Table of Contents
In most cases, you must include in gross income everything you receive in payment for personal services. In addition to wages, salaries, commissions, fees, and tips, this includes other forms of compensation such as fringe benefits and stock options.
You should receive a Form W-2 from your employer showing the pay you received for your services. Include your pay on line 7 of Form 1040 or Form 1040A or on line 1 of Form 1040EZ, even if you do not receive a Form W-2.
If you performed services, other than as an independent contractor, and your employer did not withhold social security and Medicare taxes from your pay, you must file Form 8919, Uncollected Social Security and Medicare Tax on Wages, with your Form 1040. These wages must be included on line 7 of Form 1040. See Form 8919 for more information.
This section discusses many types of employee compensation. The subjects are arranged in alphabetical order.
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A length-of-service award if you received it for less than 5 years of service or if you received another length-of-service award during the year or the previous 4 years.
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A safety achievement award if you are a manager, administrator, clerical employee, or other professional employee or if more than 10% of eligible employees previously received safety achievement awards during the year.
Example.
Ben Green received three employee achievement awards during the year: a nonqualified plan award of a watch valued at $250, and two qualified plan awards of a stereo valued at $1,000 and a set of golf clubs valued at $500. Assuming that the requirements for qualified plan awards are otherwise satisfied, each award by itself would be excluded from income. However, because the $1,750 total value of the awards is more than $1,600, Ben must include $150 ($1,750 − $1,600) in his income.
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A foreign corporation unless substantially all of its income is:
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Effectively connected with the conduct of a trade or business in the United States, or
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Subject to a comprehensive foreign income tax.
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A partnership unless substantially all of its income is allocated to persons other than:
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Foreign persons for whom the income is not subject to a comprehensive foreign income tax, and
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Tax-exempt organizations.
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A welfare fund.
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A state sickness or disability fund.
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An association of employers or employees.
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An insurance company, if your employer paid for the plan.
Fringe benefits received in connection with the performance of your services are included in your income as compensation unless you pay fair market value for them or they are specifically excluded by law. Abstaining from the performance of services (for example, under a covenant not to compete) is treated as the performance of services for purposes of these rules.
See Valuation of Fringe Benefits , later in this discussion, for information on how to determine the amount to include in income.
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The general rule: benefits are reported for a full calendar year (January 1–December 31).
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The special accounting period rule: benefits provided during the last 2 months of the calendar year (or any shorter period) are treated as paid during the following calendar year. For example, each year your employer reports the value of benefits provided during the last 2 months of the prior year and the first 10 months of the current year.
In most cases, the value of accident or health plan coverage provided to you by your employer is not included in your income. Benefits you receive from the plan may be taxable, as explained, later, under Sickness and Injury Benefits .
For information on the items covered in this section, other than Long-term care coverage , see Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans.
You may be able to exclude from your income amounts paid or expenses incurred by your employer for qualified adoption expenses in connection with your adoption of an eligible child. See Instructions for Form 8839, Qualified Adoption Expenses, for more information.
Adoption benefits are reported by your employer in box 12 of Form W-2 with code T. They also are included as social security and Medicare wages in boxes 3 and 5. However, they are not included as wages in box 1. To determine the taxable and nontaxable amounts, you must complete Part III of Form 8839. File the form with your return.
If your employer provides you with the free or low-cost use of an employer-operated gym or other athletic club on your employer's premises, the value is not included in your compensation. The gym must be used primarily by employees, their spouses, and their dependent children.
If your employer pays for a fitness program provided to you at an off-site resort hotel or athletic club, the value of the program is included in your compensation.
If your employer provides you with a product or service and the cost of it is so small that it would be unreasonable for the employer to account for it, the value is not included in your income. In most cases, the value of benefits such as discounts at company cafeterias, cab fares home when working overtime, and company picnics are not included in your income. Also see Employee Discounts , later.
If your employer provides dependent care benefits under a qualified plan, you may be able to exclude these benefits from your income. Dependent care benefits include:
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Amounts your employer pays directly to either you or your care provider for the care of your qualifying person while you work, and
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The fair market value of care in a daycare facility provided or sponsored by your employer.
The amount you can exclude is limited to the lesser of:
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The total amount of dependent care benefits you received during the year,
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The total amount of qualified expenses you incurred during the year,
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Your earned income,
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Your spouse's earned income, or
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$5,000 ($2,500 if married filing separately).
Your employer must show the total amount of dependent care benefits provided to you during the year under a qualified plan in box 10 of your Form W-2. Your employer also will include any dependent care benefits over $5,000 in your wages shown in box 1 of your Form W-2.
To claim the exclusion, you must complete Part III of Form 2441, Child and Dependent Care Expenses. See the Instructions for Form 2441 for more information.
You can exclude from your income up to $5,250 of qualified employer-provided educational assistance. For more information, see Publication 970.
If your employer sells you property or services at a discount, you may be able to exclude the amount of the discount from your income. The exclusion applies to discounts on property or services offered to customers in the ordinary course of the line of business in which you work. However, it does not apply to discounts on real property or property commonly held for investment (such as stocks or bonds).
The exclusion is limited to the price charged nonemployee customers multiplied by the following percentage.
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For a discount on property, your employer's gross profit percentage (gross profit divided by gross sales) on all property sold during the employer's previous tax year. (Ask your employer for this percentage.)
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For a discount on services, 20%.
Financial counseling fees paid for you by your employer are included in your income and must be reported as part of wages. If the fees are for tax or investment counseling, they can be deducted on Schedule A (Form 1040) as a miscellaneous deduction (subject to the 2%-of-AGI limit).
Qualified retirement planning services paid for you by your employer may be excluded from your income. For more information, see Retirement Planning Services , later.
In most cases, the cost of up to $50,000 of group-term life insurance coverage provided to you by your employer (or former employer) is not included in your income. However, you must include in income the cost of employer-provided insurance that is more than the cost of $50,000 of coverage reduced by any amount you pay toward the purchase of the insurance.
For exceptions to this rule, see Entire cost excluded , and Entire cost taxed , later.
If your employer provided more than $50,000 of coverage, the amount included in your income is reported as part of your wages in box 1 of your Form W-2. Also, it is shown separately in box 12 with code C.
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Provides a general death benefit,
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Is provided to a group of employees,
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Is provided under a policy carried by the employer, and
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Provides an amount of insurance to each employee based on a formula that prevents individual selection.
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Payments for coverage in a different tax year,
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Payments for coverage through a cafeteria plan, unless the payments are after-tax contributions, or
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Payments for coverage not taxed to you because of the exceptions discussed later under Entire cost excluded .
| 1. | Enter the total amount of your insurance coverage from your employer(s) | 1. | |||
| 2. | Limit on exclusion for employer-provided group-term life insurance coverage | 2. | 50,000 | ||
| 3. | Subtract line 2 from line 1 | 3. | |||
| 4. | Divide line 3 by $1,000. Figure to the nearest tenth | 4. | |||
| 5. | Go to Table 1. Using your age on the last day of the tax year, find your age group in the left column, and enter the cost from the column on the right for your age group | 5. | |||
| 6. | Multiply line 4 by line 5 | 6. |
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| 7. | Enter the number of full months of coverage at this cost | 7. | |||
| 8. | Multiply line 6 by line 7 | 8. | |||
| 9. | Enter the premiums you paid per month | 9. | |||
| 10. | Enter the number of months you paid the premiums | 10. | |||
| 11. | Multiply line 9 by line 10. | 11. | |||
| 12. | Subtract line 11 from line 8. Include this amount in your income as wages | 12. | |||
Table 1. Cost of $1,000 of Group-Term Life Insurance for One Month
| Age | Cost | ||
| Under 25 | $ .05 | ||
| 25 through 29 | .06 | ||
| 30 through 34 | .08 | ||
| 35 through 39 | .09 | ||
| 40 through 44 | .10 | ||
| 45 through 49 | .15 | ||
| 50 through 54 | .23 | ||
| 55 through 59 | .43 | ||
| 60 through 64 | .66 | ||
| 65 through 69 | 1.27 | ||
| 70 and older | 2.06 |
Example.
You are 51 years old and work for employers A and B. Both employers provide group-term life insurance coverage for you for the entire year. Your coverage is $35,000 with employer A and $45,000 with employer B. You pay premiums of $4.15 a month under the employer B group plan. You figure the amount to include in your income as follows.
| 1. | Enter the total amount of your insurance coverage from your employer(s) | 1. | 80,000 | ||
| 2. | Limit on exclusion for employer-provided group-term life insurance coverage | 2. | 50,000 | ||
| 3. | Subtract line 2 from line 1 | 3. | 30,000 | ||
| 4. | Divide line 3 by $1,000. Figure to the nearest tenth | 4. | 30.0 | ||
| 5. | Go to Table 1. Using your age on the last day of the tax year, find your age group in the left column, and enter the cost from the column on the right for your age group | 5. | .23 | ||
| 6. | Multiply line 4 by line 5 | 6. | 6.90 | ||
| 7. | Enter the number of full months of coverage at this cost. | 7. | 12 | ||
| 8. | Multiply line 6 by line 7 | 8. | 82.80 | ||
| 9. | Enter the premiums you paid per month | 9. | 4.15 | ||
| 10. | Enter the number of months you paid the premiums | 10. | 12 | ||
| 11. | Multiply line 9 by line 10. | 11. | 49.80 | ||
| 12. | Subtract line 11 from line 8. Include this amount in your income as wages | 12. | 33.00 | ||
The total amount to include in income for the cost of excess group-term life insurance is $33. Neither employer provided over $50,000 insurance coverage, so the wages shown on your Forms W-2 do not include any part of that $33. You must add it to the wages shown on your Forms W-2 and include the total on your return.
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You are permanently and totally disabled and have ended your employment.
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Your employer is the beneficiary of the policy for the entire period the insurance is in force during the tax year.
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A charitable organization to which contributions are deductible is the only beneficiary of the policy for the entire period the insurance is in force during the tax year. (You are not entitled to a deduction for a charitable contribution for naming a charitable organization as the beneficiary of your policy.)
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The plan existed on January 1, 1984, and:
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You retired before January 2, 1984, and were covered by the plan when you retired, or
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You reached age 55 before January 2, 1984, and were employed by the employer or its predecessor in 1983.
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The insurance is provided by your employer through a qualified employees' trust, such as a pension trust or a qualified annuity plan.
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You are a key employee and your employer's plan discriminates in favor of key employees.
You do not include in your income the value of meals and lodging provided to you and your family by your employer at no charge if the following conditions are met.
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The meals are:
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Furnished on the business premises of your employer, and
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Furnished for the convenience of your employer.
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The lodging is:
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Furnished on the business premises of your employer,
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Furnished for the convenience of your employer, and
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A condition of your employment. (You must accept it in order to be able to properly perform your duties.)
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You also do not include in your income the value of meals or meal money that qualifies as a de minimis fringe benefit. See De Minimis (Minimal) Benefits , earlier.
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Its principal purpose or function is to provide medical or hospital care or medical education or research.
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It receives payments for graduate medical education under the Social Security Act.
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One of its principal purposes or functions is to provide and teach basic and clinical medical science and research using its own faculty.
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5% of the appraised value of the lodging, or
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The average of rentals paid by individuals (other than employees or students) for comparable lodging held for rent by the educational institution.
Example.
Carl Johnson, a sociology professor for State University, rents a home from the university that is qualified campus lodging. The house is appraised at $200,000. The average rent paid for comparable university lodging by persons other than employees or students is $14,000 a year. Carl pays an annual rent of $11,000. Carl does not include in his income any rental value because the rent he pays equals at least 5% of the appraised value of the house (5% × $200,000 = $10,000). If Carl paid annual rent of only $8,000, he would have to include $2,000 in his income ($10,000 − $8,000).
In most cases, if your employer pays for your moving expenses (either directly or indirectly) and the expenses would have been deductible if you paid them yourself, the value is not included in your income. See Publication 521 for more information.
The value of services you receive from your employer for free, at cost, or for a reduced price is not included in your income if your employer:
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Offers the same service for sale to customers in the ordinary course of the line of business in which you work, and
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Does not have a substantial additional cost (including any sales income given up) to provide you with the service (regardless of what you paid for the service).
In most cases, no-additional-cost services are excess capacity services, such as airline, bus, or train tickets, hotel rooms, and telephone services.
Example.
You are employed as a flight attendant for a company that owns both an airline and a hotel chain. Your employer allows you to take personal flights (if there is an unoccupied seat) and stay in any one of their hotels (if there is an unoccupied room) at no cost to you. The value of the personal flight is not included in your income. However, the value of the hotel room is included in your income because you do not work in the hotel business.
If your employer has a qualified retirement plan, qualified retirement planning services provided to you (and your spouse) by your employer are not included in your income. Qualified services include retirement planning advice, information about your employer's retirement plan, and information about how the plan may fit into your overall individual retirement income plan. You cannot exclude the value of any tax preparation, accounting, legal, or brokerage services provided by your employer. Also, see Financial Counseling Fees , earlier.
If your employer provides you with a qualified transportation fringe benefit, it can be excluded from your income, up to certain limits. A qualified transportation fringe benefit is:
Cash reimbursement by your employer for these expenses under a bona fide reimbursement arrangement is also excludable. However, cash reimbursement for a transit pass is excludable only if a voucher or similar item that can be exchanged only for a transit pass is not readily available for direct distribution to you.
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For transporting employees between their homes and work place, and
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On trips during which employees occupy at least half of the vehicle's adult seating capacity (not including the driver).
You can exclude a qualified tuition reduction from your income. This is the amount of a reduction in tuition:
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For education (below graduate level) furnished by an educational institution to an employee, former employee who retired or became disabled, or his or her spouse and dependent children.
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For education furnished to a graduate student at an educational institution if the graduate student is engaged in teaching or research activities for that institution.
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Representing payment for teaching, research, or other services if you receive the amount under the National Health Service Corps Scholarship Program or the Armed Forces Health Professions Scholarship and Financial Assistance program.
For more information, see Publication 970.
If your employer provides you with a product or service and the cost of it would have been allowable as a business or depreciation deduction if you paid for it yourself, the cost is not included in your income.
If a fringe benefit is included in your income, the amount included is generally its value determined under the general valuation rule or under the special valuation rules. For an exception, see Group-Term Life Insurance , earlier.
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The amount, if any, you paid for the benefit, plus
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The amount, if any, specifically excluded from your income by law.
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Your perceived value of the benefit, or
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The amount your employer paid for the benefit.
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Any amount you repaid your employer, plus
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Any amount specifically excluded from income by law.
Your employer's contributions to a qualified retirement plan for you are not included in income at the time contributed. (Your employer can tell you whether your retirement plan is qualified.) However, the cost of life insurance coverage included in the plan may have to be included. See Group-Term Life Insurance , earlier, under Fringe Benefits.
If your employer pays into a nonqualified plan for you, you generally must include the contributions in your income as wages for the tax year in which the contributions are made. However, if your interest in the plan is not transferable or is subject to a substantial risk of forfeiture (you have a good chance of losing it) at the time of the contribution, you do not have to include the value of your interest in your income until it is transferable or is no longer subject to a substantial risk of forfeiture.
If you are covered by certain kinds of retirement plans, you can choose to have part of your compensation contributed by your employer to a retirement fund, rather than have it paid to you. The amount you set aside (called an elective deferral) is treated as an employer contribution to a qualified plan. An elective deferral, other than a designated Roth contribution (discussed later), is not included in wages subject to income tax at the time contributed. However, it is included in wages subject to social security and Medicare taxes.
Elective deferrals include elective contributions to the following retirement plans.
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Cash or deferred arrangements (section 401(k) plans).
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The Thrift Savings Plan for federal employees.
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Salary reduction simplified employee pension plans (SARSEP).
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Savings incentive match plans for employees (SIMPLE plans).
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Tax-sheltered annuity plans (403(b) plans).
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Section 501(c)(18)(D) plans. (But see Reporting by employer , later.)
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Section 457 plans.
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Your rights to elect not to have elective contributions made, or to have contributions made at a different percentage, and
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How contributions made will be invested in the absence of any investment decision by you.
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SEPs (SARSEPs), see Salary Reduction Simplified Employee Pension in Publication 560, Retirement Plans for Small Business.
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SIMPLE plans, see How Much Can Be Contributed on Your Behalf? in chapter 3 of Publication 590.
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Section 457 plans, see Limit for deferrals under section 457 plans , later.
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$3,000,
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$15,000, reduced by the sum of:
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The additional pre-tax elective deferrals made in earlier years because of this rule, plus
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The aggregate amount of designated Roth contributions permitted for prior tax years because of this rule, or
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$5,000 times the number of your years of service for the organization, minus the total elective deferrals made by your employer on your behalf for earlier years.
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Wages and salaries.
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Fees for professional services.
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The value of any employer-provided qualified transportation fringe benefit (defined under Transportation , earlier) that is not included in your income.
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Other amounts received (cash or noncash) for personal services you performed, including, but not limited to, the following items.
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Commissions and tips.
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Fringe benefits.
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Bonuses.
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Employer contributions (elective deferrals) to:
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The section 457 plan.
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Qualified cash or deferred arrangements (section 401(k) plans) that are not included in your income.
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A salary reduction simplified employee pension (SARSEP).
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A tax-sheltered annuity (section 403(b) plan).
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A savings incentive match plan for employees (SIMPLE plan).
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A section 125 cafeteria plan.
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Your wages as defined for income tax withholding purposes.
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Your wages as reported in box 1 of Form W-2.
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Your wages that are subject to social security withholding (including elective deferrals).
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Twice the annual limit ($34,000 for 2012), or
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The basic annual limit plus the amount of the basic limit not used in prior years (only allowed if not using age 50 or over catch-up contributions).
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You reached age 50 by the end of the year, and
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No other elective deferrals can be made for you to the plan for the year because of limits or restrictions.
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If the distribution was for a 2012 excess deferral, your Form 1099-R should have the code “8” in box 7. Add the excess deferral amount to your wages on your 2012 tax return.
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If the distribution was for a 2012 excess deferral to a designated Roth account, your Form 1099-R should have code “B” in box 7. Do not add this amount to your wages on your 2012 return.
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If the distribution was for a 2011 excess deferral, your Form 1099-R should have the code “P” in box 7. If you did not add the excess deferral amount to your wages on your 2011 tax return, you must file an amended return on Form 1040X, Amended U.S. Individual Income Tax Return. If you did not receive the distribution by April 15, 2012, you also must add it to your wages on your 2012 tax return.
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If the distribution was for the income earned on an excess deferral, your Form 1099-R should have the code “8” in box 7. Add the income amount to your wages on your 2012 income tax return, regardless of when the excess deferral was made.
If you are a highly compensated employee, the total of your elective deferrals and other contributions made for you for any year under a section 401(k) plan or SARSEP can be, as a percentage of pay, no more than 125% of the average deferral percentage (ADP) of all eligible non-highly compensated employees.
If the total contributed to the plan is more than the amount allowed under the ADP test, the excess contributions must be either distributed to you or recharacterized as after-tax employee contributions by treating them as distributed to you and then contributed by you to the plan. You must include the excess contributions in your income as wages on Form 1040, line 7. You cannot use Form 1040A or Form 1040EZ to report excess contribution amounts.
If you receive a corrective distribution of excess contributions (and allocable income), it is included in your income in the year of the distribution. The allocable income is the amount of gain or loss through the end of the plan year for which the contribution was made that is allocable to the excess contributions. You should receive a Form 1099-R for the year the excess contributions are distributed to you. Add the distribution to your wages for that year.
The amount contributed in 2012 to a defined contribution plan is generally limited to the lesser of 100% of your compensation or $50,000. Under certain circumstances, contributions that exceed these limits (excess annual additions) may be corrected by a distribution of your elective deferrals or a return of your after-tax contributions and earnings from these contributions.
A corrective payment of excess annual additions consisting of elective deferrals or earnings from your after-tax contributions is fully taxable in the year paid. A corrective payment consisting of your after-tax contributions is not taxable.
If you received a corrective payment of excess annual additions, you should receive a separate Form 1099-R for the year of the payment with the code “E” in box 7. Report the total payment shown in box 1 of Form 1099-R on line 16a of Form 1040 or line 12a of Form 1040A. Report the taxable amount shown in box 2a of Form 1099-R on line 16b of Form 1040 or line 12b of Form 1040A.
If you receive an option to buy or sell stock or other property as payment for your services, you may have income when you receive the option (the grant), when you exercise the option (use it to buy or sell the stock or other property), or when you sell or otherwise dispose of the option or property acquired through exercise of the option. The timing, type, and amount of income inclusion depend on whether you receive a nonstatutory stock option or a statutory stock option. Your employer can tell you which kind of option you hold.
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You can transfer the option.
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You can exercise the option immediately in full.
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The option or the property subject to the option is not subject to any condition or restriction (other than a condition to secure payment of the purchase price) that has a significant effect on the fair market value of the option.
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The fair market value of the option privilege can be readily determined.
There are two kinds of statutory stock options.
For either kind of option, you must be an employee of the company granting the option, or a related company, at all times during the period beginning on the date the option is granted and ending 3 months before the date you exercise the option (for an incentive stock option, 1 year before if you are disabled). Also, the option must be nontransferable except at death.
If you do not meet the employment requirements, or you receive a transferable option, your option is a nonstatutory stock option.
Example.
Your employer, M Company, granted you an incentive stock option on April 7, 2010, to buy 100 shares of M Company at $9 a share, its fair market value at the time. You exercised the option on January 6, 2011, when the stock was selling on the open market for $14 a share. On January 26, 2012, when the stock was selling on the open market for $16 a share, your rights to the stock first became transferable. You include $700 ($1,600 value when your rights first became transferable minus $900 option price) as an adjustment on Form 6251, line 14.
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You do not satisfy the holding period requirement.
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You satisfy the conditions described under Option granted at a discount , under Employee stock purchase plan, later.
Example.
Your employer, X Corporation, granted you an ISO on March 12, 2010, to buy 100 shares of X Corporation stock at $10 a share, its fair market value at the time. You exercised the option on January 6, 2011, when the stock was selling on the open market for $12 a share. On January 26, 2012, you sold the stock for $15 a share. Although you held the stock for more than a year, less than 2 years had passed from the time you were granted the option. In 2012, you must report the difference between the option price ($10) and the value of the stock when you exercised the option ($12) as wages. The rest of your gain is capital gain, figured as follows:
| Selling price ($15 × 100 shares) | $ 1,500 |
| Purchase price ($10 × 100 shares) | −1,000 |
| Gain | $ 500 |
| Amount reported as wages [($12 × 100 shares) − $1,000] |
− 200 |
| Amount reported as capital gain | $ 300 |
Example.
XYZ Company has an employee stock purchase plan. The option price is the lower of the stock price at the time the option is granted or at the time the option is exercised. The value of the stock when the option was granted was $25. XYZ deducts $5 from A's pay every week for 48 weeks (total = $240 ($5 × 48)). The value of the stock when the option is exercised is $20. A receives 12 shares of XYZ stock ($240 ÷ $20). A's holding period for all 12 shares begins the day after the option is exercised, even though the money used to purchase the shares was deducted from A's pay on 48 separate days. A's basis in each share is $20.
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The excess of the fair market value of the share at the time the option was granted over the option price, or
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The excess of the fair market value of the share at the time of the disposition or death over the amount paid for the share under the option.
Example.
Your employer, Y Corporation, granted you an option under its employee stock purchase plan to buy 100 shares of stock of Y Corporation for $20 a share at a time when the stock had a value of $22 a share. Eighteen months later, when the value of the stock was $23 a share, you exercised the option, and 14 months after that you sold your stock for $30 a share. In the year of sale, you must report as wages the difference between the option price ($20) and the value at the time the option was granted ($22). The rest of your gain ($8 per share) is capital gain, figured as follows:
| Selling price ($30 × 100 shares) | $ 3,000 |
| Purchase price (option price) ($20 × 100 shares) |
−2,000 |
| Gain | $ 1,000 |
| Amount reported as wages [($22 × 100 shares) − $2,000] |
− 200 |
| Amount reported as capital gain | $ 800 |
Example.
The facts are the same as in the previous example, except that you sold the stock only 6 months after you exercised the option. You did not satisfy the holding period requirement, so you must report $300 as wages and $700 as capital gain, figured as follows:
| Selling price ($30 × 100 shares) | $3,000 |
| Purchase price (option price) ($20 × 100 shares) |
−2,000 |
| Gain | $1,000 |
| Amount reported as wages [($23 × 100 shares) − $2,000] |
− 300 |
| Amount reported as capital gain [$3,000 – ($2,000 + $300)] |
$700 |
In most cases, if you receive property for your services, you must include its fair market value in your income in the year you receive the property. However, if you receive stock or other property that has certain restrictions that affect its value, you do not include the value of the property in your income until it has been substantially vested. (You can choose to include the value of the property in your income in the year it is transferred to you, as discussed later, rather than the year it is substantially vested.)
Until the property becomes substantially vested, it is owned by the person who makes the transfer to you, usually your employer. However, any income from the property, or the right to use the property, is included in your income as additional compensation in the year you receive the income or have the right to use the property.
When the property becomes substantially vested, you must include its fair market value, minus any amount you paid for it, in your income for that year. Your holding period for this property begins when the property becomes substantially vested.
Example.
Your employer, the RST Corporation, sells you 100 shares of its stock at $10 a share. At the time of the sale the fair market value of the stock is $100 a share. Under the terms of the sale, the stock is under a substantial risk of forfeiture (you have a good chance of losing it) for a 5-year period. Your stock is not substantially vested when it is transferred, so you do not include any amount in your income in the year you buy it. At the end of the 5-year period, the fair market value of the stock is $200 a share. You must include $19,000 in your income [100 shares × ($200 fair market value − $10 you paid)]. Dividends paid by the RST Corporation on your 100 shares of stock are taxable to you as additional compensation during the period the stock can be forfeited.
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It is transferable, or
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It is not subject to a substantial risk of forfeiture. (You do not have a good chance of losing it.)
Example.
The Spin Corporation transfers to you as compensation for services 100 shares of its corporate stock for $100 a share. Under the terms of the transfer, you must resell the stock to the corporation at $100 a share if you leave your job for any reason within 3 years from the date of transfer. You must perform substantial services over a period of time and you must resell the stock to the corporation at $100 a share (regardless of its value) if you do not perform the services, so your rights to the stock are subject to a substantial risk of forfeiture.
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Your name, address, and taxpayer identification number.
-
A description of each property for which you are making the choice.
-
The date or dates on which the property was transferred and the tax year for which you are making the choice.
-
The nature of any restrictions on the property.
-
The fair market value at the time of transfer (ignoring restrictions except those that will never lapse) of each property for which you are making the choice.
-
Any amount that you paid for the property.
-
A statement that you have provided copies to the appropriate persons.
Example.
In 2009, you paid your employer $50 for a share of stock that had a fair market value of $100 and was subject to forfeiture until 2012. In 2011, you sold the stock to your spouse for $10 in a transaction not at arm's length. You had compensation of $10 from this transaction. In 2012, when the stock had a fair market value of $120, it became substantially vested. For 2012, you must report additional compensation of $60, figured as follows:
| Fair market value of stock at time of substantial vesting | $120 | |
| Minus: Amount paid for stock | $50 | |
| Minus: Compensation previously included in income from sale to spouse | 10 | −60 |
| Additional income | $60 |
This part of the publication deals with special rules for people in certain types of employment: members of the clergy, members of religious orders, people working for foreign employers, military personnel, and volunteers.
If you are a member of the clergy, you must include in your income offerings and fees you receive for marriages, baptisms, funerals, masses, etc., in addition to your salary. If the offering is made to the religious institution, it is not taxable to you.
If you are a member of a religious organization and you give your outside earnings to the organization, you still must include the earnings in your income. However, you may be entitled to a charitable contribution deduction for the amount paid to the organization. See Publication 526, Charitable Contributions. Also, see Members of Religious Orders , later.
Special rules for housing apply to members of the clergy. Under these rules, you do not include in your income the rental value of a home (including utilities) or a designated housing allowance provided to you as part of your pay. However, the exclusion cannot be more than the reasonable pay for your service. If you pay for the utilities, you can exclude any allowance designated for utility cost, up to your actual cost. The home or allowance must be provided as compensation for your services as an ordained, licensed, or commissioned minister. However, you must include the rental value of the home or the housing allowance as earnings from self-employment on Schedule SE (Form 1040), Self-Employment Tax, if you are subject to the self-employment tax. For more information, see Publication 517, Social Security and Other Information for Members of the Clergy and Religious Workers.
If you are a member of a religious order who has taken a vow of poverty, how you treat earnings that you renounce and turn over to the order depends on whether your services are performed for the order.
Example.
You are a member of a church order and have taken a vow of poverty. You renounce any claims to your earnings and turn over to the order any salaries or wages you earn. You are a registered nurse, so your order assigns you to work in a hospital that is an associated institution of the church. However, you remain under the general direction and control of the order. You are considered to be an agent of the order and any wages you earn at the hospital that you turn over to your order are not included in your income.
-
They are the kind of services that are ordinarily the duties of members of the order.
-
They are part of the duties that you must exercise for, or on behalf of, the religious order as its agent.
Example 1.
Mark Brown is a member of a religious order and has taken a vow of poverty. He renounces all claims to his earnings and turns over his earnings to the order.
Mark is a schoolteacher. He was instructed by the superiors of the order to get a job with a private tax-exempt school. Mark became an employee of the school, and, at his request, the school made the salary payments directly to the order.
Because Mark is an employee of the school, he is performing services for the school rather than as an agent of the order. The wages Mark earns working for the school are included in his income.
Example 2.
Gene Dennis is a member of a religious order who, as a condition of membership, has taken vows of poverty and obedience. All claims to his earnings are renounced. Gene received permission from the order to establish a private practice as a psychologist and counsels members of religious orders as well as nonmembers. Although the order reviews Gene's budget annually, Gene controls not only the details of his practice but also the means by which his work as a psychologist is accomplished.
Gene's private practice as a psychologist does not make him an agent of the religious order. The psychological services provided by Gene are not the type of services that are provided by the order. The income Gene earns as a psychologist is earned in his individual capacity. Gene must include in his income the earnings from his private practice.
Special rules apply if you work for a foreign employer.
-
You are not a citizen of the United States or you are a citizen of the Philippines (whether or not you are a citizen of the United States).
-
Your work is like the work done by employees of the United States in foreign countries.
-
The foreign government gives an equal exemption to employees of the United States in its country.
Payments you receive as a member of a military service generally are taxed as wages except for retirement pay, which is taxed as a pension. Allowances generally are not taxed. For more information on the tax treatment of military allowances and benefits, see Publication 3, Armed Forces' Tax Guide.
-
Education, training, and subsistence allowances.
-
Disability compensation and pension payments for disabilities paid either to veterans or their families.
-
Grants for homes designed for wheelchair living.
-
Grants for motor vehicles for veterans who lost their sight or the use of their limbs.
-
Veterans' insurance proceeds and dividends paid either to veterans or their beneficiaries, including the proceeds of a veteran's endowment policy paid before death.
-
Interest on insurance dividends left on deposit with the VA.
-
Benefits under a dependent-care assistance program.
-
The death gratuity paid to a survivor of a member of the Armed Forces who died after September 10, 2001.
-
Payments made under the compensated work therapy program.
-
Any bonus payment by a state or political subdivision because of service in a combat zone.
The tax treatment of amounts you receive as a volunteer is covered in the following discussions.
-
Allowances paid to your spouse and minor children while you are a volunteer leader training in the United States.
-
Living allowances designated by the Director of the Peace Corps as basic compensation. These are allowances for personal items such as domestic help, laundry and clothing maintenance, entertainment and recreation, transportation, and other miscellaneous expenses.
-
Leave allowances.
-
Readjustment allowances or termination payments. These are considered received by you when credited to your account.
Example.
Gary Carpenter, a Peace Corps volunteer, gets $175 a month as a readjustment allowance during his period of service, to be paid to him in a lump sum at the end of his tour of duty. Although the allowance is not available to him until the end of his service, Gary must include it in his income on a monthly basis as it is credited to his account.
This section provides information on the treatment of income from certain rents and royalties, and from interests in partnerships and S corporations.
If you rent out personal property, such as equipment or vehicles, how you report your income and expenses is in most cases determined by:
-
Whether or not the rental activity is a business, and
-
Whether or not the rental activity is conducted for profit.
In most cases, if your primary purpose is income or profit and you are involved in the rental activity with continuity and regularity, your rental activity is a business. See Publication 535, Business Expenses, for details on deducting expenses for both business and not-for-profit activities.
Royalties from copyrights, patents, and oil, gas, and mineral properties are taxable as ordinary income.
In most cases you report royalties in Part I of Schedule E (Form 1040), Supplemental Income and Loss. However, if you hold an operating oil, gas, or mineral interest or are in business as a self-employed writer, inventor, artist, etc., report your income and expenses on Schedule C or Schedule C-EZ (Form 1040).
A partnership generally is not a taxable entity. The income, gains, losses, deductions, and credits of a partnership are passed through to the partners based on each partner's distributive share of these items. For more information, see Publication 541.
In most cases, an S corporation does not pay tax on its income. Instead, the income, losses, deductions, and credits of the corporation are passed through to the shareholders based on each shareholder's pro rata share. You must report your share of these items on your return. In most cases, the items passed through to you will increase or decrease the basis of your S corporation stock as appropriate.
In most cases, you must report as income any amount you receive for personal injury or sickness through an accident or health plan that is paid for by your employer. If both you and your employer pay for the plan, only the amount you receive that is due to your employer's payments is reported as income. However, certain payments may not be taxable to you. For information on nontaxable payments, see Military and Government Disability Pensions and Other Sickness and Injury Benefits , later in this discussion.
If you retired on disability, you must include in income any disability pension you receive under a plan that is paid for by your employer. You must report your taxable disability payments as wages on line 7 of Form 1040 or Form 1040A until you reach minimum retirement age. Minimum retirement age generally is the age at which you can first receive a pension or annuity if you are not disabled.
Beginning on the day after you reach minimum retirement age, payments you receive are taxable as a pension or annuity. Report the payments on lines 16a and 16b of Form 1040 or on lines 12a and 12b of Form 1040A. For more information on pensions and annuities, see Publication 575.
Certain military and government disability pensions are not taxable.
-
You were entitled to receive a disability payment before September 25, 1975.
-
You were a member of a listed government service or its reserve component, or were under a binding written commitment to become a member, on September 24, 1975.
-
You receive the disability payments for a combat-related injury. This is a personal injury or sickness that:
-
Results directly from armed conflict,
-
Takes place while you are engaged in extra-hazardous service,
-
Takes place under conditions simulating war, including training exercises such as maneuvers, or
-
Is caused by an instrumentality of war.
-
-
You would be entitled to receive disability compensation from the Department of Veterans Affairs (VA) if you filed an application for it. Your exclusion under this condition is equal to the amount you would be entitled to receive from the VA.
Example.
You retired in 2006 and receive a pension based on your years of service. On August 1, 2012, you receive a determination of service-connected disability retroactive to 2006. Generally, you could claim a refund for the taxes paid on your pension for 2009, 2010, and 2011. However, under the special limitation period, you can also file a claim for 2008 as long as you file the claim by August 1, 2013. You cannot file a claim for 2006 and 2007 because those tax years began more than 5 years before the determination.
In most cases, long-term care insurance contracts are treated as accident and health insurance contracts. Amounts you receive from them (other than policyholder dividends or premium refunds) are excludable in most cases from income as amounts received for personal injury or sickness. To claim an exclusion for payments made on a per diem or other periodic basis under a long-term care insurance contract, you must file Form 8853 with your return.
A long-term care insurance contract is an insurance contract that only provides coverage for qualified long-term care services. The contract must:
-
Be guaranteed renewable,
-
Not provide for a cash surrender value or other money that can be paid, assigned, pledged, or borrowed,
-
Provide that refunds, other than refunds on the death of the insured or complete surrender or cancellation of the contract, and dividends under the contract may be used only to reduce future premiums or increase future benefits, and
-
In most cases, not pay or reimburse expenses incurred for services or items that would be reimbursed under Medicare, except where Medicare is a secondary payer or the contract makes per diem or other periodic payments without regard to expenses.
-
Necessary diagnostic, preventive, therapeutic, curing, treating, mitigating, rehabilitative services, and maintenance and personal care services, and
-
Required by a chronically ill individual and provided pursuant to a plan of care prescribed by a licensed health care practitioner.
-
An individual who, for at least 90 days, is unable to perform at least two activities of daily living without substantial assistance due to a loss of functional capacity. Activities of daily living are eating, toileting, transferring, bathing, dressing, and continence.
-
An individual who requires substantial supervision to be protected from threats to health and safety due to severe cognitive impairment.
-
The cost of qualified long-term care services during the period.
-
The dollar amount for the period ($310 per day for any period in 2012).
Amounts you receive as workers' compensation for an occupational sickness or injury are fully exempt from tax if they are paid under a workers' compensation act or a statute in the nature of a workers' compensation act. The exemption also applies to your survivors. The exemption, however, does not apply to retirement plan benefits you receive based on your age, length of service, or prior contributions to the plan, even if you retired because of an occupational sickness or injury.
In addition to disability pensions and annuities, you may receive other payments for sickness or injury.
-
Compensatory damages you receive for physical injury or physical sickness, whether paid in a lump sum or in periodic payments. See Court awards and damages under Other Income, later.
-
Benefits you receive under an accident or health insurance policy on which either you paid the premiums or your employer paid the premiums but you had to include them in your income.
-
Disability benefits you receive for loss of income or earning capacity as a result of injuries under a no-fault car insurance policy.
-
Compensation you receive for permanent loss or loss of use of a part or function of your body, or for your permanent disfigurement. This compensation must be based only on the injury and not on the period of your absence from work. These benefits are not taxable even if your employer pays for the accident and health plan that provides these benefits.
This section discusses various types of income. You may have taxable income from certain transactions even if no money changes hands. For example, you may have taxable income if you lend money at a below-market interest rate or have a debt you owe canceled.
Bartering is an exchange of property or services. You must include in your income, at the time received, the fair market value of property or services you receive in bartering. If you exchange services with another person and you both have agreed ahead of time on the value of the services, that value will be accepted as fair market value unless the value can be shown to be otherwise.
Generally, you report this income on Schedule C or Schedule C-EZ (Form 1040). However, if the barter involves an exchange of something other than services, such as in Example 4 , later, you may have to use another form or schedule instead.
Example 1.
You are a self-employed attorney who performs legal services for a client, a small corporation. The corporation gives you shares of its stock as payment for your services. You must include the fair market value of the shares in your income on Schedule C or Schedule C-EZ (Form 1040) in the year you receive them.
Example 2.
You are a self-employed accountant. You and a house painter are members of a barter club. Members get in touch with each other directly and bargain for the value of the services to be performed. In return for accounting services you provided, the house painter painted your home. You must report as your income on Schedule C or Schedule C-EZ (Form 1040) the fair market value of the house painting services you received. The house painter must include in income the fair market value of the accounting services you provided.
Example 3.
You are self-employed and a member of a barter club. The club uses credit units as a means of exchange. It adds credit units to your account for goods or services you provide to members, which you can use to purchase goods or services offered by other members of the barter club. The club subtracts credit units from your account when you receive goods or services from other members. You must include in your income the value of the credit units that are added to your account, even though you may not actually receive goods or services from other members until a later tax year.
Example 4.
You own a small apartment building. In return for 6 months rent-free use of an apartment, an artist gives you a work of art she created. You must report as rental income on Schedule E (Form 1040) the fair market value of the artwork, and the artist must report as income on Schedule C or Schedule C-EZ (Form 1040) the fair rental value of the apartment.
In most cases, if a debt you owe is canceled or forgiven, other than as a gift or bequest, you must include the canceled amount in your income. You have no income from the canceled debt if it is intended as a gift to you. A debt includes any indebtedness for which you are liable or which attaches to property you hold.
If the debt is a nonbusiness debt, report the canceled amount on Form 1040, line 21. If it is a business debt, report the amount on Schedule C or Schedule C-EZ (Form 1040) (or on Schedule F (Form 1040), Profit or Loss From Farming, if the debt is farm debt and you are a farmer).
You may be able to elect to recognize a canceled business debt in income over a 5-tax-year period if the income is realized in a reacquisition in 2009 or 2010. For information on this election, see Revenue Procedure 2009-37 available at www.irs.gov/irb/2009-36_IRB/ar07.html.
There are several exceptions to the inclusion of canceled debt in income. These are explained next.
-
The Federal Government, a state or local government, or an instrumentality, agency, or subdivision thereof,
-
A tax-exempt public benefit corporation that has assumed control of a state, county, or municipal hospital, and whose employees are considered public employees under state law, or
-
An educational institution:
-
Under an agreement with an entity described in (1) or (2) that provided the funds to the institution to make the loan, or
-
As part of a program of the institution designed to encourage students to serve in occupations or areas with unmet needs and under which the services provided are for or under the direction of a governmental unit or a tax-exempt section 501(c)(3) organization (defined later).
-
-
Charitable.
-
Educational.
-
Fostering national or international amateur sports competition (but only if none of the organization's activities involve providing athletic facilities or equipment).
-
Literary.
-
Preventing cruelty to children or animals.
-
Religious.
-
Scientific.
-
Testing for public safety.
-
The debt is canceled in a bankruptcy case under Title 11 of the U.S. Code. See Publication 908, Bankruptcy Tax Guide.
-
The debt is canceled when you are insolvent. However, you cannot exclude any amount of canceled debt that is more than the amount by which you are insolvent. See Publication 908.
-
The debt is qualified farm debt and is canceled by a qualified person. See chapter 3 of Publication 225, Farmer's Tax Guide.
-
The debt is qualified real property business debt. See chapter 5 of Publication 334.
-
The cancellation is intended as a gift.
-
The debt is qualified principal residence indebtedness, discussed next.
Example.
Your principal residence is secured by a debt of $1 million, of which $800,000 is QPRI. Your residence is sold for $700,000 and $300,000 of debt is canceled. Only $100,000 of the canceled debt may be excluded from income (the $300,000 that was discharged minus the $200,000 of nonqualified debt).
If you host a party or event at which sales are made, any gift or gratuity you receive for giving the event is a payment for helping a direct seller make sales. You must report this item as income at its fair market value.
Your out-of-pocket party expenses are subject to the 50% limit for meal and entertainment expenses. These expenses are deductible as miscellaneous itemized deductions subject to the 2%-of-AGI limit on Schedule A (Form 1040), but only up to the amount of income you receive for giving the party.
For more information about the 50% limit for meal and entertainment expenses, see 50% Limit in Publication 463.
Life insurance proceeds paid to you because of the death of the insured person are not taxable unless the policy was turned over to you for a price. This is true even if the proceeds were paid under an accident or health insurance policy or an endowment contract. However, interest income received as a result of life insurance proceeds may be taxable.
Example.
The face amount of the policy is $75,000 and, as beneficiary, you choose to receive 120 monthly installments of $1,000 each. The excluded part of each installment is $625 ($75,000 ÷ 120), or $7,500 for an entire year. The rest of each payment, $375 a month (or $4,500 for an entire year), is interest income to you.
-
Before the policy is issued, you provide written notice about the insurance to the employee and the employee provides written consent to be insured.
-
Either:
-
The employee was your employee within the 12-month period before death, or, at the time the contract was issued, was a director or highly compensated employee, or
-
The amount is paid to the family or designated beneficiary of the employee.
-
-
Under the economic benefit regime, the owner of the life insurance contract is treated as providing current life insurance protection and other taxable economic benefits to the non-owner of the contract.
-
Under the loan regime, the non-owner of the life insurance contract is treated as loaning premium payments to the owner of the contract.
An endowment contract is a policy under which you are paid a specified amount of money on a certain date unless you die before that date, in which case, the money is paid to your designated beneficiary. Endowment proceeds paid in a lump-sum to you at maturity are taxable only if the proceeds are more than the cost of the policy. To determine your cost, subtract any amount that you previously received under the contract and excluded from your income from the total premiums (or other consideration) paid for the contract. Include the part of the lump-sum payment that is more than your cost in your income.
Endowment proceeds that you choose to receive in installments instead of a lump-sum payment at the maturity of the policy are taxed as an annuity. This is explained in Publication 575. For this treatment to apply, you must choose to receive the proceeds in installments before receiving any part of the lump sum. This election must be made within 60 days after the lump-sum payment first becomes payable to you.
Certain amounts paid as accelerated death benefits under a life insurance contract or viatical settlement before the insured's death are excluded from income if the insured is terminally or chronically ill.
A recovery is a return of an amount you deducted or took a credit for in an earlier year. The most common recoveries are refunds, reimbursements, and rebates of itemized deductions. You also may have recoveries of non-itemized deductions (such as payments on previously deducted bad debts) and recoveries of items for which you previously claimed a tax credit.
-
State and local income taxes, or
-
State and local general sales taxes, then
Example.
You paid 2011 estimated state income tax of $4,000 in four equal payments. You made your fourth payment in January 2012. You had no state income tax withheld during 2011. In 2012, you received a $400 tax refund based on your 2011 state income tax return. You claimed itemized deductions each year on Schedule A (Form 1040).
You must allocate the $400 refund between 2011 and 2012, the years in which you paid the tax on which the refund is based. You paid 75% ($3,000 ÷ $4,000) of the estimated tax in 2011, so 75% of the $400 refund, or $300, is for amounts you paid in 2011 and is a recovery item. If all of the $300 is a taxable recovery item, you will include $300 on Form 1040, line 10, for 2012, and attach a copy of your computation showing why that amount is less than the amount shown on the Form 1099-G you received from the state.
The balance ($100) of the $400 refund is for your January 2012 estimated tax payment. When you figure your deduction for state and local income taxes paid during 2012, you will reduce the $1,000 paid in January by $100. Your deduction for state and local income taxes paid during 2012 will include the January net amount of $900 ($1,000 − $100), plus any estimated state income taxes paid in 2012 for 2012, and any state income tax withheld during 2012.
Example.
You claimed the standard deduction on your 2011 federal income tax return. In 2012 you received a refund of your 2011 state income tax. Do not report any of the refund as income because you did not itemize deductions for 2011.
The following discussion explains how to determine the amount to include in your income from a recovery of an amount deducted in an earlier year as an itemized deduction. However, you generally do not need to use this discussion if you file Form 1040 and the recovery is for state or local income taxes paid in 2011. Instead, use the worksheet in the 2012 Form 1040 instructions for line 10 to figure the amount (if any) to include in your income.
You cannot use the Form 1040 worksheet and must use this discussion if you are a nonresident alien (discussed later) or any of the following statements are true.
-
You received a refund in 2012 that is for a tax year other than 2011.
-
You received a refund other than an income tax refund, such as a general sales tax or real property tax refund, in 2012 of an amount deducted or credit claimed in an earlier year.
-
The amount on your 2011 Form 1040, line 42 was more than the amount on your 2011 Form 1040, line 41.
-
You had taxable income on your 2011 Form 1040, line 43, but no tax on your Form 1040, line 44, because of the 0% tax rate on net capital gain and qualified dividends in certain situations. See Capital gains , later.
-
Your 2011 state and local income tax refund is more than your 2011 state and local income tax deduction minus the amount you could have deducted as your 2011 state and local general sales taxes.
-
You made your last payment of 2011 estimated state or local income tax in 2012.
-
You owed alternative minimum tax in 2011.
-
You could not use the full amount of credits you were entitled to in 2011 because the total credits were more than the amount shown on your 2011 Form 1040, line 46.
-
You could be claimed as a dependent by someone else in 2011.
-
You received a refund because of a jointly-filed state or local income tax return, but you are not filing a joint 2012 Form 1040 with the same person.
-
Your itemized deductions exceeded the standard deduction by at least the amount of the recovery. (If your itemized deductions did not exceed the standard deduction by at least the amount of the recovery, see Standard deduction limit , later.)
-
You had taxable income. (If you had no taxable income, see Negative taxable income , later.)
-
Your deduction for the item recovered equals or exceeds the amount recovered. (If your deduction was less than the amount recovered, see Recovery limited to deduction , later.)
-
Your itemized deductions were not subject to the limit on itemized deductions. (If your deductions were limited, see Itemized deductions limited , later.)
-
You had no unused tax credits. (If you had unused tax credits, see Unused tax credits , later.)
-
You were not subject to alternative minimum tax. (If you were subject to alternative minimum tax, see Subject to alternative minimum tax , later.)
Example.
For 2011, you filed a joint return on Form 1040. Your taxable income was $60,000 and you were not entitled to any tax credits. Your standard deduction was $11,600, and you had itemized deductions of $13,000. In 2012, you received the following recoveries for amounts deducted on your 2011 return:
| Medical expenses | $200 |
| State and local income tax refund | 400 |
| Refund of mortgage interest | 325 |
| Total recoveries | $925 |
None of the recoveries were more than the deductions taken for 2011. The difference between the state and local income tax you deducted and your local general sales tax was more than $400.
Your total recoveries are less than the amount by which your itemized deductions exceeded the standard deduction ($13,000 − $11,600 = $1,400), so you must include your total recoveries in your income for 2012. Report the state and local income tax refund of $400 on Form 1040, line 10, and the balance of your recoveries, $525, on Form 1040, line 21.
-
Divide your state income tax refund by the total of all your itemized deduction recoveries.
-
Multiply the amount of taxable recoveries by the percentage in (1). This is the amount you report as a state income tax refund.
-
Subtract the result in (2) above from the amount of taxable recoveries. This is the amount you report as other income.
Example.
In 2012 you recovered $2,500 of your 2011 itemized deductions claimed on Schedule A (Form 1040), but the recoveries you must include in your 2012 income are only $1,500. Of the $2,500 you recovered, $500 was due to your state income tax refund. Your state income tax was more than your state general sales tax by $600. The amount you report as a state tax refund on Form 1040, line 10, is $300 [($500 ÷ $2,500) × $1,500]. The balance of the taxable recoveries, $1,200, is reported as other income on Form 1040, line 21.
-
Your recoveries, or
-
The amount by which your itemized deductions exceeded the standard deduction.
Example.
You filed a joint return on Form 1040 for 2011 with taxable income of $45,000. Your itemized deductions were $12,050. The standard deduction that you could have claimed was $11,600. In 2012, you recovered $2,100 of your 2011 itemized deductions. None of the recoveries were more than the actual deductions for 2011. Include $450 of the recoveries in your 2012 income. This is the smaller of your recoveries ($2,100) or the amount by which your itemized deductions were more than the standard deduction ($12,050 − $11,600 = $450).
-
Form 1040, line 42 was more than line 41,
-
Form 1040NR, line 40 was more than line 39, or
-
Form 1040NR-EZ, line 13 was more than line 12.
-
The amount deducted, or
-
The amount recovered.
Example.
During 2011, you paid $1,700 for medical expenses. From this amount you subtracted $1,500, which was 7.5% of your adjusted gross income. Your actual medical expense deduction was $200. In 2012, you received a $500 reimbursement from your medical insurance for your 2011 expenses. The only amount of the $500 reimbursement that must be included in your income for 2012 is $200—the amount actually deducted.
-
3% of the amount by which your AGI exceeded the base amount.
-
80% of your otherwise allowable deductions other than medical and dental expenses, investment interest expense, nonbusiness casualty and theft losses, and gambling losses.
-
Figure the greater of:
-
The standard deduction for the earlier year, or
-
The amount of itemized deductions you would have been allowed for the earlier year (after taking into account the limit on itemized deductions) if you had figured them using only the net amount of the recovery item. The net amount is the amount you actually paid reduced by the recovery amount.
Note. If you were required to itemize your deductions in the earlier year, use step 1(b) and not step 1(a).
-
-
Subtract the amount in step 1 from the amount of itemized deductions actually allowed in the earlier year after applying the limit on itemized deductions.
| To determine whether you should complete this worksheet to figure the part of a recovery amount to include in income on your
2012 tax return, see
Itemized Deduction Recoveries
. If you recovered amounts from more than one year, such as a state income tax refund from 2011 and a casualty loss reimbursement
from 2010, complete a separate worksheet for each year. Use information from your tax return for the year the expense was
deducted. A recovery is included in income only to the extent of the deduction amount that reduced your tax in the prior year (year of the deduction). If you were subject to the alternative minimum tax or your tax credits reduced your tax to zero, see Unused tax credits and Subject to alternative minimum tax under Itemized Deduction Recoveries. If your recovery was for an itemized deduction that was limited, you should read Itemized deductions limited under Itemized Deduction Recoveries. |
||||||
| 1. | State/local income tax refund or credit1 | 1. | ||||
| 2. | Enter the total of all other Schedule A refunds or reimbursements (excluding the amount you entered on line 1)2 |
2. | ||||
| 3. | Add lines 1 and 2 | 3. | ||||
| 4. | Itemized deductions for the prior year. For 2011, Form 1040, Schedule A, line 29 Form 1040NR, Schedule A, line 17 Form 1040NR-EZ, line 11 |
4. | ||||
| 5. | Enter any amount previously refunded to you (do not enter an amount from line 1 or line 2) |
5. | ||||
| 6. | Subtract line 5 from line 4 | 6. | ||||
| 7. | Standard deduction for the prior year. (If you filed Form 1040, the standard deduction amounts for 2011, 2010, and 2009 are shown in Tables 2, 3, and 4. If you filed Form 1040NR or 1040NR-EZ, enter -0-.) | 7. | ||||
| 8. | Subtract line 7 from line 6. If the result is zero or less, stop here. The amounts on lines 1 and 2 are not taxable |
8. | ||||
| 9. | Enter the smaller of line 3 or line 8 | 9. | ||||
| 10. | Taxable income for prior year3 (2011 Form 1040, line 43; 2011 Form 1040NR, line 41; 2011 Form 1040NR-EZ, line 14) | 10. | ||||
| 11. | Amount to include in income for 2012:
|
11. | ||||
| If line 11 equals line 3— Enter the amount from line 1 on Form 1040, line 10; Form 1040NR, line 11; Form 1040NR-EZ, line 4. Enter the amount from line 2 on Form 1040, line 21; Form 1040NR, line 21. |
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| If line 11 is less than line 3 and either line 1 or line 2 is zero— If there is an amount on line 1, enter the amount from line 11 on Form 1040, line 10; Form 1040NR, line 11; Form 1040NR-EZ, line 4. If there is an amount on line 2, enter the amount from line 11 on Form 1040, line 21; Form 1040NR, line 21. |
||||||
| If line 11 is less than line 3, and there are amounts on both lines 1 and 2, complete the following worksheet. | ||||||
| A. | Divide the amount on line 1 by the amount on line 3. Enter the percentage | A. | ||||
| B. | Multiply the amount on line 11 by the percentage on line A. Enter the result here and on Form 1040, line 10; Form 1040NR, line 11 |
B. | ||||
| C. | Subtract the amount on line B from the amount on line 11. Enter the result here and on Form 1040, line 21; Form 1040NR, line 21 |
C. | ||||
| 1 Do not enter more than the amount deducted for the prior year. Do not enter more than the excess of your state and local income tax deduction over your state and local general sales taxes you could have deducted. | |
| 2 Do not enter more than the amount deducted for the prior year. If you deducted state and local general sales taxes and received a refund of those taxes, include the amount on line 2, but do not enter more than the excess of your sales tax deduction over your state and local income tax you could have deducted. | |
| 3 If taxable income is a negative amount, enter that amount in brackets. Do not enter zero unless your taxable income is exactly zero. See Negative taxable income . Taxable income will have to be adjusted for any net operating loss carryover. For more information, see Publication 536, Net Operating Losses for Individuals, Estates, and Trusts. | |
| 4 For example, $700 + ($400) = $300. |
Example.
In 2011, Jean Black filed as head of household and itemized her deductions on Schedule A (Form 1040). Her taxable income was $5,260 and her tax was $528. She claimed a child care credit of $1,200. The credit reduced her tax to zero and she had an unused tax credit of $672 ($1,200 − $528). In 2012, Jean recovered $1,000 of her itemized deductions. She reduces her 2011 itemized deductions by $1,000 and recomputes that year's tax on taxable income of $6,260. However, the child care credit exceeds the recomputed tax of $628. Jean's tax liability for 2011 is not changed by reducing her deductions by the recovery. She did not have a tax benefit from the recovered deduction and does not include any of the recovery in her income for 2012.
This section discusses recovery of deductions other than itemized deductions.
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Form 1040, line 42 was more than line 41,
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Form 1040NR, line 40 was more than line 39, or
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Form 1040NR-EZ, line 13 was more than line 12.
If you received a recovery in 2012 for an item for which you claimed a tax credit in an earlier year, you must increase your 2012 tax by the amount of the recovery, up to the amount by which the credit reduced your tax in the earlier year. You had a recovery if there was a downward price adjustment or similar adjustment on the item for which you claimed a credit.
This rule does not apply to the investment credit or the foreign tax credit. Recoveries of these credits are covered by other provisions of the law. See Publication 514, Foreign Tax Credit for Individuals, or Form 4255, Recapture of Investment Credit, for details.
In most cases, payments made by or for an employer because of an employee's death must be included in income. The following discussions explain the tax treatment of certain payments made to survivors. For additional information, see Publication 559.
The tax treatment of unemployment benefits you receive depends on the type of program paying the benefits.
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Benefits paid by a state or the District of Columbia from the Federal Unemployment Trust Fund.
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State unemployment insurance benefits.
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Railroad unemployment compensation benefits.
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Disability payments from a government program paid as a substitute for unemployment compensation. (Amounts received as workers' compensation for injuries or illness are not unemployment compensation. See Workers' Compensation under Sickness and Injury Benefits, earlier.)
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Trade readjustment allowances under the Trade Act of 1974.
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Unemployment assistance under the Disaster Relief and Emergency Assistance Act of 1974.
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Unemployment assistance under the Airline Deregulation Act of 1974 Program.
Do not include in your income governmental benefit payments from a public welfare fund based upon need, such as payments due to blindness. Payments from a state fund for the victims of crime should not be included in the victims' incomes if they are in the nature of welfare payments. Do not deduct medical expenses that are reimbursed by such a fund. You must include in your income any welfare payments that are compensation for services or that are obtained fraudulently.
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To reimburse or pay reasonable and necessary personal, family, living, or funeral expenses that result from a qualified disaster;
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To reimburse or pay reasonable and necessary expenses incurred for the repair or rehabilitation of your home or repair or replacement of its contents to the extent it is due to a qualified disaster;
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By a person engaged in the furnishing or sale of transportation as a common carrier because of the death or personal physical injuries incurred as a result of a qualified disaster; or
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By a federal, state, or local government, or agency or instrumentality in connection with a qualified disaster in order to promote the general welfare.
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A disaster which results from a terrorist or military action;
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A federally declared disaster; or
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A disaster which results from an accident involving a common carrier, or from any other event, which is determined to be catastrophic by the Secretary of the Treasury or his or her delegate.
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A State Housing Finance agency (State HFA) Hardest Hit Fund program in which program payments can be used to pay mortgage interest, or
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An Emergency Homeowners' Loan Program (EHLP) administered by the Department of Housing and Urban Development (HUD) or a state.
The following brief discussions are arranged in alphabetical order. Other income items briefly discussed below are referenced to publications which provide more information.
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A loan to the borrower in exchange for a note that requires the payment of interest at the applicable federal rate, and
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An additional payment to the borrower, which the borrower transfers back to you as interest.
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Gift,
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Dividend,
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Contribution to capital,
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Payment of compensation, or
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Another type of payment.
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Interest on any award.
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Compensation for lost wages or lost profits in most cases.
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Punitive damages, in most cases. It does not matter if they relate to a physical injury or physical sickness.
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Amounts received in settlement of pension rights (if you did not contribute to the plan).
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Damages for:
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Back pay and damages for emotional distress received to satisfy a claim under Title VII of the Civil Rights Act of 1964.
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Attorney fees and costs (including contingent fees) where the underlying recovery is included in gross income.
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The attorney fees and court costs may be paid by you or on your behalf in connection with the claim for unlawful discrimination, the claim against the United States government, or the claim under section 1862(b)(3)(A) of the Social Security Act.
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The deduction you are claiming cannot be more than the amount of the judgment or settlement you are including in income for the tax year.
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The judgment or settlement to which your attorney fees and court costs apply must occur after October 22, 2004.
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All income that is required to be distributed to you, whether or not it is actually distributed, plus
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All other amounts actually paid or credited to you,
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Otherwise includible in taxable income, and
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Received in connection with the civil action In re Exxon Valdez, No. 89-095-CV (HRH) (Consolidated) (D. Alaska).
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A corporate director,
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An executor, administrator, or personal representative of an estate,
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A manager of a trade or business you operated before declaring Chapter 11 bankruptcy,
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A notary public, or
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An election precinct official.
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Is living in a foster family home, and
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Was placed there by:
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An agency of a state or one of its political subdivisions, or
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A qualified foster care placement agency.
-
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10 qualified foster individuals under age 19, or
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5 qualified foster individuals age 19 or older.
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The financial institution is bankrupt or insolvent, or
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The state where the institution is located has placed limits on withdrawals because other financial institutions in the state are bankrupt or insolvent.
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The net amount withdrawn from the deposit during that year, and
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The amount that could have been withdrawn at the end of that tax year (not reduced by any penalty for premature withdrawals of a time deposit).
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You were selected without any action on your part to enter the contest or proceeding.
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You are not required to perform substantial future services as a condition for receiving the prize or award.
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The prize or award is transferred by the payer directly to a governmental unit or tax-exempt charitable organization as designated by you. The following conditions apply to the transfer.
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You cannot use the prize or award before it is transferred.
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You should provide the designation before the prize or award is presented to prevent a disqualifying use. The designation should contain:
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The purpose of the designation by making a reference to section 74(b)(3) of the Internal Revenue Code,
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A description of the prize or award,
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The name and address of the organization to receive the prize or award,
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Your name, address, and taxpayer identification number, and
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Your signature and the date signed.
-
-
In the case of an unexpected presentation, you must return the prize or award before using it (or spending, depositing, investing it, etc., in the case of money) and then prepare the statement as described in (b).
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After the transfer, you should receive from the payer a written response stating when and to whom the designated amounts were transferred.
-
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Tier 1 railroad retirement benefits that are more than the social security equivalent benefit.
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Tier 2 benefits.
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Vested dual benefits.
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Tuition and fees required to enroll at or attend an eligible educational institution, or
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Course related expenses, such as fees, books, and equipment that are required for courses at the eligible educational institution. These items must be required of all students in your course of instruction.
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The National Health Services Corps Scholarship Program, or
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The Armed Forces health Professions Scholarship and Financial Assistance Program.
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You received a lump-sum benefit payment during the year that is for one or more earlier years.
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You exclude employer-provided adoption benefits or interest from qualified U.S. savings bonds.
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You take the foreign earned income exclusion, the foreign housing exclusion or deduction, the exclusion of income from American Samoa, or the exclusion of income from Puerto Rico by bona fide residents of Puerto Rico.
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You receive social security or equivalent railroad retirement benefits.
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You have taxable compensation.
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You contribute to your IRA.
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You or your spouse is covered by a retirement plan at work.
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A reduction in the purchase price of electricity furnished to you (rate reduction), or
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A nonrefundable credit against the purchase price of the electricity.
If you had to repay an amount that you included in your income in an earlier year, you may be able to deduct the amount repaid from your income for the year in which you repaid it. Or, if the amount you repaid is more than $3,000, you may be able to take a credit against your tax for the year in which you repaid it. In most cases, you can claim a deduction or credit only if the repayment qualifies as an expense or loss incurred in your trade or business or in a for-profit transaction.
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Figure your tax for 2012 without deducting the repaid amount.
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Refigure your tax from the earlier year without including in income the amount you repaid in 2012.
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Subtract the tax in (2) from the tax shown on your return for the earlier year. This is the credit.
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Subtract the answer in (3) from the tax for 2012 figured without the deduction (step 1).
Example.
For 2011 you filed a return and reported your income on the cash method. In 2012 you repaid $5,000 included in your 2011 income under a claim of right. Your filing status in 2012 and 2011 is single. Your income and tax for both years are as follows:
| 2011 | ||||
| With Income | Without Income | |||
| Taxable Income | $15,000 | $10,000 | ||
| Tax | $1,829 | $1,079 | ||
| 2012 | ||||
| Without Deduction | With Deduction | |||
| Taxable Income | $49,950 | $44,950 | ||
| Tax | $8,619 | $7,369 | ||
Your tax under method 1 is $7,369. Your tax under method 2 is $7,869, figured as follows:
| Tax previously determined for 2011 | $1,829 | |
| Less: Tax as refigured | − 1,079 | |
| Decrease in 2011 tax | $750 | |
| Regular tax liability for 2012 | $8,619 | |
| Less: Decrease in 2011 tax | − 750 | |
| Refigured tax for 2012 | $7,869 | |
You pay less tax using method 1, so you should take a deduction for the repayment in 2012.
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Deductions for bad debts;
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Deductions for theft losses due to criminal fraud or embezzlement in a transaction entered into for profit;
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Deductions from sales to customers, such as returns and allowances, and similar items; or
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Deductions for legal and other expenses of contesting the repayment.
You can get help with unresolved tax issues, order free publications and forms, ask tax questions, and get information from the IRS in several ways. By selecting the method that is best for you, you will have quick and easy access to tax help.
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Check the status of your 2012 refund. Go to IRS.gov and click on Where’s My Refund. Information about your return will generally be available within 24 hours after the IRS receives your e-filed return, or 4 weeks after you mail your paper return. If you filed Form 8379 with your return, wait 14 weeks (11 weeks if you filed electronically). Have your 2012 tax return handy so you can provide your social security number, your filing status, and the exact whole dollar amount of your refund.
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E-file your return. Find out about commercial tax preparation and e-file services available free to eligible taxpayers.
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Where's My Refund? has a new look this year! The tool will include a tracker that displays progress through three stages: (1) return received, (2) refund approved, and (3) refund sent. Where's My Refund? will provide an actual personalized refund date as soon as the IRS processes your tax return and approves your refund. So in a change from previous filing seasons, you won't get an estimated refund date right away. Where's My Refund? includes information for the most recent return filed in the current year and does not include information about amended returns.
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You can obtain a free transcript online at IRS.gov by clicking on Order a Return or Account Transcript under “Tools.” For a transcript by phone, call 1-800-908-9946 and follow the prompts in the recorded message. You will be prompted to provide your SSN or Individual Taxpayer Identification Number (ITIN), date of birth, street address and ZIP code.
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Download forms, including talking tax forms, instructions, and publications.
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Order IRS products.
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Research your tax questions.
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Search publications by topic or keyword.
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Use the Internal Revenue Code, regulations, or other official guidance.
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View Internal Revenue Bulletins (IRBs) published in the last few years.
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Figure your withholding allowances using the IRS Withholding Calculator at www.irs.gov/individuals.
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Determine if Form 6251 (Alternative Minimum Tax— Individuals), must be filed by using our Alternative Minimum Tax (AMT) Assistant available at IRS.gov by typing Alternative Minimum Tax Assistant in the search box.
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Sign up to receive local and national tax news by email.
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Get information on starting and operating a small business.
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Ordering forms, instructions, and publications. Call 1-800-TAX-FORM (1-800-829-3676) to order current-year forms, instructions, and publications, and prior-year forms and instructions (limited to 5 years). You should receive your order within 10 days.
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Asking tax questions. Call the IRS with your tax questions at 1-800-829-1040.
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Solving problems. You can get face-to-face help solving tax problems most business days in IRS Taxpayer Assistance Centers (TAC). An employee can explain IRS letters, request adjustments to your account, or help you set up a payment plan. Call your local Taxpayer Assistance Center for an appointment. To find the number, go to www.irs.gov/localcontacts or look in the phone book under United States Government, Internal Revenue Service.
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TTY/TDD equipment. If you have access to TTY/TDD equipment, call 1-800-829-4059 to ask tax questions or to order forms and publications. The TTY/TDD telephone number is for individuals who are deaf, hard of hearing, or have a speech disability. These individuals can also access the IRS through relay services such as the Federal Relay Service at www.gsa.gov/fedrelay.
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TeleTax topics. Call 1-800-829-4477 to listen to pre-recorded messages covering various tax topics.
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Checking the status of your 2012 refund. To check the status of your 2012 refund, call 1-800-829-1954 or 1-800-829-4477 (automated Where's My Refund? information 24 hours a day, 7 days a week). Information about your return will generally be available within 24 hours after the IRS receives your e-filed return, or 4 weeks after you mail your paper return. If you filed Form 8379 with your return, wait 14 weeks (11 weeks if you filed electronically). Have your 2012 tax return handy so you can provide your social security number, your filing status, and the exact whole dollar amount of your refund. Where's My Refund? will provide an actual personalized refund date as soon as the IRS processes your tax return and approves your refund. Where's My Refund? includes information for the most recent return filed in the current year and does not include information about amended returns.
Evaluating the quality of our telephone services. To ensure IRS representatives give accurate, courteous, and professional answers, we use several methods to evaluate the quality of our telephone services. One method is for a second IRS representative to listen in on or record random telephone calls. Another is to ask some callers to complete a short survey at the end of the call.
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Products. You can walk in to some post offices, libraries, and IRS offices to pick up certain forms, instructions, and publications. Some IRS offices, libraries, and city and county government offices have a collection of products available to photocopy from reproducible proofs. Also, some IRS offices and libraries have the Internal Revenue Code, regulations, Internal Revenue Bulletins, and Cumulative Bulletins available for research purposes.
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Services. You can walk in to your local TAC most business days for personal, face-to-face tax help. An employee can explain IRS letters, request adjustments to your tax account, or help you set up a payment plan. If you need to resolve a tax problem, have questions about how the tax law applies to your individual tax return, or you are more comfortable talking with someone in person, visit your local TAC where you can talk with an IRS representative face-to-face. No appointment is necessary—just walk in. Before visiting, check www.irs.gov/localcontacts for hours of operation and services provided. If you have an ongoing, complex tax account problem or a special need, such as a disability, an appointment can be requested by calling your local TAC. You can leave a message and a representative will call you back within 2 business days. All other issues will be handled without an appointment. To call your local TAC, go to www.irs.gov/localcontacts or look in the phone book under United States Government, Internal Revenue Service.
Internal Revenue Service
1201 N. Mitsubishi Motorway
Bloomington, IL 61705-6613
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Your problem is causing financial difficulties for you, your family, or your business.
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You face (or your business is facing) an immediate threat of adverse action.
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You have tried repeatedly to contact the IRS but no one has responded, or the IRS has not responded to you by the date promised.
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Current-year forms, instructions, and publications.
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Prior-year forms, instructions, and publications.
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Tax Map: an electronic research tool and finding aid.
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Tax law frequently asked questions.
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Tax Topics from the IRS telephone response system.
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Internal Revenue Code—Title 26 of the U.S. Code.
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Links to other Internet-based tax research materials.
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Fill-in, print, and save features for most tax forms.
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Internal Revenue Bulletins.
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Toll-free and email technical support.
-
Two releases during the year.
– The first release will ship the beginning of January 2013.
– The final release will ship the beginning of March 2013.
Purchase the DVD from National Technical Information Service (NTIS) at www.irs.gov/cdorders for $30 (no handling fee) or call 1-877-233-6767 toll free to buy the DVD for $30 (plus a $6 handling fee).
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