleFile tax package is automatically Private delivery services. If you use a pri- (Form 1040NR or Form 1040NR – EZ) is due by: mailed to you if you are eligible. TeleFile is vate delivery service designated by the IRS to completely paperless — there are no forms to send your return, the postmark date generally is • April 15, 2004, if you use a calendar year, mail in. Just follow the instructions in the the date the private delivery service records in or TeleFile tax package. TeleFile is filed directly its database or marks on the mailing label. The • The 15th day of the 4th month after the with the IRS, usually in 10 minutes, and it's private delivery service can tell you how to get end of your fiscal year if you use a fiscal FREE. written proof of this date. year. The following are designated private delivery Parents: If your children receive a services. TIP TeleFile tax package, please en- If you do not earn wages subject to U.S. in- come tax withholding, your return is due by: courage them to use TeleFile. • Airborne Express (Airborne): Overnight Air Express Service, Next Afternoon Service, • June 15, 2004, if you use a calendar year, and Second Day Service. or Through Employers and Financial Institutions Table 1 –5. When To File Your 2003 Return For U.S. citizens and residents who file returns on a calendar year. Some businesses offer free e-file to their em- For Certain Taxpayers ployees, members, or customers. Others offer it For Most Taxpayers Outside the U.S. for a fee. Ask your employer or financial institu- tion if they offer IRS e-file as an employee, No extension requested April 15, 2004 June 15, 2004 member, or customer benefit. Automatic extension August 16, 2004 August 16, 2004 Form 4868 filed, or credit card payment made Free Help With Your Return 2nd extension October 15, 2004 October 15, 2004 Free help in preparing your return is available Form 2688 filed after getting nationwide from IRS-trained volunteers. The automatic extension Volunteer Income Tax Assistance (VITA) pro- Page 12 Chapter 1 Filing Information • The 15th day of the 6th month after the do this by phone or over the Internet. You do not Extension approved. If your application for end of your fiscal year, if you use a fiscal file Form 4868. See Credit card, under How To this extension is approved, you will be notified by year. Pay, later in this chapter. the IRS. If the IRS later determines that the state- Get Publication 519 for more filing information. Filing a paper Form 4868. You can get an ments made on your request for this extension extension of time to file by filing a paper Form are false or misleading and an extension would Filing for a decedent. If you must file a final 4868. Mail it to the address shown in the form not have been approved at the time based on income tax return for a taxpayer who died during instructions. the true facts, the extension will be null and void. the year (a decedent), the return is due by the If you want to make a payment with the form, You will have to pay the failure-to-file penalty 15th day of the 4th month after the end of the make your check or money order payable to the (discussed later under Civil Penalties). decedent's normal tax year. In most cases, for a 2003 return, this will be April 15, 2004. See Final "United States Treasury." Write your SSN, day- Extension not approved. If your applica- Return for the Decedent in chapter 4. time phone number, and "2003 Form 4868" on tion for this extension is not approved, you must your check or money order. file your return by the extended due date of the automatic extension. You may be allowed to file Extensions of Time To File When to file. You must request the automatic within 10 days of the date of the notice you get You may be able to get an extension of time to extension by the due date for your return. You from the IRS if the end of the 10-day period is file your return. Special rules apply for those who can file your return any time before the 4-month later than the due date. The notice will tell you if were: extension period ends. the 10-day grace period is granted. • Outside the United States, or When you file your return. Enter any pay- No further extensions. If you are in the United States, an extension of more than 6 • Serving in a combat zone. ment you made related to the extension of time months will not be approved. to file on line 66, Form 1040. If you file Form 1040EZ or Form 1040A, include that payment in Automatic Extension your total payments on line 9 of Form 1040EZ or line 43 of Form 1040A. Also print "Form 4868" Individuals Outside the If you cannot file your 2003 return by the due and the amount paid in the space to the left of date, you may be able to get an automatic United States line 9 or line 43. 4-month extension of time to file. You are allowed an automatic 2-month exten- Extension beyond 4 months. If you get the sion (until June 15, 2004, if you use the calendar Example. If your return is due on April 15, year) to file your 2003 return and pay any federal 4-month extension and you later find that you 2004, you will have until August 16, 2004, to file. income tax due if: are not able to file within the 4-month extension If you do not pay the tax due by the period, you may be able to get 2 more months to 1) You are a U.S. citizen or resident, and ! regular due date (generally, April 15), file, for a total of 6 months. CAUTION you will owe interest. You may also be You can apply for an extension beyond the 2) On the due date of your return: charged penalties, discussed later. 4-month extension either by writing a letter to the IRS or by filing Form 2688, Application for Addi- a) You are living outside of the United How to get the automatic extension. You tional Extension of Time To File U.S. Individual States and Puerto Rico, and your main can get the automatic extension by: Income Tax Return. Except in cases of undue place of business or post of duty is hardship, a request for additional time will not be outside the United States and 1) Using IRS e-file (electronic filing), or approved unless you have first used the auto- Puerto Rico, or 2) Filing a paper form. matic 4-month extension. Form 2688 or your b) You are in military or naval service on letter will not be considered if you file it after the duty outside the United States and extended due date. Puerto Rico. E-file options. There are three ways you can use e-file to get an extension of time to file. If you You should ask for the extension early However, if you pay the tax due after the e-file, you will get a confirmation number when ! so that, if it is not approved, you still will regular due date (generally, April 15), interest you complete the transaction. Keep the number CAUTION be able to file on time. will be charged from that date until the date the with your records. To get an extension beyond the automatic tax is paid. Complete Form 4868, Application for Auto- 4-month extension, you must give all the follow- If you served in a combat zone or qualified matic Extension of Time To File U.S. Individual ing information. hazardous duty area, you may be eligible for a Income Tax Return, to use as a worksheet. If longer extension of time to file. See Individuals you think you may owe tax when you file your • The reason for requesting the extension. Serving in Combat Zone, later, for special rules return, use Part III of the form to estimate your • The tax year to which the extension ap- that apply to you. balance due. Do not send Form 4868 to the IRS. plies. E-file by phone. You can file Form 4868 by Married taxpayers. If you file a joint return, • The length of time needed for the exten- only one spouse has to qualify for this automatic phone any time from February 2 through April sion. extension. If you and your spouse file separate 15, 2004. You will need to provide certain infor- mation from your tax return for 2002. If you wish • Whether another extension of time to file returns, this automatic extension applies only to to make a payment by electronic funds with- has already been requested for this tax the spouse who qualifies. drawal, see Electronic payment options, under year. How to get the extension. To use this special How To Pay, later in this chapter. automatic extension, you must attach a state- You must sign the request for this extension, or it E-file using your personal computer or a may be signed by your attorney, CPA, enrolled ment to your return explaining what situation tax professional. You can use a tax software agent, or a person with a power of attorney. If qualified you for the extension. (See the situa- package with your personal computer or a tax you are unable to sign the request because of tions listed under (2), earlier.) professional to file Form 4868 electronically. illness or for another good reason, a person with Extensions beyond 2 months. If you cannot You will need to provide certain information from a close personal or business relationship to you file your return within the automatic 2-month your tax return for 2002. If you wish to make a can sign for you, stating why you could not sign extension period, you may be able to get an payment by electronic funds withdrawal, see the request. additional 2-month extension, for a total of 4 Electronic payment options, under How To Pay, E-file. Refer to your tax software package or months. Generally, you must file a paper Form later in this chapter. tax preparer for ways to file Form 2688 electroni- 4868 by the end of the automatic extension E-file and pay by credit card. You can get cally. You will need to provide certain informa- period (usually June 15) to get this additional an extension by paying part or all of your esti- tion from your tax return for 2002. If you file 2-month extension. Write "Taxpayer Abroad" mate of tax due by using a credit card. You can electronically, do not mail the Form 2688. across the top of Form 4868. Chapter 1 Filing Information Page 13 This additional 2-month extension of time to months if you entered it before the beginning of • Your SSN. file is not a further extension of time to pay. You the year) are added to the 180 days. See Exten- can use a credit card to pay your estimate of tax sion of Deadline in Publication 3 for more infor- • Your dates of employment. due. See How To Pay, later in this chapter. mation. • Your employer's name, address (including The above rules on the extension for filing zip code), and phone number. Extension beyond 4 months. If you are still your return also apply when you are deployed unable to file your return within the 4-month outside the United States (away from your per- extension period, you may be able to get an Form 1099. If you received certain types of manent duty station) while participating in a des- extension for 2 more months, for a total of 6 income, you may receive a Form 1099. For ignated contingency operation. months. See Extension beyond 4 months, ear- example, if you received taxable interest of $10 lier. or more, the payer generally must give you a Form 1099 – INT. If you have not received it by No further extension. An extension of more February 2, 2004, contact the payer. If you still than 6 months will generally not be granted. How Do I Prepare do not get the form by February 16, call the IRS However, if you are outside the United States for help. and meet certain tests, you may be granted a My Return? longer extension. For more information, see Fur- ther extensions under When To File and Pay in This section explains how to get ready to fill in When Do I Report My Publication 54 . your tax return and when to report your income Income and Expenses? and expenses. It also explains how to complete certain sections of the form. You may find Table You must figure your taxable income on the Individuals Serving in 1 – 6 helpful when you prepare your return. basis of a tax year. A "tax year" is an annual Combat Zone In most cases, based on what you filed last accounting period used for keeping records year, the IRS will mail you Form 1040, Form and reporting income and expenses. You must The deadline for filing your tax return, paying 1040A, or Form 1040EZ with related instruc- account for your income and expenses in a way any tax you may owe, and filing a claim for tions, or a TeleFile package. Before you fill in the that clearly shows your taxable income. The way refund is automatically extended if you serve in a form, look at the form instructions to see if you you do this is called an accounting method. combat zone. This applies to members of the need, or would benefit from filing, a different This section explains which accounting periods Armed Forces, as well as merchant marines form this year. Also see if you need any addi- and methods you can use. serving aboard vessels under the operational tional forms or schedules. You may also want to control of the Department of Defense, Red read Does My Return Have To Be on Paper, Cross personnel, accredited correspondents, earlier. Accounting Periods and civilians under the direction of the Armed If you do not receive a tax return package in Forces in support of the Armed Forces. the mail, or if you need other forms, you can Most individual tax returns cover a calendar order them or print them from the Internet. See year — the 12 months from January 1 through Combat zone. For purposes of the automatic How To Get Tax Help in the back of this publica- December 31. If you do not use a calendar year, extension, the term "combat zone" includes the tion. your accounting period is a fiscal year. A regu- following areas. lar fiscal year is a 12-month period that ends on Substitute tax forms. You cannot use your the last day of any month except December. A 1) The Persian Gulf area, effective January own version of a tax form unless it meets the 52 – 53 week fiscal year varies from 52 to 53 17, 1991. requirements explained in Publication 1167, weeks and always ends on the same day of the 2) The qualified hazardous duty area of Bos- General Rules and Specifications for Substitute week. nia and Herzegovina, Croatia, and Mace- Forms and Schedules. You choose your accounting period (tax donia, effective November 21, 1995. year) when you file your first income tax return. It Table 1 – 6. Six Steps for Preparing cannot be longer than 12 months. 3) The qualified hazardous duty area of the Federal Republic of Yugoslavia (Serbia/ Your Return More information. For more information on Montenegro), Albania, the Adriatic Sea, accounting periods, including how to change and the Ionian Sea north of the 39th paral- 1 — Get your records together for income and expenses. your accounting period, see Publication 538, lel, effective March 24, 1999. Accounting Periods and Methods. 2 — Get the forms, schedules, and 4) Afghanistan, effective September 19, publications you need. 2001. 3 — Fill in your return. Accounting Methods See Publication 3, Armed Forces' Tax Guide, for information about other tax benefits 4 — Check your return to make sure it is Your accounting method is the way you account available to military personnel serving in a com- correct. for your income and expenses. Most taxpayers bat zone. use either the cash method or an accrual 5 — Sign and date your return. method. You choose a method when you file Extension period. The deadline for filing your 6 — Attach all required forms and your first income tax return. If you want to return, paying any tax due, and filing a claim for schedules. change your accounting method after that, you refund is extended for at least 180 days after the generally must get IRS approval. later of: Form W – 2. If you are an employee, you Cash method. If you use this method, report 1) The last day you are in a combat zone or should receive Form W – 2 from your employer. all items of income in the year in which you the last day the area qualifies as a combat You will need the information from this form to actually or constructively receive them. Gener- zone, or prepare your return. See Form W – 2 under ally, you deduct all expenses in the year you 2) The last day of any continuous qualified Credit for Withholding and Estimated Tax in actually pay them. This is the method most indi- hospitalization for injury from service in the chapter 5. vidual taxpayers use. combat zone. If you do not receive Form W – 2 by February Constructive receipt. Generally, you con- 2, 2004, contact your employer. If you still do not In addition to the 180 days, your deadline is structively receive income when it is credited to get the form by February 16, the IRS can help also extended by the number of days you had your account or set apart in any way that makes you by requesting the form from your employer. left to take action with the IRS when you entered it available to you. You do not need to have When you request IRS help, be prepared to the combat zone. For example, you have 31/2 physical possession of it. For example, interest provide the following information. months (January 1 – April 15) to file your tax credited to your bank account on December 31, return. Any days left in this period when you • Your name, address (including zip code), 2003, is taxable income to you in 2003 if you entered the combat zone (or the entire 31/2 and phone number. could have withdrawn it in 2003 (even if the Page 14 Chapter 1 Filing Information amount is not entered in your passbook or with- Additional information. For more information • You cannot get the child's existing SSN drawn until 2004). on accounting methods, including how to even though you have made a reasonable change your accounting method, get Publication attempt to get it from the birth parents, the Garnisheed wages. If your employer uses 538. placement agency, and other persons. your wages to pay your debts, or if your wages are attached or garnisheed, the full amount is • You cannot get an SSN for the child from constructively received by you. You must in- Social Security Number the SSA because, for example, the adop- clude these wages in income for the year you tion is not final. would have received them. You must enter your social security number (SSN) in the space provided on your return. Be • You cannot get an Individual Taxpayer Brokerage and other accounts. Profits sure the SSN on your return is the same as the Identification Number (ITIN) (discussed from a brokerage account, or similar account, SSN on your social security card. If you are later) for the child. are fully taxable in the year you earn them. This married, enter the SSNs for both you and your • You are eligible to claim the child as a is true even if: spouse, whether you file jointly or separately. dependent on your tax return. If you are filing a joint return, write the SSNs 1) You do not withdraw the earnings, in the same order as the names. Use this same After the adoption is final, you must apply for an order in submitting other forms and documents SSN for the child. You cannot continue using the 2) The credit balance in the account may be to the IRS. ATIN. reduced or eliminated by losses in later years, or See Form W – 7A for more information. Name change. If you changed your name be- 3) Current profits are used to reduce or elimi- cause of marriage, divorce, etc., immediately Nonresident alien spouse. If your spouse is nate a debit balance from previous years. notify your Social Security Administration (SSA) office so the name on your tax return is the same a nonresident alien and you file a joint or sepa- Debts paid for you. If another person as the one the SSA has on its records. This will rate return, your spouse must have either an cancels or pays your debts (but not as a gift or help prevent delays in issuing your refund and SSN or an ITIN. If your spouse is not eligible for loan), you have constructively received the safeguard your future social security benefits. an SSN, see the next discussion. amount and generally must include it in your gross income for the year. See Canceled Debts Dependent's social security number. You Individual taxpayer identification number in chapter 13 for more information. must provide the SSN of each dependent you (ITIN). The IRS will issue you an ITIN if you are claim, regardless of the dependent's age. This a nonresident or resident alien and you do not Payment to third party. If a third party is requirement applies to all dependents (not just have and are not eligible to get an SSN. To paid income from property you own, you have your children) claimed on your tax return. apply for an ITIN, file Form W – 7 with the IRS. It constructively received the income. It is the usually takes about 4 to 6 weeks to get an ITIN. same as if you had actually received the income Exception. If your child was born and died Enter this number on your tax return wherever and paid it to the third party. in 2003 and you do not have an SSN for the your SSN is requested. child, you may attach a copy of the child's birth Payment to an agent. Income an agent re- certificate instead. If you do, enter "DIED" in Alien dependent. If your dependent is a ceives for you is income you constructively re- column (2) of line 6c (Form 1040 or 1040A). nonresident or resident alien who does not have ceived in the year the agent receives it. If you and is not eligible to get an SSN, file Form W – 7 indicate in a contract that your income is to be No social security number. File Form with the IRS to apply for an ITIN. Enter this paid to another person, you must include the SS – 5, Application for a Social Security Card, number on your return wherever the amount in your gross income when the other with your local SSA office to get an SSN for dependent's SSN is requested. person receives it. yourself or your dependent. It usually takes about 2 weeks to get an SSN. If you or your An ITIN is for tax use only. It does not Check received or available. A valid check you received or that was made available to you dependent is not eligible for an SSN, see Individ- ! entitle you or your dependent to social ual taxpayer identification number (ITIN), later. CAUTION security benefits or change the em- before the end of the tax year is constructively If you are a U.S. citizen, you must show proof ployment or immigration status of either of you received by you in that year, even if you do not of age, identity, and citizenship with your Form under U.S. law. cash the check or deposit it in your account until SS – 5. If you are 18 or older, you must appear in the next year. person with this proof at an SSA office. Penalty for not providing social security No constructive receipt. There may be Form SS – 5 is available at any SSA office or number. If you do not include your SSN or the facts to show that you did not constructively on the Internet at www.ssa.gov. If you have any SSN of your spouse or dependent as required, receive income. questions about which documents you can use you may have to pay a penalty. See the discus- as proof of age, identity, or citizenship, contact sion on Penalties, later, for more information. Example. Alice Johnson, a teacher, agreed your SSA office. to her school board's condition that, in her ab- If your dependent does not have an SSN by SSN on correspondence. If you write to the sence, she would receive only the difference the time your return is due, you may want to ask IRS about your tax account, be sure to include between her regular salary and the salary of a for an extension of time to file, as explained your SSN (and the name and SSN of your earlier under When Do I Have To File. spouse, if you filed a joint return) in your corre- substitute teacher hired by the school board. If you do not provide a required SSN or if you spondence. Because your SSN is used to iden- Therefore, Alice did not constructively receive provide an incorrect SSN, your tax may be in- tify your account, this helps the IRS respond to the amount by which her salary was reduced to creased and any refund may be reduced. your correspondence promptly. pay the substitute teacher. Adoption taxpayer identification number Accrual method. If you use an accrual (ATIN). If you are in the process of adopting a Presidential Election method, you generally report income when you child who is a U.S. citizen or resident and cannot earn it, rather than when you receive it. You get an SSN for the child until the adoption is Campaign Fund generally deduct your expenses when you incur final, you can apply for an ATIN to use instead of This fund was set up to help pay for presidential them, rather than when you pay them. an SSN. election campaigns. If you have a tax liability of Income paid in advance. Prepaid income File Form W – 7A, Application for Taxpayer at least $3, you may have $3 of your tax liability is generally included in gross income in the year Identification Number for Pending U.S. Adop- go to this fund by checking the Yes box on Form you receive it. Your method of accounting does tions, with the IRS to get an ATIN if all of the 1040, Form 1040A, or Form 1040EZ. If you are following are true. not matter as long as the income is available to filing a joint return and have a tax liability of at you. Prepaid income may include rent or interest • You have a child living with you who was least $6, your spouse may also have $3 go to you receive in advance and pay for services you placed in your home for legal adoption by the fund. If you check Yes, it will not change the will perform later. an authorized placement agency. tax you pay or the refund you will receive. Chapter 1 Filing Information Page 15 Form 1040. Attach any forms and schedules Computations behind Form 1040 in order of the "Attachment 1) Unable to sign the return because of dis- Sequence Number" shown in the upper right ease or injury, The following information on entering numbers on your tax return may be useful in making the corner of the form or schedule. Then arrange all 2) Absent from the United States for a contin- return easier to complete. other statements or attachments in the same uous period of at least 60 days before the order as the forms and schedules they relate to due date for filing your return, or Rounding off dollars. You may round off and attach them last. Do not attach items unless 3) Given permission to do so by the IRS of- cents to whole dollars on your return and sched- required to do so. fice in your area. ules. 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 Third Party Designee Power of attorney. A return signed by an agent in any of these cases must have a power 99 cents to the next dollar. For example, $1.39 You can authorize the IRS to discuss your return of attorney (POA) attached that authorizes the becomes $1 and $2.50 becomes $3. with a friend, family member, or any other per- agent to sign for you. You can use a POA that If you have to add two or more amounts to son you choose. If you check the Yes box in the states that the agent is granted authority to sign figure the amount to enter on a line, include Third party designee area of your 2003 tax re- the return, or you can use Form 2848, Power of cents when adding the amounts and round off turn and provide the information required, you Attorney and Declaration of Representative. only the total. are authorizing: Part I of Form 2848 must state that the agent is granted authority to sign the return. Example. You receive two Forms W – 2: 1) The IRS to call the designee to answer one showing wages of $5,000.55 and one show- Unable to sign. If the taxpayer is mentally any questions that arise during the ing wages of $18,500.73. On Form 1040, line 7, incompetent and cannot sign the return, it must processing of your return, and you would enter $23,501 ($5,000.55 + be signed by a court-appointed representative $18,500.73 = $23,501.28), not $23,502 ($5,001 2) The designee to: who can act for the taxpayer. + $18,501). If the taxpayer is mentally competent but a) Give information that is missing from physically unable to sign the return or POA, a Equal amounts. If you are asked to enter the your return to the IRS, valid "signature" is defined under state law. It smaller or larger of two equal amounts, enter b) Call the IRS for information about the can be anything that clearly indicates the that amount. processing of your return or the status taxpayer's intent to sign. For example, the of your refund or payments, taxpayer's "X" with the signatures of two wit- Example. Line 1 is $500. Line 3 is $500. nesses might be considered a valid signature Line 5 asks you to enter the smaller of line 1 or 3. c) Call the IRS to ask for copies of notices under a state's law. Enter $500 on line 5. or transcripts related to your return, and Spouse unable to sign. If your spouse is una- d) Respond to certain IRS notices about ble to sign for any reason, see Signing a joint Negative amounts. If you need to enter a math errors, offsets (see Refunds, return in chapter 2. negative amount, put the amount in parentheses rather than using a minus sign. To combine later), and return preparation. Child's return. If a child has to file a tax return positive and negative amounts, add all the posi- but cannot sign the return, the child's parent, tive amounts together and then subtract the The authorization will automatically end no later than the due date (without any extensions) guardian, or another legally responsible person negative amounts. must sign the child's name, followed by the for filing your 2004 tax return. This is April 15, 2005, for most people. words "By (your signature), parent for minor Attachments See your form instructions for more informa- child." tion. Depending on the form you file and the items reported on your return, you may have to com- If you want to allow the paid preparer Paid Preparer plete additional schedules and forms and attach TIP who signed your return to discuss it Generally, anyone you pay to prepare, assist in them to your return. with the IRS, just enter "Preparer" in preparing, or review your tax return must sign it the space for the designee's name. and fill in the other blanks in the paid preparer's IRS e-file is paperless. There's nothing TIP to sign, attach, or mail, not even your area of your return. Forms W – 2. Signatures If the preparer is self-employed (that is, not employed by any person or business to prepare You must sign and date your return. If you file a the return), he or she should check the self-em- Form W – 2. Form W – 2 is a statement from joint return, both you and your spouse must sign ployed box in the Paid Preparer's Use Only your employer of wages and other compensa- the return, even if only one of you had income. space on the return. tion paid to you and taxes withheld from your The preparer must give you a copy of your pay. You should have a Form W – 2 from each If you file a joint return, both spouses return in addition to the copy filed with the IRS. employer. Be sure to attach a copy of Form W – 2 in the place indicated on the front page of ! are generally liable for the tax, and the If you prepare your own return, leave this CAUTION entire tax liability may be assessed area blank. If another person prepares your re- your return. Attach it only to the front page of against either spouse. See chapter 2. turn and does not charge you, that person your return, not to any attachments. For more should not sign your return. information, see Form W – 2 in chapter 5. If you e-file your return, you can use an If you have questions about whether a If you received a Form 1099 – R, Distribu- TIP electronic signature to sign your return. preparer must sign your return, contact any IRS tions From Pensions, Annuities, Retirement or See Does My Return Have To Be on office. Profit-Sharing Plans, IRAs, Insurance Con- Paper, earlier. tracts, etc., showing federal income tax with- If you are due a refund, it cannot be issued held, attach a copy of that form in the place unless you have signed your return. Refunds indicated on the front page of your return. Enter your occupation in the space provided When you complete your return, you will deter- Form 1040EZ. There are no additional sched- in the signature section. If you file a joint return, mine if you paid more income tax than you ules to file with Form 1040EZ. enter both your occupation and your spouse's owed. If so, you can get a refund of the amount occupation. Entering your daytime phone num- you overpaid or, if you file Form 1040 or Form Form 1040A. Attach the additional schedules ber may help speed the processing of your re- 1040A, you can choose to apply all or part of the and forms that you had to complete behind the turn. overpayment to your next year's (2004) esti- Form 1040A in order by number. If you are filing mated tax. You cannot have your overpayment Schedule EIC, put it last. Do not attach items When someone can sign for you. You can applied to your 2004 estimated tax if you file unless required to do so. appoint an agent to sign your return if you are: Form 1040EZ. Page 16 Chapter 1 Filing Information If you choose to have a 2003 overpay- wages or estimated tax payments), or Payment not honored. If your check or ! ment applied to your 2004 estimated claimed the earned income credit or other money order is not honored by your bank (or CAUTION tax, you cannot change your mind and refundable credit, and other financial institution) and the IRS does not have any of it refunded to you after the due date receive the funds, you still owe the tax. In addi- 4) Have an overpayment, all or part of which (without extensions) of your 2003 return. tion, you may be subject to a dishonored check may be applied against the past-due Follow the form instructions to complete the penalty. amount. entries to claim your refund and/or to apply your overpayment to your 2004 estimated tax. If you are an injured spouse, you can obtain Electronic payment options. Electronic pay- your portion of the joint refund by completing ment options are convenient, safe and secure If your refund for 2003 is large, you Form 8379, Injured Spouse Claim and Alloca- methods for paying individual income taxes. TIP may want to decrease the amount of tion. Follow the instructions on the form. There's no check to write, money order to buy, income tax withheld from your pay in or voucher to mail. 2004. See chapter 5 for more information. Amount You Owe Credit card. You can use your American Direct Deposit. Instead of getting a paper Express, Discover, MasterCard, or Visa check, you may be able to have your refund When you complete your return, you will deter- credit card. deposited directly into your account at a bank or mine if you have paid the full amount of tax that To pay by credit card, call a service provider other financial institution. Follow the form in- you owe. If you owe additional tax, you should and follow the recorded instructions. You can structions to request Direct Deposit. pay it with your return. also pay by credit card over the Internet using a If the Direct Deposit cannot be done, the IRS If the IRS figures your tax for you, you will service provider's web site. will send a check instead. receive a bill for any tax that is due. You should pay this bill within 30 days (or by the due date of The service providers charge a convenience Overpayment less than one dollar. If your your return, if later). See Tax Figured by IRS in fee based on the amount you are paying. Fees overpayment is less than one dollar, you will not chapter 32. may vary between the providers. You will be told get a refund unless you ask for it in writing. what the fee is during the transaction and will If you do not pay your tax when due, have the option to continue or end the transac- Cashing your refund check. Cash your tax refund check soon after you receive it. Checks ! you may have to pay a failure-to-pay tion. You may also obtain the convenience fee CAUTION penalty. See Penalties, later. For more by calling the service provider's automated cus- not cashed within 12 months of the date they are information about your balance due, see Publi- tomer service telephone number or visiting their issued will be canceled and the proceeds re- cation 594, The IRS Collection Process. respective web site. turned to the IRS. If your check has been canceled, you can If the amount you owe for 2003 is large, Do not add the convenience fee to your apply to the IRS to have it reissued. TIP you may want to increase the amount ! tax payment. of income tax withheld from your pay or CAUTION Refund more or less than expected. If you make estimated tax payments for 2004. See receive a check for a refund you are not entitled chapter 5 for more information. to, or for an overpayment that should have been If you pay by credit card, write the confirma- credited to estimated tax, do not cash the check. tion number you were given at the end of the Call the IRS. transaction and the tax payment amount in the If you receive a check for more than the How To Pay upper left corner of page 1 of your tax return. refund you claimed, do not cash the check until If you have an amount due on your tax return, you receive a notice explaining the difference. Service Providers you can pay by check, money order, or credit If your refund check is for less than you card. If you filed electronically, you also may be Link2Gov Corporation claimed, it should be accompanied by a notice able to make your payment electronically. explaining the difference. Cashing the check To make a does not stop you from claiming an additional You do not have to pay if the amount payment, call . . . . 1 – 888 – PAY – 1040SM amount of refund. TIP you owe is less than $1. or . . . . . . . . . . . 1 – 888 – 729 – 1040 If you did not receive a notice and you have any questions about the amount of your refund, For Customer Service . . . . . . . . 1 – 888 – 658 – 5465 you should wait 2 weeks. If you still have not received a notice, call the IRS. Web Address . . . . www.PAY1040.com Check or money order. If you pay by check or Offset against debts. If you are due a refund money order, make it out to the "United States Official Payments Corporation but have not paid certain amounts you owe, all Treasury." Show your correct name, address, or part of your refund may be used to pay all or SSN, daytime phone number, and the tax year To make a part of the past-due amount. This includes and form number on the front of your check or payment, call . . . . 1 – 800 – 2PAY – TAXSM past-due federal income tax, other federal debts money order. If you are filing a joint return, enter or . . . . . . . . . . . 1 – 800 – 272 – 9829 (such as student loans), state income tax, and the SSN shown first on your tax return. For Customer child and spousal support payments. You will be For example, if you file Form 1040 for 2003 Service . . . . . . . . 1 – 877 – 754 – 4413 notified if the refund you claimed has been offset and you owe additional tax, show your name, Web Address . . . . www.officialpayments.com against your debts. address, SSN, daytime phone number, and "2003 Form 1040" on the front of your check or Joint return and injured spouse. When a You can e-file and pay in a single step by money order. If you file an amended return joint return is filed and only one spouse owes a authorizing a credit card payment. This option is (Form 1040X) for 2002 and you owe tax, show past-due amount, the other spouse can be con- available through some tax software packages your name, address, SSN, daytime phone num- sidered an injured spouse. An injured spouse and tax professionals. You can also pay by ber, and "2002 Form 1040X" on the front of your can get a refund for his or her share of the credit card using the telephone or the Internet. check or money order. overpayment that would otherwise be used to pay the past-due amount. Enclose your payment with your return, but Electronic funds withdrawal. You can To be considered an injured spouse, you do not attach it to the form. If you filed Form e-file and pay in a single step by authorizing an must: 1040, please complete Form 1040 – V, Payment electronic funds withdrawal from your checking Voucher, and enclose it with your payment and or savings account. This option is available 1) File a joint return, return. Form 1040 – V will help us process your through tax software packages, tax profession- payment more accurately and efficiently. Follow als, and TeleFile. If you select this payment 2) Have reported income (such as wages, in- the instructions that come with the form. option, you will need to have your account num- terest, etc.), Do not mail cash with your return. If you pay ber, your financial institution's routing transit 3) Have made and reported tax payments cash at an IRS office, keep the receipt as part of number, and account type (checking or sav- (such as federal income tax withheld from your records. ings). You can schedule the payment for any Chapter 1 Filing Information Page 17 future date up to and including the return due For more information, get Publication 556. You can deduct this gift as a charitable con- date (April 15, 2004). tribution on next year's tax return if you itemize Installment Agreement your deductions on Schedule A (Form 1040). Be sure to check with your financial ! institution to make sure that an elec- If you cannot pay the full amount due with your Peel-Off Address Label CAUTION tronic funds withdrawal is allowed and return, you can ask to make monthly installment to get the correct routing and account numbers. payments. However, you will be charged inter- After you have completed your return, peel off Electronic Federal Tax Payment System est and may be charged a late payment penalty the label with your name and address from the (EFTPS). EFTPS offers another way to pay on the tax not paid by April 15, 2004, even if your back of your tax return package and place it in your federal taxes. Best of all, it's free and avail- request to pay in installments is granted. If your the appropriate area of the Form 1040, Form able to business and individual taxpayers. In request is granted, you must also pay a fee. To 1040A, or Form 1040EZ you send to the IRS. If fact, it's recommended for estimated tax pay- limit the interest and penalty charges, pay as you have someone prepare your return, give ments (Form 1040 – ES) and installment agree- much of the tax as possible with your return. But that person your label to use on your tax return. ment payments. For details on how to enroll, before requesting an installment agreement, If you file electronically and you are not eligi- visit www.EFTPS.gov or call EFTPS Customer you should consider other less costly alterna- ble or choose not to sign your return using your Service at 1 – 800 – 555 – 4477 or tives, such as a bank loan. self-selected PIN, use your label on Form 8453 1 – 800 – 945 – 8400. To ask for an installment agreement, use or 8453 – OL. (More information on electronic Form 9465, Installment Agreement Request. filing is found earlier in this chapter.) Estimated tax payments. Do not include any You should receive a response to your request The label helps the IRS to correctly identify 2004 estimated tax payment in the payment for within 30 days. But if you file your return after your account. It also saves processing costs and your 2003 income tax return. See chapter 5 for March 31, it may take longer for a reply. speeds up processing so that refunds can be information on how to pay estimated tax. In addition to paying by check or money issued sooner. order, you can use a credit card or EFTPS to make installment agreement payments. See You must write your SSN in the spaces Interest Credit card and Electronic Federal Tax Payment ! CAUTION provided on your tax return. System (EFTPS), under How To Pay, earlier. Interest is charged on tax you do not pay by the due date of your return. Interest is charged even Guaranteed availability of installment agree- if you get an extension of time for filing. ment. The IRS must agree to accept the pay- Correcting the label. Make necessary name ment of your tax liability in installments if, as of and address changes on the label. If you have If the IRS figures your tax for you, inter- TIP est cannot start earlier than the 31st the date you offer to enter into the agreement: an apartment number that is not shown on the day after the IRS sends you a bill. For label, please write it in. If you changed your 1) Your total taxes (not counting interest, information, see Tax Figured by IRS in chapter name, see the discussion under Social Security penalties, additions to the tax, or additional 32. Number, earlier. amounts) do not exceed $10,000, 2) In the last 5 years, you (and your spouse if No label. If you did not receive a tax return Interest on penalties. Interest is charged on the liability relates to a joint return) have package with a label, print or type your name the failure-to-file penalty, the accuracy-related not: and address in the spaces provided at the top of penalty, and the fraud penalty from the due date Form 1040 or Form 1040A. If you are married of the return (including extensions) to the date of a) Failed to file any required income tax filing a separate return, do not enter your payment. Interest on other penalties starts on return, spouse's name in the space at the top. Instead, the date of notice and demand, but is not enter his or her name in the space provided on charged on penalties paid within 21 calendar b) Failed to pay any tax shown on any line 3. days from the date of the notice (or within 10 such return, or If you file Form 1040EZ and you do not have business days if the notice is for $100,000 or c) Entered into an installment agreement a label, print or type this information in the more). for the payment of any income tax, spaces provided. Interest due to IRS error or delay. All or part of any interest you were charged can be forgiven 3) You show you cannot pay your income tax P.O. box. If your post office does not deliver if the interest is due to an unreasonable error or in full when due, mail to your street address and you have a P.O. delay by an officer or employee of the IRS in box, print your P.O. box number on the line for 4) The tax will be paid in full in 3 years or your present home address instead of your performing a ministerial or managerial act. less, and A ministerial act is a procedural or mechani- street address. cal act that occurs during the processing of your 5) You agree to comply with the tax laws while your agreement is in effect. Foreign address. If your address is outside case. A managerial act includes personnel the United States or its possessions or territo- transfers and extended personnel training. A ries, enter the information on the line for "City, decision concerning the proper application of federal tax law is not a ministerial or managerial Gift To Reduce the town or post office, state, and ZIP code" in the following order: act. Public Debt The interest can be forgiven only if you are 1) City, not responsible in any important way for the You can make a contribution (gift) to 2) Province or state, and error or delay and the IRS has notified you in reduce the public debt. If you wish to do writing of the deficiency or payment. For more 3) Name of foreign country. (Do not abbrevi- so, make a separate check payable to information, get Publication 556, Examination of ate the name of the country.) "Bureau of the Public Debt." Returns, Appeal Rights, and Claims for Refund. Send your check to: Follow the country's practice for entering the Interest and certain penalties may also be suspended for a limited period if you filed your postal code. return by the due date (including extensions) Bureau of the Public Debt and the IRS does not provide you with a notice Department G specifically stating your liability and the basis for it before the close of the 18-month period begin- P.O. Box 2188 Parkersburg, WV 26106-2188. Where Do I File? ning on the later of: After you complete your return, you must send it • The date the return is filed, or Or, enclose your separate check in the envel- to the IRS. You can mail it or you may be able to • The due date of the return without regard ope with your income tax return. Do not add file it electronically. See Does My Return Have to extensions. this gift to any tax you owe. To Be on Paper, earlier. Page 18 Chapter 1 Filing Information Mailing your return. If an addressed envel- Copies of returns. You should keep copies of refund generally will be forgiven. Any interest ope came with your tax forms package, you tax returns you have filed and the tax forms charged for the period before demand for repay- should mail your return in that envelope. package as part of your records. They may be ment was made will be forgiven unless: If you do not have an addressed envelope or helpful in amending filed returns or preparing if you moved during the year, mail your return to future ones. 1) You, or a person related to you, caused the address shown at the end of this publication If you need a copy of a prior year tax return, the erroneous refund in any way, or for the area where you now live. you can get it from the IRS. Use Form 4506, 2) The refund is more than $50,000. Request for Copy of Tax Return. There is a charge for a copy of a return, which you must For example, if you claimed a refund of $100 pay with Form 4506. It may take up to 60 days to on your return, but the IRS made an error and sent you $1,000, you would not be charged What Happens After process your request. interest for the time you held the $900 differ- Transcript. You can use Form 4506 – T, Re- ence. You must, however, repay the $900 when I File? quest for Transcript of Tax Return, to ask for a the IRS asks. transcript of your return filed this year or during After you send your return to the IRS, you may the 3 preceding years. It will show most lines have some questions. This section discusses from your original return, including accompany- Past-Due Refund concerns you may have about recordkeeping, ing forms and schedules. A transcript usually your refund, and what to do if you move. You can check on the status of your 2003 refund contains the information that a third party (such if it has been at least 6 weeks from the date you as a mortgage company) requires. filed your return (3 weeks if you filed electroni- What Records Should Tax account information. If you need a state- cally). Be sure to have a copy of your 2003 tax I Keep? ment of your tax account showing any later return available because you will need to know changes that you or the IRS made to the original the filing status, the first SSN shown on the return, you will need to ask the IRS for your tax return, and the exact whole-dollar amount of the You must keep records so that you can refund. To check on your refund, do one of the account information. You should have your prepare a complete and accurate in- following. name and address, SSN or employer identifica- RECORDS come tax return. The law does not re- tion number (if applicable), tax period, and form quire any special form of records. However, you • Go to www.irs.gov, and click on Where's number available. You will get the following in- should keep all receipts, canceled checks or My Refund. formation: other proof of payment, and any other records to • Call 1 – 800 – 829 – 4477 for automated re- support any deductions or credits you claim. • Type of return filed, fund information and follow the recorded If you file a claim for refund, you must be able • Filing status, instructions. to prove by your records that you have overpaid your tax. • Federal income tax withheld, • Call 1 – 800 – 829 – 1954 during the hours shown in your form instructions. • Tax shown on return, How long to keep records. You must keep your records for as long as they are important for • Adjusted gross income, the federal tax law. • Taxable income, Change of Address Keep records that support an item of income or a deduction appearing on a return until the • Self-employment tax, If you have moved, file your return using your new address. period of limitations for the return runs out. (A • Number of exemptions, If you move after you filed your return, you period of limitations is the period of time after which no legal action can be brought.) For as- • Refund, should give the IRS clear and concise written notification of your change of address. Send the sessment of tax you owe, this generally is 3 • Earned income credit, and notification to the Internal Revenue Service years from the date you filed the return. For filing a claim for credit or refund, this generally is 3 • Mortgage interest deduction or real estate Center serving your old address. You can use tax deduction. Form 8822, Change of Address. If you are ex- years from the date you filed the original return, pecting a refund, also notify the post office serv- or 2 years from the date you paid the tax, which- ing your old address. This will help in forwarding ever is later. Returns filed before the due date More information. For more information on your check to your new address (unless you are treated as filed on the due date. recordkeeping, get Publication 552, Record- chose Direct Deposit of your refund). If you did not report income that you should keeping for Individuals. Be sure to include your SSN (and the name have reported on your return, and it is more than and SSN of your spouse, if you filed a joint 25% of the income shown on the return, the period of limitations does not run out until 6 Interest on Refunds return) in any correspondence with the IRS. years after you filed the return. If a return is false If you are due a refund, you may get interest on or fraudulent with intent to evade tax, or if no it. The interest rates are adjusted quarterly. return is filed, an action can generally be brought at any time. If the refund is made within 45 days after the due date of your return, no interest will be paid. If What If I Made You may need to keep records relating to the basis of property longer than the period of limita- you file your return after the due date (including extensions), no interest will be paid if the refund a Mistake? tions. Keep those records as long as they are is made within 45 days after the date you filed. If important in figuring the basis of the original or Errors may delay your refund or result in notices the refund is not made within this 45-day period, replacement property. Generally, this means for being sent to you. If you discover an error, you interest will be paid from the due date of the as long as you own the property and, after you can file an amended return or claim for refund. return or from the date you filed, whichever is dispose of it, for the period of limitations that later. applies to you. See chapter 14 for information on Accepting a refund check does not change Amended Returns and basis. your right to claim an additional refund and inter- est. File your claim within the period of time that Claims for Refund Note. If you receive a Form W – 2, keep applies. See Amended Returns and Claims for Copy C until you begin receiving social security You should correct your return if, after you have Refund, later. If you do not accept a refund filed it, you find that: benefits. This will help protect your benefits in check, no more interest will be paid on the over- case there is a question about your work record payment included in the check. 1) You did not report some income, or earnings in a particular year. Review the infor- mation shown on your annual (for workers over Interest on erroneous refund. All or part of 2) You claimed deductions or credits you age 25) Social Security Statement. any interest you were charged on an erroneous should not have claimed, Chapter 1 Filing Information Page 19 3) You did not claim deductions or credits return was due (including extensions). For infor- treated as financially disabled during any period you could have claimed, or mation on postmarks, see Filing on time, under your spouse or any other person is authorized to When Do I Have To File, earlier. act on your behalf in financial matters. 4) You should have claimed a different filing status. (You cannot change your filing sta- To claim that you are financially disabled, Limit on amount of refund. If you file your you must send in the following written state- tus from married filing jointly to married claim within 3 years after the date you filed your filing separately after the due date of the ments with your claim for refund. return, the credit or refund cannot be more than original return. However, an executor may the part of the tax paid within the 3-year period be able to make this change for a de- 1) A statement from your qualified physician (plus any extension of time for filing your return) that includes: ceased spouse.) immediately before you filed the claim. This time If you need a copy of your return, see Copies of period is suspended while you are financially a) The name and a description of your returns under What Records Should I Keep, disabled, discussed later. physical or mental impairment, earlier in this chapter. Tax paid. Payments, including estimated b) The physician's medical opinion that tax payments, made before the due date (with- the impairment prevented you from Form 1040X. Use Form 1040X, Amended out regard to extensions) of the original return managing your financial affairs, U.S. Individual Income Tax Return, to correct a are considered paid on the due date. For exam- return you have already filed. An amended tax c) The physician's medical opinion that ple, income tax withheld during the year is con- return cannot be filed electronically under the the impairment was or can be expected sidered paid on the due date of the return, April e-file system. to result in death, or that its duration 15 for most taxpayers. Completing Form 1040X. On Form 1040X, has lasted, or can be expected to last, write your income, deductions, and credits as Example 1. You made estimated tax pay- at least 12 months, you originally reported them on your return, the ments of $500 and got an automatic extension of d) The specific time period (to the best of changes you are making, and the corrected time to August 15, 2001, to file your 2000 in- the physician's knowledge), and amounts. Then figure the tax on the corrected come tax return. When you filed your return on amount of taxable income and the amount you that date, you paid an additional $200 tax. On e) The following certification signed by the owe or your refund. August 16, 2004 (next business day after Au- physician: "I hereby certify that, to the If you owe tax, pay the full amount with Form gust 15, 2004), you filed an amended return and best of my knowledge and belief, the 1040X. The tax owed will not be subtracted from claimed a refund of $700. Because you filed above representations are true, correct, any amount you had credited to your estimated your claim within 3 years after you filed your and complete." tax. original return, you can get a refund of up to If you cannot pay the full amount due with $700, the tax paid within the 3 years plus the 2) A statement made by the person signing your return, you can ask to make monthly install- 4-month extension period immediately before the claim for credit or refund that no per- ment payments. See Installment Agreement, you filed the claim. son, including your spouse, was author- earlier. ized to act on your behalf in financial If you overpaid tax, you can have all or part of Example 2. The situation is the same as in matters during the period of disability (or the overpayment refunded to you, or you can Example 1, except you filed your return on Octo- the exact dates that a person was author- apply all or part of it to your estimated tax. If you ber 27, 2001, 21/2 months after the extension ized to act for you). choose to get a refund, it will be sent separately period ended. You paid an additional $200 on from any refund shown on your original return. that date. On October 27, 2004, you filed an Exceptions for special types of refunds. If amended return and claimed a refund of $700. you file a claim for one of the items listed below, Filing Form 1040X. After you finish your Although you filed your claim within 3 years from the dates and limits discussed earlier may not Form 1040X, check it to be sure that it is com- the date you filed your original return, the refund apply. These items, and where to get more infor- plete. Do not forget to show the year of your was limited to $200, the tax paid within the 3 mation, are as follows. original return and explain all changes you years plus the 4-month extension period imme- made. Be sure to attach any forms or schedules needed to explain your changes. Mail your Form diately before you filed the claim. The estimated • Bad debt. (See Nonbusiness Bad Debts in tax of $500 paid before that period cannot be chapter 15.) 1040X to the Internal Revenue Service Center refunded or credited. serving the area where you now live (as shown If you file a claim more than 3 years after • Worthless security. (See Worthless securi- in the instructions to the form). Do not use the ties in chapter 15.) you file your return, the credit or refund cannot addresses listed at the end of this publication. File a separate form for each tax year in- be more than the tax you paid within the 2 years • Foreign tax paid or accrued. (See Publica- immediately before you file the claim. tion 514, Foreign Tax Credit for Individu- volved. als.) Example 3. You filed your 2000 tax return Time for filing a claim for refund. Generally, on April 16, 2001. You paid taxes of $500. On • Net operating loss carryback. (See Publi- you must file your claim for a credit or refund cation 536, Net Operating Losses (NOLs) within 3 years after the date you filed your origi- November 1, 2002, after an examination of your 2000 return, you had to pay an additional tax of for Individuals, Estates, and Trusts.) nal return or within 2 years after the date you paid the tax, whichever is later. Returns filed $200. On May 13, 2004, you file a claim for a • Carryback of certain business tax credits. before the due date (without regard to exten- refund of $300. However, because you filed your (See Form 3800, General Business sions) are considered filed on the due date claim more than 3 years after you filed your Credit.) return, your refund will be limited to the $200 you (even if the due date was a Saturday, Sunday, or paid during the 2 years immediately before you • Claim based on an agreement with the legal holiday). These time periods are sus- IRS extending the period for assessment pended while you are financially disabled, dis- filed your claim. of tax. cussed later. If the last day for claiming a credit or refund is Financially disabled. The time periods for • Injured spouse claim. (See Offset against claiming a refund are suspended for the period debts, earlier.) a Saturday, Sunday, or legal holiday, you can in which you are financially disabled. For a joint file the claim on the next business day. income tax return, only one spouse has to be If you do not file a claim within this period, Processing claims for refund. Claims are financially disabled for the time period to be you may not be entitled to a credit or a refund. usually processed shortly after they are filed. suspended. You are financially disabled if you Late-filed return. If you were due a refund are unable to manage your financial affairs be- Your claim may be accepted as filed, disal- but you did not file a return, you generally must cause of a medically determinable physical or lowed, or subject to examination. If a claim is file your return within 3 years from the date the mental impairment which can be expected to examined, the procedures are the same as in return was due (including extensions) to get that result in death or which has lasted or can be the examination of a tax return. refund. Generally, your return must be post- expected to last for a continuous period of not If your claim is disallowed, you will receive an marked no later than 3 years from the date the less than 12 months. However, you are not explanation of why it was disallowed. Page 20 Chapter 1 Filing Information Taking your claim to court. You can sue for a 5% for each month or part of a month that a The term "disregard" includes any careless, refund in court, but you must first file a timely return is late, but not more than 25%. reckless, or intentional disregard. claim with the IRS. If the IRS disallows your Fraud. If your failure to file is due to fraud, Adequate disclosure. You can avoid the claim or does not act on your claim within 6 the penalty is 15% for each month or part of a penalty for disregard of rules or regulations if months after you file it, you can then take your month that your return is late, up to a maximum you adequately disclose on your return a posi- claim to court. For information on the burden of of 75%. tion that has at least a reasonable basis. See proof in a court proceeding, see Publication 556. Disclosure statement, later. The IRS provides a fast method to move your Return over 60 days late. If you file your This exception will not apply to an item that is claim to court if: return more than 60 days after the due date or attributable to a tax shelter. In addition, it will not extended due date, the minimum penalty is the • You are filing a claim for a credit or refund smaller of $100 or 100% of the unpaid tax. apply if you fail to keep adequate books and based solely on contested income tax or records, or substantiate items properly. on estate tax or gift tax issues considered Exception. You will not have to pay the Substantial understatement of income tax. in your previously examined returns, and penalty if you show that you failed to file on time You understate your tax if the tax shown on your because of reasonable cause and not because • You want to take your case to court in- of willful neglect. return is less than the correct tax. The under- stead of appealing it within the IRS. statement is substantial if it is more than the larger of 10% of the correct tax or $5,000. How- Paying tax late. You will have to pay a When you file your claim with the IRS, you get ever, the amount of the understatement may be failure-to-pay penalty of 1/2 of 1% (.50%) of your the fast method by requesting in writing that your reduced to the extent the understatement is due unpaid taxes for each month, or part of a month, claim be immediately rejected. A notice of claim to: after the due date that the tax is not paid. This disallowance will then be promptly sent to you. penalty does not apply during the automatic 1) Substantial authority, or You have 2 years from the date of mailing of 4-month extension of time to file period if you the notice of disallowance to file a refund suit in 2) Adequate disclosure and a reasonable paid at least 90% of your actual tax liability on or the United States District Court having jurisdic- basis. before the due date of your return and pay the tion or in the United States Court of Federal balance when you file the return. If an item on your return is attributable to a tax Claims. The monthly rate of the failure-to-pay penalty shelter, there is no reduction for an adequate Interest on refund. If you receive a refund is half the usual rate (.25% instead of .50%) if an disclosure. However, there is a reduction for a because of your amended return, interest will be installment agreement is in effect for that month. position with substantial authority, but only if you paid on it from the due date of your original You must have filed your return by the due date reasonably believed that your tax treatment was return or the date you filed your original return, (including extensions) to qualify for this reduced more likely than not the proper treatment. whichever is later, to the date you filed the penalty. Substantial authority. Whether there is or amended return. However, if the refund is not If a notice of intent to levy is issued, the rate was substantial authority for the tax treatment of made within 45 days after you file the amended will increase to 1% at the start of the first month an item depends on the facts and circum- return, interest will be paid up to the date the beginning at least 10 days after the day that the stances. Some of the items that may be consid- refund is paid. notice is issued. If a notice and demand for ered are court opinions, Treasury regulations, immediate payment is issued, the rate will in- Reduced refund. Your refund may be re- revenue rulings, revenue procedures, and no- crease to 1% at the start of the first month duced by an additional tax liability that has been tices and announcements issued by the IRS and beginning after the day that the notice and de- assessed against you. published in the Internal Revenue Bulletin that mand is issued. Also, your refund may be reduced by involve the same or similar circumstances as This penalty cannot be more than 25% of yours. amounts you owe for past-due child support, your unpaid tax. You will not have to pay the debts to another federal agency, or for state tax. Disclosure statement. To adequately dis- penalty if you can show that you had a good If your spouse owes these debts, see Offset close the relevant facts about your tax treatment reason for not paying your tax on time. against debts, earlier, for the correct refund pro- of an item, use Form 8275, Disclosure State- cedures to follow. Combined penalties. If both the failure-to-file ment. You must also have a reasonable basis penalty and the failure-to-pay penalty (dis- for treating the item the way you did. Effect on state tax liability. If your return is cussed earlier) apply in any month, the 5% (or In cases of substantial understatement only, changed for any reason, it may affect your state 15%) failure-to-file penalty is reduced by the items that meet the requirements of Revenue income tax liability. This includes changes made failure-to-pay penalty. However, if you file your Procedure 2002 – 66 (or later update) are con- as a result of an examination of your return by return more than 60 days after the due date or sidered adequately disclosed on your return the IRS. Contact your state tax agency for more extended due date, the minimum penalty is the without filing Form 8275. information. smaller of $100 or 100% of the unpaid tax. Use Form 8275 – R. Regulation Disclosure Statement, to disclose items or positions con- Penalties Accuracy-related penalty. You may have to trary to regulations. pay an accuracy-related penalty if you underpay The law provides penalties for failure to file re- Reasonable cause. You will not have to your tax because: turns or pay taxes as required. pay a penalty if you show a good reason (rea- 1) You show negligence or disregard of the sonable cause) for the way you treated an item. rules or regulations, or You must also show that you acted in good faith. Civil Penalties 2) You substantially understate your income Frivolous return. You may have to pay a pen- If you do not file your return and pay your tax by tax. alty of $500 if you file a frivolous return. A frivo- the due date, you may have to pay a penalty. lous return is one that does not include enough The penalty is equal to 20% of the underpay- You may also have to pay a penalty if you information to figure the correct tax or that con- ment. The penalty will not be figured on any part substantially understate your tax, file a frivolous tains information clearly showing that the tax of an underpayment on which the fraud penalty return, or fail to supply your SSN or individual you reported is substantially incorrect. (discussed later) is charged. taxpayer identification number. If you provide You will have to pay the penalty if you filed fraudulent information on your return, you may Negligence or disregard. The term "negli- this kind of return because of a frivolous position have to pay a civil fraud penalty. gence" includes a failure to make a reasonable on your part or a desire to delay or interfere with attempt to comply with the tax law or to exercise the administration of federal income tax laws. Filing late. If you do not file your return by the ordinary and reasonable care in preparing a This includes altering or striking out the due date (including extensions), you may have return. Negligence also includes failure to keep preprinted language above the space provided to pay a failure-to-file penalty. The penalty is adequate books and records. You will not have for your signature. based on the tax not paid by the due date (with- to pay a negligence penalty if you have a rea- This penalty is added to any other penalty out regard to extensions). The penalty is usually sonable basis for a position you took. provided by law. Chapter 1 Filing Information Page 21 The penalty must be paid in full upon notice For example, if you have a bank account that You will have to pay a penalty of $250 for each and demand from IRS even if you protest the earns interest, you must give your SSN to the failure to report a tax shelter registration number penalty. bank. The number must be shown on the Form on your return. The penalty can be excused if 1099 – INT or other statement the bank sends you have a reasonable cause for not reporting Fraud. If there is any underpayment of tax on you. If you do not give the bank your SSN, you the number. your return due to fraud, a penalty of 75% of the will be subject to the $50 penalty. (You also may underpayment due to fraud will be added to your be subject to "backup" withholding of income tax. tax. See chapter 5.) Criminal Penalties Joint return. The fraud penalty on a joint You will not have to pay the penalty if you are return does not apply to a spouse unless some You may be subject to criminal prosecution able to show that the failure was due to reasona- part of the underpayment is due to the fraud of (brought to trial) for actions such as: ble cause and not willful neglect. that spouse. 1) Tax evasion, Failure to supply social security number. If Failure to furnish tax shelter registration number. A person who sells (or otherwise 2) Willful failure to file a return, supply infor- you do not include your SSN or the SSN of transfers) to you an interest in a tax shelter must mation, or pay any tax due, another person where required on a return, statement, or other document, you will be sub- give you the tax shelter registration number or 3) Fraud and false statements, or ject to a penalty of $50 for each failure. You will be subject to a $100 penalty. If you claim any deduction, credit, or other tax benefit because of 4) Preparing and filing a fraudulent return. also be subject to a penalty of $50 if you do not give your SSN to another person when it is the tax shelter, you must attach Form 8271, required on a return, statement, or other docu- Investor Reporting of Tax Shelter Registration ment. Number, to your return to report this number. Page 22 Chapter 1 Filing Information each other in the next tax year, you and your spouse must file as married individuals. Single 2. Annulled marriages. If you obtain a court decree of annulment, which holds that no valid Your filing status is single if, on the last day of marriage ever existed, you are considered un- the year, you are unmarried or legally separated married even if you filed joint returns for earlier from your spouse under a divorce or separate maintenance decree, and you do not qualify for Filing Status years. You must file amended returns (Form 1040X, Amended U.S. Individual Income Tax another filing status. To determine your marital status on the last day of the year, see Marital Return) claiming single or head of household Status, earlier. status for all tax years affected by the annulment Your filing status may be single if you were Introduction that are not closed by the statute of limitations widowed before January 1, 2003, and did not for filing a tax return. The statute of limitations This chapter helps you determine which filing remarry in 2003. However, you might be able to generally does not expire until 3 years after your use another filing status that will give you a lower status to use. There are five filing statuses: original return was filed. tax. See Head of Household and Qualifying • Single, Head of household or qualifying widow(er) Widow(er) With Dependent Child to see if you qualify. • Married Filing Jointly, with dependent child. If you are considered unmarried, you may be able to file as a head of • Married Filing Separately, household or as a qualifying widow(er) with a How to file. You can file Form 1040EZ (if you • Head of Household, and dependent child. See Head of Household and have no dependents, are under 65 and not blind, Qualifying Widow(er) With Dependent Child to and meet other requirements), Form 1040A, or • Qualifying Widow(er) With Dependent see if you qualify. Form 1040. If you file Form 1040A or Form Child. 1040, show your filing status as single by check- Married persons. If you are considered mar- ing the box on line 1. Use the Single column of If more than one filing status applies to ried for the whole year, you and your spouse can the Tax Table or Schedule X of the Tax Rate TIP you, choose the one that will give you file a joint return, or you can file separate re- Schedules to figure your tax. the lowest tax. turns. You must determine your filing status before Considered married. You are considered you can determine your filing requirements married for the whole year if on the last day of (chapter 1), standard deduction (chapter 22), your tax year you and your spouse meet any one Married Filing Jointly and correct tax (chapter 32). You also use your of the following tests. filing status in determining whether you are eligi- You can choose married filing jointly as your ble to claim certain deductions and credits. 1) You are married and living together as filing status if you are married and both you and your spouse agree to file a joint return. On a joint husband and wife. return, you report your combined income and Useful Items 2) You are living together in a common law deduct your combined allowable expenses. You You may want to see: marriage that is recognized in the state can file a joint return even if one of you had no where you now live or in the state where income or deductions. Publication the common law marriage began. If you and your spouse decide to file a joint ❏ 501 Exemptions, Standard Deduction, return, your tax may be lower than your com- 3) You are married and living apart, but not and Filing Information bined tax for the other filing statuses. Also, your legally separated under a decree of di- standard deduction (if you do not itemize deduc- ❏ 519 U.S. Tax Guide for Aliens vorce or separate maintenance. tions) may be higher, and you may qualify for tax ❏ 555 Community Property 4) You are separated under an interlocutory benefits that do not apply to other filing statuses. (not final) decree of divorce. For purposes If you and your spouse each have in- of filing a joint return, you are not consid- TIP come, you may want to figure your tax ered divorced. both on a joint return and on separate returns (using the filing status of married filing Marital Status Spouse died. If your spouse died during the separately). Choose the method that gives the year, you are considered married for the whole two of you the lower combined tax. In general, your filing status depends on year for filing status purposes. whether you are considered unmarried or mar- If you did not remarry before the end of the ried. A marriage means only a legal union be- How to file. If you file as married filing jointly, tax year, you can file a joint return for yourself tween a man and a woman as husband and you can use Form 1040 or Form 1040A. If you and your deceased spouse. For the next 2 wife. have no dependents, are under 65 and not blind, years, you may be entitled to the special benefits and meet other requirements, you can file Form described later under Qualifying Widow(er) With 1040EZ. If you file Form 1040 or Form 1040A, Unmarried persons. You are considered un- Dependent Child. show this filing status by checking the box on married for the whole year if, on the last day of If you remarried before the end of the tax line 2. Use the Married filing jointly column of the your tax year, you are unmarried or legally sepa- year, you can file a joint return with your new Tax Table or Schedule Y – 1 of the Tax Rate rated from your spouse under a divorce or a spouse. Your deceased spouse's filing status is Schedules to figure your tax. separate maintenance decree. State law gov- married filing separately for that year. erns whether you are married or legally sepa- Married persons living apart. If you live Spouse died during the year. If your spouse rated under a divorce or separate maintenance decree. apart from your spouse and meet certain tests, died during the year, you are considered mar- you may be considered unmarried. If this ap- ried for the whole year and can choose married Divorced persons. If you are divorced plies to you, you can file as head of household filing jointly as your filing status. See Spouse under a final decree by the last day of the year, even though you are not divorced or legally died, earlier, for more information. you are considered unmarried for the whole separated. If you qualify to file as head of house- year. hold instead of as married filing separately, your Divorced persons. If you are divorced under Divorce and remarriage. If you obtain a standard deduction will be higher. Also, your tax a final decree by the last day of the year, you are divorce in one year for the sole purpose of filing may be lower, and you may be able to claim the considered unmarried for the whole year and tax returns as unmarried individuals, and at the earned income credit. See Head of Household, you cannot choose married filing jointly as your time of divorce you intended to and did remarry later. filing status. Chapter 2 Filing Status Page 23 incompetent, you can sign the return for your combined tax. However, you will generally pay Filing a Joint Return spouse as guardian. more combined tax on separate returns than Both you and your spouse must include all of you would on a joint return for the reasons listed Spouse in combat zone. If your spouse is your income, exemptions, and deductions on under Special Rules, later. unable to sign the return because he or she is your joint return. serving in a combat zone (such as the Persian How to file. If you file a separate return, you Gulf Area, Yugoslavia, or Afghanistan), or a generally report only your own income, exemp- Accounting period. Both of you must use the qualified hazardous duty area (Bosnia and Her- tions, credits, and deductions. You can claim an same accounting period, but you can use differ- zegovina, Croatia, and Macedonia), and you do exemption for your spouse if your spouse had no ent accounting methods. See Accounting Peri- not have a power of attorney or other statement, gross income and was not a dependent of an- ods and Accounting Methods in chapter 1. you can sign for your spouse. Attach a signed other person. However, if your spouse had any Joint responsibility. Both of you may be held statement to your return that explains that your gross income, or was the dependent of some- responsible, jointly and individually, for the tax spouse is serving in a combat zone. For more one else, you cannot claim an exemption for him and any interest or penalty due on your joint information on special tax rules for persons who or her on your separate return. return. One spouse may be held responsible for are serving in a combat zone, or who are in If you file as married filing separately, you all the tax due even if all the income was earned missing status as a result of serving in a combat can use Form 1040A or Form 1040. Select this by the other spouse. zone, get Publication 3, Armed Forces' Tax filing status by checking the box on line 3 of Guide. either form. You must also write your spouse's Divorced taxpayer. You may be held jointly and individually responsible for any tax, interest, Other reasons spouse cannot sign. If social security number and full name in the and penalties due on a joint return filed before your spouse cannot sign the joint return for any spaces provided. Use the Married filing sepa- your divorce. This responsibility may apply even other reason, you can sign for your spouse only rately column of the Tax Table or Schedule Y – 2 if your divorce decree states that your former if you are given a valid power of attorney (a legal of the Tax Rate Schedules to figure your tax. spouse will be responsible for any amounts due document giving you permission to act for your on previously filed joint returns. spouse). Attach the power of attorney (or a copy Special Rules of it) to your tax return. You can use Form 2848, Relief from joint liability. In some cases, Power of Attorney and Declaration of Represen- If you choose married filing separately as your one spouse may be relieved of joint liability for tative. filing status, the following special rules apply. tax, interest, and penalties on a joint return for Because of these special rules, you will usually items of the other spouse that were incorrectly Nonresident alien or dual-status alien. A pay more tax on a separate return than if you reported on the joint return. You can ask for joint return generally cannot be filed if either used another filing status that you qualify for. relief no matter how small the liability. spouse is a nonresident alien at any time during There are three types of relief available. the tax year. However, if one spouse was a nonresident alien or dual-status alien who was 1) Your tax rate generally will be higher than 1) Innocent spouse relief, which applies to married to a U.S. citizen or resident at the end of on a joint return. all joint filers. the year, the spouses can choose to file a joint 2) Your exemption amount for figuring the al- 2) Separation of liability, which applies to return. If you do file a joint return, you and your ternative minimum tax will be half that al- joint filers who are divorced, widowed, le- spouse are both treated as U.S. residents for the lowed a joint return filer. gally separated, or have not lived together entire tax year. For information on this choice, for the 12 months ending the date election see chapter 1 of Publication 519. 3) You cannot take the credit for child and of this relief is filed. dependent care expenses in most cases, and the amount that you can exclude from 3) Equitable relief, which applies to all joint income under an employer's dependent filers who do not qualify for innocent spouse relief or separation of liability. Married Filing care assistance program is limited to $2,500 (instead of $5,000 if you filed a You must file Form 8857, Request for Inno- cent Spouse Relief, to request any of these Separately joint return). For more information about these expenses, the credit, and the exclu- kinds of relief. Publication 971, Innocent Spouse sion, see chapter 34. You can choose married filing separately as Relief, explains these kinds of relief and who your filing status if you are married. This filing 4) You cannot take the earned income credit. may qualify for them. status may benefit you if you want to be respon- 5) You cannot take the exclusion or credit for Signing a joint return. For a return to be sible only for your own tax or if it results in less adoption expenses in most cases. considered a joint return, both husband and wife tax than filing a joint return. must generally sign the return. If your spouse If you and your spouse do not agree to file a 6) You cannot take the education credits (the died before signing the return, see Signing the joint return, you may have to use this filing sta- Hope credit and the lifetime learning return in chapter 4. tus. credit), the deduction for student loan in- You may be able to choose head of house- terest, or the tuition and fees deduction. Spouse away from home. If your spouse is hold filing status if you live apart from your 7) You cannot exclude any interest income away from home, you should prepare the return, spouse, meet certain tests, and are considered from qualified U.S. savings bonds that you sign it, and send it to your spouse to sign so that unmarried (defined later, under Head of House- used for higher education expenses. it can be filed on time. hold). This can apply to you even if you are not Injury or disease prevents signing. If your divorced or legally separated. If you qualify to file 8) If you lived with your spouse at any time spouse cannot sign because of disease or injury as head of household, instead of as married during the tax year: and tells you to sign, you can sign your spouse's filing separately, your tax may be lower, you may a) You cannot claim the credit for the eld- name in the proper space on the return followed be able to claim the earned income credit and erly or the disabled. by the words "By (your name), Husband (or certain other credits, and your standard deduc- Wife)." Be sure to also sign in the space pro- tion will be higher. The head of household filing b) You will have to include in income more vided for your signature. Attach a dated state- status allows you to choose the standard deduc- (up to 85%) of your social security ben- ment, signed by you, to the return. The tion even if your spouse chooses to itemize efits or equivalent railroad retirement statement should include the form number of the deductions. See Head of Household, later, for benefits you received, and return you are filing, the tax year, the reason more information. c) You cannot roll over amounts from a your spouse cannot sign, and a statement that Unless you are required to file sepa- traditional IRA into a Roth IRA. your spouse has agreed to your signing for him TIP rately, you should figure your tax both or her. ways (on a joint return and on separate 9) The following deductions and credits are Signing as guardian of spouse. If you are returns). This way you can make sure you are reduced at income levels that are half the guardian of your spouse who is mentally using the filing status that results in the lowest those for a joint return: Page 24 Chapter 2 Filing Status a) The child tax credit, Exception. A personal representative for a 4) Your home was the main home of your decedent can change from a joint return elected child, stepchild, or adopted child for more b) The retirement savings contributions by the surviving spouse to a separate return for than half the year or was the main home of credit, the decedent. The personal representative has your foster child for the entire year. (See c) Itemized deductions, and 1 year from the due date of the return to make Home of qualifying person, under Qualify- the change. See chapter 4 for more information ing Person, later, for rules applying to a d) The deduction for personal exemptions. child's birth, death, or temporary absence on filing a return for a decedent. during the year.) 10) Your capital loss deduction limit is $1,500 (instead of $3,000 if you filed a joint re- 5) You must be able to claim an exemption turn). for the child. However, you can still meet this test if you cannot claim the exemption 11) If your spouse itemizes deductions, you Head of Household only because the noncustodial parent is cannot claim the standard deduction. If allowed to claim the exemption for the you can claim the standard deduction, it is You may be able to file as head of household if child. See Exception under Support Test half the amount allowed on a joint return. you meet all of the following requirements. for Child of Divorced or Separated Parents in chapter 3 for situations where the non- Individual retirement arrangements (IRAs). 1) You are unmarried or considered unmar- custodial parent is allowed to claim the ex- You may not be able to deduct all or part of your ried on the last day of the year. emption for the child. The general rules for contributions to a traditional IRA if you or your 2) You paid more than half the cost of keep- claiming an exemption for a dependent are spouse were covered by an employee retire- ing up a home for the year. explained in chapter 3. ment plan at work during the year. Your deduc- tion is reduced or eliminated if your income is 3) A qualifying person lived with you in the If you were considered married for part more than a certain amount. This amount is lower for married individuals who file separately home for more than half the year (except ! of the year and lived in a community for temporary absences, such as school). CAUTION property state (listed earlier under Mar- and lived together at any time during the year. However, your dependent parent does not ried Filing Separately), special rules may apply For more information, see How Much Can I have to live with you. See Special rule for in determining your income and expenses. See Deduct in chapter 18. parent, later, under Qualifying Person. A Publication 555 for more information. Rental activity losses. If you actively partici- foster child must live with you all year. pated in a passive rental real estate activity that Nonresident alien spouse. You are consid- Also, see Table 2 – 1, later. ered unmarried for head of household purposes produced a loss, you generally can deduct the loss from your nonpassive income, up to if your spouse was a nonresident alien at any If you qualify to file as head of house- time during the year and you do not choose to $25,000. This is called a special allowance. TIP hold, your tax rate usually will be lower treat your nonresident spouse as a resident However, married persons filing separate re- than the rates for single or married fil- alien. However, your spouse is not a qualifying turns who lived together at any time during the ing separately. You will also receive a higher person for head of household purposes. You year cannot claim this special allowance. Mar- standard deduction than if you file as single or must have another qualifying person and meet ried persons filing separate returns who lived married filing separately. the other tests to be eligible to file as a head of apart at all times during the year are each al- lowed a $12,500 maximum special allowance household. for losses from passive real estate activities. Kidnapped children. A child may qualify you Earned income credit. Even if you are con- See Limits on Rental Losses in chapter 10. sidered unmarried for head of household pur- to file as head of household even if the child has Community property states. If you live in Ari- been kidnapped. For more information, see poses because you are married to a nonresident zona, California, Idaho, Louisiana, Nevada, Publication 501. alien, you are still considered married for pur- New Mexico, Texas, Washington, or Wisconsin poses of the earned income credit (unless you and file separately, your income may be consid- meet the five tests listed earlier). You are not ered separate income or community income for How to file. If you file as head of household, entitled to the credit unless you file a joint return income tax purposes. See Publication 555. you can use either Form 1040A or Form 1040. with your spouse and meet other qualifications. Indicate your choice of this filing status by See chapter 38 for more information. checking the box on line 4 of either form. Use the Choice to treat spouse as resident. You Joint Return After Head of a household column of the Tax Table or are considered married if you choose to treat Separate Returns Schedule Z of the Tax Rate Schedules to figure your spouse as a resident alien. your tax. You can change your filing status by filing an amended return using Form 1040X. Keeping Up a Home If you or your spouse (or both of you) file a Considered Unmarried separate return, you generally can change to a To qualify for head of household status, you You are considered unmarried on the last day of must pay more than half of the cost of keeping joint return any time within 3 years from the due the tax year if you meet all of the following tests. up a home for the year. You can determine date of the separate return or returns. This does not include any extensions. A separate return whether you paid more than half of the cost of 1) You file a separate return, defined earlier keeping up a home by using the Cost of Keeping includes a return filed by you or your spouse under Joint Return After Separate Returns. Up a Home worksheet, shown on the next page. claiming married filing separately, single, or head of household filing status. 2) You paid more than half the cost of keep- ing up your home for the tax year. Separate Returns After 3) Your spouse did not live in your home dur- ing the last 6 months of the tax year. Your Joint Return spouse is considered to live in your home Once you file a joint return, you cannot choose even if he or she is temporarily absent due to file separate returns for that year after the due to special circumstances. See Temporary date of the return. absences, under Qualifying Person, later. Chapter 2 Filing Status Page 25 Cost of Keeping Up a Home Costs you include. Include in the cost of up- mother. You are keeping up a main home for keep expenses such as rent, mortgage interest, your father or mother if you pay more than half real estate taxes, insurance on the home, re- the cost of keeping your parent in a rest home or Amount pairs, utilities, and food eaten in the home. home for the elderly. You Total Costs you do not include. Do not include in Temporary absences. You and your quali- Paid Cost the cost of upkeep expenses such as clothing, fying person are considered to live together Property taxes $ $ education, medical treatment, vacations, life in- even if one or both of you are temporarily absent Mortgage interest expense surance, or transportation. Also, do not include from your home due to special circumstances Rent the rental value of a home you own or the value such as illness, education, business, vacation, Utility charges of your services or those of a member of your or military service. It must be reasonable to Upkeep and repairs household. assume that the absent person will return to the Property insurance household after the temporary absence. You must continue to keep up the home during the Food consumed on the premises Qualifying Person absence. Other household expenses See Table 2 – 1 to see who is a qualifying per- Death or birth. You may be eligible to file as Totals $ $ son. head of household if the individual who qualifies Any person not described in Table 2 – 1 is not you for this filing status is born or dies during the Minus total amount you ( ) a qualifying person. year. You must have provided more than half of paid the cost of keeping up a home that was the Home of qualifying person. Generally, the individual's main home for more than half the Amount others paid $ qualifying person must live with you for more year or, if less, the period during which the than half of the year. individual lived. Special rule for parent. You may be eligi- If the total amount you paid is more than the amount ble to file as head of household even if the Example. You are unmarried. Your mother, others paid, you meet the requirement of paying more than half the cost of keeping up the home. parent for whom you can claim an exemption for whom you can claim an exemption, lived in does not live with you. You must pay more than an apartment by herself. She died on Septem- half the cost of keeping up a home that was the ber 2. The cost of the upkeep of her apartment main home for the entire year for your father or for the year until her death was $6,000. You paid Table 2 –1. Who Is a Qualifying Person for Filing as Head of Household?1 IF the person is your . . . AND . . . THEN that person is . . . parent, grandparent, brother, sister, you can claim an exemption for him or a qualifying person. stepbrother, stepsister, stepmother, her2 stepfather, mother-in-law, father-in-law, half brother, half sister, brother-in-law, sister-in-law, you cannot claim an exemption for him or NOT a qualifying person. son-in-law, or daughter-in-law her uncle, aunt, nephew, or niece he or she is related to you by blood and a qualifying person. you can claim an exemption for him or her2, 3 he or she is not related to you by blood3 NOT a qualifying person. you cannot claim an exemption for him or her child, grandchild, stepchild, or he or she is single a qualifying person.4 adopted child he or she is married, and you can claim an a qualifying person. exemption for him or her2 he or she is married, and you cannot claim NOT a qualifying person.5 an exemption for him or her foster child6 the child lived with you all year, and you a qualifying person. can claim an exemption for him or her2 the child lived with you all year, and you NOT a qualifying person. cannot claim an exemption for him or her 1A person cannot qualify more than one taxpayer to use the head of household filing status for the year. 2If you can claim an exemption for a person only because of a multiple support agreement, that person cannot be a qualifying person. See Multiple Support Agreement in chapter 3. 3You are related by blood to an uncle or aunt if he or she is the brother or sister of your mother or father. You are related by blood to a nephew or niece if he or she is the child of your brother or sister. 4This child is a qualifying person even if you cannot claim an exemption for the child. 5This child is a qualifying person if you could claim an exemption for the child except that the child's other parent claims the exemption under the special rules for a noncustodial parent discussed under Support Test for Child of Divorced or Separated Parents in chapter 3. 6The term "foster child" is defined under Exemptions for Dependents in chapter 3. Page 26 Chapter 2 Filing Status $4,000 and your brother paid $2,000. Your tion amount (if you do not itemize deductions). you and that child for the entire year, ex- brother made no other payments toward your This status does not entitle you to file a joint cept for temporary absences. See Tempo- mother's support. Your mother had no income. return. rary absences and Keeping Up a Home, Because you paid more than half the cost of discussed earlier under Head of House- keeping up your mother's apartment from Janu- How to file. If you file as qualifying widow(er) hold. ary 1 until her death, and you can claim an with dependent child, you can use either Form exemption for her, you can file as a head of 1040A or Form 1040. Indicate your filing status As mentioned earlier, this filing status household. by checking the box on line 5 of either form. Use the Married filing jointly column of the Tax Table ! is only available for 2 years following CAUTION the year of death of your spouse. or Schedule Y – 1 of the Tax Rate Schedules to figure your tax. Example. John Reed's wife died in 2001. Qualifying Widow(er) Eligibility rules. You are eligible to file your John has not remarried. During 2002 and 2003, With Dependent Child 2003 return as a qualifying widow(er) with de- pendent child if you meet all of the following he continued to keep up a home for himself and his child (for whom he can claim an exemption). If your spouse died in 2003, you can use married tests. For 2001 he was entitled to file a joint return for filing jointly as your filing status for 2003 if you himself and his deceased wife. For 2002 and 1) You were entitled to file a joint return with 2003 he can file as qualifying widower with a otherwise qualify to use that status. The year of your spouse for the year your spouse died. dependent child. After 2003 he can file as head death is the last year for which you can file jointly It does not matter whether you actually with your deceased spouse. See Married Filing of household if he qualifies. filed a joint return. Jointly, earlier. You may be eligible to use qualifying 2) You did not remarry before the end of Death or birth. You may be eligible to file as a widow(er) with dependent child as your filing 2003. status for 2 years following the year of death of qualifying widow(er) with dependent child if the 3) You have a child, stepchild, adopted child, child who qualifies you for this filing status is your spouse. For example, if your spouse died in or foster child for whom you can claim an born or dies during the year. You must have 2002, and you have not remarried, you may be exemption. provided more than half of the cost of keeping up able to use this filing status for 2003 and 2004. This filing status entitles you to use joint 4) You paid more than half the cost of keep- a home that was the child's main home during return tax rates and the highest standard deduc- ing up a home that is the main home for the entire part of the year he or she was alive. Chapter 2 Filing Status Page 27 or line 39 (Form 1040) by multiplying the total Death of spouse. If your spouse died during number of exemptions shown in the box on line the year, you can generally claim your spouse's 3. 6d by $3,050. If your adjusted gross income is more than $104,625, see Phaseout of Exemp- exemption under the rules just explained under Joint return and Separate return. tions, later. If you remarried during the year, you cannot take an exemption for your deceased spouse. Personal Useful Items You may want to see: 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 Exemptions and Publication both the final separate return of your deceased spouse and the separate return of your new ❏ 501 Exemptions, Standard Deduction, Dependents and Filing Information 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. Form (and Instructions) Important Changes ❏ 2120 Multiple Support Declaration Divorced or separated spouse. If you ob- ❏ 8332 Release of Claim to Exemption for tained a final decree of divorce or separate Exemption amount. The amount you can de- Child of Divorced or Separated maintenance by the end of the year, you cannot duct for each exemption has increased from Parents take your former spouse's exemption. This rule $3,000 in 2002 to $3,050 in 2003. applies even if you provided all of your former spouse's support. Exemption phaseout. You will lose all or part of the benefit of your exemptions if your adjusted Exemptions for gross income is above a certain amount. The Exemptions Dependents amount at which this phaseout begins depends on your filing status. For 2003, the phaseout There are two types of exemptions: personal begins at $104,625 for married persons filing exemptions and exemptions for dependents. You are allowed one exemption for each person separately, $139,500 for unmarried individuals, While each is worth the same amount ($3,050 you can claim as a dependent. $174,400 for heads of household, and $209,250 for 2003), different rules apply to each type. To claim the exemption for a dependent, you for married persons filing jointly. See Phaseout must meet all five of the dependency tests, of Exemptions, later. discussed later. You can claim an exemption for Personal Exemptions your dependent even if your dependent files a return. You are generally allowed one exemption for yourself and, if you are married, one exemption If you are entitled to claim an exemp- Introduction for your spouse. These are called personal ex- ! tion for a dependent, that dependent emptions. CAUTION cannot claim his or her own personal This chapter discusses exemptions. The follow- exemption. ing topics will be explained. • Personal exemptions — You generally Your Own Exemption Kidnapped children. You may be eligible to can take one for yourself and, if you are claim the exemption for a child even if the child married, one for your spouse. You can take one exemption for yourself unless has been kidnapped. For more information, see you can be claimed as a dependent by another • Exemptions for dependents — You must taxpayer. Publication 501. meet five exemption tests for each exemp- tion you claim. If you are entitled to claim Child born alive. If your child was born alive Single persons. If another taxpayer is entitled an exemption for a dependent, that depen- during the year, and the dependency tests are to claim you as a dependent, you cannot take an dent cannot claim a personal exemption met, you can claim the exemption. This is true exemption for yourself. This is true even if the on his or her own tax return. even if the child lived only for a moment. State or other taxpayer does not actually claim your ex- local law must treat the child as having been • Phaseout of exemptions — You get less emption. born alive. There must be proof of a live birth of a deduction when your adjusted gross shown by an official document, such as a birth income goes above a certain amount. Married persons. If you file a joint return, you certificate. can take your own exemption. If you file a sepa- • Social security number (SSN) requirement rate return, you can take your own exemption for dependents — You must list the social Stillborn child. You cannot claim an exemp- only if another taxpayer is not entitled to claim security number of any dependent for tion for a stillborn child. you as a dependent. whom you claim an exemption. Death of dependent. If your dependent died Deduction. Exemptions reduce your taxable Your Spouse's Exemption during the year and otherwise met the depen- income. Generally, you can deduct $3,050 for dency tests, you can claim the exemption for each exemption you claim in 2003. But, you may Your spouse is never considered your depen- your dependent. lose the benefit of part or all of your exemption if dent. You may be able to take one exemption for your adjusted gross income is above a certain your spouse only because you are married. Example. Your dependent mother died on amount. See Phaseout of Exemptions, later. January 15. The five dependency tests are met. Joint return. On a joint return you can claim You can claim the exemption for her on your How you claim an exemption. How you one exemption for yourself and one for your return. claim an exemption on your tax return depends spouse. on which form you file. Housekeepers, maids, or servants. If these If you file Form 1040EZ, the exemption Separate return. If you file a separate return, people work for you, you cannot claim exemp- amount is combined with the standard deduction you can claim the exemption for your spouse tions for them. amount and entered on line 5. only if your spouse had no gross income and If you file Form 1040A or Form 1040, follow was not the dependent of another taxpayer. This Child tax credit. You may be entitled to a child the instructions for the form. The total number of is true even if the other taxpayer does not actu- tax credit for each of your qualifying children for exemptions you can claim is the total in the box ally claim your spouse's exemption. This is also whom you can claim an exemption. For more on line 6d. Also complete line 26 (Form 1040A) true if your spouse is a nonresident alien. information, see chapter 36. Page 28 Chapter 3 Personal Exemptions and Dependents Dependency Tests • A son or daughter of your brother or sister. tests are met, you can take the exemption if your home is the child's main home and the child is a • Your father-in-law, mother-in-law, member of your household for your entire tax The following five tests must be met for you to son-in-law, daughter-in-law, claim an exemption for a dependent. year. brother-in-law, or sister-in-law. Foreign students' place of residence. For- 1) Member of Household or Relationship Any of these relationships that were established eign students brought to this country under a Test. by marriage are not ended by death or divorce. qualified international education exchange pro- 2) Citizen or Resident Test. gram and placed in American homes for a tem- Adoption. Even if your adoption of a child is porary period generally are not U.S. residents 3) Joint Return Test. not yet final, the child is considered to be your and do not meet the citizen or resident test. You child if he or she was placed with you for legal 4) Gross Income Test. cannot claim exemptions for them. However, if adoption by an authorized placement agency. you provided a home for a foreign student, you 5) Support Test. The child also must be a member of your house- may be able to take a charitable contribution hold, but does not have to be a member of your deduction. See Expenses Paid for Student Liv- household for the entire year. ing With You in chapter 26. Member of Household If the child was not placed with you by an authorized placement agency, the child will or Relationship Test meet this test only if he or she was a member of Joint Return Test To meet this test, a person must either: your household for your entire tax year. Even if the other dependency tests are met, you Authorized placement agency. An author- are generally not allowed an exemption for your 1) Live with you for the entire year as a mem- ized placement agency includes any person or ber of your household, or dependent if he or she files a joint return. court authorized by state law to place children 2) Be related to you in one of the ways listed for legal adoption. Example. You supported your daughter for later under Relatives who do not have to the entire year while her husband was in the Foster child. A foster child must live with you live with you. Armed Forces. The couple files a joint return. as a member of your household for the entire If at any time during the year the person was year to qualify as your dependent. For this test, a Even though all the other tests are met, you your spouse, that person cannot be your depen- foster child is one who is in your care that you cannot take an exemption for your daughter. dent. However, see Personal Exemptions, ear- care for as your own child. It does not matter Exception. The joint return test does not apply lier. how the child became a member of the house- if a joint return is filed by the dependent and his hold. or her spouse merely as a claim for refund and Temporary absences. A person lives with you as a member of your household even if Cousin. You can claim an exemption for your no tax liability would exist for either spouse on either (or both) of you are temporarily absent cousin only if he or she lives with you as a separate returns. due to special circumstances. Temporary ab- member of your household for the entire year. A sences due to special circumstances include Example. Your son and his wife each had cousin is a descendant of a brother or sister of absences because of illness, education, busi- less than $3,000 of wages and no unearned your father or mother. ness, vacation, or military service. income. Neither is required to file a tax return. If the person is placed in a nursing home for Joint return. If you file a joint return, you do Taxes were taken out of their pay, so they file a an indefinite period of time to receive constant not need to show that a person is related to both joint return to get a refund. You are allowed to medical care, the absence is considered tempo- you and your spouse. You also do not need to take exemptions for your son and rary. show that a person is related to the spouse who daughter-in-law if the other dependency tests provides support. are met, even though they file a joint return. Death or birth. A person who died during the For example, your spouse's uncle who re- year, but was a member of your household until ceives more than half his support from you may be your dependent, even though he does not Gross Income Test death, will meet the member of household test. The same is true for a child who was born during live with you. However, if you and your spouse Generally, you cannot take an exemption for a the year and was a member of your household file separate returns, your spouse's uncle can dependent if that person had gross income of for the rest of the year. The test is also met if a be your dependent only if he is a member of your $3,050 or more for 2003. This test does not child would have been a member except for any household and lives with you for your entire tax apply if the person is your child and is either: required hospital stay following birth. year. 1) Under age 19 at the end of the year, or Local law violated. A person does not meet the member of household test if at any time Citizen or Resident Test 2) A student under age 24 at the end of the during your tax year the relationship between year. You cannot claim an exemption for a dependent you and that person violates local law. The exceptions for children under age 19 and unless that person is a U.S. citizen or resident, or a resident of Canada or Mexico, for some part students under age 24 are discussed in detail Relatives who do not have to live with you. later. A person related to you in any of the following of the calendar year in which your tax year begins. However, there is an exception for cer- If you file on a fiscal year basis, the gross ways does not have to live with you for the entire income test applies to the calendar year in which year as a member of your household to meet tain adopted children, as explained next. your fiscal year begins. this test. Children's place of residence. Children usu- Gross income defined. All income in the form • Your child, grandchild, great grandchild, ally are citizens or residents of the country of of money, property, and services that is not etc. (a legally adopted child is considered their parents. exempt from tax is gross income. your child). If you were a U.S. citizen when your child In a manufacturing, merchandising, or min- was born, the child may be a U.S. citizen al- • Your stepchild. though the other parent was a nonresident alien ing business, gross income is the total net sales minus the cost of goods sold, plus any miscella- • Your brother, sister, half brother, half sis- and the child was born in a foreign country. If so, neous income from the business. ter, stepbrother, or stepsister. and the other dependency tests are met, you Gross receipts from rental property are gross can take the exemption. It does not matter if the • Your parent, grandparent, or other direct child lives abroad with the nonresident alien income. Do not deduct taxes, repairs, etc., to ancestor, but not foster parent. determine the gross income from rental prop- parent. erty. • Your stepfather or stepmother. Adopted child. If you are a U.S. citizen who Gross income includes a partner's share of • A brother or sister of your father or has legally adopted a child who is not a U.S. the gross, not a share of the net, partnership mother. citizen or resident, and the other dependency income. Chapter 3 Personal Exemptions and Dependents Page 29 Gross income also includes all unemploy- high schools, colleges, universities, and techni- dependent's support for the calendar year in ment compensation and certain scholarship and cal, trade, and mechanical schools. It does not which your fiscal year begins. fellowship grants. Scholarships received by de- include on-the-job training courses, correspond- Armed Forces dependency allotments. The gree candidates that are used for tuition, fees, ence schools, and night schools. part of the allotment contributed by the govern- supplies, books, and equipment required for ment and the part taken out of your military pay particular courses are not included in gross in- Example. James, 22, attends college as a are both considered provided by you in figuring come. For more information about scholarships, full-time student. During the summer, James whether you provide more than half of the sup- see chapter 13. earned $4,000. If the other dependency tests port. If your allotment is used to support persons Tax-exempt income, such as certain social are met, his parents can take the exemption for other than those you name, you can take the security payments, is not included in gross in- James. exemptions for them if they otherwise qualify. come. Vocational high school students. People Disabled dependents. For this gross in- who work on "co-op" jobs in private industry as a Example. You are in the Armed Forces. come test, gross income does not include in- part of the school's prescribed course of class- You authorize an allotment for your widowed come received by a permanently and totally room and practical training are considered mother that she uses to support herself and your disabled individual for services performed at a full-time students. sister. If the allotment provides more than half of sheltered workshop. The availability of medical their support, you can take an exemption for Night school. Your child is not a full-time care must be the main reason the individual is at each of them, if they otherwise qualify, even student while attending school only at night. the workshop. Also, the income must come though you authorize the allotment only for your However, full-time attendance at a school can solely from activities at the workshop that are mother. include some attendance at night as part of a incident to this medical care. A sheltered work- full-time course of study. Tax-exempt military quarters allowances. shop is a school operated by certain tax-exempt These allowances are treated the same way as organizations, or by a state, a U.S. possession, dependency allotments in figuring support. The a political subdivision of a state or possession, Support Test allotment of pay and the tax-exempt basic allow- the United States, or the District of Columbia, Generally, you must provide more than half of a ance for quarters are both considered as pro- that provides special instruction or training de- person's total support during the calendar year vided by you for support. signed to alleviate the disability of the individual. to meet the support test. However, there are Tax-exempt income. In figuring a person's Child defined. For purposes of the gross in- special rules that apply in the following two situa- total support, include tax-exempt income, sav- come test, your child is your son, stepson, tions. ings, and borrowed amounts used to support daughter, stepdaughter, a legally adopted child, that person. Tax-exempt income includes cer- or a child who was placed with you by an author- 1) Two or more persons provide support, but tain social security benefits, welfare benefits, ized placement agency for your legal adoption. no one person provides more than half of nontaxable life insurance proceeds, Armed A foster child who was a member of your house- a person's total support. See Multiple Sup- Forces family allotments, nontaxable pensions, hold for your entire tax year is also considered port Agreement, later. and tax-exempt interest. your child. 2) The person supported is the child of di- vorced or separated parents. See Support Example 1. You provide $4,000 toward Child under age 19. If your child is under 19 at Test for Child of Divorced or Separated your mother's support during the year. She has the end of the year, the gross income test does Parents, later. earned income of $600, nontaxable social se- not apply. Your child can have any amount of curity benefit payments of $4,800, and tax-ex- income and you can still claim an exemption if How to determine if test is met. You figure empt interest of $200. She uses all these for her the other dependency tests, including the sup- whether you have provided more than half of a support. You cannot claim an exemption for your port test, are met. person's total support by comparing the amount mother because the $4,000 you provide is not you contributed to that person's support with the more than half of her total support of $9,600. Example. Marie, 18, earned $4,000. Her fa- entire amount of support that person received ther provided more than half her support. Be- from all sources. This includes support the per- Example 2. Your daughter takes out a stu- cause Marie is under 19, the gross income test son provided from his or her own funds. dent loan of $2,500 and uses it to pay her col- does not apply. If the other dependency tests You may find Table 3 – 1 helpful in figuring lege tuition. She is personally responsible for the were met, Marie's father can claim an exemption whether you provided more than half of a loan. You provide $2,000 toward her total sup- for her. person's support. port. You cannot claim an exemption for your Student under age 24. The gross income test daughter because you provide less than half of Person's own funds not used for support. does not apply if your child is a student who is her support. A person's own funds are not support unless under age 24 at the end of the calendar year. they are actually spent for support. Social security benefit payments. If a The other dependency tests must still be met. husband and wife each receive payments that Student defined. To qualify as a student, Example. Your mother received $2,400 in are paid by one check made out to both of them, your child must be, during some part of each of 5 social security benefits and $300 in interest. She half of the total paid is considered to be for the calendar months during the calendar year (not paid $2,000 for lodging and $400 for recreation. support of each spouse, unless they can show necessarily consecutive): She put $300 in a savings account. otherwise. Even though your mother received a total of If a child receives social security benefits and 1) A full-time student at a school that has a $2,700, she spent only $2,400 for her own sup- uses them toward his or her own support, the regular teaching staff, course of study, and port. If you spent more than $2,400 for her sup- payments are considered as provided by the regularly enrolled body of students in at- port and no other support was received, you child. tendance, or have provided more than half of her support. Support provided by the state (food 2) A student taking a full-time, on-farm train- Child's wages used for own support. You stamps, housing, etc.). Benefits provided by ing course given by a school described in cannot include in your contribution to your the state to a needy person generally are con- (1) above or a state, county, or local gov- child's support any support that is paid for by the sidered support provided by the state. However, ernment. child with the child's own wages, even if you paid payments based on the needs of the recipient the wages. will not be considered as used entirely for that Full-time student defined. A full-time stu- person's support if it is shown that part of the Year support is provided. The year you pro- dent is a person who is enrolled for the number payments were not used for that purpose. vide the support is the year you pay for it, even if of hours or courses the school considers to be you do so with borrowed money that you repay Foster care payments and expenses. Pay- full-time attendance. in a later year. ments you receive for the support of a foster School defined. The term "school" in- If you use a fiscal year to report your income, child from a child placement agency are consid- cludes elementary schools, junior and senior you must provide more than half of the ered support provided by the agency. Similarly, Page 30 Chapter 3 Personal Exemptions and Dependents Table 3 –1. Worksheet for Determining Support Keep for Your Records Funds Belonging to the Person You Supported 1) 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 $ 2) Amount used for support $ 3) Amount used for other purposes $ 4) Amount in savings and other accounts at the end of the year $ (The total of lines 2, 3, and 4 should equal line 1) $ Expenses for Entire Household (where the person you supported lived) 5) Lodging (Complete item a or b) a) Rent paid $ b) If not rented, show fair rental value of home. If the person you supported owned the home, include the amount in line 19. $ 6) Food $ 7) Utilities (heat, light, water, etc. not included in line 5a or 5b) $ 8) Repairs (not included in line 5a or 5b) $ 9) Other. Do not include expenses of maintaining home, such as mortgage interest, real estate taxes, and insurance. $ 10) Total household expenses (Add lines 5 through 9) $ 11) Total number of persons who lived in household Expenses for the Person You Supported 12) Each person's part of household expenses (line 10 divided by line 11) $ 13) Clothing $ 14) Education $ 15) Medical, dental $ 16) Travel, recreation $ 17) Other (specify) $ 18) Total cost of support for the year (Add lines 12 through 17) $ Did You Provide More Than Half? 19) Amount the person provided for own support (line 2, plus line 5b if the person you supported owned the home) $ 20) Amount others provided for the person's support. Include amounts provided by state, local, and other welfare societies or agencies. Do not include any amounts included on line 1. $ 21) Amount you provided for the person's support (line 18 minus lines 19 and 20) $ 22) 50% of line 18 $ Is line 21 more than line 22? Yes. You meet the support test for the person. If the other exemption tests are met, you may claim an exemption for the person. No. You do not meet the support test for the person. You cannot claim an exemption for the person unless you can do so under a multiple support agreement. See Multiple Support Agreement in this chapter. Chapter 3 Personal Exemptions and Dependents Page 31 Figure 3–A. Can You Claim an Exemption for a Dependent? Start Here No Was the person either a member of your household for the entire tax year or related to you? (See Member of Household or Relationship Test.) Yes No Was the person a U.S. citizen or resident, or a resident of Canada or Mexico, for any part of the tax year?1 Yes Yes Did the person file a joint return for the year?2 No You cannot You can claim an No Did you provide more than half the person's total support for the claim an exemption year? (If you are a divorced or separated parent of the person, see exemption for this Support Test for Child of Divorced or Separated Parents.)3 for this person. person.5 Yes No Did the person have gross income of $3,050 or more during the tax year?4 Yes No Was the person your child? (See Child defined.) Yes Yes Was your child under 19 at the end of the year? No No Yes Was your child under 24 at the end of the year and a full-time student for some part of each of five months during the year? (See Student under age 24.) 1 If the person was your legally adopted child and lived in your home as a member of your household for the entire tax year, answer "yes" to this question. 2 If neither the person nor the person's spouse is required to file a return, but they file a joint return only to claim a refund of tax withheld, answer "no" to this question. 3 Answer "yes" to this question if you meet the multiple support requirements under Multiple Support Agreement. 4 Gross income for this purpose does not include income received by a permanently disabled individual at a sheltered workshop. See Disabled dependents. 5 If your adjusted gross income is more than $104,625, see Phaseout of Exemptions. payments you receive for the support of a foster If you are in the trade or business of provid- Total Support child from a state or county are considered sup- ing foster care, your unreimbursed expenses port provided by the state or county. are not considered support provided by you. To figure if you provided more than half of the If you are not in the trade or business of support of a person, you must first determine the Home for the aged. If you make a lump-sum providing foster care to a child and your un- total support provided for that person. Total sup- advance payment to a home for the aged to take reimbursed out-of-pocket expenses in caring for port includes amounts spent to provide food, care of your relative for life and the payment is a foster child were mainly to benefit an organiza- lodging, clothing, education, medical and dental based on that person's life expectancy, the tion qualified to receive deductible charitable care, recreation, transportation, and similar ne- amount of support you provide each year is the contributions, the expenses are deductible as cessities. lump-sum payment divided by the relative's life charitable contributions, but are not considered Generally, the amount of an item of support expectancy. The amount of support you provide support you provided. For more information is the amount of the expense incurred in provid- also includes any other amounts that you pro- about the deduction for charitable contributions, ing that item. For lodging, the amount of support vided during the year. see chapter 26. If your unreimbursed expenses is the fair rental value of the lodging. are not deductible as charitable contributions, Expenses that are not directly related to any they are considered support you provided. one member of a household, such as the cost of food for the household, must be divided among the members of the household. Page 32 Chapter 3 Personal Exemptions and Dependents Example. Your parents live with you, your total fair rental value of the lodging to be $6,000 Tuition payments and allowances under the spouse, and your two children in a house you ($3,600 fair rental value of the unfurnished GI Bill. Amounts veterans receive under the own. The fair rental value of your parents' share house, $1,800 allowance for the furnishings pro- GI Bill for tuition payments and allowances while of lodging is $2,000 a year, which includes fur- vided by your parents, and $600 cost of utilities) they attend school are included in total support. nishings and utilities. Your father receives a of which you are considered to provide $4,200 nontaxable pension of $4,200, which he spends ($3,600 + $600). Example. During the year, your son re- equally between your mother and himself for ceives $2,200 from the government under the GI Person living in his or her own home. The items of support such as clothing, transporta- Bill. He uses this amount for his education. You total fair rental value of a person's home that he tion, and recreation. Your total food expense for provide the rest of his support — $2,000. Be- or she owns is considered support contributed the household is $6,000. Your heat and utility cause GI benefits are included in total support, by that person. bills amount to $1,200. Your mother has hospital your son is not your dependent. and medical expenses of $600, which you pay Living with someone rent free. If you live during the year. Figure your parents' total sup- with a person rent free in his or her home, you Child care expenses. If you pay someone to port as follows: must reduce the amount you provide for support provide child care or disabled dependent care, by the fair rental value of lodging he or she you can include these payments in the amount Support Provided Father Mother provides you. you provided for the support of your child or disabled dependent, even if you claim a credit Fair rental value of lodging $1,000 $1,000 Property. Property provided as support is for the payments. For information on the credit, Pension spent for their measured by its fair market value. Fair market support . . . . . . . . . . . . . 2,100 2,100 see chapter 34. value is the price that property would sell for on Share of food (1/6 of the open market. It is the price that would be Other support items. Other items may be $6,000) . . . . . . . . . . . . . 1,000 1,000 agreed upon between a willing buyer and a Medical expenses for considered as support depending on the facts in willing seller, with neither being required to act, each case. mother . . . . . . . . . . . . . . 600 and both having reasonable knowledge of the Parents' total support $4,100 $4,700 relevant facts. You must apply the support test separately Do Not Include in Total Support Capital expenses. Capital items, such as to each parent. You provide $2,000 ($1,000 furniture, appliances, and cars, that are bought lodging, $1,000 food) of your father's total sup- The following items are not included in total for a person during the year can be included in port of $4,100 — less than half. You provide support. total support under certain circumstances. $2,600 to your mother ($1,000 lodging, $1,000 The following examples show when a capital 1) Federal, state, and local income taxes paid food, $600 medical) — more than half of her item is or is not support. by persons from their own income. total support of $4,700. You meet the support test for your mother, but not your father. Heat 2) Social security and Medicare taxes paid by Example 1. You buy a $200 power lawn and utility costs are included in the fair rental persons from their own income. mower for your 13-year-old child. The child is value of the lodging, so these are not considered given the duty of keeping the lawn trimmed. 3) Life insurance premiums. separately. Because a lawn mower is ordinarily an item you buy for personal and family reasons that bene- 4) Funeral expenses. Lodging defined. If you provide a person with fits all members of the household, you cannot 5) Scholarships received by your child if your lodging, you are considered to provide support include the cost of the lawn mower in the support child is a full-time student. equal to the fair rental value of the room, apart- of your child. ment, house, or other shelter in which the per- 6) Survivors' and Dependents' Educational son lives. Fair rental value includes a Assistance payments used for support of Example 2. You buy a $150 television set reasonable allowance for the use of furniture the child who receives them. as a birthday present for your 12-year-old child. and appliances and for heat and other utilities The television set is placed in your child's bed- that are provided. room. You can include the cost of the television Fair rental value defined. This is the set in the support of your child. Multiple Support amount you could reasonably expect to receive Agreement from a stranger for the same kind of lodging. It is Example 3. You pay $5,000 for a car and used instead of actual expenses, such as rent, register it in your name. You and your Sometimes no one provides more than half of taxes, interest, depreciation, paint, insurance, 17-year-old daughter use the car equally. Be- the support of a person. Instead, two or more utilities, cost of furniture and appliances, etc. In cause you own the car and do not give it to your persons, each of whom would be able to take some cases, fair rental value may be equal to daughter but merely let her use it, you cannot the exemption but for the support test, together the rent paid. include the cost of the car in your daughter's provide more than half of the person's support. If you provide the total lodging, the amount of total support. However, you can include in your When this happens, you can agree that any support you provide is the fair rental value of the daughter's support your out-of-pocket expenses one of you who individually provides more than room the person uses, or a share of the fair of operating the car for her benefit. 10% of the person's support, but only one, can rental value of the entire dwelling if the person claim an exemption for that person. Each of the has use of your entire home. If you do not pro- Example 4. Your 17-year-old son, using others must sign a statement agreeing not to vide the total lodging, the total fair rental value personal funds, buys a car for $4,500. You pro- claim the exemption for that year. The person must be divided depending on how much of the vide all the rest of your son's support — $4,000. who claims the exemption must keep these total lodging you provide. If you provide only a Since the car is bought and owned by your son, signed statements for his or her records. A multi- part and the person supplies the rest, the fair the car's fair market value ($4,500) must be ple support declaration identifying each of the rental value must be divided between both of included in his support. The $4,000 support you others who agreed not to claim the exemption you according to the amount each provides. provide is less than half of his total support of must be attached to the return of the person $8,500. You cannot claim an exemption for your claiming the exemption. Form 2120, Multiple Example. Your parents live rent free in a son. Support Declaration, can be used for this pur- house you own. It has a fair rental value of pose. Medical insurance premiums. Medical insur- $5,400 a year furnished, which includes a fair ance premiums you pay, including premiums for rental value of $3,600 for the house and $1,800 Example 1. You, your sister, and your two supplementary Medicare coverage, are in- for the furniture. This does not include heat and brothers provide the entire support of your cluded in the support you provide. utilities. The house is completely furnished with mother for the year. You provide 45%, your furniture belonging to your parents. You pay Medical insurance benefits. Medical in- sister 35%, and your two brothers each provide $600 for their utility bills. Utilities are not usually surance benefits, including basic and supple- 10%. Either you or your sister can claim an included in rent for houses in the area where mentary Medicare benefits, are not part of exemption for your mother. The other must sign your parents live. Therefore, you consider the support. a statement agreeing not to take an exemption Chapter 3 Personal Exemptions and Dependents Page 33 for your mother. The one who claims the exemp- custody of the child. This also applies if the ple, alternate years), or for all future years, as tion must attach a Form 2120 or similar declara- validity of a decree or agreement awarding cus- specified in the declaration. If the exemption is tion to his or her return and must keep for his or tody is uncertain because of legal proceedings released for more than one year, the original her records the signed statement from the one pending on the last day of the calendar year. release must be attached to the return of the agreeing not to take the exemption. Because If the parents are divorced or separated dur- noncustodial parent for the first year of such neither brother provides more than 10% of the ing the year and had joint custody of the child release, and a copy must be attached for each support, neither can take the exemption. Your before the separation, the parent who has cus- later year. brothers do not have to sign a statement. tody for the greater part of the rest of the year is Divorce decree or separation agreement considered to have custody of the child for the made after 1984. If your divorce decree or Example 2. You and your brother each pro- tax year. vide 20% of your mother's support for the year. separation agreement was executed after 1984, The remaining 60% of her support is provided Example 1. Under the terms of your di- the noncustodial parent does not have to attach equally by two persons who are not related to vorce, you have custody of your child for 10 Form 8332 if both of the following requirements her. She does not live with them. Because more months of the year. Your former spouse has are met. than half of her support is provided by persons custody for the other 2 months. You and your 1) The decree or agreement is signed by the who cannot claim an exemption for her, no one former spouse provide the child's total support. custodial parent and states all of the fol- can take the exemption. You are considered to have provided more than lowing. half of the support of the child. However, see Example 3. Your father lives with you and Exception, later. a) The custodial parent will not claim the receives 25% of his support from social security, child as a dependent for the year. 40% from you, 24% from his brother, and 11% Example 2. You and your former spouse from a friend. Either you or your uncle can take provided your child's total support for 2003. For b) The noncustodial parent can claim the the exemption for your father if the other signs a the first 8 months of the year, you had custody of child as a dependent without regard statement agreeing not to. The one who takes your child under your 1995 divorce decree (the to any condition, such as payment of the exemption must attach a Form 2120 or a most recent decree at the time). On August 31, support. similar declaration to his return and must keep 2003, a new custody decree granted custody to c) The years for which the noncustodial for his records the signed statement from the your former spouse. Because you had custody parent, rather than the custodial parent, one agreeing not to take the exemption. for the greater part of the year, you are consid- can claim the child as a dependent. ered to have provided more than half of your child's support, unless the exception described Support Test for next applies. 2) The noncustodial parent attaches a copy of the following pages of the decree or Child of Divorced or agreement to his or her tax return. Exception. The noncustodial parent will be Separated Parents treated as providing more than half of the child's a) The cover page (write the other support if: parent's social security number on this The support test for a child of divorced or sepa- rated parents is based on the special rules ex- page). 1) The custodial parent signs a written decla- plained here and shown in Figure 3 – B. ration that he or she will not claim the b) The pages that contain the information However, these special rules apply only if all of exemption for the child, and the noncus- shown in item (1). the following are true. todial parent attaches this written declara- c) The signature page with the other tion to his or her return, parent's signature and the date of the 1) The parents are divorced or legally sepa- rated under a decree of divorce or sepa- 2) The custodial parent signed a decree or agreement. rate maintenance, or separated under a agreement executed after 1984 that states written separation agreement, or lived he or she will not claim the exemption for If these requirements are not met, the apart at all times during the last 6 months the child and that the noncustodial parent of the calendar year. can claim an exemption for the child with- ! noncustodial parent must attach to his CAUTION or her return Form 8332 or a similar out regard to any condition, such as pay- statement from the custodial parent releasing 2) One or both parents provide more than ment of support, and the noncustodial the exemption. half of the child's total support for the cal- parent attaches to his or her return the endar year. documentation described later under Di- 3) One or both parents have custody of the vorce decree or separation agreement Child support. All child support payments ac- child for more than half of the calendar made after 1984, or tually received from the noncustodial parent are year. 3) A decree or agreement executed before considered used for the support of the child. "Child" is defined earlier under Gross Income 1985 provides that the noncustodial parent Test. is entitled to the exemption, and he or she Example. The noncustodial parent provides This discussion does not apply if the support provides at least $600 for the child's sup- $1,200 for the child's support. This amount is of the child is determined under a multiple sup- port during the year, unless the pre-1985 considered support provided by the noncus- port agreement, discussed earlier. decree or agreement is modified after todial parent even if the $1,200 was actually 1984 to specify that this provision will not spent on things other than support. General rule. The parent who has custody of apply. Paid in a later year. If you fail to pay child the child for the greater part of the year (the support in the year it is due, but pay it in a later custodial parent) is generally treated as the Noncustodial parent. The noncustodial year, your payment of the overdue amount is not parent who provides more than half of the child's parent is the parent who has custody of the child considered paid for the support of your child, support. It does not matter whether the custodial for the shorter part of the year or who does not either for the year the payment was due or for parent actually provided more than half of the have custody at all. the year it is paid. It is payment of an amount you support. Written declaration. The custodial parent owed to the custodial parent, but it is not consid- Custody. Custody is usually determined by may use either Form 8332 or a similar state- ered paid by you for the support of your child. the terms of the most recent decree of divorce or ment (containing the same information required separate maintenance, or a later custody de- by the form) to make the written declaration to Example. You owed but failed to pay child cree. If there is no decree, use the written sepa- release the exemption to the noncustodial par- support last year. This year, you pay all of the ration agreement. If neither a decree nor ent. The noncustodial parent must attach the amount owed from last year and the full amount agreement establishes custody, then the parent form or statement to his or her tax return. due for this year. Your payment of this year's who has the physical custody of the child for the The exemption can be released for a single child support counts as your support for this greater part of the year is considered to have year, for a number of specified years (for exam- year, but your payment of the amount owed from Page 34 Chapter 3 Personal Exemptions and Dependents Figure 3–B. Support Test for Children of Divorced or Separated Parents Start Here Are the parents divorced or legally separated, separated No under a written agreement, or did they live apart the last 6 Did any one person Yes The person who provided over months of the year? provide over half of the half of the child's support meets child's total support? the support test. Yes No Did one or both parents No furnish over half of the child's See Multiple Support total support? Agreement. Yes Is the child in the custody of No one or both parents for more than half of the year? Yes Did the custodial parent sign Did the custodial parent No a Form 8332 or similar sign a decree or statement releasing the agreement executed after exemption? 1984 releasing the exemption? Yes Yes No Is there a decree or agreement executed Is the noncustodial parent before 1985 (and not attaching the signed form No modified after 1984) or other required that entitles the documentation to his or noncustodial parent to No her return? the exemption? Yes Yes The custodial parent meets the support test. No Did the noncustodial parent provide at least $600 of the child's support during the year? Yes The noncustodial parent meets the support test. Chapter 3 Personal Exemptions and Dependents Page 35 last year does not count as support either for this Single . . . . . . . . . . . . . . . . . 139,500 No social security number. If a person for year or for last year. Head of household . . . . . . . . . 174,400 whom you expect to claim an exemption on your Married filing jointly . . . . . . . . 209,250 return does not have an SSN, either you or that Third-party support. Support provided by a Qualifying widow(er) . . . . . . . . 209,250 person should apply for an SSN as soon as third party for a divorced or separated parent is If your AGI exceeds the level for your filing possible by filing Form SS – 5, Application for a not included as support provided by that parent. status, use the Deduction for Exemptions Work- Social Security Card, with the Social Security However, see Remarried parent, later. sheet in the instructions for Form 1040 to figure Administration (SSA). Information about apply- the amount of your deduction for exemptions. ing for an SSN and Form SS – 5 is available at Example. You are divorced. During the en- You must reduce the dollar amount of your your local SSA office. tire year, you and your child live with your exemptions by 2% for each $2,500, or part of It usually takes about 2 weeks to get an mother in a house she owns. The fair rental $2,500 ($1,250 if you are married filing sepa- SSN. If you do not have a required SSN by the value of the lodging provided by your mother for rately), that your AGI exceeds the amount filing due date, you can file Form 4868 for an your child is $3,000. The home provided by your shown above for your filing status. If your AGI extension of time to file. mother is not included in the amount of support you provide. exceeds the amount shown by more than Born and died in 2003. If your child was $122,500 ($61,250 if married filing separately), born and died in 2003, and you do not have an Remarried parent. If you remarry, the sup- the amount of your deduction for exemptions is SSN for the child, you may attach a copy of the port provided by your new spouse is treated as reduced to zero. child's birth certificate instead. If you do, enter provided by you. "DIED" in column (2) of line 6c of your Form 1040 or Form 1040A. Example. You have two children from a for- mer marriage who live with you. You have re- Taxpayer identification numbers for aliens. married and are living in a home owned by your If your dependent is a resident or nonresident new spouse. The fair rental value of the home Social Security alien who does not have and is not eligible to get provided to the children by your new spouse is an SSN, the IRS will issue your dependent an treated as provided by you. Numbers for individual taxpayer identification number (ITIN) instead of an SSN. Write the number in column Home jointly owned. If you and your former spouse have the right to use and live in the Dependents (2) of line 6c of your Form 1040 or Form 1040A. To apply for an ITIN, use Form W – 7, Applica- home, each of you is considered to provide half You must list the social security number (SSN) tion for IRS Individual Taxpayer Identification of your child's lodging. However, if the divorce of any person for whom you claim an exemption Number. decree gives only you the right to use and live in in column (2) of line 6c of your Form 1040 or It usually takes about 4 to 6 weeks to get an the home, you are considered to provide your Form 1040A. ITIN. child's entire lodging. It does not matter if the legal title to the home remains in the names of If you do not list the dependent's SSN Taxpayer identification numbers for both parents. ! when required or if you list an incorrect adoptees. If you have a child who was placed CAUTION SSN, the exemption may be disal- with you by an authorized placement agency, lowed. you may be able to claim an exemption for the child. However, if you cannot get an SSN or an Phaseout of Note. If your dependent does not have and cannot get an SSN, you must list the individual ITIN for the child, you must get an adoption taxpayer identification number (ATIN) for the Exemptions taxpayer identification number (ITIN) or adop- tion taxpayer identification number (ATIN) in- child from the IRS. See Form W – 7A, Applica- tion for Taxpayer Identification Number for stead of an SSN. See Taxpayer identification Pending U.S. Adoptions, for details. The amount you can claim as a deduction for numbers for aliens or Taxpayer identification exemptions is phased out once your adjusted numbers for adoptees, later. gross income (AGI) goes above a certain level for your filing status. These levels are as follows: AGI Level Which Reduces Exemption Filing Status Amount Married filing separately . . . . . $ 104,625 Page 36 Chapter 3 Personal Exemptions and Dependents Personal Final Return 4. Representative for the Decedent A personal representative of an estate is an The same filing requirements that apply to indi- Decedents executor, administrator, or anyone who is in charge of the decedent's property. viduals determine if a final income tax return must be filed for the decedent. Filing require- ments are discussed in chapter 1. Executor. Generally, an executor (or execu- Filing to get a refund. A return should be filed Important Reminders trix) is named in a decedent's will to administer the estate (property and debts left by the dece- to obtain a refund if tax was withheld from sala- ries, wages, pensions, or annuities, or if esti- dent) and distribute properties as the decedent mated tax was paid, even if a return is not Estate tax return. Generally, if the decedent has directed. required to be filed. See Claiming a refund, later. died during 2003, an estate tax return (Form 706) must be filed if the gross estate is more Also, the decedent may be entitled to other cred- Administrator. An administrator (or adminis- than $1,000,000. its that result in a refund. See chapters 38 and tratrix) is usually appointed by the court if no will 39 for additional information on refundable cred- Estate tax repeal. The estate tax is repealed exists, if no executor was named in the will, or if its and see chapter 36 for information on the for decedents dying after 2009. the named executor cannot or will not serve. child tax credit. Consistent treatment of estate items. Bene- Personal representative. In general, an ex- Determining income and deductions. The ficiaries must generally treat estate items the ecutor and an administrator perform the same method of accounting regularly used by the de- same way on their individual returns as they are duties and have the same responsibilities. Be- cedent before death generally determines what treated on the estate's return. For more informa- cause a personal representative for a income you must include and what deductions tion, see How and When To Report under Distri- decedent's estate can be an executor, adminis- you can take on the final return. Generally, indi- butions to Beneficiaries From an Estate in trator, or anyone in charge of the decedent's viduals use one of two methods of accounting: Publication 559, Survivors, Executors, and Ad- property, the term personal representative will cash or accrual. ministrators. be used throughout this chapter. Cash method. If the decedent used the The surviving spouse may or may not be the cash method of accounting, include only the personal representative, depending on the items of income actually or constructively re- terms of the decedent's will or the court appoint- ceived before death and deduct only the ex- ment. Introduction penses the decedent paid before death. For an exception for certain medical expenses not paid This chapter discusses the tax responsibilities of Duties before death, see Decedent in chapter 23. the person who is in charge of the property Accrual method. If the decedent used an (estate) of an individual who has died (dece- The primary duties of a personal representative accrual method of accounting, report only those dent). It also covers the following topics. are to collect all of the decedent's assets, pay items of income that the decedent accrued, or the creditors, and distribute the remaining as- • Filing the decedent's final return. sets to the heirs or other beneficiaries. earned, before death. Deduct those expenses the decedent was liable for before death, re- • Tax effects on survivors. The personal representative also must per- gardless of whether the expenses were paid. form the following duties. This chapter does not discuss the require- Additional information. For more informa- ments for filing an income tax return of an estate 1) Notify the IRS (as discussed below) that tion on the cash and accrual methods, see Ac- (Form 1041). For information on Form 1041, see he or she is acting as the personal repre- counting Methods in chapter 1. Income Tax Return of an Estate — Form 1041 in sentative. Who must file the return? The personal rep- Publication 559. This chapter also does not dis- 2) File any income tax and estate tax return resentative (defined earlier) must file the final cuss the requirements for filing an estate tax when due. (See Final Return for the Dece- income tax return (Form 1040) of the decedent return (Form 706). For information, see Form dent, later.) for the year of death and any returns not filed for 706 and its instructions. preceding years. A surviving spouse, under cer- 3) Pay any tax determined up to the date of discharge from duties. tain circumstances, may have to file the returns Useful Items for the decedent. See Joint return, later. 4) Provide the payers of any interest and divi- You may want to see: dends the name(s) and identification Example. Samantha Smith died on March number(s) of the new owner(s). (See Inter- 21, 2003, before filing her 2002 tax return. Her Publication est and Dividend Income (Forms 1099), personal representative must file her 2002 re- ❏ 559 Survivors, Executors, and later.) turn by April 15, 2003. Her final tax return is due Administrators April 15, 2004. For more information on the duties and re- sponsibilities of the personal representative, see Filing the return. The word "DECEASED," Form (and Instructions) Duties under Personal Representative in Publi- the decedent's name, and the date of death ❏ 56 Notice Concerning Fiduciary cation 559. should be written across the top of the tax return. Relationship In the name and address space, you should Notifying the IRS. If you are appointed to act write the name and address of the decedent ❏ 1310 Statement of Person Claiming in any fiduciary capacity for another, you must and, if a joint return, of the surviving spouse. If a Refund Due a Deceased Taxpayer file a written notice with the IRS stating this. joint return is not being filed, the decedent's ❏ 4810 Request for Prompt Assessment Form 56 can be used for this purpose. The name should be written in the name space and Under Internal Revenue Code instructions and other requirements are given on the personal representative's name and ad- Section 6501(d) the back of the form. dress should be written in the remaining space. Chapter 4 Decedents Page 37 Example. John Stone died in early 2003. He Service Center for the place where you live. A For example, a Form 1099 – INT reporting was survived by his wife Jane. The top of their tax return for a decedent can be electronically interest payable to the decedent may include final joint return on Form 1040, which includes filed. income that should be reported on the final in- the required information, is illustrated on the come tax return of the decedent, as well as next page. Joint return. Generally, the personal repre- income that the estate or other recipient should sentative and the surviving spouse can file a report, either as income earned after death or as Signing the return. If a personal representa- joint return for the decedent and the surviving income in respect of the decedent (discussed tive has been appointed, that person must sign spouse. However, the surviving spouse alone later). For income earned after death, you the return. If it is a joint return, the surviving can file the joint return if no personal representa- should ask the payer for a Form 1099 that prop- spouse must also sign it. tive has been appointed before the due date for erly identifies the recipient (by name and identifi- If no personal representative has been ap- filing the joint return for the year of death. This cation number) and the proper amount. If that is pointed, the surviving spouse (on a joint return) also applies to the return for the preceding year not possible, or if the form includes an amount should sign the return and write in the signature if the decedent died after the close of the pre- that represents income in respect of the dece- area "Filing as surviving spouse." See Joint re- ceding tax year and before filing the return for dent, report the interest, as shown next under turn, later. that year. The income of the decedent that was How to report. If no personal representative has been ap- includible on his or her return for the year up to See U.S. savings bonds acquired from dece- pointed and if there is no surviving spouse, the dent in Publication 559 for information on sav- person in charge of the decedent's property the date of death (as explained under Determin- ings bond interest that may have to be reported must file and sign the return as "personal repre- ing income and deductions, earlier) and the in- on the final return. sentative." come of the surviving spouse for the entire year must be included in the final joint return. How to report. If you are preparing the Example. Assume in the previous example A joint return with the decedent cannot be decedent's final return and you have received a that no personal representative has been ap- filed for the year of death if the surviving spouse Form 1099 – INT for the decedent that includes pointed. The bottom of the final joint return, remarried before the end of the year of the amounts belonging to the decedent and to an- which shows that Jane is filing the return as the decedent's death. The filing status of the dece- other recipient (the decedent's estate or another surviving spouse, is illustrated on the next page. dent in this instance is married filing separate beneficiary), report the total interest shown on Third party designee. You can check the Yes return. Form 1099 – INT on Schedule 1 (Form 1040A) or box in the Third Party Designee area of the on Schedule B (Form 1040). Next, enter a sub- Personal representative may revoke joint return to authorize the IRS to discuss the return total of the interest shown on Forms 1099 and return election. A court-appointed personal with a friend, family member, or any other per- the interest reportable from other sources for representative may revoke an election to file a son you choose. This allows the IRS to call the which you did not receive Forms 1099. Then, joint return that was previously made by the person you identified as the designee to answer show any interest (including any interest you surviving spouse alone. This is done by filing a any questions that may arise during the receive as a nominee) belonging to another re- separate return for the decedent within one year processing of the return. It also allows the desig- cipient separately and subtract it from the sub- from the due date of the return (including any nee to perform certain actions. See your income total. Identify this adjustment as a "Nominee extensions). The joint return made by the surviv- tax package for details. Distribution" or other appropriate designation. ing spouse will then be regarded as the separate Report dividend income for which you re- Claiming a refund. Generally, a person who return of that spouse by excluding the ceived a Form 1099 – DIV, Dividends and Distri- is filing a return for a decedent and claiming a decedent's items and refiguring the tax liability. butions, on the appropriate schedule using the refund must file Form 1310 with the return. How- Relief from joint liability. In some cases, same procedure. ever, if the person claiming the refund is a sur- one spouse may be relieved of joint liability for viving spouse filing a joint return with the tax, interest, and penalties on a joint return for Note. If the decedent received amounts as a decedent, or a court-appointed or certified per- items of the other spouse that were incorrectly nominee, you must give the actual owner a Form sonal representative filing an original return for reported on the joint return. If the decedent qual- 1099, unless the owner is the decedent's the decedent, Form 1310 is not needed. The ified for this relief while alive, the personal repre- spouse. See General Instructions for Forms personal representative must attach to the re- sentative can pursue an existing request, or file 1099, 1098, 5498, and W – 2G, for more infor- turn a copy of the court certificate showing that a request, for relief from joint liability. For infor- mation on filing forms 1099. he or she was appointed the personal represen- mation on requesting this relief, see Filing a tative. Joint Return in chapter 2. If the personal representative is filing a claim Accelerated Death Benefits for refund on Form 1040X, Amended U.S. Indi- vidual Income Tax Return, or Form 843, Claim How To Report Accelerated death benefits are amounts re- for Refund and Request for Abatement, and the ceived under a life insurance contract before the court certificate has already been filed with the Certain Income death of the insured individual. These benefits IRS, attach Form 1310 and write "Certificate This section explains how to report certain types also include amounts received on the sale or Previously Filed" at the bottom of the form. of income on the final return. The rules on in- assignment of the contract to a viatical settle- come discussed in the other chapters of this ment provider. Example. Mr. Green died before filing his publication also apply to a decedent's final re- Generally, if the decedent received acceler- tax return. You were appointed the personal turn. See chapters 6 through 17, if they apply. ated death benefits either on his or her own life representative for Mr. Green's estate and you or on the life of another person, those benefits file his Form 1040 showing a refund due. You do are not included in the decedent's income. This not need Form 1310 to claim the refund if you exclusion applies only if the insured was a termi- Interest and Dividend Income attach a copy of the court certificate showing you nally or chronically ill individual. For more infor- were appointed the personal representative. (Forms 1099) mation, see Accelerated death benefits under A Form 1099 should be received for the dece- Gifts, Insurance, and Inheritances in Publication When and where to file. The final income tax dent reporting interest and dividends earned 559. return is due at the same time the decedent's return would have been due had death not oc- before death. These amounts must be included curred. The final return for a decedent who was on the decedent's final return. A separate Form a calendar year taxpayer is generally due April 1099 should show the interest and dividends Business Income 15 following the year death occurred. However, earned after the date of the decedent's death This section discusses some of the business when the due date falls on a Saturday, Sunday, and paid to the estate or other recipient that income which may have to be included on the or legal holiday, the return is filed timely if filed must include those amounts on its return. You final return. by the next business day. can request corrected Forms 1099 if these Generally, you must file the final income tax forms do not properly reflect the right recipient or Partnership income. The death of a partner return of the decedent with the Internal Revenue amounts. closes the partnership's tax year for that partner. Page 38 Chapter 4 Decedents DECEASED JOHN S. STONE FEBRUARY 28, 2003 1040 Department of the Treasury—Internal Revenue Service Form U.S. Individual Income Tax Return 2003 (99) IRS Use Only—Do not write or staple in this space. For the year Jan. 1–Dec. 31, 2003, or other tax year beginning , 2003, ending , 20 OMB No. 1545-0074 Label Your social security number (See L 765 00 4321 instructions A CAR-RT SORT**CR01 on page 19.) B E LP S29 30 I Spouse's social security number 123 00 4567 Use the IRS L JOHN S & JANE M STONE R label. H 9 1 92 OAK ST 103 Important! Otherwise, E SHERIDAN WY 82801 S please print R You must enter or type. E your SSN(s) above. Presidential You Spouse Election Campaign Note. Checking "Yes" will not change your tax or reduce your refund. (See page 19.) Do you, or your spouse if filing a joint return, want $3 to go to this fund? Yes No Yes No 1 Single 4 Head of household (with qualifying person). (See page 20.) If Filing Status 2 Married filing jointly (even if only one had income) the qualifying person is a child but not your dependent, enter Do you want to allow another person to discuss this return with the IRS (see page 58)? Yes. Complete the following. No Third Party Designee's Phone Personal identification Designee name no. ( ) number (PIN) Under penalties of perjury, I declare that I have examined this return and accompanying schedules and statements, and to the best of my knowledge and Sign belief, they are true, correct, and complete. Declaration of preparer (other than taxpayer) is based on all information of which preparer has any knowledge. Here Your signature Date Your occupation Daytime phone number Joint return? See page 20. Jane M. Stone 4/1/04 Engineer ( ) Keep a copy Spouse's signature. If a joint return, both must sign. Date Spouse's occupation for your records. Filing as surviving spouse Date Preparer's SSN or PTIN Preparer's Paid signature Check if self-employed Preparer's Firm's name (or EIN Use Only yours if self-employed), address, and ZIP code Phone no. ( ) Form 1040 (2003) Generally, it does not close the partnership's tax Self-employment income. Include self-em- individual with special needs. This includes an year for the remaining partners. The decedent's ployment income actually or constructively re- individual who because of a physical, mental, or distributive share of partnership items must be ceived or accrued, depending on the decedent's emotional condition (including a learning disabil- figured as if the partnership's tax year ended on accounting method. For self-employment tax ity) requires additional time to complete his or the date the partner died. To avoid an interim purposes only, the decedent's self-employment her education. closing of the partnership books, the partners income will include the decedent's distributive For more information on Coverdell ESAs, can agree to estimate the decedent's distributive share of a partnership's income or loss through see Publication 970, Tax Benefits for Education. share by prorating the amounts the partner the end of the month in which death occurred. would have included for the entire partnership For this purpose, the partnership income or loss tax year. is considered to be earned ratably over the Archer MSA On the decedent's final return, include the partnership's tax year. For more information on decedent's distributive share of partnership how to compute self-employment income, see The treatment of an Archer MSA or a items for the following periods. Medicare+Choice MSA, at the death of the ac- Publication 533, Self-Employment Tax. count holder, depends on who acquires the in- 1) The partnership's tax year that ended terest in the account. If the decedent's estate within or with the decedent's final tax year acquires the interest, the fair market value of the Coverdell Education Savings assets in the account on the date of death is (the year ending on the date of death). Account (ESA) included in income on the decedent's final re- 2) The period, if any, from the end of the turn. partnership's tax year in (1) to the Generally, the balance in a Coverdell ESA must be distributed within 30 days after the individual If a beneficiary acquires the interest, see the decedent's date of death. discussion under Income in Respect of the De- for whom the account was established reaches age 30, or dies, whichever is earlier. The treat- cedent, later. For more information on Archer S corporation income. If the decedent was a MSAs, see Publication 969, Medical Savings ment of the Coverdell ESA at the death of an shareholder in an S corporation, include on the Accounts (MSAs). individual under age 30 depends on who ac- final return the decedent's share of the S quires the interest in the account. If the corporation's items of income, loss, deduction, decedent's estate acquires the interest, the Exemptions, Deductions, and credit for the following periods. earnings on the account must be included on the final income tax return of the decedent. If a and Credits 1) The corporation's tax year that ended beneficiary acquires the interest, see the discus- Generally, the rules for exemptions, deductions, within or with the decedent's final tax year sion under Income in Respect of the Decedent, and credits allowed to an individual also apply to (the year ending on the date of death). later. the decedent's final income tax return. Show on 2) The period, if any, from the end of the The age 30 limit does not apply if the individ- the final return deductible items the decedent corporation's tax year in (1) to the ual for whom the account was established, or paid (or accrued, if the decedent reported de- decedent's date of death. the beneficiary that acquires the account, is an ductions on an accrual method) before death. Chapter 4 Decedents Page 39 Exemptions Tax withheld and estimated payments. How To Report There may have been income tax withheld from You can claim the decedent's personal exemp- the decedent's pay, pensions, or annuities Income in respect of a decedent must be in- tion on the final income tax return. If the dece- before death, and the decedent may have paid cluded in the income of one of the following. dent was another person's dependent (for estimated income tax. To get credit for these tax example, a parent's), you cannot claim the per- payments, you must claim them on the • The decedent's estate, if the estate re- sonal exemption on the decedent's final return. ceives it. decedent's final return. For more information, see Credit for Withholding and Estimated Tax in • The beneficiary, if the right to income is chapter 5. passed directly to the beneficiary and the Standard Deduction beneficiary receives it. If you do not itemize deductions on the final • Any person to whom the estate properly return, the full amount of the appropriate stan- distributes the right to receive it. dard deduction is allowed regardless of the date Tax Effect on Others of death. For information on the appropriate If you have to include income in re- standard deduction, see chapter 22. This section contains information about the ef- TIP spect of the decedent in your gross fect of an individual's death on the income tax income and an estate tax return was liability of the survivors (including the widow or filed for the decedent, you may be able to claim Itemized Deductions widower and any beneficiaries) and the estate. a deduction for the estate tax paid on that in- A survivor should coordinate the filing of his or come. For more information, see Publication If the total of the decedent's itemized deductions her own tax return with the personal representa- 559. is more than the decedent's standard deduction, tive handling the decedent's estate. The per- the federal income tax will generally be less if sonal representative can coordinate filing Example 1. Frank Johnson owned and op- you claim itemized deductions on the final re- status, exemptions, income, and deductions so erated an apple orchard. He used the cash turn. See chapters 23 through 30 for the types of that the decedent's final return and the income method of accounting. He sold and delivered expenses that are allowed as itemized deduc- tax returns of the survivors and the estate are all 1,000 bushels of apples to a canning factory for tions. filed correctly. $2,000, but did not receive payment before his death. The proceeds from the sale are income in Medical expenses. Medical expenses paid respect of the decedent. When the estate was before death by the decedent are deductible, Gifts and inheritances. Property received as a gift, bequest, or inheritance is not included in settled, payment had not been made and the subject to limits, on the final income tax return if estate transferred the right to the payment to his deductions are itemized. This includes ex- your income. However, if property you receive in this manner later produces income, such as widow. When Frank's widow collects the $2,000, penses for the decedent as well as for the she must include that amount in her return. It is decedent's spouse and dependents. interest, dividends, or rent, that income is tax- able to you. If the gift, bequest, or inheritance not to be reported on the final return of the Qualified medical expenses are not de- you receive is the income from property, that decedent or on the return of the estate. ! ductible if paid with a tax-free distribu- income is taxable to you. Example 2. Assume the same facts as in CAUTION tion from an Archer MSA. If you inherited the right to receive income in Example 1, except that Frank used an accrual For information on certain medical expenses respect of the decedent, see Income in Respect method of accounting. The amount accrued that were not paid before death, see Decedent in of the Decedent, later. from the sale of the apples would be included on chapter 23. his final return. Neither the estate nor the widow Joint return by surviving spouse. A surviv- will realize income in respect of the decedent Unrecovered investment in pension. If the when the money is later paid. ing spouse can file a joint return for the year of decedent was receiving a pension or annuity death and may qualify for special tax rates for (with an annuity starting date after 1986) and Example 3. Cathy O'Neil was entitled to a the following 2 years. For more information, see died without a surviving annuitant, you can take large salary payment at the date of her death. Qualifying Widow(er) With Dependent Child in a deduction on the decedent's final return for the The amount was to be paid in five annual install- chapter 2. amount of the decedent's investment in the pen- ments. The estate, after collecting two install- sion or annuity contract that remained unrecov- ments, distributed the right to the remaining ered at death. The deduction is a miscellaneous Decedent as your dependent. If the dece- installments to you, the beneficiary. The pay- itemized deduction that is not subject to the 2% dent qualified as your dependent for the part of ments are income in respect of the decedent. limit on adjusted gross income. See chapter 30. the year before death, you can claim the exemp- None of the payments were includible in Cathy's tion for the dependent on your tax return, regard- final return. The estate must include in its in- less of when death occurred during the year. come the two installments it received, and you Deduction for Losses If the decedent was your qualifying child, you must include in your income each of the three may be able to claim the child tax credit. See installments as you receive them. A decedent's net operating loss deduction from chapter 36. a prior year and any capital losses (including Transferring your right to income. If you capital loss carryovers) can be deducted only on transfer your right to income in respect of a the decedent's final income tax return. A net Income in Respect decedent, you must include in your income the operating loss on the decedent's final income tax return can be carried back to prior years (see of the Decedent greater of: Publication 536, Net Operating Losses (NOLs) All income that the decedent would have re- • The amount you receive for the right, or for Individuals, Estates, and Trusts). You cannot ceived had death not occurred and that was not • The fair market value of the right at the deduct any unused net operating loss or capital properly includible on the final return, discussed time of the transfer. loss on the estate's income tax return. earlier, is income in respect of the decedent. If the decedent is a specified terrorist Fair market value (FMV). FMV is the price at which the property would change hands be- Credits ! victim (see Publication 3920, Tax Re- tween a buyer and a seller, neither having to buy CAUTION lief for Victims of Terrorist Attacks), any income received after the date of death and or sell, and both having reasonable knowledge Any of the tax credits discussed in this publica- of all necessary facts. tion also apply to the final return if the decedent before the end of the decedent's tax year (deter- was eligible for the credits at the time of death. mined without regard to death) is excluded from Giving your right to income as a gift. If These credits are discussed in chapters 34 the recipient's gross income. This exclusion you give your right to receive income in respect through 39. does not apply to certain income. of a decedent as a gift, you must include in your Page 40 Chapter 4 Decedents income the fair market value of the right at the the balance in the IRA at Greg's death, including Archer MSA. If the decedent's spouse is the time you make the gift. the income earned before death, is income in designated beneficiary of the account, the ac- respect of the decedent. count becomes that spouse's Archer MSA. It is Type of income. The character or type of in- For more information on inherited IRAs, see subject to the rules discussed in Publication come that you receive in respect of a decedent Publication 590, Individual Retirement Arrange- 969. is the same as it would be to the decedent if he ments (IRAs). Any other beneficiary (including a spouse or she were alive. If the income would have been a capital gain to the decedent, it will be a capital that is not the designated beneficiary) must in- Roth IRAs. Qualified distributions from a Roth gain to you. clude in income the fair market value of the IRA are not subject to tax. A distribution made to assets in the account on the decedent's date of Inherited IRAs. If a beneficiary receives a a beneficiary or to the Roth IRA owner's estate on or after the date of death is a qualified distri- death. This amount must be reported for the lump-sum distribution from a traditional IRA he or she inherited, all or some of it may be taxable. bution if it is made after the 5-year tax period beneficiary's tax year that includes the The distribution is taxable in the year received beginning with the first tax year in which a contri- decedent's date of death. The amount included as income in respect of a decedent up to the bution was made to any Roth IRA of the owner. in income is reduced by any qualified medical decedent's taxable balance. This is the Part of any distribution to a beneficiary that is expenses for the decedent that are paid by the decedent's balance at the time of death, includ- not a qualified distribution may be includible in beneficiary within 1 year after the decedent's ing unrealized appreciation and income accrued the beneficiary's income. Generally, the part in- date of death. to date of death, minus any basis (nondeductible cludible is the earnings in the Roth IRA. Earn- contributions). Amounts distributed that are ings attributable to the period ending with the Other income. For examples of other income more than the decedent's entire IRA balance decedent's date of death are income in respect situations concerning decedents, see Specific (including taxable and nontaxable amounts) at of the decedent. Additional earnings are the Types of Income in Respect of a Decedent in the time of death are the income of the benefi- income of the beneficiary. Publication 559. ciary. For more information on Roth IRAs, see If the beneficiary of a traditional IRA is the Publication 590. decedent's surviving spouse who properly rolls Deductions in Respect over the distribution into another traditional IRA, Coverdell education savings account (ESA). of the Decedent the distribution is not currently taxed. A surviving If the decedent's spouse or other family member spouse can also roll over tax free the taxable is the designated beneficiary of the decedent's Items such as business expenses, income-pro- part of the distribution into a qualified plan, sec- account, the Coverdell ESA becomes that ducing expenses, interest, and taxes, for which tion 403(b) annuity, or section 457 plan. person's Coverdell ESA. It is subject to the rules the decedent was liable but that are not properly discussed in Publication 970. allowable as deductions on the decedent's final Example. At the time of his death, Greg Any other beneficiary (including a spouse or income tax return will be allowed as a deduction owned a traditional IRA. All of the contributions family member who is not the designated benefi- to one of the following when paid. by Greg to the IRA had been deductible contri- ciary) must include in income the earnings por- butions. Greg's nephew, Mark, was the sole tion of the distribution. Any balance remaining at • The estate. beneficiary of the IRA. The entire balance of the the close of the 30-day period is deemed to be • The person who acquired an interest in IRA, including income accruing before and after distributed at that time. The amount included in the decedent's property (subject to such Greg's death, was distributed to Mark in a lump income is reduced by any qualified education obligations) because of the decedent's sum. Mark must include the total amount re- expenses of the decedent that are paid by the death, if the estate was not liable for the ceived in his income. The portion of the beneficiary within 1 year after the decedent's obligation. lump-sum distribution that equals the amount of date of death. Chapter 4 Decedents Page 41 only income tax, but self-employment tax and alternative minimum tax as well. Salaries and Wages 5. This chapter explains both of these methods. Income tax is withheld from the pay of most employees. Your pay includes your regular pay, In addition, it explains the following. bonuses, commissions, and vacation al- lowances. It also includes reimbursements and • Credit for withholding and estimated Tax Withholding tax. When you file your 2003 income tax other expense allowances paid under a nonac- countable plan. See Supplemental Wages, return, take credit for all the income tax later, for more information about reimburse- and Estimated withheld from your salary, wages, pen- ments and allowances paid under a nonac- sions, etc., and for the estimated tax you countable plan. Tax paid for 2003. If your income is low enough that you will not have to pay income tax for the year, you may be • Underpayment penalty. If you did not exempt from withholding. This is explained pay enough tax during the year either under Exemption From Withholding, later. Important Changes through withholding or by making esti- mated tax payments, you may have to pay Military retirees. Military retirement pay is for 2004 a penalty. The IRS usually can figure this treated in the same manner as regular pay for income tax withholding purposes, even though it penalty for you. See Underpayment Pen- alty at the end of this chapter. is treated as a pension or annuity for other tax Tax law changes for 2004. When you figure purposes. how much income tax you want withheld from your pay and when you figure your estimated Household workers. If you are a household Useful Items tax, consider tax law changes effective in 2004. worker, you can ask your employer to withhold See Important Changes for 2004 in the front of You may want to see: income tax from your pay. this publication, or get Publication 553, High- Tax is withheld only if you want it withheld lights of 2003 Tax Changes. Publication and your employer agrees to withhold it. If you do not have enough income tax withheld, you ❏ 505 Tax Withholding and Estimated Tax may have to pay estimated tax, as discussed ❏ 553 Highlights of 2003 Tax Changes later under Estimated Tax. Important Reminder ❏ 919 How Do I Adjust My Tax Farmworkers. Income tax is generally with- Withholding? held from your cash wages for work on a farm Estimated tax safe harbor for higher income unless your employer both: taxpayers. If your adjusted gross income was Form (and Instructions) more than $150,000 ($75,000 if you are married 1) Pays you cash wages of less than $150 filing a separate return), you will have to deposit ❏ W – 4 Employee's Withholding Allowance during the year, and the smaller of 90% of your expected tax for 2004 Certificate 2) Has expenditures for agricultural labor to- or 110% of the tax shown on your 2003 return to ❏ W – 4P Withholding Certificate for taling less than $2,500 during the year. avoid an estimated tax penalty. Pension or Annuity Payments You can ask your employer to withhold in- Payment of estimated tax by electronic ❏ W – 4S Request for Federal Income Tax come tax from noncash wages and other wages funds withdrawal. You may be able to pay Withholding From Sick Pay not subject to withholding. If your employer does your estimated tax by authorizing an automatic not agree to withhold tax, or if not enough is withdrawal from your checking or savings ac- ❏ W – 4V Voluntary Withholding Request withheld, you may have to pay estimated tax, as count. For more information, see Payment by ❏ 1040 – ES Estimated Tax for Individuals discussed later under Estimated Tax. Electronic Funds Withdrawal in chapter 2 of Publication 505. ❏ 2210 Underpayment of Estimated Tax by Individuals, Estates, and Trusts Determining Amount of Tax Withheld Using Form W – 4 Introduction The amount of income tax your employer with- holds from your regular pay depends on two This chapter discusses how to pay your tax as you earn or receive income during the year. In Withholding things. general, the federal income tax is a pay-as- 1) The amount you earn. This section discusses income tax withholding you-go tax. There are two ways to pay as you 2) The information you give your employer on on these types of income: go. Form W – 4. • Withholding. If you are an employee, • Salaries and wages, Form W – 4 includes three types of informa- your employer probably withholds income • Tips, tion that your employer will use to figure your tax from your pay. Tax may also be with- withholding. held from certain other income — includ- • Taxable fringe benefits, ing pensions, bonuses, commissions, and • Sick pay, 1) Whether to withhold at the single rate or at gambling winnings. In each case, the the lower married rate. amount withheld is paid to the IRS in your • Pensions and annuities, 2) How many withholding allowances you name. • Gambling winnings, claim. (Each allowance reduces the • Estimated tax. If you do not pay your tax • Unemployment compensation, and amount withheld.) through withholding, or do not pay enough tax that way, you might have to pay esti- • Certain federal payments, such as social 3) Whether you want an additional amount security. withheld. mated tax. People who are in business for themselves generally will have to pay their This section explains in detail the rules for with- tax this way. You may have to pay esti- Note. You must specify a filing status and a holding tax from each of these types of income. mated tax if you receive income such as number of withholding allowances on Form dividends, interest, capital gains, rent, and This section also covers backup withholding W – 4. You cannot specify only a dollar amount royalties. Estimated tax is used to pay not on interest, dividends, and other payments. of withholding. Page 42 Chapter 5 Tax Withholding and Estimated Tax New Job not claim the same allowances with more than compensation, or self-employment in- one employer at the same time. You can claim come. When you start a new job, you must fill out Form all your allowances with one employer and none W – 4 and give it to your employer. Your em- with the other, or divide them any other way. • You will owe additional amounts with your return, such as self-employment tax. ployer should have copies of the form. If you need to change the information later, you must Married individuals. If both you and your • Your withholding is based on obsolete fill out a new form. spouse are employed and expect to file a joint Form W – 4 information for a substantial If you work only part of the year (for example, return, figure your withholding allowances using part of the year. you start working after the beginning of the your combined income, adjustments, deduc- year), too much tax may be withheld. You may tions, exemptions, and credits. Use only one set of worksheets. You can divide your total al- Cumulative wage method. If you change the be able to avoid overwithholding if your em- lowances any way, but you cannot claim an number of your withholding allowances during ployer agrees to use the part-year method. See allowance that your spouse also claims. the year, too much or too little tax may have Part-year method in chapter 1 of Publication 505 If you and your spouse expect to file sepa- been withheld for the period before you made for more information. rate returns, figure your allowances using sepa- the change. You may be able to compensate for rate worksheets based on your own individual this if your employer agrees to use the cumula- income, adjustments, deductions, exemptions, tive wage withholding method for the rest of the Changing Your Withholding year. You must ask in writing that your employer and credits. Events during the year may change your marital use this method. Alternative method of figuring withholding To be eligible, you must have been paid for status or the exemptions, adjustments, deduc- allowances. You do not have to use the Form tions, or credits you expect to claim on your the same kind of payroll period (weekly, bi- W – 4 worksheets if you use a more accurate weekly, etc.) since the beginning of the year. return. When this happens, you may need to method of figuring the number of withholding give your employer a new Form W – 4 to change allowances. See Alternative method of figuring your withholding status or number of al- withholding allowances under Completing Form lowances. Publication 919 W – 4 and Worksheets in chapter 1 of Publica- If the event changes your withholding status tion 505 for more information. To make sure you are getting the right amount of or the number of allowances you are claiming, Personal allowances worksheet. Use the tax withheld, get Publication 919. It will help you you must give your employer a new Form W – 4 Personal Allowances Worksheet on page 1 of compare the total tax to be withheld during the within 10 days after either of the following. Form W – 4 to figure your withholding al- year with the tax you can expect to figure on 1) Your divorce, if you have been claiming lowances for exemptions and any special al- your return. It also will help you determine how married status. lowances that apply. much additional withholding, if any, is needed each payday to avoid owing tax when you file 2) Any event that decreases the number of Deductions and adjustments worksheet. your return. If you do not have enough tax with- withholding allowances you can claim. Use this worksheet if you plan to itemize your held, you may have to pay estimated tax, as Generally, you can submit a new Form W – 4 deductions or claim adjustments to your income explained under Estimated Tax, later. whenever you wish to change the number of and you want to reduce your withholding. your withholding allowances for any other rea- Fill out this worksheet to adjust the number of son. your withholding allowances for deductions, ad- Rules Your Employer justments to income, and tax credits. The De- Must Follow Changing your withholding for 2005. If ductions and Adjustments Worksheet is on page events in 2004 will decrease the number of your 2 of Form W – 4. Chapter 1 of Publication 505 It may be helpful for you to know some of the withholding allowances for 2005, you must give explains this worksheet. withholding rules your employer must follow. your employer a new Form W – 4 by December These rules can affect how to fill out your Form Two-earner/two-job worksheet. You may 1, 2004. If the event occurs in December 2004, W – 4 and how to handle problems that may need to complete this worksheet if you have two submit a new Form W – 4 within 10 days. arise. jobs or a working spouse. You can also add to the amount, if any, on line 8 of this worksheet, New Form W – 4. When you start a new job, any additional withholding necessary to cover your employer should give you a Form W – 4 to Checking Your Withholding any amount you expect to owe other than in- fill out. Your employer will use the information After you have given your employer a Form come tax, such as self-employment tax. you give on the form to figure your withholding W – 4, you can check to see whether the amount beginning with your first payday. of tax withheld from your pay is too little or too If you later fill out a new Form W – 4, your much. See Publication 919 under Getting the Getting the Right Amount employer can put it into effect as soon as possi- Right Amount of Tax Withheld. If too much or too of Tax Withheld ble. The deadline for putting it into effect is the little tax is being withheld, you should give your start of the first payroll period ending 30 or more employer a new Form W – 4 to change your In most situations, the tax withheld from your days after you turn it in. withholding. pay will be close to the tax you figure on your return if you follow these two rules. No Form W – 4. If you do not give your em- ployer a completed Form W – 4, your employer Note. You cannot give your employer a pay- 1) You accurately complete all the Form must withhold at the highest rate — as if you ment to cover withholding for past pay periods or W – 4 worksheets that apply to you. were single and claimed no allowances. a payment for estimated tax. 2) You give your employer a new Form W – 4 Repaying withheld tax. If you find you are when changes occur. having too much tax withheld because you did Completing Form W –4 not claim all the withholding allowances you are But because the worksheets and withholding and Worksheets entitled to, you should give your employer a new methods do not account for all possible situa- Form W – 4. Your employer cannot repay any of tions, you may not be getting the right amount Form W – 4 has worksheets to help you figure the tax previously withheld. withheld. This is most likely to happen in the how many withholding allowances you can However, if your employer has withheld following situations. claim. The worksheets are for your own records. more than the correct amount of tax for the Form Do not give them to your employer. • You are married and both you and your W – 4 you have in effect, you do not have to fill spouse work. out a new Form W – 4 to have your withholding Two jobs. If you have income from two jobs at lowered to the correct amount. Your employer the same time, complete only one set of Form • You have more than one job at a time. can repay the amount that was incorrectly with- W – 4 worksheets. Then split your allowances • You have nonwage income, such as inter- held. If you are not repaid, your Form W – 2 will between the Forms W – 4 for each job. You can- est, dividends, alimony, unemployment reflect the full amount actually withheld. Chapter 5 Tax Withholding and Estimated Tax Page 43 Exemption From Withholding are more than your proven expenses are treated Allocated tips. Your employer should not as paid under a nonaccountable plan if you do withhold income tax, social security tax, Medi- If you claim exemption from withholding, your not return the excess payments within a reason- care tax, or railroad retirement tax on any allo- employer will not withhold federal income tax able period of time. cated tips. Withholding is based only on your from your wages. The exemption applies only to For more information about accountable and pay plus your reported tips. Your employer income tax, not to social security or Medicare nonaccountable expense allowance plans, see should refund to you any incorrectly withheld tax. Reimbursements in chapter 28. tax. See Allocated Tips in chapter 7 for more You can claim exemption from withholding information. for 2004 only if both the following situations apply. Penalties Taxable Fringe Benefits 1) For 2003 you had a right to a refund of all You may have to pay a penalty of $500 if both of federal income tax withheld because you The value of certain fringe benefits you receive the following apply. from your employer is considered part of your had no tax liability. pay. Your employer generally must withhold in- 2) For 2004 you expect a refund of all federal 1) You make statements or claim withholding come tax on these benefits from your regular income tax withheld because you expect allowances on your Form W – 4 that reduce pay. to have no tax liability. the amount of tax withheld. For information on fringe benefits, see Fringe 2) You have no reasonable basis for those Benefits under Employee Compensation in Student. If you are a student, you are not statements or allowances at the time you chapter 6. automatically exempt. See chapter 1 to see prepare your Form W – 4. Your employer can choose not to withhold whether you must file a return. If you work only income tax on the value of your personal use of part time or only during the summer, you may There is also a criminal penalty for willfully supplying false or fraudulent information on your an employer-provided car, truck, or other high- qualify for exemption from withholding. way motor vehicle. Your employer must notify Form W – 4 or for willfully failing to supply infor- Age 65 or older or blind. If you are 65 or older mation that would increase the amount withheld. you if this choice is made. or blind, use one of the worksheets in chapter 1 The penalty upon conviction can be either a fine For more information on withholding on tax- of Publication 505, under Exemption From With- of up to $1,000 or imprisonment for up to one able fringe benefits, see chapter 1 of Publication holding, to help you decide whether you can year, or both. 505. claim exemption from withholding. Do not use These penalties will apply if you deliberately either worksheet if you will itemize deductions, claim exemptions for dependents, or claim tax and knowingly falsify your Form W – 4 in an Sick Pay attempt to reduce or eliminate the proper with- credits on your 2004 return. See Itemizing de- holding of taxes. A simple error — an honest Sick pay is a payment to you to replace your ductions or claiming exemptions or tax credits in mistake — will not result in one of these penal- regular wages while you are temporarily absent Publication 505. ties. For example, a person who has tried to from work due to sickness or personal injury. To Claiming exemption from withholding. To figure the number of withholding allowances cor- qualify as sick pay, it must be paid under a plan claim exemption, you must give your employer a rectly, but claims seven when the proper num- to which your employer is a party. Form W – 4. Print "EXEMPT" on line 7. ber is six, will not be charged a W – 4 penalty. If you receive sick pay from your employer or Your employer must send the IRS a copy of an agent of your employer, income tax must be withheld. An agent who does not pay regular your Form W – 4 if you claim exemption from Tips wages to you may choose to withhold income withholding and your pay is expected to usually be more than $200 a week. If it turns out that you The tips you receive while working on your job tax at a flat rate. do not qualify for exemption, the IRS will send are considered part of your pay. You must in- However, if you receive sick pay from a third both you and your employer a written notice. clude your tips on your tax return on the same party who is not acting as an agent of your If you claim exemption, but later your situa- line as your regular pay. However, tax is not employer, income tax will be withheld only if you tion changes so that you will have to pay income withheld directly from tip income, as it is from choose to have it withheld. See Form W – 4S, tax after all, you must file a new Form W – 4 your regular pay. Nevertheless, your employer later. within 10 days after the change. If you claim will take into account the tips you report when If you receive payments under a plan in exemption in 2004, but you expect to owe in- figuring how much to withhold from your regular which your employer does not participate (such come tax for 2005, you must file a new Form pay. as an accident or health plan where you paid all W – 4 by December 1, 2004. See chapter 7 for information on reporting the premiums), the payments are not sick pay your tips to your employer. For more information and usually are not taxable. An exemption is good for only one year. You must give your employer a new Form W – 4 on the withholding rules for tip income, see Pub- lication 531, Reporting Tip Income. Union agreements. If you receive sick pay by February 15 each year to continue your ex- under a collective bargaining agreement be- emption. tween your union and your employer, the agree- How employer figures amount to withhold. The tips you report to your employer are counted ment may determine the amount of income tax as part of your income for the month you report withholding. See your union representative or Supplemental Wages your employer for more information. them. Your employer can figure your withholding Supplemental wages include bonuses, commis- in either of two ways. Form W – 4S. If you choose to have income sions, overtime pay, vacation allowances, cer- tax withheld from sick pay paid by a third party, tain sick pay, and expense allowances under 1) By withholding at the regular rate on the sum of your pay plus your reported tips. such as an insurance company, you must fill out certain plans. The payer can figure withholding Form W – 4S. Its instructions contain a work- on supplemental wages using the same method 2) By withholding at the regular rate on your sheet you can use to figure the amount you want used for your regular wages. If these payments pay plus a percentage of your reported withheld. They also explain restrictions that may are identified separately from your regular tips. apply. wages, your employer or other payer of supple- Give the completed form to the payer of your mental wages can withhold income tax from Not enough pay to cover taxes. If your regu- sick pay. The payer must withhold according to these wages at a flat rate. lar pay is not enough for your employer to with- your directions on the form. Expense allowances. Reimbursements or hold all the tax (including income tax, social If you do not request withholding on Form other expense allowances paid by your em- security tax, Medicare tax, or railroad retirement W – 4S, or if you do not have enough tax with- ployer under a nonaccountable plan are treated tax) due on your pay plus your tips, you can give held, you may have to make estimated tax pay- as supplemental wages. your employer money to cover the shortage. ments. If you do not pay enough estimated tax or Reimbursements or other expense al- See Giving your employer money for taxes in have enough income tax withheld, you may lowances paid under an accountable plan that chapter 7. have to pay a penalty. Page 44 Chapter 5 Tax Withholding and Estimated Tax ing can apply to most kinds of payments that are Pensions and Annuities Unemployment reported on Form 1099. Income tax usually will be withheld from your Compensation The payer must withhold at a flat rate in the pension or annuity distributions unless you following situations. You can choose to have income tax withheld choose not to have it withheld. This rule applies from unemployment compensation. To make • You do not give the payer your TIN in the to distributions from: this choice, you will have to fill out Form W – 4V required manner. • A traditional individual retirement arrange- (or a similar form provided by the payer) and • The IRS notifies the payer that the TIN ment (IRA), give it to the payer. you gave is incorrect. Unemployment compensation is taxable. So, • A life insurance company under an en- if you do not have income tax withheld, you may • You are required, but fail, to certify that dowment, annuity, or life insurance con- have to pay estimated tax. See Estimated Tax, you are not subject to backup withholding. tract, later. • The IRS notifies the payer to start with- • A pension, annuity, or profit-sharing plan, If you do not pay enough tax either through holding on interest or dividends because withholding or estimated tax, you may have to • A stock bonus plan, and you have underreported interest or divi- pay a penalty. See Underpayment Penalty, dends on your income tax return. The IRS • Any other plan that defers the time you later, for information. will do this only after it has mailed you four receive compensation. notices over at least a 120-day period. The amount withheld depends on whether Federal Payments See Backup Withholding in chapter 1 of Publi- you receive payments spread out over more You can choose to have income tax withheld cation 505 for more information. than one year (periodic payments), within one from certain federal payments you receive. year (nonperiodic payments), or as an eligible These payments are: Penalties. There are civil and criminal penal- rollover distribution (ERD). You cannot choose ties for giving false information to avoid backup not to have income tax withheld from an ERD. 1) Social security benefits, withholding. The civil penalty is $500. The crimi- 2) Tier 1 railroad retirement benefits, nal penalty, upon conviction, is a fine of up to More information. For more information on $1,000 or imprisonment of up to 1 year, or both. taxation of annuities and distributions (including 3) Commodity credit loans you choose to in- eligible rollover distributions) from qualified re- clude in your gross income, and tirement plans, see chapter 11. For information 4) Payments under the Agricultural Act of on IRAs, see chapter 18. For more information on withholding on pensions and annuities, in- 1949 (7 U.S.C. 1421 et. seq.), or title II of the Disaster Assistance Act of 1988, as Estimated Tax cluding a discussion of Form W – 4P, see Pen- amended, that are treated as insurance sions and Annuities in chapter 1 of Publication Estimated tax is the method used to pay tax on proceeds and that you receive because: 505. income that is not subject to withholding. This a) Your crops were destroyed or damaged includes income from self-employment, interest, dividends, alimony, rent, gains from the sale of Gambling Winnings by drought, flood, or any other natural disaster, or assets, prizes, and awards. You also may have Income tax is withheld from certain kinds of to pay estimated tax if the amount of income tax b) You were unable to plant crops be- being withheld from your salary, pension, or gambling winnings at a flat rate. cause of a natural disaster described in other income is not enough. Gambling winnings of more than $5,000 from (a). the following sources are subject to income tax Estimated tax is used to pay both income tax withholding. and self-employment tax, as well as other taxes To make this choice, you will have to fill out Form W – 4V, Voluntary Withholding Request, and amounts reported on your tax return. If you • Any sweepstakes, wagering pool, or lot- (or a similar form provided by the payer) and do not pay enough through withholding or esti- tery. give it to the payer. mated tax payments, you may have to pay a penalty. If you do not pay enough by the due • Any other wager, if the proceeds are at If you do not choose to have income tax date of each payment period (see When To Pay least 300 times the amount of the bet. withheld, you may have to pay estimated tax. Estimated Tax, later), you may be charged a See Estimated Tax, later. It does not matter whether your winnings are penalty even if you are due a refund when you paid in cash, in property, or as an annuity. Win- If you do not pay enough tax either through file your tax return. For information on when the nings not paid in cash are taken into account at withholding or estimated tax, you may have to penalty applies, see Underpayment Penalty, their fair market value. pay a penalty. See Underpayment Penalty, later. later, for information. Gambling winnings from bingo, keno, and slot machines generally are not subject to income More information. For more information Who Does Not Have To tax withholding. However, you may need to pro- about the tax treatment of social security and vide the payer with a social security number to railroad retirement benefits, see chapter 12. Get Pay Estimated Tax avoid withholding. See Backup withholding on Publication 225, Farmer's Tax Guide, for infor- If you receive salaries or wages, you can avoid gambling winnings in Publication 505. If you mation about the tax treatment of commodity having to pay estimated tax by asking your em- receive gambling winnings not subject to with- credit loans or crop disaster payments. ployer to take more tax out of your earnings. To holding, you may need to pay estimated tax. See do this, give a new Form W – 4 to your employer. Estimated Tax, later. Backup Withholding See chapter 1. If you do not pay enough tax through with- holding or estimated tax payments, you may Banks and other businesses that pay you cer- Estimated tax not required. You do not have have to pay a penalty. See Underpayment Pen- tain kinds of income must file an information to pay estimated tax for 2004 if you meet all alty, later. return (Form 1099) with the IRS. The informa- three of the following conditions. tion return shows how much you were paid dur- Form W – 2G. If a payer withholds income tax ing the year. It also includes your name and 1) You had no tax liability for 2003. from your gambling winnings, you should re- taxpayer identification number (TIN). TINs are explained in chapter 1. 2) You were a U.S. citizen or resident for the ceive a Form W – 2G, Certain Gambling Win- whole year. nings, showing the amount you won and the These payments generally are not subject to amount withheld. Report the tax withheld on line withholding. However, "backup" withholding is 3) Your 2003 tax year covered a 12-month 61 of Form 1040. required in certain situations. Backup withhold- period. Chapter 5 Tax Withholding and Estimated Tax Page 45 Figure 5–A. Do You Have To Pay Estimated Tax? Start Here Will you owe $1,000 or more Will your income tax Will your income tax for 2004 after subtracting Yes withholding and credits be at No withholding and credits be at No income tax withholding and least 90% (66-2/3% for farmers least 100%* of the tax shown credits from your total tax? and fishermen) of the tax on your 2003 tax return? (Do not subtract any shown on your 2004 tax estimated tax payments.) return? Note: Your 2003 return must have covered a 12-month Yes period. No Yes You are NOT required to pay estimated tax. You MUST make estimated tax payment(s) by the required due date(s). See When To Pay Estimated Tax. * 110% if less than two-thirds of your gross income for 2003 and 2004 is from farming or fishing and your 2003 adjusted gross income was more than $150,000 ($75,000 if your filing status for 2004 is married filing a separate return). You had no tax liability for 2003 if your total If you can make joint estimated tax payments, The tax you would have paid tax was zero or you did not have to file an you can apply these rules on a joint basis. had you filed a separate return income tax return. You and your spouse can make joint esti- The total tax you and your mated tax payments even if you are not living spouse would have paid had Who Must Pay together. you filed separate returns Estimated Tax? You and your spouse cannot make joint esti- Example. Joe and Heather filed a joint re- mated tax payments if: turn for 2003 showing taxable income of If you had a tax liability for 2003, you may have $48,500 and a tax of $6,579. Of the $48,500 to pay estimated tax for 2004. 1) You are legally separated under a decree taxable income, $40,100 was Joe's and the rest of divorce or separate maintenance, was Heather's. For 2004, they plan to file mar- General rule. You must pay estimated tax for 2004 if both of the following apply. ried filing separately. Joe figures his share of the 2) Either spouse is a nonresident alien, or tax on the 2003 joint return as follows. 1) You expect to owe at least $1,000 in tax 3) You and your spouse have different tax for 2004 after subtracting your withholding years. Tax on $40,100 based on a separate and credits. return . . . . . . . . . . . . . . . . . . . . . $ 6,841 Whether you and your spouse make joint Tax on $8,400 based on a separate 2) You expect your withholding and credits to estimated tax payments or separate payments return . . . . . . . . . . . . . . . . . . . . . 914 be less than the smaller of: will not affect your choice of filing a joint tax Total . . . . . . . . . . . . . . . . . . . . . . $ 7,755 return or separate returns for 2004. Joe's percentage of total ($6,841 ÷ • 90% of the tax to be shown on your 2004 $7,755) . . . . . . . . . . . . . . . . . . . . 88% tax return, or 2003 separate returns and 2004 joint return. If you plan to file a joint return with your Joe's share of tax on joint return • 100% of the tax shown on your 2003 tax spouse for 2004, but you filed separate returns ($6,579 × 88%) . . . . . . . . . . . . . . $ 5,790 return. Your 2003 tax return must cover all for 2003, your 2003 tax is the total of the tax 12 months. shown on your separate returns. You filed a separate return if you filed as single, head of How To Figure Special rules for farmers, fishermen, and higher income taxpayers. There are excep- household, or married filing separately. Estimated Tax tions to the general rule for farmers, fishermen, 2003 joint return and 2004 separate re- To figure your estimated tax, you must figure and certain higher income taxpayers. See Fig- turns. If you plan to file a separate return for your expected adjusted gross income, taxable ure 5 – A and chapter 2 of Publication 505 for 2004, but you filed a joint return for 2003, your income, taxes, deductions, and credits for the more information. 2003 tax is your share of the tax on the joint year. Aliens. Resident and nonresident aliens return. You file a separate return if you file as When figuring your 2004 estimated tax, it may also have to pay estimated tax. Resident single, head of household, or married filing sep- may be helpful to use your income, deductions, aliens should follow the rules in this chapter arately. and credits for 2003 as a starting point. Use your unless noted otherwise. Nonresident aliens 2003 federal tax return as a guide. You can use To figure your share of the tax on the joint Form 1040 – ES to figure your estimated tax. should get Form 1040 – ES(NR), U.S. Estimated return, first figure the tax both you and your Tax for Nonresident Alien Individuals. You must make adjustments both for spouse would have paid had you filed separate changes in your own situation and for recent Married taxpayers. To figure whether you returns for 2003 using the same filing status as changes in the tax law. For 2004, there are must pay estimated tax, apply the rules dis- for 2004. Then multiply the tax on the joint return several changes in the law. Some of these cussed here to your separate estimated income. by the following fraction. changes are discussed in Publication 553, High- Page 46 Chapter 5 Tax Withholding and Estimated Tax lights of 2003 Tax Changes, or visit the IRS tax by the due date for that period, or you can Estimated Tax Payments website at www.irs.gov. pay it in installments by the due date for that Not Required Form 1040 – ES includes a worksheet to help period and the due dates for the remaining peri- you figure your estimated tax. Keep the work- ods. The following chart shows when to make You do not have to pay estimated tax if your sheet for your records. installment payments. withholding in each payment period is at least as For more complete information and exam- much as: ples of how to figure your estimated tax for 2004, If you first see chapter 2 of Publication 505. have income • One-fourth of your required annual pay- on which you Make a Make later ment, or When To Pay must pay payment installments • Your required annualized income install- estimated tax: by: by: ment for that period. Estimated Tax You also do not have to pay estimated tax if you Before Apr. 1 Apr. 15 June 15 For estimated tax purposes, the year is divided will pay enough through withholding to keep the Sept. 15 into four payment periods. Each period has a amount you owe with your return under $1,000. Jan. 15 next specific payment due date. If you do not pay year* enough tax by the due date of each of the pay- How To Pay Estimated Tax ment periods, you may be charged a penalty even if you are due a refund when you file your After Mar. 31 June 15 Sept. 15 There are five ways to pay estimated tax. income tax return. The following chart gives the and Jan. 15 next payment periods and due dates for estimated before June 1 year* 1) By crediting an overpayment on your tax payments. 2003 return to your 2004 estimated tax. After May 31 Sept. 15 Jan. 15 next 2) By sending in your payment with a For the period: Due date: and year* payment-voucher from Form 1040 – ES. before Sept. 1 3) By using the Electronic Federal Tax Jan. 1* through Mar. 31 Apr. 15 Payment System (EFTPS). For EFTPS April 1 through May 31 June 15 After Aug. 31 Jan. 15 (None) information, call 1 – 800 – 945 – 8400 or next year* 1 – 800 – 555 – 4477. June 1 through Aug. 31 Sept. 15 4) By electronic funds withdrawal if you Sept. 1 through Dec. 31 Jan. 15 *See January payment, and Saturday, are filing Form 1040 or Form 1040A elec- next year** Sunday, holiday rule under When To Pay tronically. Estimated Tax, earlier. 5) By credit card using a pay-by-phone sys- *If your tax year does not begin on January 1, tem or the Internet. see the Form 1040 – ES instructions. How much to pay to avoid a penalty. To **See January payment, later. determine how much you should pay by each payment due date, see How To Figure Each Payment, next. If the earlier discussions of No Crediting an Overpayment Saturday, Sunday, holiday rule. If the due income subject to estimated tax during first pe- date for an estimated tax payment falls on a riod or Change in estimated tax apply to you, When you file your Form 1040 or Form 1040A Saturday, Sunday, or legal holiday, the payment you may need to read Annualized Income In- for 2003 and you have an overpayment of tax, will be on time if you make it on the next day that stallment Method in chapter 2 of Publication 505 you can apply part or all of it to your estimated is not a Saturday, Sunday, or legal holiday. For for information on how to avoid a penalty. tax for 2004. On line 71 of Form 1040, or line 46 example, a payment due Saturday, January 15, 2005, will be on time if you make it by Tuesday, of Form 1040A, write the amount you want January 18, 2005. January 17 is a legal holiday. How To Figure credited to your estimated tax rather than re- funded. The amount you have credited should January payment. If you file your 2004 Form Each Payment be taken into account when figuring your esti- 1040 or Form 1040A by January 31, 2005, and mated tax payments. pay the rest of the tax you owe, you do not need You should pay enough estimated tax by the You can use all the credited amount toward to make the payment due on January 18, 2005. due date of each payment period to avoid a your first payment, or you can spread it out in penalty for that period. You can figure your re- any way you choose among any or all of your Fiscal year taxpayers. If your tax year does quired payment for each period by using either payments. not start on January 1, see the Form 1040 – ES the regular installment method or the annualized instructions for your payment due dates. If you ask that an overpayment be credited to income installment method. These methods are your estimated tax for the next year, the pay- described in Publication 505. If you do not pay ment is considered to have been made on the enough each payment period, you may be due date of the first estimated tax installment When To Start charged a penalty even if you are due a refund (April 15 for calendar year taxpayers). You can- when you file your tax return. not have any of that amount refunded to you You do not have to make estimated tax pay- ments until you have income on which you will Underpayment penalty. If your estimated after that due date until the close of that tax year. owe the tax. If you have income subject to esti- tax payment for a previous period is less than You also cannot use that overpayment in any mated tax during the first payment period, you one-fourth of your amended estimated tax, you other way after that date. must make your first payment by the due date may be charged a penalty for underpayment of for the first payment period. You can pay all your estimated tax for that period when you file your estimated tax at that time, or you can pay it in tax return. See chapter 4 of Publication 505 for Using Payment-Vouchers installments. If you choose to pay in install- more information. ments, make your first payment by the due date Each payment of estimated tax must be accom- for the first payment period. Make your remain- Change in estimated tax. After you make an panied by a payment-voucher from Form ing installment payments by the due dates for estimated tax payment, changes in your income, 1040 – ES. If you made estimated tax payments the later periods. adjustments, deductions, credits, or exemptions last year, you should receive a copy of the 2003 may make it necessary for you to refigure your Form 1040 – ES in the mail. It will have No income subject to estimated tax during estimated tax. Pay the unpaid balance of your payment-vouchers preprinted with your name, first period. If you do not have income subject amended estimated tax by the next payment address, and social security number. Using the to estimated tax until a later payment period, you due date after the change or in installments by preprinted vouchers will speed processing, re- can make your first payment by the due date for that date and the due dates for the remaining duce the chance of error, and help save that period. You can pay your entire estimated payment periods. processing costs. Chapter 5 Tax Withholding and Estimated Tax Page 47 If you did not pay estimated tax last year, you See Credit for Excess Social Security Tax or The 1099 Series will have to get Form 1040 – ES. After you make Railroad Retirement Tax Withheld in chapter 39. your first payment, a Form 1040 – ES package Most forms in the 1099 series are not filed with with the preprinted vouchers will be mailed to your return. You should be sent these forms by you. Follow the instructions in the package to Withholding February 2, 2004. Keep these forms for your make sure you use the vouchers correctly. records. There are several different forms in this If you had income tax withheld during 2003, you Use the window envelopes that came with series, including: should be sent a statement by February 2, 2004, your Form 1040 – ES package. If you use your showing your income and the tax withheld. De- • Form 1099 – B, Proceeds From Broker and own envelope, make sure you mail your pending on the source of your income, you will Barter Exchange Transactions, payment-vouchers to the address shown in the Form 1040 – ES instructions for the place where receive: • Form 1099 – DIV, Dividends and Distribu- you live. • Form W – 2, Wage and Tax Statement, tions, Do not use the address shown in the • Form W – 2G, Certain Gambling Winnings, • Form 1099 – G, Certain Government Pay- ments, ! Form 1040 or Form 1040A instruc- or CAUTION tions. • A form in the 1099 series. • Form 1099 – INT, Interest Income, If you file a joint return and you are making • Form 1099 – MISC, Miscellaneous Income, joint estimated tax payments, please enter the names and social security numbers on the pay- Forms W – 2 and W – 2G. You file Form W – 2 • Form 1099 – OID, Original Issue Discount, with your income tax return. File Form W – 2G ment voucher in the same order as they will with your return if it shows any federal income • Form 1099 – R, Distributions From Pen- appear on the joint return. sions, Annuities, Retirement or tax withheld from your winnings. Profit-Sharing Plans, IRAs, Insurance Change of address. You must notify the IRS You should get at least two copies of each Contracts, etc., if you are making estimated tax payments and form you receive. Attach one copy to the front of your federal income tax return. Keep one copy • Form SSA – 1099, Social Security Benefit you changed your address during the year. You for your records. You should also receive copies Statement, and must send a clear and concise written statement to the IRS Service Center where you filed your to file with your state and local returns. • Form RRB – 1099, Payments by the Rail- last return and provide all of the following: road Retirement Board. • Your full name (and your spouse's full Form W –2 If you received the types of income reported name), on some forms in the 1099 series, you may not Your employer should send you a Form W – 2 for • Your signature (and spouse's signature), 2003 by February 2, 2004. You should receive a be able to use Form 1040A or Form 1040EZ. See the instructions to these forms for details. • Your old address (and spouse's old ad- separate Form W – 2 from each employer you dress if different), worked for. Form 1099 – R. Attach Form 1099 – R to your return if box 4 shows federal income tax with- • Your new address, and If you stopped working before the end of the held. Include the amount withheld in the total on year, your employer could have given you your • Your social security number (and spouse's Form W – 2 at any time after you stopped work- line 61 of Form 1040 or line 39 of Form 1040A. social security number). You cannot use Form 1040EZ if you received ing. However, your employer must send it to you payments reported on Form 1099 – R. You can use Form 8822, Change of Address, for by February 2, 2004. this purpose. If you ask for the form, your employer must Backup withholding. If you were subject to send it to you within 30 days after receiving your backup withholding on income you received dur- You can continue to use your old preprinted ing 2003, include the amount withheld, as written request or within 30 days after your final payment-vouchers until the IRS sends you new shown on your Form 1099, in the total on line 61 ones. However, do not correct the address on wage payment, whichever is later. If you have not received your Form W – 2 on of Form 1040, or line 39 of Form 1040A. the old voucher. time, you should ask your employer for it. If you do not receive it by February 17, call the IRS. Form Not Correct Payment by Electronic Funds Form W – 2 shows your total pay and other Withdrawal or Credit Card compensation and the income tax, social secur- If you receive a form with incorrect information ity tax, and Medicare tax that was withheld dur- on it, you should ask the payer for a corrected If you want to make estimated payments by ing the year. Include the federal income tax form. Call the telephone number or write to the electronic funds withdrawal or by credit card, withheld (as shown on Form W – 2) on: address given for the payer on the form. The see the Form 1040 – ES instructions or How To corrected Form W – 2G or Form 1099 you re- Pay Estimated Tax in Publication 505. • Line 61 if you file Form 1040, ceive will be marked "Corrected." A special form, • Line 39 if you file Form 1040A, or Form W – 2c, Corrected Wage and Tax State- ment, is used to correct a Form W – 2. • Line 7 if you file Form 1040EZ. Credit for Withholding Form W – 2 is also used to report any taxable Form Received After Filing sick pay you received and any income tax with- and Estimated Tax held from your sick pay. If you file your return and you later receive a form for income that you did not include on your When you file your 2003 income tax return, take Form W –2G return, you should report the income and take credit for all the income tax and excess social If you had gambling winnings in 2003, the payer credit for any income tax withheld by filing Form security or railroad retirement tax withheld from may have withheld income tax. If tax was with- 1040X, Amended U.S. Individual Income Tax your salary, wages, pensions, etc. Also, take held, the payer will give you a Form W – 2G Return. credit for the estimated tax you paid for 2003. These credits are subtracted from your tax. You showing the amount you won and the amount of should file a return and claim these credits, even tax withheld. Separate Returns if you do not owe tax. Report the amounts you won on line 21 of If you had two or more employers and were Form 1040. Take credit for the tax withheld on If you are married but file a separate return, you paid wages of more than $87,000 during 2003, line 61 of Form 1040. If you had gambling win- can take credit only for the tax withheld from too much social security or railroad retirement nings, you must use Form 1040; you cannot use your own income. Do not include any amount tax may have been withheld from your wages. Form 1040A or Form 1040EZ. withheld from your spouse's income. However, Page 48 Chapter 5 Tax Withholding and Estimated Tax different rules may apply if you live in a commu- Separate Returns ments, you will have an underpayment of esti- nity property state. mated tax and you may have to pay a penalty. Community property states are listed in If you and your spouse made separate esti- Generally, you will not have to pay a penalty for chapter 2. For more information on these rules, mated tax payments for 2003 and you file sepa- 2003 if any of the following situations applies. and some exceptions, see Publication 555, rate returns, you can take credit only for your Community Property. own payments. • The total of your withholding and esti- mated tax payments was at least as much If you made joint estimated tax payments, as your 2002 tax (or 110% of your 2002 you must decide how to divide the payments tax if your adjusted gross income was Fiscal Years between your returns. One of you can claim all more than $150,000 — $75,000 if your of the estimated tax paid and the other none, or If you file your tax return on the basis of a fiscal 2003 filing status is married filing sepa- you can divide it in any other way you agree on. year (a 12-month period ending on the last day rately) and you paid all required estimated If you cannot agree, you must divide the pay- of any month except December), you must fol- tax payments on time. ments in proportion to each spouse's individual low special rules to determine your credit for tax as shown on your separate returns for 2003. • The tax balance due on your return is no federal income tax withholding. For a discussion more than 10% of your total 2003 tax, and of how to take credit for withholding on a fiscal you paid all required estimated tax pay- year return, see Fiscal Years in chapter 3 of Divorced Taxpayers ments on time. Publication 505. If you made joint estimated tax payments for • Your total 2003 tax minus your withholding 2003, and you were divorced during the year, is less than $1,000. Estimated Tax either you or your former spouse can claim all of • You did not have a tax liability for 2002. the joint payments, or you each can claim part of Take credit for all your estimated tax payments them. If you cannot agree on how to divide the • You did not have any withholding taxes for 2003 on line 62 of Form 1040 or line 40 of and your current year tax less any house- Form 1040A. Include any overpayment from payments, you must divide them in proportion to each spouse's individual tax as shown on your hold employment taxes is less than 2002 that you had credited to your 2003 esti- $1,000. mated tax. You must use Form 1040 or Form separate returns for 2003. 1040A if you paid estimated tax. You cannot use If you claim any of the joint payments on your Special rules apply if you are a farmer or fisher- Form 1040EZ. tax return, enter your former spouse's social man. See Farmers and Fishermen in chapter 4 security number (SSN) in the space provided on of Publication 505 for more information. Name changed. If you changed your name, the front of Form 1040 or Form 1040A. If you and you made estimated tax payments using divorced and remarried in 2003, enter your pres- IRS can figure the penalty for you. If you your old name, attach a brief statement to the ent spouse's SSN in that space and write your think you owe the penalty but you do not want to front of your tax return indicating: former spouse's SSN, followed by "DIV," to the figure it yourself when you file your tax return, • When you made the payments, left of line 62, Form 1040, or line 40, Form you may not have to. Generally, the IRS will 1040A. figure the penalty for you and send you a bill. • The amount of each payment, However, you must complete Form 2210 and • The IRS address to which you sent the attach it to your return if you think you are able to payments, lower or eliminate your penalty. See chapter 4 of • Your name when you made the payments, Underpayment Penalty Publication 505. and If you did not pay enough tax either through • Your social security number. withholding or by making estimated tax pay- The statement should cover payments you made jointly with your spouse as well as any you made separately. Chapter 5 Tax Withholding and Estimated Tax Page 49 Part Two. Income 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 Schedule D (Form 1040) and for information on selling your home. ❏ 525 Taxable and Nontaxable Income reimbursed for moving expenses, get Publica- tion 521, Moving Expenses. 6. Back pay awards. Include in income amounts you are awarded in a settlement or judgment for Employee back pay. These include payments made to you for damages, unpaid life insurance premiums, Wages, Salaries, Compensation and unpaid health insurance premiums. They should be reported to you by your employer on and Other This section discusses various types of em- ployee compensation including fringe benefits, Form W – 2. Bonuses and awards. Bonuses or awards retirement plan contributions, stock options, and Earnings restricted property. you receive for outstanding work are included in your income and should be shown on your Form Form W – 2. If you are an employee, you W – 2. These include prizes such as vacation should receive Form W – 2 from your employer trips for meeting sales goals. If the prize or Important Reminder showing the pay you received for your services. award you receive is goods or services, you must include the fair market value of the goods Include your pay on line 7 of Form 1040 or Form 1040A, or on line 1 of Form 1040EZ, even if you or services in your income. However, if your Foreign income. If you are a U.S. citizen or do not receive a Form W – 2. employer merely promises to pay you a bonus or resident alien, you must report income from award at some future time, it is not taxable until sources outside the United States (foreign in- Child care providers. If you provide child- you receive it or it is made available to you. come) on your tax return unless it is exempt by U.S. law. This is true whether you reside inside care, either in the child's home or in your home Employee achievement award. If you re- or outside the United States and whether or not or other place of business, the pay you receive ceive tangible personal property (other than you receive a Form W – 2, Wage and Tax State- must be included in your income. If you are not cash, a gift certificate, or an equivalent item) as ment, or Form 1099 from the foreign payer. This an employee, you are probably self-employed an award for length of service or safety achieve- applies to earned income (such as wages and and must include payments for your services on ment, you can generally exclude its value from tips) as well as unearned income (such as inter- Schedule C (Form 1040), Profit or Loss From your income. However, the amount you can ex- est, dividends, capital gains, pensions, rents, Business, or Schedule C – EZ (Form 1040), Net clude is limited to your employer's cost and and royalties). Profit From Business. You are generally not an cannot be more than $1,600 ($400 for awards employee unless you are subject to the will and that are not qualified plan awards) for all such If you reside outside the United States, you control of the person who employs you as to awards you receive during the year. Your em- may be able to exclude part or all of your foreign what you are to do and how you are to do it. ployer can tell you whether your award is a source earned income. For details, see Publica- tion 54, Tax Guide for U.S. Citizens and Resi- Baby-sitting. If you baby-sit for relatives or qualified plan award. Your employer must make dent Aliens Abroad. neighborhood children, whether on a regular the award as part of a meaningful presentation, basis or only periodically, the rules for childcare under conditions and circumstances that do not providers apply to you. create a significant likelihood of it being dis- guised pay. However, the exclusion does not apply to the Introduction Miscellaneous following awards. This chapter discusses compensation received Compensation • A length-of-service award if you received for services as an employee, such as wages, it for less than 5 years of service or if you salaries, and fringe benefits. The topics include: This section discusses different types of em- received another length-of-service award ployee compensation. • Bonuses and awards, during the year or the previous 4 years. • Special rules for certain employees, and Advance commissions and other earnings. • A safety achievement award if you are a If you receive advance commissions or other manager, administrator, clerical employee, • Sickness and injury benefits. amounts for services to be performed in the or other professional employee or if more future and you are a cash method taxpayer, you than 10% of eligible employees previously The chapter explains what income is included must include these amounts in your income in received safety achievement awards dur- in the employee's gross income and what is not the year you receive them. ing the year. included. If you repay unearned commissions or other amounts in the same year you receive them, reduce the amount included in your income by Example. Ben Green received three em- Useful Items the repayment. If you repay them in a later tax ployee achievement awards during the year: a You may want to see: year, you can deduct the repayment as an item- nonqualified plan award of a watch valued at ized deduction on your Schedule A (Form 1040), $250, and two qualified plan awards of a stereo Publication or you may be able to take a credit for that year. valued at $1,000 and a set of golf clubs valued at ❏ 463 Travel, Entertainment, Gift, and Car See Repayments in chapter 13. $500. Assuming that the requirements for quali- Expenses fied plan awards are otherwise satisfied, each Allowances and reimbursements. If you re- award by itself would be excluded from income. ❏ 503 Child and Dependent Care ceive travel, transportation, or other business However, since the $1,750 total value of the Expenses expense allowances or reimbursements from awards is more than $1,600, Ben must include ❏ 505 Tax Withholding and Estimated Tax your employer, get Publication 463. If you are $150 ($1,750 – $1,600) in his income. Page 50 Chapter 6 Wages, Salaries, and Other Earnings Government cost-of-living allowances. 3) An association of employers or employ- your fringe benefits may also be noted in box 12. Cost-of-living allowances are generally included ees. The value of your fringe benefits may be added in your income. However, they are not included to your other compensation on one Form W – 2, 4) An insurance company, if your employer in your income if you are a federal civilian em- or you may receive a separate Form W – 2 show- paid for the plan. ployee or a federal court employee who is sta- ing just the value of your fringe benefits in box 1 tioned in Alaska, Hawaii, or outside the United However, if you paid the premiums on an acci- with a notation in box 12. States. dent or health insurance policy, the benefits you Allowances and differentials that increase receive under the policy are not taxable. your basic pay as an incentive for taking a less Social security and Medicare taxes paid by Accident or Health Plan desirable post of duty are part of your compen- employer. If you and your employer have an Generally, the value of accident or health plan sation and must be included in income. For agreement that your employer pays your social coverage provided to you by your employer is example, your compensation includes Foreign security and Medicare taxes without deducting not included in your income. Benefits you re- Post, Foreign Service, and Overseas Tropical them from your gross wages, you must report ceive from the plan are generally taxable, as differentials. For more information, get Publica- the amount of tax paid for you as taxable wages explained later under Sickness and Injury Bene- tion 516, U.S. Government Civilian Employees on your tax return. The payment is also treated fits. Stationed Abroad. as wages for figuring your social security and Note received for services. If your employer Medicare taxes and your social security and Long-term care coverage. Contributions by gives you a secured note as payment for your Medicare benefits. However, these payments your employer to provide coverage for long-term services, you must include the fair market value are not treated as social security and Medicare care services are generally not included in your (usually the discount value) of the note in your wages if you are a household worker or a farm income. However, contributions made through a income for the year you receive it. When you worker. flexible spending or similar arrangement (such later receive payments on the note, a propor- as a cafeteria plan) must be included in your Stock appreciation rights. Do not include a income. This amount will be reported as wages tionate part of each payment is the recovery of stock appreciation right granted by your em- the fair market value that you previously in- in box 1 of your Form W – 2. ployer in income until you exercise (use) the Contributions you make to the plan are dis- cluded in your income. Do not include that part right. When you use the right, you are entitled to again in your income. Include the rest of the cussed in Publication 502, Medical and Dental a cash payment equal to the fair market value of Expenses. payment in your income in the year of payment. the corporation's stock on the date of use minus If your employer gives you a nonnegotiable the fair market value on the date the right was Archer MSA contributions. Contributions by unsecured note as payment for your services, granted. You include the cash payment in your your employer to your Archer MSA generally are payments on the note that are credited toward income in the year you use the right. not included in your income. Their total will be the principal amount of the note are compensa- reported in box 12 of Form W – 2 with code R. tion income when you receive them. You must report this amount on Form 8853, Fringe Benefits Archer MSAs and Long-Term Care Insurance Severance pay. Amounts you receive as sev- erance pay are taxable. A lump-sum payment Contracts. File the form with your return. Fringe benefits you receive in connection with for cancellation of your employment contract If your employer does not make contributions the performance of your services are included in must be included in your income in the tax year to your MSA, you can make your own contribu- your income as compensation unless you pay you receive it. tions to your MSA. These contributions are dis- fair market value for them or they are specifically cussed in Publication 969, Medical Savings Accrued leave payment. If you are a fed- excluded by law. Abstaining from the perform- Accounts (MSAs). Also, see Form 8853. eral employee and receive a lump-sum payment ance of services (for example, under a covenant for accrued annual leave when you retire or not to compete) is treated as the performance of resign, this amount will be included as wages on services for purposes of these rules. Adoption Assistance your Form W – 2. Accounting period. You must use the same If you resign from one agency and are reem- accounting period your employer uses to report You may be able to exclude from your income ployed by another agency, you may have to your taxable noncash fringe benefits. Your em- amounts paid or expenses incurred by your em- repay part of your lump-sum annual leave pay- ployer has the option to report taxable noncash ployer for qualified adoption expenses in con- ment to the second agency. You can reduce fringe benefits by using either of the following nection with your adoption of an eligible child. gross wages by the amount you repaid in the rules. See Publication 968, Tax Benefits for Adoption, same tax year in which you received it. Attach to for more information. your tax return a copy of the receipt or statement 1) The general rule: benefits are reported for Adoption benefits are reported by your em- given to you by the agency you repaid to explain a full calendar year (January 1 – Decem- ployer in box 12 of Form W – 2 with code T. They the difference between the wages on the return ber 31). are also included as social security and Medi- and the wages on your Forms W – 2. 2) The special accounting period rule: care wages in boxes 3 and 5. However, they are benefits provided during the last 2 months not included as wages in box 1. To determine Outplacement services. If you choose to of the calendar year (or any shorter period) the taxable and nontaxable amounts, you must accept a reduced amount of severance pay so are treated as paid during the following complete Part III of Form 8839, Qualified Adop- that you can receive outplacement services calendar year. For example, each year tion Expenses. File the form with your return. ´ (such as training in resume writing and interview techniques), you must include the unreduced your employer reports the value of benefits amount of the severance pay in income. provided during the last 2 months of the However, you can deduct the value of these prior year and the first 10 months of the De Minimis (Minimal) Benefits outplacement services (up to the difference be- current year. If your employer provides you with a product or tween the severance pay included in income service and the cost of it is so small that it would and the amount actually received) as a miscella- Your employer does not have to use the same be unreasonable for the employer to account for neous deduction (subject to the 2% limit) on accounting period for each fringe benefit, but it, the value is not included in your income. Schedule A (Form 1040). must use the same period for all employees who Generally, the value of benefits such as dis- Sick pay. Pay you receive from your employer receive a particular benefit. counts at company cafeterias, cab fares home while you are sick or injured is part of your salary You must use the same accounting period when working overtime, and company picnics or wages. In addition, you must include in your that you use to report the benefit to claim an are not included in your income. income sick pay benefits received from any of employee business deduction (for use of a car, Holiday gifts. If your employer gives you a the following payers. for example). turkey, ham, or other item of nominal value at Form W – 2. Your employer reports your tax- Christmas or other holidays, do not include the 1) A welfare fund. able fringe benefits in box 1 (Wages, tips, other value of the gift in your income. However, if your 2) A state sickness or disability fund. compensation) of Form W – 2. The total value of employer gives you cash, a gift certificate, or a Chapter 6 Wages, Salaries, and Other Earnings Page 51 similar item that you can easily exchange for does not provide general death benefits (travel Table 6 –1. Cost of $1,000 of cash, you include the value of that gift as extra insurance, for example) is not group-term life Group-Term Life Insurance for One salary or wages regardless of the amount in- insurance. Month volved. Former employer. If your former employer provides more than $50,000 of group-term life Age Cost insurance coverage during the year, the amount Under 25 . . . . . . . . . . . . . . . . . . $ .05 Educational Assistance included in your income is reported as wages in 25 through 29 . . . . . . . . . . . . . . . .06 box 1 of Form W – 2. Also, it is shown separately 30 through 34 . . . . . . . . . . . . . . . .08 You can exclude from your income up to $5,250 35 through 39 . . . . . . . . . . . . . . . .09 of qualified employer-provided educational as- in box 12 with code C. Box 12 also will show the amount of uncollected social security and Medi- 40 through 44 . . . . . . . . . . . . . . . .10 sistance. The exclusion applies to undergradu- 45 through 49 . . . . . . . . . . . . . . . .15 ate and graduate-level courses. For more care taxes on the excess coverage, with codes M and N. You must pay these taxes with your 50 through 54 . . . . . . . . . . . . . . . .23 information, see Publication 970, Tax Benefits 55 through 59 . . . . . . . . . . . . . . . .43 for Education. income tax return. Include them in your total tax 60 through 64 . . . . . . . . . . . . . . . .66 on line 60, Form 1040, and enter "UT" and the 65 through 69 . . . . . . . . . . . . . . . 1.27 amount of the taxes on the dotted line next to 70 and older . . . . . . . . . . . . . . . . 2.06 Employer-Provided Vehicles line 60. Two or more employers. Your exclusion for Example. You are 51 years old and work for If your employer provides a car (or other high- employer-provided group-term life insurance way motor vehicle) to you, your personal use of employers A and B. Both employers provide coverage cannot exceed the cost of $50,000 of group-term life insurance coverage for you for the car is usually a taxable noncash fringe bene- coverage, whether the insurance is provided by fit. the entire year. Your coverage is $35,000 with a single employer or multiple employers. If two employer A and $45,000 with employer B. You Your employer must determine the actual or more employers provide insurance coverage value of this fringe benefit to include in your pay premiums of $4.15 a month under the em- that totals more than $50,000, the amounts re- ployer B group plan. You figure the amount to income. ported as wages on your Forms W – 2 will not be include in your income as follows. Certain employer-provided transporta- correct. You must figure how much to include in your income. Reduce the amount you figure by Worksheet 6 –1. Figuring the Cost TIP tion can be excluded from gross in- come. See the discussion on any amount reported with code C in box 12 of of Group-Term Life Insurance to Transportation, later. your Forms W – 2, add the result to the wages Include in Income —Illustrated reported in box 1, and report the total on your return. 1. Enter the total amount of your insurance coverage Group-Term Life Insurance Figuring the taxable cost. Use the following from your employers . . . . . 1. 80,000 Premiums worksheet to figure the amount to include in your 2. Limit on exclusion for income. employer-provided Generally, the cost of up to $50,000 of Worksheet 6 –1. Figuring the Cost group-term life insurance group-term life insurance coverage provided to of Group-Term Life Insurance To coverage . . . . . . . . . . . . . 2. 50,000 you by your employer (or former employer) is not 3. Subtract line 2 from line 1 . . 3. 30,000 included in your income. However, you must Include in Income 4. Divide line 3 by $1,000. include in income the cost of employer-provided Figure to the nearest tenth 4. 30.0 1. Enter the total amount of insurance that is more than the cost of $50,000 5. Go to Table 6 – 1. Using your your insurance coverage of coverage reduced by any amount you pay from your employers . . . . . 1. age on the last day of the tax toward the purchase of the insurance. 2. Limit on exclusion for year, find your age group in For exceptions to this rule, see Entire cost employer-provided the left column, and enter the excluded, and Entire cost taxed, later. group-term life insurance cost from the column on the If your employer provided more than $50,000 coverage . . . . . . . . . . . . . 2. 50,000 right for your age group . . . 5. .23 of coverage, the amount included in your in- 3. Subtract line 2 from line 1 . . 3. 6. Multiply line 4 by line 5 . . . . 6. 6.90 come is reported as part of your wages in box 1 4. Divide line 3 by $1,000. 7. Enter the number of full of your Form W – 2. It is also shown separately in Figure to the nearest tenth 4. months of coverage at this box 12 with code C. 5. Go to Table 6 – 1. Using your cost. . . . . . . . . . . . . . . . . 7. 12 age on the last day of the tax 8. Multiply line 6 by line 7 . . . . 8. 82.80 Group-term life insurance. This insurance is year, find your age group in 9. Enter the premiums term life insurance protection (insurance for a you paid per month 9. 4.15 fixed period of time) that: the left column, and enter the cost from the column on the 10. Enter the number 1) Provides a general death benefit, right for your age group . . . 5. of months you paid 6. Multiply line 4 by line 5 . . . . 6. the premiums . . . 10. 12 2) Is provided to a group of employees, 7. Enter the number of full 11. Multiply line 9 by line 10. . . . 11. 49.80 3) Is provided under a policy carried by the months of coverage at this 12. Subtract line 11 from line 8. employer, and cost. . . . . . . . . . . . . . . . . 7. Include this amount in your 8. Multiply line 6 by line 7 . . . . 8. income as wages . . . . . . . 12. 33.00 4) Provides an amount of insurance to each 9. Enter the premiums employee based on a formula that pre- you paid per month 9. vents individual selection. 10. Enter the number of months you paid Permanent benefits. If your group-term life the premiums . . . 10. insurance policy includes permanent benefits, 11. Multiply line 9 by line 10. . . . 11. such as a paid-up or cash surrender value, you 12. Subtract line 11 from line 8. must include in your income, as wages, the cost Include this amount in your of the permanent benefits minus the amount you income as wages . . . . . . . 12. 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 Page 52 Chapter 6 Wages, Salaries, and Other Earnings Entire cost excluded. You are not taxed on If the benefits have a value that is more than 4) Savings incentive match plans for employ- the cost of group-term life insurance if any of the these limits, the excess must be included in your ees (SIMPLE plans). following circumstances apply. income. 5) Tax-sheltered annuity plans (403(b) 1) You are permanently and totally disabled Commuter highway vehicle. This is a plans). and have ended your employment. highway vehicle that seats at least six adults (not 6) Section 501(c)(18)(D) plans. including the driver). At least 80% of the 2) Your employer is the beneficiary of the pol- vehicle's mileage must reasonably be expected 7) Section 457 plans. icy for the entire period the insurance is in to be: force during the tax year. Overall limit on deferrals. For 2003, you • For transporting employees between their 3) A charitable organization (defined in chap- generally should not have deferred more than a homes and work place, and ter 26) is the only beneficiary of the policy total of $12,000 of contributions to the plans for the entire period the insurance is in • On trips during which employees occupy listed in (1) through (6) above. You should not force during the tax year. (You are not at least half of the vehicle's adult seating have deferred more than the lesser of your in- entitled to a deduction for a charitable con- capacity (not including the driver). cludible compensation or $12,000 of contribu- tribution for naming a charitable organiza- tions to the plan listed in (7) above (section 457 tion as the beneficiary of your policy.) Transit pass. This is any pass, token, fare- plan). If you set aside more than the limit, the card, voucher, or similar item entitling a person excess generally must be included in your in- Entire cost taxed. You are taxed on the entire to ride mass transit (whether public or private) come for that year. See Publication 525 for a cost of group-term life insurance if either of the free or at a reduced rate or to ride in a commuter discussion of the tax treatment of corrective dis- following circumstances apply. highway vehicle operated by a person in the tributions of excess deferrals. business of transporting persons for compensa- 1) The insurance is provided by your em- tion. You may be allowed an additional elec- ployer through a qualified employees' TIP tive deferral if you are age 50 or older. Qualified parking. This is parking provided trust, such as a pension trust or a qualified to an employee at or near the employer's place annuity plan. of business. It also includes parking provided on 2) You are a key employee and your or near a location from which the employee Your employer or plan administrator should employer's plan discriminates in favor of commutes to work by mass transit, in a com- apply the proper annual limit when figuring your key employees. muter highway vehicle, or by carpool. It does not plan contributions. However, you are responsi- include parking at or near the employee's home. ble for monitoring the total you defer to ensure that the deferrals are not more than the overall limit. Retirement Planning Services Retirement Plan If your employer has a qualified retirement plan, Contributions Stock Options qualified retirement planning services provided Your employer's contributions to a qualified re- to you (and your spouse) by your employer are If you receive a nonstatutory option to buy or sell tirement plan for you are not included in income not included in your income. Qualified services stock or other property as payment for your at the time contributed. (Your employer can tell include retirement planning advice, information services, you will usually have income when you you whether your retirement plan is qualified.) about your employer's retirement plan, and in- receive the option, when you exercise the option However, the cost of life insurance coverage formation about how the plan may fit into your (use it to buy or sell the stock or other property), included in the plan may have to be included. overall individual retirement income plan. You or when you sell or otherwise dispose of the See Group-Term Life Insurance Premiums, ear- cannot exclude the value of any tax preparation, lier, under Fringe Benefits. option. However, if your option is a statutory accounting, legal, or brokerage services pro- If your employer pays into a nonqualified stock option, you will not have any income until vided by your employer. plan for you, you generally must include the you sell or exchange your stock. Your employer contributions in your income as wages for the can tell you which kind of option you hold. For tax year in which the contributions are made. details, get Publication 525. Transportation However, if your interest in the plan is not trans- If your employer provides you with a qualified ferable or is subject to a substantial risk of forfei- Restricted Property ture (meaning you have a good chance of losing transportation fringe benefit, it can be excluded it) at the time of the contribution, you do not have Generally, if you receive property for your serv- from your income, up to certain limits. A qualified to include the value of your interest in your ices, you must include its fair market value in transportation fringe benefit is: income until it is transferable or is no longer your income in the year you receive the prop- 1) Transportation in a commuter highway ve- subject to a substantial risk of forfeiture. erty. However, if you receive stock or other prop- hicle (such as a van) between your home erty that has certain restrictions that affect its Elective deferrals. If you are covered by cer- and work place, value, you do not include the value of the prop- tain kinds of retirement plans, you can choose to have part of your compensation contributed by erty in your income until it has substantially 2) A transit pass, or your employer to a retirement fund, rather than vested. (You can choose to include the value of 3) Qualified parking. have it paid to you. The amount you set aside the property in your income in the year it is (called an elective deferral) is treated as an transferred to you.) For details, see Restricted Cash reimbursement by your employer for these employer contribution to a qualified plan. It is not Property in Publication 525. expenses under a bona fide reimbursement ar- rangement is also excludable. However, cash included in wages subject to income tax at the Dividends you receive on restricted stock reimbursement for a transit pass is excludable time contributed. However, it is included in are treated as compensation and not as divi- only if a voucher or similar item that can be wages subject to social security and Medicare dend income. Your employer should include exchanged only for a transit pass is not readily taxes. these payments on your Form W – 2. available for direct distribution to you. Elective deferrals include elective contribu- Stock you chose to include in income. tions to the following retirement plans. Exclusion limit. The exclusion for commuter Dividends you receive on restricted stock you highway vehicle transportation and transit pass 1) Cash or deferred arrangements (section chose to include in your income in the year fringe benefits cannot be more than a total of 401(k) plans). transferred are treated the same as any other $100 a month, regardless of the total value of dividends. Report them on your return as divi- 2) The Thrift Savings Plan for federal employ- dends. For a discussion of dividends, see chap- both benefits. ees. ter 9. The exclusion for the qualified parking fringe benefit cannot be more than $190 a month, 3) Salary reduction simplified employee pen- For information on how to treat dividends regardless of its value. sion plans (SARSEP). reported on both your Form W – 2 and Form Chapter 6 Wages, Salaries, and Other Earnings Page 53 1099 – DIV, see Dividends received on restricted order that you turn over to the order are not tion is exempt from federal income tax if you are stock in Publication 525. included in your income. not a citizen of the United States or you are a citizen of the Philippines (whether or not you are Example. You are a member of a church a citizen of the United States). order and have taken a vow of poverty. You Your compensation for official services to a Special Rules for renounce any claims to your earnings and turn over to the order any salaries or wages you foreign government is exempt from federal in- come tax if all of the following are true. Certain Employees earn. You are a registered nurse, so your order assigns you to work in a hospital that is an 1) You are not a citizen of the United States associated institution of the church. However, or you are a citizen of the Philippines This section deals with special rules for people you remain under the general direction and con- (whether or not you are a citizen of the in certain types of employment: members of the trol of the order. You are considered to be an United States). clergy, members of religious orders, people agent of the order and any wages you earn at working for foreign employers, military person- 2) Your work is like the work done by employ- the hospital that you turn over to your order are nel, and volunteers. ees of the United States in foreign coun- not included in your income. tries. Clergy Services performed outside the order. If you are directed to work outside the order, your 3) The foreign government gives an equal ex- services are not an exercise of duties required emption to employees of the United States If you are a member of the clergy, you must in its country. include in your income offerings and fees you by the order unless they meet both of the follow- receive for marriages, baptisms, funerals, ing requirements. Waiver of alien status. If you are an alien masses, etc., in addition to your salary. If the who works for a foreign government or interna- 1) They are the kind of services that are ordi- offering is made to the religious institution, it is tional organization and you file a waiver under narily the duties of members of the order. not taxable to you. section 247(b) of the Immigration and National- If you are a member of a religious organiza- 2) They are part of the duties that you must ity Act to keep your immigrant status, different tion and you give your outside earnings to the exercise for, or on behalf of, the religious rules may apply. See Foreign Employer in Publi- organization, you still must include the earnings order as its agent. cation 525. in your income. However, you may be entitled to If you are an employee of a third party, the a charitable contribution deduction for the services you perform for the third party will not Employment abroad. For information on in- amount paid to the organization. See chapter be considered directed or required of you by the come earned abroad, get Publication 54. 26. order. Amounts you receive for these services Housing. Special rules for housing apply to are included in your income, even if you have Military taken a vow of poverty. members of the clergy. Under these rules, you do not include in your income the rental value of Payments you receive as a member of a military Example. Mark Brown is a member of a service generally are taxed as wages except for a home (including utilities) or a designated hous- religious order and has taken a vow of poverty. retirement pay, which is taxed as a pension. ing allowance provided to you as part of your He renounces all claims to his earnings and Allowances generally are not taxed. For more pay. However, the exclusion cannot be more turns over his earnings to the order. information on the tax treatment of military al- than the reasonable pay for your service. The Mark is a school teacher. He was instructed lowances and benefits, get Publication 3, Armed home or allowance must be provided as com- by the superiors of the order to get a job with a Forces' Tax Guide. pensation for your services as an ordained, li- private tax-exempt school. Mark became an em- censed, or commissioned minister. However, ployee of the school, and, at his request, the Military retirement pay. If your retirement you must include the rental value of the home or school made the salary payments directly to the pay is based on age or length of service, it is the housing allowance as earnings from order. taxable and must be included in your income as self-employment on Schedule SE (Form 1040) if Because Mark is an employee of the school, a pension on lines 16a and 16b of Form 1040, or you are subject to the self-employment tax. For he is performing services for the school rather on lines 12a and 12b of Form 1040A. Do not more information, see Publication 517, Social than as an agent of the order. The wages Mark include in your income the amount of any reduc- Security and Other Information for Members of earns working for the school are included in his tion in retirement or retainer pay to provide a the Clergy and Religious Workers. income. survivor annuity for your spouse or children Pension. A pension or retirement pay for a under the Retired Serviceman's Family Protec- member of the clergy is usually treated as any tion Plan or the Survivor Benefit Plan. other pension or annuity. It must be reported on Foreign Employer For more information on survivor annuities, lines 16a and 16b of Form 1040 or on lines 12a Special rules apply if you work for a foreign see chapter 11. and 12b of Form 1040A. employer. Disability. If you are retired on disability, U.S. citizen. If you are a U.S. citizen who see Military and Government Disability Pen- Members of Religious works in the United States for a foreign govern- sions under Sickness and Injury Benefits, later. Orders ment, an international organization, a foreign embassy, or any foreign employer, you must Veterans' benefits. Do not include in your in- If you are a member of a religious order who has include your salary in your income. come any veterans' benefits paid under any law, taken a vow of poverty, how you treat earnings regulation, or administrative practice adminis- Social security and Medicare taxes. You tered by the Department of Veterans Affairs that you renounce and turn over to the order are exempt from social security and Medicare (VA). The following amounts paid to veterans or depends on whether your services are per- taxes if you are employed in the United States their families are not taxable. formed for the order. by an international organization or a foreign gov- Services performed for the order. If you are ernment. However, you must pay self-employ- • Education, training, and subsistence al- ment tax on your earnings from services lowances. performing the services as an agent of the order performed in the United States, even though you in the exercise of duties required by the order, are not self-employed. This rule also applies if • Disability compensation and pension pay- do not include in your income the amounts ments for disabilities paid either to veter- you are an employee of a qualifying turned over to the order. ans or their families. wholly-owned instrumentality of a foreign gov- If your order directs you to perform services for another agency of the supervising church or ernment. • Grants for homes designed for wheelchair living. an associated institution, you are considered to Employees of international organizations or be performing the services as an agent of the foreign governments. Your compensation • Grants for motor vehicles for veterans who order. Any wages you earn as an agent of an for official services to an international organiza- lost their sight or the use of their limbs. Page 54 Chapter 6 Wages, Salaries, and Other Earnings • Veterans' insurance proceeds and divi- out-of-pocket expenses from SCORE, do not you receive in your income. If the amount of the dends paid either to veterans or their ben- include these amounts in income. premiums was included in your income, you are eficiaries, including the proceeds of a considered to have paid the premiums, and any veteran's endowment policy paid before Volunteer tax counseling. Do not include in benefits you receive are not taxable. death. your income any reimbursements you receive for transportation, meals, and other expenses Accrued leave payment. If you retire on disa- • Interest on insurance dividends you leave you have in training for, or actually providing, bility, any lump-sum payment you receive for on deposit with the VA. volunteer federal income tax counseling for the accrued annual leave is a salary payment. The elderly (TCE). payment is not a disability payment. Include it in Rehabilitative program payments. VA You can deduct as a charitable contribution your income in the tax year you receive it. payments to hospital patients and resident vet- your unreimbursed out-of-pocket expenses in erans for their services under the VA's therapeu- taking part in the volunteer income tax assis- Retirement and profit-sharing plans. If you tic or rehabilitative programs are not treated as tance (VITA) program. See chapter 26. receive payments from a retirement or nontaxable veterans' benefits. Report these profit-sharing plan that does not provide for disa- payments as income on line 21 of Form 1040. bility retirement, do not treat the payments as a disability pension. The payments must be re- Volunteers ported as a pension or annuity. For more infor- Sickness and Injury mation on pensions, see chapter 11. The tax treatment of amounts you receive as a volunteer worker for the Peace Corps or similar Benefits How to report. If you retired on disability, you must include in income any disability pension agency is covered in the following discussions. This section discusses sickness and injury ben- you receive under a plan that is paid for by your efits including disability pensions, long-term employer. You must report your taxable disabil- Peace Corps. Living allowances you receive care insurance contracts, workers' compensa- ity payments as wages on line 7 of Form 1040 or as a Peace Corps volunteer or volunteer leader tion, and other benefits. Form 1040A, until you reach minimum retire- for housing, utilities, household supplies, food, and clothing are exempt from tax. ment age. Minimum retirement age generally is Taxable allowances. The following al- Disability Pensions the age at which you can first receive a pension or annuity if you are not disabled. lowances must be included in your income and Generally, if you retire on disability, you must Beginning on the day after you reach mini- reported as wages. report your pension or annuity as income. mum retirement age, payments you receive are • Allowances paid to your spouse and minor There is a tax credit for people who are taxable as a pension or annuity. Report the children while you are a volunteer leader payments on lines 16a and 16b of Form 1040, or TIP permanently and totally disabled. For on lines 12a and 12b of Form 1040A. The rules training in the United States. information on this credit and the defi- for reporting pensions are explained in How To • Living allowances designated by the Di- nition of permanent and total disability, see Report in chapter 11. rector of the Peace Corps as basic com- chapter 35. pensation. These are allowances for For information on disability payments from a personal items such as domestic help, governmental program provided as a substitute Military and Government laundry and clothing maintenance, enter- for unemployment compensation, see chapter tainment and recreation, transportation, Disability Pensions 13. and other miscellaneous expenses. Certain military and government disability pen- Disability income. Generally, you must report • Leave allowances. as income any amount you receive for personal sions are not taxable. • Readjustment allowances or termination injury or sickness through an accident or health Service-connected disability. You may be payments. These are considered received plan that is paid for by your employer. If both you able to exclude from income amounts you re- by you when credited to your account. and your employer pay for the plan, only the ceive as a pension, annuity, or similar allowance amount you receive that is due to your for personal injury or sickness resulting from employer's payments is reported as income. active service in one of the following govern- Example. Gary Carpenter, a Peace Corps However, certain payments may not be taxable ment services. volunteer, gets $175 a month as a readjustment to you. Your employer should be able to give you allowance during his period of service, to be paid specific details about your pension plan and tell • The armed forces of any country. to him in a lump sum at the end of his tour of duty. Although the allowance is not available to you the amount you paid for your disability pen- • The National Oceanic and Atmospheric sion. In addition to disability pensions and annui- Administration. him until the end of his service, Gary must in- ties, you may be receiving other payments for clude it in his income on a monthly basis as it is sickness and injury. • The Public Health Service. credited to his account. Do not report as income any amounts • The Foreign Service. Volunteers in Service to America (VISTA). If TIP paid to reimburse you for medical ex- you are a VISTA volunteer, you must include Conditions for exclusion. Do not include penses you incurred after the plan was meal and lodging allowances paid to you in your the disability payments in your income if any of established. income as wages. the following conditions apply. Cost paid by you. If you pay the entire cost of 1) You were entitled to receive a disability National Senior Services Corps programs. a health or accident insurance plan, do not in- payment before September 25, 1975. Do not include in your income amounts you clude any amounts you receive from the plan for receive for supportive services or reimburse- 2) You were a member of a listed govern- personal injury or sickness as income on your ments for out-of-pocket expenses from the fol- ment service or its reserve component, or tax return. If your plan reimbursed you for medi- lowing programs. were under a binding written commitment cal expenses you deducted in an earlier year, • Retired Senior Volunteer Program you may have to include some, or all, of the to become a member, on September 24, (RSVP). reimbursement in your income. See Reim- 1975. bursement in a later year in chapter 23. • Foster Grandparent Program. 3) You receive the disability payments for a Cafeteria plans. Generally, if you are cov- combat-related injury. This is a personal • Senior Companion Program. ered by an accident or health insurance plan injury or sickness that: through a cafeteria plan, and the amount of the a) Results directly from armed conflict, Service Corps of Retired Executives insurance premiums was not included in your (SCORE). If you receive amounts for support- income, you are not considered to have paid the b) Takes place while you are engaged in ive service s or reim bur s em ent s f or premiums and you must include any benefits extra-hazardous service, Chapter 6 Wages, Salaries, and Other Earnings Page 55 c) Takes place under conditions simulat- • Provide that refunds, other than refunds Return to work. If you return to work after ing war, including training exercises on the death of the insured or complete qualifying for workers' compensation, payments such as maneuvers, or surrender or cancellation of the contract, you continue to receive while assigned to light and dividends under the contract may be duties are taxable. Report these payments as d) Is caused by an instrumentality of war. used only to reduce future premiums or wages on line 7 of Form 1040 or Form 1040A, or increase future benefits, and on line 1 of Form 1040EZ. 4) You would be entitled to receive disability compensation from the Department of Vet- • Generally not pay or reimburse expenses erans Affairs (VA) if you filed an applica- incurred for services or items that would Other Sickness and Injury tion for it. Your exclusion under this condition is equal to the amount you would be reimbursed under Medicare, except Benefits where Medicare is a secondary payer or be entitled to receive from the VA. the contract makes per diem or other peri- In addition to disability pensions and annuities, odic payments without regard to ex- you may receive other payments for sickness or Pension based on years of service. If you penses. injury. receive a disability pension based on years of Railroad sick pay. Payments you receive as service, you generally must include it in your Qualified long-term care services. Qualified sick pay under the Railroad Unemployment In- income. However, if the pension qualifies for the long-term care services are: surance Act are taxable and you must include exclusion for a service-connected disability (dis- them in your income. However, do not include cussed earlier), do not include in income the part • Necessary diagnostic, preventive, thera- them in your income if they are for an on-the-job of your pension that you would have received if peutic, curing, treating, mitigating, and re- injury. the pension had been based on a percentage of habilitative services, and maintenance and If you received income because of a disabil- disability. You must include the rest of your pen- personal care services, and ity, see Disability Pensions, earlier. sion in your income. • Required by a chronically ill individual Federal Employees' Compensation Act Retroactive VA determination. If you retire and provided pursuant to a plan of care as (FECA). Payments received under this Act for from the armed services based on years of serv- prescribed by a licensed health care prac- personal injury or sickness, including payments ice and are later given a retroactive service-con- titioner. to beneficiaries in case of death, are not taxable. nected disability rating by the VA, your However, you are taxed on amounts you receive retirement pay for the retroactive period is ex- Chronically ill individual. A chronically ill in- under this Act as continuation of pay for up to cluded from income up to the amount of VA dividual is one who has been certified by a 45 days while a claim is being decided. Report disability benefits you would have been entitled licensed health care practitioner within the previ- this income on line 7 of Form 1040 or Form to receive. You can claim a refund of any tax ous 12 months as one of the following. 1040A, or on line 1 of Form 1040EZ. Also, pay paid on the excludable amount (subject to the for sick leave while a claim is being processed is statute of limitations) by filing an amended re- • An individual who, for at least 90 days, is taxable and must be included in your income as turn on Form 1040X for each previous year unable to perform at least two activities of wages. during the retroactive period. daily living without substantial assistance If you receive a lump-sum disability sever- If part of the payments you receive due to loss of functional capacity. Activi- ance payment and are later awarded VA disabil- ties of daily living are eating, toileting, ! under FECA reduces your social se- ity benefits, do not include in your income the CAUTION curity or equivalent railroad retirement transferring, bathing, dressing, and conti- portion of the severance payment equal to the benefits received, that part is considered social nence. VA benefit you would have been entitled to re- security (or equivalent railroad retirement) bene- ceive in that same year. However, you must • An individual who requires substantial su- fits and may be taxable. For a discussion of the include in your income any lump-sum readjust- pervision to be protected from threats to taxability of these benefits, see Social security ment or other nondisability severance payment health and safety due to severe cognitive and equivalent railroad retirement benefits you received on release from active duty, even if impairment. under Other Income, in Publication 525. you are later given a retroactive disability rating You can deduct the amount you spend to by the VA. buy back sick leave for an earlier year to be Limit on exclusion. You can generally ex- clude from gross income up to $220 a day for eligible for nontaxable FECA benefits for that Terrorist attack or military action. Do not period. It is a miscellaneous deduction subject to include in your income disability payments you 2003. See Limit on exclusion, under Long-Term Care Insurance Contracts, under Sickness and the 2% limit on Schedule A (Form 1040). If you receive for injuries resulting directly from a ter- buy back sick leave in the same year you used it, roristic or military action. Injury Benefits in Publication 525 for more infor- the amount reduces your taxable sick leave pay. mation. Do not deduct it separately. Long-Term Care Other compensation. Many other amounts Workers' Compensation Insurance Contracts you receive as compensation for sickness or Amounts you receive as workers' compensation injury are not taxable. These include the follow- Long-term care insurance contracts are gener- for an occupational sickness or injury are fully ing amounts. ally treated as accident and health insurance contracts. Amounts you receive from them exempt from tax if they are paid under a workers' • Compensatory damages you receive for compensation act or a statute in the nature of a physical injury or physical sickness, (other than policyholder dividends or premium workers' compensation act. The exemption also whether paid in a lump sum or in periodic refunds) generally are excludable from income applies to your survivors. The exemption, how- payments. as amounts received for personal injury or sick- ever, does not apply to retirement plan benefits ness. To claim an exclusion for payments made you receive based on your age, length of serv- • Benefits you receive under an accident or on a per diem or other periodic basis under a ice, or prior contributions to the plan, even if you health insurance policy on which either long-term care insurance contract, you must file you paid the premiums or your employer retired because of an occupational sickness or Form 8853 with your return. paid the premiums but you had to include injury. A long-term care insurance contract is an them in your income. insurance contract that only provides coverage If part of your workers' compensation • Disability benefits you receive for loss of for qualified long-term care services. The ! reduces your social security or income or earning capacity as a result of contract must: CAUTION equivalent railroad retirement benefits injuries under a no-fault car insurance pol- received, that part is considered social security • Be guaranteed renewable, (or equivalent railroad retirement) benefits and icy. • Not provide for a cash surrender value or may be taxable. For more information, see Pub- • Compensation you receive for permanent other money that can be paid, assigned, lication 915, Social Security and Equivalent Rail- loss or loss of use of a part or function of pledged, or borrowed, road Retirement Benefits. your body, or for your permanent disfig- Page 56 Chapter 6 Wages, Salaries, and Other Earnings urement. This compensation must be Reimbursement for medical care. A reim- expense deduction. For more information, see based only on the injury and not on the bursement for medical care is generally not tax- chapter 23. period of your absence from work. These able. However, it may reduce your medical benefits are not taxable even if your em- ployer pays for the accident and health plan that provides these benefits. Chapter 6 Wages, Salaries, and Other Earnings Page 57 What tips to report. Report to your employer 1) Write information about your tips in a tip only cash, check, or credit card tips you receive. diary, or 7. 2) Keep copies of documents that show your If your total tips for any one month from any one job are less than $20, do not report the tips tips, such as restaurant bills and credit for that month to that employer. card charge slips. Do not report the value of any noncash tips, Tip Income You should keep your daily tip record with your such as tickets or passes, to your employer. You do not pay social security and Medicare taxes or personal records. You must keep your records railroad retirement tax on these tips. for as long as they are important for administra- tion of the federal tax law. For information on Introduction how long to keep records, see Publication 552, How to report. If your employer does not give you any other way to report tips, you can This chapter is for employees who receive tips Recordkeeping for Individuals. use Form 4070. To get a year's supply of the from customers. If you keep a tip diary, you can use Form form, ask the IRS or your employer for Publica- All tips you receive are income and are sub- 4070A, Employee's Daily Record of Tips. To get tion 1244. Fill in the information asked for on the ject to federal income tax. You must include in Form 4070A, ask the Internal Revenue Service form, sign and date the form, and give it to your gross income all tips you receive directly from (IRS) or your employer for Publication 1244. employer. customers, tips from charge customers that are Publication 1244 includes a year's supply of If you do not use Form 4070, give your em- paid to you by your employer, and your share of Form 4070A. Each day, write in the information ployer a statement with the following informa- any tips you receive under a tip-splitting or asked for on the form. tion. tip-pooling arrangement. The value of noncash tips, such as tickets, If you do not use Form 4070A, start your • Your name, address, and social security records by writing your name, your employer's number. passes, or other items of value are also income name, and the name of the business if it is and subject to tax. different from your employer's name. Then, • Your employer's name, address, and busi- Reporting your tip income correctly is not ness name (if it is different from the each workday, write the date and the following difficult. You must do three things. employer's name). information. • The month (or the dates of any shorter 1) Keep a daily tip record. • Cash tips you get directly from customers period) in which you received tips. or from other employees. 2) Report tips to your employer. • The total tips required to be reported for 3) Report all your tips on your income tax • Tips from credit card charge customers that period. return. that your employer pays you. You must sign and date the statement. You • The value of any noncash tips you get, should keep a copy with your personal records. This chapter will show you how to do these three such as tickets, passes, or other items of Your employer may require you to report your things and what to do on your tax return if you value. tips more than once a month. However, the have not done the first two. This chapter will also • The amount of tips you paid out to other statement cannot cover a period of more than show you how to treat allocated tips. employees through tip pools or tip split- one calendar month. ting, or other arrangements, and the Electronic tip statement. Your employer Useful Items names of the employees to whom you can have you furnish your tip statements elec- You may want to see: paid the tips. tronically. Publication When to report. Give your report for each Do not write in your tip diary the ❏ 531 Reporting Tip Income ! amount of any service charge that your month to your employer by the 10th of the next month. If the 10th falls on a Saturday, Sunday, CAUTION employer adds to a customer's bill and ❏ 1244 Employee's Daily Record of Tips or legal holiday, give your employer the report by then pays to you and treats as wages. This is and Report to Employer the next day that is not a Saturday, Sunday, or part of your wages, not a tip. legal holiday. Form (and Instructions) Electronic tip record. You may use an ❏ 4137 Social Security and Medicare Tax electronic system provided by your employer to Example 1. You must report your tips re- on Unreported Tip Income record your daily tips. You must receive and ceived in May 2004 by June 10, 2004. keep a paper copy of this record. ❏ 4070 Employee's Report of Tips to Example 2. You must report your tips re- Employer ceived in June 2004 by July 12, 2004. July 10th is on a Saturday, and the 12th is the next day that is not a Saturday, Sunday, or legal holiday. Reporting Tips to Your Final report. If your employment ends dur- Keeping a Daily Tip Employer ing the month, you can report your tips when your employment ends. Record Why report tips to your employer? You Penalty for not reporting tips. If you do not must report tips to your employer so that: report tips to your employer as required, you Why keep a daily tip record? You must keep may be subject to a penalty equal to 50% of the a daily tip record so you can: • Your employer can withhold federal in- social security and Medicare taxes or railroad come tax and social security and Medicare retirement tax you owe on the unreported tips. • Report your tips accurately to your em- taxes or railroad retirement tax, (For information about these taxes, see Report- ployer, ing social security and Medicare taxes on tips • Your employer can report the correct • Report your tips accurately on your tax amount of your earnings to the Social Se- not reported to your employer under Reporting return, and Tips on Your Tax Return, later.) The penalty curity Administration or Railroad Retire- amount is in addition to the taxes you owe. • Prove your tip income if your return is ever ment Board (which affects your benefits when you retire or if you become disabled, You can avoid this penalty if you can show questioned. reasonable cause for not reporting the tips to or your family's benefits if you die), and your employer. To do so, attach a statement to How to keep a daily tip record. There are two • You can avoid the penalty for not reporting your return explaining why you did not report ways to keep a daily tip record. You can either: tips to your employer (explained later). them. Page 58 Chapter 7 Tip Income Giving your employer money for taxes. cluded in the wages shown in box 1 of your Form Form 1040EZ or Form 1040A.) Include the taxes Your regular pay may not be enough for your W – 2. Add to the amount in box 1 only the tips in your total tax amount on line 61, and write employer to withhold all the taxes you owe on you did not report to your employer. "UT" and the total of the uncollected taxes on the your regular pay plus your reported tips. If this dotted line next to line 60. If you received $20 or more in cash and happens, you can give your employer money until the close of the calendar year to pay the ! charge tips in a month and did not CAUTION report all of those tips to your em- rest of the taxes. ployer, see Reporting social security and Medi- If you do not give your employer enough money, your employer will apply your regular care taxes on tips not reported to your employer, Allocated Tips later. pay and any money you give to the taxes in the If your employer allocated tips to you, they are following order. If you did not keep a daily tip record as shown separately in box 8 of your Form W – 2. 1) All taxes on your regular pay. ! required and an amount is shown in They are not included in box 1 with your wages CAUTION box 8 of your Form W – 2, see Allocated and reported tips. If box 8 is blank, this discus- 2) Social security and Medicare taxes or rail- Tips, later. sion does not apply to you. road retirement tax on your reported tips. If you kept a daily tip record and reported tips to your employer as required under the rules What are allocated tips? These are tips that 3) Federal, state, and local income taxes on explained earlier, add the following tips to the your reported tips. your employer assigned to you in addition to the amount in box 1 of your Form W – 2. tips you reported to your employer for the year. Any taxes that remain unpaid can be col- lected by your employer from your next • Cash and charge tips you received that Your employer will have done this only if: paycheck. If withholding taxes remain uncol- totaled less than $20 for any month. • You worked in a restaurant, cocktail lected at the end of the year, you may be subject • The value of noncash tips, such as tickets, lounge, or similar business that must allo- to a penalty for underpayment of estimated passes, or other items of value. cate tips to employees, and taxes. See Publication 505, Tax Withholding • The tips you reported to your employer and Estimated Tax, for more information. Example. John Allen began working at the were less than your share of 8% of food Uncollected taxes. You must report Diamond Restaurant (his only employer in 2003) and drink sales. ! on your tax return any social security on June 30 and received $10,000 in wages CAUTION and Medicare taxes or railroad retire- during the year. John kept a daily tip record How were your allocated tips figured? The ment tax that remained uncollected at the end of showing that his tips for June were $18 and his tips allocated to you are your share of an amount 2003. See Reporting uncollected social security tips for the rest of the year totaled $7,000. He figured by subtracting the reported tips of all and Medicare taxes on tips under Reporting was not required to report his June tips to his employees from 8% (or an approved lower rate) Tips on Your Tax Return, later. These uncol- employer, but he reported all of the rest of his of food and drink sales (other than carryout lected taxes will be shown in box 12 of your 2003 tips to his employer as required. sales and sales with a service charge of 10% or Form W – 2 (codes A and B). John's Form W – 2 from Diamond Restaurant more). Your share of that amount was figured shows $17,000 ($10,000 wages plus $7,000 re- using either a method provided by an ported tips) in box 1. He adds the $18 unre- Tip Rate Determination ported tips to that amount and reports $17,018 employer-employee agreement or a method provided by IRS regulations based on employ- and Education Program as wages on his tax return. ees' sales or hours worked. For information Your employer may participate in the Tip Rate about the exact allocation method used, ask Reporting social security and Medicare your employer. Determination and Education Program. The pro- taxes on tips not reported to your employer. gram was developed to help employees and If you received $20 or more in cash and charge employers understand and meet their tip report- Must you report your allocated tips on your tips in a month from any one job and did not ing responsibilities. return? You must report allocated tips on your report all of those tips to your employer, you There are two agreements under the pro- must report the social security and Medicare tax return unless either of the following excep- gram — the Tip Rate Determination Agreement taxes on the unreported tips as additional tax on tions applies. (TRDA) and the Tip Reporting Alternative Com- your return. To report these taxes, you must file 1) You kept a daily tip record, or other evi- mitment (TRAC). In addition, employers in the a return even if you would not otherwise have to food and beverage industry may be able to get dence that is as credible and as reliable as file. You must use Form 1040. (You cannot file approval of an employer-designed EmTRAC a daily tip record, as required under rules Form 1040EZ or Form 1040A.) program. For information on the EmTRAC pro- explained earlier. Use Form 4137 to figure these taxes. Enter gram, see Notice 2001 – 1 in Internal Revenue the tax on line 56, Form 1040, and attach Form 2) Your tip record is incomplete, but it shows Bulletin No. 2001 – 2 (or Cumulative Bulletin 4137 to your return. that your actual tips were more than the 2001 – 1). tips you reported to your employer plus the Your employer can provide you with a copy If you are subject to the Railroad Re- allocated tips. of the agreement. If you want to learn more ! tirement Tax Act, you cannot use Form If either exception applies, report your actual tips about these agreements, contact the local IRS CAUTION 4137 to pay railroad retirement tax on unreported tips. To get railroad retirement credit, on your return. Do not report the allocated tips. tip coordinator. A list of tip coordinators is avail- you must report tips to your employer. See What tips to report under Reporting Tips on able at www.irs.gov. Your Tax Return, earlier. Reporting uncollected social security and Medicare taxes on tips. If your employer How to report allocated tips. If you must could not collect all the social security and Medi- report allocated tips on your return, add the Reporting Tips on Your care taxes or railroad retirement tax you owe on amount in box 8 of your Form W – 2 to the tips reported for 2003, the uncollected taxes will amount in box 1. Report the total as wages on Tax Return be shown in box 12 of your Form W – 2 (codes A line 7 of Form 1040. (You cannot file Form and B). You must report these amounts as addi- 1040EZ or Form 1040A.) How to report tips. Report your tips with tional tax on your return. You may have uncol- Because social security and Medicare taxes your wages on line 1, Form 1040EZ, or line 7, lected taxes if your regular pay was not enough were not withheld from the allocated tips, you Form 1040A or Form 1040. for your employer to withhold all the taxes you must report those taxes as additional tax on your owe and you did not give your employer enough return. Complete Form 4137, and include the What tips to report. You must report all tips money to pay the rest of the taxes. allocated tips on line 1 of the form. See Report- you received in 2003, including both cash tips To report these uncollected taxes, you must ing social security and Medicare taxes on tips and noncash tips, on your tax return. Any tips file a return even if you would not otherwise have not reported to your employer under Reporting you reported to your employer for 2003 are in- to file. You must use Form 1040. (You cannot file Tips on Your Tax Return, earlier. Chapter 7 Tip Income Page 59 ❏ 8815 Exclusion of Interest From Series recorded in your name as custodian for the child, EE and I U.S. Savings Bonds give the child's SSN to the payer. For example, Issued After 1989 you must give your child's SSN to the payer of 8. ❏ 8818 Optional Form To Record dividends on stock owned by your child, even though the dividends are paid to you as custo- Redemption of Series EE and I dian. U.S. Savings Bonds Issued After 1989 Penalty for failure to supply SSN. If you Interest Income do not give your SSN to the payer of interest, you may have to pay a penalty. See Failure to supply social security number under Penalties in chapter 1. Backup withholding also may apply. Important Reminder General Information Backup withholding. Your interest income is Foreign-source income. If you are a U.S. citi- A few items of general interest are covered here. generally not subject to regular withholding. zen with interest income from sources outside However, it may be subject to backup withhold- Tax on investment income of a child under ing to ensure that income tax is collected on the the United States (foreign income), you must age 14. Part of a child's 2003 investment in- report that income on your tax return unless it is income. Under backup withholding, the payer of come may be taxed at the parent's tax rate. This interest must withhold, as income tax, a percent- exempt by U.S. law. This is true whether you may happen if all the following are true. reside inside or outside the United States and age of the amount you are paid. For 2004, the whether or not you receive a Form 1099 from the 1) The child was under age 14 at the end of percentage is 28%. 2003. A child born on January 1, 1990, is Backup withholding may also be required if foreign payer. considered to be age 14 at the end of the Internal Revenue Service (IRS) has deter- 2003. mined that you underreported your interest or dividend income. For more information, see 2) The child had more than $1,500 of invest- Backup Withholding in chapter 5. Introduction ment income (such as taxable interest and dividends) and has to file a tax return. Reporting backup withholding. If backup This chapter discusses: withholding is deducted from your interest in- 3) Either parent was alive at the end of 2003. come, the payer must give you a Form • Different types of interest income, If all these statements are true, Form 8615, Tax 1099 – INT for the year that indicates the amount withheld. The Form 1099 – INT will show any • What interest is taxable and what interest for Children Under Age 14 Who Have Invest- ment Income of More Than $1,500, must be backup withholding as "Federal income tax with- is nontaxable, completed and attached to the child's tax return. held." • When to report interest income, and If any of these statements is not true, Form 8615 Joint accounts. If two or more persons hold • How to report interest income on your tax is not required and the child's income is taxed at property (such as a savings account or bond) as return. his or her own tax rate. joint tenants, tenants by the entirety, or tenants However, the parent can choose to include in common, each person's share of any interest In general, any interest that you receive or that the child's interest and dividends on the parent's from the property is determined by local law. is credited to your account and can be with- return if certain requirements are met. Use drawn is taxable income. (It does not have to be Form 8814, Parents' Election To Report Child's Income from property given to a child. entered in your passbook.) Exceptions to this Interest and Dividends, for this purpose. Property you give as a parent to your child under rule are discussed later in this chapter. For more information about the tax on invest- the Model Gifts of Securities to Minors Act, the ment income of children and the parents' elec- Uniform Gifts to Minors Act, or any similar law, You may be able to deduct expenses you tion, see chapter 33. becomes the child's property. have in earning this income on Schedule A Income from the property is taxable to the (Form 1040) if you itemize your deductions. See Beneficiary of an estate or trust. Interest child, except that any part used to satisfy a legal chapter 30. you receive as a beneficiary of an estate or trust obligation to support the child is taxable to the is generally taxable income. You should receive Recordkeeping. You should keep a parent or legal guardian having that legal obliga- a Schedule K – 1 (Form 1041), Beneficiary's list showing sources and amounts of tion. Share of Income, Deductions, Credits, etc., from RECORDS interest received during the year. Also, the fiduciary. Your copy of Schedule K – 1 and its Savings account with parent as trustee. keep the forms you receive that show your inter- instructions will tell you where to report the in- Interest income from a savings account opened est income (Forms 1099 – INT, for example) as come on your Form 1040. for a child who is a minor, but placed in the name an important part of your records. and subject to the order of the parents as trust- Social security number (SSN). You must ees, is taxable to the child if, under the law of the give your name and SSN to any person required Useful Items by federal tax law to make a return, statement, state in which the child resides, both of the You may want to see: following are true. or other document that relates to you. This in- cludes payers of interest. 1) The savings account legally belongs to the Publication child. SSN for joint account. If the funds in a joint ❏ 537 Installment Sales account belong to one person, list that person's 2) The parents are not legally permitted to ❏ 550 Investment Income and Expenses name first on the account and give that person's use any of the funds to support the child. SSN to the payer. (For information on who owns ❏ 1212 List of Original Issue Discount the funds in a joint account, see Joint accounts, Instruments Form 1099 – INT. Interest income is generally later.) If the joint account contains combined reported to you on Form 1099 – INT, Interest funds, give the SSN of the person whose name Form (and Instructions) Income, or a similar statement, by banks, sav- is listed first on the account. ings and loans, and other payers of interest. This ❏ Schedule B (Form 1040) Interest and These rules apply both to joint ownership by form shows you the interest you received during Ordinary Dividends a married couple and to joint ownership by other the year. Keep this form for your records. You do individuals. For example, if you open a joint ❏ Schedule 1 (Form 1040A) Interest and not have to attach it to your tax return. savings account with your child using funds be- Report on your tax return the total amount of Ordinary Dividends for Form 1040A longing to the child, list the child's name first on interest income that you receive for the tax year. Filers the account and give the child's SSN. This includes amounts reported to you on Form ❏ 3115 Application for Change in Custodian account for your child. If your 1099 – INT and amounts for which you did not Accounting Method child is the actual owner of an account that is receive a Form 1099 – INT. Page 60 Chapter 8 Interest Income Nominees. Generally, if someone receives • Domestic savings and loan associations, earns $20 interest. You also receive a $15 cal- interest as a nominee for you, that person will culator. If no other interest is credited to your give you a Form 1099 – INT showing the interest • Federal savings and loan associations, account during the year, the Form 1099 – INT and received on your behalf. you receive will show $35 interest for the year. If you receive a Form 1099 – INT that in- • Mutual savings banks. You must report $35 interest income on your tax cludes amounts belonging to another person, return. see the discussion on nominee distributions Money market funds. Generally, amounts Interest on insurance dividends. Interest on under How To Report Interest Income in chapter you receive from money market funds should be insurance dividends left on deposit with an in- 1 of Publication 550, or see the Schedule 1 reported as dividends, not as interest. surance company that can be withdrawn annu- (Form 1040A) or Schedule B (Form 1040) in- ally is taxable to you in the year it is credited to structions. Money market certificates, savings certifi- your account. However, if you can withdraw it Incorrect amount. If you receive a Form cates, and other deferred interest accounts. only on the anniversary date of the policy (or 1099 – INT that shows an incorrect amount (or If you open any of these accounts, interest may other specified date), the interest is taxable in other incorrect information), you should ask the be paid at fixed intervals of 1 year or less during the year that date occurs. issuer for a corrected form. The new Form the term of the account. You generally must 1099 – INT you receive will be marked "Cor- include this interest in your income when you Prepaid insurance premiums. Any increase rected." actually receive it or are entitled to receive it in the value of prepaid insurance premiums, without paying a substantial penalty. The same advance premiums, or premium deposit funds is Form 1099 – OID. Reportable interest income is true for accounts that mature in 1 year or less interest if it is applied to the payment of premi- may also be shown on Form 1099 – OID, Origi- and pay interest in a single payment at maturity. ums due on insurance policies or made avail- nal Issue Discount. For more information about If interest is deferred for more than 1 year, see able for you to withdraw. amounts shown on this form, see Original Issue Original Issue Discount (OID), later. Discount (OID), later in this chapter. U.S. obligations. Interest on U.S. obligations, Interest subject to penalty for early with- such as U.S. Treasury bills, notes, and bonds, Exempt-interest dividends. Exempt-interest drawal. If you withdraw funds from a deferred issued by any agency or instrumentality of the dividends you receive from a regulated invest- interest account before maturity, you may have United States is taxable for federal income tax ment company (mutual fund) are not included in to pay a penalty. You must report the total purposes. your taxable income. (However, see amount of interest paid or credited to your ac- Treasury bills generally have a 4-week, Information-reporting requirement, next.) You count during the year, without subtracting the 13-week, or 26-week maturity period. They are will receive a notice from the mutual fund telling penalty. See Penalty on early withdrawal of sav- issued at a discount in the amount of $1,000 and you the amount of the exempt-interest dividends ings in chapter 1 of Publication 550, for more multiples of $1,000. The difference between the that you received. Exempt-interest dividends information on how to report the interest and discounted price you pay for the bills and the are not shown on Form 1099 – DIV or Form deduct the penalty. face value you receive at maturity is interest 1099 – INT. income. Generally, you report this interest in- Money borrowed to invest in money mar- Information-reporting requirement. Al- come when the bill is paid at maturity. ket certificate. The interest you pay on money though exempt-interest dividends are not tax- Treasury notes have maturity periods of borrowed from a bank or savings institution to able, you must show them on your tax return if more than 1 year, ranging up to 10 years. Matur- meet the minimum deposit required for a money you have to file. This is an information-reporting ity periods for Treasury bonds are longer than market certificate from the institution and the requirement and does not change the 10 years. Both notes and bonds generally pay interest you earn on the certificate are two sepa- exempt-interest dividends into taxable income. interest every 6 months. Generally, you report rate items. You must report the total interest you this interest for the year paid. For more informa- earn on the certificate in your income. If you Note. Exempt-interest dividends paid from tion, see U.S. Treasury Bills, Notes, and Bonds itemize deductions, you can deduct the interest specified private activity bonds may be subject in chapter 1 of Publication 550. you pay as investment interest, up to the amount to the alternative minimum tax. See Alternative of your net investment income. See Interest Ex- For other information on Treasury Minimum Tax in chapter 32 for more informa- penses in chapter 3 of Publication 550. notes or bonds, write to: tion. Chapter 1 of Publication 550 contains a discussion on private activity bonds, under State Example. You deposited $5,000 with a or Local Government Obligations. bank and borrowed $5,000 from the bank to Treasury Direct make up the $10,000 minimum deposit required Attn: Customer Information Interest on VA dividends. Interest on insur- to buy a 6-month money market certificate. The P.O. Box 9150 ance dividends that you leave on deposit with certificate earned $575 at maturity in 2003, but Minneapolis, MN 55480 – 9150 the Department of Veterans Affairs (VA) is not taxable. This includes interest paid on dividends you received only $265, which represented the $575 you earned minus $310 interest charged Or, on the Internet, visit: on converted United States Government Life www. publicdebt.treas.gov Insurance and on National Service Life Insur- on your $5,000 loan. The bank gives you a Form ance policies. 1099 – INT for 2003 showing the $575 interest you earned. The bank also gives you a state- ment showing that you paid $310 interest for For information on series EE, series I, and 2003. You must include the $575 in your in- series HH savings bonds, see U.S. Savings come. If you itemize your deductions on Sched- Bonds, later. Taxable Interest ule A (Form 1040), you can deduct $310, subject to the net investment income limit. Treasury inflation-indexed securities. Taxable interest includes interest you receive These securities pay interest twice a year at a from bank accounts, loans you make to others, Gift for opening account. If you receive non- fixed rate, based on a principal amount that is and other sources. The following are some other cash gifts or services for making deposits or for adjusted to take into account inflation and defla- sources of taxable interest. opening an account in a savings institution, you tion. For the tax treatment of these securities, may have to report the value as interest. see Inflation-Indexed Debt Instruments under Dividends that are actually interest. Certain Original Issue discount (OID), in Publication For deposits of less than $5,000, gifts or distributions commonly called dividends are ac- 550. services valued at more than $10 must be re- tually interest. You must report as interest ported as interest. For deposits of $5,000 or so-called "dividends" on deposits or on share Interest on tax refunds. Interest you receive more, gifts or services valued at more than $20 accounts in: on tax refunds is taxable income. must be reported as interest. The value is deter- • Cooperative banks, mined by the cost to the financial institution. Interest on condemnation award. If the con- demning authority pays you interest to compen- • Credit unions, Example. You open a savings account at sate you for a delay in paying an award, the • Domestic building and loan associations, your local bank and deposit $800. The account interest is taxable. Chapter 8 Interest Income Page 61 Installment sale payments. If a contract for your bond. Interest that accrues after the date of bonds were issued. The original 10-year matur- the sale or exchange of property provides for purchase, however, is taxable interest income ity period of series E bonds has been extended deferred payments, it also usually provides for for the year it is received or accrued. See Bonds to 40 years for bonds issued before December interest payable with the deferred payments. Sold Between Interest Dates, later, for more 1965 and 30 years for bonds issued after No- That interest is taxable when you receive it. If information. vember 1965. Series EE and series E bonds are little or no interest is provided for in a deferred issued at a discount. The face value is payable Bel ow - m a rk e t l o a n s . I n g e n e r a l , a payment contract, part of each payment may be to you at maturity. below-market loan is a loan on which no interest treated as interest. See Unstated Interest and is charged or on which interest is charged at a Series I bonds. Series I bonds were first Original Issue Discount in Publication 537, In- rate below the applicable federal rate. See offered in 1998. These are inflation-indexed stallment Sales. Below-Market Loans in chapter 1 of Publication bonds issued at their face amount with a matur- Interest on annuity contract. Accumulated 550 for more information. ity period of 30 years. The face value plus all interest on an annuity contract you sell before its accrued interest is payable to you at maturity. maturity date is taxable. U.S. Savings Bonds Reporting options for cash method tax- Usurious interest. Usurious interest is inter- payers. If you use the cash method of report- est charged at an illegal rate. This is taxable as This section provides tax information on U.S. ing income, you can report the interest on series interest unless state law automatically changes savings bonds. It explains how to report the EE, series E, and series I bonds in either of the it to a payment on the principal. interest income on these bonds and how to treat following ways. transfers of these bonds. Individual retirement arrangements (IRAs). Interest on a Roth IRA generally is not taxable. For other information on U.S. savings 1) Method 1. Postpone reporting the interest Interest on a traditional IRA is tax deferred. You bonds, write to: until the earlier of the year you cash or generally do not include it in your income until dispose of the bonds or the year they ma- you make withdrawals from the IRA. See chap- For series EE and I: ture. (However, see Savings bonds traded, ter 18. Bureau of the Public Debt later.) Note. Series E bonds issued in Accrual Services Division 1963 and 1973 matured in 2003. If you Interest income on frozen deposits. Ex- P.O. Box 1328 have used method 1, you generally must clude from your gross income interest on frozen Parkersburg, WV 26106 – 1328 report the interest on these bonds on your deposits. A deposit is frozen if, at the end of the 2003 return. year, you cannot withdraw any part of the de- For series HH/H: posit because: 2) Method 2. Choose to report the increase Bureau of the Public Debt in redemption value as interest each year. Current Income Services Division 1) The financial institution is bankrupt or in- HH/H Assistance Branch You must use the same method for all series EE, solvent, or P.O. Box 2186 series E, and series I bonds you own. If you do 2) The state where the institution is located Parkersburg, WV 26106 – 2186 not choose method 2 by reporting the increase has placed limits on withdrawals because in redemption value as interest each year, you other financial institutions in the state are Or, on the Internet, visit: must use method 1. bankrupt or insolvent. www.savingsbonds.gov If you plan to cash your bonds in the The amount of interest you must exclude is TIP same year that you will pay for higher the interest that was credited on the frozen de- education expenses, you may want to posits minus the sum of: Accrual method taxpayers. If you use an ac- use method 1 because you may be able to crual method of accounting, you must report exclude the interest from your income. To learn 1) The net amount you withdrew from these interest on U.S. savings bonds each year as it how, see Education Savings Bond Program, deposits during the year, and accrues. You cannot postpone reporting interest later. 2) The amount you could have withdrawn as until you receive it or the bonds mature. Accrual of the end of the year (not reduced by any methods of accounting are explained in chapter Change from method 1. If you want to penalty for premature withdrawals of a 1 under Accounting Methods. change your method of reporting the interest time deposit). from method 1 to method 2, you can do so Cash method taxpayers. If you use the cash without permission from the IRS. In the year of If you receive a Form 1099 – INT for interest method of accounting, as most individual tax- change you must report all interest accrued to income on deposits that were frozen at the end payers do, you generally report the interest on date and not previously reported for all your of 2003, see Frozen deposits under How To U.S. savings bonds when you receive it. The bonds. Report Interest Income in chapter 1 of Publica- cash method of accounting is explained in chap- Once you choose to report the interest each tion 550, for information about reporting this ter 1 under Accounting Methods. year, you must continue to do so for all series interest income exclusion on your tax return. Series HH Bonds. These bonds are issued at EE, series E, and series I bonds you own and for The interest you exclude is treated as face value. Interest is paid twice a year by direct any you get later, unless you request permission credited to your account in the following year. deposit to your bank account. If you are a cash to change, as explained next. You must include it in income when you can method taxpayer, you must report interest on withdraw it. Change from method 2. To change from these bonds as income in the year you receive it. method 2 to method 1, you must request permis- Series HH Bonds were first offered in 1980. Example. $100 of interest was credited on sion from the IRS. Permission for the change is Before 1980, series H bonds were issued. Se- your frozen deposit during the year. You with- automatically granted if you send the IRS a ries H bonds are treated the same as series HH drew $80 but could not withdraw any more as of statement that meets all the following require- bonds. If you are a cash method taxpayer, you the end of the year. You must include $80 in ments. must report the interest when you receive it. your income and exclude $20 from your income Series H bonds have a maturity period of 30 for the year. You must include the $20 in your 1) You have typed or printed at the top as years. Series HH bonds mature in 20 years. income for the year you can withdraw it. follows:"Change in Method of Account- Series EE and series I bonds. Interest on ing Under Section 6.01 of the Appendix Bonds traded flat. If you buy a bond when these bonds is payable when you redeem the of Rev. Proc. 2002 – 9 (or later update)." interest has been defaulted or when the interest bonds. The difference between the purchase has accrued but has not been paid, the transac- 2) It includes your name and social security price and the redemption value is taxable inter- tion is described as trading a bond flat. The number under the label in (1). est. defaulted or unpaid interest is not income and is 3) It identifies the savings bonds for which not taxable as interest if paid later. When you Series EE bonds. Series EE bonds were you are requesting this change. receive a payment of that interest, it is a return of first offered in July 1980. They have a maturity capital that reduces the remaining cost basis of period of 30 years. Before July 1980, series E 4) It includes your agreement to: Page 62 Chapter 8 Interest Income Table 8 –1. Who Pays the Tax on U.S. Savings Bond Interest have to include in gross income at the time of reissue his or her share of the interest earned IF ... THEN the interest must be reported by ... that was not reported before the transfer. This interest, however, as well as all interest earned you buy a bond in your name and the name of you. after the reissue, is income to the former another person as co-owners, using only your co-owner. own funds This income-reporting rule also applies when you buy a bond in the name of another person, the person for whom you bought the bond. the bonds are reissued in the name of your who is the sole owner of the bond former co-owner and a new co-owner. But the new co-owner will report only his or her share of you and another person buy a bond as both you and the other co-owner, in proportion the interest earned after the transfer. co-owners, each contributing part of the to the amount each paid for the bond. If bonds that you and a co-owner bought purchase price jointly are reissued to each of you separately in you and your spouse, who live in a community you and your spouse. if you file separate the same proportion as your contribution to the property state, buy a bond that is community returns, both you and your spouse generally purchase price, neither you nor your co-owner property report one-half of the interest. has to report at that time the interest earned before the bonds were reissued. a) Report all interest on any bonds ac- One co-owner's funds used. If you used Example 1. You and your spouse each quired during or after the year of your funds to buy the bond, you must pay the tax spent an equal amount to buy a $1,000 series change when the interest is realized on the interest. This is true even if you let the EE savings bond. The bond was issued to you upon disposition, redemption, or final other co-owner redeem the bond and keep all and your spouse as co-owners. You both post- maturity, whichever is earliest, and the proceeds. Under these circumstances, since pone reporting interest on the bond. You later the other co-owner will receive a Form have the bond reissued as two $500 bonds, one b) Report all interest on the bonds ac- in your name and one in your spouse's name. At 1099 – INT at the time of redemption, the other quired before the year of change when that time neither you nor your spouse has to co-owner must provide you with another Form the interest is realized upon disposition, report the interest earned to the date of reissue. 1099 – INT showing the amount of interest from redemption, or final maturity, whichever the bond that is taxable to you. The co-owner is earliest, with the exception of the in- Example 2. You bought a $1,000 series EE who redeemed the bond is a "nominee." See terest reported in prior tax years. savings bond entirely with your own funds. The Nominee distributions under How To Report In- terest Income in chapter 1 of Publication 550 for bond was issued to you and your spouse as 5) It includes your signature. co-owners. You both postpone reporting interest more information about how a person who is a You must attach this statement to your tax re- nominee reports interest income belonging to on the bond. You later have the bond reissued turn for the year of change, which you must file another person. as two $500 bonds, one in your name and one in by the due date (including extensions). your spouse's name. You must report half the Both co-owners' funds used. If you and interest earned to the date of reissue. You can have an automatic extension of 6 the other co-owner each contribute part of the months from the due date of your return for the bond's purchase price, the interest is generally Transfer to a trust. If you own series E, series year of change (excluding extensions) to file the taxable to each of you, in proportion to the EE, or series I bonds and transfer them to a statement with an amended return. At the top of amount each of you paid. trust, giving up all rights of ownership, you must the statement, write "Filed pursuant to section include in your income for that year the interest 301.9100 – 2." To get this extension, you must Community property. If you and your earned to the date of transfer if you have not have filed your original return for the year of spouse live in a community property state and already reported it. However, if you are consid- change by the due date (including extensions). hold bonds as community property, one-half of ered the owner of the trust and if the increase in the interest is considered received by each of By the date you file the original state- value both before and after the transfer contin- you. If you file separate returns, each of you ment with your return, you must also ues to be taxable to you, you can continue to generally must report one-half of the bond inter- send a copy to the address below. defer reporting the interest earned each year. est. For more information about community You must include the total interest in your in- property, see Publication 555, Community Prop- Internal Revenue Service come in the year you cash or dispose of the erty. Attention: CC:IT&A (Automatic Rulings bonds or the year the bonds finally mature, Branch) Table 8 – 1. These rules are also shown in whichever is earlier. P.O. Box 7604 Table 8 – 1. The same rules apply to previously unre- Benjamin Franklin Station ported interest on series EE or series E bonds if Washington, DC 20044 Ownership transferred. If you bought series the transfer to a trust consisted of series HH or E, series EE, or series I bonds entirely with series H bonds you acquired in a trade for the your own funds and had them reissued in your series EE or series E bonds. See Savings bonds If you use a private delivery service, send the co-owner's name or beneficiary's name alone, traded, later. copy to the address below. you must include in your gross income for the year of reissue all interest that you earned on Decedents. The manner of reporting interest Internal Revenue Service income on series E, series EE, or series I bonds, these bonds and have not previously reported. Attention: CC:IT&A (Automatic Rul- after the death of the owner, depends on the But, if the bonds were reissued in your name ings Branch), accounting and income-reporting method previ- alone, you do not have to report the interest 1111 Constitution Avenue, NW ously used by the decedent. This is explained in accrued at that time. Room 4516 chapter 1 of Publication 550. Washington, DC 20224 This same rule applies when bonds (other than bonds held as community property) are Instead of filing this statement, you can re- Savings bonds traded. If you postponed re- transferred between spouses incident to di- quest permission to change from method 2 to porting the interest on your series EE or series E vorce. method 1 by filing Form 3115. In that case, bonds, you did not recognize taxable income follow the form instructions for an automatic Purchased jointly. If you and a co-owner when you traded the bonds for series HH or change. No user fee is required. each contributed funds to buy series E, series series H bonds, unless you received cash in the EE, or series I bonds jointly and later have the trade. (You cannot trade series I bonds for se- Co-owners. If a U.S. savings bond is issued in bonds reissued in the co-owner's name alone, ries HH bonds.) Any cash you received is in- the names of co-owners, such as you and your you must include in your gross income for the come up to the amount of the interest earned on child or you and your spouse, interest on the year of reissue your share of all the interest the bonds traded. When your series HH or se- bond is generally taxable to the co-owner who earned on the bonds that you have not previ- ries H bonds mature, or if you dispose of them bought the bond. ously reported. The former co-owner does not before maturity, you report as interest the differ- Chapter 8 Interest Income Page 63 ence between their redemption value and your includes examples showing how to report these 2) Any other nontaxable payments (other cost. Your cost is the sum of the amount you amounts. than gifts, bequests, or inheritances) re- paid for the traded series EE or series E bonds ceived for educational expenses, such as: Interest on U.S. savings bonds is ex- plus any amount you had to pay at the time of TIP empt from state and local taxes. The a) Veterans' educational assistance bene- the trade. Form 1099 – INT you receive will indi- fits, cate the amount that is for U.S. savings bond Example. You own series EE bonds with b) Benefits under a qualified tuition pro- interest in box 3. Do not include this amount on accrued interest of $523 and a redemption value your state or local income tax return. gram, or of $2,723 and have postponed reporting the interest. You trade the bonds for $2,500 in series c) Certain employer-provided educational assistance benefits. HH bonds and $223 in cash. You must report the Education Savings $223 as taxable income in the year of the trade. Bond Program Effect of other education benefits. Do not Choice to report interest in year of trade. You may be able to exclude from income all or include in your qualified expenses any expenses You can choose to treat all of the previously part of the interest you receive on the redemp- used to: unreported accrued interest on the series EE or series E bonds traded for series HH bonds as tion of qualified U.S. savings bonds during the year if you pay qualified higher educational ex- 1) Figure an education credit on Form 8863, income in the year of the trade. If you make this choice, it is treated as a change from method 1. penses during the same year. This exclusion is 2) Figure the nontaxable amount of a distri- See Change from method 1 under Series EE known as the Education Savings Bond Program. bution from a Coverdell ESA, or and series I bonds, earlier. You do not qualify for this exclusion if your 3) Figure the nontaxable amount of a distri- filing status is married filing separately. bution from a qualified state tuition pro- Form 1099 – INT for U.S. savings bonds inter- gram. Form 8815. Use Form 8815 to figure your est. When you cash a bond, the bank or other exclusion. Attach the form to your Form 1040 or payer that redeems it must give you a Form Amount excludable. If the total proceeds Form 1040A. 1099 – INT if the interest part of the payment you (interest and principal) from the qualified U.S. receive is $10 or more. Box 3 of your Form Qualified U.S. savings bonds. A qualified savings bonds you redeem during the year are 1099 – INT should show the interest as the differ- U.S. savings bond is a series EE bond issued not more than your qualified higher educational ence between the amount you received and the after 1989 or a series I bond. The bond must be expenses for the year, you can exclude all of the amount paid for the bond. However, your Form issued either in your name (sole owner) or in interest. If the proceeds are more than the ex- 1099 – INT may show more interest than you your and your spouse's names (co-owners). penses, you can exclude only part of the inter- have to include on your income tax return. For You must be at least 24 years old before the est. example, this may happen if any of the following bond's issue date. To determine the excludable amount, multi- are true. The date a bond is issued may be ear- ply the interest part of the proceeds by a fraction. 1) You chose to report the increase in the ! lier than the date the bond is pur- The numerator (top part) of the fraction is the CAUTION chased because bonds are issued as qualified higher educational expenses you paid redemption value of the bond each year. of the first day of the month in which they are during the year. The denominator (bottom part) The interest shown on your Form purchased. of the fraction is the total proceeds you received 1099 – INT will not be reduced by amounts during the year. previously included in income. Beneficiary. You can designate any individual 2) You received the bond from a decedent. Example. In February 2003, Mark and (including a child) as a beneficiary of the bond. The interest shown on your Form Joan, a married couple, cashed a qualified se- 1099 – INT will not be reduced by any inter- Verification by IRS. If you claim the exclu- ries EE U.S. savings bond they bought in April est reported by the decedent before death, sion, the IRS will check it by using bond redemp- 1995. They received proceeds of $7,256, repre- or on the decedent's final return, or by the tion information from the Department of the senting principal of $5,000 and interest of estate on the estate's income tax return. Treasury. $2,256. In 2003, they paid $4,000 of their daughter's college tuition. They are not claiming 3) Ownership of the bond was transferred. Qualified expenses. Qualified higher edu- an education credit for that amount, and they do The interest shown on your Form cational expenses are tuition and fees required not have a Coverdell ESA. They can exclude 1099 – INT will not be reduced by interest for you, your spouse, or your dependent (for $1,244 ($2,256 × ($4,000 ÷ $7,256)) of interest that accrued before the transfer. whom you can claim an exemption) to attend an in 2003. They must pay tax on the remaining eligible educational institution. 4) You were named as a co-owner and the $1,012 ($2,256 − $1,244) interest. other co-owner contributed funds to buy Qualified expenses include any contribution Modified adjusted gross income limit. the bond. The interest shown on your you make to a qualified tuition program or to a The interest exclusion is limited if your modified Form 1099 – INT will not be reduced by the Coverdell education savings account. adjusted gross income (modified AGI) is: amount you received as nominee for the Qualified expenses do not include expenses other co-owner. (See Co-owners, earlier in for room and board or for courses involving • $58,500 to $73,500 for taxpayers filing sin- this chapter, for more information about sports, games, or hobbies that are not part of a gle or head of household, and the reporting requirements.) degree or certificate granting program. • $87,750 to $117,750 for married taxpayers 5) You received the bond in a taxable distri- Eligible educational institutions. These filing jointly or for a qualifying widow(er) bution from a retirement or profit-sharing institutions include most public, private, and with dependent child. plan. The interest shown on your Form nonprofit universities, colleges and vocational You do not qualify for the interest exclusion if 1099 – INT will not be reduced by the inter- schools that are accredited and are eligible to your modified AGI is equal to or more than the est portion of the amount taxable as a dis- participate in student aid programs run by the upper limit for your filing status. tribution from the plan and not taxable as Department of Education. interest. (This amount is generally shown Modified AGI, for purposes of this exclusion, Reduction for certain benefits. You must on Form 1099 – R, Distributions From Pen- is adjusted gross income (line 21 of Form 1040A reduce your qualified higher educational ex- sions, Annuities, Retirement or Profit-Shar- or line 35 of Form 1040) figured before the penses by certain benefits the student may have ing Plans, IRAs, Insurance Contracts, etc., interest exclusion, and modified by adding back received. These benefits include: for the year of distribution.) any: For more information on including the correct 1) Qualified scholarships that are exempt 1) Foreign earned income exclusion, amount of interest on your return, see How To from tax (see chapter 13 for information on Report Interest Income, later. Publication 550 qualified scholarships), and 2) Foreign housing exclusion or deduction, Page 64 Chapter 8 Interest Income 3) Exclusion of income for bona fide re- a) The lender is not in the business of sidents of American Samoa, Original Issue lending money. 4) Exclusion for income from Puerto Rico, Discount (OID) b) The amount of the loan, plus the Original issue discount (OID) is a form of inter- amount of any outstanding prior loans 5) Exclusion for adoption benefits received est. You generally include OID in your income as between the same individuals, is under an employer's adoption assistance it accrues over the term of the debt instrument, $10,000 or less. program, whether or not you receive any payments from c) Avoiding any federal tax is not one of 6) Deduction for tuition and fees, and the issuer. the principal purposes of the loan. 7) Deduction for student loan interest. A debt instrument generally has OID when the instrument is issued for a price that is less Use the worksheet in the instructions for line Form 1099 – OID. The issuer of the debt in- than its stated redemption price at maturity. OID 9, Form 8815, to figure your modified AGI. If you strument (or your broker, if you held the instru- is the difference between the stated redemption claim any of the exclusion or deduction items ment through a broker) should give you Form listed above (except items 6 and 7), add the price at maturity and the issue price. 1099 – OID, Original Issue Discount, or a similar amount of the exclusion or deduction (except All instruments that pay no interest before statement, if the total OID for the calendar year any deduction for tuition and fees or student loan maturity are presumed to be issued at a dis- is $10 or more. Form 1099 – OID will show, in interest) to the amount on line 5 of the work- count. Zero coupon bonds are one example of box 1, the amount of OID for the part of the year sheet, and enter the total on Form 8815, line 9, these instruments. that you held the bond. It also will show, in box 2, as your modified AGI. The OID accrual rules generally do not apply other interest that you must include in your in- If you have investment interest expense in- to short-term obligations (those with a fixed ma- come. A copy of Form 1099 – OID will be sent to curred to earn royalties and other investment turity date of 1 year or less from date of issue). the IRS. Do not file your copy with your return. income, see Education Savings Bond Program See Discount on Short-Term Obligations in Keep it for your records. in chapter 1 of Publication 550. chapter 1 of Publication 550. In most cases, you must report the entire Recordkeeping. If you claim the inter- amount in boxes 1 and 2 of Form 1099 – OID as De minimis OID. You can treat the discount interest income. But see Refiguring OID shown est exclusion, you must keep a written as zero if it is less than one-fourth of 1% (.0025) on Form 1099 – OID, later in this discussion, for RECORDS record of the qualified U.S. savings of the stated redemption price at maturity multi- more information. bonds you redeem. Your record must include plied by the number of full years from the date of the serial number, issue date, face value, and Nominee. If someone else is the holder of original issue to maturity. This small discount is total redemption proceeds (principal and inter- record (the registered owner) of an OID instru- known as "de minimis" OID. est) of each bond. You can use Form 8818, ment that belongs to you and receives a Form Optional Form To Record Redemption of Series 1099 – OID on your behalf, that person must give Example 1. You bought a 10-year bond with EE and I U.S. Savings Bonds Issued After 1989, you a Form 1099 – OID. a stated redemption price at maturity of $1,000, to record this information. You should also keep issued at $980 with OID of $20. One-fourth of Refiguring OID shown on Form 1099 – OID. bills, receipts, canceled checks, or other docu- 1% of $1,000 (stated redemption price) times 10 You must refigure the OID shown in box 1 of mentation that shows you paid qualified higher (the number of full years from the date of original Form 1099 – OID if either of the following apply. educational expenses during the year. issue to maturity) equals $25. Because the $20 discount is less than $25, the OID is treated as 1) You bought the debt instrument after its Bonds Sold Between zero. (If you hold the bond at maturity, you will original issue and paid a premium or an recognize $20 ($1,000 − $980) of capital gain.) acquisition premium. Interest Dates 2) The debt instrument is a stripped bond or Example 2. The facts are the same as in If you sell a bond between interest payment a stripped coupon (including certain zero Example 1, except that the bond was issued at dates, part of the sales price represents interest coupon instruments). $950. The OID is $50. Because the $50 discount accrued to the date of sale. You must report that is more than the $25 figured in Example 1, you For information about figuring the correct part of the sales price as interest income for the must include the OID in income as it accrues amount of OID to include in your income, see year of sale. over the term of the bond. Figuring OID on Long-Term Debt Instruments in If you buy a bond between interest payment Publication 1212. dates, part of the purchase price represents Debt instrument bought after original is- interest accrued before the date of purchase. sue. If you buy a debt instrument with de Form 1099 – OID not received. If you had When that interest is paid to you, treat it as a minimis OID at a premium, the discount is not OID for the year but did not receive a Form return of your capital investment, rather than includible in income. If you buy a debt instrument 1099 – OID, see Publication 1212, which lists interest income, by reducing your basis in the with de minimis OID at a discount, the discount total OID on certain debt instruments and has bond. See Accrued interest on bonds under is reported under the market discount rules. See information that will help you figure OID. If your How To Report Interest Income in chapter 1 of Market Discount Bonds in chapter 1 of Publica- debt instrument is not listed in Publication 1212, Publication 550 for information on reporting the tion 550. consult the issuer for further information about payment. the accrued OID for the year. Exceptions to reporting OID. The OID rules Refiguring periodic interest shown on Form Insurance discussed in this chapter do not apply to the following debt instruments. 1099 – OID. If you disposed of a debt instru- ment or acquired it from another holder during Life insurance proceeds paid to you as benefi- 1) Tax-exempt obligations. (However, see the year, see Bonds Sold Between Interest ciary of the insured person are usually not tax- Stripped tax-exempt obligations under Dates, earlier, for information about the treat- able. But if you receive the proceeds in Stripped Bonds and Coupons in chapter 1 ment of periodic interest that may be shown in installments, you must usually report a part of of Publication 550). box 2 of Form 1099 – OID for that instrument. each installment payment as interest income. For more information about insurance pro- 2) U.S. savings bonds. Certificates of deposit (CDs). If you buy a ceeds received in installments, see Publication CD with a maturity of more than 1 year that pays 525, Taxable and Nontaxable Income. 3) Short-term debt instruments (those with a interest at maturity, you must include in income fixed maturity date of not more than 1 year each year a part of the total interest due and Annuity. If you buy an annuity with life insur- from the date of issue). report it in the same manner as other OID. ance proceeds, the annuity payments you re- 4) Obligations issued by an individual before This also applies to similar deposit arrange- ceive are taxed as pension and annuity income March 2, 1984. ments with banks, building and loan associa- from a nonqualified plan, not as interest income. tions, etc., including: See chapter 11 for information on pension and 5) Loans between individuals, if all the follow- annuity income from nonqualified plans. ing are true. • Time deposits, Chapter 8 Interest Income Page 65 • Bonus plans, pal and $508.80 interest). If you use the cash 4) You received a Form 1099 – INT for tax- method, you must include in income on your exempt interest. • Savings certificates, 2003 return the $508.80 interest you received in 5) You received a Form 1099 – INT for U.S. • Deferred income certificates, that year. savings bond interest that includes • Bonus savings certificates, and Constructive receipt. You constructively amounts you reported before 2003. receive income when it is credited to your ac- • Growth savings certificates. 6) You received, as a nominee, interest that count or made available to you. You do not need actually belongs to someone else. to have physical possession of it. For example, Bearer CDs. CDs issued after 1982 gener- you are considered to receive interest, divi- 7) You received a Form 1099 – INT for inter- ally must be in registered form. Bearer CDs are dends, or other earnings on any deposit or ac- est or frozen deposits. CDs that are not in registered form. They are not count in a bank, savings and loan, or similar issued in the depositor's name and are transfer- List each payer's name and the amount of inter- financial institution, or interest on life insurance able from one individual to another. est income received from each payer on line 1. If policy dividends left to accumulate, when they Banks must provide the IRS and the person you received a Form 1099 – INT or Form are credited to your account and subject to your redeeming a bearer CD with a Form 1099 – INT. 1099 – OID from a brokerage firm, list the broker- withdrawal. This is true even if they are not yet entered in your passbook. age firm as the payer. More information. See chapter 1 of Publica- tion 550 for more information about OID and You constructively receive income on the You cannot use Form 1040A if you must use related topics, such as market discount bonds. deposit or account even if you must: Form 1040, as described next. 1) Make withdrawals in multiples of even Form 1040. You must use Form 1040 instead State or Local amounts, of Form 1040A or Form 1040EZ if: Government Obligations 2) Give a notice to withdraw before making the withdrawal, 1) You forfeited interest income because of Generally, interest on a bond used to finance the early withdrawal of a time deposit, government operations is not taxable if the bond 3) Withdraw all or part of the account to with- draw the earnings, or 2) You received or paid accrued interest on is issued by a state, the District of Columbia, a securities transferred between interest possession of the United States, or any of their 4) Pay a penalty on early withdrawals, unless payment dates, political subdivisions. the interest you are to receive on an early Bonds issued after 1982 by an Indian tribal withdrawal or redemption is substantially 3) You had a financial account in a foreign government are treated as issued by a state. less than the interest payable at maturity. country, unless the combined value of all Interest on these bonds is generally tax exempt foreign accounts was $10,000 or less dur- if the bonds are part of an issue of which sub- ing all of 2003 or the accounts were with stantially all of the proceeds are used in the Accrual method. If you use an accrual certain U.S. military banking facilities, exercise of any essential government function. method, you report your interest income when you earn it, whether or not you have received it. 4) You acquired taxable bonds after 1987 Interest on arbitrage bonds issued by state Interest is earned over the term of the debt and choose to reduce interest income from or local governments after October 9, 1969, is instrument. the bonds by any amortizable bond pre- taxable. mium (see Bond Premium Amortization in Generally, interest on private activity bonds Example. If, in the previous example, you chapter 3 of Publication 550), or is taxable. For more information on whether such interest is taxable or tax exempt, see State use an accrual method, you must include the 5) You are reporting OID in an amount more or Local Government Obligations in chapter 1 of interest in your income as you earn it. You would or less than the amount shown on Form Publication 550. report the interest as follows: 2001, $80; 2002, 1099 – OID. $249.60; and 2003, $179.20. Information reporting requirement. If you Schedule B. You must complete Part I of must file a tax return, you are required to show Coupon bonds. Interest on coupon bonds is Schedule B (Form 1040) if you file Form 1040 any tax-exempt interest you received on your taxable in the year the coupon becomes due and and any of the following apply. return. This is an information-reporting require- payable. It does not matter when you mail the ment only. It does not change tax-exempt inter- coupon for payment. 1) Your taxable interest income is more than est to taxable interest. $1,500. 2) You are claiming the interest exclusion How To Report under the Education Savings Bond Pro- When To Report gram (discussed earlier). Interest Income 3) You had a foreign account. Interest Income 4) You received interest from a seller-fi- Generally, you report all of your taxable interest nanced mortgage, and the buyer used the When to report your interest income depends on income on line 8a, Form 1040; line 8a, Form property as a home. whether you use the cash method or an accrual 1040A; or line 2, Form 1040EZ. method to report income. You cannot use Form 1040EZ if your interest 5) You received a Form 1099 – INT for tax-ex- income is more than $1,500. Instead, you must empt interest. Cash method. Most individual taxpayers use use Form 1040A or Form 1040. the cash method. If you use this method, you 6) You received a Form 1099 – INT for U.S. generally report your interest income in the year Form 1040A. You must complete Part I of savings bond interest that includes in which you actually or constructively receive it. Schedule 1 (Form 1040A) if you file Form 1040A amounts you reported before 2003. However, there are special rules for reporting and any of the following are true. 7) You received, as a nominee, interest that the discount on certain debt instruments. See actually belongs to someone else. U.S. Savings Bonds and Original Issue Dis- 1) Your taxable interest income is more than count, earlier. $1,500. 8) You received a Form 1099 – INT for inter- est on frozen deposits. 2) You are claiming the interest exclusion Example. On September 1, 2001, you under the Education Savings Bond Pro- 9) You received a Form 1099 – INT for inter- loaned another individual $2,000 at 12%, com- gram (discussed earlier). est on a bond that you bought between pounded annually. You are not in the business interest payment dates. of lending money. The note stated that principal 3) You received interest from a seller-fi- and interest would be due on August 31, 2003. nanced mortgage, and the buyer used the 10) Statement (4) or (5) in the preceding list is In 2003, you received $2,508.80 ($2,000 princi- property as a home. true. Page 66 Chapter 8 Interest Income On line 1, Part I, list each payer's name and the to any other taxable interest income you re- Form 1099 – INT for U.S. savings bonds interest, amount received from each. If you received a ceived, unless part of the amount in box 3 was earlier, under U.S. Savings Bonds. Form 1099 – INT or Form 1099 – OID from a bro- previously included in interest income. If part of On line 1, Part I of Schedule B (Form 1040), kerage firm, list the brokerage firm as the payer. the amount shown in box 3 was previously in- or on line 1, Part I of Schedule 1 (Form 1040A), cluded in your interest income, see U.S. savings report all the interest shown on your Form Form 1099 – INT. Your taxable interest in- bond interest previously reported, later. 1099 – INT. Then follow these steps. come, except for interest from U.S. savings Box 4 of Form 1099 – INT (federal income tax bonds and Treasury obligations, is shown in box 1) Several lines above line 2, enter a subtotal withheld) will contain an amount if you were 1 of Form 1099 – INT. Add this amount to any of all interest listed on line 1. subject to backup withholding. Report the other taxable interest income you received. You amount from box 4 on Form 1040EZ, line 7, on 2) Below the subtotal write "U.S. Savings must report all of your taxable interest income Form 1040A, line 39, or on Form 1040, line 61 Bond Interest Previously Reported" and even if you do not receive a Form 1099 – INT. (federal income tax withheld). enter amounts previously reported or inter- If you forfeited interest income because of Box 5 of Form 1099 – INT shows investment est accrued before you received the bond. the early withdrawal of a time deposit, the de- expenses you may be able to deduct as an ductible amount will be shown on Form 3) Subtract these amounts from the subtotal itemized deduction. See chapter 3 of Publication 1099 – INT in box 2. See Penalty on early with- and enter the result on line 2. 550 for more information about investment ex- drawal of savings in chapter 1 of Publication penses. 550. Box 3 of Form 1099 – INT shows the amount U.S. savings bond interest previously More information. For more information of interest income you received from U.S. sav- reported. If you received a Form 1099 – INT about how to report interest income, see chapter ings bonds, Treasury bills, Treasury notes, and for U.S. savings bond interest, the form may 1 of Publication 550 or the instructions for the Treasury bonds. Add the amount shown in box 3 show interest you do not have to report. See form you must file. Chapter 8 Interest Income Page 67 more stock, stock rights, other property, or serv- includes payers of dividends. If you do not give ices. your SSN or ITIN to the payer of dividends, you may have to pay a penalty. 9. Useful Items For more information on SSNs and ITINs, You may want to see: see Social security number (SSN) in chapter 8. Backup withholding. Your dividend income Dividends and Publication is generally not subject to regular withholding. ❏ 514 Foreign Tax Credit for Individuals However, it may be subject to backup withhold- Other Corporate ❏ 550 Investment Income and Expenses ing to ensure that income tax is collected on the income. Under backup withholding, the payer of ❏ 564 Mutual Fund Distributions dividends must withhold, as income tax, a per- Distributions Form (and Instructions) centage of the amount you are paid. For 2004, this percentage is 28%. Backup withholding may also be required if ❏ Schedule B (Form 1040) Interest and the Internal Revenue Service (IRS) has deter- Ordinary Dividends Important Change mined that you underreported your interest or ❏ Schedule 1 (Form 1040A) Interest and dividend income. For more information, see Dividends taxed at new tax rate. After De- Ordinary Dividends for Form 1040A Backup Withholding in chapter 5. cember 31, 2002, qualified dividends are taxed Filers Stock certificate in two or more names. If at the new capital gain rates. The maximum tax two or more persons hold stock as joint tenants, rate for qualified dividends is 15% (generally 5% tenants by the entirety, or tenants in common, for people whose other income is taxed at the each person may receive a share of any divi- 10% or 15% rate). See Qualified Dividends. General Information dends from the stock. Each person's share is determined by local law. This section discusses general rules on dividend Form 1099 – DIV. Most corporations use Form income. Important Reminder Tax on investment income of a child under 1099 – DIV, Dividends and Distributions, to show you the distributions you received from them age 14. Part of a child's 2003 investment in- during the year. Keep this form with your rec- Reporting dividends on your return. Ordi- ords. You do not have to attach it to your tax come may be taxed at the parent's tax rate. This nary dividend income that exceeds a certain return. Even if you do not receive Form may happen if all of the following are true. amount must be reported on a separate sched- 1099 – DIV, you must still report all of your tax- ule. If you file Form 1040A, you must attach able dividend income. Schedule 1 to your return if your ordinary divi- 1) The child was under age 14 at the end of dend income is more than $1,500; if you file Reporting tax withheld. If tax is withheld 2003. A child born on January 1, 1990, is Form 1040, you must attach Schedule B to your from your dividend income, the payer must give considered to be age 14 at the end of return if your ordinary dividend income is more you a Form 1099 – DIV that indicates the amount 2003. than $1,500. withheld. 2) The child had more than $1,500 of invest- Nominees. If someone receives distribu- Foreign income. If you are a U.S. citizen with ment income (such as taxable interest and tions as a nominee for you, that person will give dividend income from sources outside the dividends) and has to file a tax return. you a Form 1099 – DIV, which will show distribu- United States (foreign income), you must report 3) At least one of the child's parents was tions received on your behalf. that income on your tax return unless it is ex- alive at the end of 2003. empt by U.S. law. This is true whether you re- Form 1099 – MISC. Certain substitute pay- side inside or outside the United States and If all of these statements are true, Form 8615, ments in lieu of dividends or tax-exempt interest whether or not you receive a Form 1099 from the Tax for Children Under Age 14 With Investment that are received by a broker on your behalf foreign payer. Income of More Than $1,500, must be com- must be reported to you on Form 1099 – MISC, pleted and attached to the child's tax return. If Miscellaneous Income, or a similar statement. any of these statements is not true, Form 8615 is See Reporting Substitute Payments under Short not required and the child's income is taxed at Sales in chapter 4 of Publication 550 for more his or her own tax rate. Introduction However, the parent can choose to include information about reporting these payments. This chapter discusses the tax treatment of: the child's interest and dividends on the parent's Incorrect amount shown on a Form 1099. If return if certain requirements are met. Use you receive a Form 1099 that shows an incorrect • Ordinary dividends, Form 8814, Parents' Election To Report Child's amount (or other incorrect information), you • Capital gain distributions, Interest and Dividends, for this purpose. should ask the issuer for a corrected form. The For more information about the tax on invest- new Form 1099 you receive will be marked "Cor- • Nontaxable distributions, and ment income of children and the parents' elec- rected." • Other distributions you may receive from a tion, see chapter 33. Dividends on stock sold. If stock is sold, corporation or a mutual fund. Beneficiary of an estate or trust. Dividends exchanged, or otherwise disposed of after a and other distributions you receive as a benefi- dividend is declared, but before it is paid, the This chapter also explains how to report divi- ciary of an estate or trust are generally taxable owner of record (usually the payee shown on the dend income on your tax return. income. You should receive a Schedule K – 1 dividend check) must include the dividend in Dividends are distributions of money, stock, (Form 1041), Beneficiary's Share of Income, income. or other property paid to you by a corporation. Deductions, Credits, etc., from the fiduciary. You also may receive dividends through a part- Dividends received in January. If a regu- Your copy of Schedule K – 1 and its instructions nership, an estate, a trust, or an association that lated investment company (mutual fund) or real will tell you where to report the income on your is taxed as a corporation. However, some estate investment trust (REIT) declares a divi- Form 1040. amounts you receive that are called dividends dend (including any exempt-interest dividend or are actually interest income. (See Dividends that Social security number (SSN). You must capital gain distribution) in October, November, are actually interest under Taxable Interest in give your name and SSN (or individual taxpayer or December payable to shareholders of record chapter 8.) identification number (ITIN)) to any person re- on a date in one of those months but actually Most distributions are paid in cash (or quired by federal tax law to make a return, state- pays the dividend during January of the next check). However, distributions can consist of ment, or other document that relates to you. This calendar year, you are considered to have re- Page 68 Chapter 9 Dividends and Other Corporate Distributions ceived the dividend on December 31. You report Corp. paid a cash dividend of 10 cents per 2) The corporation is eligible for the benefits the dividend in the year it was declared. share. The ex-dividend date was July 9, 2003. of a comprehensive income tax treaty with Your Form 1099 – DIV from XYZ Corp. shows the United States that the Treasury De- $500 in box 1a (ordinary dividends) and in box partment determines is satisfactory for this 1b (qualified dividends). However, you sold the purpose and that includes an exchange of Ordinary Dividends 5,000 shares on August 4, 2003. You held your information program. For a list of those shares of XYZ Corp. for only 34 days of the treaties, seeTable 9 – 1. Ordinary (taxable) dividends are the most com- 121 – day period (from July 2, 2003, through mon type of distribution from a corporation. They August 4, 2003). The 121 – day period began on 3) The corporation does not meet (1) or (2) are paid out of the earnings and profits of a May 10, 2003 (60 days before the ex-dividend above, but the stock for which the dividend corporation and are ordinary income to you. This date), and ended on September 7, 2003. You is paid is readily tradable on an estab- means they are not capital gains. You can as- have no qualified dividends from XYZ Corp. be- lished securities market in the United sume that any dividend you receive on common cause you did not hold the XYZ stock for more States. See Readily tradable stock, later. or preferred stock is an ordinary dividend unless than 60 days. the paying corporation tells you otherwise. Ordi- Exception. A corporation is not a qualified nary dividends will be shown in box 1a of the Example 2. Assume the same facts as in foreign corporation if it is a foreign personal Form 1099 – DIV you receive. Example 1 except that you bought the stock on holding company, foreign investment company, July 8, 2003 (the day before the ex-dividend or a passive foreign investment company during Qualified Dividends date), and you sold the stock on September 9, its tax year in which the dividends are paid or 2003. You held the stock for 63 days (from July during its previous tax year. Qualified dividends are the ordinary dividends 9, 2003, through September 9, 2003). The $500 received in tax years beginning after 2002 that of qualified dividends shown in box 1b of your Readily tradable stock. Common or ordi- are subject to the same 5% or 15% maximum Form 1099 – DIV are all qualified dividends be- nary stock, or an American depositary receipt in tax rate that applies to net capital gain. They cause of the 121 – day period (from July 9, 2003, respect of that stock, is considered to satisfy should be shown in box 1b of Form 1099 – DIV through September 7, 2003). requirement (3) if it is listed on one of the follow- you receive. ing securities markets: the New York Stock Ex- Qualified dividends are subject to the 15% Example 3. You bought 10,000 shares of change, the NASDAQ Stock Market, the rate if the regular tax rate that would apply is ABC Mutual Fund common stock on July 1, American Stock Exchange, the Boston Stock 25% or higher. If the regular tax rate that would 2003. ABC Mutual Fund paid a cash dividend of Exchange, the Cincinnati Stock Exchange, the apply is lower than 25%, qualified dividends are 10 cents a share. The ex-dividend date was July Chicago Stock Exchange, the Philadelphia subject to the 5% rate. 9, 2003. The ABC Mutual Fund advises you that Stock Exchange, or the Pacific Exchange. To qualify for the 5% or 15% maximum rate, the portion of the dividend eligible to be treated all of the following requirements must be met. as qualified dividends equals 2 cents per share. 1) The dividends must have been paid by a Your Form 1099 – DIV from ABC Mutual Fund Dividends that are not qualified dividends. U.S. corporation or a qualified foreign cor- shows total ordinary dividends of $1,000 and The following dividends are not qualified divi- poration. (See Qualified foreign corpora- qualified dividends of $200. However, you sold dends. They are not qualified dividends even if tion later.) the 10,000 shares on August 4, 2003. You have they are shown in box 1b of Form 1099 – DIV. 2) The dividends are not of the type listed no qualified dividends from ABC Mutual Fund later under Dividends that are not qualified because you held the ABC Mutual Fund stock • Capital gain distributions. dividends. for less than 61 days. • Dividends paid on deposits with mutual 3) You meet the holding period (discussed Holding period reduced where risk of loss savings banks, cooperative banks, credit next). is diminished. When determining whether unions, U.S. building and loan associa- you met the minimum holding period discussed tions, U.S. savings and loan associations, Holding period. You must have held the stock earlier, you cannot count any day during which federal savings and loan associations, and for more than 60 days during the 121-day period you meet any of the following conditions. similar financial institutions. (Report these that begins 60 days before the ex-dividend date. amounts as interest income.) The ex-dividend date is the first date following 1) You had an option to sell, were under a the declaration of a dividend on which the buyer contractual obligation to sell, or had made • Dividends from a corporation that is a of a stock will not receive the next dividend (and not closed) a short sale of substan- tax-exempt organization or farmer's coop- payment. Instead, the seller will get the divi- tially identical stock or securities. erative during the corporation's tax year in dend. which the dividends were paid or during 2) You were grantor (writer) of an option to When counting the number of days you held the corporation's previous tax year. buy substantially identical stock or securi- the stock, include the day you disposed the stock, but not the day you acquired it. See the ties. • Dividends paid by a corporation on em- examples later. ployer securities which are held on the 3) Your risk of loss is diminished by holding date of record by an employee stock own- Exception for preferred stock. In the case one or more other positions in substantially similar or related property. ership plan (ESOP) maintained by that of preferred stock, you must have held the stock corporation. more than 90 days during the 181-day period For information about how to apply condition that begins 90 days before the ex-dividend date (3), see Regulations section 1.246 – 5. • Dividends on any share of stock to the if the dividends are attributable to periods total- extent that you are obligated (whether ing more than 366 days. If the preferred divi- under a short sale or otherwise) to make dends are attributable to periods totaling less Qualified foreign corporation. A foreign cor- related payments for positions in substan- than 367 days, the holding period in the previous poration is a qualified foreign corporation if it tially similar or related property. paragraph applies. meets any of the following conditions. • Payments in lieu of dividends, but only if Example 1. You bought 5,000 shares of 1) The corporation is incorporated in a U.S. you know or have reason to know that the XYZ Corp. common stock on July 1, 2003. XYZ possession. payments are not qualified dividends. Chapter 9 Dividends and Other Corporate Distributions Page 69 Table 9 –1. Income Tax Treaties stock in a corporation in different lots at different Income tax treaties that the United States Capital Gain times, and you cannot definitely identify the shares subject to the return of capital, reduce has with the following countries satisfy requirement (2) under Qualified foreign Distributions the basis of your earliest purchases first. When the basis of your stock has been re- corporation. duced to zero, report any additional return of Capital gain distributions (also called capital gain dividends) are paid to you or credited to capital that you receive as a capital gain. Australia Ireland Romania your account by regulated investment compa- Whether you report it as a long-term or Austria Israel Russian nies (commonly called mutual funds) and real short-term capital gain depends on how long Belgium Italy Federation estate investment trusts (REITs). They will be you have held the stock. See Holding Period in Canada Jamaica Slovak shown in box 2a of the Form 1099 – DIV you chapter 15. China Japan Republic receive from the mutual fund or REIT. Report capital gain distributions as long-term Example. You bought stock in 1991 for Cyprus Kazakhstan Slovenia capital gains regardless of how long you owned $100. In 1994, you received a return of capital of Czech Korea South Africa your shares in the mutual fund or REIT. $80. You did not include this amount in your Republic Latvia Spain income, but you reduced the basis of your stock Denmark Lithuania Sweden Undistributed capital gains of mutual funds to $20. You received a return of capital of $30 in Egypt Luxembourg Switzerland and REITs. Some mutual funds and REITs 2003. The first $20 of this amount reduced your Estonia Mexico Thailand keep their long-term capital gains and pay tax on basis to zero. You report the other $10 as a Finland Morocco Trinidad and them. You must treat your share of these gains long-term capital gain for 2003. You must report France Netherlands Tobago as distributions, even though you did not actu- as a long-term capital gain any return of capital Germany New Zealand Tunisia ally receive them. However, they are not in- you receive on this stock in later years. Greece Norway Turkey cluded on Form 1099 – DIV. Instead, they are Hungary Pakistan Ukraine reported to you on Form 2439, Notice to Share- Liquidating distributions. Liquidating distri- Iceland Philippines United holder of Undistributed Long-Term Capital butions, sometimes called liquidating dividends, India Poland Kingdom Gains. are distributions you receive during a partial or Indonesia Portugal Venezuela Report undistributed capital gains shown in complete liquidation of a corporation. These dis- box 1a of Form 2439 as long-term capital gains tributions are, at least in part, one form of a in column (f) on line 11 of Schedule D (Form return of capital. They may be paid in one or 1040). If there is an amount shown in box 1b of more installments. You will receive a Form Dividends Used to Buy Form 2439, report that amount in column (g) on 1099 – DIV from the corporation showing you the More Stock line 11 of Schedule D. The tax paid on these amount of the liquidating distribution in box 8 or gains by the mutual fund or REIT is shown in box 9. The corporation in which you own stock may 2 of Form 2439. You take credit for this tax by For more information on liquidating distribu- have a dividend reinvestment plan. This plan including it on line 67, Form 1040, and checking tions, see chapter 1 of Publication 550. lets you choose to use your dividends to buy box a on that line. Attach Copy B of Form 2439 (through an agent) more shares of stock in the to your return, and keep Copy C for your rec- corporation instead of receiving the dividends in ords. Distributions of Stock cash. If you are a member of this type of plan and you use your dividends to buy more stock at Basis adjustment. Increase your basis in and Stock Rights your mutual fund or your interest in a REIT by a price equal to its fair market value, you still the difference between the gain you report and Distributions by a corporation of its own stock must report the dividends as income. the credit you claim for the tax paid. are commonly known as stock dividends. Stock If you are a member of a dividend reinvest- rights (also known as "stock options") are distri- ment plan that lets you buy more stock at a price Additional information. For more information butions by a corporation of rights to acquire the less than its fair market value, you must report on the treatment of distributions from mutual corporation's stock. Generally, stock dividends as dividend income the fair market value of the funds, see Publication 564. and stock rights are not taxable to you, and you additional stock on the dividend payment date. do not report them on your return. You also must report as dividend income any service charge subtracted from your cash divi- Taxable stock dividends and stock rights. dends before the dividends are used to buy the additional stock. But you may be able to deduct Nontaxable Distributions of stock dividends and stock rights are taxable to you if any of the following apply. the service charge. See chapter 30 for more information about deducting expenses of pro- Distributions 1) You or any other shareholder has the ducing income. You may receive a return of capital or a tax-free choice to receive cash or other property In some dividend reinvestment plans, you distribution of more shares of stock or stock instead of stock or stock rights. can invest more cash to buy shares of stock at a rights. These distributions are not treated the 2) The distribution gives cash or other prop- price less than fair market value. If you choose same as ordinary dividends or capital gain distri- erty to some shareholders and an increase to do this, you must report as dividend income butions. in the percentage interest in the the difference between the cash you invest and corporation's assets or earnings and prof- the fair market value of the stock you buy. When figuring this amount, use the fair market value of Return of Capital its to other shareholders. the stock on the dividend payment date. 3) The distribution is in convertible preferred A return of capital is a distribution that is not paid stock and has the same result as in (2). out of the earnings and profits of a corporation. It Money Market Funds is a return of your investment in the stock of the 4) The distribution gives preferred stock to company. You should receive a Form some common stock shareholders and Report amounts you receive from money market 1099 – DIV or other statement from the corpora- common stock to other common stock funds as dividend income. Money market funds tion showing you what part of the distribution is a shareholders. are a type of mutual fund and should not be return of capital. On Form 1099 – DIV, a nontax- confused with bank money market accounts that 5) The distribution is on preferred stock. (The able return of capital will be shown in box 3. If pay interest. distribution, however, is not taxable if it is you do not receive such a statement, you report an increase in the conversion ratio of con- the distribution as an ordinary dividend. vertible preferred stock made solely to Basis adjustment. A return of capital reduces take into account a stock dividend, stock the basis of your stock. It is not taxed until your split, or similar event that would otherwise basis in the stock is fully recovered. If you buy result in reducing the conversion right.) Page 70 Chapter 9 Dividends and Other Corporate Distributions The term "stock" includes rights to acquire in the corporation's stock that is allocated to the Alaska Permanent Fund dividends. Do not stock, and the term "shareholder" includes a certificate. report these amounts as dividends. Instead, re- holder of rights or of convertible securities. However, if you receive a scrip certificate port these amounts on line 21 of Form 1040, line If you receive taxable stock dividends or that you can choose to redeem for cash instead 13 of Form 1040A, or line 3 of Form 1040EZ. stock rights, include their fair market value at the of stock, the certificate is taxable when you re- time of the distribution in your income. ceive it. You must include its fair market value in income on the date you receive it. Preferred stock redeemable at a premium. If you hold preferred stock having a redemption How To Report price higher than its issue price, the difference (the redemption premium) generally is taxable Dividend Income as a constructive distribution of additional stock Other Distributions on the preferred stock. For more information, Generally, you can use either Form 1040 or see chapter 1 of Publication 550. You may receive any of the following distribu- Form 1040A to report your dividend income. tions during the year. Report the total of your ordinary dividends on Basis. Your basis in stock or stock rights re- line 9a of Form 1040 or Form 1040A. Report ceived in a taxable distribution is their fair market Exempt-interest dividends. Exempt-interest qualified dividends on line 9b of that form. value when distributed. If you receive stock or dividends you receive from a regulated invest- If you receive capital gain distributions, you stock rights that are not taxable to you, see ment company (mutual fund) are not included in may be able to use Form 1040A or you may Stocks and Bonds under Basis of Investment your taxable income. You will receive a notice have to use Form 1040. See Capital gain distri- Property in chapter 4 of Publication 550 for infor- from the mutual fund telling you the amount of butions only in chapter 17. If you receive nontax- mation on how to figure their basis. the exempt-interest dividends you received. able distributions required to be reported as Exempt-interest dividends are not shown on capital gains, you must use Form 1040. You Fractional shares. You may not own enough Form 1099 – DIV or Form 1099 – INT. cannot use Form 1040EZ if you receive any stock in a corporation to receive a full share of Information reporting requirement. Al- dividend income. stock if the corporation declares a stock divi- though exempt-interest dividends are not tax- dend. However, with the approval of the share- able, you must show them on your tax return if Form 1099 – DIV. If you owned stock on which holders, the corporation may set up a plan in you have to file a return. This is an information you received $10 or more in dividends and other which fractional shares are not issued, but in- reporting requirement and does not change the distributions, you should receive a Form stead are sold, and the cash proceeds are given exempt-interest dividends to taxable income. 1099 – DIV. Even if you do not receive Form to the shareholders. Any cash you receive for 1099 – DIV, you must report all of your taxable fractional shares under such a plan is treated as Alternative minimum tax treatment. dividend income. an amount realized on the sale of the fractional Exempt-interest dividends paid from specified See Form 1099 – DIV for more information shares. You must determine your gain or loss private activity bonds may be subject to the on how to report dividend income. and report it as a capital gain or loss on Sched- alternative minimum tax. See Alternative Mini- ule D (Form 1040). Your gain or loss is the mum Tax in chapter 32 for more information. Form 1040A. You must complete Part II of difference between the cash you receive and the Schedule 1 (Form 1040A) and attach it to your basis of the fractional shares sold. Dividends on insurance policies. Insurance Form 1040A, if: policy dividends that the insurer keeps and uses Example. You own one share of common to pay your premiums are not taxable. However, 1) Your ordinary dividends (box 1a of Form stock that you bought on January 3, 1995, for you must report as taxable interest income the 1099 – DIV) are more than $1,500, or $100. The corporation declared a common stock interest that is paid or credited on dividends left dividend of 5% on June 30, 2003. The fair mar- with the insurance company. 2) You received, as a nominee, ordinary divi- ket value of the stock at the time the stock If dividends on an insurance contract (other dends that actually belong to someone dividend was declared was $200. You were paid than a modified endowment contract) are distrib- else. $10 for the fractional-share stock dividend under uted to you, they are a partial return of the List on line 5 each payer's name and the a plan described in the above paragraph. You premiums you paid. Do not include them in your amount of ordinary dividends you received. If figure your gain or loss as follows: gross income until they are more than the total of you received a Form 1099 – DIV from a broker- all net premiums you paid for the contract. Re- age firm, list the brokerage firm as the payer. Fair market value of old stock . . . . . $200.00 port any taxable distributions on insurance poli- cies on line 16b (Form 1040) or line 12b (Form Enter on line 6 the total of the amounts listed Fair market value of stock dividend 1040A). on line 5. Also enter this total on line 9a, Form (cash received) . . . . . . . . . . . . . . . +10.00 1040A. Fair market value of old stock and stock dividend . . . . . . . . . . . . . . . . $210.00 Dividends on veterans' insurance. Divi- dends you receive on veterans' insurance poli- Form 1040. You must fill in Part II of Schedule Basis (cost) of old stock after the B and attach it to your Form 1040, if: stock dividend (($200 ÷ $210) × $100) $95.24 cies are not taxable. In addition, interest on Basis (cost) of stock dividend (($10 ÷ dividends left with the Department of Veterans 1) Your ordinary dividends (box 1a of Form $210) × $100) . . . . . . . . . . . . . . . . + 4.76 Affairs is not taxable. 1099 – DIV) are more than $1,500, or Total . . . . . . . . . . . . . . . . . . . . . . $100.00 Patronage dividends. Generally, patronage 2) You received, as a nominee, ordinary divi- Cash received . . . . . . . . . . . . . . . . $10.00 dividends you receive in money from a coopera- dends that actually belong to someone Basis (cost) of stock dividend . . . . . . − 4.76 tive organization are included in your income. else. Gain $5.24 Do not include in your income patronage If your ordinary dividends are more than $1,500, Because you had held the share of stock for dividends you receive on: you must also complete Part III of Schedule B. more than 1 year at the time the stock dividend 1) Property bought for your personal use, or List on line 5, Part II of Schedule B, each was declared, your gain on the stock dividend is payer's name and the amount of ordinary divi- a long-term capital gain. 2) Capital assets or depreciable property dends you received. If your securities are held bought for use in your business. But you Scrip dividends. A corporation that de- by a brokerage firm (in "street name"), list the must reduce the basis (cost) of the items clares a stock dividend may issue you a scrip name of the brokerage firm that is shown on bought. If the dividend is more than the certificate that entitles you to a fractional share. Form 1099 – DIV as the payer. If your stock is adjusted basis of the assets, you must re- The certificate is generally nontaxable when you held by a nominee who is the owner of record, port the excess as income. receive it. If you choose to have the corporation and the nominee credited or paid you dividends sell the certificate for you and give you the pro- These rules are the same whether the coop- on the stock, show the name of the nominee and ceeds, your gain or loss is the difference be- erative paying the dividend is a taxable or the dividends you received or for which you were tween the proceeds and the portion of your basis tax-exempt cooperative. credited. Chapter 9 Dividends and Other Corporate Distributions Page 71 Enter on line 6 the total of the amounts listed If you have qualified dividends, you must fig- come when figuring the limit on your investment on line 5. Also enter this total on line 9a, Form ure your tax by completing either Schedule D interest deduction. This is done on lines 4 – 6 of 1040. (Form 1040) or the Qualified Dividends and the Qualified Dividends and Capital Gain Tax Capital Gain Tax Worksheet in the Form 1040 or Worksheet in the Form 1040 instructions, lines Qualified dividends. Report qualified divi- 1040A instructions. If you have to file Schedule 24 – 26 of Schedule D, or lines 4 – 6 of the dends (box 1b of Form 1099 – DIV) on line 9b of D (Form 1040), enter qualified dividends on line Schedule D Tax Worksheet. For more informa- Form 1040 or Form 1040A. Do not include any 23 of that schedule or line 2 of the Schedule D tion about the limit on investment interest, see of the following on line 9b. Tax Worksheet. If you do not have to file Sched- Interest Expenses in chapter 25. • Qualified dividends you received as a ule D (Form 1040), enter qualified dividends on Expenses related to dividend income. You nominee. See Nominees under How to line 2 of the Qualified Dividends and Capital may be able to deduct expenses related to divi- Report Dividend Income in chapter 1 of Gain Tax Worksheet. To find out whether you dend income if you itemize your deductions on Publication 550. have to file Schedule D, see the Form 1040 Schedule A (Form 1040). See chapter 30 for instructions. • Dividends on stock for which you did not general information about deducting expenses meet the holding period. See Holding pe- Investment interest deducted. If you claim of producing income. riod earlier under Qualified Dividends. a deduction for investment interest, you may More information. For more information have to reduce the amount of your qualified • Dividends on any share of stock to the about how to report dividend income, see chap- dividends that are eligible for the 5% or 15% tax extent that you are obligated (whether ter 1 of Publication 550 or the instructions for the rate. Reduce it by the amount of qualified divi- under a short sale or otherwise) to make form you must file. dends you choose to include in investment in- related payments for positions in substan- tially similar or related property. • Payments in lieu of dividends, but only if you know or have reason to know that the payments are not qualified dividends. Page 72 Chapter 9 Dividends and Other Corporate Distributions Form (and Instructions) market value unless there is evidence to the contrary. ❏ 4562 Depreciation and Amortization 10. ❏ 6251 Alternative Minimum Tax — Rental of property also used as a home. If you rent property that you also use as your Individuals home and you rent it fewer than 15 days during ❏ 8582 Passive Activity Loss Limitations the tax year, do not include the rent you receive Rental Income ❏ Schedule E (Form 1040) Supplemental in your income and do not deduct rental ex- penses. However, you can deduct on Schedule Income and Loss and Expenses 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. Important Change Rental Income Part interest. If you own a part interest in You generally must include in your gross income rental property, you must report your part of the Special depreciation allowance increased. all amounts you receive as rent. Rental income rental income from the property. For qualified property you placed in service after is any payment you receive for the use or occu- May 5, 2003, you can claim a special deprecia- pation of property. In addition to amounts you tion allowance that is an additional depreciation receive as normal rent payments, there are deduction equal to 50% of the property's depre- ciable basis. However, you can still choose to other amounts that may be rental income. Rental Expenses claim an allowance at the 30% rate for property When to report. Report rental income on your This part discusses repairs and certain other that qualifies for the 50% rate. return for the year you actually or constructively expenses of renting property that you ordinarily Qualified property includes property depreci- receive it, if you are a cash basis taxpayer. You can deduct from your rental income. It includes ated under the modified accelerated cost recov- are a cash basis taxpayer if you report income in information on the expenses you can deduct if ery system (MACRS) with a recovery period of the year you receive it, regardless of when it was you rent part of your property, or if you change 20 years or less. See Special Depreciation Al- earned. You constructively receive income your property to rental use. Depreciation, which lowance under Depreciation later, for more infor- when it is made available to you, for example, by you can also deduct from your rental income, is mation. being credited to your bank account. discussed later. For more information about when you con- structively receive income, see Accounting When to deduct. You generally deduct your Methods in chapter 1. rental expenses in the year you pay them. Introduction Advance rent. Advance rent is any amount you receive before the period that it covers. Vacant rental property. If you hold property for rental purposes, you may be able to deduct This chapter discusses rental income and ex- Include advance rent in your rental income in the your ordinary and necessary expenses (includ- penses. It covers the following topics. year you receive it regardless of the period cov- ing depreciation) for managing, conserving, or • Rental income. ered or the method of accounting you use. maintaining the property while the property is vacant. However, you cannot deduct any loss of • Rental expenses. Example. You sign a 10-year lease to rent rental income for the period the property is va- • Personal use of dwelling unit (including your property. In the first year, you receive cant. vacation home). $5,000 for the first year's rent and $5,000 as rent for the last year of the lease. You must include Pre-rental expenses. You can deduct your • Depreciation. $10,000 in your income in the first year. ordinary and necessary expenses for managing, • Limits on rental losses. Security deposits. Do not include a security conserving, or maintaining rental property from the time you make it available for rent. • How to report your rental income and ex- deposit in your income when you receive it if you penses. plan to return it to your tenant at the end of the Depreciation. You can begin to depreciate lease. But if you keep part or all of the security rental property when it is ready and available for If you sell or otherwise dispose of your rental deposit during any year because your tenant rent. See Placed-in-Service Date under Depre- property, see Publication 544, Sales and Other does not live up to the terms of the lease, include ciation, later. Dispositions of Assets. the amount you keep in your income for that year. Expenses for rental property sold. If you sell If you have a loss from damage to, or theft of, property you held for rental purposes, you can If an amount called a security deposit is to be rental property, see Publication 547, Casualties, deduct the ordinary and necessary expenses for used as a final payment of rent, it is advance Disasters, and Thefts. managing, conserving, or maintaining the prop- rent. Include it in your income when you receive If you rent a condominium or a cooperative it. erty until it is sold. apartment, some special rules apply to you even though you receive the same tax treatment as Payment for canceling a lease. If your tenant Personal use of rental property. If you other owners of rental property. See Publication pays you to cancel a lease, the amount you sometimes use your rental property for personal 527, Residential Rental Property, for more infor- receive is rent. Include the payment in your purposes, you must divide your expenses be- mation. income in the year you receive it regardless of tween rental and personal use. Also, your rental your method of accounting. expense deductions may be limited. See Per- Useful Items sonal Use of Dwelling Unit (Including Vacation Expenses paid by tenant. If your tenant pays Home), later. You may want to see: any of your expenses, the payments are rental income. You must include them in your income. Part interest. If you own a part interest in Publication You can deduct the expenses if they are deduct- rental property, you can deduct your part of the ible rental expenses. See Rental Expenses, expenses that you paid. ❏ 527 Residential Rental Property later, for more information. ❏ 534 Depreciating Property Placed in Service Before 1987 Property or services. If you receive property Repairs and Improvements or services, instead of money, as rent, include ❏ 535 Business Expenses the fair market value of the property or services You can deduct the cost of repairs to your rental in your rental income. property. You cannot deduct the cost of im- ❏ 925 Passive Activity and At-Risk Rules If the services are provided at an agreed provements. You recover the cost of improve- ❏ 946 How To Depreciate Property upon or specified price, that price is the fair ments by taking depreciation (explained later). Chapter 10 Rental Income and Expenses Page 73 Separate the costs of repairs and im- systems. These charges are nondepreciable provements, and keep accurate rec- capital expenditures. You must add them to the RECORDS ords. You will need to know the cost of basis of your property. You can deduct local Property Changed improvements when you sell or depreciate your benefit taxes if they are for maintaining, repair- property. ing, or paying interest charges for the benefits. to Rental Use Repairs. A repair keeps your property in good Travel expenses. You can deduct the ordi- If you change your home or other property, (or a operating condition. It does not materially add to nary and necessary expenses of traveling away part of it), to rental use at any time other than at the value of your property or substantially pro- from home if the primary purpose of the trip was the beginning of your tax year, you must divide long its life. Repainting your property inside or to collect rental income or to manage, conserve, yearly expenses, such as taxes and insurance, out, fixing gutters or floors, fixing leaks, plaster- or maintain your rental property. You must prop- between rental use and personal use. ing, and replacing broken windows are exam- erly allocate your expenses between rental and You can deduct as rental expenses only the ples of repairs. nonrental activities. For information on travel part of the expense that is for the part of the year If you make repairs as part of an extensive expenses, see chapter 28. the property was used or held for rental pur- remodeling or restoration of your property, the To deduct travel expenses, you must poses. whole job is an improvement. keep records that follow the rules in Treat the property as being placed in service Improvements. An improvement adds to the RECORDS chapter 28. on the conversion date for depreciation. value of your property, prolongs its useful life, or You cannot deduct depreciation or insurance adapts it to new uses. Improvements include the Local transportation expenses. You can for the part of the year the property was held for following items. deduct your ordinary and necessary local trans- personal use. However, you can include the portation expenses if you incur them to collect home mortgage interest and real estate tax ex- • Putting a recreation room in an unfinished rental income or to manage, conserve, or main- penses for the part of the year the property was basement. tain your rental property. held for personal use as an itemized deduction • Paneling a den. Generally, if you use your personal car, on Schedule A (Form 1040). pickup truck, or light van for rental activities, you • Adding a bathroom or bedroom. can deduct the expenses using one of two meth- Example. Your tax year is the calendar • Putting decorative grillwork on a balcony. ods: actual expenses or the standard mileage year. You moved from your home in May and rate. For 2003, the standard mileage rate for all started renting it on June 1. You can deduct as • Putting up a fence. business miles is 36 cents a mile. For more rental expenses seven-twelfths of your yearly • Putting in new plumbing or wiring. information, see chapter 28. expenses, such as taxes and insurance. Starting with June, you can deduct as rental • Putting in new cabinets. To deduct car expenses under either expenses the amounts you pay for items gener- method, you must keep records that • Putting on a new roof. RECORDS follow the rules in chapter 28. In addi- ally billed monthly, such as utilities. • Paving a driveway. tion, you must complete Part V of Form 4562 and attach it to your tax return. If you make an improvement to property, the cost of the improvement must be capitalized. Tax return preparation. You can deduct, as a rental expense, the part of the tax return prepa- Renting Part of The capitalized cost can generally be depreci- ated as if the improvement were separate prop- ration fees you paid to prepare Part I of Sched- ule E (Form 1040). You can also deduct, as a Property erty. rental expense, any portion of the total expense If you rent part of your property, you must divide you paid to resolve a tax underpayment related certain expenses between the part of the prop- Other Expenses to your rental activities. On your 2003 Schedule erty used for rental purposes and the part of the E, you can deduct fees paid in 2003 to prepare Other expenses you can deduct from your rental property used for personal purposes as though Part I of your 2002 Schedule E. income include advertising, cleaning and main- you actually had two separate pieces of prop- tenance services, utilities, fire and liability insur- erty. ance, taxes, interest, commissions for the You can deduct the expenses related to the collection of rent, ordinary and necessary travel part of the property used for rental purposes, and transportation, and other expenses, dis- Not Rented for Profit such as home mortgage interest and real estate cussed next. taxes, as rental expenses on Schedule E (Form If you do not rent your property to make a profit, 1040). You can deduct the expenses for the part Rental payments for property. You can de- you can deduct your rental expenses only up to of the property used for personal purposes, sub- duct the rent you pay for property that you use the amount of your rental income. Any rental ject to certain limitations, only if you itemize your for rental purposes. If you buy a leasehold for expenses in excess of rental income cannot be deductions on Schedule A (Form 1040). You rental purposes, you can deduct an equal part of carried forward to the next year. For more infor- can also deduct as a rental expense a part of the cost each year over the term of the lease. mation about the rules for an activity not en- other expenses that normally are nondeductible gaged in for profit, see chapter 1 of Publication personal expenses, such as expenses for elec- Rental of equipment. You can deduct the 535. tricity or painting the outside of your house. You rent you pay for equipment that you use for rental purposes. However, in some cases, lease Where to report. Report your not-for-profit cannot deduct any part of the cost of the first contracts are actually purchase contracts. If so, rental income on line 21, Form 1040. You can phone line even if your tenants have unlimited you cannot deduct these payments. You can include your mortgage interest (if you use the use of it. recover the cost of purchased equipment property as your main home or second home), You do not have to divide the expenses that through depreciation. real estate taxes, and casualty losses on the belong only to the rental part of your property. appropriate lines of Schedule A (Form 1040), For example, if you paint a room that you rent, or Insurance premiums paid in advance. If you Itemized Deductions, if you itemize your deduc- if you pay premiums for liability insurance in pay an insurance premium for more than one tions. connection with renting a room in your home, year in advance, each year you can deduct the Claim your other rental expenses, subject to your entire cost is a rental expense. If you install part of the premium payment that will apply to the rules explained in chapter 1 of Publication a second phone line strictly for your tenants' that year. You cannot deduct the total premium 535, as miscellaneous itemized deductions on use, all of the cost of the second line is deducti- in the year you pay it. line 22 of Schedule A (Form 1040). You can ble as a rental expense. You can deduct depre- Local benefit taxes. Generally, you cannot deduct these expenses only if they, together ciation, discussed later, on the part of the deduct charges for local benefits that increase with certain other miscellaneous itemized de- property used for rental purposes as well as on the value of your property, such as charges for ductions, total more than 2% of your adjusted the furniture and equipment you use for rental putting in streets, sidewalks, or water and sewer gross income. purposes. Page 74 Chapter 10 Rental Income and Expenses How to divide expenses. If an expense is for 160 (170 − 10) days. Your family also used the both rental use and personal use, such as mort- Dwelling Unit cottage for 7 other days during the year. gage interest or heat for the entire house, you Used as Home You used the cottage as a home because must divide the expense between the rental use you used it for personal purposes for 17 days. The tax treatment of rental income and ex- That is more than the greater of 14 days or 10% and the personal use. You can use any reasona- penses for a dwelling unit that you also use for of the 160 days it was rented (16 days). ble method for dividing the expense. It may be personal purposes depends on whether you use reasonable to divide the cost of some items (for it as a home. (See How To Figure Rental Income example, water) based on the number of people and Deductions, later.) using them. However, the two most common Use As Main Home Before or After You use a dwelling unit as a home during the methods for dividing an expense are one based tax year if you use it for personal purposes more Renting on the number of rooms in your home and one than the greater of: For purposes of determining whether a dwelling based on the square footage of your home. unit was used as a home, do not count as days 1) 14 days, or of personal use the days you used the property 2) 10% of the total days it is rented to others as your main home before or after renting it or at a fair rental price. offering it for rent in either of the following cir- Personal Use of See Figuring Days of Personal Use, later. cumstances. If a dwelling unit is used for personal pur- 1) You rented or tried to rent the property for Dwelling Unit poses on a day it is rented at a fair rental price, 12 or more consecutive months. do not count that day as a day of rental in (Including Vacation applying (2) above. Instead, count it as a day of 2) You rented or tried to rent the property for personal use in applying both (1) and (2) above. a period of less than 12 consecutive Home) This rule does not apply when dividing expenses months and the period ended because you sold or exchanged the property. between rental and personal use. If you have any personal use of a dwelling unit This special rule does not apply when dividing Fair rental price. A fair rental price for your (including vacation home) that you rent, you expenses between rental and personal use. property generally is an amount that a person must divide your expenses between rental use who is not related to you would be willing to pay. and personal use. See Figuring Days of Per- sonal Use and How To Divide Expenses, later. The rent you charge is not a fair rental price if it is Figuring Days substantially less than the rents charged for If you used your dwelling unit for personal other properties that are similar to your property. of Personal Use purposes long enough during 2003, it will be A day of personal use of a dwelling unit is any considered a dwelling unit used as a home. If so, day that it is used by any of the following per- you cannot deduct rental expenses that exceed Examples sons. rental income for that property. See Dwelling The following examples show how to determine Unit Used as Home and How To Figure Rental whether you used your rental property as a 1) You or any other person who has an inter- Income and Deductions, later. If your dwelling home. est in it, unless you rent it to another unit is not considered a dwelling unit used as a owner as his or her main home under a home, you can deduct rental expenses that ex- Example 1. You converted the basement of shared equity financing agreement (de- ceed rental income for that property subject to your home into an apartment with a bedroom, a fined later). certain limits. See Limits on Rental Losses, bathroom, and a small kitchen. You rented the 2) A member of your family or a member of later. basement apartment at a fair rental price to the family of any other person who has a college students during the regular school year. financial interest in it, unless the family You rented to them on a 9-month lease (273 member uses the dwelling unit as his or Exception for minimal rental use. If you use days). her main home and pays a fair rental price. the dwelling unit as a home and you rent it fewer During June (30 days), your brother stayed Family includes only brothers and sisters, than 15 days during the year, do not include any with you and lived in the basement apartment half-brothers and half-sisters, spouses, an- of the rent in your income and do not deduct any rent free. cestors (parents, grandparents, etc.) and of the rental expenses. See Dwelling Unit Used Your basement apartment was used as a lineal descendants (children, grandchild- as Home, later. home because you used it for personal pur- ren, etc.). poses for 30 days. Rent-free use by your brother is considered personal use. Your personal use 3) Anyone under an arrangement that lets Dwelling unit. A dwelling unit includes a you use some other dwelling unit. (30 days) is more than the greater of 14 days or house, apartment, condominium, mobile home, 10% of the total days it was rented (27 days). 4) Anyone at less than a fair rental price. boat, vacation home, or similar property. A dwelling unit has basic living accommodations, Example 2. You rented the guest bedroom such as sleeping space, a toilet, and cooking Main home. If the other person or member of in your home at a fair rental price during the local facilities. A dwelling unit does not include prop- the family in (1) or (2) above has more than one college's homecoming, commencement, and home, his or her main home is ordinarily the one erty used solely as a hotel, motel, inn, or similar football weekends (a total of 27 days). Your lived in most of the time. establishment. sister-in-law stayed in the room, rent free, for the Property is used solely as a hotel, motel, last 3 weeks (21 days) in July. Shared equity financing agreement. This is inn, or similar establishment if it is regularly The room was used as a home because you an agreement under which two or more persons used it for personal purposes for 21 days. That is available for occupancy by paying customers acquire undivided interests for more than 50 more than the greater of 14 days or 10% of the and is not used by an owner as a home during years in an entire dwelling unit, including the 27 days it was rented (3 days). the year. land, and one or more of the co-owners is enti- tled to occupy the unit as his or her main home Example 3. You own a cottage in a resort Example. You rent a room in your home upon payment of rent to the other co-owner or area. You rented it at a fair rental price for a total that is always available for short-term occu- owners. of 170 days during the year. For 12 of those pancy by paying customers. You do not use the days, the tenant was not able to use the cottage room yourself, and you allow only paying cus- Donation of use of property. You use a and allowed you to use it even though you did dwelling unit for personal purposes if: tomers to use the room. The room is used solely not refund any of the rent. Your family actually as a hotel, motel, inn, or similar establishment used the cottage for 10 of those days. Therefore, • You donate the use of the unit to a charita- and is not a dwelling unit. the cottage is treated as having been rented for ble organization, Chapter 10 Rental Income and Expenses Page 75 • The organization sells the use of the unit that day. This rule does not apply when Property Used as a Home at a fund-raising event, and determining whether you used the unit as If you use a dwelling unit as a home during the • The "purchaser" uses the unit. a home. year (see Dwelling Unit Used as Home, earlier), 2) Any day that the unit is available for rent how you figure your rental income and deduc- Examples but not actually rented is not a day of tions depends on how many days the unit was rental use. rented. The following examples show how to determine days of personal use. Rented fewer than 15 days. If you use a Example. Your beach cottage was avail- dwelling unit as a home and you rent it fewer able for rent from June 1 through August 31 (92 than 15 days during the year, do not include any Example 1. You and your neighbor are days). Your family uses the cottage during the rental income in your income. Also, you cannot co-owners of a condominium at the beach. You rent the unit to vacationers whenever possible. last 2 weeks in May (14 days). You were unable deduct any expenses as rental expenses. The unit is not used as a main home by anyone. to find a renter for the first week in August (7 days). The person who rented the cottage for Rented 15 days or more. If you use a dwell- Your neighbor uses the unit for two weeks every July allowed you to use it over a weekend (2 ing unit as a home and rent it 15 days or more year. days) without any reduction in or refund of rent. during the year, you include all your rental in- Because your neighbor has an interest in the come in your income. See How To Report unit, both of you are considered to have used the The cottage was not used at all before May 17 or Rental Income and Expenses, later. If you had a unit for personal purposes during those 2 after August 31. net profit from the rental property for the year weeks. You figure the part of the cottage expenses (that is, if your rental income is more than the to treat as rental expenses as follows. total of your rental expenses, including depreci- Example 2. You and your neighbors are ation), deduct all of your rental expenses. How- co-owners of a house under a shared equity 1) The cottage was used for rental a total of ever, if you had a net loss, you may not be able financing agreement. Your neighbors live in the 85 days (92 − 7). The days it was available to deduct all of your rental expenses. house and pay you a fair rental price. for rent but not rented (7 days) are not Use Worksheet 10 – 1 to figure your deducti- Even though your neighbors have an interest days of rental use. The July weekend (2 ble expenses. in the house, the days your neighbors live there are not counted as days of personal use by you. days) you used it is rental use because This is because your neighbors rent the house you received a fair rental price for the as their main home under a shared equity fi- weekend. nancing agreement. 2) You used the cottage for personal pur- Depreciation poses for 14 days (the last 2 weeks in You recover your cost in income producing Example 3. You own a rental property that May). property through yearly tax deductions. You do you rent to your son. Your son has no interest in this dwelling unit. He uses it as his main home. 3) The total use of the cottage was 99 days this by depreciating the property; that is, by He pays you a fair rental price for the property. (14 days personal use + 85 days rental deducting some of your cost on your tax return Your son's use of the property is not personal use). each year. use by you because your son is using it as his Three basic factors determine how much de- main home, he has no interest in the property, 4) Your rental expenses are 85/99 (86%) of preciation you can deduct. They are: (1) your and he is paying you a fair rental price. the cottage expenses. basis in the property, (2) the recovery period for When determining whether you used the cot- the property, and (3) the depreciation method Example 4. You rent your beach house to used. You cannot simply deduct your mortgage tage as a home, the July weekend (2 days) you Joshua. Joshua rents his house in the moun- or principal payments, or the cost of furniture, used it is personal use even though you re- tains to you. You each pay a fair rental price. fixtures and equipment, as an expense. ceived a fair rental price for the weekend. There- You can deduct depreciation only on the part You are using your house for personal pur- fore, you had 16 days of personal use and 83 of your property used for rental purposes. De- poses on the days that Joshua uses it because your house is used by Joshua under an arrange- days of rental use for this purpose. Because you preciation reduces your basis for figuring gain or ment that allows you to use his house. used the cottage for personal purposes more loss on a later sale or exchange. than 14 days or more than 10% of the days of You may have to use Form 4562 to figure rental use, you used it as a home. If you have a and report your depreciation. See How To Re- Days Used for Repairs and net loss, you may not be able to deduct all of the port Rental Income and Expenses, later. Maintenance rental expenses. See Property Used as a Home Claiming the correct amount of depreciation. in the following discussion. Any day that you spend working substantially full You should claim the correct amount of depreci- time repairing and maintaining your property is ation each tax year. Even if you did not claim not counted as a day of personal use. Do not How To Figure Rental depreciation that you were entitled to deduct, you must still reduce your basis in the property count such a day as a day of personal use even Income and Deductions by the full amount of depreciation that you could if family members use the property for recrea- tional purposes on the same day. How you figure your rental income and deduc- have deducted. If you did not deduct the correct amount of depreciation for property in any year, tions depends on whether the dwelling unit was you may be able to make a correction for that How To Divide Expenses used as a home (see Dwelling Unit Used as year by filing Form 1040X Amended U.S Individ- Home, earlier) and, if used as a home, how ual Income Tax Return. If you are not allowed to If you use a dwelling unit for both rental and many days the property was rented. make the correction on an amended return, you personal purposes, divide your expenses be- can change your accounting method to claim the tween the rental use and the personal use based correct amount of depreciation. See Claiming on the number of days used for each purpose. Property Not Used as a Home the correct amount of depreciation in Publication Expenses for the rental use of the unit are de- 527 for more information. ductible under the rules explained in How To If you do not use a dwelling unit as a home, Figure Rental Income and Deductions, later. report all the rental income and deduct all the Changing your accounting method to de- When dividing your expenses follow these rental expenses. See How To Report Rental duct unclaimed depreciation. If you claimed rules. Income and Expenses, later. less depreciation than allowable in an earlier year, you can change your accounting method Your deductible rental expenses can be 1) Any day that the unit is rented at a fair to take a deduction in the current year for the rental price is a day of rental use even if more than your gross rental income. However, unclaimed depreciation. To change your ac- you used the unit for personal purposes see Limits on Rental Losses, later. counting method, you must have the consent of Page 76 Chapter 10 Rental Income and Expenses Worksheet 10–1. Worksheet for Figuring the Limit on Rental Deductions for a Dwelling Unit Used as a Home Use this worksheet only if you answer "yes" to all of the following questions. ● Did you use the dwelling unit as a home this year? (See Dwelling Unit Used as Home.) ● Did you rent the dwelling unit 15 days or more this year? ● Is the total of your rental expenses and depreciation more than your rental income? 1. Enter rents received 2.a. Enter the rental portion of deductible home mortgage interest (see instructions) b. Enter the rental portion of real estate taxes c. Enter the rental portion of deductible casualty and theft losses (see instructions) d. Enter direct rental expenses (see instructions) e. Fully deductible rental expenses. Add lines 2a–2d 3. Subtract line 2e from line 1. If zero or less, enter zero 4.a. Enter the rental portion of expenses directly related to operating or maintaining the dwelling unit (such as repairs, insurance, and utilities) b. Enter the rental portion of excess mortgage interest (see instructions) c. Add lines 4a and 4b d. Allowable operating expenses. Enter the smaller of line 3 or line 4c 5. Subtract line 4d from line 3. If zero or less, enter zero 6.a. Enter the rental portion of excess casualty and theft losses (see instructions) b. Enter the rental portion of depreciation of the dwelling unit c. Add lines 6a and 6b d. Allowable excess casualty and theft losses and depreciation. Enter the smaller of line 5 or line 6c 7.a. Operating expenses to be carried over to next year. Subtract line 4d from line 4c b. Excess casualty and theft losses and depreciation to be carried over to next year. Subtract line 6d from line 6c Enter the amounts on lines 2e, 4d, and 6d on the appropriate lines of Schedule E (Form 1040), Part I. Worksheet Instructions Follow these instructions for the worksheet figured without your rental income and dwelling unit (as explained in the line 2a above. If you were unable to deduct all your expenses from the dwelling unit. Enter the instructions). expenses last year because of the rental rental portion of the result from line 18 of Line 6a. To find the rental portion of excess income limit, add these unused amounts to Form 4684 on line 2c of this worksheet. casualty and theft losses, use the Form your expenses for this year. Note. Do not file this Form 4684 or use it 4684 you prepared for line 2c of this Line 2a. Figure the mortgage interest on the to figure your personal losses on Schedule worksheet. dwelling unit that you could deduct on A. Instead, figure the personal portion on a Schedule A (Form 1040) if you had not separate Form 4684. A. Enter the amount from line 10 rented the unit. Do not include interest on Line 2d. Enter the total of your rental of Form 4684 a loan that did not benefit the dwelling unit. expenses that are directly related only to the B. Enter the rental portion of A For example, do not include interest on a rental activity. These include interest on C. Enter the amount from line 2c home equity loan used to pay off credit loans used for rental activities other than to of this worksheet cards or other personal loans, buy a car, or buy, build, or improve the dwelling unit. Also pay college tuition. Include interest on a loan include rental agency fees, advertising, D. Subtract C from B. Enter the used to buy, build, or improve the dwelling office supplies, and depreciation on office result here and on line 6a of unit, or to refinance such a loan. Enter the equipment used in your rental activity. this worksheet rental portion of this interest on line 2a of Line 4b. On line 2a, you entered the rental the worksheet. Allocating the limited deduction. If you portion of the mortgage interest you could cannot deduct all of the amount on line 4c Line 2c. Figure the casualty and theft losses deduct on Schedule A if you had not rented or 6c this year, you can allocate the related to the dwelling unit that you could the dwelling unit. Enter on line 4b of this allowable deduction in any way you wish deduct on Schedule A (Form 1040) if you worksheet the rental portion of the among the expenses included on line 4c or had not rented the dwelling unit. To do this, mortgage interest you could not deduct on 6c. Enter the amount you allocate to each complete Section A of Form 4684, Schedule A because it is more than the limit expense on the appropriate line of Schedule Casualties and Thefts, treating the losses as on home mortgage interest. Do not include E, Part I. personal losses. On line 17 of Form 4684, interest on a loan that did not benefit the enter 10% of your adjusted gross income the IRS. In some instances, you can receive type of property and when the property was This chapter discusses MACRS only. If automatic consent. For more information, see placed in service. For property used in rental ! you need more information about de- chapter 1 of Publication 946. activities you use one of the following. CAUTION preciating property placed in service before 1987, see Publication 534. Land. You can never depreciate the cost of • MACRS (Modified Accelerated Cost Re- If you placed property in service before 2003, land because land does not wear out, become covery System) for property placed in continue to use the same method of figuring obsolete, or get used up. The costs of clearing, service after 1986. depreciation that you used in the past. grading, planting, and landscaping are usually all part of the cost of land and are not deprecia- • ACRS (Accelerated Cost Recovery Sys- tem) for property placed in service after Section 179 election. You cannot claim the ble. section 179 deduction for property held to pro- 1980 but before 1987. duce rental income. See chapter 2 of Publication Depreciation Methods • Useful lives and either straight line or an 946. accelerated method of depreciation, such There are three ways to figure depreciation. The as the declining balance method, if placed No deduction greater than basis. The total depreciation method you use depends on the in service before 1981. of all your yearly depreciation deductions cannot Chapter 10 Rental Income and Expenses Page 77 be more than the cost or other basis of the Example. Dave bought and placed in serv- Recovery periods for property used in rental property. For this purpose, your yearly deprecia- ice a new refrigerator ($700) for one of his resi- activities are shown in Table 10 – 1. tion deductions include any depreciation that dential rental properties in June of 2003. Dave The class to which property is assigned is you were allowed to claim, even if you did not notes that the refrigerator has a 5-year recovery determined by its class life. Class lives and re- claim it. period (see Table 10 – 1.). Dave's refrigerator is covery periods for most assets are listed in Ap- qualifying property and he claims the special pendix B in Publication 946. Cooperative apartments. If you are a depreciation allowance using the 50% rate. tenant-stockholder in a cooperative housing cor- Dave determines the total depreciable basis poration and rent your cooperative apartment to Additions or improvements to property. of the property to be $700. Next, he multiplies Treat depreciable additions or improvements others, you can deduct depreciation for the this amount by 50% to figure his special depreci- apartment even though it is owned by the corpo- you make to any property as separate property ation allowance deduction of $350 ($700 × items for depreciation purposes. The recovery ration. Your depreciation deduction is your 50%). This leaves an adjusted basis of $350 share of the corporation's depreciation. See Co- period for an addition or improvement to prop- ($700 − $350), which he will use to figure his erty begins on the later of: operative apartments in Publication 527 for in- MACRS deduction. formation on how to figure your depreciation For more information, see Special Deprecia- 1) The date the addition or improvement is deduction. tion Allowance in Publication 946. placed in service, or Special Depreciation 2) The date the property to which the addition MACRS or improvement was made is placed in Allowance service. Most business and investment property placed You can claim a special depreciation allowance in service after 1986 is depreciated using The class and recovery period of the addition (in addition to your regular MACRS depreciation MACRS. or improvement is the one that would apply to deduction) for qualified property you placed in MACRS consists of two systems that deter- the original property if it were placed in service at service in 2003. For qualified property placed in mine how you depreciate your property — the the same time as the addition or improvement. service before May 6, 2003, the allowance is a General Depreciation System (GDS) and the depreciation deduction equal to 30% of the Alternative Depreciation System (ADS). GDS Example. You own a residential rental property's depreciable basis. For qualified prop- is used to figure your depreciation deduction for house that you have been renting since 1986 erty placed in service after May 5, 2003, it is a property used in most rental activities, unless and are depreciating under ACRS. You put an depreciation deduction equal to 50% of the you elect ADS. addition onto the house and you placed it in property's depreciable basis, or you can choose service in 2003. You must use MACRS for the To figure your MACRS deduction, you need to figure the deduction at the old 30% rate. The addition. Under MACRS, the addition would be to know the following information about your special depreciation allowance is figured before depreciated as residential rental property over property: you calculate your regular MACRS deduction. 27.5 years. You should claim the special deprecia- 1) Its recovery period, ! tion allowance for all qualified property. 2) Its placed-in-service date, and Placed-in-Service Date CAUTION However, you can elect not to claim the allowance. If you make this election for any 3) Its depreciable basis. You can begin to depreciate property when you property, it applies to all property in the same place it in service in your trade or business or for property class placed in service during the year. Personal home changed to rental use. You the production of income. Property is considered See How Can You Elect Not To Claim an Allow- must use MACRS to figure the depreciation on placed in service in a rental activity when it is ance? in Publication 946 for more information. property you used as your home and changed to ready and available for a specific use in that rental property in 2003. activity. Qualified property. To qualify for the special depreciation allowance, your property must Excluded property. You cannot use MACRS meet the following requirements. for certain personal property placed in service in Depreciable Basis your rental property in 2003 if it had been previ- 1) It must be new property that is depreciated ously placed in service before MACRS became To deduct the proper amount of depreciation under MACRS with a recovery period of 20 effective in 1987 (before August 1, 1986, if elec- each year, you must first determine your basis in years or less. tion made). the property you intend to depreciate. The basis 2) It must meet the following tests. In addition, you may elect to exclude certain used for figuring depreciation is your original property from the application of MACRS. See basis in the property increased by any additions a) Acquisition date test. Publication 946 for more information. or improvements made to the property. Your b) Placed-in-service date test. original basis is usually your cost. However, if you acquire the property in some other way, c) Original use test. Recovery Periods Under GDS such as by inheriting it, getting it as a gift, or building it yourself, you may have to figure your Each item of property that can be depreciated is original basis in another way. Other adjustments Acquisition date test. Generally, you must assigned to a property class. The recovery pe- could also affect your basis. See chapter 14. have acquired the property after September 10, riod of the property depends on the class the 2001 (after May 5, 2003, to be eligible for the property is in. Under GDS, the recovery period 50% special depreciation allowance). of an asset is generally the same as its property Conventions Placed-in-service date test. Generally, the class. The property classes under GDS are: Under MACRS, conventions establish when the property must be placed in service for use in • 3-year property, recovery period begins and ends. The conven- your trade or business or for the production of income after September 10, 2001 (after May 5, • 5-year property, tion you use determines the number of months for which you can claim depreciation in the year 2003, to be eligible for the 50% special deprecia- • 7-year property, you place property in service and in the year you tion allowance), and before January 1, 2005. • 10-year property, dispose of the property. Original use test. The original use of the property must have begun with you after Sep- • 15-year property, Mid-month convention. A mid-month con- tember 10, 2001 (after May 5, 2003, to be eligi- • 20-year property, vention is used for all residential rental property ble for the 50% special depreciation allowance). and nonresidential real property. Under this con- "Original use" means the first use to which the • Nonresidential real property, and vention, you treat all property placed in service, property is put, whether or not by you. • Residential rental property. or disposed of, during any month as placed in Page 78 Chapter 10 Rental Income and Expenses Table 10 –1. MACRS Recovery Periods for Property Used in Rental 2) Actually figure the deduction using the de- Activities preciation method and convention that ap- ply over the recovery period of the property. MACRS Recovery Period Publication 946 discusses computing deprecia- General Alternative tion using the proper method and convention. Depreciation Depreciation Type of Property System System Using the Optional Tables Computers and their peripheral equipment . . . . . . . . . . . . . 5 years 5 years Office machinery, such as: You can use the tables in Table 10 – 2 to com- Typewriters pute annual depreciation under MACRS. The Calculators tables show the percentages for the first 6 years. Copiers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 years 6 years The percentages in Tables 10 – 2 – A, 10 – 2 – B, Automobiles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 years 5 years and 10 – 2 – C make the change from declining Light trucks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 years 5 years balance to straight line in the year that straight Appliances, such as: line will yield an equal or larger deduction. See Stoves Appendix A of Publication 946 for complete ta- Refrigerators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 years 9 years bles. Carpets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 years 9 years If you elect to use the straight line method for Furniture used in rental property . . . . . . . . . . . . . . . . . . . . 5 years 9 years 5-, 7-, or 15-year property, or the 150% declining balance method for 5- or 7-year property, use Office furniture and equipment, such as: the tables in Appendix A of Publication 946. Desks Files . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 years 10 years Figure any special depreciation allow- Any property that does not have a class life and that has not ! ance on qualified property before using been designated by law as being in any other class . . . 7 years 12 years CAUTION Table 10 – 2 – A, 10 – 2 – B, or 10 – 2 – C, or the 5-, 7