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Part 21. Customer Account Services

Chapter 6. Individual Tax Returns

Section 4. Tax Computation/Tax Period Changes

21.6.4  Tax Computation/Tax Period Changes

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21.6.4.1  (10-01-2002)
Tax Computation/Tax Period Changes Overview

  1. This section provides information on computing tax and determining deductions allowed before the tax is computed. The following subjects are covered in this chapter:

    • Itemized and Standard Deductions

    • Tax Computation

    • Self-Employment Income and Tax

    • Tax Period Changes

    • Capital gains

  2. The Self-Employment Tax is added to the regular tax in determining the total tax.

21.6.4.2  (10-01-2007)
What Are Tax Computation and Tax Period Changes

  1. Various schedules/forms are used in computing tax. The schedules/forms and their purposes covered in this section are:

    • Schedule A, http://publish.no.irs.gov/FORMS/PUBLIC/PDF/11330Y05.PDF Itemized Deductions

    • Schedule D, Capital Gains and Losses

    • Schedule H, Household Employment Taxes

    • Schedule J, Income Averaging for Farmers and Fishermen

    • Form 8615, Tax for Children Under Age 18 With Investment Income of More Than $1,700

    • Form 8814, Parents' Election to Report Child's Interest and Dividends

    • Form 6251, Alternative Minimum Tax Individuals

    • Schedule SE, Self-Employment Tax

    • Form 4137, Social Security and Medicare Tax on Unreported Tip Income

    • Form 1128, Application to Adopt, Change, or Retain a Tax Year

21.6.4.3  (10-01-2006)
Tax Computation/Tax Period Changes Research

  1. Refer to IRM 21.5.1, General Adjustments, IRM 21.5.2, Adjustment Guidelines, and each topic in this section for research requirements.

  2. During a taxpayer contact when:

    • it appears there may be a hardship situation, or

    • the taxpayer insists on being referred to Taxpayer Advocate Office (TAO), or

    • the contact meets TAO criteria and you cannot resolve it the issue in the same day

    • prepare and forward Form 911, Application for Taxpayer Assistance Order (ATAO), to the local TAO. See IRM 13, Taxpayer Advocate Service, for more information.

21.6.4.4  (10-01-2006)
Working Tax Computation/Tax Period Changes Procedures

  1. This section contains procedures for computing tax and for tax period changes.

  2. Refer to IRM 21.5.1, General Adjustments, IRM 21.5.2, Adjustment Guidelines, IRM 21.5.3, General Claims Procedures, for specific guidance on adjustment input and claim processing.

21.6.4.4.1  (10-01-2003)
Itemized and Standard Deductions

  1. The taxpayer may claim Schedule A, Itemized Deductions, as limited, or the standard deduction whichever is larger, on Form 1040, U.S. Individual Income Tax Return.

21.6.4.4.1.1  (02-12-2004)
Procedures for Schedule A Itemized Deductions

  1. This section provides procedures for checking Schedule A, Itemized Deductions. Schedule A changes affect the taxable income amount.

    Note:

    Do not decrease taxable income below zero. This causes an unpostable 189 condition.

    1. Math verify the Schedule A http://publish.no.irs.gov/FORMS/PUBLIC/PDF/11330Y06.PDF.

    2. Input the appropriate increase or decrease.

    3. Use Reason Code (RC) 076, the appropriate Blocking Series (BS) and Source Code (SC).

  2. Update the Return Processable Date (RPD) if the Schedule A http://publish.no.irs.gov/FORMS/PUBLIC/PDF/11330Y06.PDF is a late reply to a "U" coded return. The RPD is the received date of the Schedule A.

  3. Refer to IRM 21.5.1.4.2.10, Late Replies, for more information.

21.6.4.4.1.2  (10-01-2003)
Information on Itemized Deductions Required Research

  1. Determine if itemized deductions are required. The following states do not permit taxpayers to itemize deductions on the state return unless they itemize on the federal return.

    • Georgia

    • Kansas

    • Maine

    • Maryland

    • Missouri

    • Nebraska

    • New York

    • North Dakota

    • Oklahoma

    • Rhode Island

    • Virginia

  2. Idaho requires taxpayers to itemize if excluding income from:

    • Form 4563, Exclusion of Income for Bona Fide Residents of American Samoa

    • Form 2555, Foreign Earned Income

21.6.4.4.1.3  (10-01-2004)
Schedule A Itemized Deductions

  1. Schedule A, Itemized Deductions, must be attached to Form 1040, U.S. Individual Income Tax Return, if the taxpayer itemizes deductions or Form 1040X, Amended U.S. Individual Income Tax Return, if the taxpayer is amending the return and Schedule A was not previously filed with the original return. Schedule A is divided into eight sections.

    • Medical and Dental Expenses

    • Taxes You Paid

    • Interest You Paid

    • Gifts to Charity

    • Casualty and Theft Losses

    • Job Expenses and Certain Miscellaneous Deductions

    • Other Miscellaneous Deductions

    • Total Itemized Deductions

21.6.4.4.1.4  (10-01-2003)
Medical and Dental Expenses

  1. Schedule A, http://publish.no.irs.gov/FORMS/PUBLIC/PDF/11330Y06.PDF Itemized Deductions, deductible medical and dental expenses must exceed 7.5% of the Adjusted Gross Income (AGI).

  2. Include as a medical expense (itemized deduction) the expense of :

    • Breast reconstruction following a mastectomy

    • Vision correction surgery

      Note:

      See Rev. Rul. 2003–57 for detailed information

  3. Include as a medical expense (itemized deduction) the expense of admission and transportation to a medical conference if:

    • The medical conference concerns the chronic illness of the taxpayer, the taxpayer's spouse, or dependent

    • The cost is primarily for and in the case of transportation essential to the medical care of the taxpayer, taxpayer's spouse, or taxpayer's dependent

    • The majority of the taxpayer's time is spent at the conference attending sessions on medical information

      Note:

      The costs of meals and lodging while attending the conference are not deductible. See Rev. Rul. 2000–24 for more information.

  4. Amounts paid for medicine or drugs that are purchased without a prescription of a physician are not deductible medical expenses. See Rev. Rul. 2003–58 for more information.

  5. Rev. Rul. 2002–19 explains the conditions under which the expense of a weight-loss program is deductible.

    • The weight loss program must be for treatment of a specific disease (including obesity) diagnosed by a physician

    • Deductible expenses include fees to join the weight loss program, and the cost to attend periodic meetings

    • The expenses must be uncompensated

    • The cost to purchase diet food items is not deductible

    • The deduction is subject to the same rules and limitations as other medical expenses

    • This revenue ruling applies to all open years

21.6.4.4.1.5  (10-01-2007)
Taxes and Fees-Deductible and Nondeductible

  1. The following taxes paid are deductible:

    • Income taxes—state, local, or foreign

    • General sales tax - state and local
      The American Jobs Creation Act of 2004 ( HR 4520, Pub.L. 108-357), allowed taxpayers to deduct state and local sales tax in lieu of state and local income tax for tax years 2004 and 2005. Additional information is available in Publication 600, State and Local General Sales Taxes.

      Note:

      HR 6111, extends this provision for tax years 2006 and 2007.

    • Real property taxes—state, local, or foreign

    • Personal property taxes—state and local

    • Taxes paid as an expense of carrying on a trade or business or an income producing activity - state, local or foreign

    • Generation skipping transfer ("GST" ) tax imposed on income distributions

    • The environmental tax imposed by IRC Section 59A

    • Excess profits and war profits taxes - state, local, or foreign

    Note:

    Taxes of a business are deducted on Schedule C, Profit or Loss from Business (Sole Proprietorship), or Schedule C–EZ, Net Profit From Business. Taxes of a farmer are deducted on Schedule F, Profit or Loss From Farming.

  2. Taxes and fees cannot be deducted unless they fall into one of the specifically allowable categories stated above. Nondeductible taxes and fees include, but are not limited to:

    • Federal income taxes

    • Social security taxes

    • Estate, inheritance, legacy, or succession taxes

    • Fines (e.g., parking and speeding)

    • Gift taxes

    • License fees for personal purposes (e.g., marriage, driver's, dog, etc.)

21.6.4.4.1.6  (10-01-2004)
Deductible and Nondeductible Interest Paid

  1. The types of deductible interest are:

    • Home mortgage interest on up to two residences

    • Points paid for a home. Points may be reported on Form 1098, Mortgage Interest Statement, but not all points reported on Form 1098, are deductible.

    • Home refinancing interest and home equity loan interest is restricted. Refer to Publication 17, Your Federal Income Tax for Individuals and Publication 936, Home Mortgage Interest Deduction, for details.

    • Investment interest—limited to the amount of net investment income Form 4952, Investment Interest Expense may be required

    • Periodic rental payments on a redeemable ground rent

      Note:

      Educational loan interest is subject to two percent miscellaneous deduction limit.

  2. The following types of interest are NOT deductible:

    • Points—if you are a seller. Paying points for the benefit of the buyer.

    • Non-redeemable ground rent

    • Service charges

    • Annual fees for credit cards

    • Loan fees

    • Credit investigation fees

    • Federal Housing Authority (FHA) mortgage insurance premium and Veteran's Administration (VA) funding fees

    • Interest relating to tax-exempt income

    • Interest to purchase or carry certain straddle positions

    • Finance charges on personal credit cards and interest on personal car loans

21.6.4.4.1.7  (01-03-2006)
Gifts to Charity

  1. A charitable contribution is deductible if it is:

    • A properly substantiated donation or gift to, or for the use of, a qualified organization

    • Voluntary and made without receiving, or expecting to receive, anything of equal value in return. If something of value is received in return, and is of lesser value than the amount given to charity, a deduction is allowed for the excess of the amount given over the value of what was received.

  2. The Katrina Emergency Tax Relief Act of 2005 (KETRA, Pub. Law 109-73) enacted on September 23, 2005, provides temporary suspension of limitations on charitable contributions. Generally, qualified contributions by individuals are exempt from percentage limitations and the phase-out of itemized deductions if:

    1. contribution is cash

    2. contribution is made on or after August 28, 2005 and before January 1, 2006

    3. contribution is made to organizations described in IRC Section 170(b)(1)(A) (religious institutions, public charities, governments, and certain private operating foundations.

  3. The Gulf Opportunity (GO) Zone Act of 2005, ( Pub. Law 109-135) enacted on December 21, 2005, provides temporary suspension of limitations on charitable contributions made on or after August 28, 2005 and before January 1, 2006 for relief efforts related to Hurricanes Rita or Wilma. Contributions are subject to the same limitations and qualifications as those enacted in KETRA as listed above.

  4. See Publication 4492, Information for Taxpayers Affected by Hurricanes Katrina, Rita and Wilma, for additional information on relief provisions enacted by KETRA and GO Zone legislation. See Publication 526, Charitable Contributions, for more information on reporting and claiming charitable contributions not related to disasters.

  5. A law enacted on January 7, 2005, permits taxpayers to claim as charitable contributions in tax year 2004 donations made during January 2005 to assist victims of the tsunami disaster. The deduction is limited to cash gifts made specifically for the tsunami disaster relief and must meet all charitable contribution requirements. Taxpayers may choose whether to claim the deduction for tax year 2004 or tax year 2005.

21.6.4.4.1.8  (10-01-2005)
Non-Cash Charitable Contributions

  1. The substantiation rules for non-cash charitable contributions were changed by The American Jobs Creation Act of 2004 (Pub. L. 108-357).

  2. Noncash charitable contributions over $500 must be supported by Form 8283, Noncash Charitable Contribution. Verify the Form 8283, Noncash Charitable Contribution.

  3. Form 8283, Section B, Donated Property Over $5,000, must be completed and the Declaration of Appraiser (Part III) must be signed for contributions (of other than publicly traded securities) claimed over $5,000. The appraisal date must NOT be:

    • Earlier than 60 days before the date of the contribution of the property

    • Later than the due date of the return, including extensions, unless the deduction is first claimed on an amended return, then it is the date that the amended return is filed. See Treas. Reg. § 1.170A-13(c)(3)(i)(A).

  4. For contributions made after June 30, 2004, a qualified appraisal must be attached to a return for contributions of over $500,000. See IRC § 170 (f)(11)(D).

  5. Taxpayer inquiries may be received regarding balance due and disallowance notices relating to missing or incomplete Forms 8283, Noncash Charitable Contribution.

    1. Secure the related return.

    2. Determine the reason for issuance of the notice.

    3. Inform the taxpayer the issue will be given further consideration if IRS receives an accurately completed Form 8283, Noncash Charitable Contribution, within 90 days of the request.

      Exception:

      A deduction over $5,000 is disallowed due to the time frames stated in (3) above.

    4. Refile the return.

    5. Recompute the tax if a properly completed Form 8283 is received.

21.6.4.4.1.9  (01-03-2006)
Standard Mileage Rate for Charitable Services

  1. For tax years 2006 and 2007, the standard mileage rate for use of the taxpayer's care in giving services to a charitable organization is 14 cents per mile.

  2. For 2005 the standard mileage rate for use of the taxpayer's car in giving services to a charitable organization is 14 cents per mile, other than activities related to Hurricane Katrina relief.

  3. Special rates apply for Hurricane Katrina related charitable miles:

    • For the period August 25 - August 31, 2005, the rate for charitable miles driven providing Hurricane Katrina relief is 29 cents per mile for deduction purposes.

    • For the months of September through December 2005 the rate for charitable miles driven providing Hurricane Katrina relief is 34 cents per mile for deduction purposes.

    • For 2006, the rate for charitable miles driven providing Hurricane Katrina relief is 32 cents per mile for deduction purposes.

  4. See Publication 4492, Information for Taxpayers Affected by Hurricanes Katrina, Rita and Wilma, for additional information on relief provisions enacted by KETRA and GO Zone legislation. See Publication 526, Charitable Contributions, for more information on reporting and claiming standard mileage rates for charitable services.

21.6.4.4.1.10  (02-13-2006)
Casualty and Theft Losses

  1. A casualty is the damage, destruction, or loss of property resulting from an identifiable event that is sudden, unexpected, or unusual, such as a fire, shipwreck or storm, not compensated for by insurance or otherwise. Taxpayer must file Form 4684, Casualties and Thefts, to support the deduction.

  2. A theft is the unlawful taking and removing of property or money with the intent to deprive the owner of it. The loss is allowable to the extent not compensated for by insurance or otherwise. Loss must be supported by Form 4684.

  3. The Katrina Emergency Tax Relief Act of 2005 (KETRA Pub. Law 109-73) enacted on September 23, 2005, and the Gulf (GO) Zone Opportunity Act of 2005 (Pub. Law 109-135), enacted on December 21, 2005, provide suspension of certain limitations on personal casualty losses. These provisions removed two limitations on personal casualty or theft losses to the extent the losses arose in the Hurricane Katrina disaster area on or after August 25, 2005, or in the Hurricane Rita disaster on or after September 23, 2005, or in the Hurricane Wilma disaster on or after October 23, 2005 and were attributable to the hurricane. The two limitations removed are:

    • Casualty and theft losses need not exceed $100 per casualty or theft.

    • Losses are deductible without regard to whether the aggregate net losses exceed 10 percent of the taxpayer's adjusted gross income (AGI).

  4. KETRA and GO Zone legislation treat personal casualty or theft losses from Hurricanes Katrina, Rita and Wilma as a deduction separate from all other casualty losses.

    • For tax year (TY) 2005, Form 4684, Casualties and Thefts, is revised to reflect the new legislation for Hurricanes Katrina, Rita and Wilma losses.

    • For TY 2004, taxpayers filing or amending tax returns to claim casualty and theft losses caused by Hurricanes Katrina, Rita or Wilma are instructed to write "Hurricane Katrina" , "Hurricane Rita" or "Hurricane Wilma" in red ink at the top of the form. Taxpayers must attach Form 4684 and write "Hurricane Katrina" , "Hurricane Rita" or "Hurricane Wilma" on the dotted line next to line 11 (the smaller of line 10 or $100), and enter "0" on lines 11 and 17 (10 percent of AGI).

    • Victims of Hurricanes Katrina, Rita or Wilma have until October 16, 2006 to claim disaster-related losses on 2004 federal income tax returns. The original deadline for individuals choosing to claim disaster-related losses on prior year federal income tax returns was April 17, 2006.

  5. Taxpayers filing or amending tax returns with additional casualty and theft losses not related to Hurricane Katrina must complete Form 4684 following normal procedures. If the taxpayer has both normal casualty and theft losses in addition to Hurricane Katrina, Rita or Wilma casualty and theft losses, two Forms 4684 must be submitted.

  6. See Publication 4492, Information for Taxpayers Affected by Hurricanes Katrina, Rita and Wilma, for additional information on relief provisions enacted by KETRA and GO Zone legislation. See Publication 547, Casualties, Disasters, and Thefts; Publication 584, Casualty, Disaster, and Theft Loss Workbook; and Rev. Proc. 2006–32, Internal Revenue Bulletin 61 for additional information.

21.6.4.4.1.11  (10-01-2003)
Job Expenses and Other Miscellaneous Itemized Deductions Subject to Two Percent Floor

  1. Certain expenses (e.g., unreimbursed employee expenses) can be claimed as miscellaneous itemized deductions on lines 20–22 of Schedule A, Form 1040, and are deductible to the extent that such expenses exceed 2% of AGI. Attach Form 2106, Employee Business Expenses, or Form 2106-EZ, Unreimbursed Employee Business Expenses, if required.

21.6.4.4.1.12  (10-01-2003)
Other Itemized Deductions Not Subject to Two Percent Reduction

  1. Some other expenses listed as miscellaneous deductions are not subject to the 2% limit. These expenses include, but are not limited to:

    • Deductible Gambling losses (to the extent of winnings claimed as income)

    • Impairment-related work expenses of a disabled individual

21.6.4.4.1.13  (10-01-2007)
Limitation on Itemized Deductions

  1. There is an overall limitation on itemized deductions which applies to individuals whose income from line 37 (AGI) of the Form 1040, U.S. Individual Income Tax Return, exceeds the amounts listed below. These taxpayers must reduce the amount of their otherwise allowable itemized deductions by the lesser of:

    • 3% of the excess of AGI over the applicable amount, or

    • 80% of the amount of otherwise allowable itemized deductions


    SCHEDULE A Phase-Out
    FILING
    STATUS    		 2007 2006 2005 2004
    Single, Head of Household, Married Filing Joint, Qualifying Widow(er) 156,400 150,500 145,950 142,700
    Married Filing Separate 75,250 75,250 72,975 71,350

    Note:

    When determining the overall limitation, the term itemized deduction does not include the deduction under:

    IRC Section Deduction For
    IRC§213 Medical Expenses
    IRC§163(d) Investment Interest
    IRC§165(a), IRC§165(c)(2) or (3) Casualty or Theft Losses from personal property
    IRC§165(d) Wagering Losses

21.6.4.4.2  (10-01-2007)
Standard Deduction

  1. The standard deduction depends on the year of the return and taxpayer's filing status.

  2. If the taxpayer and or his/her spouse is over 65 (for TY 2007, born before January 2, 1943) and/or blind a higher standard deduction applies. Taxpayer checks a box on the Form 1040 to indicate the reason for the additional standard deduction. Refer to the table below to determine the correct standard deduction amount.

    FILING
    STATUS for    		 Boxes Checked The Standard Deduction for 2007 is The Standard Deduction for 2006 is The Standard Deduction for 2005 is The Standard Deduction for 2004 is
    SINGLE 1
    2     		$6,650
    $7,950     		$6,400
    $7,650     		$6,250
    $7,500     		$6,050
    $7,250
    MARRIED FILING JOINT 1
    2
    3
    4     		$11,750
    $12,800
    $13,850
    $14,900     		$11,300
    $12,300
    $13,300
    $14,300     		$11,000
    $12,000
    $13,000
    $14,000     		$10,650
    $11,600
    $12,550
    $13,500
    MARRIED FILING SEPARATE 1
    2
    3
    4     		$6,400
    $7,450
    $8,500
    $9,550     		$6,150
    $7,150
    $8,150
    $9,150     		$6,000
    $7,000
    $8,000
    $9,000     		$5,800
    $6,750
    $7,700
    $8,650
    HEAD OF HOUSEHOLD 1
    2     		$9,150
    $10,450     		$8,800
    $10,050     		$8,550
    $9,800     		$8,350
    $9,550

    Note:

    Certain individuals are not eligible to claim the Standard Deduction. See Form 1040 instructions for additional information.

21.6.4.4.3  (10-01-2006)
Tax Computation

  1. The Jobs and Growth Tax Relief Reconciliation Act of 2003 accelerates the reduction for the marginal tax rates for individuals originally scheduled for a 5 year phase-in under the Economic Growth and Tax Relief Reconciliation Act of 2001.

    If Then ...
    Taxpayer does not elect to itemize deductions Taxable income is:
    AGI minus the Standard Deduction, and the deduction for personal exemptions provided in
    § 151.
    Taxpayer elects to itemize deductions Taxable income is
    AGI minus excess itemized deductions and personal exemptions provided in § 151.

  2. Compute tax on the taxable income.

    1. Use the Tax Table to compute the tax on taxable income under $100,000.

    2. Use the Tax Computation Worksheet to compute the tax on taxable income of $100,000 or over.

  3. Consider the following when computing tax:

    • Schedule D, Capital Gains and Losses

    • Schedule D, Tax Worksheet

    • Form 8615, Tax for Children Under Age 18 With Investment Income of More Than $1,700

    • Form 8814, Parent's Election to Report Child's Interest and Dividends

    • Form 6251, Alternative Minimum Tax—Individuals

    • Schedule J, Income Averaging for Farmers and Fishermen

    • TY 2001 Tax Computation Worksheet for Certain Dependents

    • Form 4972, Tax on Lump Sum Distributions

  4. Self-Employment Tax rules usually apply if taxpayer had net earnings from self-employment of $400.00 or more. See Publication 17, Your Federal Income Tax, and Publication 334, Tax Guide for Small Business for exceptions.

    Note:

    Use the Capital Gains work sheet from Form 1040, US. Individual Income Tax Return, instructions if applicable.

21.6.4.4.4  (10-01-2005)
Applying Capital Gains and Losses Provisions for Sales After 5/6/97

  1. For sales after 5/6/97:

    • The capital gain tax rates vary from 8% to 28%, depending on the year of gain, holding period, type of property sold, and the taxpayer's taxable income. (The 8% did not apply until 2001.) See Publication 544, Sales and Other Dispositions of Assets, and Publication 550, Investment Income and Expenses, for more information.

    • Generally, the property must have been held for more than one year for the lower 20/10% capital gain tax rates to apply.

      Exception:

      For sales after 7/28/97 and before 1/1/98, there is an 18–month holding period for the 20%/10% rates to apply.

    • Capital gain distributions from mutual funds or real estate investment trust must be reported on Schedule D for 1997 and 1998. After 1998, a taxpayer whose only capital gain is from these distributions may be able to use the Capital Gain Tax Worksheet ( Form 1040, U.S. Individual Income Tax Return Instructions).

    • If a taxpayer has more than five entries on line 1 or 8 of the Schedule D, additional items are listed on Schedule D–1, combined, and then carried to Schedule D.

  2. The IRS issued Notice 2002–67 on October 21, 2002, addressing the federal tax treatment of payments from the Department of Agriculture to peanut quota holders. Recent agricultural legislation repealed the marketing quota program for peanuts and directs the Department of Agriculture to make payments to peanut quota holders for the lost value of the quota resulting from the repeal. Notice 2002–67 states that the peanut quota holders who held a quota for investment purposes generally should treat a gain as a capital gain and a loss as a capital loss. For more information, see Notice 2002–67 dated October 21, 2002.

  3. The Service issued Notice 2005–51 on July 11, 2005, addressing the federal tax treatment of payments from the Department of Agriculture to tobacco quota holders.

  4. Use RC 013 for changes to Schedule D, investment gains/losses. Use RC 043 for changes to Schedule D tax computation.

21.6.4.4.5  (10-01-2006)
Reduction in Taxes on Dividends and Capital Gains for 2003 and Later

  1. The Jobs and Growth Tax Relief Reconciliation Act of 2003 reduced the 10 and 20 percent rate on adjusted net capital gains to 5 and 15 percent respectively. The Tax Increase Prevention and Reconciliation Act of 2005 extended the dates of this provision. This is effective in taxable years ending on or after May 6, 2003, and beginning before January 1, 2011. For taxable years beginning in 2008 only, the 5 percent rate is reduced to zero.

  2. For taxable years that include May 6, 2003, the lower rates apply to adjusted net capital gains properly taken into account for the portion of the year on or after that date. Generally, this has the effect of applying the lower rates to capital assets sold or exchanged on or after May 6, 2003.

  3. Reporting Capital Gains on Form 1040, U.S. Individual Income Tax Return:

    1. For tax year 2003, capital gain or loss was reported on Form 1040, Line 13a, including capital gain distributions.

    2. For tax year 2003, Line 13b was added to Form 1040 to report capital gain distributions received on or after May 6, 2003, qualifying for the 5 or 15 percent rate.

    3. A taxpayer not required to file Schedule D should use the Qualified Dividends and Capital Gain Tax Worksheet to compute the Form 1040, Line 41 entry for tax year 2003. See the 2003 Form 1040 instructions for more information on completing the worksheet.

    4. For tax year 2004, Form 1040, Line 13b, is not present since only the 5 and 15 percent rates are applicable to capital gain distributions.

    5. For tax year 2004 and subsequent years, taxpayers with 25% or 28% rate gain are required to use the Schedule D, Tax Worksheet in the Schedule D instructions.

    6. For tax year 2004 and subsequent years, taxpayers with a capital loss carryover from 2003 to 2004, 2004 to 2005 or 2005 to 2006, must use the Capital Loss Carryover Worksheet in the Schedule D instructions to compute their capital loss carryover.

    7. Schedule D may or may not be attached to the Form 1040. See Schedule D instructions for more information on when it is required as an attachment to Form 1040. Additional information is available in Publication 544, Sales and Other Disposition of Assets, and Publication 550, Investment Income and Expenses.

  4. Under The Jobs and Growth Tax Relief Reconciliation Act of 2003, dividends received by an individual shareholder from domestic and qualified foreign corporations are taxed at the same rates that apply to net capital gains (5 or 15 percent rate). This provision applies to dividends received in taxable years beginning after 2002 and before 2009.

  5. Generally, for the dividends to qualify for capital gains rates, the shareholder must own the stock for more than 60 days during the 121 day period beginning 60 days before the ex-dividend date. There is a different holding period requirement for certain preferred stock.

  6. For tax year 2003, Line 9b, was added to Form 1040 to report the qualifying dividends.

  7. For tax years beginning after 2010, the capital gain and dividend reduced tax rates provided by the Jobs and Growth Tax Relief Reconciliation Act of 2003 will expire.

21.6.4.4.5.1  (10-01-2006)
Election to Establish New Holding Period For Certain Assets

  1. Taxpayers (other than corporations) can make an election to treat certain assets held on 01/01/2001 as sold and then reacquired on the same date. Gain resulting from the election must be included in gross income for the year that includes 01/01/2001. This election is made to give the asset a new holding period and to make any future gain on the asset eligible for the 18% rate.

  2. Property qualifying for the election is:

    • Readily tradable stock that is a capital asset that the taxpayer held on 01/01/2001 and did not sell prior to 01/02/2001. If the taxpayer makes this election, the stock is treated as sold (deemed sale) on 01/02/2001 at its closing market price on that date. The stock is then treated as acquired on that same date for the same amount.

    • Any other capital asset or property used in a trade or business that the taxpayer held on 01/01/2001. This property is treated as sold on 01/01/2001, for its fair market value, then treated as if acquired on the same date at the same price.

    • Any gain on a deemed sale is included in gross income. A loss is not allowed.

    • The deemed sale is reported on the taxpayer's return for the year that includes the date of the sale. To make the election, the taxpayer attaches a statement to the return stating, that they are making an election under §311 of the Taxpayer Relief Act of 1997 and specifying the assets for which they are making the election. Once made, the election is irrevocable.

  3. Per Notice 2002-58, if the taxpayer has already filed their return without making an election under §311, the election can still be made by filing an amended return within six months of the due date of the original return (excluding extensions). One of the following statements must be written across the top of the amended return: "Election Under Section 311 of the Taxpayer Relief Act of 1997" or "Filed Pursuant to Section 301.9100-2." Once made, an election for any asset is irrevocable. Follow normal procedures in IRM 21.5.3, General Claims.

  4. Per Notice 2002-58, if a taxpayer did not timely file an original return on which a §311 (e) election could have been made, as described above, or failed to make a §311 (e) election with respect to one or more eligible assets on a timely filed original return and failed to make the §311 (e) election on an amended return, then the taxpayer may apply for relief under section 301.9100-3, in accordance with the provisions of Rev. Proc. 2002-1, I.R.B. 2002-1, C.B.1 (or any successor).

21.6.4.4.6  (10-01-2005)
Allowing Constructive Sales

  1. Constructive Sales — Generally, taxpayer must recognize gain (but not loss) on the date taxpayer entered into a constructive sale of any appreciated Financial position (in stock, a partnership interest, or certain debt instruments) as if the position were disposed of at fair market value on that date. A constructive sale generally arises with regard to an appreciated Financial position where the taxpayer enters into one of three listed transactions, including a short sale of the same or substantially identical property. In most cases, this rule applies to constructive sales entered into after June 8, 1997.

21.6.4.4.7  (10-26-2006)
Sale of Your Home

  1. Form 2119, Sale of Your Home, is obsolete after 1997. For sales in 1998 and later the sale is reported only if there is a gain, and the taxpayer either does not qualify to exclude all the gain or elects not to exclude any gain. The gain is reported on Schedule D.

    1. Reminder:

      Refer to Publication 17, Your Federal Income Tax, and Publication 523, Selling Your Home for specific information.

  2. Different tax rules apply to personal residence sales on or after May 7, 1997:

    • All taxpayers, regardless of age, can exclude up to $250,000 ($500,000 on certain joint returns) from capital gains taxation, Schedule D

    • The "one-time" exclusion no longer applies

    • The provision only applies to one sale or exchange every two years:

    If And Then
    Taxpayer owned the home for two out of five years Used it as a principal residence for two out of five years Taxpayer qualifies for exclusion.
    Taxpayer sold home due to job move, health problems, or unforeseen circumstances.   A reduced amount may be excluded more often than every two years. Refer to Publication 523 for ratio to figure exclusion.
    Taxpayer was/is in the military and does not/did not meet the ownership and use test Taxpayer may qualify to make an election to suspend the running of the 5 year period for testing ownership and use. See paragraph (5) below.

    Note:

    Special rules apply in cases of transfer due to divorce, joint filers not sharing a principal residence, and deceased spouse. See IRC Section 121(d) for more information.

  3. The Katrina Emergency Tax Relief Act of 2005 (KETRA Pub. Law 109-73) enacted on September 23, 2005 extends the replacement period from two to five years for property that is in the Hurricane Katrina disaster area if the property was compulsorily or involuntarily converted on or after August 25, 2005 by reason of Hurricane Katrina. All of the use of the replacement property must be in this area.

  4. The IRS issued Notice 2002-60 on August 22, 2002, providing home sale exclusion rules for taxpayers affected by the September 11, 2001 te