Table of Contents
- Compensation for Services
- Retirement Plan Distributions
- Social Security and Equivalent Railroad Retirement Benefits
- Sickness and Injury Benefits
- Life Insurance Proceeds
- Sale of Home
- Reverse Mortgages
- Other Items
Generally, income is taxable unless it is specifically exempt (not taxed) by law. Your taxable income may include compensation for services, interest, dividends, rents, royalties, income from partnerships, estate or trust income, gain from sales or exchanges of property, and business income of all kinds.
Under special provisions of the law, certain items are partially or fully exempt from tax. Provisions that are of special interest to older taxpayers are discussed in this chapter.
Generally, 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 need not receive the compensation in cash for it to be taxable. Payments you receive in the form of goods or services generally must be included in gross income at their fair market value.
Retired Senior Volunteer Program (RSVP).
Foster Grandparent Program.
Senior Companion Program.
Service Corps of Retired Executives (SCORE).
This section summarizes the tax treatment of amounts you receive from traditional individual retirement arrangements (IRA), employee pensions or annuities, and disability pensions or annuities. A traditional IRA is any IRA that is not a Roth or SIMPLE IRA. A Roth IRA is an individual retirement plan that can be either an account or an annuity and features nondeductible contributions and tax-free distributions. A SIMPLE IRA is a tax-favored retirement plan that certain small employers (including self-employed individuals) can set up for the benefit of their employees. More detailed information can be found in Publication 590, Individual Retirement Arrangements (IRAs), and Publication 575, Pension and Annuity Income.
In general, distributions from a traditional IRA are taxable in the year you receive them. Exceptions to the general rule are rollovers, tax-free withdrawals of contributions, and the return of nondeductible contributions. These are discussed in Publication 590.
59½. You must include early distributions of taxable amounts in your gross income. These taxable amounts are also subject to an additional 10% tax unless the distribution qualifies for an exception. See Tax on Early Distributions , later.
Generally, if you did not pay any part of the cost of your employee pension or annuity, and your employer did not withhold part of the cost of the contract from your pay while you worked, the amounts you receive each year are fully taxable. However, see Insurance Premiums for Retired Public Safety Officers , later.
If you paid part of the cost of your pension or annuity plan (see Cost , later), you can exclude part of each annuity payment from income as a recovery of your cost (investment in the contract). This tax-free part of the payment is figured when your annuity starts and remains the same each year, even if the amount of the payment changes. The rest of each payment is taxable. However, see Insurance Premiums for Retired Public Safety Officers , later.
You figure the tax-free part of the payment using one of the following methods.
Simplified Method. You generally must use this method if your annuity is paid under a qualified plan (a qualified employee plan, a qualified employee annuity, or a tax-sheltered annuity plan or contract). You cannot use this method if your annuity is paid under a nonqualified plan.
You determine which method to use when you first begin receiving your annuity, and you continue using it each year that you recover part of your cost.
A nonqualified plan, such as a private annuity, a purchased commercial annuity, or a nonqualified employee plan, or
A qualified plan if you are age 75 or older on your annuity starting date and you are entitled to at least 5 years of guaranteed payments (defined above).
Bill Smith, age 65, began receiving retirement benefits in 2012, under a joint and survivor annuity. Bill's annuity starting date is January 1, 2012. The benefits are to be paid over the joint lives of Bill and his wife, Kathy, age 65. Bill had contributed $31,000 to a qualified plan and had received no distributions before the annuity starting date. Bill is to receive a retirement benefit of $1,200 a month, and Kathy is to receive a monthly survivor benefit of $600 upon Bill's death.
Bill must use the Simplified Method to figure his taxable annuity because his payments are from a qualified plan and he is under age 75. See the illustrated Worksheet 2-A, Simplified Method Worksheet, later. You can also find a blank version of this worksheet in Publication 575.
His annuity is payable over the lives of more than one annuitant, so Bill uses his and Kathy's combined ages, 130 (65 + 65), and Table 2 at the bottom of the worksheet in completing line 3 of the worksheet and finds the line 3 amount to be 310. Bill's tax-free monthly amount is $100 ($31,000 ÷ 310 as shown on line 4 of the worksheet). Upon Bill's death, if Bill has not recovered the full $31,000 investment, Kathy will also exclude $100 from her $600 monthly payment. The full amount of any annuity payments received after 310 payments are paid must generally be included in gross income.
If Bill and Kathy die before 310 payments are made, a miscellaneous itemized deduction will be allowed for the unrecovered cost on the final income tax return of the last to die. This deduction is not subject to the 2%-of-adjusted-gross-income limit.
|1.||Enter the total pension or annuity payments received this year. Also, add this amount to the total for Form 1040, line 16a; Form 1040A, line 12a; or Form 1040NR, line 17a||1.||$ 14,400|
|2.||Enter your cost in the plan (contract) at the annuity starting date plus any death benefit exclusion*||2.||31,000|
|Note. If your annuity starting date was before this year and you completed this worksheet last year, skip line 3 and enter the amount from line 4 of last year's worksheet on line 4 below. Otherwise, go to line 3.|
|3.||Enter the appropriate number from Table 1 below. But if your annuity starting date was after 1997 and the payments are for your life and that of your beneficiary, enter the appropriate number from Table 2 below||3.||310|
|4.||Divide line 2 by line 3||4.||100|
|5.||Multiply line 4 by the number of months for which this year's payments were made. If your annuity starting date was before 1987, enter this amount on line 8 below and skip lines 6, 7, 10, and 11. Otherwise, go to line 6||5.||1,200|
|6.||Enter any amount previously recovered tax free in years after 1986. This is the amount shown on line 10 of your worksheet for last year||6.||0|
|7.||Subtract line 6 from line 2||7.||31,000|
|8.||Enter the smaller of line 5 or line 7||8.||1,200|
|9.||Taxable amount for year. Subtract line 8 from line 1. Enter the result, but not less than zero. Also, add this amount to the total for Form 1040, line 16b; Form 1040A, line 12b; or Form 1040NR, line 17b. Note. If your Form 1099-R shows a larger taxable amount, use the amount on this line instead. If you are a retired public safety officer, see Insurance Premiums for Retired Public Safety Officers , later, before entering an amount on your tax return.||9.||$ 13,200|
|10.||Was your annuity starting date before 1987?
□ Yes. STOP. Do not complete the rest of this worksheet.
☑ No. Add lines 6 and 8. This is the amount you have recovered tax free through 2012. You will need this number if you need to fill out this worksheet next year.
|11.||Balance of cost to be recovered. Subtract line 10 from line 2. If zero, you will not have to complete this worksheet next year. The payments you receive next year will generally be fully taxable||11.||$ 29,800|
* A death benefit exclusion (up to $5,000) applied to certain benefits received by employees who died before August 21, 1996.
|Table 1 for Line 3 Above|
|AND your annuity starting date was—|
|IF your age on your
annuity starting date was . . .
|before November 19, 1996, THEN enter on line 3 . . .||after November 18, 1996,
THEN enter on line 3 . . .
|55 or under||300||360|
|71 or over||120||160|
|Table 2 for Line 3 Above|
|IF the annuitants' combined ages on your annuity starting date were . . .||THEN enter on line 3 . . .|
|110 or under||410|
|141 or over||210|
You are a Form 1040 filer and you received monthly payments totaling $1,200 (12 months x $100) during 2012 from a pension plan that was completely financed by your employer. You had paid no tax on the payments that your employer made to the plan, and the payments were not used to pay for accident, health, or long-term care insurance premiums (as discussed later under Insurance Premiums for Retired Public Safety Officers ). The entire $1,200 is taxable. You include $1,200 only on Form 1040, line 16b.
If you receive a nonperiodic distribution from your retirement plan, you may be able to exclude all or part of it from your income as a recovery of your cost. Nonperiodic distributions include cash withdrawals, distributions of current earnings (dividends) on your investment, and certain loans. For information on how to figure the taxable amount of a nonperiodic distribution, see Taxation of Nonperiodic Payments in Publication 575.
Most distributions you receive from your qualified retirement plan and nonqualified annuity contracts before you reach age 59½ are subject to an additional tax of 10%. The tax applies to the taxable part of the distribution.
A qualified employee plan,
A qualified employee annuity plan,
A tax-sheltered annuity plan (403(b) plan),
An IRA, or
An eligible state or local government section 457 deferred compensation plan (to the extent that any distribution is attributable to amounts the plan received in a direct transfer or rollover from one of the other plans listed here).
Made as part of a series of substantially equal periodic payments (made at least annually) for your life (or life expectancy) or the joint lives (or joint life expectancies) of you and your designated beneficiary (if from a qualified retirement plan, the payments must begin after separation from service),
Made because you are totally and permanently disabled, or
Made on or after the death of the plan participant or contract holder.
To make sure that most of your retirement benefits are paid to you during your lifetime, rather than to your beneficiaries after your death, the payments that you receive from qualified retirement plans must begin no later than your required beginning date. Unless the rule for 5% owners applies, this is generally April 1 of the year that follows the later of:
The calendar year in which you reach age 70½, or
The calendar year in which you retire from employment with the employer maintaining the plan.
However, your plan may require you to begin to receive payments by April 1 of the year that follows the year in which you reach 70½, even if you have not retired.
For this purpose, a qualified retirement plan includes:
A qualified employee plan,
A qualified employee annuity plan,
An eligible section 457 deferred compensation plan, or
A tax-sheltered annuity plan (403(b) plan) (for benefits accruing after 1986).
If you are an eligible retired public safety officer (law enforcement officer, firefighter, chaplain, or member of a rescue squad or ambulance crew), you can elect to exclude from income distributions made from your eligible retirement plan that are used to pay the premiums for accident or health insurance or long-term care insurance. The premiums can be for coverage for you, your spouse, or dependent(s). The distribution must be made directly from the plan to the insurance provider. You can exclude from income the smaller of the amount of the insurance premiums or $3,000. You can only make this election for amounts that would otherwise be included in your income. The amount excluded from your income cannot be used to claim a medical expense deduction.
An eligible retirement plan is a governmental plan that is a:
Section 403(a) plan,
Section 403(b) annuity, or
Section 457(b) plan.
If you make this election, reduce the otherwise taxable amount of your pension or annuity by the amount excluded. The taxable amount shown in box 2a of any Form 1099-R that you receive does not reflect the exclusion. Report your total distributions on Form 1040, line 16a; Form 1040A, line 12a; or Form 1040NR, line 17a. Report the taxable amount on Form 1040, line 16b; Form 1040A, line 12b; or Form 1040NR, line 17b. Enter “PSO” next to the appropriate line on which you report the taxable amount.
Benefits paid under the Railroad Retirement Act fall into two categories. These categories are treated differently for income tax purposes.
Military retirement pay based on age or length of service is taxable and must be included in income as a pension on Form 1040, lines 16a and 16b; on Form 1040A, lines 12a and 12b; or on Form 1040NR, lines 17a and 17b. But, certain military and government disability pensions that are based on a percentage of disability from active service in the Armed Forces of any country generally are not taxable. For more information, including information about veterans' benefits and insurance, see Publication 525.
This discussion explains the federal income tax rules for social security benefits and equivalent tier 1 railroad retirement benefits.
Social security benefits include monthly retirement, survivor, and disability benefits. They do not include supplemental security income (SSI) payments, which are not taxable.
Equivalent tier 1 railroad retirement benefits are the part of tier 1 benefits that a railroad employee or beneficiary would have been entitled to receive under the social security system. They commonly are called the social security equivalent benefit (SSEB) portion of tier 1 benefits.
If you received these benefits during 2012, you should have received a Form SSA-1099 or Form RRB-1099 (Form SSA-1042S or Form RRB-1042S if you are a nonresident alien), showing the amount of the benefits.
When the term “benefits” is used in this section, it applies to both social security benefits and the SSEB portion of tier 1 railroad retirement benefits.
To find out whether any of your benefits may be taxable, compare the base amount for your filing status (explained later) with the total of:
One-half of your benefits, plus
All your other income, including tax-exempt interest.
When making this comparison, do not reduce your other income by any exclusions for:
Interest from qualified U.S. savings bonds,
Employer-provided adoption benefits,
Foreign earned income or foreign housing,
Income earned in American Samoa or Puerto Rico by bona fide residents,
Deductions for domestic production activities, or
Interest paid on student loans, or
Qualified education tuition and fees.
If you are married and file a joint return for 2012, you and your spouse must combine your incomes and your benefits to figure whether any of your combined benefits are taxable. Even if your spouse did not receive any benefits, you must add your spouse's income to yours to figure whether any of your benefits are taxable.
|A.||Enter the amount from box 5 of all your Forms SSA-1099 and RRB-1099. Include
the full amount of any lump-sum benefit payments received in 2012, for 2012 and
earlier years. (If you received more than one form, combine the amounts from box 5
and enter the total.)
|Note. If the amount on line A is zero or less, stop here; none of your benefits are
taxable this year.
|B.||Enter one-half of the amount on line A||B.|
|C.||Enter your taxable pensions, wages, interest, dividends, and other taxable income||C.|
|D.||Enter any tax-exempt interest income (such as interest on municipal bonds) plus any exclusions from income for:
•Interest from qualified U.S. savings bonds,
•Employer-provided adoption benefits,
•Foreign earned income or foreign housing,
•Income earned in American Samoa or Puerto Rico by bona fide residents,
• Deductions for domestic production activities, or
• Interest paid on student loans
• Qualified education tuition and fees
|E.||Add lines B, C, and D and enter the total||E.|
|F.||If you are:
•Married filing jointly, enter $32,000
•Single, head of household, qualifying widow(er), or married filing separately and you
lived apart from your spouse for all of 2012, enter $25,000
•Married filing separately and you lived with your spouse at any time during 2012,
|G.||Is the amount on line F less than or equal to the amount on line E?
□ No.None of your benefits are taxable this year.
□ Yes.Some of your benefits may be taxable. To figure how much of your benefits
are taxable, see Which worksheet to use under How Much Is Taxable, above.
Your base amount is:
$25,000 if you are single, head of household, or qualifying widow(er) with dependent child,
$25,000 if you are married filing separately and lived apart from your spouse for all of 2012,
$32,000 if you are married filing jointly, or
$0 if you are married filing separately and lived with your spouse at any time during 2012.
Any repayment of benefits you made during 2012 must be subtracted from the gross benefits you received in 2012. It does not matter whether the repayment was for a benefit you received in 2012 or in an earlier year. If you repaid more than the gross benefits you received in 2012, see Repayments More Than Gross Benefits , later.
Your gross benefits are shown in box 3 of Form SSA-1099 or Form RRB-1099. Your repayments are shown in box 4. The amount in box 5 shows your net benefits for 2012 (box 3 minus box 4). Use the amount in box 5 to figure whether any of your benefits are taxable.
You can choose to have federal income tax withheld from your social security and/or the SSEB portion of your tier 1 railroad retirement benefits. If you choose to do this, you must complete a Form W-4V, Voluntary Withholding Request. You can choose withholding at 7%, 10%, 15%, or 25% of your total benefit payment.
If you do not choose to have income tax withheld, you may have to request additional withholding from other income, or pay estimated tax during the year. For details, see Publication 505, Tax Withholding and Estimated Tax, or the instructions for Form 1040-ES, Estimated Tax for Individuals.
If part of your benefits is taxable, how much is taxable depends on the total amount of your benefits and other income. Generally, the higher that total amount, the greater the taxable part of your benefits.
The total of one-half of your benefits and all your other income is more than $34,000 ($44,000 if you are married filing jointly).
You are married filing separately and lived with your spouse at any time during 2012.
You contributed to a traditional individual retirement arrangement (IRA) and you or your spouse were covered by a retirement plan at work. In this situation, you must use the special worksheets in Appendix B of Publication 590 to figure both your IRA deduction and your taxable benefits.
Situation (1) does not apply and you take one or more of the following exclusions:
Interest from qualified U.S. savings bonds (Form 8815),
Employer-provided adoption benefits (Form 8839),
Foreign earned income or housing (Form 2555 or Form 2555-EZ),
Income earned in American Samoa (Form 4563) or Puerto Rico by bona fide residents,
Deductions for domestic production activities, or
Interest paid on student loans.
Qualified education tuition and fees.
In these situations, you must use Worksheet 1 in Publication 915, Social Security and Equivalent Railroad Retirement Benefits, to figure your taxable benefits.
You received a lump-sum payment for an earlier year. In this situation, also complete Worksheet 2 or 3 and Worksheet 4 in Publication 915. See Lump-Sum Election , later.
If part of your benefits are taxable, you must use Form 1040, Form 1040A, or Form 1040NR. You cannot use Form 1040EZ.
You must include the taxable part of a lump-sum (retroactive) payment of benefits received in 2012 in your 2012 income, even if the payment includes benefits for an earlier year.
Generally, you use your 2012 income to figure the taxable part of the total benefits received in 2012. However, you may be able to figure the taxable part of a lump-sum payment for an earlier year separately, using your income for the earlier year. You can elect this method if it lowers your taxable benefits. See Publication 915 for more information.
In some situations, your Form SSA-1099 or Form RRB-1099 will show that the total benefits you repaid (box 4) are more than the gross benefits (box 3) you received. If this occurred, your net benefits in box 5 will be a negative figure (a figure in parentheses) and none of your benefits will be taxable. If you receive more than one form, a negative figure in box 5 of one form is used to offset a positive figure in box 5 of another form for that same year.
If you have any questions about this negative figure, contact your local Social Security Administration office or your local U.S. Railroad Retirement Board field office.
Generally, 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. Some of these payments are discussed later in this section. Also, see Military and Government Disability Pensions and Other Sickness and Injury Benefits in Publication 525.
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 or on line 8 of Form 1040NR 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, on lines 12a and 12b of Form 1040A, or on lines 17a and 17b of Form 1040NR. For more information on pensions and annuities, see Publication 575.
Long-term care insurance contracts generally are treated as accident and health insurance contracts. Amounts you receive from them (other than policyholder dividends or premium refunds) generally are excludable from income as amounts received for personal injury or sickness. However, the amount you can exclude may be limited. Long-term care insurance contracts are discussed in more detail in Publication 525.
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.
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, for your permanent disfigurement, or for such loss or disfigurement suffered by your spouse or dependent(s). 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.
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.
An endowment contract is a policy that pays over to you 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 from the total premiums (or other consideration) paid for the contract any amount that you previously received under the contract and excluded from your income. Include in your income the part of the lump-sum payment that is more than your cost.
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. The tax treatment of an annuity 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 generally excluded from income if the insured is terminally or chronically ill. However, see Exception , later. For a chronically ill individual, accelerated death benefits paid on the basis of costs incurred for qualified long-term care services are fully excludable. Accelerated death benefits paid on a per diem or other periodic basis without regard to the costs are excludable up to a limit.
In addition, if any portion of a death benefit under a life insurance contract on the life of a terminally or chronically ill individual is sold or assigned to a viatical settlement provider, the amount received also is excluded from income. Generally, a viatical settlement provider is one who regularly engages in the business of buying or taking assignment of life insurance contracts on the lives of insured individuals who are terminally or chronically ill.
The person is unable to perform (without substantial help) at least two activities of daily living (eating, toileting, transferring, bathing, dressing, and continence) for a period of 90 days or more because of a loss of functional capacity.
The person requires substantial supervision to protect himself or herself from threats to health and safety due to severe cognitive impairment.
Is a director, officer, or employee of the other person, or
Has a financial interest in the business of the other person.
You may be able to exclude from income any gain up to $250,000 ($500,000 on a joint return in most cases) on the sale of your main home. Generally, if you can exclude all of the gain, you do not need to report the sale on your tax return. You can choose not to take the exclusion by including the gain from the sale in your gross income on your tax return for the year of the sale.
Cooperative apartment, or
You can generally exclude up to $250,000 of the gain on the sale of your main home if all of the following are true.
You meet the ownership test.
You meet the use test.
During the 2-year period ending on the date of the sale, you did not exclude gain from the sale of another home.
You may be able to exclude up to $500,000 of the gain on the sale of your main home if you are married and file a joint return and meet the requirements listed in the discussion of the special rules for joint returns, later, under Married Persons .
To claim the exclusion, you must meet the ownership and use tests. This means that during the 5-year period ending on the date of the sale, you must have:
Owned the home for at least 2 years (the ownership test), and
Lived in the home as your main home for at least 2 years (the use test).
You become physically or mentally unable to care for yourself, and
You owned and lived in your home as your main home for a total of at least 1 year.
In the special situations discussed below, if you and your spouse file a joint return for the year of sale and one spouse meets the ownership and use test, you can exclude up to $250,000 of gain. However, see Special rules for joint returns , next.
You are married and file a joint return for the year.
Either you or your spouse meets the ownership test.
Both you and your spouse meet the use test.
During the 2-year period ending on the date of the sale, neither you nor your spouse exclude gain from the sale of another home.
The sale or exchange took place no more than 2 years after the date of death of your spouse.
You have not remarried.
You and your spouse met the use test at the time of your spouse's death.
You or your spouse met the ownership test at the time of your spouse's death.
Neither you nor your spouse excluded gain from the sale of another home during the last 2 years.
You may be able to exclude gain from the sale of a home that you have used for business or to produce rental income. However, you must meet the ownership and use tests. See Publication 523 for more information.
Do not report the 2012 sale of your main home on your tax return unless:
You have a gain and you do not qualify to exclude all of it,
You have a gain and you choose not to exclude it, or
You have a loss and you received Form 1099-S.
If you have any taxable gain on the sale of your main home that cannot be excluded, report the entire gain on Schedule D (Form 1040). If you used your home for business or to produce rental income, you may have to use Form 4797, Sales of Business Property, to report the sale of the business or rental part. See Publication 523 for more information.
A reverse mortgage is a loan where the lender pays you (in a lump sum, a monthly advance, a line of credit, or a combination of all three) while you continue to live in your home. With a reverse mortgage, you retain title to your home. Depending on the plan, your reverse mortgage becomes due with interest when you move, sell your home, reach the end of a pre-selected loan period, or die. Because reverse mortgages are considered loan advances and not income, the amount you receive is not taxable. Any interest (including original interest discount) accrued on a reverse mortgage is not deductible until you actually pay it, which is usually when you pay off the loan in full. Your deduction may be limited because a reverse mortgage loan generally is subject to the limit on home equity debt discussed in Publication 936, Home Mortgage Interest Deduction.
The following items generally are excluded from taxable income. You should not report them on your return, unless otherwise indicated as taxable or includable in income.
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