]>
1710311GYour Federal
Income TaxFor IndividualsWhat's New for 2005What's new
This section summarizes important tax changes that took effect in 2005. Most of these changes are discussed in more detail throughout this
publication.
Changes are also discussed in Publication 553, Highlights of 2005 Tax Changes.
Katrina Emergency Tax Relief Act of 2005.
This Act provides tax relief for persons affected by Hurricane Katrina. The provisions of the Act are explained in Publication 4492.
At the time this publication went to print, Congress was considering legislation that would provide additional tax relief for individuals affected
by Hurricanes Katrina, Rita, and Wilma. For more details, and to find out if this legislation was enacted, see Pub. 4492.
Telefile no longer available.
You no longer can use Telefile to file your tax return. There are other IRS e-file options you can use. See chapter 1.
Automatic six month extension to file tax return.
You can now use Form 4868, Application for Automatic Extension of Time To File U.S. Individual Income Tax Return, to obtain an automatic 6-month
extension of time to file your tax return. See chapter 1.
New definition of a qualifying child.
A new definition of a qualifying child applies for each of the following tax benefits.
Head of household filing status. See chapter 2.
Dependency exemption. See chapter 3.
Child and dependent care credit. See chapter 32.
Child tax credit. See chapter 34.
Earned income credit (EIC). See chapter 36.
Standard mileage rates.What's new:Standard mileage ratesMileage ratesStandard mileage ratesStandard mileage rates:2005 ratesTravel and transportation expensesMileage ratesStandard mileage rates
The standard mileage rate for the cost of operating your car increased to 40.5 cents a mile for all business miles driven before September 1, 2005.
For business miles driven after August 31, 2005, the rate increased to 48.5 cents a mile. See chapter 26.
The standard mileage rate allowed for use of your car for medical reasons increased to 15 cents for miles driven before September 1, 2005, and to
22 cents for miles driven after August 31, 2005. See chapter 21.
What's new:Medical and dental expensesStandard mileage
The standard mileage rate allowed for use of your car for determining moving expenses increased to 15 cents for miles driven before September 1,
2005, and to 22 cents for miles driven after August 31, 2005. See Publication 521.
What's new:Moving expensesStandard mileageMoving expenses:Standard mileage rates
The following paragraphs highlight changes that affect individual retirement arrangements (IRAs) and pension plans.
Traditional IRA income limits. If you have a traditional IRA and are covered by a retirement plan at work, the amount of income you can
have and not be affected by the deduction phaseout increases. The amounts vary depending on filing status. See chapter 17.
Limit on elective deferrals.What's new:Elective deferral amountsPensions:Contributions:Elective deferral amountsRetirement plans:Contributions:Elective deferral amountsSIMPLE plans:Contribution limitsThe maximum amount of elective deferrals under a salary reduction agreement that could be contributed to
a qualified plan increased to $14,000 ($18,000 if you were age 50 or older). However, for SIMPLE plans, the amount increased to $10,000 ($12,000 if
you were age 50 or older).
IRA deduction expanded. The amount you, and your spouse if filing jointly, may be able to deduct as an IRA contribution will increase to
$4,000 ($4,500 if age 50 or older at the end of 2005). See chapter 17.
Contributions.Cars Travel and transportationDonations ofBoats, donations ofAirplanes, donations ofPlanes:AirplanesForm:1098-CIntellectual property, donations ofPatents, donations of
If you donate a car, boat, or airplane or a patent or other intellectual property to a qualified organization, your deduction may be limited. See
chapter 24.
Domestic production activities deduction.
There is a new deduction for domestic production activities. This deduction can be passed to you from a business. For more information, see Form
8903.
Disaster mitigation payments.
You may be able to exclude from income grants you use to mitigate (reduce the severity of) potential damage from future natural disasters that is
paid to you through state and local governments. If you reported income from qualified disaster mitigation payments in previous years, you may be able
to file a claim for refund. See chapter 12.
Certain amounts increased.
Some tax items that are indexed for inflation increased for 2005.
Earned income credit (EIC).What's new:Earned Income CreditEarned Income Credit:2005 changesThe maximum amount of income you can earn and still get EIC increased. The amount depends on your filing status
and number of children. The maximum amount of investment income you can have and still be eligible for the credit has increased to $2,700. See chapter
36.
Earned Income Credit:Amount of earned incomeEarned Income Credit:Investment income, limit on
Standard deduction.What's new:Standard deductionStandard deduction:2005 changes The standard deduction for taxpayers who do not itemize deductions on Schedule A (Form 1040) has increased.
The amount depends on your filing status. See chapter 20.
Exemption amount.What's new:Exemption amountExemption amount:2005 changesYou are allowed a $3,200 deduction for each exemption to which you are entitled. However, your exemption amount
could be phased out if you have high income. See chapter 3.
Limit on itemized deduction.What's new:Limit on itemized deductionLimit on itemized deduction:2005 changes Some of your itemized deductions may be limited if your adjusted gross income is more than $145,950 ($72,975
if you are married filing separately). See chapter 29.
Tax benefits for adoption.What's new:Adoption benefitsAdoption:Employer's assistance program The adoption credit and the maximum exclusion from income of benefits under an employer's
adoption assistance program are increased to $10,630. See Adoption Credit in chapter 37.
Hope or lifetime learning credit income limits increased.What's new:Hope creditLifetime learning creditEducation credits:Hope credit; Lifetime learning credit The amount of income you can have and still receive a Hope or lifetime learning credit has
increased. See chapter 37.
Social security and Medicare taxes.What's new:Social security and Medicare taxesSocial security and Medicare taxes:2005 changes The maximum wages subject to social security tax (6.2%) increased to $90,000. All wages are subject to
Medicare tax (1.45%).
Mailing your return.Mailing returnsTax returnsTax returns:Mailing of
If you are filing a paper return, you may be mailing your return to a different address because the IRS has changed the filing location for several
areas. If you received an envelope with your tax package, please use it. Otherwise, see Where to File near the end of this publication for
a list of IRS addresses.
What's New for 2006
This section summarizes the important changes that take effect in 2006 that could affect your estimated tax payments for 2006. More information on
these and other changes can be found in Publication 553.
What's newEnergy credits.What's new:Tax credits for energy efficiency
You may be able to claim a new tax credit for the purchase of qualified energy efficiency improvements to your existing home. You may be able to
claim a tax credit for the purchase of residential solar water heating, photovoltaic equipment, or fuel cell property.
Retirement savings plans.
The following paragraphs highlight changes that affect individual retirement arrangements (IRAs) and pension plans.
Individual retirement arrangements (IRAs):Employer retirement plan participants
Traditional IRA income limits. If you have a traditional IRA, are covered by a retirement plan at work, and are married filing jointly
or a qualifying widow(er), the amount of income you can have and not be affected by the deduction phaseout increases. The amounts for other filing
statuses are not changed.
Limit on elective deferrals.Pensions:Contributions:Elective deferral amountsRetirement plans:Contributions:Elective deferral amountsSIMPLE plans:Contribution limitsThe maximum amount of elective deferrals under a salary reduction agreement that can be contributed to a
qualified plan increases to $15,000 ($20,000 if you are age 50 or older). However, for SIMPLE plans, the amount is $10,000 ($12,500 if you are age 50
or older).
IRA catch-up contribution. The catch-up contribution for persons age 50 or older at the end of 2006 is increased to $1,000. The maximum
contribution for such person is $5,000.
Alternative minimum tax (AMT).
The AMT exemption amount will decrease. The amount depends on your filing status.
Phaseouts reduced.
Personal exemptions. The phaseout of the limitation on personal exemptions will be reduced by 1/3.
Itemized deductions. The phaseout of the limitation on itemized deductions will be reduced by 1/3.
Alternative technology vehicles.What's new:Alternative technology vehicle credit
You may be able to take a credit if you place an alternative technology vehicle in service during the year. See chapter 37. You no longer can take
a deduction for clean-fuel vehicles.
Reminders
Listed below are important reminders and other items that may help you file your 2005 tax return. Many of these items are explained in more detail
later in this publication.
Write in your social security number.Labels:Social Security Number to be written onSocial Security Numbers (SSNs):Label, number need to be written in
To protect your privacy, social security numbers (SSNs) are not printed on the peel-off label that comes in the mail with your tax instruction
booklet. This means you must enter your SSN in the space provided on your tax form. If you filed a joint return for 2004 and are filing a joint return
for 2005 with the same spouse, enter your names and SSNs in the same order as on your 2004 return. See chapter 1.
Victim of identity theft. If you believe someone has assumed your identity to file federal income tax returns, or to commit other tax
fraud, call 1-800-829-0433. Victims of identity theft who are having trouble filing their returns should call the IRS Taxpayer Advocates Office at
1-877-777-4778. You should also know that the IRS does not initiate communication with taxpayers through email. If you do receive this type of
request, it may be an attempt by identity thieves to get your private tax information.
You must provide the taxpayer identification number for each person for whom you claim certain tax benefits. This applies even if the person was
born in 2005. Generally, this number is the person's social security number (SSN). See chapter 1.
Foreign source income.Foreign income:Reporting of
If you are a U.S. citizen with income from sources outside the United States (foreign income), you must report all such income on your tax return
unless it is exempt by U.S. law. This is true whether you reside inside or outside the United States and whether or not you receive a Form W-2 or 1099
from the foreign payer. This applies to earned income (such as wages and tips) as well as unearned income (such as interest, dividends, capital gains,
pensions, rents and royalties).
Citizens outside U.S.:Earned income exclusionExclusions from gross income:Foreign earned incomeForeign income:Earned income exclusionIf you reside outside the United States, you may be able to exclude part or all of your foreign
source earned income. For details, see Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad.
Earned income credit.
You can choose to include combat pay in your earned income for purposes of computing this credit. If you are married, each of you can make this
election separately.
Form 8836.Form:8836 If you received Form 8836, Qualifying Children Residency Statement, you have been selected to participate in the EIC
certification program. See chapter 36.
Advance earned income credit.Advance earned income creditEarned Income Credit:Advance
If a qualifying child lives with you and you expect to qualify for the earned income credit in 2006, you may be able to get part of the credit paid
to you in advance throughout the year (by your employer) instead of waiting until you file your tax return. See chapter 36.
Sales tax deduction.
You can choose to deduct state and local general sales taxes instead of state and local income taxes as an itemized deduction on Form 1040,
Schedule A. See chapter 22.
If your taxable income is $100,000 or more, figure your tax using the Tax Computation Worksheet. The Tax Computation Worksheet is found near the
end of this publication immediately following the Tax Rate Schedules. (The Tax Rate Schedules are shown so you can see the tax rate that applies to
all levels of taxable income. Do not use the Tax Rate Schedules to figure your tax.)
Generally, both spouses are responsible for the tax and any interest or penalties on a joint tax return. In some cases, one spouse may be relieved
of that responsibility for items of the other spouse that were incorrectly reported on the joint return. See chapter 2.
Include your phone number on your return.Tax returns:Phone number to be includedTelephones:Tax return to include phone number
To promptly resolve any questions we have in processing your tax return, we would like to be able to call you. Please enter your daytime telephone
number on your tax form next to your signature.
Third party designee.Tax returns:Third party designeeThird parties:Designee for IRS to discuss return with
You can check the Yes box in the Third Party Designee area of your return to authorize the IRS to discuss your return with a friend,
family member, or any other person you choose. This allows the IRS to call the person you identified as your designee to answer any questions that may
arise during the processing of your return. It also allows your designee to perform certain actions. See chapter 1.
Payment of taxes.Payment of tax
Credit cards:Payment of taxesElectronic payment optionsPayment of tax:By check or money orderPayment of tax:By credit cardPayment of tax:Payable to "United States Treasury"Make your check or money order payable to United States Treasury. You can pay
your taxes by credit card, using the Electronic Federal Tax Payment System (EFTPS), or, if you file electronically, by electronic funds withdrawal.
See chapter 1.
Faster ways to file your return.
The IRS offers fast, accurate ways to file your tax return information without filing a paper tax return. You can use IRS e-file
(electronic filing). See chapter 1.
Free electronic filing.E-file
You may be able to file your 2005 taxes online for free thanks to an electronic filing agreement. See chapter 1.
Change of address.
If you change your address, you should notify the IRS. See Change of Address, under What Happens After I File, in chapter 1.
You may be able to use a designated private delivery service to mail your tax returns and payments. See chapter 1.
Refund on a late filed return.Late filingTax refunds:Late filed returns
If you were due a refund but you did not file a return, you generally must file your return within 3 years from the date the return was due
(including extensions) to get that refund. See chapter 1.
Privacy Act and paperwork reduction information.Confidential information:Privacy Act and paperwork reduction informationPaperwork Reduction Act of 1980Privacy Act and paperwork reduction information
Declaration of rights of taxpayers:IRS request for informationThe IRS Restructuring and Reform Act of 1998, the Privacy Act of 1974, and the Paperwork
Reduction Act of 1980 require that when we ask you for information we must first tell you what our legal right is to ask for the information, why we
are asking for it, how it will be used, what could happen if we do not receive it, and whether your response is voluntary, required to obtain a
benefit, or mandatory under the law. A complete statement on this subject can be found in your tax form instruction booklet.
Customer service for taxpayers expanded.Assistance, taxTax helpHelpTax helpTax help
Taxpayer Assistance CenterThe Internal Revenue Service has expanded customer service for taxpayers. Through the agency's
Everyday Tax Solutions service, you can set up a personal appointment at the most convenient Taxpayer Assistance Center, on the most convenient
business day. See How To Get Tax Help in the back of this publication.
Treasury Inspector General for Tax Administration.Fraud:Reporting anonymously to IRSInternal Revenue Service (IRS):Fraud or misconduct of employee, reporting anonymouslyTreasury Inspector General:Telephone number to report anonymously fraud or misconduct of IRS employee
Telephones:Fraud or misconduct of IRS employee, number for reporting anonymouslyIf you want to confidentially report misconduct,
waste, fraud, or abuse by an IRS employee, you can call 1-800-366-4484 (1-800-877- 8339 for TTY/TDD users). You can remain anonymous.
Photographs of missing children.Missing children:Photographs of, included in IRS publications
The Internal Revenue Service is a proud partner with the National Center for Missing and Exploited Children. Photographs of missing children
selected by the Center may appear in this publication on pages that would otherwise be blank. You can help bring these children home by looking at the
photographs and calling 1-800-THE-LOST (1-800-843-5678) if you recognize a child.
This publication covers the general rules for filing a federal income tax return. It supplements the information contained in your tax form
instruction booklet. It explains the tax law to make sure you pay only the tax you owe and no more.
How this publication is arranged.
This publication closely follows Form 1040, U.S. Individual Income Tax Return. It is divided into six parts which cover different sections of Form
1040. Each part is further divided into chapters which generally discuss one line of the form. Do not worry if you file Form 1040A or Form 1040EZ.
Anything included on a line of either of these forms is also included on Form 1040.
The table of contents inside the front cover and the index in the back of the publication are useful tools to help you find the information you
need.
What is in this publication.
The publication begins with the rules for filing a tax return. It explains:
Who must file a return,
Which tax form to use,
When the return is due,
How to e-file your return, and
Other general information.
It will help you identify which filing status you qualify for, whether you can claim any dependents, and whether the income you receive is
taxable. The publication goes on to explain the standard deduction, the kinds of expenses you may be able to deduct, and the various kinds of credits
you may be able to take to reduce your tax.
Throughout the publication are examples showing how the tax law applies in typical situations. Sample forms and schedules show you how to report
certain items on your return. Also throughout the publication are flowcharts and tables that present tax information in an easy-to-understand manner.
Many of the subjects discussed in this publication are discussed in greater detail in other IRS publications. References to those other
publications are provided for your information.
Icons.Icons, use of
Small graphic symbols, or icons, are used to draw your attention to special information. See Table 1, Legend of Icons, below, for an explanation of
each icon used in this publication.
What is not covered in this publication.
Some material that you may find helpful is not included in this publication but can be found in your tax form instruction booklet. This includes
lists of:
Where to report certain items shown on information documents, and
Recorded tax information topics (TeleTax).
If you operate your own business or have other self-employment income, such as from babysitting or selling crafts, see the following publications
for more information.
Publication 334, Tax Guide for Small Business (For Individuals Who Use Schedule C or C-EZ).
Publication 535, Business Expenses.
Publication 587, Business Use of Your Home (Including Use by Daycare Providers).
Help from the IRS.Tax help
There are many ways you can get help from the IRS. These are explained under How To Get Tax Help in the back of this publication.
Comments and suggestions.Comments on publicationSuggestions for publication
We welcome your comments about this publication and your suggestions for future editions.
You can write to us at the following address:
Internal Revenue Service
Individual Forms and Publications Branch
SE:W:CAR:MP:T:I
1111 Constitution Ave. NW IR-6406
Washington, DC 20224
We respond to many letters by telephone. Therefore, it would be helpful if you would include your daytime phone number, including the area code, in
your correspondence.
You can email us at
*taxforms@irs.gov. (The asterisk must be included in the
address.) Please put Publications Comment on the subject line. Although we cannot respond individually to each email, we do appreciate your
feedback and will consider your comments as we revise our tax products.
Tax questions.
If you have a tax question, visit
www.irs.gov or call 1-800-829-1040. We cannot answer tax questions at either
of the addresses listed above.
Ordering forms and publications.
Visit
www.irs.gov/formspubs to download forms and publications, call 1-800-829-3676, or write to the National Distribution Center at the
address shown under How To Get Tax Help in the back of this publication.
IRS mission.Internal Revenue Service (IRS):Mission of
Provide America's taxpayers top quality service by helping them understand and meet their tax responsibilities and by applying the tax law with
integrity and fairness to all.
Icons, use of
<ROM>Table 1.</ROM> Legend of IconsIconExplanationItems that may cause you particular problems, or an alert about pending legislation that may be enacted after this publication
goes to print.An Internet site or an email address.An address you may need.Items you should keep in your personal records.Items you may need to figure or a worksheet you may need to complete.An important phone number.Helpful information you may need.
The Income Tax Return
The four chapters in this part provide basic information on the tax system. They take you through the first steps of filling out a tax
return— such as deciding what your filing status is, how many exemptions you can take, and what form to file. They also discuss recordkeeping
requirements, IRS e-file (electronic filing), certain penalties, and the two methods used to pay tax during the year: withholding and
estimated tax.
Filing InformationTax returns:Filing ofFiling requirementsFiling requirementsWhat's NewFiling requirements:Who must fileReturns, taxTax returnsTax returns:Who must fileWho must file.
Generally, the amount of income you can receive before you must file a return has been increased. See Table 1-1, Table 1-2, and Table 1-3 for the
specific amounts.
Telefile no longer available.
You can no longer use Telefile to file your tax return. There are other IRS e-file options that you can use.
Automatic 6-month extension.
You can now use Form 4868, Application for Automatic Extension of Time To File U.S. Individual Income Tax Return, to obtain an automatic 6-month
extension to file your tax return.
Mailing your return.Filing requirements:Where to fileFormsTax returnsPlace for filingTax returns:Filing of
You may be mailing your return to a different address this year because the IRS has changed the filing location for several areas. If you received
an envelope with your tax package, please use it. Otherwise, see Where Do I File, later in this chapter.
Rather than filing a return on paper, you may be able to file electronically using IRS e-file. Create your own personal identification
number (PIN) and file a completely paperless tax return. For more information, see Does My Return Have To Be on Paper, later.
Change of address.
If you change your address, you should notify the IRS. See Change of Address, later, under What Happens After I File. If you
were affected by Hurricane Katrina or Rita, you may be able to verbally change your address.
Enter your social security number.
You must enter your social security number (SSN) in the spaces provided on your tax return. If you file a joint return, enter the SSNs in the same
order as the names.
Direct deposit of refund.
Instead of getting a paper check, you may be able to have your refund deposited directly into your account at a bank or other financial
institution. See Direct Deposit under Refunds, later.
Alternative payment methods.
If you owe additional tax, you may be able to pay electronically. See How To Pay, later.
Installment agreement.
If you cannot pay the full amount due with your return, you may ask to make monthly installment payments. See Installment Agreement,
later, under Amount You Owe.
Service in combat zone.
You are allowed extra time to take care of your tax matters if you are a member of the Armed Forces who served in a combat zone, or if you served
in the combat zone in support of the Armed Forces. See Individuals Serving in Combat Zone, later, under When Do I Have To File.
Adoption taxpayer identification number.
If a child has been placed in your home for purposes of legal adoption and you will not be able to get a social security number for the child in
time to file your return, you may be able to get an adoption taxpayer identification number (ATIN). For more information, see Social Security
Number, later.
Taxpayer identification number for aliens.
If you or your dependent is a nonresident or resident alien who does not have and is not eligible to get a social security number, file Form W-7,
Application for IRS Individual Taxpayer Identification Number, with the IRS. For more information, see Social Security Number, later.
This chapter discusses:
Whether you have to file a return,
Which form to use,
How to file electronically,
When, how, and where to file your return,
What happens if you pay too little or too much tax,
What records you should keep and how long you should keep them, and
How you can change a return you have already filed.
Do I Have To
File a Return?Filing requirements:Who must fileReturns, taxTax returnsTax returns:Who must file
You must file a federal income tax return if you are a citizen or resident of the United States or a resident of Puerto Rico and you meet the
filing requirements for any of the following categories that apply to you.
Individuals in general. (There are special rules for surviving spouses, executors, administrators, legal representatives, U.S. citizens and
residents living outside the United States, residents of Puerto Rico, and individuals with income from U.S. possessions.)
Dependents.
Children under age 14.
Self-employed persons.
Aliens.
The filing requirements for each category are explained in this chapter.
The filing requirements apply even if you do not owe tax.
Even if you do not have to file a return, it may be to your advantage to do so. See Who Should File, later.
File only one federal income tax return for the year regardless of how many jobs you had, how many Forms W-2 you received, or how many states you
lived in during the year.
If you are a U.S. citizen or resident, whether you must file a return depends on three factors:
Your gross income,
Your filing status, and
Your age.
To find out whether you must file, see Table 1-1, Table 1-2, and Table 1-3. Even if no table shows that you must file, you may need to file to get
money back. (See Who Should File, later.)
Gross income.Gross income:Defined
This includes all income you receive in the form of money, goods, property, and services that is not exempt from tax. It also includes income from
sources outside the United States (even if you may exclude all or part of it). Common types of income are discussed in Part Two of this
publication.
Community income.Community property
If you are married and your permanent home is in a community property state, half of any income described by state law as community income may be
considered yours. This affects your federal taxes, including whether you must file if you do not file a joint return with your spouse. See Publication
555, Community Property, for more information.
Self-employed individuals.Self-employed persons:Gross income
If you are self-employed, your gross income includes the amount on line 7 of Schedule C (Form 1040), Profit or Loss From Business, line 1 of
Schedule C-EZ, (Form 1040), Net Profit From Business, and line 11 of Schedule F (Form 1040), Profit or Loss From Farming. See Self-Employed
Persons, later, for more information about your filing requirements.
If you do not report all of your self-employment income, your social security benefits may be lower when you retire.
Your filing status depends on whether you are single or married and on your family situation. Your filing status is determined on the last day of
your tax year, which is December 31 for most taxpayers. See chapter 2 for an explanation of each filing status.
Age.Gross income:Age, higher filing threshold after 65
If you are 65 or older at the end of the year, you generally can have a higher amount of gross income than other taxpayers before you must file.
See Table 1-1. You are considered 65 on the day before your 65th birthday. For example, if your 65th birthday is on January 1, 2006, you are
considered 65 for 2005.
Table 1-1. 2005 Filing Requirements for Most Taxpayers
Age:Gross income and filing requirements (Table 1-1)Filing requirements:Gross income levels (Table 1-1)Filing requirements:Most taxpayers (Table 1-1)Gross income:Defined:Filing requirements (Table 1-1)Married taxpayers:Deceased spouseSurviving spouseMarried taxpayers:Filing statusSingle taxpayers:Gross income filing requirements (Table 1-1)Surviving spouse:Gross income filing requirements (Table 1-1)Tables and figures:Filing requirements:Gross income levels (Table 1-1)Unmarried personsSingle taxpayers
IF your filing status is... AND at the end of 2005 you
were...* THEN file a return if
your gross income
was at least...**single under 65$ 8,200 65 or older$ 9,450married filing jointly*** under 65 (both spouses)$16,400 65 or older (one spouse)$17,400 65 or older (both spouses)$18,400married filing separately any age$ 3,200head of household under 65$10,500 65 or older$11,750qualifying widow(er) with under 65$13,200dependent child 65 or older$14,200
*If you were born on January 1, 1941, you are considered to be age 65 at the end of 2005.**Gross income means all income you received in the form of money, goods, property, and services that is not exempt from tax, including any
income from sources outside the United States (even if you may exclude part or all of it). Do not include social security benefits unless
you are married filing a separate return and you lived with your spouse at any time during 2005. ***If you did not live with your spouse at the end of 2005 (or on the date your spouse died) and your gross income was at least $3,200, you must
file a return regardless of your age.
You must file a final return for a decedent (a person who died) if both of the following are true.
You are the surviving spouse, executor, administrator, or legal representative.
Administrators, estateExecutors and administratorsDecedentsExecutors and administratorsExecutors and administratorsFiduciariesExecutors and administrators
The decedent met the filing requirements at the date of death.
For more information on rules for filing a decedent's final return, see Publication 559, Survivors, Executors, and Administrators.
U.S. Citizens and Residents Living Outside the United StatesAmerican citizens abroadCitizens outside U.S.Citizens outside U.S.:Filing requirementsFiling requirements:Citizens outside U.S.
If you are a U.S. citizen or resident living outside the United States, you must file a return if you meet the filing requirements. For information
on special tax rules that may apply to you, get Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad. It is available at most U.S.
embassies and consulates. Also see How To Get Tax Help in the back of this publication.
Residents of Puerto RicoPuerto Rico:Residents of
Generally, if you are a U.S. citizen and a resident of Puerto Rico, you must file a U.S. income tax return if you meet the filing requirements.
This is in addition to any legal requirement you may have to file an income tax return for Puerto Rico.
If you are a resident of Puerto Rico for the entire year, gross income does not include income from sources within Puerto Rico, except for amounts
received as an employee of the United States or a U.S. agency. If you receive income from Puerto Rican sources that is not subject to U.S. tax, you
must reduce your standard deduction. As a result, the amount of income you must have before you are required to file a U.S. income tax return is lower
than the applicable amount in Table 1-1 or Table 1-2. For more information, see Publication 570, Tax Guide for Individuals With Income From U.S.
Possessions.
Individuals With Income From
U.S. PossessionsAmerican Samoa:Income fromGuam:Income fromNorthern Mariana Islands:Income fromU.S. possessions:Income fromVirgin Islands:Income from
If you had income from Guam, the Commonwealth of the Northern Mariana Islands, American Samoa, or the Virgin Islands, special rules may apply when
determining whether you must file a U.S. federal income tax return. In addition, you may have to file a return with the individual island government.
See Publication 570 for more information.
Dependents
If you are a dependent (one who meets the dependency tests in chapter 3), see Table 1-2 to find whether you must file a return. You also must file
if your situation is described in Table 1-3.
Responsibility of parent.
Generally, a child is responsible for filing his or her own tax return and for paying any tax on the return. But if a dependent child who must file
an income tax return cannot file it for any reason, such as age, then a parent, guardian, or other legally responsible person must file it for the
child. If the child cannot sign the return, the parent or guardian must sign the child's name followed by the words By (your signature), parent for
minor child.
Child's earnings.Children:Filing requirementsDependents:Filing requirementsFamilyDependentsFiling requirements:DependentsChildren:Earnings ofFamilyChildrenWages and salaries:Children's earnings
Amounts a child earns by performing services are his or her gross income. This is true even if under local law the child's parents have the right
to the earnings and may actually have received them. If the child does not pay the tax due on this income, the parent is liable for the tax.
Children Under Age 14AgeChildren's investmentsChildren, subheading: Investment income of child under age 14ChildrenDividends ofthis heading: Investment income of child under age 14Children:Investment income of child under age 14:Interest and dividendsChildrenDividends ofthis heading: Investment income of child under age 14Children:Investment income of child under age 14:Interest and dividendsChildren:Investment income of child under age 14:Parents' election to report on Form 1040
If a child's only income is interest and dividends (including capital gain distributions and Alaska Permanent Fund dividends) and certain other
conditions are met, a parent can elect to include the child's income on the parent's return. If this election is made, the child does not have to file
a return. See Parent's Election To Report Child's Interest and Dividends in chapter 31.
Carry on a trade or business as a sole proprietor,
Are an independent contractor,
Are a member of a partnership, or
Are in business for yourself in any other way.
Self-employment can include work in addition to your regular full-time business activities, such as certain part-time work you do at home or in
addition to your regular job.
Form:1040, Schedule SESchedules A–F, R, SE (Form 1040)Form 1040
You must file a return if your gross income is at least as much as the filing requirement amount for your filing status and age (shown in Table
1-1). Also, you must file Form 1040 and Schedule SE (Form 1040), Self-Employment Tax, if:
Your net earnings from self-employment (excluding church employee income) were $400 or more, or
You had church employee income of $108.28 or more. (See Table 1-3.)
Use Schedule SE (Form 1040) to figure your self-employment tax. Self-employment tax is comparable to the social security and Medicare tax withheld
from an employee's wages. For more information about this tax, get Publication 334, Tax Guide for Small Business.
Employees of foreign governments or international organizations.Abroad, citizens traveling or workingForeign employmentAmerican citizens abroadEmploymentForeign employmentCitizens outside U.S.EmploymentForeign employmentEmployeesOverseas employmentForeign employmentEmployersOverseas employmentForeign employmentForeign employmentInternational employmentForeign employmentOverseas workForeign employmentSelf-employed persons:Foreign government or international organizations, U.S. citizens employed by
If you are a U.S. citizen who works in the United States for an international organization, a foreign government, or a wholly owned instrumentality
of a foreign government, and your employer is not required to withhold social security and Medicare taxes from your wages, you must include your
earnings from services performed in the United States when figuring your net earnings from self-employment.
You must include income from services you performed as a minister when figuring your net earnings from self-employment, unless you have an
exemption from self-employment tax. This also applies to Christian Science practitioners and members of a religious order who have not taken a vow of
poverty. For more information, get Publication 517, Social Security and Other Information for Members of the Clergy and Religious Workers.
<ROM>Table 1-2.</ROM>
<IMARK>2005 Filing Requirements for DependentsSee chapter 3 to find out if someone can claim you as a dependent.If your parents (or someone else) can claim you as a dependent, and any of the situations below apply
to you, you must file a return. (See Table 1-3 for other situations when you must file.) In this table, earned income includes salaries, wages, tips, and professional fees. It also
includes taxable scholarship and fellowship grants. (See Scholarships and fellowships in chapter 12.) Unearned income includes
investment-type income such as taxable interest, ordinary dividends, and capital gain distributions. It also includes unemployment compensation,
taxable social security benefits, pensions, annuities, and distributions of unearned income from a trust. Gross income is the total of your earned and
unearned income.Single dependents—Were you either age 65 or older or blind?□No.You must file a return if any of the following apply.•Your unearned income was more than $800.•Your earned income was more than $5,000.•Your gross income was more than the larger of:•$800, or•Your earned income (up to $4,750) plus $250.□Yes.You must file a return if any of the following apply.•Your unearned income was more than $2,050 ($3,300 if 65 or older and blind).•Your earned income was more than $6,250 ($7,500 if 65 or older and blind).•Your gross income was more than $1,250 ($2,500 if 65 or older and blind)
plus the larger of:•$800, or•Your earned income (up to $4,750) plus $250.Married dependents—Were you either age 65 or older or blind?□No.You must file a return if any of the following apply.•Your unearned income was more than $800.•Your earned income was more than $5,000.•Your gross income was at least $5 and your spouse files a separate return and itemizes
deductions.•Your gross income was more than the larger of:•$800, or•Your earned income (up to $4,750) plus $250.□Yes.You must file a return if any of the following apply.•Your unearned income was more than $1,800 ($2,800 if 65 or older and blind).•Your earned income was more than $6,000 ($7,000 if 65 or older and blind).•Your gross income was at least $5 and your spouse files a separate return and itemizes
deductions.•Your gross income was more than $1,000 ($2,000 if 65 or older and blind)
plus the larger of:•$800, or•Your earned income (up to $4,750) plus $250.
Children:Filing requirements:As dependents (Table 1-2)Children:Investment income of child under age 14:Dependent filing requirements (Table 1-2)Dependents:Filing requirements:Earned income, unearned income, and gross income levels (Table 1-2)Earned income:Dependent filing requirements (Table 1-2)Filing requirements:DependentsGross income:Dependent filing requirements (Table 1-2)Tables and figures:Filing requirements:Dependents (Table 1-2)
AliensAliens:Filing requiredTax returns:Aliens
Your status as an alien—resident, nonresident, or dual-status—determines whether and how you must file an income tax return.
The rules used to determine your alien status are discussed in Publication 519, U.S. Tax Guide for Aliens.
If you are a resident alien for the entire year, you must file a tax return following the same rules that apply to U.S. citizens. Use the forms
discussed in this publication.
If you are a nonresident alien, the rules and tax forms that apply to you are different from those that apply to U.S. citizens and resident aliens.
See Publication 519 to find out if U.S. income tax laws apply to you and which forms you should file.
If you are a resident alien for part of the tax year and a nonresident alien for the rest of the year, you are a dual-status taxpayer. Different
rules apply for each part of the year. For information on dual-status taxpayers, see Publication 519.
Who Should FileFiling requirements:Who must fileTax returns:Who must file
Even if you do not have to file, you should file a federal income tax return to get money back if any of the following conditions apply.
You had federal income tax withheld from your pay. Tax refunds:WithholdingWithholding:Claim for refund
You qualify for the earned income credit. See chapter 36 for more information. CreditsEarned incomeEarned Income CreditEarned Income Credit:Filing claim
You qualify for the additional child tax credit. See chapter 34 for more information.
You qualify for the health coverage tax credit. See chapter 37 for more information.
Health coverage tax creditCreditsHealth coverage taxHealth coverage tax credit
Which Form
Should I Use?Returns, taxTax returnsTax returns:Forms to use
You must use one of three forms to file your return: Form 1040EZ, Form 1040A, or Form 1040. (But also see Does My Return Have To Be on
Paper, later.)
Form 1040EZForm:1040EZ:Use of
Form 1040EZ is the simplest form to use.
You can use Form 1040EZ if all of the following apply.
Your filing status is single or married filing jointly. If you were a nonresident alien at any time in 2005, your filing status must be
married filing jointly.
AliensNonresidentNonresident aliensJoint returns:Form 1040EZ, use ofMarried taxpayers:Form 1040EZ, use ofMarried taxpayersJoint returnsNonresident aliens:Form 1040EZ, use ofSingle taxpayers:Form 1040EZ, use ofTax returnsJoint returnsJoint Returns
You (and your spouse if married filing a joint return) were under age 65 and not blind at the end of 2005. If you were born on January 1,
1941, you are considered to be age 65 at the end of 2005.
Age:Form 1040EZ, taxpayer under 65 may use
You do not claim any dependents.
Your taxable income is less than $100,000.
Income:Taxable income less than $100,000
Your income is only from wages, salaries, tips, unemployment compensation, Alaska Permanent Fund dividends, taxable scholarship and
fellowship grants, and taxable interest of $1,500 or less.
Alaska Permanent Fund dividends:Income fromDividendsAlaska Permanent FundAlaska Permanent Fund dividendsEducational assistanceScholarshipsScholarships and fellowshipsFellowshipsScholarships and fellowshipsGrantsScholarships and fellowshipsInterest income:Reporting on Forms 1040, 1040A, or 1040EZ:Form 1040EZ filing thresholdSalariesWages and salariesScholarships and fellowshipsStudentsScholarshipsScholarships and fellowshipsUnemployment compensationWages and salaries:Income
You did not receive any advance earned income credit (EIC) payments.
Advance earned income creditCreditsEarned incomeEarned Income CreditEarned Income Credit:Advance
You do not claim any adjustments to income, such as a deduction for IRA contributions or student loan interest.
You do not claim any credits other than the earned income credit.
You do not owe any household employment taxes on wages you paid to a household employee.
You must meet all of these requirements to use Form 1040EZ. If you do not, you must use Form 1040A or Form 1040.
Figuring tax.
On Form 1040EZ, you can use only the tax table to figure your tax. You cannot use Form 1040EZ to report any other tax.
Form 1040AForm:1040A:Use of
If you do not qualify to use Form 1040EZ, you may be able to use Form 1040A.
You can use Form 1040A if all of the following apply.
Your income is only from wages, salaries, tips, IRA distributions, pensions and annuities, taxable social security and railroad retirement
benefits, taxable scholarship and fellowship grants, interest, ordinary dividends (including Alaska Permanent Fund dividends), capital gain
distributions, and unemployment compensation.
Alaska Permanent Fund dividends:Income fromCapital gains or losses:Form 1040 or 1040A to be usedDividends:Form 1040A, use ofEducational assistanceScholarshipsScholarships and fellowshipsFellowshipsScholarships and fellowshipsGains and lossesCapital gainsGrantsScholarships and fellowshipsInterest income:Reporting on Forms 1040, 1040A, or 1040EZRailroad retirement benefits:IncomeSalariesWages and salariesScholarships and fellowshipsSocial security benefits:IncomeStudentsScholarshipsScholarships and fellowshipsUnemployment compensationWages and salaries:Income
Your taxable income is less than $100,000.
Income:Taxable income less than $100,000
Your adjustments to income are for only the following items.
Educator expenses.
Deductions:Educator expensesEducation expenses:Teacher's out-of-pocket expensesEducator out-of-pocket expensesTeachers:Expenses, deduction of
IRA deduction.
DeductionsIRA contributionsIndividual retirement arrangements (IRAs)Individual retirement arrangements (IRAs):Deduction for
Colleges and universitiesEducation costsTuitionDeductionsTuition and feesTuitionEducation expensesTuitionEducational assistanceTuitionGraduate schoolTuition deductionTuitionStudentsTuition deductionTuitionTuition:Deduction for
You do not itemize your deductions.
Deductions:Not itemizing, use of Form 1040A
Your taxes are from only the following items.
Tax Table.
Alternative minimum tax. (See chapter 30.)
Alternative minimum tax (AMT):PaymentsAMTAlternative minimum tax (AMT)
Advance earned income credit (EIC) payments, if you received any. (See chapter 36.)
CreditsEarned incomeEarned Income Credit
Recapture of an education credit. (See chapter 35.)
Education credits:Recapture ofRecapture:Credits
Form 8615, Tax for Children Under Age 14 With Investment Income of More Than $1,600.
AgeChildren's investmentsChildren, subheading: Investment income of child under age 14ChildrenDividends ofthis heading: Investment income of child under age 14Children:Investment income of child under age 14:Interest and dividendsForm:8615:Form 1040A may be used when filing
Qualified Dividends and Capital Gain Tax Worksheet.
Capital gains or losses:Form 1040 or 1040A to be used
You claim only the following tax credits.
The credit for child and dependent care expenses. (See chapter 32.)
Child and dependent care creditChild careCreditChild and dependent care creditChildrenCredit forChild and dependent care creditCreditsChild and dependent careChild and dependent care creditDaycare centersChild and dependent care creditFamilyCare creditChild and dependent care creditNursery schoolsChild and dependent care credit
The credit for the elderly or the disabled. (See chapter 33.)
Disabilities, persons withCredit forElderly or disabled, credit forElderly or disabled, credit forElderly personsCredit forElderly or disabled, credit forHandicapped personsDisabilities, persons withMentally incompetent personsDisabilities, persons withMentally incompetent personsElderly or disabled, credit forPersons with disabilitiesDisabilities, persons with
You did not have an alternative minimum tax adjustment on stock you acquired from the exercise of an incentive stock option. (See
Publication 525, Taxable and Nontaxable Income.)Alternative minimum tax (AMT):Incentive stock optionAMTAlternative minimum tax (AMT)
You must meet all of the above requirements to use Form 1040A. If you do not, you must use Form 1040.
If you meet the above requirements, you can use Form 1040A even if you received employer-provided adoption benefits or dependent care benefits.
If you receive a capital gain distribution that includes unrecaptured section 1250 gain, section 1202 gain, or collectibles (28%) gain, you cannot
use Form 1040A. You must use Form 1040.
Form 1040Form:1040:Use of
If you cannot use Form 1040EZ or Form 1040A, you must use Form 1040. You can use Form 1040 to report all types of income, deductions, and credits.
You may have received Form 1040A or Form 1040EZ in the mail because of the return you filed last year. If your situation has changed this year, it
may be to your advantage to file Form 1040 instead. You may pay less tax by filing Form 1040 because you can take itemized deductions, some
adjustments to income, and credits you cannot take on Form 1040A or Form 1040EZ.
You must use Form 1040 if any of the following apply.
Your taxable income is $100,000 or more.
Income:Taxable income in excess of $100,000
You itemize your deductions.
DeductionsItemizingItemized deductionsItemized deductions:Form 1040 to be used
You had income that cannot be reported on Form 1040EZ or Form 1040A, including tax-exempt interest from private activity bonds issued after
August 7, 1986.
Interest income:Securities, Form 1040 to be used
You claim any adjustments to gross income other than the adjustments listed earlier under Form 1040A.
Gross income:Adjustments other than on Form 1040A, Form 1040 to be used
Your Form W-2, box 12, shows uncollected employee tax (social security and Medicare tax) on tips (see chapter 6) or group-term life
insurance (see chapter 5).
Employment:Taxes:Tip incomeGratuitiesTip incomeGroup-term life insurance:Uncollected social security/Medicare taxesLife insuranceGroup-term life insuranceMedicareSocial security and Medicare taxesSocial security benefits:Group-term life insurance, taxes owed onSocial security benefits:Tips, taxes owed onTip income:Social security and Medicare tax:Uncollected
You received $20 or more in tips in any one month and did not report all of them to your employer. (See chapter 6.)
Tip income:Reporting tips to employer:Failure to report to employer
You claim any credits other than the credits listed earlier under Form 1040A.
Credits:Other than those on Form 1040A, Form 1040 to be usedTax creditsCredits
You owe the excise tax on insider stock compensation from an expatriated corporation.
Your Form W-2 shows an amount in box 12 with a code Z.
You have to file other forms with your return to report certain exclusions, taxes, or transactions.
Form:Requiring Form 1040 to be used when filing
Table 1-3. Other Situations When You Must File a 2005 Return
If any of the four conditions listed below apply, you must file a return, even if your income is less than the
amount shown in Table 1-1 or Table 1-2.1.You owe any special taxes, such as:•
•
•
•
•
•
•
•
•
•
•
•
•Social security or Medicare tax on tips you did not report to your employer. (See chapter 6.)
Uncollected social security, Medicare, or railroad retirement tax on tips you reported to your employer. (See chapter 6.)
Uncollected social security, Medicare, or railroad retirement tax on your group-term life insurance. This amount should be shown in box 12 of your
Form W-2.
Alternative minimum tax. (See chapter 30.)
Additional tax on a qualified retirement plan, including an individual retirement arrangement (IRA). (See chapter 17.)
Additional tax on an Archer MSA or health savings account. (See Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans.)
Additional tax on a Coverdell ESA or qualified tuition program. (See Publication 970, Tax Benefits for Education.)
Recapture of an investment credit or a low-income housing credit. (See the instructions for Form 4255, Recapture of Investment Credit, or Form
8611, Recapture of Low-Income Housing Credit.)
Recapture tax on the disposition of a home purchased with a federally-subsidized mortgage. (See chapter 15.)
Recapture of the qualified electric vehicle credit. (See chapter 37.)
Recapture of an education credit. (See chapter 35.)
Recapture of the Indian employment credit. (See the instructions for Form 8845, Indian Employment Credit.)
Recapture of the new markets credit. (See Form 8874, New Markets Credit.)2.You received any advance earned income credit (EIC) payments from your employer. This amount should be
shown in box 9 of your Form W-2. (See chapter 36.)3.You had net earnings from self-employment of at least $400. (See Self-Employed Persons earlier
in this chapter.)4.You had wages of $108.28 or more from a church or qualified church-controlled organization that is exempt
from employer social security and Medicare taxes. (See Publication 334.)
Does My Return Have
To Be on Paper?
You may be able to file a paperless return using IRS e-file (electronic filing). It's so easy, over 68 million taxpayers preferred
e-file over filing a paper tax return last year.
Internal Revenue Service e-file logoSummary: Internal Revenue Service e-file logo
Table 1-4 lists the benefits of IRS e-file. IRS e-file uses automation to replace most of the manual steps needed to process
paper returns. As a result, the processing of e-file returns is faster and more accurate than the processing of paper returns. However, as
with a paper return, you are responsible for making sure your return contains accurate information and is filed on time.
Using e-file does not affect your chances of an IRS examination of your return.
Electronic signatures.Signatures:Self-Select PIN acting as electronic signature
Create your own personal identification number (PIN) and use a tax professional or file your own paperless return electronically. If you are
married filing jointly, you and your spouse will each need to create a PIN and enter these PINs as your electronic signatures.
A PIN is any combination of five numbers, except five zeros. If you use a PIN, there is nothing to sign and nothing to mail—not even your
Forms W-2.
To verify your identity, you will be asked to enter your adjusted gross income (AGI) from your originally filed 2004 income tax return, if
applicable. Do not use your AGI from an amended return (Form 1040X), math error notice, or other changed amount from the IRS. AGI is the amount shown
on your 2004 Form 1040, line 36; Form 1040A, line 21; Form 1040EZ, line 4; and on TeleFile Tax Record, line 1. If you do not have your 2004 income tax
return, call the IRS at 1-800-829-1040 to get a free transcript of your account. You will also be asked to enter your date of birth (DOB). Make sure
your DOB is accurate and matches the information on record with the Social Security Administration by checking your annual Social Security Statement.
Table 1-4. Benefits of IRS e-file
Eligible for Free File•Free File allows qualified taxpayers to prepare and e-file their own tax returns for free using commercially available online tax
preparation software.•Review online tax software provider offerings and determine if you are eligible by visiting the Free File page at
www.irs.gov.Fast! Easy! Convenient!•Get your refund in half the time as paper filers do, even faster and safer with direct deposit.•Sign electronically and file a completely paperless return.•Receive an electronic proof of receipt within 48 hours that the IRS received your return.•If you owe, you can e-file and authorize an electronic funds withdrawal or pay by credit card. If you e-file before April
17, 2006, you can schedule an electronic funds withdrawal from your checking or savings account as late as April 17, 2006.•Prepare and file your federal and state returns together and save time.Accurate! Secure!•IRS computers quickly and automatically check for errors or other missing information.•The chance of being audited does not differ whether you e-file or file a paper tax return.•Your bank account information is safeguarded along with other tax return information. The IRS does not have access to credit card
numbers.
You cannot sign your return electronically if you are a first-time filer under age 16 at the end of 2005, or if you are filing Form 3115, 3468 (if
attachments are required), 5713, 8283 (if completing Section B), 8332, 8858, or 8885.
For more details on the PIN method, visit
www.irs.gov/efile and click on IRS
e-file for Individual Taxpayers.
An Authorized IRS e-file Provider can, with your authorization, generate a PIN for you.
Forms 8453 and 8453-OL.E-file:Forms 8453 and 8453-OL for signature requirementsForm:8453:E-file, for signature requirementForm:8453-OL:E-file, for signature requirementSignatures:E-file Forms 8453 and 8453-OL for signature requirements
Your return is not complete without your signature. If you are not eligible or choose not to sign your return electronically, you must complete,
sign, and file Form 8453, U.S. Individual Income Tax Declaration for an IRS e-file Return, or Form 8453-OL, U.S. Individual Income Tax
Declaration for an IRS e-file Online Return, whichever applies.
State returns.State or local income taxes:Electronic returns filed with federal
In most states, you can file an electronic state return simultaneously with your federal return. For more information, check with your local IRS
office, state tax agency, tax professional, or the IRS website at
www.irs.gov/efile.
Refunds.Tax refunds:General rules
You can have a refund check mailed to you, or you can have your refund deposited directly to your checking or savings account. With
e-file, your refund will be issued in half the time as when filing on paper.
Debts:Refund offset againstTax refunds:Offset:Against debtsOffset against debts
As with a paper return, you may not get all of your refund if you owe certain past-due amounts, such as federal tax, state tax, a student loan, or
child support. See Offset against debts under Refunds, later.
If you do not receive your refund within 3 weeks after your electronically-filed return was accepted by IRS, see Past-Due Refund, later.
Balance due.DeadlinesDue datesDue datesPayment of taxPayment of taxInstallment agreementsInstallment agreements
If you owe tax, you must pay it by April 17, 2006, to avoid late-payment penalties and interest. You can make your payment electronically by credit
card or by scheduling an electronic funds withdrawal from your checking or savings account.
See How To Pay, later, for information on how to pay the balance due.
Using an Authorized IRS e-fileProvider
Many tax professionals electronically file tax returns for their clients. As a taxpayer, you have two options.
1)You can prepare your return, take it to an Authorized IRS e-file Provider, and have the provider transmit it electronically to the
IRS.2)You can have a tax professional prepare your return and transmit it for you electronically.
Form:8879:Authorization for E-file provider to use self-selected PIN
You may personally enter your PIN or complete Form 8879, IRS e-file Signature Authorization, to authorize the provider to enter your PIN
on your return.
Note.
Tax professionals may charge a fee for IRS e-file. Fees may vary depending on the professional and the specific services rendered.
Using Your Personal Computer
You can file your tax return in a fast, easy, convenient way using your personal computer. A computer with a modem or Internet access and tax
preparation software are all you need. Best of all, you can e-file from the comfort of your home 24 hours a day, 7 days a week.
IRS approved tax preparation software is available for online use on the Internet, for download from the Internet, and in retail stores.
Through Employers and Financial InstitutionsEmployers:E-file options
Some businesses offer free e-file to their employees, members, or customers. Others offer it for a fee. Ask your employer or financial
institution if they offer IRS e-file as an employee, member, or customer benefit.
Free Help With Your ReturnAssistance, taxTax helpHelpTax helpTax helpTax returns:Free preparation helpElderly persons:Tax Counseling for the ElderlyTax Counseling for the ElderlyTax help:Tax Counseling for the ElderlyTax help:Volunteer counseling (Volunteer Income Tax Assistance program)Volunteer work:Tax counseling (Volunteer Income Tax Assistance program)
Free help in preparing your return is available nationwide from IRS-trained volunteers. The Volunteer Income Tax Assistance (VITA) program is
designed to help low-income taxpayers and the Tax Counseling for the Elderly (TCE) program is designed to assist taxpayers age 60 or older with their
tax returns. Many VITA sites offer free electronic filing and all volunteers will let you know about the credits and deductions you may be entitled to
claim. To find a site near you, call 1-800-829-1040. Or to find the nearest AARP TaxAide site, visit AARP's website at
www.aarp.org/taxaide or call 1-888-227-7669. For more
information on these programs, go to
www.irs.gov and enter keyword VITA in the upper right-hand corner.
When Do I
Have To File?Accounting periods:Calendar yearCalendar year taxpayers:Accounting periodsCalendar year taxpayers:Filing due dateDeadlinesDue datesDue datesFiling requirements:Calendar year filersFiling requirements:When to fileTax yearAccounting periods
April 17, 2006, is the due date for filing your 2005 income tax return if you use the calendar year. For a quick view of due dates for filing a
return with or without an extension of time to file (discussed later), see Table 1-5.
<ROM>Table 1-5.</ROM>
<IMARK>When To File Your 2005 ReturnDue dates:2004 dates (Table 1-5)Tables and figures:Tax returns:Due dates (Table 1-5)Tax returnsDue datesFor U.S. citizens and residents who file returns on a calendar year.For Most TaxpayersFor Certain Taxpayers
Outside the U.S. No extension requestedApril 17, 2006June 15, 2006Automatic extension Form 4868 filed, or credit
card payment madeOctober 16, 2006October 16, 2006
If you use a fiscal year (a year ending on the last day of any month except December, or a 52-53-week year), your income tax return is due by the
15th day of the 4th month after the close of your fiscal year.
When the due date for doing any act for tax purposes—filing a return, paying taxes, etc.—falls on a Saturday, Sunday, or legal holiday,
the due date is delayed until the next business day.
Filing on time.
Your paper return is filed on time if it is mailed in an envelope that is properly addressed, has enough postage, and is postmarked by the due
date. If you send your return by registered mail, the date of the registration is the postmark date. The registration is evidence that the return was
delivered. If you send a return by certified mail and have your receipt postmarked by a postal employee, the date on the receipt is the postmark date.
The postmarked certified mail receipt is evidence that the return was delivered.
If you use a private delivery service designated by the IRS to send your return, the postmark date generally is the date the private delivery
service records in its database or marks on the mailing label. The private delivery service can tell you how to get written proof of this date.
The following are designated private delivery services.
DHL Express (DHL): DHL Same Day Service, DHL Next Day 10:30 am, DHL Next Day 12:00 pm, DHL Next Day 3:00 pm, and DHL 2nd Day
Service.
Federal Express (FedEx): FedEx Priority Overnight, FedEx Standard Overnight, FedEx 2Day, FedEx International Priority, and FedEx
International First.
United Parcel Service (UPS): UPS Next Day Air, UPS Next Day Air Saver, UPS 2nd Day Air, UPS 2nd Day Air A.M., UPS Worldwide Express Plus,
and UPS Worldwide Express.
Private delivery services cannot deliver items to P.O. boxes. You must use the U.S. Postal Service to mail any item to an IRS P.O. box address.
Electronically filed returns.DeadlinesDue datesE-file:On time filing
If you use IRS e-file, your return is considered filed on time if the authorized electronic return transmitter postmarks the
transmission by the due date. An authorized electronic return transmitter is a participant in the IRS e-file program that transmits
electronic tax return information directly to the IRS.
The electronic postmark is a record of when the authorized electronic return transmitter received the transmission of your electronically filed
return on its host system. The date and time in your time zone controls whether your electronically filed return is timely.
If you do not file your return by the due date, you may have to pay a failure-to-file penalty and interest. For more information, see
Penalties, later. Also see Interest under Amount You Owe.
If you were due a refund but you did not file a return, you generally must file within 3 years from the date the return was due (including
extensions) to get that refund.
If you are a nonresident alien and earn wages subject to U.S. income tax withholding, your 2005 U.S. income tax return (Form 1040NR or Form
1040NR-EZ) is due by:
April 17, 2006, if you use a calendar year, or
The 15th day of the 4th month after the end of your fiscal year if you use a fiscal year.
If you do not earn wages subject to U.S. income tax withholding, your return is due by:
June 15, 2006, if you use a calendar year, or
The 15th day of the 6th month after the end of your fiscal year, if you use a fiscal year.
Get Publication 519 for more filing information.
Filing for a decedent.Decedents:Due dates
If you must file a final income tax return for a taxpayer who died during the year (a decedent), the return is due by the 15th day of the 4th month
after the end of the decedent's normal tax year. In most cases, for a 2005 return, this will be April 17, 2006. See Publication 559.
Extensions of Time To FileDue datesExtensionExtension of time to fileExtension of time to fileFiling requirements:Extensions
You may be able to get an extension of time to file your return. Special rules apply for those who were:
Outside the United States, or
Serving in a combat zone.
Automatic ExtensionAutomatic extension of time to fileExtension of time to file:Automatic
If you cannot file your 2005 return by the due date, you may be able to get an automatic 6-month extension of time to file.
Example.
If your return is due on April 17, 2006, you will have until October 16, 2006, to file.
If you do not pay the tax due by the regular due date (generally, April 15), you will owe interest. You may also be charged penalties, discussed
later.
How to get the automatic extension.
You can get the automatic extension by:
Using IRS e-file (electronic filing), or
E-file:Extensions of time to fileExtension of time to file:E-file options
Filing a paper form.
E-file options.Automatic extension of time to file:Form 4868Form:4868Form:4868:Automatic extension of time to file
There are two ways you can use e-file to get an extension of time to file. Complete Form 4868, Application for Automatic Extension of
Time To File U.S. Individual Income Tax Return, to use as a worksheet. If you think you may owe tax when you file your return, use Part II
of the form to estimate your balance due. If you e-file Form 4868 to the IRS, do not also send a paper Form 4868.
E-file using your personal computer or a tax professional.Form:4868:Filing electronic form
You can use a tax software package with your personal computer or a tax professional to file Form 4868 electronically. You will need to provide
certain information from your tax return for 2004. If you wish to make a payment by electronic funds withdrawal, see Electronic payment
options, under How To Pay, later in this chapter.
E-file and pay by credit card.Credit cards:Payment of taxesPayment of tax:By credit card
You can get an extension by paying part or all of your estimate of tax due by using a credit card. You can do this by phone or over the Internet.
You do not file Form 4868. See Credit card, under How To Pay, later in this chapter.
Filing a paper Form 4868.Form:4868:Filing paper form
You can get an extension of time to file by filing a paper Form 4868. Mail it to the address shown in the form instructions.
If you want to make a payment with the form, make your check or money order payable to the United States Treasury. Write your SSN, daytime
phone number, and 2005 Form 4868 on your check or money order.
When to file.Automatic extension of time to fileExtension of time to file:Automatic
You must request the automatic extension by the due date for your return. You can file your return any time before the 6-month extension period
ends.
When you file your return.Extension of time to file:Inclusion on return
Enter any payment you made related to the extension of time to file on Form 1040, line 69. If you file Form 1040EZ or Form 1040A, include that
payment in your total payments on Form 1040EZ, line 9, or Form 1040A, line 43. Also enter Form 4868 and the amount paid in the space to the
left of line 9 or line 43.
Individuals Outside the
United StatesCitizens outside U.S.:Extension of time to fileExtension of time to file:Citizens outside U.S.
You are allowed an automatic 2-month extension (until June 15, 2006, if you use the calendar year) to file your 2005 return and pay any federal
income tax due if:
You are a U.S. citizen or resident, and
On the due date of your return:
You are living outside the United States and Puerto Rico, and your main place of business or post of duty is outside the United States and
Puerto Rico, or
You are in military or naval service on duty outside the United States and
Puerto Rico.
However, if you pay the tax due after the regular due date (generally, April 15), interest will be charged from that date until the date the tax is
paid.
If you served in a combat zone or qualified hazardous duty area, you may be eligible for a longer extension of time to file. See Individuals
Serving in Combat Zone, later, for special rules that apply to you.
Married taxpayers.Joint returns:Extension for citizens outside U.S.
If you file a joint return, only one spouse has to qualify for this automatic extension. If you and your spouse file separate returns, this
automatic extension applies only to the spouse who qualifies.
How to get the extension.
To use this automatic extension, you must attach a statement to your return explaining what situation qualified you for the extension. (See the
situations listed under (2), earlier.)
Extensions beyond 2 months.
If you cannot file your return within the automatic 2-month extension period, you may be able to get an additional 4-month extension, for a total
of 6 months. File Form 4868 and check the box on line 8.
This additional 4-month extension of time to file is not a further extension of time to pay. You can use a credit card to pay your estimate of tax
due. See How To Pay, later in this chapter.
No further extension.
An extension of more than 6 months will generally not be granted. However, if you are outside the United States and meet certain tests, you may be
granted a longer extension. For more information, see Further extensions under When To File and Pay in Publication 54.
Individuals Serving in
Combat ZoneArmed forces:Combat zone:Extension to file returnCombat zone:Extension to file returnMilitaryArmed forcesWar zoneCombat zone
The deadline for filing your tax return, paying any tax you may owe, and filing a claim for refund is automatically extended if you serve in a
combat zone. This applies to members of the Armed Forces, as well as merchant marines serving aboard vessels under the operational control of the
Department of Defense, Red Cross personnel, accredited correspondents, and civilians under the direction of the Armed Forces in support of the Armed
Forces.
Combat zone.
For purposes of the automatic extension, the term combat zone includes the following areas.
The Persian Gulf area, effective January 17, 1991.
The qualified hazardous duty area of Bosnia and Herzegovina, Croatia, and Macedonia, effective November 21, 1995.
The qualified hazardous duty area of the Federal Republic of Yugoslavia (Serbia/Montenegro), Albania, the Adriatic Sea, and the Ionian Sea
north of the 39th parallel, effective March 24, 1999.
Afghanistan, effective September 19, 2001.
See Publication 3, Armed Forces' Tax Guide, for information about other tax benefits available to military personnel serving in a combat zone.
Extension period.
The deadline for filing your return, paying any tax due, and filing a claim for refund is extended for at least 180 days after the later of:
The last day you are in a combat zone or the last day the area qualifies as a combat zone, or
The last day of any continuous qualified hospitalization for injury from service in the combat zone.
In addition to the 180 days, your deadline is also extended by the number of days you had left to take action with the IRS when you entered the
combat zone. For example, you have 3 months (January 1–April 15) to file your tax return. Any days left in this period when you
entered the combat zone (or the entire 3 months if you entered it before the beginning of the year) are added to the 180 days. See
Extension of Deadline in Publication 3 for more information.
The above rules on the extension for filing your return also apply when you are deployed outside the United States (away from your permanent duty
station) while participating in a designated contingency operation.
How Do I Prepare
My Return?Tax returns:How to file
This section explains how to get ready to fill in your tax return and when to report your income and expenses. It also explains how to complete
certain sections of the form. You may find Table 1-6 helpful when you prepare your return.
In most cases, based on what you filed last year, the IRS will mail you Form 1040, Form 1040A, or Form 1040EZ with related instructions. Before you
fill in the form, look at the form instructions to see if you need, or would benefit from filing, a different form this year. Also see if you need any
additional forms or schedules. You may also want to read Does My Return Have To Be on Paper, earlier.
Returns, taxTax returnsTables and figures:Tax returns:Steps to prepare (Table 1-6)Tax returns:Steps to prepare (Table 1-6)
If you do not receive a tax return package in the mail, or if you need other forms, you can order them or print them from the Internet. See
How To Get Tax Help in the back of this publication.
<ROM>Table 1-6.</ROM>
<IMARK>Six Steps for Preparing Your Return
1—Get your records together for income and expenses.2—Get the forms, schedules, and publications you need.3—Fill in your return.4—Check your return to make sure it is correct.5—Sign and date your return.6—Attach all required forms and schedules.
Substitute tax forms.Substitute forms
You cannot use your own version of a tax form unless it meets the requirements explained in Publication 1167, General Rules and Specifications for
Substitute Forms and Schedules.
Form W-2.CarsElectric vehiclesElectric carsEmploymentTaxes:FICA withholdingWithholdingFICA withholdingWithholdingForm:W-2:Employer-reported income statementInformation returnsForm W-2W-2 formForm W-2Wages and salariesForm W-2WithholdingForm W-2
If you are an employee, you should receive Form W-2 from your employer. You will need the information from this form to prepare your return. See
Form W-2 under Credit for Withholding and Estimated Tax in chapter 4.
If you do not receive Form W-2 by January 31, 2006, contact your employer. If you still do not get the form by February 15, the IRS can help you by
requesting the form from your employer. When you request IRS help, be prepared to provide the following information.
Your name, address (including zip code), and phone number.
Your SSN.
Your dates of employment.
Your employer's name, address (including zip code), and phone number.
Form 1099.Form:1099:Taxable income reportInformation returnsForm 1099Interest income:Form 1099-INT
If you received certain types of income, you may receive a Form 1099. For example, if you received taxable interest of $10 or more, the payer
generally must give you a Form 1099-INT. If you have not received it by January 31, 2006, contact the payer. If you still do not get the form by
February 15, call the IRS for help.
When Do I Report My
Income and Expenses?Tax year
You must figure your taxable income on the basis of a tax year. A tax year is an annual accounting period used for keeping records and
reporting income and expenses. You must account for your income and expenses in a way that clearly shows your taxable income. The way you do this is
called an accounting method. This section explains which accounting periods and methods you can use.
Accounting PeriodsAccounting periodsAccounting periods:Calendar yearAccounting periods:Fiscal yearCalendar year taxpayers:Accounting periodsFiscal yearTax yearAccounting periods
Most individual tax returns cover a calendar year—the 12 months from January 1 through December 31. If you do not use a calendar year, your
accounting period is a fiscal year. A regular fiscal year is a 12-month period that ends on the last day of any month except December. A 52-53-week
fiscal year varies from 52 to 53 weeks and always ends on the same day of the week.
You choose your accounting period (tax year) when you file your first income tax return. It cannot be longer than 12 months.
More information.
For more information on accounting periods, including how to change your accounting period, see Publication 538, Accounting Periods and Methods.
Accounting MethodsAccounting methods
Your accounting method is the way you account for your income and expenses. Most taxpayers use either the cash method or an accrual method. You
choose a method when you file your first income tax return. If you want to change your accounting method after that, you generally must get IRS
approval.
If you use this method, report all items of income in the year in which you actually or constructively receive them. Generally, you deduct all
expenses in the year you actually pay them. This is the method most individual taxpayers use.
Constructive receipt.Constructive receipt of incomeIncome:Constructive receipt of
Generally, you constructively receive income when it is credited to your account or set apart in any way that makes it available to you. You do not
need to have physical possession of it. For example, interest credited to your bank account on December 31, 2005, is taxable income to you in 2005 if
you could have withdrawn it in 2005 (even if the amount is not entered in your passbook or withdrawn until 2006).
Garnisheed wages.Attachment of wagesGarnishment and attachmentWages and salaries:Garnisheed
If your employer uses your wages to pay your debts, or if your wages are attached or garnisheed, the full amount is constructively received by you.
You must include these wages in income for the year you would have received them.
Brokerage and other accounts.BrokersSecuritiesBrokers
Profits from a brokerage account, or similar account, are fully taxable in the year you earn them. This is true even if:
You do not withdraw the earnings,
The credit balance in the account may be reduced or eliminated by losses in later years, or
Current profits are used to reduce or eliminate a debit balance from previous years.
Debts paid for you.Debts:Paid by another
If another person cancels or pays your debts (but not as a gift or loan), you have constructively received the amount and generally must include it
in your gross income for the year. See Canceled Debts in chapter 12 for more information.
Payment to third party.Income:Paid to third partyThird parties:Income from taxpayer's property paid to
If a third party is paid income from property you own, you have constructively received the income. It is the same as if you had actually received
the income and paid it to the third party.
Payment to an agent.Agents:Income paid toConstructive receipt of incomeIncome:Constructive receipt ofIncome:Paid to agent
Income an agent receives for you is income you constructively received in the year the agent receives it. If you indicate in a contract that your
income is to be paid to another person, you must include the amount in your gross income when the other person receives it.
Check received or available.Checks:Constructive receipt of
A valid check that was made available to you before the end of the tax year is constructively received by you in that year. A check that was
made available to you includes a check you have already received, but not cashed or deposited. It also includes, for example, your last
paycheck of the year that your employer made available for you to pick up at the office before the end of the year. It is constructively received by
you in that year whether or not you pick it up before the end of the year or wait to receive it by mail after the end of the year.
No constructive receipt.
There may be facts to show that you did not constructively receive income.
Example.
Alice Johnson, a teacher, agreed to her school board's condition that, in her absence, she would receive only the difference between her regular
salary and the salary of a substitute teacher hired by the school board. Therefore, Alice did not constructively receive the amount by which her
salary was reduced to pay the substitute teacher.
If you use an accrual method, you generally report income when you earn it, rather than when you receive it. You generally deduct your expenses
when you incur them, rather than when you pay them.
Income paid in advance.Income:Prepaid
An advance payment of income is generally included in gross income in the year you receive it. Your method of accounting does not matter as long as
the income is available to you. An advance payment may include rent or interest you receive in advance and pay for services you will perform later.
A limited deferral until the next tax year may be allowed for certain advance payments. See Publication 538 for specific information.
Additional information.
For more information on accounting methods, including how to change your accounting method, get Publication 538.
Social Security NumberSocial security number (SSN)SSNSocial security number (SSN)Taxpayer identification number (TIN):Social security numberSocial security number (SSN)
You must enter your social security number (SSN) in the space provided on your return. Be sure the SSN on your return is the same as the SSN on
your social security card. If you are married, enter the SSNs for both you and your spouse, whether you file jointly or separately.
If you are filing a joint return, write the SSNs in the same order as the names. Use this same order in submitting other forms and documents to the
IRS.
Name change.Change of nameName change
If you changed your name because of marriage, divorce, etc., immediately notify your Social Security Administration (SSA) office so the name on
your tax return is the same as the one the SSA has on its records. This will help prevent delays in issuing your refund and safeguard your future
social security benefits.
Dependent's social security number.Dependents:Social security numberSocial security number (SSN):Dependents
You must provide the SSN of each dependent you claim, regardless of the dependent's age. This requirement applies to all dependents (not just your
children) claimed on your tax return.
Exception.Social security number (SSN):Dependents:Exception
Dependents:Born and died within yearIf your child was born and died in 2005 and you do not have an SSN for the child, you may attach a
copy of the child's birth certificate instead. If you do, enter DIED in column (2) of line 6c (Form 1040 or 1040A).
No social security number.Form:SS-5:Social security number requestSocial security number (SSN):Form SS-5 to request numberResident aliensTaxpayer identification number (TIN):Social security numberSocial security number (SSN)Resident aliens:Social security number (SSN)
File Form SS-5, Application for a Social Security Card, with your local SSA office to get an SSN for yourself or your dependent. It usually takes
about 2 weeks to get an SSN. If you or your dependent is not eligible for an SSN, see Individual taxpayer identification number (ITIN),
later.
If you are a U.S. citizen or resident alien, you must show proof of age, identity, and citizenship or alien status with your Form SS-5. If you are
12 or older and have never been assigned an SSN, you must appear in person with this proof at an SSA office.
Form SS-5 is available at any SSA office, on the Internet at
www.socialsecurity.gov, or by calling 1-800-772-1213. If
you have any questions about which documents you can use as proof of age, identity, or citizenship, contact your SSA office.
If your dependent does not have an SSN by the time your return is due, you may want to ask for an extension of time to file, as explained earlier
under When Do I Have To File.
If you do not provide a required SSN or if you provide an incorrect SSN, your tax may be increased and any refund may be reduced.
Adoption taxpayer identification number (ATIN).Adoption:Taxpayer identification numberATINATIN (Adoption taxpayer identification number)Dependents:Social security number:Adoption taxpayer identification numberTaxpayer identification number (TIN):Adoption (ATIN)
If you are in the process of adopting a child who is a U.S. citizen or resident and cannot get an SSN for the child until the adoption is final,
you can apply for an ATIN to use instead of an SSN.
Form:W-7A:Adoption taxpayer identification number requestFile Form W-7A, Application for Taxpayer Identification Number for
Pending U.S. Adoptions, with the IRS to get an ATIN if all of the following are true.
You have a child living with you who was placed in your home for legal adoption.
You cannot get the child's existing SSN even though you have made a reasonable attempt to get it from the birth parents, the placement
agency, and other persons.
You cannot get an SSN for the child from the SSA because, for example, the adoption is not final.
You cannot get an individual taxpayer identification number (ITIN) (discussed later) for the child.
You are eligible to claim the child as a dependent on your tax return.
After the adoption is final, you must apply for an SSN for the child. You cannot continue using the ATIN.
See Form W-7A for more information.
Nonresident alien spouse.AliensNonresidentNonresident aliensMarried taxpayers:Nonresident alien spouseNonresident aliens:SpouseIndividual taxpayer identification number (ITIN)Social security number (SSN):Nonresident alien spouseSpouseMarried taxpayers
If your spouse is a nonresident alien and you file a joint or separate return, your spouse must have either an SSN or an ITIN. If your spouse is
not eligible for an SSN, see the next discussion.
Individual taxpayer identification number (ITIN).Individual taxpayer identification numbers (ITINs)ITINsIndividual taxpayer identification numbers (ITINs)Taxpayer identification number (TIN):Individual (ITIN)
The IRS will issue you an ITIN if you are a nonresident or resident alien and you do not have and are not eligible to get an SSN. To apply for an
ITIN, file Form W-7 with the IRS. It usually takes about 4 to 6 weeks to get an ITIN. Enter this number on your tax return wherever your SSN is
requested.
If you are applying for an ITIN in order to file your tax return, attach your completed tax return to your Form W-7. See the Form W-7 instructions
for how and where to file.
If your dependent is a nonresident or resident alien who does not have and is not eligible to get an SSN, file Form W-7 with the IRS to apply for
an ITIN. Enter this number on your return wherever the dependent's SSN is requested.
An ITIN is for tax use only. It does not entitle you or your dependent to social security benefits or change the employment or immigration status
of either of you under U.S. law.
Penalty for not providing social security number.Penalties:Failure to include social security numberSocial security number (SSN):Failure to include penalty
If you do not include your SSN or the SSN of your spouse or dependent as required, you may have to pay a penalty. See the discussion on
Penalties, later, for more information.
SSN on correspondence.Social security number (SSN):Correspondence with IRS, include SSN
If you write to the IRS about your tax account, be sure to include your SSN (and the name and SSN of your spouse, if you filed a joint return) in
your correspondence. Because your SSN is used to identify your account, this helps the IRS respond to your correspondence promptly.
This fund helps pay for Presidential election campaigns. The fund reduces candidates' dependence on large contributions from individuals and groups
and places candidates on an equal financial footing in the general election. If you want $3 to go to this fund, check the box. If you are filing a
joint return, your spouse can also have $3 go to the fund. If you check a box, your tax or refund will not change.
ComputationsComputation of tax
The following information on entering numbers on your tax return may be useful in making the return easier to complete.
Rounding off dollars.Computation of tax:Rounding off dollarsRounding off dollars
You may round off cents to whole dollars on your return and schedules. If you do round to whole dollars, you must round all amounts. To round, drop
amounts under 50 cents and increase amounts from 50 to 99 cents to the next dollar. For example, $1.39 becomes $1 and $2.50 becomes $3.
If you have to add two or more amounts to figure the amount to enter on a line, include cents when adding the amounts and round off only the total.
Example.
You receive two Forms W-2: one showing wages of $5,000.55 and one showing wages of $18,500.73. On Form 1040, line 7, you would enter $23,501
($5,000.55 + $18,500.73 = $23,501.28), not $23,502 ($5,001 + $18,501).
Equal amounts.Computation of tax:Equal amounts
If you are asked to enter the smaller or larger of two equal amounts, enter that amount.
Example.
Line 1 is $500. Line 3 is $500. Line 5 asks you to enter the smaller of line 1 or 3. Enter $500 on line 5.
Negative amounts.Computation of tax:Negative amounts
If you need to enter a negative amount, put the amount in parentheses rather than using a minus sign. To combine positive and negative amounts, add
all the positive amounts together and then subtract the negative amounts.
AttachmentsAttachments to returnTax returns:Attachments to returns
Depending on the form you file and the items reported on your return, you may have to complete additional schedules and forms and attach them to
your return.
You may be able to file a paperless return using IRS e-file. There's nothing to sign, attach, or mail, not even your Forms W-2.
Form W-2.Form:W-2:Employer-reported income statementInformation returnsForm W-2
Form W-2 is a statement from your employer of wages and other compensation paid to you and taxes withheld from your pay. You should have a Form W-2
from each employer. Be sure to attach a copy of Form W-2 in the place indicated on the front page of your return. Attach it only to the front page of
your return, not to any attachments. For more information, see Form W-2 in chapter 4.
If you received a Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., showing
federal income tax withheld, attach a copy of that form in the place indicated on the front page of your return.
Annuities:Decedent's unrecovered investment inAnnuities:WithholdingForm:1099-R:Retirement plan distributionsIndividual retirement arrangements (IRAs):WithholdingInsurance:Withholding against benefitsPensions:Decedent's unrecovered investment inPensions:WithholdingProfit-sharing plans:WithholdingRetirement plans:Decedent's unrecovered investment inRetirement plans:WithholdingWithholding:Pensions and annuitiesForm 1040EZ.Form:1040EZ:No attachments
There are no additional schedules to file with Form 1040EZ.
Form 1040A.Form:1040A:Attachments to return
Attach the additional schedules and forms that you had to complete behind the Form 1040A in order by number. If you are filing Schedule EIC, put it
last. Do not attach items unless required to do so.
Form 1040.Form:1040:Attachments to
Attach any forms and schedules behind Form 1040 in order of the Attachment Sequence Number shown in the upper right corner of the form or
schedule. Then arrange all other statements or attachments in the same order as the forms and schedules they relate to and attach them last. Do not
attach items unless required to do so.
Third Party DesigneeTax returns:Third party designeeThird parties:Designee for IRS to discuss return with
You can authorize the IRS to discuss your return with a friend, family member, or any other person you choose. If you check the Yes box in
the Third party designee area of your 2005 tax return and provide the information required, you are authorizing:
The IRS to call the designee to answer any questions that arise during the processing of your return, and
The designee to:
Give information that is missing from your return to the IRS,
Call the IRS for information about the processing of your return or the status of your refund or payments,
Receive copies of notices or transcripts related to your return, upon request, and
Respond to certain IRS notices about math errors, offsets (see Refunds, later), and return preparation.
The authorization will automatically end no later than the due date (without any extensions) for filing your 2006 tax return. This is April 16,
2007, for most people.
See your form instructions for more information.
If you want to allow the paid preparer who signed your return to discuss it with the IRS, just enter Preparer in the space for the
designee's name.
SignaturesDating your returnSignaturesTax returns:Dating ofTax returnsSignatures
You must sign and date your return. If you file a joint return, both you and your spouse must sign the return, even if only one of you had income.
If you file a joint return, both spouses are generally liable for the tax, and the entire tax liability may be assessed against either spouse. See
chapter 2.
If you e-file your return, you can use an electronic signature to sign your return. See Does My Return Have To Be on Paper,
earlier.
If you are due a refund, it cannot be issued unless you have signed your return.
Enter your occupation in the space provided in the signature section. If you file a joint return, enter both your occupation and your spouse's
occupation. Entering your daytime phone number may help speed the processing of your return.
When someone can sign for you.Agents:Signing returnSignatures:Agent, use of
You can appoint an agent to sign your return if you are:
Unable to sign the return because of disease or injury,
Absent from the United States for a continuous period of at least 60 days before the due date for filing your return, or
Given permission to do so by the IRS office in your area.
Power of attorney.Form:2848:Power of attorney and declaration of representativePower of attorney
A return signed by an agent in any of these cases must have a power of attorney (POA) attached that authorizes the agent to sign for you. You can
use a POA that states that the agent is granted authority to sign the return, or you can use Form 2848, Power of Attorney and Declaration of
Representative. Part I of Form 2848 must state that the agent is granted authority to sign the return.
Unable to sign.Disabilities, persons with:Signing of return by court-appointed representativeMentally incompetent persons:Signing of return by court-appointed representativeSignatures:Mentally incompetentSignatures:Physically disabled
If the taxpayer is mentally incompetent and cannot sign the return, it must be signed by a court-appointed representative who can act for the
taxpayer.
If the taxpayer is mentally competent but physically unable to sign the return or POA, a valid signature is defined under state law. It can
be anything that clearly indicates the taxpayer's intent to sign. For example, the taxpayer's X with the signatures of two witnesses might be
considered a valid signature under a state's law.
Spouse unable to sign.Children:Signing return, parent for childJoint returns:SigningMarried taxpayers:Signatures when spouse unable to signParental responsibilityChildrenSignatures:Parent for childSpouseMarried taxpayersTax returns:Child
If your spouse is unable to sign for any reason, see Signing a joint return in chapter 2.
Child's return.
If a child has to file a tax return but cannot sign the return, the child's parent, guardian, or another legally responsible person must sign the
child's name, followed by the words By (your signature), parent for minor child.
Paid PreparerAccountants:Preparers of tax returnsPreparers of tax returnsTax returns:Paid preparer
Generally, anyone you pay to prepare, assist in preparing, or review your tax return must sign it and fill in the other blanks in the paid
preparer's area of your return.
A paid preparer can sign the return manually or use a rubber stamp, mechanical device, or computer software program. The preparer is personally
responsible for affixing his or her signature to the return.
If the preparer is self-employed (that is, not employed by any person or business to prepare the return), he or she should check the self-employed
box in the Paid Preparer's Use Only space on the return.
The preparer must give you a copy of your return in addition to the copy filed with the IRS.
If you prepare your own return, leave this area blank. If another person prepares your return and does not charge you, that person should not sign
your return.
If you have questions about whether a preparer must sign your return, contact any IRS office.
RefundsOverpayment of taxOverpayment of taxTax refundsTax refunds:Offset:Against next year's taxEstimated tax:Overpayment applied to
When you complete your return, you will determine if you paid more income tax than you owed. If so, you can get a refund of the amount you overpaid
or, if you file Form 1040 or Form 1040A, you can choose to apply all or part of the overpayment to your next year's (2006) estimated tax. You cannot
have your overpayment applied to your 2006 estimated tax if you file Form 1040EZ.
If you choose to have a 2005 overpayment applied to your 2006 estimated tax, you cannot change your mind and have any of it refunded to you after
the due date (without extensions) of your 2005 return.
Follow the form instructions to complete the entries to claim your refund and/or to apply your overpayment to your 2006 estimated tax.
If your refund for 2005 is large, you may want to decrease the amount of income tax withheld from your pay in 2006. See chapter 4 for more
information.
Direct deposit of refundsTax refunds:Direct deposit
Instead of getting a paper check, you may be able to have your refund deposited directly into your account at a bank or other financial
institution. Follow the form instructions to request direct deposit.
If the direct deposit cannot be done, the IRS will send a check instead.
Overpayment less than one dollar.Tax refunds:Less than $1
If your overpayment is less than one dollar, you will not get a refund unless you ask for it in writing.
Cashing your refund check.Tax refunds:Cashing checkTax refunds:Check's expiration date
Cash your tax refund check soon after you receive it. Checks not cashed within 12 months of the date they are issued will be canceled and the
proceeds returned to the IRS.
If your check has been canceled, you can apply to the IRS to have it reissued.
Refund more or less than expected.Tax refunds:More or less than expected
If you receive a check for a refund you are not entitled to, or for an overpayment that should have been credited to estimated tax, do not cash the
check. Call the IRS.
If you receive a check for more than the refund you claimed, do not cash the check until you receive a notice explaining the difference.
If your refund check is for less than you claimed, it should be accompanied by a notice explaining the difference. Cashing the check does not stop
you from claiming an additional amount of refund.
If you did not receive a notice and you have any questions about the amount of your refund, you should wait 2 weeks. If you still have not received
a notice, call the IRS.
Offset against debts.Debts:Refund offset againstTax refunds:Offset:Against debtsOffset against debts
If you are due a refund but have not paid certain amounts you owe, all or part of your refund may be used to pay all or part of the past-due
amount. This includes past-due federal income tax, other federal debts (such as student loans), state income tax, and child and spousal support
payments. You will be notified if the refund you claimed has been offset against your debts.
Joint return and injured spouse.Injured spouseJoint returns:Injured spouse
When a joint return is filed and only one spouse owes a past-due amount, the other spouse can be considered an injured spouse. An injured spouse
can get a refund for his or her share of the overpayment that would otherwise be used to pay the past-due amount.
To be considered an injured spouse, you must:
File a joint return, and
Have reported income (such as wages, interest, etc.), or
Have made and reported tax payments (such as federal income tax withheld from wages or estimated tax payments), or claimed the earned income
credit or other refundable credit, and
Not be required to pay the past-due amount.
Note.
If the injured spouse's permanent home is in a community property state, then the injured spouse must only meet (1) and (4) above. For more
information, see Publication 555, Community Property.
Form:8379:Injured spouse claimInjured spouse:Claim for refund
If you are an injured spouse, you must file Form 8379, Injured Spouse Allocation, to have your portion of the overpayment refunded to you. Follow
the instructions for the form.
If you have not filed your joint return and you know that your joint refund will be offset, file Form 8379 with your return. You should receive
your refund within 14 weeks from the date the paper return is filed or within 11 weeks from the date the return is filed electronically.
If you filed your joint return and your joint refund was offset, file Form 8379 by itself. When filed after offset, it can take up to 8 weeks to
receive your refund. Do not attach the previously filed tax return, but do include copies of all Forms W-2 and W-2G for both spouses and any Forms
1099 that show income tax withheld.
Statute of limitations:Claim for refund
Generally, you must file Form 8379 no later than 2 years after the date of the Notice of Offset. A separate Form 8379 must be filed for each tax
year to be considered.
An injured spouse claim is different from an innocent spouse relief request. An injured spouse uses Form 8379 to request the division of the tax
overpayment attributed to each spouse. An innocent spouse uses Form 8857, Request for Innocent Spouse Relief, to request relief from joint liability
for tax, interest, and penalties on a joint return for items of the other spouse (or former spouse) that were incorrectly reported on the joint
return. For information on innocent spouses, see Relief from joint liability under Filing a Joint Return in chapter 2.
Amount You OwePayment of taxPayment of taxInstallment agreementsInstallment agreementsTax returns:Payment with
When you complete your return, you will determine if you have paid the full amount of tax that you owe. If you owe additional tax, you should pay
it with your return.
If the IRS figures your tax for you, you will receive a bill for any tax that is due. You should pay this bill within 30 days (or by the due date
of your return, if later). See Tax Figured by IRS in chapter 30.
If you do not pay your tax when due, you may have to pay a failure-to-pay penalty. See Penalties, later. For more information about your
balance due, see Publication 594, The IRS Collection Process.
If the amount you owe for 2005 is large, you may want to increase the amount of income tax withheld from your pay or make estimated tax payments
for 2006. See chapter 4 for more information.
How To Pay
If you have an amount due on your tax return, you can pay by check, money order, or credit card. If you filed electronically, you also may be able
to make your payment electronically.
You do not have to pay if the amount you owe is less than $1.
Check or money order.Checks:Payment of taxMoney orders:Payment of taxPayment of tax:By check or money order
If you pay by check or money order, make it out to the United States Treasury. Show your correct name, address, SSN, daytime phone number,
and the tax year and form number on the front of your check or money order. If you are filing a joint return, enter the SSN shown first on your tax
return.
Form:1040:Check mailed withForm:1040X:Check mailed with
For example, if you file Form 1040 for 2005 and you owe additional tax, show your name, address, SSN, daytime phone number, and 2005 Form
1040 on the front of your check or money order. If you file an amended return (Form 1040X) for 2004 and you owe tax, show your name, address, SSN,
daytime phone number, and 2004 Form 1040X on the front of your check or money order.
Form:1040-V:Payment voucher
Enclose your payment with your return, but do not attach it to the form. If you filed Form 1040, please complete Form 1040-V, Payment Voucher, and
enclose it with your payment and return. Form 1040-V will help us process your payment more accurately and efficiently. Follow the instructions that
come with the form.
Do not mail cash with your return. If you pay cash at an IRS office, keep the receipt as part of your records.
Payment not honored.Checks:Penalty if not honoredMoney orders:Penalty if not honoredPenalties:Check not honoredBad check penalty
If your check or money order is not honored by your bank (or other financial institution) and the IRS does not receive the funds, you still owe the
tax. In addition, you may be subject to a dishonored check penalty.
Electronic payment options.
Electronic payment options are convenient, safe, and secure methods for paying individual income taxes. There's no check to write, money order to
buy, or voucher to mail. Payments can be made 24 hours a day, 7 days a week.
Credit card.Credit cards:Payment of taxesPayment of tax:By credit card
You can use your American Express®, Discover®, MasterCard®, or Visa® credit card.
To pay by credit card, call a service provider and follow the recorded instructions. You can also pay by credit card over the Internet using a
service provider's website.
Credit cards:Payment of taxes:Convenience fee of service providersService charges:Credit card payment of taxesElectronic payment options:Credit cardPayment of tax:By electronic means:Credit card
The service providers charge a convenience fee based on the amount you are paying. Fees may vary between the providers. You will be told what the
fee is during the transaction and will have the option to continue or end the transaction. You may also obtain the convenience fee by calling the
service provider's automated customer service telephone number or visiting their respective website.
Do not add the convenience fee to your tax payment.
If you pay by credit card, write the confirmation number you were given at the end of the transaction and the tax payment amount in the upper left
corner of page 1 of your tax return.
Service Providers
<BIT>Link2Gov Corporation</BIT>To make a payment, call1-888-PAY-1040
SMor1-888-729-1040For Customer Service1-888-658-5465Web Addresswww.PAY1040.com
Official Payments CorporationTo make a payment, call1-800-2PAY-TAX
SMor1-800-272-9829For Customer Service1-877-754-4413Web Addresswww.officialpayments.com
Electronic payment optionsPayment of tax:By electronic means
You can e-file and pay in a single step by authorizing a credit card payment. This option is available through some tax software
packages and tax professionals. You can also pay by credit card using the telephone or the Internet.
You can e-file and pay in a single step by authorizing an electronic funds withdrawal from your checking or savings account. If you
select this payment option, you will need to have your account number, your financial institution's routing transit number, and account type (checking
or savings). You can schedule the payment for any future date up to and including the return due date (April 17, 2006).
Be sure to check with your financial institution to make sure that an electronic funds withdrawal is allowed and to get the correct routing and
account numbers.
Electronic Federal Tax Payment System (EFTPS).Electronic payment options:Electronic Federal Tax Payment System (EFTPS)Payment of tax:By electronic means:Electronic Federal Tax Payment System (EFTPS)
EFTPS is a free tax payment system that all individual and business taxpayers can use. You can make payments online or by phone.
Here are just a few of the benefits of this easy-to-use system.
Convenient and flexible. You can use it to schedule payments in advance. For example, you can schedule estimated tax payments (Form 1040-ES)
or installment agreement payments weekly, monthly, or quarterly.
Fast and accurate. You can make a tax payment in minutes. Because there are verification steps along the way, you can check and review your
information before sending it.
Safe and secure. It offers the highest available levels of security. Every transaction receives an immediate confirmation.
For more information or details on enrolling, visit
www.EFTPS.gov or call EFTPS Customer Service at 1-800-316-6541
(individual) or 1-800-555-4477 (business).
Estimated tax payments.Estimated tax:PaymentsPayment of tax:Estimated tax
Do not include any 2006 estimated tax payment in the payment for your 2005 income tax return. See chapter 4 for information on how to pay estimated
tax.
Interest
Interest is charged on tax you do not pay by the due date of your return. Interest is charged even if you get an extension of time for filing.
If the IRS figures your tax for you, interest cannot start earlier than the 31st day after the IRS sends you a bill. For information, see Tax
Figured by IRS in chapter 30.
Interest on penalties.Penalties:Interest on
Interest is charged on the failure-to-file penalty, the accuracy-related penalty, and the fraud penalty from the due date of the return (including
extensions) to the date of payment. Interest on other penalties starts on the date of notice and demand, but is not charged on penalties paid within
21 calendar days from the date of the notice (or within 10 business days if the notice is for $100,000 or more).
Interest due to IRS error or delay.
All or part of any interest you were charged can be forgiven if the interest is due to an unreasonable error or delay by an officer or employee of
the IRS in performing a ministerial or managerial act.
A ministerial act is a procedural or mechanical act that occurs during the processing of your case. A managerial act includes personnel transfers
and extended personnel training. A decision concerning the proper application of federal tax law is not a ministerial or managerial act.
The interest can be forgiven only if you are not responsible in any important way for the error or delay and the IRS has notified you in writing of
the deficiency or payment. For more information, get Publication 556, Examination of Returns, Appeal Rights, and Claims for Refund.
Interest and certain penalties may also be suspended for a limited period if you filed your return by the due date (including extensions) and the
IRS does not provide you with a notice specifically stating your liability and the basis for it before the close of the 18-month period beginning on
the later of:
The date the return is filed, or
The due date of the return without regard to extensions.
For more information, get Publication 556.
Installment AgreementInstallment agreementsPayment of taxInstallment agreementsInstallment agreementsPayment of tax
If you cannot pay the full amount due with your return, you can ask to make monthly installment payments for the full or a partial amount. However,
you will be charged interest and may be charged a late payment penalty on the tax not paid by April 17, 2006, even if your request to pay in
installments is granted. If your request is granted, you must also pay a fee. To limit the interest and penalty charges, pay as much of the tax as
possible with your return. But before requesting an installment agreement, you should consider other less costly alternatives, such as a bank loan.
Form:9465:Installment agreement request
To ask for an installment agreement, use Form 9465, Installment Agreement Request. You should receive a response to your request within 30 days.
But if you file your return after March 31, it may take longer for a reply.
Credit cards:Payment of taxes:Installment agreements
In addition to paying by check or money order, you can use a credit card or EFTPS to make installment agreement payments. See Credit
card and Electronic Federal Tax Payment System (EFTPS), under How To Pay, earlier.
Guaranteed availability of installment agreement.
The IRS must agree to accept the full payment of your tax liability in installments if, as of the date you offer to enter into the agreement:
Your total taxes (not counting interest, penalties, additions to the tax, or additional amounts) do not exceed $10,000,
In the last 5 years, you (and your spouse if the liability relates to a joint return) have not:
Failed to file any required income tax return,
Failed to pay any tax shown on any such return, or
Entered into an installment agreement for the payment of any income tax,
You show you cannot pay your income tax in full when due,
The tax will be paid in full in 3 years or less, and
You agree to comply with the tax laws while your agreement is in effect.
Gift To Reduce Debt
Held by the PublicDebts:Public, gifts to reduceGifts:To reduce the public debtPublic debt:Gifts to reduce
You can make a contribution (gift) to reduce debt held by the public. If you wish to do so, make a separate check payable to Bureau of the
Public Debt.
Send your check to:
Bureau of the Public Debt
Department G
P.O. Box 2188
Parkersburg, WV 26106-2188.Or, enclose your separate check in the envelope with your income tax return. Do not add this gift to any tax you
owe.
Charitable contributions:Gifts to reduce public debtContributionsCharitable contributionsDonationsCharitable contributionsForm:1040, Schedule ACharitable contributionsScheduleForm 1040
You can deduct this gift as a charitable contribution on next year's tax return if you itemize your deductions on Schedule A (Form 1040).
After you have completed your return, peel off the label with your name and address from the back of your tax return package and place it in the
appropriate area of the Form 1040, Form 1040A, or Form 1040EZ you send to the IRS. If you have someone prepare your return, give that person your
label to use on your tax return.
Form:8453:Address labelForm:8453-OL:Address label
If you file electronically and you are not eligible or choose not to sign your return using your PIN, use your label on Form 8453 or 8453-OL. (More
information on electronic filing is found earlier in this chapter.)
The label helps the IRS to correctly identify your account. It also saves processing costs and speeds up processing so that refunds can be issued
sooner.
You must write your SSN in the spaces provided on your tax return.
Correcting the label.Address:Correcting labelCorrectionsErrorsErrors:Address label, correction ofLabels:Address correction
Make necessary name and address changes on the label. If you have an apartment number that is not shown on the label, please write it in. If you
changed your name, see the discussion under Social Security Number, earlier.
No label.Address:No label received
If you did not receive a tax return package with a label, print or type your name and address in the spaces provided at the top of Form 1040 or
Form 1040A. If you are married filing a separate return, do not enter your spouse's name in the space at the top. Instead, enter his or her name in
the space provided on line 3.
If you file Form 1040EZ and you do not have a label, print or type this information in the spaces provided.
P.O. box.Address:P.O. box
If your post office does not deliver mail to your street address and you have a P.O. box, print your P.O. box number on the line for your present
home address instead of your street address.
Foreign address.Address:Foreign
If your address is outside the United States or its possessions or territories, enter the information on the line for City, town or post office,
state, and ZIP code in the following order:
City,
Province or state, and
Name of foreign country. (Do not abbreviate the name of the country.)
Follow the country's practice for entering the postal code.
Where Do I File?Filing requirements:Where to filePlace for filing
After you complete your return, you must send it to the IRS. You can mail it or you may be able to file it electronically. See Does My Return
Have To Be on Paper, earlier.
Mailing your return.Mailing returnsTax returnsTax returns:Mailing of
If an addressed envelope came with your tax forms package, you should mail your return in that envelope.
Address:Service CentersService Center addresses
If you do not have an addressed envelope or if you moved during the year, mail your return to the address shown at the end of this publication for
the area where you now live.
What Happens After
I File?
After you send your return to the IRS, you may have some questions. This section discusses concerns you may have about recordkeeping, your refund,
and what to do if you move.
What Records Should
I Keep?BookkeepingRecordkeeping requirementsRecordkeeping requirements
You must keep records so that you can prepare a complete and accurate income tax return. The law does not require any special form of records.
However, you should keep all receipts, canceled checks or other proof of payment, and any other records to support any deductions or credits you
claim.
If you file a claim for refund, you must be able to prove by your records that you have overpaid your tax.
How long to keep records.Recordkeeping requirements:Period of retention
You must keep your records for as long as they are important for the federal tax law.
Keep records that support an item of income or a deduction appearing on a return until the period of limitations for the return runs out. (A period
of limitations is the period of time after which no legal action can be brought.) For assessment of tax you owe, this generally is 3 years from the
date you filed the return. For filing a claim for credit or refund, this generally is 3 years from the date you filed the original return, or 2 years
from the date you paid the tax, whichever is later. Returns filed before the due date are treated as filed on the due date.
If you did not report income that you should have reported on your return, and it is more than 25% of the income shown on the return, the period of
limitations does not run out until 6 years after you filed the return. If a return is false or fraudulent with intent to evade tax, or if no return is
filed, an action can generally be brought at any time.
You may need to keep records relating to the basis of property longer than the period of limitations. Keep those records as long as they are
important in figuring the basis of the original or replacement property. Generally, this means for as long as you own the property and, after you
dispose of it, for the period of limitations that applies to you. See chapter 13 for information on basis.
Note.
Form:W-2:RecordkeepingRecordkeeping requirements:Form W-2If you receive a Form W-2, keep Copy C until you begin receiving social security benefits. This will help protect
your benefits in case there is a question about your work record or earnings in a particular year. Review the information shown on your annual (for
workers over age 25) Social Security Statement.
Copies of returns.Recordkeeping requirements:Copies of returnsTax returns:Copies of
You should keep copies of tax returns you have filed and the tax forms package as part of your records. They may be helpful in amending filed
returns or preparing future ones.
Form:4506:Copy of tax return requestRequests for information from IRSTax returns:Request copy of, Form 4506
If you need a copy of a prior year tax return, you can get it from the IRS. Use Form 4506, Request for Copy of Tax Return. There is a charge for a
copy of a return, which you must pay with Form 4506. It may take up to 60 days to process your request.
If your main home, principal place of business, or tax records are located in a Presidentially declared disaster area, the charge will be waived.
Transcript of tax return.Tax returns:Transcript ofForm:4506-TTax return transcript requestTax returns:Request transcript of, Form 4506-T
If you just need information from your return, you can order a transcript by calling 1-800-829-1040, or using Form 4506-T, Request for Transcript
of Tax Return. There is no fee for a transcript.
You can request the following items.
Return transcript.
This includes most of the line items of a tax return as filed with the IRS. Return transcripts are available for the current year and returns
processed during the prior 3 processing years. Most requests will be processed within 10 business days.
Account transcript.
This contains information on the financial status of the account, such as payments made on the account, penalty assessments, and adjustments made
by you or the IRS after the return was filed. Return information is limited to items such as tax liability and estimated tax payments. Account
transcripts are available for most returns. Most requests will be processed within 20 business days.
Record of account.
This is a combination of line item information and later adjustments to the account. This information is available for the current year and 3 prior
tax years. Most requests will be processed within 20 business days.
More information.
For more information on recordkeeping, get Publication 552, Recordkeeping for Individuals.
Interest on RefundsTax refunds:Interest on
If you are due a refund, you may get interest on it. The interest rates are adjusted quarterly.
If the refund is made within 45 days after the due date of your return, no interest will be paid. If you file your return after the due date
(including extensions), no interest will be paid if the refund is made within 45 days after the date you filed. If the refund is not made within this
45-day period, interest will be paid from the due date of the return or from the date you filed, whichever is later.
RefundsTaxesTax refundsTax refunds:Claim for
Accepting a refund check does not change your right to claim an additional refund and interest. File your claim within the period of time that
applies. See Amended Returns and Claims for Refund, later. If you do not accept a refund check, no more interest will be paid on the
overpayment included in the check.
Interest on erroneous refund.CorrectionsErrorsErrors:RefundsInterest income:Tax refunds, fromMistakesErrorsTax refunds:Erroneous refunds
All or part of any interest you were charged on an erroneous refund generally will be forgiven. Any interest charged for the period before demand
for repayment was made will be forgiven unless:
You, or a person related to you, caused the erroneous refund in any way, or
The refund is more than $50,000.
For example, if you claimed a refund of $100 on your return, but the IRS made an error and sent you $1,000, you would not be charged interest for
the time you held the $900 difference. You must, however, repay the $900 when the IRS asks.
Past-Due RefundTax refunds:Past-due
You can check on the status of your 2005 refund if it has been at least 6 weeks from the date you filed your return (3 weeks if you filed
electronically). Be sure to have a copy of your 2005 tax return available because you will need to know the filing status, the first SSN shown on the
return, and the exact whole-dollar amount of the refund. To check on your refund, do one of the following.
Go to
www.irs.gov, and click on Where's My Refund.
Call 1-800-829-4477 24 hours a day, 7 days a week for automated refund information.
Call 1-800-829-1954 during the hours shown in your form instructions.
Change of AddressAddress:Change ofChange of address
If you have moved, file your return using your new address.
Form:8822:Change of address
If you move after you filed your return, you should give the IRS clear and concise written notification of your change of address. Send the
notification to the Internal Revenue Service Center serving your old address. You can use Form 8822, Change of Address. If you are expecting a refund,
also notify the post office serving your old address. This will help in forwarding your check to your new address (unless you chose direct deposit of
your refund).
Be sure to include your SSN (and the name and SSN of your spouse, if you filed a joint return) in any correspondence with the IRS.
What If I Made
a Mistake?Errors:Discovery after filing, need to amend return
Errors may delay your refund or result in notices being sent to you. If you discover an error, you can file an amended return or claim for refund.
Amended Returns and
Claims for RefundAmended returnsReturns, taxTax returnsTax refunds:Claim forTax returns:Amended
You should correct your return if, after you have filed it, you find that:
You did not report some income,
Income:Underreported
You claimed deductions or credits you should not have claimed,
Credits:Changing claimDeductions:Changing claim after filing, need to amendTax creditsCredits
You did not claim deductions or credits you could have claimed, or
You should have claimed a different filing status. (Once you file a joint return, you cannot choose to file separate returns for that year
after the due date of the return. However, an executor may be able to make this change for a deceased spouse.)
Filing status:Change to, after time of filingIf you need a copy of your return, see Copies of returns under What Records Should I Keep, earlier in this chapter.
Form 1040X.Amended returnsForm 1040XForm:1040X:Amended individual returnTax returns:AmendedForm 1040X
Use Form 1040X, Amended U.S. Individual Income Tax Return, to correct a return you have already filed. An amended tax return cannot be filed
electronically under the e-file system.
Completing Form 1040X.Form:1040X:Completing
On Form 1040X, write your income, deductions, and credits as you originally reported them on your return, the changes you are making, and the
corrected amounts. Then figure the tax on the corrected amount of taxable income and the amount you owe or your refund.
If you owe tax, pay the full amount with Form 1040X. The tax owed will not be subtracted from any amount you had credited to your estimated tax.
If you cannot pay the full amount due with your return, you can ask to make monthly installment payments. See Installment Agreement,
earlier.
If you overpaid tax, you can have all or part of the overpayment refunded to you, or you can apply all or part of it to your estimated tax. If you
choose to get a refund, it will be sent separately from any refund shown on your original return.
Filing Form 1040X.Amended returnsForm 1040XForm:1040X:FilingTax returns:AmendedForm 1040X
After you finish your Form 1040X, check it to be sure that it is complete. Do not forget to show the year of your original return and explain all
changes you made. Be sure to attach any forms or schedules needed to explain your changes. Mail your Form 1040X to the Internal Revenue Service Center
serving the area where you now live (as shown in the instructions to the form). However, if you are filing Form 1040X in response to a notice you
received from the IRS, mail it to the address shown on the notice. Do not use the addresses listed at the end of this publication.
File a separate form for each tax year involved.
Time for filing a claim for refund.Statute of limitations:Claim for refundsTax refunds:Claim for:Limitations period
Generally, you must file your claim for a credit or refund within 3 years after the date you filed your original return or within 2 years after the
date you paid the tax, whichever is later. Returns filed before the due date (without regard to extensions) are considered filed on the due date (even
if the due date was a Saturday, Sunday, or legal holiday). These time periods are suspended while you are financially disabled, discussed later.
If the last day for claiming a credit or refund is a Saturday, Sunday, or legal holiday, you can file the claim on the next business day.
If you do not file a claim within this period, you may not be entitled to a credit or a refund.
If you were due a refund but you did not file a return, you generally must file your return within 3 years from the date the return was due
(including extensions) to get that refund. Generally, your return must be postmarked no later than 3 years from the date the return was due (including
extensions). For information on postmarks, see Filing on time, under When Do I Have To File, earlier.
Limit on amount of refund.Tax refunds:Limits
If you file your claim within 3 years after the date you filed your return, the credit or refund cannot be more than the part of the tax paid
within the 3-year period (plus any extension of time for filing your return) immediately before you filed the claim. This time period is suspended
while you are financially disabled, discussed later.
Tax paid.Payment of taxPayment of taxInstallment agreementsInstallment agreements
Payments, including estimated tax payments, made before the due date (without regard to extensions) of the original return are considered paid on
the due date. For example, income tax withheld during the year is considered paid on the due date of the return, April 15 for most taxpayers.
Example 1.
You made estimated tax payments of $500 and got an automatic extension of time to August 15, 2003, to file your 2002 income tax return. When you
filed your return on that date, you paid an additional $200 tax. On August 15, 2006, you filed an amended return and claimed a refund of $700. Because
you filed your claim within 3 years after you filed your original return, you can get a refund of up to $700, the tax paid within the 3 years plus the
4-month extension period immediately before you filed the claim.
Example 2.
The situation is the same as in Example 1, except you filed your return on October 27, 2003, 2 months after the
extension period ended. You paid an additional $200 on that date. On October 27, 2006, you filed an amended return and claimed a refund of $700.
Although you filed your claim within 3 years from the date you filed your original return, the refund was limited to $200, the tax paid within the 3
years plus the 4-month extension period immediately before you filed the claim. The estimated tax of $500 paid before that period cannot be refunded
or credited.
Tax refunds:Limits
If you file a claim more than 3 years after you file your return, the credit or refund cannot be more than the tax you paid within the 2
years immediately before you file the claim.
Example.
You filed your 2002 tax return on April 15, 2003. You paid taxes of $500. On November 3, 2004, after an examination of your 2002 return, you had to
pay an additional tax of $200. On May 10, 2006, you file a claim for a refund of $300. However, because you filed your claim more than 3 years after
you filed your return, your refund will be limited to the $200 you paid during the 2 years immediately before you filed your claim.
The time periods for claiming a refund are suspended for the period in which you are financially disabled. For a joint income tax return, only one
spouse has to be financially disabled for the time period to be suspended. You are financially disabled if you are unable to manage your financial
affairs because of a medically determinable physical or mental impairment which can be expected to result in death or which has lasted or can be
expected to last for a continuous period of not less than 12 months. However, you are not treated as financially disabled during any period your
spouse or any other person is authorized to act on your behalf in financial matters.
To claim that you are financially disabled, you must send in the following written statements with your claim for refund.
A statement from your qualified physician that includes:
The name and a description of your physical or mental impairment,
The physician's medical opinion that the impairment prevented you from managing your financial affairs,
The physician's medical opinion that the impairment was or can be expected to result in death, or that its duration has lasted, or can be
expected to last, at least 12 months,
The specific time period (to the best of the physician's knowledge), and
The following certification signed by the physician: I hereby certify that, to the best of my knowledge and belief, the above
representations are true, correct, and complete.
A statement made by the person signing the claim for credit or refund that no person, including your spouse, was authorized to act on your
behalf in financial matters during the period of disability (or the exact dates that a person was authorized to act for you).
Exceptions for special types of refunds.Tax refunds:Limits:Exceptions
If you file a claim for one of the items listed below, the dates and limits discussed earlier may not apply. These items, and where to get more
information, are as follows.
Bad debt. (See Nonbusiness Bad Debts in chapter 14.)
Bad debts:Claim for refundDebtsBad debtsLoansDebtsTax refunds:Bad debts
Worthless security. (See Worthless securities in chapter 14.)
Securities:Claim for refundStockholdersSecuritiesStocksSecuritiesTax refunds:Worthless securities
Foreign tax paid or accrued. (See Publication 514, Foreign Tax Credit for Individuals.)
Tax refunds:Foreign tax paid or accrued
Net operating loss carryback. (See Publication 536, Net Operating Losses (NOLs) for Individuals, Estates, and Trusts.)
Gains and losses:Claim for refund for lossLossesGains and lossesNet operating losses:Refund of carrybackOrdinary gain and lossGains and lossesTax refunds:Net operating loss carryback
Carryback of certain business tax credits. (See Form 3800, General Business Credit.)
Business tax credits:Claim for refundCarrybacks:Business tax credit carrybacksForm:3800:General business creditTax refunds:Business tax credit carrybacks
Claim based on an agreement with the IRS extending the period for assessment of tax.
Tax refunds:Agreement with IRS extending assessment period, claim based on
Processing claims for refund.Tax refunds:Claim for
Claims are usually processed shortly after they are filed. Your claim may be accepted as filed, disallowed, or subject to examination. If a claim
is examined, the procedures are the same as in the examination of a tax return.
If your claim is disallowed, you will receive an explanation of why it was disallowed.
Taking your claim to court.Tax refunds:Claim for:Litigation
You can sue for a refund in court, but you must first file a timely claim with the IRS. If the IRS disallows your claim or does not act on your
claim within 6 months after you file it, you can then take your claim to court. For information on the burden of proof in a court proceeding, see
Publication 556.
The IRS provides a fast method to move your claim to court if:
You are filing a claim for a credit or refund based solely on contested income tax or on estate tax or gift tax issues considered in your
previously examined returns, and
You want to take your case to court instead of appealing it within the IRS.
When you file your claim with the IRS, you get the fast method by requesting in writing that your claim be immediately rejected. A notice of claim
disallowance will then be promptly sent to you.
You have 2 years from the date of mailing of the notice of disallowance to file a refund suit in the United States District Court having
jurisdiction or in the United States Court of Federal Claims.
Interest on refund.Tax refunds:Interest on
If you receive a refund because of your amended return, interest will be paid on it from the due date of your original return or the date you filed
your original return, whichever is later, to the date you filed the amended return. However, if the refund is not made within 45 days after you file
the amended return, interest will be paid up to the date the refund is paid.
Reduced refund.Tax refunds:Reduced
Your refund may be reduced by an additional tax liability that has been assessed against you.
Also, your refund may be reduced by amounts you owe for past-due child support, debts to another federal agency, or for state tax. If your spouse
owes these debts, see Offset against debts, under Refunds, earlier, for the correct refund procedures to follow.
Effect on state tax liability.State or local income taxes:Federal changes, effect onTax refunds:State liability, effect on
If your return is changed for any reason, it may affect your state income tax liability. This includes changes made as a result of an examination
of your return by the IRS. Contact your state tax agency for more information.
Penalties
The law provides penalties for failure to file returns or pay taxes as required.
If you do not file your return and pay your tax by the due date, you may have to pay a penalty. You may also have to pay a penalty if you
substantially understate your tax, understate a reportable transaction, file a frivolous return, or fail to supply your SSN or individual taxpayer
identification number. If you provide fraudulent information on your return, you may have to pay a civil fraud penalty.
If you do not file your return by the due date (including extensions), you may have to pay a failure-to-file penalty. The penalty is usually 5% for
each month or part of a month that a return is late, but not more than 25%. The penalty is based on the tax not paid by the due date (without regard
to extensions).
Fraud.Fraud:PenaltiesPenalties:Fraud
If your failure to file is due to fraud, the penalty is 15% for each month or part of a month that your return is late, up to a maximum of 75%.
Return over 60 days late.Filing requirementsLate filing penaltiesPenaltiesLate filing:PenaltiesPenalties:Late filing
If you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $100 or 100% of the unpaid
tax.
You will not have to pay the penalty if you show that you failed to file on time because of reasonable cause and not because of willful neglect.
Paying tax late.Failure to comply with tax lawsPenaltiesFinesPenaltiesLate payment:Penalties on tax paymentsPayment of tax:Late payment penaltiesPenalties:Failure to pay taxPenalties:Late payment
You will have to pay a failure-to-pay penalty of of 1% (.50%) of your unpaid taxes for each month, or part of a month, after the
due date that the tax is not paid. This penalty does not apply during the automatic 6-month extension of time to file period if you paid at least 90%
of your actual tax liability on or before the due date of your return and pay the balance when you file the return.
The monthly rate of the failure-to-pay penalty is half the usual rate (.25% instead of .50%) if an installment agreement is in effect for that
month. You must have filed your return by the due date (including extensions) to qualify for this reduced penalty.
If a notice of intent to levy is issued, the rate will increase to 1% at the start of the first month beginning at least 10 days after the day that
the notice is issued. If a notice and demand for immediate payment is issued, the rate will increase to 1% at the start of the first month beginning
after the day that the notice and demand is issued.
This penalty cannot be more than 25% of your unpaid tax. You will not have to pay the penalty if you can show that you had a good reason for not
paying your tax on time.
Combined penalties.
If both the failure-to-file penalty and the failure-to-pay penalty (discussed earlier) apply in any month, the 5% (or 15%) failure-to-file penalty
is reduced by the failure-to-pay penalty. However, if you file your return more than 60 days after the due date or extended due date, the minimum
penalty is the smaller of $100 or 100% of the unpaid tax.
You may have to pay an accuracy-related penalty if you underpay your tax because:
You show negligence or disregard of the rules or regulations, or
You substantially understate your income tax.
The penalty is equal to 20% of the underpayment. The penalty will not be figured on any part of an underpayment on which the fraud penalty
(discussed later) is charged.
Negligence or disregard.Negligence penaltiesPenalties:Negligence
The term negligence includes a failure to make a reasonable attempt to comply with the tax law or to exercise ordinary and reasonable care
in preparing a return. Negligence also includes failure to keep adequate books and records. You will not have to pay a negligence penalty if you have
a reasonable basis for a position you took.
The term disregard includes any careless, reckless, or intentional disregard.
Adequate disclosure.Penalties:Defenses
You can avoid the penalty for disregard of rules or regulations if you adequately disclose on your return a position that has at least a reasonable
basis. See Disclosure statement, later.
This exception will not apply to an item that is attributable to a tax shelter. In addition, it will not apply if you fail to keep adequate books
and records, or substantiate items properly.
Substantial understatement of income tax.Penalties:Substantial understatement of income taxReportable transaction understatements
You understate your tax if the tax shown on your return is less than the correct tax. The understatement is substantial if it is more than the
larger of 10% of the correct tax or $5,000. However, the amount of the understatement may be reduced to the extent the understatement is due to:
Substantial authority, or
Adequate disclosure and a reasonable basis.
If an item on your return is attributable to a tax shelter, there is no reduction for an adequate disclosure. However, there is a reduction for
a position with substantial authority, but only if you reasonably believed that your tax treatment was more likely than not the proper treatment.
Substantial authority.
Whether there is or was substantial authority for the tax treatment of an item depends on the facts and circumstances. Some of the items that may
be considered are court opinions, Treasury regulations, revenue rulings, revenue procedures, and notices and announcements issued by the IRS and
published in the Internal Revenue Bulletin that involve the same or similar circumstances as yours.
To adequately disclose the relevant facts about your tax treatment of an item, use Form 8275, Disclosure Statement. You must also have a reasonable
basis for treating the item the way you did.
In cases of substantial understatement only, items that meet the requirements of Revenue Procedure 2004-73 (or later update) are considered
adequately disclosed on your return without filing Form 8275.
Form:8275-R:Regulation disclosure statement
Use Form 8275-R, Regulation Disclosure Statement, to disclose items or positions contrary to regulations.
Reasonable cause.
You will not have to pay a penalty if you show a good reason (reasonable cause) for the way you treated an item. You must also show that you acted
in good faith.
Frivolous return.Penalties:Frivolous return
You may have to pay a penalty of $500 if you file a frivolous return. A frivolous return is one that does not include enough information to figure
the correct tax or that contains information clearly showing that the tax you reported is substantially incorrect.
You will have to pay the penalty if you filed this kind of return because of a frivolous position on your part or a desire to delay or interfere
with the administration of federal income tax laws. This includes altering or striking out the preprinted language above the space provided for your
signature.
This penalty is added to any other penalty provided by law.
The penalty must be paid in full upon notice and demand from IRS even if you protest the penalty.
Fraud.Penalties:Fraud
If there is any underpayment of tax on your return due to fraud, a penalty of 75% of the underpayment due to fraud will be added to your tax.
Joint return.Joint returns:Fraud penalty
The fraud penalty on a joint return does not apply to a spouse unless some part of the underpayment is due to the fraud of that spouse.
Failure to supply social security number.Penalties:Failure to include social security number
If you do not include your SSN or the SSN of another person where required on a return, statement, or other document, you will be subject to a
penalty of $50 for each failure. You will also be subject to a penalty of $50 if you do not give your SSN to another person when it is required on a
return, statement, or other document.
For example, if you have a bank account that earns interest, you must give your SSN to the bank. The number must be shown on the Form 1099-INT or
other statement the bank sends you. If you do not give the bank your SSN, you will be subject to the $50 penalty. (You also may be subject to
backup withholding of income tax. See chapter 4.)
You will not have to pay the penalty if you are able to show that the failure was due to reasonable cause and not willful neglect.
Failure to furnish tax shelter registration number.Penalties:Failure to furnish tax shelter registration numberTax shelters:Penalty for failure to furnish registration numberForm:8271:Investor report of tax shelter registration number
A person who sells (or otherwise transfers) to you an interest in a tax shelter must give you the tax shelter registration number or be subject to
a $100 penalty. If you claim any deduction, credit, or other tax benefit because of the tax shelter, you must attach Form 8271, Investor Reporting of
Tax Shelter Registration Number, to your return to report this number. You will have to pay a penalty of $250 for each failure to report a tax shelter
registration number on your return. The penalty can be excused if you have a reasonable cause for not reporting the number.
You may be subject to criminal prosecution (brought to trial) for actions such as:
Tax evasion,
Penalties:Tax evasionTax evasion
Willful failure to file a return, supply information, or pay any tax due,
Failure to comply with tax lawsPenaltiesPenalties:Willful failure to file
Fraud and false statements, or
Penalties:Fraud
Preparing and filing a fraudulent return.
Filing requirements
Filing StatusFiling statusWhat's New for 2005Head of household.
Beginning in 2005, you will use new rules to determine whether someone is your qualifying person so you can claim head of household filing status.
To be your qualifying person, a child generally must be your qualifying child. See Head of Household.
Katrina Emergency Tax Relief Act of 2005.
This Act provides tax relief for persons affected by Hurricane Katrina. Under the Act, you may be able to maintain head of household filing status.
See Publication 4492.
This chapter helps you determine which filing status to use. There are five filing statuses:
Single,
Married Filing Jointly,
Married Filing Separately,
Head of Household, and
Qualifying Widow(er) With Dependent Child.
If more than one filing status applies to you, choose the one that will give you the lowest tax.
You must determine your filing status before you can determine your filing requirements (chapter 1), standard deduction (chapter 20), and correct
tax (chapter 30). You also use your filing status in determining whether you are eligible to claim certain deductions and credits.
Publication501Exemptions, Standard Deduction, and Filing Information519U.S. Tax Guide for Aliens555Community Property
Marital Status
In general, your filing status depends on whether you are considered unmarried or married. A marriage means only a legal union between a man and a
woman as husband and wife.
You are considered unmarried for the whole year if, on the last day of your tax year, you are unmarried or legally separated from your spouse under
a divorce or separate maintenance decree. State law governs whether you are married or legally separated under a divorce or separate maintenance
decree.
If you are divorced under a final decree by the last day of the year, you are considered unmarried for the whole year.
Divorce and remarriage.
If you obtain a divorce in one year for the sole purpose of filing tax returns as unmarried individuals, and at the time of divorce you intended to
and did remarry each other in the next tax year, you and your spouse must file as married individuals.
Form:1040X:Annulled marriagesIf you obtain a court decree of annulment, which holds that no valid marriage ever existed, you are
considered unmarried even if you filed joint returns for earlier years. You must file Form 1040X, Amended U.S. Individual Income Tax Return, claiming
single or head of household status for each tax year affected by the annulment that is not closed by the statute of limitations for filing a tax
return. The statute of limitations generally does not expire until 3 years after your original return was filed.
Head of household or qualifying widow(er) with dependent child.Filing status:Head of householdFiling status:Surviving spouseHead of householdHousehold membersHead of householdMarried taxpayers:Deceased spouseSurviving spouseSpouseSurviving spouseMarried taxpayersSurviving spouse:Filing statusWidow/widowerSurviving spouse
If you are considered unmarried, you may be able to file as a head of household or as a qualifying widow(er) with a dependent child. See Head
of Household and Qualifying Widow(er) With Dependent Child to see if you qualify.
Married persons.Married taxpayers:Filing status
If you are considered married for the whole year, you and your spouse can file a joint return, or you can file separate returns.
Considered married.
You are considered married for the whole year if on the last day of your tax year you and your spouse meet any one of the following tests.
You are married and living together as husband and wife.
You are living together in a common law marriage that is recognized in the state where you now live or in the state where the common law
marriage began.
Common law marriage
You are married and living apart, but not legally separated under a decree of divorce or separate maintenance.
You are separated under an interlocutory (not final) decree of divorce. For purposes of filing a joint return, you are not considered
divorced.
If your spouse died during the year, you are considered married for the whole year for filing status purposes.
If you did not remarry before the end of the tax year, you can file a joint return for yourself and your deceased spouse. For the next 2 years, you
may be entitled to the special benefits described later under Qualifying Widow(er) With Dependent Child.
If you remarried before the end of the tax year, you can file a joint return with your new spouse. Your deceased spouse's filing status is married
filing separately for that year.
Married persons living apart.Married taxpayers:Living apartSeparated taxpayers
If you live apart from your spouse and meet certain tests, you may be considered unmarried. If this applies to you, you can file as head of
household even though you are not divorced or legally separated. If you qualify to file as head of household instead of as married filing separately,
your standard deduction will be higher. Also, your tax may be lower, and you may be able to claim the earned income credit. See Head of
Household, later.
Your filing status is single if, on the last day of the year, you are unmarried or legally separated from your spouse under a divorce or separate
maintenance decree, and you do not qualify for another filing status. To determine your marital status on the last day of the year, see Marital
Status, earlier.
Your filing status may be single if you were widowed before January 1, 2005, and did not remarry in 2005. However, you might be able to use another
filing status that will give you a lower tax. See Head of Household and Qualifying Widow(er) With Dependent Child to see if you
qualify.
Form:1040:Use ofForm:1040A:Use ofForm:1040EZ:Use ofSchedule:XTax rates for single personsSingle taxpayers:Form 1040EZ, use ofSingle taxpayers:Tax rates:Single person filing (Schedule X)
How to file.
You can file Form 1040EZ (if you have no dependents, are under 65 and not blind, and meet other requirements), Form 1040A, or Form 1040. If you
file Form 1040A or Form 1040, show your filing status as single by checking the box on line 1. Use the Single column of the Tax Table or
Section A of the Tax Computation Worksheet to figure your tax.
You can choose married filing jointly as your filing status if you are married and both you and your spouse agree to file a joint return. On a
joint return, you report your combined income and deduct your combined allowable expenses. You can file a joint return even if one of you had no
income or deductions.
If you and your spouse decide to file a joint return, your tax may be lower than your combined tax for the other filing statuses. Also, your
standard deduction (if you do not itemize deductions) may be higher, and you may qualify for tax benefits that do not apply to other filing statuses.
If you and your spouse each have income, you may want to figure your tax both on a joint return and on separate returns (using the filing status of
married filing separately). Choose the method that gives the two of you the lower combined tax.
Form:1040:Use ofForm:1040A:Use ofForm:1040EZ:Use ofSchedule:Y-1Tax rates for married filing jointlyTax rates:Married filing jointly (Schedule Y–1)
How to file.
If you file as married filing jointly, you can use Form 1040 or Form 1040A. If you have no dependents, are under 65 and not blind, and meet other
requirements, you can file Form 1040EZ. If you file Form 1040 or Form 1040A, show this filing status by checking the box on line 2. Use the
Married filing jointly column of the Tax Table or Section B of the Tax Computation Worksheet to figure your tax.
Spouse died during the year.DeathDecedentsDeceased taxpayersDecedentsDecedents:Spouse's deathJoint returns:Deceased spouseMarried taxpayers:Deceased spouseSpouseSurviving spouseMarried taxpayers
If your spouse died during the year, you are considered married for the whole year and can choose married filing jointly as your filing status. See
Spouse died, earlier, for more information.
If you are divorced under a final decree by the last day of the year, you are considered unmarried for the whole year and you cannot choose married
filing jointly as your filing status.
Filing a Joint Return
Both you and your spouse must include all of your income, exemptions, and deductions on your joint return.
Both of you must use the same accounting period, but you can use different accounting methods. See Accounting Periods and
Accounting Methods in chapter 1.
Joint responsibility.
Both of you may be held responsible, jointly and individually, for the tax and any interest or penalty due on your joint return. One spouse may be
held responsible for all the tax due even if all the income was earned by the other spouse.
You may be held jointly and individually responsible for any tax, interest, and penalties due on a joint return filed before your divorce. This
responsibility may apply even if your divorce decree states that your former spouse will be responsible for any amounts due on previously filed joint
returns.
Relief from joint liability.
In some cases, one spouse may be relieved of joint liability for tax, interest, and penalties on a joint return for items of the other spouse that
were incorrectly reported on the joint return. You can ask for relief no matter how small the liability.
There are three types of relief available.
Innocent spouse relief, which applies to all joint filers.
Separation of liability, which applies to joint filers who are divorced, widowed, legally separated, or have not lived together for the 12
months ending on the date election of this relief is filed.
Equitable relief, which applies to all joint filers who do not qualify for innocent spouse relief or separation of liability and to married
couples filing separate returns in community property states.
Form:8857:Innocent spouse reliefInnocent spouse relief:Form 8857You must file Form 8857, Request for Innocent Spouse Relief, to request any of these kinds of relief. Publication
971, Innocent Spouse Relief, explains these kinds of relief and who may qualify for them.
Signing a joint return.Joint returns:SigningSignatures:Joint returns
For a return to be considered a joint return, both husband and wife generally must sign the return.
Spouse died before signing.
If your spouse died before signing the return, the executor or administrator must sign the return for your spouse. If neither you nor anyone else
has yet been appointed as executor or administrator, you can sign the return for your spouse and enter Filing as surviving spouse in the area
where you sign the return.
Spouse away from home.
If your spouse is away from home, you should prepare the return, sign it, and send it to your spouse to sign so that it can be filed on time.
Injury or disease prevents signing.
If your spouse cannot sign because of disease or injury and tells you to sign, you can sign your spouse's name in the proper space on the return
followed by the words By (your name), Husband (or Wife). Be sure to also sign in the space provided for your signature. Attach a dated
statement, signed by you, to the return. The statement should include the form number of the return you are filing, the tax year, the reason your
spouse cannot sign, and that your spouse has agreed to your signing for him or her.
Signing as guardian of spouse.Joint returns:Guardian of spouse, signing as
If you are the guardian of your spouse who is mentally incompetent, you can sign the return for your spouse as guardian.
Spouse in combat zone.Armed forces:Combat zone:Signing return for spouseCombat zone:Signing return for spouseWar zoneCombat zone
If your spouse is unable to sign the return because he or she is serving in a combat zone (such as the Persian Gulf Area, Yugoslavia, or
Afghanistan), or a qualified hazardous duty area (Bosnia and Herzegovina, Croatia, and Macedonia), and you do not have a power of attorney or other
statement, you can sign for your spouse. Attach a signed statement to your return that explains that your spouse is serving in a combat zone. For more
information on special tax rules for persons who are serving in a combat zone, or who are in missing status as a result of serving in a combat zone,
get Publication 3, Armed Forces' Tax Guide.
Other reasons spouse cannot sign.
Form:2848:Power of attorney and declaration of representativePower of attorneyIf your spouse cannot sign the joint return for any other reason, you can sign for your spouse only if you are
given a valid power of attorney (a legal document giving you permission to act for your spouse). Attach the power of attorney (or a copy of it) to
your tax return. You can use Form 2848, Power of Attorney and Declaration of Representative.
Nonresident alien or dual-status alien.AliensDual-statusDual-status taxpayersAliensNonresidentNonresident aliensDual-status taxpayers:Joint returns not availableJoint returns:Nonresident or dual-status alien spouseMarried taxpayers:Dual-status alien spouseMarried taxpayers:Nonresident alien spouseNonresident aliens:Spouse:Joint returns not availableSpouseSurviving spouseMarried taxpayers
A joint return generally cannot be filed if either spouse is a nonresident alien at any time during the tax year. However, if one spouse was a
nonresident alien or dual-status alien who was married to a U.S. citizen or resident at the end of the year, the spouses can choose to file a joint
return. If you do file a joint return, you and your spouse are both treated as U.S. residents for the entire tax year. For information on this choice,
see chapter 1 of Publication 519.
Married Filing SeparatelyFiling requirements:Married filing separatelyFiling status:Married filing separatelyMarried filing separatelyMarried taxpayers:Married filing separatelySeparate returnsMarried filing separatelySeparated taxpayers:Filing status
You can choose married filing separately as your filing status if you are married. This filing status may benefit you if you want to be responsible
only for your own tax or if it results in less tax than filing a joint return.
If you and your spouse do not agree to file a joint return, you may have to use this filing status unless you qualify for head of household status,
discussed next.
You may be able to choose head of household filing status if you live apart from your spouse, meet certain tests, and are considered unmarried
(explained later, under Head of Household). This can apply to you even if you are not divorced or legally separated. If you qualify to file
as head of household, instead of as married filing separately, your tax may be lower, you may be able to claim the earned income credit and certain
other credits, and your standard deduction will be higher. The head of household filing status allows you to choose the standard deduction even if
your spouse chooses to itemize deductions. See Head of Household, later, for more information.
Unless you are required to file separately, you should figure your tax both ways (on a joint return and on separate returns). This way you can make
sure you are using the filing status that results in the lowest combined tax. However, you will generally pay more combined tax on separate returns
than you would on a joint return for the reasons listed under Special Rules, later.
How to file.Form:1040:Use ofForm:1040A:Use ofHead of household:Filing requirements (Table 1-1)Married filing separately:Gross income filing requirements (Table 1-1)Married filing separately:How to fileMarried taxpayers:Gross income filing requirements (Table 1-1)Separate returnsMarried filing separately
If you file a separate return, you generally report only your own income, exemptions, credits, and deductions on your individual return. You can
claim an exemption for your spouse if your spouse had no gross income and was not the dependent of another person. However, if your spouse had any
gross income or was the dependent of someone else, you cannot claim an exemption for him or her on your separate return.
Schedule:Y-2Tax rates for married filing separatelyTax rates:Married filing separately (Schedule Y–2)If you file as married filing separately, you can use Form 1040A or Form
1040. Select this filing status by checking the box on line 3 of either form. You also must enter your spouse's social security number and full name
in the spaces provided. Use the Married filing separately column of the Tax Table or Section C of the Tax Computation Worksheet to figure
your tax.
If you choose married filing separately as your filing status, the following special rules apply. Because of these special rules, you will usually
pay more tax on a separate return than if you used another filing status that you qualify for.
Your tax rate generally will be higher than it would be on a joint return.
Your exemption amount for figuring the alternative minimum tax will be half that allowed to a joint return filer.
You cannot take the credit for child and dependent care expenses in most cases, and the amount that you can exclude from income under an
employer's dependent care assistance program is limited to $2,500 (instead of $5,000 if you filed a joint return). For more information about these
expenses, the credit, and the exclusion, see chapter 32.
You cannot take the earned income credit.
You cannot take the exclusion or credit for adoption expenses in most cases.
You cannot take the education credits (the Hope credit and the lifetime learning credit), the deduction for student loan interest, or the
tuition and fees deduction.
You cannot exclude any interest income from qualified U.S. savings bonds that you used for higher education expenses.
If you lived with your spouse at any time during the tax year:
You cannot claim the credit for the elderly or the disabled.
You will have to include in income more (up to 85%) of any social security or equivalent railroad retirement benefits you received, and
You cannot roll over amounts from a traditional IRA into a Roth IRA.
The following deductions and credits are reduced at income levels that are half those for a joint return:
The child tax credit,
The retirement savings contributions credit,
Itemized deductions, and
The deduction for personal exemptions.
Your capital loss deduction limit is $1,500 (instead of $3,000 if you filed a joint return).
If your spouse itemizes deductions, you cannot claim the standard deduction. If you can claim the standard deduction, your basic standard
deduction is half the amount allowed on a joint return.
You may not be able to deduct all or part of your contributions to a traditional IRA if you or your spouse was covered by an employee retirement
plan at work during the year. Your deduction is reduced or eliminated if your income is more than a certain amount. This amount is much lower for
married individuals who file separately and lived together at any time during the year. For more information, see How Much Can You Deduct
in chapter 17.
Rental activity losses.Gains and losses:Passive activityPassive activityLossesGains and lossesPassive activityLossesRental income and expenses:Losses from rental real estate activities
If you actively participated in a passive rental real estate activity that produced a loss, you generally can deduct the loss from your nonpassive
income, up to $25,000. This is called a special allowance. However, married persons filing separate returns who lived together at any time during the
year cannot claim this special allowance. Married persons filing separate returns who lived apart at all times during the year are each allowed a
$12,500 maximum special allowance for losses from passive real estate activities. See Limits on Rental Losses in chapter 9.
Community property states.Community property:Married filing separatelyMarried filing separately:Community property states
If you live in Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, or Wisconsin and file separately, your income may be
considered separate income or community income for income tax purposes. See Publication 555.
Joint Return After
Separate ReturnsJoint returns:After separate return
Form:1040X:Change of filing statusYou can change your filing status by filing an amended return using Form 1040X.
If you or your spouse (or both of you) file a separate return, you generally can change to a joint return any time within 3 years from the due date
of the separate return or returns. This does not include any extensions. A separate return includes a return filed by you or your spouse claiming
married filing separately, single, or head of household filing status.
Separate Returns After
Joint ReturnJoint returns:Separate return after joint
Once you file a joint return, you cannot choose to file separate returns for that year after the due date of the return.
Exception.
A personal representative for a decedent can change from a joint return elected by the surviving spouse to a separate return for the decedent. The
personal representative has 1 year from the due date of the return to make the change. See Publication 559 for more information on filing a return for
a decedent.
Head of HouseholdFiling status:Head of household
You may be able to file as head of household if you meet all the following requirements.
You are unmarried or considered unmarried on the last day of the year.
You paid more than half the cost of keeping up a home for the year.
A qualifying person lived with you in the home for more than half the year (except for temporary absences, such as school). However,
if the qualifying person is your dependent parent, he or she does not have to live with you. See Special rule for parent, later,
under Qualifying Person.
Head of householdQualifying person
If you qualify to file as head of household, your tax rate usually will be lower than the rates for single or married filing separately. You will
also receive a higher standard deduction than if you file as single or married filing separately.
Kidnapped child.
A child may qualify you to file as head of household even if the child has been kidnapped. For more information, see Publication 501.
How to file.Head of household:How to file
If you file as head of household, you can use either Form 1040A or Form 1040. Indicate your choice of this filing status by checking the box on
line 4 of either form. Use the Head of household column of the Tax Table or Section D of the Tax Computation Worksheet to figure your tax.
Considered UnmarriedMarried taxpayers:Joint returnsMarried filing separatelyTenants by the entiretySeparated taxpayers:Filing status
To qualify for head of household status, you must be either unmarried or considered unmarried on the last day of the year. You are considered
unmarried on the last day of the tax year if you meet all the following tests.
You file a separate return, defined earlier under Joint Return After Separate Returns.
You paid more than half the cost of keeping up your home for the tax year.
Your spouse did not live in your home during the last 6 months of the tax year. Your spouse is considered to live in your home even if he or
she is temporarily absent due to special circumstances. See Temporary absences, under Qualifying Person, later.
Your home was the main home of your child, stepchild, or eligible foster child for more than half the year. (See Home of qualifying
person, under Qualifying Person, later, for rules applying to a child's birth, death, or temporary absence during the year.)
You must be able to claim an exemption for the child. However, you meet this test if you cannot claim the exemption only because the
noncustodial parent can claim the child using the rules described in Children of divorced or separated parents under Qualifying
Child in chapter 3, or in Support Test for Children of Divorced or Separated Parents under Qualifying Relative in chapter
3. The general rules for claiming an exemption for a dependent are explained under Exemptions for Dependents in chapter 3.
If you were considered married for part of the year and lived in a community property state (listed earlier under Married Filing Separately),
special rules may apply in determining your income and expenses. See Publication 555 for more information.
You are considered unmarried for head of household purposes if your spouse was a nonresident alien at any time during the year and you do not
choose to treat your nonresident spouse as a resident alien. However, your spouse is not a qualifying person for head of household purposes. You must
have another qualifying person and meet the other tests to be eligible to file as a head of household.
Earned income credit.Credits:Earned incomeEarned Income CreditEarned Income Credit:Considered unmarried
Even if you are considered unmarried for head of household purposes because you are married to a nonresident alien, you are still considered
married for purposes of the earned income credit (unless you meet the five tests listed earlier). You are not entitled to the credit unless you file a
joint return with your spouse and meet other qualifications. See chapter 36 for more information.
Choice to treat spouse as resident.AliensResidentResident aliensForeign nationalsResident aliensResident aliens:Spouse treated as
You are considered married if you choose to treat your spouse as a resident alien.
Keeping Up a HomeDwelling unitsHomeHead of household:Cost of keeping up homeHome:Cost of keeping upHousingHomePrincipal residenceHome
To qualify for head of household status, you must pay more than half of the cost of keeping up a home for the year. You can determine whether you
paid more than half of the cost of keeping up a home by using the worksheet
shown on the next page.
Cost of Keeping Up a Home Head of household:Cost of keeping up home:WorksheetHome:Cost of keeping up:WorksheetWorksheets:Head of household status and cost of keeping up homeAmount
YouPaidTotalCostProperty taxes $ $ Mortgage interest expense Rent Utility charges Upkeep and repairs Property insurance Food consumed
on the premises Other household expenses Totals$ $ Minus total amount you paid (
) Amount others paid$ If the total amount you paid is more than the amount others paid, you meet the requirement of paying
more than half the cost of keeping up the home.
Costs you include.
Include in the cost of upkeep expenses such as rent, mortgage interest, real estate taxes, insurance on the home, repairs, utilities, and food
eaten in the home.
Costs you do not include.
Do not include in the cost of upkeep expenses such as clothing, education, medical treatment, vacations, life insurance, or transportation. Also,
do not include the rental value of a home you own or the value of your services or those of a member of your household.
Qualifying PersonFiling status:Head of household:Qualifying person to file asHead of household:Qualifying person to file as
See Table 2-1
to see who is a qualifying person.
Any person not described in Table 2-1 is not a qualifying person.
Home of qualifying person.
Generally, the qualifying person must live with you for more than half of the year.
Special rule for parent.
If your qualifying person is your father or mother, you may be eligible to file as head of household even if your father or mother does not live
with you. However, you must be able to claim an exemption for your father or mother. Also, you must pay more than half the cost of keeping up a home
that was the main home for the entire year for your father or mother. You are keeping up a main home for your father or mother if you pay more than
half the cost of keeping your parent in a rest home or home for the elderly.
Temporary absences.
You and your qualifying person are considered to live together even if one or both of you are temporarily absent from your home due to special
circumstances such as illness, education, business, vacation, or military service. It must be reasonable to assume that the absent person will return
to the home after the temporary absence. You must continue to keep up the home during the absence.
Death or birth.Birth of child:Head of household, qualifying person to file asChildren:Birth of child:Head of household, qualifying person to file asChildren:Death of child:Head of household, qualifying person to file as
You may be eligible to file as head of household if the individual who qualifies you for this filing status is born or dies during the year. You
must have provided more than half of the cost of keeping up a home that was the individual's main home for more than half the year or, if less, the
period during which the individual lived.
Example.
You are unmarried. Your mother, for whom you can claim an exemption, lived in an apartment by herself. She died on September 2. The cost of the
upkeep of her apartment for the year until her death was $6,000. You paid $4,000 and your brother paid $2,000. Your brother made no other payments
toward your mother's support. Your mother had no income. Because you paid more than half the cost of keeping up your mother's apartment from January 1
until her death, and you can claim an exemption for her, you can file as a head of household.
Married child.
Your child who is married at the end of the year generally cannot be your qualifying person unless you can claim the child as a dependent. However,
the child is a qualifying person if all three of the following requirements are met.
The child is your qualifying child (as defined under Exemptions for Dependents) in chapter 3.
The child does not file a joint return, unless the return is filed only as a claim for refund and no tax liability would exist for either
spouse if they had filed separate returns.
The child is a U.S. citizen or resident, or a resident of Canada or Mexico. (This requirement is met if you are a U.S. citizen and the child
is an adopted child who lived with you all year as a member of your household.)
Head of household:Qualifying person to file as:Summary (Table 2-1)Tables and figures:Head of household, qualifying person (Table 2-1)
<ROM>Table 2-1.</ROM> Who Is a Qualifying Person for Filing as Head of Household?<ROM>
<SUP>1</SUP></ROM>Caution: See the text of this chapter for the other requirements you must meet to claim head of household filing status.IF the person is your . . .AND . . .THEN that person is . . .qualifying child (such as a son, daughter, or grandchild who lived with you more than half the year
and meets certain other tests)
2he or she is singlea qualifying person, whether or not you can claim an exemption for the person.he or she is married
and you can claim an exemption for him or hera qualifying person.he or she is married
and you cannot claim an exemption for him or hernot a qualifying person.
3qualifying relative
4 who is your father or motheryou can claim an exemption for him or hera qualifying person.
5you cannot claim an exemption for him or hernot a qualifying person.qualifying relative
4 other than
your father or mother (such as a grandparent, brother, or sister
who meets certain tests)
6he or she lived with you more than half the year,
and you can claim an exemption for him or her
7a qualifying person.he or she did not live with you more than half the yearnot a qualifying person.you cannot claim an exemption for him or hernot a qualifying person.1A person cannot qualify more than one taxpayer to use the head of household filing status for the year.2The term qualifying child is defined under Exemptions for Dependents in chapter 3. Note: If you are a
noncustodial parent, the term qualifying child for head of household filing status does not include a child who is your qualifying child for
exemption purposes only because of the rules described under Children of divorced or separated parents under Qualifying Child in
chapter 3. If you are the custodial parent and those rules apply, the child generally is your qualifying child for head of household filing status
even though the child is not a qualifying child for whom you can claim an exemption.3 This person is a qualifying person if the requirements described under Married child in this chapter are met.4The term qualifying relative is defined under Exemptions for Dependents in chapter 3.5See Special rule for parent in this chapter for an additional requirement.6A person who is your qualifying relative only because he or she lived with you all year as a member of your household is not a qualifying
person.7If you can claim an exemption for a person only because of a multiple support agreement, that person is not a qualifying person. See
Multiple Support Agreement, in chapter 3.
Qualifying Widow(er)
With Dependent ChildHead of household:Qualifying surviving spouse with dependent childSurviving spouse:Filing status:With dependent child
If your spouse died in 2005, you can use married filing jointly as your filing status for 2005 if you otherwise qualify to use that status. The
year of death is the last year for which you can file jointly with your deceased spouse. See Married Filing Jointly, earlier.
You may be eligible to use qualifying widow(er) with dependent child as your filing status for 2 years following the year your spouse died. For
example, if your spouse died in 2004, and you have not remarried, you may be able to use this filing status for 2005 and 2006.
This filing status entitles you to use joint return tax rates and the highest standard deduction amount (if you do not itemize deductions). This
status does not entitle you to file a joint return.
How to file.
If you file as qualifying widow(er) with dependent child, you can use either Form 1040A or Form 1040. Indicate your filing status by checking the
box on line 5 of either form. Use the Married filing jointly column of the Tax Table or Section B of the Tax Computation Worksheet to
figure your tax.
Eligibility rules.
You are eligible to file your 2005 return as a qualifying widow(er) with dependent child if you meet all of the following tests.
You were entitled to file a joint return with your spouse for the year your spouse died. It does not matter whether you actually filed a
joint return.
Your spouse died in 2003 or 2004 and you did not remarry before the end of 2005.
You have a child or stepchild for whom you can claim an exemption (This does not include a foster child).
You paid more than half the cost of keeping up a home that is the main home for you and that child for the entire year, except for temporary
absences. See Temporary absences and Keeping Up a Home, discussed earlier under Head of Household.
As mentioned earlier, this filing status is only available for 2 years following the year your spouse died.
Example.
John Reed's wife died in 2003. John has not remarried. During 2004 and 2005, he continued to keep up a home for himself and his child (for whom he
can claim an exemption). For 2003 he was entitled to file a joint return for himself and his deceased wife. For 2004 and 2005, he can file as
qualifying widower with a dependent child. After 2005 he can file as head of household if he qualifies.
Death or birth.Birth of child:Head of household, qualifying person to file asChildren:Birth of child:Head of household, qualifying person to file asChildren:Death of child:Head of household, qualifying person to file as
Filing statusYou may be eligible to file as a qualifying widow(er) with dependent child if the child who qualifies
you for this filing status is born or dies during the year. You must have provided more than half of the cost of keeping up a home that was the
child's main home during the entire part of the year he or she was alive.
Personal Exemptions and DependentsPersonal exemptionDeductions:Personal exemptionExemptions:PersonalPersonal exemptionWhat's New for 2005Exemption for dependent.
Beginning in 2005, you will use new rules to determine whether you can claim an exemption for a dependent. You can claim an exemption for a
qualifying child or a qualifying relative. See Exemptions for Dependents.
Exemption amount.
The amount you can deduct for each exemption has increased from $3,100 in 2004 to $3,200 in 2005.
You lose all or part of the benefit of your exemptions if your adjusted gross income is above a certain amount. The amount at which this phaseout
begins depends on your filing status. For 2005, the phaseout begins at $109,475 for married persons filing separately, $145,950 for single
individuals, $182,450 for heads of household, and $218,950 for married persons filing jointly or qualifying widow(er)s. See Phaseout of
Exemptions, later.
Katrina Emergency Tax Relief Act of 2005.
This Act provides tax relief for persons affected by Hurricane Katrina. Under the Act, you may be able to claim a $500 exemption if you housed an
individual displaced by Hurricane Katrina. You may also be able to claim a student even if he or she was prevented from completing the normal school
term. See Publication 4492.
This chapter discusses exemptions. The following topics will be explained.
Personal exemptions — You generally can take one for yourself and, if you are married, one for your spouse.
Exemptions for dependents — You generally can take an exemption for each of your dependents. A dependent is your qualifying child or
qualifying relative. If you are entitled to claim an exemption for a dependent, that dependent cannot claim a personal exemption on his or her own tax
return.
Phaseout of exemptions — You get less of a deduction when your adjusted gross income goes above a certain amount.
Social security number (SSN) requirement for dependents — You must list the social security number of any dependent for whom you claim
an exemption.
Deduction.
Exemptions reduce your taxable income. Generally, you can deduct $3,200 for each exemption you claim in 2005. But, you may lose the benefit of part
or all of your exemptions if your adjusted gross income is above a certain amount. See Phaseout of Exemptions, later.
How you claim an exemption.
How you claim an exemption on your tax return depends on which form you file.
Form:1040EZ:Personal exemptionIf you file Form 1040EZ, the exemption amount is combined with the standard deduction amount and
entered on line 5.
Form:1040:Personal exemptionForm:1040A:Personal exemptionIf you file Form 1040A or Form 1040, follow the instructions for the form. The total number of
exemptions you can claim is the total in the box on line 6d. Also complete line 26 (Form 1040A) or line 42 (Form 1040) by multiplying the total number
of exemptions shown in the box on line 6d by $3,200. If your adjusted gross income is more than $109,475, see Phaseout of Exemptions,
later.
Publication501Exemptions, Standard Deduction, and Filing InformationForm (and Instructions)Multiple Support DeclarationRelease of Claim to Exemption for Child of Divorced or Separated Parents
Exemptions
There are two types of exemptions: personal exemptions and exemptions for dependents. While each is worth the same amount ($3,200 for 2005),
different rules apply to each type.
Personal Exemptions
You are generally allowed one exemption for yourself and, if you are married, one exemption for your spouse. These are called personal exemptions.
Your Own ExemptionDeductions:Personal exemptionExemptions:PersonalPersonal exemptionPersonal exemption
You can take one exemption for yourself unless you can be claimed as a dependent by another taxpayer. If another taxpayer is entitled to claim you
as a dependent, you cannot take an exemption for yourself even if the other taxpayer does not actually claim you as a dependent.
Your Spouse's ExemptionPersonal exemption:Spouse's exemption
On a joint return you can claim one exemption for yourself and one for your spouse.
Separate return.
If you file a separate return, you can claim the exemption for your spouse only if your spouse had no gross income, is not filing a return, and was
not the dependent of another taxpayer. This is true even if the other taxpayer does not actually claim your spouse as a dependent. This is also true
if your spouse is a nonresident alien.
Death of spouse.Decedents:Deceased spouse:Personal exemption
If your spouse died during the year, you generally can claim your spouse's exemption under the rules just explained under Joint return and
Separate return.
If you remarried during the year, you cannot take an exemption for your deceased spouse.
If you are a surviving spouse without gross income and you remarry in the year your spouse died, you can be claimed as an exemption on both the
final separate return of your deceased spouse and the separate return of your new spouse for that year. If you file a joint return with your new
spouse, you can be claimed as an exemption only on that return.
Divorced or separated spouse.Divorced taxpayers:Personal exemptionSeparated taxpayers:Personal exemption
If you obtained a final decree of divorce or separate maintenance by the end of the year, you cannot take your former spouse's exemption. This rule
applies even if you provided all of your former spouse's support.
Exemptions for DependentsExemptions:DependentsDependents:Exemption for
You are allowed one exemption for each person you can claim as a dependent. You can claim an exemption for a dependent even if your dependent files
a return.
Beginning in 2005, the term dependent means:
A qualifying child, or
A qualifying relative.
The terms qualifying child and qualifying relative are defined later.
You can claim an exemption for a qualifying child or qualifying relative only if these three tests are met.
Dependent taxpayer test.
Joint return test.
Citizen or resident test.
These three tests are explained in detail later.
All the requirements for claiming an exemption for a dependent are summarized in Table 3-1.
<ROM>Table 3-1.</ROM>
<IMARK> Overview of the Rules for Claiming an Exemption for a Dependent Caution: This table is only an overview of the rules. For details, see the rest of this chapter.
You cannot claim any dependents if you, or your spouse if filing jointly, could be claimed as a dependent by another taxpayer.
You cannot claim a married person who files a joint return as a dependent unless that joint return is only a claim for refund and there
would be no tax liability for either spouse on separate returns.
You cannot claim a person as a dependent unless that person is a U.S. citizen, U.S. resident, U.S. national, or a resident of Canada or
Mexico, for some part of the year.
1
You cannot claim a person as a dependent unless that person is your qualifying child or qualifying
relative.
Tests To Be a Qualifying ChildTests To Be a Qualifying Relative
The child must be your son, daughter, stepchild, eligible foster child, brother, sister, half brother, half sister, stepbrother, stepsister,
or a descendant of any of them.
The child must be (a) under age 19 at the end of the year, (b) under age 24 at the end of the year and a full-time student, or (c) any age
if permanently and totally disabled.
The child must have lived with you for more than half of the year.
2
The child must not have provided more than half of his or her own support for the year.
If the child meets the rules to be a qualifying child of more than one person, you must be the person entitled to claim the child as a
qualifying child.
The person cannot be your qualifying child or the qualifying child of anyone else.
The person either (a) must be related to you in one of the ways listed under Relatives who do not have to live with you, or (b)
must live with you all year as a member of your household.
2
The person's gross income for the year must be less than $3,200.
3
You must provide more than half of the person's total support for the year.
4
1There is an exception for certain adopted children.2There are exceptions for temporary absences, children who were born or died during the year, children of divorced or separated parents,
and kidnapped children.3There is an exception if the person is disabled and has income from a sheltered workshop.4There is an exception for multiple support agreements.
Dependent not allowed a personal exemption. If you can claim an exemption for your dependent, the dependent cannot claim his or her own
exemption on his or her own tax return. This is true even if you do not claim the dependent's exemption on your return or if the exemption will be
reduced or eliminated under the phaseout rule described under Phaseout of Exemptions, later.
Housekeepers, maids, or servants.Domestic help, no exemption forHousehold workers, no exemption for
If these people work for you, you cannot claim exemptions for them.
Child tax credit.Child tax credit
You may be entitled to a child tax credit for each qualifying child who was under age 17 at the end of the year. For more information, see the
instructions in your tax forms package.
Dependent Taxpayer TestDependent taxpayer testDependents not allowed to claim dependents
If you could be claimed as a dependent by another person, you cannot claim anyone else as a dependent. Even if you have a qualifying child or
qualifying relative, you cannot claim that person as a dependent.
If you are filing a joint return and your spouse could be claimed as a dependent by someone else, you and your spouse cannot claim any dependents
on your joint return.
You generally cannot claim a married person as a dependent if he or she files a joint return.
Example.
You supported your 18-year-old daughter, and she lived with you all year while her husband was in the Armed Forces. The couple files a joint
return. Even though your daughter is your qualifying child, you cannot take an exemption for her.
Exception.
The joint return test does not apply if a joint return is filed by the dependent and his or her spouse merely as a claim for refund and no tax
liability would exist for either spouse on separate returns.
Example.
Your son and his wife each had less than $3,000 of wages and no unearned income. Neither is required to file a tax return. Taxes were taken out of
their pay, so they filed a joint return to get a refund. You are not disqualified from claiming their exemptions just because they filed a joint
return.
Citizen or Resident TestCitizen or resident testU.S. citizen or residentCanada, resident ofMexico, resident of
You cannot claim a person as a dependent unless that person is a U.S. citizen, U.S. resident, U.S. national, or a resident of Canada or Mexico, for
some part of the year. However, there is an exception for certain adopted children, as explained next.
If you are a U.S. citizen who has legally adopted a child who is not a U.S. citizen, U.S. resident, or U.S. national, this test is met if the child
lived with you as a member of your household all year. This also applies if the child was lawfully placed with you for legal adoption.
Child's place of residence.
Children usually are citizens or residents of the country of their parents.
If you were a U.S. citizen when your child was born, the child may be a U.S. citizen even if the other parent was a nonresident alien and the child
was born in a foreign country. If so, this test is met.
Foreign students' place of residence.Foreign studentsStudents:Foreign
Foreign students brought to this country under a qualified international education exchange program and placed in American homes for a temporary
period generally are not U.S. residents and do not meet this test. You cannot claim an exemption for them. However, if you provided a home for a
foreign student, you may be able to take a charitable contribution deduction. See Expenses Paid for Student Living With You in chapter 24.
U.S. national.U.S. nationalNational of the United States
A U.S. national is an individual who, although not a U.S. citizen, owes his or her allegiance to the United States. U.S. nationals include American
Samoans and Northern Mariana Islanders who chose to become U.S. nationals instead of U.S. citizens.
Qualifying ChildQualifying childChild, qualifyingDependents:Qualifying child
There are five tests that must be met for a child to be your qualifying child. The five tests are:
Relationship,
Age,
Residency,
Support, and
Special test for qualifying child of more than one person.
These tests are explained next.
Relationship TestRelationship test
To meet this test, a child must be:
Your son, daughter, stepchild, eligible foster child, or a descendant (for example, your grandchild) of any of them, or
Your brother, sister, half brother, half sister, stepbrother, stepsister, or a descendant (for example, your niece or nephew) of any of
them.
Adopted child.Adopted child
An adopted child is always treated as your own child. The term adopted child includes a child who was lawfully placed with you for legal
adoption.
An eligible foster child is an individual who is placed with you by an authorized placement agency or by judgment, decree, or other order of any
court of competent jurisdiction.
Age TestAge test
To meet this test, a child must be:
Under age 19 at the end of the year,
A full-time student under age 24 at the end of the year, or
Permanently and totally disabled at any time during the year, regardless of age.
Example.
Your son turned 19 on December 10. Unless he was disabled or a full-time student, he does not meet the age test because, at the end of the year, he
was not under age 19.
Full-time student.
A full-time student is a student who is enrolled for the number of hours or courses the school considers to be full-time attendance.
Student defined.Students:Defined
To qualify as a student, your child must be, during some part of each of any 5 calendar months of the year:
A full-time student at a school that has a regular teaching staff, course of study, and a regularly enrolled student body at the school, or
A student taking a full-time, on-farm training course given by a school described in (1), or by a state, county, or local government
agency.
The 5 calendar months do not have to be consecutive.
School defined.
A school can be an elementary school, junior and senior high school, college, university, or technical, trade, or mechanical school. However, an
on-the-job training course, correspondence school, or Internet school does not count as a school.
Vocational high school students.
Students who work on co-op jobs in private industry as a part of a school's regular course of classroom and practical training are
considered full-time students.
Permanently and totally disabled.
Your child is permanently and totally disabled if both of the following apply.
He or she cannot engage in any substantial gainful activity because of a physical or mental condition.
A doctor determines the condition has lasted or can be expected to last continuously for at least a year or can lead to death.
Residency TestResidency test
To meet this test, your child must have lived with you for more than half of the year. There are exceptions for temporary absences, children who
were born or died during the year, kidnapped children, and children of divorced or separated parents.
Your child is considered to have lived with you during periods of time when one of you, or both, are temporarily absent due to special
circumstances such as:
Illness,
Education,
Business,
Vacation, or
Military service.
Death or birth of child.Death of childBirth of child
A child who was born or died during the year is treated as having lived with you all year if your home was the child's home the entire time he or
she was alive during the year. The same is true if the child lived with you all year except for any required hospital stay following birth.
Child born alive.Child born alive
You may be able to claim an exemption for a child who was born alive during the year, even if the child lived only for a moment. State or local law
must treat the child as having been born alive. There must be proof of a live birth shown by an official document, such as a birth certificate. The
child must be your qualifying child or qualifying relative, and all the other tests to claim an exemption for a dependent must be met.
Stillborn child.Stillborn childChildren:Stillborn
You cannot claim an exemption for a stillborn child.
You can treat your child as meeting the residency test even if the child has been kidnapped, but both of the following statements must be true.
The child is presumed by law enforcement authorities to have been kidnapped by someone who is not a member of your family or the child's
family.
In the year the kidnapping occurred, the child lived with you for more than half of the part of the year before the date of the
kidnapping.
This treatment applies for all years until the child is returned. However, the last year this treatment can apply is the earlier of:
The year there is a determination that the child is dead, or
The year the child would have reached age 18.
Children of divorced or separated parents.Parents, divorced or separatedDivorced parentsSeparated parents
A child will be treated as the qualifying child of his or her noncustodial parent if all of the following apply.
The parents:
Are divorced or legally separated under a decree of divorce or separate maintenance,
Are separated under a written separation agreement, or
Lived apart at all times during the last 6 months of the year.
The child received over half of his or her support for the year from the parents.
The child is in the custody of one or both parents for more than half of the year.
A decree of divorce or separate maintenance or written separation agreement that applies to 2005 provides that the noncustodial parent can
claim the child as a dependent (and, in the case of a pre-1985 agreement, the noncustodial parent provides at least $600 for the support of the child
during the year) or the custodial parent signs a written declaration that he or she will not claim the child as a dependent for the
year.
Written declaration.Form:8332Release of exemption to noncustodial parent
The custodial parent may use either Form 8332 or a similar statement (containing the information required by the form) to make the written
declaration to release the exemption to the noncustodial parent.
The exemption can be released for 1 year, for a number of specified years (for example, alternate years), or for all future years, as specified in
the declaration.
Custodial parent and noncustodial parent.Child custodyChildren:Custody ofCustody of childDivorced taxpayers:Child custody
The custodial parent is the parent with whom the child lived for the greater part of the year. The other parent is the noncustodial parent.
If the parents divorced or separated during the year and the child lived with both parents before the separation, the custodial parent is the one
with whom the child lived for the greater part of the rest of the year.
Example.
Your child lived with you for 10 months of the year. The child lived with your former spouse for the other 2 months. You are considered the
custodial parent.
Parents who never married.
This special rule for divorced or separated parents also applies to parents who never married.
Support Test (To Be a Qualifying Child)Support test:Qualifying child
To meet this test, the child cannot have provided more than half of his or her own support for the year.
This test is different from the support test to be a qualifying relative, which is described later. However, to see what is or is not support, see
Support Test (To Be a Qualifying Relative), later. If you are not sure whether a child provided more than half of his or her own support,
you may find Worksheet 3-1 helpful.
Scholarships.Scholarships
A scholarship received by a child who is a full-time student is not taken into account in determining whether the child provided more than half of
his or her own support.
Special Test for Qualifying Child of More Than One Person
If your qualifying child is not a qualifying child for anyone else, this test does not apply to you and you do not need to read about it. This is
also true if your qualifying child is not a qualifying child for anyone else except your spouse with whom you file a joint return.
If a child is treated as the qualifying child of the noncustodial parent under the rules for children of divorced or separated parents described
earlier, see Applying this special test to divorced or separated parents, later.
Sometimes, a child meets the relationship, age, residency, and support tests to be a qualifying child of more than one person. Although the child
is a qualifying child of each of these persons, only one person can actually treat the child as a qualifying child. To meet this special test, you
must be the person who can treat the child as a qualifying child.
If you and another person have the same qualifying child, you and the other person(s) can decide which of you will treat the child as a qualifying
child. That person can take all of the following tax benefits (provided the person is eligible for each benefit) based on the qualifying child.
The exemption for the child.
The child tax credit.
Head of household filing status.
The credit for child and dependent care expenses.
The earned income credit.
The other person cannot take any of these benefits based on this qualifying child. In other words, you and the other person cannot agree to
divide these tax benefits between you.
If you and the other person(s) cannot agree on who will claim the child and more than one person files a return claiming the same child, the IRS
will disallow all but one of the claims using the tie-breaker rule in Table 3-2.
<ROM>Table 3-2.</ROM>
<IMARK>When More Than One Person Files a Return Claiming the Same Qualifying Child (Tie-Breaker Rule)Caution. If a child is treated as the qualifying child of the noncustodial parent under the rules for children of divorced or
separated parents, see Applying this special test to divorced or separated parents.IF more than one person files a return claiming the same
qualifying child and . . .THEN the child will be treated as the qualifying child of the. .
.only one of the persons is the child's parent,parent.two of the persons are parents of the child and they do not file a joint
return together,parent with whom the child lived for the longer period of time during the year.two of the persons are parents of the child, they do not file a joint
return together, and the child lived with each parent the same amount of time during the year,parent with the highest adjusted gross income (AGI).none of the persons are the child's parent,person with the highest AGI.
Example 1—child lived with parent and grandparent.
You and your 3-year-old daughter Jade lived with your mother all year. You are 25 years old and earned $9,000 for the year. Jade is a qualifying
child of both you and your mother because she meets the relationship, age, residency, and support tests for both you and your mother. However, only
one of you can claim her. You agree to let your mother claim Jade. This means she can claim Jade as a dependent and can claim her as a qualifying
child for the child tax credit, head of household filing status, credit for child and dependent care expenses, and the earned income credit, if she
qualifies for each of those tax benefits.
Example 2—two persons unable to agree.
The facts are the same as in Example 1 except that you and your mother are unable to agree and both of you claim Jade as a dependent and claim her
as a qualifying child for the child tax credit and earned income credit. You as the child's parent will be the only one allowed to claim Jade as a
dependent and claim her as a qualifying child for the child tax credit and earned income credit. The IRS will disallow your mother's claim to these
tax benefits unless she has another qualifying child.
Example 3—qualifying children split between two persons.
The facts are the same as in Example 1 except that you also have two other young children who are qualifying children of both you and your mother.
Only one of you can claim each child as a dependent. However, you and your mother can split the three qualifying children between you. For example,
you can claim one child as a dependent and your mother can claim the other two.
Example 4—taxpayer who is a qualifying child.
The facts are the same as in Example 1 except that you are only 18 years old and did not provide more than half of your own support for the year.
This means you are your mother's qualifying child and she could claim you as a dependent. Because of the Dependent Taxpayer Test explained
earlier, you cannot treat your daughter as a qualifying child and cannot claim her as a dependent. Only your mother can treat your daughter as a
qualifying child.
Example 5—separated parents.
You, your husband, and your 10-year-old son lived together until August 1, 2005, when your husband moved out of the household. In August and
September, your son lived with you. For the rest of the year, your son lived with your husband. Your son is a qualifying child of both you and your
husband because your son lived with each of you for more than half the year and because he met the relationship, age, and support tests for both of
you. You and your husband are not divorced, legally separated, or separated under a written separation agreement, so the special rule for divorced or
separated parents does not apply.
You and your husband will file separate returns. Your husband agrees to let you treat your son as a qualifying child. This means, if your husband
does not claim your son as a qualifying child, you can claim your son as a dependent and treat him as a qualifying child for the child tax credit.
However, you cannot claim head of household filing status because you and your husband did not live apart the last 6 months of the year. As a result,
your filing status is married filing separately, so you cannot claim the earned income credit or the credit for child and dependent care expenses.
Example 6—separated parents.
The facts are the same as in Example 5 except that you and your husband are unable to agree and both of you claim your son as a qualifying child.
Only your husband will be allowed to treat your son as a qualifying child. This is because, during 2005, the boy lived with him longer than with you.
If you claimed an exemption, the child tax credit, head of household filing status, credit for child and dependent care expenses, or the earned income
credit for your son, the IRS will disallow your claim to all these tax benefits. In addition, because you and your husband did not live apart the last
6 months of the year, your husband cannot claim head of household filing status. As a result, his filing status is married filing separately, so he
cannot claim the earned income credit or the credit for child and dependent care expenses
Example 7—unmarried parents.
You, your 5-year-old son, and your son's father lived together all year. You and your son's father are not married. Your son is a qualifying child
of both you and his father because he meets the relationship, age, residency, and support tests for both you and his father. Your adjusted gross
income (AGI) is $8,000 and your son's father's AGI is $18,000. Your son's father agrees to let you treat the child as a qualifying child. This means
you can claim him as a dependent and treat him as a qualifying child for the child tax credit, head of household filing status, credit for child and
dependent care expenses, and the earned income credit, if you qualify for each of those tax benefits.
Example 8—unmarried parents.
The facts are the same as in Example 7 except that you and your son's father are unable to agree and both of you claim your son as a qualifying
child. Only your son's father will be allowed to treat your son as a qualifying child. This is because his AGI, $18,000, is more than your AGI,
$8,000. If you claimed an exemption, the child tax credit, head of household filing status, credit for child and dependent care expenses, or the
earned income credit for your son, the IRS will disallow your claim to all these tax benefits.
Example 9—child did not live with a parent.
You and your 7-year-old niece, your sister's child, lived with your mother all year. You are 25 years old, and your AGI is $9,300. Your mother's
AGI is $15,000. Your niece is a qualifying child of both you and your mother because she meets the relationship, age, residency, and support tests for
both you and your mother. However, only one of you can treat her as a qualifying child. Your mother agrees to let you treat the child as a qualifying
child.
Example 10—child did not live with a parent.
The facts are the same as in Example 9 except that you and your mother are unable to agree and both of you claim your niece as a qualifying child.
Only your mother will be allowed to treat your niece as a qualifying child. This is because your mother's AGI, $15,000, is more than your AGI, $9,300.
If you claimed an exemption, the child tax credit, head of household filing status, credit for child and dependent care expenses, or the earned income
credit for your niece, the IRS will disallow your claim to all these tax benefits.
Applying this special test to divorced or separated parents.
If a child is treated as the qualifying child of the noncustodial parent under the rules for children of divorced or separated parents described
earlier, the noncustodial parent can claim an exemption and the child tax credit for the child but cannot claim the child as a qualifying child for
head of household filing status, the credit for child and dependent care expenses, or the earned income credit. If the child is the qualifying child
of more than one other person, only one of those persons can claim the child as a qualifying child for head of household filing status, the credit for
child and dependent care expenses, and the earned income credit. No other person can claim any of these three tax benefits unless he or she has a
different qualifying child. If you and any other person file a return claiming the child as a qualifying child for any of these three tax benefits,
the IRS will disallow all but one of the claims using the tie-breaker rule in Table 3-2.
Qualifying RelativeQualifying relativeRelative, qualifyingDependents:Qualifying relative
There are four tests that must be met for a person to be your qualifying relative. The four tests are:
Not a qualifying child test,
Member of household or relationship test,
Gross income test, and
Support test.
Age.
Unlike a qualifying child, a qualifying relative can be any age. There is no age test for a qualifying relative.
You can treat a child as your qualifying relative even if the child has been kidnapped, but both of the following statements must be true.
The child is presumed by law enforcement authorities to have been kidnapped by someone who is not a member of your family or the child's
family.
In the year the kidnapping occurred, the child met the tests to be your qualifying relative for the part of the year before the date of the
kidnapping.
This treatment applies for all years until the child is returned. However, the last year this treatment can apply is the earlier of:
The year there is a determination that the child is dead, or
The year the child would have reached age 18.
Not a Qualifying Child Test
A child is not your qualifying relative if the child is your qualifying child or the qualifying child of anyone else.
Example 1.
Your 22-year-old daughter, who is a student, lives with you and meets all the tests to be your qualifying child. She is not your qualifying
relative.
Example 2.
Your 2-year-old son lives with your parents and meets all the tests to be their qualifying child. He is not your qualifying relative.
Example 3.
Your son lives with you but is not your qualifying child because he is 30 years old and does not meet the age test. He may be your qualifying
relative if the gross income test and the support test are met.
Example 4.
Your 13-year-old grandson lived with his mother for 3 months, with his uncle for 4 months, and with you for 5 months during the year. He is not
your qualifying child because he does not meet the residency test. He may be your qualifying relative if the gross income test and the support test
are met.
Member of Household or Relationship TestMember of household or relationship testRelationship test
To meet this test, a person must either:
Live with you all year as a member of your household, or
Be related to you in one of the ways listed under Relatives who do not have to live with you.
If at any time during the year the person was your spouse, that person cannot be your qualifying relative. However, see Personal
Exemptions, earlier.
Relatives who do not have to live with you.
A person related to you in any of the following ways does not have to live with you all year as a member of your household to meet this test.
Your child, stepchild, eligible foster child, or a descendant of any of them (for example, your grandchild). (A legally adopted child is
considered your child.)
Your brother, sister, half brother, half sister, stepbrother, or stepsister.
Your father, mother, grandparent, or other direct ancestor, but not foster parent.
Your stepfather or stepmother.
A son or daughter of your brother or sister.
A brother or sister of your father or mother.
Your son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law.
Any of these relationships that were established by marriage are not ended by death or divorce.
An eligible foster child is an individual who is placed with you by an authorized placement agency or by judgment, decree, or other order of any
court of competent jurisdiction.
Joint return.Joint returns:Dependents on
If you file a joint return, the person can be related to either you or your spouse. Also, the person does not need to be related to the spouse who
provides support.
For example, your spouse's uncle who receives more than half of his support from you may be your qualifying relative, even though he does not live
with you. However, if you and your spouse file separate returns, your spouse's uncle can be your qualifying relative only if he lives with you all
year as a member of your household.
A person is considered to live with you as a member of your household during periods of time when one of you, or both, are temporarily absent due
to special circumstances such as:
Illness,
Education,
Business,
Vacation, or
Military service.
If the person is placed in a nursing home for an indefinite period of time to receive constant medical care, the absence may be considered
temporary.
Death or birth.Death of dependentBirth of dependentDependents:Death ofDependents:Birth of
A person who died during the year, but lived with you as a member of your household until death, will meet this test. The same is true for a child
who was born during the year and lived with you as a member of your household for the rest of the year. The test is also met if a child lived with you
as a member of your household except for any required hospital stay following birth.
If your dependent died during the year and you otherwise qualified to claim an exemption for the dependent, you can still claim the exemption.
Example.
Your dependent mother died on January 15. She met the tests to be your qualifying relative. The other tests to claim an exemption for a dependent
were also met. You can claim an exemption for her on your return.
Local law violated.Local law violated
A person does not meet this test if at any time during the year the relationship between you and that person violates local law.
Example.
Your girlfriend lived with you as a member of your household all year. However, your relationship with her violated the laws of the state where you
live, because she was married to someone else. Therefore, she does not meet this test and you cannot claim her as a dependent.
Adopted child.Adopted child
An adopted child is always treated as your own child. The term adopted child includes a child who was lawfully placed with you for legal
adoption.
Cousin.Cousin
Your cousin meets this test only if he or she lives with you all year as a member of your household. A cousin is a descendant of a brother or
sister of your father or mother.
Gross Income TestGross income testIncome:Gross
To meet this test, a person's gross income for the year must be less than $3,200.
Gross income defined.
Gross income is all income in the form of money, property, and services that is not exempt from tax.
In a manufacturing, merchandising, or mining business, gross income is the total net sales minus the cost of goods sold, plus any miscellaneous
income from the business.
Gross receipts from rental property are gross income. Do not deduct taxes, repairs, etc., to determine the gross income from rental property.
Gross income includes a partner's share of the gross (not a share of the net) partnership income.
ScholarshipsGross income also includes all unemployment compensation and certain scholarship and fellowship grants. Scholarships
received by degree candidates that are used for tuition, fees, supplies, books, and equipment required for particular courses may not be included in
gross income. For more information about scholarships, see chapter 12.
Tax-exempt income, such as certain social security benefits, is not included in gross income.
Disabled dependent working at sheltered workshop.
For purposes of this test (the gross income test), the gross income of an individual who is permanently and totally disabled at any time during the
year does not include income for services the individual performs at a sheltered workshop. The availability of medical care at the workshop must be
the main reason for the individual's presence there. Also, the income must come solely from activities at the workshop that are incident to this
medical care.
A sheltered workshop is a school that:
Provides special instruction or training designed to alleviate the disability of the individual, and
Is operated by certain tax-exempt organizations, or by a state, a U.S. possession, a political subdivision of a state or possession, the
United States, or the District of Columbia.
Support Test (To Be a Qualifying Relative)Support test:Qualifying relative
To meet this test, you generally must provide more than half of a person's total support during the calendar year.
However, if two or more persons provide support, but no one person provides more than half of a person's total support, see Multiple Support
Agreement, later.
How to determine if support test is met.
You figure whether you have provided more than half of a person's total support by comparing the amount you contributed to that person's support
with the entire amount of support that person received from all sources. This includes support the person provided from his or her own funds.
You may find Worksheet 3-1 helpful in figuring whether you provided more than half of a person's support.
Person's own funds not used for support.
A person's own funds are not support unless they are actually spent for support.
Example.
Your mother received $2,400 in social security benefits and $300 in interest. She paid $2,000 for lodging and $400 for recreation. She put $300 in
a savings account.
Even though your mother received a total of $2,700, she spent only $2,400 for her own support. If you spent more than $2,400 for her support and no
other support was received, you have provided more than half of her support.
Child's wages used for own support.
You cannot include in your contribution to your child's support any support that is paid for by the child with the child's own wages, even if you
paid the wages.
Year support is provided.
The year you provide the support is the year you pay for it, even if you do so with borrowed money that you repay in a later year.
If you use a fiscal year to report your income, you must provide more than half of the dependent's support for the calendar year in which your
fiscal year begins.
The part of the allotment contributed by the government and the part taken out of your military pay are both considered provided by you in figuring
whether you provide more than half of the support. If your allotment is used to support persons other than those you name, you can take the exemptions
for them if they otherwise qualify.
Example.
You are in the Armed Forces. You authorize an allotment for your widowed mother that she uses to support herself and her sister. If the allotment
provides more than half of each person's support, you can take an exemption for each of them, if they otherwise qualify, even though you authorize the
allotment only for your mother.
Tax-exempt military quarters allowances.Armed forces:Military quarters allotments
These allowances are treated the same way as dependency allotments in figuring support. The allotment of pay and the tax-exempt basic allowance for
quarters are both considered as provided by you for support.
Tax-exempt income.Income:Tax exemptTax-exempt income
In figuring a person's total support, include tax-exempt income, savings, and borrowed amounts used to support that person. Tax-exempt income
includes certain social security benefits, welfare benefits, nontaxable life insurance proceeds, Armed Forces family allotments, nontaxable pensions,
and tax-exempt interest.
Example 1.
You provide $4,000 toward your mother's support during the year. She has earned income of $600, nontaxable social security benefits of $4,800, and
tax-exempt interest of $200. She uses all these for her support. You cannot claim an exemption for your mother because the $4,000 you provide is not
more than half of her total support of $9,600.
Example 2.
Your brother's daughter takes out a student loan of $2,500 and uses it to pay her college tuition. She is personally responsible for the loan. You
provide $2,000 toward her total support. You cannot claim an exemption for her because you provide less than half of her support.
Social security benefits.Social security benefits
If a husband and wife each receive benefits that are paid by one check made out to both of them, half of the total paid is considered to be for the
support of each spouse, unless they can show otherwise.
If a child receives social security benefits and uses them toward his or her own support, the benefits are considered as provided by the child.
Support provided by the state (welfare, food stamps, housing, etc.).Food stampsWelfare benefits
Benefits provided by the state to a needy person generally are considered support provided by the state. However, payments based on the needs of
the recipient will not be considered as used entirely for that person's support if it is shown that part of the payments were not used for that
purpose.
Foster care payments and expenses.Foster childFoster care payments and expenses
Payments you receive for the support of a foster child from a child placement agency are considered support provided by the agency. Similarly,
payments you receive for the support of a foster child from a state or county are considered support provided by the state or county.
If you are not in the trade or business of providing foster care and your unreimbursed out-of-pocket expenses in caring for a foster child were
mainly to benefit an organization qualified to receive deductible charitable contributions, the expenses are deductible as charitable contributions
but are not considered support you provided. For more information about the deduction for charitable contributions, see chapter 24. If your
unreimbursed expenses are not deductible as charitable contributions, they are considered support you provided.
If you are in the trade or business of providing foster care, your unreimbursed expenses are not considered support provided by you.
Example.
Lauren, an eligible foster child, lived with Mr. and Mrs. Smith for the last 3 months of the year. The Smiths cared for Lauren because they wanted
to adopt her (although she had not been placed with them for adoption). They did not care for her as a trade or business or to benefit the agency that
placed her in their home. The Smiths' unreimbursed expenses are not deductible as charitable contributions but are considered support they provided
for Lauren.
Home for the aged.Elderly persons:Home for the agedHome:Aged, home for
If you make a lump-sum advance payment to a home for the aged to take care of your relative for life and the payment is based on that person's life
expectancy, the amount of support you provide each year is the lump-sum payment divided by the relative's life expectancy. The amount of support you
provide also includes any other amounts you provided during the year.
Total SupportTotal support
To figure if you provided more than half of a person's support, you must first determine the total support provided for that person. Total support
includes amounts spent to provide food, lodging, clothing, education, medical and dental care, recreation, transportation, and similar necessities.
Generally, the amount of an item of support is the amount of the expense incurred in providing that item. For lodging, the amount of support is the
fair rental value of the lodging.
Expenses that are not directly related to any one member of a household, such as the cost of food for the household, must be divided among the
members of the household.
Example 1.
Grace Brown, mother of Mary Miller, lives with Frank and Mary Miller and their two children. Grace gets social security benefits of $2,400, which
she spends for clothing, transportation, and recreation. Grace has no other income. Frank and Mary's total food expense for the household is $5,200.
They pay Grace's medical and drug expenses of $1,200. The fair rental value of the lodging provided for Grace is $1,800 a year, based on the cost of
similar rooming facilities. Figure Grace's total support as follows:
Fair rental value of lodging $ 1,800 Clothing, transportation and recreation 2,400 Medical expenses 1,200 Share of food (1/5 of $5,200) 1,040 Total support$6,440
The support Frank and Mary provide ($1,800 lodging + $1,200 medical expenses + $1,040 food = $4,040) is more than half of Grace's $6,440 total
support.
Example 2.
Your parents live with you, your spouse, and your two children in a house you own. The fair rental value of your parents' share of the lodging is
$2,000 a year ($1,000 each), which includes furnishings and utilities. Your father receives a nontaxable pension of $4,200, which he spends equally
between your mother and himself for items of support such as clothing, transportation, and recreation. Your total food expense for the household is
$6,000. Your heat and utility bills amount to $1,200. Your mother has hospital and medical expenses of $600, which you pay during the year. Figure
your parents' total support as follows:
Support provided Father Mother Fair rental value of lodging $1,000 $1,000 Pension spent for their support 2,100 2,100 Share of food (1/6 of $6,000) 1,000 1,000 Medical expenses for mother 600 Parents' total support$4,100 $4,700
You must apply the support test separately to each parent. You provide $2,000 ($1,000 lodging, $1,000 food) of your father's total support of
$4,100 – less than half. You provide $2,600 to your mother ($1,000 lodging, $1,000 food, $600 medical) – more than half of her total
support of $4,700. You meet the support test for your mother, but not your father. Heat and utility costs are included in the fair rental value of the
lodging, so these are not considered separately.
Lodging.Lodging
If you provide a person with lodging, you are considered to provide support equal to the fair rental value of the room, apartment, house, or other
shelter in which the person lives. Fair rental value includes a reasonable allowance for the use of furniture and appliances, and for heat and other
utilities that are provided.
Fair rental value defined.Fair rental value
This is the amount you could reasonably expect to receive from a stranger for the same kind of lodging. It is used instead of actual expenses such
as taxes, interest, depreciation, paint, insurance, utilities, cost of furniture and appliances, etc. In some cases, fair rental value may be equal to
the rent paid.
If you provide the total lodging, the amount of support you provide is the fair rental value of the room the person uses, or a share of the fair
rental value of the entire dwelling if the person has use of your entire home. If you do not provide the total lodging, the total fair rental value
must be divided depending on how much of the total lodging you provide. If you provide only a part and the person supplies the rest, the fair rental
value must be divided between both of you according to the amount each provides.
Example.
Your parents live rent free in a house you own. It has a fair rental value of $5,400 a year furnished, which includes a fair rental value of $3,600
for the house and $1,800 for the furniture. This does not include heat and utilities. The house is completely furnished with furniture belonging to
your parents. You pay $600 for their utility bills. Utilities are not usually included in rent for houses in the area where your parents live.
Therefore, you consider the total fair rental value of the lodging to be $6,000 ($3,600 fair rental value of the unfurnished house, $1,800 allowance
for the furnishings provided by your parents, and $600 cost of utilities) of which you are considered to provide $4,200 ($3,600 + $600).
Person living in his or her own home.
The total fair rental value of a person's home that he or she owns is considered support contributed by that person.
Living with someone rent free.
If you live with a person rent free in his or her home, you must reduce the amount you provide for support by the fair rental value of lodging he
or she provides you.
Property.
Property provided as support is measured by its fair market value. Fair market value is the price that property would sell for on the open market.
It is the price that would be agreed upon between a willing buyer and a willing seller, with neither being required to act, and both having reasonable
knowledge of the relevant facts.
Capital expenses.Capital expenses
Capital items, such as furniture, appliances, and cars, that are bought for a person during the year can be included in total support under certain
circumstances.
The following examples show when a capital item is or is not support.
Example 1.
You buy a $200 power lawn mower for your 13-year-old child. The child is given the duty of keeping the lawn trimmed. Because the lawn mower
benefits all members of the household, you cannot include the cost of the lawn mower in the support of your child.
Example 2.
You buy a $150 television set as a birthday present for your 12-year-old child. The television set is placed in your child's bedroom. You can
include the cost of the television set in the support of your child.
Example 3.
You pay $5,000 for a car and register it in your name. You and your 17-year-old daughter use the car equally. Because you own the car and do not
give it to your daughter but merely let her use it, you cannot include the cost of the car in your daughter's total support. However, you can include
in your daughter's support your out-of-pocket expenses of operating the car for her benefit.
Example 4.
Your 17-year-old son, using personal funds, buys a car for $4,500. You provide all the rest of your son's support – $4,000. Since the car is
bought and owned by your son, the car's fair market value ($4,500) must be included in his support. Your son has provided more than half of his own
total support of $8,500 ($4,500 + $4,000), so he is not your qualifying child. You did not provide more than half of his total support, so he is not
your qualifying relative. You cannot claim an exemption for your son.
Medical insurance premiums.Health insurance premiumsInsurance premiums:MedicalMedical insurance premiums
Medical insurance premiums you pay, including premiums for supplementary Medicare coverage, are included in the support you provide.
Medical insurance benefits.
Medical insurance benefits, including basic and supplementary Medicare benefits, are not part of support.
Tuition payments and allowances under the GI Bill.Armed forces:GI Bill benefitsGI Bill benefitsTuition, benefits under GI Bill
Amounts veterans receive under the GI Bill for tuition payments and allowances while they attend school are included in total support.
Example.
During the year, your son receives $2,200 from the government under the GI Bill. He uses this amount for his education. You provide the rest of his
support – $2,000. Because GI benefits are included in total support, your son's total support is $4,200 ($2,200 + $2,000). You have not provided
more than half of his support.
Child care expenses.Child care:Expenses
If you pay someone to provide child or dependent care, you can include these payments in the amount you provided for the support of your child or
disabled dependent, even if you claim a credit for the payments. For information on the credit, see chapter 32.
Other support items.
Other items may be considered as support depending on the facts in each case.
Do Not Include
in Total Support
The following items are not included in total support.
Federal, state, and local income taxes paid by persons from their own income. Taxes, not support
Social security and Medicare taxes paid by persons from their own income. Medicare taxes, not supportSocial security and Medicare taxes:Support, not included in
Life insurance premiums. Life insurance premiums
Insurance premiums:Life
Funeral expenses. Funeral expenses
Scholarships received by your child if your child is a full-time student. Scholarships
Survivors' and Dependents' Educational Assistance payments used for the support of the child who receives them.
Multiple Support AgreementMultiple support agreement
Sometimes no one provides more than half of the support of a person. Instead, two or more persons, each of whom would be able to take the exemption
but for the support test, together provide more than half of the person's support.
When this happens, you can agree that any one of you who individually provides more than 10% of the person's support, but only one, can claim an
exemption for that person as a qualifying relative. Each of the others must sign a statement agreeing not to claim the exemption for that year. The
person who claims the exemption must keep these signed statements for his or her records. A multiple support declaration identifying each of the
others who agreed not to claim the exemption must be attached to the return of the person claiming the exemption. Form 2120, Multiple Support
Declaration, can be used for this purpose.
Example 1.
You, your sister, and your two brothers provide the entire support of your mother for the year. You provide 45%, your sister 35%, and your two
brothers each provide 10%. Either you or your sister can claim an exemption for your mother. The other must sign a statement agreeing not to take an
exemption for your mother. The one who claims the exemption must attach Form 2120, or a similar declaration, to his or her return and must keep the
statement signed by the other for his or her records. Because neither brother provides more than 10% of the support, neither can take the exemption
and neither has to sign a statement.
Example 2.
You and your brother each provide 20% of your mother's support for the year. The remaining 60% of her support is provided equally by two persons
who are not related to her. She does not live with them. Because more than half of her support is provided by persons who cannot claim an exemption
for her, no one can take the exemption.
Example 3.
Your father lives with you and receives 25% of his support from social security, 40% from you, 24% from his brother (your uncle), and 11% from a
friend. Either you or your uncle can take the exemption for your father if the other signs a statement agreeing not to. The one who takes the
exemption must attach Form 2120, or a similar declaration, to his return and must keep for his records the signed statement from the one agreeing not
to take the exemption.
<ROM>Worksheet 3-1.</ROM>
<IMARK>Worksheet for Determining SupportFunds Belonging to the Person You Supported1.Enter the total funds belonging to the person you supported, including income
received (taxable and nontaxable) and amounts borrowed during the year, plus the amount in savings and other accounts at the beginning of the
year1.2.Enter the amount on line 1 that was used for the person's support2.3.Enter the amount on line 1 that was used for other purposes3.4.Enter the total amount in the person's savings and other accounts at the end of the
year4.5.Add lines 2 through 4. (This amount should equal line 1.)5.Expenses for Entire Household (where the person you supported lived)6.Lodging (complete line 6a or 6b):6a. Enter the total rent paid6a.6b. Enter the fair rental value of the home. If the
person you supported owned the home,
also include this amount in line 21.6b.7.Enter the total food expenses7.8.Enter the total amount of utilities (heat, light, water, etc. not included in line 6a
or 6b)8.9.Enter the total amount of repairs (not included in line 6a or 6b)9.10.Enter the total of other expenses. Do not include expenses of maintaining the home,
such as mortgage interest, real estate taxes, and insurance.10.11.Add lines 6a through 10. These are the total household expenses11.12.Enter total number of persons who lived in the household12.Expenses for the Person You Supported13.Divide line 11 by line 12. This is the person's share of the household
expenses13.14.Enter the person's total clothing expenses14.15.Enter the person's total education expenses15.16.Enter the person's total medical and dental expenses not paid for or
reimbursed by insurance16.17.Enter the person's total travel and recreation expenses17.18.Enter the total of the person's other expenses18.19.Add lines 13 through 18. This is the total cost of the person's support for
the year19.Did the Person Provide More Than Half of His or Her Own Support?20.Multiply line 19 by 50% (.50)20.21.Enter the amount from line 2, plus the amount from line 6b if the person
you supported owned
the home. This is the amount the person provided for his or her own support21.22.Is line 21 more than line 20?
No. You meet the support test for this person to be your qualifying child. If this person
also meets the other tests to be a qualifying child, stop here; do not complete lines 23–26. Otherwise, go to line 23 and fill out the rest of
the worksheet to determine if this person is your qualifying relative.
Yes. You do not meet the support test for this person to be either your qualifying child
or your qualifying relative. Stop here.Did You Provide More Than Half?23.Enter the amount others provided for the person's support. Include amounts
provided by state, local, and other welfare societies or agencies. Do not include any amounts included on line 1.23.24.Add lines 21 and 2324.25.Subtract line 24 from line 19. This is the amount you provided for the
person's support25.26.Is line 25 more than line 20?
Yes. You meet the support test for this person to be your qualifying relative.
No. You do not meet the support test for this person to be your qualifying relative. You
cannot claim an exemption for this person unless you can do so under a multiple support agreement or the support test for children of divorced or
separated parents. See Multiple Support Agreement or Support Test for Children of Divorced or Separated Parents.
Tables and figures:WorksheetsWorksheets:Support test
Support Test for Children of Divorced or Separated Parents
In most cases, a child of divorced or separated parents will be a qualifying child of one of the parents. See Children of divorced or
separated parents under Qualifying Child, earlier. However, if the child does not meet the requirements to be a qualifying child of
either parent, the child may be a qualifying relative of one of the parents. In that case, the following rules must be used in applying the support
test.
A child will be treated as being the qualifying relative of his or her noncustodial parent if all of the following apply.
The parents:
Are divorced or legally separated under a decree of divorce or separate maintenance,
Are separated under a written separation agreement, or
Lived apart at all times during the last 6 months of the year.
The child received over half of his or her support for the year from the parents.
The child is in the custody of one or both parents for more than half of the year.
A decree of divorce or separate maintenance or written separation agreement that applies to 2005 provides that the noncustodial parent can
claim the child as a dependent (and, in the case of a pre-1985 agreement, the noncustodial parent provides at least $600 for the support of the child
during the year) or the custodial parent signs a written declaration that he or she will not claim the child as a dependent for the
year.
Written declaration.
The custodial parent may use either Form 8332 or a similar statement (containing the information required by the form) to make the written
declaration to release the exemption to the noncustodial parent.
The exemption can be released for 1 year, for a number of specified years (for example, alternate years), or for all future years, as specified in
the declaration.
Custodial parent and noncustodial parent.
The custodial parent is the parent with whom the child lived for the greater part of the year. The other parent is the noncustodial parent.
If the parents divorced or separated during the year and the child lived with both parents before the separation, the custodial parent is the one
with whom the child lived for the greater part of the rest of the year.
Example.
Your child lived with you for 10 months of the year. The child lived with your former spouse for the other 2 months. You are considered the
custodial parent.
Child support under pre-1985 agreement.Child support under pre-1985 agreement
All child support payments actually received from the noncustodial parent under a pre-1985 agreement are considered used for the support of the
child.
Example.
Under a pre-1985 agreement, the noncustodial parent provides $1,200 for the child's support. This amount is considered support provided by the
noncustodial parent even if the $1,200 was actually spent on things other than support.
Alimony.Alimony
Payments to a spouse that are includible in the spouse's gross income as either alimony, separate maintenance payments, or similar payments from an
estate or trust, are not treated as a payment for the support of a dependent.
Parents who never married.
This special rule for divorced or separated parents also applies to parents who never married.
Multiple support agreement.
If the support of the child is determined under a multiple support agreement, this special support test for divorced or separated parents does not
apply.
Exemptions:DependentsDependents:Exemption forPhaseout of ExemptionsDeductions:Personal exemptionExemptions:PersonalPersonal exemptionExemptions:PhaseoutPersonal exemption:Phaseout
The amount you can claim as a deduction for exemptions is phased out once your adjusted gross income (AGI) goes above a certain level for your
filing status. These levels are as follows:
Filing StatusAGI Level Which Reduces Exemption AmountMarried filing separately $ 109,475Single 145,950Head of household 182,450Married filing jointly 218,950Qualifying widow(er) 218,950
You must reduce the dollar amount of your exemptions by 2% for each $2,500, or part of $2,500 ($1,250 if you are married filing separately), that
your AGI exceeds the amount shown above for your filing status. If your AGI exceeds the amount shown by more than $122,500 ($61,250 if married filing
separately), the amount of your deduction for exemptions is reduced to zero.
If your AGI exceeds the level for your filing status, use the Deduction for Exemptions Worksheet in the instructions for Form 1040 or Form 1040A to
figure the amount of your deduction for exemptions.
Form:1040:Social Security NumbersForm:1040A:Social Security NumbersDependents:Social Security Number
Social Security
Numbers for
Dependents
You must list the social security number (SSN) of any dependent for whom you claim an exemption in column (2) of line 6c of your Form 1040 or Form
1040A.
If you do not list the dependent's SSN when required or if you list an incorrect SSN, the exemption may be disallowed.
No SSN.
Form:SS-5:Social Security Number requestIf a person for whom you expect to claim an exemption on your return does not have an
SSN, either you or that person should apply for an SSN as soon as possible by filing Form SS-5, Application for a Social Security Card, with the
Social Security Administration (SSA). Information about applying for an SSN and Form SS-5 is available at your local SSA office.
Form:4868Form:4868:Automatic extension of time to fileIt usually takes about 2 weeks to get an SSN. If you do not have a required SSN by
the filing due date, you can file Form 4868 for an extension of time to file.
Born and died in 2005.Dependents:Born and died within year
Birth of child:Social Security Number to be obtainedChildren:Birth of child:Social Security Number to be obtainedSocial Security Numbers (SSNs):Child's:Number to be obtained at birthIf your child was born and died in 2005, and you do not have an SSN for the child, you
may attach a copy of the child's birth certificate instead. If you do, enter DIED in column (2) of line 6c of your Form 1040 or Form 1040A.
Dependents:Social Security Number:Alien dependentsIndividual taxpayer identification numbers (ITINs)ITINsIndividual taxpayer identification numbers (ITINs)Taxpayer identification numbers (TINs):Individual (ITIN)Form:1040:Alien taxpayer identification numbersForm:1040A:Alien taxpayer identification numbersForm:W-7:Individual taxpayer identification number request
Alien or adoptee with no SSN.
If your dependent does not have and cannot get an SSN, you must list the individual taxpayer identification number (ITIN) or adoption taxpayer
identification number (ATIN) instead of an SSN.
Taxpayer identification numbers for aliens.
If your dependent is a resident or nonresident alien who does not have and is not eligible to get an SSN, your dependent must apply for an
individual taxpayer identification number (ITIN). Write the number in column (2) of line 6c of your Form 1040 or Form 1040A. To apply for an ITIN, use
Form W-7, Application for IRS Individual Taxpayer Identification Number.
Adoption:Taxpayer identification numberDependents:Social Security Number:Adoption taxpayer identification numberForm:W-7A:Adoption taxpayer identification number requestPersonal exemption
Taxpayer identification numbers for adoptees.
If you have a child who was placed with you by an authorized placement agency, you may be able to claim an exemption for the child. However, if you
cannot get an SSN or an ITIN for the child, you must get an adoption taxpayer identification number (ATIN) for the child from the IRS. See Form W-7A,
Application for Taxpayer Identification Number for Pending U.S. Adoptions, for details.
Tax Withholding and Estimated TaxEstimated taxWithholdingFICA withholdingWithholdingPayroll deductionsWithholdingWithholdingPayroll taxesWithholdingTaxes:EstimatedEstimated taxWhat's New
for 2006Tax law changes for 2006.
When you figure how much income tax you want withheld from your pay and when you figure your estimated tax, consider tax law changes effective in
2006. See What's New for 2006 in the front of this publication, or get Publication 553, Highlights of 2005 Tax Changes.
RemindersEstimated tax safe harbor for higher income taxpayers.Estimated tax:Safe harbor for higher income individuals
If your adjusted gross income was more than $150,000 ($75,000 if you are married filing a separate return), you will have to deposit the smaller of
90% of your expected tax for 2006 or 110% of the tax shown on your 2005 return to avoid an estimated tax penalty.
Payment of estimated tax by electronic funds withdrawal.Electronic payment options:Electronic funds withdrawalEstimated tax:Electronic funds withdrawalPayment of tax:By electronic means:Funds withdrawal
You may be able to pay your estimated tax by authorizing an automatic withdrawal from your checking or savings account. For more information, see
Payment by Electronic Funds Withdrawal in chapter 2 of Publication 505.
This chapter discusses how to pay your tax as you earn or receive income during the year. In general, the federal income tax is a pay-as-you-go
tax. There are two ways to pay as you go.
Withholding. If you are an employee, your employer probably withholds income tax from your pay. Tax may also be withheld from
certain other income, including pensions, bonuses, commissions, and gambling winnings. In each case, the amount withheld is paid to the IRS in your
name.
Estimated tax. If you do not pay your tax through withholding, or do not pay enough tax that way, you might have to pay estimated
tax. People who are in business for themselves generally will have to pay their tax this way. You may have to pay estimated tax if you receive income
such as dividends, interest, capital gains, rent, and royalties. Estimated tax is used to pay not only income tax, but self-employment tax and
alternative minimum tax as well.
Estimated tax:Definition
This chapter explains both of these methods. In addition, it explains the following.
Credit for withholding and estimated tax. When you file your 2005 income tax return, take credit for all the income tax withheld from your
salary, wages, pensions, etc., and for the estimated tax you paid for 2005.
Employment taxesFICA withholdingWithholdingEstimated tax:Credit forFICA withholdingWithholdingWithholding:Credit for
Underpayment penalty. If you did not pay enough tax during the year either through withholding or by making estimated tax payments, you may
have to pay a penalty. The IRS usually can figure this penalty for you. See Underpayment Penalty at the end of this chapter.
Estimated tax:Penalty for underpaymentPenalties:Estimated taxthis heading: Underpayment of estimated taxPenalties:Underpayment of estimated taxUnderpayment penaltiesWithholding:Penalties
Publication505Tax Withholding and Estimated Tax553Highlights of 2005 Tax Changes919How Do I Adjust My Tax Withholding?Form (and Instructions)Employee's Withholding Allowance CertificateWithholding Certificate for Pension or Annuity PaymentsRequest for Federal Income Tax Withholding From Sick PayVoluntary Withholding RequestEstimated Tax for IndividualsUnderpayment of Estimated Tax by Individuals, Estates, and Trusts
This section discusses income tax withholding on these types of income:
Salaries and wages,
Tips,
Taxable fringe benefits,
Sick pay,
Pensions and annuities,
Gambling winnings,
Unemployment compensation, and
Certain federal payments, such as social security.
This section explains in detail the rules for withholding tax from each of these types of income.
This section also covers backup withholding on interest, dividends, and other payments.
Salaries and WagesWages and salaries:WithholdingWithholdingWithholding:Salaries and wages
Income tax is withheld from the pay of most employees. Your pay includes your regular pay, bonuses, commissions, and vacation allowances. It also
includes reimbursements and other expense allowances paid under a nonaccountable plan. See Supplemental Wages, later, for more information
about reimbursements and allowances paid under a nonaccountable plan.
If your income is low enough that you will not have to pay income tax for the year, you may be exempt from withholding. This is explained under
Exemption From Withholding, later.
Military retirees.Armed forces:Retirees' pay:WithholdingMilitaryArmed forcesPensions:MilitaryArmed forcesRetirees:Armed forces:WithholdingRetirement plans:MilitaryArmed forcesWages and salaries:Military retirees
Military retirement pay is treated in the same manner as regular pay for income tax withholding purposes, even though it is treated as a pension or
annuity for other tax purposes.
Household workers.Domestic help:WithholdingHousehold workersDomestic helpNanny taxDomestic helpTaxes:Nanny taxDomestic helpWages and salaries:Household workersYard-care workersDomestic help
If you are a household worker, you can ask your employer to withhold income tax from your pay.
Tax is withheld only if you want it withheld and your employer agrees to withhold it. If you do not have enough income tax withheld, you may have
to pay estimated tax, as discussed later under Estimated Tax.
Farmworkers.Agricultural workersFarmworkersFarmworkers:WithholdingWages and salaries:Farmworkers
Income tax is generally withheld from your cash wages for work on a farm unless your employer both:
Pays you cash wages of less than $150 during the year, and
Has expenditures for agricultural labor totaling less than $2,500 during the year.
You can ask your employer to withhold income tax from noncash wages and other wages not subject to withholding. If your employer does not agree to
withhold tax, or if not enough is withheld, you may have to pay estimated tax, as discussed later under Estimated Tax.
Determining Amount of Tax
Withheld Using Form W-4Employment taxesFICA withholdingWithholdingFICA withholdingWithholdingForm W–4:Employee withholding allowance certificateWithholding:Determining amount to withhold
The amount of income tax your employer withholds from your regular pay depends on two things.
The amount you earn.
The information you give your employer on Form W-4.
Form W-4 includes three types of information that your employer will use to figure your withholding.
Whether to withhold at the single rate or at the lower married rate.
How many withholding allowances you claim. (Each allowance reduces the amount withheld.)
Whether you want an additional amount withheld.
Note.
You must specify a filing status and a number of withholding allowances on Form W-4. You cannot specify only a dollar amount of withholding.
New JobWithholding:New job
When you start a new job, you must fill out Form W-4 and give it to your employer. Your employer should have copies of the form. If you need to
change the information later, you must fill out a new form.
If you work only part of the year (for example, you start working after the beginning of the year), too much tax may be withheld. You may be able
to avoid overwithholding if your employer agrees to use the part-year method. See Part-Year Method in chapter 1 of Publication 505 for more
information.
Changing Your WithholdingWithholding:Changing amount withheld
Events during the year may change your marital status or the exemptions, adjustments, deductions, or credits you expect to claim on your return.
When this happens, you may need to give your employer a new Form W-4 to change your withholding status or number of allowances.
If the event changes your withholding status or the number of allowances you are claiming, you must give your employer a new Form W-4 within 10
days after either of the following.
Your divorce, if you have been claiming married status.
Any event that decreases the number of withholding allowances you can claim.
Generally, you can submit a new Form W-4 whenever you wish to change the number of your withholding allowances for any other reason.
Changing your withholding for 2007.Withholding:Changing amount withheld:For 2007
If events in 2006 will decrease the number of your withholding allowances for 2007, you must give your employer a new Form W-4 by December 1, 2006.
If the event occurs in December 2006, submit a new Form W-4 within 10 days.
Checking Your WithholdingWithholding:Checking amount of
After you have given your employer a Form W-4, you can check to see whether the amount of tax withheld from your pay is too little or too much. See
Publication 919, later. If too much or too little tax is being withheld, you should give your employer a new Form W-4 to change your
withholding.
Note.
You cannot give your employer a payment to cover withholding for past pay periods or a payment for estimated tax.
Completing Form W-4
and WorksheetsForm W–4:Filling out form and worksheetsWithholding:Worksheets:Withholding (Form W–4)
Form W-4 has worksheets to help you figure how many withholding allowances you can claim. The worksheets are for your own records. Do not give them
to your employer.
Two jobs.
If you have income from two jobs at the same time, complete only one set of Form W-4 worksheets. Then split your allowances between the Forms W-4
for each job. You cannot claim the same allowances with more than one employer at the same time. You can claim all your allowances with one employer
and none with the other, or divide them any other way.
Married individuals.
If both you and your spouse are employed and expect to file a joint return, figure your withholding allowances using your combined income,
adjustments, deductions, exemptions, and credits. Use only one set of worksheets. You can divide your total allowances any way, but you cannot claim
an allowance that your spouse also claims.
If you and your spouse expect to file separate returns, figure your allowances using separate worksheets based on your own individual income,
adjustments, deductions, exemptions, and credits.
Alternative method of figuring withholding allowances.
You do not have to use the Form W-4 worksheets if you use a more accurate method of figuring the number of withholding allowances. See
Alternative method of figuring withholding allowances under Completing Form W-4 and Worksheets in chapter 1 of Publication 505
for more information.
Personal Allowances Worksheet.
Use the Personal Allowances Worksheet on page 1 of Form W-4 to figure your withholding allowances for exemptions and any special allowances that
apply.
Deductions and Adjustments Worksheet.
Use this worksheet if you plan to itemize your deductions or claim adjustments to your income and you want to reduce your withholding.
Fill out this worksheet to adjust the number of your withholding allowances for deductions, adjustments to income, and tax credits. The Deductions
and Adjustments Worksheet is on page 2 of Form W-4. Chapter 1 of Publication 505 explains this worksheet.
Two-Earner/Two-Job Worksheet.
You may need to complete this worksheet if you have two jobs or a working spouse. You can also add to the amount, if any, on line 8 of this
worksheet, any additional withholding necessary to cover any amount you expect to owe other than income tax, such as self-employment tax.
Getting the Right Amount
of Tax WithheldEmployment taxesFICA withholdingWithholdingFICA withholdingWithholdingWithholding:Determining amount to withhold
In most situations, the tax withheld from your pay will be close to the tax you figure on your return if you follow these two rules.
You accurately complete all the Form W-4 worksheets that apply to you.
You give your employer a new Form W-4 when changes occur.
But because the worksheets and withholding methods do not account for all possible situations, you may not be getting the right amount
withheld. This is most likely to happen in the following situations.
You are married and both you and your spouse work.
You have more than one job at a time.
You have nonwage income, such as interest, dividends, alimony, unemployment compensation, or self-employment income.
You will owe additional amounts with your return, such as self-employment tax.
Your withholding is based on obsolete Form W-4 information for a substantial part of the year.
If you change the number of your withholding allowances during the year, too much or too little tax may have been withheld for the period before
you made the change. You may be able to compensate for this if your employer agrees to use the cumulative wage withholding method for the rest of the
year. You must ask in writing that your employer use this method.
To be eligible, you must have been paid for the same kind of payroll period (weekly, biweekly, etc.) since the beginning of the year.
Publication 919
To make sure you are getting the right amount of tax withheld, get Publication 919. It will help you compare the total tax to be withheld during
the year with the tax you can expect to figure on your return. It also will help you determine how much additional withholding, if any, is needed each
payday to avoid owing tax when you file your return. If you do not have enough tax withheld, you may have to pay estimated tax, as explained under
Estimated Tax, later.
Rules Your Employer
Must FollowEmployers:Withholding rulesEmployment taxesFICA withholdingWithholdingFICA withholdingWithholdingWithholding:Employers, rules for
It may be helpful for you to know some of the withholding rules your employer must follow. These rules can affect how to fill out your Form W-4 and
how to handle problems that may arise.
New Form W-4.Employees:Form W-4 to be filled out when starting new jobEmployers:Form W-4, having new employees fill outForm W-4:Employee withholding allowance certificateWithholding:Form W-4:Provided by employer
When you start a new job, your employer should give you a Form W-4 to fill out. Your employer will use the information you give on the form to
figure your withholding beginning with your first payday.
If you later fill out a new Form W-4, your employer can put it into effect as soon as possible. The deadline for putting it into effect is the
start of the first payroll period ending 30 or more days after you turn it in.
No Form W-4.Withholding:Highest rate, employer must withhold at if no W-4
If you do not give your employer a completed Form W-4, your employer must withhold at the highest rate, as if you were single and claimed no
allowances.
If you find you are having too much tax withheld because you did not claim all the withholding allowances you are entitled to, you should give your
employer a new Form W-4. Your employer cannot repay any of the tax previously withheld.
However, if your employer has withheld more than the correct amount of tax for the Form W-4 you have in effect, you do not have to fill out a new
Form W-4 to have your withholding lowered to the correct amount. Your employer can repay the amount that was incorrectly withheld. If you are not
repaid, your Form W-2 will reflect the full amount actually withheld.
Exemption From WithholdingExemptions:From withholdingWithholding:Exemption from
If you claim exemption from withholding, your employer will not withhold federal income tax from your wages. The exemption applies only to income
tax, not to social security or Medicare tax.
You can claim exemption from withholding for 2006 only if both the following situations apply.
For 2005 you had a right to a refund of all federal income tax withheld because you had no tax liability.
For 2006 you expect a refund of all federal income tax withheld because you expect to have no tax liability.
Student.Students:Exemption from withholding
If you are a student, you are not automatically exempt. See chapter 1 to see whether you must file a return. If you work only part time or only
during the summer, you may qualify for exemption from withholding.
Age 65 or older or blind.Blind persons:Exemption from withholdingDisabilities, persons withBlindBlind personsElderly persons:Exemption from withholding
If you are 65 or older or blind, use one of the worksheets in chapter 1 of Publication 505, under Exemption From Withholding, to help
you decide whether you can claim exemption from withholding. Do not use either worksheet if you will itemize deductions, claim exemptions for
dependents, or claim tax credits on your 2006 return. See Itemizing deductions or claiming exemptions or credits in Publication 505.
Claiming exemption from withholding.
To claim exemption, you must give your employer a Form W-4. Enter exempt on line 7.
If you claim exemption, but later your situation changes so that you will have to pay income tax after all, you must file a new Form W-4 within 10
days after the change. If you claim exemption in 2006, but you expect to owe income tax for 2007, you must file a new Form W-4 by December 1, 2006.
Your claim of exempt status may be reviewed by the IRS.
An exemption is good for only 1 year.
You must give your employer a new Form W-4 by February 15 each year to continue your exemption.
Supplemental WagesBonusesCommissionsOvertime payPrizes and awards:BonusesSick pay:WithholdingSupplemental wagesWages and salaries:SupplementalWithholding:Supplemental wages
Supplemental wages include bonuses, commissions, overtime pay, vacation allowances, certain sick pay, and expense allowances under certain plans.
The payer can figure withholding on supplemental wages using the same method used for your regular wages. If these payments are identified separately
from your regular wages, your employer or other payer of supplemental wages can withhold income tax from these wages at a flat rate.
Expense allowances.Business expenses:ReimbursementsBusiness expenses:Reimbursements:Returning excess for business expensesDeductions:Business expensesBusiness expensesEmployee business expenses:ReimbursementsEmployee business expenses:Reimbursements:Returning excessEmployees:Business expensesEmployee business expensesExcess reimbursements:Business expense reimbursementsReimbursement:Employee business expensesReimbursement:Returning excess for business expensesWages and salaries:Allowances and reimbursements
Reimbursements or other expense allowances paid by your employer under a nonaccountable plan are treated as supplemental wages.
Reimbursements or other expense allowances paid under an accountable plan that are more than your proven expenses are treated as paid under a
nonaccountable plan if you do not return the excess payments within a reasonable period of time.
For more information about accountable and nonaccountable expense allowance plans, see Reimbursements in chapter 26.
You may have to pay a penalty of $500 if both of the following apply.
You make statements or claim withholding allowances on your Form W-4 that reduce the amount of tax withheld.
You have no reasonable basis for those statements or allowances at the time you prepare your Form W-4.
There is also a criminal penalty for willfully supplying false or fraudulent information on your Form W-4 or for willfully failing to supply
information that would increase the amount withheld. The penalty upon conviction can be either a fine of up to $1,000 or imprisonment for up to 1
year, or both.
These penalties will apply if you deliberately and knowingly falsify your Form W-4 in an attempt to reduce or eliminate the proper withholding of
taxes. A simple error, an honest mistake, will not result in one of these penalties. For example, a person who has tried to figure the number of
withholding allowances correctly, but claims seven when the proper number is six, will not be charged a W-4 penalty.
TipsGratuitiesTip incomeTip income:WithholdingWithholding:TipsTip income
The tips you receive while working on your job are considered part of your pay. You must include your tips on your tax return on the same line as
your regular pay. However, tax is not withheld directly from tip income, as it is from your regular pay. Nevertheless, your employer will take into
account the tips you report when figuring how much to withhold from your regular pay.
See chapter 6 for information on reporting your tips to your employer. For more information on the withholding rules for tip income, see
Publication 531, Reporting Tip Income.
How employer figures amount to withhold.
The tips you report to your employer are counted as part of your income for the month you report them. Your employer can figure your withholding in
either of two ways.
By withholding at the regular rate on the sum of your pay plus your reported tips.
By withholding at the regular rate on your pay plus a percentage of your reported tips.
Not enough pay to cover taxes.Tip income:Withholding:Underwithholding
If your regular pay is not enough for your employer to withhold all the tax (including income tax, social security tax, Medicare tax, or railroad
retirement tax) due on your pay plus your tips, you can give your employer money to cover the shortage. See Giving your employer money for taxes
in chapter 6.
Allocated tips.Tip income:Allocated tips
Your employer should not withhold income tax, social security tax, Medicare tax, or railroad retirement tax on any allocated tips. Withholding is
based only on your pay plus your reported tips. Your employer should refund to you any incorrectly withheld tax. See Allocated Tips in
chapter 6 for more information.
Taxable Fringe BenefitsEmployee benefitsFringe benefitsEmployee benefitsspecific type of benefit (e.g., Health insurance, Life insurance, etc.)Employees:Fringe benefitsFringe benefitsFringe benefits:WithholdingJobheadings starting with "Employee" or "Employer"Withholding:Fringe benefits
The value of certain fringe benefits you receive from your employer is considered part of your pay. Your employer generally must withhold income
tax on these benefits from your regular pay.
For information on fringe benefits, see Fringe Benefits under Employee Compensation in chapter 5.
Your employer can choose not to withhold income tax on the value of your personal use of an employer-provided car, truck, or other highway motor
vehicle. Your employer must notify you if this choice is made.
For more information on withholding on taxable fringe benefits, see chapter 1 of Publication 505.
Sick PaySick pay:WithholdingWithholding:Sick pay
Sick pay is a payment to you to replace your regular wages while you are temporarily absent from work due to sickness or personal injury. To
qualify as sick pay, it must be paid under a plan to which your employer is a party.
If you receive sick pay from your employer or an agent of your employer, income tax must be withheld. An agent who does not pay regular wages to
you may choose to withhold income tax at a flat rate.
However, if you receive sick pay from a third party who is not acting as an agent of your employer, income tax will be withheld only if you choose
to have it withheld. See Form W-4S, later.
If you receive payments under a plan in which your employer does not participate (such as an accident or health plan where you paid all the
premiums), the payments are not sick pay and usually are not taxable.
Union agreements.Collective bargaining agreementsLabor unions:Collective bargaining agreementsLabor unions:Sick pay withholding under union agreementsUnionsLabor unions
If you receive sick pay under a collective bargaining agreement between your union and your employer, the agreement may determine the amount of
income tax withholding. See your union representative or your employer for more information.
Form W-4S.Form W–4S:Sick pay withholding request
If you choose to have income tax withheld from sick pay paid by a third party, such as an insurance company, you must fill out Form W-4S. Its
instructions contain a worksheet you can use to figure the amount you want withheld. They also explain restrictions that may apply.
Give the completed form to the payer of your sick pay. The payer must withhold according to your directions on the form.
If you do not request withholding on Form W-4S, or if you do not have enough tax withheld, you may have to make estimated tax payments. If you do
not pay enough estimated tax or have enough income tax withheld, you may have to pay a penalty.
Pensions and AnnuitiesAnnuities:WithholdingIndividual retirement arrangements (IRAs):WithholdingPensions:WithholdingProfit-sharing plans:WithholdingRetirement plans:WithholdingWithholding:Pensions and annuities
Income tax usually will be withheld from your pension or annuity distributions unless you choose not to have it withheld. This rule applies to
distributions from:
A traditional individual retirement arrangement (IRA),
A life insurance company under an endowment, annuity, or life insurance contract,
Any other plan that defers the time you receive compensation.
The amount withheld depends on whether you receive payments spread out over more than 1 year (periodic payments), within 1 year (nonperiodic
payments), or as an eligible rollover distribution (ERD). You cannot choose not to have income tax withheld from an ERD.
More information.
Form W–4P:Pensions and annuities withholding certificateFor more information on taxation of annuities and distributions (including
eligible rollover distributions) from qualified retirement plans, see chapter 10. For information on IRAs, see chapter 17. For more information on
withholding on pensions and annuities, including a discussion of Form W-4P, see Pensions and Annuities in chapter 1 of Publication 505.
Gambling WinningsGambling winnings and losses:WithholdingWithholding:Gambling winnings
Income tax is withheld from certain kinds of gambling winnings at a flat rate.
Gambling winnings of more than $5,000 from the following sources are subject to income tax withholding.
Any sweepstakes, wagering pool, or lottery.
Any other wager, if the proceeds are at least 300 times the amount of the bet.
It does not matter whether your winnings are paid in cash, in property, or as an annuity. Winnings not paid in cash are taken into account at
their fair market value.
Gambling winnings from bingo, keno, and slot machines generally are not subject to income tax withholding. However, you may need to provide the
payer with a social security number to avoid withholding. See Backup withholding on gambling winnings in Publication 505. If you receive
gambling winnings not subject to withholding, you may need to pay estimated tax. See Estimated Tax, later.
If you do not pay enough tax through withholding or estimated tax payments, you may have to pay a penalty. See Underpayment Penalty,
later.
Form W-2G.Form 1040:Gambling winningsForm W–2G:Gambling winnings withholding statementGambling winnings and losses:Form 1040
If a payer withholds income tax from your gambling winnings, you should receive a Form W-2G, Certain Gambling Winnings, showing the amount you won
and the amount withheld. Report the tax withheld on line 64 of Form 1040.
You can choose to have income tax withheld from unemployment compensation. To make this choice, you will have to fill out Form W-4V (or a similar
form provided by the payer) and give it to the payer.
Unemployment compensation is taxable. So, if you do not have income tax withheld, you may have to pay estimated tax. See Estimated Tax,
later.
If you do not pay enough tax either through withholding or estimated tax, you may have to pay a penalty. See Underpayment Penalty,
later, for information.
Federal Payments
You can choose to have income tax withheld from certain federal payments you receive. These payments are:
Social security benefits,
Social security benefits:Withholding forWithholding:Social security benefits
Commodity credit loans you choose to include in your gross income, and
Withholding:Commodity credit loans
Payments under the Agricultural Act of 1949 (7 U.S.C. 1421 et. seq.), or title II of the Disaster Assistance Act of 1988, as amended, that
are treated as insurance proceeds and that you receive because:Disaster Assistance Act of 1988:WithholdingWithholding:Agricultural Act of 1949 paymentsWithholding:Disaster Assistance Act of 1988 payments
Your crops were destroyed or damaged by drought, flood, or any other natural disaster, or
You were unable to plant crops because of a natural disaster described in (a).
Form W–4V:Unemployment compensation, voluntary withholding requestTo make this choice, you will have to fill out Form W-4V (or a
similar form provided by the payer) and give it to the payer.
If you do not choose to have income tax withheld, you may have to pay estimated tax. See Estimated Tax, later.
If you do not pay enough tax either through withholding or estimated tax, you may have to pay a penalty. See Underpayment Penalty,
later, for information.
More information.
For more information about the tax treatment of social security and railroad retirement benefits, see chapter 11. Get Publication 225, Farmer's Tax
Guide, for information about the tax treatment of commodity credit loans or crop disaster payments.
Form(s) 1099:Taxable income reportInformation returnsForm 1099Banks and other businesses that pay you certain kinds of income must file an information return (Form 1099) with the
IRS. The information return shows how much you were paid during the year. It also includes your name and taxpayer identification number (TIN). TINs
are explained in chapter 1.
These payments generally are not subject to withholding. However, backup withholding is required in certain situations. Backup withholding
can apply to most kinds of payments that are reported on Form 1099.
The payer must withhold at a flat rate in the following situations.
You do not give the payer your TIN in the required manner.
The IRS notifies the payer that the TIN you gave is incorrect.
You are required, but fail, to certify that you are not subject to backup withholding.
The IRS notifies the payer to start withholding on interest or dividends because you have underreported interest or dividends on your income
tax return. The IRS will do this only after it has mailed you four notices over at least a 210-day period.
See Backup Withholding in chapter 1 of Publication 505 for more information.
There are civil and criminal penalties for giving false information to avoid backup withholding. The civil penalty is $500. The criminal penalty,
upon conviction, is a fine of up to $1,000 or imprisonment of up to 1 year, or both.
Estimated Tax
Estimated tax is the method used to pay tax on income that is not subject to withholding. This includes income from self-employment, interest,
dividends, alimony, rent, gains from the sale of assets, prizes, and awards. You also may have to pay estimated tax if the amount of income tax being
withheld from your salary, pension, or other income is not enough.
Estimated tax is used to pay both income tax and self-employment tax, as well as other taxes and amounts reported on your tax return. If you do not
pay enough through withholding or estimated tax payments, you may have to pay a penalty. If you do not pay enough by the due date of each payment
period (see When To Pay Estimated Tax, later), you may be charged a penalty even if you are due a refund when you file your tax return. For
information on when the penalty applies, see Underpayment Penalty, later.
Who Does Not Have To Pay Estimated TaxEstimated tax:Avoiding
Form W–4:Employee withholding allowance certificateIf you receive salaries or wages, you can avoid having to pay estimated tax by
asking your employer to take more tax out of your earnings. To do this, give a new Form W-4 to your employer. See chapter 1 of Publication 505.
Estimated tax not required.Estimated tax:Not required
You do not have to pay estimated tax for 2006 if you meet all three of the following conditions.
You had no tax liability for 2005.
You were a U.S. citizen or resident for the whole year.
Your 2005 tax year covered a 12-month period.
You had no tax liability for 2005 if your total tax was zero or you did not have to file an income tax return.
Who Must Pay
Estimated Tax?Estimated tax:Payments:Who must make
If you had a tax liability for 2005, you may have to pay estimated tax for 2006.
Figure 4-A. Do You Have To Pay Estimated Tax?Summary: This flowchart is used to determine if you have to pay estimated tax.StartThis is the starting of the flowchart.Decision (1)Will you owe $1,000 or more for 2006 after subtracting income tax withholding and credits from your total tax? (Do not subtract any estimated
tax payments.)IF Yes Continue To Decision (2)IF No Continue To Process (a)Decision (2)Will your income tax withholding and credits be at least 90% (66-2/3% for farmers and fishermen) of the tax shown on your 2006 tax
return?IF Yes Continue To Process (a)IF No Continue To Decision (3)Decision (3)Will your income tax withholding and credits be at least 100% (see Footnote) of the tax shown on your 2005 tax return?Note: Your 2005 return must have covered a 12-month period.Footnote: 110% if less than two-thirds of your gross income for 2005 and 2006 is from farming or fishing and your 2005 adjusted gross income
was more than $150,000 ($75,000 if your filing status for 2006 is married filing a separate return).IF Yes Continue To Process (a)IF No Continue To Process (b)Process (a)You are NOT required to pay estimated tax.Continue To EndProcess (b)You MUST make estimated tax payment(s) by the required due date(s).See When To Pay Estimated Tax.Continue To EndEndThis is the ending of the flowchart.Tables and figures:Estimated tax, who must make payments (Figure 4–A)
General rule.
You must pay estimated tax for 2006 if both of the following apply.
You expect to owe at least $1,000 in tax for 2006 after subtracting your withholding and credits.
You expect your withholding and credits to be less than the smaller of:
90% of the tax to be shown on your 2006 tax return, or
100% of the tax shown on your 2005 tax return. Your 2005 tax return must cover all 12 months.
Special rules for farmers, fishermen, and higher income taxpayers.Farmworkers:Estimated taxFishermen:Estimated taxHigh income taxpayers:Estimated tax
There are exceptions to the general rule for farmers, fishermen, and certain higher income taxpayers. See Figure 4-A and chapter 2 of Publication
505 for more information.
Form 1040-ES(NR):Estimated tax for nonresident aliensResident and nonresident aliens may also have to pay estimated tax. Resident aliens
should follow the rules in this chapter unless noted otherwise. Nonresident aliens should get Form 1040-ES(NR), U.S. Estimated Tax for Nonresident
Alien Individuals.
Married taxpayers.Estimated tax:Married taxpayersJoint returns:Estimated taxMarried taxpayers:Estimated tax
To figure whether you must pay estimated tax, apply the rules discussed here to your separate estimated income. If you can make joint estimated tax
payments, you can apply these rules on a joint basis.
You and your spouse can make joint estimated tax payments even if you are not living together.
You and your spouse cannot make joint estimated tax payments if:
You are legally separated under a decree of divorce or separate maintenance,
You and your spouse have different tax years, or
Either spouse is a nonresident alien (unless you elected to be treated as a resident alien (see chapter 1 of Publication 519)).
Whether you and your spouse make joint estimated tax payments or separate payments will not affect your choice of filing a joint tax return or
separate returns for 2006.
2005 separate returns and 2006 joint return.Married taxpayers:Estimated tax
If you plan to file a joint return with your spouse for 2006, but you filed separate returns for 2005, your 2005 tax is the total of the tax shown
on your separate returns. You filed a separate return if you filed as single, head of household, or married filing separately.
2005 joint return and 2006 separate returns.
If you plan to file a separate return for 2006, but you filed a joint return for 2005, your 2005 tax is your share of the tax on the joint return.
You file a separate return if you file as single, head of household, or married filing separately.
To figure your share of the tax on the joint return, first figure the tax both you and your spouse would have paid had you filed separate returns
for 2005 using the same filing status as for 2006. Then multiply the tax on the joint return by the following fraction.
The tax you would have paid had you filed a separate returnThe total tax you and your spouse would have paid had you filed separate returns
Example.
Joe and Heather filed a joint return for 2005 showing taxable income of $48,500 and a tax of $6,549. Of the $48,500 taxable income, $40,100 was
Joe's and the rest was Heather's. For 2006, they plan to file married filing separately. Joe figures his share of the tax on the 2005 joint return as
follows.
Tax on $40,100 based on a separate
return $6,696 Tax on $8,400 based on a separate
return 899Total $ 7,595 Joe's percentage of total ($6,696 ÷
$7,595) 88% Joe's share of tax on joint return
($6,549 × 88%) $ 5,763
How To Figure
Estimated TaxEstimated tax:Figuring amount of tax
Form 1040-ES:Estimated taxTo figure your estimated tax, you must figure your expected adjusted gross income, taxable income, taxes,
deductions, and credits for the year.
When figuring your 2006 estimated tax, it may be helpful to use your income, deductions, and credits for 2005 as a starting point. Use your 2005
federal tax return as a guide. You can use Form 1040-ES to figure your estimated tax.
You must make adjustments both for changes in your own situation and for recent changes in the tax law. For 2006, there are several changes in the
law. Some of these changes are discussed in Publication 553, Highlights of 2005 Tax Changes, or visit the IRS website at
www.irs.gov.
Form 1040-ES includes a worksheet to help you figure your estimated tax. Keep the worksheet for your records.
For more complete information and examples of how to figure your estimated tax for 2006, see chapter 2 of Publication 505.
When To Pay
Estimated TaxEstimated tax:Payments:Schedule
For estimated tax purposes, the year is divided into four payment periods. Each period has a specific payment due date. If you do not pay enough
tax by the due date of each of the payment periods, you may be charged a penalty even if you are due a refund when you file your income tax return.
The following chart gives the payment periods and due dates for estimated tax payments.
For the period:Due date:Jan. 1* through Mar. 31 Apr. 15 April 1 through May 31 June 15 June 1 through Aug. 31 Sept. 15 Sept. 1 through Dec. 31 Jan. 15
next year**
*If your tax year does not begin on January 1, see the Form 1040-ES instructions. **See January payment, later.
If the due date for an estimated tax payment falls on a Saturday, Sunday, or legal holiday, the payment will be on time if you make it on the next
day that is not a Saturday, Sunday, or legal holiday. For example, a payment due Monday, January 15, 2007, will be on time if you make it by Tuesday,
January 16, 2007. January 15 is a legal holiday.
January payment.
If you file your 2006 Form 1040 or Form 1040A by January 31, 2007, and pay the rest of the tax you owe, you do not need to make the payment due on
January 16, 2007.
Fiscal year taxpayers.Accounting periods:Fiscal yearEstimated tax:Fiscal year taxpayersFiscal year
If your tax year does not start on January 1, see the Form 1040-ES instructions for your payment due dates.
When To StartEstimated tax:Payments:When to start
You do not have to make estimated tax payments until you have income on which you will owe the tax. If you have income subject to estimated tax
during the first payment period, you must make your first payment by the due date for the first payment period. You can pay all your estimated tax at
that time, or you can pay it in installments. If you choose to pay in installments, make your first payment by the due date for the first payment
period. Make your remaining installment payments by the due dates for the later periods.
No income subject to estimated tax during first period.Estimated tax:First period, no income subject to estimated tax in
Estimated tax:Payments:ScheduleIf you do not have income subject to estimated tax until a later payment period, you can make your first
payment by the due date for that period. You can pay your entire estimated tax by the due date for that period, or you can pay it in installments by
the due date for that period and the due dates for the remaining periods. The following chart shows when to make installment payments.
If you first have income on which you must pay estimated tax:
Make a
payment
by:Make later
installments
by:Before Apr. 1 Apr. 15 June 15
Sept. 15
Jan. 15 next
year* After Mar. 31
and
before June 1 June 15 Sept. 15
Jan. 15 next
year* After May 31
and
before Sept. 1 Sept. 15 Jan. 15 next
year* After Aug. 31 Jan. 15
next year* (None)
*See January payment, and Saturday, Sunday, holiday rule under When To Pay Estimated Tax, earlier.
How much to pay to avoid a penalty.Estimated tax:Amount to pay to avoid penalty
To determine how much you should pay by each payment due date, see How To Figure Each Payment, next. If the earlier discussion of
No income subject to estimated tax during first period or the later discussion of Change in estimated tax applies to you, you
may need to read Annualized Income Installment Method in chapter 2 of Publication 505 for information on how to avoid a penalty.
How To Figure
Each PaymentEstimated tax:Payments:Figuring amount of each payment
You should pay enough estimated tax by the due date of each payment period to avoid a penalty for that period. You can figure your required payment
for each period by using either the regular installment method or the annualized income installment method. These methods are described in Publication
505. If you do not pay enough each payment period, you may be charged a penalty even if you are due a refund when you file your tax return.
Underpayment penalty.Estimated tax:Penalty for underpaymentPenalties:Estimated taxthis heading: Underpayment of estimated taxPenalties:Underpayment of estimated taxUnderpayment penalties
If your estimated tax payment for a previous period is less than one-fourth of your amended estimated tax, you may be charged a penalty for
underpayment of estimated tax for that period when you file your tax return. See chapter 4 of Publication 505 for more information.
Change in estimated tax.Estimated tax:Change in estimated tax
After you make an estimated tax payment, changes in your income, adjustments, deductions, credits, or exemptions may make it necessary for you to
refigure your estimated tax. Pay the unpaid balance of your amended estimated tax by the next payment due date after the change or in installments by
that date and the due dates for the remaining payment periods.
Estimated Tax Payments
Not Required
You do not have to pay estimated tax if your withholding in each payment period is at least as much as:
One-fourth of your required annual payment, or
Your required annualized income installment for that period.
You also do not have to pay estimated tax if you will pay enough through withholding to keep the amount you owe with your return under $1,000.
How To Pay Estimated TaxEstimated tax:PaymentsPayment of tax:Estimated tax
There are five ways to pay estimated tax.
By crediting an overpayment on your 2005 return to your 2006 estimated tax.
Tax refunds:Offset:Against next year's tax
By sending in your payment with a payment voucher from Form 1040-ES.
Estimated tax:Payment vouchersPayment of tax:By check or money orderPayment of tax:VouchersVouchers for payment of tax
By using the Electronic Federal Tax Payment System (EFTPS). For EFTPS information, see chapter 1.
Electronic payment options:Electronic Federal Tax Payment System (EFTPS)Payment of tax:By electronic means:Electronic Federal Tax Payment System (EFTPS)
By electronic funds withdrawal if you are filing Form 1040 or Form 1040A electronically.
By credit card using a pay-by-phone system or the Internet.
Credit card payment of taxes:Estimated taxElectronic payment options:Credit cardPayment of tax:By electronic means:Credit card
Crediting an OverpaymentForm 1040:Overpayment offset against next year's taxForm 1040A:Overpayment offset against next year's taxTax refunds:Offset:Against next year's tax
When you file your Form 1040 or Form 1040A for 2005 and you have an overpayment of tax, you can apply part or all of it to your estimated tax for
2006. On line 74 of Form 1040, or line 46 of Form 1040A, enter the amount you want credited to your estimated tax rather than refunded. The amount you
have credited should be taken into account when figuring your estimated tax payments.
The credit will be applied to your payments in the order necessary to avoid the penalty for underpayment of estimated tax. You cannot have any of
that amount refunded to you until the close of that tax year. You also cannot use that overpayment in any other way.
Using the Payment VouchersEstimated tax:Payment vouchersPayment of tax:VouchersVouchers for payment of tax
Each payment of estimated tax must be accompanied by a payment voucher from Form 1040-ES. If you made estimated tax payments last year, you should
receive a copy of the 2006 Form 1040-ES in the mail. It will have payment vouchers preprinted with your name, address, and social security number.
Using the preprinted vouchers will speed processing, reduce the chance of error, and help save processing costs.
Form 1040-ES:Estimated taxIf you did not pay estimated tax last year, you will have to get Form 1040-ES. After you make your first
payment, a Form 1040-ES package with the preprinted vouchers will be mailed to you. Follow the instructions in the package to make sure you use the
vouchers correctly.
Use the window envelopes that came with your Form 1040-ES package. If you use your own envelope, make sure you mail your payment vouchers to the
address shown in the Form 1040-ES instructions for the place where you live.
Do not use the address shown in the Form 1040 or Form 1040A instructions.
If you file a joint return and you are making joint estimated tax payments, please enter the names and social security numbers on the payment
voucher in the same order as they will appear on the joint return.
Change of address.
You must notify the IRS if you are making estimated tax payments and you changed your address during the year. You must send a clear and concise
written statement to the IRS Service Center where you filed your last return and provide all of the following:
Your full name (and spouse's full name),
Your signature (and spouse's signature),
Your old address (and spouse's old address if different),
Your new address, and
Your social security number (and spouse's social security number).
You can use Form 8822, Change of Address, for this purpose.
You can continue to use your old preprinted payment vouchers until the IRS sends you new ones. However, do not correct the address on the old
voucher.
Payment by Electronic Funds Withdrawal or Credit CardCredit card payment of taxes:Estimated taxElectronic payment options:Electronic funds withdrawalEstimated tax:Electronic funds withdrawal
If you want to make estimated payments by electronic funds withdrawal or by credit card, see the Form 1040-ES instructions or How To Pay
Estimated Tax in Publication 505.
Credit for Withholding
and Estimated TaxEmployment taxesFICA withholdingWithholdingEstimated tax:Credit forFICA withholdingWithholdingWithholding:Credit for
When you file your 2005 income tax return, take credit for all the income tax and excess social security or railroad retirement tax withheld from
your salary, wages, pensions, etc. Also, take credit for the estimated tax you paid for 2005. These credits are subtracted from your tax. You should
file a return and claim these credits, even if you do not owe tax.
If you had two or more employers and were paid wages of more than $90,000 during 2005, too much social security or railroad retirement tax may have
been withheld from your wages. See Credit for Excess Social Security Tax or Railroad Retirement Tax Withheld in chapter 37.
WithholdingEmployment taxesFICA withholdingWithholdingFICA withholdingWithholdingForm W-2:Employer-reported income statementForm W–2G:Gambling winnings withholding statementInformation returnsForm W–2W-2 formForm W–2Wages and salaries:Form W–2Form W–2
If you had income tax withheld during 2005, you should be sent a statement by January 31, 2006, showing your income and the tax withheld. Depending
on the source of your income, you will receive:
Form W-2, Wage and Tax Statement,
Form W-2G, Certain Gambling Winnings, or
A form in the 1099 series.
Forms W-2 and W-2G.Form W-2:Filing with return
You file Form W-2 with your income tax return. File Form W-2G with your return if it shows any federal income tax withheld from your winnings.
You should get at least two copies of each form you receive. Attach one copy to the front of your federal income tax return. Keep one copy for your
records. You should also receive copies to file with your state and local returns.
Form W-2Form W-2:Separate form from each employer
Your employer should send you a Form W-2 for 2005 by January 31, 2006. You should receive a separate Form W-2 from each employer you worked for.
If you stopped working before the end of the year, your employer could have given you your Form W-2 at any time after you stopped working. However,
your employer must send it to you by January 31, 2006.
If you ask for the form, your employer must send it to you within 30 days after receiving your written request or within 30 days after your final
wage payment, whichever is later.
If you have not received your Form W-2 on time, you should ask your employer for it. If you do not receive it by February 15, call the IRS.
Form W-2 shows your total pay and other compensation and the income tax, social security tax, and Medicare tax that was withheld during the year.
Include the federal income tax withheld (as shown on Form W-2) on:
Line 64 if you file Form 1040,
Line 39 if you file Form 1040A, or
Line 7 if you file Form 1040EZ.
Form W-2 is also used to report any taxable sick pay you received and any income tax withheld from your sick pay.
Form W-2GForm W–2G:Gambling winnings withholding statementGambling winnings and losses:WithholdingWithholding:Gambling winnings
If you had gambling winnings in 2005, the payer may have withheld income tax. If tax was withheld, the payer will give you a Form W-2G showing the
amount you won and the amount of tax withheld.
Report the amounts you won on line 21 of Form 1040. Take credit for the tax withheld on line 64 of Form 1040. If you had gambling winnings, you
must use Form 1040; you cannot use Form 1040A or Form 1040EZ.
The 1099 SeriesForm(s) 1099:Taxable income report
Most forms in the 1099 series are not filed with your return. You should be sent these forms by January 31, 2006. Keep these forms for your
records. There are several different forms in this series, including:
Form 1099-B, Proceeds From Broker and Barter Exchange Transactions,
Barter income:Form 1099-BBrokers:Form 1099-BForm 1099-B:Barter income
Form 1099-DIV, Dividends and Distributions,
Distributions:DividendsDividendsForm 1099-DIVForm 1099-DIVForm 1099-DIV:Dividend income statementStocksDividends
Form 1099-G, Certain Government Payments,
Form 1099-G:Government payments
Form 1099-INT, Interest Income,
Form 1099-INT:Interest income statementInterest income:Form 1099-INT
Form 1099-MISC, Miscellaneous Income,
Form 1099-MISC:Miscellaneous income
Form 1099-OID, Original Issue Discount,
Discounted debt instruments:Original issue discount (OID)Form 1099-OID:Original issue discount, from issuer or brokerOIDOriginal issue discount (OID)Original issue discount (OID):Form 1099-OID
Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.,
Annuities:Form 1099-RForm 1099-R:Retirement plan distributionsIndividual retirement arrangements (IRAs):Forms to use:Form 1099-R for reporting distributionsInsurance:Form 1099-R to report benefitsPensions:Form 1099-RProfit-sharing plans:Form 1099-RRetirement plans:Form 1099-R
Form SSA-1099, Social Security Benefit Statement, and
Form SSA-1099:Social security benefitsSocial security benefits:Form SSA-1099
Form RRB-1099, Payments by the Railroad Retirement Board.
Form RRB-1099:Railroad retirement benefitsRailroad retirement benefits:Form RRB-1099
If you received the types of income reported on some forms in the 1099 series, you may not be able to use Form 1040A or Form 1040EZ. See the
instructions to these forms for details.
Form 1099-R.
Attach Form 1099-R to your return if box 4 shows federal income tax withheld. Include the amount withheld in the total on line 64 of Form 1040 or
line 39 of Form 1040A. You cannot use Form 1040EZ if you received payments reported on Form 1099-R.
Backup withholding.Backup withholding
If you were subject to backup withholding on income you received during 2005, include the amount withheld, as shown on your Form 1099, in the total
on line 64 of Form 1040, line 39 of Form 1040A, or line 7 of Form 1040EZ.
Form Not CorrectWithholding:Incorrect form
Errors:Form W-2c for corrected wage and tax statementForm W-2c:Corrected wage and tax statementIf you receive a form with incorrect information on it, you should ask the payer for a
corrected form. Call the telephone number or write to the address given for the payer on the form. The corrected Form W-2G or Form 1099 you receive
will be marked Corrected. A special form, Form W-2c, Corrected Wage and Tax Statement, is used to correct a Form W-2.
Form Received After Filing
If you file your return and you later receive a form for income that you did not include on your return, you should report the income and take
credit for any income tax withheld by filing Form 1040X, Amended U.S. Individual Income Tax Return.
Separate ReturnsWithholding:Separate returns
If you are married but file a separate return, you can take credit only for the tax withheld from your own income. Do not include any amount
withheld from your spouse's income. However, different rules may apply if you live in a community property state.
Community property states are listed in chapter 2. For more information on these rules, and some exceptions, see Publication 555, Community
Property.
Fiscal YearsAccounting periods:Fiscal yearFiscal yearWithholding:Fiscal years
If you file your tax return on the basis of a fiscal year (a 12-month period ending on the last day of any month except December), you must follow
special rules to determine your credit for federal income tax withholding. For a discussion of how to take credit for withholding on a fiscal year
return, see Fiscal Years in chapter 3 of Publication 505.
Estimated TaxEstimated tax:Credit for
Form 1040:Estimated tax paymentsForm 1040A:Estimated tax paymentsTake credit for all your estimated tax payments for 2005 on line 65 of Form 1040 or line 40 of Form
1040A. Include any overpayment from 2004 that you had credited to your 2005 estimated tax. You must use Form 1040 or Form 1040A if you paid estimated
tax. You cannot use Form 1040EZ.
Name changed.Change of nameEstimated tax:Name changeName change
If you changed your name, and you made estimated tax payments using your old name, attach a brief statement to the front of your tax return
indicating:
When you made the payments,
The amount of each payment,
The IRS address to which you sent the payments,
Your name when you made the payments, and
Your social security number.
The statement should cover payments you made jointly with your spouse as well as any you made separately.
Separate ReturnsEstimated tax:Separate returns
If you and your spouse made separate estimated tax payments for 2005 and you file separate returns, you can take credit only for your own payments.
If you made joint estimated tax payments, you must decide how to divide the payments between your returns. One of you can claim all of the
estimated tax paid and the other none, or you can divide it in any other way you agree on. If you cannot agree, you must divide the payments in
proportion to each spouse's individual tax as shown on your separate returns for 2005.
If you made joint estimated tax payments for 2005, and you were divorced during the year, either you or your former spouse can claim all of the
joint payments, or you each can claim part of them. If you cannot agree on how to divide the payments, you must divide them in proportion to each
spouse's individual tax as shown on your separate returns for 2005.
If you claim any of the joint payments on your tax return, enter your former spouse's social security number (SSN) in the space provided on the
front of Form 1040 or Form 1040A. If you divorced and remarried in 2005, enter your present spouse's SSN in that space and write your former spouse's
SSN, followed by DIV, to the left of line 65, Form 1040, or line 40, Form 1040A.
Underpayment PenaltyEstimated tax:Penalty for underpaymentPenalties:Estimated taxthis heading: Underpayment of estimated taxPenalties:Underpayment of estimated taxUnderpayment penalties
If you did not pay enough tax either through withholding or by making estimated tax payments, you will have an underpayment of estimated tax and
you may have to pay a penalty. Generally, you will not have to pay a penalty for 2005 if any of the following situations applies.
The total of your withholding and estimated tax payments was at least as much as your 2004 tax (or 110% of your 2004 tax if your adjusted
gross income was more than $150,000, $75,000 if your 2005 filing status is married filing separately) and you paid all required estimated tax payments
on time.
The tax balance due on your return is no more than 10% of your total 2005 tax, and you paid all required estimated tax payments on time.
Your total 2005 tax minus your withholding is less than $1,000.
You did not have a tax liability for 2004.
You did not have any withholding taxes and your current year tax less any household employment taxes is less than $1,000.
Special rules apply if you are a farmer or fisherman. See Farmers and Fishermen in chapter 4 of Publication 505 for more
information.
IRS can figure the penalty for you.Form 2210:Underpayment of estimated taxEstimated tax:Penalty for underpayment:IRS computation of, Form 2210Internal Revenue Service (IRS):Underpayment penalties, computation byUnderpayment penalties:IRS computation
Estimated taxWithholdingIf you think you owe the penalty but you do not want to figure it yourself when you file your tax return,
you may not have to. Generally, the IRS will figure the penalty for you and send you a bill. However, you must complete Form 2210 and attach it to
your return if you think you are able to lower or eliminate your penalty. See chapter 4 of Publication 505.
Income
The eight chapters in this part discuss many kinds of income. They explain which income is and is not taxed. See Part Three for
information on gains and losses you report on Schedule D (Form 1040) and for information on selling your home.
Wages, Salaries, and Other EarningsIncomeWages and salariesCompensationWages and salariesIncome:Wages and salariesSalariesWages and salariesWhat's NewElective deferrals.
The limit on the amount of your wages you can elect to defer into certain retirement plans (such as section 401(k) plans) increases each year
through 2006. If you are age 50 or older, you may be able to make additional catch-up elective deferrals. See Elective deferrals in
Retirement Plan Contributions under Employee Compensation.
Katrina Emergency Tax Relief Act of 2005.
This Act provides tax relief for persons affected by Hurricane Katrina. Under this Act, you may be able to exclude from income amounts you receive
as mileage reimbursements from a qualified charitable organization. See Publication 4492.
ReminderForeign income.SalariesWages and salariesWages and salaries:Income:Foreign
Form:1099:Taxable income reportForm:W-2:Employer-reported income statementInformation returns:Form 1099Information returns:Form W-2W-2 formForm W-2Wages and salaries:Form W-2If you are a U.S. citizen or resident alien, you must report income from sources outside the United States (foreign
income) on your tax return unless it is exempt by U.S. law. This is true whether you reside inside or outside the United States and whether or not you
receive a Form W-2, Wage and Tax Statement, or Form 1099 from the foreign payer. This applies to earned income (such as wages and tips) as well as
unearned income (such as interest, dividends, capital gains, pensions, rents, and royalties).
If you reside outside the United States, you may be able to exclude part or all of your foreign source earned income. For details, see Publication
54, Tax Guide for U.S. Citizens and Resident Aliens Abroad.
This chapter discusses compensation received for services as an employee, such as wages, salaries, and fringe benefits. The topics include:
Bonuses and awards,
Special rules for certain employees, and
Sickness and injury benefits.
The chapter explains what income is included in the employee's gross income and what is not included.
Publication463Travel, Entertainment, Gift, and Car Expenses 503Child and Dependent Care Expenses 505Tax Withholding and Estimated Tax 525Taxable and Nontaxable Income
Employee CompensationCompensation:EmployeeWages and salaries:Employee compensation
This section discusses various types of employee compensation including fringe benefits, retirement plan contributions, stock options, and
restricted property.
Form W-2.
Form:1040:Wages and salary reportingForm:1040A:Reporting payForm:1040EZ:Reporting payForm:W-2:Employer-reported income statementIf you are an employee, you should receive 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.
Child care providers.
Child care:Care providersChildren:Care providersChildren:Care providersChild careDaycare centersChild careWages and salaries:Baby-sittingWages and salaries:Child care providersForm:1040, Schedule CChild care providersForm:1040, Schedule C-EZChild care providersScheduleForm 1040If you provide childcare, either in the child's home or in your home or other place of business, the pay you receive must be
included in your income. If you are not an employee, you are probably self-employed and must include payments for your services on Schedule C (Form
1040), Profit or Loss From Business, or Schedule C-EZ (Form 1040), Net Profit From Business. You generally are not an employee unless you are subject
to the will and control of the person who employs you as to what you are to do and how you are to do it.
If you baby-sit for relatives or neighborhood children, whether on a regular basis or only periodically, the rules for childcare providers apply to
you.
Miscellaneous CompensationCompensation:Miscellaneous compensationSalariesWages and salariesWages and salaries:Miscellaneous compensation
This section discusses different types of employee compensation.
Advance commissions and other earnings.Commissions:AdvanceWages and salaries:Advance commissions
If you receive advance commissions or other amounts for services to be performed in the future and you are a cash-method taxpayer, you must include
these amounts in your income in the year you receive them.
Commissions:Unearned, deduction for repayment ofForm:1040, Schedule AUnearned commission, deduction for repayment ofSchedule:Form 1040, A-F, R, SEForm 1040If you repay unearned commissions or other amounts in the same year you receive them, reduce the amount included in your
income by the repayment. If you repay them in a later tax year, you can deduct the repayment as an itemized deduction on your Schedule A (Form 1040),
or you may be able to take a credit for that year. See Repayments in chapter 12.
Allowances and reimbursements.
Business expenses:ReimbursementsEmployee business expenses:ReimbursementsEmployees:Business expensesEmployee business expensesReimbursement:Employee business expensesWages and salaries:Allowances and reimbursementsBusiness expenses:ReimbursementsEmployees:Business expensesEmployee business expensesReimbursement:Employee business expensesWages and salaries:Allowances and reimbursementsIf you receive travel, transportation, or other business expense allowances or reimbursements
from your employer, see Publication 463. If you are reimbursed for moving expenses, see Publication 521, Moving Expenses.
Back pay awards.
Back pay, award forWages and salaries:Back pay awardsForm:W-2:Employer-reported income statementInformation returns:Form W-2Include in income amounts you are awarded in a settlement or judgment for back pay. These include payments made to you
for damages, unpaid life insurance premiums, and unpaid health insurance premiums. They should be reported to you by your employer on Form W-2.
Bonuses and awards.AwardsPrizes and awardsBonusesEmployees:Awards for servicePrizes and awardsBonusesPrizes and awardsWages and salaries:Awards and prizesWages and salaries:Bonuses
Bonuses or awards you receive for outstanding work are included in your income and should be shown on your Form W-2. These include prizes such as
vacation trips for meeting sales goals. If the prize or award you receive is goods or services, you must include the fair market value of the goods or
services in your income. However, if your employer merely promises to pay you a bonus or award at some future time, it is not taxable until you
receive it or it is made available to you.
Employee achievement award.Exclusions from gross income:Employee awardsPrizes and awards:Exclusion from incomeWages and salaries:Employee achievement award
If you receive tangible personal property (other than cash, a gift certificate, or an equivalent item) as an award for length of service or safety
achievement, you generally can exclude its value from your income. However, the amount you can exclude is limited to your employer's cost and cannot
be more than $1,600 ($400 for awards that are not qualified plan awards) for all such awards you receive during the year. Your employer can tell you
whether your award is a qualified plan award. Your employer must make the award as part of a meaningful presentation, under conditions and
circumstances that do not create a significant likelihood of it being disguised pay.
However, the exclusion does not apply to the following awards.
A length-of-service award if you received it for less than 5 years of service or if you received another length-of-service award during the
year or the previous 4 years.
A safety achievement award if you 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.
Government cost-of-living allowances.Cost-of-living allowancesFederal employees:Cost-of-living allowancesFederal governmentEmployeesFederal employeesGovernment employeesFederalFederal employeesWages and salaries:Government cost-of-living allowances
Cost-of-living allowances generally are included in your income. However, they are not included in your income if you are a federal civilian
employee or a federal court employee who is stationed in Alaska, Hawaii, or outside the United States.
Allowances and differentials that increase your basic pay as an incentive for taking a less desirable post of duty are part of your compensation
and must be included in income. For example, your compensation includes Foreign Post, Foreign Service, and Overseas Tropical differentials. For more
information, see Publication 516, U.S. Government Civilian Employees Stationed Abroad.
Your employer will report to you the total amount of deferrals for the year under a nonqualified deferred compensation plan. This amount is shown
on Form W-2, box 12, using code Y. This amount is not included in your income.
However, if at any time during the tax year, the plan fails to meet certain requirements, or is not operated under those requirements, all amounts
deferred under the plan for the tax year and all preceding tax years are included in your income for the current year. This amount is included in your
wages shown on Form W-2, box 1. It is also shown on Form W-2, box 12, using code Z.
For information on the requirements and the amount to include in income, see Internal Revenue Code section 409A and Notice 2005-1. The notice is on
page 274 of Internal Revenue Bulletin 2005-2 at www.irs.gov/pub/irs-irbs/irb05-02.pdf.
Note received for services.Debt instrumentsBonds or NotesNotes:Received for servicesWages and salaries:Note for services
Notes:DiscountedIf your employer gives you a secured note as payment for your services, you must include the fair market value
(usually the discount value) of the note in your income for the year you receive it. When you later receive payments on the note, a proportionate part
of each payment is the recovery of the fair market value that you previously included in your income. Do not include that part again in your income.
Include the rest of the payment in your income in the year of payment.
If your employer gives you a nonnegotiable unsecured note as payment for your services, payments on the note that are credited toward the principal
amount of the note are compensation income when you receive them.
Severance pay.Severance payWages and salaries:Severance pay
Amounts you receive as severance pay are taxable. A lump-sum payment for cancellation of your employment contract must be included in your income
in the tax year you receive it.
Accrued leave payment.
Federal employees:Accrued leave paymentGovernment employeesFederalFederal employeesSeverance pay:Accrued leave paymentWages and salaries:Accrued leave paymentForm:W-2:Employer-reported income statementInformation returns:Form W-2If you are a federal employee and receive a lump-sum payment for accrued annual leave when you retire or resign, this
amount will be included as wages on your Form W-2.
If you resign from one agency and are reemployed by another agency, you may have to repay part of your lump-sum annual leave payment to the second
agency. You can reduce gross wages by the amount you repaid in the same tax year in which you received it. Attach to your tax return a copy of the
receipt or statement given to you by the agency you repaid to explain the difference between the wages on the return and the wages on your Forms W-2.
Outplacement services.Outplacement servicesSeverance pay:Outplacement servicesWages and salaries:Outplacement services
If you choose to accept a reduced amount of severance pay so that you can receive outplacement services (such as training in résumé
writing and interview techniques), you must include the unreduced amount of the severance pay in income.
Form:1040, Schedule AOutplacement services, deductionMiscellaneous deductions:Outplacement agency feesOutplacement services:Deduction of agency feesScheduleForm 1040However, you can deduct the value of these outplacement services (up to the difference between the severance pay included in
income and the amount actually received) as a miscellaneous deduction (subject to the 2% of adjusted gross income (AGI) limit) on Schedule A (Form
1040).
Sick pay.Sick pay:IncomeWages and salaries:Sick pay
Pay you receive from your employer while you are sick or injured is part of your salary or wages. In addition, you must include in your income sick
pay benefits received from any of the following payers.
A welfare fund.
A state sickness or disability fund.
An association of employers or employees.
An insurance company, if your employer paid for the plan.
However, if you paid the premiums on an accident or health insurance policy, the benefits you receive under the policy are not taxable. For
more information, see Publication 525.
Social security and Medicare taxes paid by employer.Employment:Taxes:Social security and Medicare taxesFICA withholdingSocial security and Medicare taxesMedicare:Social security and Medicare taxesPayroll taxesSocial security and Medicare taxesSocial security benefits:Paid by employerWages and salaries:Social security and Medicare taxes paid by employer
If you and your employer have an agreement that your employer pays your social security and Medicare taxes without deducting them from your gross
wages, you must report the amount of tax paid for you as taxable wages on your tax return. The payment is also treated as wages for figuring your
social security and Medicare taxes and your social security and Medicare benefits. However, these payments are not treated as social security and
Medicare wages if you are a household worker or a farm worker.
Stock appreciation rights.Securities:Stock appreciation rightsStock appreciation rightsWages and salaries:Stock appreciation rights
Do not include a stock appreciation right granted by your employer in income until you exercise (use) the right. When you use the right, you are
entitled to a cash payment equal to the fair market value of the corporation's stock on the date of use minus the fair market value on the date the
right was granted. You include the cash payment in your income in the year you use the right.
Fringe BenefitsEmployee benefitsFringe benefitsEmployees:Fringe benefitsFringe benefits:Taxable incomeWages and salaries:Fringe benefits
Fringe benefits received in connection with the performance of your services are included in your income as compensation unless you pay fair market
value for them or they 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.
Accounting period.Accounting periods:Fringe benefitsFringe benefits:Accounting period
You must use the same accounting period your employer uses to report your taxable noncash fringe benefits. Your employer has the option to report
taxable noncash fringe benefits by using either of the following rules.
The general rule: benefits are reported for a full calendar year (January 1– December 31).Accounting periods:Calendar yearCalendar year taxpayers:Accounting periods
The special accounting period rule: benefits provided during the last 2 months of the calendar year (or any shorter period) are treated as
paid during the following calendar year. For example, each year your employer reports the value of benefits provided during the last 2 months of the
prior year and the first 10 months of the current year.
Your employer does not have to use the same accounting period for each fringe benefit, but must use the same period for all employees who receive a
particular benefit.
You must use the same accounting period that you use to report the benefit to claim an employee business deduction (for use of a car, for example).
Form W-2.Form:W-2:Fringe benefitsFringe benefits:Form W-2
Your employer reports your taxable fringe benefits in box 1 (Wages, tips, other compensation) of Form W-2. The total value of your fringe benefits
may also be noted in box 14. The value of your fringe benefits may be added to your other compensation on one Form W-2, or you may receive a separate
Form W-2 showing just the value of your fringe benefits in box 1 with a notation in box 14.
Accident or Health PlanAccident insuranceFringe benefits:Accident and health insuranceHealth insurance:Accident insuranceInsuranceAccidentAccident insuranceMedical insuranceAccident insuranceWages and salaries:Accident and health insuranceWages and salaries:Long-term care coverage
Generally, 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.
Long-term care coverage.Accident insurance:Long-term care
Form:W-2:Fringe benefitsContributions by your employer to provide coverage for long-term care services generally are not
included in your income. However, contributions made through a flexible spending or similar arrangement (such as a cafeteria plan) must be included in
your income. This amount will be reported as wages in box 1 of your Form W-2.
Contributions you make to the plan are discussed in Publication 502, Medical and Dental Expenses.
Form:8853:Archer MSAs and long-term care insurance contractsForm:W-2:Fringe benefitsContributions by your employer to your Archer MSA generally are not included in your income. Their
total will be reported in box 12 of Form W-2 with code R. You must report this amount on Form 8853, Archer MSAs and Long-Term Care Insurance
Contracts. File the form with your return.
If your employer does not make contributions to your MSA, you can make your own contributions to your MSA. These contributions are discussed in
Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans. Also, see Form 8853.
Health flexible spending arrangement (health FSA).Health:Flexible spending arrangement
If your employer provides a health FSA that qualifies as an accident or health plan, the amount of your salary reduction, and reimbursements of
your medical care expenses and those of your spouse and dependents, generally are not included in your income.
Health reimbursement arrangement (HRA).Health:Reimbursement arrangement
If your employer provides an HRA that qualifies as an accident or health plan, coverage and reimbursements of your medical care expenses and those
of your spouse and dependents generally are not included in your income.
See also Reimbursement for medical care under Other Sickness and Injury Benefits, later.
Health savings accounts (HSA).Health:Savings account
If you are an eligible individual, you and any other person, including your employer or a family member, can make contributions to your HSA.
Contributions, other than employer contributions, are deductible on your return whether or not you itemize deductions. Contributions made by your
employer are not included in your income. Distributions from your HSA that are used to pay qualified medical expenses are not included in your income.
Distributions not used for qualified medical expenses are included in your income. See Publication 969, Health Savings Accounts and Other Tax-Favored
Health Plans, for more information.
Contributions by a partnership to a bona fide partner's HSA are not contributions by an employer. The contributions are treated as a
distribution of money and are not included in the partner's gross income. Contributions by a partnership to a partner's HSA for services rendered are
treated as guaranteed payments that are includible in the partner's gross income. In both situations, the partner can deduct the contribution made to
the partner's HSA.
Contributions by an S corporation to a 2% shareholder-employee's HSA for services rendered are treated as guaranteed payments and are includible in
the shareholder-employee's gross income. The shareholder-employee can deduct the contribution made to the shareholder-employee's HSA.
Adoption AssistanceAdoption:Employer assistanceChildren:AdoptionFringe benefits:Adoption, employer assistanceWages and salaries:Adoption, employer assistance
You may be able to exclude from your income amounts paid or expenses incurred by your employer for qualified adoption expenses in connection with
your adoption of an eligible child. See the Instructions for Form 8839, for more information.
Form:8839:Qualified adoption expensesForm:W-2:Fringe benefitsAdoption benefits are reported by your employer in box 12 of Form W-2 with code T. They are also
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, Qualified Adoption Expenses. File the form with your return.
De Minimis (Minimal) BenefitsDe minimis benefitsEmployee benefitsFringe benefitsEmployees:Fringe benefitsExclusions from gross income:De minimis benefitsFringe benefits:De minimis benefitsWages and salaries:De minimis benefits
If your employer provides you with a product or service and the cost of it is so small that it would be unreasonable for the employer to account
for it, the value is not included in your income. Generally, 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.
If your employer gives you a turkey, ham, or other item of nominal value at Christmas or other holidays, do not include the value of the gift in
your income. However, if your employer gives you cash, a gift certificate, or a similar item that you can easily exchange for cash, you include the
value of that gift as extra salary or wages regardless of the amount involved.
Educational AssistanceEducation expensesEmployer-providedEducational assistanceEducational assistance:Employer-providedEmployers:Educational assistance fromEducational assistanceExclusions from gross income:Educational assistance from employerFringe benefits:Education assistance
You can exclude from your income up to $5,250 of qualified employer-provided educational assistance. For more information, see Publication 970, Tax
Benefits for Education.
Employer-Provided VehiclesAutomobilesCarsCars:Employer-providedEmployers:Vehicles provided byFringe benefits:Employer-provided vehiclesTravel and transportation expenses:Employer-provided vehiclesVehiclesCars
If your employer provides a car (or other highway motor vehicle) to you, your personal use of the car is usually a taxable noncash fringe benefit.
Your employer must determine the actual value of this fringe benefit to include in your income. For more information, see Publication 525.
Certain employer-provided transportation can be excluded from gross income. See the discussion on Transportation, later.
Group-Term Life InsuranceFringe benefits:Group-term life insurance premiumsGroup-term life insurance:Exclusion from income:Limitation on
Generally, 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, 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. It is also shown separately in box 12 with code C.
Group-term life insurance.Group-term life insurance:DefinitionInsuranceLifeGroup-term life insuranceLife insurance:Group-term life insurance
This insurance is term life insurance protection (insurance for a fixed period of time) that:
Provides a general death benefit,
Is provided to a group of employees,
Is provided under a policy carried by the employer, and
Provides an amount of insurance to each employee based on a formula that prevents individual selection.
Permanent benefits.Group-term life insurance:Permanent benefits
If your group-term life insurance policy includes permanent benefits, such as a paid-up or cash surrender value, you must include in your income,
as wages, the cost of the permanent benefits minus the amount you pay for them. Your employer should be able to tell you the amount to include in your
income.
Accidental death benefits.Accidental death benefitsGroup-term life insurance:Accidental death benefits
Insurance that provides accidental or other death benefits but does not provide general death benefits (travel insurance, for example) is not
group-term life insurance.
Former employer.
If your former employer provided more than $50,000 of group-term life insurance coverage during the year, the amount included in your income is
reported as wages in box 1 of Form W-2. Also, it is shown separately in box 12 with code C. Box 12 also will show the amount of uncollected social
security and Medicare taxes on the excess coverage, with codes M and N. You must pay these taxes with your income tax return. Include them in your
total tax on line 63, Form 1040, and enter UT and the amount of the taxes on the dotted line next to line 63.
Two or more employers.
Your exclusion for employer-provided group-term life insurance coverage cannot exceed the cost of $50,000 of coverage, whether the insurance is
provided by a single employer or multiple employers. If two or more employers provide insurance coverage that totals more than $50,000, the amounts
reported as wages on your Forms W-2 will not be correct. You must figure how much to include in your income. Reduce the amount you figure by any
amount reported with code C in box 12 of your Forms W-2, add the result to the wages reported in box 1, and report the total on your return.
Figuring the taxable cost.Group-term life insurance:Taxable cost, calculation of
Use the following worksheet to figure the amount to include in your income.
<ROM>Worksheet 5-1.</ROM> Figuring the Cost of Group-Term Life Insurance To Include in Income
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 coverage2.50,0003.Subtract line 2 from line 13.4.Divide line 3 by $1,000. Figure to the nearest tenth4.5.Go to Table 5-1. Using your age on the last day of the tax year, find your age group in the
left column, and enter the cost from the column on the right for your age group 5.6.Multiply line 4 by line 56.7.Enter the number of full months of coverage at this cost.7.8.Multiply line 6 by line 78.9.Enter the premiums you paid per month9.10.Enter the number of months you paid the premiums10.11.Multiply line 9 by line 10.11.12.Subtract line 11 from line 8. Include this amount in your income as wages12.
<ROM>Table 5-1.</ROM> 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 691.27 70 and older2.06
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.
<ROM>Worksheet 5-1.</ROM> Figuring the Cost of Group-Term Life Insurance to Include in Income—Illustrated
1.Enter the total amount of your insurance coverage from your employer(s)1.80,0002.Limit on exclusion for employer-provided group-term life insurance coverage2.50,0003.Subtract line 2 from line 13.30,0004.Divide line 3 by $1,000. Figure to the nearest tenth4.30.05.Go to Table 5-1. Using your age on the last day of the tax year, find your age group in the
left column, and enter the cost from the column on the right for your age group 5..236.Multiply line 4 by line 56.6.907.Enter the number of full months of coverage at this cost.7.128.Multiply line 6 by line 78.82.809.Enter the premiums you paid per month9.4.1510.Enter the number of months you paid the premiums10.1211.Multiply line 9 by line 10.11.49.8012.Subtract line 11 from line 8. Include this amount in your income as wages12.33.00
Entire cost excluded.Exclusions from gross income:Group-term life insuranceGroup-term life insurance:Exclusion from income
You are not taxed on the cost of group-term life insurance if any of the following circumstances apply.
You are permanently and totally disabled and have ended your employment.
Your employer is the beneficiary of the policy for the entire period the insurance is in force during the tax year.
A charitable organization (defined in chapter 24) to which contributions are deductible is the only beneficiary of the policy for the entire
period the insurance is in force during the tax year. (You are not entitled to a deduction for a charitable contribution for naming a charitable
organization as the beneficiary of your policy.)
The plan existed on January 1, 1984, and:
You retired before January 2, 1984, and were covered by the plan when you retired, or
You reached age 55 before January 2, 1984, and were employed by the employer or its predecessor in 1983.
Entire cost taxed.
You are taxed on the entire cost of group-term life insurance if either of the following circumstances apply.
The insurance is provided by your employer through a qualified employees' trust, such as a pension trust or a qualified annuity
plan.
You are a key employee and your employer's plan discriminates in favor of key employees.
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.
TransportationCarsTravel and transportationFringe benefits:TransportationTravel and transportation expenses:Fringe benefits
If your employer provides you with a qualified transportation fringe benefit, it can be excluded from your income, up to certain limits. A
qualified transportation fringe benefit is:
Transportation in a commuter highway vehicle (such as a van) between your home and work place,
A transit pass, or
Qualified parking.
Exclusions from gross income:Parking fees, employer-providedParking fees:Employer-provided fringe benefit:Exclusion from incomeCash 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.
Exclusion limit.Exclusions from gross income:Commuting benefits for employees
The exclusion for commuter highway vehicle transportation and transit pass fringe benefits cannot be more than a total of $105 a month.
The exclusion for the qualified parking fringe benefit cannot be more than $200 a month.
If the benefits have a value that is more than these limits, the excess must be included in your income.
This is a highway vehicle that seats at least six adults (not including the driver). At least 80% of the vehicle's mileage must reasonably be
expected to be:
For transporting employees between their homes and work place, and
On trips during which employees occupy at least half of the vehicle's adult seating capacity (not including the driver).
This is any pass, token, farecard, voucher, or similar item entitling a person to ride mass transit (whether public or private) free or at a
reduced rate or to ride in a commuter highway vehicle operated by a person in the business of transporting persons for compensation.
Qualified parking.Travel and transportation expenses:Parking fees:Employer-provided fringe benefit
This is parking provided to an employee at or near the employer's place of business. It also includes parking provided on or near a location from
which the employee commutes to work by mass transit, in a commuter highway vehicle, or by carpool. It does not include parking at or near the
employee's home.
Retirement Plan ContributionsPensions:Contributions:Taxation ofRetirement plans:ContributionsRetirement plans:Contributions:Taxation ofWages and salaries:Retirement plan contributions by employer
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.
Elective deferrals.Deferred compensation:LimitElective deferrals:LimitsExclusions from gross income:Elective deferrals, limit on exclusion401(k) plans:Tax treatment of contributionsPensions:Elective deferral limitationRetirement plans:Elective deferral limitationWages and salaries:Elective deferrals
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. It 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.
Cash or deferred arrangements (section 401(k) plans).
Savings incentive match plans for employees (SIMPLE plans).
Tax-sheltered annuity plans (403(b) plans).
Section 501(c)(18)(D) plans.
Section 457 plans.
Overall limit on deferrals.
For 2005, you generally should not have deferred more than a total of $14,000 of contributions to the plans listed in (1) through (6) above. You
should not have deferred more than the lesser of your includible compensation or $14,000 of contributions to the plan listed in (7) above (section 457
plan).
Excess deferrals.
Your employer or plan administrator should apply the proper annual limit when figuring your plan contributions. However, you are responsible for
monitoring the total you defer to ensure that the deferrals are not more than the overall limit.
If you set aside more than the limit, the excess generally must be included in your income for that year. See Publication 525 for a discussion of
the tax treatment of excess deferrals.
Catch-up contributions.
You may be allowed catch-up contributions (additional elective deferral) if you are age 50 or older by the end of your tax year.
Stock OptionsOptionsSecurities:OptionsStock optionsWages and salaries:Stock options
If you receive a nonstatutory option to buy or sell stock or other property as payment for your services, you usually will have income when you
receive the option, when you exercise the option (use it to buy or sell the stock or other property), or when you sell or otherwise dispose of the
option. However, if your option is a statutory stock option, you will not have any income until you sell or exchange your stock. Your employer can
tell you which kind of option you hold. For more information, see Publication 525.
Restricted PropertyWages and salaries:Restricted property
Generally, 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 substantially vested. (You can choose to include the value of the property in your income in the year it is transferred to
you.) For more information, see Restricted Property in Publication 525.
Form:W-2:Employer-reported income statementW-2 formForm W-2Wages and salaries:Form W-2Dividends received on restricted stock.
Dividends you receive on restricted stock are treated as compensation and not as dividend income. Your employer should include these payments on
your Form W-2.
Stock you chose to include in income.Wages and salaries:Restricted property:Dividends on restricted stock
Dividends you receive on restricted stock you chose to include in your income in the year transferred are treated the same as any other dividends.
Report them on your return as dividends. For a discussion of dividends, see chapter 8.
Form:1099-DIV:Dividend income statementForm:W-2:Employer-reported income statementInformation returns:Form W-2For information on how to treat dividends reported on both your Form W-2 and Form 1099-DIV, see Dividends
received on restricted stock in Publication 525.
Special Rules for
Certain Employees
This section deals with special rules for people in certain types of employment: members of the clergy, members of religious orders, people working
for foreign employers, military personnel, and volunteers.
ClergyClergy:Special income rulesMinistersClergyReligious organizationsClergyWages and salaries:ClergyFunerals:Clergy, payment for
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.
Clergy:HousingHousing:ClergyMinistersClergyReligious organizationsClergyIf 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
chapter 24.
Pension.
Clergy:PensionsMinistersClergyPensions:ClergyReligious organizationsClergyRetirement plans:ClergyForm:1040:Clergy pensionForm:1040A:Clergy pensionA pension or retirement pay for a member of the clergy is usually treated as any other pension or
annuity. It must be reported on lines 16a and 16b of Form 1040 or on lines 12a and 12b of Form 1040A.
Housing.
Form:1040, Schedule SEScheduleForm 1040 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) 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.
Members of Religious OrdersWages and salaries:Religious orders
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.
Services performed for the order.
If you are performing the services as an agent of the order in the exercise of duties required by the order, do not include in your income the
amounts turned over to the order.
If your order directs you to perform services for another agency of the supervising church or an associated institution, you are considered to be
performing the services as an agent of the order. Any wages you earn as an agent of an order that you turn over to the order are not included in your
income.
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.
Services performed outside the order.
If you are directed to work outside the order, your services are not an exercise of duties required by the order unless they meet both of the
following requirements.
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.
If you are an employee of a third party, the services you perform for the third party will not be considered directed or required of you by the
order. Amounts you receive for these services are included in your income, even if you have taken a vow of poverty.
Example.
Mark Brown is a member of a religious order and has taken a vow of poverty. He renounces all claims to his earnings and turns over his earnings to
the order.
Mark is a schoolteacher. He was instructed by the superiors of the order to get a job with a private tax-exempt school. Mark became an employee of
the school, and, at his request, the school made the salary payments directly to the order.
Because Mark is an employee of the school, he is performing services for the school rather than as an agent of the order. The wages Mark earns
working for the school are included in his income.
Special rules apply if you work for a foreign employer.
U.S. citizen.Foreign employment:U.S. citizen
If you are a U.S. citizen who works in the United States for a foreign government, an international organization, a foreign embassy, or any foreign
employer, you must include your salary in your income.
Social security and Medicare taxes.Foreign employment:Social security and Medicare taxesMedicare:Social security and Medicare taxesSocial security benefits:Foreign employer
You are exempt from social security and Medicare employee taxes if you are employed in the United States by an international organization or a
foreign government. However, you must pay self-employment tax on your earnings from services performed in the United States, even though you are not
self-employed. This rule also applies if you are an employee of a qualifying wholly owned instrumentality of a foreign government.
Employees of international organizations or foreign governments.International organizations, employees ofForeign governments, employees of
Your compensation for official services to an international organization is exempt from federal income tax if 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 compensation for official services to a foreign government is exempt from federal income tax if all of the following are true.
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.
Waiver of alien status.AliensNonresidentNonresident aliensForeign employment:Waiver of alien statusNonresident aliens:Waiver of alien status
If you are an alien who works for a foreign government or international organization and you file a waiver under section 247(b) of the Immigration
and Nationality Act to keep your immigrant status, different rules may apply. See Foreign Employer in Publication 525.
For information on the tax treatment of income earned abroad, see Publication 54.
MilitaryWages and salaries:Military service
Armed forces:WagesMilitaryArmed forcesPayments 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.
Military retirement pay.Armed forces:Retirees' pay:Taxable incomeForm:1040:Armed forces' retirement payForm:1040A:Armed forces' retirement payPensions:MilitaryArmed forcesRetirees:Armed forces:Taxable incomeRetirement plans:MilitaryArmed forcesWages and salaries:Military retirees
If your retirement pay is based on age or length of service, it is taxable and must be included in your income as a pension on lines 16a and 16b of
Form 1040 or on lines 12a and 12b of Form 1040A. Do not include in your income the amount of any reduction in retirement or retainer pay to provide a
survivor annuity for your spouse or children under the Retired Serviceman's Family Protection Plan or the Survivor Benefit Plan.
For more detailed discussion of survivor annuities, see chapter 10.
Do not include in your income any veterans' benefits paid under any law, regulation, or administrative practice administered by the Department of
Veterans Affairs (VA). The following amounts paid to veterans or their families are not taxable.
Education, training, and subsistence allowances.
Disability compensation and pension payments for disabilities paid either to veterans or their families.
Grants for homes designed for wheelchair living.
Grants for motor vehicles for veterans who lost their sight or the use of their limbs.
Veterans' insurance proceeds and dividends paid either to veterans or their beneficiaries, including the proceeds of a veteran's endowment
policy paid before death.
Interest on insurance dividends you leave on deposit with the VA.
Benefits under a dependent-care assistance program.
The death gratuity paid to a survivor of a member of the Armed Forces who died after September 10, 2001.
Rehabilitative program payments.Armed forces:Rehabilitative program paymentsForm:1040A:Rehabilitative program payments
VA payments to hospital patients and resident veterans for their services under the VA's therapeutic or rehabilitative programs are not treated as
nontaxable veterans' benefits. Report these payments as income on Form 1040, line 21.
VolunteersVolunteer workWages and salaries:Volunteer work
The tax treatment of amounts you receive as a volunteer worker for the Peace Corps or similar agency is covered in the following discussions.
Peace Corps.Peace Corps allowances
Living allowances you receive as a Peace Corps volunteer or volunteer leader for housing, utilities, household supplies, food, and clothing are
exempt from tax.
Taxable allowances.
The following allowances must be included in your income and reported as wages.
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.
Volunteers in Service to America (VISTA).VISTA volunteers
If you are a VISTA volunteer, you must include meal and lodging allowances paid to you in your income as wages.
National Senior Services Corps programs.
Do not include in your income amounts you receive for supportive services or reimbursements for out-of-pocket expenses from the following programs.
Retired Senior Volunteer Program (RSVP).
Retired Senior Volunteer Program
Foster Grandparent Program.
Foster Grandparent Program
Senior Companion Program.
Senior Companion Program
Service Corps of Retired Executives (SCORE).Service Corps of Retired Executives (SCORE)
If you receive amounts for supportive services or reimbursements for out-of-pocket expenses from SCORE, do not include these amounts in income.
Volunteer tax counseling.HelpTax helpTax help:Volunteer counseling (Volunteer Income Tax Assistance program)Volunteer work:Tax counseling (Volunteer Income Tax Assistance program)
Do not include in your income any reimbursements you receive for transportation, meals, and other expenses you have in training for, or actually
providing, volunteer federal income tax counseling for the elderly (TCE).
You can deduct as a charitable contribution your unreimbursed out-of-pocket expenses in taking part in the volunteer income tax assistance (VITA)
program. See chapter 24.
Sickness and Injury Benefits
This section discusses sickness and injury benefits including disability pensions, long-term care insurance contracts, workers' compensation, and
other benefits.
Disability PensionsDisabilities, persons with:IncomePersons with disabilitiesDisabilities, persons withWages and salaries:Disability income
Generally, if you retire on disability, you must report your pension or annuity as income.
You may be entitled to a tax credit if you were permanently and totally disabled when you retired. For information on this credit and the
definition of permanent and total disability, see chapter 33.
For information on disability payments from a governmental program provided as a substitute for unemployment compensation, see chapter 12.
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. Your employer should be able to give you specific details about your pension plan and
tell you the amount you paid for your disability pension. In addition to disability pensions and annuities, you may be receiving other payments for
sickness and injury.
Do not report as income any amounts paid to reimburse you for medical expenses you incurred after the plan was established.
Cost paid by you.Disabilities, persons with:Insurance costs
If you pay the entire cost of a health or accident insurance plan, do not include any amounts you receive from the plan for personal injury or
sickness as income on your tax return. If your plan reimbursed you for medical expenses you deducted in an earlier year, you may have to include some,
or all, of the reimbursement in your income. See Reimbursement in a later year in chapter 21.
Generally, if you are covered by an accident or health insurance plan through a cafeteria plan, and the amount of the insurance premiums was not
included in your income, you are not considered to have paid the premiums and you must include any benefits you receive in your income. If the amount
of the premiums was included in your income, you are considered to have paid the premiums, and any benefits you receive are not taxable.
Retirement and profit-sharing plans.Disabilities, persons with:Retirement, pensions, and profit-sharing plans
If you receive payments from a retirement or profit-sharing plan that does not provide for disability retirement, do not treat the payments as a
disability pension. The payments must be reported as a pension or annuity. For more information on pensions, see chapter 10.
If you retire on disability, any lump-sum payment you receive for accrued annual leave is a salary payment. The payment is not a disability
payment. Include it in your income in the tax year you receive it.
How to report.
Disabilities, persons with:Reporting of disability pension incomeHandicapped personsDisabilities, persons withMentally incompetent persons:Disabilities, persons withForm:1040:Disability retirement payForm:1040A:Disability retirement payIf 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. The rules for reporting pensions are explained in How To Report in chapter
10.
Military and Government
Disability PensionsArmed forces:Disability pensionsDisabilities, persons with:Military and government pensionsExclusions from gross income:Disability pensions of federal employees and militaryFederal employees:Disability pensionsFederal governmentEmployeesFederal employeesGovernment employeesFederalFederal employeesMilitaryArmed forces
Certain military and government disability pensions are not taxable.
Service-connected disability.
You may be able to exclude from income amounts you receive as a pension, annuity, or similar allowance for personal injury or sickness resulting
from active service in one of the following government services.
The armed forces of any country.
The National Oceanic and Atmospheric Administration.
The Public Health Service.
The Foreign Service.
Conditions for exclusion.Exclusions from gross income:Disability pensions of federal employees and militaryFederal employees:Disability pensions:Exclusion, conditions for
Do not include the disability payments in your income if any of the following conditions apply.
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.
Pension based on years of service.Federal employees:Disability pensions:Based on years of service
If you receive a disability pension based on years of service, you generally must include it in your income. However, if the pension qualifies for
the exclusion for a service-connected disability (discussed earlier), do not include in income the part of your pension that you would have received
if the pension had been based on a percentage of disability. You must include the rest of your pension in your income.
Retroactive VA determination.Veterans' benefits:Retroactive determination
If you retire from the armed services based on years of service and are later given a retroactive service-connected disability rating by the VA,
your retirement pay for the retroactive period is excluded from income up to the amount of VA disability benefits you would have been entitled to
receive. You can claim a refund of any tax paid on the excludable amount (subject to the statute of limitations) by filing an amended return on Form
1040X for each previous year during the retroactive period.
If you receive a lump-sum disability severance payment and are later awarded VA disability benefits, exclude 100% of the severance benefit from
your income. However, you must include in your income any lump-sum readjustment or other nondisability severance payment you received on release from
active duty, even if you are later given a retroactive disability rating by the VA.
Terrorist attack or military action.Anthrax incidentsTerrorist attacksDisaster reliefTerrorist attacksFederal employees:Disability pensions:Terrorist attackTerrorist attacks:Disability pensions for federal employees
Do not include in your income disability payments you receive for injuries resulting directly from a terrorist or military action.
Long-Term Care
Insurance ContractsAccident insurance:Long-term careElderly personsLong-term careLong-term care insurance contractsExclusions from gross income:Long-term care insurance contractsInsuranceAccidentAccident insuranceLong-term care insurance contractsNursing homesInsurance for care inLong-term care insurance contracts
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. 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
Generally not pay or reimburse expenses incurred for services or items that would be reimbursed under Medicare, except where Medicare is a
secondary payer or the contract makes per diem or other periodic payments without regard to expenses.
Qualified long-term care services.Long-term care insurance contracts:Qualified services defined
Qualified long-term care services are:
Necessary diagnostic, preventive, therapeutic, curing, treating, mitigating, and rehabilitative services, and maintenance and personal care
services, and
Required by a chronically ill individual and provided pursuant to a plan of care as prescribed by a licensed health care
practitioner.
Chronically ill individual.Long-term care insurance contracts:Chronically ill individual
A chronically ill individual is one who has been certified by a licensed health care practitioner within the previous 12 months as one of the
following.
An individual who, for at least 90 days, is unable to perform at least two activities of daily living without substantial assistance due to
loss of functional capacity. Activities of daily living are eating, toileting, transferring, bathing, dressing, and continence.
An individual who requires substantial supervision to be protected from threats to health and safety due to severe cognitive
impairment.
Limit on exclusion.Exclusions from gross income:Long-term care insurance contractsLong-term care insurance contracts:Exclusion, limit of
You can generally exclude from gross income up to $240 a day for 2005. See Limit on exclusion, under Long-Term Care Insurance
Contracts, under Sickness and Injury Benefits in Publication 525 for more information.
Workers' CompensationDisabilities, persons with:Workers' compensationPersons with disabilitiesDisabilities, persons withWorkers' compensation
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.
If part of your workers' compensation reduces your social security or equivalent railroad retirement benefits received, that part is considered
social security (or equivalent railroad retirement) benefits and may be taxable. For more information, see Publication 915, Social Security and
Equivalent Railroad Retirement Benefits.
Return to work.Workers' compensation:Return to work
Form:1040:Workers' compensationForm:1040A:Workers' compensationForm:1040EZ:Workers' compensationIf you return to work after qualifying for workers' compensation, salary payments you receive for
performing light duties are taxable as wages.
Other Sickness and Injury Benefits
In addition to disability pensions and annuities, you may receive other payments for sickness or injury.
Form:1040:FECA benefitsForm:1040A:FECA benefitsForm:1040EZ:FECA benefitsScheduleForm 1040Payments you receive as sick pay under the Railroad Unemployment Insurance Act are taxable and you must include them in your
income. However, do not include them in your income if they are for an on-the-job injury.
If you received income because of a disability, see Disability Pensions, earlier.
Payments received under this Act for personal injury or sickness, including payments to beneficiaries in case of death, are not taxable. However,
you are taxed on amounts you receive under this Act as continuation of pay for up to 45 days while a claim is being decided. Report this income on
line 7 of Form 1040 or Form 1040A or on line 1 of Form 1040EZ. Also, pay for sick leave while a claim is being processed is taxable and must be
included in your income as wages.
If part of the payments you receive under FECA reduces your social security or equivalent railroad retirement benefits received, that part is
considered social security (or equivalent railroad retirement) benefits and may be taxable. For a discussion of the taxability of these benefits, see
Social security and equivalent railroad retirement benefits under Other Income, in Publication 525.
Form:1040, Schedule AFederal employees buying back sick leaveMiscellaneous deductions:Federal employees buying back sick leaveSick leave:Federal employees buying backYou can deduct the amount you spend to buy back sick leave for an earlier year to be eligible
for nontaxable FECA benefits for that period. It is a miscellaneous deduction subject to the 2% of AGI limit on Schedule A (Form 1040). If you buy
back sick leave in the same year you used it, the amount reduces your taxable sick leave pay. Do not deduct it separately.
Other compensation.Wages and salaries:Sick pay
Many other amounts you receive as compensation for sickness or injury are not taxable. These include the following amounts.
Compensatory damages you receive for physical injury or physical sickness, whether paid in a lump sum or in periodic payments.
Benefits you receive under an accident or health insurance policy on which either you paid the premiums or your employer paid the premiums
but you had to include them in your income.
Disability benefits you receive for loss of income or earning capacity as a result of injuries under a no-fault car insurance policy.
Compensation you receive for permanent loss or loss of use of a part or function of your body, or for your permanent disfigurement. This
compensation must be based only on the injury and not on the period of your absence from work. These benefits are not taxable even if your employer
pays for the accident and health plan that provides these benefits.
Reimbursement for medical care.Medical and dental expenses:Reimbursements, treatment of
Wages and salariesIncomeA reimbursement for medical care is generally not taxable. However, it may reduce your medical expense
deduction. For more information, see chapter 21.
Tip IncomeTip incomeBar employeesTipsTip incomeGratuitiesTip incomeIncomeTipsTip incomeRestaurant employeesTipsTip incomeWaiters and waitressesTipsTip income
This chapter is for employees who receive tips.
Tip income:Tip-splitting or tip-pooling arrangementsAll tips you receive are income and are subject to federal income tax. You must
include in gross income all tips you receive directly, charged tips that are paid to you by your employer, and your share of any tips you receive
under a tip-splitting or tip-pooling arrangement.
Tip income:Noncash tipsThe value of noncash tips, such as tickets, passes, or other items of value are also income and subject to tax.
Reporting your tip income correctly is not difficult. You must do three things.
Keep a daily tip record.
Recordkeeping requirements:Tip incomeTip income:Daily record of tips
Report tips to your employer.
Tip income:Reporting tips to employer
Report all your tips on your income tax return.
This chapter will show you how to do these three things and what to do on your tax return if you have not done the first two. This chapter will
also show you how to treat allocated tips.
Publication531Reporting Tip Income1244Employee's Daily Record of Tips and Report to EmployerForm (and Instructions)Social Security and Medicare Tax on Unreported Tip IncomeEmployee's Report of Tips to Employer
Keeping a Daily Tip RecordTip income:Daily record of tipsWhy keep a daily tip record?
You must keep a daily tip record so you can:
Report your tips accurately to your employer,
Report your tips accurately on your tax return, and
Prove your tip income if your return is ever questioned.
How to keep a daily tip record.
There are two ways to keep a daily tip record. You can either:
Write information about your tips in a tip diary, or
Keep copies of documents that show your tips, such as restaurant bills and credit card charge slips.
You should keep your daily tip record with your personal records. You must keep your records for as long as they are important for
administration of the federal tax law. For information on how long to keep records, see Publication 552, Recordkeeping for Individuals.
Form:4070A:Daily record of tipsPublication 1244:Daily record of tips (Form 1244)Tip income:Form 4070A for daily recordsIf you keep a tip diary, you can use Form 4070A, Employee's Daily Record of Tips. To get Form
4070A, ask the Internal Revenue Service (IRS) or your employer for Publication 1244. Publication 1244 includes a year's supply of Form 4070A. Each
day, write in the information asked for on the form.
If you do not use Form 4070A, start your records by writing your name, your employer's name, and the name of the business if it is different from
your employer's name. Then, each workday, write the date and the following information.
Cash tips you get directly from customers or from other employees.
Tips from credit card charge customers that your employer pays you. (Also include tips from debit card charge customers.)
The value of any noncash tips you get, such as tickets, passes, or other items of value.
Tip income:Noncash tips
The amount of tips you paid out to other employees through tip pools or tip splitting, or other arrangements, and the names of the employees
to whom you paid the tips.
Tip income:Tip-splitting or tip-pooling arrangements
Service charges:Employer treating as wages for tip incomeTip income:Service charges paid by employer as wages
Do not write in your tip diary the amount of any service charge that your employer adds to a customer's bill and then pays to you and treats as
wages. This is part of your wages, not a tip.
Electronic tip record.Recordkeeping requirements:Electronic records of tipsTip income:Electronic tip record
You may use an electronic system provided by your employer to record your daily tips. You must receive and keep a paper copy of this record.
Reporting Tips to Your EmployerTip income:Reporting tips to employerWhy report tips to your employer?
You must report tips to your employer so that:
Your employer can withhold federal income tax and social security and Medicare taxes or railroad retirement tax,
Tip income:WithholdingWithholding:TipsTip income
Your employer can report the correct amount of your earnings to the Social Security Administration or Railroad Retirement Board (which
affects your benefits when you retire or if you become disabled, or your family's benefits if you die), and
Employment::Taxes:Tip incomeTip income:Social security and Medicare tax:Employer reporting for purposes of
You can avoid the penalty for not reporting tips to your employer (explained later).
What tips to report.Tip income:Reporting tips to employer
Report to your employer only cash, check, debit, or credit card tips you receive.
If your total tips for any one month from any one job are less than $20, do not report the tips for that month to that employer.
Tip income:Noncash tipsDo not report the value of any noncash tips, such as tickets or passes, to your employer. You do not pay social
security and Medicare taxes or railroad retirement tax on these tips.
How to report.
Form:4070:Reporting tips to employerPublication 1244:Reporting tips to employerTip income:Reporting tips to employer:Form 4070 forIf your employer does not give you any other way to report tips, you can use Form 4070. Fill in the
information asked for on the form, sign and date the form, and give it to your employer. To get a year's supply of the form, ask the IRS or your
employer for Publication 1244.
If you do not use Form 4070, give your employer a statement with the following information.
Your name, address, and social security number.
Your employer's name, address, and business name (if it is different from the employer's name).
The month (or the dates of any shorter period) in which you received tips.
The total tips required to be reported for that period.
You must sign and date the statement. You should keep a copy with your personal records.
Your employer may require you to report your tips more than once a month. However, the statement cannot cover a period of more than one calendar
month.
Electronic tip statement.Electronic reporting:Tip statement from employees to employers
Your employer can have you furnish your tip statements electronically.
When to report.
Give your report for each month to your employer by the 10th of the next month. If the 10th falls on a Saturday, Sunday, or legal holiday, give
your employer the report by the next day that is not a Saturday, Sunday, or legal holiday.
Example 1.
You must report your tips received in April 2006 by May 10, 2006.
Example 2.
You must report your tips received in May 2006 by June 12, 2006. June 10th is on a Saturday, and the 12th is the next day that is not a Saturday,
Sunday, or legal holiday.
Final report.
If your employment ends during the month, you can report your tips when your employment ends.
Penalty for not reporting tips.Penalties:Tips, failure to reportTip income:Penalty for failure to reportTip income:Reporting tips to employer:Failure to report to employer
If you do not report tips to your employer as required, you may be subject to a penalty equal to 50% of the social security and Medicare taxes or
railroad retirement tax you owe on the unreported tips. (For information about these taxes, see Reporting social security and Medicare taxes on
tips not reported to your employer under Reporting Tips on Your Tax Return, later.) The penalty amount is in addition to the taxes
you owe.
You can avoid this penalty if you can show reasonable cause for not reporting the tips to your employer. To do so, attach a statement to your
return explaining why you did not report them.
Giving your employer money for taxes.Tip income:Withholding:Employee contributing to
Your regular pay may not be enough for your employer to withhold all the taxes you owe on your regular pay plus your reported tips. If this
happens, you can give your employer money until the close of the calendar year to pay the rest of the taxes.
If you do not give your employer enough money, your employer will apply your regular pay and any money you give to the taxes in the following
order.
All taxes on your regular pay.
Social security and Medicare taxes or railroad retirement tax on your reported tips.
Federal, state, and local income taxes on your reported tips.
Tip income:Withholding:UnderwithholdingAny taxes that remain unpaid can be collected by your employer from your next paycheck. If withholding
taxes remain uncollected at the end of the year, you may be subject to a penalty for underpayment of estimated taxes. See Publication 505, Tax
Withholding and Estimated Tax, for more information.
Uncollected taxes. Form:W-2:Uncollected taxesTip income:Uncollected taxesYou must report on your tax return any social security and Medicare taxes or railroad retirement tax that
remained uncollected at the end of 2005. See Reporting uncollected social security and Medicare taxes on tips under Reporting Tips on
Your Tax Return, later. These uncollected taxes will be shown in box 12 of your 2005 Form W-2 (codes A and B).
Tip Rate Determination and Education ProgramTip income:Tip Rate Determination and Education Program
Your employer may participate in the Tip Rate Determination and Education Program. The program was developed to help employees and employers
understand and meet their tip reporting responsibilities.
There are two agreements under the program: the Tip Rate Determination Agreement (TRDA) and the Tip Reporting Alternative Commitment (TRAC). In
addition, employers in the food and beverage industry may be able to get approval of an employer-designed EmTRAC program. For information on the
EmTRAC program, see Notice 2001-1, which is on page 261 of Internal Revenue Bulletin 2001-2 at
www.irs.gov/pub/irs-irbs/irb01–02.pdf.
Gaming Industry Tip Compliance Agreement ProgramIf you are employed in the gaming industry, your employer may have a Gaming
Industry Tip Compliance Agreement Program. See Revenue Procedure 2003-35, which is on page 919 of Internal Revenue Bulletin No. 2003-20 at
www.irs.gov/pub/irs-irbs/irb03–20.pdf.
Your employer can provide you with a copy of any applicable agreement. If you want to learn more about these agreements, contact your local IRS
Taxpayer Education Communication (TEC) office. You may call 1-800-829-4933 for the IRS TEC office in your area or send an email to
TEC.TIP.Program@irs.gov.
Reporting Tips on Your Tax ReturnTip income:Reporting on tax returnHow to report tips.
Form:1040:Tip income reportingForm:1040A:Tip income reportingForm:1040EZ:Tip income reportingReport your tips with your wages on line 1, Form 1040EZ, or line 7, Form 1040A or Form 1040.
What tips to report.
You must report all tips you received in 2005, including both cash tips and noncash tips, on your tax return. Any tips you reported to your
employer for 2005 are included in the wages shown in box 1 of your Form W-2. Add to the amount in box 1 only the tips you did not report to your
employer.
If you received $20 or more in cash and charge tips in a month and did not report all of those tips to your employer, see Reporting social
security and Medicare taxes on tips not reported to your employer, later.
If you did not keep a daily tip record as required and an amount is shown in box 8 of your Form W-2, see Allocated Tips, later.
If you kept a daily tip record and reported tips to your employer as required under the rules explained earlier, add the following tips to the
amount in box 1 of your Form W-2.
Cash and charge tips you received that totaled less than $20 for any month.
The value of noncash tips, such as tickets, passes, or other items of value.
Tip income:Noncash tips
Example.
John Allen began working at the Diamond Restaurant (his only employer in 2005) on June 30 and received $10,000 in wages during the year. John kept
a daily tip record showing that his tips for June were $18 and his tips for the rest of the year totaled $7,000. He was not required to report his
June tips to his employer, but he reported all of the rest of his tips to his employer as required.
John's Form W-2 from Diamond Restaurant shows $17,000 ($10,000 wages plus $7,000 reported tips) in box 1. He adds the $18 unreported tips to that
amount and reports $17,018 as wages on his tax return.
Reporting social security and Medicare taxes on tips not reported to your employer.
Form:1040:Reporting taxes on tips not reported to employerIf you received $20 or more in cash and charge tips in a month from
any one job and did not report all of those tips to your employer, you must report the social security and Medicare taxes on the unreported tips as
additional tax on your return. To report these taxes, you must file a return even if you would not otherwise have to file. You must use Form 1040.
(You cannot file Form 1040EZ or Form 1040A.)
Form:4137:Social security and Medicare taxes on tips not reported to employerUse Form 4137 to figure these taxes. Enter the tax
on line 59, Form 1040, and attach Form 4137 to your return.
If you are subject to the Railroad Retirement Tax Act, you cannot use Form 4137 to pay railroad retirement tax on unreported tips. To get railroad
retirement credit, you must report tips to your employer.
Reporting uncollected social security and Medicare taxes on tips.Tip income:Uncollected taxes
If your employer could not collect all the social security and Medicare taxes or railroad retirement tax you owe on tips reported for 2005, the
uncollected taxes will be shown in box 12 of your Form W-2 (codes A and B). You must report these amounts as additional tax on your return. You may
have uncollected taxes if your regular pay was not enough for your employer to withhold all the taxes you owe and you did not give your employer
enough money to pay the rest of the taxes.
Form:1040:Reporting uncollected taxes on tipsTo report these uncollected taxes, you must file a return even if you would not
otherwise have to file. You must use Form 1040. (You cannot file Form 1040EZ or Form 1040A.) Include the taxes in your total tax amount on line 63,
and write UT and the total of the uncollected taxes on the dotted line next to line 63.
Allocated TipsTip income:Allocated tips
If your employer allocated tips to you, they are shown separately in box 8 of your Form W-2. They are not included in box 1 with your wages and
reported tips. If box 8 is blank, this discussion does not apply to you.
What are allocated tips?
These are tips that your employer assigned to you in addition to the tips you reported to your employer for the year. Your employer will have done
this only if:
You worked in a restaurant, cocktail lounge, or similar business that must allocate tips to employees, and
The tips you reported to your employer were less than your share of 8% of food and drink sales.
How were your allocated tips figured?
The tips allocated to you are your share of an amount figured by subtracting the reported tips of all employees from 8% (or an approved lower rate)
of food and drink sales (other than carryout sales and sales with a service charge of 10% or more). Your share of that amount was figured using either
a method provided by an employer-employee agreement or a method provided by IRS regulations based on employees' sales or hours worked. For information
about the exact allocation method used, ask your employer.
Must you report your allocated tips on your return?Tip income:Allocated tips
You must report allocated tips on your tax return unless either of the following exceptions applies.
You kept a daily tip record, or other evidence that is as credible and as reliable as a daily tip record, as required under rules explained
earlier.
Your tip record is incomplete, but it shows that your actual tips were more than the tips you reported to your employer plus the allocated
tips.
If either exception applies, report your actual tips on your return. Do not report the allocated tips. See What tips to report under
Reporting Tips on Your Tax Return, earlier.
How to report allocated tips.Tip income:Allocated tips
If you must report allocated tips on your return, add the amount in box 8 of your Form W-2 to the amount in box 1. Report the total as wages on
line 7 of Form 1040. (You cannot file Form 1040EZ or Form 1040A.)
Tip incomeBecause social security and Medicare taxes were not withheld from the allocated tips, you must report
those taxes as additional tax on your return. Complete Form 4137, and include the allocated tips on line 1 of the form. See Reporting social
security and Medicare taxes on tips not reported to your employer under Reporting Tips on Your Tax Return, earlier.
If you are a U.S. citizen with interest income from sources outside the United States (foreign income), you must report that income on your tax
return unless it is exempt by U.S. law. This is true whether you reside inside or outside the United States and whether or not you receive a Form 1099
from the foreign payer.
This chapter discusses:
Different types of interest income,
What interest is taxable and what interest is nontaxable,
When to report interest income, and
How to report interest income on your tax return.
In general, any interest that you receive or that is credited to your account and can be withdrawn is taxable income. Exceptions to this rule are
discussed later in this chapter.
You may be able to deduct expenses you have in earning this income on Schedule A (Form 1040) if you itemize your deductions. See chapter 28.
Publication537 Installment Sales550 Investment Income and Expenses1212List of Original Issue Discount InstrumentsForm (and Instructions)Interest and Ordinary DividendsInterest and Ordinary Dividends for Form 1040A FilersApplication for Change in Accounting MethodExclusion of Interest From Series EE and I U.S. Savings Bonds Issued After 1989Optional Form To Record Redemption of Series EE and I U.S. Savings Bonds Issued After 1989
General Information
A few items of general interest are covered here.
Recordkeeping. You should keep a list showing sources and amounts of interest received during the year. Also, keep the forms you receive
that show your interest income (Forms 1099-INT, for example) as an important part of your records.
Tax on investment income of a child under age 14.Form:8615
Part of a child's 2005 investment income may be taxed at the parent's tax rate. This may happen if all the following are true.
The child was under age 14 at the end of 2005. A child born on January 1, 1992, is considered to be age 14 at the end of 2005.
The child had more than $1,600 of investment income (such as taxable interest and dividends) and has to file a tax return.
Either parent was alive at the end of 2005.
If all these statements are true, Form 8615, Tax for Children Under Age 14 Who Have Investment Income of More Than $1,600, must be completed
and attached to the child's tax return. If any of these statements is not true, Form 8615 is not required and the child's income is taxed at his or
her own tax rate.
However, the parent can choose to include the child's interest and dividends on the parent's return if certain requirements are met. Use
Form:8814Form 8814, Parents' Election To Report Child's Interest and Dividends, for this purpose.
For more information about the tax on investment income of children and the parents' election, see chapter 31.
Beneficiary of an estate or trust.Schedule:K-1, Form 1041
Interest you receive as a beneficiary of an estate or trust is generally taxable income. You should receive a Schedule K-1 (Form 1041),
Beneficiary's Share of Income, Deductions, Credits, etc., from the fiduciary. Your copy of Schedule K-1 and its instructions will tell you where to
report the income on your Form 1040.
Social security number (SSN).
You must give your name and SSN to any person required by federal tax law to make a return, statement, or other document that relates to you. This
includes payers of interest.
SSN for joint account.
If the funds in a joint account belong to one person, list that person's name first on the account and give that person's SSN to the payer. (For
information on who owns the funds in a joint account, see Joint accounts, later.) If the joint account contains combined funds, give the
SSN of the person whose name is listed first on the account.
These rules apply both to joint ownership by a married couple and to joint ownership by other individuals. For example, if you open a joint savings
account with your child using funds belonging to the child, list the child's name first on the account and give the child's SSN.
Custodian account for your child.
If your child is the actual owner of an account that is recorded in your name as custodian for the child, give the child's SSN to the payer. For
example, you must give your child's SSN to the payer of interest on an account owned by your child, even though the interest is paid to you as
custodian.
Penalty for failure to supply SSN.
If you do not give your SSN to the payer of interest, you may have to pay a penalty. See Failure to supply social security number under
Penalties in chapter 1. Backup withholding also may apply.
Backup withholding.Backup withholding
Your interest income is generally not subject to regular withholding. However, it may be subject to backup withholding to ensure that income tax is
collected on the income. Under backup withholding, the payer of interest must withhold, as income tax, 28% of the amount you are paid.
Backup withholding may also be required if the Internal Revenue Service (IRS) has determined that you underreported your interest or dividend
income. For more information, see Backup Withholding in chapter 4.
Reporting backup withholding.
If backup withholding is deducted from your interest income, the payer must give you a Form 1099-INT for the year that indicates the amount
withheld. The Form 1099-INT will show any backup withholding as Federal income tax withheld.
Joint accounts.Joint accounts
If two or more persons hold property (such as a savings account or bond) as joint tenants, tenants by the entirety, or tenants in common, each
person's share of any interest from the property is determined by local law.
Tenants:By the entiretyIn common
Income from property given to a child.Children:Gifts to
Property you give as a parent to your child under the Model Gifts of Securities to Minors Act, the Uniform Gifts to Minors Act, or any similar law,
becomes the child's property.
Income from the property is taxable to the child, except that any part used to satisfy a legal obligation to support the child is taxable to the
parent or guardian having that legal obligation.
Savings account with parent as trustee.
Interest income from a savings account opened for a child who is a minor, but placed in the name and subject to the order of the parents as
trustees, is taxable to the child if, under the law of the state in which the child resides, both of the following are true.
The savings account legally belongs to the child.
The parents are not legally permitted to use any of the funds to support the child.
Form 1099-INT.Form:1099-INT
Interest income is generally reported to you on Form 1099-INT, or a similar statement, by banks, savings and loans, and other payers of interest.
This form shows you the interest you received during the year. Keep this form for your records. You do not have to attach it to your tax return.
Report on your tax return the total amount of interest income that you receive for the tax year.
Interest not reported on Form 1099-INT.
Even if you do not receive Form 1099-INT, you must still report all of your taxable interest income. For example, you may receive distributive
shares of interest from partnerships or S corporations. This interest is reported to you on Schedule K-1 (Form 1065) or Schedule K-1 (Form 1120S).
Nominees.Nominees
Generally, if someone receives interest as a nominee for you, that person will give you a Form 1099-INT showing the interest received on your
behalf.
If you receive a Form 1099-INT that includes amounts belonging to another person, see the discussion on nominee distributions under How To
Report Interest Income in chapter 1 of Publication 550, or see the Schedule 1 (Form 1040A) or Schedule B (Form 1040) instructions.
Incorrect amount.
If you receive a Form 1099-INT that shows an incorrect amount (or other incorrect information), you should ask the issuer for a corrected form. The
new Form 1099-INT you receive will be marked Corrected.
Form 1099-OID.
Reportable interest income may also be shown on Form 1099-OID, Original Issue Discount. For more information about amounts shown on this form, see
Original Issue Discount (OID), later in this chapter.
Exempt-interest dividends you receive from a regulated investment company (mutual fund) are not included in your taxable income. (However, see
Information-reporting requirement, next.) You will receive a notice from the mutual fund telling you the amount of the exempt-interest
dividends that you received. Exempt-interest dividends are not shown on Form 1099-DIV or Form 1099-INT.
Information-reporting requirement.
Although exempt-interest dividends are not taxable, you must show them on your tax return if you have to file. This is an information-reporting
requirement and does not change the exempt-interest dividends into taxable income.
Note.
Exempt-interest dividends paid from specified private activity bonds may be subject to the alternative minimum tax. See Alternative Minimum
Tax in chapter 30 for more information. Chapter 1 of Publication 550 contains a discussion on private activity bonds, under State or Local
Government Obligations.
Interest on VA dividends.
Interest on insurance dividends that you leave on deposit with the Department of Veterans Affairs (VA) is not taxable. This includes interest paid
on dividends on converted United States Government Life Insurance and on National Service Life Insurance policies.
Individual retirement arrangements (IRAs).
Interest on a Roth IRA generally is not taxable. Interest on a traditional IRA is tax deferred. You generally do not include it in your income
until you make withdrawals from the IRA. See chapter 17.
Taxable Interest
Taxable interest includes interest you receive from bank accounts, loans you make to others, and other sources. The following are some other
sources of taxable interest.
Dividends that are actually interest.
Certain distributions commonly called dividends are actually interest. You must report as interest so-called dividends on deposits or on
share accounts in:
Cooperative banks,
Credit unions,
Domestic building and loan associations,
Domestic savings and loan associations,
Federal savings and loan associations, and
Mutual savings banks.
Money market funds.
Generally, amounts you receive from money market funds should be reported as dividends, not as interest.
Certificates of deposit and other deferred interest accounts.Money market certificatesSavings:Certificate
If you open any of these accounts, interest may be paid at fixed intervals of 1 year or less during the term of the account. You generally must
include this interest in your income when you actually receive it or are entitled to receive it without paying a substantial penalty. The same is true
for accounts that mature in 1 year or less and pay interest in a single payment at maturity. If interest is deferred for more than 1 year, see
Original Issue Discount (OID), later.
Interest subject to penalty for early withdrawal.
If you withdraw funds from a deferred interest account before maturity, you may have to pay a penalty. You must report the total amount of interest
paid or credited to your account during the year, without subtracting the penalty. See Penalty on early withdrawal of savings in chapter 1
of Publication 550 for more information on how to report the interest and deduct the penalty.
Money borrowed to invest in certificate of deposit.
The interest you pay on money borrowed from a bank or savings institution to meet the minimum deposit required for a certificate of deposit from
the institution and the interest you earn on the certificate are two separate items. You must report the total interest you earn on the certificate in
your income. If you itemize deductions, you can deduct the interest you pay as investment interest, up to the amount of your net investment income.
See Interest Expenses in chapter 3 of Publication 550.
Example.
You deposited $5,000 with a bank and borrowed $5,000 from the bank to make up the $10,000 minimum deposit required to buy a 6-month certificate of
deposit. The certificate earned $575 at maturity in 2005, but you received only $265, which represented the $575 you earned minus $310 interest
charged on your $5,000 loan. The bank gives you a Form 1099-INT for 2005 showing the $575 interest you earned. The bank also gives you a statement
showing that you paid $310 interest for 2005. You must include the $575 in your income. If you itemize your deductions on Schedule A (Form 1040), you
can deduct $310, subject to the net investment income limit.
Gift for opening account.
If you receive noncash gifts or services for making deposits or for opening an account in a savings institution, you may have to report the value
as interest.
For deposits of less than $5,000, gifts or services valued at more than $10 must be reported as interest. For deposits of $5,000 or more, gifts or
services valued at more than $20 must be reported as interest. The value is determined by the cost to the financial institution.
Example.
You open a savings account at your local bank and deposit $800. The account earns $20 interest. You also receive a $15 calculator. If no other
interest is credited to your account during the year, the Form 1099-INT you receive will show $35 interest for the year. You must report $35 interest
income on your tax return.
Interest on insurance dividends.Insurance proceeds:Dividends, interest on
Interest on insurance dividends left on deposit with an insurance company that can be withdrawn annually is taxable to you in the year it is
credited to your account. However, if you can withdraw it only on the anniversary date of the policy (or other specified date), the interest is
taxable in the year that date occurs.
Prepaid insurance premiums.Insurance premiums:Paid in advancePrepaid:Insurance
Any increase in the value of prepaid insurance premiums, advance premiums, or premium deposit funds is interest if it is applied to the payment of
premiums due on insurance policies or made available for you to withdraw.
U.S. obligations.Treasury notesU.S. obligations, interest
Interest on U.S. obligations, such as U.S. Treasury bills, notes, and bonds, issued by any agency or instrumentality of the United States is
taxable for federal income tax purposes.
Interest on tax refunds.Tax refunds:Interest on
Interest you receive on tax refunds is taxable income.
Interest on condemnation award.
If the condemning authority pays you interest to compensate you for a delay in payment of an award, the interest is taxable.
Installment sale payments.
If a contract for the sale or exchange of property provides for deferred payments, it also usually provides for interest payable with the deferred
payments. That interest is taxable when you receive it. If little or no interest is provided for in a deferred payment contract, part of each payment
may be treated as interest. See Unstated Interest and Original Issue Discount in Publication 537, Installment Sales.
Interest on annuity contract.
Accumulated interest on an annuity contract you sell before its maturity date is taxable.
Usurious interest is interest charged at an illegal rate. This is taxable as interest unless state law automatically changes it to a payment on the
principal.
Interest income on frozen deposits.Interest:Frozen deposits
Exclude from your gross income interest on frozen deposits. A deposit is frozen if, at the end of the year, you cannot withdraw any part of the
deposit because:
The financial institution is bankrupt or insolvent, or
The state where the institution is located has placed limits on withdrawals because other financial institutions in the state are bankrupt
or insolvent.
The amount of interest you must exclude is the interest that was credited on the frozen deposits minus the sum of:
The net amount you withdrew from these deposits during the year, and
The amount you could have withdrawn as of the end of the year (not reduced by any penalty for premature withdrawals of a time
deposit).
If you receive a Form 1099-INT for interest income on deposits that were frozen at the end of 2005, see Frozen deposits under
How To Report Interest Income in chapter 1 of Publication 550, for information about reporting this interest income exclusion on your tax
return.
The interest you exclude is treated as credited to your account in the following year. You must include it in income in the year you can withdraw
it.
Example.
$100 of interest was credited on your frozen deposit during the year. You withdrew $80 but could not withdraw any more as of the end of the year.
You must include $80 in your income and exclude $20 from your income for the year. You must include the $20 in your income for the year you can
withdraw it.
Bonds traded flat.
If you buy a bond at a discount when interest has been defaulted or when the interest has accrued but has not been paid, the transaction is
described as trading a bond flat. The defaulted or unpaid interest is not income and is not taxable as interest if paid later. When you receive a
payment of that interest, it is a return of capital that reduces the remaining cost basis of your bond. Interest that accrues after the date of
purchase, however, is taxable interest income for the year it is received or accrued. See Bonds Sold Between Interest Dates, later, for
more information.
Below-market loans.
In general, a below-market loan is a loan on which no interest is charged or on which interest is charged at a rate below the applicable federal
rate. See Below-Market Loans in chapter 1 of Publication 550 for more information.
U.S. Savings BondsU.S. obligations, interestBonds:SavingsSavings:Bonds
This section provides tax information on U.S. savings bonds. It explains how to report the interest income on these bonds and how to treat
transfers of these bonds.
For other information on U.S. savings bonds, write to:
For series EE and I:
Bureau of the Public Debt
Accrual Services Division
P.O. Box 1328
Parkersburg, WV 26106-1328
For series HH/H:
Bureau of the Public Debt
Current Income Services Division
HH/H Assistance Branch
P.O. Box 2186
Parkersburg, WV 26106-2186
If you use an accrual method of accounting, you must report interest on U.S. savings bonds each year as it accrues. You cannot postpone reporting
interest until you receive it or until the bonds mature. Accrual methods of accounting are explained in chapter 1 under Accounting Methods.
Cash method taxpayers.
If you use the cash method of accounting, as most individual taxpayers do, you generally report the interest on U.S. savings bonds when you receive
it. The cash method of accounting is explained in chapter 1 under Accounting Methods.
Series HH Bonds.Bonds:SavingsSeries HH and H savings bonds
These bonds were issued at face value. Interest is paid twice a year by direct deposit to your bank account. If you are a cash method taxpayer,
you must report interest on these bonds as income in the year you receive it.
Series HH bonds were first offered in 1980; they were last offered in August 2004. Before 1980, series H bonds were issued. Series H bonds are
treated the same as series HH bonds. If you are a cash method taxpayer, you must report the interest when you receive it.
Series H bonds have a maturity period of 30 years. Series HH bonds mature in 20 years.
Series EE and series I bonds.Bonds:SavingsSeries EE and E savings bondsBonds:SavingsSeries I savings bonds
Interest on these bonds is payable when you redeem the bonds. The difference between the purchase price and the redemption value is taxable
interest.
Series EE bonds.
Series EE bonds were first offered in July 1980. They have a maturity period of 30 years.
Before July 1980, series E bonds were issued. The original 10-year maturity period of series E bonds has been extended to 40 years for bonds issued
before December 1965 and 30 years for bonds issued after November 1965. Paper series EE and series E bonds are issued at a discount. The face value is
payable to you at maturity. Electronic series EE bonds are issued at their face value. The face value plus accrued interest is payable to you at
maturity.
Beginning in 2005, owners of paper series EE bonds are able to convert them to electronic bonds. These converted bonds do not retain the
denomination listed on the paper certificate but are posted at their purchase price (with accrued interest).
Series I bonds.
Series I bonds were first offered in 1998. These are inflation-indexed bonds issued at their face amount with a maturity period of 30 years. The
face value plus all accrued interest is payable to you at maturity.
Reporting options for cash method taxpayers.
If you use the cash method of reporting income, you can report the interest on series EE, series E, and series I bonds in either of the following
ways.
Method 1. Postpone reporting the interest until the earlier of the year you cash or dispose of the bonds or the year they mature.
(However, see Savings bonds traded, later.)
Note. Series E bonds issued in January through November 1965 and all of 1975 matured in 2005. If you have used method 1, you generally
must report the interest on these bonds on your 2005 return.
Method 2. Choose to report the increase in redemption value as interest each year.
You must use the same method for all series EE, series E, and series I bonds you own. If you do not choose method 2 by reporting the increase
in redemption value as interest each year, you must use method 1.
If you plan to cash your bonds in the same year that you will pay for higher education expenses, you may want to use method 1 because you may be
able to exclude the interest from your income. To learn how, see Education Savings Bond Program, later.
Change from method 1.
If you want to change your method of reporting the interest from method 1 to method 2, you can do so without permission from the IRS. In the year
of change you must report all interest accrued to date and not previously reported for all your bonds.
Once you choose to report the interest each year, you must continue to do so for all series EE, series E, and series I bonds you own and for any
you get later, unless you request permission to change, as explained next.
Change from method 2.
To change from method 2 to method 1, you must request permission from the IRS. Permission for the change is automatically granted if you send the
IRS a statement that meets all the following requirements.
You have typed or printed at the top: Change in Method of Accounting Under Section 6.01 of the Appendix of Rev. Proc. 2002-9 (or later
update).
It includes your name and social security number under the label in (1).
It identifies the savings bonds for which you are requesting this change.
It includes your agreement to:
Report all interest on any bonds acquired during or after the year of change when the interest is realized upon disposition, redemption, or
final maturity, whichever is earliest, and
Report all interest on the bonds acquired before the year of change when the interest is realized upon disposition, redemption, or final
maturity, whichever is earliest, with the exception of the interest reported in prior tax years.
It includes your signature.
You must attach this statement to your tax return for the year of change, which you must file by the due date (including extensions).
You can have an automatic extension of 6 months from the due date of your return for the year of change (excluding extensions) to file the
statement with an amended return. At the top of the statement, enter Filed pursuant to section 301.9100-2. To get this extension, you must have
filed your original return for the year of change by the due date (including extensions).
By the date you file the original statement with your return, you must also send a copy to the address below.
Internal Revenue Service
Attention: CC:IT&A (Automatic Rulings Branch)
P.O. Box 7604
Benjamin Franklin Station
Washington, DC 20044
If you use a private delivery service, send the copy to the address below.
Internal Revenue Service
Attention: CC:IT&A (Automatic Rulings Branch)
1111 Constitution Avenue, NW
Room 4516
Washington, DC 20224
Instead of filing this statement, you can request permission to change from method 2 to method 1 by filing Form 3115.
Form:3115In that case, follow the form instructions for an automatic change. No user fee is required.
Co-owners.
If a U.S. savings bond is issued in the names of co-owners, such as you and your child or you and your spouse, interest on the bond is generally
taxable to the co-owner who bought the bond.
One co-owner's funds used.
If you used your funds to buy the bond, you must pay the tax on the interest. This is true even if you let the other co-owner redeem the bond and
keep all the proceeds. Under these circumstances, since the other co-owner will receive a Form 1099-INT at the time of redemption, the other co-owner
must provide you with another Form 1099-INT showing the amount of interest from the bond that is taxable to you. The co-owner who redeemed the bond is
a nominee. See Nominee distributions under How To Report Interest Income in chapter 1 of Publication 550 for more
information about how a person who is a nominee reports interest income belonging to another person.
Both co-owners' funds used.
If you and the other co-owner each contribute part of the bond's purchase price, the interest is generally taxable to each of you, in proportion to
the amount each of you paid.
Community property.Community property
If you and your spouse live in a community property state and hold bonds as community property, one-half of the interest is considered received by
each of you. If you file separate returns, each of you generally must report one-half of the bond interest. For more information about community
property, see Publication 555, Community Property.
Table 7-1.
These rules are also shown in Table 7-1.
Ownership transferred.
If you bought series E, series EE, or series I bonds entirely with your own funds and had them reissued in your co-owner's name or beneficiary's
name alone, you must include in your gross income for the year of reissue all interest that you earned on these bonds and have not previously
reported. But, if the bonds were reissued in your name alone, you do not have to report the interest accrued at that time.
This same rule applies when bonds (other than bonds held as community property) are transferred between spouses or incident to divorce.
Purchased jointly.
If you and a co-owner each contributed funds to buy series E, series EE, or series I bonds jointly and later have the bonds reissued in the
co-owner's name alone, you must include in your gross income for the year of reissue your share of all the interest earned on the bonds that you have
not previously reported. The former co-owner does not have to include in gross income at the time of reissue his or her share of the interest earned
that was not reported before the transfer. This interest, however, as well as all interest earned after the reissue, is income to the former co-owner.
This income-reporting rule also applies when the bonds are reissued in the name of your former co-owner and a new co-owner. But the new co-owner
will report only his or her share of the interest earned after the transfer.
If bonds that you and a co-owner bought jointly are reissued to each of you separately in the same proportion as your contribution to the purchase
price, neither you nor your co-owner has to report at that time the interest earned before the bonds were reissued.
<ROM>Table 7-1.</ROM> Who Pays the Tax on U.S. Savings Bond Interest
IF ...THEN the interest must be reported by ...you buy a bond in your name and the name of another person as co-owners, using only your own fundsyou.you buy a bond in the name of another person, who is the sole owner of the bondthe person for whom you bought the bond.you and another person buy a bond as co-owners, each contributing part of the purchase priceboth you and the other co-owner, in proportion to the amount each paid for the bond.you and your spouse, who live in a community property state, buy a bond that is community propertyyou and your spouse. If you file separate returns, both you and your spouse generally report one-half of the
interest.
Example 1.
You and your spouse each spent an equal amount to buy a $1,000 series EE savings bond. The bond was issued to you and your spouse as co-owners. You
both postpone reporting interest on the bond. You later have the bond reissued as two $500 bonds, one in your name and one in your spouse's name. At
that time neither you nor your spouse has to report the interest earned to the date of reissue.
Example 2.
You bought a $1,000 series EE savings bond entirely with your own funds. The bond was issued to you and your spouse as co-owners. You both postpone
reporting interest on the bond. You later have the bond reissued as two $500 bonds, one in your name and one in your spouse's name. You must report
half the interest earned to the date of reissue.
Transfer to a trust.
If you own series E, series EE, or series I bonds and transfer them to a trust, giving up all rights of ownership, you must include in your income
for that year the interest earned to the date of transfer if you have not already reported it. However, if you are considered the owner of the trust
and if the increase in value both before and after the transfer continues to be taxable to you, you can continue to defer reporting the interest
earned each year. You must include the total interest in your income in the year you cash or dispose of the bonds or the year the bonds finally
mature, whichever is earlier.
The same rules apply to previously unreported interest on series EE or series E bonds if the transfer to a trust consisted of series HH or series H
bonds you acquired in a trade for the series EE or series E bonds. See Savings bonds traded, later.
Decedents.Decedents:Savings bonds
The manner of reporting interest income on series E, series EE, or series I bonds, after the death of the owner, depends on the accounting and
income-reporting method previously used by the decedent. This is explained in chapter 1 of Publication 550.
Savings bonds traded.
If you postponed reporting the interest on your series EE or series E bonds, you did not recognize taxable income when you traded the bonds for
series HH or series H bonds, unless you received cash in the trade. (You cannot trade series I bonds for series HH bonds. After August 31, 2004, you
cannot trade any other series of bonds for series HH bonds.) Any cash you received is income up to the amount of the interest earned on the bonds
traded. When your series HH or series H bonds mature, or if you dispose of them before maturity, you report as interest the difference between their
redemption value and your cost. Your cost is the sum of the amount you paid for the traded series EE or series E bonds plus any amount you had to pay
at the time of the trade.
Example.
In 2004, you traded series EE bonds (on which you postponed reporting the interest) for $2,500 in series HH bonds and $223 in cash. You reported
the $223 as taxable income in 2004, the year of the trade. At the time of the trade, the series EE bonds had accrued interest of $523 and a redemption
value of $2,723. You hold the series HH bonds until maturity, when you receive $2,500. You must report $300 as interest income in the year of
maturity. This is the difference between their redemption value, $2,500, and your cost, $2,200 (the amount you paid for the series EE bonds). (It is
also the difference between the accrued interest of $523 on the series EE bonds and the $223 cash received on the trade.)
Choice to report interest in year of trade.
You could have chosen to treat all of the previously unreported accrued interest on the series EE or series E bonds traded for series HH bonds as
income in the year of the trade. If you made this choice, it is treated as a change from method 1. See Change from method 1 under
Series EE and series I bonds, earlier.
Form 1099-INT for U.S. savings bonds interest.
When you cash a bond, the bank or other payer that redeems it must give you a Form 1099-INT if the interest part of the payment you receive is $10
or more. Box 3 of your Form 1099-INT should show the interest as the difference between the amount you received and the amount paid for the bond.
However, your Form 1099-INT may show more interest than you have to include on your income tax return. For example, this may happen if any of the
following are true.
You chose to report the increase in the redemption value of the bond each year. The interest shown on your Form 1099-INT will not be reduced
by amounts previously included in income.
You received the bond from a decedent. The interest shown on your Form 1099-INT will not be reduced by any interest reported by the decedent
before death, or on the decedent's final return, or by the estate on the estate's income tax return.
Ownership of the bond was transferred. The interest shown on your Form 1099-INT will not be reduced by interest that accrued before the
transfer.
You were named as a co-owner and the other co-owner contributed funds to buy the bond. The interest shown on your Form 1099-INT will not be
reduced by the amount you received as nominee for the other co-owner. (See Co-owners, earlier in this chapter, for more information about
the reporting requirements.)
You received the bond in a taxable distribution from a retirement or profit-sharing plan. The interest shown on your Form 1099-INT will not
be reduced by the interest portion of the amount taxable as a distribution from the plan and not taxable as interest. (This amount is generally shown
on Form 1099-R,
Form:1099-RDistributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., for the
year of distribution.)
For more information on including the correct amount of interest on your return, see How To Report Interest Income, later. Publication
550 includes examples showing how to report these amounts.
Interest on U.S. savings bonds is exempt from state and local taxes. The Form 1099-INT you receive will indicate the amount that is for U.S.
savings bond interest in box 3.
Education Savings
Bond ProgramEducation:Savings bond programSavings:Bonds used for education
You may be able to exclude from income all or part of the interest you receive on the redemption of qualified U.S. savings bonds during the year if
you pay qualified higher educational expenses during the same year. This exclusion is known as the Education Savings Bond Program.
You do not qualify for this exclusion if your filing status is married filing separately.
Form 8815.Form:8815
Use Form 8815 to figure your exclusion. Attach the form to your Form 1040 or Form 1040A.
Qualified U.S. savings bonds.
A qualified U.S. savings bond is a series EE bond issued after 1989 or a series I bond. The bond must be issued either in your name (sole owner) or
in your and your spouse's names (co-owners). You must be at least 24 years old before the bond's issue date. For example, a bond bought by a parent
and issued in the name of his or her child under age 24 does not qualify for the exclusion by the parent or child.
The issue date of a bond may be earlier than the date the bond is purchased because the issue date assigned to a bond is the first day of the month
in which it is purchased.
Beneficiary.
You can designate any individual (including a child) as a beneficiary of the bond.
Verification by IRS.
If you claim the exclusion, the IRS will check it by using bond redemption information from the Department of the Treasury.
Qualified expenses.
Qualified higher educational expenses are tuition and fees required for you, your spouse, or your dependent (for whom you can claim an exemption)
to attend an eligible educational institution.
Qualified expenses include any contribution you make to a qualified tuition program or to a Coverdell education savings account.
Qualified expenses do not include expenses for room and board or for courses involving sports, games, or hobbies that are not part of a degree or
certificate granting program.
Eligible educational institutions.
These institutions include most public, private, and nonprofit universities, colleges, and vocational schools that are accredited and are eligible
to participate in student aid programs run by the Department of Education.
Reduction for certain benefits.
You must reduce your qualified higher educational expenses by all of the following tax-free benefits.
Tax-free part of scholarships and fellowships (see Scholarships and fellowships in chapter 12), and
Expenses used to figure the tax-free portion of distributions from a Coverdell ESA.
Any tax-free payments (other than gifts or inheritances) received for educational expenses, such as:
Veterans' educational assistance benefits,
Qualified tuition reductions, or
Employer-provided educational assistance.
Any expense used in figuring the Hope and lifetime learning credits.
Amount excludable.
If the total proceeds (interest and principal) from the qualified U.S. savings bonds you redeem during the year are not more than your adjusted
qualified higher educational expenses for the year, you may be able to exclude all of the interest. If the proceeds are more than the expenses, you
may be able to exclude only part of the interest.
To determine the excludable amount, multiply the interest part of the proceeds by a fraction. The numerator (top part) of the fraction is the
qualified higher educational expenses you paid during the year. The denominator (bottom part) of the fraction is the total proceeds you received
during the year.
Example.
In February 2005, Mark and Joan, a married couple, cashed a qualified series EE U.S. savings bond they bought in April 1996. They received proceeds
of $7,068, representing principal of $5,000 and interest of $2,068. In 2005, they paid $4,000 of their daughter's college tuition. They are not
claiming an education credit for that amount, and their daughter does not have any tax-free educational assistance. They can exclude $1,170 ($2,068
× ($4,000 ÷ $7,068)) of interest in 2005. They must pay tax on the remaining $898 ($2,068 − $1,170) interest.
Modified adjusted gross income limit.
The interest exclusion is limited if your modified adjusted gross income (modified AGI) is:
$61,200 to $76,200 for taxpayers filing single or head of household, and
$91,850 to $121,850 for married taxpayers filing jointly or for a qualifying widow(er) with dependent child.
You do not qualify for the interest exclusion if your modified AGI is equal to or more than the upper limit for your filing status.
Modified AGI, for purposes of this exclusion, is adjusted gross income (Form 1040A, line 21 or Form 1040, line 37) figured before the interest
exclusion, and modified by adding back any:
Foreign earned income exclusion,
Foreign housing exclusion and deduction,
Exclusion of income for bona fide residents of American Samoa,
Exclusion for income from Puerto Rico,
Exclusion for adoption benefits received under an employer's adoption assistance program,
Deduction for tuition and fees,
Deduction for student loan interest, and
Deduction for domestic production activities.
Use the worksheet in the instructions for line 9, Form 8815, to figure your modified AGI. If you claim any of the exclusion or deduction items
listed above (except items 6, 7, and 8), add the amount of the exclusion or deduction (except any deduction for tuition and fees, student loan
interest, or domestic production activities) to the amount on line 5 of the worksheet, and enter the total on Form 8815, line 9, as your modified AGI.
If you have investment interest expense incurred to earn royalties and other investment income, see Education Savings Bond Program in
chapter 1 of Publication 550.
Recordkeeping.Recordkeeping:Savings bonds used for educationIf you claim the interest exclusion, you must keep a written record of the qualified U.S.
savings bonds you redeem. Your record must include the serial number, issue date, face value, and total redemption proceeds (principal and interest)
of each bond. You can use
Form:8818Form 8818, Optional Form To Record Redemption of Series EE and I U.S. Savings Bonds Issued After 1989, to record this
information. You should also keep bills, receipts, canceled checks, or other documentation that shows you paid qualified higher educational expenses
during the year.
U.S. Treasury Bills,
Notes, and BondsU.S. Treasury bills, notes, and bondsTreasury bills, notes, and bonds
Treasury bills, notes, and bonds are direct debts (obligations) of the U.S. Government.
Taxation of interest.
Interest income from Treasury bills, notes, and bonds is subject to federal income tax, but is exempt from all state and local income taxes. You
should receive Form 1099-INT showing the amount of interest (in box 3) that was paid to you for the year.
Payments of principal and interest generally will be credited to your designated checking or savings account by direct deposit through the TREASURY
DIRECT system.
Treasury bills.
These bills generally have a 4-week, 13-week, or 26-week maturity period. They are issued at a discount in the amount of $1,000 and multiples of
$1,000. The difference between the discounted price you pay for the bills and the face value you receive at maturity is interest income. Generally,
you report this interest income when the bill is paid at maturity.
Treasury notes and bonds.
Treasury notes have maturity periods of more than 1 year, ranging up to 10 years. Maturity periods for Treasury bonds are longer than 10 years.
Both notes and bonds generally pay interest every 6 months. Generally, you report this interest for the year paid. For more information, see U.S.
Treasury Bills, Notes, and Bonds in chapter 1 of Publication 550.
For other information on Treasury notes or bonds, write to:
Treasury Direct
Attn: Customer Information
P.O. Box 9150
Minneapolis, MN 55480-9150
For information on series EE, series I, and series HH savings bonds, see U.S. Savings Bonds, earlier.
Treasury inflation-protected securities (TIPS).
These securities pay interest twice a year at a fixed rate, based on a principal amount that is adjusted to take into account inflation and
deflation. For the tax treatment of these securities, see Inflation-Indexed Debt Instruments under Original Issue Discount
(OID), in Publication 550.
Bonds Sold Between
Interest DatesBonds:Sale ofSales and exchanges:Bonds
If you sell a bond between interest payment dates, part of the sales price represents interest accrued to the date of sale. You must report that
part of the sales price as interest income for the year of sale.
If you buy a bond between interest payment dates, part of the purchase price represents interest accrued before the date of purchase. When that
interest is paid to you, treat it as a return of your capital investment, rather than interest income, by reducing your basis in the bond. See
Accrued interest on bonds under How To Report Interest Income in chapter 1 of Publication 550 for information on reporting the
payment.
Life insurance proceeds paid to you as beneficiary of the insured person are usually not taxable. But if you receive the proceeds in installments,
you must usually report a part of each installment payment as interest income.
For more information about insurance proceeds received in installments, see Publication 525, Taxable and Nontaxable Income.
Annuity.
If you buy an annuity with life insurance proceeds, the annuity payments you receive are taxed as pension and annuity income from a nonqualified
plan, not as interest income. See chapter 10 for information on pension and annuity income from nonqualified plans.
State or Local
Government ObligationsBonds:Tax-exemptMunicipal bondsTax-exempt:Bonds and other obligationsTax-exempt:Interest
Interest on a bond used to finance government operations generally is not taxable if the bond is issued by a state,
State:Obligations, interest onthe District of Columbia, a possession of the United States, or any of their political
subdivisions.
Bonds issued after 1982 by an Indian tribal government are treated as issued by a state. Interest on these bonds is generally tax exempt if the
bonds are part of an issue of which substantially all of the proceeds are to be used in the exercise of any essential government function.
Interest on arbitrage bonds issued by state or local governments after October 9, 1969, is taxable.
Interest on a private activity bond that is not a qualified bond is taxable. For more information on whether such interest is taxable or tax
exempt, see State or Local Government Obligations in chapter 1 of Publication 550.
Information reporting requirement.
If you must file a tax return, you are required to show any tax-exempt interest you received on your return. This is an information-reporting
requirement only. It does not change tax-exempt interest to taxable interest.
Original Issue
Discount (OID)Bonds:Issued at discountBonds:Original issue discountDiscount, bonds and notes issued atNotes:DiscountedOriginal issue discount (OID)
Original issue discount (OID) is a form of interest. You generally include OID in your income as it accrues over the term of the debt instrument,
whether or not you receive any payments from the issuer.
A debt instrument generally has OID when the instrument is issued for a price that is less than its stated redemption price at maturity. OID is the
difference between the stated redemption price at maturity and the issue price.
All debt instruments that pay no interest before maturity are presumed to be issued at a discount. Zero coupon bonds are one example of these
instruments.
The OID accrual rules generally do not apply to short-term obligations (those with a fixed maturity date of 1 year or less from date of issue). See
Discount on Short-Term Obligations in chapter 1 of Publication 550.
De minimis OID.
You can treat the discount as zero if it is less than one-fourth of 1% (.0025) of the stated redemption price at maturity multiplied by the number
of full years from the date of original issue to maturity. This small discount is known as de minimis OID.
Example 1.
You bought a 10-year bond with a stated redemption price at maturity of $1,000, issued at $980 with OID of $20. One-fourth of 1% of $1,000 (stated
redemption price) times 10 (the number of full years from the date of original issue to maturity) equals $25. Because the $20 discount is less than
$25, the OID is treated as zero. (If you hold the bond at maturity, you will recognize $20 ($1,000 − $980) of capital gain.)
Example 2.
The facts are the same as in Example 1, except that the bond was issued at $950. The OID is $50. Because the $50 discount is more than
the $25 figured in Example 1, you must include the OID in income as it accrues over the term of the bond.
Debt instrument bought after original issue.
If you buy a debt instrument with de minimis OID at a premium, the discount is not includible in income. If you buy a debt instrument
with de minimis OID at a discount, the discount is reported under the market discount rules. See Market Discount Bonds in
chapter 1 of Publication 550.
Exceptions to reporting OID.
The OID rules discussed in this chapter do not apply to the following debt instruments.
Tax-exempt obligations. (However, see Stripped tax-exempt obligations under Stripped Bonds and Coupons in chapter 1 of
Publication 550).
U.S. savings bonds.
Short-term debt instruments (those with a fixed maturity date of not more than 1 year from the date of issue).
Obligations issued by an individual before March 2, 1984.
Loans between individuals, if all the following are true.
The lender is not in the business of lending money.
The amount of the loan, plus the amount of any outstanding prior loans between the same individuals, is $10,000 or less.
Avoiding any federal tax is not one of the principal purposes of the loan.
Form 1099-OID.Form:1099-OID
The issuer of the debt instrument (or your broker, if you held the instrument through a broker) should give you Form 1099-OID, Original Issue
Discount, or a similar statement, if the total OID for the calendar year is $10 or more. Form 1099-OID will show, in box 1, the amount of OID for the
part of the year that you held the bond. It also will show, in box 2, the stated interest that you must include in your income. A copy of Form
1099-OID will be sent to the IRS. Do not file your copy with your return. Keep it for your records.
In most cases, you must report the entire amount in boxes 1 and 2 of Form 1099-OID as interest income. But see Refiguring OID shown on
Form 1099-OID, later in this discussion, for more information.
Form 1099-OID not received.
If you had OID for the year but did not receive a Form 1099-OID, see Publication 1212, which lists total OID on certain debt instruments and has
information that will help you figure OID. If your debt instrument is not listed in Publication 1212, consult the issuer for further information about
the accrued OID for the year.
Nominee.Nominees
If someone else is the holder of record (the registered owner) of an OID instrument that belongs to you and receives a Form 1099-OID on your
behalf, that person must give you a Form 1099-OID.
Refiguring OID shown on Form 1099-OID.
You must refigure the OID shown in box 1 or box 6 of Form 1099-OID if either of the following apply.
You bought the debt instrument after its original issue and paid a premium or an acquisition premium.
The debt instrument is a stripped bond or a stripped coupon (including certain zero coupon instruments).
For information about figuring the correct amount of OID to include in your income, see Figuring OID on Long-Term Debt Instruments
in Publication 1212.
Refiguring periodic interest shown on Form 1099-OID.
If you disposed of a debt instrument or acquired it from another holder during the year, see Bonds Sold Between Interest Dates, earlier,
for information about the treatment of periodic interest that may be shown in box 2 of Form 1099-OID for that instrument.
Certificates of deposit (CDs).Savings:CertificateCertificates of deposit (CDs)
If you buy a CD with a maturity of more than 1 year, you must include in income each year a part of the total interest due and report it in the
same manner as other OID.
This also applies to similar deposit arrangements with banks, building and loan associations, etc., including:
Time deposits,
Bonus plans,
Savings certificates,
Deferred income certificates,
Bonus savings certificates, and
Growth savings certificates.
Bearer CDs.
CDs issued after 1982 generally must be in registered form. Bearer CDs are CDs that are not in registered form. They are not issued in the
depositor's name and are transferable from one individual to another.
Banks must provide the IRS and the person redeeming a bearer CD with a Form 1099-INT.
More information.
See chapter 1 of Publication 550 for more information about OID and related topics, such as market discount bonds.
When To Report Interest Income
When to report your interest income depends on whether you use the cash method or an accrual method to report income.
Cash method.
Most individual taxpayers use the cash method. If you use this method, you generally report your interest income in the year in which you actually
or constructively receive it. However, there are special rules for reporting the discount on certain debt instruments. See U.S. Savings
Bonds and Original Issue Discount, earlier.
Example.
On September 1, 2003, you loaned another individual $2,000 at 12%, compounded annually. You are not in the business of lending money. The note
stated that principal and interest would be due on August 31, 2005. In 2005, you received $2,508.80 ($2,000 principal and $508.80 interest). If you
use the cash method, you must include in income on your 2005 return the $508.80 interest you received in that year.
Constructive receipt.Constructive receipt of incomeIncome:Constructive receipt of
You constructively receive income when it is credited to your account or made available to you. You do not need to have physical possession of it.
For example, you are considered to receive interest, dividends, or other earnings on any deposit or account in a bank, savings and loan, or similar
financial institution, or interest on life insurance policy dividends left to accumulate, when they are credited to your account and subject to your
withdrawal. This is true even if they are not yet entered in your passbook.
You constructively receive income on the deposit or account even if you must:
Make withdrawals in multiples of even amounts,
Give a notice to withdraw before making the withdrawal,
Withdraw all or part of the account to withdraw the earnings, or
Pay a penalty on early withdrawals, unless the interest you are to receive on an early withdrawal or redemption is substantially less than
the interest payable at maturity.
Accrual method.
If you use an accrual method, you report your interest income when you earn it, whether or not you have received it. Interest is earned over the
term of the debt instrument.
Example.
If, in the previous example, you use an accrual method, you must include the interest in your income as you earn it. You would report the interest
as follows: 2003, $80; 2004, $249.60; and 2005, $179.20.
Coupon bonds.Coupon bonds
Interest on coupon bonds is taxable in the year the coupon becomes due and payable. It does not matter when you mail the coupon for payment.
How To Report
Interest Income
Generally, you report all of your taxable interest income on Form 1040, line 8a; Form 1040A, line 8a; or Form 1040EZ, line 2.
You cannot use Form 1040EZ if your interest income is more than $1,500. Instead, you must use Form 1040A or Form 1040.
Form 1040A.Form:1040ASchedule:1 (Form 1040A), Part I
You must complete Schedule 1 (Form 1040A), Part I, if you file Form 1040A and any of the following are true.
Your taxable interest income is more than $1,500.
You are claiming the interest exclusion under the Education Savings Bond Program (discussed earlier).
You received interest from a seller-financed mortgage, and the buyer used the property as a home.
You received a Form 1099-INT for tax-exempt interest.
You received a Form 1099-INT for U.S. savings bond interest that includes amounts you reported before 2005.
You received, as a nominee, interest that actually belongs to someone else.
You received a Form 1099-INT for interest on frozen deposits.
List each payer's name and the amount of interest income received from each payer on line 1. If you received a Form 1099-INT or Form 1099-OID
from a brokerage firm, list the brokerage firm as the payer.
You cannot use Form 1040A if you must use Form 1040, as described next.
Form 1040.Form:1040
You must use Form 1040 instead of Form 1040A or Form 1040EZ if:
You forfeited interest income because of the early withdrawal of a time deposit,
You received or paid accrued interest on securities transferred between interest payment dates,
You had a financial account in a foreign country, unless the combined value of all foreign accounts was $10,000 or less during all of 2005
or the accounts were with certain U.S. military banking facilities,
You acquired taxable bonds after 1987 and choose to reduce interest income from the bonds by any amortizable bond premium (see Bond
Premium Amortization in chapter 3 of Publication 550),
You are reporting OID in an amount more or less than the amount shown on Form 1099-OID, or
You received tax-exempt interest from private activity bonds issued after August 7, 1986.
Schedule B.
You must complete Schedule B (Form 1040), Part I, if you file Form 1040 and any of the following apply.
Your taxable interest income is more than $1,500.
You are claiming the interest exclusion under the Education Savings Bond Program (discussed earlier).
You had a foreign account or you received a distribution from, or were a grantor of, or transferor to, a foreign trust.
You received interest from a seller-financed mortgage, and the buyer used the property as a home.
You received a Form 1099-INT for tax-exempt interest.
You received a Form 1099-INT for U.S. savings bond interest that includes amounts you reported before 2005.
You received, as a nominee, interest that actually belongs to someone else.
You received a Form 1099-INT for interest on frozen deposits.
You received a Form 1099-INT for interest on a bond that you bought between interest payment dates.
Statement (4) or (5) in the preceding list is true.
On Part I, line 1, list each payer's name and the amount received from each. If you received a Form 1099-INT or Form 1099-OID from a brokerage
firm, list the brokerage firm as the payer.
Form 1099-INT.Form:1099-INT
Your taxable interest income, except for interest from U.S. savings bonds and Treasury obligations, is shown in box 1 of Form 1099-INT. Add this
amount to any other taxable interest income you received. You must report all of your taxable interest income even if you do not receive a Form
1099-INT.
If you forfeited interest income because of the early withdrawal of a time deposit, the deductible amount will be shown on Form 1099-INT in box 2.
See Penalty on early withdrawal of savings in chapter 1 of Publication 550.
Box 3 of Form 1099-INT shows the amount of interest income you received from U.S. savings bonds, Treasury bills, Treasury notes, and Treasury
bonds. Add the amount shown in box 3 to any other taxable interest income you received, unless part of the amount in box 3 was previously included in
interest income. If part of the amount shown in box 3 was previously included in your interest income, see U.S. savings bond interest previously
reported, later.
Box 4 of Form 1099-INT (federal income tax withheld) will contain an amount if you were subject to backup withholding. Report the amount from box 4
on Form 1040EZ, line 7, on Form 1040A, line 39, or on Form 1040, line 64 (federal income tax withheld).
Box 5 of Form 1099-INT shows investment expenses you may be able to deduct as an itemized deduction. See chapter 3 of Publication 550 for more
information about investment expenses.
U.S. savings bond interest previously reported.Savings:Bonds
If you received a Form 1099-INT for U.S. savings bond interest, the form may show interest you do not have to report. See Form 1099-INT for
U.S. savings bonds interest, earlier, under U.S. Savings Bonds.
On Schedule B (Form 1040), Part I, line 1, or on Schedule 1 (Form 1040A), Part I, line 1, report all the interest shown on your Form 1099-INT. Then
follow these steps.
Several lines above line 2, enter a subtotal of all interest listed on line 1.
Below the subtotal enter U.S. Savings Bond Interest Previously Reported and enter amounts previously reported or interest accrued
before you received the bond.
Subtract these amounts from the subtotal and enter the result on line 2.
More information.
For more information about how to report interest income, see chapter 1 of Publication 550 or the instructions for the form you must file.
Dividends and Other Corporate DistributionsDividendsOrdinary dividendsDividendsSecurities:DividendsReminderForeign income.Dividends:Foreign incomeForeign income:Dividends
If you are a U.S. citizen with dividend income from sources outside the United States (foreign income), you must report that income on your tax
return unless it is exempt by U.S. law. This is true whether you reside inside or outside the United States and whether or not you receive a Form 1099
from the foreign payer.
This chapter discusses the tax treatment of:
Ordinary dividends,
Capital gain distributions,
Nondividend distributions, and
Other distributions you may receive from a corporation or a mutual fund.
This chapter also explains how to report dividend income on your tax return.
Dividends:DefinedDividends:Reporting of:As interestInterest income:Dividends asDividends are distributions of money, stock, or other property paid to you by a corporation. You also may
receive dividends through a partnership, an estate, a trust, or an association that is taxed as a corporation. However, some amounts you receive that
are called dividends are actually interest income. (See Dividends that are actually interest under Taxable Interest in chapter
7.)
Cash:Dividends paid asMost distributions are paid in cash (or check). However, distributions can consist of more stock, stock
rights, other property, or services.
Publication514 Foreign Tax Credit for Individuals550 Investment Income and Expenses564 Mutual Fund DistributionsForm (and Instructions)Interest and Ordinary DividendsInterest and Ordinary Dividends for Form 1040A Filers
General Information
This section discusses general rules for dividend income.
Tax on investment income of a child under age 14.Children:Investment income of child under age 14:Interest and dividends
Part of a child's 2005 investment income may be taxed at the parent's tax rate. This may happen if all of the following are true.
The child was under age 14 at the end of 2005. A child born on January 1, 1992, is considered to be age 14 at the end of 2005.
The child had more than $1,600 of investment income (such as taxable interest and dividends) and has to file a tax return.
AgeChildren's investmentsChildren, subheading: Investment income of child under age 14Children:Investment income of child under age 14Kiddie taxChildren, subheading: Investment income of child under age 14TaxesKiddie taxChildren, subheading: Investment income of child under age 14Unearned income of childChildren, subheading: Investment income of child under age 14
Either parent was alive at the end of 2005.
Form:8615:Children under age 14 with more than $1,600 of investment incomeIf all of these statements are true, Form 8615, Tax for Children Under Age 14 With Investment Income of More Than $1,600, must be completed and
attached to the child's tax return. If any of these statements is not true, Form 8615 is not required and the child's income is taxed at his or her
own tax rate.
Form:8814:Parents' election to report child's interest and dividendsHowever, the parent can choose to include the child's
interest and dividends on the parent's return if certain requirements are met. Use Form 8814, Parents' Election To Report Child's Interest and
Dividends, for this purpose.
For more information about the tax on investment income of children and the parents' election, see chapter 31.
Beneficiary of an estate or trust.BeneficiariesEstate beneficiariesDividends:Beneficiary of estate or trust receivingEstate beneficiaries:Dividends received byTrust beneficiaries:Dividends received byTrustsTrust beneficiaries
Schedule:K-1Beneficiaries receiving income from estate or trustDividends and other distributions you receive as a beneficiary of
an estate or trust are generally taxable income. You should receive a Schedule K-1 (Form 1041), Beneficiary's Share of Income, Deductions, Credits,
etc., from the fiduciary. Your copy of Schedule K-1 and its instructions will tell you where to report the income on your Form 1040.
Social security number (SSN).Social Security Numbers (SSNs):Dividend payers to use
Penalties:Failure to provide social security number or TIN:To dividend payersSocial Security Numbers (SSNs):Penalty for failure to provide:To dividend payersYou must give your name and SSN (or individual taxpayer identification number (ITIN)) to any person
required by federal tax law to make a return, statement, or other document that relates to you. This includes payers of dividends. If you do not give
your SSN or ITIN to the payer of dividends, you may have to pay a penalty.
For more information on SSNs and ITINs, see Social security number (SSN) in chapter 7.
Your dividend income is generally not subject to regular withholding. However, it may be subject to backup withholding to ensure that income tax is
collected on the income. Under backup withholding, the payer of dividends must withhold, as income tax, 28% of the amount you are paid.
Backup withholding may also be required if the Internal Revenue Service (IRS) has determined that you underreported your interest or dividend
income. For more information, see Backup Withholding in chapter 4.
Stock certificate in two or more names.Joint accounts:Dividends, reporting ofMarried taxpayersTenants by the entiretySecurities:Joint owners, reporting of dividendsSecurities:Tenants by the entirety owning, reporting of dividendsSecurities:Tenants in common owning, reporting of dividendsTenants by the entirety:Dividends, reporting ofTenants in common:Dividends, reporting of
If two or more persons hold stock as joint tenants, tenants by the entirety, or tenants in common, each person's share of any dividends from the
stock is determined by local law.
Form 1099-DIV.Dividends:Form 1099-DIVForm:1099-DIV:Dividend income statement
Most corporations use Form 1099-DIV, Dividends and Distributions, to show you the distributions you received from them during the year. Keep this
form with your records. You do not have to attach it to your tax return.
Dividends not reported on Form 1099-DIV.
Even if you do not receive Form 1099-DIV, you must still report all of your taxable dividend income. For example, you may receive distributive
shares of dividends from partnerships or subchapter S corporations. These dividends are reported to you on Schedule K-1 (Form 1065) and Schedule K-1
(Form 1120S).
Reporting tax withheld.Backup withholding:Dividend incomeWithholding:Dividend income
If tax is withheld from your dividend income, the payer must give you a Form 1099-DIV that indicates the amount withheld.
Nominees.Dividends:Nominees receiving on behalf of anotherNominees:Dividends that belong to someone else
If someone receives distributions as a nominee for you, that person will give you a Form 1099-DIV, which will show distributions received on your
behalf.
Form 1099-MISC.Brokers:Receiving dividends, reporting on Form 1099-MISCForm:1099-MISC:Brokers receiving dividends
Certain substitute payments in lieu of dividends or tax-exempt interest that are received by a broker on your behalf must be reported to you on
Form 1099-MISC, Miscellaneous Income, or a similar statement. See Reporting Substitute Payments under Short Sales in chapter 4
of Publication 550 for more information about reporting these payments.
Incorrect amount shown on a Form 1099.CorrectionsErrorsErrors:Form 1099 showing incorrect amount
If you receive a Form 1099 that shows an incorrect amount (or other incorrect information), you should ask the issuer for a corrected form. The new
Form 1099 you receive will be marked Corrected.
Dividends on stock sold.Dividends:Sold stock
If stock is sold, exchanged, or otherwise disposed of after a dividend is declared, but before it is paid, the owner of record (usually the payee
shown on the dividend check) must include the dividend in income.
Dividends received in January.
If a regulated investment company (mutual fund) or real estate investment trust (REIT) declares a dividend (including any exempt-interest dividend
or capital gain distribution) in October, November, or December payable to shareholders of record on a date in one of those months but actually pays
the dividend during January of the next calendar year, you are considered to have received the dividend on December 31. You report the dividend in the
year it was declared.
Ordinary DividendsDividends:Ordinary dividends
Ordinary (taxable) dividends are the most common type of distribution from a corporation. They are paid out of the earnings and profits of a
corporation and are ordinary income to you. This means they are not capital gains. You can assume that any dividend you receive on common or preferred
stock is an ordinary dividend unless the paying corporation tells you otherwise. Ordinary dividends will be shown in box 1a of the Form 1099-DIV you
receive.
Qualified dividends are the ordinary dividends that are subject to the same 5% or 15% maximum tax rate that applies to net capital gain. They
should be shown in box 1b of the Form 1099-DIV you receive.
Qualified dividends are subject to the 15% rate if the regular tax rate that would apply is 25% or higher. If the regular tax rate that would apply
is lower than 25%, qualified dividends are subject to the 5% rate.
To qualify for the 5% or 15% maximum rate, all of the following requirements must be met.
The dividends must have been paid by a U.S. corporation or a qualified foreign corporation. (See Qualified foreign corporation
later.)
The dividends are not of the type listed later under Dividends that are not qualified dividends.
You meet the holding period (discussed next).
Holding period.
You must have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date. The ex-dividend date
is the first date following the declaration of a dividend on which the buyer of a stock will not receive the next dividend payment. Instead, the
seller will get the dividend.
When counting the number of days you held the stock, include the day you disposed the stock, but not the day you acquired it. See the examples
later.
Exception for preferred stock.
In the case of preferred stock, you must have held the stock more than 90 days during the 181-day period that begins 90 days before the ex-dividend
date if the dividends are due to periods totaling more than 366 days. If the preferred dividends are due to periods totaling less than 367 days, the
holding period in the previous paragraph applies.
Example 1.
You bought 5,000 shares of XYZ Corp. common stock on June 30, 2005. XYZ Corp. paid a cash dividend of 10 cents per share. The ex-dividend date was
July 8, 2005. Your Form 1099-DIV from XYZ Corp. shows $500 in box 1a (ordinary dividends) and in box 1b (qualified dividends). However, you sold the
5,000 shares on August 3, 2005. You held your shares of XYZ Corp. for only 34 days of the 121-day period (from July 1, 2005, through August 3, 2005).
The 121-day period began on May 9, 2005 (60 days before the ex-dividend date), and ended on September 6, 2005. You have no qualified dividends from
XYZ Corp. because you held the XYZ stock for less than 61 days.
Example 2.
Assume the same facts as in Example 1 except that you bought the stock on July 7, 2005 (the day before the ex-dividend date), and you sold the
stock on September 8, 2005. You held the stock for 63 days (from July 8, 2005, through September 8, 2005). The $500 of qualified dividends shown in
box 1b of your Form 1099-DIV are all qualified dividends because you held the stock for 61 days of the 121-day period (from July 8, 2005, through
September 6, 2005).
Example 3.
You bought 10,000 shares of ABC Mutual Fund common stock on June 30, 2005. ABC Mutual Fund paid a cash dividend of 10 cents a share. The
ex-dividend date was July 8, 2005. The ABC Mutual Fund advises you that the portion of the dividend eligible to be treated as qualified dividends
equals 2 cents per share. Your Form 1099-DIV from ABC Mutual Fund shows total ordinary dividends of $1,000 and qualified dividends of $200. However,
you sold the 10,000 shares on August 3, 2005. You have no qualified dividends from ABC Mutual Fund because you held the ABC Mutual Fund stock for less
than 61 days.
Holding period reduced where risk of loss is diminished.
When determining whether you met the minimum holding period discussed earlier, you cannot count any day during which you meet any of the following
conditions.
You had an option to sell, were under a contractual obligation to sell, or had made (and not closed) a short sale of substantially identical
stock or securities.
You were grantor (writer) of an option to buy substantially identical stock or securities.
Your risk of loss is diminished by holding one or more other positions in substantially similar or related property.
For information about how to apply condition (3), see Regulations section 1.246-5.
Qualified foreign corporation.
A foreign corporation is a qualified foreign corporation if it meets any of the following conditions.
The corporation is incorporated in a U.S. possession.
The corporation is eligible for the benefits of a comprehensive income tax treaty with the United States that the Treasury Department
determines is satisfactory for this purpose and that includes an exchange of information program. For a list of those treaties, seeTable
8-1.
The corporation does not meet (1) or (2) above, but the stock for which the dividend is paid is readily tradable on an established
securities market in the United States. See Readily tradable stock, later.
Exception.
A corporation is not a qualified foreign corporation if it is a passive foreign investment company during its tax year in which the dividends are
paid or during its previous tax year.
Readily tradable stock.
Any stock (such as common, ordinary stock, or preferred stock) or an American depositary receipt in respect of that stock, is considered to satisfy
requirement (3) if it is listed on one of the following securities markets: the New York Stock Exchange, the NASDAQ Stock Market, the American Stock
Exchange, the Boston Stock Exchange, the Cincinnati Stock Exchange, the Chicago Stock Exchange, the Philadelphia Stock Exchange, or the Pacific
Exchange, Inc.
Dividends that are not qualified dividends.
The following dividends are not qualified dividends. They are not qualified dividends even if they are shown in box 1b of Form 1099-DIV.
Capital gain distributions.
Dividends paid on deposits with mutual savings banks, cooperative banks, credit unions, U.S. building and loan associations, U.S. savings
and loan associations, federal savings and loan associations, and similar financial institutions. (Report these amounts as interest
income.)
Dividends from a corporation that is a tax-exempt organization or farmer's cooperative during the corporation's tax year in which the
dividends were paid or during the corporation's previous tax year.
Dividends paid by a corporation on employer securities which are held on the date of record by an employee stock ownership plan (ESOP)
maintained by that corporation.
Dividends on any share of stock to the extent that you are obligated (whether under a short sale or otherwise) to make related payments for
positions in substantially similar or related property.
Payments in lieu of dividends, but only if you know or have reason to know that the payments are not qualified dividends.
Payments shown in Form 1099-DIV, box 1b, from a foreign corporation to the extent you know or have reason to know the payments are not
qualified dividends.
<ROM>Table 8-1.</ROM> Income Tax TreatiesIncome tax treaties that the United States has with the following countries satisfy requirement (2)
under Qualified foreign corporation.AustraliaIrelandRomaniaAustriaIsraelRussian BelgiumItaly FederationCanadaJamaicaSlovak ChinaJapan RepublicCyprusKazakhstanSloveniaCzech KoreaSouth Africa RepublicLatviaSpainDenmarkLithuaniaSwedenEgyptLuxembourgSwitzerlandEstoniaMexicoThailandFinlandMoroccoTrinidad andFranceNetherlands TobagoGermanyNew ZealandTunisiaGreeceNorwayTurkeyHungaryPakistanUkraineIcelandPhilippinesUnited IndiaPoland KingdomIndonesiaPortugalVenezuela
Dividends Used to Buy More StockDividends:Buying more stock withDividends:Reinvestment plansReinvestment plans:Dividends used forSecurities:Reinvestment plan, dividends used for
The corporation in which you own stock may have a dividend reinvestment plan. This plan lets you choose to use your dividends to buy
(through an agent) more shares of stock in the corporation instead of receiving the dividends in cash. If you are a member of this type of plan and
you use your dividends to buy more stock at a price equal to its fair market value, you still must report the dividends as income.
If you are a member of a dividend reinvestment plan that lets you buy more stock at a price less than its fair market value, you must report as
dividend income the fair market value of the additional stock on the dividend payment date.
You also must report as dividend income any service charge subtracted from your cash dividends before the dividends are used to buy the additional
stock. But you may be able to deduct the service charge. See chapter 28 for more information about deducting expenses of producing income.
In some dividend reinvestment plans, you can invest more cash to buy shares of stock at a price less than fair market value. If you choose to do
this, you must report as dividend income the difference between the cash you invest and the fair market value of the stock you buy. When figuring this
amount, use the fair market value of the stock on the dividend payment date.
Banks:Money market accountsReport amounts you receive from money market funds as dividend income. Money market funds are a type
of mutual fund and should not be confused with bank money market accounts that pay interest.
Capital Gain DistributionsCapital gains or losses:Distributions
Capital gains or losses:Mutual funds payingDividends:Real estate investment trusts (REITs) payingMutual funds:Capital gainsMutual funds:Dividends fromReal estate investment trusts (REITs):Dividends fromCapital gain distributions (also called capital gain dividends) are paid to you or credited to your account
by regulated investment companies (commonly called mutual funds) and real estate investment trusts (REITs). They will be shown in box 2a of the Form
1099-DIV you receive from the mutual fund or REIT.
Report capital gain distributions as long-term capital gains regardless of how long you owned your shares in the mutual fund or REIT.
Undistributed capital gains of mutual funds and REITs.Capital gains or losses:Undistributed gains:Credit for tax onCredits:Capital gains, undistributed, credit for tax onReal estate investment trusts (REITs):Undistributed capital gains:Credit for tax onUndistributed capital gains
Form:2439:Notice to shareholder on undistributed long-term capital gainsSome mutual funds and REITs keep their long-term capital
gains and pay tax on them. You must treat your share of these gains as distributions, even though you did not actually receive them. However, they are
not included on Form 1099-DIV. Instead, they are reported to you on Form 2439, Notice to Shareholder of Undistributed Long-Term Capital Gains.
Report undistributed capital gains (box 1a of Form 2439) as long-term capital gains on Schedule D (Form 1040), column (f), line 11.
The tax paid on these gains by the mutual fund or REIT is shown in box 2 of Form 2439. You take credit for this tax by including it on Form 1040,
line 70, and checking box a on that line. Attach Copy B of Form 2439 to your return, and keep Copy C for your records.
Basis adjustment.
Increase your basis in your mutual fund, or your interest in a REIT, by the difference between the gain you report and the credit you claim for the
tax paid.
Additional information.
For more information on the treatment of distributions from mutual funds, see Publication 564.
Nondividend
DistributionsDistributions:Nondividend distributionsDividends:Nondividend distributionsDistributions:Return of capital
Form:1099-DIV:Return of capitalA nondividend distribution is a distribution that is not paid out of the earnings and profits of a
corporation. You should receive a Form 1099-DIV or other statement from the corporation showing the nondividend distribution. On Form 1099-DIV, a
nondividend distribution will be shown in box 3. If you do not receive such a statement, you report the distribution as an ordinary dividend.
Basis adjustment.
A nondividend distribution reduces the basis of your stock. It is not taxed until your basis in the stock is fully recovered. This nontaxable
portion is also called a return of capital. It is a return of your investment in the stock of the company. If you buy stock in a corporation in
different lots at different times, and you cannot definitely identify the shares subject to the nondividend distribution, reduce the basis of your
earliest purchases first.
When the basis of your stock has been reduced to zero, report any additional nondividend distribution that you receive as a capital gain. Whether
you report it as a long-term or short-term capital gain depends on how long you have held the stock. See Holding Period in chapter 14.
Example.
You bought stock in 1993 for $100. In 1996, you received a nondividend distribution of $80. You did not include this amount in your income, but you
reduced the basis of your stock to $20. You received a nondividend distribution of $30 in 2005. The first $20 of this amount reduced your basis to
zero. You report the other $10 as a long-term capital gain for 2005. You must report as a long-term capital gain any nondividend distribution you
receive on this stock in later years.
Liquidating Distributions
Distributions:Liquidating distributionsLiquidating distributionsLiquidating distributions, sometimes called liquidating dividends, are distributions you receive during
a partial or complete liquidation of a corporation. These distributions are, at least in part, one form of a return of capital. They may be paid in
one or more installments. You will receive a Form 1099-DIV from the corporation showing you the amount of the liquidating distribution in box 8 or 9.
For more information on liquidating distributions, see chapter 1 of Publication 550.
Distributions of Stock
and Stock RightsDividends:As stock dividends and stock rightsSecurities:Stock rights:Dividends as
OptionsSecurities:OptionsStock optionsDistributions by a corporation of its own stock are commonly known as stock dividends. Stock rights (also known as
stock options) are distributions by a corporation of rights to acquire the corporation's stock. Generally, stock dividends and stock rights are
not taxable to you, and you do not report them on your return.
Taxable stock dividends and stock rights.
Distributions of stock dividends and stock rights are taxable to you if any of the following apply.
You or any other shareholder has the choice to receive cash or other property instead of stock or stock rights.
The distribution gives cash or other property to some shareholders and an increase in the percentage interest in the corporation's assets or
earnings and profits to other shareholders.
The distribution is in convertible preferred stock and has the same result as in (2).
The distribution gives preferred stock to some common stock shareholders and common stock to other common stock shareholders.
The distribution is on preferred stock. (The distribution, however, is not taxable if it is an increase in the conversion ratio of
convertible preferred stock made solely to take into account a stock dividend, stock split, or similar event that would otherwise result in reducing
the conversion right.)
The term stock includes rights to acquire stock, and the term shareholder includes a holder of rights or of convertible securities.
If you receive taxable stock dividends or stock rights, include their fair market value at the time of the distribution in your income.
Preferred stock redeemable at a premium.Preferred stock:Redeemable at a premiumSecurities:Preferred stock, redeemable at a premium
If you hold preferred stock having a redemption price higher than its issue price, the difference (the redemption premium) generally is taxable as
a constructive distribution of additional stock on the preferred stock. For more information, see chapter 1 of Publication 550.
Basis.Basis:Stock or stock rights
Your basis in stock or stock rights received in a taxable distribution is their fair market value when distributed. If you receive stock or stock
rights that are not taxable to you, see Stocks and Bonds under Basis of Investment Property in chapter 4 of Publication 550 for
information on how to figure their basis.
Form:1040, Schedule DFractional shares, sale ofYou may not own enough stock in a corporation to receive a full share of stock if the
corporation declares a stock dividend. However, with the approval of the shareholders, the corporation may set up a plan in which fractional shares
are not issued, but instead are sold, and the cash proceeds are given to the shareholders. Any cash you receive for fractional shares under such a
plan is treated as an amount realized on the sale of the fractional shares. You must determine your gain or loss and report it as a capital gain or
loss on Schedule D (Form 1040). Your gain or loss is the difference between the cash you receive and the basis of the fractional shares sold.
Example.
You own one share of common stock that you bought on January 3, 1997, for $100. The corporation declared a common stock dividend of 5% on June 30,
2005. The fair market value of the stock at the time the stock dividend was declared was $200. You were paid $10 for the fractional-share stock
dividend under a plan described in the above paragraph. You figure your gain or loss as follows:
Fair market value of old stock $200.00 Fair market value of stock dividend (cash received) +10.00Fair market value of old stock and stock dividend $210.00Basis (cost) of old stock after the stock dividend (($200 ÷ $210) × $100)$95.24Basis (cost) of stock dividend (($10 ÷ $210) × $100)+ 4.76Total$100.00Cash received$10.00Basis (cost) of stock dividend − 4.76Gain$5.24
Because you had held the share of stock for more than 1 year at the time the stock dividend was declared, your gain on the stock dividend is a
long-term capital gain.
A corporation that declares a stock dividend may issue you a scrip certificate that entitles you to a fractional share. The certificate is
generally nontaxable when you receive it. If you choose to have the corporation sell the certificate for you and give you the proceeds, your gain or
loss is the difference between the proceeds and the portion of your basis in the corporation's stock that is allocated to the certificate.
However, if you receive a scrip certificate that you can choose to redeem for cash instead of stock, the certificate is taxable when you receive
it. You must include its fair market value in income on the date you receive it.
Other DistributionsDividends:Exempt-interest dividendsMutual funds:Exempt-interest dividends
You may receive any of the following distributions during the year.
Exempt-interest dividends you receive from a regulated investment company (mutual fund) are not included in your taxable income. You will receive a
notice from the mutual fund telling you the amount of the exempt-interest dividends you received. Exempt-interest dividends are not shown on Form
1099-DIV or Form 1099-INT.
Information reporting requirement.Exempt-interest dividends:Information-reporting requirement
Although exempt-interest dividends are not taxable, you must show them on your tax return if you have to file a return. This is an information
reporting requirement and does not change the exempt-interest dividends to taxable income.
Exempt-interest dividends paid from specified private activity bonds may be subject to the alternative minimum tax. See Alternative Minimum
Tax in chapter 30 for more information.
Dividends on insurance policies.Dividends:Insurance dividends
Insurance:Dividends:Interest onInsurance policy dividends that the insurer keeps and uses to pay your premiums are not taxable. However,
you must report as taxable interest income the interest that is paid or credited on dividends left with the insurance company.
Form:1040:Insurance distributionsForm:1040A:Insurance distributionsInsurance:Distributions from, reporting ofIf dividends on an insurance contract (other than a modified endowment contract) are
distributed to you, they are a partial return of the premiums you paid. Do not include them in your gross income until they are more than the total of
all net premiums you paid for the contract. Report any taxable distributions on insurance policies on Form 1040, line 16b, or Form 1040A, line 12b.
Dividends on veterans' insurance.Dividends:Veterans' insuranceVeterans' insurance:Dividends on
Dividends you receive on veterans' insurance policies are not taxable. In addition, interest on dividends left with the Department of Veterans
Affairs is not taxable.
Generally, patronage dividends you receive in money from a cooperative organization are included in your income.
Do not include in your income patronage dividends you receive on:
Property bought for your personal use, or
Capital assets or depreciable property bought for use in your business. But you must reduce the basis (cost) of the items bought. If the
dividend is more than the adjusted basis of the assets, you must report the excess as income.
These rules are the same whether the cooperative paying the dividend is a taxable or tax-exempt cooperative.
Alaska Permanent Fund dividends.Alaska Permanent Fund dividends:Income from
Form:1040:Alaska Permanent Fund dividendsForm:1040A:Alaska Permanent Fund dividendsForm:1040EZ:Alaska Permanent Fund dividendsDo not report these amounts as dividends. Instead, report these amounts on Form 1040,
line 21, Form 1040A, line 13, or Form 1040EZ, line 3.
How To Report Dividend IncomeDividends:Reporting of
Form:1040:DividendsForm:1040A:DividendsGenerally, you can use either Form 1040 or Form 1040A to report your dividend income. Report the total of
your ordinary dividends on line 9a of Form 1040 or Form 1040A. Report qualified dividends on line 9b.
Capital gains or losses:Form 1040 or 1040A to be usedForm:1040:Capital gainsForm:1040A:Capital gainsIf you receive capital gain distributions, you may be able to use Form 1040A or you may have to use Form
1040. See Capital gain distributions only in chapter 16. If you receive nondividend distributions required to be reported as capital gains,
you must use Form 1040. You cannot use Form 1040EZ if you receive any dividend income.
Form 1099-DIV.Form:1099-DIV:Dividend income statement
If you owned stock on which you received $10 or more in dividends and other distributions, you should receive a Form 1099-DIV. Even if you do not
receive Form 1099-DIV, you must report all of your taxable dividend income.
See Form 1099-DIV for more information on how to report dividend income.
Form 1040A. Form:1040A:Dividend income reportingForm:1040A, Schedule 1Dividends
You must complete Schedule 1 (Form 1040A), Part II, and attach it to your Form 1040A, if:
Your ordinary dividends (Form 1099-DIV, box 1a) are more than $1,500, or
You received, as a nominee, dividends that actually belong to someone else.
Nominees:Dividends that belong to someone else
List on line 5 each payer's name and the amount of ordinary dividends you received. If you received a Form 1099-DIV from a brokerage firm, list the
brokerage firm as the payer.
Enter on line 6 the total of the amounts listed on line 5. Also enter this total on Form 1040A, line 9a.
Form 1040.Form:1040:Dividends
Form:1040, Schedule BDividendsYou must fill in Schedule B, Part II, and attach it to your Form 1040, if:
Your ordinary dividends (Form 1099-DIV, box 1a) are more than $1,500, or
You received, as a nominee, dividends that actually belong to someone else.
Nominees:Dividends that belong to someone elseIf your ordinary dividends are more than $1,500, you must also complete Schedule B, Part III.
List on Schedule B, Part II, line 5, each payer's name and the amount of ordinary dividends you received. If your securities are held by a
brokerage firm (in street name), list the name of the brokerage firm that is shown on Form 1099-DIV as the payer. If your stock is held by a
nominee who is the owner of record, and the nominee credited or paid you dividends on the stock, show the name of the nominee and the dividends you
received or for which you were credited.
Enter on line 6 the total of the amounts listed on line 5. Also enter this total on Form 1040, line 9a.
Report qualified dividends (Form 1099-DIV, box 1b) on line 9b of Form 1040 or Form 1040A. Do not include any of the following on line 9b.
Qualified dividends you received as a nominee. See Nominees under How to Report Dividend Income in chapter 1 of
Publication 550.
Dividends on stock for which you did not meet the holding period. See Holding period earlier under Qualified
Dividends.
Dividends on any share of stock to the extent that you are obligated (whether under a short sale or otherwise) to make related payments for
positions in substantially similar or related property.
Payments in lieu of dividends, but only if you know or have reason to know that the payments are not qualified dividends.
Payments shown in Form 1099-DIV, box 1b, from a foreign corporation to the extent you know or have reason to know the payments are not
qualified dividends.
If you have qualified dividends, you must figure your tax by completing the Qualified Dividends and Capital Gain Tax Worksheet in the Form 1040 or
1040A instructions or the Schedule D Tax Worksheet in the Schedule D instructions, whichever applies. Enter qualified dividends on line 2 of the
worksheet.
Investment interest deducted.
If you claim a deduction for investment interest, you may have to reduce the amount of your qualified dividends that are eligible for the 5% or 15%
tax rate. Reduce it by the amount of qualified dividends you choose to include in investment income when figuring the limit on your investment
interest deduction. This is done on the Qualified Dividends and Capital Gain Tax Worksheet or the Schedule D Tax Worksheet. For more information about
the limit on investment interest, see Interest Expenses in chapter 23.
Expenses related to dividend income.Dividends:Expenses related to, deduction of
You may be able to deduct expenses related to dividend income if you itemize your deductions on Schedule A (Form 1040). See chapter 28 for general
information about deducting expenses of producing income.
More information.
DividendsFor more information about how to report dividend income, see chapter 1 of Publication 550 or the
instructions for the form you must file.
Rental Income and ExpensesRental income and expensesHousingRental propertyRental income and expensesIncomeRentalRental income and expensesInvestment propertyRental propertyRental income and expensesLeasesRental income and expensesReal estateRentalRental income and expenses
This chapter discusses rental income and expenses. It covers the following topics.
Rental income.
Rental expenses.
Personal use of dwelling unit (including vacation home).
Depreciation.
Limits on rental losses.
How to report your rental income and expenses.
If you sell or otherwise dispose of your rental property, see Publication 544, Sales and Other Dispositions of Assets.
If you have a loss from damage to, or theft of, rental property, see Publication 547, Casualties, Disasters, and Thefts.
Cooperative housing:Dwelling unit used as homeIf you rent a condominium or a cooperative apartment, some special rules apply to you even though
you receive the same tax treatment as other owners of rental property. See Publication 527, Residential Rental Property, for more information.
Publication527Residential Rental Property534Depreciating Property Placed in Service Before 1987535Business Expenses925Passive Activity and At-Risk Rules946How To Depreciate PropertyForm (and Instructions)Depreciation and AmortizationAlternative Minimum Tax—IndividualsPassive Activity Loss LimitationsSupplemental Income and Loss
Rental IncomeLandlordsRental income and expensesLeasesRental income and expensesTenantsRental income and expenses
Gross income:Rental incomeYou generally must include in your gross income all amounts you receive as rent. Rental income is any payment
you receive for the use or occupation of property. In addition to amounts you receive as normal rent payments, there are other amounts that may be
rental income.
When to report.Rental income and expenses:Time to report
If you are a cash basis taxpayer, report rental income on your return for the year you actually or constructively receive it. You are a cash basis
taxpayer if you report income in the year you receive it, regardless of when it was earned. You constructively receive income when it is made
available to you, for example, by being credited to your bank account.
For more information about when you constructively receive income, see Accounting Methods in chapter 1.
Advance rent.Prepayment:Rent paid in advanceRental income and expenses:Advance rent
Advance rent is any amount you receive before the period that it covers. Include advance rent in your rental income in the year you receive it
regardless of the period covered or the method of accounting you use.
Example.
You sign a 10-year lease to rent your property. In the first year, you receive $5,000 for the first year's rent and $5,000 as rent for the last
year of the lease. You must include $10,000 in your income in the first year.
Security deposits.Rental income and expenses:Security depositsSecurity deposits:Rental property, for
Do not include a security deposit in your income when you receive it if you plan to return it to your tenant at the end of the lease. But if you
keep part or all of the security deposit during any year because your tenant does not live up to the terms of the lease, include the amount you keep
in your income for that year.
If an amount called a security deposit is to be used as a final payment of rent, it is advance rent. Include it in your income when you receive it.
Payment for canceling a lease.Rental income and expenses:Canceling lease, payments for
If your tenant pays you to cancel a lease, the amount you receive is rent. Include the payment in your income in the year you receive it regardless
of your method of accounting.
Expenses paid by tenant.Rental income and expenses:Expenses paid by tenant
If your tenant pays any of your expenses, the payments are rental income. You must include them in your income. You can deduct the expenses if they
are deductible rental expenses. See Rental Expenses, later, for more information.
Property or services.Rental income and expenses:Property or services received instead of money
If you receive property or services, instead of money, as rent, include the fair market value of the property or services in your rental income.
If the services are provided at an agreed upon or specified price, that price is the fair market value unless there is evidence to the contrary.
Rental of property also used as a home.Rental income and expenses:Dwelling unit used as home:Rented for fewer than 15 days
If you rent property that you also use as your home and you rent it fewer than 15 days during the tax year, do not include the rent you receive in
your income and do not deduct rental expenses. However, you can deduct on Schedule A (Form 1040) the interest, taxes, and casualty and theft losses
that are allowed for nonrental property. See Personal Use of Dwelling Unit (Including Vacation Home), later.
Part interest.Rental income and expenses:Part interest
If you own a part interest in rental property, you must report your part of the rental income from the property.
Rental ExpensesLandlordsRental income and expensesLeasesRental income and expenses
This part discusses expenses of renting property that you ordinarily can deduct from your rental income. It includes information on the expenses
you can deduct if you rent part of your property, or if you change your property to rental use. Depreciation, which you can also deduct from your
rental income, is discussed later.
When to deduct.Deductions:Rental expensesRental income and expenses:Deductions
You generally deduct your rental expenses in the year you pay them.
Vacant rental property.Rental income and expenses:Vacant rental property
If you hold property for rental purposes, you may be able to deduct your ordinary and necessary expenses (including depreciation) for managing,
conserving, or maintaining the property while the property is vacant. However, you cannot deduct any loss of rental income for the period the property
is vacant.
Pre-rental expenses.Rental income and expenses:Pre-rental expenses
You can deduct your ordinary and necessary expenses for managing, conserving, or maintaining rental property from the time you make it available
for rent.
Depreciation.Depreciation:Rental propertyRental income and expenses:Depreciation
You can begin to depreciate rental property when it is ready and available for rent. See Placed-in-Service Date under Depreciation,
in Publication 527.
Expenses for rental property sold.Rental income and expenses:Sale of rental property
If you sell property you held for rental purposes, you can deduct the ordinary and necessary expenses for managing, conserving, or maintaining the
property until it is sold.
Personal use of rental property.Rental income and expenses:Personal use of property including vacation home:Allocation of expenses
If you sometimes use your rental property for personal purposes, you must divide your expenses between rental and personal use. Also, your rental
expense deductions may be limited. See Personal Use of Dwelling Unit (Including Vacation Home), later.
Part interest.Rental income and expenses:Part interest
If you own a part interest in rental property, you can deduct your part of the expenses that you paid.
If you are a cash basis taxpayer, you do not report uncollected rent. Because you do not include it in your income, you cannot deduct it.
If you use an accrual method, you report income when you earn it. If you are unable to collect the rent, you may be able to deduct it as a business
bad debt. See chapter 11 of Publication 535 for more information about business bad debts.
Repairs and ImprovementsImprovementsRental propertyRental income and expensesRental income and expenses:ImprovementsRental income and expenses:RepairsRepairs:Rental expenses
You can deduct the cost of repairs to your rental property. You cannot deduct the cost of improvements. You recover the cost of improvements by
taking depreciation (explained later).
Separate the costs of repairs and improvements, and keep accurate records. You will need to know the cost of improvements when you sell or
depreciate your property.
Repairs.
A repair keeps your property in good operating condition. It does not materially add to the value of your property or substantially prolong its
life. Repainting your property inside or out, fixing gutters or floors, fixing leaks, plastering, and replacing broken windows are examples of
repairs.
If you make repairs as part of an extensive remodeling or restoration of your property, the whole job is an improvement.
Improvements.ImprovementsRental propertyRental income and expensesRental income and expenses:Improvements:Defined
An improvement adds to the value of property, prolongs its useful life, or adapts it to new uses. Improvements include the following items.
Putting a recreation room in an unfinished basement.
Paneling a den.
Adding a bathroom or bedroom.
Putting decorative grillwork on a balcony.
Putting up a fence.
Putting in new plumbing or wiring.
Putting in new cabinets.
Putting on a new roof.
Paving a driveway.
Rental income and expenses:Capitalized costsIf you make an improvement to property, the cost of the improvement must be capitalized. The capitalized
cost can generally be depreciated as if the improvement were separate property.
Other Expenses
Other expenses you can deduct from your rental income include advertising, cleaning and maintenance, utilities, fire and liability insurance,
taxes, interest, commissions for the collection of rent, ordinary and necessary travel and transportation, and other expenses, discussed next.
Rental payments for property.
You can deduct the rent you pay for property that you use for rental purposes. If you buy a leasehold for rental purposes, you can deduct an equal
part of the cost each year over the term of the lease.
Rental of equipment.Equipment:Rental for rental propertyMachinery:Rental for rental propertyRental income and expenses:Equipment rental for rental propertyTools:Rental for use on rental property
You can deduct the rent you pay for equipment that you use for rental purposes. However, in some cases, lease contracts are actually purchase
contracts. If so, you cannot deduct these payments. You can recover the cost of purchased equipment through depreciation.
Insurance premiums paid in advance.Insurance premiums:Rental expenses, deduction of premiums paid in advanceRental income and expenses:Insurance premiums paid in advance
If you pay an insurance premium for more than one year in advance, each year you can deduct the part of the premium payment that will apply to that
year. You cannot deduct the total premium in the year you pay it.
Local benefit taxes.Assessments, localLocal assessmentsLocal assessments:Rental property, deductions forRental income and expenses:Local assessments
Generally, you cannot deduct charges for local benefits that increase the value of your property, such as charges for putting in streets,
sidewalks, or water and sewer systems. These charges are nondepreciable capital expenditures. You must add them to the basis of your property. You can
deduct local benefit taxes if they are for maintaining, repairing, or paying interest charges for the benefits.
Travel expenses.Maintenance of rental propertyRental income and expensesRental income and expenses:Travel expenses associated with management and maintenanceTravel and transportation expenses:Rental property maintenance and management, for
You can deduct the ordinary and necessary expenses of traveling away from home if the primary purpose of the trip was to collect rental income or
to manage, conserve, or maintain your rental property. You must properly allocate your expenses between rental and nonrental activities. You cannot
deduct the cost of traveling away from home if the primary purpose of the trip was the improvement of your property. You recover the cost of
improvements by taking depreciation. For information on travel expenses, see chapter 26.
To deduct travel expenses, you must keep records that follow the rules in chapter 26.
Local transportation expenses.Rental income and expenses:Travel expenses associated with management and maintenanceTravel and transportation expenses:Rental property maintenance and management, for
You can deduct your ordinary and necessary local transportation expenses if you incur them to collect rental income or to manage, conserve, or
maintain your rental property.
Generally, if you use your personal car, pickup truck, or light van for rental activities, you can deduct the expenses using one of two methods:
actual expenses or the standard mileage rate. For 2005, the standard mileage rate for all business miles driven before September 1 is 40 cents a mile. The rate is 48 cents a mile for all business miles driven after August 31. For more information, see chapter 26.
To deduct car expenses under either method, you must keep records that follow the rules in chapter 26. In addition, you must complete Form 4562,
Part V, and attach it to your tax return.
Tax return preparation.Rental income and expenses:Tax return preparationTax return preparation:Rental expenses
You can deduct, as a rental expense, the part of the tax return preparation fees you paid to prepare Schedule E (Form 1040), Part I. For example,
on your 2005 Schedule E, you can deduct fees paid in 2005 to prepare your 2004 Schedule E, Part I. You can also deduct, as a rental expense, any
expense (other than federal taxes and penalties) you paid to resolve a tax underpayment related to your rental activities.
Not Rented for ProfitRental income and expenses:Not-rented-for-profit property
If you do not rent your property to make a profit, you can deduct your rental expenses only up to the amount of your rental income. You cannot
carry forward to the next year any rental expenses that are more than your rental income for the year. For more information about the rules for an
activity not engaged in for profit, see chapter 1 of Publication 535.
Where to report.
Report your not-for-profit rental income on Form 1040, line 21. You can include your mortgage interest (if you use the property as your main home
or second home), real estate taxes, and casualty losses on the appropriate lines of Form 1040, Schedule A, Itemized Deductions, if you itemize your
deductions.
Claim your other rental expenses, subject to the rules explained in chapter 1 of Publication 535, as miscellaneous itemized deductions on Form
1040, Schedule A, line 22. You can deduct these expenses only if they, together with certain other miscellaneous itemized deductions, total more than
2% of your adjusted gross income.
Property Changed
to Rental UseRental income and expenses:Change of property to rental use
If you change your home or other property, (or a part of it), to rental use at any time other than at the beginning of your tax year, you must
divide yearly expenses, such as taxes and insurance, between rental use and personal use.
You can deduct as rental expenses only the part of the expense that is for the part of the year the property was used or held for rental purposes.
For depreciation purposes, treat the property as being placed in service on the conversion date.
You cannot deduct depreciation or insurance for the part of the year the property was held for personal use. However, you can include the home
mortgage interest and real estate tax expenses for the part of the year the property was held for personal use as an itemized deduction on Schedule A
(Form 1040).
Example.
Your tax year is the calendar year. You moved from your home in May and started renting it on June 1. You can deduct as rental expenses
seven-twelfths of your yearly expenses, such as taxes and insurance.
Starting with June, you can deduct as rental expenses the amounts you pay for items generally billed monthly, such as utilities.
Renting Part of
PropertyRental income and expenses:Part of property rented
If you rent part of your property, you must divide certain expenses between the part of the property used for rental purposes and the part of the
property used for personal purposes, as though you actually had two separate pieces of property.
You can deduct the expenses related to the part of the property used for rental purposes, such as home mortgage interest and real estate taxes, as
rental expenses on Schedule E (Form 1040). You can also deduct as a rental expense a part of other expenses that normally are nondeductible personal
expenses, such as expenses for electricity or painting the outside of your house.
You can deduct the expenses for the part of the property used for personal purposes, subject to certain limitations, only if you itemize your
deductions on Schedule A (Form 1040).
You cannot deduct any part of the cost of the first phone line even if your tenants have unlimited use of it.
You do not have to divide the expenses that belong only to the rental part of your property. For example, if you paint a room that you rent, or if
you pay premiums for liability insurance in connection with renting a room in your home, your entire cost is a rental expense. If you install a second
phone line strictly for your tenants' use, all of the cost of the second line is deductible as a rental expense. You can deduct depreciation,
discussed later, on the part of the property used for rental purposes as well as on the furniture and equipment you use for rental purposes.
How to divide expenses.
If an expense is for both rental use and personal use, such as mortgage interest or heat for the entire house, you must divide the expense between
the rental use and the personal use. You can use any reasonable method for dividing the expense. It may be reasonable to divide the cost of some items
(for example, water) based on the number of people using them. However, the two most common methods for dividing an expense are one based on the
number of rooms in your home and one based on the square footage of your home.
Personal Use of
Dwelling Unit
(Including Vacation Home)Dwelling units:RentingRental income and expensesDwelling units:Vacation homesHomeVacation homesHousingVacation homesReal estateVacation homesRental income and expenses:Personal use of property including vacation homeVacation homes:Rental expenses
If you have any personal use of a dwelling unit (including a vacation home) that you rent, you must divide your expenses between rental use and
personal use. See Figuring Days of Personal Use and How To Divide Expenses, later.
If you used your dwelling unit for personal purposes, it may be considered a dwelling unit used as a home. If it is, you cannot deduct
rental expenses that are more than your rental income for the unit. See Dwelling Unit Used as Home and How To Figure Rental Income and
Deductions, later. If your dwelling unit is not considered a dwelling unit used as a home, you can deduct rental expenses that are more than
rental income for the unit subject to certain limits. See Limits on Rental Losses, later.
Exception for minimal rental use.Rental income and expenses:Dwelling unit used as home:Rented for fewer than 15 days
If you use the dwelling unit as a home and you rent it fewer than 15 days during the year, do not include any of the rent in your income and do not
deduct any of the rental expenses. To determine if you use a dwelling unit as a home, see Dwelling Unit Used as Home, later.
Dwelling unit.Dwelling units:Defined
A dwelling unit includes a house, apartment, condominium, mobile home, boat, vacation home, or similar property. A dwelling unit has basic living
accommodations, such as sleeping space, a toilet, and cooking facilities. A dwelling unit does not include property used solely as a hotel, motel,
inn, or similar establishment.
Boarding housesHotels:Not considered dwelling unitsMotelsHotelsProperty is used solely as a hotel, motel, inn, or similar establishment if it is regularly available for occupancy by paying
customers and is not used by an owner as a home during the year.
Example.
You rent a room in your home that is always available for short-term occupancy by paying customers. You do not use the room yourself, and you allow
only paying customers to use the room. The room is used solely as a hotel, motel, inn, or similar establishment and is not a dwelling unit.
Dwelling Unit
Used as HomeDwelling units:RentingRental income and expensesDwelling units:Vacation homesHomeVacation homesHousingVacation homesReal estateVacation homesRental income and expenses:Dwelling unit used as homeRental income and expenses:Personal use of property including vacation homeVacation homes:Rental expenses
The tax treatment of rental income and expenses for a dwelling unit that you also use for personal purposes depends on whether you use it as a
home. (See How To Figure Rental Income and Deductions, later.)
You use a dwelling unit as a home during the tax year if you use it for personal purposes more than the greater of:
14 days, or
10% of the total days it is rented to others at a fair rental price.
See Figuring Days of Personal Use, later.
If a dwelling unit is used for personal purposes on a day it is rented at a fair rental price, do not count that day as a day of rental use in
applying (2) above. Instead, count it as a day of personal use in applying both (1) and (2) above. This rule does not apply when dividing expenses
between rental and personal use.
Fair rental price.Fair rental priceRental income and expenses:Fair rental price
A fair rental price for your property generally is the amount of rent that a person who is not related to you would be willing to pay. The rent you
charge is not a fair rental price if it is substantially less than the rents charged for other properties that are similar to your property.
ExamplesDwelling units:Vacation homesHomeVacation homesHousingVacation homesReal estateVacation homesRental income and expenses:Dwelling unit used as home:Determining if used as homeSecond homesVacation homesVacation homes:Determining if used as home
The following examples show how to determine whether you used your rental property as a home.
Example 1.
You converted the basement of your home into an apartment with a bedroom, a bathroom, and a small kitchen. You rented the basement apartment at a
fair rental price to college students during the regular school year. You rented to them on a 9-month lease (273 days). You figured 10% of the total
days rented to others at a fair rental price is 27 days.
During June (30 days), your brother stayed with you and lived in the basement apartment rent free.
Your basement apartment was used as a home because you used it for personal purposes for 30 days. Rent-free use by your brother is considered
personal use. Your personal use (30 days) is more than the greater of 14 days or 10% of the total days it was rented (27 days).
Example 2.
You rented the guest bedroom in your home at a fair rental price during the local college's homecoming, commencement, and football weekends (a
total of 27 days). Your sister-in-law stayed in the room, rent free, for the last 3 weeks (21 days) in July. You figured 10% of the total days rented
to others at a fair rental price is 3 days.
The room was used as a home because you used it for personal purposes for 21 days. That is more than the greater of 14 days or 10% of the 27 days
it was rented (3 days).
Example 3.
You own a condominium apartment in a resort area. You rented it at a fair rental price for a total of 170 days during the year. For 12 of those
days, the tenant was not able to use the apartment and allowed you to use it even though you did not refund any of the rent. Your family actually used
the apartment for 10 of those days. Therefore, the apartment is treated as having been rented for 160 (170 − 10) days. You figure 10% of the
total days rented to others at a fair rental price is 16 days. Your family also used the apartment for 7 other days during the year.
You used the apartment as a home because you used it for personal purposes for 17 days. That is more than the greater of 14 days or 10% of the 160
days it was rented (16 days).
Use As Main Home Before or After Renting
For purposes of determining whether a dwelling unit was used as a home, you may not have to count days you used the property as your main home
before or after renting it or offering it for rent as days of personal use. Do not count them as days of personal use if:
You rented or tried to rent the property for 12 or more consecutive months.
You rented or tried to rent the property for a period of less than 12 consecutive months and the period ended because you sold or exchanged
the property.
This special rule does not apply when dividing expenses between rental and personal use.
Figuring Days
of Personal UseRental income and expenses:Dwelling unit used as home:Figuring days of personal use
A day of personal use of a dwelling unit is any day that the unit is used by any of the following persons.
You or any other person who has an interest in it, unless you rent it to another owner as his or her main home under a shared equity
financing agreement (defined later). However, see Use as Main Home Before or After Renting under Dwelling Unit Used As Home,
earlier.
A member of your family or a member of the family of any other person who has an interest in it, unless the family member uses the dwelling
unit as his or her main home and pays a fair rental price. Family includes only brothers and sisters, half-brothers and half-sisters, spouses,
ancestors (parents, grandparents, etc.) and lineal descendants (children, grandchildren, etc.).
Anyone under an arrangement that lets you use some other dwelling unit.
Anyone at less than a fair rental price.
Main home.Rental income and expenses:Dwelling unit used as home:Main home determination
If the other person or member of the family in (1) or (2) above has more than one home, his or her main home is ordinarily the one he or she lived
in most of the time.
Shared equity financing agreement.Co-owners:Dwelling unit used as home by co-owner, rental income and expense allocationRental income and expenses:Dwelling unit used as home:Shared equity financing agreement
This is an agreement under which two or more persons acquire undivided interests for more than 50 years in an entire dwelling unit, including the
land, and one or more of the co-owners is entitled to occupy the unit as his or her main home upon payment of rent to the other co-owner or owners.
Donation of use of property.Rental income and expenses:Dwelling unit used as home:Donation of use of property
You use a dwelling unit for personal purposes if:
You donate the use of the unit to a charitable organization,
Charitable contributions:Dwelling unit used as homeContributionsCharitable contributionsDonationsCharitable contributions
The organization sells the use of the unit at a fund-raising event, and
Fund-raising events:Rental of dwelling unit used as home
The purchaser uses the unit.
Examples
The following examples show how to determine days of personal use.
Example 1.
You and your neighbor are co-owners of a condominium at the beach. You rent the unit to vacationers whenever possible. The unit is not used as a
main home by anyone. Your neighbor uses the unit for 2 weeks every year.
Because your neighbor has an interest in the unit, both of you are considered to have used the unit for personal purposes during those 2 weeks.
Example 2.
You and your neighbors are co-owners of a house under a shared equity financing agreement. Your neighbors live in the house and pay you a fair
rental price.
Even though your neighbors have an interest in the house, the days your neighbors live there are not counted as days of personal use by you. This
is because your neighbors rent the house as their main home under a shared equity financing agreement.
Example 3.
You own a rental property that you rent to your son. Your son has no interest in this property. He uses it as his main home. He pays you a fair
rental price for the property.
Your son's use of the property is not personal use by you because your son is using it as his main home, he has no interest in the property, and he
is paying you a fair rental price.
Example 4.
You rent your beach house to Joshua. Joshua rents his house in the mountains to you. You each pay a fair rental price.
You are using your house for personal purposes on the days that Joshua uses it because your house is used by Joshua under an arrangement that
allows you to use his house.
Days Used for Repairs and MaintenanceMaintenance of rental propertyRental income and expensesRental income and expenses:Dwelling unit used as home:Days used for repairs and maintenance
Any day that you spend working substantially full time repairing and maintaining (not improving) your property is not counted as a day of personal
use. Do not count such a day as a day of personal use even if family members use the property for recreational purposes on the same day.
How To Divide ExpensesDwelling units:Vacation homesHomeVacation homesHousingVacation homesReal estateVacation homesRental income and expenses:Dwelling unit used as home:Division of expensesVacation homes:Rental expenses
If you use a dwelling unit for both rental and personal purposes, divide your expenses between the rental use and the personal use based on the
number of days used for each purpose. You can deduct expenses for the rental use of the unit under the rules explained in How To Figure Rental
Income and Deductions, later.
When dividing your expenses follow these rules.
Any day that the unit is rented at a fair rental price is a day of rental use even if you used the unit for personal purposes that day. This
rule does not apply when determining whether you used the unit as a home.
Any day that the unit is available for rent but not actually rented is not a day of rental use.
Example.
Your beach cottage was available for rent from June 1 through August 31 (92 days). Your family uses the cottage during the last 2 weeks in May (14
days). You were unable to find a renter for the first week in August (7 days). The person who rented the cottage for July allowed you to use it over a
weekend (2 days) without any reduction in or refund of rent. The cottage was not used at all before May 17 or after August 31.
You figure the part of the cottage expenses to treat as rental expenses as follows.
The cottage was used for rental a total of 85 days (92 − 7). The days it was available for rent but not rented (7 days) are not days
of rental use. The July weekend (2 days) you used it is rental use because you received a fair rental price for the weekend.
You used the cottage for personal purposes for 14 days (the last 2 weeks in May).
The total use of the cottage was 99 days (14 days personal use + 85 days rental use).
Your rental expenses are 85/99 (86%) of the cottage expenses.
When determining whether you used the cottage as a home, the July weekend (2 days) you used it is personal use even though you received a fair
rental price for the weekend. Therefore, you had 16 days of personal use and 83 days of rental use for this purpose. Because you used the cottage for
personal purposes more than 14 days and more than 10% of the days of rental use (8 days), you used it as a home. If you have a net loss, you may not
be able to deduct all of the rental expenses. See Property Used as a Home in the following discussion.
How To Figure Rental
Income and Deductions
How you figure your rental income and deductions depends on whether you used the dwelling unit as a home (see Dwelling Unit Used as
Home, earlier) and, if you used it as a home, how many days the property was rented at a fair rental price.
Property Not Used as a HomeRental income and expenses:Dwelling unit not used as home
If you do not use a dwelling unit as a home, report all the rental income and deduct all the rental expenses. See How To Report Rental Income
and Expenses, later.
Deductions:Rental expensesRental income and expenses:DeductionsYour deductible rental expenses can be more than your gross rental income. However, see Limits on Rental
Losses, later.
<ROM>Worksheet 9-1.</ROM>
<IMARK>Worksheet for Figuring the Limit on Rental Deductions for a Dwelling unit Used as a HomeUse this worksheet only if you answer yes to all the following questions.
Did you use the dwelling unit as a home this year? (See Dwelling Unit Used as Home.)
Did you rent the dwelling unit 15 days or more this year?
Is the total or your rental expenses and depreciation more than your rental income?
1.Enter rents received2a.Enter the rental portion of deductible home mortgage interest (see instructions)b.Enter the rental portion of real estate taxesc.Enter the rental portion of deduction casualty and theft losses (see instructions)d.Enter direct rental expenses (see instructions)e.Fully deductible rental expenses. Add lines 2a–2d3.Subtract line 2e from line 1. If zero or less, enter zero4a.Enter the rental portion of expenses directly related to operating or maintaining the dwelling unit (such as repairs,
insurance, and utilities)b.Enter the rental portion of excess mortgage interest (see instructions)c.Add lines 4a and 4bd.Allowable expenses. Enter the smaller of line 3 or line 4c5.Subtract line 4d fro line 3. If zero or less, enter zero6a.Enter the rental portion of excess casualty and theft losses (see instructions)b.Enter the rental portion of depreciation of the dwelling unitc.Add lines 6a and 6bd.Allowable excess casualty and theft losses and depreciation. Enter the smaller of line 5 or line 6c7a.Operating expenses to be carried over to next year. Subtract line 4d from line 4cb.Excess casualty and theft losses and depreciation to be carried over to next year. Subtract line 6d from line
6cEnter the amounts on lines 2e, 4d, and 6d on the appropriate lines of Schedule E (Form 1040), Part
I.
Worksheet Instructions
Follow these instructions for the worksheet above. If you were unable to deduct all your expenses last year, because of the rental income limit,
add these unused amounts to your expenses for this year.
Line 2a. Figure the mortgage interest on the dwelling unit that you could deduct on Schedule A (Form 1040) if you had not rented the
unit. Do not include interest on a loan that did not benefit the dwelling unit. For example, do not include interest on a home equity loan used to pay
off credit cards or other personal loans, buy a car, or pay college tuition. Include interest on a loan used to buy, build, or improve the dwelling
unit, or to refinance such a loan. Enter the rental portion of this interest on line 2a of the worksheet.
Line 2c. Figure the casualty and theft losses related to the dwelling unit that you could deduct on Schedule A (Form 1040) if you had
not rented the dwelling unit. To do this, complete Form 4684, Casualties and Thefts, Section A, treating the losses as personal losses. On Form 4684,
line 19, enter 10% of your adjusted gross income figured without your rental income and expenses from the dwelling unit. If your loss occurred after
August 24, 2005, and was the result of Hurricane Katrina, enter zero on line 19. Enter the rental portion of the result from Form 4684, line 18, on
line 2c of this worksheet.
Note. Do not file this Form 4684 or use it to figure your personal losses on Schedule A. Instead, figure the personal portion on a
separate Form 4684.
Line 2d. Enter the total of your rental expenses that are directly related only to the rental activity. These include interest on loans
used for rental activities other than to buy, build, or improve the dwelling unit. Also include rental agency fees, advertising, office supplies, and
depreciation on office equipment used in your rental activity.
Line 4b. On line 2a, you entered the rental portion of the mortgage interest you could deduct on Schedule A if you had not rented the
dwelling unit. Enter on line 4b of this worksheet the rental portion of the mortgage interest you could not deduct on Schedule A because it is more
than the limit on home mortgage interest. Do not include interest on a loan that did not benefit the dwelling unit (as explained in the line 2a
instructions).
Line 6a. To find the rental portion of excess casualty and theft losses, use the Form 4684 you prepared for line 2c of this worksheet.
A.Enter the amount from Form 4684, line 10B.Enter the rental portion of AC.Enter the amount from line 2c of this worksheetD.Subtract C from B. Enter the result here and on line 6a of this worksheet
Allocating the limited deduction. If you cannot deduct all of the amount on line 4c or 6c this year, you can allocate the allowable
deduction in any way you wish among the expenses included on line 4c or 6c. Enter the amount you allocate to each expense on the appropriate line of
Schedule E, Part I.
Property Used as a HomeRental income and expenses:Dwelling unit used as home:Computation of income and expenses
If you use a dwelling unit as a home during the year (see Dwelling Unit Used as Home, earlier), how you figure your rental income and
deductions depends on how many days the unit was rented at a fair rental price.
Rented fewer than 15 days.Rental income and expenses:Dwelling unit used as home:Rented for fewer than 15 days
If you use a dwelling unit as a home and you rent it fewer than 15 days during the year, do not include any rental income in your income. Also, you
cannot deduct any expenses as rental expenses.
Rented 15 days or more.Rental income and expenses:Dwelling unit used as home:Rented for 15 days or more
If you use a dwelling unit as a home and rent it 15 days or more during the year, you include all your rental income in your income. See How
To Report Rental Income and Expenses, later. If you had a net profit from the rental property for the year (that is, if your rental income is
more than the total of your rental expenses, including depreciation), deduct all of your rental expenses. However, if you had a net loss, your
deduction for certain rental expenses is limited.
Use Worksheet 9-1 to figure your deductible expenses.
DepreciationDepreciation:Rental propertyRental income and expenses:DepreciationRental income and expenses:DepreciationDepreciation
You recover your cost in income producing property through yearly tax deductions. You do this by depreciating the property; that is, by deducting
some of the cost on your tax return each year.
Three basic factors determine how much depreciation you can deduct. They are: (1) your basis in the property, (2) the recovery period for the
property, and (3) the depreciation method used. You cannot simply deduct your mortgage or principal payments, or the cost of furniture, fixtures and
equipment, as an expense.
You can deduct depreciation only on the part of your property used for rental purposes. Depreciation reduces your basis for figuring gain or loss
on a later sale or exchange.
Depreciation:Form 4562:Rental property depreciationForm:4562:Depreciation of rental property You may have to use Form 4562 to figure and report your depreciation. See How To
Report Rental Income and Expenses, later.
Claiming the correct amount of depreciation.Depreciation:Correcting amount claimedErrors:Depreciation, correcting amount on Form 1040XForm:1040X:Depreciation| Correcting amount of
You should claim the correct amount of depreciation each tax year. Even if you did not claim depreciation that you were entitled to deduct, you
must still reduce your basis in the property by the full amount of depreciation that you could have deducted. If you did not deduct the correct amount
of depreciation for property in any year, you may be able to make a correction for that year by filing Form 1040X, Amended U.S Individual Income Tax
Return. If you are not allowed to make the correction on an amended return, you can change your accounting method to claim the correct amount of
depreciation. See Claiming the correct amount of depreciation in Publication 527 for more information.
Changing your accounting method to deduct unclaimed depreciation.Accounting methods:Change of:Depreciation, to deduct unclaimed amount
To change your accounting method, you must file Form 3115, Application for Change in Accounting Method, to get the consent of the IRS. In some
instances, that consent is automatic. For more information, see chapter 1 of Publication 946.
Land.Depreciation:Real property:Land, no depreciation ofLand:Depreciation not allowed for
You can never depreciate the cost of land because land does not wear out, become obsolete, or get used up. The costs of clearing, grading,
planting, and landscaping are usually all part of the cost of land and cannot be depreciated.
More information.
See Publication 527 for more information about depreciating rental property and see Publication 946, How To Depreciate Property, for more
information about depreciation.
Other Rules About
Depreciable Property
In addition to the rules about what methods you can use, there are other rules you should be aware of with respect to depreciable property.
Gain from disposition.Depreciation:Real property:Gain from disposition of property
If you dispose of depreciable property at a gain, you may have to report, as ordinary income, all or part of the gain. See Publication 544, Sales
and Other Dispositions of Assets.
If you use accelerated depreciation, you may have to file Form 6251. Accelerated depreciation can be determined under MACRS, ACRS, and any other
method that allows you to deduct more depreciation than you could deduct using a straight line method.
Limits on
Rental LossesRental income and expenses:Deductions:Losses that exceed passive income
Passive activity:LossesRental propertyRental real estate activities are generally considered passive activities, and the amount of loss you
can deduct is limited. Generally, you cannot deduct losses from rental real estate activities unless you have income from other passive activities.
However, you may be able to deduct rental losses without regard to whether you have income from other passive activities if you materially or
actively participated in your rental activity. See Passive Activity Limits, later.
At-risk rules:Rental propertyLosses from passive activities are first subject to the at-risk rules. At-risk rules limit the amount of
deductible losses from holding most real property placed in service after 1986.
Exception.
If your rental losses are less than $25,000 and you actively participated in the rental activity, the passive activity limits probably do not apply
to you. See Losses From Rental Real Estate Activities, later.
Property used as a home.Rental income and expenses:Dwelling unit used as home:Limit for rental losses
If you used the rental property as a home during the year, the passive activity rules do not apply to that home. Instead, you must follow the rules
explained earlier under Personal Use of Dwelling Unit (Including Vacation Home).
At-Risk RulesAt-risk rules:Rental property
Rental income and expenses:Tax shelters and at-risk rulesTax shelters:Rental property and at-risk rulesThe at-risk rules place a limit on the amount you can deduct as losses from activities
often described as tax shelters. Losses from holding real property (other than mineral property) placed in service before 1987 are not subject to the
at-risk rules.
Generally, any loss from an activity subject to the at-risk rules is allowed only to the extent of the total amount you have at risk in the
activity at the end of the tax year. You are considered at risk in an activity to the extent of cash and the adjusted basis of other property you
contributed to the activity and certain amounts borrowed for use in the activity. See Publication 925 for more information.
Passive Activity LimitsGains and losses:Passive activityPassive activityLossesPassive activityPassive activity:LossesRental property
In general, all rental activities (except those meeting the exception for real estate professionals, later) are passive activities. For this
purpose, a rental activity is an activity from which you receive income mainly for the use of tangible property, rather than for services.
Limits on passive activity deductions and credits.Passive activity:LossesRental propertyRental income and expenses:Deductions:Losses that exceed passive income
Deductions for losses from passive activities are limited. You generally cannot offset income, other than passive income, with losses from passive
activities. Nor can you offset taxes on income, other than passive income, with credits resulting from passive activities. Any excess loss or credit
is carried forward to the next tax year.
For a detailed discussion of these rules, see Publication 925.
Form:8582:Passive activity gains or lossesYou may have to complete Form 8582 to figure the amount of any passive activity loss
for the current tax year for all activities and the amount of the passive activity loss allowed on your tax return.
Exception for real estate professionals.Passive activity:LossesException for real estate professionalsSale of homeReal estate
Rental activities in which you materially participated during the year are not passive activities if, for that year, you were a real estate
professional. For a detailed discussion of the requirements, see Publication 527. For a detailed discussion of material participation, see Publication
925.
Losses From Rental Real Estate ActivitiesRental income and expenses:Losses from rental real estate activities
If you or your spouse actively participated in a passive rental real estate activity, you can deduct up to $25,000 of loss from the activity from
your nonpassive income. This special allowance is an exception to the general rule disallowing losses in excess of income from passive activities.
Similarly, you can offset credits from the activity against the tax on up to $25,000 of nonpassive income after taking into account any losses allowed
under this exception.
If you are married, filing a separate return, and lived apart from your spouse for the entire tax year, your special allowance cannot be more than
$12,500. If you lived with your spouse at any time during the year and are filing a separate return, you cannot use the special allowance to reduce
your nonpassive income or tax on nonpassive income.
The maximum amount of the special allowance is reduced if your modified adjusted gross income is more than $100,000 ($50,000 if married filing
separately).
Active participation.
You actively participated in a rental real estate activity if you (and your spouse) owned at least 10% of the rental property and you made
management decisions in a significant and bona fide sense. Management decisions include approving new tenants, deciding on rental terms,
approving expenditures, and similar decisions.
More information.
See Publication 925 for more information on the passive loss limits, including information on the treatment of unused disallowed passive losses and
credits and the treatment of gains and losses realized on the disposition of a passive activity.
How To Report
Rental Income
and ExpensesRental income and expenses:Schedule E for reporting ofForm:1040, Schedule ERental income and expensesRental income and expenses:Reporting of
If you rent buildings, rooms, or apartments, and provide only heat and light, trash collection, etc., you normally report your rental income and
expenses on Form 1040, Schedule E, Part I. However, do not use that schedule to report a not-for-profit activity. See Not Rented for
Profit, earlier.
Form:1040, Schedule CRental income and expensesForm:1040, Schedule C-EZRental income and expensesRental income and expenses:Self-employment tax, when applicableSelf-employment tax:Rental incomeIf you provide significant services that are primarily for your tenant's convenience, such as regular
cleaning, changing linen, or maid service, you report your rental income and expenses on Schedule C (Form 1040), Profit or Loss From Business or
Schedule C-EZ, Net Profit From Business (Sole Proprietorship). Significant services do not include the furnishing of heat and light, cleaning of
public areas, trash collection, etc. For information, see Publication 334, Tax Guide for Small Business (For Individuals Who Use Schedule C or C-EZ).
You also may have to pay self-employment tax on your rental income.
Form 1098.Form:1098:Mortgage interest statementInterest paymentsMortgagesLoansHome mortgagesMortgagesMortgages:Interest:Form 1098 (interest statement)
Form:1040, Schedule ERental income and expensesIf you paid $600 or more of mortgage interest on your rental property to any one person, you
should receive a Form 1098, Mortgage Interest Statement, or similar statement showing the interest you paid for the year. If you and at least one
other person (other than your spouse if you file a joint return) were liable for, and paid interest on the mortgage, and the other person received the
Form 1098, report your share of the interest on Form 1040, Schedule E, line 13. Attach a statement to your return showing the name and address of the
other person. In the left margin of Schedule E (Form 1040), next to line 13, enter See attached.
Schedule E (Form 1040)Form:1040, Schedule ERental income and expenses
Use Form 1040, Schedule E, Part I, to report your rental income and expenses. List your total income, expenses, and depreciation for each rental
property. Be sure to answer the question on line 2.
If you have more than three rental or royalty properties, complete and attach as many Schedules E as are needed to list the properties. Complete
lines 1 and 2 for each property. However, fill in the Totals column on only one Schedule E. The figures in the Totals column on that
Schedule E should be the combined totals of all Schedules E.
Schedule E, page 2, is used to report income or loss from partnerships, S corporations, estates, trusts, and real estate mortgage investment
conduits. If you need to use Schedule E, page 2, use page 2 of the same Schedule E you used to enter the combined totals in Part I.
On Schedule E, page 1, line 20, enter the depreciation you are claiming. You must complete and attach Form 4562 for rental activities only if you
are claiming:
Depreciation on property placed in service during 2005,
Depreciation on listed property (such as a car), regardless of when it was placed in service, or
Any car expenses reported on a form other than Schedule C or C-EZ (Form 1040) or Form 2106 or Form 2106-EZ.
Otherwise, figure your depreciation on your own worksheet. You do not have to attach these computations to your return.
Retirement Plans, Pensions, and AnnuitiesAnnuities:Retirement annuitiesPensionsRetirement plansAnnuities:Retirement annuitiesRetirement plansContributionsRetirementspecific type of planDeferred compensation plansRetirement plansElderly personsPensionsElective deferralsRetirement plansKeogh plansRetirement plansPensionsAnnuitiesQualified plans:Retirement plansRetireesRetirement plansRetirement plansAnnuitiesWhat's NewKatrina Emergency Tax Relief Act of 2005.
This Act provides tax relief for persons affected by Hurricane Katrina. Under the Act, you may qualify for tax-favored withdrawals,
recontributions, and loans. See Publication 4492.
This chapter discusses the tax treatment of distributions you receive from:
An employee pension or annuity from a qualified plan,
A disability retirement, and
A purchased commercial annuity.
What is not covered in this chapter.
The following topics are not discussed in this chapter.
The General Rule.
This is the method generally used to determine the tax treatment of pension and annuity income from nonqualified plans (including commercial
annuities). For a qualified plan, you generally cannot use the General Rule unless your annuity starting date is before November 19, 1996. For more
information about the General Rule, see Publication 939.
Civil service retirement benefits.
Civil service retirement benefitsIf you are retired from the federal government (either regular or disability retirement), see
Publication 721, Tax Guide to U.S. Civil Service Retirement Benefits. Publication 721 also covers the information that you need if you are the
survivor or beneficiary of a federal employee or retiree who died.
Individual retirement arrangements (IRAs).
Information on the tax treatment of amounts you receive from an IRA is in chapter 17.
Publication575Pension and Annuity Income 721Tax Guide to U.S. Civil Service Retirement Benefits939General Rule for Pensions and AnnuitiesForm (and Instructions)Withholding Certificate for Pension or Annuity PaymentsDistributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.Tax on Lump-Sum DistributionsAdditional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts
General InformationDisability Pensions.Disabilities, persons with:Terrorist attack as cause of injury, disability payments excluded from taxationDisaster reliefTerrorist attacksExclusions from gross income:Terrorist attack as cause of injury, disability paymentsHandicapped personsDisabilities, persons withMentally incompetent persons:Disabilities, persons withPentagon attacksTerrorist attacksTerrorist attacks:Disability payments for injuries from, tax exclusionVictims of terrorismTerrorist attacks
If you retired on disability, you generally must include in income any disability pension you receive under a plan that is paid for by your
employer. You must report your taxable disability payments as wages on line 7 of Form 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.
You may be entitled to a tax credit if you were permanently and totally disabled when you retired. For information on this credit, see chapter 33.
Beginning on the day after you reach minimum retirement age, payments you receive are taxable as a pension or annuity. Report the payments on Form
1040, lines 16a and 16b or on Form 1040A, lines 12a and 12b.
Disabilities, persons with:Terrorist attack as cause of injury, disability payments excluded from taxationDisaster reliefTerrorist attacksExclusions from gross income:Terrorist attack as cause of injury, disability paymentsHandicapped personsDisabilities, persons withMentally incompetent personsDisabilities, persons withPentagon attacksTerrorist attacksTerrorist attacks:Disability payments for injuries from, tax exclusionVictims of terrorismTerrorist attacksDisability payments for injuries incurred as a direct result of a terrorist attack directed against the United States
(or its allies) are not included in income. For more information about payments to survivors of terrorist attacks, see Publication 3920, Tax Relief
for Victims of Terrorist Attacks.
For more information on how to report disability pensions, including military and certain government disability pensions, see chapter 5.
More than one program.Annuities:Multiple plan benefitsPensions:Multiple pension plan benefitsRetirement plans:Multiple pension plan benefits
If you receive benefits from more than one program under a single trust or plan of your employer, such as a pension plan and a profit-sharing plan,
you may have to figure the taxable part of each separately. Your former employer or the plan administrator should be able to tell you if you have more
than one pension or annuity contract.
Part of the railroad retirement benefits you receive is treated for tax purposes like social security benefits, and part is treated like an
employee pension. For information about railroad retirement benefits treated as social security benefits, see Publication 915, Social Security and
Equivalent Railroad Retirement Benefits. For information about railroad retirement benefits treated as an employee pension, see Railroad
Retirement in Publication 575.
Credit for the elderly or the disabled.Annuities:Credit for elderly or disabled personsPensions:Disability pensions:Credit forPensions:Elderly persons, credit forRetirement plans:Disability pensions:Credit forRetirement plans:Elderly persons, credit for
If you receive a pension or annuity, you may be able to take the credit for the elderly or the disabled. See chapter 33.
Withholding and estimated tax.Annuities:Estimated taxAnnuities:WithholdingEstimated tax:Pension paymentsPensions:Estimated taxPensions:WithholdingRetirement plans:Estimated taxRetirement plans:WithholdingWithholding:Pensions and annuities
The payer of your pension, profit-sharing, stock bonus, annuity, or deferred compensation plan will withhold income tax on the taxable parts of
amounts paid to you. You can choose not to have tax withheld unless they are eligible rollover distributions. See Eligible rollover distributions
under Rollovers, later. You make this choice by filing Form W-4P.
Form:W-4P:Rollover distributions, election not to have tax withheldFor payments other than eligible rollover distributions, you
can tell the payer how to withhold by filing Form W-4P. If you receive an eligible rollover distribution, 20% will generally be withheld. There is no
withholding on a direct rollover of an eligible rollover distribution. See Direct rollover option under Rollovers, later. If you
choose not to have tax withheld or you do not have enough tax withheld, you may have to pay estimated tax.
For more information, see Pensions and Annuities under Withholding in chapter 4.
Loans.Annuities:Loans from planBorrowed fundsLoansLoans:Retirement plans, fromPensions:Loans from planRetirement plans:Loans from plan
If you borrow money from your qualified pension or annuity plan, tax-sheltered annuity program, government plan, or contract purchased under any of
these plans, you may have to treat the loan as a nonperiodic distribution unless certain exceptions apply. This means that you must include in income
all or part of the amount borrowed. Even if you do not have to treat the loan as a nonperiodic distribution, you may not be able to deduct the
interest on the loan in some situations. For details, see Loans Treated as Distributions in Publication 575. For information on the
deductibility of interest, see chapter 23.
Qualified plans for self-employed individuals.Self-employed persons:Qualified retirement plans for
Qualified plans set up by self-employed individuals are sometimes called Keogh or H.R. 10 plans. Qualified plans can be set up by sole proprietors,
partnerships (but not a partner), and corporations. They can cover self-employed persons, such as the sole proprietor or partners, as well as regular
(common-law) employees.
H.R. 10 plansKeogh plansRetirement plans:Keogh plansSmall businesses:Keogh plansDistributions from a qualified plan are usually fully taxable because most recipients have no cost basis. If you
have an investment (cost) in the plan, however, your pension or annuity payments from a qualified plan are taxed under the Simplified Method. For more
information about qualified plans, see Publication 560, Retirement Plans for Small Business.
Section 457 deferred compensation plans.457 plansSection 457 deferred compensation plansGovernment employeesStateState or local governmentsLocal government employeesSection 457 plans for employeesSection 457 deferred compensation plansPensions457 plansSection 457 deferred compensation plansPensionsState and local government employeesSection 457 deferred compensation plansRetirement plansSection 457 plansSection 457 deferred compensation plansRetirement plansState and local government employeesSection 457 deferred compensation plansSection 457 deferred compensation plansState or local governmentsEmployeesSection 457 plans forSection 457 deferred compensation plans
Local government employeesSection 457 plans for employeesSection 457 deferred compensation plansPensions457 plansSection 457 deferred compensation plansPensionsState and local government employeesSection 457 deferred compensation plansRetirement plans457 plansSection 457 deferred compensation plansRetirement plansState and local government employeesSection 457 deferred compensation plansState or local governmentsEmployeesSection 457 plans forSection 457 deferred compensation plansTax-exempt:OrganizationsSection 457 deferred compensation plansIf you work for a state or local government or for a tax-exempt organization,
you may be able to participate in a section 457 deferred compensation plan. If your plan is an eligible plan, you are not taxed currently on pay that
is deferred under the plan or on any earnings from the plan's investment of the deferred pay. You are taxed on amounts deferred in an eligible state
or local government plan only when they are distributed from the plan. You are taxed on amounts deferred in an eligible tax-exempt organization plan
when they are distributed or otherwise made available to you.
This chapter covers the tax treatment of benefits under eligible section 457 plans, but it does not cover the treatment of deferrals. For
information on deferrals under section 457 plans, see Retirement Plan Contributions under Employee Compensation in Publication
525.
For general information on these deferred compensation plans, see Section 457 Deferred Compensation Plans in Publication 575.
If you receive pension or annuity payments from a privately purchased annuity contract from a commercial organization, such as an insurance
company, you generally must use the General Rule to figure the tax-free part of each annuity payment. For more information about the General Rule, get
Publication 939. Also, see Variable Annuities in Publication 575 for the special provisions that apply to these annuity contracts.
Tax-free exchange.Annuities:Sale of:Gain as ordinary income
You do not recognize gain or loss on an exchange of an annuity contract for another annuity contract if the insured or annuitant remains the same.
However, if an annuity contract is exchanged for a life insurance or endowment contract, any gain due to interest accumulated on the contract is
ordinary income. See Transfers of Annuity Contracts in Publication 575 for more information about exchanges of annuity contracts.
How To ReportAnnuities:Reporting ofPensions:Reporting ofRetirement plans:Reporting of
If you file Form 1040, report your total annuity on line 16a and the taxable part on line 16b. If your pension or annuity is fully taxable, enter
it on line 16b; do not make an entry on line 16a.
If you file Form 1040A, report your total annuity on line 12a and the taxable part on line 12b. If your pension or annuity is fully taxable, enter
it on line 12b; do not make an entry on line 12a.
More than one annuity.Annuities:Multiple plan benefitsPensions:Multiple pension plan benefitsRetirement plans:Multiple pension plan benefits
If you receive more than one annuity and at least one of them is not fully taxable, enter the total amount received from all annuities on Form
1040, line 16a or Form 1040A, line 12a, and enter the taxable part on Form 1040, line 16b, or Form 1040A, line 12b. If all the annuities you receive
are fully taxable, enter the total of all of them on Form 1040, line 16b, or Form 1040A, line 12b.
If you file a joint return and you and your spouse each receive one or more pensions or annuities, report the total of the pensions and annuities
on Form 1040, line 16a, or Form 1040A, line 12a, and report the taxable part on Form 1040, line 16b, or Form 1040A, line 12b.
Cost (Investment in the Contract)Annuities:Cost computationPensions:Cost computationRetirement plans:Cost computation
Before you can figure how much, if any, of a distribution from your pension or annuity plan is taxable, you must determine your cost (your
investment in the contract) in the pension or annuity. Your total cost in the plan includes everything that you paid. It also includes amounts your
employer paid that were taxable to you when paid. Cost does not include any amounts you deducted or excluded from income.
From this total cost, subtract any refunds of premiums, rebates, dividends, unrepaid loans, or other tax-free amounts you received by the later of
the annuity starting date or the date on which you received your first payment.
Your annuity starting date is the later of the first day of the first period for which you received a payment, or the date the plan's obligations
became fixed.
If you worked in a foreign country and contributions were made to your retirement plan, special rules apply in determining your cost. See
Publication 575.
Taxation of Periodic PaymentsFully taxable payments.
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 from
your pay while you worked, the amounts you receive each year are fully taxable. You must report them on your income tax return.
If you paid part of the cost of your annuity, you are not taxed on the part of the annuity you receive that represents a return of your cost. The
rest of the amount you receive is taxable. Your annuity starting date determines which method you must or may use.
If you contributed to your pension or annuity plan, you figure the tax-free and the taxable parts of your annuity payments under either the
Simplified Method or the General Rule. If your annuity starting date is after November 18, 1996, and your payments are from a qualified plan, you must
use the Simplified Method. Generally, you must use the General Rule only for nonqualified plans.
If your annuity is paid under a qualified plan and your annuity starting date is after July 1, 1986 and before November 19, 1996, you could have
chosen to use either the General Rule or the Simplified Method.
Simplified MethodAnnuities:Simplified method to calculate tax-free part of annuity payment
Under the Simplified Method, you figure the tax-free part of each annuity payment by dividing your cost by the total number of anticipated monthly
payments. For an annuity that is payable for the lives of the annuitants, this number is based on the annuitants' ages on the annuity starting date
and is determined from a table. For any other annuity, this number is the number of monthly annuity payments under the contract.
Who must use the Simplified Method.
You must use the Simplified Method if your annuity starting date is after November 18, 1996, and you receive pension or annuity payments from a
qualified plan or annuity, unless you were at least 75 years old and entitled to annuity payments from a qualified plan that are guaranteed for 5
years or more.
Guaranteed payments.Annuities:Guaranteed payments
Your annuity contract provides guaranteed payments if a minimum number of payments or a minimum amount (for example, the amount of your investment)
is payable even if you and any survivor annuitant do not live to receive the minimum. If the minimum amount is less than the total amount of the
payments you are to receive, barring death, during the first 5 years after payments begin (figured by ignoring any payment increases), you are
entitled to less than 5 years of guaranteed payments.
Who must use the General Rule.Age:Retirement plan recipients over age 75Annuities:General Rule:Nonqualified plans and qualified plans for recipients over 75 yearsPensions:General Rule for nonqualified plans and qualified plans for recipients over 75 yearsRetirement plans:General Rule for nonqualified and qualified plans for recipients over 75 years
You must use the General Rule if you receive pension or annuity payments from:
A nonqualified plan (such as a private annuity, a purchased commercial annuity, or a nonqualified employee plan), or
A qualified plan if you are age 75 or older on your annuity starting date and your annuity payments are guaranteed for at least 5
years.
Annuity starting before November 19, 1996.Annuities:General Rule:Annuity starting before November 19, 1996General RuleAnnuities
If your annuity starting date is after July 1, 1986, and before November 19, 1996, you had to use the General Rule for either circumstance
described above. You also had to use it for any fixed-period annuity. If you did not have to use the General Rule, you could have chosen to use it. If
your annuity starting date is before July 2, 1986, you had to use the General Rule unless you could use the Three-Year Rule.
If you had to use the General Rule (or chose to use it), you must continue to use it each year that you recover your cost.
Who cannot use the General Rule.
You cannot use the General Rule if you receive your pension or annuity from a qualified plan and none of the circumstances described in the
preceding discussions apply to you. See Who must use the Simplified Method, earlier.
More information.
For complete information on using the General Rule, including the actuarial tables you need, see Publication 939.
Exclusion limit.Annuities:Exclusion limitExclusions from gross income:Annuities
Your annuity starting date determines the total amount that you can exclude from your taxable income over the years.
Exclusion limited to cost.
If your annuity starting date is after 1986, the total amount of annuity income that you can exclude over the years as a recovery of the cost
cannot exceed your total cost. Any unrecovered cost at your (or the last annuitant's) death is allowed as a miscellaneous itemized deduction on the
final return of the decedent. This deduction is not subject to the 2%-of-adjusted-gross-income limit.
Exclusion not limited to cost.
If your annuity starting date is before 1987, you can continue to take your monthly exclusion for as long as you receive your annuity. If you chose
a joint and survivor annuity, your survivor can continue to take the survivor's exclusion figured as of the annuity starting date. The total exclusion
may be more than your cost.
How to use the Simplified Method.Annuities:Simplified method to calculate tax-free part of annuity payment:Worksheet for computationSimplified Method:Computation of taxable annuity:WorksheetWorksheets:Simplified Method computation of taxable annuity
Simplified Method:Computation of taxable annuityComplete the Simplified Method Worksheet in Publication 575 to figure your taxable annuity
for 2005. If the annuity is payable only over your life, use your age at the annuity starting date to determine the total number of expected monthly
payments for your annuity. For annuity starting dates beginning in 1998, if your annuity is payable over your life and the lives of other individuals,
use the combined ages of you and the youngest survivor annuitant at the annuity starting date. However, if your annuity starting date began before
January 1, 1998, the total number of monthly annuity payments expected to be received is based on the primary annuitant's age at the annuity starting
date.
Be sure to keep a copy of the completed worksheet; it will help you figure your taxable annuity in later years.
Example.
Bill Smith, age 65, began receiving retirement benefits in 2005, under a joint and survivor annuity. Bill's annuity starting date is January 1,
2005. The benefits are to be paid for the joint lives of Bill and his wife Kathy, age 65. Bill had contributed $31,000 to a qualified plan and had
received no distributions before the annuity starting date. Bill is to receive a retirement benefit of $1,200 a month, and Kathy is to receive a
monthly survivor benefit of $600 upon Bill's death.
Bill must use the Simplified Method to figure his taxable annuity because his payments are from a qualified plan and he is under age 75. Because
his annuity is payable over the lives of more than one annuitant, he uses his and Kathy's combined ages and Table 2 at the bottom of the worksheet in
completing line 3 of the worksheet. His completed worksheet is shown in Worksheet 10-A.
Bill's tax-free monthly amount is $100 ($31,000 ÷ 310 as shown on line 4 of the worksheet). Upon Bill's death, if Bill 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 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.
Had Bill's retirement annuity payments been from a nonqualified plan, he would have used the General Rule. He uses the Simplified Method Worksheet
because his annuity payments are from a qualified plan.
<ROM>Worksheet 10-A.</ROM> Simplified Method Worksheet for Bill SmithAnnuities:Joint return:WorksheetJoint returns:Pensions or annuities:WorksheetWorksheets:Pensions or annuities, joint returns1.Enter the total pension or annuity payments received this year. Also, add this amount to the total for
Form 1040, line 16a, or Form 1040A, line 12a1.2.Enter your cost in the plan (contract) at the annuity starting date2.Note: If your annuity starting date wasbefore 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 below3.4.Divide line 2 by the number on line 34.5.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 65.6.Enter any amounts previously recovered tax free in years after 19866.7.Subtract line 6 from line 27.8.Enter the smaller of line 5 or line 78.9.Taxable amount for year. Subtract line 8 from line 1. Enter the result, but not less than zero.
Also, add this amount to the total for Form 1040, line 16b, or Form 1040A, line 12b.9.Note: If your Form 1099-R shows a larger taxable amount, use the amount on line 9
instead.10.Add lines 6 and 810.11.Balance of cost to be recovered. Subtract line 10 from line 211.
TABLE 1 FOR LINE 3 ABOVEAND your annuity starting date was—IF the age at annuity
starting date was...before November 19,
1996, enter on line 3...after November 18,
1996, enter on line 3...55 or under30036056–6026031061–6524026066–7017021071 or older120160TABLE 2 FOR LINE 3 ABOVEIF the combined ages
at annuity starting
date were... THEN enter
on line 3...110 or under410111–120360121–130310131–140260141 or older210
Taxation of Nonperiodic Payments
Nonperiodic distributions are also known as amounts not received as an annuity. They include all payments other than periodic payments and
corrective distributions.
Corrective distributions of excess plan contributions.
If the contributions made for you during the year to certain retirement plans exceed certain limits, the excess is taxable to you. To correct an
excess, your plan may distribute it to you (along with any income earned on the excess). For information on plan contribution limits and how to report
corrective distributions of excess contributions, see Retirement Plan Contributions under Employee Compensation in Publication
525.
Figuring the taxable amount of nonperiodic payments.
How you figure the taxable amount of a nonperiodic distribution depends on whether it is made before the annuity starting date or on or after the
annuity starting date. The annuity starting date is either the first day of the first period for which you receive an annuity payment under the
contract or the date on which the obligation under the contract becomes fixed, whichever is later. If it is made before the annuity starting date, its
tax treatment also depends on whether it is made under a qualified or nonqualified plan and, if it is made under a nonqualified plan, whether it fully
discharges the contract or is allocable to an investment you made before August 14, 1982.
If you receive a nonperiodic payment from your annuity contract on or after the annuity starting date, you generally must include all of the
payment in gross income.
If you receive a nonperiodic distribution before the annuity starting date from a qualified retirement plan, you generally can allocate only part
of it to the cost of the contract. You exclude from your gross income the part that you allocate to the cost. You include the remainder in your gross
income.
If you receive a nonperiodic distribution before the annuity starting date from a plan other than a qualified retirement plan, it is generally
allocated first to earnings (the taxable part) and then to the cost of the contract (the tax-free part). This allocation rule applies, for example, to
a commercial annuity contract you bought directly from the issuer.
For more information, see Figuring the Taxable Amount, under Taxation of Nonperiodic Payments, in Publication 575.
A lump-sum distribution is the distribution or payment in one tax year of a plan participant's entire balance from all of the employer's qualified
plans of one kind (for example, pension, profit-sharing, or stock bonus plans). A distribution from a nonqualified plan (such as a privately purchased
commercial annuity or a section 457 deferred compensation plan of a state or local government or tax-exempt organization) cannot qualify as a lump-sum
distribution.
The participant's entire balance from a plan does not include certain forfeited amounts. It also does not include any deductible voluntary employee
contributions allowed by the plan after 1981 and before 1987. For more information about distributions that do not qualify as lump-sum distributions,
see Distributions that do not qualify under Lump-Sum Distributions in Publication 575.
If you receive a lump-sum distribution from a qualified employee plan or qualified employee annuity and the plan participant was born before
January 2, 1936, you may be able to elect optional methods of figuring the tax on the distribution. The part from active participation in the plan
before 1974 may qualify as capital gain subject to a 20% tax rate. The part from participation after 1973 (and any part from participation before 1974
that you do not report as capital gain) is ordinary income. You may be able to use the 10-year tax option, discussed later, to figure tax on the
ordinary income part.
Form:4972:Lump-sum distributionsLump-sum distributions:Form 4972Use Form 4972 to figure the separate tax on a lump-sum distribution using the optional methods. The tax figured on
Form 4972 is added to the regular tax figured on your other income. This may result in a smaller tax than you would pay by including the taxable
amount of the distribution as ordinary income in figuring your regular tax.
How to treat the distribution.
If you receive a lump-sum distribution, you may have the following options for how you treat the taxable part.
Report the part of the distribution from participation before 1974 as a capital gain (if you qualify) and the part from participation after
1973 as ordinary income.
Report the part of the distribution from participation before 1974 as a capital gain (if you qualify) and use the 10-year tax option to
figure the tax on the part from participation after 1973 (if you qualify).
Use the 10-year tax option to figure the tax on the total taxable amount (if you qualify).
Roll over all or part of the distribution. See Rollovers, later. No tax is currently due on the part rolled over. Report any part
not rolled over as ordinary income.
Report the entire taxable part of the distribution as ordinary income on your tax return.
The first three options are explained in the following discussions.
Electing optional lump-sum treatment.Lump-sum distributions:Election of
You can choose to use the 10-year tax option or capital gain treatment only once after 1986 for any plan participant. If you make this choice, you
cannot use either of these optional treatments for any future distributions for the participant.
Taxable and tax-free parts of the distribution.DistributionsLump sumLump-sum distributionsLump-sum distributions:Taxable and tax-free parts
Lump-sum distributions:Net unrealized appreciation (NUA)The taxable part of a lump-sum distribution is the employer's contributions and income
earned on your account. You may recover your cost in the lump sum and any net unrealized appreciation (NUA) in employer securities tax free.
Cost.Lump-sum distributions:Cost calculation
In general, your cost is the total of:
The plan participant's nondeductible contributions to the plan,
The plan participant's taxable costs of any life insurance contract distributed,
Any employer contributions that were taxable to the plan participant, and
Repayments of any loans that were taxable to the plan participant.
You must reduce this cost by amounts previously distributed tax free.
Net unrealized appreciation (NUA).Lump-sum distributions:Net unrealized appreciation (NUA)
The NUA in employer securities (box 6 of Form 1099-R) received as part of a lump-sum distribution is generally tax free until you sell or exchange
the securities. (For more information, see Distributions of employer securities under Taxation of Nonperiodic Payments in
Publication 575.)
Capital Gain TreatmentCapital gains or losses:Lump-sum distributions from pensions and annuitiesLump-sum distributions:Capital gain treatment
Capital gain treatment applies only to the taxable part of a lump-sum distribution resulting from participation in the plan before 1974. The amount
treated as capital gain is taxed at a 20% rate. You can elect this treatment only once for any plan participant, and only if the plan participant was
born before January 2, 1936.
Complete Part II of Form 4972 to choose the 20% capital gain election. For more information, see Capital Gain Treatment under
Lump-Sum Distributions in Publication 575.
The 10-year tax option is a special formula used to figure a separate tax on the ordinary income part of a lump-sum distribution. You pay the tax
only once, for the year in which you receive the distribution, not over the next 10 years. You can elect this treatment only once for any plan
participant, and only if the plan participant was born before January 2, 1936.
The ordinary income part of the distribution is the amount shown in box 2a of the Form 1099-R given to you by the payer, minus the amount, if any,
shown in box 3. You also can treat the capital gain part of the distribution (box 3 of Form 1099-R) as ordinary income for the 10-year tax option if
you do not choose capital gain treatment for that part.
Complete Part III of Form 4972 to choose the 10-year tax option. You must use the special tax rates shown in the instructions for Part III to
figure the tax. Publication 575 illustrates how to complete Form 4972 to figure the separate tax.
If you withdraw cash or other assets from a qualified retirement plan in an eligible rollover distribution, you can defer tax on the distribution
by rolling it over to another qualified retirement plan or a traditional IRA.
For this purpose, the following plans are qualified retirement plans.
A qualified employee plan.
A qualified employee annuity.
Annuities:Rollovers
A tax-sheltered annuity plan (403(b) plan).
403(b) plans:Rollovers
An eligible state or local government section 457 deferred compensation plan.
Time for making rollover.
You generally must complete the rollover by the 60th day following the day on which you receive the distribution from your employer's plan. (This
60-day period is extended for the period during which the distribution is in a frozen deposit in a financial institution.) For all rollovers to an
IRA, you must irrevocably elect rollover treatment by written notice to the trustee or issuer of the IRA.
The IRS may waive the 60-day requirement where the failure to do so would be against equity or good conscience, such as in the event of a casualty,
disaster, or other event beyond your reasonable control.
Generally, an eligible rollover distribution is any distribution of all or the balance to your credit in a qualified retirement plan. For
information about exceptions to eligible rollover distributions, see Publication 575.
Rollover of nontaxable amounts.Rollovers:Nontaxable amounts
You may be able to roll over the nontaxable part of a distribution (such as your after-tax contributions) made to another qualified retirement plan
or traditional IRA. The transfer must be made either through a direct rollover to a qualified plan that separately accounts for the taxable and
nontaxable parts of the rollover or through a rollover to a traditional IRA.
If you roll over only part of a distribution that includes both taxable and nontaxable amounts, the amount you roll over is treated as coming first
from the taxable part of the distribution.
Direct rollover option.Rollovers:Direct rollovers
You can choose to have any part or all of an eligible rollover distribution paid directly to another qualified plan (if permitted) or to a
traditional IRA. If you decide on a rollover, it is generally to your advantage to choose this direct rollover option. Under this option, the plan
administrator would not withhold tax from any part of the distribution that is directly paid to the other plan.
Withholding tax.Pensions:WithholdingRetirement plans:WithholdingRollovers:Withholding taxWithholding:Pensions and annuitiesWithholding:Rollovers
If you choose to have all or any part of the distribution paid to you, it is taxable in the year distributed unless you roll it over to another
qualified plan or to a traditional IRA within 60 days. The plan administrator must withhold income tax of 20% from the amount of the distribution paid
to you. (See Pensions and Annuities under Withholding in chapter 4.)
If you decide to roll over an amount equal to the distribution before withholding, your contribution to the new plan or IRA must include other
money (for example, from savings or amounts borrowed) to replace the amount withheld.
The administrator must give you a written explanation of your distribution options within a reasonable period of time before making an eligible
rollover distribution.
Rollover by surviving spouse.Rollovers:Surviving spouseSpouseSurviving spouseSurviving spouse:Rollovers by
You may be able to roll over tax free all or part of a distribution from a qualified retirement plan you receive as the surviving spouse of a
deceased employee. The rollover rules apply to you as if you were the employee. You can roll over a distribution into a qualified retirement plan or a
traditional IRA.
BeneficiariesTrust beneficiariesEstate beneficiaries:Rollover restrictionsRollovers:Beneficiaries, restrictionsTrust beneficiaries:Rollover restrictionsA beneficiary other than the employee's surviving spouse cannot roll over a distribution.
Alternate payee under qualified domestic relations order.Domestic relations orders, qualified (QDROs):Rollover of retirement plan distributionQualified domestic relations orders (QDROs):Rollover of retirement plan distributionRollovers:Qualified domestic relations orders for distribution of retirement plan funds
You may be able to roll over tax free all or part of a distribution from a qualified retirement plan that you receive under a qualified domestic
relations order (QDRO). If you receive the distribution as an employee's spouse or former spouse (not as a nonspousal beneficiary), the rollover rules
apply to you as if you were the employee. You can roll over the distribution from the plan into a traditional IRA or to another eligible retirement
plan. See Publication 575 for more information on benefits received under a QDRO.
Retirement bonds.Bonds:Retirement ofRetirement of bonds:Rollover of amount redeemedRollovers:Retirement bond redemption
If you redeem a retirement bond purchased under a qualified bond purchase plan, you can defer the tax on the amount received that exceeds your
basis by rolling it over to an IRA or qualified employer plan as discussed in Publication 590.
Special Additional TaxesDistributionsEarlyEarly withdrawal from deferred interest accountEarly withdrawal from deferred interest account:Tax onPensions:Early distributions:Tax onRetirement plans:Early distributions:Tax onRetirement plans:Excess accumulation, tax on10% tax for early withdrawal from IRA or retirement planEarly withdrawal from deferred interest account, subheading: Tax on
To discourage the use of pension funds for purposes other than normal retirement, the law imposes additional taxes on early distributions of those
funds and on failures to withdraw the funds timely. Ordinarily, you will not be subject to these taxes if you roll over all early distributions you
receive, as explained earlier, and begin drawing out the funds at a normal retirement age, in reasonable amounts over your life expectancy. These
special additional taxes are the taxes on:
Pensions:Excess accumulation, tax onRetirement plans:Excess accumulation, tax onThese taxes are discussed in the following sections.
Early withdrawal from deferred interest accountForm 1099-R reportingForm 1099-REarly withdrawal from deferred interest accountForm 5329 reportingForm 5329Form:1099-R:Early distributions of pension fundsForm:5329:Early distributions of sheltered fundsIf you must pay either of these taxes, report them on Form 5329. However, you do
not have to file Form 5329 if you owe only the tax on early distributions and your Form 1099-R correctly shows a 1 in box 7. Instead, enter 10%
of the taxable part of the distribution on Form 1040, line 60 and write No under the heading Other Taxes to the left of line 60.
Early withdrawal from deferred interest accountForm 1099-R reportingForm 1099-RForm:1099-R:Early distributions of pension fundsEven if you do not owe any of these taxes, you may have to complete Form 5329 and
attach it to your Form 1040. This applies if you meet an exception to the tax on early distributions but box 7 of your Form 1099-R does not indicate
an exception.
Tax on Early DistributionsDistributionsEarlyEarly withdrawal from deferred interest accountEarly withdrawal from deferred interest account:Tax onPensions:Early distributions:Tax onRetirement plans:Early distributions:Tax on
Most distributions (both periodic and nonperiodic) from qualified retirement plans and nonqualified annuity contracts made to you before you reach
age 59 are subject to an additional tax of 10%. This tax applies to the part of the distribution that you must include in gross
income.
For this purpose, a qualified retirement plan is:
A qualified employee plan,
Pensions:Definition ofRetirement plans:Definition of
A qualified employee annuity plan,
A tax-sheltered annuity plan, or
Annuities:Early distributions fromDistributionsEarlyEarly withdrawal from deferred interest accountEarly withdrawal from deferred interest account:Annuities
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).
Early withdrawal from deferred interest account:Section 457 deferred compensation plansSection 457 deferred compensation plans:Early distributions from
5% rate on certain early distributions from deferred annuity contracts.Annuities:Early distributions from:Deferred annuity contractsDeferred annuity contractsAnnuities
If an early withdrawal from a deferred annuity is otherwise subject to the 10% additional tax, a 5% rate may apply instead. A 5% rate applies to
distributions under a written election providing a specific schedule for the distribution of your interest in the contract if, as of March 1, 1986,
you had begun receiving payments under the election. On line 4 of Form 5329, multiply by 5% instead of 10%. Attach an explanation to your return.
Exceptions to tax.Pensions:Early distributions:Exceptions to tax onRetirement plans:Early distributions:Exceptions to tax on
Early withdrawal from deferred interest accountForm 1099-R reportingForm 1099-REarly withdrawal from deferred interest accountForm 5329 reportingForm 5329Form:1099-R:Early distributions of pension fundsForm:5329:Early distributions of sheltered fundsCertain early distributions are excepted from the early distribution tax. If the
payer knows that an exception applies to your early distribution, distribution code 2,3, or 4 should be shown in box 7 of your
Form 1099-R and you do not have to report the distribution on Form 5329. If an exception applies but distribution code 1 (early distribution,
no known exception) is shown in box 7, you must file Form 5329. Enter the taxable amount of the distribution shown in box 2a of your Form 1099-R on
line 1 of Form 5329. On line 2, enter the amount that can be excluded and the exception number shown in the Form 5329 instructions.
Early withdrawal from deferred interest accountForm 1099-R reportingForm 1099-REarly withdrawal from deferred interest accountForm 5329 reportingForm 5329Form:1099-R:Early distributions of pension fundsForm:5329:Early distributions of sheltered fundsIf distribution code 1 is incorrectly shown on your Form 1099-R for a
distribution received when you were age 59 or older, include that distribution on Form 5329. Enter exception number 11 on line
2.
General exceptions.
The tax does not apply to distributions that are:
Made as part of a series of substantially equal periodic payments (made at least annually) for your life (or life expectancy) or the joint
lives (or joint life expectancies) of you and your designated beneficiary (if from a qualified retirement plan, the payments must begin after your
separation from service),
Made because you are totally and permanently disabled, or
Made on or after the death of the plan participant or contract holder.
Additional exceptions for qualified retirement plans.Pensions:Early distributions:Exceptions to tax onPensions:Early distributions:Qualified retirement plans, exceptions forRetirement plans:Early distributions:Exceptions to tax on
The tax does not apply to distributions that are:
From a qualified retirement plan (other than an IRA) if you separated from service in or after the year you reached age 55,
From a qualified retirement plan (other than an IRA) to an alternate payee under a qualified domestic relations order,
From a qualified retirement plan to the extent you have deductible medical expenses (medical expenses that exceed 7.5% of your adjusted
gross income), whether or not you itemize your deductions for the year,
From an employer plan under a written election that provides a specific schedule for distribution of your entire interest if, as of March 1,
1986, you had separated from service and had begun receiving payments under the election,
From an employee stock ownership plan for dividends on employer securities held by the plan, or
From a qualified retirement plan due to an IRS levy of the plan.
From a deferred annuity contract to the extent allocable to investment in the contract before August 14, 1982,
From a deferred annuity contract under a qualified personal injury settlement,
From a deferred annuity contract purchased by your employer upon termination of a qualified employee plan or qualified employee annuity plan
and held by your employer until your separation from service, or
From an immediate annuity contract (a single premium contract providing substantially equal annuity payments that start within one year from
the date of purchase and are paid at least annually).
Tax on Excess AccumulationsPensions:Excess accumulation, tax onRetirement plans:Excess accumulation, tax on
To make sure that most of your retirement benefits are paid to you during your lifetime, rather than to your beneficiaries after your death, the
payments that you receive from qualified retirement plans must begin no later than your required beginning date (defined next). The payments each year
cannot be less than the minimum required distribution.
Required beginning date.
Unless the rule for 5% owners applies, you must begin to receive distributions from your qualified retirement plan by April 1 of the year that
follows the later of:
The calendar year in which you reach age 70, or
The calendar year in which you retire from employment with the employer maintaining the plan.
However, your plan may require you to begin to receive distributions by April 1 of the year that follows the year in which you reach age 70, even if you have not retired.
For this purpose, a qualified retirement plan includes a:
Qualified employee plan,
Pensions:Definition ofRetirement plans:Definition of
Qualified employee annuity plan,
Section 457 deferred compensation plan, orLocal government employeesSection 457 plans for employeesSection 457 deferred compensation plansPensions457 plansSection 457 deferred compensation plansPensionsState and local government employeesSection 457 deferred compensation plansRetirement plans457 plansSection 457 deferred compensation plansRetirement plansState and local government employeesSection 457 deferred compensation plansSection 457 deferred compensation plans:Required distributionsState or local governmentsEmployeesSection 457 plans forSection 457 deferred compensation plans
Tax-sheltered annuity plan (for benefits accruing after 1986).
Age 70.Age:Pension distributions required at age 70Pensions:Required distributions:At age 70Retirement plans:Required distributions:At age 70
You reach age 70 on the date that is 6 calendar months after the date of your 70th birthday.
For example, if you are retired and your 70th birthday was on June 30, 2005, you were age 70 on December 30, 2005. If your 70th
birthday was on July 1, 2005, you reached age 70 on January 1, 2006.
5% owners.
If you are a 5% owner of the company maintaining your qualified retirement plan, you must begin to receive distributions by April 1 of the calendar
year that follows the year in which you reach age 70, regardless of when you retire.
By the required beginning date, as explained earlier, you must either:
Receive your entire interest in the plan (for a tax-sheltered annuity, your entire benefit accruing after 1986), or
Begin receiving periodic distributions in annual amounts calculated to distribute your entire interest (for a tax-sheltered annuity, your
entire benefit accruing after 1986) over your life or life expectancy or over the joint lives or joint life expectancies of you and a designated
beneficiary (or over a shorter period).
Additional information.
For more information on this rule, see Tax on Excess Accumulation in Publication 575.
Required distributions not made.Pensions:Required distributions:Excise tax for failure to take minimum distributionsRetirement plans:Required distributions:Excise tax for failure to take minimum distributions
If the actual distributions to you in any year are less than the minimum required distribution, you are subject to an additional excise tax. The
tax equals 50% of the part of the minimum required distribution that was not distributed. You can get this excise tax waived if you establish that the
shortfall in distributions was due to reasonable error and that you are taking reasonable steps to remedy the shortfall.
You might not receive the minimum distribution because of state insurer delinquency proceedings for an insurance company. If your payments are
reduced below the minimum due to these proceedings, you should contact your plan administrator. Under certain conditions, you will not have to pay the
excise tax.
Form 5329.Form:5329:Required minimum distributions, failure to takePensions:Required distributions:Form 5329 for failure to receive required minimum,Retirement plans:Required distributions:Form 5329 for failure to receive required minimum retirement plan distributions
You must file a Form 5329 if you owe a tax because you did not receive a minimum required distribution from your qualified retirement plan.
If you receive a survivor annuity because of the death of a retiree who had reported the annuity under the Three-Year Rule, include the total
received in income.
Annuities:General Rule:Survivor's annuityIf the retiree was reporting the annuity payments under the General Rule, you must apply the same
exclusion percentage to your initial survivor annuity payment called for in the contract. The resulting tax-free amount will then remain fixed for
future payments. Any increases in the survivor annuity are fully taxable.
Annuities:Simplified method to calculate tax-free part of annuity payment:Survivor's annuityIf the retiree was reporting the annuity payments under the Simplified Method, the part of each
payment that is tax free is the same as the tax-free amount figured by the retiree at the annuity starting date. See Simplified Method,
earlier.
If you are the survivor of an employee, or former employee, who died before becoming entitled to any annuity payments, you must figure the taxable
and tax-free parts of your annuity payments using the method that applies as if you were the employee.
Estate tax.EstatesTaxSurvivor's annuity
If your annuity was a joint and survivor annuity that was included in the decedent's estate, an estate tax may have been paid on it. You can
deduct, as a miscellaneous itemized deduction, the part of the total estate tax that was based on the annuity. This deduction is not subject to the
2%-of-adjusted gross-income limit. The deceased annuitant must have died after the annuity starting date. (For details, see section 1.691(d)-1 of the
regulations.) This amount cannot be deducted in one year. It must be deducted in equal amounts over your remaining life expectancy.
If the decedent died before the annuity starting date of a deferred annuity contract and you receive a death benefit under that contract, the
amount you receive (either in a lump sum or as periodic payments) in excess of the decedent's cost is included in your gross income as income in
respect of a decedent for which you may be able to claim an estate tax deduction.
See Publication 559, Survivors, Executors, and Administrators, for more information on the estate tax deduction.
This chapter explains the federal income tax rules for social security benefits and equivalent tier 1 railroad retirement benefits. It explains:
How to figure whether your benefits are taxable,
How to use the social security benefits worksheet (with examples),
How to report your taxable benefits, and
How to treat repayments that are more than the benefits you received during the year.
Social security benefits include monthly survivor and disability benefits. They do not include supplemental security income (SSI) payments, which
are not taxable.
Railroad retirement benefits:Equivalent tier 1 (social security equivalent benefit (SSEB))Equivalent tier 1 railroad retirement benefits are the part of
tier 1 benefits that a railroad employee or beneficiary would have been entitled to receive under the social security system. They are commonly called
the social security equivalent benefit (SSEB) portion of tier 1 benefits.
Form:RRB-1042S:Railroad retirement benefits for nonresident aliensForm:RRB-1099:Railroad retirement benefitsForm:SSA-1042S:Social security benefits for nonresident aliensForm:SSA-1099:Social security benefitsRailroad retirement benefits:Form RRB-1099Social security benefits:Form SSA-1042S for nonresident aliensSocial security benefits:Form SSA-1099
If you received these benefits during 2005, you should have received a Form SSA-1099, Social Security Benefit Statement, or Form RRB-1099, Payments
by the Railroad Retirement Board, (Form SSA-1042S, Social Security Benefit Statement, or Form RRB-1042S Statement for Nonresident Alien Recipients of:
Payments by the Railroad Retirement Board, if you are a nonresident alien). These forms show the amounts received and repaid, and taxes withheld for
the year. You may receive more than one of these forms for the same year. You should add the amounts shown on all forms you receive for the year to
determine the total amounts received and repaid, and taxes withheld for that year. See the Appendix at the end of Publication 915
for more information.
Note.
When the term benefits is used in this chapter, it applies to both social security benefits and the SSEB portion of tier 1 railroad
retirement benefits.
What is not covered in this chapter.
This chapter does not cover the tax rules for the following railroad retirement benefits:
Non-social security equivalent benefit (NSSEB) portion of tier 1 benefits,
Tier 2 benefits,
Vested dual benefits, and
Supplemental annuity benefits.
For information on these benefits, see Publication 575, Pension and Annuity Income.
This chapter also does not cover the tax rules for foreign social security benefits. These benefits are taxable as annuities, unless they are
exempt from U.S. tax or treated as a U.S. social security benefit under a tax treaty.
Publication575 Pension and Annuity Income590 Individual Retirement Arrangements (IRAs) 915 Social Security and Equivalent Railroad Retirement BenefitsForms (and Instructions)Estimated Tax for IndividualsVoluntary Withholding Request
Are Any of Your Benefits Taxable?Railroad retirement benefits:Taxability ofSocial security benefits:Taxability of
To find out whether any of your benefits may be taxable, compare the base amount for your filing status 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, or
Income earned by bona fide residents of American Samoa or Puerto Rico.
Figuring total income.
To figure the total of one-half of your benefits plus your other income, use the worksheet later in this discussion. If the total is more than your
base amount, part of your benefits may be taxable.
Married taxpayers:Social security or railroad retirement benefits, taxabilityIf you are married and file a joint return for 2005, 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.
If the only income you received during 2005 was your social security or the SSEB portion of tier 1 railroad retirement benefits, your benefits
generally are not taxable and you probably do not have to file a return. If you have income in addition to your benefits, you may have to file a
return even if none of your benefits are taxable.
Base amount.
Your base amount is:
$25,000 if you are single, head of household, or qualifying widow(er),
$25,000 if you are married filing separately and lived apart from your spouse for all of 2005,
$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 2005.
Worksheet.Figuring taxes and creditsWorksheetsWorksheets:Social security or railroad retirement benefits, to figure taxabilityFiguring taxes and creditsWorksheetsWorksheets:Social security or railroad retirement benefits, to figure taxability You can use the following worksheet to figure the
amount of income to compare with your base amount. This is a quick way to check whether some of your benefits may be taxable.
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 2005, for 2005 and earlier years. (If you received more than one form, combine the amounts from box 5 and
enter the total.) A. Note. If the amount on line A is zero or less, stop here; none of your benefits are
taxable this year.B. Enter one-half of 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
(listed earlier). D. E.Add lines B, C, and D E.Note. Compare the amount on line E to your base amount for your filing status.
If the amount on line E equals or is less than the base amount for your filing status, none of your benefits are taxable this year. If the
amount on line E is more than your base amount, some of your benefits may be taxable. You need to complete Worksheet 1 in
Publication 915 (or the Social Security Benefits Worksheet in your tax form instruction booklet).
Example.
You and your spouse (both over 65) are filing a joint return for 2005, and you both received social security benefits during the year. In January
2006, you received a Form SSA-1099 showing net benefits of $7,500 in box 5. Your spouse received a Form SSA-1099 showing net benefits of $3,500 in box
5. You also received a taxable pension of $19,000 and interest income of $500. You did not have any tax-exempt interest income. Your benefits are not
taxable for 2005 because your income, as figured in the following worksheet, is not more than your base amount ($32,000) for married filing jointly.
Even though none of your benefits are taxable, you must file a return for 2005 because your taxable gross income ($19,500) exceeds the minimum
filing requirement amount for your filing status.
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 2005, for 2005 and earlier years. (If you received more than one form, combine the amounts from box 5 and
enter the total.) A. $ 11,000Note. 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. 5,500C. Enter your taxable pensions, wages, interest, dividends, and other taxable income C. 19,500D. Enter any tax-exempt interest income (such as interest on municipal bonds) plus any exclusions from income
(listed earlier).D. -0-E. Add lines B, C, and D E.$25,000Note. Compare the amount on line E to your base amount for your filing status.
If the amount on line E equals or is less than the base amount for your filing status, none of your benefits are taxable this year. If the
amount on line E is more than your base amount, some of your benefits may be taxable. You then need to complete Worksheet 1 in
Publication 915 (or the Social Security Benefits Worksheet in your tax form instruction booklet).
Who is taxed.
The person who has the legal right to receive the benefits must determine whether the benefits are taxable. For example, if you and your child
receive benefits, but the check for your child is made out in your name, you must use only your part of the benefits to see whether any benefits are
taxable to you. One-half of the part that belongs to your child must be added to your child's other income to see whether any of those benefits are
taxable to your child.
Repayment of benefits.Railroad retirement benefits:Repayment of benefitsRepayments:Social security benefitsSocial security benefits:Repayment of benefits
Any repayment of benefits you made during 2005 must be subtracted from the gross benefits you received in 2005. It does not matter whether the
repayment was for a benefit you received in 2005 or in an earlier year. If you repaid more than the gross benefits you received in 2005, see
Repayments More Than Gross Benefits, later.
Your gross benefits are shown in box 3 of Form SSA-1099 or RRB-1099. Your repayments are shown in box 4. The amount in box 5 shows your net
benefits for 2005 (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 benefits and/or the SSEB portion of your tier 1 railroad retirement
benefits. If you choose to do this, you must complete a Form W-4V. 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, get Publication 505, Tax Withholding and Estimated Tax, or the instructions for Form 1040-ES.
How To Report
Your BenefitsRailroad retirement benefits:Reporting ofSocial security benefits:Reporting of
If part of your benefits are taxable, you must use Form 1040 or Form 1040A. You cannot use Form 1040EZ.
Reporting on Form 1040.Form:1040:Railroad retirement benefits, reporting onForm:1040:Social security benefits, reporting on
Report your net benefits (the amount in box 5 of your Form SSA-1099 or Form RRB-1099) on line 20a and the taxable part on line 20b. If you are
married filing separately and you lived apart from your spouse for all of 2005, also enter D to the right of the word benefits on line
20a.
Reporting on Form 1040A.Form:1040A:Railroad retirement benefits, reporting onForm:1040A:Social security benefits, reporting on
Report your net benefits (the amount in box 5 of your Form SSA-1099 or Form RRB-1099) on line 14a and the taxable part on line 14b. If you are
married filing separately and you lived apart from your spouse for all of 2005, also enter D to the right of the word benefits on line
14a.
Benefits not taxable.Married filing separately:Social security and railroad retirement benefitsRailroad retirement benefits:Married filing separatelySocial security benefits:Married filing separately
If none of your benefits are taxable, do not report any of them on your tax return. But if you are married filing separately and you lived apart
from your spouse for all of 2005, make the following entries. On Form 1040, enter D to the right of the word benefits on line 20a and
-0- on line 20b. On Form 1040A, enter D to the right of the word benefits on line 14a and -0- on line 14b.
How Much Is Taxable?Railroad retirement benefits:Taxability ofSocial security benefits:Taxability of
If part of your benefits are taxable, how much is taxable depends on the total amount of your benefits and other income. Generally, the higher that
total amount, the greater the taxable part of your benefits.
Maximum taxable part.
Generally, up to 50% of your benefits will be taxable. However, up to 85% of your benefits can be taxable if either of the following situations
applies to you.
The total of one-half of your benefits and all your other income is more than $34,000 ($44,000 if you are married filing
jointly).
You are married filing separately and lived with your spouse at any time during 2005.
Which worksheet to use.Worksheets:Social security or railroad retirement benefits, to figure taxability
A worksheet to figure your taxable benefits is in the instructions for your Form 1040 or Form 1040A. You can use either that worksheet or Worksheet
1 in Publication 915, unless any of the following situations applies to you.
You contributed to a traditional individual retirement arrangement (IRA) and you or your spouse is covered by a retirement plan at work. In
this situation, you must use the special worksheets in Appendix B of Publication 590 to figure both your IRA deduction and your taxable
benefits.
Situation (1) does not apply and you take an exclusion for interest from qualified U.S. savings bonds (Form 8815), for adoption benefits
(Form 8839), for foreign earned income or housing (Form 2555 or Form 2555-EZ), or for income earned in American Samoa (Form 4563) or Puerto Rico by
bona fide residents. In this situation, you must use Worksheet 1 in Publication 915 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.
You must include the taxable part of a lump-sum (retroactive) payment of benefits received in 2005 in your 2005 income, even if the payment
includes benefits for an earlier year.
This type of lump-sum benefit payment should not be confused with the lump-sum death benefit that both the SSA and RRB pay to many of their
beneficiaries. No part of the lump-sum death benefit is subject to tax.
Generally, you use your 2005 income to figure the taxable part of the total benefits received in 2005. However, you may be able to figure the
taxable part of a lump-sum payment for an earlier year separately, using your income for the earlier year. You can elect this method if it lowers your
taxable benefits.
Making the election.
If you received a lump-sum benefit payment in 2005 that includes benefits for one or more earlier years, follow the instructions in Publication 915
under Lump-Sum Election to see whether making the election will lower your taxable benefits. That discussion also explains how to make the
election.
Because the earlier year's taxable benefits are included in your 2005 income, no adjustment is made to the earlier year's return. Do not file an
amended return for the earlier year.
Examples
The following are a few examples you can use as a guide to figure the taxable part of your benefits.
Example 1.
George White is single and files Form 1040 for 2005. He received the following income in 2005:
Fully taxable pension $18,600 Wages from part-time job 9,400 Taxable interest income 990 Total $28,990
George also received social security benefits during 2005. The Form SSA-1099 he received in January 2006 shows $5,980 in box 5. To figure his
taxable benefits, George completes the worksheet shown here.
Worksheet 1.
<L> Figuring Your Taxable Benefits1.Enter the total amount from box 5 of ALL your Forms SSA-1099 and RRB-1099$5,980Note. If line 1 is zero or less, stop here; none of your benefits are taxable. Otherwise,
go to line 2.2.Enter one-half of line 12,9903.Enter the total of the amounts from:Form 1040: Lines 7, 8a, 8b, 9a, 10 through 14, 15b, 16b, 17 through 19, and 21.Form 1040A: Lines 7, 8a, 8b, 9a, 10, 11b, 12b, and 1328,9904.Form 1040 filers: Enter the total of any exclusions/adjustments for:• Qualified U.S. savings bond
interest (Form 8815, line 14),• Adoption benefits (Form 8839, line
30),• Foreign earned income or housing
(Form 2555, lines 43 and 48, or
Form 2555-EZ, line 18), and• Certain income of bona fide
residents of American
Samoa (Form 4563, line 15)
or Puerto RicoForm 1040A filers: Enter the total of any exclusions for qualified U.S. savings bond interest ( Form 8815,
line 14) or for adoption benefits ( Form 8839, line 30).-0-5.Add lines 2, 3, and 431,9806.Form 1040 filers: Enter the amount from Form 1040, line 36, minus any amounts on Form 1040,
lines 33, 34, and 35Form 1040A filers: Enter the amount from Form 1040A, line 20, minus any amounts on Form 1040A, lines 18 and 19.-0-7.Is the amount on line 6 less than the amount on line 5? No. None of your social security benefits are taxable.Yes. Subtract line 6 from line 531,9808.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
2005, enter $25,000.
25,000Note. If you are married filing separately and you lived with your spouse at any time in 2005, skip lines 8 through 15; multiply
line 7 by 85% (.85) and enter the result on line 16. Then go to line 17. 9.Is the amount on line 8 less than the amount on line 7? No. None of your benefits are taxable. Do not enter any amounts on Form 1040, line 20a or 20b, or on
Form 1040A, line 14a or 14b. But if you are married filing separately and you lived apart from your spouse for all of 2005, enter -0- on
Form 1040, line 20b, or on Form 1040A, line 14b.Yes. Subtract line 8 from line 76,98010.Enter $12,000 if married filing jointly; $9,000 if single, head of household, qualifying widow(er), or
married filing separately and you lived apart from your spouse for all of 20059,00011.Subtract line 10 from line 9. If zero or less, enter -0--0- 12.Enter the smaller of line 9 or line 106,98013.Enter one-half of line 123,49014.Enter the smaller of line 2 or line 132,99015.Multiply line 11 by 85% (.85). If line 11 is zero, enter -0--0- 16.Add lines 14 and 152,99017.Multiply line 1 by 85% (.85)5,083 18.Taxable benefits. Enter the smaller of line 16 or line 17 $2,990• Enter the amount from line 1 above
on Form 1040, line 20a or on
Form 1040A, line 14a. • Enter the amount from line 18 above
on Form 1040, line 20b or on
Form 1040A, line 14b.
The amount on line 18 of George's worksheet shows that $2,990 of his social security benefits is taxable. On line 20a of his Form 1040, George
enters his net benefits of $5,980. On line 20b, he enters his taxable benefits of $2,990.
Example 2.
Ray and Alice Hopkins file a joint return on Form 1040A for 2005. Ray is retired and received a fully taxable pension of $15,500. He also received
social security benefits, and his Form SSA-1099 for 2004 shows net benefits of $5,600 in box 5. Alice worked during the year and had wages of $14,000.
She made a deductible payment to her IRA account of $1,000. Ray and Alice have two savings accounts with a total of $250 in interest income. They
complete Worksheet 1 and find that none of Ray's social security benefits are taxable. They leave lines 14a and 14b of their Form 1040A blank.
Worksheet 1.
<L>Figuring Your Taxable Benefits1.Enter the total amount from box 5 of ALL your Forms SSA-1099 and RRB-1099 $5,600Note. If line 1 is zero or less, stop here; none of your benefits are taxable. Otherwise,
go to line 2. 2.Enter one-half of line 1 2,8003.Enter the total of the amounts from:Form 1040: Lines 7, 8a, 8b, 9a, 10 through 14, 15b, 16b, 17 through 19, and 21.Form 1040A: Lines 7, 8a, 8b, 9a, 10, 11b, 12b, and 1329,7504.Form 1040 filers: Enter the total of any exclusions/adjustments for:• Qualified U.S. savings bond
interest (Form 8815, line 14),• Adoption benefits (Form 8839, line
30),• Foreign earned income or housing
(Form 2555, lines 43 and 48, or
Form 2555-EZ, line 18), and• Certain income of bona fide
residents of American
Samoa (Form 4563, line 15)
or Puerto RicoForm 1040A filers: Enter the total of any exclusion for qualified U.S. savings bond interest (Form 8815, line 14) or
for adoption benefits ( Form 8839, line 30).-0-5.Add lines 2, 3, and 4 32,5506.Form 1040 filers: Enter the amount from Form 1040, line 36, minus any amounts on Form 1040, lines 33,
34, and 35Form 1040A filers: Enter the amount from Form 1040A, line 20, minus any amounts on Form 1040A, lines 18 and 19.1,0007.Is the amount on line 6 less than the amount on line 5? No. None of your benefits are taxable.Yes. Subtract line 6 from line 531,5508.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
2005, enter $25,000.
32,000Note. If you are married filing separately and you lived with your spouse at any time in 2005, skip lines 8 through 15; multiply
line 7 by 85% (.85) and enter the result on line 16. Then go to line 17. 9.Is the amount on line 8 less than the amount on line 7? No. None of your benefits are taxable. Do not enter any amounts on Form 1040, line 20a or 20b, or on
Form 1040A, line 14a or 14b. But if you are married filing separately and you lived apart from your spouse for all of 2005, enter -0- on
Form 1040, line 20b, or on Form 1040A, line 14b.Yes. Subtract line 8 from line 710.Enter $12,000 if married filing jointly; $9,000 if single, head of household, qualifying widow(er), or
married filing separately and you lived apart from your spouse for all of 200511.Subtract line 10 from line 9. If zero or less, enter -0- 12.Enter the smaller of line 9 or line 10 13.Enter one-half of line 1214.Enter the smaller of line 2 or line 13 15.Multiply line 11 by 85% (.85). If line 11 is zero, enter -0-16.Add lines 14 and 1517.Multiply line 1 by 85% (.85)18.Taxable benefits. Enter the smaller of line 16 or line 17• Enter the amount from line 1 above
on Form 1040, line 20a or on
Form 1040A, line 14a. • Enter the amount from line 18 above
on Form 1040, line 20b or on
Form 1040A, line 14b.
Example 3.
Joe and Betty Johnson file a joint return on Form 1040 for 2005. Joe is a retired railroad worker and in 2005 received the social security
equivalent benefit (SSEB) portion of tier 1 railroad retirement benefits. Joe's Form RRB-1099 shows $10,000 in box 5. Betty is a retired government
worker and receives a fully taxable pension of $38,000. They had $2,300 in interest income plus interest of $200 on a qualified U.S. savings bond. The
savings bond interest qualified for the exclusion. Thus, they have a total income of $40,300 ($38,000 + $2,300). They figure their taxable benefits by
completing Worksheet 1.
Worksheet 1.
<L>Figuring Your Taxable Benefits1.Enter the total amount from box 5 of ALL your Forms SSA-1099 and RRB-1099 $10,000Note. If line 1 is zero or less, stop here; none of your benefits are taxable. Otherwise,
go to line 2. 2.Enter one-half of line 1 5,0003.Enter the total of the amounts from:Form 1040: Lines 7, 8a, 8b, 9a, 10 through 14, 15b, 16b, 17 through 19, and 21.Form 1040A: Lines 7, 8a, 8b, 9a, 10, 11b, 12b, and 1340,3004.Form 1040 filers: Enter the total of any exclusions/adjustments for:• Qualified U.S. savings bond
interest (Form 8815, line 14),• Adoption benefits (Form 8839, line
30),• Foreign earned income or housing
(Form 2555, lines 43 and 48, or
Form 2555-EZ, line 18), and• Certain income of bona fide
residents of American
Samoa (Form 4563, line 15)
or Puerto RicoForm 1040A filers: Enter the total of any exclusions for qualified U.S. savings bond interest (Form 8815,
line 14) or for adoption benefits (Form 8839, line 30).2005.Add lines 2, 3, and 4 45,5006.Form 1040 filers: Enter the amount from Form 1040, line 36, minus any amounts on Form 1040, lines 33,
34, and 35Form 1040A filers: Enter the amount from Form 1040A, line 20, minus any amounts on Form 1040A,
lines 18 and 19.-0-7.Is the amount on line 6 less than the amount on line 5? No. None of your benefits are taxable.Yes. Subtract line 6 from line 545,5008. . 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
2005, enter $25,000
32,000Note. If you are married filing separately and you lived with your spouse at any time in 2005, skip lines 8 through 15;
multiply line 7 by 85% (.85) and enter the result on line 16. Then go to line 179.Is the amount on line 8 less than the amount on line 7? No. None of your benefits are taxable. Do not enter any amounts on Form 1040, line 20a or 20b, or on
Form 1040A, line 14a or 14b. But if you are married filing separately and you lived apart from your spouse for all of 2005, enter -0- on Form 1040,
line 20b, or on Form 1040A, line 14b.Yes. Subtract line 8 from line 713,50010.Enter $12,000 if married filing jointly; $9,000 if single, head of household, qualifying widow(er), or
married filing separately and you lived apart from your spouse for all of 200512,00011.Subtract line 10 from line 9. If zero or less, enter -0- 1,50012.Enter the smaller of line 9 or line 10 12,00013.Enter one-half of line 126,00014.Enter the smaller of line 2 or line 135,00015.Multiply line 11 by 85% (.85). If line 11 is zero, enter -0-1,27516.Add lines 14 and 156,27517.Multiply line 1 by 85% (.85)8,50018.Taxable benefits. Enter the smaller of line 16 or line 17$6,275• Enter the amount from line 1 above
on Form 1040, line 20a or on
Form 1040A, line 14a. • Enter the amount from line 18 above
on Form 1040, line 20b or on
Form 1040A, line 14b.
More than 50% of Joe's net benefits are taxable because the income on line 7 of the worksheet ($45,500) is more than $44,000. Joe and Betty enter
$10,000 on Form 1040, line 20a, and $6,275 on Form 1040, line 20b.
Deductions Related to Your BenefitsDeductions:Social security and railroad retirement benefitsRailroad retirement benefits:Deductions related toSocial security benefits:Deductions related to
You may be entitled to deduct certain amounts related to the benefits you receive.
Disability payments.Disabilities, persons with:Social security and railroad retirement benefits, deductions for
You may have received disability payments from your employer or an insurance company that you included as income on your tax return in an earlier
year. If you received a lump-sum payment from SSA or RRB, and you had to repay the employer or insurance company for the disability payments, you can
take an itemized deduction for the part of the payments you included in gross income in the earlier year. If the amount you repay is more than $3,000,
you may be able to claim a tax credit instead. Claim the deduction or credit in the same way explained under Repayments More Than Gross Benefits,
later.
Legal expenses.Attorneys' fees:Social security and railroad retirement benefits, deductions for
You can usually deduct legal expenses that you pay or incur to produce or collect taxable income or in connection with the determination,
collection, or refund of any tax.
Legal expenses for collecting the taxable part of your benefits are deductible as a miscellaneous itemized deduction on Schedule A (Form 1040),
line 22.
Repayments More Than Gross Benefits
In some situations, your Form SSA-1099 or Form RRB-1099 will show that the total benefits you repaid (box 4) are more than the gross benefits (box
3) you received. If this occurred, your net benefits in box 5 will be a negative figure (a figure in parentheses) and none of your benefits will be
taxable. If you receive more than one form, a negative figure in box 5 of one form is used to offset a positive figure in box 5 of another form for
that same year.
If you have any questions about this negative figure, contact your local SSA office or your local RRB field office.
If you and your spouse file a joint return, and your Form SSA-1099 or RRB-1099 has a negative figure in box 5, but your spouse's does not, subtract
the amount in box 5 of your form from the amount in box 5 of your spouse's form. You do this to get your net benefits when figuring if your combined
benefits are taxable.
Example.
John and Mary file a joint return for 2005. John received Form SSA-1099 showing $3,000 in box 5. Mary also received Form SSA-1099 and the amount in
box 5 was ($500). John and Mary will use $2,500 ($3,000 minus $500) as the amount of their net benefits when figuring if any of their combined
benefits are taxable.
Repayment of benefits received in an earlier year.
If the total amount shown in box 5 of all of your Forms SSA-1099 and RRB-1099 is a negative figure, you can take an itemized deduction for the part
of this negative figure that represents benefits you included in gross income in an earlier year.
Deduction $3,000 or less.
If this deduction is $3,000 or less, it is subject to the 2%-of-adjusted-gross-income limit that applies to certain miscellaneous itemized
deductions. Claim it on Schedule A (Form 1040), line 22.
Deduction more than $3,000.
Railroad retirement benefits:Social security benefits:If this deduction is more than $3,000, you should figure your tax two ways:
Figure your tax for 2005 with the itemized deduction included on Schedule A line 27.
Figure your tax for 2005 in the following steps.
Figure the tax without the itemized deduction included on Schedule A line 27.
For each year after 1983 for which part of the negative figure represents a repayment of benefits, refigure your taxable benefits as if your
total benefits for the year were reduced by that part of the negative figure. Then refigure the tax for that year.
Subtract the total of the refigured tax amounts in (b) from the total of your actual tax amounts.
Subtract the result in (c) from the result in (a).
Compare the tax figured in methods (1) and (2). Your tax for 2005 is the smaller of the two amounts. If method (1) results in less tax, take
the itemized deduction on line 27, Schedule A (Form 1040). If method (2) results in less tax, claim a credit for the amount from step 2(c) above on
Form 1040, line 70, and enter I.R.C. 1341 in the margin to the left of line 70. If both methods produce the same tax, deduct the repayment on
Schedule A (Form 1040), line 27.
Other IncomeIncome:What's NewDisaster mitigation payments.
You can exclude from income grants you use to mitigate (reduce the severity of) potential damage from future natural disasters that is paid to you
through state and local governments. If you reported income from qualified disaster mitigation payments in previous years, you may be able to file a
claim for refund. For more information, see Disaster mitigation payments under Welfare and Other Public Assistance Benefits.
Katrina Emergency Tax Relief Act of 2005.
This Act provides tax relief for persons affected by Hurricane Katrina. Under this Act, you may be able to exclude from income canceled nonbusiness
debt. See Publication 4492.
You must include on your return all income you receive in the form of money, property, and services unless the tax law states that you do not
include them. Some items, however, are only partly excluded from income. This chapter discusses many kinds of income and explains whether they are
taxable or nontaxable.
Income that is taxable must be reported on your tax return and is subject to tax.
Income that is nontaxable may have to be shown on your tax return but is not taxable.
This chapter begins with discussions of the following income items.
Bartering.
Canceled debts.
Host or Hostess.
Life insurance proceeds.
Partnership income.
Alimony:Reporting of income
S Corporation income.
Recoveries (including state income tax refunds).
Rents from personal property.
Repayments.
Royalties.
Unemployment benefits.
Welfare and other public assistance benefits.
These discussions are followed by brief discussions of other income items arranged in alphabetical order.
Publication525Taxable and Nontaxable Income544Sales and Other Dispositions of Assets550Investment Income and Expenses
BarteringBarter income:Income:BarteringBarter income:Definition of bartering
Bartering is an exchange of property or services. You must include in your income, at the time received, the fair market value of property or
services you receive in bartering. If you exchange services with another person and you both have agreed ahead of time as to the value of the
services, that value will be accepted as fair market value unless the value can be shown to be otherwise.
Form:1040, Schedule CBarter incomeGenerally, you report this income on Schedule C, Profit or Loss From Business, or Schedule C-EZ, Net
Profit From Business (Form 1040). However, if the barter involves an exchange of something other than services, such as in Example 3 below,
you may have to use another form or schedule instead.
Example 1.
You 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 self-employed and a member of a barter club. The club uses credit units as a means of exchange. It adds credit units to your account
for goods or services you provide to members, which you can use to purchase goods or services offered by other members of the barter club. The club
subtracts credit units from your account when you receive goods or services from other members. You must include in your income the value of the
credit units that are added to your account, even though you may not actually receive goods or services from other members until a later tax year.
Example 3.
You own a small apartment building. In return for 6 months rent-free use of an apartment, an artist gives you a work of art she created. You must
report as rental income on Schedule E, Supplemental Income and Loss (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.
Form 1099-B from barter exchange.Barter income:Form 1099-BForm:1099-B:Barter income
If you exchanged property or services through a barter exchange, Form 1099-B, Proceeds From Broker and Barter Exchange Transactions, or a similar
statement from the barter exchange should be sent to you by January 31, 2006. It should show the value of cash, property, services, credits, or scrip
you received from exchanges during 2005. The IRS will also receive a copy of Form 1099-B.
Canceled DebtsCancellation of debt:DebtsCanceledCancellation of debtForgiveness of debtCancellation of debtIncome:Canceled debtsWrite-offsCancellation of debt
Generally, 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.
Form:1040, Schedule CForgiveness of debtsIf 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, Profit or Loss From Farming (Form 1040), if the debt is
farm debt and you are a farmer).
Form 1099-C.Form:1099-C:Cancellation of debt
If a Federal Government agency, financial institution, or credit union cancels or forgives a debt you owe of $600 or more, you will receive a Form
1099-C, Cancellation of Debt. The amount of the canceled debt is shown in box 2.
Interest included in canceled debt.Interest payments:Canceled debt including
If any interest is forgiven and included in the amount of canceled debt in box 2, the amount of interest will also be shown in box 3. Whether or
not you must include the interest portion of the canceled debt in your income depends on whether the interest would be deductible if you paid it. See
Deductible debt, under Exceptions, later.
If the interest would not be deductible (such as interest on a personal loan), include in your income the amount from Form 1099-C, box 2. If the
interest would be deductible (such as on a business loan), include in your income the net amount of the canceled debt (the amount shown in box 2 less
the interest amount shown in box 3).
If your financial institution offers a discount for the early payment of your mortgage loan, the amount of the discount is canceled debt. You must
include the canceled amount in your income.
Mortgage relief upon sale or other disposition.Mortgage:ReliefDebts:RecourseDebts:Nonrecourse
If you are personally liable for a mortgage (recourse debt), and you are relieved of the mortgage when you dispose of the property, you may realize
gain or loss up to the fair market value of the property. To the extent the mortgage discharge exceeds the fair market value of the property, it is
income from discharge of indebtedness unless it qualifies for exclusion under Excluded debt, later. Report any income from discharge of
indebtedness on nonbusiness debt that does not qualify for exclusion as other income on Form 1040, line 21.
If you are not personally liable for a mortgage (nonrecourse debt), and you are relieved of the mortgage when you dispose of the property (such as
through foreclosure or repossession), that relief is included in the amount you realize. You may have a taxable gain if the amount you realize exceeds
your adjusted basis in the property. Report any gain on nonbusiness property as a capital gain.
See Foreclosures and Repossessions in Publication 544 for more information.
Stockholder debt.Dividends:Stockholder debts when canceled asStockholders:Debts
If you are a stockholder in a corporation and the corporation cancels or forgives your debt to it, the canceled debt is a constructive distribution
that is generally dividend income to you. For more information, see Publication 542, Corporations.
If you are a stockholder in a corporation and you cancel a debt owed to you by the corporation, you generally do not realize income. This is
because the canceled debt is considered as a contribution to the capital of the corporation equal to the amount of debt principal that you canceled.
Repayment of canceled debt.
If you included a canceled amount in your income and later pay the debt, you may be able to file a claim for refund for the year the amount was
included in income. You can file a claim on Form 1040X if the statute of limitations for filing a claim is still open. The statute of limitations
generally does not end until 3 years after the due date of your original return.
ExceptionsCancellation of debt:Exceptions to treatment as income
There are several exceptions to the inclusion of canceled debt in income. These are explained next.
Student loans.Student loans:Cancellation of debtStudentsLoansStudent loans
Certain student loans contain a provision that all or part of the debt incurred to attend the qualified educational institution will be canceled if
you work for a certain period of time in certain professions for any of a broad class of employers.
You do not have income if your student loan is canceled after you agreed to this provision and then performed the services required. To qualify,
the loan must have been made by:
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.
Section 501(c)(3) organizations are defined in Publication 525.
A loan to refinance a qualified student loan will also qualify if it was made by an educational institution or a tax-exempt 501(a) organization
under its program designed as described in (3)(b) above.
Deductible debt.
You do not have income from the cancellation of a debt if your payment of the debt would be deductible. This exception applies only if you use the
cash method of accounting. For more information, see chapter 5 of Publication 334, Tax Guide for Small Business.
Education loan repayment assistance.
Education loan repayments made to you by the National Health Service Corps Loan Repayment Program (NHSC Loan Repayment Program) or a state
education loan repayment program eligible for funds under the Public Health Service Act are not taxable if you agree to provide primary health
services in health professional shortage areas. For more information, see Publication 970, Tax Benefits for Education.
Price reduced after purchase.Price reduced after purchase
Generally, if the seller reduces the amount of debt you owe for property you purchased, you do not have income from the reduction. The reduction of
the debt is treated as a purchase price adjustment and reduces your basis in the property.
Excluded debt.Exclusions from gross income:Canceled debt
Do not include a canceled debt in your gross income in the following situations.
The debt is canceled in a bankruptcy case under title 11 of the U.S. Code. See Publication 908, Bankruptcy Tax Guide.
Bankruptcy:Canceled debt not deemed to be income
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.
Insolvency:Canceled debt not deemed to be income
The debt is qualified farm debt and is canceled by a qualified person. See chapter 3 of Publication 225, Farmer's Tax Guide.
AgricultureFarmingFarming:Canceled debt, treatment of
The debt is qualified real property business debt. See chapter 5 of Publication 334.
Real estate:Canceled business debt, treatment of
The cancellation is intended as a gift.
Host or HostessHost or hostess
If you host a party at which sales are made, any gift you receive for giving the party is a payment for helping a direct seller make sales. You
must report it 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 chapter 26.
Life Insurance ProceedsDeath benefits:Life insurance proceedsLife insuranceIncome:Life insurance proceedsLife insurance:ProceedsAs income
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.
Proceeds not received in installments.
If death benefits are paid to you in a lump sum or other than at regular intervals, include in your income only the benefits that are more than the
amount payable to you at the time of the insured person's death. If the benefit payable at death is not specified, you include in your income the
benefit payments that are more than the present value of the payments at the time of death.
Proceeds received in installments.
If you receive life insurance proceeds in installments, you can exclude part of each installment from your income.
To determine the excluded part, divide the amount held by the insurance company (generally the total lump sum payable at the death of the insured
person) by the number of installments to be paid. Include anything over this excluded part in your income as interest.
Surviving spouse.SpouseSurviving spouseSurviving spouse:Life insurance proceeds paid to
If your spouse died before October 23, 1986, and insurance proceeds paid to you because of the death of your spouse are received in installments,
you can exclude up to $1,000 a year of the interest included in the installments. If you remarry, you can continue to take the exclusion.
More information.
For more information, see Life Insurance Proceeds in Publication 525.
Surrender of policy for cash.Life insurance:Surrender of policy for cash
If you surrender a life insurance policy for cash, you must include in income any proceeds that are more than the cost of the life insurance
policy. In general, your cost (or investment in the contract) is the total of premiums that you paid for the life insurance policy, less any refunded
premiums, rebates, dividends, or unrepaid loans that were not included in your income.
Form:1099-R:Life insurance policy surrendered for cashLife insurance:Form 1099-R for surrender of policy for cashYou should receive a Form 1099-R showing the total proceeds and the taxable
part. Report these amounts on lines 16a and 16b of Form 1040 or lines 12a and 12b of Form 1040A.
Endowment Contract ProceedsEndowment proceeds
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.
Accelerated Death BenefitsAccelerated death benefitsChronic illnessAccelerated payment of life insurance proceedsAccelerated death benefitsDeath benefits:AcceleratedExclusions from gross income:Accelerated death benefitsLife insurance:Accelerated death benefitsTerminal illness:Accelerated payment of life insurance proceedsAccelerated death benefits
Certain amounts paid as accelerated death benefits under a life insurance contract or viatical settlement before the insured's death are excluded
from income if the insured is terminally or chronically ill.
This is the sale or assignment of any part of the death benefit under a life insurance contract to a viatical settlement provider. A viatical
settlement provider is a person who regularly engages in the business of buying or taking assignment of life insurance contracts on the lives of
insured individuals who are terminally or chronically ill and who meets the requirements of section 101(g)(2)(B) of the Internal Revenue Code.
Exclusion for terminal illness.
Accelerated death benefitsDeath benefits:AcceleratedViatical settlementsAccelerated death benefits are fully excludable if the insured is a terminally ill individual. This is a
person who has been certified by a physician as having an illness or physical condition that can reasonably be expected to result in death within 24
months from the date of the certification.
Exclusion for chronic illness.Chronic illnessLong-term careLong-term care insurance contracts
Long-term care insurance contracts:Chronically ill individualIf the insured is a chronically ill individual who is not terminally ill, accelerated death
benefits paid on the basis of costs incurred for qualified long-term care services are fully excludable. Accelerated death benefits paid on a per
diem or other periodic basis are excludable up to a limit. This limit applies to the total of the accelerated death benefits and any periodic
payments received from long-term care insurance contracts. For information on the limit and the definitions of chronically ill individual, qualified
long-term care services, and long-term care insurance contracts, see Long-Term Care Insurance Contracts under Sickness and Injury
Benefits in chapter 5.
Exception.
The exclusion does not apply to any amount paid to a person (other than the insured) who has an insurable interest in the life of the insured
because the insured:
Is a director, officer, or employee of the person, or
Has a financial interest in the person's business.
Form 8853.Form:8853:Accelerated death benefits
To claim an exclusion for accelerated death benefits made on a per diem or other periodic basis, you must file Form 8853, Archer MSAs
and Long-term Care Insurance Contracts, with your return. You do not have to file Form 8853 to exclude accelerated death benefits paid on the basis of
actual expenses incurred.
Public Safety Officer Killed in the Line of DutyDeath benefits:Public safety officers who died or were killed in line of duty, tax exclusionExclusions from gross income:Public safety officers who died or were killed in line of duty, death benefitsLife insurance:Public safety officers who died or were killed in line of duty, tax exclusion
If you are a survivor of a public safety officer who was killed in the line of duty, you may be able to exclude from income certain amounts you
receive.
Ambulance service personnel:Life insurance proceeds when death in line of dutyChaplains:Life insurance proceeds when death in line of dutyClergy:Life insurance proceeds when chaplain died in line of dutyEmergency medical service personnel:Life insurance proceeds when death in line of dutyFirefighters:Life insurance proceeds when death in line of dutyLaw enforcement officers:Life insurance proceeds when death in line of dutyRescue squad members:Life insurance proceeds when death in line of dutyFor this purpose, the term public safety officer includes law enforcement
officers, firefighters, chaplains, and rescue squad and ambulance crew members. For more information, see Publication 559, Survivors, Executors, and
Administrators.
Partnership IncomeIncome:PartnershipPartners and partnerships:Income
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.
Schedule K-1 (Form 1065).Form:1065:Partnership incomeSchedule:K-1Partnership income
Information returns:Partnerships to provideAlthough a partnership generally pays no tax, it must file an information return on Form 1065, U.S.
Return of Partnership Income, and send Schedule K-1 (Form 1065) to each partner. In addition, the partnership will send each partner a copy of the
Partner's Instructions for Schedule K-1 (Form 1065) to help each partner report his or her share of the partnership's income, deductions, credits, and
tax preference items.
Keep Schedule K-1 (Form 1065) for your records. Do not attach it to your Form 1040.
For more information on partnerships, see Publication 541, Partnerships.
S Corporation IncomeCorporationsS corporationsIncome:S corporationS corporations:Shareholders
In general, 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.
Schedule K-1 (Form 1120S).Form:1120S:S corporation incomeSchedule:K-1S corporation income
An S corporation must file a return on Form 1120S, U.S. Income Tax Return for an S Corporation, and send Schedule K-1 (Form 1120S) to each
shareholder. In addition, the S corporation will send each shareholder a copy of the Shareholder's Instructions for Schedule K-1 (Form 1120S) to help
each shareholder report his or her share of the S corporation's income, losses, credits, and deductions.
Keep Schedule K-1 (Form 1120S) for your records. Do not attach it to your Form 1040.
For more information on S corporations and their shareholders, see Instructions for Form 1120S.
RecoveriesReimbursementRecovery of amounts previously deductedDebtsBad debtsBad debts:RecoveryDeductions:Recovery of amounts previously deductedIncome:RecoveryRecovery of amounts previously deducted:
A recovery is a return of an amount you deducted or took a credit for in an earlier year. The most common recoveries are refunds, reimbursements,
and rebates of deductions itemized on Schedule A (Form 1040). You also may have recoveries of non-itemized deductions (such as payments on previously
deducted bad debts) and recoveries of items for which you previously claimed a tax credit.
Tax benefit rule.
You must include a recovery in your income in the year you receive it up to the amount by which the deduction or credit you took for the recovered
amount reduced your tax in the earlier year. For this purpose, any increase to an amount carried over to the current year that resulted from the
deduction or credit is considered to have reduced your tax in the earlier year. For more information, see Publication 525.
Federal income tax refund.Recovery of amounts previously deducted:Tax refundsTax refunds:Federal income tax refunds
Refunds of federal income taxes are not included in your income because they are never allowed as a deduction from income.
State tax refund.Form 1099–G:State tax refundsRefunds:State taxState or local taxes:Refunds
If you received a state or local income tax refund (or credit or offset) in 2005, you generally must include it in income if you deducted the tax
in an earlier year. The payer should send Form 1099-G, Certain Government Payments, to you by January 31, 2006. The IRS also will receive a copy of
the Form 1099-G. Use the State and Local Income Tax Refund worksheet in the 2005 Form 1040 instructions for line 10 to figure the amount (if any) to
include in your income.
For 2004 you could choose to deduct:
State and local income taxes, or
State and local general sales taxes.
For 2005, the refund that you must include in income is limited to the excess of the tax you chose to deduct over the tax you did not choose to
deduct. For examples, see Publication 525.
Form:1098:Mortgage interest statementIf you received a refund or credit in 2005 of mortgage interest paid in an earlier year,
the amount should be shown in box 3 of your Form 1098, Mortgage Interest Statement. Do not subtract the refund amount from the interest you paid in
2005. You may have to include it in your income under the rules explained in the following discussions.
Interest on recovery.Interest income:Recovery of income, on
Interest on any of the amounts you recover must be reported as interest income in the year received. For example, report any interest you received
on state or local income tax refunds on Form 1040, line 8a.
Recovery and expense in same year.
If the refund or other recovery and the expense occur in the same year, the recovery reduces the deduction or credit and is not reported as income.
Recovery for 2 or more years.Recovery of amounts previously deducted:Over multiple years
If you receive a refund or other recovery that is for amounts you paid in 2 or more separate years, you must allocate, on a pro rata
basis, the recovered amount between the years in which you paid it. This allocation is necessary to determine the amount of recovery from any earlier
years and to determine the amount, if any, of your allowable deduction for this item for the current year. For information on how to compute the
allocation, see Recoveries in Publication 525.
Itemized Deduction RecoveriesItemized deductions:RecoveryRecovery of amounts previously deducted:Itemized deductions
If you recover any amount that you deducted in an earlier year on Schedule A (Form 1040), you generally must include the full amount of the
recovery in your income in the year you receive it.
Where to report.Itemized deductions:Form 1040 to be used
Enter your state or local income tax refund on Form 1040, line 10, and the total of all other recoveries as other income on Form 1040, line 21. You
cannot use Form 1040A or Form 1040EZ.
Standard deduction limit.
You generally are allowed to claim the standard deduction if you do not itemize your deductions. Only your itemized deductions that are more than
your standard deduction are subject to the recovery rule (unless you are required to itemize your deductions). If your total deductions on the earlier
year return were not more than your income for that year, include in your income this year the lesser of:
Your recoveries, or
The amount by which your itemized deductions exceeded the standard deduction.
Example.
For 2004, you filed a joint return. Your taxable income was $60,000 and you were not entitled to any tax credits. Your standard deduction was
$9,700, and you had itemized deductions of $11,000. In 2005, you received the following recoveries for amounts deducted on your 2004 return:
Medical expenses$200State and local income tax refund400Refund of mortgage interest325Total recoveries$925
None of the recoveries were more than the deductions taken for 2004. 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 ($11,000 − 9,700 = $1,300),
so you must include your total recoveries in your income for 2005. Report the state and local income tax refund of $400 on Form 1040, line 10, and the
balance of your recoveries, $525, on Form 1040, line 21.
Standard deduction for earlier years.
To determine if amounts recovered in 2005 must be included in your income, you must know the standard deduction for your filing status for the year
the deduction was claimed. Standard deduction amounts for 2004, 2003, and 2002 are in Publication 525.
Example.
You filed a joint return for 2004 with taxable income of $45,000. Your itemized deductions were $10,350. The standard deduction that you could have
claimed was $9,700. In 2005 you recovered $2,100 of your 2004 itemized deductions. None of the recoveries were more than the actual deductions for
2004. Include $650 of the recoveries in your 2005 income. This is the smaller of your recoveries ($2,100) or the amount by which your itemized
deductions were more than the standard deduction ($10,350 − 9,700 = $650).
Recovery limited to deduction.
You do not include in your income any amount of your recovery that is more than the amount you deducted in the earlier year. The amount you include
in your income is limited to the smaller of:
The amount deducted on Schedule A (Form 1040), or
The amount recovered.
Example.
During 2004 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 2005, you received a $500 reimbursement from your medical insurance for your 2004 expenses. The only amount of
the $500 reimbursement that must be included in your income for 2005 is $200—the amount actually deducted.
Other recoveries.
See Recoveries in Publication 525 if:
You have recoveries of items other than itemized deductions, or
You received a recovery for an item for which you claimed a tax credit (other than investment credit or foreign tax credit) in a prior
year.
Rents from Personal PropertyPersonal property:Rental income fromRental income and expenses:Personal property rental
If you rent out personal property, such as equipment or vehicles, how you report your income and expenses is generally determined by:
Whether or not the rental activity is a business, and
Whether or not the rental activity is conducted for profit.
Generally, 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.
Reporting business income and expenses.
Form:1040, Schedule CRental income and expensesForm:1040, Schedule C-EZRental income and expensesIf you are in the business of renting personal property, report your income and expenses on
Schedule C or Schedule C-EZ (Form 1040). The form instructions have information on how to complete them.
Reporting nonbusiness income.
If you are not in the business of renting personal property, report your rental income on Form 1040, line 21. List the type and amount of the
income on the dotted line next to line 21.
Reporting nonbusiness expenses.
If you rent personal property for profit, include your rental expenses in the total amount you enter on Form 1040, line 36. Also enter the amount
and PPR on the dotted line next to line 36.
If you do not rent personal property for profit, your deductions are limited and you cannot report a loss to offset other income. See
Activity not for profit, under Other Income, later.
Repayments
Repayments:Deductions:RepaymentsIf you had to repay an amount that you included in your income in an earlier year, you may be able to deduct the
amount repaid from your income for the year in which you repaid it. Or, if the amount you repaid is more than $3,000, you may be able to take a credit
against your tax for the year in which you repaid it. Generally, you can claim a deduction or credit only if the repayment qualifies as an expense or
loss incurred in your trade or business or in a for-profit transaction.
Type of deduction.
The type of deduction you are allowed in the year of repayment depends on the type of income you included in the earlier year. You generally deduct
the repayment on the same form or schedule on which you previously reported it as income. For example, if you reported it as self-employment income,
deduct it as a business expense on Schedule C or Schedule C-EZ (Form 1040) or Schedule F (Form 1040). If you reported it as a capital gain, deduct it
as a capital loss on Schedule D (Form 1040). If you reported it as wages, unemployment compensation, or other nonbusiness income, deduct it as a
miscellaneous itemized deduction on Schedule A (Form 1040).
Repayment of $3,000 or less.
If the amount you repaid was $3,000 or less, deduct it from your income in the year you repaid it. If you must deduct it as a miscellaneous
itemized deduction, enter it on Schedule A (Form 1040), line 22.
Repayment over $3,000.
If the amount you repaid was more than $3,000, you can deduct the repayment (as explained under Type of deduction, earlier). However,
you can instead choose to take a tax credit for the year of repayment if you included the income under a claim of right. This means that at the time
you included the income, it appeared that you had an unrestricted right to it. If you qualify for this choice, figure your tax under both methods and
compare the results. Use the method (deduction or credit) that results in less tax.
Method 1.
Figure your tax for 2005 claiming a deduction for the repaid amount. If you must deduct it as a miscellaneous itemized deduction, enter it on
Schedule A (Form 1040), line 27.
Method 2.
Figure your tax for 2005 claiming a credit for the repaid amount. Follow these steps.
Figure your tax for 2005 without deducting the repaid amount.
Refigure your tax from the earlier year without including in income the amount you repaid in 2005.
Subtract the tax in (2) from the tax shown on your return for the earlier year. This is the credit.
Subtract the answer in (3) from the tax for 2005 figured without the deduction (Step 1).
If method 1 results in less tax, deduct the amount repaid. If method 2 results in less tax, claim the credit figured in (3) above on Form 1040,
line 70, and enter I.R.C. 1341 next to line 70.
An example of this computation can be found in Publication 525.
Repaid social security benefits.Repayments:Social security benefitsSocial security benefits:Repayment of benefits
If you repaid social security benefits, see Repayment of benefits in chapter 11.
Royalties from copyrights, patents, and oil, gas, and mineral properties are taxable as ordinary income.
Form:1040, Schedule COil, gas, or mineral interest royaltiesForm:1040, Schedule C-EZOil, gas, or mineral interest royaltiesOil, gas, and minerals:Royalties from:Schedule C or C-EZ
You generally report royalties in Part I of Schedule E (Form 1040). However, if you hold an operating oil, gas, or mineral interest or are in
business as a self-employed writer, inventor, artist, etc., report your income and expenses on Schedule C or Schedule C-EZ (Form 1040).
Copyrights and patents.Patents:Royalties
Royalties from copyrights on literary, musical, or artistic works, and similar property, or from patents on inventions, are amounts paid to you for
the right to use your work over a specified period of time. Royalties generally are based on the number of units sold, such as the number of books,
tickets to a performance, or machines sold.
Oil, gas, and minerals.Gas royaltiesMineral royaltiesOil, gas, and minerals:Royalties from
Royalty income from oil, gas, and mineral properties is the amount you receive when natural resources are extracted from your property. The
royalties are based on units, such as barrels, tons, etc., and are paid to you by a person or company who leases the property from you.
Depletion.Depletion allowance
If you are the owner of an economic interest in mineral deposits or oil and gas wells, you can recover your investment through the depletion
allowance. For information on this subject, see chapter 10 of Publication 535.
Coal and iron ore.Capital assets:Coal and iron oreCoal and iron ore
Under certain circumstances, you can treat amounts you receive from the disposal of coal and iron ore as payments from the sale of a capital asset,
rather than as royalty income. For information about gain or loss from the sale of coal and iron ore, see Publication 544.
Sale of property interest.Oil, gas, and minerals:Sale of property interest
If you sell your complete interest in oil, gas, or mineral rights, the amount you receive is considered payment for the sale of section 1231
property, not royalty income. Under certain circumstances, the sale is subject to capital gain or loss treatment on Schedule D (Form 1040). For more
information on selling section 1231 property, see chapter 3 of Publication 544.
If you retain a royalty, an overriding royalty, or a net profit interest in a mineral property for the life of the property, you have made a lease
or a sublease, and any cash you receive for the assignment of other interests in the property is ordinary income subject to a depletion allowance.
Part of future production sold.Oil, gas, and minerals:Future production sold
If you own mineral property but sell part of the future production, you generally treat the money you receive from the buyer at the time of the
sale as a loan from the buyer. Do not include it in your income or take depletion based on it.
When production begins, you include all the proceeds in your income, deduct all the production expenses, and deduct depletion from that amount to
arrive at your taxable income from the property.
Unemployment BenefitsUnemployment compensation:
The tax treatment of unemployment benefits you receive depends on the type of program paying the benefits.
Unemployment compensation.
Unemployment compensation:Reporting on Forms 1040, 1040A, or 1040EZYou must include in your income all unemployment compensation you receive. You
should receive a Form 1099-G, Certain Government Payments, showing the amount paid to you. Generally, you enter unemployment compensation on line 19
of Form 1040, line 13 of Form 1040A, or line 3 of Form 1040EZ.
Types of unemployment compensation.
Unemployment compensation generally includes any amount received under an unemployment compensation law of the United States or of a state. It
includes the following benefits.
Benefits paid by a state or the District of Columbia from the Federal Unemployment Trust Fund.
State unemployment insurance benefits.
Railroad unemployment compensation benefits.
Disability payments from a government program paid as a substitute for unemployment compensation. (Amounts received as workers' compensation
for injuries or illness are not unemployment compensation. See chapter 5 for more information.)
Trade readjustment allowances under the Trade Act of 1974.
Trade Act of 1974:Trade readjustment allowances under
Unemployment assistance under the Disaster Relief and Emergency Assistance Act.
Disaster relief:Disaster Relief and Emergency Assistance Act:Unemployment assistance
Governmental program.
If you contribute to a governmental unemployment compensation program and your contributions are not deductible, amounts you receive under the
program are not included as unemployment compensation until you recover your contributions.
Repayment of unemployment compensation.Repayments:Unemployment compensationUnemployment compensation:Repayment of benefits
If you repaid in 2005 unemployment compensation you received in 2005, subtract the amount you repaid from the total amount you received and enter
the difference on line 19 of Form 1040, line 13 of Form 1040A, or line 3 of Form 1040EZ. On the dotted line next to your entry enter Repaid and
the amount you repaid. If you repaid unemployment compensation in 2005 that you included in income in an earlier year, you can deduct the amount
repaid on Schedule A (Form 1040), line 22, if you itemize deductions. If the amount is more than $3,000, see Repayments, earlier.
You can choose to have federal income tax withheld from your unemployment compensation. To make this choice, complete Form W-4V, Voluntary
Withholding Request, and give it to the paying office. Tax will be withheld at 10% of your payment.
Estimated tax:Unemployment compensationIf you do not choose to have tax withheld from your unemployment compensation, you may be liable
for estimated tax. For more information on estimated tax, see chapter 4.
Supplemental unemployment benefits.Unemployment compensation:Supplemental benefitsUnemployment compensation:Reporting on Forms 1040, 1040A, or 1040EZ
Benefits received from an employer-financed fund (to which the employees did not contribute) are not unemployment compensation. They are taxable as
wages and are subject to withholding for income tax. They may be subject to social security and Medicare taxes. For more information, see
Supplemental Unemployment Benefits in section 5 of Publication 15-A, Employer's Supplemental Tax Guide. Report these payments on line 7 of
Form 1040 or Form 1040A or on line 1 of Form 1040EZ.
Repayment of benefits.Repayments:Unemployment compensationUnemployment compensation:Repayment of benefits
You may have to repay some of your supplemental unemployment benefits to qualify for trade readjustment allowances under the Trade Act of 1974. If
you repay supplemental unemployment benefits in the same year you receive them, reduce the total benefits by the amount you repay. If you repay the
benefits in a later year, you must include the full amount of the benefits received in your income for the year you received them.
Deduct the repayment in the later year as an adjustment to gross income on Form 1040. (You cannot use Form 1040A or Form 1040EZ.) Include the
repayment on Form 1040, line 36, and enter Sub-Pay TRA and the amount on the dotted line next to line 36. If the amount you repay in a later
year is more than $3,000, you may be able to take a credit against your tax for the later year instead of deducting the amount repaid. For more
information on this, see Repayments, earlier.
Private unemployment fund.Unemployment compensation:Private fund, from
Unemployment benefit payments from a private (nonunion) fund to which you voluntarily contribute are taxable only if the amounts you receive are
more than your total payments into the fund. Report the taxable amount on Form 1040, line 21.
Payments by a union.Labor unions:Unemployment compensation payments fromUnionsLabor unions
Benefits paid to you as an unemployed member of a union from regular union dues are included in your income on Form 1040, line 21. However, if the
unemployment benefits are paid from a special fund to which you contributed, your payments to the fund are not deductible, and the benefit payments
are includible in your income only to the extent they are more than your contributions.
Guaranteed annual wage.
Payments you receive from your employer during periods of unemployment, under a union agreement that guarantees you full pay during the year, are
taxable as wages. Include them on line 7 of Form 1040 or Form 1040A or on line 1 of Form 1040EZ.
State employees.State or local governments:Employees:Unemployment compensation
Payments similar to a state's unemployment compensation may be made by the state to its employees who are not covered by the state's unemployment
compensation law. Although the payments are fully taxable, do not report them as unemployment compensation. Report these payments on Form 1040, line
21.
Welfare and Other Public Assistance BenefitsPublic assistance benefitsWelfare benefits
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.
Alternative trade adjustment assistance (ATAA) payments.
Payments you receive from a state agency under the Demonstration Project for Alternative Trade Adjustment Assistance for Older Workers (ATAA) must
be included in your income. The state must send you Form 1099-G to advise you of the amount you should include in income. The amount should be
reported on Form 1040, line 21.
Persons with disabilities.Disabilities, persons with:Public assistance benefits
If you have a disability, you must include in income compensation you receive for services you perform unless the compensation is otherwise
excluded. However, you do not include in income the value of goods, services, and cash that you receive, not in return for your services, but for your
training and rehabilitation because you have a disability. Excludable amounts include payments for transportation and attendant care, such as
interpreter services for the deaf, reader services for the blind, and services to help mentally retarded persons do their work.
Disaster relief grants.
Disaster relief:Grants or paymentsGrants, disaster reliefDisaster relief:Disaster Relief and Emergency Assistance Act:GrantsDo not include post-disaster grants received under the Disaster Relief and Emergency Assistance Act in your
income if the grant payments are made to help you meet necessary expenses or serious needs for medical, dental, housing, personal property,
transportation, or funeral expenses. Do not deduct casualty losses or medical expenses that are specifically reimbursed by these disaster relief
grants. Unemployment assistance payments under the Act are taxable unemployment compensation. See Unemployment compensation under
Unemployment Benefits, earlier.
You can exclude from income any amount you receive that is a qualified disaster relief payment. A qualified disaster relief payment is an amount
paid to you:
To reimburse or pay reasonable and necessary personal, family, living, or funeral expenses that result from a qualified
disaster,
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,
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
By a federal, state, or local government, or agency, or instrumentality in connection with a qualified disaster in order to promote the
general welfare.
You can only exclude this amount to the extent any expense it pays for is not paid for by insurance or otherwise. The exclusion does not apply
if you were a participant or conspirator in a terrorist action or his or her representative.
A qualified disaster is:
A disaster which results from a terrorist or military action,
A Presidentially declared disaster, or
A disaster which results from an accident involving a common carrier, or from any other event, which is determined to be catastrophic by the
Secretary of the Treasury or his or her delegate.
For amounts paid under item (4), a disaster is qualified if it is determined by an applicable federal, state, or local authority to warrant
assistance from the federal, state, or local government, agency, or instrumentality.
You can also exclude from income any amount you receive that is a qualified disaster mitigation payment. Like qualified disaster relief payments,
qualified disaster mitigation payments are also most commonly paid to you in the period immediately following damage to property as a result of a
natural disaster. However, disaster mitigation payments are grants you use to mitigate (reduce the severity of) potential damage from future natural
disasters. They are paid to you through state and local governments based on the provisions of the Robert T. Stafford Disaster Relief and Emergency
Assistance Act or the National Flood Insurance Act.
You cannot increase the basis or adjusted basis of your property for improvements made with nontaxable disaster mitigation payments.
If in a previous year you filed a tax return reporting disaster mitigation payments as taxable income, you should file Form 1040X to claim a
refund. You must file an amended return for tax years that are not closed by the statute of limitations. The statute of limitations generally does not
end until 3 years after the due date of your original return.
Payments made under section 235 of the National Housing Act for mortgage assistance are not included in the homeowner's income. Interest paid for
the homeowner under the mortgage assistance program cannot be deducted.
Medicare.Medicare:Benefits
Medicare benefits received under title XVIII of the Social Security Act are not includible in the gross income of the individuals for whom they are
paid. This includes basic (part A (Hospital Insurance Benefits for the Aged)) and supplementary (part B (Supplementary Medical Insurance Benefits for
the Aged)).
Old-age, survivors, and disability insurance benefits (OASDI).OASDI
OASDI payments under section 202 of title II of the Social Security Act are not includible in the gross income of the individuals for whom they are
paid. This applies to old-age insurance benefits, and insurance benefits for wives, husbands, children, widows, widowers, mothers and fathers, and
parents, as well as the lump-sum death payment.
Nutrition Program for the Elderly.Elderly persons:Nutrition Program for the ElderlyNutrition Program for the Elderly
Food benefits:Nutrition program for the elderlyFood benefits you receive under the Nutrition Program for the Elderly are not taxable. If
you prepare and serve free meals for the program, include in your income as wages the cash pay you receive, even if you are also eligible for food
benefits.
Payments to reduce cost of winter energy.Energy assistance
Payments made by a state to qualified people to reduce their cost of winter energy use are not taxable.
Other Income
The following brief discussions are arranged in alphabetical order. Income items that are discussed in greater detail in another publication
include a reference to that publication.
Activity not for profit.Activities not for profitAgricultureFarmingFarming:Activity not for profitHobbies:Activity not for profitNot-for-profit activities
You must include on your return income from an activity from which you do not expect to make a profit. An example of this type of activity is a
hobby or a farm you operate mostly for recreation and pleasure. Enter this income on Form 1040, line 21. Deductions for expenses related to the
activity are limited. They cannot total more than the income you report and can be taken only if you itemize deductions on Schedule A (Form 1040). See
Not-for-Profit Activities in chapter 1 of Publication 535 for information on whether an activity is considered carried on for a profit.
Alaska Permanent Fund dividend.Alaska Permanent Fund dividendsDividends:Alaska Permanent FundAlaska Permanent Fund dividends
If you received a payment from Alaska's mineral income fund (Alaska Permanent Fund dividend), report it as income on line 21 of Form 1040, line 13
of Form 1040A, or line 3 of Form 1040EZ. The state of Alaska sends each recipient a document that shows the amount of the payment with the check. The
amount is also reported to IRS.
Alimony.Alimony:Reporting of incomeDivorced taxpayersAlimonyIncome:Alimony
Include in your income on Form 1040, line 11, any alimony payments you receive. Amounts you receive for child support are not income to you.
Alimony and child support payments are discussed in chapter 18.
Bribes.Bribes
If you receive a bribe, include it in your income.
These contributions are not income to a candidate unless they are diverted to his or her personal use. To be exempt from tax, the contributions
must be spent for campaign purposes or kept in a fund for use in future campaigns. However, interest earned on bank deposits, dividends received on
contributed securities, and net gains realized on sales of contributed securities are taxable and must be reported on Form 1120-POL, U.S. Income Tax
Return for Certain Political Organizations. Excess campaign funds transferred to an office account must be included in the officeholder's income on
Form 1040, line 21, in the year transferred.
Cash rebates.Cash:RebatesCash rebates
A cash rebate you receive from a dealer or manufacturer of an item you buy is not income, but you must reduce your basis by the amount of the
rebate.
Example.
You buy a new car for $9,000 cash and receive a $400 rebate check from the manufacturer. The $400 is not income to you. Your basis in the car is
$8,600. This is your basis on which you figure gain or loss if you sell the car, and depreciation if you use it for business.
Casualty insurance and other reimbursements.Casualty insurance:Reimbursements fromInsurance:Reimbursements:From casualty insuranceLiability insurance:Reimbursements from
You generally should not report these reimbursements on your return, unless you are figuring gain or loss from the casualty or theft. See
Publication 547, Casualties, Disasters, and Thefts, for more information.
Child support payments.Child supportChildren:Support ofChild support
You should not report these payments on your return. See Publication 504, Divorced or Separated Individuals, for more information.
Court awards and damages.Civil suitsDamages from lawsuitsCourt awards and damagesDamages from lawsuitsDamages from lawsuitsPersonal injury suits:Damages from
To determine if settlement amounts you receive by compromise or judgment must be included in your income, you must consider the item that the
settlement replaces. Include the following as ordinary income.
Interest on any award.
Compensation for lost wages or lost profits in most cases.
Punitive damages. It does not matter if they relate to a physical injury or physical sickness.
Punitive damages:As income
Amounts received in settlement of pension rights (if you did not contribute to the plan).
Interference with business operations:Damages as income
Back pay and damages for emotional distress received to satisfy a claim under Title VII of the Civil Rights Act of 1964.
Back pay, award for:Emotional distress damages under Title VII of Civil Rights Act of 1964
Attorney fees and costs (including contingent fees) where the underlying recovery is included in gross income.
Do not include in your income compensatory damages for personal physical injury or physical sickness (whether received in a lump sum or
installments).
Emotional distress.Emotional distress damages
Emotional distress itself is not a physical injury or physical sickness, but damages you receive for emotional distress due to a physical injury or
sickness are treated as received for the physical injury or sickness. Do not include them in your income.
If the emotional distress is due to a personal injury that is not due to a physical injury or sickness (for example, employment discrimination or
injury to reputation), you must include the damages in your income, except for any damages you receive for medical care due to that emotional
distress. Emotional distress includes physical symptoms that result from emotional distress, such as headaches, insomnia, and stomach disorders.
Deduction for costs involved in unlawful discrimination suits.Unlawful discrimination suitsDeduction for costsDeductionCosts of discrimination suits
You may be able to deduct attorney fees and court costs paid to recover a judgement or settlement for a claim of unlawful discrimination under
various provisions of federal, state, and local law listed in Internal Revenue Code section 62(e), a claim against the United States government, or a
claim under section 1862(b)(3)(A) of the Social Security Act. For more information, see Publication 525.
Generally, if you receive benefits under a credit card disability or unemployment insurance plan, the benefits are taxable to you. These plans make
the minimum monthly payment on your credit card account if you cannot make the payment due to injury, illness, disability, or unemployment. Report on
Form 1040, line 21, the amount of benefits you received during the year that is more than the amount of the premiums you paid during the year.
Employment agency fees.Employment:Agency fees
If you get a job through an employment agency, and the fee is paid by your employer, the fee is not includible in your income if you are not liable
for it. However, if you pay it and your employer reimburses you for it, it is includible in your income.
Energy conservation subsidies.Energy conservation:SubsidiesExclusions from gross income:Energy conservation subsidiesUtilities:Energy conservation subsidiesWinter energy payments
You can exclude from gross income any subsidy provided, either directly or indirectly, by public utilities for the purchase or installation of an
energy conservation measure for a dwelling unit.
Energy conservation measure.Energy conservation:Measures and modifications
This includes installations or modifications that are primarily designed to reduce consumption of electricity or natural gas, or improve the
management of energy demand.
Dwelling unit.
This includes a house, apartment, condominium, mobile home, boat, or similar property. If a building or structure contains both dwelling and other
units, any subsidy must be properly allocated.
Estate and trust income.BeneficiariesTrust beneficiariesEstates:IncomeTrust beneficiaries:Receiving income from trustTrusts:Income
BeneficiariesEstate beneficiariesBequestsEstate beneficiariesEstate beneficiaries:Receiving income from estateEstates:Estate beneficiariesInheritanceEstate beneficiariesAn estate or trust, unlike a partnership, may have to pay federal income tax. If you are a beneficiary of
an estate or trust, you may be taxed on your share of its income distributed or required to be distributed to you. However, there is never a double
tax. Estates and trusts file their returns on Form 1041, U.S. Income Tax Return for Estates and Trusts, and your share of the income is reported to
you on Schedule K-1 (Form 1041).
Current income required to be distributed.Trust beneficiaries:Receiving income from trustTrusts:Trust beneficiaries
If you are the beneficiary of an estate or trust that must distribute all of its current income, you must report your share of the distributable
net income, whether or not you actually received it.
Current income not required to be distributed.
Estate beneficiaries:Receiving income from estateTrust beneficiaries:Receiving income from trustIf you are the beneficiary of an estate or trust and the fiduciary has the choice of whether to
distribute all or part of the current income, you must report:
All income that is required to be distributed to you, whether or not it is actually distributed, plus
All other amounts actually paid or credited to you,
up to the amount of your share of distributable net income.
How to report.
Treat each item of income the same way that the estate or trust would treat it. For example, if a trust's dividend income is distributed to you,
you report the distribution as dividend income on your return. The same rule applies to distributions of tax-exempt interest and capital gains.
The fiduciary of the estate or trust must tell you the type of items making up your share of the estate or trust income and any credits you are
allowed on your individual income tax return.
Losses.BeneficiariesEstate beneficiariesBeneficiariesTrust beneficiariesBequestsEstate beneficiariesEstate beneficiaries:Losses of estateTrust beneficiaries:Losses of trustTrusts:Trust beneficiaries
Losses of estates and trusts generally are not deductible by the beneficiaries.
Grantor trust.Trusts:Grantor trusts
Income earned by a grantor trust is taxable to the grantor, not the beneficiary, if the grantor keeps certain control over the trust. (The grantor
is the one who transferred property to the trust.) This rule applies if the property (or income from the property) put into the trust will or may
revert (be returned) to the grantor or the grantor's spouse.
Generally, a trust is a grantor trust if the grantor has a reversionary interest valued (at the date of transfer) at more than 5% of the value of
the transferred property.
Expenses paid by another.Expenses paid by another
If your personal expenses are paid for by another person, such as a corporation, the payment may be taxable to you depending upon your relationship
with that person and the nature of the payment. But if the payment makes up for a loss caused by that person, and only restores you to the position
you were in before the loss, the payment is not includible in your income.
Fees for services.Feesspecific types of deductions and income
Include all fees for your services in your income. Examples of these fees are amounts you receive for services you perform as:
A corporate director,
An executor, administrator, or personal representative of an estate,
If you are not an employee and the fees for your services from the same payer total $600 or more for the year, you may receive a Form 1099-MISC.
You may need to report your fees as self-employment income. See Self-Employed Persons, in chapter 1, for a discussion of when you are
considered self-employed.
Corporate director.Corporations:Director fees as self-employment incomeDirectors' feesForm:1040, Schedule CCorporate director feesForm:1040, Schedule C-EZCorporate director feesSelf-employed persons:Corporate directors as
Corporate director fees are self-employment income. Report these payments on Schedule C or Schedule C-EZ (Form 1040).
Personal representatives.Fiduciaries:Fees for servicesPersonal representativesFiduciaries
All personal representatives must include in their gross income fees paid to them from an estate. If you are not in the trade or business of being
an executor (for instance, you are the executor of a friend's or relative's estate), report these fees on Form 1040, line 21. If you are in the trade
or business of being an executor, report these fees as self-employment income on Schedule C or Schedule C-EZ (Form 1040). The fee is not includible in
income if it is waived.
Notary public.Notary fees
Form:1040, Schedule CNotary feesForm:1040, Schedule C-EZNotary feesReport payments for these services on Schedule C or Schedule C-EZ (Form 1040). These payments are not
subject to self-employment tax. (See the separate instructions for Schedule SE (Form 1040) for details.)
Election precinct official.Election precinct officials:Fees, reporting of
Form:W-2:Election precinct officials' feesYou should receive a Form W-2 showing payments for services performed as an election
official or election worker. Report these payments on line 7 of Form 1040 or Form 1040A or on line 1 of Form 1040EZ.
Payments you receive from a state, political subdivision, or a qualified foster care placement agency for providing care to qualified foster
individuals in your home generally are not included in your income. However, you must include in your income payments received for the care of more
than 5 individuals age 19 or older and certain difficulty-of-care payments.
A qualified foster individual is a person who:
Is living in a foster family home, and
Was placed there by:
An agency of a state or one of its political subdivisions, or
These are additional payments that are designated by the payer as compensation for providing the additional care that is required for physically,
mentally, or emotionally handicapped qualified foster individuals. A state must determine that the additional compensation is needed, and the care for
which the payments are made must be provided in your home.
You must include in your income difficulty-of-care payments received for more than:
10 qualified foster individuals under age 19, or
5 qualified foster individuals age 19 or older.
Maintaining space in home.Foster care:Emergency foster care, maintaining space in home for
If you are paid to maintain space in your home for emergency foster care, you must include the payment in your income.
Reporting taxable payments.
Form:1040, Schedule CFoster-care providersForm:1040, Schedule C-EZFoster-care providersIf you receive payments that you must include in your income, you are in business as a
foster-care provider and you are self-employed. Report the payments on Schedule C or Schedule C-EZ (Form 1040). See Publication 587, Business Use of
Your Home (Including Use by Daycare Providers), to help you determine the amount you can deduct for the use of your home.
Found property.Found propertyProperty:Found
If you find and keep property that does not belong to you that has been lost or abandoned (treasure-trove), it is taxable to you at its fair market
value in the first year it is your undisputed possession.
Free tour.Tour guides:Free tour for organizing tour
If you received a free tour from a travel agency for organizing a group of tourists, you must include its value in your income. Report the fair
market value of the tour on Form 1040, line 21, if you are not in the trade or business of organizing tours. You cannot deduct your expenses in
serving as the voluntary leader of the group at the group's request. If you organize tours as a trade or business, report the tour's value on Schedule
C or Schedule C-EZ (Form 1040).
Gambling winnings.Gains and losses:GamblingGambling winnings and lossesGambling winnings and lossesLossesGamblingGambling winnings and lossesLotteries and rafflesGambling winnings and lossesRecordkeeping requirements:Gambling
You must include your gambling winnings in income on Form 1040, line 21. If you itemize your deductions on Schedule A (Form 1040), you can deduct
gambling losses you had during the year, but only up to the amount of your winnings. See chapter 28 for information on recordkeeping.
Lotteries and raffles.Lotteries and raffles:Lotteries and rafflesGambling winnings and lossesRaffles
Winnings from lotteries and raffles are gambling winnings. In addition to cash winnings, you must include in your income the fair market value of
bonds, cars, houses, and other noncash prizes.
If you win a state lottery prize payable in installments, see Publication 525 for more information.
Form W-2G.Form:W-2G:Gambling winnings withholding statement
You may have received a Form W-2G, Certain Gambling Winnings, showing the amount of your gambling winnings and any tax taken out of them. Include
the amount from box 1 on Form 1040, line 21. Include the amount shown in box 2 on Form 1040, line 64, as federal income tax withheld.
Gifts and inheritances.BequestsInheritanceGifts:Not taxedInheritance:Not taxed
Trust beneficiaries:Receiving income from trustGenerally, property you receive as a gift, bequest, or inheritance is not included in your
income. However, if property you receive this way later produces income such as interest, dividends, or rents, that income is taxable to you. If
property is given to a trust and the income from it is paid, credited, or distributed to you, that income is also taxable to you. If the gift,
bequest, or inheritance is the income from the property, that income is taxable to you.
If you inherited a pension or an individual retirement arrangement (IRA), you may have to include part of the inherited amount in your income. See
chapter 10 if you inherited a pension. See chapter 17 if you inherited an IRA.
Hobby losses.Gains and losses:Hobby lossesHobbies:Losses
Losses from a hobby are not deductible from other income. A hobby is an activity from which you do not expect to make a profit. See Activity
not for profit, earlier.
Capital gains or losses:Hobbies, sales from collectionsIf you collect stamps, coins, or other items as a hobby for recreation and pleasure, and you
sell any of the items, your gain is taxable as a capital gain. (See chapter 16.) However, if you sell items from your collection at a loss, you cannot
deduct the loss.
Holocaust victims restitution.Exclusions from gross income:Holocaust victims restitutionHolocaust victims restitution
Restitution payments you receive as a Holocaust victim (or the heir of a Holocaust victim) and interest earned on the payments, including interest
earned on amounts held in certain escrow accounts or funds, are not taxable. You also do not include them in any computations in which you would
ordinarily add excludable income to your adjusted gross income, such as the computation to determine the taxable part of social security benefits. If
the payments are made in property, your basis in the property is its fair market value when you receive it.
Excludable restitution payments are payments or distributions made by any country or any other entity because of persecution of an individual on
the basis of race, religion, physical or mental disability, or sexual orientation by Nazi Germany, any other Axis regime, or any other Nazi-controlled
or Nazi-allied country, whether the payments are made under a law or as a result of a legal action. They include compensation or reparation for
property losses resulting from Nazi persecution, including proceeds under insurance policies issued before and during World War II by European
insurance companies.
Illegal income.Embezzlement:Reporting embezzled fundsIllegal income:Reporting of
Illegal income, such as money from dealing illegal drugs, must be included in your income on Form 1040, line 21, or on Schedule C or Schedule C-EZ
(Form 1040) if from your self-employment activity.
Indian fishing rights.American IndiansIndiansFishermen:Indian fishing rightsIndians:Fishing rightsNative AmericansIndians
If you are a member of a qualified Indian tribe that has fishing rights secured by treaty, executive order, or an Act of Congress as of March 17,
1988, do not include in your income amounts you receive from activities related to those fishing rights. The income is not subject to income tax,
self-employment tax, or employment taxes.
Interest on frozen deposits.Exclusions from gross income:Frozen deposit interestFrozen deposits:Interest onInterest income:Frozen deposits, from
In general, you exclude from your income the amount of interest earned on a frozen deposit. See Interest income on frozen deposits in
chapter 7.
Interest on qualified savings bonds.Exclusions from gross income:Education Savings Bond ProgramInterest income:Savings bondsInterest income:Savings bondsU.S. savings bondsU.S. savings bonds:Interest on
You may be able to exclude from income the interest from qualified U.S. savings bonds you redeem if you pay qualified higher educational expenses
in the same year. For more information on this exclusion, see Education Savings Bond Program under U.S. Savings Bonds in chapter
7.
Job interview expenses.Business expenses:Job search expensesJob search:Deduction of expenses for InterviewsTravel and transportation expenses:Job search expenses
If a prospective employer asks you to appear for an interview and either pays you an allowance or reimburses you for your transportation and other
travel expenses, the amount you receive is generally not taxable. You include in income only the amount you receive that is more than your actual
expenses.
Jury duty.
Employees:Jury duty payIncome:Jury duty payJury duty payJury duty pay you receive must be included in your income on Form 1040, line 21. If you must give the pay to your
employer because your employer continues to pay your salary while you serve on the jury, you can deduct the amount turned over to your employer as an
adjustment to your income. Include the amount you repay your employer on Form 1040, line 36. Enter Jury Pay and the amount on the dotted line
next to line 36.
Kickbacks.Kickbacks
Commissions:Sharing of (kickbacks)Form:1040, Schedule CKickbacksForm:1040, Schedule C-EZKickbacksYou must include kickbacks, side commissions, push money, or similar payments you receive in your income on
Form 1040, line 21, or on Schedule C or Schedule C-EZ (Form 1040), if from your self-employment activity.
Example.
You sell cars and help arrange car insurance for buyers. Insurance brokers pay back part of their commissions to you for referring customers to
them. You must include the kickbacks in your income.
Medical savings accounts (MSAs).
Medical savings accounts (MSAs):MSAsMedical savings accounts (MSAs)Archer MSAsMedical savings accounts (MSAs):Medicare Advantage MSAMedicareMedicare Advantage MSAMedical savings accounts (MSAs)You generally do not include in income amounts you withdraw from your Archer MSA or Medicare
Advantage MSA if you use the money to pay for qualified medical expenses. Generally, qualified medical expenses are those you can deduct on Schedule A
(Form 1040), Itemized Deductions. For more information about qualified medical expenses, see chapter 21. For more information about Archer MSAs or
Medicare Advantage MSAs, see Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans.
Prizes and awards.AwardsPrizes and awardsPrizes and awards:
If you win a prize in a lucky number drawing, television or radio quiz program, beauty contest, or other event, you must include it in your income.
For example, if you win a $50 prize in a photography contest, you must report this income on Form 1040, line 21. If you refuse to accept a prize, do
not include its value in your income.
Prizes and awards in goods or services must be included in your income at their fair market value.
Employee awards or bonuses.AwardsPrizes and awardsBonusesPrizes and awardsBonuses
Cash awards or bonuses given to you by your employer for good work or suggestions generally must be included in your income as wages. However,
certain noncash employee achievement awards can be excluded from income. See Bonuses and awards in chapter 5.
Pulitzer, Nobel, and similar prizes.AwardsPrizes and awardsNobel PrizePrizes and awards:Pulitzer, Nobel, and similar prizesPulitzer Prize
If you were awarded a prize in recognition of accomplishments in religious, charitable, scientific, artistic, educational, literary, or civic
fields, you generally must include the value of the prize in your income. However, you do not include this prize in your income if you meet all of the
following requirements.
You were selected without any action on your part to enter the contest or proceeding.
You are not required to perform substantial future services as a condition to receiving the prize or award.
The prize or award is transferred by the payer directly to a governmental unit or tax-exempt charitable organization as designated by
you.
See Publication 525 for more information about the conditions that apply to the transfer.
A qualified tuition program (also known as a 529 program) is a program set up to allow you to either prepay, or contribute to an account
established for paying, a student's qualified higher education expenses at an eligible educational institution. A program can be established and
maintained by a state, an agency or instrumentality of a state, or an eligible educational institution.
The part of a distribution representing the amount paid or contributed to a QTP is not included in income. This is a return of the investment in
the program.
The beneficiary generally does not include in income any earnings distributed from a QTP if the total distribution is less than or equal to
adjusted qualified higher education expenses. See Publication 970 for more information.
If you receive a reward for providing information, include it in your income.
Sale of home.Exclusions from gross income:Sale of homeSale of home
You may be able to exclude from income all or part of any gain from the sale or exchange of a personal residence. See chapter 15.
Sale of personal items.Sale of property:Personal items
Capital gains or losses:Sale of personal itemsIf you sold an item you owned for personal use, such as a car, refrigerator, furniture, stereo,
jewelry, or silverware, your gain is taxable as a capital gain. Report it on Schedule D (Form 1040). You cannot deduct a loss.
Capital gains or losses:Sale of personal itemsHowever, if you sold an item you held for investment, such as gold or silver bullion, coins, or gems,
any gain is taxable as a capital gain and any loss is deductible as a capital loss.
Example.
You sold a painting on an online auction website for $100. You bought the painting for $20 at a garage sale years ago. Report your gain as a
capital gain on Schedule D (Form 1040).
Scholarships and fellowships.Educational assistanceScholarshipsScholarships and fellowshipsExclusions from gross income:ScholarshipsFellowshipsScholarships and fellowshipsScholarships and fellowships:Exclusion from gross incomeStudentsScholarshipsScholarships and fellowships
A candidate for a degree can exclude amounts received as a qualified scholarship or fellowship. A qualified scholarship or fellowship is any amount
you receive that is for:
Tuition and fees to enroll at or attend an educational institution, or
Fees, books, supplies, and equipment required for courses at the educational institution.
Amounts used for room and board do not qualify for the exclusion. See Publication 970 for more information on qualified scholarships and
fellowship grants.
Payment for services.
Scholarships and fellowships:Teaching or research fellowshipsGenerally, you must include in income the part of any scholarship or fellowship that
represents payment for past, present, or future teaching, research, or other services. This applies even if all candidates for a degree must perform
the services to receive the degree.
For information about the rules that apply to a tax-free qualified tuition reduction provided to employees and their families by an educational
institution, see Publication 970.
VA payments.Veterans' benefits:Educational assistance
Allowances paid by the Department of Veterans Affairs are not included in your income. These allowances are not considered scholarship or
fellowship grants.
Prizes.Prizes and awards:Scholarship prizes
Scholarship prizes won in a contest are not scholarships or fellowships if you do not have to use the prizes for educational purposes. You must
include these amounts in your income on Form 1040, line 21, whether or not you use the amounts for educational purposes.
If you steal property, you must report its fair market value in your income in the year you steal it unless in the same year, you return it to its
rightful owner.
Transporting school children.CarsTravel and transportationChildren:Transporting school childrenTravel and transportation expenses:School children, transporting of
Do not include in your income a school board mileage allowance for taking children to and from school if you are not in the business of taking
children to school. You cannot deduct expenses for providing this transportation.
Union benefits and dues.Labor unions:Dues and feesUnionsLabor unions
Amounts deducted from your pay for union dues, assessments, contributions, or other payments to a union cannot be excluded from your income.
You may be able to deduct some of these payments as a miscellaneous deduction subject to the 2% of AGI limit if they are related to your job and if
you itemize deductions on Schedule A (Form 1040). For more information, see Union Dues and Expenses in chapter 28.
Strike and lockout benefits.Exclusions from gross income:Strike benefitsLabor unions:Strike and lockout benefitsLockout benefitsStrike benefitsUnionsLabor unions
Benefits paid to you by a union as strike or lockout benefits, including both cash and the fair market value of other property, are usually
included in your income as compensation. You can exclude these benefits from your income only when the facts clearly show that the union intended them
as gifts to you.
Income:If you are a customer of an electric utility company and you participate in the utility's energy conservation
program, you may receive on your monthly electric bill either:
A reduction in the purchase price of electricity furnished to you (rate reduction), or
A nonrefundable credit against the purchase price of the electricity.
Exclusions from gross income:Energy conservation subsidiesUtilities:Energy conservation subsidiesThe amount of the rate reduction or nonrefundable credit is not included in your income.
Gains and Losses
The four chapters in this part discuss investment gains and losses, including how to figure your basis in property. A gain from selling or trading
stocks, bonds, or other investment property may be taxed or it may be tax free, at least in part. A loss may or may not be deductible. These chapters
also discuss gains from selling property you personally use — including the special rules for selling your home. Nonbusiness casualty and theft
losses are discussed in chapter 25 in Part Five.
Basis of PropertyValuations
This chapter discusses how to figure your basis in property. It is divided into the following sections.
Cost basis.
Adjusted basis.
Basis other than cost.
Basis:Definition ofYour basis is the amount of your investment in property for tax purposes. Use the basis to figure gain or loss
on the sale, exchange, or other disposition of property. Also use it to figure deductions for depreciation, amortization, depletion, and casualty
losses.
Basis:Allocation between business and personal useIf you use property for both business or investment purposes and for personal
purposes, you must allocate the basis based on the use. Only the basis allocated to the business or investment use of the property can be depreciated.
Your original basis in property is adjusted (increased or decreased) by certain events. For example, if you make improvements to the property,
increase your basis. If you take deductions for depreciation or casualty losses, or claim certain credits, reduce your basis.
Keep accurate records of all items that affect the basis of your property. For more information on keeping records, see chapter 1.
PublicationBasis:Cost basisCost basis15-BEmployer's Tax Guide to Fringe Benefits525Taxable and Nontaxable Income535Business Expenses537Installment Sales544Sales and Other Dispositions of Assets550Investment Income and Expenses551Basis of Assets564Mutual Fund Distributions946How To Depreciate Property
Cost BasisSales tax:Basis to includeTaxesSales tax
The basis of property you buy is usually its cost. The cost is the amount you pay in cash, debt obligations, other property, or services. Your cost
also includes amounts you pay for the following items:
Sales tax (less any applicable sales tax claimed on Schedule A (Form 1040)), 108-357, sec 501">
Freight,Freight:Basis to include
Installation and testing,
Excise taxes,
Excise taxes:Basis to include
Legal and accounting fees (when they must be capitalized),
Accountants:Basis to include fees ofAttorneys' fees:Basis to include
Revenue stamps,
Revenue stamps:Basis to include
Recording fees, and
Recording fees:Basis to include
Real estate taxes (if you assume liability for the seller).
Real estate:TaxesReal estate taxesReal estate taxes:Basis of property andIn addition, the basis of real estate and business assets may include other items.
Loans with low or no interest.
Interest payments:Unstated interestUnstated interestIf you buy property on a time-payment plan that charges little or no interest, the basis of your property is
your stated purchase price minus any amount considered to be unstated interest. You generally have unstated interest if your interest rate is less
than the applicable federal rate.
For more information, see Unstated Interest and Original Issue Discount (OID) in Publication 537.
Real PropertyReal estate:BasisBasis:Real estateLandReal estatePropertyReal estate:Definition of
Real property, also called real estate, is land and generally anything built on, growing on, or attached to land.
If you buy real property, certain fees and other expenses you pay are part of your cost basis in the property.
Lump sum purchase.
If you buy buildings and the land on which they stand for a lump sum, allocate the cost basis among the land and the buildings. Allocate the cost
basis according to the respective fair market values (FMVs) of the land and buildings at the time of purchase. Figure the basis of each asset by
multiplying the lump sum by a fraction. The numerator is the FMV of that asset and the denominator is the FMV of the whole property at the time of
purchase.
If you are not certain of the FMVs of the land and buildings, you can allocate the basis according to their assessed values for real estate tax
purposes.
Fair market value (FMV).Fair market value (FMV):Definition ofReal estate:Fair market value (FMV)ValuationsFair market value (FMV)
FMV is the price at which the property would change hands between a willing buyer and a willing seller, neither having to buy or sell, and both
having reasonable knowledge of all the necessary facts. Sales of similar property on or about the same date may be helpful in figuring the FMV of the
property.
Assumption of mortgage.Assumption of mortgageMortgages:Assumption of
If you buy property and assume (or buy the property subject to) an existing mortgage on the property, your basis includes the amount you pay for
the property plus the amount to be paid on the mortgage.
Your basis includes the settlement fees and closing costs you paid for buying the property. (A fee for buying property is a cost that must be paid
even if you buy the property for cash.) Do not include fees and costs for getting a loan on the property in your basis.
The following are some of the settlement fees or closing costs you can include in the basis of your property:
Abstract fees (abstract of title fees);
Title to property:Abstract fees, property basis to include
Charges for installing utility services;
Utilities:Charges for installing included in property basis
Legal fees (including fees for the title search and preparation of the sales contract and deed);
Attorneys' fees:Title to property, for preparation, filing, etc.Title to property:Attorneys' fees:Property basis to include
Recording fees;
Survey fees;
Surveys:Property basis to include
Transfer taxes;
Transfer taxes:Property basis to include
Owner's title insurance; and
Title insurance:Property basis to include
Any amounts the seller owes that you agree to pay, such as back taxes or interest, recording or mortgage fees, charges for improvements or
repairs, and sales commissions.
Commissions:Property basis to include when buyer paysRepairs:Basis, effect on
Settlement costs do not include amounts placed in escrow for the future payment of items such as taxes and insurance.
The following are some of the settlement fees and closing costs you cannot include in the basis of property:
Casualty insurance premiums;
Casualty insurance:Premiums not in property basisInsurance premiums:Casualty insurance
Rent for occupancy of the property before closing;
Rental income and expenses:Purchaser's payment of rent, not included in property basis
Charges for utilities or other services related to occupancy of the property before closing;
Charges connected with getting a loan, such as points (discount points, loan origination fees), mortgage insurance premiums, loan assumption
fees, cost of a credit report, and fees for an appraisal required by a lender; and
Basis:Points not to be includedPoints:Basis in property not to includeMortgage insurance premiums:Basis in property not to includeAssumption of mortgage:Fees not included in basisMortgages:Assumption of:Fees not included in basisCredit reports:Costs not included in property basisAppraisal fees:Real estate transactions, when required by lender
Fees for refinancing a mortgage.
Refinancing:Fees for, not part of property basis
Real estate taxes.Real estate taxes:Basis of property and:When not reimbursed by property seller
If you pay real estate taxes the seller owed on real property you bought, and the seller did not reimburse you, treat those taxes as part of your
basis. You cannot deduct them as an expense.
Deeds:Recording fees, basis to includeIf you reimburse the seller for taxes the seller paid for you, you can usually deduct that
amount as an expense in the year of purchase. Do not include that amount in the basis of your property. If you did not reimburse the seller, you must
reduce your basis by the amount of those taxes.
Points.Basis:Points not to be includedPoints:Basis in property not to include
If you pay points to get a loan (including a mortgage, second mortgage, line of credit, or a home equity loan), do not add the points to the basis
of the related property. Generally, you deduct the points over the term of the loan. For more information on how to deduct points, see chapter 23.
Points on home mortgage.HomePointsPoints:Main home purchase, special treatment of
Special rules may apply to points you and the seller pay when you get a mortgage to buy your main home. If certain requirements are met, you can
deduct the points in full for the year in which they are paid. Reduce the basis of your home by any seller-paid points.
Adjusted BasisAdjusted basisBasis:Adjusted basis
Before figuring gain or loss on a sale, exchange, or other disposition of property or figuring allowable depreciation, depletion, or amortization,
you must usually make certain adjustments (increases and decreases) to the cost of the property. The result is the adjusted basis.
Increases to BasisAdjusted basis:Increases to basis
Increase the basis of any property by all items properly added to a capital account. Examples of items that increase basis are shown in Table 13-1.
The following discussions provide information about many of these items.
Improvements.Adjusted basis:ImprovementsBasis:Improvements to real estateImprovements:Real estate, adjustments to basis for
Add to your basis in property the cost of improvements having a useful life of more than 1 year, that increase the value of the property, lengthen
its life, or adapt it to a different use. For example, improvements include putting a recreation room in your unfinished basement, adding another
bathroom or bedroom, putting up a fence, putting in new plumbing or wiring, installing a new roof, or paving your driveway.
Assessments for local improvements.Adjusted basis:Local assessmentsLocal assessments:Adjusted basis forReal estate taxes:AssessmentsLocal assessments
Add to the basis of property assessments for improvements such as streets and sidewalks if they increase the value of the property assessed. Do not
deduct them as taxes. However, you can deduct as taxes assessments for maintenance or repairs, or for meeting interest charges related to the
improvements.
Example.
Your city changes the street in front of your store into an enclosed pedestrian mall and assesses you and other affected property owners for the
cost of the conversion. Add the assessment to your property's basis. In this example, the assessment is a depreciable asset.
Decreases to BasisAdjusted basis:Decreases to basis
Decrease the basis of any property by all items that represent a return of capital for the period during which you held the property. Examples of
items that decrease basis are shown in Table 13-1. These include the items discussed below.
<ROM>Table 13-1.</ROM> Examples of Adjustments to BasisAdjusted basis:Examples (Table 13-1)Tables and figures:Adjusted basis, examples of (Table 13-1)Increases to BasisDecreases to Basis• Capital improvements:• Exclusion from income of Putting an addition on your home subsidies for energy conservation Replacing an entire roof measuresPaving your drivewayInstalling central air conditioning• Casualty or theft loss deductions Rewiring your home and insurance reimbursements• Assessments for local improvements:• Credit for qualified electric vehiclesWater connectionsExtending utility service lines to the
property• Postponed gain from the sale of a homeSidewalks • Deduction for clean-fuel vehicles andRoads clean-fuel vehicle refueling property• Casualty losses:• Depreciation and section 179 deductionRestoring damaged property• Nontaxable corporate distributions• Legal fees: Cost of defending and perfecting a title• Certain canceled debt excluded fromFees for getting a reduction of an assessment income• Zoning costs• Easements• Adoption tax benefits
Casualty and theft losses.Casualty losses:Adjusted basis in propertyTheft losses:Adjusted basis in property
If you have a casualty or theft loss, decrease the basis in your property by any insurance proceeds or other reimbursement and by any deductible
loss not covered by insurance.
Repairs:Basis, effect onYou must increase your basis in the property by the amount you spend on repairs that substantially prolong
the life of the property, increase its value, or adapt it to a different use. To make this determination, compare the repaired property to the
property before the casualty.
For more information on casualty and theft losses, see chapter 25.
Depreciation and section 179 deduction.Adjusted basis:DepreciationAdjusted basis:Section 179 deductionDeductions:DepreciationDeductions:Section 179 deductions:Adjustment to basis forDepreciation:Adjustment to basis forFirst-year expensingSection 179 deductionsSection 179 deductions:Adjustment to basis for
Decrease the basis of your qualifying business property by any section 179 deduction you take and the depreciation you deducted, or could have
deducted (including any special depreciation allowance), on your tax returns under the method of depreciation you selected.
For more information about depreciation and the section 179 deduction, see Publication 946.
Example.
You owned a duplex used as rental property that cost you $40,000, of which $35,000 was allocated to the building and $5,000 to the land. You added
an improvement to the duplex that cost $10,000. In February last year, the duplex was damaged by fire. Up to that time, you had been allowed
depreciation of $23,000. You sold some salvaged material for $1,300 and collected $19,700 from your insurance company. You deducted a casualty loss of
$1,000 on your income tax return for last year. You spent $19,000 of the insurance proceeds for restoration of the duplex, which was completed this
year. You must use the duplex's adjusted basis after the restoration to determine depreciation for the rest of the property's recovery period. Figure
the adjusted basis of the duplex as follows:
Original cost of duplex$35,000Addition to duplex10,000Total cost of duplex$45,000Minus:Depreciation23,000Adjusted basis before casualty$22,000Minus:Insurance proceeds$19,700Deducted casualty loss1,000Salvage proceeds 1,300 22,000Adjusted basis after casualty$-0-Add: Cost of restoring duplex19,000Adjusted basis after restoration$19,000
Note.
Your basis in the land is its original cost of $5,000.
Easements.Adjusted basis:EasementsEasements:Adjustment to basis for
The amount you receive for granting an easement is generally considered to be proceeds from the sale of an interest in real property. It reduces
the basis of the affected part of the property. If the amount received is more than the basis of the part of the property affected by the easement,
reduce your basis in that part to zero and treat the excess as a recognized gain.
If the gain is on a capital asset, see chapter 16 for information about how to report it. If the gain is on property used in a trade or business,
see Publication 544 for information about how to report it.
Credit for qualified electric vehicles.Adjusted basis:Electric vehicle creditElectric cars:Credits:Adjustment to basis
If you claim the credit for a qualified electric vehicle, you must reduce your basis in that vehicle by the maximum credit allowable even if the
credit allowed is less than that maximum amount. For information on this credit, see chapter 12 in Publication 535.
Deduction for clean-fuel vehicle and refueling property.Adjusted basis:Clean-fuel vehicle and refueling propertyAlternative motor vehicle creditClean-fuel vehiclesDeductions:Clean-fuel vehiclesAlternative motor vehicle creditFuels:Clean-fuel vehicles
If you take the deduction for clean-fuel vehicles or clean-fuel vehicle refueling property placed in service in 2005, decrease the basis of the
property by the amount deducted. For more information about this deduction, see chapter 12 in Publication 535.
Exclusion of subsidies for energy conservation measures.Adjusted basis:Energy conservation subsidies exclusionEnergy conservation:Subsidies:Exclusion as adjustment to basis
You can exclude from gross income any subsidy you received from a public utility company for the purchase or installation of an energy conservation
measure for a dwelling unit. Reduce the basis of the property for which you received the subsidy by the excluded amount. For more information about
this subsidy, see chapter 12.
Postponed gain from sale of home.Postponement of gain:Sale of home:Adjusted basisSale of home:Postponed gain from
Adjusted basisIf you postponed gain from the sale of your main home under rules in effect before May 7, 1997, you
must reduce the basis of the home you acquired as a replacement by the amount of the postponed gain. For more information on the rules for the sale of
a home, see chapter 15.
Basis Other Than CostBasis:Other than cost
There are many times when you cannot use cost as basis. In these cases, the fair market value or the adjusted basis of the property can be used.
Fair market value (FMV) and adjusted basis were discussed earlier.
Property Received
for ServicesBasis:Property received for servicesServices:Property received for
If you receive property for your services, include its FMV in income. The amount you include in income becomes your basis. If the services were
performed for a price agreed on beforehand, it will be accepted as the FMV of the property if there is no evidence to the contrary.
Restricted property.Basis:Restricted property
If you receive property for your services and the property is subject to certain restrictions, your basis in the property is its FMV when it
becomes substantially vested. However, this rule does not apply if you make an election to include in income the FMV of the property at the time it is
transferred to you, less any amount you paid for it. Property is substantially vested when it is transferable or when it is not subject to a
substantial risk of forfeiture (you do not have a good chance of losing it). For more information, see Restricted Property in Publication
525.
Bargain purchases.Bargain sales:Basis of purchaseBasis:Bargain purchases
A bargain purchase is a purchase of an item for less than its FMV. If, as compensation for services, you buy goods or other property at less than
FMV, include the difference between the purchase price and the property's FMV in your income. Your basis in the property is its FMV (your purchase
price plus the amount you include in income).
Discounts:Employee discounts, effect on basisEmployees:Discounts for, effect on basisIf the difference between your purchase price and the FMV is a qualified employee discount,
do not include the difference in income. However, your basis in the property is still its FMV. See Employee Discounts in Publication 15-B.
Taxable ExchangesExchanges:Taxable exchange, definedTaxable exchanges:Definition ofTrade of property:Taxable exchange, defined
A taxable exchange is one in which the gain is taxable or the loss is deductible. A taxable gain or deductible loss also is known as a recognized
gain or loss. If you receive property in exchange for other property in a taxable exchange, the basis of the property you receive is usually its FMV
at the time of the exchange.
Involuntary ConversionsBasis:Involuntary conversionCasualty losses:Adjusted basis in propertyCondemnation of property:Basis computationInvoluntary conversion:Basis computationTheft losses:Adjusted basis in propertyCasualty losses:Adjusted basis in propertyTheft losses:Adjusted basis in property
If you receive replacement property as a result of an involuntary conversion, such as a casualty, theft, or condemnation, figure the basis of the
replacement property using the basis of the converted property.
Similar or related property.
If you receive replacement property similar or related in service or use to the converted property, the replacement property's basis is the same as
the converted property's basis on the date of the conversion, with the following adjustments.
Decrease the basis by the following.
Any loss you recognize on the involuntary conversion.
Any money you receive that you do not spend on similar property.
Increase the basis by the following.
Any gain you recognize on the involuntary conversion.
Any cost of acquiring the replacement property.
Money or property not similar or related.
If you receive money or property not similar or related in service or use to the converted property, and you buy replacement property similar or
related in service or use to the converted property, the basis of the replacement property is its cost decreased by the gain not recognized on the
conversion.
Example.
The state condemned your property. The adjusted basis of the property was $26,000 and the state paid you $31,000 for it. You realized a gain of
$5,000 ($31,000 − $26,000). You bought replacement property similar in use to the converted property for $29,000. You recognize a gain of $2,000
($31,000 − $29,000), the unspent part of the payment from the state. Your unrecognized gain is $3,000, the difference between the $5,000
realized gain and the $2,000 recognized gain. The basis of the replacement property is figured as follows:
Cost of replacement property$29,000Minus: Gain not recognized3,000Basis of replacement property$26,000
Allocating the basis.
If you buy more than one piece of replacement property, allocate your basis among the properties based on their respective costs.
Basis for depreciation.Involuntary conversion:Basis for depreciation
Special rules apply in determining and depreciating the basis of MACRS property acquired in an involuntary conversion. For information, see
What Is the Basis of Your Depreciable Property? in chapter 1 of Publication 946.
Nontaxable ExchangesTrade of property:Nontaxable exchangesExchanges:Tax-free:Definition ofNontaxable tradesTax-free exchangesTax-free exchanges:Definition of
A nontaxable exchange is an exchange in which you are not taxed on any gain and you cannot deduct any loss. If you receive property in a nontaxable
exchange, its basis is generally the same as the basis of the property you transferred. See Nontaxable Trades in chapter 14.
Like-Kind ExchangesExchanges:Like-kind exchangesLike-kind exchanges:QualificationsTrade of property:Like-kind exchanges
The exchange of property for the same kind of property is the most common type of nontaxable exchange. To qualify as a like-kind exchange, the
property traded and the property received must be both of the following.
Qualifying property.
Like-kind property.
The basis of the property you receive is generally the same as the adjusted basis of the property you gave up. If you trade property in a like-kind
exchange and also pay money, the basis of the property received is the adjusted basis of the property you gave up increased by the money you paid.
Qualifying property.
In a like-kind exchange, you must hold for investment or for productive use in your trade or business both the property you give up and the
property you receive.
Like-kind property.
There must be an exchange of like-kind property. Like-kind properties are properties of the same nature or character, even if they differ in grade
or quality. The exchange of real estate for real estate and personal property for similar personal property are exchanges of like-kind property.
Example.
You trade in an old truck used in your business with an adjusted basis of $1,700 for a new one costing $6,800. The dealer allows you $2,000 on the
old truck, and you pay $4,800. This is a like-kind exchange. The basis of the new truck is $6,500 (the adjusted basis of the old one, $1,700, plus the
amount you paid, $4,800).
If you sell your old truck to a third party for $2,000 instead of trading it in and then buy a new one from the dealer, you have a taxable gain of
$300 on the sale (the $2,000 sale price minus the $1,700 adjusted basis). The basis of the new truck is the price you pay the dealer.
Partially nontaxable exchanges.Exchanges:Partially nontaxable exchangeTrade of property:Like property and money transferredTrade of property:Partially nontaxable exchange
A partially nontaxable exchange is an exchange in which you receive unlike property or money in addition to like-kind property. The basis of the
property you receive is the same as the adjusted basis of the property you gave up, with the following adjustments.
Decrease the basis by the following amounts.
Any money you receive.
Any loss you recognize on the exchange.
Increase the basis by the following amounts.
Any additional costs you incur.
Any gain you recognize on the exchange.
If the other party to the exchange assumes your liabilities, treat the debt assumption as money you received in the exchange.
Allocation of basis.
If you receive like-kind and unlike properties in the exchange, allocate the basis first to the unlike property, other than money, up to its FMV on
the date of the exchange. The rest is the basis of the like-kind property.
More information.
See Like-Kind Exchanges in chapter 1 of Publication 544 for more information.
Basis for depreciation.Like-kind exchanges:Basis for depreciation
Special rules apply in determining and depreciating the basis of MACRS property acquired in a like-kind exchange. For information, see What Is
the Basis of Your Depreciable Property? in chapter 1 of Publication 946.
Property Transferred
From a SpouseBasis:Transfers between spousesMarried taxpayers:Transfers between spouses
Divorced taxpayers:Transfers between spousesThe basis of property transferred to you or transferred in trust for your benefit by your spouse
is the same as your spouse's adjusted basis. The same rule applies to a transfer by your former spouse that is incident to divorce. However, for
property transferred in trust, adjust your basis for any gain recognized by your spouse or former spouse if the liabilities assumed, plus the
liabilities to which the property is subject, are more than the adjusted basis of the property transferred.
EE series bondsU.S. savings bondsSeries EE and E savings bondsU.S. savings bondsU.S. savings bonds:Transfer between spouses
If the property transferred to you is a series E, series EE, or series I U.S. savings bond, the transferor must include in income the interest
accrued to the date of transfer. Your basis in the bond immediately after the transfer is equal to the transferor's basis increased by the interest
income includible in the transferor's income. For more information on these bonds, see chapter 7.
At the time of the transfer, the transferor must give you the records needed to determine the adjusted basis and holding period of the property as
of the date of the transfer.
For more information about the transfer of property from a spouse, see chapter 14.
Property Received
as a GiftAdjusted basis:GiftsBasis:GiftsGifts:Adjusted basis for
To figure the basis of property you receive as a gift, you must know its adjusted basis to the donor just before it was given to you, its FMV at
the time it was given to you, and any gift tax paid on it.
FMV less than donor's adjusted basis.
If the FMV of the property at the time of the gift is less than the donor's adjusted basis, your basis depends on whether you have a gain or a loss
when you dispose of the property. Your basis for figuring gain is the same as the donor's adjusted basis plus or minus any required adjustments to
basis while you held the property. Your basis for figuring loss is its FMV when you received the gift plus or minus any required adjustments to basis
while you held the property. See Adjusted Basis, earlier.
Example.
You received an acre of land as a gift. At the time of the gift, the land had an FMV of $8,000. The donor's adjusted basis was $10,000. After you
received the property, no events occurred to increase or decrease your basis. If you later sell the property for $12,000, you will have a $2,000 gain
because you must use the donor's adjusted basis at the time of the gift ($10,000) as your basis to figure gain. If you sell the property for $7,000,
you will have a $1,000 loss because you must use the FMV at the time of the gift ($8,000) as your basis to figure loss.
If the sales price is between $8,000 and $10,000, you have neither gain nor loss.
Business property.Business property:As gift, adjusted basis for
If you hold the gift as business property, your basis for figuring any depreciation, depletion, or amortization deductions is the same as the
donor's adjusted basis plus or minus any required adjustments to basis while you hold the property.
FMV equal to or greater than donor's adjusted basis.
If the FMV of the property is equal to or greater than the donor's adjusted basis, your basis is the donor's adjusted basis at the time you
received the gift. Increase your basis by all or part of any gift tax paid, depending on the date of the gift, explained later.
Also, for figuring gain or loss from a sale or other disposition or for figuring depreciation, depletion, or amortization deductions on business
property, you must increase or decrease your basis (the donor's adjusted basis) by any required adjustments to basis while you held the property. See
Adjusted Basis, earlier.
If you received a gift during the tax year, increase your basis in the gift (the donor's adjusted basis) by the part of the gift tax paid on it due
to the net increase in value of the gift. Figure the increase by multiplying the gift tax paid by a fraction. The numerator of the fraction is the net
increase in value of the gift and the denominator is the amount of the gift.
The net increase in value of the gift is the FMV of the gift minus the donor's adjusted basis. The amount of the gift is its value for gift tax
purposes after reduction by any annual exclusion and marital or charitable deduction that applies to the gift. For information on the gift tax, see
Publication 950, Introduction to Estate and Gift Taxes.
Example.
In 2005, you received a gift of property from your mother that had an FMV of $50,000. Her adjusted basis was $20,000. The amount of the gift for
gift tax purposes was $39,000 ($50,000 minus the $11,000 annual exclusion). She paid a gift tax of $9,000 on the property. Your basis is $26,930,
figured as follows:
Fair market value$50,000Minus: Adjusted basis−20,000Net increase in value$30,000Gift tax paid$9,000Multiplied by ($30,000 ÷ $39,000)× .77Gift tax due to net increase in value$6,930Adjusted basis of property to your mother+20,000Your basis in the property$26,930
Note.
If you received a gift before 1977, your basis in the gift (the donor's adjusted basis) includes any gift tax paid on it. However, your basis
cannot exceed the FMV of the gift at the time it was given to you.
Inherited PropertyBasis:InheritanceEstate beneficiariesInheritanceInheritance:Adjusted basis for
Your basis in property you inherit from a decedent is generally one of the following.
The FMV of the property at the date of the decedent's death.
The FMV on the alternate valuation date if the personal representative for the estate elects to use alternate valuation.
The value under the special-use valuation method for real property used in farming or a closely held business if elected for estate tax
purposes.
The decedent's adjusted basis in land to the extent of the value excluded from the decedent's taxable estate as a qualified conservation
easement.
If a federal estate tax return does not have to be filed, your basis in the inherited property is its appraised value at the date of death for
state inheritance or transmission taxes.
For more information, see the instructions to Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return.
Community property.Community property
In community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin), husband and wife are
each usually considered to own half the community property. When either spouse dies, the total value of the community property, even the part
belonging to the surviving spouse, generally becomes the basis of the entire property. For this rule to apply, at least half the value of the
community property interest must be includible in the decedent's gross estate, whether or not the estate must file a return.
Example.
You and your spouse owned community property that had a basis of $80,000. When your spouse died, half the FMV of the community interest was
includible in your spouse's estate. The FMV of the community interest was $100,000. The basis of your half of the property after the death of your
spouse is $50,000 (half of the $100,000 FMV). The basis of the other half to your spouse's heirs is also $50,000.
For more information about community property, see Publication 555, Community Property.
Property Changed to Business or Rental UseBusiness property:Property use changed to, adjusted basis forRental income and expenses:Change of property to rental use
If you hold property for personal use and then change it to business use or use it to produce rent, you can begin to depreciate the property at the
time of the change. To do so, you must figure its basis for depreciation. An example of changing property held for personal use to business or rental
use would be renting out your former personal residence.
Basis for depreciation.Business property:Basis for depreciationDepreciation:Change of use of property
The basis for depreciation is the lesser of the following amounts.
The FMV of the property on the date of the change.
Your adjusted basis on the date of the change.
Example.
Several years ago, you paid $160,000 to have your house built on a lot that cost $25,000. You paid $20,000 for permanent improvements to the house
and claimed a $2,000 casualty loss deduction for damage to the house before changing the property to rental use last year. Because land is not
depreciable, you include only the cost of the house when figuring the basis for depreciation.
Your adjusted basis in the house when you changed its use was $178,000 ($160,000 + $20,000 − $2,000). On the same date, your property had an
FMV of $180,000, of which $15,000 was for the land and $165,000 was for the house. The basis for figuring depreciation on the house is its FMV on the
date of the change ($165,000) because it is less than your adjusted basis ($178,000).
Sale of property.Sale of property:Business property that has undergone change of useSale of property:Rental property that has undergone change of use
If you later sell or dispose of property changed to business or rental use, the basis you use will depend on whether you are figuring gain or loss.
Gain.
The basis for figuring a gain is your adjusted basis in the property when you sell the property.
Example.
Assume the same facts as in the previous example except that you sell the property at a gain after being allowed depreciation deductions of
$37,500. Your adjusted basis for figuring gain is $165,500 ($178,000 + $25,000 (land) − $37,500).
Loss.
Figure the basis for a loss starting with the smaller of your adjusted basis or the FMV of the property at the time of the change to business or
rental use. Then make adjustments (increases and decreases) for the period after the change in the property's use, as discussed earlier under
Adjusted Basis.
Example.
Assume the same facts as in the previous example, except that you sell the property at a loss after being allowed depreciation deductions of
$37,500. In this case, you would start with the FMV on the date of the change to rental use ($180,000), because it is less than the adjusted basis of
$203,000 ($178,000 + $25,000 (land)) on that date. Reduce that amount ($180,000) by the depreciation deductions ($37,500). The basis for loss is
$142,500 ($180,000 − $37,500).
Stocks and BondsBasis:BondsBonds:Adjusted basis forSecurities:Adjusted basis for
The basis of stocks or bonds you buy generally is the purchase price plus any costs of purchase, such as commissions and recording or transfer
fees. If you get stocks or bonds other than by purchase, your basis is usually determined by the FMV or the previous owner's adjusted basis, as
discussed earlier.
You must adjust the basis of stocks for certain events that occur after purchase. For example, if you receive additional stock from nontaxable
stock dividends or stock splits, reduce your basis for each share of stock by dividing the adjusted basis of the old stock by the number of shares of
old and new stock. This rule applies only when the additional stock received is identical to the stock held. Also reduce your basis when you receive
nontaxable distributions. They are a return of capital.
Example.
In 2003 you bought 100 shares of XYZ stock for $1,000 or $10 a share. In 2004 you bought 100 shares of XYZ stock for $1,600 or $16 a share. In 2005
XYZ declared a 2-for-1 stock split. You now have 200 shares of stock with a basis of $5 a share and 200 shares with a basis of $8 a share.
Other basis.
There are other ways to figure the basis of stocks or bonds depending on how you acquired them. For detailed information, see Stocks and
Bonds under Basis of Investment Property in chapter 4 of Publication 550.
Identifying stocks or bonds sold.
If you can adequately identify the shares of stock or the bonds you sold, their basis is the cost or other basis of the particular shares of stocks
or bonds. If you buy and sell securities at various times in varying quantities and you cannot adequately identify the shares you sell, the basis of
the securities you sell is the basis of the securities you acquired first. For more information about identifying securities you sell, see Stocks
and Bonds under Basis of Investment Property in chapter 4 of Publication 550.
Mutual fund shares.Mutual funds:Adjusted basis of shares
If you sell mutual fund shares you acquired at various times and prices and left on deposit in an account kept by a custodian or agent, you can
elect to use an average basis. For more information, see Publication 564.
Bond premium.Basis:BondsBonds:Sold at premium, computation of adjusted basisDebt instrumentsBonds or Notes
If you buy a taxable bond at a premium and elect to amortize the premium, reduce the basis of the bond by the amortized premium you deduct each
year. See Bond Premium Amortization in chapter 3 of Publication 550 for more information. Although you cannot deduct the premium on a
tax-exempt bond, you must amortize the premium each year and reduce your basis in the bond by the amortized amount.
Original issue discount (OID) on debt instruments.Original issue discount (OID):Adjusted basis and
You must increase your basis in an OID debt instrument by the OID you include in income for that instrument. See Original Issue Discount
(OID) in chapter 7 and Publication 1212, List of Original Issue Discount Instruments.
Basis:Other than costOID on tax-exempt obligations is generally not taxable. However, when you dispose of a tax-exempt obligation
issued after September 3, 1982, and acquired after March 1, 1984, you must accrue OID on the obligation to determine its adjusted basis. The accrued
OID is added to the basis of the obligation to determine your gain or loss. See chapter 4 of Publication 550.
Sale of PropertySale of propertyTrade of propertySale of propertyReminderForeign income.Foreign income:Sale of foreign property
If you are a U.S. citizen who sells property located outside the United States, you must report all gains and losses from the sale of that property
on your tax return unless it is exempt by U.S. law. This is true whether you reside inside or outside the United States and whether or not you receive
a Form 1099 from the payer.
This chapter discusses the tax consequences of selling or trading investment property. It explains:
What a sale or trade is,
Figuring gain or loss,
Nontaxable trades,
Related party transactions,
Capital gains or losses,
Capital assets and noncapital assets,
Holding period, and
Rollover of gain from publicly traded securities.
Other property transactions.
Certain transfers of property are not discussed here. They are discussed in other IRS publications. These include:
Installment sales, covered in Publication 537, Installment Sales,
Installment sales
Transfers of property at death, covered in Publication 559, Survivors, Executors, and Administrators,
Decedents:Transfer of property at death
Transactions involving business property, covered in Publication 544, Sales and Other Dispositions of Assets,
Business property:Sales or exchanges
Dispositions of an interest in a passive activity, covered in Publication 925, Passive Activity and At-Risk Rules, and
Passive activity
Sales of a main home, covered in chapter 15.
Wash salesPublication 550, Investment Income and Expenses (Including Capital Gains and Losses), provides more detailed
discussion about sales and trades of investment property. Publication 550 includes information about the rules covering nonbusiness bad debts,
straddles, section 1256 contracts, puts and calls, commodity futures, short sales, and wash sales. It also discusses investment-related expenses.
Publication550 Investment Income and Expenses564 Mutual Fund DistributionsForm (and Instructions)Capital Gains and LossesLike-Kind Exchanges
Sales and TradesBrokers:Form 1099-BForm:1099-B:Broker to report sales of stocks, bonds, or commodities
If you sold property such as stocks, bonds, or certain commodities through a broker during the year, you should receive, for each sale, a Form
1099-B, Proceeds From Broker and Barter Exchange Transactions, or an equivalent statement from the broker. You should receive the statement by January
31 of the next year. It will show the gross proceeds from the sale. The IRS will also get a copy of Form 1099-B from the broker.
Sale of property:Form 1099-BUse Form 1099-B (or an equivalent statement received from your broker) to complete Schedule D (Form 1040).
What Is a Sale or Trade?ExchangesTrade of propertySale of property:Definition ofTrade of property:Definition of
This section explains what is a sale or trade. It also explains certain transactions and events that are treated as sales or trades.
A sale is generally a transfer of property for money or a mortgage, note, or other promise to pay money.
A trade is a transfer of property for other property or services and may be taxed in the same way as a sale.
Sale and purchase.
Ordinarily, a transaction is not a trade when you voluntarily sell property for cash and immediately buy similar property to replace it. The sale
and purchase are two separate transactions. But see Like-kind exchanges under Nontaxable Trades, later.
Redemption of stock.Redemption of stockSale of property:Redemption of stockSecurities:Redemption of stock
A redemption of stock is treated as a sale or trade and is subject to the capital gain or loss provisions unless the redemption is a dividend or
other distribution on stock.
Dividend versus sale or trade.Dividends:Redemption treated as
Whether a redemption is treated as a sale, trade, dividend, or other distribution depends on the circumstances in each case. Both direct and
indirect ownership of stock will be considered. The redemption is treated as a sale or trade of stock if:
The redemption is not essentially equivalent to a dividend (see chapter 8),
There is a substantially disproportionate redemption of stock,
There is a complete redemption of all the stock of the corporation owned by the shareholder, or
The redemption is a distribution in partial liquidation of a corporation.
Redemption or retirement of bonds.Bonds:Redemption ofBonds:Retirement ofRedemption of bondsRetirement of bonds
A redemption or retirement of bonds or notes at their maturity is generally treated as a sale or trade.
Surrender of stock.Securities:Surrender of stock
A surrender of stock by a dominant shareholder who retains control of the corporation is treated as a contribution to capital rather than as an
immediate loss deductible from taxable income. The surrendering shareholder must reallocate his or her basis in the surrendered shares to the shares
he or she retains.
Securities:Stock rights:WorthlessStocks, stock rights, and bonds (other than those held for sale by a securities dealer) that became worthless
during the tax year are treated as though they were sold on the last day of the tax year. This affects whether your capital loss is long-term or
short-term. See Holding Period, later.
Cash method taxpayers:Worthless securities and negotiable promissory notesIf you are a cash basis taxpayer and make payments on a negotiable
promissory note that you issued for stock that became worthless, you can deduct these payments as losses in the years you actually make the payments.
Do not deduct them in the year the stock became worthless.
How to report loss.
Form:1040, Schedule DWorthless securitiesReport worthless securities on Schedule D (Form 1040), line 1 or line 8, whichever applies. In
columns (c) and (d), enter Worthless. Enter the amount of your loss in parentheses in column (f).
Filing a claim for refund.Form:1040X:Worthless securities, claim for refundTax refunds:Worthless securities:Claim for refund
If you do not claim a loss for a worthless security on your original return for the year it becomes worthless, you can file a claim for a credit or
refund due to the loss. You must use Form 1040X, Amended U.S. Individual Income Tax Return, to amend your return for the year the security became
worthless. You must file it within 7 years from the date your original return for that year had to be filed, or 2 years from the date you paid the
tax, whichever is later. For more information about filing a claim, see Amended Returns and Claims for Refund in chapter 1.
How To Figure
Gain or LossSale of property:Figuring gain or loss
You figure gain or loss on a sale or trade of property by comparing the amount you realize with the adjusted basis of the property.
Gain.
If the amount you realize from a sale or trade is more than the adjusted basis of the property you transfer, the difference is a gain.
Loss.
If the adjusted basis of the property you transfer is more than the amount you realize, the difference is a loss.
Adjusted basis.Adjusted basis:Sales of propertySale of property:Adjusted basis
The adjusted basis of property is your original cost or other original basis properly adjusted (increased or decreased) for certain items. See
chapter 13 for more information about determining the adjusted basis of property.
Amount realized.Sale of property:Amount realized
The amount you realize from a sale or trade of property is everything you receive for the property. This includes the money you receive plus the
fair market value of any property or services you receive. If you received a note or other debt instrument for the property, see How To Figure
Gain or Loss in chapter 4 of Publication 550 to figure the amount realized.
Interest income:Property purchase financed without adequate stated interest, treatment ofInterest payments:Unstated interestUnstated interestIf you finance the buyer's purchase of your property and the debt instrument does not provide for adequate
stated interest, the unstated interest that you must report as ordinary income will reduce the amount realized from the sale. For more information,
see Publication 537.
Fair market value.Fair market value (FMV):Sales of propertySale of property:Fair market value (FMV)
Fair market value is the price at which the property would change hands between a buyer and a seller, neither being forced to buy or sell and both
having reasonable knowledge of all the relevant facts.
Example.
You trade A Company stock with an adjusted basis of $7,000 for B Company stock with a fair market value of $10,000, which is your amount realized.
Your gain is $3,000 ($10,000 − $7,000).
Debt paid off.Debts:Payoff of debt included in sales transaction
Sale of property:Debt payoff included inA debt against the property, or against you, that is paid off as a part of the transaction, or that
is assumed by the buyer, must be included in the amount realized. This is true even if neither you nor the buyer is personally liable for the debt.
For example, if you sell or trade property that is subject to a nonrecourse loan, the amount you realize generally includes the full amount of the
note assumed by the buyer even if the amount of the note is more than the fair market value of the property.
Example.
You sell stock that you had pledged as security for a bank loan of $8,000. Your basis in the stock is $6,000. The buyer pays off your bank loan and
pays you $20,000 in cash. The amount realized is $28,000 ($20,000 + $8,000). Your gain is $22,000 ($28,000 − $6,000).
Payment of cash.Cash:Sales of property forSale of property:Cash payment
If you trade property and cash for other property, the amount you realize is the fair market value of the property you receive. Determine your gain
or loss by subtracting the cash you pay plus the adjusted basis of the property you trade in from the amount you realize. If the result is a positive
number, it is a gain. If the result is a negative number, it is a loss.
No gain or loss.Basis:Other than costSale of property:Basis other than cost
You may have to use a basis for figuring gain that is different from the basis used for figuring loss. In this case, you may have neither a gain
nor a loss. See Basis Other Than Cost in chapter 13.
Nontaxable TradesTrade of property:Nontaxable exchanges
This section discusses trades that generally do not result in a taxable gain or deductible loss. For more information on nontaxable trades, see
chapter 1 of Publication 544.
Like-kind exchanges.Exchanges:Like-kind exchangesLike-kind exchangesSale of property:Like-kind exchangesTrade of property:Like-kind exchanges
If you trade business or investment property for other business or investment property of a like kind, you do not pay tax on any gain or deduct any
loss until you sell or dispose of the property you receive. To be nontaxable, a trade must meet all six of the following conditions.
The property must be business or investment property. You must hold both the property you trade and the property you receive for productive
use in your trade or business or for investment. Neither property may be property used for personal purposes, such as your home or family car.
Business property:Sales or exchanges:Like-kind exchangesInvestments:PropertyLike-kind exchanges
The property must not be held primarily for sale. The property you trade and the property you receive must not be property you sell to
customers, such as merchandise.
The property must not be stocks, bonds, notes, choses in action, certificates of trust or beneficial interest, or other securities or
evidences of indebtedness or interest, including partnership interests. However, you can have a nontaxable trade of corporate stocks under a different
rule, as discussed later.
There must be a trade of like property. The trade of real estate for real estate, or personal property for similar personal property, is a
trade of like property. The trade of an apartment house for a store building, or a panel truck for a pickup truck, is a trade of like property. The
trade of a piece of machinery for a store building is not a trade of like property. Real property located in the United States and real property
located outside the United States are not like property. Also, personal property used predominantly within the United States and personal property
used predominantly outside the United States are not like property.
The property to be received must be identified in writing within 45 days after the date you transfer the property given up in the trade.
The property to be received must be received by the earlier of:
The 180th day after the date on which you transfer the property given up in the trade, or
The due date, including extensions, for your tax return for the year in which the transfer of the property given up occurs.
Related party transactions:Like-kind exchangesIf you trade property with a related party in a like-kind exchange, a special rule may apply. See
Related Party Transactions, later in this chapter. Also, see chapter 1 of Publication 544 for more information on exchanges of business
property and special rules for exchanges using qualified intermediaries or involving multiple properties.
Partly nontaxable exchange.Exchanges:Partially nontaxable exchangeTrade of property:Partially nontaxable exchange
If you receive money or unlike property in addition to like property, and the above six conditions are met, you have a partly nontaxable trade. You
are taxed on any gain you realize, but only up to the amount of the money and the fair market value of the unlike property you receive. You cannot
deduct a loss.
Like property and unlike property transferred.
If you give up unlike property in addition to the like property, you must recognize gain or loss on the unlike property you give up. The gain or
loss is the difference between the adjusted basis of the unlike property and its fair market value.
Like property and money transferred.Trade of property:Like property and money transferred
If conditions (1) – (6) are met, you have a nontaxable trade even if you pay money in addition to the like property.
Basis of property received.Basis:Like-kind exchanges
To figure the basis of the property received, see Nontaxable Exchanges in chapter 13.
How to report.Trade of property:Reporting of
ExchangesTrade of propertyForm:1040, Schedule DBusiness property salesForm:4797:Sales of business propertyForm:8824:Like-kind exchangesTrade of property:Form 8824 for reportingYou must report the trade of like property on Form 8824. If you figure a recognized gain or loss on
Form 8824, report it on Schedule D (Form 1040) or on Form 4797, Sales of Business Property, whichever applies.
For information on using Form 4797, see chapter 4 of Publication 544.
Corporate stocks.Securities:Nontaxable trades
The following trades of corporate stocks generally do not result in a taxable gain or a deductible loss.
Corporate reorganizations.Corporations:Reorganizations and nontaxable trade of stockReorganizations, corporate:Nontaxable trade of stock
In some instances, a company will give you common stock for preferred stock, preferred stock for common stock, or stock in one corporation for
stock in another corporation. If this is a result of a merger, recapitalization, transfer to a controlled corporation, bankruptcy, corporate division,
corporate acquisition, or other corporate reorganization, you do not recognize gain or loss.
Stock for stock of the same corporation.
You can exchange common stock for common stock or preferred stock for preferred stock in the same corporation without having a recognized gain or
loss. This is true for a trade between two stockholders as well as a trade between a stockholder and the corporation.
Convertible stocks and bonds.Bonds:Convertible bondsConvertible stocks and bondsSecurities:Convertible stocks and bonds
You generally will not have a recognized gain or loss if you convert bonds into stock or preferred stock into common stock of the same corporation
according to a conversion privilege in the terms of the bond or the preferred stock certificate.
Property for stock of a controlled corporation.Controlled corporations:Nontaxable stock purchase ofCorporations:Controlled corporations
If you transfer property to a corporation solely in exchange for stock in that corporation, and immediately after the trade you are in control of
the corporation, you ordinarily will not recognize a gain or loss. This rule applies both to individuals and to groups who transfer property to a
corporation. It does not apply if the corporation is an investment company.
For this purpose, to be in control of a corporation, you or your group of transferors must own, immediately after the exchange, at least 80% of the
total combined voting power of all classes of stock entitled to vote and at least 80% of the outstanding shares of each class of nonvoting stock of
the corporation.
If this provision applies to you, you must attach to your return a complete statement of all facts pertinent to the exchange.
Additional information.
For more information on trades of stock, see Nontaxable Trades in chapter 4 of Publication 550.
Insurance policies and annuities.Annuities:Trade of insurance policies and annuitiesInsurance:Trade of policies and annuities
You will not have a recognized gain or loss if the insured or annuitant is the same under both contracts and you trade:
A life insurance contract for another life insurance contract or for an endowment or annuity contract,
An endowment contract for an annuity contract or for another endowment contract that provides for regular payments beginning at a date not
later than the beginning date under the old contract, or
An annuity contract for another annuity contract.
You also may not have to recognize gain or loss on an exchange of a portion of an annuity contract for another annuity contract. See Revenue Ruling
2003-76 and Notice 2003-51.
Exchanges of contracts not included in this list, such as an annuity contract for an endowment contract, or an annuity or endowment contract for a
life insurance contract, are taxable.
Demutualization of life insurance companies. Demutualization of life insurance companiesLife insurance:Demutualization of companies
If you received stock in exchange for your equity interest as a policyholder or an annuitant, you generally will not have a recognized gain or
loss. See Demutualization of Life Insurance Companies in Publication 550.
U.S. Treasury notes or bonds.U.S. Treasury bills or notes:Trade of
You can trade certain issues of U.S. Treasury obligations for other issues designated by the Secretary of the Treasury, with no gain or loss
recognized on the trade.
Transfers Between SpousesMarried taxpayers:Transfers between spousesNonresident aliens:Spouse:Transfers between spouses when one spouse is nonresident alienSale of property:Transfers between spouses
Generally, no gain or loss is recognized on a transfer of property from an individual to (or in trust for the benefit of) a spouse, or if incident
to a divorce, a former spouse. This nonrecognition rule does not apply in the following situations.
The recipient spouse or former spouse is a nonresident alien.
Property is transferred in trust. Gain must be recognized to the extent the amount of the liabilities assumed by the trust, plus any
liabilities on the property, exceed the adjusted basis of the property.
For other situations, see Publication 550.
Basis:Transfers between spousesAny transfer of property to a spouse or former spouse on which gain or loss is not recognized is
treated by the recipient as a gift and is not considered a sale or exchange. The recipient's basis in the property will be the same as the adjusted
basis of the giver immediately before the transfer. This carryover basis rule applies whether the adjusted basis of the transferred property is less
than, equal to, or greater than either its fair market value at the time of transfer or any consideration paid by the recipient. This rule applies for
purposes of determining loss as well as gain. Any gain recognized on a transfer in trust increases the basis.
Divorced taxpayers:Transfers between spousesA transfer of property is incident to a divorce if the transfer occurs within 1 year after the
date on which the marriage ends, or if the transfer is related to the ending of the marriage.
Related Party TransactionsFamilyRelated party transactionsRelated party transactions
Special rules apply to the sale or trade of property between related parties.
Gain on sale or trade of depreciable property.Gains and losses:Related party sale or trade of depreciable property
Your gain from the sale or trade of property to a related party may be ordinary income, rather than capital gain, if the property can be
depreciated by the party receiving it. See chapter 3 of Publication 544 for more information.
Like-kind exchanges.Related party transactions:Like-kind exchanges
Generally, if you trade business or investment property for other business or investment property of a like kind, no gain or loss is recognized.
See Like-kind exchanges earlier under Nontaxable Trades.
This rule also applies to trades of property between related parties, defined next under Losses on sales or trades of property. However,
if either you or the related party disposes of the like property within 2 years after the trade, you both must report any gain or loss not recognized
on the original trade on your return filed for the year in which the later disposition occurs.
Losses on sales or trades of property.
You cannot deduct a loss on the sale or trade of property, other than a distribution in complete liquidation of a corporation, if the transaction
is directly or indirectly between you and the following related parties.
Members of your family. This includes only your brothers and sisters, half-brothers and half-sisters, spouse, ancestors (parents,
grandparents, etc.), and lineal descendants (children, grandchildren, etc.).
A partnership in which you directly or indirectly own more than 50% of the capital interest or the profits interest.
Controlled corporations:Related party transactionsCorporations:Controlled corporationsPartners and partnerships:Related party transactions
A corporation in which you directly or indirectly own more than 50% in value of the outstanding stock. (See Constructive ownership of
stock, later.)
A tax-exempt charitable or educational organization that is directly or indirectly controlled, in any manner or by any method, by you or by
a member of your family, whether or not this control is legally enforceable.
Educational organizations:As related party in transactionsTax-exempt:OrganizationsRelated party transactions
In addition, a loss on the sale or trade of property is not deductible if the transaction is directly or indirectly between the following related
parties.
A grantor and fiduciary, or the fiduciary and beneficiary, of any trust.
AgentsFiduciariesFiduciaries:Related party transactions
Fiduciaries of two different trusts, or the fiduciary and beneficiary of two different trusts, if the same person is the grantor of both
trusts.
Trusts:Related party transactions with fiduciaries
A trust fiduciary and a corporation of which more than 50% in value of the outstanding stock is directly or indirectly owned by or for the
trust, or by or for the grantor of the trust.
A corporation and a partnership if the same persons own more than 50% in value of the outstanding stock of the corporation and more than 50%
of the capital interest, or the profits interest, in the partnership.
Two S corporations if the same persons own more than 50% in value of the outstanding stock of each corporation.
S corporations:Related party transactions
Two corporations, one of which is an S corporation, if the same persons own more than 50% in value of the outstanding stock of each
corporation.
An executor and a beneficiary of an estate (except in the case of a sale or trade to satisfy a pecuniary bequest).
Executors and administrators:Related party transactions
Two corporations that are members of the same controlled group. (Under certain conditions, however, these losses are not disallowed but must
be deferred.)
Controlled corporations:Related party transactions
Two partnerships if the same persons own, directly or indirectly, more than 50% of the capital interests or the profit interests in both
partnerships.
Partners and partnerships:Related party transactions
Multiple property sales or trades.Related party transactions:Multiple property sales or trades
If you sell or trade to a related party a number of blocks of stock or pieces of property in a lump sum, you must figure the gain or loss
separately for each block of stock or piece of property. The gain on each item may be taxable. However, you cannot deduct the loss on any item. Also,
you cannot reduce gains from the sales of any of these items by losses on the sales of any of the other items.
Indirect transactions.Related party transactions:Indirect transactions
You cannot deduct your loss on the sale of stock through your broker if, under a prearranged plan, a related party buys the same stock you had
owned. This does not apply to a trade between related parties through an exchange that is purely coincidental and is not prearranged.
Constructive ownership of stock.Securities:Constructive ownership of stock, determination of
In determining whether a person directly or indirectly owns any of the outstanding stock of a corporation, the following rules apply.
Rule 1.
Stock directly or indirectly owned by or for a corporation, partnership, estate, or trust is considered owned proportionately by or for its
shareholders, partners, or beneficiaries.
Rule 2.
An individual is considered to own the stock that is directly or indirectly owned by or for his or her family. Family includes only brothers and
sisters, half-brothers and half-sisters, spouse, ancestors, and lineal descendants.
Rule 3.
An individual owning, other than by applying rule 2, any stock in a corporation is considered to own the stock that is directly or indirectly owned
by or for his or her partner.
Rule 4.
When applying rule 1, 2, or 3, stock constructively owned by a person under rule 1 is treated as actually owned by that person. But stock
constructively owned by an individual under rule 2 or rule 3 is not treated as owned by that individual for again applying either rule 2 or rule 3 to
make another person the constructive owner of the stock.
Property received from a related party.
Wash salesIf you sell or trade at a gain property that you acquired from a related party, you recognize the gain only to the
extent it is more than the loss previously disallowed to the related party. This rule applies only if you are the original transferee and you acquired
the property by purchase or exchange. This rule does not apply if the related party's loss was disallowed because of the wash sale rules described in
chapter 4 of Publication 550 under Wash sales.
If you sell or trade at a loss property that you acquired from a related party, you cannot recognize the loss that was not allowed to the related
party.
Example 1.
Your brother sells you stock for $7,600. His cost basis is $10,000. Your brother cannot deduct the loss of $2,400. Later, you sell the same stock
to an unrelated party for $10,500, realizing a gain of $2,900. Your reportable gain is $500 — the $2,900 gain minus the $2,400 loss not allowed
to your brother.
Example 2.
If, in Example 1, you sold the stock for $6,900 instead of $10,500, your recognized loss is only $700 (your $7,600 basis minus $6,900).
You cannot deduct the loss that was not allowed to your brother.
Capital Gains
and LossesCapital gains or losses
This section discusses the tax treatment of gains and losses from different types of investment transactions.
Capital gains or losses:Character of gainCapital gains or losses:Character of lossCapital gains or losses:Net capital gainCapital gains or losses:Section 1250 gains from sale of real propertyGains and losses:Short-termShort-term gains and lossesUnrecaptured Section 1250 gain
Character of gain or loss.
You need to classify your gains and losses as either ordinary or capital gains or losses. You then need to classify your capital gains and losses
as either short term or long term. If you have long-term gains and losses, you must identify your 28% rate gains and losses. If you have a net capital
gain, you must also identify any unrecaptured section 1250 gain.
The correct classification and identification helps you figure the limit on capital losses and the correct tax on capital gains. Reporting capital
gains and losses is explained in chapter 16.
Capital or Ordinary
Gain or LossGains and losses:Ordinary gain and lossGains and losses:Ordinary lossOrdinary gain
If you have a taxable gain or a deductible loss from a transaction, it may be either a capital gain or loss or an ordinary gain or loss, depending
on the circumstances. Generally, a sale or trade of a capital asset (defined next) results in a capital gain or loss. A sale or trade of a noncapital
asset generally results in ordinary gain or loss. Depending on the circumstances, a gain or loss on a sale or trade of property used in a trade or
business may be treated as either capital or ordinary, as explained in Publication 544. In some situations, part of your gain or loss may be a capital
gain or loss and part may be an ordinary gain or loss.
Capital Assets and Noncapital AssetsCapital assets:Definition of
For the most part, everything you own and use for personal purposes, pleasure, or investment is a capital asset. Some examples are:
Stocks or bonds held in your personal account,
Bonds:As capital assetsSecurities:As capital assets
A house owned and used by you and your family,
Home:As capital asset
Household furnishings,
Household furnishings:As capital assets
A car used for pleasure or commuting,
Cars:As capital assets
Coin or stamp collections,
Art works:As capital assetsCollectibles:As capital assets
Gems and jewelry, and
Gems:As capital assetsJewelry:As capital assets
Gold, silver, or any other metal.
Gold and silver:As capital assetsMetals, preciousGold and silverSilverGold and silver
Noncapital assetsAny property you own is a capital asset, except the following noncapital assets.
Property held mainly for sale to customers or property that will physically become a part of the merchandise that is for sale to customers.
Inventory, retailRetail inventory
Depreciable property used in your trade or business, even if fully depreciated. Depreciation:Property used in trade or business, as noncapital assets
Real property used in your trade or business. Real estate:As noncapital assets
A copyright, a literary, musical, or artistic composition, a letter or memorandum, or similar property:
Created by your personal efforts,
Prepared or produced for you (in the case of a letter, memorandum, or similar property), or
Acquired under circumstances (for example, by gift) entitling you to the basis of the person who created the property or for whom it was
prepared or produced.
Copyrights
Accounts or notes receivable acquired in the ordinary course of a trade or business for services rendered or from the sale of property
described in (1).
U.S. Government publications that you received from the government for free or for less than the normal sales price, or that you acquired
under circumstances entitling you to the basis of someone who received the publications for free or for less than the normal sales price.
Certain commodities derivative financial instruments held by commodities derivatives dealers.Commodities:Derivative financial instruments
Hedging transactions, but only if the transaction is clearly identified as a hedging transaction before the close of the day on which it was
acquired, originated, or entered into.Hedging transactions
Supplies of a type you regularly use or consume in the ordinary course of your trade or business.Supplies:Regularly used or consumed in ordinary course of trade or business
Investment PropertyInvestments:PropertyAs capital asset
Investment property is a capital asset. Any gain or loss from its sale or trade is generally a capital gain or loss.
Gold, silver, stamps, coins, gems, etc.Art works:As capital assetsCoinsCollectiblesCollectibles:As capital assetsGold and silver:As capital assets
These are capital assets except when they are held for sale by a dealer. Any gain or loss you have from their sale or trade generally is a capital
gain or loss.
Stocks, stock rights, and bonds.Bonds:As capital assetsSecurities:As capital assetsSecurities:Stock rights:As capital assets
All of these (including stock received as a dividend) are capital assets except when held for sale by a securities dealer. However, if you own
small business stock, see Losses on Section 1244 (Small Business) Stock and Losses on Small Business Investment Company Stock in
chapter 4 of Publication 550.
Personal use property.Personal property:As capital assetsPropertyPersonal property
Property held for personal use only, rather than for investment, is a capital asset, and you must report a gain from its sale as a capital gain.
However, you cannot deduct a loss from selling personal use property.
Discounted Debt InstrumentsBonds:DiscountedCapital gain or lossDiscounted debt instruments:Capital gain or loss
Treat your gain or loss on the sale, redemption, or retirement of a bond or other debt instrument originally issued at a discount or bought at a
discount as capital gain or loss, except as explained in the following discussions.
Short-term government obligations.Short-term debt instruments:Government obligations
Treat gains on short-term federal, state, or local government obligations (other than tax-exempt obligations) as ordinary income up to your ratable
share of the acquisition discount. This treatment applies to obligations that have a fixed maturity date not more than 1 year from the date of issue.
Acquisition discount is the stated redemption price at maturity minus your basis in the obligation.
However, do not treat these gains as income to the extent you previously included the discount in income. See Discount on Short-Term
Obligations in chapter 1 of Publication 550.
Short-term nongovernment obligations.Short-term debt instruments:Ordinary gain
Treat gains on short-term nongovernment obligations as ordinary income up to your ratable share of original issue discount (OID). This treatment
applies to obligations that have a fixed maturity date of not more than 1 year from the date of issue.
However, to the extent you previously included the discount in income, you do not have to include it in income again. See Discount on
Short-Term Obligations in chapter 1 of Publication 550.
Tax-exempt state and local government bonds.Bonds:State or local government, tax-exemptDebt instrumentsBonds or NotesExemptions:State or local government bonds, tax-exemptOriginal issue discount (OID):Discounted debt instrumentsState or local governments:Bonds, tax-exempt
If these bonds were originally issued at a discount before September 4, 1982, or you acquired them before March 2, 1984, treat your part of the OID
as tax-exempt interest. To figure your gain or loss on the sale or trade of these bonds, reduce the amount realized by your part of the OID.
If the bonds were issued after September 3, 1982, and acquired after March 1, 1984, increase the adjusted basis by your part of the OID to figure
gain or loss. For more information on the basis of these bonds, see Discounted Debt Instruments in chapter 4 of Publication 550.
Any gain from market discount is usually taxable on disposition or redemption of tax-exempt bonds. If you bought the bonds before May 1, 1993, the
gain from market discount is capital gain. If you bought the bonds after April 30, 1993, the gain is ordinary income.
You figure the market discount by subtracting the price you paid for the bond from the sum of the original issue price of the bond and the amount
of accumulated OID from the date of issue that represented interest to any earlier holders. For more information, see Market Discount Bonds
in chapter 1 of Publication 550.
Capital gains or losses:State or local government bonds, tax-exemptA loss on the sale or other disposition of a tax-exempt state or local
government bond is deductible as a capital loss.
Redeemed before maturity.Redemption of bonds:State and local bonds, before maturity
If a state or local bond that was issued before June 9, 1980, is redeemed before it matures, the OID is not taxable to you.
If a state or local bond issued after June 8, 1980, is redeemed before it matures, the part of the OID that is earned while you hold the bond is
not taxable to you. However, you must report the unearned part of the OID as a capital gain.
Example.
On July 1, 1994, the date of issue, you bought a 20-year, 6% municipal bond for $800. The face amount of the bond was $1,000. The $200 discount was
OID. At the time the bond was issued, the issuer had no intention of redeeming it before it matured. The bond was callable at its face amount
beginning 10 years after the issue date.
The issuer redeemed the bond at the end of 11 years (July 1, 2005) for its face amount of $1,000 plus accrued annual interest of $60. The OID
earned during the time you held the bond, $73, is not taxable. The $60 accrued annual interest also is not taxable. However, you must report the
unearned part of the OID ($127) as a capital gain.
Long-term debt instruments issued after 1954 and before May 28, 1969 (or before July 2, 1982, if a government instrument).Long-term debt instruments
If you sell, trade, or redeem for a gain one of these debt instruments, the part of your gain that is not more than your ratable share of the OID
at the time of the sale or redemption is ordinary income. The rest of the gain is capital gain. If, however, there was an intention to call the debt
instrument before maturity, all of your gain that is not more than the entire OID is treated as ordinary income at the time of the sale. This
treatment of taxable gain also applies to corporate instruments issued after May 27, 1969, under a written commitment that was binding on May 27,
1969, and at all times thereafter.
Long-term debt instruments issued after May 27, 1969 (or after July 1, 1982, if a government instrument).
If you hold one of these debt instruments, you must include a part of the OID in your gross income each year that you own the instrument. Your
basis in that debt instrument is increased by the amount of OID that you have included in your gross income. See Original Issue Discount
(OID) in chapter 7 for information about the OID that you must report on your tax return.
If you sell or trade the debt instrument before maturity, your gain is a capital gain. However, if at the time the instrument was originally issued
there was an intention to call it before its maturity, your gain generally is ordinary income to the extent of the entire OID reduced by any amounts
of OID previously includible in your income. In this case, the rest of the gain is a capital gain.
If the debt instrument has market discount and you chose to include the discount in income as it accrued, increase your basis in the debt
instrument by the accrued discount to figure capital gain or loss on its disposition. If you did not choose to include the discount in income as it
accrued, you must report gain as ordinary interest income up to the instrument's accrued market discount. The rest of the gain is capital gain. See
Market Discount Bonds in chapter 1 of Publication 550.
A different rule applies to market discount bonds issued before July 19, 1984, and purchased by you before May 1, 1993. See Market discount
bonds under Discounted Debt Instruments in chapter 4 of Publication 550.
Retirement of debt instrument.Retirement of bonds
Any amount that you receive on the retirement of a debt instrument is treated in the same way as if you had sold or traded that instrument.
Notes of individuals.Debt instrumentsBonds or NotesNotes:As obligations of individuals
If you hold an obligation of an individual that was issued with OID after March 1, 1984, you generally must include the OID in your income
currently, and your gain or loss on its sale or retirement is generally capital gain or loss. An exception to this treatment applies if the obligation
is a loan between individuals and all of the following requirements are met.
The lender is not in the business of lending money.
The amount of the loan, plus the amount of any outstanding prior loans, is $10,000 or less.
Avoiding federal tax is not one of the principal purposes of the loan.
If the exception applies, or the obligation was issued before March 2, 1984, you do not include the OID in your income currently. When you sell or
redeem the obligation, the part of your gain that is not more than your accrued share of the OID at that time is ordinary income. The rest of the
gain, if any, is capital gain. Any loss on the sale or redemption is capital loss.
Deposit in Insolvent or Bankrupt Financial InstitutionBanks:Losses on deposits, when casualty lossesDeposits:Losses onFinancial institutionsBanksInsolvency:Financial institution's insolvency causing deductible loss
If you lose money you have on deposit in a qualified financial institution that becomes insolvent or bankrupt, you may be able to deduct your loss
in one of three ways.
Ordinary loss,
Casualty loss, or
Nonbusiness bad debt (short-term capital loss).
For more information, see Deposit in Insolvent or Bankrupt Financial Institution, in chapter 4 of Publication 550.
Sale of AnnuityAnnuities:Sale of
The part of any gain on the sale of an annuity contract before its maturity date that is based on interest accumulated on the contract is ordinary
income.
Losses on Section 1244 (Small Business) StockSmall businesses:Losses on stock of
Form:4797:Small business stock lossesSection 1244 stock:Losses onYou can deduct as an ordinary loss, rather than as a capital loss, your loss on the sale, trade, or worthlessness
of section 1244 stock. Report the loss on Form 4797, line 10.
Any gain on section 1244 stock is a capital gain if the stock is a capital asset in your hands. Report the gain on Schedule D (Form 1040). See
Losses on Section 1244 (Small Business) Stock in chapter 4 of Publication 550.
Losses on Small Business Investment Company Stock
See Losses on Small Business Investment Company Stock in chapter 4 of Publication 550.
Holding PeriodCapital gains or losses:Holding period, determination ofCapital gains or losses:Holding period, determination ofHolding period:Determination of
If you sold or traded investment property, you must determine your holding period for the property. Your holding period determines whether any
capital gain or loss was a short-term or long-term capital gain or loss.
Long term or short term.Capital gains or losses:Sale or trade of property held more than 1 yearCapital gains or losses:Sale or trade of property held more than 1 yearGains and losses:Short-term:Sale or trade of property held 1 year or lessShort-term gains and losses:Sale or trade of property held 1 year or less
If you hold investment property more than 1 year, any capital gain or loss is a long-term capital gain or loss. If you hold the property 1 year or
less, any capital gain or loss is a short-term capital gain or loss.
To determine how long you held the investment property, begin counting on the date after the day you acquired the property. The day you disposed of
the property is part of your holding period.
Example.
If you bought investment property on February 5, 2004, and sold it on February 5, 2005, your holding period is not more than 1 year and you have a
short-term capital gain or loss. If you sold it on February 6, 2005, your holding period is more than 1 year and you will have a long-term capital
gain or loss.
Securities traded on established market.Securities:Holding period, determination of
For securities traded on an established securities market, your holding period begins the day after the trade date you bought the securities, and
ends on the trade date you sold them.
Settlement date of securities transactionTrading date of securities transaction
Do not confuse the trade date with the settlement date, which is the date by which the stock must be delivered and payment must be made.
Example.
You are a cash method, calendar year taxpayer. You sold stock at a gain on December 29, 2005. According to the rules of the stock exchange, the
sale was closed by delivery of the stock 3 trading days after the sale, on January 4, 2006. You received payment of the sales price on that same day.
Report your gain on your 2005 return, even though you received the payment in 2006. The gain is long term or short term depending on whether you held
the stock more than 1 year. Your holding period ended on December 29. If you had sold the stock at a loss, you would also report it on your 2005
return.
Automatic investment service.Automatic investment services:Holding period, determination ofBanks:Automatic investment service, determination of holding period
In determining your holding period for shares bought by the bank or other agent, full shares are considered bought first and any fractional shares
are considered bought last. Your holding period starts on the day after the bank's purchase date. If a share was bought over more than one purchase
date, your holding period for that share is a split holding period. A part of the share is considered to have been bought on each date that stock was
bought by the bank with the proceeds of available funds.
Nontaxable trades.Exchanges:Tax-free:Holding period, determination ofNontaxable tradesTax-free exchangesTax-free exchanges:Holding period, determination ofTrade of property:Nontaxable exchanges:Holding period, determination of
If you acquire investment property in a trade for other investment property and your basis for the new property is determined, in whole or in part,
by your basis in the old property, your holding period for the new property begins on the day following the date you acquired the old property.
Property received as a gift.Gifts:Holding period, determination of
If you receive a gift of property and your basis is determined by the donor's adjusted basis, your holding period is considered to have started on
the same day the donor's holding period started.
If your basis is determined by the fair market value of the property, your holding period starts on the day after the date of the gift.
Inherited property.Estate beneficiariesInheritanceInheritance:Holding period, determination of
If you inherit investment property, your capital gain or loss on any later disposition of that property is treated as a long-term capital gain or
loss. This is true regardless of how long you actually held the property.
Real property bought.PropertyReal estateReal estate:Holding period, determination of
To figure how long you have held real property bought under an unconditional contract, begin counting on the day after you received title to it or
on the day after you took possession of it and assumed the burdens and privileges of ownership, whichever happened first. However, taking delivery or
possession of real property under an option agreement is not enough to start the holding period. The holding period cannot start until there is an
actual contract of sale. The holding period of the seller cannot end before that time.
Stock dividends.Dividends:Holding period, determination of
The holding period for stock you received as a taxable stock dividend begins on the date of distribution.
The holding period for new stock you received as a nontaxable stock dividend begins on the same day as the holding period of the old stock. This
rule also applies to stock acquired in a spin-off, which is a distribution of stock or securities in a controlled corporation.
Nontaxable stock rights.Securities:Stock rights:Holding period, determination of
Your holding period for nontaxable stock rights begins on the same day as the holding period of the underlying stock. The holding period for stock
acquired through the exercise of stock rights begins on the date the right was exercised.
Nonbusiness Bad DebtsBad debts:NonbusinessDeductionsBad debts
If someone owes you money that you cannot collect, you have a bad debt. You may be able to deduct the amount owed to you when you figure your tax
for the year the debt becomes worthless.
Bad debts that did not come from operating your trade or business are nonbusiness bad debts and are deductible as short-term capital losses. To be
deductible, nonbusiness bad debts must be totally worthless. You cannot deduct a partly worthless nonbusiness debt.
Genuine debt required.
A debt must be genuine for you to deduct a loss. A debt is genuine if it arises from a debtor-creditor relationship based on a valid and
enforceable obligation to repay a fixed or determinable sum of money.
Basis in bad debt required.Basis:Bad debts
Cash method taxpayers:Bad debtsTo deduct a bad debt, you must have a basis in it — that is, you must have already included the amount in
your income or loaned out your cash. For example, you cannot claim a bad debt deduction for court-ordered child support not paid to you by your former
spouse. If you are a cash method taxpayer (as most individuals are), you generally cannot take a bad debt deduction for unpaid salaries, wages, rents,
fees, interest, dividends, and similar items.
How to report bad debts.Bad debts:Reporting ofDeductionsBad debts
Bad debts:Short-term capital lossCapital gains or losses:Bad debts as short-term capital lossDeduct nonbusiness bad debts as short-term capital losses on Schedule D (Form 1040).
On Schedule D, Part I, line 1, enter the name of the debtor and statement attached in column (a). Enter the amount of the bad debt in
parentheses in column (f). Use a separate line for each bad debt.
For each bad debt, attach a statement to your return that contains:
A description of the debt, including the amount, and the date it became due,
The name of the debtor, and any business or family relationship between you and the debtor,
The efforts you made to collect the debt, and
Why you decided the debt was worthless. For example, you could show that the borrower has declared bankruptcy, or that legal action to
collect would probably not result in payment of any part of the debt.
Filing a claim for refund.
Bad debts:Claim for refundForm:1040X:Bad debts, claim for refundIf you do not deduct a bad debt on your original return for the year it becomes worthless,
you can file a claim for a credit or refund due to the bad debt. To do this, use Form 1040X to amend your return for the year the debt became
worthless. You must file it within 7 years from the date your original return for that year had to be filed, or 2 years from the date you paid the
tax, whichever is later. For more information about filing a claim, see Amended Returns and Claims for Refund in chapter 1.
Additional information.
For more information, see Nonbusiness Bad Debts in Publication 550. For information on business bad debts, see chapter 11 of Publication
535, Business Expenses.
Wash SalesWash sales
You cannot deduct losses from sales or trades of stock or securities in a wash sale.
A wash sale occurs when you sell or trade stock or securities at a loss and within 30 days before or after the sale you:
Buy substantially identical stock or securities,
Acquire substantially identical stock or securities in a fully taxable trade, or
Acquire a contract or option to buy substantially identical stock or securities.
If your loss was disallowed because of the wash sale rules, add the disallowed loss to the cost of the new stock or securities. The result is your
basis in the new stock or securities. This adjustment postpones the loss deduction until the disposition of the new stock or securities.
For more information, see Wash Sales, in chapter 4 of Publication 550.
Rollover of Gain From Publicly Traded SecuritiesRollovers:Gain from publicly traded securitiesSecurities:Rollover of gain from publicly traded securities
You may qualify for a tax-free rollover of certain gains from the sale of publicly traded securities. This means that if you buy certain
replacement property and make the choice described in this section, you postpone part or all of your gain.
You postpone the gain by adjusting the basis of the replacement property as described in Basis of replacement property, later. This
postpones your gain until the year you dispose of the replacement property.
You qualify to make this choice if you meet all the following tests.
You sell publicly traded securities at a gain. Publicly traded securities are securities traded on an established securities market.
Your gain from the sale is a capital gain.
During the 60-day period beginning on the date of the sale, you buy replacement property. This replacement property must be either common
stock or a partnership interest in a specialized small business investment company (SSBIC). This is any partnership or corporation licensed by the
Small Business Administration under section 301(d) of the Small Business Investment Act of 1958, as in effect on May 13, 1993.
Amount of gain recognized.
If you make the choice described in this section, you must recognize gain only up to the following amount.
The amount realized on the sale, minus
The cost of any common stock or partnership interest in an SSBIC that you bought during the 60-day period beginning on the date of sale (and
did not previously take into account on an earlier sale of publicly traded securities).
If this amount is less than the amount of your gain, you can postpone the rest of your gain, subject to the limit described next. If this
amount is equal to or more than the amount of your gain, you must recognize the full amount of your gain.
Limit on gain postponed.
The amount of gain you can postpone each year is limited to the smaller of:
$50,000 ($25,000 if you are married and file a separate return), or
$500,000 ($250,000 if you are married and file a separate return), minus the amount of gain you postponed for all earlier years.
Basis of replacement property.
You must subtract the amount of postponed gain from the basis of your replacement property.
How to report and postpone gain.
Capital gains or lossesSale of propertySee chapter 4 of Publication 550 for details on how to report and postpone the gain.
Selling Your HomeSale of homeWhat's NewKatrina Emergency Tax Relief Act of 2005.
This Act provides tax relief for persons affected by Hurricane Katrina. Under this Act, some of the rules that determine when to recapture a
federal mortgage subsidy have changed. See Publication 4492.
RemindersChange of address.
If you change your mailing address, be sure to notify the IRS using Form 8822, Change of Address. Mail it to the Internal Revenue Service Center
for your old address. (Addresses for the Service Centers are on the back of the form.)
Home sold with undeducted points.Sale of home:Undeducted points
If you have not deducted all the points you paid to secure a mortgage on your old home, you may be able to deduct the remaining points in the year
of the sale. See Mortgage ending early under Points in chapter 23.
This chapter explains the tax rules that apply when you sell your main home. Generally, your main home is the one in which you live most of the
time.
If you sold your main home in 2005, you may be able to exclude from income any gain up to a limit of $250,000 ($500,000 on a joint return in most
cases). See Excluding the Gain, later. If you can exclude all of the gain, you do not need to report the sale on your tax return.
If you have gain that cannot be excluded, it is taxable. Report it on Schedule D (Form 1040). You may also have to include Form 4797, Sales of
Business Property. See Reporting the Sale, later.
If you have a loss on the sale, you cannot deduct it on your return.
The main topics in this chapter are:
Figuring gain or loss,
Basis,
Excluding the gain,
Ownership and use tests, and
Reporting the sale.
Other topics include:
Business use or rental of home, and
Recapturing a federal mortgage subsidy.
Publication523 Selling Your Home 530 Tax Information for First-Time Homeowners Form (and Instructions)Capital Gains and Losses Change of Address Recapture of Federal Mortgage Subsidy
Main HomeHome:Main home, definedResidency:Main home, definedSale of home:Main home, defined
This section explains the term main home. Usually, the home you live in most of the time is your main home and can be a:
House,
Houseboat,
Mobile home,
Cooperative apartment, or
Condominium.
To exclude gain under the rules of this chapter, you generally must have owned and lived in the property as your main home for at least 2 years
during the 5-year period ending on the date of sale.
Land.Sale of home:Land
If you sell the land on which your main home is located, but not the house itself, you cannot exclude any gain you have from the sale of the land.
Example.
On March 4, 2005, you sell the land on which your main home is located. You buy another piece of land and move your house to it. This sale is not
considered a sale of your main home, and you cannot exclude any gain on the sale of the land.
More than one home.Sale of home:More than one home
If you have more than one home, you can exclude gain only from the sale of your main home. You must include in income the gain from the sale of any
other home. If you have two homes and live in both of them, your main home is ordinarily the one you live in most of the time.
Example 1.
You own and live in a house in the city. You also own a beach house, which you use during summer months. The house in the city is your main home.
Example 2.
You own a house, but you live in another house that you rent. The rented house is your main home.
Property used partly as your main home.
If you use only part of the property as your main home, the rules discussed in this chapter apply only to the gain or loss on the sale of that part
of the property. For details, see Business Use or Rental of Home, later.
Figuring Gain or LossSale of home:Gain or loss, figuring of
To figure the gain or loss on the sale of your main home, you must know the selling price, the amount realized, and the adjusted basis. Subtract
the adjusted basis from the amount realized to get your gain or loss.
Selling price−Selling expensesAmount realizedAmount realized−Adjusted basisGain or loss
Selling PriceSale of home:Selling price
The selling price is the total amount you receive for your home. It includes money, all notes, mortgages, or other debts assumed by the buyer as
part of the sale, and the fair market value of any other property or any services you receive.
Payment by employer.Sale of home:Employer, payment by
You may have to sell your home because of a job transfer. If your employer pays you for a loss on the sale or for your selling expenses, do not
include the payment as part of the selling price. Your employer will include it as wages in box 1 of your Form W-2 and you will include it on Form
1040, line 7.
Option to buy.Sale of home:Option to buy
If you grant an option to buy your home and the option is exercised, add the amount you receive for the option to the selling price of your home.
If the option is not exercised, you must report the amount as ordinary income in the year the option expires. Report this amount on Form 1040, line
21.
Form 1099-S.Form:1099-S:Real estate transactions proceedsSale of home:Form 1099-S
If you received Form 1099-S, Proceeds From Real Estate Transactions, box 2 (gross proceeds) should show the total amount you received for your
home.
However, box 2 will not include the fair market value of any property other than cash or notes, or any services, you received or will receive.
Instead, box 4 will be checked to indicate your receipt (or expected receipt) of these items.
If you can exclude the entire gain, the person responsible for closing the sale generally will not have to report it on Form 1099-S. If you do not
receive Form 1099-S, use sale documents and other records to figure the total amount you received for your home.
Amount RealizedSale of home:Amount realized
The amount realized is the selling price minus selling expenses.
Selling expenses.
Selling expenses include:
Commissions,
Advertising fees,
Legal fees, and
Loan charges paid by the seller, such as loan placement fees or points.
Adjusted BasisAdjusted basisHome saleSale of homeBasisHome salesSale of homeSale of home:Adjusted basis
While you owned your home, you may have made adjustments (increases or decreases) to the basis. This adjusted basis must be determined before you
can figure gain or loss on the sale of your home. For information on how to figure your home's adjusted basis, see Determining Basis,
later.
Amount of Gain or Loss
To figure the amount of gain or loss, compare the amount realized to the adjusted basis.
Gain on sale.
If the amount realized is more than the adjusted basis, the difference is a gain and, except for any part you can exclude, generally is taxable.
Loss on sale.
If the amount realized is less than the adjusted basis, the difference is a loss. A loss on the sale of your main home cannot be deducted.
Jointly owned home.Sale of home:Jointly owned home
If you and your spouse sell your jointly owned home and file a joint return, you figure your gain or loss as one taxpayer.
Separate returns.
If you file separate returns, each of you must figure your own gain or loss according to your ownership interest in the home. Your ownership
interest is determined by state law.
Joint owners not married.
If you and a joint owner other than your spouse sell your jointly owned home, each of you must figure your own gain or loss according to your
ownership interest in the home. Each of you applies the rules discussed in this chapter on an individual basis.
Other Dispositions
The following rules apply to foreclosures and repossessions, abandonments, trades, and transfers to a spouse.
Foreclosure or repossession.ForeclosureHome:ForeclosureHome:RepossessionRepossession of homeSale of home:Foreclosure or repossession
If your home was foreclosed on or repossessed, you have a sale.
You figure the gain or loss from the sale in generally the same way as gain or loss from any sale. But the amount of your gain or loss depends, in
part, on whether you were personally liable for repaying the debt secured by the home. See Publication 523 for more information.
Form 1099-A and Form 1099-C.Form:1099-A:Acquisition or abandonment of secured propertyForm:1099-C:Cancellation of debt
Generally, you will receive Form 1099-A, Acquisition or Abandonment of Secured Property, from your lender. This form will have the information you
need to determine the amount of your gain or loss and any ordinary income from cancellation of debt. If your debt is canceled, you may receive Form
1099-C, Cancellation of Debt.
Abandonment.Abandonment of homeHome:Abandonment ofSale of home:Abandonment
If you abandon your home, you may have ordinary income. If the abandoned home secures a debt for which you are personally liable and the debt is
canceled, you have ordinary income equal to the amount of the canceled debt. See Publication 523 for more information.
Trading homes.Sale of home:Trading homes
If you trade your old home for another home, treat the trade as a sale and a purchase.
Example.
You owned and lived in a home that had an adjusted basis of $41,000. A real estate dealer accepted your old home as a trade-in and allowed you
$50,000 toward a new home priced at $80,000. This is treated as a sale of your old home for $50,000 with a gain of $9,000 ($50,000 – $41,000).
If the dealer had allowed you $27,000 and assumed your unpaid mortgage of $23,000 on your old home, your sales price would still be $50,000 (the
$27,000 trade-in allowed plus the $23,000 mortgage assumed).
Transfer to spouse.Married taxpayers:Transfer of home to spouseSale of home:Transfer to spouse
If you transfer your home to your spouse, or to your former spouse incident to your divorce, you generally have no gain or loss. This is true even
if you receive cash or other consideration for the home. Therefore, the rules in this chapter do not apply.
More information.
If you need more information, see Transfer to spouse in Publication 523 and Property Settlements in Publication 504, Divorced
or Separated Individuals.
Determining BasisBasisHome salesSale of homeHome:BasisSale of homeSale of home:Basis
You need to know your basis in your home to determine any gain or loss when you sell it. Your basis in your home is determined by how you got the
home. Your basis is its cost if you bought it or built it. If you got it in some other way (inheritance, gift, etc.), its basis is either its fair
market value when you got it or the adjusted basis of the person you got it from.
While you owned your home, you may have made adjustments (increases or decreases) to your home's basis. The result of these adjustments is your
home's adjusted basis, which is used to figure gain or loss on the sale of your home. See Adjusted Basis, later.
You can find more information on basis and adjusted basis in chapter 13 of this publication and in Publication 523.
Cost As Basis
The cost of property is the amount you pay for it in cash, debt obligations, other property, or services.
Purchase.
If you buy your home, your basis is its cost to you. This includes the purchase price and certain settlement or closing costs. Generally, your
purchase price includes your down payment and any debt, such as a first or second mortgage or notes you gave the seller in payment for the home. If
you build, or contract to build, a new home, your purchase price can include costs of construction, as discussed in Publication 523.
Settlement fees or closing costs.Closing costs:Sale of homeHome:Closing costsHome:Settlement feesSale of home:Settlement fees or closing costsSettlement fees:Sale of home
When you bought your home, you may have paid settlement fees or closing costs in addition to the contract price of the property. You can include in
your basis some of the settlement fees and closing costs you paid for buying the home. You cannot include in your basis the fees and costs for getting
a mortgage loan. A fee paid for buying the home is any fee you would have had to pay even if you paid cash for the home.
Chapter 13 lists some of the settlement fees and closing costs that you can include in the basis of property, including your home. It also lists
some settlement costs that cannot be included in basis.
Also see Publication 523 for additional items and a discussion of basis other than cost.
Adjusted BasisSale of home:Adjusted basis
Adjusted basis is your basis increased or decreased by certain amounts.
Increases to basis.
These include any:
Additions and other improvements that have a useful life of more than 1 year,
Special assessments for local improvements, and
Amounts you spent after a casualty to restore damaged property.
Decreases to basis.
These include any:
Gain you postponed from the sale of a previous home before May 7, 1997,
Deductible casualty losses,
Insurance payments you received or expect to receive for casualty losses,
Payments you received for granting an easement or right-of-way,
Depreciation allowed or allowable if you used your home for business or rental purposes,
Residential energy credit (generally allowed from 1977 through 1987) claimed for the cost of energy improvements that you added to the basis
of your home,
Adoption credit you claimed for improvements added to the basis of your home,
Nontaxable payments from an adoption assistance program of your employer that you used for improvements you added to the basis of your home,
First-time homebuyer credit (allowed to certain first-time buyers of a home in the District of Columbia), and
Energy conservation subsidy excluded from your gross income because you received it (directly or indirectly) from a public utility after
1992 to buy or install any energy conservation measure. An energy conservation measure is an installation or modification that is primarily designed
either to reduce consumption of electricity or natural gas or to improve the management of energy demand for a home.
Improvements.
These add to the value of your home, prolong its useful life, or adapt it to new uses. You add the cost of additions and other improvements to the
basis of your property.
Examples.
Putting a recreation room or another bathroom in your unfinished basement, putting up a new fence, putting in new plumbing or wiring, putting on a
new roof, or paving your unpaved driveway are improvements. An addition to your house, such as a new deck, a sunroom, or a garage, is also an
improvement.
Repairs.
These maintain your home in good condition but do not add to its value or prolong its life. You do not add their cost to the basis of your
property.
Examples.
Repainting your house inside or outside, fixing your gutters or floors, repairing leaks or plastering, and replacing broken window panes are
examples of repairs.
Recordkeeping. Recordkeeping:Sale of homeSale of home:RecordkeepingYou should keep records to prove your home's adjusted basis. Ordinarily, you must keep records for 3 years
after the due date for filing your return for the tax year in which you sold your home. But if you sold a home before May 7, 1997, and postponed tax
on any gain, the basis of that home affects the basis of the new home you bought. Keep records proving the basis of both homes as long as they are
needed for tax purposes.
The records you should keep include:
Form:2119:Postponement of gain from sale of homePostponement of gain:Sale of home
Proof of the home's purchase price and purchase expenses,
Receipts and other records for all improvements, additions, and other items that affect the home's adjusted basis,
Any worksheets you used to figure the adjusted basis of the home you sold, the gain or loss on the sale, the exclusion, and the taxable
gain,
Any Form 2119, Sale of Your Home, that you filed to postpone gain from the sale of a previous home before May 7, 1997, and
Any worksheets you used to prepare Form 2119, such as the Adjusted Basis of Home Sold Worksheet or the Capital Improvements
Worksheet from the Form 2119 instructions.
Excluding the GainExclusions from gross incomeCapital gains from home saleSale of homeSale of home:Capital gains exclusion
You may qualify to exclude from your income all or part of any gain from the sale of your main home. This means that, if you qualify, you will not
have to pay tax on the gain up to the limit described under Maximum Exclusion, next. To qualify, you must meet the ownership and use tests
described later.
You can choose not to take the exclusion by including the gain from the sale in your gross income on your tax return for the year of the sale.
Maximum Exclusion
You can 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 can exclude up to $500,000 of the gain on the sale of your main home if all of the following are true.
You are married and file a joint return for the year.
Either you or your spouse meets the ownership test.
Both you and your spouse meet the use test.
During the 2-year period ending on the date of the sale, neither you nor your spouse excluded gain from the sale of another
home.
Ownership and Use Tests
To claim the exclusion, you must meet the ownership and use tests. This means that during the 5-year period ending on the date of the sale, you
must have:
Owned the home for at least 2 years (the ownership test), and
Lived in the home as your main home for at least 2 years (the use test).
Exception.
If you owned and lived in the property as your main home for less than 2 years, you can still claim an exclusion in some cases. The maximum amount
you can claim will be reduced. See Reduced Maximum Exclusion, later.
Example 1—home owned and occupied for 3 years.
Amanda bought and moved into her main home in September 2002. She sold the home at a gain on September 15, 2005. During the 5-year period ending on
the date of sale (September 16, 2000 – September 15, 2005), she owned and lived in the home for 3 years. She meets the ownership and use tests.
Example 2—met ownership test but not use test.
Dan bought a home in 1999. After living in it for 6 months, he moved out. He never lived in the home again and sold it at a gain on June 28, 2005.
He owned the home during the entire 5-year period ending on the date of sale (June 29, 2000 – June 28, 2005). However, he did not live in it for
the required 2 years. He meets the ownership test but not the use test. He cannot exclude any part of his gain on the sale, unless he qualified for a
reduced maximum exclusion (explained later).
Period of Ownership and UseSale of home:Period of ownership and use
The required 2 years of ownership and use during the 5-year period ending on the date of the sale do not have to be continuous.
You meet the tests if you can show that you owned and lived in the property as your main home for either 24 full months or 730 days (365 ×
2) during the 5-year period ending on the date of sale.
Temporary absence.
Short temporary absences for vacations or other seasonal absences, even if you rent out the property during the absences, are counted as periods of
use.
Example.
Professor Paul Beard, who is single, bought and moved into a house on August 28, 2002. He lived in it as his main home continuously until January
5, 2004, when he went abroad for a 1-year sabbatical leave. During part of the period of leave, the house was unoccupied, and during the rest of the
period, he rented it. On January 6, 2005, he sold the house at a gain.
Because his leave was not a short temporary absence, he cannot include the period of leave to meet the 2-year use test. He cannot exclude any part
of his gain, unless he qualifies for a reduced maximum exclusion (explained later). Even if he does qualify for a reduced maximum exclusion, he cannot
exclude the part of the gain equal to the depreciation he claimed (or could have claimed) while renting the house. See Depreciation after May 6,
1997, later.
Ownership and use tests met at different times.
You can meet the ownership and use tests during different 2-year periods. However, you must meet both tests during the 5-year period ending on the
date of the sale.
Example.
In 1996, Helen Jones lived in a rented apartment. The apartment building was later changed to a condominium, and she bought her apartment on
December 3, 2002. In 2003, Helen became ill and on April 14 of that year she moved to her daughter's home. On July 12, 2005, while still living in her
daughter's home, she sold her apartment.
Helen can exclude gain on the sale of her apartment because she met the ownership and use tests. Her 5-year period is from July 13, 2000, to July
12, 2005, the date she sold the apartment. She owned her apartment from December 3, 2002, to July 12, 2005 (more than 2 years). She lived in the
apartment from July 13, 2000 (the beginning of the 5-year period), to April 14, 2003 (more than 2 years).
Cooperative apartment.Cooperative housing:Sale or trade of:Period of ownership and use
If you sold stock in a cooperative housing corporation, the ownership and use tests are met if, during the 5-year period ending on the date of
sale, you:
Owned the stock for at least 2 years, and
Lived in the house or apartment that the stock entitles you to occupy as your main home for at least 2 years.
Members of the uniformed services or Foreign Service.MilitaryUniformed servicesForeign ServiceMembers of the uniformed services or Foreign Service
You can choose to have the 5-year test period for ownership and use suspended during any period you or your spouse serve on qualified official
extended duty as a member of the uniformed services or Foreign Service of the United States. This means that you may be able to meet the 2-year
use test even if, because of your service, you did not actually live in your home for at least the required 2 years during the 5-year period ending on
the date of sale.
If this helps you qualify to exclude gain, you can choose to have the 5-year test period suspended by filing a return for the year of sale that
does not include the gain.
Example.
David bought and moved into a home in 1997. He lived in it as his main home for 2 years. For the next 6 years, he did not live in
it because he was on qualified official extended duty with the Army. He then sold the home at a gain in 2005. To meet the use test, David chooses to
suspend the 5-year test period for the 6 years he was on qualifying official extended duty. This means he can disregard those 6 years. Therefore,
David's 5-year test period consists of the 5 years before he went on qualifying official extended duty. He meets the ownership and use tests because
he owned and lived in the home for 2 years during this test period.
Period of suspension.
The period of suspension cannot last more than 10 years. Together, the 10-year suspension period and the 5-year test period can be as long as, but
no more than, 15 years. You cannot suspend the 5-year period for more than one property at a time. You can revoke your choice to suspend the 5-year
period at any time.
For more information about the suspension of the 5-year test period, see Members of the uniformed services or Foreign Service in
Publication 523.
Exception for individuals with a disability.
There is an exception to the use test if during the 5-year period before the sale of your home:
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.
Under this exception, you are considered to live in your home during any time that you own the home and live in a facility (including a
nursing home) that is licensed by a state or political subdivision to care for persons in your condition.
If you meet this exception to the use test, you still have to meet the 2-out-of-5-year ownership test to claim the exclusion.
Previous home destroyed or condemned.Condemnation of property:Period of ownership and use
For the ownership and use tests, you add the time you owned and lived in a previous home that was destroyed or condemned to the time you owned and
lived in the home on which you wish to exclude gain. This rule applies if any part of the basis of the home you sold depended on the basis of the
destroyed or condemned home. Otherwise, you must have owned and lived in the same home for 2 of the 5 years before the sale to qualify for the
exclusion.
Married Persons
If you and your spouse file a joint return for the year of sale, you can exclude gain if either spouse meets the ownership and use tests. (But see
Maximum Exclusion, earlier.)
Example 1—one spouse sells a home.
Emily sells her home in June 2005. She marries Jamie later in the year. She meets the ownership and use tests, but Jamie does not. She can exclude
up to $250,000 of gain on a separate or joint return for 2005.
Example 2—each spouse sells a home.
The facts are the same as in Example 1 except that Jamie also sells a home in 2005. He meets the ownership and use tests on his home.
Emily and Jamie can each exclude up to $250,000 of gain.
Death of spouse before sale.
If your spouse died and you did not remarry before the date of sale, you are considered to have owned and lived in the property as your main home
during any period of time when your spouse owned and lived in it as a main home.
Home transferred from spouse.Sale of home:Transfer to spouse
If your home was transferred to you by your spouse (or former spouse if the transfer was incident to divorce), you are considered to have owned it
during any period of time when your spouse owned it.
Use of home after divorce.Divorced taxpayers:Use of home after divorce
You are considered to have used property as your main home during any period when:
You owned it, and
Your spouse or former spouse is allowed to live in it under a divorce or separation instrument and uses it as his or her main
home.
Reduced Maximum Exclusion
You can claim an exclusion, but the maximum amount of gain you can exclude will be reduced, if either of the following is true.
You did not meet the ownership and use tests, but the reason you sold the home was:
A change in place of employment,
Health, or
Unforeseen circumstances (as defined later).
Your exclusion would have been disallowed because of the rule described in More Than One Home Sold During 2-Year Period, later,
except that the reason you sold the home was:
A change in place of employment,
Health, or
Unforeseen circumstances (as defined next).
Use Worksheet 3 in Publication 523 to figure your reduced maximum exclusion.
Unforeseen circumstances.
The sale of your main home is because of an unforeseen circumstance if your primary reason for the sale is the occurrence of an event that you
could not reasonably have anticipated before buying and occupying your main home. For more information on unforeseen circumstances, see Publication
523.
More Than One Home Sold During 2-Year PeriodSale of home:More than one home:Sold in 2-year period
You cannot exclude gain on the sale of your home if, during the 2-year period ending on the date of the sale, you sold another home at a gain and
excluded all or part of that gain. If you cannot exclude the gain, you must include it in your income.
Exception.
You still can claim an exclusion, but the maximum amount of gain you can exclude will be reduced, if the reason you sold the home was:
A change in place of employment,
Health, or
Unforeseen circumstances (as defined earlier).
For more information about this exception, see More Than One Home Sold During 2-Year Period in Publication 523.
Business Use or
Rental of HomeHome office:Capital gains exclusionRental income and expenses:Dwelling unit used as home:Capital gains exclusion
You may be able to exclude your gain from the sale of a home that you have used for business or to produce rental income. But you must meet the
ownership and use tests.
Example 1.
On May 29, 1999, Amy bought a house. She moved in on that date and lived in it until May 31, 2001, when she moved out of the house and put it up
for rent. The house was rented from June 1, 2001, to March 31, 2003. Amy moved back into the house on April 1, 2003, and lived there until she sold it
on January 30, 2005. During the 5-year period ending on the date of the sale (January 31, 2000 – January 30, 2005), Amy owned and lived in the
house for more than 2 years as shown in the table below.
Five Year
Period Used as
Home Used as
Rental 1/31/00 –
5/31/0116 months 6/1/01 –
3/31/03 22 months 4/1/03 –
1/30/0522 months38 months22 months
Amy can exclude gain up to $250,000. However, she generally cannot exclude the part of the gain equal to the depreciation she claimed or could
have claimed for renting the house, as explained after Example 2.Example 2.
William owned and used a house as his main home from 1999 through 2002. On January 1, 2003, he moved to another state. He rented his house from
that date until April 30, 2005, when he sold it. During the 5-year period ending on the date of sale (May 1, 2000 – April 30, 2005), William
owned and lived in the house for 32 months (more than 2 years). He must report the sale on Form 4797. He can exclude gain up to $250,000. However, he
generally cannot exclude the part of the gain equal to the depreciation he claimed or could have claimed for renting the house, as explained next.
Depreciation after May 6, 1997.Depreciation:Real property:Gain from disposition of property
If you were entitled to take depreciation deductions because you used your home for business purposes or as rental property, you cannot exclude the
part of your gain equal to any depreciation allowed as a deduction for periods after May 6, 1997. If you can show by adequate records or other
evidence that the depreciation allowed was less than the amount allowable, the amount you cannot exclude is the amount allowed.
Property used partly for business or rental.
If you used property partly as a home and partly for business or to produce income, see Publication 523.
Reporting the SaleSale of home:Reporting of gain
Do not report the 2005 sale of your main home on your tax return unless:
You have a gain and you do not qualify to exclude all of it, or
You have a gain and you choose not to exclude it.
Form:1040, Schedule DHome sale, capital gains fromIf you have any taxable gain on the sale of your main home that cannot be excluded,
report the entire gain realized on Schedule D (Form 1040). Report it in column (f) of line 1 or line 8 of Schedule D, depending on how long you owned
the home. If you qualify for an exclusion, show it on the line directly below the line on which you report the gain. Write Section 121
exclusion in column (a) of that line and show the amount of the exclusion in column (f) as a loss (in parentheses).
Form:4797:Sales of business propertyIf you used the home for business or to produce rental income, you may have to use Form 4797
to report the sale of the business or rental part (or the sale of the entire property if used entirely for business or rental in that year). See
Business Use or Rental of Home in Publication 523.
Installment sale.
Installment sales:Home saleSome sales are made under arrangements that provide for part or all of the selling price to be paid in a later
year. These sales are called installment sales. If you finance the buyer's purchase of your home yourself, instead of having the buyer get a
loan or mortgage from a bank, you probably have an installment sale. You may be able to report the part of the gain you cannot exclude on the
installment basis.
Form:6252:Installment sale incomeUse Form 6252, Installment Sale Income, to report the sale. Enter your exclusion on line 15 of
Form 6252.
Seller-financed mortgage.Mortgages:Seller-financedSale of home:Seller-financed mortgageSeller-financed mortgages
If you sell your home and hold a note, mortgage, or other financial agreement, the payments you receive generally consist of both interest and
principal. You must report the interest you receive as part of each payment separately as interest income. If the buyer of your home uses the property
as a main or second home, you must also report the name, address, and social security number (SSN) of the buyer on line 1 of either Schedule B (Form
1040) or Schedule 1 (Form 1040A). The buyer must give you his or her SSN and you must give the buyer your SSN. Failure to meet these requirements may
result in a $50 penalty for each failure. If you or the buyer does not have and is not eligible to get an SSN, see Social Security Number
in chapter 1.
More information.
For more information on installment sales, see Publication 537, Installment Sales.
Special Situations
The situations that follow may affect your exclusion.
Sale of home acquired in like-kind exchange.Like-kind exchange
You cannot claim the exclusion if:
You acquired your home in a like-kind exchange (also known as a section 1031 exchange), and
You sold the home:
After October 22, 2004, and
During the 5-year period beginning with the date you acquired the home.
To defer gain from a like-kind exchange, you must have exchanged business or investment property for business or investment property of a like
kind. For more information about like-kind exchanges, see Publication 544, Sales and Other Dispositions of Assets.
Like-kind exchange of property used partly for business.
If you use your main home partly for business or rental purposes and then exchange the home for another property, see Publication 523.
Expatriates.Expatriates
You cannot claim the exclusion if the expatriation tax applies to you. The expatriation tax applies to U.S. citizens who have renounced their
citizenship (and long-term residents who have ended their residency) if one of their principal purposes was to avoid U.S. taxes. For more information
about the expatriation tax, see chapter 4 of Publication 519, U.S. Tax Guide for Aliens.
Home destroyed or condemned.CasualtiesCondemnation of property
If your home was destroyed or condemned, any gain (for example, because of insurance proceeds you received) qualifies for the exclusion.
Any part of the gain that cannot be excluded (because it is more than the limit) may be postponed under the rules explained in:
Publication 547, Casualties, Disasters, and Thefts, in the case of a home that was destroyed, or
Publication 544, in the case of a home that was condemned.
Sale of remainder interest.Remainder interest, sale of
Subject to the other rules in this chapter, you can choose to exclude gain from the sale of a remainder interest in your home. If you make this
choice, you cannot choose to exclude gain from your sale of any other interest in the home that you sell separately.
Exception for sales to related persons.Sales to related persons, exception
You cannot exclude gain from the sale of a remainder interest in your home to a related person. Related persons include your brothers and sisters,
half-brothers and half-sisters, spouse, ancestors (parents, grandparents, etc.), and lineal descendants (children, grandchildren, etc.). Related
persons also include certain corporations, partnerships, trusts, and exempt organizations.
Recapturing (Paying Back) a Federal Mortgage SubsidySale of home:Federal subsidy, recapture of
If you financed your home under a federally subsidized program (loans from tax-exempt qualified mortgage bonds or loans with mortgage credit
certificates), you may have to recapture (pay back) all or part of the benefit you received from that program when you sell or otherwise dispose of
your home. You recapture the benefit by increasing your federal income tax for the year of the sale. You may have to pay this recapture tax even if
you can exclude your gain from income under the rules discussed earlier; that exclusion does not affect the recapture tax.
Loans subject to recapture rules.
The recapture applies to loans that:
Came from the proceeds of qualified mortgage bonds, or
Were based on mortgage credit certificates.
The recapture also applies to assumptions of these loans.
When the recapture applies.
The recapture of the federal mortgage subsidy applies only if you meet both of the following conditions.
You sell or otherwise dispose of your home:
At a gain, and
During the first 9 years after the date you closed your mortgage loan.
Your income for the year of disposition is more than that year's adjusted qualifying income for your family size for that year (related to
the income requirements a person must meet to qualify for the federally subsidized program).
When recapture does not apply.
The recapture does not apply if any of the following situations apply to you:
Your mortgage loan was a qualified home improvement loan of not more than $15,000,
The home is disposed of as a result of your death,
You dispose of the home more than 9 years after the date you closed your mortgage loan,
You transfer the home to your spouse, or to your former spouse incident to a divorce, where no gain is included in your income,
You dispose of the home at a loss,
Your home is destroyed by a casualty, and you repair it or replace it on its original site within 2 years after the end of the tax year when
the destruction happened, or
You refinance your mortgage loan (unless you later meet all of the conditions listed previously under When the recapture
applies).
Notice of amounts.
At or near the time of settlement of your mortgage loan, you should receive a notice that provides the federally subsidized amount and other
information you will need to figure your recapture tax.
How to figure and report the recapture.
Sale of homeForm:8828:Recapture of federal mortgage subsidyThe recapture tax is figured on Form 8828, Recapture of Federal Mortgage Subsidy.
If you sell your home and your mortgage is subject to recapture rules, you must file Form 8828 even if you do not owe a recapture tax. Attach Form
8828 to your Form 1040. For more information, see Form 8828 and its instructions.
Reporting Gains and LossesCapital gains or lossesGains and lossesCapital gains or lossesSecurities:Capital gains
This chapter discusses how to report capital gains and losses from sales, exchanges, and other dispositions of investment property on Schedule D of
Form 1040. The discussion includes:
How to report short-term gains and losses,
How to report long-term gains and losses,
How to figure capital loss carryovers,
How to figure your tax on a net capital gain, and
An illustrated example of how to complete Schedule D.
If you sell or otherwise dispose of property used in a trade or business or for the production of income, see Publication 544, Sales and Other
Dispositions of Assets, before completing Schedule D.
Publication537 Installment Sales 544 Sales and Other Dispositions of Assets550 Investment Income and ExpensesForm (and Instructions)Capital Gains and LossesSales of Business PropertyInstallment Sale IncomePassive Activity Loss Limitations
Reporting Capital Gains and LossesCapital gains or losses:How to reportCapital gains or losses:Schedule DForm:1040, Schedule DCapital gains or losses
Report capital gains and losses on Schedule D (Form 1040). Enter your sales and trades of stocks, bonds, etc., and real estate (if not reported on
Form 4684, 4797, 6252, 6781, or 8824) on line 1 of Part I or line 8 of Part II, as appropriate. Include all these transactions even if you did not
receive a Form 1099-B, Proceeds From Broker and Barter Exchange Transactions, or Form 1099-S, Proceeds From Real Estate Transactions (or substitute
statement). You can use Schedule D-1 as a continuation schedule to report more transactions.
Be sure to add all sales price entries in column (d) of lines 1 and 2 and enter the total on line 3. Also add all sales price entries in column (d)
of lines 8 and 9 and enter the total on line 10. Then add the following amounts reported to you for 2005 on Forms 1099-B and Forms 1099-S (or on
substitute statements):
Proceeds from transactions involving stocks, bonds, and other securities, and
Gross proceeds from real estate transactions (other than the sale of your main home if you had no taxable gain) not reported on another form
or schedule.
If this total is more than the total of lines 3 and 10, attach a statement to your return explaining the difference.
Installment sales.Capital gains or losses:Installment sales andInstallment sales:Capital gains and
You cannot use the installment method to report a gain from the sale of stock or securities traded on an established securities market. You must
report the entire gain in the year of sale (the year in which the trade date occurs).
Passive activity gains and losses.Gains and losses:Passive activityPassive activity:Reporting of gains or losses
Form:8582:Passive activity gains or lossesIf you have gains or losses from a passive activity, you may also have to report them
on Form 8582. In some cases, the loss may be limited under the passive activity rules. Refer to Form 8582 and its separate instructions for more
information about reporting capital gains and losses from a passive activity.
Form 1099-B transactions.Form:1099-B:Broker to report sales of stocks, bonds, or commodities
If you sold property, such as stocks, bonds, or certain commodities, through a broker, you should receive Form 1099-B or equivalent statement from
the broker. Use the Form 1099-B or the equivalent statement to complete Schedule D.
Report the gross proceeds shown in box 2 of Form 1099-B as the gross sales price in column (d) of either line 1 or line 8 of Schedule D, whichever
applies. However, if the broker advises you, in box 2 of Form 1099-B, that gross proceeds (gross sales price) less commissions and option premiums
were reported to the IRS, enter that net sales price in column (d) of either line 1 or line 8 of Schedule D, whichever applies.
If the net sales price is entered in column (d), do not include the commissions and option premiums in column (e).
Form 1099-S transactions.Form:1099-S:Real estate transactions proceedsReal estate:Form 1099-S to report sale proceeds
If you sold or traded reportable real estate, you generally should receive from the real estate reporting person a Form 1099-S showing the gross
proceeds.
Reportable real estate is defined as any present or future ownership interest in any of the following:
Improved or unimproved land, including air space,
Inherently permanent structures, including any residential, commercial, or industrial building,
A condominium unit and its accessory fixtures and common elements, including land, and
Stock in a cooperative housing corporation (as defined in section 216 of the Internal Revenue Code).
Cooperative housing:Sale or trade of:Form 1099-S to report
A real estate reporting person could include the buyer's attorney, your attorney, the title or escrow company, a mortgage lender, your
broker, the buyer's broker, or the person acquiring the biggest interest in the property.
Your Form 1099-S will show the gross proceeds from the sale or exchange in box 2. Follow the instructions for Schedule D to report these
transactions and include them on line 1 or 8 as appropriate.
Nominees.
If you receive gross proceeds as a nominee (that is, the gross proceeds are in your name but actually belong to someone else), report on Schedule
D, lines 3 and 10, only the proceeds that belong to you. Then add the following amounts reported to you for 2005 on Forms 1099-B and 1099-S (or
substitute statements) that you are not reporting on another form or schedule included with your return:
Proceeds from transactions involving stocks, bonds, and other securities, and
Gross proceeds from real estate transactions (other than the sale of your main home if you are not required to report it).
If the total of (1) and (2) is more than the total of lines 3 and 10, attach a statement to your return explaining the reason for the
difference.
File Form 1099-B or Form 1099-S with the IRS.Form:10961099-B1099-S
If you received gross proceeds as a nominee in 2005, you must file a Form 1099-B or Form 1099-S for those proceeds with the IRS. Send the Form
1099-B or Form 1099-S with a Form 1096, Annual Summary and Transmittal of U.S. Information Returns, to your Internal Revenue Service Center by
February 28, 2006 (March 31, 2006, if you file Form 1099-B or Form 1099-S electronically). Give the actual owner of the proceeds Copy B of the Form
1099-B or Form 1099-S by January 31, 2006. On Form 1099-B, you should be listed as the Payer. The other owner should be listed as the
Recipient. On Form 1099-S, you should be listed as the Filer. The other owner should be listed as the Transferor. You do not,
however, have to file a Form 1099-B or Form 1099-S to show proceeds for your spouse. For more information about the reporting requirements and the
penalties for failure to file (or furnish) certain information returns, see the General Instructions for Forms 1099, 1098, 5498, and W-2G.
Sale of property bought at various times.Securities:Bought at various times, how to indicate
If you sell a block of stock or other property that you bought at various times, report the short-term gain or loss from the sale on one line in
Part I of Schedule D and the long-term gain or loss on one line in Part II. Write Various in column (b) for the Date acquired. See
Comprehensive Example later in this chapter.
Sale expenses.
Form:1040, Schedule DSale expensesSecurities:Sale expenses, how to adjust forAdd to your cost or other basis any expense of sale such as brokers' fees, commissions,
state and local transfer taxes, and option premiums. Enter this adjusted amount in column (e) of either Part I or Part II of Schedule D, whichever
applies, unless you reported the net sales price amount in column (d).
For more information about adjustments to basis, see chapter 13.
Short-term gains and losses.Gains and losses:Short-termSecurities:Short-term gains and lossesShort-term gains and losses
Capital gain or loss on the sale or trade of investment property held 1 year or less is a short-term capital gain or loss. You report it in Part I
of Schedule D. If the amount you report in column (f) is a loss, show it in parentheses.
You combine your share of short-term capital gain or loss from partnerships, S corporations, and fiduciaries, and any short-term capital loss
carryover, with your other short-term capital gains and losses to figure your net short-term capital gain or loss on line 7 of Schedule D.
Long-term gains and losses.Long-term gains and lossesCapital gains or losses
Capital gains or losses:Sale or trade of property held more than 1 yearA capital gain or loss on the sale or trade of investment property held more
than 1 year is a long-term capital gain or loss. You report it in Part II of Schedule D. If the amount you report in column (f) is a loss, show it in
parentheses.
You also report the following in Part II of Schedule D:
Undistributed long-term capital gains from a regulated investment company (mutual fund) or real estate investment trust (REIT),
Capital gains or losses:Undistributed gainsForm:1040, Schedule DUndistributed long-term capital gainsMutual funds:Undistributed capital gainsReal estate investment trusts (REITs):Undistributed capital gainsUndistributed capital gains
Your share of long-term capital gains or losses from partnerships, S corporations, and fiduciaries,
Partners and partnerships:Capital gains or losses fromS corporations:Capital gains or losses from
All capital gain distributions from mutual funds and REITs not reported directly on line 10 of Form 1040A or line 13 of Form 1040,
and
Long-term capital loss carryovers.
Capital gains or losses:Carryover ofCarryovers:Capital loss
Capital gains or losses:Net capital gainCapital gains or losses:Net long-term capital lossThe result after combining these items with your other long-term capital gains and losses is your
net long-term capital gain or loss (line 15 of Schedule D).
Capital gain distributions only.
Form:1040, Schedule DCapital gains or lossesYou do not have to file Schedule D if both of the following are true.
The only amounts you would have to report on Schedule D are capital gain distributions from box 2a of Form 1099-DIV (or substitute
statement).
You do not have an amount in box 2b, 2c, or 2d of any Form 1099-DIV (or substitute statement).
Capital gains or losses:Form 1040 or 1040A to be usedIf both of the above statements are true, report your capital gain distributions directly on line 13 of Form 1040 and check the box on line 13.
Also, use the Qualified Dividends and Capital Gain Tax Worksheet in the Form 1040 instructions to figure your tax.
You can report your capital gain distributions on line 10 of Form 1040A, instead of on Form 1040, if both of the following are true.
None of the Forms 1099-DIV (or substitute statements) you received have an amount in box 2b, 2c, or 2d.
You do not have to file Form 1040 for any other capital gains or losses.
Total net gain or loss.Capital gains :Total net gainCapital gains or losses:Total net lossGains and losses:Total net gain
To figure your total net gain or loss, combine your net short-term capital gain or loss (line 7) with your net long-term capital gain or loss (line
15). Enter the result on Schedule D, Part III, line 16. If your losses are more than your gains, see Capital Losses, next. If both lines 15
and 16 are gains and line 43 of Form 1040 is more than zero, see Capital Gain Tax Rates, later.
Capital LossesCapital gains or losses:DeductionsDeductionsCapital losses
If your capital losses are more than your capital gains, you can claim a capital loss deduction. Report the deduction on line 13 of Form 1040,
enclosed in parentheses.
Limit on deduction.Capital gains or losses:Deductions:Limit on
Your allowable capital loss deduction, figured on Schedule D, is the lesser of:
$3,000 ($1,500 if you are married and file a separate return), or
Your total net loss as shown on line 16 of Schedule D.
You can use your total net loss to reduce your income dollar for dollar, up to the $3,000 limit.
Capital loss carryover.Capital gains or losses:Carryover ofCarryovers:Capital loss
If you have a total net loss on line 16 of Schedule D that is more than the yearly limit on capital loss deductions, you can carry over the unused
part to the next year and treat it as if you had incurred it in that next year. If part of the loss is still unused, you can carry it over to later
years until it is completely used up.
When you figure the amount of any capital loss carryover to the next year, you must take the current year's allowable deduction into account,
whether or not you claimed it.
When you carry over a loss, it remains long term or short term. A long-term capital loss you carry over to the next tax year will reduce that
year's long-term capital gains before it reduces that year's short-term capital gains.
Figuring your carryover.
The amount of your capital loss carryover is the amount of your total net loss that is more than the lesser of:
Your allowable capital loss deduction for the year, or
Your taxable income increased by your allowable capital loss deduction for the year and your deduction for personal exemptions.
If your deductions are more than your gross income for the tax year, use your negative taxable income in computing the amount in item (2).
Capital gains or losses:Carryover of:WorksheetCarryovers:Capital loss:WorksheetWorksheets:Capital loss carryoverComplete the Capital Loss Carryover Worksheet in Publication 550 to determine the part of your
capital loss for 2005 that you can carry over to 2006.
Example.
Bob and Gloria sold securities in 2005. The sales resulted in a capital loss of $7,000. They had no other capital transactions. Their taxable
income was $26,000. On their joint 2005 return, they can deduct $3,000. The unused part of the loss, $4,000 ($7,000 − $3,000), can be carried
over to 2006.
If their capital loss had been $2,000, their capital loss deduction would have been $2,000. They would have no carryover.
Use short-term losses first.Gains and losses:Short-term:Priority in deductingShort-term gains and losses:Priority in deducting
When you figure your capital loss carryover, use your short-term capital losses first, even if you incurred them after a long-term capital loss. If
you have not reached the limit on the capital loss deduction after using the short-term capital losses, use the long-term capital losses until you
reach the limit.
Decedent's capital loss.Decedents:Capital loss of
Final return for decedent:Capital loss deduction onA capital loss sustained by a decedent during his or her last tax year (or carried over to that
year from an earlier year) can be deducted only on the final income tax return filed for the decedent. The capital loss limits discussed earlier still
apply in this situation. The decedent's estate cannot deduct any of the loss or carry it over to following years.
Joint and separate returns.Joint returns:Carryover of capital lossMarried filing separately:Carryover of capital loss
If you and your spouse once filed separate returns and are now filing a joint return, combine your separate capital loss carryovers. However, if
you and your spouse once filed a joint return and are now filing separate returns, any capital loss carryover from the joint return can be deducted
only on the return of the spouse who actually had the loss.
Capital Gain Tax RatesCapital gains or losses:Tax rates
The tax rates that apply to a net capital gain are generally lower than the tax rates that apply to other income. These lower rates are called the
maximum capital gain rates.
Capital gains or losses:Net capital gainThe term net capital gain means the amount by which your net long-term capital gain for the year is
more than your net short-term capital loss.
For 2005, the maximum capital gain rates are 5%, 15%, 25%, or 28%. See Table 16-1 for details.
If you figure your tax using the maximum capital gain rates and the regular tax computation results in a lower tax, the regular tax computation
applies.
Example.
All of your net capital gain is from selling collectibles, so the capital gain rate would be 28%. Because you are single and your taxable income is
$25,000, none of your taxable income will be taxed above the 15% rate. The 28% rate does not apply.
Investment interest deducted.
If you claim a deduction for investment interest, you may have to reduce the amount of your net capital gain that is eligible for the capital gain
tax rates. Reduce it by the amount of the net capital gain you choose to include in investment income when figuring the limit on your investment
interest deduction. This is done on the Schedule D Tax Worksheet or the Qualified Dividends and Capital Gain Tax Worksheet. For more information about
the limit on investment interest, see chapter 3 of Publication 550.
Capital gains or losses:CollectiblesCollectibles:Gains or losses from sale or trade ofGains and losses:CollectiblesAntiquesCollectiblesArt works:Capital gains or losses from sale or trade ofGold and silver:Capital gains or losses from sale or trade ofHousehold furnishingsAntiquesCollectiblesMetals, preciousGold and silverSilverGold and silver
<ROM>Table 16-1.</ROM> What Is Your Maximum Capital Gain Rate?Capital gains or losses:Tax rates:Maximum capital gain rates (Table 16-1)Tables and figures:Capital gain rates (Table 16-1)IF your net capital gain is from ...THEN your
maximum capital
gain rate is ...Collectibles gain28%Gain on qualified small business stock minus the section 1202 exclusion28%Unrecaptured section 1250 gain25%Other gain
1 and the regular tax rate that would apply is 25% or higher15%Other gain
1 and the regular tax rate that would apply is lower than 25%5%
1 Other gain means any gain that is not collectibles gain, gain on qualified small business stock, or
unrecaptured section 1250 gain.
Collectibles gain or loss.
This is gain or loss from the sale or trade of a work of art, rug, antique, metal (such as gold, silver, and platinum bullion), gem, stamp, coin,
or alcoholic beverage held more than 1 year.
Gain on qualified small business stock.Small businesses:Capital gains or losses from stock of
Section 1202 exclusion:Capital gains or losses underIf you realized a gain from qualified small business stock that you held more than 5 years,
you generally can exclude up to 50% of your gain from income. The exclusion can be up to 60% for certain empowerment zone business stock. The gain
minus your section 1202 exclusion is a 28% rate gain. See Gains on Qualified Small Business Stock in chapter 4 of Publication 550.
Unrecaptured section 1250 gain.Unrecaptured Section 1250 gain
Capital gains or losses:Section 1250 gains from sale of real propertySection 1250 gains:Sale of real property subject toGenerally, this is any part of your capital gain from selling section 1250 property (real
property) that is due to depreciation (but not more than your net section 1231 gain), reduced by any net loss in the 28% group. Use the Unrecaptured
Section 1250 Gain Worksheet in the Schedule D instructions to figure your unrecaptured section 1250 gain. For more information about section 1250
property and section 1231 gain, see chapter 3 of Publication 544.
Tax computation using maximum capital gains rates.
Use the Qualified Dividends and Capital Gain Tax Worksheet or the Schedule D Tax Worksheet (whichever applies) to figure your tax if you have
qualified dividends or net capital gain. You have net capital gain if Schedule D, lines 15 and 16, are both gains.
Schedule D Tax Worksheet.
You must use the Schedule D Tax Worksheet in the Schedule D instructions to figure your tax if:
You have to file Schedule D, and
Schedule D, line 18 (28% rate gain) or line 19 (unrecaptured section 1250 gain), is more than zero.
See Comprehensive Example, later, for an example of how to figure your tax using the Schedule D Tax Worksheet.
Qualified Dividends and Capital Gain Tax Worksheet.
If you do not have to use the Schedule D Tax Worksheet (as explained above) and any of the following apply, use the Qualified Dividends and Capital
Gain Tax Worksheet in the instructions for Form 1040 or Form 1040A (whichever you file) to figure your tax.
You received qualified dividends. (See Qualified Dividends in chapter 8.)
You do not have to file Schedule D and you received capital gain distributions. (See Capital gain distributions only,
earlier.)
Schedule D, lines 15 and 16, are both more than zero.
Comprehensive Example
Emily Jones is single and, in addition to wages from her job, she has income from stocks and other securities. For the 2005 tax year, she had the
following capital gains and losses, which she reports on Schedule D. All the Forms 1099 she received showed net sales prices. Her filled-in Schedule D
is shown in this chapter.
Capital gains and losses — Schedule D.
Emily sold stock in two different companies that she held for less than a year. In June, she sold 100 shares of Trucking Co. stock that she had
bought in February. She had an adjusted basis of $650 in the stock and sold it for $900, for a gain of $250. In July, she sold 25 shares of Computer
Co. stock that she bought in June. She had an adjusted basis in the stock of $2,500 and she sold it for $2,000, for a loss of $500. She reports these
short-term transactions on line 1 in Part I of Schedule D.
Emily had three other stock sales that she reports as long-term transactions on line 8 in Part II of Schedule D. In February, she sold 60 shares of
Car Co. for $2,100. She had inherited the Car Co. stock from her father. Its fair market value at the time of his death was $2,500, which became her
basis. Her loss on the sale is $400. Because she had inherited the stock, her loss is a long-term loss, regardless of how long she and her father
actually held the stock. She enters the loss in column (f) of line 8.
In June, she sold 500 shares of Furniture Co. stock for $14,000. She had bought 100 of those shares in 1994, for $1,000. She had bought 100 more
shares in 1996 for $2,200, and an additional 300 shares in 1999 for $1,500. Her total basis in the stock is $4,700. She has a $9,300 ($14,000 −
$4,700) gain on this sale, which she enters in column (f) of line 8.
In December, she sold 20 shares of Toy Co. for $4,100. This was qualified small business stock that she had bought in September 2000. Her basis is
$1,100, so she has a $3,000 gain which she enters in column (f) of line 8. Because she held the stock more than 5 years, she has a $1,500 section 1202
exclusion. She claims the exclusion on the line below by entering $1,500 as a loss in column (f). She also enters the exclusion as a positive amount
on line 2 of the 28% Rate Gain Worksheet.
She received a Form 1099-B (not shown) from her broker for each of these transactions.
Reconciliation of Forms 1099-B.
Emily makes sure that the total of the amounts reported in column (d) of lines 3 and 10 of Schedule D is not less than the total of the amounts
shown on the Forms 1099-B she received from her broker. For 2005, the total is $23,100.
Capital loss carryover from 2004.
Emily has a capital loss carryover to 2005 of $800, of which $300 is short-term capital loss, and $500 is long-term capital loss. She enters these
amounts on lines 6 and 14 of Schedule D. She also enters the $500 long-term capital loss carryover on line 5 of the 28% Rate Gain Worksheet. Her
filled-in 28% Rate Gain Worksheet is shown below.
She kept the completed Capital Loss Carryover Worksheet (not illustrated) in her 2004 edition of Publication 550, so she could properly report her
loss carryover for the 2005 tax year without refiguring it.
Tax computation.
Because Emily has gains on both lines 15 and 16 of Schedule D, she checks the Yes box on line 17 and goes to line 18. On line 18 she enters
$450 from line 7 of the 28% Rate Gain Worksheet. Because line 18 is greater than zero, she checks the No box on line 20 and uses the Schedule D
Tax Worksheet to figure her tax.
After entering the gain from line 16 on line 13 of her Form 1040, she completes the rest of Form 1040 through line 43. She enters the amount from
that line, $30,000, on line 1 of the Schedule D Tax Worksheet. After filling out the rest of that worksheet, she figures her tax is $3,279. This is
less than the $4,171 tax she would have figured without the capital gain tax rates.
28% Rate Gain Worksheet for Emily Jones—Line 181.Enter the total of all collectibles gain or (loss) from items you reported on line 8,
column (f), of Schedules D and D-11.02.Enter as a positive number the amount of any section 1202 exclusion you reported on
line 8, column (f), of Schedules D and D-12.1,5003.Enter the total of all collectibles gain or (loss) from Form 4684, line 4 (but only
if Form 4684, line 15, is more than zero); Form 6252; Form 6781, Part II; and Form 88243.4.Enter the total of any collectibles gain reported to you on:
Form 1099-DIV, box 2d;
Form 2439, box 1d; and
Schedule K-1 from a partnership, S corporation, estate, or trust.
4.5.Enter your long-term capital loss carryovers from Schedule D, line 14, and Schedule
K-1 (Form 1041), box 11, code C5.( 500)6.If Schedule D, line 7, is a (loss), enter that (loss) here. Otherwise, enter
-0-6.( 550)7.Combine lines 1 through 6. If zero or less, enter -0-. If more than zero, also enter
this amount on Schedule D, line 187.450
Capital gains or losses
Schedule D Tax WorksheetComplete this worksheet only if line 18 or line 19 of Schedule D is more than zero. Otherwise,
complete the Qualified Dividends and Capital Gain Tax Worksheet on page 38 of the Instructions for Form 1040 to figure your tax.Exception: Do not use the Qualified Dividends and Capital Gain Tax Worksheet or this worksheet to figure your tax if:
Line 15 or line 16 of Schedule D is zero or less and you have no qualified dividends on Form 1040, line 9b, or
Form 1040, line 43, is zero or less.
Instead, see the instructions for Form 1040, line 44.1.Enter your taxable income from Form 1040, line 431.30,0002.Enter your qualified dividends from Form 1040, line 9b2.3.Enter the amount from Form 4952, line 4g3.4.Enter the amount from Form 4952, line 4e*4.5.Subtract line 4 from line 3. If zero or less, enter -0-5.6.Subtract line 5 from line 2. If zero or less, enter -0-6.7.Enter the smaller of line 15 or line 16 of Schedule D7.9,3508.Enter the smaller of line 3 or line 48.9.Subtract line 8 from line 7. If zero or less, enter -0-9.9,35010.Add lines 6 and 910.9,35011.Add lines 18 and 19 of Schedule D11.45012.Enter the smaller of line 9 or line 1112.45013.Subtract line 12 from line 10.13.8,90014.Subtract line 13 from line 1. If zero or less, enter -0-.14.21,10015.Enter the smaller of:• The amount on line 1 or• $29,700 if single or married filing separately;
$59,400 if married filing jointly or qualifying widow(er); or
$39,800 if head of household15.29,70016.Enter the smaller of line 14 or line 1516.21,10017.Subtract line 10 from line 1. If zero or less, enter -0-17.20,65018.Enter the larger of line 16 or line 1718.21,100If lines 15 and 16 are the same, skip lines 19 and 20 and go to line 21. Otherwise, go to
line 19.19.Subtract line 16 from line 1519.8,60020.Multiply line 19 by 5% (.05)20.430If lines 1 and 15 are the same, skip lines 21 through 33 and go to line 34. Otherwise, go
to line 21.21.Enter the smaller of line 1 or line 1321.8,90022.Enter the amount from line 19 (if line 19 is blank, enter -0-)22.8,60023.Subtract line 22 from line 21. If zero or less, enter -0-23.30024.Multiply line 23 by 15% (.15)24.45If Schedule D, line 19, is zero or blank, skip lines 25 through 30 and go to line 31.
Otherwise, go to line 25.25.Enter the smaller of line 9 above or Schedule D, line 1925.26.Add lines 10 and 1826.27.Enter the amount from line 1 above27.28.Subtract line 27 from line 26. If zero or less, enter -0-28.29.Subtract line 28 from line 25. If zero or less, enter -0-29.30.Multiply line 29 by 25% (.25)30.If Schedule D, line 18, is zero or blank, skip lines 31 through 33 and go to line 34.
Otherwise, go to line 31.31.Add lines 18, 19, 23, and 2931.30,00032.Subtract line 31 from line 132.033.Multiply line 32 by 28% (.28)33.034.Figure the tax on the amount on line 18. Use the Tax Table or Tax
Computation Worksheet, whichever applies34.2,80435.Add lines 20, 24, 30, 33, and 3435.3,27936.Figure the tax on the amount on line 1. Use the Tax Table or Tax
Computation Worksheet, whichever applies36.4,17137.Tax on all taxable income (including capital gains and qualified
dividends). Enter the smaller of line 35 or line 36. Also enter this amount on Form 1040, line 4437.3,279*If applicable, enter instead the smaller amount you entered on the dotted line
next to line 4e of Form 4952.
SCHEDULE D (FORM 1040) Capital Gains and Losses 2005Summary: This is an example Schedule D (Form 1040), Page 1 with included items as described in the comprehensive example. Additionally, these
line items were filled out:Name(s) shown on Form 1040 field contains Emily JonesYour social security number field contains 111-00-1111Under Part I: Short-Term Capital Gains and Losses--Assets Held One Year or Less:3. Total short-term sales price amounts. Add lines 1 and 2 in column (d) field contains 2,9006. Short-term capital loss carryover from line 8 of Capital Loss Carryover Worksheet. field contains negative 3007. Net short-term capital gain or (loss). Combine lines 1 through 6 in column (f). field contains negative
550Under Part II Long-Term Capital Gains and Losses--Assets Held More Than One Year:10. Total long-term sales price amounts. Add lines 8 and 9 in column (d) field contains 20,20014. Long-term capital loss carryover from line 13 of Capital Loss Carryover Worksheet. field contains negative 50015. Net long-term capital gain or (loss). Combine lines 8 through 14 in column (f). field contains
9,900
SCHEDULE D (FORM 1040) Capital Gains and Losses 2005 Page 2Summary: This is an example Schedule D (Form 1040), Page 2 with these line items filled out:Under Part III: Taxable Gain or Deductible Loss:16. Combine lines 7 and 15 and enter the result. If a loss, go to line 21. If a gain, enter the gain on Form 1040, line 13, and go to line 17
below. 17. If lines 15 and 16 are both gains, go to line 18. If the amounts on line 15 and 16 are not both gains, skip line 18 through 21, and go to
line 22.22. If you have qualified dividends on Form 1040, line 9b, complete Form 1040 through line 43, and complete the Qualified Dividends and
Capital Gain Tax Worksheet on page 38 of the Instructions for Form 1040. If you do not have qualified dividends on Form 1040, line 9b, complete the
rest of Form 1040.
Adjustments to Income
The three chapters in this part discuss some of the adjustments to income that you can deduct in figuring your adjusted gross income. These
chapters cover:
Contributions you make to traditional individual retirement arrangements (IRAs) — chapter 17,
Alimony you pay — chapter 18, and
Educator expenses, student loan interest, and tuition and fees you pay—chapter 19.
Other adjustments to income are discussed elsewhere. See Table V below.
<ROM>Table V.</ROM> Other Adjustments to IncomeUse this table to find information about other adjustments to income not covered in this part of the publication.IF you are looking for more information about the deduction for...THEN see...Certain business expenses of reservists, performing artists, and fee-basis officials Chapter 26.Contributions to a health savings accountPublication 969, Health Savings Accounts and Other Tax-Favored Health Plans.Moving expensesPublication 521, Moving Expenses.One-half of self-employment taxChapter 22.Self-employed health insuranceChapter 21.Payments to self-employed SEP, SIMPLE, and qualified plansPublication 560, Retirement Plans for Small Business.Penalty on the early withdrawal of savingsChapter 7.Contributions to an Archer MSAChapter 21.Reforestation amortization or expenseChapter 9 of Publication 535, Business Expenses.Contributions to Internal Revenue Code section 501(c)(18)(D) pension plansPublication 525, Taxable and Nontaxable Income.Expenses from the rental of personal propertyChapter 12.Certain required repayments of supplemental unemployment benefits (sub-pay) Chapter 12.Foreign housing costsChapter 4 of Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad.Deduction for clean-fuel vehicleChapter 12 of Publication 535, Business Expenses.Jury duty pay given to your employerChapter 12.Contributions by certain chaplains to Internal Revenue Code section 403(b) plansPublication 517, Social Security and Other Information for Members of the Clergy and Religious Workers.Attorney fees and certain costs for actions involving certain unlawful discrimination claimsPublication 525.Domestic production activities deductionForm 8903.
Individual Retirement Arrangements (IRAs)Individual retirement arrangements (IRAs)Certificates of deposit (CDs)Individual retirement arrangements (IRAs)IRAsIndividual retirement arrangements (IRAs)Retirement plans:IRAsIndividual retirement arrangements (IRAs)Traditional IRAsIndividual retirement arrangements (IRAs)What's New for 2005Katrina Emergency Tax Relief Act of 2005.
This Act provides tax relief for persons affected by Hurricane Katrina. Under the Act, if you have funds in certain retirement plans, including
IRAs, you may qualify for tax-favored withdrawals and recontributions. See Publication 4492.
Traditional IRA contribution and deduction limit.
The contribution limit to your traditional IRA for 2005 increased to the smaller of the following amounts:
$4,000, or
Your taxable compensation for the year.
If you reached age 50 before 2006, the most that could be contributed to your traditional IRA for 2005 is the smaller of the following amounts:
$4,500, or
Your taxable compensation for the year.
Roth IRA contribution limit.
If contributions were made on your behalf only to Roth IRAs, your contribution limit for 2005 is generally the lesser of:
$4,000, or
Your taxable compensation for the year.
If you were 50 or older in 2005 and contributions on your behalf were made only to Roth IRAs, your contribution limit for 2005 is generally the
lesser of:
$4,500, or
Your taxable compensation for the year.
However, if your modified adjusted gross income (AGI) is above a certain amount, your contribution limit may be reduced.
Modified AGI limit for traditional IRA contributions increased.
For 2005, if you were covered by a retirement plan at work, your deduction for contributions to a traditional IRA is reduced (phased out) if your
modified adjusted gross income (AGI) is:
More than $70,000 but less than $80,000 for a married couple filing a joint return or a qualifying widow(er),
More than $50,000 but less than $60,000 for a single individual or head of household, or
Less than $10,000 for a married individual filing a separate return.
For all filing statuses other than married filing separately, the upper and lower limits of the phaseout range increased by $5,000.
Modified AGI.
Beginning in 2005, the domestic production activities deduction is added back to income when figuring modified AGI.
Modified AGI for conversion purposes.
Beginning in 2005, modified AGI for conversion purposes does not include required distributions from IRAs. See Modified AGI under
Roth IRAs.
What's New for 2006Traditional IRA contribution and deduction limit.
The contribution limit to your traditional IRA for 2006 will be the smaller of the following amounts:
$4,000, or
Your taxable compensation for the year.
If you will be age 50 before 2007, the most that can be contributed to your traditional IRA for 2006 will be the smaller of the following amounts:
$5,000, or
Your taxable compensation for the year.
For more information, see How Much Can Be Contributed.
Roth IRA contribution limit.
If contributions are made on your behalf only to Roth IRAs, your contribution limit for 2006 will generally be the lesser of:
$4,000, or
Your taxable compensation for the year.
If you will be age 50 before 2007 and contributions on your behalf are made only to Roth IRAs, your contribution limit for 2006 will generally be
the lesser of:
$5,000, or
Your taxable compensation for the year.
However, if your modified AGI is above a certain amount, your contribution limit may be reduced. For more information, see How Much Can Be
Contributed? under Can You Contribute to a Roth IRA.
Modified AGI limit for traditional IRA contributions increased for a married couple filing a joint return.
For 2006, if you are covered by a retirement plan at work, your deduction for contributions to a traditional IRA will be reduced (phased out) if
your modified adjusted gross income (AGI) is:
More than $75,000 but less than $85,000 for a married couple filing a joint return or a qualifying widow(er),
More than $50,000 but less than $60,000 for a single individual or head of household, or
Less than $10,000 for a married individual filing a separate return.
See How Much Can You Deduct.
RemindersStatement of required minimum distribution.
If a minimum distribution is required from your IRA, the trustee, custodian, or issuer that held the IRA at the end of the preceding year must
either report the amount of the required minimum distribution to you, or offer to calculate it for you. The report or offer must include the date by
which the amount must be distributed. The report is due January 31 of the year in which the minimum distribution is required. It can be provided with
the year-end fair market value statement that you normally get each year. No report is required for IRAs of owners who have died.
IRA interest.Early withdrawal from deferred interest account:Higher education expenses, exception from penaltyIndividual retirement arrangements (IRAs)Early distributionsEarly withdrawal from deferred interest accountIndividual retirement arrangements (IRAs):Interest on, treatment ofIndividual retirement arrangements (IRAs)Married couplesthis heading: Spousal IRAsIndividual retirement arrangements (IRAs)PenaltiesEarly distributionsEarly withdrawal from deferred interest accountIndividual retirement arrangements (IRAs):Spousal IRAsIndividual retirement arrangements (IRAs)WithdrawalsEarlyEarly withdrawal from deferred interest accountPremature distributionsEarly withdrawal from deferred interest account
Although interest earned from your IRA is generally not taxed in the year earned, it is not tax-exempt interest. Do not report this interest on
your tax return as tax-exempt interest.
Form 8606.
Form:8606:IRA contributions, NondeductibleIndividual retirement arrangements (IRAs):Forms to use:Form 8606 for nondeductible contributionsIndividual retirement arrangements (IRAs):Penalties:Form 8606 not filed for nondeductible contributionsPenalties:Form 8606 not filed for nondeductible IRA contributionsPenalties:IRAs:Form 8606 not filed for nondeductible contributionsIf you make nondeductible contributions to a traditional IRA and
you do not file Form 8606, Nondeductible IRAs, with your tax return, you may have to pay a $50 penalty.
You cannot claim a deduction for any contributions to a Roth IRA. But, if you satisfy the requirements, all earnings are tax free and neither your
nondeductible contributions nor any earnings on them are taxable when you withdraw them. See Roth IRAs, later.
The term 50 or older is used several times in this chapter. It refers to an IRA owner who is age 50 or older by the end of the tax year.
Traditional IRAsIndividual retirement arrangements (IRAs)An individual retirement arrangement (IRA) is a personal savings plan that gives you tax
advantages for setting aside money for your retirement.
This chapter discusses:
The rules for a traditional IRA (any IRA that is not a Roth or SIMPLE IRA), and
The Roth IRA, which features nondeductible contributions and tax-free distributions.
Simplified Employee Pensions (SEPs) and Savings Incentive Match Plans for Employees (SIMPLEs) are not discussed in this chapter. For more
information on these plans and employees' SEP-IRAs and SIMPLE IRAs that are part of these plans, see Publications 560 and 590.
Publication560Retirement Plans for Small Business590Individual Retirement Arrangements (IRAs) Form (and Instructions)Additional Taxes on Qualified Plans (including IRAs) and Other Tax-Favored AccountsNondeductible IRAs
Traditional IRAsIndividual retirement arrangements (IRAs):Definition of
In this chapter the original IRA (sometimes called an ordinary or regular IRA) is referred to as a traditional IRA. Two advantages of a
traditional IRA are:
You may be able to deduct some or all of your contributions to it, depending on your circumstances, and,
Generally, amounts in your IRA, including earnings and gains, are not taxed until they are distributed.
Individual retirement arrangements (IRAs):Time of taxation
What Is a Traditional IRA?Individual retirement arrangements (IRAs):Definition of
A traditional IRA is any IRA that is not a Roth IRA or a SIMPLE IRA.
Who Can Set Up
a Traditional IRA?Individual retirement arrangements (IRAs):Establishing account
You can set up and make contributions to a traditional IRA if:
You (or, if you file a joint return, your spouse) received taxable compensation during the year, and
You were not age 70 by the end of the year.
What is compensation?Compensation:Defined for IRA purposesIndividual retirement arrangements (IRAs):Compensation, defined
Generally, compensation is what you earn from working. Compensation includes wages, salaries, tips, professional fees, bonuses, and other amounts
you receive for providing personal services. The IRS treats as compensation any amount properly shown in box 1 (Wages, tips, other compensation) of
Form W-2, Wage and Tax Statement, provided that amount is reduced by any amount properly shown in box 11 (Nonqualified plans).
Scholarship and fellowship payments are compensation for this purpose only if shown in box 1 of Form W-2.
Compensation also includes commissions and taxable alimony and separate maintenance payments.
If you are self-employed (a sole proprietor or a partner), compensation is the net earnings from your trade or business (provided your personal
services are a material income-producing factor) reduced by the total of:
The deduction for contributions made on your behalf to retirement plans, and
The deduction allowed for one-half of your self-employment taxes.
Compensation includes earnings from self-employment even if they are not subject to self-employment tax because of your religious beliefs.
What is not compensation?
Compensation does not include any of the following items.
Earnings and profits from property, such as rental income, interest income, and dividend income.
Pension or annuity income.
Deferred compensation received (compensation payments postponed from a past year).
Income from a partnership for which you do not provide services that are a material income-producing factor.
Any amounts you exclude from income, such as foreign earned income and housing costs.
When and How Can a Traditional IRA Be Set Up?Individual retirement arrangements (IRAs):Establishing account:Time of
You can set up a traditional IRA at any time. However, the time for making contributions for any year is limited. See When Can Contributions
Be Made, later.
Banks:IRAs withBrokers:IRAs withFinancial institutionsBanksIndividual retirement arrangements (IRAs):Establishing account:Where to set up accountYou can set up different kinds of IRAs with a variety of organizations. You can set up an IRA
at a bank or other financial institution or with a mutual fund or life insurance company. You can also set up an IRA through your stockbroker. Any IRA
must meet Internal Revenue Code requirements.
Kinds of traditional IRAs.Annuities:IRAs asIndividual retirement arrangements (IRAs):Types ofSEPsSimplified employee pensions (SEPs)Simplified employee pensions (SEPs):IRAs as
Your traditional IRA can be an individual retirement account or annuity. It can be part of either a simplified employee pension (SEP) or an
employer or employee association trust account.
How Much Can Be
Contributed?Individual retirement arrangements (IRAs):Contribution limits
There are limits and other rules that affect the amount that can be contributed to a traditional IRA. These limits and other rules are explained
below.
Community property laws.Community property:IRAs
Except as discussed later under Spousal IRA limit, each spouse figures his or her limit separately, using his or her own compensation.
This is the rule even in states with community property laws.
Brokers' commissions.Brokers:IRAs with::CommissionsCommissions:IRAs with brokers
Brokers' commissions paid in connection with your traditional IRA are subject to the contribution limit.
Trustees' administrative fees are not subject to the contribution limit.
Individual retirement arrangements (IRAs):Contributions:Roth IRA contribution for same yearRoth IRAs:Contributions:To traditional IRA for same year
Contributions on your behalf to your traditional IRAs reduce your limit for contributions to Roth IRAs. (See Roth IRAs, later.)
General limit.Individual retirement arrangements (IRAs):Contribution limitsIndividual retirement arrangements (IRAs):Contribution limits:Under age 50,Individual retirement arrangements (IRAs):Contribution limits:Age 50 or older,
The most that can be contributed to your traditional IRA is the smaller of the following amounts.
$4,000 ($4,500 if you are 50 or older in 2005). For 2006, the amount is $4,000 (but increases to $5,000 if you are 50 or older).
Your taxable compensation (defined earlier) for the year.
This is the most that can be contributed regardless of whether the contributions are to one or more traditional IRAs or whether all or part of
the contributions are nondeductible. (See Nondeductible Contributions, later.)
Example 1.
Betty, who is 34 years old and single, earned $24,000 in 2005. Her IRA contributions for 2005 are limited to $4,000.
Example 2.
John, an unmarried college student working part time, earned $3,500 in 2005. His IRA contributions for 2005 are limited to $3,500, the amount of
his compensation.
If you file a joint return and your taxable compensation is less than that of your spouse, the most that can be contributed for the year to your
IRA is the smaller of the following amounts.
$4,000 ($4,500 if you are 50 or older in 2005). For 2006, the amount is $4,000 (but increases to $5,000 if you are 50 or older in
2006).
The total compensation includible in the gross income of both you and your spouse for the year, reduced by the following two amounts.
Your spouse's IRA contribution for the year to a traditional IRA.
Any contribution for the year to a Roth IRA on behalf of your spouse.
This means that the total combined contributions that can be made for the year to your IRA and your spouse's IRA can be as much as $8,000
($8,500 if only one of you is 50 or older, or $9,000 if both of you are 50 or older). For 2006, combined total contributions can be as much as $8,000
($9,000 if only one of you is 50 or older or $10,000 if both of you are 50 or older.
When Can Contributions Be Made?Individual retirement arrangements (IRAs):Contributions:Time of
As soon as you set up your traditional IRA, contributions can be made to it through your chosen sponsor (trustee or other administrator).
Contributions must be in the form of money (cash, check, or money order). Property cannot be contributed.
Contributions must be made by due date.
Contributions can be made to your traditional IRA for a year at any time during the year or by the due date for filing your return for that year,
not including extensions. For most people, this means that contributions for 2005 must be made by April 17, 2006, and contributions for 2006 must be
made by April 16, 2007.
Age 70 rule.70 ruleAge:IRAs:Contribution cutoff at age 70Individual retirement arrangements (IRAs):Age 70:Contributions cut off at
Contributions cannot be made to your traditional IRA for the year in which you reach age 70 or for any later year.
You attain age 70 on the date that is six calendar months after the 70th anniversary of your birth. If you were born on June 30,
1935, the 70th anniversary of your birth is June 30, 2005, and you attained age 70 on December 30, 2005. If you were born on July 1,
1935, the 70th anniversary of your birth was July 1, 2005, and you attained age 70 on January 1, 2006.
Designating year for which contribution is made.Individual retirement arrangements (IRAs):Contributions:Designating year for which contribution is made
If an amount is contributed to your traditional IRA between January 1 and April 15, you should tell the sponsor which year (the current year or the
previous year) the contribution is for. If you do not tell the sponsor which year it is for, the sponsor can assume, and report to the IRS, that the
contribution is for the current year (the year the sponsor received it).
Filing before a contribution is made.Individual retirement arrangements (IRAs):Contributions:Filing before contribution is made
You can file your return claiming a traditional IRA contribution before the contribution is actually made. However, the contribution must be made
by the due date of your return, not including extensions.
Contributions not required.Individual retirement arrangements (IRAs):Contributions:Not required annually
You do not have to contribute to your traditional IRA for every tax year, even if you can.
How Much Can You Deduct?Individual retirement arrangements (IRAs):Deduction for
Generally, you can deduct the lesser of:
The contributions to your traditional IRA for the year, or
The general limit (or the spousal IRA limit, if it applies).
Married taxpayers:IRAs:Spouse covered by employer planHowever, if you or your spouse was covered by an employer retirement plan, you may not be able to deduct this amount. See Limit If Covered
by Employer Plan, later.
You may be eligible to claim a credit for contributions to your traditional IRA. For more information see chapter 37.
Trustees' administrative fees that are billed separately and paid in connection with your traditional IRA are not deductible as IRA contributions.
However, they may be deductible as a miscellaneous itemized deduction on Schedule A (Form 1040). See chapter 28.
Brokers' commissions.Brokers:IRAs with::CommissionsCommissions:IRAs with brokers
Brokers' commissions are part of your IRA contribution and, as such, are deductible subject to the limits.
Full deduction.
If neither you nor your spouse was covered for any part of the year by an employer retirement plan, you can take a deduction for total
contributions to one or more traditional IRAs of up to the lesser of the following amounts.
$4,000 ($4,500 if you are 50 or older in 2005). For 2006, the amount is $4,000 (but increases to $5,000 if you are 50 or older in
2006).
100% of your compensation.
This limit is reduced by any contributions made to a 501(c)(18) plan on your behalf.
In the case of a married couple with unequal compensation who file a joint return, the deduction for contributions to the traditional IRA of the
spouse with less compensation is limited to the lesser of the following amounts.
$4,000 ($4,500 if you are 50 or older in 2005). For 2006, the amount is $4,000 (but increases to $5,000 if that spouse is 50 or older in
2006).
The total compensation includible in the gross income of both spouses for the year reduced by the following three amounts.
The IRA deduction for the year of the spouse with the greater compensation.
Any designated nondeductible contribution for the year made on behalf of the spouse with the greater compensation.
Any contributions for the year to a Roth IRA on behalf of the spouse with the greater compensation.
This limit is reduced by any contributions to a 501(c)(18) plan on behalf of the spouse with the lesser compensation.
If you were divorced or legally separated (and did not remarry) before the end of the year, you cannot deduct any contributions to your spouse's
IRA. After a divorce or legal separation, you can deduct only contributions to your own IRA. Your deductions are subject to the rules for single
individuals.
Covered by an employer retirement plan.Individual retirement arrangements (IRAs):Employer retirement plan participants
If you or your spouse was covered by an employer retirement plan at any time during the year for which contributions were made, your deduction may
be further limited. This is discussed later under Limit If Covered by Employer Plan. Limits on the amount you can deduct do not affect the
amount that can be contributed. See Nondeductible Contributions, later.
Are You Covered by an Employer Plan?
Form:W-2:Employer retirement plan participation indicatedThe Form W-2 you receive from your employer has a box used to indicate
whether you were covered for the year. The Retirement plan box should be checked if you were covered.
Reservists and volunteer firefighters should also see Situations in Which You Are Not Covered, later.
If you are not certain whether you were covered by your employer's retirement plan, you should ask your employer.
Federal judges.Federal judges:Employer retirement plan coverageJudges, federal:Employer retirement plan coverage
For purposes of the IRA deduction, federal judges are covered by an employer retirement plan.
For Which Year(s) Are You Covered?
Special rules apply to determine the tax years for which you are covered by an employer plan. These rules differ depending on whether the plan is a
defined contribution plan or a defined benefit plan.
Tax year.
Your tax year is the annual accounting period you use to keep records and report income and expenses on your income tax return. For almost all
people, the tax year is the calendar year.
Defined contribution plan.
Generally, you are covered by a defined contribution plan for a tax year if amounts are contributed or allocated to your account for the plan year
that ends with or within that tax year.
A defined contribution plan is a plan that provides for a separate account for each person covered by the plan. Types of defined contribution plans
include profit-sharing plans, stock bonus plans, and money purchase pension plans.
Defined benefit plan.
If you are eligible to participate in your employer's defined benefit plan for the plan year that ends within your tax year, you are covered by the
plan. This rule applies even if you:
Declined to participate in the plan,
Did not make a required contribution, or
Did not perform the minimum service required to accrue a benefit for the year.
A defined benefit plan is any plan that is not a defined contribution plan. Defined benefit plans include pension plans and annuity plans.
No vested interest.
If you accrue a benefit for a plan year, you are covered by that plan even if you have no vested interest in (legal right to) the accrual.
Situations in Which You Are Not CoveredPensions:Employer plans:Situations in which no coverageRetirement plans:Employer plans:Situations in which no coverage
Unless you are covered under another employer plan, you are not covered by an employer plan if you are in one of the situations described below.
Social security or railroad retirement.Railroad retirement benefits:Employer retirement plans different fromSocial security benefits:Employer retirement plans different from
Coverage under social security or railroad retirement is not coverage under an employer retirement plan.
Benefits from a previous employer's plan.Pensions:Employer plans:Benefits from previous employer's planRetirement plans:Employer plans:Benefits from previous employer's plan
If you receive retirement benefits from a previous employer's plan, you are not covered by that plan.
Reservists.Reservists:IRAs
If the only reason you participate in a plan is because you are a member of a reserve unit of the armed forces, you may not be covered by the plan.
You are not covered by the plan if both of the following conditions are met.
The plan you participate in is established for its employees by:
The United States,
A state or political subdivision of a state, or
An instrumentality of either (a) or (b) above.
You did not serve more than 90 days on active duty during the year (not counting duty for training).
If the only reason you participate in a plan is because you are a volunteer firefighter, you may not be covered by the plan. You are not covered by
the plan if both of the following conditions are met.
The plan you participate in is established for its employees by:
The United States,
A state or political subdivision of a state, or
An instrumentality of either (a) or (b) above.
Your accrued retirement benefits at the beginning of the year will not provide more than $1,800 per year at retirement.
Limit If Covered by Employer PlanIndividual retirement arrangements (IRAs):Employer retirement plan participants
If either you or your spouse was covered by an employer retirement plan, you may be entitled to only a partial (reduced) deduction or no deduction
at all, depending on your income and your filing status.
Your deduction begins to decrease (phase out) when your income rises above a certain amount and is eliminated altogether when it reaches a higher
amount. These amounts vary depending on your filing status.
To determine if your deduction is subject to phaseout, you must determine your modified adjusted gross income (AGI) and your filing status. See
Filing status and Modified adjusted gross income (AGI), later. Then use Table 17-1 or 17-2 to determine if the phaseout applies.
Social security recipients.Social security benefits:IRAs for recipients of benefits
Instead of using Table 17-1 or 17-2, use the worksheets in Appendix B of Publication 590 if, for the year, all of the following apply.
You received social security benefits.
You received taxable compensation.
Contributions were made to your traditional IRA.
You or your spouse was covered by an employer retirement plan.
Use those worksheets to figure your IRA deduction, your nondeductible contribution, and the taxable portion, if any, of your social security
benefits.
If you were covered by an employer retirement plan and you did not receive any social security retirement benefits, your IRA deduction may be
reduced or eliminated depending on your filing status and modified AGI as shown in Table 17-1.
<ROM>Table 17-1.</ROM>
<IMARK>Effect of Modified AGI
<SUP>1</SUP> on Deduction if You Are Covered by Retirement Plan at WorkIndividual retirement arrangements (IRAs):Deduction for:Participant covered by employer retirement plan (Table 17-1)Individual retirement arrangements (IRAs):Modified adjusted gross income (MAGI):Effect on deduction if covered by employer retirement plan (Table 17-1)Modified adjusted gross income (MAGI):IRAs, computation for:Effect on deduction if covered by employer retirement plan (Table 17-1)Tables and figures:Individual retirement arrangements (IRAs):Modified AGI, effect on deduction if covered by retirement plan at work (Table 17-1)If you are covered by a retirement plan at work, use this table to determine if your modified AGI affects the amount of your
deduction.IF your filing status is...AND your modified AGI is...THEN you can take...singleor
head of household $50,000 or lessa full deduction.more than $50,000
but less than $60,000a partial deduction.$60,000 or moreno deduction.married filing jointly or
qualifying widow(er) $70,000 or lessa full deduction.more than $70,000
but less than $80,000a partial deduction.$80,000 or moreno deduction.married filing separately
2less than $10,000a partial deduction.$10,000 or moreno deduction.
1Modified AGI (adjusted gross income). See Modified adjusted gross income (AGI).2If you did not live with your spouse at any time during the year, your filing status is considered Single for this purpose (therefore,
your IRA deduction is determined under the Single column).
Individual retirement arrangements (IRAs):Deduction for:Filing status andFor 2006, if you are covered by a retirement plan at work, your IRA deduction will not be reduced
(phased out) unless your modified AGI is:
More than $50,000 but less than $60,000 for a single individual (or head of household),
More than $75,000 but less than $85,000 for a married couple filing a joint return (or a qualifying widow(er)), or
Less than $10,000 for a married individual filing a separate return.
If your spouse is covered.Individual retirement arrangements (IRAs):Spousal IRAsMarried taxpayers:IRAs:Spouse covered by employer plan
If you are not covered by an employer retirement plan, but your spouse is, and you did not receive any social security benefits, your IRA deduction
may be reduced or eliminated entirely depending on your filing status and modified AGI as shown in Table 17-2.
<ROM>Table 17-2.</ROM>
<IMARK>Effect of Modified AGI
<SUP>1</SUP> on Deduction if You Are NOT Covered by Retirement Plan at WorkIndividual retirement arrangements (IRAs):Deduction for:Participant not covered by employer retirement plan (Table 17-2)Individual retirement arrangements (IRAs):Modified adjusted gross income (MAGI):Effect on deduction if not covered by employer retirement plan (Table 17-2)Modified adjusted gross income (MAGI):IRAs, computation for:Effect on deduction if not covered by employer retirement plan (Table 17-2)Tables and figures:Individual retirement arrangements (IRAs):Modified AGI, effect on deduction if not covered by retirement plan at work (Table 17-2)If you are not covered by a retirement plan at work, use this table to determine
if your modified AGI affects the amount of your deduction.IF your filing status is...AND your modified AGI is...THEN you can take...single,head of household, or
qualifying widow(er)any amounta full deduction.married filing jointly or separately with a spouse who is not covered by
a plan at workany amounta full deduction.married filing jointly with a spouse who is covered by a plan at work$150,000 or lessa full deduction.more than $150,000
but less than $160,000a partial deduction.$160,000 or moreno deduction.married filing separately with a spouse who is covered by a plan at work
2less than $10,000a partial deduction.$10,000 or moreno deduction.
1Modified AGI (adjusted gross income). See Modified adjusted gross income (AGI).2You are entitled to the full deduction if you did not live with your spouse at any time during the year.
Filing status.
Your filing status depends primarily on your marital status. For this purpose, you need to know if your filing status is single or head of
household, married filing jointly or qualifying widow(er), or married filing separately. If you need more information on filing status, see chapter 2.
Lived apart from spouse.
If you did not live with your spouse at any time during the year and you file a separate return, your filing status, for this purpose, is single.
Modified adjusted gross income (AGI).Individual retirement arrangements (IRAs):Modified adjusted gross income (MAGI):Computation of
How you figure your modified AGI depends on whether you are filing Form 1040 or Form 1040A. If you made contributions to your IRA for 2005 and
received a distribution from your IRA in 2005, see Publication 590.
Do not assume that your modified AGI is the same as your compensation. Your modified AGI may include income in addition to your compensation
(discussed earlier), such as interest, dividends, and income from IRA distributions.
Form 1040.
If you file Form 1040, refigure the amount on the page 1 adjusted gross income line without taking into account any of the following
amounts.
IRA deduction.
Student loan interest deduction.
Tuition and fees deduction.
Domestic production activities deduction.
Foreign earned income exclusion.
Foreign housing exclusion or deduction.
Exclusion of qualified savings bond interest shown on Form 8815, Exclusion of Interest From Series EE and I U.S. Savings Bonds Issued After
1989 (For Filers With Qualified Higher Education Expenses).
Exclusion of employer-provided adoption benefits shown on Form 8839, Qualified Adoption Expenses.
This is your modified AGI.
Form 1040A.
If you file Form 1040A, refigure the amount on the page 1 adjusted gross income line without taking into account any of the following
amounts.
IRA deduction.
Student loan interest deduction.
Tuition and fees deduction.
Exclusion of qualified savings bond interest shown on Form 8815.
Exclusion of employer-provided adoption benefits shown on Form 8839.
This is your modified AGI.
Both contributions for 2005 and distributions in 2005.
If all three of the following apply, any IRA distributions you received in 2005 may be partly tax free and partly taxable.
You received distributions in 2005 from one or more traditional IRAs.
You made contributions to a traditional IRA for 2005.
Some of those contributions may be nondeductible contributions.
If this is your situation, you must figure the taxable part of the traditional IRA distribution before you can figure your modified AGI. To do
this, you can use Worksheet 1-5, Figuring the Taxable Part of Your IRA Distribution, in Publication 590.
If at least one of the above does not apply, figure your modified AGI using Worksheet 17-1
in this chapter.
How to figure your reduced IRA deduction.
You can figure your reduced IRA deduction for either Form 1040 or Form 1040A by using the worksheets in chapter 1 of Publication 590. Also, the
instructions for Form 1040 and Form 1040A include similar worksheets that you may be able to use instead.
Reporting Deductible Contributions
If you file Form 1040, enter your IRA deduction on line 32 of that form. If you file Form 1040A, enter your IRA deduction on line 17. You cannot
deduct IRA contributions on Form 1040EZ.
<ROM>Worksheet 17-1.</ROM>
<IMARK>Figuring Your Modified AGIAdjusted gross income (AGI)ModifiedModified adjusted gross income (MAGI)Individual retirement arrangements (IRAs):Figuring modified AGI (Worksheet 17-1)Individual retirement arrangements (IRAs):Modified adjusted gross income (MAGI):Worksheet 17-1MAGIModified adjusted gross income (MAGI)Modified adjusted gross income (MAGI):IRAs, computation for:Effect on deduction if covered by employer retirement plan (Table 17-1)Modified adjusted gross income (MAGI):IRAs, computation for:Worksheet 17-1Tables and figures:Individual retirement arrangements (IRAs):Figuring modified AGI (Worksheet 17-1)Worksheets:Individual retirement arrangements (IRAs), modified AGI computation (Worksheet 17-1)Use this worksheet to figure your modified adjusted gross income for traditional IRA purposes.1.Enter your adjusted gross income (AGI) shown on line 22, Form 1040A, or line 38, Form 1040 figured without
taking into account
line 17, Form 1040A, or line 32, Form 10401.2.Enter any Student loan interest deduction from line 18, Form
1040A, or line 33, Form 10402.3.Enter any Tuition and fees deduction from line 19, Form 1040A,
or line 34, Form 10403.4.Enter any domestic production activity deduction from line 35, Form 10404.5.Enter any Foreign earned income and/or housing exclusion from
line 18, Form 2555-EZ, or line 43, Form 25555.6.Enter any Foreign housing deduction from line 48, Form 25556.7.Enter any Excluded qualified savings bond interest shown on
line 3, Schedule 1, Form 1040A, or line 3, Schedule B,
Form 1040 (from line 14, Form 8815)7.8.Enter any Exclusion of employer-provided adoption benefits shown
on line 30, Form 88398.9.Add lines 1 through 8. This is your Modified AGI for traditional
IRA purposes9.
Although your deduction for IRA contributions may be reduced or eliminated, contributions can be made to your IRA up to the general limit or, if it
applies, the spousal IRA limit. The difference between your total permitted contributions and your IRA deduction, if any, is your nondeductible
contribution.
Example.
Mike is 28 years old and single. In 2005, he was covered by a retirement plan at work. His salary was $57,312. His modified AGI was $65,000. Mike
made a $4,000 IRA contribution for 2005. Because he was covered by a retirement plan and his modified AGI was over $60,000, he cannot deduct his
$4,000 IRA contribution. He must designate this contribution as a nondeductible contribution by reporting it on Form 8606, as explained next.
Form 8606.Form:8606:IRA contributions, Nondeductible
To designate contributions as nondeductible, you must file Form 8606.
You do not have to designate a contribution as nondeductible until you file your tax return. When you file, you can even designate otherwise
deductible contributions as nondeductible.
You must file Form 8606 to report nondeductible contributions even if you do not have to file a tax return for the year.
Failure to report nondeductible contributions.
If you do not report nondeductible contributions, all of the contributions to your traditional IRA will be treated as deductible. All distributions
from your IRA will be taxed unless you can show, with satisfactory evidence, that nondeductible contributions were made.
Penalty for overstatement.Individual retirement arrangements (IRAs):Penalties:Overstatement of nondeductible contributionsPenalties:IRAs:Overstatement of nondeductible contributions
If you overstate the amount of nondeductible contributions on your Form 8606 for any tax year, you must pay a penalty of $100 for each
overstatement, unless it was due to reasonable cause.
Penalty for failure to file Form 8606.Individual retirement arrangements (IRAs):Penalties:Form 8606 not filed for nondeductible contributionsPenalties:Form 8606 not filed for nondeductible IRA contributionsPenalties:IRAs:Form 8606 not filed for nondeductible contributions
You will have to pay a $50 penalty if you do not file a required Form 8606, unless you can prove that the failure was due to reasonable cause.
Tax on earnings on nondeductible contributions.Individual retirement arrangements (IRAs):Nondeductible contributions:Tax on earnings on
As long as contributions are within the contribution limits, none of the earnings or gains on contributions (deductible or nondeductible) will be
taxed until they are distributed. See When Can You Withdraw or Use IRA Assets, later.
Cost basis.Basis:Cost basis:IRAs for nondeductible contributionsCost basis:IRAs for nondeductible contributionsIndividual retirement arrangements (IRAs):Cost basis
You will have a cost basis in your traditional IRA if you made any nondeductible contributions. Your cost basis is the sum of the nondeductible
contributions to your IRA minus any withdrawals or distributions of nondeductible contributions.
If you inherit a traditional IRA, you are called a beneficiary. A beneficiary can be any person or entity the owner chooses to receive the benefits
of the IRA after he or she dies. Beneficiaries of a traditional IRA must include in their gross income any taxable distributions they receive.
Inherited from spouse.
If you inherit a traditional IRA from your spouse, you generally have the following three choices.
Treat it as your own IRA by designating yourself as the account owner.
Treat it as your own by rolling it over into your traditional IRA, or to the extent it is taxable, into a:
Qualified employer plan,
Qualified employee annuity plan (section 403(a) plan),
Tax-sheltered annuity plan (section 403(b) plan), or
Deferred compensation plan of a state or local government (section 457 plan).
Treat yourself as the beneficiary rather than treating the IRA as your own.
Treating it as your own.
You will be considered to have chosen to treat the IRA as your own if:
Contributions (including rollover contributions) are made to the inherited IRA, or
You do not take the required minimum distribution for a year as a beneficiary of the IRA.
You will only be considered to have chosen to treat the IRA as your own if:
You are the sole beneficiary of the IRA, and
You have an unlimited right to withdraw amounts from it.
However, if you receive a distribution from your deceased spouse's IRA, you can roll that distribution over into your own IRA within the 60-day
time limit, as long as the distribution is not a required distribution, even if you are not the sole beneficiary of your deceased spouse's IRA.
Inherited from someone other than spouse.
If you inherit a traditional IRA from anyone other than your deceased spouse, you cannot treat the inherited IRA as your own. This means that you
cannot make any contributions to the IRA. It also means you cannot roll over any amounts into or out of the inherited IRA. However, you can make a
trustee-to-trustee transfer as long as the IRA into which amounts are being moved is set up and maintained in the name of the deceased IRA owner for
the benefit of you as beneficiary.
For more information, see the discussion of inherited IRAs under Rollover From One IRA Into Another, later.
Can You Move Retirement Plan Assets?Individual retirement arrangements (IRAs):Transfers permitted
You can transfer, tax free, assets (money or property) from other retirement plans (including traditional IRAs) to a traditional IRA. You can make
the following kinds of transfers.
Transfers from one trustee to another.
Rollovers.
Transfers incident to a divorce.
Transfers to Roth IRAs.Individual retirement arrangements (IRAs):Transfers permitted:To Roth IRAsRoth IRAs:IRA transfer to
Under certain conditions, you can move assets from a traditional IRA to a Roth IRA. See Can You Move Amounts Into a Roth IRA under
Roth IRAs, later.
Trustee-to-Trustee TransferIndividual retirement arrangements (IRAs):Trustee-to-trustee transfersTrustees:IRAs:Transfer from trustee to trustee
A transfer of funds in your traditional IRA from one trustee directly to another, either at your request or at the trustee's request, is not a
rollover. Because there is no distribution to you, the transfer is tax free. Because it is not a rollover, it is not affected by the 1-year waiting
period required between rollovers, discussed later under Rollover From One IRA Into Another. For information about direct transfers to IRAs
from retirement plans other than IRAs, see Publication 590.
Rollovers
Individual retirement arrangements (IRAs)RolloversQualified plansRolloversRolloversRollovers:Definition ofGenerally, a rollover is a tax-free distribution to you of cash or other assets from one retirement plan that
you contribute (roll over) to another retirement plan. The contribution to the second retirement plan is called a rollover contribution.
Note.
Rollovers:TaxabilityAn amount rolled over tax free from one retirement plan to another is generally includible in income when it is
distributed from the second plan.
Kinds of rollovers to a traditional IRA.
You can roll over amounts from the following plans into a traditional IRA:
A traditional IRA,
Rollovers:From IRA to IRA
An employer's qualified retirement plan for its employees,
Rollovers:From employer's plan to IRA
A deferred compensation plan of a state or local government (section 457 plan), or
Rollovers:From section 457 plan to IRA
A tax-sheltered annuity plan (section 403(b) plan).
Rollovers:From 403 plan to IRATreatment of rollovers.Rollovers:Treatment of
You cannot deduct a rollover contribution, but you must report the rollover distribution on your tax return as discussed later under Reporting
rollovers from IRAs and under Reporting rollovers from employer plans.
Kinds of rollovers from a traditional IRA.
You may be able to roll over, tax free, a distribution from your traditional IRA into a qualified plan. These plans include the federal Thrift
Savings Fund (for federal employees), deferred compensation plans of state or local governments (section 457 plans), and tax-sheltered annuity plans
(section 403(b) plans). The part of the distribution that you can roll over is the part that would otherwise be taxable (includible in your income).
Qualified plans may, but are not required to, accept such rollovers.
Time limit for making a rollover contribution.60 day ruleRollovers:Time limits (60-day rule)
You generally must make the rollover contribution by the 60th day after the day you receive the distribution from your traditional IRA or your
employer's plan.
Rollovers:Time limits (60-day rule)The IRS may waive the 60-day requirement where the failure to do so would be against equity or
good conscience, such as in the event of a casualty, disaster, or other event beyond your reasonable control. For more information, see Publication
590.
Extension of rollover period.Frozen deposits:IRA rollover period extension
If an amount distributed to you from a traditional IRA or a qualified employer retirement plan is a frozen deposit at any time during the 60-day
period allowed for a rollover, special rules extend the rollover period. For more information, see Publication 590.
More information.
For more information on rollovers, see Publication 590.
Rollover From One IRA Into AnotherRollovers:From IRA to IRA
You can withdraw, tax free, all or part of the assets from one traditional IRA if you reinvest them within 60 days in the same or another
traditional IRA. Because this is a rollover, you cannot deduct the amount that you reinvest in an IRA.
Waiting period between rollovers.Rollovers:Waiting period between
Generally, if you make a tax-free rollover of any part of a distribution from a traditional IRA, you cannot, within a 1-year period, make a
tax-free rollover of any later distribution from that same IRA. You also cannot make a tax-free rollover of any amount distributed, within the same
1-year period, from the IRA into which you made the tax-free rollover.
The 1-year period begins on the date you receive the IRA distribution, not on the date you roll it over into an IRA.
Example.
You have two traditional IRAs, IRA-1 and IRA-2. You make a tax-free rollover of a distribution from IRA-1 into a new traditional IRA (IRA-3). You
cannot, within 1 year of the distribution from IRA-1, make a tax-free rollover of any distribution from either IRA-1 or IRA-3 into another traditional
IRA.
However, the rollover from IRA-1 into IRA-3 does not prevent you from making a tax-free rollover from IRA-2 into any other traditional IRA. This is
because you have not, within the last year, rolled over, tax free, any distribution from IRA-2 or made a tax-free rollover into IRA-2.
Exception.
There is an exception to the rule that amounts rolled over tax free into an IRA cannot be rolled over tax free again within the 1-year period
beginning on the date of the original distribution. The exception applies to a distribution which meets all three of the following requirements.
It is made from a failed financial institution by the Federal Deposit Insurance Corporation (FDIC) as receiver for the
institution.
It was not initiated by either the custodial institution or the depositor.
It was made because:
The custodial institution is insolvent, and
The receiver is unable to find a buyer for the institution.
Partial rollovers.Rollovers:Partial rollovers
If you withdraw assets from a traditional IRA, you can roll over part of the withdrawal tax free and keep the rest of it. The amount you keep will
generally be taxable (except for the part that is a return of nondeductible contributions). The amount you keep may be subject to the 10% additional
tax on early distributions, discussed later under What Acts Result in Penalties or Additional Taxes.
Amounts that must be distributed during a particular year under the required distribution rules (discussed later) are not eligible for rollover
treatment.
If you inherit a traditional IRA from your spouse, you generally can roll it over, or you can choose to make the inherited IRA your own. See
Treating it as your own, earlier.
Not inherited from spouse.
If you inherit a traditional IRA from someone other than your spouse, you cannot roll it over or allow it to receive a rollover contribution. You
must withdraw the IRA assets within a certain period. For more information, see Publication 590.
Reporting rollovers from IRAs.Rollovers:Reporting:IRA to IRA
Report any rollover from one traditional IRA to the same or another traditional IRA on lines 15a and 15b, Form 1040 or lines 11a and 11b, Form
1040A.
Enter the total amount of the distribution on Form 1040, line 15a, or Form 1040A, line 11a. If the total amount on Form 1040, line 15a, or Form
1040A, line 11a, was rolled over, enter zero on Form 1040, line 15b, or Form 1040A, line 11b. If the total distribution was not rolled over, enter the
taxable portion of the part that was not rolled over on Form 1040, line 15b, or Form 1040A, line 11b. Put Rollover next to Form 1040, line 15b,
or Form 1040A, line 11b. See the forms instructions.
If you rolled over the distribution in 2006 or from an IRA into a qualified plan (other than an IRA), attach a statement explaining what you did.
Rollover From Employer's Plan Into an IRARollovers:From employer's plan to IRA
You can roll over into a traditional IRA all or part of an eligible rollover distribution you receive from your (or your deceased spouse's):
Employer's qualified pension, profit-sharing or stock bonus plan,
Pensions:Employer plans:Rollover to IRARetirement plans:Employer plans:Rollover to IRA
Annuity plan,
Tax-sheltered annuity plan (section 403(b) plan), or
403(b) plans:Rollovers
Governmental deferred compensation plan (section 457 plan).
A qualified plan is one that meets the requirements of the Internal Revenue Code.
Eligible rollover distribution.
Generally, an eligible rollover distribution is any distribution of all or part of the balance to your credit in a qualified retirement plan except
the following.
A required minimum distribution (explained later under When Must You Withdraw IRA Assets? (Required Minimum
Distributions).
Hardship distributions.
Any of a series of substantially equal periodic distributions paid at least once a year over:
Your lifetime or life expectancy,
The lifetimes or life expectancies of you and your beneficiary, or
A period of 10 years or more.
Corrective distributions of excess contributions or excess deferrals, and any income allocable to the excess, or of excess annual additions
and any allocable gains.
A loan treated as a distribution because it does not satisfy certain requirements either when made or later (such as upon default), unless
the participant's accrued benefits are reduced (offset) to repay the loan.
Dividends on employer securities.
The cost of life insurance coverage.
Generally, a distribution to the plan participant's beneficiary.
Reporting rollovers from employer plans.Rollovers:Reporting:From employer's plan to IRAReporting:Rollovers
Enter the total distribution (before income tax or other deductions were withheld) on Form 1040, line 16a or Form 1040A, line 12a. This amount
should be shown in box 1 of Form 1099-R. From this amount, subtract any contributions (usually shown in box 5 of Form 1099-R) that were taxable to you
when made. From that result, subtract the amount that was rolled over either directly or within 60 days of receiving the distribution. Enter the
remaining amount, even if zero, on Form 1040, line 16b, or Form 1040A, line 12b. Also, enter "Rollover" next to Form 1040, line 16b, or Form 1040A,
line 12b.
Transfers Incident to DivorceDivorced taxpayers:IRAsIndividual retirement arrangements (IRAs):Divorced taxpayers
If an interest in a traditional IRA is transferred from your spouse or former spouse to you by a divorce or separate maintenance decree or a
written document related to such a decree, the interest in the IRA, starting from the date of the transfer, is treated as your IRA. The transfer is
tax free. For detailed information, see Publication 590.
Converting From Any Traditional IRA to a Roth IRAIndividual retirement arrangements (IRAs):Transfers permitted:To Roth IRAsRoth IRAs:IRA transfer to
You can convert amounts from a traditional IRA into a Roth IRA if, for the tax year you make the withdrawal from the traditional IRA, both of the
following requirements are met.
Your modified AGI (explained later under Roth IRAs) is not more than $100,000.
You are not a married individual filing a separate return.
Note.
If you did not live with your spouse at any time during the year and you file a separate return, your filing status, for this purpose, is single.
Required distributions.
You cannot convert amounts that must be distributed from your traditional IRA for a particular year (including the calendar year in which you reach
age 70) under the required distribution rules (discussed later).
If you inherited a traditional IRA from someone other than your spouse, you cannot convert it to a Roth IRA.
Income.
You must include in your gross income distributions from a traditional IRA that you would have had to include in income if you had not converted
them into a Roth IRA. You do not include in gross income any part of a distribution from a traditional IRA that is a return of your basis, as
discussed later.
If you must include any amount in your gross income, you may have to increase your withholding or make estimated tax payments. See chapter 4.
RecharacterizationsIndividual retirement arrangements (IRAs):Recharacterization of contributionRecharacterization:IRA contributionsRoth IRAs:Failed conversions and recharacterizations
You may be able to treat a contribution made to one type of IRA as having been made to a different type of IRA. This is called recharacterizing the
contribution. More detailed information is in Publication 590.
How to recharacterize a contribution.
To recharacterize a contribution, you generally must have the contribution transferred from the first IRA (the one to which it was made) to the
second IRA in a trustee-to-trustee transfer. If the transfer is made by the due date (including extensions) for your tax return for the year during
which the contribution was made, you can elect to treat the contribution as having been originally made to the second IRA instead of to the first IRA.
If you recharacterize your contribution, you must do all three of the following.
Include in the transfer any net income allocable to the contribution. If there was a loss, the net income you must transfer may be a
negative amount.
Report the recharacterization on your tax return for the year during which the contribution was made.
Treat the contribution as having been made to the second IRA on the date that it was actually made to the first IRA.
No deduction allowed.
You cannot deduct the contribution to the first IRA. Any net income you transfer with the recharacterized contribution is treated as earned in the
second IRA.
Required notifications.Trustees:IRAs:Notification of recharacterization
To recharacterize a contribution, you must notify both the trustee of the first IRA (the one to which the contribution was actually made) and the
trustee of the second IRA (the one to which the contribution is being moved) that you have elected to treat the contribution as having been made to
the second IRA rather than the first. You must make the notifications by the date of the transfer. Only one notification is required if both IRAs are
maintained by the same trustee. The notification(s) must include all of the following information.
The type and amount of the contribution to the first IRA that is to be recharacterized.
The date on which the contribution was made to the first IRA and the year for which it was made.
A direction to the trustee of the first IRA to transfer in a trustee-to-trustee transfer the amount of the contribution and any net income
(or loss) allocable to the contribution to the trustee of the second IRA.
The name of the trustee of the first IRA and the name of the trustee of the second IRA.
Any additional information needed to make the transfer.
Reporting a recharacterization.Form:8606:IRA contributions, Recharacterization ofIndividual retirement arrangements (IRAs):Reporting of:Recharacterization of contributions
If you elect to recharacterize a contribution to one IRA as a contribution to another IRA, you must report the recharacterization on your tax
return as directed by Form 8606 and its instructions. You must treat the contribution as having been made to the second IRA.
When Can You Withdraw or Use IRA Assets?Individual retirement arrangements (IRAs):Withdrawals
There are rules limiting use of your IRA assets and distributions from it. Violation of the rules generally results in additional taxes in the year
of violation. See What Acts Result in Penalties or Additional Taxes, later.
Contributions returned before the due date of return.Individual retirement arrangements (IRAs):Contributions:Withdrawal before filing due date
If you made IRA contributions in 2005, you can withdraw them tax free by the due date of your return. If you have an extension of time to file your
return, you can withdraw them tax free by the extended due date. You can do this if, for each contribution you withdraw, both of the following
conditions apply.
You did not take a deduction for the contribution.
You withdraw any interest or other income earned on the contribution. You can take into account any loss on the contribution while it was in
the IRA when calculating the amount that must be withdrawn. If there was a loss, the net income earned on the contribution may be a negative
amount.
Note.
To calculate the amount you must withdraw, see Publication 590.
Earnings includible in income.
You must include in income any earnings on the contributions you withdraw. Include the earnings in income for the year in which you made the
contributions, not in the year in which you withdraw them.
Generally, except for any part of a withdrawal that is a return of nondeductible contributions (basis), any withdrawal of your contributions after
the due date (or extended due date) of your return will be treated as a taxable distribution. Excess contributions can also be recovered tax free as
discussed under What Acts Result in Penalties or Additional Taxes, later.
Early distributions tax.Early withdrawal from deferred interest account:IRAs:Penalties
The 10% additional tax on distributions made before you reach age 59 does not apply to these tax-free withdrawals of your
contributions. However, the distribution of interest or other income must be reported on Form 5329 and, unless the distribution qualifies as an
exception to the age 59 rule, it will be subject to this tax.
When Must You Withdraw IRA Assets? (Required Minimum Distributions)
DistributionsRequired minimum distributionsIndividual retirement arrangements (IRAs)Individual retirement arrangements (IRAs)DistributionsRequired minimum distributionsthis heading: Required distributionsIndividual retirement arrangements (IRAs):Required distributionsIndividual retirement arrangements (IRAs)WithdrawalsRequiredthis heading: Required distributionsRequired minimum distributionsIndividual retirement arrangements (IRAs)Excise taxes:PenaltiesExcise taxes:IRAs for failure to take minimum distributionsIndividual retirement arrangements (IRAs):Penalties:Required distributions, failure to takePenalties:IRAs:Required distributions, failure to takeYou cannot keep funds in a traditional IRA indefinitely. Eventually they must
be distributed. If there are no distributions, or if the distributions are not large enough, you may have to pay a 50% excise tax on the amount not
distributed as required. See Excess Accumulations (Insufficient Distributions), later. The requirements for distributing IRA funds differ
depending on whether you are the IRA owner or the beneficiary of a decedent's IRA.
Required minimum distribution.
The amount that must be distributed each year is referred to as the required minimum distribution.
Required distributions not eligible for rollover.
Amounts that must be distributed (required minimum distributions) during a particular year are not eligible for rollover treatment.
IRA owners.Age:IRAs:Distribution required at age 70Individual retirement arrangements (IRAs):Age 70:Distributions required at
If you are the owner of a traditional IRA, you must start receiving distributions from your IRA by April 1 of the year following the year in which
you reach age 70. April 1 of the year following the year in which you reach age 70 is referred to as the required
beginning date.
Distributions by the required beginning date.
You must receive at least a minimum amount for each year starting with the year you reach age 70 (your 70 year). If
you do not (or did not) receive that minimum amount in your 70 year, then you must receive distributions for your 70
year by April 1 of the next year.
If an IRA owner dies after reaching age 70, but before April 1 of the next year, no minimum distribution is required because death
occurred before the required beginning date.
Even if you begin receiving distributions before you attain age 70, you must begin calculating and receiving required minimum
distributions by your required beginning date.
Distributions after the required beginning date.
The required minimum distribution for any year after the year you turn 70 must be made by December 31 of that later year.
If you are the beneficiary of a decedent's traditional IRA, the requirements for distributions from that IRA generally depend on whether the IRA
owner died before or after the required beginning date for distributions.
More information.
For more information, including how to figure your minimum required distribution each year and how to figure your required distribution if you are
a beneficiary of a decedent's IRA, see Publication 590.
Are Distributions Taxable?Individual retirement arrangements (IRAs):Taxability:Distributions
In general, distributions from a traditional IRA are taxable in the year you receive them.
Exceptions.
Exceptions to distributions from traditional IRAs being taxable in the year you receive them are:
Rollovers,
Tax-free withdrawals of contributions, discussed earlier, and
The return of nondeductible contributions, discussed later under Distributions Fully or Partly Taxable.
Although a conversion of a traditional IRA is considered a rollover for Roth IRA purposes, it is not an exception to the rule that distributions
from a traditional IRA are taxable in the year you receive them. Conversion distributions are includible in your gross income subject to this rule and
the special rules for conversions explained in Publication 590.
Ordinary income.Individual retirement arrangements (IRAs):Ordinary income, distributions as
Distributions from traditional IRAs that you include in income are taxed as ordinary income.
No special treatment.
In figuring your tax, you cannot use the 10-year tax option or capital gain treatment that applies to lump-sum distributions from qualified
employer plans.
Distributions Fully or Partly Taxable
Distributions from your traditional IRA may be fully or partly taxable, depending on whether your IRA includes any nondeductible contributions.
Fully taxable.
If only deductible contributions were made to your traditional IRA (or IRAs, if you have more than one), you have no basis in your IRA. Because you
have no basis in your IRA, any distributions are fully taxable when received. See Reporting taxable distributions on your return, later.
Partly taxable.
Basis:Cost basis:IRAs for nondeductible contributionsCost basis:IRAs for nondeductible contributionsIndividual retirement arrangements (IRAs):Cost basisIf you made nondeductible contributions to any of your traditional IRAs, you have a cost basis (investment in the
contract) equal to the amount of those contributions. These nondeductible contributions are not taxed when they are distributed to you. They are a
return of your investment in your IRA.
Only the part of the distribution that represents nondeductible contributions (your cost basis) is tax free. If nondeductible contributions have
been made, distributions consist partly of nondeductible contributions (basis) and partly of deductible contributions, earnings, and gains (if there
are any). Until all of your basis has been distributed, each distribution is partly nontaxable and partly taxable.
Form 8606.Form:8606:IRA contributions, Nondeductible
You must complete Form 8606 and attach it to your return if you receive a distribution from a traditional IRA and have ever made nondeductible
contributions to any of your traditional IRAs. Using the form, you will figure the nontaxable distributions for 2005 and your total IRA basis for 2005
and earlier years.
Note.
If you are required to file Form 8606, but you are not required to file an income tax return, you still must file Form 8606. Send it to the IRS at
the time and place you would otherwise file an income tax return.
Distributions reported on Form 1099-R.Form:1099-R:IRA distributionsIndividual retirement arrangements (IRAs):Forms to use:Form 1099-R for reporting distributions
If you receive a distribution from your traditional IRA, you will receive Form 1099-R, Distributions From Pensions, Annuities, Retirement or
Profit-Sharing Plans, IRAs, Insurance Contracts, etc., or a similar statement. IRA distributions are shown in boxes 1 and 2a of Form 1099-R. A number
or letter code in box 7 tells you what type of distribution you received from your IRA.
Federal income tax is withheld from distributions from traditional IRAs unless you choose not to have tax withheld. See chapter 4.
IRA distributions delivered outside the United States.Citizens outside U.S.:Withholding from IRA distributionsResidencyHome outside U.S.Citizens outside U.S.Resident aliens:IRA distributions, withholding from
In general, if you are a U.S. citizen or resident alien and your home address is outside the United States or its possessions, you cannot choose
exemption from withholding on distributions from your traditional IRA.
Reporting taxable distributions on your return.
Form:1040:IRAsIndividual retirement arrangements (IRAs):Reporting of:DistributionsForm:1040A:IRA distributionsReport fully taxable distributions, including early distributions on Form 1040, line 15b, or Form
1040A, line 11b (no entry is required on Form 1040, line 15a, or Form 1040A, line 11a). If only part of the distribution is taxable, enter the total
amount on Form 1040, line 15a, or Form 1040A, line 11a, and the taxable part on Form 1040, line 15b, or Form 1040A, line 11b. You cannot report
distributions on Form 1040EZ.
What Acts Result in Penalties or Additional Taxes?Individual retirement arrangements (IRAs):PenaltiesPenalties:IRAs
The tax advantages of using traditional IRAs for retirement savings can be offset by additional taxes and penalties if you do not follow the rules.
There are additions to the regular tax for using your IRA funds in prohibited transactions. There are also additional taxes for the following
activities.
Investing in collectibles.
Making excess contributions.
Taking early distributions.
Allowing excess amounts to accumulate (failing to take required distributions).
There are penalties for overstating the amount of nondeductible contributions and for failure to file a Form 8606, if required.
Generally, a prohibited transaction is any improper use of your traditional IRA by you, your beneficiary, or any disqualified person.
Fiduciaries:Prohibited transactionsDisqualified persons include your fiduciary and members of your family (spouse, ancestor, lineal
descendent, and any spouse of a lineal descendent).
The following are examples of prohibited transactions with a traditional IRA.
Borrowing money from it.
Selling property to it.
Receiving unreasonable compensation for managing it.
Using it as security for a loan.
Buying property for personal use (present or future) with IRA funds.
Effect on an IRA account.Individual retirement arrangements (IRAs):Penalties:Prohibited transactions
Generally, if you or your beneficiary engages in a prohibited transaction in connection with your traditional IRA account at any time during the
year, the account stops being an IRA as of the first day of that year.
Effect on you or your beneficiary.
If your account stops being an IRA because you or your beneficiary engaged in a prohibited transaction, the account is treated as distributing all
its assets to you at their fair market values on the first day of the year. If the total of those values is more than your basis in the IRA, you will
have a taxable gain that is includible in your income. For information on figuring your gain and reporting it in income, see Are Distributions
Taxable, earlier. The distribution may be subject to additional taxes or penalties.
Taxes on prohibited transactions.
If someone other than the owner or beneficiary of a traditional IRA engages in a prohibited transaction, that person may be liable for certain
taxes. In general, there is a 15% tax on the amount of the prohibited transaction and a 100% additional tax if the transaction is not corrected.
More information.
For more information on prohibited transactions, see Publication 590.
Investment in CollectiblesCollectibles:IRA investment in
If your traditional IRA invests in collectibles, the amount invested is considered distributed to you in the year invested. You may have to pay the
10% additional tax on early distributions, discussed later.
Alcoholic beverages:IRA prohibited transactions in
Certain other tangible personal property.
Exception.
Collectibles:IRA investment inGold and silver:IRA investments inSilverGold and silverYour IRA can invest in one, one-half, one-quarter, or one-tenth ounce U.S. gold coins, or one-ounce silver coins minted
by the Treasury Department. It can also invest in certain platinum coins and certain gold, silver, palladium, and platinum bullion.
Generally, an excess contribution is the amount contributed to your traditional IRA(s) for the year that is more than the smaller of the following
amounts.
The maximum deductible amount for the year. For 2005, this is $4,000 ($4,500 if you are 50 or older).
Your taxable compensation for the year.
Tax on excess contributions.
In general, if the excess contributions for a year are not withdrawn by the date your return for the year is due (including extensions), you are
subject to a 6% tax. You must pay the 6% tax each year on excess amounts that remain in your traditional IRA at the end of your tax year. The tax
cannot be more than 6% of the value of your IRA as of the end of your tax year.
Excess contributions withdrawn by due date of return.
You will not have to pay the 6% tax if you withdraw an excess contribution made during a tax year and you also withdraw interest or other income
earned on the excess contribution. You must complete your withdrawal by the date your tax return for that year is due, including extensions.
How to treat withdrawn contributions.Individual retirement arrangements (IRAs):Withdrawals
Do not include in your gross income an excess contribution that you withdraw from your traditional IRA before your tax return is due if both the
following conditions are met.
No deduction was allowed for the excess contribution.
You withdraw the interest or other income earned on the excess contribution.
You can take into account any loss on the contribution while it was in the IRA when calculating the amount that must be withdrawn. If there was
a loss, the net income you must withdraw may be a negative amount.
How to treat withdrawn interest or other income.
You must include in your gross income the interest or other income that was earned on the excess contribution. Report it on your return for the
year in which the excess contribution was made. Your withdrawal of interest or other income may be subject to an additional 10% tax on early
distributions, discussed later.
Excess contributions withdrawn after due date of return.
In general, you must include all distributions (withdrawals) from your traditional IRA in your gross income. However, if the following conditions
are met, you can withdraw excess contributions from your IRA and not include the amount withdrawn in your gross income.
Total contributions (other than rollover contributions) for 2005 to your IRA were not more than $4,000 ($4,500 if you are 50 or
older).
You did not take a deduction for the excess contribution being withdrawn.
The withdrawal can take place at any time, even after the due date, including extensions, for filing your tax return for the year.
Excess contribution deducted in an earlier year.
If you deducted an excess contribution in an earlier year for which the total contributions were not more than the maximum deductible amount for
that year ($2,000 for 2001 and earlier years, $3,000 for 2002 through 2004 ($3,500 for 2002 through 2004 if you were 50 or older)), you can still
remove the excess from your traditional IRA and not include it in your gross income. To do this, file Form 1040X, Amended U.S. Individual Income Tax
Return, for that year and do not deduct the excess contribution on the amended return. Generally, you can file an amended return within 3 years after
you filed your return, or 2 years from the time the tax was paid, whichever is later.
Excess due to incorrect rollover information.Rollovers:Excess due to incorrect rollover information
If an excess contribution in your traditional IRA is the result of a rollover and the excess occurred because the information the plan was required
to give you was incorrect, you can withdraw the excess contribution. The limits mentioned above are increased by the amount of the excess that is due
to the incorrect information. You will have to amend your return for the year in which the excess occurred to correct the reporting of the rollover
amounts in that year. Do not include in your gross income the part of the excess contribution caused by the incorrect information.
Early DistributionsEarly withdrawal from deferred interest account:IRAs:PenaltiesIndividual retirement arrangements (IRAs)Early distributionsEarly withdrawal from deferred interest accountIndividual retirement arrangements (IRAs)PenaltiesEarly distributionsEarly withdrawal from deferred interest accountIndividual retirement arrangements (IRAs)WithdrawalsEarlyEarly withdrawal from deferred interest accountPenalties:IRAs:Early distributionsPremature distributionsEarly withdrawal from deferred interest account10% tax for early withdrawal from IRA or retirement planEarly withdrawal from deferred interest account, subheading: Tax on
You must include early distributions of taxable amounts from your traditional IRA in your gross income. Early distributions are also subject to an
additional 10% tax. See the discussion of Form 5329 under Reporting Additional Taxes, later, to figure and report the tax.
Early distributions defined.Early withdrawal from deferred interest account:IRAs:Early distributions, defined
Early distributions generally are amounts distributed from your traditional IRA account or annuity before you are age 59.
Age 59 rule.Age:IRAs:Distribution prior to age 5959 ruleIndividual retirement arrangements (IRAs):Age 59 for distributionIndividual retirement arrangements (IRAs):Distributions:At age 59
Generally, if you are under age 59, you must pay a 10% additional tax on the distribution of any assets (money or other property)
from your traditional IRA. Distributions before you are age 59 are called early distributions.
The 10% additional tax applies to the part of the distribution that you have to include in gross income. It is in addition to any regular income
tax on that amount.
Exceptions.Individual retirement arrangements (IRAs):Age 59 for distribution:Exception to ruleIndividual retirement arrangements (IRAs):Distributions:At age 59
There are several exceptions to the age 59 rule. Even if you receive a distribution before you are age 59, you may
not have to pay the 10% additional tax if you are in one of the following situations.
You have unreimbursed medical expenses that are more than 7.5% of your adjusted gross income.
The distributions are not more than the cost of your medical insurance.
You are disabled.
You are the beneficiary of a deceased IRA owner.
You are receiving distributions in the form of an annuity.
The distributions are not more than your qualified higher education expenses.
You use the distributions to buy, build, or rebuild a first home.
The distribution is due to an IRS levy of the qualified plan.
Most of these exceptions are explained in Publication 590.
Note.
Individual retirement arrangements (IRAs):TaxabilityDistributions that are timely and properly rolled over, as discussed earlier, are not subject to either regular
income tax or the 10% additional tax. Certain withdrawals of excess contributions after the due date of your return are also tax free and therefore
not subject to the 10% additional tax. (See Excess contributions withdrawn after due date of return, earlier.) This also applies to
transfers incident to divorce, as discussed earlier.
Additional 10% tax.
The additional tax on early distributions is 10% of the amount of the early distribution that you must include in your gross income. This tax is in
addition to any regular income tax resulting from including the distribution in income.
The tax on early distributions does not apply to the part of a distribution that represents a return of your nondeductible contributions (basis).
More information.
For more information on early distributions, see Publication 590.
Excess Accumulations
(Insufficient Distributions)
Individual retirement arrangements (IRAs):Penalties:Required distributions, failure to takeIndividual retirement arrangements (IRAs):Required distributions:Excess accumulationsAge:IRAs:Distribution required at age 70Individual retirement arrangements (IRAs):Age 70:Distributions required atYou cannot keep amounts in your traditional IRA indefinitely. Generally, you must begin
receiving distributions by April 1 of the year following the year in which you reach age 70. The required minimum distribution for any
year after the year in which you reach age 70 must be made by December 31 of that later year.
Tax on excess.
If distributions are less than the required minimum distribution for the year, you may have to pay a 50% excise tax for that year on the amount not
distributed as required.
Request to excuse the tax.Errors:IRAs, failure to take required distribution
If the excess accumulation is due to reasonable error, and you have taken, or are taking, steps to remedy the insufficient distribution, you can
request that the tax be excused.
If you believe you qualify for this relief, do the following.
File Form 5329 with your Form 1040.
Form:5329:Required minimum distributions, failure to take
Pay any tax you owe on excess accumulations.
Attach a letter of explanation.
If the IRS approves your request, it will refund the excess accumulations tax you paid.
Exemption from tax.Insurance companies:State delinquency proceedings, IRA distributions not made due to
If you are unable to take required distributions because you have a traditional IRA invested in a contract issued by an insurance company that is
in state insurer delinquency proceedings, the 50% excise tax does not apply if the conditions and requirements of Revenue Procedure 92-10 are
satisfied.
More information.
For more information on excess accumulations, see Publication 590.
Reporting Additional Taxes
Form:5329:Required minimum distributions, failure to takeGenerally, you must use Form 5329 to report the tax on excess
contributions, early distributions, and excess accumulations. If you must file Form 5329, you cannot use Form 1040A or Form 1040EZ.
Filing a tax return.Form:1040:IRAs
If you must file an individual income tax return, complete Form 5329 and attach it to your Form 1040. Enter the total amount of additional taxes
due on Form 1040, line 60.
Not filing a tax return.
Form:5329:Required minimum distributions, failure to takeIf you do not have to file a tax return but do have to pay one of the
additional taxes mentioned earlier, file the completed Form 5329 with the IRS at the time and place you would have filed your Form 1040. Be sure to
include your address on page 1 and your signature and date on page 2. Enclose, but do not attach, a check or money order payable to the United States
Treasury for the tax you owe, as shown on Form 5329. Enter your social security number and 2005 Form 5329 on your check or money order.
Form 5329 not required.Form:5329:Required minimum distributions, failure to take
You do not have to use Form 5329 if either of the following situations exist.
Distribution code 1 (early distribution) is correctly shown in box 7 of all Forms 1099-R. If you do not owe any other additional tax on a
distribution, multiply the taxable part of the early distribution by 10% and enter the result on Form 1040, line 60. Put No to the left of line
60 to indicate that you do not have to file Form 5329. However, if you owe this tax and also owe any other additional tax on a distribution, do not
enter this 10% additional tax directly on your Form 1040. You must file Form 5329 to report your additional taxes. Form:1099-R:IRA distributions
If you rolled over part or all of a distribution from a qualified retirement plan, the part rolled over is not subject to the tax on early
distributions.
Regardless of your age, you may be able to establish and make nondeductible contributions to a retirement plan called a Roth IRA.
Contributions not reported.
You do not report Roth IRA contributions on your return.
What Is a Roth IRA?Roth IRAs:Definition of
A Roth IRA is an individual retirement plan that, except as explained in this chapter, is subject to the rules that apply to a traditional IRA
(defined earlier). It can be either an account or an annuity. Individual retirement accounts and annuities are described in Publication 590.
To be a Roth IRA, the account or annuity must be designated as a Roth IRA when it is set up. A deemed IRA can be a Roth IRA, but neither a SEP-IRA
nor a SIMPLE IRA can be designated as a Roth IRA.
Roth IRAs:Contributions:No deduction forUnlike a traditional IRA, you cannot deduct contributions to a Roth IRA. But, if you satisfy the
requirements, qualified distributions (discussed later) are tax free. Contributions can be made to your Roth IRA after you reach age 70 and you can leave amounts in your Roth IRA as long as you live.
When Can a Roth IRA Be Set Up?Roth IRAs:Establishing account
You can set up a Roth IRA at any time. However, the time for making contributions for any year is limited. See When Can You Make
Contributions, later under Can You Contribute to a Roth IRA?
Can You Contribute to a Roth IRA?Roth IRAs:Contributions
Generally, you can contribute to a Roth IRA if you have taxable compensation (defined later) and your modified AGI (defined later) is less than:
$160,000 for married filing jointly or qualifying widow(er),
$10,000 for married filing separately and you lived with your spouse at any time during the year, or
$110,000 for single, head of household, or married filing separately and you did not live with your spouse at any time during the
year.
You may be eligible to claim a credit for contributions to your Roth IRA. For more information, see chapter 37.
Is there an age limit for contributions?Age:Roth IRAsRoth IRAs:Age:No limit for contributions
Contributions can be made to your Roth IRA regardless of your age.
Can you contribute to a Roth IRA for your spouse?Married taxpayers:Roth IRAsRoth IRAs:Spousal contributions
You can contribute to a Roth IRA for your spouse provided the contributions satisfy the spousal IRA limit (discussed in How Much Can Be
Contributed under Traditional IRAs), you file jointly, and your modified AGI is less than $160,000.
Compensation.Compensation:Defined for Roth IRA purposesRoth IRAs:Compensation, defined
Compensation includes wages, salaries, tips, professional fees, bonuses, and other amounts received for providing personal services. It also
includes commissions, self-employment income, and taxable alimony and separate maintenance payments.
Modified AGI.Modified adjusted gross income (MAGI):Roth IRAs, computation forRoth IRAs:Modified adjusted gross income (MAGI)
Your modified AGI for Roth IRA purposes is your adjusted gross income (AGI) as shown on your return modified as follows.
Subtract the following:
Conversion income. This is any income resulting from the conversion of an IRA (other than a Roth IRA) to a Roth IRA.
Exclusion of qualified savings bond interest shown on Form 8815, and
Exclusion of employer-provided adoption benefits shown on Form 8839.
Domestic production activities deduction from Form 1040, line 35, or Form 1040NR, line 33.
You can use Worksheet 17-2
to figure your modified AGI.
<ROM>Worksheet 17-2.</ROM>
<IMARK>Modified Adjusted Gross Income for Roth IRA PurposesModified adjusted gross income (MAGI):Roth IRAs, computation for:Worksheet 17-2Roth IRAs:Effect of modified AGI on contributions (Table 17-3)Roth IRAs:Modified adjusted gross income (MAGI):Computation (Worksheet 17-2)Tables and figures:Individual retirement arrangements (IRAs):Roth IRAs, effect of modified AGI on contributions (Table 17-3)Tables and figures:Individual retirement arrangements (IRAs):Roth IRAs, modified AGI (Worksheet 17-2)Worksheets:Roth IRA modified adjusted gross income (MAGI), computation (Worksheet 17-2)Use this worksheet to figure your modified adjusted gross income for Roth IRA purposes.1.Enter your adjusted gross income (Form 1040, line 38, or
Form 1040A, line 22)1.2.Enter any income resulting from the conversion of an IRA
(other than a Roth IRA) to a Roth IRA or a minimum required distribution from an IRA (if figuring MAGI for conversion purposes)2.3.Subtract line 2 from line 13.4.Enter any traditional IRA deduction (Form 1040, line 32, or
Form 1040A, line 17)4.5.Enter any student loan interest deduction (Form 1040,
line 33, or Form 1040A, line 18)5.6.Enter any tuition and fees deduction (Form 1040, line 34, or
Form 1040A, line 19)6.7.Enter any foreign earned income and/or housing exclusion
(Form 2555, line 43, or Form 2555-EZ, line 18)7.8.Enter any foreign housing deduction (Form 2555, line 48)8.9.Enter any exclusion of bond interest (Form 8815, line 14)9.10.Enter any exclusion of employer-provided adoption benefits
(Form 8839, line 30)10.11.Enter any domestic production activities deduction (Form 1040, line 35 or Form 1040NR,
line 33)11.12.Add the amounts on lines 3 through 11 12.13.Enter:
• $160,000 if married filing jointly or qualifying widow(er)
• $10,000 if married filing separately and you lived with your
spouse at any time during the year
• $110,000 for all others13. Next.If yes,If no,Is the amount on line 12 more than the amount on line 13?
then see the Note below.
then the amount on line 12 is your modified AGI for Roth IRA purposes.Note. If the amount on line 12 is more than the amount on line 13 and you have other income or
loss items, such as social security income or passive activity losses, that are subject to AGI-based phaseouts, you can refigure your AGI solely for
the purpose of figuring your modified AGI for Roth IRA purposes. When figuring your modified AGI for conversion purposes, or minimum required
distributions from IRAs, refigure your AGI without taking into account any income from conversions. (If you receive social security benefits, use
Worksheet 1 in Appendix B of Publication 590 to refigure your AGI.) Then go to list item (2) under Modified AGI or
line 4 above in Worksheet 17-2 to refigure your modified AGI. If you do not have other income or loss items subject to AGI-based phaseouts,
your modified AGI for Roth IRA purposes is the amount on line 12.
How Much Can Be Contributed?Roth IRAs:Contribution limits
The contribution limit for Roth IRAs depends on whether contributions are made only to Roth IRAs or to both traditional IRAs and Roth IRAs.
Roth IRAs only.Roth IRAs:Contributions:Roth IRA only
If contributions are made only to Roth IRAs, your contribution limit generally is the lesser of the following amounts.
$4,000 ($4,500 if you are 50 or older in 2005). For 2006, the amount is $4,000 (and increases to $5,000 if you are 50 or older in
2006).
Your taxable compensation.
However, if your modified AGI is above a certain amount, your contribution limit may be reduced, as explained later under Contribution
limit reduced.
Roth IRAs and traditional IRAs.Individual retirement arrangements (IRAs):Contributions:Roth IRA contribution for same yearRoth IRAs:Contributions:To traditional IRA for same year
If contributions are made to both Roth IRAs and traditional IRAs established for your benefit, your contribution limit for Roth IRAs generally is
the same as your limit would be if contributions were made only to Roth IRAs, but then reduced by all contributions (other than employer contributions
under a SEP or SIMPLE IRA plan) for the year to all IRAs other than Roth IRAs.
This means that your contribution limit is the lesser of the following amounts.
$4,000 ($4,500 if you are 50 or older in 2005). For 2006, $4,000 ($5,000 if you are 50 or older in 2006) minus all contributions (other than
employer contributions under a SEP or SIMPLE IRA plan) for the year to all IRAs other than Roth IRAs.
Roth IRAs:Contribution limits:Under age 50,Roth IRAs:Contribution limits:Age 50 or older,
Your taxable compensation minus all contributions (other than employer contributions under a SEP or SIMPLE IRA plan) for the year to all
IRAs other than Roth IRAs.
However, if your modified AGI is above a certain amount, your contribution limit may be reduced, as explained later under Contribution
limit reduced.
Contribution limit reduced.
If your modified AGI is above a certain amount, your contribution limit is gradually reduced. Use Table 17-3
to determine if this reduction applies to you.
<ROM>Table 17-3.</ROM>
<IMARK>Effect of Modified AGI on Roth IRA ContributionModified adjusted gross income (MAGI):Roth IRAs, computation for:Phaseout (Table 17–3)Roth IRAs:Modified adjusted gross income (MAGI):Phaseout (Table 17–3)Tables and figures:Roth IRA and modified adjusted gross income (MAGI) phaseout (Table 17–3)This table shows whether your contribution to a Roth IRA is affected by the amount of your modified adjusted gross income (modified
AGI).IF you have taxable compensation and your filing status is...AND your modified
AGI is...THEN...married filing jointly, or
qualifying widow(er)less than $150,000you can contribute up to $4,000 ($4,500 if you are 50 or older in 2005). For 2006, this amount is $4,000 ($5,000 if
you are 50 or older in 2006).at least $150,000
but less than $160,000the amount you can contribute is reduced as explained under Contribution limit reduced in Publication
590.$160,000 or moreyou cannot contribute to a Roth IRA.married filing separately and you lived with your spouse at any time during the
yearzero (-0-)you can contribute up to $4,000 ($4,500 if you are 50 or older in 2005). For 2006, this amount is $4,000 ($5,000 if
you are 50 or older in 2006).more than zero (-0-)
but less than $10,000the amount you can contribute is reduced as explained under Contribution limit reduced in Publication
590.$10,000 or moreyou cannot contribute to a Roth IRA.single,head of household, or married filing separately and you did not live with your spouse at any time during the yearless than $95,000you can contribute up to $4,000 ($4,500 if you are 50 or older in 2005). For 2006, this amount is $4,000 ($5,000 if
you are 50 or older in 2006).at least $95,000
but less than $110,000the amount you can contribute is reduced as explained under Contribution limit reduced in Publication
590.$110,000 or moreyou cannot contribute to a Roth IRA.
Figuring the reduction.
If the amount you can contribute to your Roth IRA is reduced, see Publication 590 for how to figure the reduction.
When Can You Make Contributions?Roth IRAs:Contributions:Time to make
You can make contributions to a Roth IRA for a year at any time during the year or by the due date of your return for that year (not including
extensions).
You can make contributions for 2005 by the due date (not including extensions) for filing your 2005 tax return. This means that most people can
make contributions for 2005 by April 17, 2006.
What If You Contribute Too Much?Excise taxes:Roth IRAsPenalties:Roth IRAs:Excess contributionsRoth IRAs:Excess contributionsRoth IRAs:Penalties:Excess contributionsTaxesExciseExcise taxes
A 6% excise tax applies to any excess contribution to a Roth IRA.
Excess contributions.
These are the contributions to your Roth IRAs for a year that equal the total of:
Amounts contributed for the tax year to your Roth IRAs (other than amounts properly and timely rolled over from a Roth IRA or properly
converted from a traditional IRA, as described later) that are more than your contribution limit for the year, plus
Any excess contributions for the preceding year, reduced by the total of:
Any distributions out of your Roth IRAs for the year, plus
Your contribution limit for the year minus your contributions to all your IRAs for the year.
Withdrawal of excess contributions.Roth IRAs:Withdrawals:Excess contributions
For purposes of determining excess contributions, any contribution that is withdrawn on or before the due date (including extensions) for filing
your tax return for the year is treated as an amount not contributed. This treatment applies only if any earnings on the contributions are also
withdrawn. The earnings are considered to have been earned and received in the year the excess contribution was made.
Applying excess contributions.
If contributions to your Roth IRA for a year were more than the limit, you can apply the excess contribution in one year to a later year if the
contributions for that later year are less than the maximum allowed for that year.
Can You Move Amounts Into a Roth IRA?
You may be able to convert amounts from either a traditional, SEP, or SIMPLE IRA into a Roth IRA. You may be able to recharacterize contributions
made to one IRA as having been made directly to a different IRA. You can roll amounts over from one Roth IRA to another Roth IRA.
ConversionsConversionspecific retirement or IRA planRoth IRAs:Conversion
You can convert a traditional IRA to a Roth IRA. The conversion is treated as a rollover, regardless of the conversion method used. Most of the
rules for rollovers, described earlier under Rollover From One IRA Into Another under Traditional IRAs, apply to these
rollovers. However, the 1-year waiting period does not apply.
Conversion methods.
Rollovers:From IRA to Roth IRAYou can convert amounts from a traditional IRA to a Roth IRA in any of the following ways.
Rollover. You can receive a distribution from a traditional IRA and roll it over (contribute it) to a Roth IRA within 60 days
after the distribution.
Trustee-to-trustee transfer. You can direct the trustee of the traditional IRA to transfer an amount from the traditional IRA to
the trustee of the Roth IRA.
Individual retirement arrangements (IRAs):Trustee-to-trustee transfers:IRA to Roth IRATrustees:IRAs:Transfer from trustee to trustee
Same trustee transfer. If the trustee of the traditional IRA also maintains the Roth IRA, you can direct the trustee to transfer
an amount from the traditional IRA to the Roth IRA.
Same trustee.
Conversions made with the same trustee can be made by redesignating the traditional IRA as a Roth IRA, rather than opening a new account or issuing
a new contract.
Converting from a SIMPLE IRA.Rollovers:From SIMPLE IRA to Roth IRASIMPLE plans:Rollover to Roth IRA
Generally, you can convert an amount in your SIMPLE IRA to a Roth IRA under the same rules explained earlier under Converting From Any
Traditional IRA to a Roth IRA.
However, you cannot convert any amount distributed from the SIMPLE IRA during the 2-year period beginning on the date you first participated in
any SIMPLE IRA plan maintained by your employer.
More information.
For more detailed information on conversions, see Publication 590.
Failed ConversionsRoth IRAs:Failed conversions and recharacterizations
If, when you converted amounts from a traditional IRA into a Roth IRA, you expected to have modified AGI of less than $100,000 and a filing status
other than married filing separately, but your expectations did not come true, you have made a failed conversion.
Results of failed conversions.
If the converted amount (contribution) is not recharacterized (explained earlier), the contribution will be treated as a regular contribution to
the Roth IRA and subject to the following tax consequences.
A 6% excise tax per year will apply to any excess contribution not withdrawn from the Roth IRA.
Excise taxes:Roth IRAsRoth IRAs:Penalties
The distributions from the traditional IRA must be included in your gross income.
The 10% additional tax on early distributions may apply to any distribution.
How to avoid.
You must move the amount converted (including all earnings from the date of conversion) into a traditional IRA by the due date (including
extensions) for your tax return for the year during which you made the conversion to the Roth IRA. You do not have to include this distribution
(withdrawal) in income. See Recharacterizations, earlier, for more information.
Rollover From a Roth IRARollovers:From Roth IRA to Roth IRARoth IRAs:Rollovers
You can withdraw, tax free, all or part of the assets from one Roth IRA if you contribute them within 60 days to another Roth IRA. Most of the
rules for rollovers, explained earlier under Rollover From One IRA Into Another under Traditional IRAs, apply to these
rollovers.
Are Distributions Taxable?Roth IRAs:TaxabilityRoth IRAs:Withdrawals:Not taxable
You do not include in your gross income qualified distributions or distributions that are a return of your regular contributions from your Roth
IRA(s). You also do not include distributions from your Roth IRA that you roll over tax free into another Roth IRA. You may have to include part of
other distributions in your income. See Ordering rules for distributions, later.
What are qualified distributions?Roth IRAs:Distributions:Qualified distributions
A qualified distribution is any payment or distribution from your Roth IRA that meets the following requirements.
It is made after the 5-year period beginning with the first taxable year for which a contribution was made to a Roth IRA set up for your
benefit, and
The payment or distribution is:
Made on or after the date you reach age 59,
Roth IRAs:Age:Distributions after age 59
Made because you are disabled,
Made to a beneficiary or to your estate after your death, or
To pay up to $10,000 (lifetime limit) of certain qualified first-time homebuyer amounts. See Publication 590 for more
information.
Additional tax on distributions of conversion contributions within 5-year period.Penalties:Roth IRAs:Conversion contributions withdrawn in 5-year periodRoth IRAs:Penalties:Conversion contributions withdrawn in 5-year period
If, within the 5-year period starting with the first day of your tax year in which you convert an amount from a traditional IRA to a Roth IRA, you
take a distribution from a Roth IRA, you may have to pay the 10% additional tax on early distributions. You generally must pay the 10% additional tax
on any amount attributable to the part of the amount converted (the conversion contribution) that you had to include in income. A separate 5-year
period applies to each conversion. See Ordering rules for distributions, later, to determine the amount, if any, of the distribution that
is attributable to the part of the conversion contribution that you had to include in income.
Additional tax on other early distributions.
Unless an exception applies, the taxable part of other distributions from your Roth IRA(s) that are not qualified distributions is subject to the
10% additional tax on early distributions. See Publication 590 for more information.
Ordering rules for distributions.
If you receive a distribution from your Roth IRA that is not a qualified distribution, part of it may be taxable. There is a set order in which
contributions (including conversion contributions) and earnings are considered to be distributed from your Roth IRA. Regular contributions are
distributed first. See Publication 590 for more information.
Must you withdraw or use Roth IRA assets?Age:Roth IRAsRoth IRAs:Age:No required distribution ageRoth IRAs:Withdrawals
You are not required to take distributions from your Roth IRA at any age. The minimum distribution rules that apply to traditional IRAs do not
apply to Roth IRAs while the owner is alive. However, after the death of a Roth IRA owner, certain of the minimum distribution rules that apply to
traditional IRAs also apply to Roth IRAs.
More information.
Individual retirement arrangements (IRAs)Roth IRAsFor more detailed information on Roth IRAs, see Publication 590.
AlimonyAlimony
This chapter discusses the rules that apply if you pay or receive alimony. It covers the following topics:
What payments are alimony,
What payments are not alimony, such as child support,
How to deduct alimony you paid,
How to report alimony income you received, and
Whether you must recapture the tax benefits of alimony. Recapture means adding back in your income all or part of a deduction you took in a
prior year.
Alimony:Definition of
Alimony is a payment to or for a spouse or former spouse under a divorce or separation instrument. It does not include voluntary payments that are
not made under a divorce or separation instrument.
Deductions:Alimony, deductible by payer
Alimony is deductible by the payer and must be included in the spouse's or former spouse's income. Although this chapter is generally written for
the payer of the alimony, the recipient can use the information to determine whether an amount received is alimony.
Alimony:Definition of
To be alimony, a payment must meet certain requirements. Different requirements apply to payments under instruments executed after 1984 and to
payments under instruments executed before 1985. This chapter discusses the rules for payments under instruments executed after 1984. If you need the
rules for payments under pre-1985 instruments, get and keep a copy of the 2004 version of Publication 504. That was the last year the information on
pre-1985 instruments was included in Publication 504.
Use Table 18-1
in this chapter as a guide to determine
whether certain payments are considered alimony.
Definitions.
The following definitions apply throughout this chapter.
Spouse or former spouse.Alimony:Spouse defined for purposes ofMarried taxpayers:Definition of spouse for purposes of alimony
Unless otherwise stated in the following discussions about alimony, the term spouse includes former spouse.
Divorce or separation instrument.Divorced taxpayers:Definition of divorce instrument for purposes of alimonySeparation agreements:Defined for purposes of alimony
The term divorce or separation instrument means:
A decree of divorce or separate maintenance or a written instrument incident to that decree,
A written separation agreement, or
A decree or any type of court order requiring a spouse to make payments for the support or maintenance of the other spouse. This includes a
temporary decree, an interlocutory (not final) decree, and a decree of alimony pendente lite (while awaiting action on the final decree or
agreement).
Publication504 Divorced or Separated Individuals
General Rules
The following rules apply to alimony regardless of when the divorce or separation instrument was executed.
Payments not alimony.Alimony:Payments not included as
Not all payments under a divorce or separation instrument are alimony. Alimony does not include any of the following.
Child support.
Child support:Alimony, difference from
Noncash property settlements.
Payments that are your spouse's part of community income. (See Community Property in Publication 504.)
Community property:Alimony, difference from
Payments to keep up the payer's property.
Use of property.
Payments to a third party.Alimony:Payments to third partyHousing:Alimony payments made to coverMedical and dental expenses:Alimony payments made to coverThird parties:Alimony payments made toTuition:Alimony payments made to cover
Cash payments (including checks and money orders) to a third party on behalf of your spouse under the terms of your divorce or separation
instrument may be alimony if they otherwise qualify. These include payments for your spouse's medical expenses, housing costs (rent, utilities, etc.),
taxes, tuition, etc. The payments are treated as received by your spouse and then paid to the third party.
Life insurance premiums.Alimony:Life insurance premiumsInsurance premiums:Alimony when spouse owns life insurance policyInsurance premiums:Life insurance:AlimonyLife insurance:Alimony, premiums when spouse owns policy
Alimony includes premiums you must pay under your divorce or separation instrument for insurance on your life to the extent your spouse owns the
policy.
Payments for jointly-owned home.Alimony:Jointly owned homeHome:Jointly owned:Mortgage payments as alimony
If your divorce or separation instrument states that you must pay expenses for a home owned by you and your spouse or former spouse, some of your
payments may be alimony.
Mortgage payments.Alimony:Mortgage paymentsMortgages:Alimony, payments as
If you must pay all the mortgage payments (principal and interest) on a jointly-owned home, and they otherwise qualify, you can deduct one-half of
the total payments as alimony. If you itemize deductions and the home is a qualified home, you can claim half of the interest in figuring your
deductible interest. Your spouse must report one-half of the payments as alimony received. If your spouse itemizes deductions and the home is a
qualified home, he or she can claim one-half of the interest on the mortgage in figuring deductible interest.
Taxes and insurance.Alimony:Taxes and insurance paid on home owned as tenants in commonHome:Tenants in common, taxes and insurance premiums as alimonyInsurance:Alimony deduction for, when home owned as tenants in commonReal estate taxes:Alimony deduction for, when home owned as tenants in commonTenants in common:Alimony deduction for taxes and insurance paid on home owned as
If you must pay all the real estate taxes or insurance on a home held as tenants in common, you can deduct one-half of these payments as alimony.
Your spouse must report one-half of these payments as alimony received. If you and your spouse itemize deductions, you can each claim one-half of the
real estate taxes and none of the home insurance.
Alimony:Jointly owned home:Taxes and insurance premiumsHome:Jointly owned:Taxes and insurance premiums as alimonyTenants by the entirety:Alimony, no deduction for taxes and insurance paid on home owned as
If your home is held as tenants by the entirety or joint tenants, none of your payments for taxes or insurance are alimony. But if you itemize
deductions, you can claim all of the real estate taxes and none of the home insurance.
Other payments to a third party.Alimony:Payments to third partyThird parties:Alimony payments made to
If you made other third-party payments, see Publication 504 to see whether any part of the payments qualifies as alimony.
Instruments
Executed After 1984Alimony:Instruments executed after 1984
The following rules for alimony apply to payments under divorce or separation instruments executed after 1984.
Exception for instruments executed before 1985.Alimony:Instruments executed before 1985
There are two situations where the rules for instruments executed after 1984 apply to instruments executed before 1985.
A divorce or separation instrument executed before 1985 and then modified after 1984 to specify that the after-1984 rules will
apply.
A temporary divorce or separation instrument executed before 1985 and incorporated into, or adopted by, a final decree executed after 1984
that:
Changes the amount or period of payment, or
Adds or deletes any contingency or condition.
For the rules for alimony payments under pre-1985 instruments not meeting these exceptions, see the 2004 revision of Publication 504 on the IRS
website at
www.irs.gov.
Example 1.
In November 1984, you and your former spouse executed a written separation agreement. In February 1985, a decree of divorce was substituted for the
written separation agreement. The decree of divorce did not change the terms for the alimony you pay your former spouse. The decree of divorce is
treated as executed before 1985. Alimony payments under this decree are not subject to the rules for payments under instruments executed after 1984.
Example 2.
Assume the same facts as in Example 1 except that the decree of divorce changed the amount of the alimony. In this example, the decree
of divorce is not treated as executed before 1985. The alimony payments are subject to the rules for payments under instruments executed after 1984.
Alimony requirements.Alimony:Joint return of spouses not allowed
A payment to or for a spouse under a divorce or separation instrument is alimony if the spouses do not file a joint return with each other and all
the following requirements are met.
The payment is in cash.
The instrument does not designate the payment as not alimony.
The spouses are not members of the same household at the time the payments are made. This requirement applies only if the spouses are
legally separated under a decree of divorce or separate maintenance.
There is no liability to make any payment (in cash or property) after the death of the recipient spouse.
The payment is not treated as child support.
Child support:Alimony, difference from
Each of these requirements is discussed next.
Payments must be in cash.Alimony:Payments must be in cash
Only cash payments, including checks and money orders, qualify as alimony. The following do not qualify as alimony.
Transfers of services or property (including a debt instrument of a third party or an annuity contract).
Execution of a debt instrument by the payor.
The use of property.
Payments to a third party.Alimony:Payments to third partyThird parties:Alimony payments made to
Cash payments to a third party under the terms of your divorce or separation instrument can qualify as cash payments to your spouse. See
Payments to a third party under General Rules, earlier.
Also, cash payments made to a third party at the written request of your spouse qualify as alimony if all the following requirements are met.
The payments are in lieu of payments of alimony directly to your spouse.
The written request states that both spouses intend the payments to be treated as alimony.
You receive the written request from your spouse before you file your return for the year you made the payments.
Payments designated as not alimony.Alimony:Payments designated as not alimony
You and your spouse can designate that otherwise qualifying payments are not alimony. You do this by including a provision in your divorce or
separation instrument that states the payments are not deductible as alimony by you and are excludable from your spouse's income. For this purpose,
any instrument (written statement) signed by both of you that makes this designation and that refers to a previous written separation agreement is
treated as a written separation agreement. If you are subject to temporary support orders, the designation must be made in the original or a later
temporary support order.
Your spouse can exclude the payments from income only if he or she attaches a copy of the instrument designating them as not alimony to his or her
return. The copy must be attached each year the designation applies.
Spouses cannot be members of the same household.Alimony:Spouses cannot be members of same householdHousehold members:Alimony payments, spouses cannot be members of same householdAlimony:Jointly owned home:Separate residences inHome:Jointly owned:Separate residences in and alimony payments
Payments to your spouse while you are members of the same household are not alimony if you are legally separated under a decree of divorce or
separate maintenance. A home you formerly shared is considered one household, even if you physically separate yourselves in the home.
You are not treated as members of the same household if one of you is preparing to leave the household and does leave no later than 1 month after
the date of the payment.
Exception.
If you are not legally separated under a decree of divorce or separate maintenance, a payment under a written separation agreement, support decree,
or other court order may qualify as alimony even if you are members of the same household when the payment is made.
Table 18-1. Alimony Requirements (Instruments Executed After 1984)
Alimony:Instruments executed after 1984:Alimony requirements (Table 18-1)Tables and figures:Alimony requirements (instruments executed after 1984) (Table 18-1)Payments ARE alimony if
all of the following are true:Payments are NOT alimony if
any of the following are true:Payments are required by a divorce or separation instrument.Payments are not required by a divorce or separation instrument.Payer and recipient spouse do not file a joint return with each other.Payer and recipient spouse file a joint return with each other.Payment is in cash (including checks or money orders).Payment is:
Not in cash,
A noncash property settlement,
Spouse's part of community income, or
To keep up the payer's property.
Payment is not designated in the instrument as not alimony.Payment is designated in the instrument as not alimony.Spouses legally separated under a decree of divorce or separate maintenance are not members of the same household.Spouses legally separated under a decree of divorce or separate maintenance are members of the same household.Payments are not required after death of the recipient spouse.Payments are required after death of the recipient spouse.Payment is not treated as child support.Payment is treated as child support.These payments are deductible by the payer and includible in income by the recipient.These payments are neither deductible by the payer nor includible in income by the
recipient.
Liability for payments after death of recipient spouse.Alimony:Death of recipient spouse
If you must continue to make payments for any period after your spouse's death, the part of the payment that would continue is not alimony, whether
made before or after the death. If all of the payment would continue, then none of the payments made before or after the death are alimony.
The divorce or separation instrument does not have to expressly state that the payments cease upon the death of your spouse if, for example, the
liability for continued payments would end under state law.
Example.
You must pay your former spouse $10,000 in cash each year for 10 years. Your divorce decree states that the payments will end upon your former
spouse's death. You must also pay your former spouse or your former spouse's estate $20,000 in cash each year for 10 years. The death of your spouse
would not terminate these payments under state law.
The $10,000 annual payments are alimony. But because the $20,000 annual payments will not end upon your former spouse's death, they are not
alimony.
Substitute payments.Alimony:Substitute payments
If you must make any payments in cash or property after your spouse's death as a substitute for continuing otherwise qualifying payments, the
otherwise qualifying payments are not alimony. To the extent that your payments begin, accelerate, or increase because of the death of your spouse,
otherwise qualifying payments you made may be treated as payments that were not alimony. Whether or not such payments will be treated as not alimony
depends on all the facts and circumstances.
Example 1.
Under your divorce decree, you must pay your former spouse $30,000 annually. The payments will stop at the end of 6 years or upon your former
spouse's death, if earlier.
Your former spouse has custody of your minor children. The decree provides that if any child is still a minor at your spouse's death, you must pay
$10,000 annually to a trust until the youngest child reaches the age of majority. The trust income and corpus (principal) are to be used for your
children's benefit.
These facts indicate that the payments to be made after your former spouse's death are a substitute for $10,000 of the $30,000 annual payments. Of
each of the $30,000 annual payments, $10,000 is not alimony.
Example 2.
Under your divorce decree, you must pay your former spouse $30,000 annually. The payments will stop at the end of 15 years or upon your former
spouse's death, if earlier. The decree provides that if your former spouse dies before the end of the 15-year period, you must pay the estate the
difference between $450,000 ($30,000 × 15) and the total amount paid up to that time. For example, if your spouse dies at the end of the tenth
year, you must pay the estate $150,000 ($450,000 − $300,000).
These facts indicate that the lump-sum payment to be made after your former spouse's death is a substitute for the full amount of the $30,000
annual payments. None of the annual payments are alimony. The result would be the same if the payment required at death were to be discounted by an
appropriate interest factor to account for the prepayment.
Child support.Child support:Alimony, difference from
A payment that is specifically designated as child support or treated as specifically designated as child support under your divorce or separation
instrument is not alimony. The designated amount or part may vary from time to time. Child support payments are neither deductible by the payer nor
taxable to the recipient.
Specifically designated as child support.
A payment will be treated as specifically designated as child support to the extent that the payment is reduced either:
On the happening of a contingency relating to your child, or
At a time that can be clearly associated with the contingency.
A payment may be treated as specifically designated as child support even if other separate payments are specifically designated as child
support.
Contingency relating to your child.
A contingency relates to your child if it depends on any event relating to that child. It does not matter whether the event is certain or likely to
occur. Events relating to your child include the child's:
Becoming employed,
Dying,
Leaving the household,
Leaving school,
Marrying, or
Reaching a specified age or income level.
Clearly associated with a contingency.
Payments are presumed to be reduced at a time clearly associated with the happening of a contingency relating to your child only in the following
situations.
The payments are to be reduced not more than 6 months before or after the date the child will reach 18, 21, or local age of
majority.
The payments are to be reduced on two or more occasions that occur not more than 1 year before or after a different one of your children
reaches a certain age from 18 to 24. This certain age must be the same for each child, but need not be a whole number of years.
In all other situations, reductions in payments are not treated as clearly associated with the happening of a contingency relating to your
child.
Either you or the IRS can overcome the presumption in the two situations above. This is done by showing that the time at which the payments are to
be reduced was determined independently of any contingencies relating to your children. For example, if you can show that the period of alimony
payments is customary in the local jurisdiction, such as a period equal to one-half of the duration of the marriage, you can treat the amount as
alimony.
How To Deduct Alimony PaidForm:1040:Deduction for alimony paidAlimony:Form 1040 to be used:Deduction for amount paidAlimony:DeductionDeductions:Alimony, deductible by payer
You can deduct alimony you paid, whether or not you itemize deductions on your return. You must file Form 1040. You cannot use Form 1040A or Form
1040EZ.
Enter the amount of alimony you paid on Form 1040, line 31a. In the space provided on line 31b, enter your spouse's social security number.
Social security numbers (SSNs):Alimony recipient's number required
If you paid alimony to more than one person, enter the social security number of one of the recipients. Show the social security number and amount
paid to each other recipient on an attached statement. Enter your total payments on line 31a.
Alimony:Penalty for failure to provide social security number of recipientPenalties:Failure to provide social security number or TIN:Alimony deduction
If you do not provide your spouse's social security number, you may have to pay a $50 penalty and your deduction may be disallowed.
How To Report Alimony ReceivedAlimony:Reporting of incomeForm:1040:Reporting of alimony receivedAlimony:Form 1040 to be used:Income received, reporting ofAlimony:Recipient reporting of
Report alimony you received on Form 1040, line 11. You cannot use Form 1040A or Form 1040EZ.
Alimony:Penalty for failure to provide social security number of recipientPenalties:Alimony deduction, failure to provide social security number of recipientSocial Security Numbers (SSNs):Alimony recipient's number required
You must give the person who paid the alimony your social security number. If you do not, you may have to pay a $50 penalty.
Recapture RuleAlimony:Termination of and recapture ruleAlimony:Deduction:Difference from one year to another of more than $15,000Alimony:Decrease in amount and recapture ruleAlimony:Recapture ruleRecapture:Alimony
If your alimony payments decrease or terminate during the first 3 calendar years, you may be subject to the recapture rule. If you are subject to
this rule, you have to include in income in the third year part of the alimony payments you previously deducted. Your spouse can deduct in the third
year part of the alimony payments he or she previously included in income.
The 3-year period starts with the first calendar year you make a payment qualifying as alimony under a decree of divorce or separate maintenance or
a written separation agreement. Do not include any time in which payments were being made under temporary support orders. The second and third years
are the next 2 calendar years, whether or not payments are made during those years.
The reasons for a reduction or termination of alimony payments that can require a recapture include:
A change in your divorce or separation instrument,
A failure to make timely payments,
A reduction in your ability to provide support, or
A reduction in your spouse's support needs.
When to apply the recapture rule.
You are subject to the recapture rule in the third year if the alimony you pay in the third year decreases by more than $15,000 from the second
year or the alimony you pay in the second and third years decreases significantly from the alimony you pay in the first year.
When you figure a decrease in alimony, do not include the following amounts.
Payments made under a temporary support order.
Payments required over a period of at least 3 calendar years of a fixed part of your income from a business or property, or from
compensation for employment or self-employment.
Payments that decrease because of the death of either spouse or the remarriage of the spouse receiving the payments.
Figuring the recapture.
You can use Worksheet 1 in Publication 504 to figure recaptured alimony.
Including the recapture in income.Alimony:Form 1040 to be used:RecaptureForm:1040:Recapture of alimonyRecapture:Alimony:Reporting on Form 1040
If you must include a recapture amount in income, show it on Form 1040, line 11 (Alimony received). Cross out received and enter
recapture. On the dotted line next to the amount, enter your spouse's last name and social security number.
Deducting the recapture.Alimony:Form 1040 to be used:RecaptureAlimony
If you can deduct a recapture amount, show it on Form 1040, line 31a (Alimony paid). Cross out paid and enter recapture. In
the space provided, enter your spouse's social security number.
Education-
Related
AdjustmentsAdjusted gross income (AGI):DeductionsWhat's NewKatrina Emergency Tax Relief Act of 2005.
This Act provides tax relief for persons affected by Hurricane Katrina. Under the Act, you may be able to claim a student loan interest deduction
and/or a tuition and fees deduction. See Publication 4492.
This chapter discusses the education-related adjustments you can deduct in figuring your adjusted gross income.
If you were an eligible educator in 2005, you can deduct up to $250 of qualified expenses you paid in 2005 as an adjustment to gross income, rather
than as a miscellaneous itemized deduction. If you and your spouse are filing jointly
Married taxpayers:Educator expensesand both of you were eligible educators, the maximum deduction is $500. However, neither spouse can deduct
more than $250 of his or her qualified expenses.
Eligible educator.
An eligible educator is a kindergarten through grade 12 teacher, instructor, counselor, principal, or aide who worked in a school for at least 900
hours during a school year.
Qualified expenses.
Qualified expenses include ordinary and necessary expenses paid in connection with books, supplies, equipment (including computer equipment,
software, and services), and other materials used in the classroom. An ordinary expense is one that is common and accepted in your educational field.
A necessary expense is one that is helpful and appropriate for your profession as an educator. An expense does not have to be required to be
considered necessary.
Qualified expenses do not include expenses for home schooling
Home schooling:Expenses not deductible or for nonathletic supplies for courses in health or physical education.
You must reduce your qualified expenses by the following amounts.
Tax-free interest on U.S. series EE and I savings bonds (Form 8815). See Figuring the Tax-Free Amount in chapter 10 of
Publication 970.
Tax-free portion of a distribution from a qualified tuition program (QTP). See Figuring the Taxable Portion of a Distribution in
chapter 8 of Publication 970.
Tax-free portion of a distribution from a Coverdell education savings account (ESA). See Figuring the Taxable Portion of a
Distribution in chapter 7 of Publication 970.
Any reimbursements you received for these expenses that were not reported to you in box 1 of your Form W-2.
How the deduction is claimed.Form:1040:Educator expensesForm:1040A:Educator expenses
To claim the deduction, enter the allowable amount on line 23 of Form 1040, or line 16 of Form 1040A.
Generally, personal interest you pay, other than certain mortgage interest, is not deductible. However, if your modified adjusted gross income
(MAGI) is less than $65,000 ($135,000 if filing a joint return) you may be able to take a deduction for interest paid on a student loan (also known as
an education loan) used for higher education. For most taxpayers, MAGI is the adjusted gross income as figured on their federal income tax return
before subtracting any deduction for student loan interest. This deduction can reduce the amount of your income subject to tax by up to $2,500 in
2005. Table 19-1 summarizes the features of the student loan interest deduction.
Table 19-1.Student Loan Interest Deduction at a Glance
Do not rely on this table alone. Refer to the text for more details.
FeatureDescriptionMaximum benefitYou can decrease your income subject to tax by up to $2,500. Loan qualificationsYour student loan•
must have been taken out solely to pay qualified education expenses, and•cannot be from a related person or made under a qualified employer plan. Student qualificationsThe student must be•you, your spouse, or your dependent, and•enrolled at least half-time in a degree program. Time limit on deductionYou can deduct interest paid during the remaining period of your student loan. PhaseoutThe amount of your deduction depends on your income level.
Student loans:Interest deduction:Features of (Table 19-1)Tables and figures:Student loan interest deduction (Table 19-1)Student Loan Interest DefinedStudent loans:Interest, defined
Student loan interest is interest you paid during the year on a qualified student loan. It includes both required and voluntary interest payments.
This is a loan you took out solely to pay qualified education expenses (defined later) that were:
For you, your spouse, or a person who was your dependent (defined in chapter 3) when you took out the loan,
Paid or incurred within a reasonable period of time before or after you took out the loan, and
For education provided during an academic period for an eligible student.
Loans from the following sources are not qualified student loans.
A related person.
A qualified employer plan.
Exceptions.
For purposes of the student loan interest deduction, there are the following exceptions to the general rules for dependents.
You can have a dependent even if you are the dependent of another taxpayer.
An individual can be your dependent even if the individual made a joint return with a spouse.
An individual can be your dependent even if the individual had gross income for the year that was equal to or more than the exemption amount
for the year ($3,200 for 2005).
Reasonable period of time.
Qualified education expenses are treated as paid or incurred within a reasonable period of time before or after you take out the loan if they are
paid with the proceeds of student loans that are part of a federal postsecondary education loan program.
Even if not paid with the proceeds of that type of loan, the expenses are treated as paid or incurred within a reasonable period of time if both of
the following requirements are met.
The expenses relate to a specific academic period, and
The loan proceeds are disbursed within a period that begins 90 days before the start of that academic period and ends 90 days after the end
of that academic period.
If neither of the above situations applies, the reasonable period of time usually is determined based on all the relevant facts and circumstances.
Academic period.Student loans:Interest deductionAcademic period
An academic period includes a semester, trimester, quarter, or other period of study (such as a summer school session) as reasonably determined by
an educational institution. In the case of an educational institution that uses credit hours or clock hours and does not have academic terms, each
payment period can be treated as an academic period.
This is a student who was enrolled at least half-time in a program leading to a degree, certificate, or other recognized educational credential.
Enrolled at least half-time.
A student was enrolled at least half-time if the student was taking at least half the normal full-time work load for his or her course of study.
The standard for what is half of the normal full-time work load is determined by each eligible educational institution. However, the standard may
not be lower than any of those established by the Department of Education under the Higher Education Act of 1965.
Loan from a related person.
You cannot deduct interest on a loan you get from a related person. Related persons include:
Your spouse,
Your brothers and sisters,
Your half brothers and half sisters,
Your ancestors (parents, grandparents, etc.),
Your lineal descendants (children, grandchildren, etc.), and
Certain corporations, partnerships, trusts, and exempt organizations.
Loan from a qualified employer plan.
You cannot deduct interest on a loan made under a qualified employer plan or under a contract purchased under such a plan.
Generally, for purposes of the student loan interest deduction, these expenses are the total costs of attending an eligible educational
institution, including graduate school. They include amounts paid for the following items.
Tuition and fees.
Room and board.
Books, supplies, and equipment.
Other necessary expenses (such as transportation).
The cost of room and board qualifies only to the extent that it is not more than the greater of the following amounts.
The allowance for room and board, as determined by the eligible educational institution, that was included in the cost of attendance (for
federal financial aid purposes) for a particular academic period and living arrangement of the student.
The actual amount charged if the student is residing in housing owned or operated by the eligible educational institution.
An eligible educational institution is any college, university, vocational school, or other postsecondary educational institution eligible to
participate in a student aid program administered by the Department of Education. It includes virtually all accredited public, nonprofit, and
proprietary (privately owned profit-making) postsecondary institutions.
Certain educational institutions located outside the United States also participate in the U.S. Department of Education's Federal Student Aid (FSA)
programs.
For purposes of the student loan interest deduction, an eligible educational institution also includes an institution conducting an internship or
residency program leading to a degree or certificate from an institution of higher education, a hospital, or a health care facility that offers
postgraduate training.
An educational institution must meet the above criteria only during the academic period(s) for which the student loan was incurred. The
deductibility of interest on the loan is not affected by the institution's subsequent loss of eligibility.
The educational institution should be able to tell you if it is an eligible educational institution.
Adjustments to qualified education expenses.
You must reduce your qualified education expenses by certain tax-free items (such as the tax-free part of scholarships and fellowships). See
chapter 4 of Publication 970 for details.
Include As Interest
In addition to simple interest on the loan, certain loan origination fees, capitalized interest, interest on revolving lines of credit, and
interest on refinanced student loans can be student loan interest if all other requirements are met.
Loan origination fee.
This is a one-time fee charged by the lender for the use of money, which is treated as interest accrued over the life of the loan. This payment
cannot be for property or services provided by the lender, such as commitment fees or processing costs.
Capitalized interest.
This is unpaid interest on a student loan that is added by the lender to the outstanding principal balance of the loan.
Interest on revolving lines of credit.
This interest, which includes interest on credit card debt, is student loan interest if the borrower uses the line of credit (credit card) only to
pay qualified education expenses. See Qualified Education Expenses, earlier.
Interest on refinanced student loans.
This includes interest on both:
Consolidated loans—loans used to refinance more than one student loan of the same borrower, and
Collapsed loans—two or more loans of the same borrower that are treated by both the lender and the borrower as one loan.
If you refinance a qualified student loan for more than your original loan and you use the additional amount for any purpose other than qualified
education expenses, you cannot deduct any interest paid on the refinanced loan.
Voluntary interest payments.
These are payments made on a qualified student loan during a period when interest payments are not required, such as when the borrower has been
granted a deferment or the loan has not yet entered repayment status.
Do Not Include As Interest
You cannot claim a student loan interest deduction for:
Interest you paid on a loan if under the terms of the loan, you are not legally obligated to make interest payments.
Loan origination fees that are payments for property or services provided by the lender, such as commitment fees or processing
costs.
Interest you paid on a loan to the extent payments were made through your participation in the National Health Service Corps Loan Repayment
Program (the NHSC Loan Repayment Program) or certain other state loan repayment programs. This is effective beginning January 1, 2004. For more
information, see Student Loan Repayment Assistance in Publication 970. Student loan interest deduction:Loan repayment assistance
Can You Claim the DeductionStudent loans:Interest deduction:Claiming
Generally, you can claim the deduction if all three of the following requirements are met.
Your filing status is any filing status except married filing separately.
Married filing separately:Student loan interest deduction and
No one else is claiming an exemption for you on his or her tax return.
Student loans:Student claimed as exemption on tax return of another person
You paid interest on a qualified student loan.
Expenses paid by others.
If you are the person legally obligated to make interest payments and someone else makes a payment of interest on your behalf, you are treated as
receiving the payments from the other person and, in turn, paying the interest. See chapter 4 of Publication 970 for more information.
No Double Benefit AllowedStudent loans:Interest deduction:Double deduction not allowed
You cannot deduct as interest on a student loan any amount that is an allowable deduction under any other provision of the tax law (for example,
home mortgage interest).
Who Can Claim a Dependent's ExpensesStudent loans:Interest deduction:Expenses of dependent
You can deduct interest paid on a student loan for your dependent only if you:
Are legally obligated to make the interest payments,
Actually made the payments during the tax year, and
Claim an exemption for your dependent on your tax return.
How Much Can You DeductStudent loans:Interest deduction:Amount of deduction
Your student loan interest deduction for 2005 is generally the smaller of:
$2,500, or
The interest you paid in 2005.
The amount determined above is phased out (gradually reduced) if your MAGI is between $50,000 and $65,000 ($105,000 and $135,000 if you file a
joint return). You cannot take a student loan interest deduction if your MAGI is $65,000 or more ($135,000 or more if you file a joint return). For
details on figuring your MAGI, see chapter 4 of Publication 970.
How Do You Figure the DeductionWorksheets:Student loan interest deductionStudent loans:Interest deduction:WorksheetFiguring taxes and creditsWorksheets
Generally, you figure the deduction using the Student Loan Interest Deduction Worksheet in the Form 1040 or Form 1040A instructions. However, if
you are filing Form 2555, 2555-EZ, or 4563, or you are excluding income from sources within Puerto Rico, you must complete Worksheet 4-1 in chapter 4
of Publication 970.
To help you figure your student loan interest deduction, you should receive Form 1098-E,
Form:1098-EStudent Loan Interest Statement. Generally, an institution (such as a bank or governmental agency) that received
interest payments of $600 or more during 2005 on one or more qualified student loans must send Form 1098-E (or acceptable substitute) to each borrower
by January 31, 2006.
For qualified student loans taken out before September 1, 2004, the institution is required to include on Form 1098-E only payments of stated
interest. Other interest payments, such as certain loan origination fees and capitalized interest, may not appear on the form you receive. However, if
you pay qualifying interest that is not included on Form 1098-E, you can also deduct those amounts. For information on allocating payments between
interest and principal, see chapter 4 of Publication 970.
Student loans:Interest deduction:Claiming
Form:1040:Student loan interest deductionForm:1040A:Student loan interest deductionTo claim the deduction, enter the allowable amount on line 33 (Form 1040), or line 18
(Form 1040A).
Tuition and Fees DeductionMarried filing separately:Tuition deduction andDeductions:Tuition and feesTuitionEducation expenses:TuitionEducational assistance:TuitionGraduate schoolTuition deductionTuitionStudentsTuition deductionTuitionTuition:Deduction for
You may be able to deduct qualified education expenses paid during the year for yourself, your spouse, or a dependent. You cannot claim this
deduction if your filing status is married filing separately or if another person can claim an exemption for you as a dependent on his or her tax
return. The qualified expenses must be for higher education, as explained later under What Expenses Qualify.
The tuition and fees deduction can reduce the amount of your income subject to tax by up to $4,000.
Table 19-2 summarizes the features of the tuition and fees deduction.
You may be able to take a credit for your education expenses instead of a deduction. You can choose the one that will give you the lower tax. See
chapter 35 for details about the credits.
Can You Claim the Deduction
The following rules will help you determine if you can claim the tuition and fees deduction.
Who Can Claim the Deduction
Generally, you can claim the tuition and fees deduction if all three of the following requirements are met.
You paid qualified education expenses of higher education.
You paid the education expenses for an eligible student.
The eligible student is yourself, your spouse, or a dependent for whom you claim an exemption (defined in chapter 3) on your tax
return.
Qualified education expenses are defined under What Expenses Qualify. Eligible students are defined later under Who Is an Eligible
Student.
Who Cannot Claim the Deduction
You cannot claim the tuition and fees deduction if any of the following apply.
Your filing status is married filing separately.
Married filing separately:Tuition deduction and
Another person can claim an exemption for you as a dependent on his or her tax return. You cannot take the deduction even if the other
person does not actually claim that exemption.
Your modified adjusted gross income (MAGI) is more than $80,000 ($160,000 if filing a joint return).
You were a nonresident alien for any part of the year and did not elect to be treated as a resident alien for tax purposes. More information
on nonresident aliens can be found in Publication 519, U.S. Tax Guide for Aliens.
Nonresident aliens:Tuition deduction and
You or anyone else claims a Hope or lifetime learning credit in 2005 with respect to expenses of the student for whom the qualified
education expenses were paid.
Hope credit:Tuition deduction andLifetime learning credit:Tuition deduction and
Table 19-2.Tuition and Fees Deduction at a Glance
Do not rely on this table alone. Refer to the text for more details.
QuestionAnswerWhat is the maximum benefit?You can decrease your income subject to tax by up to $4,000. Where is the deduction taken?As an adjustment to income on Form 1040, line 34, or 1040A, line 16. For whom must the expenses be paid?A student enrolled in an eligible educational institution who is either:
• you,
• your spouse, or
• your dependent for whom you claim an exemption. What tuition and fees are deductible?Tuition and fees required for enrollment or attendance at an eligible postsecondary educational institution, but not including
personal, living, or family expenses, such as room and board.
Tables and figures:Tuition deduction (Table 19-2)TuitionWhat Expenses Qualify
The tuition and fees deduction is based on qualified education expenses you pay for yourself, your spouse, or a dependent for whom you claim an
exemption on your tax return. Generally, the deduction is allowed for qualified education expenses paid in 2005 in connection with enrollment at an
institution of higher education during 2005 or for an academic period (defined earlier under Student Loan Interest Deduction) beginning in
2005 or in the first 3 months of 2006.
Payments with borrowed funds.
You can claim a tuition and fees deduction for qualified education expenses paid with the proceeds of a loan. You use the expenses to figure the
deduction for the year in which the expenses are paid, not the year in which the loan is repaid. Treat loan payments sent directly to the educational
institution as paid on the date the institution credits the student's account.
Student withdraws from class(es).
You can claim a tuition and fees deduction for qualified education expenses not refunded when a student withdraws.
Qualified Education ExpensesTuition:Eligible educational institution, defined
For purposes of the tuition and fees deduction, qualified education expenses are tuition and certain related expenses required for enrollment or
attendance at an eligible educational institution.
Eligible educational institution.
An eligible educational institution is any college, university, vocational school, or other postsecondary educational institution eligible to
participate in a student aid program administered by the Department of Education. It includes virtually all accredited public, nonprofit, and
proprietary (privately owned profit-making) postsecondary institutions. The educational institution should be able to tell you if it is an eligible
educational institution.
Eligible educational institution:Foreign schoolsTuition and fees deductionForeign schools
Certain educational institutions located outside the United States also participate in the U.S. Department of Education's FSA programs.
Related expenses.Tuition:Related expenses, defined
Student-activity fees and expenses for course-related books, supplies, and equipment are included in qualified education expenses only if the fees
and expenses must be paid to the institution as a condition of enrollment or attendance.
No Double Benefit Allowed
You cannot do any of the following.
Deduct qualified education expenses you deduct under any other provision of the law, for example, as a business expense,
Deduct qualified education expenses for a student on your income tax return if you or anyone else claims a Hope or lifetime learning credit
for that same student in the same year,
Deduct qualified education expenses that have been used to figure the tax-free portion of a distribution from a Coverdell education savings
account (ESA) or a qualified tuition program (QTP). For a QTP, this applies only to the amount of tax-free earnings that were distributed, not to the
recovery of contributions to the program. See Figuring the Taxable Portion of a Distribution in chapter 7 (Coverdell ESA) and in chapter 8
(QTP) of Publication 970.
Deduct qualified education expenses that have been paid with tax-free interest on U.S. savings bonds (Form 8815). See Figuring the
Tax-Free Amount in chapter 10 of Publication 970.
Deduct qualified education expenses that have been paid with tax-free scholarship, grant, or employer-provided educational assistance. See
the following section on Adjustments to qualified education expenses.
Adjustments to qualified education expenses.
If you paid qualified education expenses with certain tax-free funds, you cannot claim a deduction for those amounts. You must reduce the qualified
education expenses by the amount of any tax-free educational assistance and refunds you received.
Tax-free educational assistance.
This includes:
Tax-free part of scholarships and fellowships (see chapter 1 of Publication 970),
Scholarships and fellowships:Tuition deduction, effect on
Pell grants (see chapter 1 of Publication 970),
Pell grants:Tuition deduction, effect on
Employer-provided educational assistance (see chapter 11 of Publication 970),
Educational assistance:Employer-provided:Tuition deduction, effect on
Veterans' educational assistance (see chapter 1 of Publication 970), and
Veterans' benefits:Educational assistance:Tuition deduction, effect on
Any other nontaxable (tax-free) payments (other than gifts or inheritances) received as educational assistance.
Refunds.Tuition:Deduction for:Refund of expensesRefund of expensesname of benefitRefunds:Tuition refundsTuition and fees deduction:Refund of expenses
Qualified education expenses do not include expenses for which you, or someone else who paid qualified education expenses on behalf of a student,
receive a refund. (For information on expenses paid by a dependent student or third party, see Who Can Claim a Dependent's Expenses,
later.)
If a refund of expenses paid in 2005 is received before you file your tax return for 2005, simply reduce the amount of the expenses paid by the
amount of the refund received. If the refund is received after you file your 2005 tax return, see When Must the Deduction Be Repaid
(Recaptured), in chapter 6 of Publication 970.
You are considered to receive a refund of expenses when an eligible educational institution refunds loan proceeds to the lender on behalf of the
borrower. Follow the above instructions according to when you are considered to receive the refund.
Amounts that do not reduce qualified education expenses.
Do not reduce qualified education expenses by amounts paid with funds the student receives as:
Payment for services, such as wages,
A loan,
A gift,
An inheritance, or
A withdrawal from the student's personal savings.
Do not reduce the qualified education expenses by any scholarship or fellowship reported as income on the student's tax return in the following
situations.
The use of the money is restricted to costs of attendance (such as room and board) other than qualified education expenses.
The use of the money is not restricted and is used to pay education expenses that are not qualified (such as room and board).
Expenses That Do Not QualifyTuition:Expenses that do not qualify
Qualified education expenses do not include amounts paid for:
Insurance,
Medical expenses (including student health fees),
Room and board,
Transportation, or
Similar personal, living, or family expenses.
This is true even if the amount must be paid to the institution as a condition of enrollment or attendance.
Sports, games, hobbies, and noncredit courses.
Qualified education expenses generally do not include expenses that relate to any course of instruction or other education that involves sports,
games or hobbies, or any noncredit course. However, if the course of instruction or other education is part of the student's degree program, these
expenses can qualify.
Comprehensive or bundled fees.Fees, comprehensive/ bundled
Some eligible educational institutions combine all of their fees for an academic period into one amount. If you do not receive, or do not have
access to, an allocation showing how much you paid for qualified education expenses and how much you paid for personal expenses, such as those listed
above, contact the institution. The institution is required to make this allocation and provide you with the amount you paid (or were billed) for
qualified education expenses on Form 1098-T, Tuition Statement. See How Do You Figure the Deduction, later, for more information about Form
1098-T.
Who Is an Eligible StudentEligible student:Tuition and fees deduction
For purposes of the tuition and fees deduction, an eligible student is a student who is enrolled in one or more courses at an eligible educational
institution. The student must have either a high school diploma or a General Educational Development (GED) credential.
Who Can Claim a Dependent's ExpensesDependents:Tuition deduction forTuition:Deduction for:Claiming for dependent
Generally, to claim the tuition and fees deduction for qualified education expenses for a dependent, you must:
Have paid the expenses, and
Claim an exemption for the student as a dependent.
Table 19-3 summarizes who can claim the deduction.
How Much Can You Deduct
The maximum tuition and fees deduction in 2005 is $4,000, $2,000, or $0, depending on the amount of your MAGI. For details on figuring your MAGI,
see chapter 6 of Publication 970.
How Do You Figure the DeductionFiguring taxes and creditsWorksheets
Generally, you figure the deduction using the Tuition and Fees Deduction Worksheet in the Form 1040 or Form 1040A instructions. However, if you are
filing Form 2555, Form 2555-EZ, or Form 4563, or if you exclude income from sources within Puerto Rico, you must complete the worksheet in chapter 6
of Publication 970.
To help you figure your tuition and fees deduction, you should receive Form 1098-T, Tuition Statement. Generally, an eligible educational
institution (such as a college or university) must send Form 1098-T (or acceptable substitute) to each enrolled student by January 31, 2006.
To claim the deduction, enter the allowable amount on Form 1040, line 34, or Form 1040A, line 19.
Table 19-3.Who Can Claim a Dependent's Expenses?
Do not rely on this table alone. See Who Can Claim a Dependent's Expenses in chapter 6 of Publication
970.
IF your dependent is an eligible student and you...AND...THEN...claim an exemption for your dependentyou paid all qualified education expenses for your dependentonly you can deduct the qualified education expenses that you paid. Your dependent cannot take a
deduction.claim an exemption for your dependentyour dependent paid all qualified education expensesno one is allowed to take a deduction.do not claim an exemption for your dependent, but are eligible toyou paid all qualified education expensesno one is allowed to take a deduction.do not claim an exemption for your dependent, but are eligible toyour dependent paid all qualified education expensesno one is allowed to take a deduction.are not eligible to claim an exemption for your dependentyou paid all qualified education expensesonly your dependent can deduct the amount you paid. The amount you paid is treated as a gift to your
dependent.are not eligible to claim an exemption for your dependentyour dependent paid all qualified education expensesonly your dependent can take a deduction.
Tables and figures:Tuition deduction (Table 19-2):Claiming dependent's expenses (Table 19-3)Standard Deduction and Itemized Deductions
After you have figured your adjusted gross income, you are ready to subtract the deductions used to figure taxable income. You can subtract either
the standard deduction or itemized deductions. Itemized deductions are deductions for certain expenses that are listed on Schedule A (Form 1040). The
ten chapters in this part discuss the standard deduction, each itemized deduction, and the limit on some of your itemized deductions if your adjusted
gross income exceeds certain amounts. See chapter 20 for the factors to consider when deciding whether to subtract the standard deduction or itemized
deductions.
Standard DeductionDeductions:Standard deductionStandard deductionDeductions:Standard deductionWhat's NewIncrease in standard deduction.Standard deduction:Increase in
The standard deduction for most taxpayers who do not itemize deductions on Schedule A of Form 1040 is higher in 2005 than it was in 2004. The
amount depends on your filing status. There are tables at the end of this chapter to help you figure your standard deduction for 2005.
This chapter discusses:
How to figure the amount of your standard deduction,
The standard deduction for dependents, and
Who should itemize deductions.
Most taxpayers have a choice of either taking a standard deduction or itemizing their deductions. The standard deduction is a dollar amount that
reduces the amount of income on which you are taxed.
The standard deduction is a benefit that eliminates the need for many taxpayers to itemize actual deductions, such as medical expenses, charitable
contributions, and taxes, on Schedule A of Form 1040. The standard deduction is higher for taxpayers who are 65 or older or blind. If you have a
choice, you should use the method that gives you the lower tax.
Blind persons:Standard deduction forDisabilities, persons withBlindBlind personsElderly persons:Standard deduction for age 65 or olderStandard deduction:Purpose ofStandard deduction:Defined
You benefit from the standard deduction if your standard deduction is more than the total of your allowable itemized deductions.
Persons not eligible for the standard deduction.Standard deduction:Not allowed in certain situations
Your standard deduction is zero and you should itemize any deductions you have if:
You are married and filing a separate return, and your spouse itemizes deductions,
Itemized deductions:Married filing separately:One spouse has itemizedMarried filing separately:Itemized deductions:One spouse has itemized so other must as wellStandard deduction:Married filing separately:One spouse has itemized
You are filing a tax return for a short tax year because of a change in your annual accounting period, or
Accounting periods:Change in, standard deduction not allowedShort tax year:Change in annual accounting period
You are a nonresident or dual-status alien during the year. You are considered a dual-status alien if you were both a nonresident and
resident alien during the year.Dual-status taxpayers:Standard deductionNonresident aliens:Standard deduction
Note. If you are a nonresident alien who is married to a U.S. citizen or resident at the end of the year, you can choose to be treated
as a U.S. resident. (See Publication 519, U.S. Tax Guide for Aliens.) If you make this choice, you can take the standard deduction.
Children:Standard deduction forIf an exemption for you can be claimed on another person's return (such as your parents' return),
your standard deduction may be limited. See Standard Deduction for Dependents, later.
Standard Deduction Amount
The standard deduction amount depends on your filing status, whether you are 65 or older or blind, and whether an exemption can be claimed for you
by another taxpayer. Generally, the standard deduction amounts are adjusted each year for inflation. The standard deduction amounts for most taxpayers
for 2005 are shown in Table 20-1.
Standard deduction:Amount
Decedent's final return.Decedents:Standard deductionFinal return for decedent:Standard deductionStandard deduction:Final return of decedent
The amount of the standard deduction for a decedent's final tax return is the same as it would have been had the decedent continued to live.
However, if the decedent was not 65 or older at the time of death, the higher standard deduction for age cannot be claimed.
Higher Standard Deduction
for Age (65 or Older)Age:Standard deduction for age 65 or olderElderly persons:Standard deduction for age 65 or olderStandard deduction:Age 65 or older
If you do not itemize deductions, you are entitled to a higher standard deduction if you are age 65 or older at the end of the year. You are
considered 65 on the day before your 65th birthday. Therefore, you can take a higher standard deduction for 2005 if you were born before January 2,
1941.
Use Table 20-2 to figure the standard deduction amount.
Higher Standard Deduction
for BlindnessBlind persons:Standard deduction forStandard deduction:Blind persons
If you are blind on the last day of the year and you do not itemize deductions, you are entitled to a higher standard deduction as shown in Table
20-2. You qualify for this benefit if you are totally or partly blind.
Partly blind.
If you are partly blind, you must get a certified statement from an eye doctor or registered optometrist that:
You cannot see better than 20/200 in the better eye with glasses or contact lenses, or
Your field of vision is not more than 20 degrees.
If your eye condition will never improve beyond these limits, the statement should include this fact. You must keep the statement in your records.
If your vision can be corrected beyond these limits only by contact lenses that you can wear only briefly because of pain, infection, or ulcers,
you can take the higher standard deduction for blindness if you otherwise qualify.
Spouse 65 or Older or BlindMarried taxpayers:Age 65 or older spouse:Standard deductionMarried taxpayers:Blind spouse:Standard deduction
You can take the higher standard deduction if your spouse is age 65 or older or blind and:
You file a joint return, or
You file a separate return and can claim an exemption for your spouse because your spouse had no gross income and an exemption for your
spouse could not be claimed by another taxpayer.
You cannot claim the higher standard deduction for an individual other than yourself and your spouse.
Examples
The following examples illustrate how to determine your standard deduction using Tables 20-1 and 20-2.
Example 1.
Larry, 46, and Donna, 33, are filing a joint return for 2005. Neither is blind. They decide not to itemize their deductions. They use Table 20-1.
Their standard deduction is $10,000.
Example 2.
Assume the same facts as in Example 1, except that Larry is blind at the end of 2005. Larry and Donna use Table 20-2. Their standard deduction is
$11,000.
Example 3.
Bill, 72, and Terry, 66, are filing a joint return for 2005. Neither is blind. They decide not to itemize their deductions. They use Table 20-2.
Their standard deduction is $12,000.
Standard Deduction
for DependentsChildren:Standard deduction forDependents:Standard deduction forStandard deduction:Dependents
The standard deduction for an individual for whom an exemption can be claimed on another person's tax return is generally limited to the greater
of:
$800, or
The individual's earned income for the year plus $250 (but not more than the regular standard deduction amount, generally $5,000).
However, if the individual is 65 or older or blind, the standard deduction may be higher.
If an exemption for you (or your spouse if you are filing jointly) can be claimed on someone else's return, use Table 20-3 to determine your
standard deduction.
Earned income defined.Earned income:Defined:For purposes of standard deduction
Earned income is salaries, wages, tips, professional fees, and other amounts received as pay for work you actually perform.
FellowshipsScholarships and fellowshipsScholarships and fellowships:Earned income includingFor purposes of the standard deduction, earned income also includes any part of a scholarship or
fellowship grant that you must include in your gross income. See Scholarship and Fellowship Grants in chapter 1 of Publication 970 for more
information on what qualifies as a scholarship or fellowship grant.
Example 1.
Michael is single. His parents claim an exemption for him on their 2005 tax return. He has interest income of $780 and wages of $150. He has no
itemized deductions. Michael uses Table 20-3 to find his standard deduction. He enters $150 (his earned income) on line 1, $400 ($150 plus $250) on
line 3, $800 (the larger of $400 and $800) on line 5, and $5,000 on line 6. The amount of his standard deduction, on line 7a, is $800 (the smaller of
$800 and $5,000).
Example 2.
Joe, a 22-year-old full-time college student, is claimed on his parents' 2005 tax return. Joe is married and files a separate return. His wife does
not itemize deductions on her separate return.
Joe has $1,500 in interest income and wages of $3,800. He has no itemized deductions. Joe finds his standard deduction by using Table 20-3. He
enters his earned income, $3,800, on line 1. He adds lines 1 and 2 and enters $4,050 on line 3. On line 5 he enters $4,050, the larger of lines 3 and
4. Since Joe is married filing a separate return, he enters $5,000 on line 6. On line 7a he enters $4,050 as his standard deduction because it is
smaller than $5,000, the amount on line 6.
Example 3.
Amy, who is single, is claimed on her parents' 2005 tax return. She is 18 years old and blind. She has interest income of $1,300 and wages of
$2,900. She has no itemized deductions. Amy uses Table 20-3 to find her standard deduction. She enters her wages of $2,900 on line 1. She adds lines 1
and 2 and enters $3,150 on line 3. On line 5 she enters $3,150, the larger of lines 3 and 4. Since she is single, Amy enters $5,000 on line 6. She
enters $3,150 on line 7a. This is the smaller of the amounts on lines 5 and 6. Because she checked one box in the top part of the worksheet, she
enters $1,250 on line 7b. She then adds the amounts on lines 7a and 7b and enters her standard deduction of $4,400 on line 7c.
Who Should ItemizeItemized deductions:Choosing to itemize
You should itemize deductions if your total deductions are more than the standard deduction amount. Also, you should itemize if you do not qualify
for the standard deduction, as discussed earlier under Persons not eligible for the standard deduction.
Itemized deductions:Standard deduction to be compared withStandard deduction:Comparison with itemized deduction amountYou should first figure your itemized deductions and compare that amount to your
standard deduction to make sure you are using the method that gives you the greater benefit.
You may be subject to a limit on some of your itemized deductions if your adjusted gross income (AGI) is more than $145,950 ($72,975 if you are
married filing separately). See chapter 29 and the instructions for Schedule A (Form 1040), line 28, for more information on figuring the correct
amount of your itemized deductions.
When to itemize.Itemized deductions:Choosing to itemize
You may benefit from itemizing your deductions on Schedule A (Form 1040) if you:
Do not qualify for the standard deduction, or the amount you can claim is limited,
Had large uninsured medical and dental expenses during the year,
Paid interest and taxes on your home,
Had large unreimbursed employee business expenses or other miscellaneous deductions,
Had large uninsured casualty or theft losses,
Made large contributions to qualified charities, or
Have total itemized deductions that are more than the standard deduction to which you otherwise are entitled.
These deductions are explained in chapters 21–28.
Form:1040, Schedule AItemized deduction limitIf you decide to itemize your deductions, complete Schedule A and attach it to your Form 1040.
Enter the amount from Schedule A, line 28, on Form 1040, line 40.
Electing to itemize for state tax or other purposes.Itemized deductions:State tax, forState or local income taxes:Itemized deductionsItemized deductions:IE written on Form 1040
Even if your itemized deductions are less than the amount of your standard deduction, you can elect to itemize deductions on your federal return
rather than take the standard deduction. You may want to do this, for example, if the tax benefit of being able to itemize your deductions on your
state tax return is greater than the tax benefit you lose on your federal return by not taking the standard deduction. To make this election, you must
check the box on line 29 of Schedule A.
Changing your mind.Itemized deductions:Changing from standard to itemized deduction (or vice versa)Standard deduction:Changing from itemized to standard deduction (or vice versa)Amended returns:Standard deduction, change to itemized deductionsAmended returns:Itemized deduction, change to standard deductionForm:1040X:Itemized deduction, change to standard deductionForm:1040X:Standard deduction, change to itemized deductionsTax returns:Amended
If you do not itemize your deductions and later find that you should have itemized — or if you itemize your deductions and later find you
should not have — you can change your return by filing Form 1040X, Amended U.S. Individual Income Tax Return. See Amended Returns and
Claims for Refund in chapter 1 for more information on amended returns.
Married persons who filed separate returns.Itemized deductions:Married filing separatelyMarried filing separately:Deductions:Changing method from or to itemized deductionsMarried filing separately:Itemized deductions
You can change methods of taking deductions only if you and your spouse both make the same changes. Both of you must file a consent to assessment
for any additional tax either one may owe as a result of the change.
Deductions:Standard deductionStandard deductionYou and your spouse can use the method that gives you the lower total tax, even though one of you may pay more
tax than you would have paid by using the other method. You both must use the same method of claiming deductions. If one itemizes deductions, the
other should itemize because he or she will not qualify for the standard deduction. See Persons not eligible for the standard deduction,
earlier.
2005 Standard Deduction Tables
If you are married filling a separate return and your spouse itemizes deductions, or if you are a dual-status alien, you cannot take the standard
deduction even if you were born before January 2, 1941, or you are blind.
<ROM>Table 20-1.</ROM>
<IMARK>Standard Deduction Chart
<L>for Most People*IF your filing status is...THEN your standard deduction is...Single or Married filing separately$ 5,000 Married filing jointly or Qualifying widow(er) with dependent child10,000 Head of household7,300
* Do not use this chart if you were born before January 2, 1941, or you are blind, or if someone else can claim an exemption
for you (or your spouse if married filing jointly). Use Table 20-2 or 20-3 instead.
<ROM>Table 20-2.</ROM>
<IMARK>Standard Deduction Chart for People
<L>Born Before January 2, 1941, or
<L>Who are Blind*Check the correct number of boxes below. Then go to the chart.YouBorn before January 2, 1941
Blind
Your spouse, if claiming spouse's exemptionBorn before January 2, 1941
Blind
Total number of boxes you checked
IF your
filing status is...AND the number in the box above is...THEN your standard deduction is...Single1$ 6,250 27,500 Married filing jointly or 111,000 Qualifying widow(er)212,000 with dependent child313,000 414,000 Married filing 16,000 separately27,000 38,000 49,000 Head of household18,550 29,800
* If someone can claim an exemption for you (or your spouse if married filing jointly), use Table 20-3,
instead.
<ROM>Table 20-3.</ROM>
<IMARK>Standard Deduction Worksheet
<L>for DependentsUse this worksheet only if someone else can claim an exemption for you (or your spouse if married filing jointly).If you were born before January 2, 1941, or you are blind, check the correct number of boxes below. Then go to the
worksheet.YouBorn before January 2, 1941
Blind
Your spouse, if claiming spouse's exemptionBorn before January 2, 1941
Blind
Total number of boxes you checked
1.Enter your earned income (defined below). If none, enter -0-.1.2.Additional amount2.$2503.Add lines 1 and 2.3.4.Minimum standard deduction.4.$8005.Enter the larger of line 3 or line 4.5.6.Enter the amount shown below for your filing status.• Single or Married filing separately— $5,0006.• Married filing jointly or Qualifying
widow(er) with dependent child—$10,000• Head of household—$7,3007.Standard deduction.a.Enter the smaller of line 5 or line 6. If born after January 1, 1941, and not blind, stop here. This is your standard deduction.
Otherwise, go on to line 7b.7a.b. If born before January 2, 1941, or blind, multiply $1,250 ($1,000 if married or qualifying widow(er) with dependent child) by the number in the
box above. 7b.c.Add lines 7a and 7b. This is your standard deduction for 2005.7c.
Earned income includes wages, salaries, tips, professional fees, and other compensation received for personal services you
performed. It also includes any amount received as a scholarship that you must include in your income.
Medical and Dental ExpensesMedical and dental expensesDeductions:Dental expensesMedical and dental expensesDeductions:Medical expensesMedical and dental expensesDental expensesMedical and dental expensesDoctors' billsMedical and dental expensesWhat's NewStandard mileage rate.Mileage ratesStandard mileage ratesStandard mileage rates:Medical reasons for use of carTravel and transportation expenses:Mileage ratesStandard mileage rates
The standard mileage rate allowed for out-of-pocket expenses for a car when you use it for medical reasons is:
15 cents a mile from January 1 to August 31, 2005, and
22 cents a mile from September 1 to December 31, 2005.
See Transportation under What Medical Expenses Are Includible.
Dependent.DependentDependent
Beginning in 2005, you will use new rules to determine if a person qualifies as your dependent. See Dependent under Whose Medical
Expenses Can You Include.
RemindersHealth coverage tax credit.Health insurance:Premiums:Credit for workers displaced by foreign trade or receiving pension from PBGCInsurance premiums:Health insurance:Credit for workers displaced by foreign trade or receiving pension from PBGC
There is a credit for health insurance premiums paid by certain workers who are displaced by foreign trade or who are receiving a pension from the
Pension Benefit Guaranty Corporation. For more information, see Health Coverage Tax Credit in chapter 37.
This chapter will help you determine:
What medical expenses are,
What expenses you can include this year,
How much of the expenses you can deduct,
Whose medical expenses you can include,
What medical expenses are includible,
How you treat reimbursements,
How to report the deduction on your tax return,
How to report impairment-related work expenses, and
How to report health insurance costs if you are self-employed.
Publications502Medical and Dental Expenses969Health Savings Accounts and Other Tax-Favored Health PlansForm (and Instructions)Itemized Deductions
What Are Medical Expenses?Medical and dental expenses:Medical care, definedMedical and dental expenses:Purpose of expenses
Medical expenses are the costs of diagnosis, cure, mitigation, treatment, or prevention of disease, and the costs for treatments affecting any part
or function of the body. They include the costs of equipment, supplies, and diagnostic devices needed for these purposes. They also include dental
expenses.
Medical care expenses must be primarily to alleviate or prevent a physical or mental defect or illness. Do not include expenses that are merely
beneficial to general health, such as vitamins or a vacation.
Medical expenses include the premiums you pay for insurance that covers the expenses of medical care, and the amounts you pay for transportation to
get medical care. Medical expenses also include amounts paid for qualified long-term care services and limited amounts paid for any qualified
long-term care insurance contract.
What Expenses Can You Include This Year?Medical and dental expenses:Determination of date paid
You can include only the medical and dental expenses you paid this year, regardless of when the services were provided. If you pay medical expenses
by check, the day you mail or deliver the check generally is the date of payment. If you use a pay-by-phone or online account to pay
your medical expenses, the date reported on the statement of the financial institution showing when payment was made is the date of payment. If you
use a credit card, include medical expenses you charge to your credit card in the year the charge is made, not when you actually pay the amount
charged.
Separate returns.Married filing separately:Medical and dental expensesMarried taxpayers:Medical and dental expenses
If you and your spouse live in a noncommunity property state and file separate returns, each of you can include only the medical expenses each
actually paid. Any medical expenses paid out of a joint checking account in which you and your spouse have the same interest are considered to have
been paid equally by each of you, unless you can show otherwise.
Community property states.Community property:Medical and dental expenses
If you and your spouse live in a community property state and file separate returns, any medical expenses paid out of community funds are divided
equally. Each of you should include half the expenses. If medical expenses are paid out of the separate funds of one spouse, only the spouse who paid
the medical expenses can include them. If you live in a community property state, are married, and file a separate return, see Publication 555,
Community Property.
How Much of the Expenses Can You Deduct?Medical and dental expenses:DeductionAdjusted gross income (AGI):Medical and dental expenses and limit of deductionAGIAdjusted gross income (AGI)Medical and dental expenses:Adjusted gross income and limit of deduction
You can deduct only the amount of your medical and dental expenses that is more than 7.5% of your adjusted gross income (Form 1040, line 38).
In this chapter, the term 7.5% limit is used to refer to 7.5% of your adjusted gross income. The phrase subject to the 7.5% limit is
also used. This phrase means that you must subtract 7.5% (.075) of your adjusted gross income from your medical expenses to figure your medical
expense deduction.
Example.
Your adjusted gross income is $40,000, 7.5% of which is $3,000. You paid medical expenses of $2,500. You cannot deduct any of your medical expenses
because they are not more than 7.5% of your adjusted gross income.
Whose Medical Expenses
Can You Include?Medical and dental expenses:Included expenses:Individuals covered
You can generally include medical expenses you pay for yourself as well as those you pay for someone who was your spouse or your dependent either
when the services were provided or when you paid for them. There are different rules for decedents and for individuals who are the subject of multiple
support agreements.
What if you are claimed as a dependent on some else's return?
Even if you, or your spouse if you are filing a joint return, are claimed as a dependent on someone else's tax return, you can include the medical
expenses of any person you could have claimed as a dependent if you, or your spouse if filing jointly, were not being claimed as a dependent on some
else's return.
Spouse
You can include medical expenses you paid for your spouse. To include these expenses, you must have been married either at the time your spouse
received the medical services or at the time you paid the medical expenses.
Example 1.
Mary received medical treatment before she married Bill. Bill paid for the treatment after they married. Bill can include these expenses in
figuring his medical expense deduction even if Bill and Mary file separate returns.
If Mary had paid the expenses, Bill could not include Mary's expenses in his separate return. Mary would include the amounts she paid during the
year in her separate return. If they filed a joint return, the medical expenses both paid during the year would be used to figure their medical
expense deduction.
Example 2.
This year, John paid medical expenses for his wife Louise, who died last year. John married Belle this year and they file a joint return. Because
John was married to Louise when she received the medical services, he can include those expenses in figuring his medical deduction for this year.
DependentDependents:Medical and dental expenses ofMedical and dental expenses:Dependent's expenses
You can include medical expenses you paid for your dependent. For you to include these expenses, the person must have been your dependent either at
the time the medical services were provided or at the time you paid the expenses. A person generally qualifies as your dependent for purposes of the
medical expense deduction if both of the following requirements are met.
The person was a qualifying child or a qualifying relative, and
The person was a U.S. citizen or national, or a resident of the United States, Canada, or Mexico. If your qualifying child was adopted, see
Exception for adopted child.
Exception for adopted child.Adoption:Exception for adopted childDependents
If you are a U.S. citizen or U.S. national and your adopted child lived with you as a member of your household for 2005, that child does not have
to be a U.S. citizen or national or a resident of the United States, Canada, or Mexico.
Qualifying ChildDependentsQualifying childQualifying relative
A qualifying child is a child who:
Is your son, daughter, stepchild, foster child, brother, sister, stepbrother, stepsister, or a descendant of any of them (for example, your
grandchild, niece, or nephew),
At the end of 2005 was:
Under age 19,
Under age 24 and a full-time student, or
Permanently and totally disabled,
Lived with you for more than half of 2005, and
Did not provide over half of his or her own support for 2005.
Adopted child.Adoption:Medical and dental expenses of adopted childMedical and dental expenses:Adopted child
A legally adopted child is treated as your own child. This includes a child lawfully placed with you for legal adoption.
You can include medical expenses that you paid for a child before adoption if the child qualified as your dependent when the medical services were
provided or when the expenses were paid.
If you pay back an adoption agency or other persons for medical expenses they paid under an agreement with you, you are treated as having paid
those expenses provided you clearly substantiate that the payment is directly attributable to the medical care of the child.
But if you pay the agency or other person for medical care that was provided and paid for before adoption negotiations began, you cannot include
them as medical expenses.
You may be able to take a credit or exclusion for other expenses related to adoption. See the Instructions for Form 8839, for more
information.
Child of divorced or separated parents.Divorced taxpayers:Medical and dental expenses of children ofSeparated taxpayers:Medical and dental expenses of children of
For purposes of the medical and dental expenses deduction, a child of divorced or separated parents can be treated as a dependent of both parents.
Each parent can include the medical expenses he or she pays for the child, even if the other parent claims the child's dependency exemption, if:
The child is in the custody of one or both parents for more than half the year,
The child receives over half of his or her support during the year from his or her parents, and
The child's parents:
Are divorced or legally separated under a decree of divorce or separate maintenance,
Are separated under a written separation agreement, or
Live apart at all times during the last 6 months of the year.
This does not apply if the child's exemption is being claimed under a multiple support agreement.
Qualifying Relative
A qualifying relative is a person:
Who is your:
Son, daughter, stepchild, foster child, or a descendant of any of them (for example, your grandchild),
Brother, sister, or a son or daughter of either of them,
Father, mother, or an ancestor or sibling of either of them (for example, your grandmother, grandfather, aunt, or uncle),
Stepbrother, stepsister, stepfather, stepmother, son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or
sister-in-law, or
Any other person (other than your spouse) who lived with you all year as a member of your household if your relationship does not violate
local law,
Who was not a qualifying child (see Qualifying Child earlier) of any other person for 2005, and
For whom you provided over half of the support in 2005. But see Children of divorced or separated parents, earlier and
Support claimed under a multiple support agreement, next.
Support claimed under a multiple support agreement.
If you are considered to have provided more than half of a qualifying relative's support under a multiple support agreement, you can include
medical expenses you pay for that relative. A multiple support agreement is used when two or more people provide more than half of a person's support,
but no one alone provides more than half.
For rules regarding what expenses you can include this year, see What Expenses Can You Include This Year, earlier.
Any medical expenses paid by others who joined you in the agreement cannot be included as medical expenses by anyone. However, you can include the
entire unreimbursed amount you paid for medical expenses.
Example.
You and your three brothers each provide one-fourth of your mother's total support. Under a multiple support agreement, you treat your mother as
your dependent. You paid all of her medical expenses. Your brothers reimbursed you for three-fourths of these expenses. In figuring your medical
expense deduction, you can include only one-fourth of your mother's medical expenses. Your brothers cannot include any part of the expenses. However,
if you and your brothers share the nonmedical support items and you separately pay all of your mother's medical expenses without receiving any
reimbursement, you can include the amount you paid for her medical expenses in your medical expenses.
DecedentDecedents:Medical and dental expensesFinal return for decedent:Medical expensesMedical and dental expenses:Decedent's expensesDecedents:Medical and dental expensesMedical and dental expenses:Decedent's expenses
Medical expenses paid before death by the decedent are included in figuring any deduction for medical and dental expenses on the decedent's final
income tax return. This includes expenses for the decedent's spouse and dependents as well as for the decedent.
The survivor or personal representative of a decedent can choose to treat certain expenses paid by the decedent's estate for the decedent's medical
care as paid by the decedent at the time the medical services were provided. The expenses must be paid within the 1-year period beginning with the day
after the date of death. If you are the survivor or personal representative making this choice, you must attach a statement to the decedent's Form
1040 (or the decedent's amended return, Form 1040X) saying that the expenses have not been and will not be claimed on the estate tax return.
Archer MSAs:Medical expenses paid for decedent fromMedical savings accounts (MSAs):Medicare Advantage MSA:Medical expenses paid for decedent from
Qualified medical expenses paid before death by the decedent are not deductible if paid with a tax-free distribution from any Archer MSA or health
savings account.
Amended returns and claims for refund are discussed in chapter 1.
What if you pay medical expenses of a deceased spouse or dependent?Dependents:Deceased dependent's medical and dental expensesMarried taxpayers:Medical and dental expenses:Deceased spouse's expenses
If you paid medical expenses for your deceased spouse or dependent, include them as medical expenses on your Form 1040 in the year paid, whether
they are paid before or after the decedent's death. The expenses can be included if the person was your spouse or dependent either at the time the
medical services were provided or at the time you paid the expenses.
What Medical Expenses Are Includible?Checklists:Medical and dental expense deductions (Table 21-1)Medical and dental expenses:Deduction:Checklist for deductible expenses (Table 21-1)Tables and figures:Medical and dental expenses:Checklist for deductible expense (Table 21-1)
Use Table 21-1 in this chapter as a guide to determine which medical and dental expenses you can include on Schedule A (Form 1040). See Publication
502 for information about other expenses you can include.
<BLD><ROM>Table 21-1.</ROM> Medical and Dental Expenses Checklist</BLD>You can include:You cannot include:
Bandages
Birth control pills prescribed by your doctor
Birth control pills
Capital expenses for equipment or improvements to your home needed for medical care (see Publication 502)
Home:Improvements:For medical care, deductibility
Certain fertility enhancement procedures (see Publication 502)
Fertility enhancement procedures:Deductibility as medical expense
Certain weight-loss expenses for obesity
Diagnostic devices
Expenses of an organ donor
Organ donors:Deductibility of medical expense
Eye surgery—to promote the correct function of the eye
Eye surgery:Deductibility as medical expense
Guide dogs or other animals aiding the blind, deaf, and disabled
Blind persons:Guide dogs, deductible as medical expenseDisabilities, persons with:BlindBlind personsDisabilities, persons with:Guide dogs, deductible as medical expenseGuide dogs:Deductibility as medical expense
Hospitals:Services fees, deductibility of medical expense
Lead-based paint removal (see Publication 502)
Lead-based paint removal:Deductibility as medical expense
Legal abortion
Abortion:Deductibility as medical expense
Legal operation to prevent having children such as a vasectomy or tubal ligation
Tubal ligation:Deductibility as medical expenseVasectomy:Deductibility as medical expense
Long-term care contracts, qualified (see Publication 502)
Deductions:Long-term care insurance contractsLong-term care insurance contracts:Deductibility of medical expense
Meals and lodging provided by a hospital during medical treatment
Hospitals:Meals and lodging provided for patients, deductibility
Medical and hospital insurance premiums
Health insurance:Premiums:Deductible as medical expenseInsurance premiums:Health insurance:Deductible as medical expenseMedical and dental expenses:Health insurance premiumsHealth insurance
Medical services fees (from doctors, dentists, surgeons, specialists, and other medical practitioners)
Doctors' billsMedical and dental expenses
Oxygen equipment and oxygen
Oxygen equipment and oxygen:Deductibility as medical expense
Part of life-care fee paid to retirement home designated for medical care
Life-care fees:Paid to retirement home and designated for medical care, deductibility
Prescription medicines (prescribed by a doctor) and insulin
Deductions:Prescription medicinesDrugs:As medical expenses:Prescription medicines, deductibilityInsulin:Deductibility as medical expenseMedications:Deductibility as medical expensePrescription medicines:Deductibility as medical expense
Psychiatric and psychological treatment
Psychiatric care:Specially equipped medical centers, deductibility of expense
Social Security tax, Medicare tax, FUTA, and state employment tax for worker providing medical care (see Wages for nursing
services, below)
Nursing care:Employment taxes for worker providing medical care, deductibility of
Dentures:Deductibility as medical expenseEyeglasses:As medical expenseGlasses:As medical expenseHearing aids:As medical expenseMedical devices:Deductibility ofProstheses:Deductibility of medical expenseWheelchairs:As medical expense
Special education for mentally or physically disabled persons (see Publication 502)
Disabilities, persons with:Special school or home for, deductibility of medical expense
Stop-smoking programs
Deductions:Stop-smoking programsSmoking cessation programs:Deductibility as medical expenseStop-smoking programs:Deductibility as medical expense
Transportation for needed medical care
Cars:Medical transportationTravel and transportation expenses:Medical purposes, for
Treatment at a drug or alcohol center (includes meals and lodging provided by the center)
Alcohol rehabilitation centers:Deductibility of medical expenseDrug or alcohol rehabilitation centers:Deductibility of medical expense
Wages for nursing services (see Publication 502)
Nursing care:Wages for, deductibility as medical expense
Baby sitting and childcare
Bottled water
Bottled water
Nutritional supplements:Not deductible as medical expenseVitamins:Not deductible as medical expense
Contributions to Archer MSAs (see Publication 969)
Archer MSAs:Not deductible as medical expense
Diaper service
Diaper service
Expenses for your general health (even if following your doctor's advice) such as—
—Health club dues
—Household help (even if recommended by a doctor)
—Social activities, such as dancing or swimming lessons
—Trip for general health improvement
Flexible spending account reimbursements for medical expenses (if contributions were on a pre-tax basis) (see Publication 502)
Flexible spending account or arrangement
Funeral, burial, or cremation expenses
Cremation:Not deductible as medical expenseFunerals:Expenses:Not deductible
Health savings account payments for medical expenses (see Publication 502)
Health savings account
Illegal operation or treatment
Life insurance or income protection policies, or policies providing payment for loss of life, limb, sight, etc.
Maternity clothes:Not deductible as medical expense
Medical insurance included in a car insurance policy covering all persons injured in or by your car
Auto insurance:Medical expenses covered by, not deductibleHealth insurance:Auto insurance policy covering, not deductible as medical expense
Medicine you buy without a prescription
Drugs:As medical expenses:Over-the-counter drugs, not deductibleOver-the-counter drugs:Not deductible as medical expense
Nursing care for a healthy baby
Child care:Nursing care for healthy baby, not deductible as medical expenseCosmetic surgery:Not deductible as medical expenseElective surgery:Not deductible as medical expenseNursing care:For healthy baby, not deductible as medical expensePlastic surgery:Not deductible as medical expense when cosmetic
Prescription drugs you brought in (or ordered shipped) from another country, in most cases (see Publication 502)
Nutritional supplements, vitamins, herbal supplements, natural medicines, etc., unless recommended by a medical practitioner as a
treatment for a specific medical condition diagnosed by a physician
Cosmetics:Not deductible as medical expense
Surgery for purely cosmetic reasons (see Publication 502)
Health insurance:Premiums:Deductible as medical expenseInsurance premiums:Health insurance:Deductible as medical expense
Toothpaste, toiletries, cosmetics, etc.
Teeth whitening
Weight-loss expenses not for the treatment of obesity or other disease
Insurance Premiums
You can include in medical expenses insurance premiums you pay for policies that cover medical care. Policies can provide payment for:
Hospitalization, surgical fees, X-rays, etc.,
Prescription drugs,
Replacement of lost or damaged contact lenses,
Membership in an association that gives cooperative or so-called free-choice medical service, or group hospitalization and clinical
care, or
Qualified long-term care insurance contracts (subject to additional limitations). See Qualified Long-term Care Insurance
Contracts in Publication 502.
If you have a policy that provides more than one kind of payment, you can include the premiums for the medical care part of the policy if the
charge for the medical part is reasonable. The cost of the medical part must be separately stated in the insurance contract or given to you in a
separate statement.
Note.
When figuring the amount of insurance premiums you can deduct on Schedule A, do not include any health coverage tax credit advance payments shown
in box 1 of Form 1099-H. Also, if you are claiming the health coverage tax credit, subtract the amount shown on line 4 of Form 8885 (reduced by any
advance payments shown on line 6 of that form) from the total insurance premiums you paid.
Employer-sponsored health insurance plan.
Do not include in your medical and dental expenses on Schedule A (Form 1040) any insurance premiums paid by an employer-sponsored health insurance
plan unless the premiums are included in box 1 of your Form W-2. Also, do not include on Schedule A (Form 1040) any other medical and dental expenses
paid by the plan unless the amount paid is included in box 1 of your Form W-2.
Example.
You are a federal employee participating in the premium conversion plan of the Federal Employee Health Benefits (FEHB) program. Your share of the
FEHB premium is paid by making a pre-tax reduction in your salary. Because you are an employee whose insurance premiums are paid with money that is
never included in your gross income, you cannot deduct the premiums paid with that money.
Long-term care services.Flexible spending account or arrangement
Contributions made by your employer to provide coverage for qualified long-term care services under a flexible spending or similar arrangement must
be included in your income. This amount will be reported as wages in box 1 of your Form W-2.
Health reimbursement arrangement (HRA).
If you have medical expenses that are reimbursed by a health reimbursement arrangement, you cannot include those expenses in your medical expenses.
This is because an HRA is funded solely by the employer.
Medicare A.Medicare:Medicare A, when deductible as medical expense
If you are covered under social security (or if you are a government employee who paid Medicare tax), you are enrolled in Medicare A. The payroll
tax paid for Medicare A is not a medical expense. If you are not covered under social security (or were not a government employee who paid Medicare
tax), you can voluntarily enroll in Medicare A. In this situation you can include the premiums paid for Medicare A as a medical expense.
Medicare B.Medicare:Medicare B, when deductible as medical expense
Medicare B is a supplemental medical insurance. Premiums you pay for Medicare B are a medical expense. If you applied for it at age 65 or after you
became disabled, you can include in medical expenses the monthly premiums you paid. Check the information you received from the Social Security
Administration to find out your premium.
Prepaid insurance premiums.Deductions:Prepaid insurance premiumsPrepayment:Insurance premiums:Deductibility as medical expense
Premiums you pay before you are age 65 for insurance for medical care for yourself, your spouse, or your dependents after you reach age 65 are
medical care expenses in the year paid if they are:
Payable in equal yearly installments, or more often, and
Payable for at least 10 years, or until you reach age 65 (but not for less than 5 years).
Unused sick leave used to pay premiums.Sick leave:Cash payments for unused leaveUnused sick leave:Cash payments for
You must include in gross income cash payments you receive at the time of retirement for unused sick leave. You also must include in gross income
the value of unused sick leave that, at your option, your employer applies to the cost of your continuing participation in your employer's health plan
after you retire. You can include this cost of continuing participation in the health plan as a medical expense.
If you participate in a health plan where your employer automatically applies the value of unused sick leave to the cost of your continuing
participation in the health plan (and you do not have the option to receive cash), do not include the value of the unused sick leave in gross income.
You cannot include this cost of continuing participation in that health plan as a medical expense.
Meals and LodgingMedical and dental expenses:Meals and lodging related to receiving medical care
You can include in medical expenses the cost of meals and lodging at a hospital or similar institution if a principal reason for being there is to
get medical care. See Nursing home, later.
You may be able to include in medical expenses the cost of lodging not provided in a hospital or similar institution. You can include the cost of
such lodging while away from home if all of the following requirements are met.
The lodging is primarily for and essential to medical care.
The medical care is provided by a doctor in a licensed hospital or in a medical care facility related to, or the equivalent of, a licensed
hospital.
The lodging is not lavish or extravagant under the circumstances.
There is no significant element of personal pleasure, recreation, or vacation in the travel away from home.
The amount you include in medical expenses for lodging cannot be more than $50 for each night for each person. You can include lodging for a
person traveling with the person receiving the medical care. For example, if a parent is traveling with a sick child, up to $100 per night can be
included as a medical expense for lodging. Meals are not included.
Nursing home.Nursing homes:Meals and lodging, deductible as medical expense
You can include in medical expenses the cost of medical care in a nursing home, home for the aged, or similar institution, for yourself, your
spouse, or your dependents. This includes the cost of meals and lodging in the home if a principal reason for being there is to get medical care.
Do not include the cost of meals and lodging if the reason for being in the home is personal. You can, however, include in medical expenses the
part of the cost that is for medical or nursing care.
TransportationCars:Medical transportationTravel and transportation expenses:Medical purposes, for
You can include in medical expenses amounts paid for transportation primarily for, and essential to, medical care.
You can include:
Bus, taxi, train, or plane fares, or ambulance service,
Transportation expenses of a parent who must go with a child who needs medical care,
Transportation expenses of a nurse or other person who can give injections, medications, or other treatment required by a patient who is
traveling to get medical care and is unable to travel alone, and
Transportation expenses for regular visits to see a mentally ill dependent, if these visits are recommended as a part of treatment.
Car expenses.Cars:Medical transportationTravel and transportation expenses:Medical purposes, for
You can include out-of-pocket expenses, such as the cost of gas and oil, when you use your car for medical reasons. You cannot include
depreciation, insurance, general repair, or maintenance expenses.
Mileage ratesStandard mileage ratesStandard mileage rates:Medical reasons for use of carTravel and transportation expenses:Mileage ratesStandard mileage rates
If you do not want to use your actual expenses, for 2005 you can use a standard rate of 15 cents a mile for use of a car for medical reasons before
September 1, 2005. The standard mileage rate allowed for use of a car when you use it for medical reasons after August 31, 2005, is 22 cents a mile.
Parking fees:Medical-related travelTravel and transportation expenses:Parking fees:Medical-related travelYou can also include parking fees and tolls. You can add these fees and tolls to your medical
expenses whether you use actual expenses or use the standard mileage rate.
Example.
Bill Jones drove 2,800 miles for medical reasons during the year (2,200 miles from January 1 through August 31 and 600 miles from September 1
through December 31). He spent $250 for gas, $5 for oil, and $50 for tolls and parking. He wants to figure the amount he can include in medical
expenses both ways to see which gives him the greater deduction.
He figures the actual expenses first. He adds the $250 for gas, the $5 for oil, and the $50 for tolls and parking for a total of $305.
He then figures the standard mileage amount. He multiplies the 2,200 miles by 15 cents a mile for a total of $330 and the 600 miles by 22 cents a
mile for a total of $132. His standard mileage amount is $462 ($330 + $132). He then adds the $50 tolls and parking for a total of $512.
Bill includes the $512 of car expenses with his other medical expenses for the year because the $512 is more than the $305 he figured using actual
expenses.
Transportation expenses you cannot include.
You cannot include in medical expenses the cost of transportation expenses in the following situations.
Going to and from work, even if your condition requires an unusual means of transportation.
Travel for purely personal reasons to another city for an operation or other medical care.
Travel that is merely for the general improvement of one's health.
Disabled Dependent
Care ExpensesDependents:Disabled dependent care expenses, deduction forDisabilities, persons with:Dependent who is disabled, deduction for care expenses
Some disabled dependent care expenses may qualify as either:
Medical expenses or
Work-related expenses for purposes of taking a credit for dependent care. (See chapter 32.)
You can choose to apply them either way as long as you do not use the same expenses to claim both a credit and a medical expense deduction.
How Do You Treat Reimbursements?Medical and dental expenses:Reimbursements, treatment ofReimbursement:Medical and dental expenses
You can include in medical expenses only those amounts paid during the taxable year for which you received no insurance or other reimbursement.
You must reduce your total medical expenses for the year by all reimbursements for medical expenses that you receive from insurance or other
sources during the year. This includes payments from Medicare.
Even if a policy provides reimbursement for only certain specific medical expenses, you must use amounts you receive from that policy to reduce
your total medical expenses, including those it does not provide reimbursement for.
Example.
You have insurance policies which cover your hospital and doctors' bills but not your nursing bills. The insurance you receive for the hospital and
doctors' bills is more than their charges. In figuring your medical deduction, you must reduce the total amount you spent for medical care by the
total amount of insurance you received even if the policies do not cover some of your medical expenses.
Health reimbursement arrangement (HRA).
A health reimbursement arrangement is an employer-funded plan that reimburses employees for medical care expenses and allows unused amounts to be
carried forward. An HRA is funded solely by the employer and the reimbursements for medical expenses, up to a maximum dollar amount for a coverage
period, are not included in your income.
Other reimbursements.
Generally, you do not reduce medical expenses by payments you receive for:
Permanent loss or loss of use of a member or function of the body (loss of limb, sight, hearing, etc.) or disfigurement to the extent the
payment is based on the nature of the injury without regard to the amount of time lost from work, or
Loss of earnings.
You must, however, reduce your medical expenses by any part of these payments that is designated for medical costs. See How Do You Figure and
Report the Deduction on Your Tax Return, later.
For how to treat damages received for personal injury or sickness, see Damages for Personal Injuries, later.
You do not have a medical deduction if you are reimbursed for all of your medical expenses for the year.
Excess reimbursement.Excess reimbursements:Medical expensesIncome:Excess reimbursement of medical expenses
If you are reimbursed more than your medical expenses, you may have to include the excess in income. You may want to use Figure 21-A to help you
decide if any of your reimbursement is taxable.
Premiums paid by you.
If you pay the entire premium for your medical insurance or all of the costs of a plan similar to medical insurance, you generally do not include
an excess reimbursement in your gross income.
Premiums paid by you and your employer.
If both you and your employer contribute to your medical insurance plan and your employer's contributions are not included in your gross income,
you must include in your gross income the part of your excess reimbursement that is from your employer's contribution.
See Publication 502 to figure the amount of the excess reimbursement you must include in gross income.
Reimbursement in a later year.Reimbursement:Health insurance, reimbursement in later year
If you are reimbursed in a later year for medical expenses you deducted in an earlier year, you must report the reimbursement as income up to the
amount you previously deducted as medical expenses.
However, do not report as income the reimbursement you received up to the amount of your medical deductions that did not reduce your tax for the
earlier year. For more information about the recovery of an amount that you claimed as an itemized deduction in an earlier year, see Itemized
Deduction Recoveries in chapter 12.
Figure 21-A. Is Your Excess Medical Reimbursement Taxable?Summary: This flowchart is used to determine if your excess medical reimbursement is taxable.StartThis is the starting of the flowchart.Decision (1)Was any part of your premiums paid by your employer?IF Yes Continue To Decision (2)IF No Continue To Process (a)Decision (2)Were your employer's contributions to your premiums included in your income?IF Yes Continue To Process (a)IF No Continue To Decision (3)Decision (3)Did you pay any part of the premiums?IF Yes Continue To Process (c)IF No Continue To Process (b)Process (a)NONE of the excess reimbursement is taxable.Continue To End Process (b)ALL of the excess reimbursement is taxable.Continue To End Process (c)PART of the excess reimbursement is taxable.Footnote: See Premiums paid by you and your employer in this chapter.Continue To End EndThis is the ending of the flowchart.Excess reimbursements:Medical expenses:Excess reimbursement flowchart (Figure 21-A)Reimbursement:Medical and dental expenses:Excess reimbursement flowchart (Figure 21-A)Tables and figures:Medical and dental expenses:Reimbursement, excess algorithm (Figure 21-A)
Medical expenses not deducted.
If you did not deduct a medical expense in the year you paid it because your medical expenses were not more than 7.5% of your adjusted gross
income, or because you did not itemize deductions, do not include the reimbursement up to the amount of the expense in income. However, if the
reimbursement is more than the expense, see Excess reimbursement, earlier.
Example.
Last year, you had medical expenses of $500. You cannot deduct the $500 because it is less than 7.5% of your adjusted gross income. If, in a later
year, you are reimbursed for any of the $500 in medical expenses, you do not include that amount in your gross income.
Damages for Personal InjuriesDamages from lawsuits:Medical expenses as part of settlementMedical and dental expenses:Damages including
If you receive an amount in settlement of a personal injury suit, part of that award may be for medical expenses that you deducted in an earlier
year. If it is, you must include that part in your income in the year you receive it to the extent it reduced your taxable income in the earlier year.
See Reimbursement in a Later Year, discussed earlier.
Future medical expenses.Medical and dental expenses:Future expenses, settlement including
If you receive an amount in settlement of a damage suit for personal injuries, part of that award may be for future medical expenses. If it is, you
must reduce any future medical expenses for these injuries until the amount you received has been completely used.
How Do You Figure and Report the Deduction on Your
Tax Return?
Once you have determined which medical care expenses you can include, you figure and report the deduction on your tax return.
What Tax Form Do You Use?Medical and dental expenses:Form 1040, Schedule A, for reporting
Form:1040, Schedule AMedical and dental expensesYou figure your medical expense deduction on lines 1–4 of Schedule A, Form 1040. You
cannot claim medical expenses on Form 1040A or Form 1040EZ. If you need more information on itemized deductions or you are not sure if you can
itemize, see chapters 20 and 29.
Enter the amount you paid for medical and dental expenses on line 1, Schedule A (Form 1040). This should be your expenses that were not reimbursed
by insurance or any other sources.
Adjusted gross income (AGI):Medical and dental expenses and limit of deductionYou can deduct only the amount of your medical and dental expenses that
is more than 7.5% of your adjusted gross income shown on line 38, Form 1040. For an example, see the partial Schedule A, in this chapter.
SCHEDULES A&B (Form 1040) 2005 Schedule A--Itemized DeductionsSummary: This is a portion of Schedule A (Form 1040) with the following line items included:Name(s) shown on Form 1040 field contains Bill and Helen JonesYour social security number field contains 000-00-0000Under the Medical and Dental Expenses Section:1. Medical and dental expenses (see page A-2) field contains 3,4342. Enter amount from Form 1040, line 38 field contains 33,0003. Multiply line 2 by 7.5% (.075) field contains 2,4754. Subtract line 3 from line 1. If line 3 is more than line 1, enter 0 field contains
959
Impairment-Related
Work Expenses
(Business or Medical)Deductions:Impairment-related work expensesDisabilities, persons with:Impairment-related work expenses ofEmployee business expenses:Impairment-related work expenses, deduction forImpairmentDisabilities, persons with
If you are disabled, you can take a business deduction for expenses that are necessary for you to be able to work. If you take a business deduction
for these impairment-related work expenses, they are not subject to the 7.5% limit that applies to medical expenses.
You are disabled if you have:
A physical or mental disability (for example, blindness or deafness) that functionally limits your being employed, or
Blind persons:Impairment-related work expenses, deduction for
A physical or mental impairment (for example, a sight or hearing impairment) that substantially limits one or more of your major life
activities, such as performing manual tasks, walking, speaking, breathing, learning, or working.
Impairment-related expenses defined.
Impairment-related expenses are those ordinary and necessary business expenses that are:
Necessary for you to do your work satisfactorily,
For goods and services not required or used, other than incidentally, in your personal activities, and
Not specifically covered under other income tax laws.
Where to report.
If you are self-employed, deduct the business expenses on the appropriate form (Schedule C, C-EZ, E, or F) used to report your business income and
expenses.
If you are an employee, complete Form 2106, Employee Business Expenses, or Form 2106-EZ, Unreimbursed Employee Business Expenses. Enter on line 27,
Schedule A (Form 1040) that part of the amount on line 10 of Form 2106, or line 6 of Form 2106-EZ, that is related to your impairment. Enter the
amount that is unrelated to your impairment on line 20, Schedule A (Form 1040). Your impairment-related work expenses are not subject to the
2%-of-adjusted-gross-income limit that applies to other employee business expenses.
Example.
You are blind. You must use a reader to do your work. You use the reader both during your regular working hours at your place of work and outside
your regular working hours away from your place of work. The reader's services are only for your work. You can deduct your expenses for the reader as
business expenses.
Health Insurance Costs for Self-Employed
PersonsDeductions:Self-employed persons:Health insurance premiumsHealth insurance:Premiums:Self-employed persons, deductible expensesInsurance premiums:Health insurance:Self-employed persons, deductibleSelf-employed persons:Health insurance costs, deductible as medical expense
If you were self-employed and had a net profit for the year, were a general partner (or a limited partner receiving guaranteed payments), or
received wages from an S corporation in which you were a more than 2% shareholder (who is treated as a partner), you may be able to deduct, as an
adjustment to income, all of the amount paid for medical and qualified long-term care insurance on behalf of yourself, your spouse, and dependents.
The insurance plan must be established under your trade or business, and you cannot take this deduction to the extent that the amount of the
deduction is more than your earned income from that trade or business.
You cannot take this deduction for any month in which you were eligible to participate in any subsidized health plan maintained by your employer or
your spouse's employer. This rule is applied separately to plans that provide long-term care insurance and plans that do not provide long-term care
insurance.
If you qualify to take the deduction, use the Self-Employed Health Insurance Deduction Worksheet in the Form 1040 instructions to figure the amount
you can deduct. But if any of the following applies, do not use the worksheet.
You had more than one source of income subject to self-employment tax.
You file Form 2555, Foreign Earned Income, or Form 2555-EZ, Foreign Earned Income Exclusion.
You are using amounts paid for qualified long-term care insurance to figure the deduction.
If you cannot use the worksheet in the Form 1040 instructions, use the worksheet in Publication 535, Business Expenses, to figure your
deduction.
Note.
When figuring the amount you may deduct for insurance premiums, do not include any advance payments shown in box 1 of Form 1099-H, Health Coverage
Tax Credit (HCTC) Advance Payments. Also, if you are claiming the health coverage tax credit, subtract the amount shown on line 4 of Form 8885
(reduced by any advance payments shown on line 6 of that form) from the total insurance premiums you paid.
Where to report.
Medical and dental expensesYou take this deduction on Form 1040, line 29. If you itemize your deductions and do not
claim 100% of your self-employed health insurance on line 29, include any remaining premiums with all other medical care expenses on Schedule A (Form
1040), subject to the 7.5% limit. See chapter 7 of Publication 535, Business Expenses, for more information.
TaxesTaxesTaxesReminderLimit on itemized deductions.
If your adjusted gross income is more than $145,950 ($72,975 if you are married filing separately), the overall amount of your itemized deductions
may be limited. See chapter 29 for more information about this limit.
This chapter discusses which taxes you can deduct if you itemize deductions on Schedule A (Form 1040). It also explains which taxes you can deduct
on other schedules or forms and which taxes you cannot deduct.
This chapter covers:
Income taxes (state, local, and foreign),
General sales taxes (state and local),
Real estate taxes (state, local, and foreign),
Personal property taxes (state and local), and
Taxes and fees you cannot deduct.
Use Table 22-1 as a guide to determine which taxes you can deduct.
At the end of the chapter is a section that explains which form you use to deduct the different types of taxes.
Business taxes.Taxes:Business taxes, deduction of
You can deduct certain taxes only if they are ordinary and necessary expenses of your trade or business or of producing income. For information on
these taxes, see Publication 535, Business Expenses.
State or local taxes.Income taxesState or localState or local income taxesState or local income taxes:Deduction of
These are taxes imposed by the 50 states, U.S. possessions, or any of their political subdivisions (such as a county or city), or by the District
of Columbia.
Indian tribal government.Indians:Taxes collected by tribal governments, deduction ofTaxes:Indian tribal government taxes, deduction of
An Indian tribal government that is recognized by the Secretary of the Treasury as performing substantial government functions will be treated as a
state for this purpose. Income taxes, real estate taxes, and personal property taxes imposed by that Indian tribal government (or by any of its
subdivisions that are treated as political subdivisions of a state) are deductible.
Foreign taxes.Foreign income taxes:Definition ofIncome taxesForeignForeign income taxesTaxes:Foreign taxes
These are taxes imposed by a foreign country or any of its political subdivisions.
Publication514 Foreign Tax Credit for Individuals 530 Tax Information for First-Time HomeownersForm (and Instructions)Itemized Deductions Supplemental Income and Loss Foreign Tax Credit
Tests To Deduct
Any TaxTaxes:Deduction of
The following two tests must be met for any tax to be deductible by you.
The tax must be imposed on you.
The tax must be paid during your tax year.
The tax must be imposed on you.
Generally, you can deduct only taxes that are imposed on you.
Generally, you can deduct property taxes only if you are the property owner. If your spouse owns property and pays real estate taxes on it, the
taxes are deductible on your spouse's separate return or on your joint return.
The tax must be paid during your tax year.Cash method taxpayers:Taxes paid during tax year, deduction of
If you are a cash basis taxpayer, you can deduct only those taxes actually paid during your tax year. If you pay your taxes by check, the day you
mail or deliver the check is the date of payment, provided the check is honored by the financial institution. If you use a pay-by-phone account, the
date reported on the statement of the financial institution showing when payment was made is the date of payment. If you contest a tax liability and
are a cash basis taxpayer, you can deduct the tax only in the year it is actually paid.
Accrual method taxpayers:Taxes paid during tax year, deduction ofIf you use an accrual method of accounting, see Publication 538, Accounting Periods
and Methods, for more information.
Income TaxesTaxes:Income taxes, deduction of
This section discusses the deductibility of state and local income taxes (including employee contributions to state benefit funds) and foreign
income taxes.
State and Local Income TaxesIncome taxesState or localState or local income taxesState or local income taxes:Deduction of
You can deduct state and local income taxes. You can elect to deduct state and local general sales taxes instead of state and local income taxes.
Exception.State or local income taxes:Exception to deduction
You cannot deduct state and local income taxes you pay on income that is exempt from federal income tax, unless the exempt income is interest
income. For example, you cannot deduct the part of a state's income tax that is on a cost-of-living allowance that is exempt from federal income tax.
What To Deduct
Your deduction may be for withheld taxes, estimated tax payments, or other tax payments as follows.
Withheld taxes.State or local income taxes:Form W-2 to show withheld taxesForm W-2G:Withheld state and local taxes shown onForm W-2:Withheld state and local taxesForm 1099-R:Withheld state and local taxes shown onForm 1099-MISC:Withheld state and local taxesWithholding:State and local income taxes, deduction for
You can deduct state and local income taxes withheld from your salary in the year they are withheld. For 2005, these taxes will be shown in boxes
17 and 19 of your Form W-2. You may also have state or local income tax withheld on Form W-2G (box 14), Form 1099-MISC (box 16), or Form 1099-R (boxes
10 and 13).
Estimated tax payments.Estimated tax:State and local income taxes, deduction of
You can deduct estimated tax payments you made during the year to a state or local government. However, you must have a reasonable basis for making
the estimated tax payments. Any estimated state or local tax payments you make that are not reasonably determined in good faith at the time of payment
are not deductible. For example, you made an estimated state income tax payment. However, the estimate of your state tax liability shows that you will
get a refund of the full amount of your estimated payment. You had no reasonable basis to believe you had any additional liability for state income
taxes and you cannot deduct the estimated tax payment.
Refund applied to taxes.State or local income taxes:Refunds, treatment ofTax refunds:State and local income tax refunds
You can deduct any part of a refund of prior-year state or local income taxes that you chose to have credited to your 2005 estimated state or local
income taxes.
Do not reduce your deduction by either of the following items.
Any state or local income tax refund (or credit) you expect to receive for 2005.
Any refund of (or credit for) prior year state and local income taxes you actually received in 2005.
However, part or all of this refund (or credit) may be taxable. See Refund (or credit) of state or local income taxes, later.
Separate federal returns.Married filing separately:State and local income taxesState or local income taxes:Married filing separately
If you and your spouse file separate state, local, and federal income tax returns, you each can deduct on your federal return only the amount of
your own state and local income tax.
Joint state and local returns.Married filing separately:Joint state and local income taxes filed, but separate federal returnsState or local income taxes:Joint state and local returns but federal returns filed separately
If you and your spouse file joint state and local returns and separate federal returns, each of you can deduct on your separate federal return part
of the state and local income taxes. You can deduct only the amount of the total taxes that is proportionate to your gross income compared to the
combined gross income of you and your spouse. However, you cannot deduct more than the amount you actually paid during the year. You can avoid this
calculation if you and your spouse are jointly and individually liable for the full amount of the state and local income taxes. If so, you and your
spouse can deduct on your separate federal returns the amount you each actually paid.
Joint federal return.Joint returns:State and local income taxes, deduction of
If you file a joint federal return, you can deduct the total of the state and local income taxes both of you paid.
Contributions to state benefit funds.Unemployment compensation:Mandatory contributions to state funds, deduction ofWorkers' compensation:Mandatory contributions to state funds, deduction of
Form 1040:Schedule A:State benefit funds, mandatory contributions toAs an employee, you can deduct mandatory contributions to state benefit
funds that provide protection against loss of wages. Mandatory payments made to the following state benefit funds are deductible as state income taxes
on Schedule A (Form 1040), line 5.
California Nonoccupational Disability Benefit Fund.
California Nonoccupational Disability Benefit Fund
New Jersey Nonoccupational Disability Benefit Fund.
New Jersey Nonoccupational Disability Benefit Fund
New Jersey Unemployment Compensation Fund.
New Jersey Unemployment Compensation Fund
New York Nonoccupational Disability Benefit Fund.
New York Nonoccupational Disability Benefit Fund
Rhode Island Temporary Disability Benefit Fund.
Rhode Island Temporary Disability Benefit Fund
Washington State Supplemental Worker's Compensation Fund.
Washington State Supplemental Workmen's Compensation Fund
West Virginia Unemployment Compensation Fund.
West Virginia Unemployment Compensation Fund
Employee contributions to private or voluntary disability plans are not deductible.
Refund (or credit) of state or local income taxes.State or local income taxes:Refunds, treatment ofTax refunds:State and local income tax refunds
If you receive a refund of (or credit for) state or local income taxes in a year after the year in which you paid them, you may have to include the
refund in income on Form 1040, line 10, in the year you receive it. This includes refunds resulting from taxes that were overwithheld, applied from a
prior year return, not figured correctly, or figured again because of an amended return. If you did not itemize your deductions in the previous year,
do not include the refund in income. If you deducted the taxes in the previous year, include all or part of the refund on Form 1040, line 10, in the
year you receive the refund. For a discussion of how much to include, see Recoveries in chapter 12.
Foreign Income TaxesForeign income taxes:Deduction ofIncome taxesForeignForeign income taxesTaxes:Foreign taxes:Income tax. deduction ofU.S. possessions:Deduction of income tax paid to
Generally, you can take either a deduction or a credit for income taxes imposed on you by a foreign country or a U.S. possession. However, you
cannot take a deduction or credit for foreign income taxes paid on income that is exempt from U.S. tax under the foreign earned income exclusion or
the foreign housing exclusion. For information on these exclusions, see Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad. For
information on the foreign tax credit, see Publication 514.
General Sales TaxesGeneral sales taxes:Taxes:General sales taxesGeneral sales taxes
You can elect to deduct state and local general sales taxes, instead of state and local income taxes, as an itemized deduction on Schedule A (Form
1040), line 5. Generally, you can use either your actual expenses or the state and local sales tax tables to figure your state and local general sales
tax deduction. See the Instructions for Schedule A (Form 1040), line 5, for details.
Real Estate TaxesReal estate taxes:deduction ofTaxes:Real estate taxesReal estate taxes
Deductible real estate taxes are any state, local, or foreign taxes on real property levied for the general public welfare. You can deduct these
taxes only if they are based on the assessed value of the real property and charged uniformly against all property under the jurisdiction of the
taxing authority.
Deductible real estate taxes generally do not include taxes charged for local benefits and improvements that increase the value of the property.
They also do not include itemized charges for services (such as trash collection) to specific property or people, even if the charge is paid to the
taxing authority. For more information about taxes and charges that are not deductible, see Real Estate-Related Items You Cannot Deduct,
later.
Generally, you can deduct your share of the real estate taxes the corporation paid or incurred on the property. The corporation should provide you
with a statement showing your share of the taxes. For more information, see Special Rules for Cooperatives in Publication 530.
Buyers and sellers of real estate.Real estate:Division of real estate taxesSale of home:Division of real estate taxes
If you bought or sold real estate during the year, the real estate taxes must be divided between the buyer and the seller.
The buyer and the seller must divide the real estate taxes according to the number of days in the real property tax year (the period to which the
tax imposed relates) that each owned the property. The seller is treated as paying the taxes up to, but not including, the date of sale. The buyer is
treated as paying the taxes beginning with the date of sale. This applies regardless of the lien dates under local law. Generally, this information is
included on the settlement statement provided at the closing.
Cash method taxpayers:Real estate transactions, tax allocationIf you (the seller) cannot deduct taxes until they are paid because you use the
cash method of accounting, and the buyer of your property is personally liable for the tax, you are considered to have paid your part of the tax at
the time of the sale. This lets you deduct the part of the tax to the date of sale even though you did not actually pay it. However, you must also
include the amount of that tax in the selling price of the property. The buyer must include the same amount in his or her cost of the property.
You figure your deduction for taxes on each property bought or sold during the real property tax year as follows.
Worksheet 22-1.1. Enter the total real estate taxes for the real property tax year 2. Enter the number of days in the real property tax year that you owned the property 3. Divide line 2 by 365 (for leap years, divide line 2 by 366). 4. Multiply line 1 by line 3. This is your deduction. Enter it on Schedule A (Form 1040), line 6 Note. Repeat steps 1 through 4 for each property you bought or sold during the real
property tax year.
Real estate taxes for prior years.Delinquent taxes:Real estate transactions, tax allocation
Do not divide delinquent taxes between the buyer and seller if the taxes are for any real property tax year before the one in which the property is
sold. Even if the buyer agrees to pay the delinquent taxes, the buyer cannot deduct them. The buyer must add them to the cost of the property. The
seller can deduct these taxes paid by the buyer. However, the seller must include them in the selling price.
Examples.
The following examples illustrate how real estate taxes are divided between buyer and seller.
Example 1.
Dennis and Beth White's real property tax year for both their old home and their new home is the calendar year, with payment due August 1. The tax
on their old home, sold on May 7, was $620. The tax on their new home, bought on May 3, was $732. Dennis and Beth are considered to have paid a
proportionate share of the real estate taxes on the old home even though they did not actually pay them to the taxing authority. On the other hand,
they can claim only a proportionate share of the taxes they paid on their new property even though they paid the entire amount.
Dennis and Beth owned their old home during the real property tax year for 127 days (January 1 to May 6, the day before the sale). They figure
their deduction for taxes on their old home as follows.
Taxes On Old Home1. Enter the total real estate taxes for the real property tax year $620 2. Enter the number of days in the real property tax year that you owned the property 126 3. Divide line 2 by 365 (for leap years, divide line 2 by 366).345 4. Multiply line 1 by line 3. This is your deduction. Enter it on Schedule A (Form 1040), line 6 $214
Since the buyers of their old home paid all of the taxes, Dennis and Beth also include the $214 in the selling price of the old home. (The
buyers add the $214 to their cost of the home.)
Dennis and Beth owned their new home during the real property tax year for 243 days (May 3 to December 31, including their date of purchase). They
figure their deduction for taxes on their new home as follows.
Taxes On New Home 1. Enter the total real estate taxes for the real property tax year $732 2. Enter the number of days in the real property tax year that you owned the property 243 3. Divide line 2 by 365 (for leap years, divide line 2 by 366).666 4. Multiply line 1 by line 3. This is your deduction. Enter it on Schedule A (Form 1040), line 6$488
Since Dennis and Beth paid all of the taxes on the new home, they add $244 ($732 paid less $488 deduction) to their cost of the new home. (The
sellers add this $244 to their selling price and deduct the $244 as a real estate tax.)
Dennis and Beth's real estate tax deduction for their old and new homes is the sum of $214 and $488, or $702. They will enter this amount on
Schedule A (Form 1040), line 6.
Example 2.
George and Helen Brown bought a new home on May 3, 2005. Their real property tax year for the new home is the calendar year. Real estate taxes for
2004 were assessed in their state on January 1, 2005. The taxes became due on May 31, 2005, and October 31, 2005.
The Browns agreed to pay all taxes due after the date of purchase. Real estate taxes for 2004 were $680. They paid $340 on May 31, 2005, and $340
on October 31, 2005. These taxes were for the 2004 real property tax year. The Browns cannot deduct them since they did not own the property until
2005. Instead, they must add $680 to the cost of their new home.
In January 2006, the Browns receive their 2005 property tax statement for $752, which they will pay in 2006. The Browns owned their new home during
the 2005 real property tax year for 243 days (May 3 to December 31). They will figure their 2006 deduction for taxes as follows.
1. Enter the total real estate taxes for the real property tax year $752 2. Enter the number of days in the real property tax year that you owned the property 243 3. Divide line 2 by 365 (for leap years, divide line 2 by 366).666 4. Multiply line 1 by line 3. This is your deduction. Claim it on Schedule A (Form 1040), line 6$501
The remaining $251 ($752 paid less $501 deduction) of taxes paid in 2006, along with the $680 paid in 2005, is added to the cost of their new
home.
Because the taxes up to the date of sale are considered paid by the seller on the date of sale, the seller is entitled to a 2005 tax deduction of
$931. This is the sum of the $680 for 2004 and the $251 for the 122 days the seller owned the home in 2005. The seller must also include the $931 in
the selling price when he or she figures the gain or loss on the sale. The seller should contact the Browns in January 2006 to find out how much real
estate tax is due for 2005.
Form 1099-S.Form 1099-S:Real estate transactions proceedsReal estate:Form 1099-S to report sale proceeds
For certain sales or exchanges of real estate, the person responsible for closing the sale (generally the settlement agent) prepares Form 1099-S,
Proceeds From Real Estate Transactions, to report certain information to the IRS and to the seller of the property. Box 2 of the form is for the gross
proceeds of the sale and should include the portion of the seller's real estate tax liability that the buyer will pay after the date of sale. The
buyer includes these taxes in the cost basis of the property, and the seller both deducts this amount as a tax paid and includes it in the sales price
of the property.
For a real estate transaction that involves a home, any real estate tax the seller paid in advance but that is the liability of the buyer appears
on Form 1099-S, box 5. The buyer deducts this amount as a real estate tax, and the seller reduces his or her real estate tax deduction (or includes it
in income) by the same amount. See Refund (or rebate), later.
Taxes placed in escrow.Escrow:Taxes placed in, when deductible
If your monthly mortgage payment includes an amount placed in escrow (put in the care of a third party) for real estate taxes, you may not be able
to deduct the total amount placed in escrow. You can deduct only the real estate tax that the third party actually paid to the taxing authority. If
the third party does not notify you of the amount of real estate tax that was paid for you, contact the third party or the taxing authority to find
the proper amount to show on your return.
Tenants by the entirety.Married filing separately:Tenants by the entirety, allocation of real estate taxesTenants by the entirety:Real estate taxes, allocation when filing separately
If you and your spouse held property as tenants by the entirety and you file separate federal returns, each of you can deduct only the taxes each
of you paid on the property.
Divorced individuals.Divorced taxpayers:Real estate taxes, allocation of
If your divorce or separation agreement states that you must pay the real estate taxes for a home owned by you and your spouse, part of your
payments may be deductible as alimony and part as real estate taxes. See Taxes and insurance in chapter 18 for more information.
Minister's and military personnel housing allowances.Armed forces:Real estate taxes when receiving housing allowanceClergy:Housing:Real estate taxes when receiving housing allowance
If you are a minister or a member of the uniformed services and receive a housing allowance that you can exclude from income, you still can deduct
all of the real estate taxes you pay on your home.
If you receive a refund or rebate in 2005 of real estate taxes you paid in 2005, you must reduce your deduction by the amount refunded to you. If
you receive a refund or rebate in 2005 of real estate taxes you deducted in an earlier year, you generally must include the refund or rebate in income
in the year you receive it. However, you only need to include the amount of the deduction that reduced your tax in the earlier year. For more
information, see Recoveries in chapter 12.
If you did not itemize deductions in the year you paid the tax, do not report the refund as income.
<ROM>Table 22-1.</ROM> Which Taxes Can You Deduct?Cooperative housing:Real estate taxes, deduction of:Taxes that are deductible (Table 22-1)Excise taxes:Deductibility (Table 22-1)Federal income tax:Not deductible:Deductibility (Table 22-1)Garbage pickup:Deductibility (Table 22-1)Homeowners' associations:Charges:Deductibility (Table 22-1)Occupational taxes:Deduction of:Taxes that are deductible (Table 22-1)Real estate taxes:Deduction of:List of deductible taxes (Table 22-1)Rental income and expenses:Increase due to higher real estate taxes:Deductibility (Table 22-1)Sales tax:Deductibility of (Table 22-1)Self-employment tax:Deduction of:List of deductible taxes (Table 22-1)State or local income taxes:Deduction of:List of deductible taxes (Table 22-1)Tables and figures:Taxes that are deductible (Table 22-1)Taxes:Deduction of:Types of taxes deductible (Table 22-1)You Can DeductYou Cannot DeductIncome TaxesState and local income taxes.
Foreign income taxes.
Employee contributions to state funds listed
under Contributions to state benefit funds.One-half of self-employment tax paid. Federal income taxes.
Employee contributions to private or voluntary
disability plans.
State and local general sales taxes (if you choose to deduct state and local income taxes).General Sales TaxesState and local general sales taxes.State and local income taxes (if you choose to deduct state and local general sales taxes).Real Estate Taxes State and local real estate taxes.
Foreign real estate taxes.
Tenant's share of real estate taxes paid by
cooperative housing corporation. Taxes for local benefits (with exceptions).
Trash and garbage pickup fees (with exceptions).
Rent increase due to higher real estate taxes.
Homeowners association charges.Personal Property TaxesState and local personal property taxes.Import duties.Other TaxesTaxes that are expenses of your trade or business
or of producing income.
Taxes on property producing rent or royalty
income.
Occupational taxes. See chapter 28.State and local sales and use taxes.
Federal excise taxes, such as telephone taxes
(see Taxes and Fees You Cannot Deduct).
Per capita taxes.Fees and ChargesFees and charges that are expenses of your trade or business or of producing income.Fees and charges that are not expenses of your trade or business or of producing income, such as fees for
driver's licenses, car inspections, parking, or charges for water bills (see Taxes and Fees You Cannot Deduct).Fines and penalties.
Real Estate-Related Items You Cannot DeductReal estate:Real estate-related items not deductible
Payments for the following items generally are not deductible as real estate taxes.
Taxes for local benefits.
Itemized charges for services (such as trash and garbage pickup fees).
Transfer taxes (or stamp taxes).
Rent increases due to higher real estate taxes.
Homeowners' association charges.
Taxes for local benefits.Local assessments:Deductibility ofReal estate taxes:AssessmentsLocal assessments
Deductible real estate taxes generally do not include taxes charged for local benefits and improvements tending to increase the value of your
property. These include assessments for streets, sidewalks, water mains, sewer lines, public parking facilities, and similar improvements. You should
increase the basis of your property by the amount of the assessment.
Local benefit taxes are deductible only if they are for maintenance, repair, or interest charges related to those benefits. If only a part of the
taxes is for maintenance, repair, or interest, you must be able to show the amount of that part to claim the deduction. If you cannot determine what
part of the tax is for maintenance, repair, or interest, none of it is deductible.
Taxes for local benefits may be included in your real estate tax bill. If your taxing authority (or mortgage lender) does not furnish you a copy of
your real estate tax bill, ask for it. You should use the rules above to determine if the local benefit tax is deductible.
Itemized charges for services.Real estate:Itemized charges for services not deductible
An itemized charge for services to specific property or people is not a tax, even if the charge is paid to the taxing authority. For example, you
cannot deduct the charge as a real estate tax if it is:
A unit fee for the delivery of a service (such as a $5 fee charged for every 1,000 gallons of water you use),
A periodic charge for a residential service (such as a $20 per month or $240 annual fee charged to each homeowner for trash collection),
or
A flat fee charged for a single service provided by your government (such as a $30 charge for mowing your lawn because it was allowed to
grow higher than permitted under your local ordinance).
You must look at your real estate tax bill to determine if any nondeductible itemized charges, such as those just listed, are included in the bill.
If your taxing authority (or mortgage lender) does not furnish you a copy of your real estate tax bill, ask for it.
Exception.
Service charges used to maintain or improve services (such as trash collection or police and fire protection) are deductible as real estate taxes
if:
The fees or charges are imposed at a like rate against all property in the taxing jurisdiction,
The funds collected are not earmarked; instead, they are commingled with general revenue funds, and
Funds used to maintain or improve services are not limited to or determined by the amount of these fees or charges collected.
Transfer taxes (or stamp taxes).Real estate:Transfer taxesStamp taxes:Real estate transactions andTransfer taxes:Real estate transactions and
Transfer taxes and similar taxes and charges on the sale of a personal home are not deductible. If they are paid by the seller, they are expenses
of the sale and reduce the amount realized on the sale. If paid by the buyer, they are included in the cost basis of the property.
Rent increase due to higher real estate taxes.Rental income and expenses:Increase due to higher real estate taxes
If your landlord increases your rent in the form of a tax surcharge because of increased real estate taxes, you cannot deduct the increase as
taxes.
Homeowners' association charges.Homeowners' associations:Charges
These charges are not deductible because they are imposed by the homeowners' association, rather than the state or local government.
Personal Property TaxesPersonal property taxes:Taxes:Personal property taxesPersonal property taxes:Deduction ofTaxes:Personal property taxes:Deduction of
Personal property tax is deductible if it is a state or local tax that is:
Charged on personal property,
Based only on the value of the personal property, and
Charged on a yearly basis, even if it is collected more or less than once a year.
Cars:Personal property taxes on, deduction ofA tax that meets the above requirements can be considered charged on personal
property even if it is for the exercise of a privilege. For example, a yearly tax based on value qualifies as a personal property tax even if it is
called a registration fee and is for the privilege of registering motor vehicles or using them on the highways.
If the tax is partly based on value and partly based on other criteria, it may qualify in part.
Example.
Your state charges a yearly motor vehicle registration tax of 1% of value plus 50 cents per hundredweight. You paid $32 based on the value ($1,500)
and weight (3,400 lbs.) of your car. You can deduct $15 (1% × $1,500) as a personal property tax because it is based on the value. The remaining
$17 ($.50 × 34), based on the weight, is not deductible.
Taxes and Fees
You Cannot DeductTaxes:Not deductible
Many federal, state, and local government taxes are not deductible because they do not fall within the categories discussed earlier. Other taxes
and fees, such as federal income taxes, are not deductible because the tax law specifically prohibits a deduction for them. See Table 22-1.
Taxes and fees that are generally not deductible include the following items.
Estate, inheritance, legacy, or succession taxes. However, you can deduct the estate tax attributable to income in respect of a
decedent if you, as a beneficiary, must include that income in your gross income. In that case, deduct the estate tax as a miscellaneous deduction
that is not subject to the 2%-of-adjusted-gross-income limit. For more information, see Publication 559.
Federal income taxes. This includes taxes withheld from your pay.
Federal income tax:Not deductibleIncome taxesFederalFederal income taxTaxes:Federal income taxes, not deductibleWithholding:Federal income taxes, not deductible
Fines. You cannot deduct penalties for violation of any law, including forfeiture of related collateral deposits.
Federal income tax:Not deductibleIncome taxesFederalFederal income taxTaxes:Federal income taxes, not deductibleWithholding:Federal income taxes, not deductible
Gift taxes.
Gift taxes:Not deductibleTaxes:Gift taxes
License fees. You cannot deduct license fees for personal purposes (such as marriage, driver's, and dog license fees).
License fees:Deductibility of
Per capita taxes. You cannot deduct state or local per capita taxes.
Per capita taxes:Deductibility of
Social security. This includes social security, Medicare, or railroad retirement taxes withheld from your pay.
Social security and other employment taxes for household workers. However, the social security and other employment taxes you pay
on the wages of a household worker may qualify as medical or child care expenses. For more information, see chapters 21 and 32.
Many taxes and fees other than those listed above are also nondeductible, unless they are ordinary and necessary expenses of a business or income
producing activity. For other nondeductible items, see Real Estate-Related Items You Cannot Deduct, earlier.
Where To DeductTaxes:Deduction of:Schedules to use
You deduct taxes on the following schedules.
State and local income taxes.
Form 1040:Schedule A:State and local income taxes, deduction ofState or local income taxes:Deduction of:Schedule A (Form 1040)These taxes are deducted on Schedule A (Form 1040), line 5, even if your only source of income
is from business, rents, or royalties. You must check box a on line 5. If you deduct these taxes, you cannot elect to deduct general sales taxes.
General sales tax deduction.
Form 1040:Schedule A:General sales taxes, deduction ofGeneral sales taxes:Deduction of:Schedule A (Form 1040)These taxes are deducted on Schedule A (Form 1040), line 5. You must check box b on line 5. If
you elect to deduct these taxes, you cannot deduct state and local income taxes.
Foreign income taxes.Foreign income taxes:Deduction of:Form 1116 to claim creditForeign income taxes:Deduction of:Schedule A or Form 1040 reportingForm 1040:Foreign income taxes, deduction ofForm 1116:Foreign tax creditIncome taxesForeignForeign income taxes
Generally, income taxes you pay to a foreign country or U.S. possession can be claimed as an itemized deduction on Schedule A (Form 1040), line 8,
or as a credit against your U.S. income tax on Form 1040, line 47. To claim the credit, you may have to complete and attach Form 1116. For more
information, see chapter 37, the Form 1040 instructions, or Publication 514.
Real estate taxes and personal property taxes.Form 1040:Schedule C:Real estate or personal property taxes on property used in business, deduction ofForm 1040:Schedule E:Real estate or personal property taxes on rental property, deduction ofForm 1040:Schedule F:Real estate or personal property taxes on property used in business, deduction ofPersonal property taxes:Deduction of:Schedule A, C, E, or F (Form 1040)
Real estate taxes:TaxesReal estate taxesReal estate taxes:Deduction of:Schedule A, C, E, or F (Form 1040)These taxes are deducted on Schedule A (Form 1040), lines 6 and 7, unless they are
paid on property used in your business in which case they are deducted on Schedule C, Schedule C-EZ, or Schedule F (Form 1040). Taxes on property that
produces rent or royalty income are deducted on Schedule E (Form 1040).
Self-employment tax.Self-employed persons:Self-employment taxSelf-employment tax:Deduction of
Form 1040:Self-employment tax, deduction ofDeduct one-half of your self-employment tax on Form 1040, line 27.
Other taxes.
Form 1040:Schedule A:Taxes, deduction ofTaxesAll other deductible taxes are deducted on Schedule A (Form 1040), line 8.
Interest payments:Personal interest not deductiblePersonal interest:Not deductibleInterest payments:Student loans deductionStudent loans:Interest deductionPersonal interest is not deductible. Examples of personal interest include interest on a loan to purchase
an automobile for personal use and credit card and installment interest incurred for personal expenses.
But you may be able to deduct interest you pay on a qualified student loan. For details, see Publication 970, Tax Benefits for Education.
Limit on itemized deductions.Adjusted gross income (AGI):Itemized deduction limitItemized deductions:Adjusted gross income limiting
If your adjusted gross income is more than $145,950 ($72,975 if you are married filing separately), the overall amount of your itemized deductions
may be limited. See chapter 29 for more information about this limit.
This chapter discusses interest. Interest is the amount you pay for the use of borrowed money.
The types of interest you can deduct as itemized deductions on Schedule A (Form 1040) are:
Home mortgage interest, including certain points, and
Investment interest.
This chapter explains these deductions. It also explains where to deduct other types of interest and lists some types of interest you cannot
deduct.
Use Table 23-1 to find out where to get more information on various types of interest, including investment interest.
Publication936 Home Mortgage Interest Deduction
Home Mortgage
Interest
Home:MortgagesHome equity loans:Interest deductionLine of credit for home:InterestMortgages:Interest:DefinitionSecond mortgages:InterestGenerally, home mortgage interest is any interest you pay on a loan secured by your home (main home or a second
home). The loan may be a mortgage to buy your home, a second mortgage, a line of credit, or a home equity loan.
You can deduct home mortgage interest only if you meet all the following conditions.
You must file Form 1040 and itemize deductions on Schedule A (Form 1040).
You must be legally liable for the loan. You cannot deduct payments you make for someone else if you are not legally liable to make them.
Both you and the lender must intend that the loan be repaid. In addition, there must be a true debtor-creditor relationship between you and the
lender.
The mortgage must be a secured debt on a qualified home. (Generally, your mortgage is a secured debt if you put your home up as collateral
to protect the interests of the lender. The term qualified home means your main home or second home. For details, see Publication
936.)
Amount DeductibleReal estate:Mortgages
In most cases, you will be able to deduct all of your home mortgage interest. Whether you can deduct all of it depends on the date you took out the
mortgage, the amount of the mortgage, and your use of its proceeds.
Fully deductible interest.
If all of your mortgages fit into one or more of the following three categories at all times during the year, you can deduct all of the interest on
those mortgages. (If any one mortgage fits into more than one category, add the debt that fits in each category to your other debt in the same
category.)
The three categories are:
Mortgages you took out on or before October 13, 1987 (called grandfathered debt).
Mortgages you took out after October 13, 1987, to buy, build, or improve your home (called home acquisition debt), but only if throughout
2005 these mortgages plus any grandfathered debt totaled $1 million or less ($500,000 or less if married filing separately).
Mortgages you took out after October 13, 1987, other than to buy, build, or improve your home (called home equity debt), but only if
throughout 2005 these mortgages totaled $100,000 or less ($50,000 or less if married filing separately) and totaled no more than the fair market value
of your home reduced by (1) and (2).
Home equity loans:Interest deduction
The dollar limits for the second and third categories apply to the combined mortgages on your main home and second home.
See Part II of Publication 936 for more detailed definitions of grandfathered, home acquisition, and home equity debt.
Deductions:Mortgage interestMortgagesMortgages:Interest deduction:Computation for amount deductible (Figure 23-A)Tables and figures:Mortgage deduction (Figure 23-A)You can use Figure 23-A to check whether your home mortgage interest is fully deductible.
Figure 23-A. Is My Home Mortgage Interest Fully Deductible?Summary: This flowchart is used to determine if your home mortgage interest is fully deductible.(Instructions: Include balances of ALL mortgages secured by your main home and second home.)StartThis is the starting of the flowchart.Decision (1)Do you meet the conditions to deduct home (See footnote 1) mortgage interest?Footnote 1: You must itemize deductions on Schedule A (Form 1040) and be legally liable for the loan. The loan must be a secured debt on a
qualified home. See Home Mortgage Interest.IF Yes Continue To Decision (2)IF No Continue To Process (a)Decision (2)Were your total mortgage balances $100,000 or less (see Footnote 2) ($50,000 or less if married filing separately) at all times during the
year?Footnote 2: If all mortgages on your main or second home exceed the home's fair market value, a lower limit may apply. See Home equity debt
limit under Home Equity Debt in Part II of Publication 936.IF Yes Continue To Process (b)IF No Continue To Decision (3)Decision (3)Were all of your home mortgages taken out on or before 10-13-87?IF Yes Continue To Process (b)IF No Continue To Decision (4)Decision (4)Were all of your home mortgages taken out after 10-13-87 used to buy, build, or improve the main home secured by that main home mortgage or
used to buy, build, or improve the second home secured by that second home mortgage, or both?IF Yes Continue To Decision (7)IF No Continue To Decision (5)Decision (5)Were your home equity debt balances $100,000 or less (see Footnote 2) ($50,000 or less if married filing separately) at all times during the
year?Footnote 2: If all mortgages on your main or second home exceed the home's fair market value, a lower limit may apply. See Home equity debt
limit under Home Equity Debt in Part II of Publication 936.IF Yes Continue To Decision (6)IF No Continue To Process (c)Decision (6)Were your grandfathered debt plus home acquisition debt balances $1,000,000 or less (see Footnote 3) ($500,000 or less if married filing
separately) at all times during the year?Footnote 3: Amounts over the $1,000,000 limit ($500,000 if married filing separately) qualify as home equity debt if they are not more than
the total home equity debt limit. See Publication 936 for more information about grandfathered debt, home acquisition debt, and home equity
debt.IF Yes Continue To Process (b)IF No Continue To Process (c)Decision (7)Were the mortgage balances $1,000,000 or less ($500,000 or less if married filing separately) at all times during the year?IF Yes Continue To Process (b)IF No Continue To Decision (5)Process (a)You cannot deduct the interest payments as home mortgage interest. (see Footnote 4) Footnote 4: See Table 23-1 for where to deduct other types of interest payments.Continue To End Process (b)Your home mortgage interest is fully deductible. You do not need Publication 936.Continue To End Process (c)Go to Part II of Publication 936 to determine the limits on your deductible home mortgage interest.Continue To End EndThis is the ending of the flowchart.
Limits on deduction.
You cannot fully deduct interest on a mortgage that does not fit into any of the three categories listed above. If this applies to you, see
Part II of Publication 936 to figure the amount of interest you can deduct.
Special Situations
This section describes certain items that can be included as home mortgage interest and others that cannot. It also describes certain special
situations that may affect your deduction.
Late payment charge on mortgage payment.Mortgages:Late payment charges, deduction of
You can deduct as home mortgage interest a late payment charge if it was not for a specific service performed in connection with your mortgage
loan.
Mortgage prepayment penalty.Mortgages:Prepayment:Penalty for, deduction ofPrepaymentMortgage interestMortgages
If you pay off your home mortgage early, you may have to pay a penalty. You can deduct that penalty as home mortgage interest provided the penalty
is not for a specific service performed or cost incurred in connection with your mortgage loan.
Sale of home.Mortgages:Interest deduction:Sale of homePrincipal residenceHomeSale of home:Interest deduction for mortgage
If you sell your home, you can deduct your home mortgage interest (subject to any limits that apply) paid up to, but not including, the date of
sale.
Example.
John and Peggy Harris sold their home on May 7. Through April 30, they made home mortgage interest payments of $1,220. The settlement sheet for the
sale of the home showed $50 interest for the 6-day period in May up to, but not including, the date of sale. Their mortgage interest deduction is
$1,270 ($1,220 + $50).
Prepaid interest.Mortgages:Prepayment:Allocation of deduction
If you pay interest in advance for a period that goes beyond the end of the tax year, you must spread this interest over the tax years to which it
applies. You can deduct in each year only the interest that qualifies as home mortgage interest for that year. However, see Points, later.
Mortgage interest credit.Form:8396:Mortgage interest creditMortgage interest credit:Form 8396Mortgages:Credit certificate (MCC) from state or local governmentMortgages:Interest creditMortgage interest credit
You may be able to claim a mortgage interest credit if you were issued a mortgage credit certificate (MCC) by a state or local government. Figure
the credit on Form 8396, Mortgage Interest Credit. If you take this credit, you must reduce your mortgage interest deduction by the amount of the
credit.
For more information on the credit, see chapter 37.
Ministers' and military housing allowance.Armed forces:Real estate taxes when receiving housing allowanceClergy:Housing:Real estate taxes when receiving housing allowance
If you are a minister or a member of the uniformed services and receive a housing allowance that is not taxable, you can still deduct your home
mortgage interest.
If you qualify for mortgage assistance payments for lower-income families under section 235 of the National Housing Act, part or all of the
interest on your mortgage may be paid for you. You cannot deduct the interest that is paid for you.
No other effect on taxes.
Do not include these mortgage assistance payments in your income. Also, do not use these payments to reduce other deductions, such as real estate
taxes.
Divorced or separated individuals.Alimony:Mortgage payments:Interest deductionDivorced taxpayers:Mortgage interest, payment as alimonySeparated taxpayers:Mortgage interest
If a divorce or separation agreement requires you or your spouse or former spouse to pay home mortgage interest on a home owned by both of you, the
payment of interest may be alimony. See the discussion of Payments for jointly-owned home in chapter 18.
Redeemable ground rent.Redeemable ground rent:Deduction as mortgage interest
If you make annual or periodic rental payments on a redeemable ground rent, you can deduct them as mortgage interest.
Payments made to end the lease and to buy the lessor's entire interest in the land are not ground rents. You cannot deduct them. For more
information, see Publication 936.
Nonredeemable ground rents .
Payments on a nonredeemable ground rent are not mortgage interest. You can deduct them as rent if they are a business expense or if they are for
rental property.
Rental payments.Home:Possession before final settlement, rent not deductible as interestRental income and expenses:Home possession before final settlement, rent not deductible as interest
If you live in a house before final settlement on the purchase, any payments you make for that period are rent and not interest. This is true even
if the settlement papers call them interest. You cannot deduct these payments as home mortgage interest.
Mortgage proceeds invested in tax-exempt securities.ExemptionsSecurities, tax-exemptSecuritiesHome equity loans:Proceeds invested in tax-exempt securities, interest not deductibleSecurities:Tax-exempt:Home equity loan proceeds invested in
You cannot deduct the home mortgage interest on grandfathered debt or home equity debt if you used the proceeds of the mortgage to buy securities
or certificates that produce tax-free income. Grandfathered debt and home equity debt are defined earlier under Amount
Deductible.
Refunds of interest.Mortgages:Refund of interest:Treatment ofRefunds:Mortgage interest, treatment of
If you receive a refund of interest in the same tax year you paid it, you must reduce your interest expense by the amount refunded to you. If you
receive a refund of interest you deducted in an earlier year, you generally must include the refund in income in the year you receive it. However, you
need to include it only up to the amount of the deduction that reduced your tax in the earlier year. This is true whether the interest overcharge was
refunded to you or was used to reduce the outstanding principal on your mortgage.
Form:1098:Mortgage interest overpaid in earlier yearIf you received a refund of interest you overpaid in an earlier year, you
generally will receive a Form 1098, Mortgage Interest Statement, showing the refund in box 3. For information about Form 1098, see Mortgage
Interest Statement, later.
For more information on how to treat refunds of interest deducted in earlier years, see Recoveries in chapter 12.
Points
Loans:Origination feesPointsMortgages:PointsOrigination feesPointsPointsReal estate:PointsDeductions:PointsPoints:DefinitionThe term points is used to describe certain charges paid, or treated as paid, by a borrower to obtain a
home mortgage. Points may also be called loan origination fees, maximum loan charges, loan discount, or discount points.
A borrower is treated as paying any points that a home seller pays for the borrower's mortgage. See Points paid by the seller, later.
General rule.Mortgages:Prepayment:Points
You generally cannot deduct the full amount of points in the year paid. Because they are prepaid interest, you generally deduct them ratably over
the life (term) of the mortgage. See Deduction allowed ratably, later.
For exceptions to the general rule, see Deduction allowed in year paid, next.
Deduction allowed in year paid.
Points:Guide to determine if points deductible in year paid (Figure 23-B)Tables and figures:Points, to determine if deductible in year paid (Figure 23-B)You can fully deduct points in the year paid if you meet all
the following tests. (You can use Figure 23-B as a quick guide to see whether your points are fully deductible in the year paid.)
Your loan is secured by your main home. (Your main home is the one you live in most of the time.)
Paying points is an established business practice in the area where the loan was made.
The points paid were not more than the points generally charged in that area.
You use the cash method of accounting. This means you report income in the year you receive it and deduct expenses in the year you pay them.
(If you want more information about this method, see Accounting Methods in chapter 1.)
Cash method taxpayers:Points, deduction of
The points were not paid in place of amounts that ordinarily are stated separately on the settlement statement, such as appraisal fees,
inspection fees, title fees, attorney fees, and property taxes.
The funds you provided at or before closing, plus any points the seller paid, were at least as much as the points charged. The funds you
provided do not have to have been applied to the points. They can include a down payment, an escrow deposit, earnest money, and other funds you paid
at or before closing for any purpose. You cannot have borrowed these funds from your lender or mortgage broker.
You use your loan to buy or build your main home.
The points were computed as a percentage of the principal amount of the mortgage.
The amount is clearly shown on the settlement statement (such as the Settlement Statement, Form HUD-1) as points charged for the mortgage.
The points may be shown as paid from either your funds or the seller's.
Points:Settlement statement shows as charged for mortgageUniform Settlement Statement (Form HUD-1):Points shown onFigure 23-B. Are My Points Fully Deductible This Year?Summary: This flowchart is used to determine if your home mortgage points are fully deductible this year.StartThis is the starting of the flowchart.Decision (1)Is the loan secured by your main home?IF Yes Continue To Decision (2)IF No Continue To Process (a)Decision (2)Is the payment of points an established business practice in your area?IF Yes Continue To Decision (3)IF No Continue To Process (a)Decision (3)Were the points paid more than the amount generally charged in your area?IF Yes Continue To Process (a)IF No Continue To Decision (4)Decision (4)Do you use the cash method of accounting?IF Yes Continue To Decision (5)IF No Continue To Process (a)Decision (5)Were the points paid in place of amounts that ordinarily are separately stated on the settlement sheet?IF Yes Continue To Process (a)IF No Continue To Decision (6)Decision (6)Were the funds you provided (other than those you borrowed from your lender or mortgage broker), plus any points the seller paid, at least as
much as the points charged? (See Footnote)Footnote: The funds you provided do not have to have been applied to the points. They can include a down payment, an escrow deposit, earnest
money, and other funds you paid at or before closing for any purpose.IF Yes Continue To Decision (7)IF No Continue To Process (a)Decision (7)Did you take out the loan to improve your main home?IF Yes Continue To Process (b)IF No Continue To Decision (8)Decision (8)Did you take out the loan to buy or build your new home?IF Yes Continue To Decision (9)IF No Continue To Process (a)Decision (9)Were the points computed as a percentage of the principal amount of the mortgage?IF Yes Continue To Decision (10)IF No Continue To Process (a)Decision (10)Is the amount paid clearly shown as points on the settlement statement?IF Yes Continue To Process (b)IF No Continue To Process (a)Process (a)You cannot fully deduct the points this year. See the discussion on Points.Continue To End Process (b)You can fully deduct the points this year on Schedule A (Form 1040).Continue To End EndThis is the ending of the flowchart.
Note.
If you meet all of these tests, you can choose to either fully deduct the points in the year paid, or deduct them over the life of the loan.
Home improvement loan.Home:Improvements:Loans forHome improvement loansLoans:Home improvement loans
You can also fully deduct in the year paid points paid on a loan to improve your main home, if tests (1) through (6) are met.
Points:Second homeVacation homes:PointsSecond home. You cannot fully deduct in the year paid points you pay on loans secured by your second home.
You can deduct these points only over the life of the loan.
Generally, points you pay to refinance a mortgage are not deductible in full in the year you pay them. This is true even if the new mortgage is
secured by your main home.
However, if you use part of the refinanced mortgage proceeds to improve your main home and you meet the first six tests listed under Deduction
allowed in year paid, earlier, you can fully deduct the part of the points related to the improvement in the year you paid them with your own
funds. You can deduct the rest of the points over the life of the loan.
Example 1.
In 1992, Bill Fields got a mortgage to buy a home. In 2005, Bill refinanced that mortgage with a 15-year $100,000 mortgage loan. The mortgage is
secured by his home. To get the new loan, he had to pay three points ($3,000). Two points ($2,000) were for prepaid interest, and one point ($1,000)
was charged for services, in place of amounts that ordinarily are stated separately on the settlement statement. Bill paid the points out of his
private funds, rather than out of the proceeds of the new loan. The payment of points is an established practice in the area, and the points charged
are not more than the amount generally charged there. Bill's first payment on the new loan was due July 1. He made six payments on the loan in 2005
and is a cash basis taxpayer.
Bill used the funds from the new mortgage to repay his existing mortgage. Although the new mortgage loan was for Bill's continued ownership of his
main home, it was not for the purchase or improvement of that home. He cannot deduct all of the points in 2005. He can deduct two points ($2,000)
ratably over the life of the loan. He deducts $67 [($2,000 ÷ 180 months) × 6 payments] of the points in 2005. The other point ($1,000)
was a fee for services and is not deductible.
Example 2.
The facts are the same as in Example 1, except that Bill used $25,000 of the loan proceeds to improve his home and $75,000 to repay his
existing mortgage. Bill deducts 25% ($25,000 ÷ $100,000) of the points ($2,000) in 2005. His deduction is $500 ($2,000 × 25%).
Bill also deducts the ratable part of the remaining $1,500 ($2,000 − $500) that must be spread over the life of the loan. This is $50
[($1,500 ÷ 180 months) × 6 payments] in 2005. The total amount Bill deducts in 2005 is $550 ($500 + $50).
Deduction allowed ratably.
If you do not meet the tests above under Deduction allowed in year paid, the loan is not a home improvement loan, or you choose not to
deduct your points in full in the year paid, you can deduct the points ratably (equally) over the life of the loan if you meet all the following
tests.
You use the cash method of accounting. This means you report income in the year you receive it and deduct expenses in the year you pay them.
Most individuals use this method.
Your loan is secured by a home. (The home does not need to be your main home.)
Your loan period is not more than 30 years.
If your loan period is more than 10 years, the terms of your loan are the same as other loans offered in your area for the same or longer
period.
Either your loan amount is $250,000 or less, or the number of points is not more than:
4, if your loan period is 15 years or less, or
6, if your loan period is more than 15 years.
Original issue discount.
If you do not qualify to either deduct the points in the year paid or deduct them ratably over the life of the loan, or if you choose not to use
either of these methods, the points reduce the issue price of the loan. This reduction results in original issue discount, which is discussed in
chapter 5 of Publication 535.
Amounts charged for services.Mortgages:Lender's charges for services
Amounts charged by the lender for specific services connected to the loan are not interest. Examples of these charges are:
Appraisal fees,
Appraisal fees:Not deductible as interest
Notary fees,
Notary fees:Not deductible as interest
Preparation costs for the mortgage note or deed of trust,
Deeds:Preparation costs forMortgages:Preparation costs for notes or deeds of trust
Veterans Affairs (VA):Funding fees, not deductible as interestYou cannot deduct these amounts as points either in the year paid or over the life of the mortgage. For information about the tax treatment of
these amounts and other settlement fees and closing costs, get Publication 530, Tax Information for First-Time Homeowners.
Points paid by the seller.Points:Paid by sellerSale of home:Points paid by seller
The term points includes loan placement fees that the seller pays to the lender to arrange financing for the buyer.
Treatment by seller.
The seller cannot deduct these fees as interest. They are a selling expense that reduces the amount realized by the seller. See chapter 15 for
information on the sale of your home.
Treatment by buyer.
Deductions:PointsThe buyer reduces the basis of the home by the amount of the seller-paid points and treats the points as if he or she
had paid them. If all the tests under Deduction allowed in year paid, earlier, are met, the buyer can deduct the points in the year paid.
If any of those tests is not met, the buyer deducts the points over the life of the loan.
For information about basis, see chapter 13.
Funds provided are less than points.
If you meet all the tests in Deduction allowed in year paid, earlier, except that the funds you provided were less than the points
charged to you (test 6), you can deduct the points in the year paid, up to the amount of funds you provided. In addition, you can deduct any points
paid by the seller.
Example 1.
When you took out a $100,000 mortgage loan to buy your home in December, you were charged one point ($1,000). You meet all the tests for deducting
points in the year paid, except the only funds you provided were a $750 down payment. Of the $1,000 charged for points, you can deduct $750 in the
year paid. You spread the remaining $250 over the life of the mortgage.
Example 2.
The facts are the same as in Example 1, except that the person who sold you your home also paid one point ($1,000) to help you get your
mortgage. In the year paid, you can deduct $1,750 ($750 of the amount you were charged plus the $1,000 paid by the seller). You spread the remaining
$250 over the life of the mortgage. You must reduce the basis of your home by the $1,000 paid by the seller.
Excess points.Points:Excess points
If you meet all the tests in Deduction allowed in year paid, earlier, except that the points paid were more than are generally paid in
your area (test 3), you deduct in the year paid only the points that are generally charged. You must spread any additional points over the life of the
mortgage.
Mortgage ending early.Mortgages:Ending early, treatment of pointsPoints:Mortgage ending early
If you spread your deduction for points over the life of the mortgage, you can deduct any remaining balance in the year the mortgage ends. However,
if you refinance the mortgage with the same lender, you cannot deduct any remaining balance of spread points. Instead, deduct the remaining balance
over the term of the new loan.
ForeclosureA mortgage may end early due to a prepayment, refinancing, foreclosure, or similar event.
Example.
Dan paid $3,000 in points in 1995 that he had to spread out over the 15-year life of the mortgage. He had deducted $2,000 of these points through
2004.
Dan prepaid his mortgage in full in 2005. He can deduct the remaining $1,000 of points in 2005.
Limits on deduction.Points:Limits on deduction
You cannot fully deduct points on a mortgage unless the mortgage fits into one of the categories listed earlier under Fully deductible
interest. See Publication 936 for details.
Mortgage Interest Statement
Deductions:Mortgage interestMortgagesMortgages:Interest:Form 1098 (interest statement)Cooperative housing:Mortgage interest statementsForm:1098:Mortgage interest statementIf you paid $600 or more of mortgage interest (including certain points) during the year on
any one mortgage, you generally will receive a Form 1098, Mortgage Interest Statement, or a similar statement from the mortgage holder. You will
receive the statement if you pay interest to a person (including a financial institution or a cooperative housing corporation) in the course of that
person's trade or business. A governmental unit is a person for purposes of furnishing the statement.
The statement for each year should be sent to you by January 31 of the following year. A copy of this form will also be sent to the IRS.
The statement will show the total interest you paid during the year. If you purchased a main home during the year, it will also show the deductible
points paid during the year, including seller-paid points. However, it should not show any interest that was paid for you by a government agency.
Form:1098:Points reported onPoints:Form 1098 reportingAs a general rule, Form 1098 will include only points that you can fully deduct in the year paid.
However, certain points not included on Form 1098 also may be deductible, either in the year paid or over the life of the loan. See Points,
earlier, to determine whether you can deduct points not shown on Form 1098.
Prepaid interest on Form 1098.Form:1098:Prepaid interest reported onMortgages:Prepayment:Reported on Form 1098
If you prepaid interest in 2005 that accrued in full by January 15, 2006, this prepaid interest may be included in box 1 of Form 1098. However, you
cannot deduct the prepaid amount for January 2006 in 2005. (See Prepaid interest, earlier.) You will have to figure the interest that
accrued for 2006 and subtract it from the amount in box 1. You will include the interest for January 2006 with the other interest you pay for 2006.
See How To Report, later.
Refunded interest.Form:1098:Refund of interest reported onMortgages:Refund of interest:Reported on Form 1098
If you received a refund of mortgage interest you overpaid in an earlier year, you generally will receive a Form 1098 showing the refund in box 3.
See Refunds of interest, earlier.
This section discusses the interest expenses you may be able to deduct as an investor.
ExemptionsSecurities, tax-exemptSecuritiesSecurities:Tax-exempt:Interest incurred to produce income fromStraddles:Interest fromIf you borrow money to buy property you hold for investment, the interest you pay is investment interest. You
can deduct investment interest subject to the limit discussed later. However, you cannot deduct interest you incurred to produce tax-exempt income.
Nor can you deduct interest expenses on straddles.
Passive activity:LossesInvestment interest andInvestment interest does not include any qualified home mortgage interest or any interest taken
into account in computing income or loss from a passive activity.
Investment Property
Investments:PropertyDefinitionProperty held for investment includes property that produces interest, dividends, annuities, or royalties
not derived in the ordinary course of a trade or business. It also includes property that produces gain or loss (not derived in the ordinary course of
a trade or business) from the sale or trade of property producing these types of income or held for investment (other than an interest in a passive
activity). Investment property also includes an interest in a trade or business activity in which you did not materially participate (other than a
passive activity).
Partners, shareholders, and beneficiaries.Estates:Investment interestPartners and partnerships:Investment interestS corporations:Shareholders:Investment interestTrusts:Investment interest
To determine your investment interest, combine your share of investment interest from a partnership, S corporation, estate, or trust with your
other investment interest.
Allocation of Interest Expense
If you borrow money for business or personal purposes as well as for investment, you must allocate the debt among those purposes. Only the interest
expense on the part of the debt used for investment purposes is treated as investment interest. The allocation is not affected by the use of property
that secures the debt.
Limit on Deduction
Interest payments:Investment interest:Limit on deductionNet investment incomeGenerally, your deduction for investment interest expense is limited to the amount of your net investment
income.
Carryovers:Investment interestYou can carry over to the next tax year the amount of investment interest that you could not deduct
because of this limit. The interest carried over is treated as investment interest paid or accrued in that next year.
You can carry over disallowed investment interest to the next tax year even if it is more than your taxable income in the year the interest was
paid or accrued.
Net Investment Income
Determine the amount of your net investment income by subtracting your investment expenses (other than interest expense) from your investment
income.
Investment income.
Alaska Permanent Fund dividends:Investment income not to includeThis generally includes your gross income from property held for investment (such as
interest, dividends, annuities, and royalties). Investment income does not include Alaska Permanent Fund dividends. It also does not include qualified
dividends or capital gain distributions unless you choose to include them.
Choosing to include qualified dividends.
Investment income generally does not include qualified dividends (discussed in chapter 8). However, you can choose to include all or part of your
qualified dividends in investment income.
You make this choice by completing Form 4952, line 4g, according to its instructions.
If you choose to include any amount of your qualified dividends in investment income, you must reduce your qualified dividends that are eligible
for the lower capital gains tax rates by the same amount.
Choosing to include net capital gain.Capital gains or losses:Net capital gain:Included as investment income
Investment income generally does not include net capital gain from disposing of investment property (including capital gain distributions from
mutual funds). However, you can choose to include all or part of your net capital gain in investment income.
Form:4952:Net capital gain, election to include as investment incomeYou make this choice by completing Form 4952, line 4g,
according to its instructions.
If you choose to include any amount of your net capital gain in investment income, you must reduce your net capital gain that is eligible for the
lower capital gains tax rates by the same amount.
Before making either choice, consider the overall effect on your tax liability. Compare your tax if you make one or both of these choices with your
tax if you do not.
Investment income of child reported on parent's return.
Children:Investment income of child under age 14:Parents' election to report on Form 1040Form:8814:Parents' election to report child's interest and dividendsInvestment income includes the part of your child's interest
and dividend income that you choose to report on your return. If the child does not have qualified dividends, Alaska Permanent Fund dividends, or
capital gain distributions, this is the amount on line 6 of Form 8814, Parents' Election To Report Child's Interest and Dividends.
Child's qualified dividends.
If part of the amount you report is your child's qualified dividends, that part (which is reported on line 9b of Form 1040 or Form 1040A) generally
does not count as investment income. However, you can choose to include all or part of it in investment income, as explained under Choosing to
include qualified dividends, earlier.
Your investment income also includes the amount on Form 8814, line 6, (or, if applicable, the amount figured next under Child's Alaska
Permanent Fund dividends).
Child's Alaska Permanent Fund dividends.Alaska Permanent Fund dividends:Child's dividends
If part of the amount you report is your child's Alaska Permanent Fund dividends, that part does not count as investment income. To figure the
amount of your child's income that you can consider your investment income, start with the amount on Form 8814, line 6. Multiply that amount by a
percentage that is equal to the Alaska Permanent Fund dividends divided by the total amount of interest and dividend income on Form 8814, lines 1a and
2. Subtract the result from the amount on Form 8814, line 6.
Child's capital gain distributions.
Capital gains or losses:Child's distributions and dividends, reporting ofForm:1040:Child's capital gain distributionsForm:1040, Schedule DChild's capital gain distributionsIf part of the amount you report is your child's capital gain distributions, that
part (which is reported on Schedule D, line 13 or Form 1040, line 13) generally does not count as investment income. However, you can choose to
include all or part of it in investment income, as explained in Choosing to include net capital gain, earlier.
Your investment income also includes the amount on Form 8814, line 6, (or, if applicable, the amount figured under Child's Alaska Permanent
Fund dividends, earlier).
Investment expenses include all income-producing expenses (other than interest expense) relating to investment property that are allowable
deductions after applying the 2% limit that applies to miscellaneous itemized deductions. Use the smaller of:
The investment expenses included on Schedule A (Form 1040), line 22, or
Losses from passive activities.Passive activity:Losses
Income or expenses that you used in computing income or loss from a passive activity are not included in determining your investment income or
investment expenses (including investment interest expense). See Publication 925, Passive Activity and At-Risk Rules, for information about passive
activities.
Form 4952Form:4952:Investment interest expense deduction
Use Form 4952, Investment Interest Expense Deduction, to figure your deduction for investment interest.
Exception to use of Form 4952.
You do not have to complete Form 4952 or attach it to your return if you meet all of the following tests.
Your investment interest expense is not more than your investment income from interest and ordinary dividends minus any qualified
dividends.
You have no other deductible investment expenses.
You have no disallowed investment interest expense from 2004.
If you meet all of these tests, you can deduct all of your investment interest.
More Information
For more information on investment interest, see Investment Expenses in chapter 3 of Publication 550.
Items You
Cannot DeductDeductions:InterestInterest paymentsInterest payments:Deductions:Not allowed
Some interest payments are not deductible. Certain expenses similar to interest also are not deductible. Nondeductible expenses include the
following items.
Personal interest (discussed later).
Interest payments:Personal interest not deductiblePersonal interest:Not deductible
Service charges (however, see Other Expenses in chapter 28).
Service charges:Deductibility of
Annual fees for credit cards.
Credit cards:Annual fees, not deductible
Loan fees.
Borrowed fundsLoansLoans:Fees for, not deductible
Credit investigation fees.
Credit reports:Fees for, not deductible
FHA mortgage insurance premiums and VA funding fees.
Insurance premiums:FHA mortgage insurance premiums, not deductibleMortgages:FHA mortgage insurance premiums and VA funding fees, not deductibleVeterans Affairs (VA):Funding fees, not deductible as interest
Interest to purchase or carry tax-exempt securities.
Securities:Tax-exempt:Interest to purchase or carry, not deductible
Penalties.Deductions:Penalties, no deduction permittedPenalties:Deductibility
You cannot deduct fines and penalties paid to a government for violations of law, regardless of their nature.
Personal InterestInterest payments:Personal interest not deductiblePersonal interest:Not deductible
Personal interest is not deductible. Personal interest is any interest that is not home mortgage interest, investment interest, business interest,
or other deductible interest. It includes the following items.
Interest on car loans (unless you use the car for business).
Cars:Interest on loans, not deductible
Interest on federal, state, or local income tax.
Federal income tax:Interest on, not deductibleIncome taxesFederal income taxState or local income taxes:Interest on, not deductible
Finance charges on credit cards, retail installment contracts, and revolving charge accounts incurred for personal expenses.
Credit cards:Finance charges, not deductibleFinance charges:Credit cards, retail installment contracts, etc., not deductibleRetail installment contracts:Finance charges, not deductibleRevolving charge accounts:Finance charges, not deductible
Late payment charges by a public utility.
Late payment:Public utility charges, not deductiblePublic utilitiesUtilitiesUtilities:Late payment charges, not deductible
You may be able to deduct interest you pay on a qualified student loan. For details, see Publication 970.
Allocation of InterestInterest payments:Allocation of interest according to use of loan
If you use the proceeds of a loan for more than one purpose (for example, personal and business), you must allocate the interest on the loan to
each use. However, you do not have to allocate home mortgage interest if it is fully deductible, regardless of how the funds are used.
You allocate interest (other than fully deductible home mortgage interest) on a loan in the same way as the loan itself is allocated. You do this
by tracing disbursements of the debt proceeds to specific uses. For details on how to do this, see chapter 5 of Publication 535.
How To Report
Deductions:InterestInterest paymentsInterest payments:Deductions:Reporting ofInterest payments:Reporting of deductionsDeductions:Mortgage interestMortgagesYou must file Form 1040 to deduct any home mortgage interest or investment interest on your tax return. Where you deduct
your interest expense generally depends on how you use the loan proceeds. See Table 23-1 for a summary of where to deduct your interest expense.
Home mortgage interest and points.Mortgages:Interest deduction:Schedule A (Form 1040) to deductMortgages:PointsPoints:Schedule A (Form 1040) to deduct
Deduct the home mortgage interest and points reported to you on Form 1098 on Schedule A (Form 1040), line 10. If you paid more deductible interest
to the financial institution than the amount shown on Form 1098, show the larger deductible amount on line 10. Attach a statement explaining the
difference and print See attached next to line 10.
Form:W-9:TIN of home seller and purchaserPenalties:Failure to provide social security number or TIN:Home seller and purchaserSale of home:Interest paid to seller, reporting ofDeduct home mortgage interest that was not reported to you on Form 1098 on Schedule A
(Form 1040), line 11. If you paid home mortgage interest to the person from whom you bought your home, show that person's name, address, and taxpayer
identification number (TIN) on the dotted lines next to line 11. The seller must give you this number and you must give the seller your TIN. A Form
W-9 can be used for this purpose. Failure to meet any of these requirements may result in a $50 penalty for each failure. The TIN can be either a
social security number, an individual taxpayer identification number (issued by the Internal Revenue Service), or an employer identification number.
See Social Security Number in chapter 1 for more information about TINs.
Points:Schedule A (Form 1040) to deductIf you can take a deduction for points that were not reported to you on Form 1098, deduct
those points on Schedule A (Form 1040), line 12.
More than one borrower.Form:1098:More than one borrower (not spouse), reporting of mortgage interest deduction by attaching ofMortgages:More than one borrower (not spouse), reporting of interest deduction
If you and at least one other person (other than your spouse if you file a joint return) were liable for and paid interest on a mortgage that was
for your home, and the other person received a Form 1098 showing the interest that was paid during the year, attach a statement to your return
explaining this. Show how much of the interest each of you paid, and give the name and address of the person who received the form. Deduct your share
of the interest on Schedule A (Form 1040), line 11, and print See attached next to the line.
Similarly, if you are the payer of record on a mortgage on which there are other borrowers entitled to a deduction for the interest shown on the
Form 1098 you received, deduct only your share of the interest on Schedule A (Form 1040), line 10. You should let each of the other borrowers know
what his or her share is.
Mortgage proceeds used for business or investment.
Mortgages:Proceeds used for business or investment, deduction ofDeductions:InterestInterest paymentsInterest payments:Deductions:Forms to use (Table 23-1)Tables and figures:Interest deductions, forms to use (Table 23-1)If your home mortgage interest deduction is limited but all or part of the
mortgage proceeds were used for business, investment, or other deductible activities, see Table 23-1. It shows where to deduct the part of your excess
interest that is for those activities.
Investment interest.
Form:1040, Schedule AInvestment interest deductionDeduct investment interest, subject to certain limits discussed in Publication 550, on
Schedule A (Form 1040), line 13.
Amortization of bond premium.Amortization:Bond premiums, treatment ofBonds:Amortization of premium
There are various ways to treat the premium you pay to buy taxable bonds. See Bond Premium Amortization in Publication 550.
Income-producing rental or royalty interest.Form:1040, Schedule EIncome-producing property, deduction of interest on loan forIncome-producing property:Deduction of interest on loan for
Deduct interest on a loan for income-producing rental or royalty property that is not used in your business in Part I of Schedule E (Form 1040).
Example.
Interest paymentsYou rent out part of your home and borrow money to make repairs. You can deduct only the interest
payment for the rented part in Part I of Schedule E (Form 1040). Deduct the rest of the interest payment on Schedule A (Form 1040) if it is deductible
home mortgage interest.
Interest payments:Deductions:Forms to use (Table 23-1)Tables and figures:Interest deductions, forms to use (Table 23-1)
<ROM>Table 23-1.</ROM> Where To Deduct Your Interest ExpenseIF you have ...THEN deduct it on ...AND for more information go to ...Deductible student loan interestForm 1040, line 33 or Form 1040A, line 18Publication 970Deductible home mortgage interest and points reported on Form 1098Schedule A (Form 1040), line 10Publication 936Deductible home mortgage interest not reported on Form 1098Schedule A (Form 1040), line 11Publication 936 Deductible points not reported on Form 1098Schedule A (Form 1040), line 12Publication 936 Deductible investment interest (other than interest incurred to produce rents or royalties)Schedule A (Form 1040), line 13Publication 550Deductible business interest (non-farm)Schedule C or C-EZ (Form 1040)Publication 535Deductible farm business interestSchedule F (Form 1040)Publications 225 and 535Deductible interest incurred to produce rents or royaltiesSchedule E (Form 1040)Publications 527 and 535Personal interestNot Deductible
ContributionsCharitable contributionsContributionsDeductions:Charitable contributionsContributionsCharitable contributionsDeductions:Charitable contributionsCharitable contributionsSalvation ArmyCharitable contributionsWhat's New for 2005Katrina Emergency Tax Relief Act of 2005.
This Act provides tax relief for persons affected by Hurricane Katrina. Under the Act, you may be able to:
Use a higher standard mileage rate,
Exclude mileage reimbursements from income, and
Claim a deduction in excess of the usual limits shown in Limits on Deductions in this chapter.
See Publication 4492.
Contributions of cars, boats, and airplanes.Planes:AircraftForm:1098-CContributions of Motor Vehicles, Boats and Airplanes
If you donate a car, boat, or airplane to a qualified organization after 2004, your deduction generally is limited to the gross proceeds from its
sale by the organization. This rule applies if the claimed value of the donated vehicle is more than $500.
For exceptions and more information, see Cars, Boats and Airplanes under Contributions of Property.
RemindersDisaster relief.Deductions:Disaster relief contributions to qualified organizationsDisaster relief:Deductions for contributions to qualified organizations
You can deduct contributions earmarked for flood relief, hurricane relief, or other disaster relief to a qualified organization (defined later
under Organizations That Qualify To Receive Deductible Contributions). However, you cannot deduct contributions earmarked for relief of a
particular individual or family.
Written acknowledgment required.Charitable contributions:Written acknowledgment from recipient organizationRecordkeeping requirements:Charitable contributions
You can claim a deduction for a contribution of $250 or more only if you have a written acknowledgment of your contribution from the qualified
organization or if you have certain payroll deduction records. For more information, see Records To Keep, later in this chapter.
Payment partly for goods or services.Charitable contributions:Payment partly for goods or services
A qualified organization must give you a written statement if you make a payment that is more than $75 and is partly a contribution and partly for
goods or services. The statement must tell you that you can deduct only the amount of your payment that is more than the value of the goods or
services you received. It must also give you a good faith estimate of the value of those goods or services. See Contributions From Which You
Benefit, later in this chapter, for more information.
Limit on itemized deductions.Charitable contributions:Itemized deductions, limit onItemized deductions:Limits on:Charitable donations, deduction for
If your adjusted gross income is more than $145,950 ($72,975 if you are married filing separately), the overall amount of your itemized deductions
may be limited. See chapter 29 for more information about this limit.
This chapter explains how to claim a deduction for your charitable contributions. It discusses:
Organizations that are qualified to receive deductible charitable contributions,
The types of contributions you can deduct,
How much you can deduct,
What records to keep, and
How to report your charitable contributions.
Charitable contributions:Definition ofA charitable contribution is a donation or gift to, or for the use of, a qualified organization. It is
voluntary and is made without getting, or expecting to get, anything of equal value.
Form 1040 required.Form:1040:Charitable contributions, deduction to be itemized
Form:1040, Schedule ACharitable contributionsTo deduct a charitable contribution, you must file Form 1040 and itemize deductions on
Schedule A. The amount of your deduction may be limited if certain rules and limits explained in this chapter apply to you.
Publication78Cumulative List of Organizations526Charitable Contributions561Determining the Value of Donated PropertyForm (and Instructions)Itemized DeductionsNoncash Charitable Contributions
Organizations That Qualify To Receive Deductible ContributionsCharitable contributions:Qualified organizations
You can deduct your contributions only if you make them to a qualified organization. To become a qualified organization, most organizations other
than churches and governments, as described below, must apply to the IRS.
Charitable contributions:Publication 78, list of qualified organizationsPublication 78:List of qualified organizations for charitable contributions
You can ask any organization whether it is a qualified organization, and most will be able to tell you. Or you can check IRS Publication 78, which
lists most qualified organizations. You may find Publication 78 in your local library's reference section, or on the internet at
www.irs.gov. You can also call the IRS Tax Exempt/Government Entities Customer Service at
1-877-829-5500 to find out if an organization is qualified.
Types of Qualified OrganizationsCharitable contributions:Qualified organizations:Types of
Generally, only the five following types of organizations can be qualified organizations.
A community chest, corporation, trust, fund, or foundation organized or created in or under the laws of the United States, any state, the
District of Columbia, or any possession of the United States (including Puerto Rico). It must be organized and operated only for one or more of the
following purposes.
Religious.
Religious organizations:Charitable contributions to
Charitable.
Educational.
Educational organizations:Charitable contributions to
Scientific.
Scientific organizations:Charitable contributions to
Literary.
The prevention of cruelty to children or animals.
Prevention of cruelty to children or animals organizations:Charitable contributions
Amateur sports organizations:Charitable contributions toCertain organizations that foster national or international amateur sports competition also
qualify.
War veterans' organizations, including posts, auxiliaries, trusts, or foundations, organized in the United States or any of its possessions.
Domestic fraternal societies, orders, and associations operating under the lodge system.
Note. Your contribution to this type of organization is deductible only if it is to be used solely for charitable, religious,
scientific, literary, or educational purposes, or for the prevention of cruelty to children or animals.
Fraternal societies:Charitable contributions to
Certain nonprofit cemetery companies or corporations.
Note. Your contribution to this type of organization is not deductible if it can be used for the care of a specific lot or mausoleum
crypt.
Cemeteries:Charitable contributions to
The United States or any state, the District of Columbia, a U.S. possession (including Puerto Rico), a political subdivision of a state or
U.S. possession, or an Indian tribal government or any of its subdivisions that perform substantial government functions.
Note. To be deductible, your contribution to this type of organization must be made solely for public purposes.
Federal government:Charitable contributions toState or local governments:Charitable contributions toUnited Statesheadings starting with Federal or U.S.U.S. possessions:Charitable contributions to
Churches, a convention or association of churches, temples, synagogues, mosques, and other religious organizations.
Most nonprofit charitable organizations such as the Red Cross and the United Way.
Red Cross:Charitable contributions toUnited WayCharitable contributions
Most nonprofit educational organizations, including the Boy and Girl Scouts of America, colleges, museums, and day-care centers if
substantially all the child care provided is to enable individuals (the parents) to be gainfully employed and the services are available to the
general public. However, if your contribution is a substitute for tuition or other enrollment fee, it is not deductible as a charitable contribution,
as explained later under Contributions You Cannot Deduct.
Boy Scouts:Charitable contributions toColleges and universities:Charitable contributions toEducational organizations:Charitable contributions toGirl Scouts:Charitable contributions toHigher educationColleges and universitiesMuseums:Charitable contributions toUniversitiesColleges and universities
Nonprofit hospitals and medical research organizations.
Hospitals:Charitable contributions to nonprofitsMedical research organizations:Charitable contributions to
Utility company emergency energy programs, if the utility company is an agent for a charitable organization that assists individuals with
emergency energy needs.
Utilities:Emergency energy programs, charitable contributions to
Nonprofit volunteer fire companies.
Firefighters:Volunteer firefighters:Charitable contributions toVolunteer firefighters:Charitable contributions to
Public parks and recreation facilities (but not entry or usage fees).
Parks and recreation facilities:Charitable contributions toPublic parks and recreation facilities:Charitable contributions to
Civil defense organizations.
Civil defense organizations:Charitable contributions to
Certain foreign charitable organizations.Foreign organizations:Charitable contributions toTreaties:Foreign charitable organizations, contributions to
Canada:Contributions to charitable organizations inIsrael:Contributions to charitable organizations inMexico:Contributions to charitable organizations inUnder income tax treaties with Canada, Israel, and Mexico, you may be able to
deduct contributions to certain Canadian, Israeli, or Mexican charitable organizations. Generally, you must have income from sources in that country.
For additional information on the deduction of contributions to Canadian charities, see Publication 597, Information on the United States–Canada
Income Tax Treaty. If you need more information on how to figure your contribution to Mexican and Israeli charities, see Publication 526.
Contributions
You Can Deduct
Generally, you can deduct your contributions of money or property that you make to, or for the use of, a qualified organization. A gift or
contribution is for the use of a qualified organization when it is held in a legally enforceable trust for the qualified organization or in a
similar legal arrangement.
Charitable contributions:Fair market value of property contributionsIf you give property to a qualified organization, you generally can deduct the
fair market value of the property at the time of the contribution. See Contributions of Property, later in this chapter.
Charitable contributions:Deductions:Limits onYour deduction for charitable contributions is generally limited to 50% of your adjusted gross income, but in
some cases 20% and 30% limits may apply. See Limits on Deductions, later.
Table 24-1 lists some examples of contributions you can deduct and some that you cannot deduct.
Contributions From
Which You BenefitCharitable contributions:Benefit received as result of contribution
If you receive a benefit as a result of making a contribution to a qualified organization, you can deduct only the amount of your contribution that
is more than the value of the benefit you receive.
If you pay more than fair market value to a qualified organization for merchandise, goods, or services, the amount you pay that is more than the
value of the item can be a charitable contribution. For the excess amount to qualify, you must pay it with the intent to make a charitable
contribution.
Example 1.
You pay $65 for a ticket to a dinner-dance at a church. All of the proceeds of the function go to the church. The ticket to the dinner-dance has a
fair market value of $25. When you buy your ticket, you know that its value is less than your payment. To figure the amount of your charitable
contribution, you subtract the value of the benefit you receive ($25) from your total payment ($65). You can deduct $40 as a contribution to the
church.
Example 2.
Fund-raising events:Charitable contributions, amount deductibleAt a fund-raising auction conducted by a charity, you pay $600 for a week's stay
at a beach house. The amount you pay is no more than the fair rental value. You have not made a deductible charitable contribution.
If you make a payment to, or for the benefit of, a college or university and, as a result, you receive the right to buy tickets to an athletic
event in the athletic stadium of the college or university, you can deduct 80% of the payment as a charitable contribution.
If any part of your payment is for tickets (rather than the right to buy tickets), that part is not deductible. In that case, subtract the price of
the tickets from your payment. 80% of the remaining amount is a charitable contribution.
Example 1.
You pay $300 a year for membership in an athletic scholarship program maintained by a university (a qualified organization). The only benefit of
membership is that you have the right to buy one season ticket for a seat in a designated area of the stadium at the university's home football games.
You can deduct $240 (80% of $300) as a charitable contribution.
<ROM>Table 24-1.</ROM> Examples of Charitable Contributions—A Quick CheckCharitable contributions:Deductions:Examples of (Table 24-1)Tables and figures:Charitable contributions, deductibility of (Table 24-1)Volunteer work:Out-of-pocket expenses, deductible when serving for qualified organizationUse the following lists for a quick check of contributions you can or cannot deduct. See the rest of this chapter
for more information and additional rules and limits that may apply.Deductible AsCharitable ContributionsNot DeductibleAs Charitable ContributionsMoney or property you give to:
Churches, synagogues, temples, mosques, and other religious organizations
Armed forcesVeterans' organizationsVeterans' organizations:Charitable contributions toWar veterans' organizationsVeterans' organizationsMoney or property you give to:
Civic leagues, social and sports clubs, labor unions, and chambers of commerce
Chambers of commerce:Charitable contributions toCivic associations:Contributions to, no charitable deduction forLabor unions:Contributions to, no charitable deduction forSocial clubs:Contributions to, no charitable deduction for
Foreign organizations (except certain Canadian, Israeli, and Mexican charities)
Foreign organizations:Charitable contributions to
Groups that are run for personal profit
Groups whose purpose is to lobby for law changes
Lobbying:Contributions for, not charitable deductions
Homeowners' associations
Homeowners' associations:Charitable contributions to
Individuals
Charitable contributions:To individuals, not deductibleSingle taxpayers:Charitable contributions to, no deduction for
Political groups or candidates for public office
BingoBlood banks:No charitable deduction for blood donations toCampaign contributionsCandidates for public office:Contributions to, no charitable deduction forContributionsCampaign contributionsCountry clubs:Dues:Charitable deduction not allowedFraternal societies:Dues, no charitable deductionLodgesSocial clubsLotteries and raffles:No charitable deduction for ticketsPolitical contributionsCampaign contributionsRaffles:No charitable deduction for ticketsRed Cross:Blood donations not deductibleServices:No charitable deduction for value ofTuition:Charitable deduction not allowed for payingValue of time or services:No charitable deduction forCosts you pay for a student living with you, sponsored by a qualified organizationNoncharitable payments to federal, state, and local governmentsOut-of-pocket expenses when you serve a qualified organization as a volunteerCost of raffle, bingo, or lottery ticketsDues, fees, or bills paid to country clubs, lodges, fraternal orders, or similar
groupsTuitionValue of your time or servicesValue of blood given to a blood bank
Example 2.
The facts are the same as in Example 1 except that your $300 payment included the purchase of one season ticket for the stated ticket price of
$120. You must subtract the usual price of a ticket ($120) from your $300 payment. The result is $180. Your deductible charitable contribution is $144
(80% of $180).
Charity benefit events.Charity benefit events:Deduction amount for charitable contributions
If you pay a qualified organization more than fair market value for the right to attend a charity ball, banquet, show, sporting event, or other
benefit event, you can deduct only the amount that is more than the value of the privileges or other benefits you receive.
If there is an established charge for the event, that charge is the value of your benefit. If there is no established charge, your contribution is
that part of your payment that is more than the reasonable value of the right to attend the event. Whether you use the tickets or other privileges has
no effect on the amount you can deduct. However, if you return the ticket to the qualified organization for resale, you can deduct the entire amount
you paid for the ticket.
Even if the ticket or other evidence of payment indicates that the payment is a contribution, this does not mean you can deduct the entire
amount. If the ticket shows the price of admission and the amount of the contribution, you can deduct the contribution amount.
Example.
You pay $40 to see a special showing of a movie for the benefit of a qualified organization. Printed on the ticket is
Contribution—$40. If the regular price for the movie is $8, your contribution is $32 ($40 payment − $8 regular price).
Membership fees or dues.Membership feesspecific type of organization
Country clubs:Dues:Charitable deduction not allowedYou may be able to deduct membership fees or dues you pay to a qualified organization.
However, you can deduct only the amount that is more than the value of the benefits you receive. You cannot deduct dues, fees, or assessments paid to
country clubs and other social organizations. They are not qualified organizations.
Certain membership benefits can be disregarded.
Both you and the organization can disregard certain membership benefits you get in return for an annual payment of $75 or less to the qualified
organization. You can pay more than $75 to the organization if the organization does not require a larger payment for you to get the benefits. The
following benefits are covered under this rule.
Any rights or privileges, other than those discussed under Athletic events, earlier, that you can use frequently while you are a
member, such as:
Free or discounted admission to the organization's facilities or events,
Free or discounted parking,
Preferred access to goods or services, and
Discounts on the purchase of goods and services.
Admission, while you are a member, to events that are open only to members of the organization, if the organization reasonably projects that
the cost per person (excluding any allocated overhead) is not more than $8.30.
Token items.Charitable contributions:Token items given by recipients
You can deduct your entire payment to a qualified organization as a charitable contribution if both of the following are true.
You get a small item or other benefit of token value.
The qualified organization correctly determines that the value of the item or benefit you received is not substantial and informs you that
you can deduct your payment in full.
Written statement.Charitable contributions:Qualified organizations:Written statement from
A qualified organization must give you a written statement if you make a payment to it that is more than $75 and is partly a contribution and
partly for goods or services. The statement must tell you that you can deduct only the amount of your payment that is more than the value of the goods
or services you received. It must also give you a good faith estimate of the value of those goods or services.
The organization can give you the statement either when it solicits or when it receives the payment from you.
Exception.
An organization will not have to give you this statement if one of the following is true.
The organization is:
The type of organization described in (5) under Types of Qualified Organizations, earlier, or
Formed only for religious purposes, and the only benefit you receive is an intangible religious benefit (such as admission to a religious
ceremony) that generally is not sold in commercial transactions outside the donative context.
You receive only items whose value is not substantial. See Token items, earlier.
MosquesChurches, temples, etc.Religious organizations:Charitable contributions to:Written statement not neededSynagoguesChurches, temples, etc.TemplesChurches, temples, etc.
You receive only membership benefits that can be disregarded, as described earlier.
Expenses Paid for Student Living With YouExchange students:Expenses paid for, deductible when under agreement with qualified organizationForeign students:Expenses paid for, deductible when under agreement with qualified organizationStudents:Foreign students
You may be able to deduct some expenses of having a student live with you. You can deduct qualifying expenses for a foreign or American student
who:
Lives in your home under a written agreement between you and a qualified organization as part of a program of the organization to provide
educational opportunities for the student,
Is not your relative or dependent, and
Is a full-time student in the twelfth or any lower grade at a school in the United States.
You can deduct up to $50 a month for each full calendar month the student lives with you. Any month when conditions (1) through (3) above are met
for 15 days or more counts as a full month.
For additional information, see Expenses Paid for Student Living With You in Publication 526.
Mutual exchange program.
You cannot deduct the costs of a foreign student living in your home under a mutual exchange program through which your child will live with a
family in a foreign country.
<ROM>Table 24-2.</ROM> Volunteers' Questions and AnswersCharitable contributions:Volunteers, deductibility of contributions (Table 24-2)Tables and figures:Volunteers, deductibility of contributions (Table 24-2)Value of time or services:No charitable deduction forVolunteer work:Deductibility of contributions (Table 24-2)If you do volunteer work for a qualified organization, the following questions and answers may apply to you. All
of the rules explained in this chapter also apply. See, in particular, Out-of-Pocket Expenses in Giving Services. QuestionAnswerI do volunteer work 6 hours a week in the office of a qualified organization. The receptionist is paid $6 an hour to do the same
work I do. Can I deduct $36 a week for my time?
No, you cannot deduct the value of your time or services.The office is 30 miles from my home. Can I deduct any of my car expenses for these trips?Yes, you can deduct the costs of gas and oil that are directly related to getting to and from the place where you are a
volunteer. If you don't want to figure your actual costs, you can deduct 14 cents for each mile.I volunteer as a Red Cross nurse's aide at a hospital. Can I deduct the cost of uniforms that I must wear?Yes, you can deduct the cost of buying and cleaning your uniforms if the hospital is a qualified organization, the uniforms are
not suitable for everyday use, and you must wear them when volunteering.I pay a babysitter to watch my children while I do volunteer work for a qualified organization. Can I deduct these
costs?No, you cannot deduct payments for child care expenses as a charitable contribution, even if they are necessary so you can do
volunteer work for a qualified organization. (If you have child care expenses so you can work for pay, see chapter 32.)
Out-of-Pocket Expenses in Giving ServicesVolunteer work:Out-of-pocket expenses, deductible when serving for qualified organization
You may be able to deduct some amounts you pay in giving services to a qualified organization. The amounts must be:
Unreimbursed,
Directly connected with the services,
Expenses you had only because of the services you gave, and
Not personal, living, or family expenses.
Table 24-2 contains questions and answers that apply to some individuals who volunteer their services.
Conventions.Conventions:Delegates:Deduction of unreimbursed expensesTravel and transportation expenses:Conventions:Delegates, deduction of unreimbursed amount
If you are a chosen representative attending a convention of a qualified organization, you can deduct actual unreimbursed expenses for travel and
transportation, including a reasonable amount for meals and lodging, while away from home overnight in connection with the convention. However, see
Travel, later.
You cannot deduct personal expenses for sightseeing, fishing parties, theater tickets, or nightclubs. You also cannot deduct travel, meals and
lodging, and other expenses for your spouse or children.
Churches, temples, etc.:Convention delegates, deduction of unreimbursed expensesReligious organizationsChurches, temples, etc.You cannot deduct your expenses in attending a church convention if you go only as a member of your
church rather than as a chosen representative. You can deduct unreimbursed expenses that are directly connected with giving services for your church
during the convention.
Uniforms.Clothing:Uniforms:Charitable organization requiring, deduction for cost and upkeep ofUniforms:Charitable organization requiring, deduction for cost and upkeep of
You can deduct the cost and upkeep of uniforms that are not suitable for everyday use and that you must wear while performing donated services for
a charitable organization.
Foster parents.Foster care:Charitable deduction for nonprofit care
You may be able to deduct as a charitable contribution some of the costs of being a foster parent (foster care provider) if you have no profit
motive in providing the foster care and are not, in fact, making a profit. A qualified organization must designate the individuals you take into your
home for foster care.
Foster care:Expenses unreimbursed and not deductible as charitable contributionsYou can deduct expenses that meet both of the following
requirements.
They are unreimbursed out-of-pocket expenses to feed, clothe, and care for the foster child.
They must be mainly to benefit the qualified organization.
Unreimbursed expenses that you cannot deduct as charitable contributions may be considered support provided by you in determining whether you can
claim the foster child as a dependent. For details, see chapter 3.
Example.
Adoption:Expenses not deductible:Foster care prior to, no charitable deductionFoster care:Adoption as motive for, no charitable deductionYou cared for a foster child because you wanted to adopt her, not to benefit
the agency that placed her in your home. Your unreimbursed expenses are not deductible as charitable contributions.
Car expenses.Cars:Charitable organization service, use for
You can deduct unreimbursed out-of-pocket expenses, such as the cost of gas and oil, that are directly related to the use of your car in giving
services to a charitable organization. You cannot deduct general repair and maintenance expenses, depreciation, registration fees, or the costs of
tires or insurance.
Mileage ratesStandard mileage ratesStandard mileage rates:Charitable organization service, auto use forTravel and transportation expenses:Mileage ratesStandard mileage ratesIf you do not want to deduct your actual expenses, you can use a standard mileage rate of 14 cents a mile
to figure your contribution.
You can deduct parking fees and tolls whether you use your actual expenses or the standard mileage rate.
You must keep reliable written records of your car expenses. For more information, see Car expenses under Records To Keep,
later.
Travel.Travel and transportation expenses:Charitable organization service, deduction for
Generally, you can claim a charitable contribution deduction for travel expenses necessarily incurred while you are away from home performing
services for a charitable organization only if there is no significant element of personal pleasure, recreation, or vacation in the travel. This
applies whether you pay the expenses directly or indirectly. You are paying the expenses indirectly if you make a payment to the charitable
organization and the organization pays for your travel expenses.
The deduction for travel expenses will not be denied simply because you enjoy providing services to the charitable organization. Even if you enjoy
the trip, you can take a charitable contribution deduction for your travel expenses if you are on duty in a genuine and substantial sense throughout
the trip. However, if you have only nominal duties, or if for significant parts of the trip you do not have any duties, you cannot deduct your travel
expenses.
Example 1.
Youth groups:Troop leader's travel expensesYou are a troop leader for a tax-exempt youth group and you help take the group on a camping
trip. You are responsible for overseeing the setup of the camp and for providing adult supervision for other activities during the entire trip. You
participate in the activities of the group and really enjoy your time with them. You oversee the breaking of camp and you help transport the group
home. You can deduct your travel expenses.
Example 2.
You sail from one island to another and spend 8 hours a day counting whales and other forms of marine life. The project is sponsored by a
charitable organization. In most circumstances, you cannot deduct your expenses.
Example 3.
You work for several hours each morning on an archaeological dig sponsored by a charitable organization. The rest of the day is free for recreation
and sightseeing. You cannot take a charitable contribution deduction even though you work very hard during those few hours.
Example 4.
You spend the entire day attending a charitable organization's regional meeting as a chosen representative. In the evening you go to the theater.
You can claim your travel expenses as charitable contributions, but you cannot claim the cost of your evening at the theater.
Daily allowance (per diem).Daily allowancePer diemPer diem:Charitable organization service, for
If you provide services for a charitable organization and receive a daily allowance to cover reasonable travel expenses, including meals and
lodging while away from home overnight, you must include in income the amount of the allowance that is more than your deductible travel expenses. You
can deduct your necessary travel expenses that are more than the allowance.
Deductible travel expenses.Travel and transportation expenses:Charitable organization service, deduction for
These include:
Air, rail, and bus transportation,
Out-of-pocket expenses for your car,
Taxi fares or other costs of transportation between the airport or station and your hotel,
Lodging costs, and
The cost of meals.
Because these travel expenses are not business-related, they are not subject to the same limits as business-related expenses. For information
on business travel expenses, see Travel Expenses in chapter 26.
Contributions
You Cannot DeductCharitable contributions:Not deductible
There are some contributions you cannot deduct, such as those made to specific individuals and those made to nonqualified organizations. (See
Contributions to Individuals and Contributions to Nonqualified Organizations, next). There are others you can deduct only part
of, as discussed later under Contributions From Which You Benefit.
Contributions to IndividualsCharitable contributions:To individuals, not deductibleSingle taxpayers:Charitable contributions to, no deduction for
You cannot deduct contributions to specific individuals, including the following:
Contributions to fraternal societies made for the purpose of paying medical or burial expenses of deceased members.
Burial expensesFuneralsDecedentsFuneral expensesFunerals:Expenses:Contributions to cover, not deductible as charitable donationsMedical and dental expenses:Contributions to cover, not deductible as charitable donations
Contributions to individuals who are needy or worthy. This includes contributions to a qualified organization if you indicate that your
contribution is for a specific person. But you can deduct a contribution that you give to a qualified organization that in turn helps needy or worthy
individuals if you do not indicate that your contribution is for a specific person.
Payments to a member of the clergy that can be spent as he or she wishes, such as for personal expenses.
Clergy:Contributions that can be spent as individual wishes, not deductible charitable contribution
Expenses you paid for another person who provided services to a qualified organization.
Example. Your son does missionary work. You pay his expenses. You cannot claim a deduction for your son's unreimbursed expenses related
to his contribution of services.
Payments to a hospital that are for services for a specific patient. You cannot deduct these payments even if the hospital is operated by a
city, a state, or other qualified organization.
Hospitals:Payments for services for specific patient, not deductible as charitable contributions
Contributions to Nonqualified OrganizationsCharitable contributions:Nonqualified organizations
You cannot deduct contributions to organizations that are not qualified to receive tax-deductible contributions, including the following.
Certain state bar associations if:
The state bar is not a political subdivision of a state,
The bar has private, as well as public, purposes, such as promoting the professional interests of members, and
Your contribution is unrestricted and can be used for private purposes.
Bar associations:Charitable contributions toState bar associations:Charitable contributions to
Chambers of commerce and other business leagues or organizations (but see chapter 28).
Business organizations:Charitable contributions toChambers of commerce:Charitable contributions to
Civic leagues and associations.
Civic associations:Charitable contributions to
Communist organizations.
Communist organizations:Charitable contributions to
Country clubs and other social clubs.
Country clubs:Charitable contributions to
Foreign organizations other than:
A U.S. organization that transfers funds to a charitable foreign organization if the U.S. organization controls the use of the funds or if
the foreign organization is only an administrative arm of the U.S. organization, or
Certain Canadian, Israeli, or Mexican charitable organizations. See Certain foreign charitable organizations under
Organizations That Qualify To Receive Deductible Contributions, earlier.
Canada:Contributions to charitable organizations inIsrael:Contributions to charitable organizations inMexico:Contributions to charitable organizations in
Foreign organizations:Charitable contributions to
Homeowners' associations.
Homeowners' associations:Charitable contributions to
Labor unions (but see chapter 28).
Deductions:Union duesLabor unionsLabor unions:Dues and fees
Political organizations and candidates.
Campaign contributionsCandidates for public office:Contributions to, no charitable deduction forContributionsCampaign contributionsPolitical contributionsCampaign contributions
Contributions From
Which You BenefitCharitable contributions:Benefit received as result of contribution
If you receive or expect to receive a financial or economic benefit as a result of making a contribution to a qualified organization, you cannot
deduct the part of the contribution that represents the value of the benefit you receive. These contributions include the following.
Contributions for lobbying. This includes amounts that you earmark for use in, or in connection with, influencing specific legislation.
Lobbying:Contributions for, not charitable deductions
Contributions to a retirement home that are clearly for room, board, maintenance, or admittance. Also, if the amount of your contribution
depends on the type or size of apartment you will occupy, it is not a charitable contribution.
Costs of raffles, bingo, lottery, etc. You cannot deduct as a charitable contribution amounts you pay to buy raffle or lottery tickets or to
play bingo or other games of chance. For information on how to report gambling winnings and losses, see chapters 12 and 28.
BingoLotteries and raffles:No charitable deduction for ticketsRaffles:No charitable deduction for tickets
Dues to fraternal orders and similar groups. However, see Membership fees or dues, earlier, under Contributions You Can
Deduct.
Fraternal societies:Dues, no charitable deduction
Tuition, or amounts you pay instead of tuition, even if you pay them for children to attend parochial schools or qualifying nonprofit
day-care centers. You also cannot deduct any fixed amount you may be required to pay in addition to the tuition fee to enroll in a private school,
even if it is designated as a donation.
Parochial school tuition:No charitable deductionPrivate schools:Charitable deduction for tuitionTuition:Charitable deduction not allowed for paying
Value of Time or ServicesValue of time or services:No charitable deduction for
You cannot deduct the value of your time or services, including:
Blood donations to the Red Cross or to blood banks, and
Blood banks:No charitable deduction for blood donations toRed Cross:Blood donations not deductible
The value of income lost while you work as an unpaid volunteer for a qualified organization.
Volunteer work:Value of income lost by, not deductible
Personal ExpensesAdoption:CreditsAdoption:Expenses not deductible:No charitable deduction forFamilyAdoption creditAdoption
You cannot deduct personal, living, or family expenses, such as:
The cost of meals you eat while you perform services for a qualified organization unless it is necessary for you to be away from home
overnight while performing the services, or
Adoption expenses, including fees paid to an adoption agency and the costs of keeping a child in your home before adoption is final (but see
Adoption Credit in chapter 37, and the instructions for Form 8839, Qualified Adoption Expenses).Adoption:Exemption for childChildrenAdoption
You also may be able to claim an exemption for the child. See Adopted child in chapter 3.
Appraisal FeesAppraisal fees:Donated property
Fees that you pay to find the fair market value of donated property are not deductible as contributions (but see chapter 28).
Contributions
of PropertyCharitable contributions:Property contributions
If you contribute property to a qualified organization, the amount of your charitable contribution is generally the fair market value of the
property at the time of the contribution. However, if the property has increased in value, you may have to make some adjustments to the amount of your
deduction. See Giving Property That Has Increased in Value, later.
For information about the records you must keep and the information you must furnish with your return if you donate property, see Records To
Keep and How To Report, later.
Cars, boats, and airplanes.
Cars Travel and transportationDonations ofBoats, donations ofAirplanes, donations ofThe following rules apply to any donation of a car to a qualified organization after December 31, 2004.
These rules also apply to any donation of a boat, airplane, or any motor vehicle manufactured mainly for use on public streets, roads, and highways.
Deduction more than $500.
If the qualified organization sells the car and you claim a deduction of more than $500, the following rules apply.
You can deduct the smaller of:
The gross proceeds from the sale of the car by the organization, or
The car's fair market value on the date of the contribution. If the car's fair market value was more than your cost or other basis, you may
have to reduce the fair market value to get the deductible amount, as described under Giving Property That Has Increased in Value in
Publication 526.
Form:1098-CContributions of Motor Vehicles, Boats, and AirplanesYou must attach to your return the copy of the Form 1098-C,
Contributions of Motor Vehicles, Boats, and Airplanes, (or other statement containing the same information as Form 1098-C) you received from the
organization. The Form 1098-C (or other statement) will show the gross proceeds from the sale of the car.
However, different rules apply if exception 1 or exception 2 (described next) applies.
If you do not attach Form 1098-C (or other statement), you cannot deduct your contribution.
You must get Form 1098-C (or other statement) within 30 days of the sale of the car. However, if you donated the car before September 2, 2005, you
must get Form 1098-C (or other statement) within 30 days of the sale of the car or, if later, October 1, 2005.
Exception 1—vehicle used or improved by organization.
If the qualified organization makes a significant intervening use of or material improvement to the car before transferring it and you claim a
deduction of more than $500, the following rules apply.
You generally can deduct the car's fair market value at the time of the contribution. But if the car's fair market value was more than your
cost or other basis, you may have to reduce the fair market value to get the deductible amount, as described under Giving Property That Has
Increased in Value in Publication 526.
You must attach to your return a copy of Form 1098-C (or other statement containing the same information as Form 1098-C).
The Form 1098-C (or other statement) will show whether the qualified organization makes a significant intervening use of or material
improvement to the car.
If you do not attach Form 1098-C (or other statement), you cannot deduct your contribution.
You must get Form 1098-C (or other statement) within 30 days of your donation. However, if you donated the car before September 2, 2005, you have
until October 1, 2005, to get Form 1098-C (or other statement).
Exception 2—vehicle given or sold to needy individual.
If the qualified organization will give the car, or sell it for a price well below fair market value, to a needy individual to further the
organization's charitable purpose, and you claim a deduction of more than $500, the following rules apply.
You generally can deduct the car's fair market value at the time of the contribution. But if the car's fair market value was more than your
cost or other basis, you may have to reduce the fair market value to get the deductible amount, as described under Giving Property That Has
Increased in Value in Publication 526.
You must attach to your return a copy of Form 1098-C (or other statement containing the same information as Form 1098-C).
The Form 1098-C (or other statement) will show whether this exception applies.
If you do not attach Form 1098-C (or other statement), you cannot deduct your contribution.
You must get Form 1098-C (or other statement) within 30 days of your donation. However, if you donated the car before September 2, 2005, you have
until October 1, 2005, to get Form 1098-C (or other statement).
Example.
Anita donates a used car to a qualified organization. A used car guide shows the fair market value for this type of car is $6,000. However, Anita
gets a Form 1098-C from the organization showing the car was sold for $900. Neither exception 1 nor exception 2 applies. If Anita itemizes her
deductions, she can deduct $900 for her donation. She must attach the Form 1098-C to her return.
Deduction $500 or less.
If the qualified organization sells the car for $500 or less and exceptions 1 and 2 (described earlier) do not apply, the following rules apply.
You can deduct the smaller of:
$500, or
The car's fair market value on the date of the contribution. But if the car's fair market value was more than your cost or other basis, you
may have to reduce the fair market value to get the deductible amount, as described under Giving Property That Has Increased in Value in
Publication 526.
If the car's fair market value is $250 or more, you must have a written statement from the qualified organization acknowledging your
donation. The statement must contain the information and meet the tests for an acknowledgement described under Deductions of At Least $250 But
Not More Than $500 under Records To Keep, later.
Partial interest in property.
Generally, you cannot deduct a charitable contribution (not made by a transfer in trust) of less than your entire interest in property.
Right to use property.
A contribution of the right to use property is a contribution of less than your entire interest in that property and is not deductible. For
exceptions and more information, see Partial Interest in Property Not in Trust in Publication 561.
Future interests in tangible personal property.Future interests:Tangible personal property, charitable deduction for
You can deduct the value of a charitable contribution of a future interest in tangible personal property only after all intervening interests in
and rights to the actual possession or enjoyment of the property have either expired or been turned over to someone other than yourself, a related
person, or a related organization.
Future interest.Future interests:Definition of
This is any interest that is to begin at some future time, regardless of whether it is designated as a future interest under state law.
Determining
Fair Market ValueCharitable contributions:Fair market value of property contributions
This section discusses general guidelines for determining the fair market value of various types of donated property.
Fair market value is the price at which property would change hands between a willing buyer and a willing seller, neither having to buy or sell,
and both having reasonable knowledge of all the relevant facts. Publication 561 contains a more complete discussion.
Used clothing and household goods.Clothing:Used clothing, charitable deduction for fair market valueUsed clothing and household goods:Charitable deduction for fair market value
Generally, the fair market value of used clothing and household goods is far less than its original cost.
For used clothing, you should claim as the value the price that buyers of used items actually pay in used clothing stores, such as consignment or
thrift shops. See Household Goods in Publication 561 for information on the valuation of household goods, such as furniture, appliances,
and linens.
Example.
Dawn Greene donated a coat to a thrift store operated by her church. She paid $300 for the coat 3 years ago. Similar coats in the thrift store sell
for $50. The fair market value of the coat is reasonably determined to be $50. Dawn's donation is limited to $50.
Cars, boats, and aircraft.Aircraft:Charitable gift of, deduction for fair market valueBoats:Charitable gift of, deduction for fair market valueCars:Charitable gift of, deduction for fair market value
If you contribute a car, boat, or aircraft to a charitable organization, you must determine its fair market value.
Blue books to determine fair market valueCars:Blue book to determine fair market valueCertain commercial firms and trade organizations publish used car pricing guides,
commonly called blue books, containing complete dealer sale prices or dealer average prices for recent model years. The guides may be published
monthly or seasonally and for different regions of the country. These guides also provide estimates for adjusting for unusual equipment, unusual
mileage, and physical condition. The prices are not official and these publications are not considered an appraisal of any specific donated
property. But they do provide clues for making an appraisal and suggest relative prices for comparison with current sales and offerings in your area.
Example.
You donate a used car in poor condition to a local high school for use by students studying car repair. A used car guide shows the dealer retail
value for this type of car in poor condition is $1,600. However, the guide shows the price for a private party sale of the car is only $750. The fair
market value of the car is considered to be $750.
Large quantities.Charitable contributions:Large quantities of items
If you contribute a large number of the same item, fair market value is the price at which comparable numbers of the item are being sold.
Giving Property That
Has Decreased in ValueCharitable contributions:Property contributions:Decreased in value
If you contribute property with a fair market value that is less than your basis in it, your deduction is limited to its fair market value. You
cannot claim a deduction for the difference between the property's basis and its fair market value.
Giving Property That
Has Increased in ValueCharitable contributions:Property contributions:Increased in value
If you contribute property with a fair market value that is more than your basis in it, you may have to reduce the fair market value by the amount
of appreciation (increase in value) when you figure your deduction.
Your basis in property is generally what you paid for it. See chapter 13 if you need more information about basis.
Different rules apply to figuring your deduction, depending on whether the property is:
Ordinary income property, or
Capital gain property.
Ordinary income property.Charitable contributions:Ordinary income property as donation
Property is ordinary income property if its sale at fair market value on the date it was contributed would have resulted in ordinary income or in
short-term capital gain. Examples of ordinary income property are inventory, works of art created by the donor, manuscripts prepared by the donor, and
capital assets held 1 year or less.
Amount of deduction.
The amount you can deduct for a contribution of ordinary income property is its fair market value minus the amount that would be ordinary income or
short-term capital gain if you sold the property for its fair market value. Generally, this rule limits the deduction to your basis in the property.
Example.
You donate stock that you held for 5 months to your church. The fair market value of the stock on the day you donate it is $1,000, but you paid
only $800 (your basis). Because the $200 of appreciation would be short-term capital gain if you sold the stock, your deduction is limited to $800
(fair market value minus the appreciation).
Capital gain property.Charitable contributions:Capital gain property as donation
Property is capital gain property if its sale at fair market value on the date of the contribution would have resulted in long-term capital gain.
It includes capital assets held more than 1 year, as well as certain real property and depreciable property used in your trade or business and,
generally, held more than 1 year.
Amount of deduction — general rule.Charitable contributions:Fair market value of property contributions
When figuring your deduction for a gift of capital gain property, you usually can use the fair market value of the gift.
Exceptions.
In certain situations, you must reduce the fair market value by any amount that would have been long-term capital gain if you had sold the property
for its fair market value. Generally, this means reducing the fair market value to the property's cost or other basis.
Bargain sales.Bargain sales:As charitable contributionsCharitable contributions:Bargain sales as
A bargain sale of property to a qualified organization (a sale or exchange for less than the property's fair market value) is partly a charitable
contribution and partly a sale or exchange. A bargain sale may result in a taxable gain.
More information.
For more information on donated appreciated property, see Giving Property That Has Increased in Value in Publication 526.
When To DeductCharitable contributions:Deductions:Year to claim deduction
You can deduct your contributions only in the year you actually make them in cash or other property (or in a later carryover year, as explained
later under Carryovers). This applies whether you use the cash or an accrual method of accounting.
Tsunami donations deducted in 2004. If you made a cash contribution in January 2005 for the relief of victims of the December 26, 2004,
Indian Ocean tsunami and chose to deduct it on your 2004 return, you cannot deduct it on your 2005 return.
Time of making contribution.Charitable contributions:Time of making contribution, how to determine
Usually, you make a contribution at the time of its unconditional delivery.
Checks.Checks:As charitable contributions
A check that you mail to a charity is considered delivered on the date you mail it.
Credit card.Credit cards:Charitable contributions charged to
Contributions charged on your credit card are deductible in the year you make the charge.
Pay-by-phone account.
If you use a pay-by-phone account, the date you make a contribution is the date the financial institution pays the amount. This date should be
shown on the statement the financial institution sends to you.
Stock certificate.Stock certificates:Charitable contributions, date of
A gift to a charity of a properly endorsed stock certificate is completed on the date of mailing or other delivery to the charity or to the
charity's agent. However, if you give a stock certificate to your agent or to the issuing corporation for transfer to the name of the charity, your
gift is not completed until the date the stock is transferred on the books of the corporation.
Promissory note.Promissory notes:Charitable contributions, date of
If you issue and deliver a promissory note to a charitable organization as a contribution, it is not a contribution until you make the note
payments.
Option.Options:Charitable contributions, date of
If you grant an option to buy real property at a bargain price to a charitable organization, you cannot take a deduction until the organization
exercises the option.
Borrowed funds.Borrowed funds:Used for charitable contributions, deduction for
If you make a contribution with borrowed funds, you can deduct the contribution in the year you make it, regardless of when you repay the loan.
Limits on DeductionsCharitable contributions:Deductions:Limits on
If your total contributions for the year are 20% or less of your adjusted gross income, you do not need to read this section. The limits discussed
here do not apply to you.
The amount of your deduction is limited to 50% of your adjusted gross income and may be limited to 30% or 20% of your adjusted gross income,
depending on the type of property you give and the type of organization you give it to. These limits are described below.
If your contributions are more than any of the limits that apply, see Carryovers, later.
50% LimitAdjusted gross income (AGI):Charitable contribution deduction limitCharitable contributions:Deductions:50% limit of adjusted gross income
This limit applies to the total of all charitable contributions you make during the year. This means that your deduction for charitable
contributions cannot be more than 50% of your adjusted gross income for the year.
Charitable contributions:Capital gain property as donation:Limit on deductionGenerally, the 50% limit is the only limit that applies to gifts to organizations listed below under
50% limit organizations. But there is one exception. A 30% limit also applies to these gifts if they are gifts of capital gain property for
which you figure your deduction using fair market value without reduction for appreciation. (See Special 30% Limit for Capital Gain Property,
later.)
50% limit organizations.
You can ask any organization whether it is a 50% limit organization and most will be able to tell you. Or you can check IRS Publication 78 or call
the IRS Tax Exempt/Government Entities Customer Service at the number listed earlier under Organizations that Qualify To Receive Deductible
Contributions. The following is a partial list of the types of organizations that are 50% limit organizations.
Churches and conventions or associations of churches. Churches, temples, etc.:Charitable contributions to:50% limit on deductionReligious organizations:Charitable contributions to:50% limit on deduction
Educational organizations with a regular faculty and curriculum that normally have a regularly enrolled student body attending classes on
site. Colleges and universities:Charitable contributions to:50% limit on deductionEducational organizations:Charitable contributions to:50% limit on deduction
Hospitals and certain medical research organizations associated with these hospitals. Hospitals:Charitable contributions to nonprofits:50% limit on deduction
Publicly supported charities.
Private operating foundations.
Private nonoperating foundations that make qualifying distributions of 100% of contributions within 2 months following the
year they receive the contributions.
Certain private foundations whose contributions are pooled in a common fund, the income and principal of which are paid to public charities.
30% LimitAdjusted gross income (AGI):Charitable contribution deduction limitCharitable contributions:Capital gain property as donation:Limit on deductionCharitable contributions:Deductions:30% limit of adjusted gross income
A 30% limit applies to the following gifts.
Gifts to all qualified organizations other than 50% limit organizations. This includes gifts to veterans' organizations, fraternal
societies, nonprofit cemeteries, and certain private nonoperating foundations.
Gifts for the use of any organization. However, if these gifts are of capital gain property, they are subject to the 20% limit, described
later, rather than the 30% limit.
Student living with you.StudentsCharitable deduction for living expenses
Amounts you spend on behalf of a student living with you are subject to the 30% limit. These amounts are considered a contribution for the use of a
qualified organization. See Expenses Paid for Student Living With You, earlier.
Special 30% Limit for
Capital Gain Property
A special 30% limit applies to gifts of capital gain property to 50% limit organizations. (For gifts of capital gain property to other
organizations, see 20% Limit, later.) However, the special 30% limit does not apply when you choose to reduce the fair market value of the
property by the amount that would have been long-term capital gain if you had sold the property. Instead, only the 50% limit applies.
Two separate 30% limits.
This special 30% limit for capital gain property is separate from the other 30% limit. Therefore, the deduction of a contribution subject to one
30% limit does not reduce the amount you can deduct for contributions subject to the other 30% limit. However, the total you deduct cannot be more
than 50% of your adjusted gross income.
Example.
Your adjusted gross income is $50,000. During the year, you gave capital gain property with a fair market value of $15,000 to a 50% limit
organization. You do not choose to reduce the property's fair market value by its appreciation in value. You also gave $10,000 cash to a qualified
organization that is not a 50% limit organization. The $15,000 gift of property is subject to the special 30% limit. The $10,000 cash gift is subject
to the other 30% limit. Both gifts are fully deductible because neither is more than the 30% limit that applies ($15,000 in each case) and together
they are not more than the 50% limit ($25,000).
For more information, see the rules for electing the 50% limit for capital gain property under How To Figure Your Deduction When Limits
Apply in Publication 526.
20% LimitCharitable contributions:Capital gain property as donation:Limit on deduction
This limit applies to all gifts of capital gain property to or for the use of qualified organizations (other than gifts of capital gain property to
50% limit organizations).
CarryoversCarryovers:Charitable contributions, when deduction exceeds adjusted-gross-income limitsCharitable contributions:Carryover of excess deduction
You can carry over your contributions that you are not able to deduct in the current year because they exceed your adjusted-gross-income limits.
You can deduct the excess in each of the next 5 years until it is used up, but not beyond that time. For more information, see Carryovers
in Publication 526.
Records To KeepCharitable contributions:Recordkeeping requirementsRecordkeeping requirements:Charitable contributions
You must keep records to prove the amount of the cash and noncash contributions you make during the year. The kind of records you must keep depends
on the amount of your contributions and whether they are cash or noncash contributions.
Note.Charitable contributionsWritten acknowledgement from recipient organization
An organization generally must give you a written statement if it receives a payment from you that is more than $75 and is partly a contribution
and partly for goods or services. (See Contributions From Which You Benefit under Contributions You Can Deduct, earlier.) Keep
the statement for your records. It may satisfy all or part of the recordkeeping requirements explained in the following discussions.
Cash contributions include those paid by cash, check, credit card, or payroll deduction. They also include your out-of-pocket expenses when
donating your services.
For a contribution made in cash, the records you must keep depend on whether the contribution is:
Less than $250, or
$250 or more.
Amount of contribution.
In figuring whether your contribution is $250 or more, do not combine separate contributions. For example, if you gave your church $25 each week,
your weekly payments do not have to be combined. Each payment is a separate contribution.
EmployersPayroll deductions If contributions are made by payroll deduction, the deduction from each paycheck is treated as a separate
contribution.
If you made a payment that is partly for goods and services, as described earlier under Contributions From Which You Benefit, your
contribution is the amount of the payment that is more than the value of the goods and services.
Contributions of Less Than $250Charitable contributions:Less than $250, recordkeeping requirements
For each cash contribution that is less than $250, you must keep one of the following items.
A canceled check, or a legible and readable account statement that shows:
If payment was by check: the check number, amount, date posted, and to whom paid.
If payment was by electronic funds transfer: the amount, date posted, and to whom paid.
If payment was charged to a credit card: the amount, transaction date, and to whom paid.
A receipt (or a letter or other written communication) from the charitable organization showing the name of the organization, the date of
the contribution, and the amount of the contribution.
Other reliable written records that include the information described in (2). Records may be considered reliable if they were made at or
near the time of the contribution, and were regularly kept by you, or if, in the case of small donations, you have emblems, buttons, or other tokens
that are regularly given to persons making small cash contributions.
Car expenses.Cars:Charitable organization service, use for
If you claim expenses directly related to the use of your car in giving services to a qualified organization, you must keep reliable written
records of your expenses. Whether your records are considered reliable depends on all the facts and circumstances. Generally, they may be considered
reliable if you made them regularly and at or near the time you had the expenses.
Your records must show the name of the organization you were serving and the date each time you used your car for a charitable purpose. If you use
the standard mileage rate of 14 cents a mile, your records must show the miles you drove your car for the charitable purpose. If you deduct your
actual expenses, your records must show the costs of operating the car that are directly related to a charitable purpose.
See Car expenses, earlier, under Out-of-Pocket Expenses in Giving Services, for the expenses you can deduct.
Contributions of $250 or MoreCharitable contributions:$250 or more, recordkeeping requirements
You can claim a deduction for a contribution of $250 or more only if you have an acknowledgment of your contribution from the qualified
organization or certain payroll deduction records.
If you made more than one contribution of $250 or more, you must have either a separate acknowledgment for each or one acknowledgment that shows
your total contributions.
Acknowledgment.Charitable contributions:Written acknowledgment from recipient organization
The acknowledgment must meet these tests.
It must be written.
It must include:
The amount of cash you contributed,
Whether the qualified organization gave you any goods or services as a result of your contribution (other than certain token items and
membership benefits), and
A description and good faith estimate of the value of any goods or services described in (b). If the only benefit you received was an
intangible religious benefit (such as admission to a religious ceremony) that generally is not sold in a commercial transaction outside the donative
context, the acknowledgment must say so and does not need to describe or estimate the value of the benefit.
You must get it on or before the earlier of:
The date you file your return for the year you make the contribution, or
The due date, including extensions, for filing the return.
If you make a contribution by payroll deduction, you do not need an acknowledgment from the qualified organization. But if your employer deducted
$250 or more from a single paycheck, you must keep:
A pay stub, Form W-2, or other document furnished by your employer that proves the amount withheld, and
A pledge card or other document from the qualified organization that states the organization does not provide goods or services in return
for any contribution made to it by payroll deduction.
Out-of-pocket expenses.
If you render services to a qualified organization and have unreimbursed out-of-pocket expenses related to those services, you can satisfy the
written acknowledgment requirement just discussed if:
You have adequate records to prove the amount of the expenses, and
By the required date, you get an acknowledgment from the qualified organization that contains:
A description of the services you provided,
A statement of whether or not the organization provided you any goods or services to reimburse you for the expenses you
incurred,
A description and a good faith estimate of the value of any goods or services (other than intangible religious benefits) provided to
reimburse you, and
A statement of any intangible religious benefits provided to you.
For a contribution not made in cash, the records you must keep depend on whether your deduction for the contribution is:
Less than $250,
At least $250 but not more than $500,
Over $500 but not more than $5,000, or
Over $5,000.
Amount of deduction.
In figuring whether your deduction is $500 or more, combine your claimed deductions for all similar items of property donated to any charitable
organization during the year. If you received goods or services in return, as described earlier in Contributions From Which You Benefit,
reduce your contribution by the value of those goods or services. If you figure your deduction by reducing the fair market value of the donated
property by its appreciation, as described earlier in Giving Property That Has Increased in Value, your contribution is the reduced amount.
Deductions of Less Than $250
If you make any noncash contribution, you must get and keep a receipt from the charitable organization showing:
The name of the charitable organization,
The date and location of the charitable contribution, and
A reasonably detailed description of the property.
A letter or other written communication from the charitable organization acknowledging receipt of the contribution and containing the information
in (1), (2), and (3) will serve as a receipt.
You are not required to have a receipt where it is impractical to get one (for example, if you leave property at a charity's unattended drop site).
Additional records.
You must also keep reliable written records for each item of donated property. Your written records must include the following information.
The name and address of the organization to which you contributed.
The date and location of the contribution.
A description of the property in detail reasonable under the circumstances. For a security, keep the name of the issuer, the type of
security, and whether it is regularly traded on a stock exchange or in an over-the-counter market.
The fair market value of the property at the time of the contribution and how you figured the fair market value. If it was determined by
appraisal, keep a signed copy of the appraisal. Charitable contributions:Fair market value of property contributions:Recordkeeping requirements
The cost or other basis of the property if you must reduce its fair market value by appreciation. Your records should also include the
amount of the reduction and how you figured it. If you choose the 50% limit instead of the special 30% limit on certain capital gain property, you
must keep a record showing the years for which you made the choice, contributions for the current year to which the choice applies, and carryovers
from preceding years to which the choice applies. See How To Figure Your Deduction When Limits Apply in Publication 526 for information on
how to make the capital gain property election.
The amount you claim as a deduction for the tax year as a result of the contribution, if you contribute less than your entire interest in
the property during the tax year. Your records must include the amount you claimed as a deduction in any earlier years for contributions of other
interests in this property. They must also include the name and address of each organization to which you contributed the other interests, the place
where any such tangible property is located or kept, and the name of any person in possession of the property, other than the organization to which
you contributed.
The terms of any conditions attached to the gift of property.
Deductions of At Least $250
But Not More Than $500
If you claim a deduction of at least $250 but not more than $500 for a noncash charitable contribution, you must get and keep an acknowledgment of
your contribution from the qualified organization. If you made more than one contribution of $250 or more, you must have either a separate
acknowledgment for each or one acknowledgment that shows your total contribution.
The acknowledgment must contain the information in items (1) through (3) listed under Deductions of Less Than $250, earlier, and your
written records must include the information listed in that discussion under Additional records.
The acknowledgment must also meet these tests.
It must be written.
It must include:
A description (but not necessarily the value) of any property you contributed,
Whether the qualified organization gave you any goods or services as a result of your contribution (other than certain token items and
membership benefits), and
A description and good faith estimate of the value of any goods or services described in (b). If the only benefit you received was an
intangible religious benefit (such as admission to a religious ceremony) that generally is not sold in a commercial transaction outside the donative
context, the acknowledgment must say so and does not need to describe or estimate the value of the benefit.
You must get it on or before the earlier of:
The date you file your return for the year you make the contribution, or
The due date, including extensions, for filing the return.
Deductions Over $500
You are required to give additional information if you claim a deduction over $500 for noncash charitable contributions. See Records To Keep
in Publication 526 for more information.
Qualified Conservation ContributionConservation:Charitable contribution to promote, recordkeeping requirement
If the gift was a qualified conservation contribution, your records must also include the fair market value of the underlying property before and
after the gift and the conservation purpose furthered by the gift. See Qualified conservation contribution in Publication 561 for more
information.
How To ReportCharitable contributions:Schedule A (Form 1040) to be used for deductionsForm:1040, Schedule ACharitable contributionsCharitable contributions:$500 or more noncash contribution:Form 8283 to be usedForm:8283:Charitable noncash contribution of more than $500 valueContributionsCharitable contributionsDeductions:Charitable contributions
Report your charitable contributions on Schedule A (Form 1040).
If your total deduction for all noncash contributions for the year is over $500, you must also file Form 8283. See How To Report in
Publication 526 for more information.
Nonbusiness Casualty and Theft LossesCasualty lossesTheft lossesDamage to propertyCasualty lossesGains and losses:CasualtyCasualty lossesGains and losses:TheftTheft lossesHome:Casualty lossesHomeDamage toCasualty lossesLossesCasualtyCasualty lossesLossesTheftTheft lossesStolen propertyTheft lossesWhat's NewKatrina Emergency Tax Relief Act of 2005.
This Act provides tax relief for persons affected by Hurricane Katrina. Under the Act, you may be able to forgo the limits on personal casualty
losses and extend the replacement period for property in the Hurricane Katrina disaster area. You may also be able to postpone certain tax deadlines.
See Publication 4492.
This chapter explains the tax treatment of personal (not business related) casualty losses, theft losses, and losses on deposits.
The chapter also explains the following topics.
How to figure the amount of your loss.
How to treat insurance and other reimbursements you receive.
The deduction limits.
When and how to report a casualty or theft.
Forms to file.
Casualty losses:Form 4684 to be filedForm:4684:Casualty or theft lossTheft losses:Form 4684 to be filedWhen you have a casualty or theft, you have to file Form 4684. You will also have to file one or both
of the following forms.
Schedule A (Form 1040), Itemized Deductions
Schedule D (Form 1040), Capital Gains and Losses
Condemnations.Condemnation of propertyInvoluntary conversionCondemnation of property
For information on condemnations of property, see Involuntary Conversions in chapter 1 of Publication 544.
Workbook for casualties and thefts.Worksheets:Casualty and theft losses
Publication 584:Casualty and theft losses, workbook forPublication 584 is available to help you make a list of your stolen or damaged
personal-use property and figure your loss. It includes schedules to help you figure the loss on your home, its contents, and your motor vehicles.
Other sources of information.
For information on a casualty or theft loss of business or income-producing property, see Publication 547.
Publication544Sales and Other Dispositions
of Assets547Casualties, Disasters, and
Thefts584Casualty, Disaster, and Theft
Loss Workbook (Personal-Use
Property)Form (and Instructions)Itemized DeductionsCapital Gains and LossesCasualties and Thefts
CasualtyGains and losses:CasualtyCasualty lossesLossesCasualtyCasualty losses
Casualty losses:Definition of casualtyA casualty is the damage, destruction, or loss of property resulting from an identifiable event that
is sudden, unexpected, or unusual.
A sudden event is one that is swift, not gradual or progressive.
An unexpected event is one that is ordinarily unanticipated and unintended.
An unusual event is one that is not a day-to-day occurrence and that is not typical of the activity in which you were engaged.
Deductible casualty losses can result from a number of different causes, including the following.
Car accidents (but see Nondeductible losses, next, for exceptions).
Accidents, carCars:Accidents resulting in casualty loss
Earthquakes.
Earthquakes:Casualty loss caused by
Fires (but see Nondeductible losses, next, for exceptions).
Fires:Casualty loss caused by
Floods.
Floods:Casualty loss caused by
Government-ordered demolition or relocation of a home that is unsafe to use because of a disaster as discussed under Disaster Area
Losses in Publication 547.
Condemnation of property:Disaster areas, government-ordered demolition of unsafe homeDisaster relief:Government-ordered demolition or relocation of home that is unsafe due toInvoluntary conversionCondemnation of property
Mine cave-ins.
Shipwrecks.
Shipwrecks:Casualty loss due to
Sonic booms.
Sonic booms:Casualty loss due to
Storms, including hurricanes and tornadoes.
Hurricanes:Casualty loss due toStorms:Casualty loss due toTornadoes:Casualty loss due to
Terrorist attacks.
Pentagon attacksTerrorist attacksTerrorist attacks:Casualty loss due toVictims of terrorismTerrorist attacksWorld Trade Center attacksTerrorist attacks
Vandalism.
Vandalism:Casualty loss due to
Volcanic eruptions.
Casualty losses:Nondeductible losses
Nondeductible losses.
A casualty loss is not deductible if the damage or destruction is caused by the following.
Accidentally breaking articles such as glassware or china under normal conditions.
A family pet.
A fire if you willfully set it or pay someone else to set it.
Fires:Arson, no casualty loss for
A car accident if your willful negligence or willful act caused it. The same is true if the willful act or willful negligence of someone
acting for you caused the accident.
Accidents, car:Willful negligence or intentional act as causeCars:Accidents resulting in casualty loss:Willful negligence or intentional act as cause
Progressive deterioration (explained next).
Progressive deterioration.
Real estate:Progressive deterioration, not casualty lossLoss of property due to progressive deterioration is not deductible as a
casualty loss. This is because the damage results from a steadily operating cause or a normal process, rather than from a sudden event. The following
are examples of damage due to progressive deterioration.
The steady weakening of a building due to normal wind and weather conditions.
The deterioration and damage to a water heater that bursts. However, the rust and water damage to rugs and drapes caused by the bursting of
a water heater does qualify as a casualty.
Appliances:Deterioration and damage, not casualty loss
Most losses of property caused by droughts. To be deductible, a drought-related loss generally must be incurred in a trade or business or in
a transaction entered into for profit.
The damage or destruction of trees, shrubs, or other plants by a fungus, disease, insects, worms, or similar pests. However, a sudden
destruction due to an unexpected or unusual infestation of beetles or other insects may result in a casualty loss.
Beetles:Damage or destruction to trees and plants, when casualty lossLandscaping:Cost of, when casualty or theft loss involvedPlants and trees:Cost of, when casualty or theft loss involvedTrees and plants:Cost of, when casualty or theft loss involved
TheftGains and losses:TheftTheft lossesLossesTheftTheft lossesStolen propertyTheft losses
Theft losses:Definition of theftA theft is the taking and removing of money or property with the intent to deprive the owner of it. The
taking of property must be illegal under the laws of the state where it occurred and it must have been done with criminal intent.
Theft includes the taking of money or property by the following means.
Blackmail.
Blackmail:Losses due to
Burglary.
Burglary:Losses due to
Embezzlement.
Embezzlement:Losses due to
Extortion.
Extortion:Losses due to
Kidnapping for ransom.
Kidnapped childrenLosses due to ransom
Larceny.
Larceny:Losses due to
Robbery.
Robbery:Losses due to
Threats.
Threats:Losses due to
Fraud:Losses due toThe taking of money or property through fraud or misrepresentation is theft if it is illegal under state or
local law.
Decline in market value of stock.
You cannot deduct as a theft loss the decline in market value of stock acquired on the open market for investment if the decline is caused by
disclosure of accounting fraud or other illegal misconduct by the officers or directors of the corporation that issued the stock. However, you can
deduct as a capital loss the loss you sustain when you sell or exchange the stock or the stock becomes completely worthless. You report a capital loss
on Schedule D (Form 1040). For more information about stock sales, worthless stock, and capital losses, see chapter 4 of Publication 550.
Mislaid or lost property.Lost property:When deemed casualty loss
The simple disappearance of money or property is not a theft. However, an accidental loss or disappearance of property can qualify as a casualty if
it results from an identifiable event that is sudden, unexpected, or unusual. Sudden, unexpected, and unusual events are defined earlier.
Example.
A car door is accidentally slammed on your hand, breaking the setting of your diamond ring. The diamond falls from the ring and is never found. The
loss of the diamond is a casualty.
Loss on DepositsBanks:Losses on deposits, when casualty lossesDeposits:Losses onBankruptcy:Financial institution's bankruptcy causing deductible lossGains and losses:Financial institution's bankruptcy causing deductible loss
A loss on deposits can occur when a bank, credit union, or other financial institution becomes insolvent or bankrupt. If you incurred this type of
loss, you can choose one of the following ways to deduct the loss.
As a casualty loss.
As an ordinary loss.
As a nonbusiness bad debt.
Casualty loss or ordinary loss.Casualty losses:Bank deposit, loss due to bank's insolvency or bankruptcyGains and losses:Ordinary gain and loss:Bank deposit, loss due to bank's insolvency or bankruptcy
You can choose to deduct a loss on deposits as a casualty loss or as an ordinary loss for any year in which you can reasonably estimate how much of
your deposits you have lost in an insolvent or bankrupt financial institution. The choice is generally made on the return you file for that year and
applies to all your losses on deposits for the year in that particular financial institution. If you treat the loss as a casualty or ordinary loss,
you cannot treat the same amount of the loss as a nonbusiness bad debt when it actually becomes worthless. However, you can take a nonbusiness bad
debt deduction for any amount of loss that is more than the estimated amount you deducted as a casualty or ordinary loss. Once you make this choice,
you cannot change it without approval of the Internal Revenue Service.
If you claim an ordinary loss, report it as a miscellaneous itemized deduction on Schedule A (Form 1040), line 22. The maximum amount you can claim
is $20,000 ($10,000 if you are married filing separately) reduced by any expected state insurance proceeds. Your loss is subject to the
2%-of-adjusted-gross-income limit. You cannot choose to claim an ordinary loss if any part of the deposit is federally insured.
Nonbusiness bad debt.Bad debts:Bank deposit, loss due to bank's insolvency or bankruptcy
If you do not choose to deduct the loss as a casualty loss or as an ordinary loss, you must wait until the year the actual loss is determined and
deduct the loss as a nonbusiness bad debt in that year.
How to report.
The kind of deduction you choose for your loss on deposits determines how you report your loss. If you choose:
Casualty loss — report it on Form 4684 first and then on Schedule A (Form 1040).
Form:4684:Bank deposit, loss due to bank's insolvency or bankruptcy
Ordinary loss — report it on Schedule A (Form 1040) as a miscellaneous itemized deduction.
Form:1040, Schedule ALoss of deposits due to bank's insolvency or bankruptcy cause
Nonbusiness bad debt — report it on Schedule D (Form 1040).
Bad debts:Bank deposit, loss due to bank's insolvency or bankruptcy:Reporting on Schedule D (Form 1040)Form:1040, Schedule DNonbusiness bad debts, loss of deposits due to bank's insolvency or bankruptcy
More information.
For more information, see Special Treatment for Losses on Deposits in Insolvent or Bankrupt Financial Institutions in the Instructions
for Form 4684.
Proof of Loss
To deduct a casualty or theft loss, you must be able to prove that you had a casualty or theft. You must be able to support the amount you claim
for the loss as discussed next.
Casualty loss proof.Casualty losses:Proof of lossProof of loss
For a casualty loss, your records should show all the following.
The type of casualty (car accident, fire, storm, etc.) and when it occurred.
That the loss was a direct result of the casualty.
That you were the owner of the property or, if you leased the property from someone else, that you were contractually liable to the owner
for the damage.
Whether a claim for reimbursement exists for which there is a reasonable expectation of recovery.
Theft loss proof.Theft losses:Proof of loss
For a theft loss, your records should show all the following.
When you discovered that your property was missing.
That your property was stolen.
That you were the owner of the property.
Whether a claim for reimbursement exists for which there is a reasonable expectation of recovery.
Amount of LossCasualty losses:Amount of lossTheft losses:Amount of loss
Figure the amount of your loss using the following steps.
Determine your adjusted basis in the property before the casualty or theft.
Determine the decrease in fair market value of the property as a result of the casualty or theft.
From the smaller of the amounts you determined in (1) and (2), subtract any insurance or other reimbursement you received or expect to
receive.
For personal-use property and property used in performing services as an employee, apply the deduction limits, discussed later, to determine
the amount of your deductible loss.
Leased property.Leased property:Casualty or theft loss
If you are liable for casualty damage to property you lease, your loss is the amount you must pay to repair the property minus any insurance or
other reimbursement you receive or expect to receive.
Adjusted BasisCasualty losses:Adjusted basis in propertyTheft losses:Adjusted basis in property
Adjusted basis is your basis in the property (usually cost) increased or decreased by various events, such as improvements and casualty losses. For
more information, see chapter 13.
Decrease in
Fair Market ValueCasualty losses:Fair market value of propertyFair market value (FMV):Casualty lossFMVFair market value
Fair market value (FMV) is the price for which you could sell your property to a willing buyer when neither of you has to sell or buy and both of
you know all the relevant facts.
The decrease in FMV is the difference between the property's fair market value immediately before and immediately after the casualty or theft.
FMV of stolen property.Fair market value (FMV):Stolen propertyTheft losses:Fair market value of stolen property
The FMV of property immediately after a theft is considered to be zero, since you no longer have the property.
Example.
Several years ago, you purchased silver dollars at face value for $150. This is your adjusted basis in the property. Your silver dollars were
stolen this year. The FMV of the coins was $1,000 just before they were stolen, and insurance did not cover them. Your theft loss is $150.
Recovered stolen property.Recovery of amounts previously deducted:Stolen property, adjustment of theft lossTheft losses:Recovered stolen property
Recovered stolen property is your property that was stolen and later returned to you. If you recovered property after you had already taken a theft
loss deduction, you must refigure your loss using the smaller of the property's adjusted basis (explained earlier) or the decrease in FMV from the
time just before it was stolen until the time it was recovered. Use this amount to refigure your total loss for the year in which the loss was
deducted.
If your refigured loss is less than the loss you deducted, you generally have to report the difference as income in the recovery year. But report
the difference only up to the amount of the loss that reduced your tax. For more information on the amount to report, see Recoveries in
chapter 12.
Figuring Decrease in FMV—
Items To Consider
To figure the decrease in FMV because of a casualty or theft, you generally need a competent appraisal. But other measures can also be used to
establish certain decreases.
Appraisal.Appraisals:Casualty or theft lossesCasualty losses:AppraisalsTheft losses:AppraisalsValuations:Appraisals
An appraisal to determine the difference between the FMV of the property immediately before a casualty or theft and immediately afterward should be
made by a competent appraiser. The appraiser must recognize the effects of any general market decline that may occur along with the casualty. This
information is needed to limit any deduction to the actual loss resulting from damage to the property.
Several factors are important in evaluating the accuracy of an appraisal, including the following.
The appraiser's familiarity with your property before and after the casualty or theft.
The appraiser's knowledge of sales of comparable property in the area.
The appraiser's knowledge of conditions in the area of the casualty.
The appraiser's method of appraisal.
Cost of cleaning up or making repairs.Casualty losses:Costs:Cleaning up or making repairsRepairs:Cost of, when casualty or theft loss involvedTheft losses:Cost of cleaning up or making repairs
The cost of repairing damaged property is not part of a casualty loss. Neither is the cost of cleaning up after a casualty. But you can use the
cost of cleaning up or making repairs as a measure of the decrease in FMV if you meet all the following conditions.
The repairs are actually made.
The repairs are necessary to bring the property back to its condition before the casualty.
The amount spent for repairs is not excessive.
The repairs take care of the damage only.
The value of the property after the repairs is not, due to the repairs, more than the value of the property before the casualty.
Landscaping.Landscaping:Cost of, when casualty or theft loss involvedPlants and trees:Cost of, when casualty or theft loss involvedTrees and plants:Cost of, when casualty or theft loss involved
The cost of restoring landscaping to its original condition after a casualty may indicate the decrease in FMV. You may be able to measure your loss
by what you spend on the following.
Removing destroyed or damaged trees and shrubs minus any salvage you receive.
Pruning and other measures taken to preserve damaged trees and shrubs.
Replanting necessary to restore the property to its approximate value before the casualty.
Car value.Accidents, car:Value determinationCars:Accidents resulting in casualty loss:Value determination
Books to determine fair market valueCars:Books to determine fair market valueBooks issued by various automobile organizations that list your car may be useful in
figuring the value of your car. You can modify the book's retail value by such factors as mileage and the condition of your car to figure its value.
The prices are not official, but they may be useful in determining value and suggesting relative prices for comparison with current sales and
offerings in your area. If your car is not listed in the books, determine its value from other sources. A dealer's offer for your car as a trade-in on
a new car is not usually a measure of its true value.
Figuring Decrease in FMV—
Items Not To Consider
The following items are generally not considered when establishing the decrease in the FMV of your property.
Replacement cost.
The cost of replacing stolen or destroyed property is not part of a casualty or theft loss.
Cost of protection.
The cost of protecting your property against a casualty or theft is not part of a casualty or theft loss. For example, you cannot deduct the amount
you spend on insurance or to board up your house against a storm.
If you make permanent improvements to your property to protect it against a casualty or theft, add the cost of these improvements to your basis in
the property. An example would be the cost of a dike to prevent flooding.
Related expenses.
Any incidental expenses you have due to a casualty or theft, such as expenses for the treatment of personal injuries, for temporary housing, or for
a rental car, are not part of your casualty or theft loss.
Sentimental value.
Do not consider sentimental value when determining your loss. If a family portrait, heirloom, or keepsake is damaged, destroyed, or stolen, you
must base your loss only on its FMV.
Decline in market value of property in or near casualty area.
A decrease in the value of your property because it is in or near an area that suffered a casualty, or that might again suffer a casualty, is not
to be taken into consideration. You have a loss only for actual casualty damage to your property. However, if your home is in a federally declared
disaster area, see Disaster Area Losses in Publication 547.
Costs of photographs and appraisals.Casualty losses:Costs:Photographs and appraisalsTheft losses:Costs of photographs and appraisals
Photographs:Casualty or theft loss claimsPhotographs taken after a casualty will be helpful in establishing the condition and value of
the property after it was damaged. Photographs showing the condition of the property after it was repaired, restored, or replaced may also be helpful.
Appraisals:Casualty or theft lossesCasualty losses:AppraisalsTheft losses:AppraisalsValuations:AppraisalsAppraisals are used to figure the decrease in FMV because of a casualty or theft. See Appraisal, earlier, under
Figuring Decrease in FMV — Items To Consider, for information about appraisals.
The costs of photographs and appraisals used as evidence of the value and condition of property damaged as a result of a casualty are not a part of
the loss. You can claim these costs as a miscellaneous itemized deduction subject to the 2%-of-adjusted-gross-income limit on Schedule A (Form 1040).
For information about miscellaneous deductions, see chapter 28.
Insurance and Other
ReimbursementsCasualty losses:Insurance proceeds, treatment ofCasualty losses:ReimbursementInsurance:Casualty or theft loss, reimbursement to adjust lossReimbursement:Casualty lossesReimbursement:Theft lossesTheft losses:Insurance proceeds, treatment ofTheft losses:Reimbursement
If you receive an insurance payment or other type of reimbursement, you must subtract the reimbursement when you figure your loss. You do not have
a casualty or theft loss to the extent you are reimbursed.
If you expect to be reimbursed for part or all of your loss, you must subtract the expected reimbursement when you figure your loss. You must
reduce your loss even if you do not receive payment until a later tax year. See Reimbursement Received After Deducting Loss, later.
Failure to file a claim for reimbursement.
If your property is covered by insurance, you must file a timely insurance claim for reimbursement of your loss. Otherwise, you cannot deduct this
loss as a casualty or theft loss. However, this rule does not apply to the portion of the loss not covered by insurance (for example, a deductible).
Example.
You have a car insurance policy with a $500 deductible. Because your insurance did not cover the first $500 of an auto collision, the $500 would be
deductible (subject to the deduction limits discussed later). This is true even if you do not file an insurance claim, since your insurance policy
would never have reimbursed you for the deductible.
Gain from reimbursement.Reimbursement:Gain from casualty or theft loss
If your reimbursement is more than your adjusted basis in the property, you have a gain. This is true even if the decrease in the FMV of the
property is smaller than your adjusted basis. If you have a gain, you may have to pay tax on it, or you may be able to postpone reporting the gain.
See Publication 547 for more information on how to treat a gain from a reimbursement for a casualty or theft.
Types of ReimbursementsReimbursement:Types of
The most common type of reimbursement is an insurance payment for your stolen or damaged property. Other types of reimbursements are discussed
next. Also see the Instructions for Form 4684.
Employer's emergency disaster fund.Casualty losses:DisastersDisaster reliefCasualty losses:Employer's emergency disaster fundDamage to propertyDisastersDisaster reliefDisaster relief:Employer's emergency disaster fund
If you receive money from your employer's emergency disaster fund and you must use that money to rehabilitate or replace property on which you are
claiming a casualty loss deduction, you must take that money into consideration in computing the casualty loss deduction. Take into consideration only
the amount you used to replace your destroyed or damaged property.
Example.
Your home was extensively damaged by a tornado. Your loss after reimbursement from your insurance company was $10,000. Your employer set up a
disaster relief fund for its employees. Employees receiving money from the fund had to use it to rehabilitate or replace their damaged or destroyed
property. You received $4,000 from the fund and spent the entire amount on repairs to your home. In figuring your casualty loss, you must reduce your
unreimbursed loss ($10,000) by the $4,000 you received from your employer's fund. Your casualty loss before applying the deduction limits discussed
later is $6,000.
Cash gifts.Disaster relief:Cash gifts to victimsGifts:Disaster victims receiving cash gifts
If you receive excludable cash gifts as a disaster victim and there are no limits on how you can use the money, you do not reduce your casualty
loss by these excludable cash gifts. This applies even if you use the money to pay for repairs to property damaged in the disaster.
Example.
Your home was damaged by a hurricane. Relatives and neighbors made cash gifts to you which were excludable from your income. You used part of the
cash gifts to pay for repairs to your home. There were no limits or restrictions on how you could use the cash gifts. Because it was an excludable
gift, the money you received and used to pay for repairs to your home does not reduce your casualty loss on the damaged home.
Insurance payments for living expenses.Insurance:Living expenses paid by, possible income fromLiving expenses:Insurance paying, possible income from
You do not reduce your casualty loss by insurance payments you receive to cover living expenses in either of the following situations.
You lose the use of your main home because of a casualty.
Government authorities do not allow you access to your main home because of a casualty or threat of one.
Inclusion in income.
If these insurance payments are more than the temporary increase in your living expenses, you must include the excess in your income. Report this
amount on Form 1040, line 21. However, if the casualty occurs in a Presidentially declared disaster area, none of the insurance payments are taxable.
See Qualified disaster relief payments, under Disaster Area Losses in Publication 547.
A temporary increase in your living expenses is the difference between the actual living expenses you and your family incurred during the period
you could not use your home and your normal living expenses for that period. Actual living expenses are the reasonable and necessary expenses incurred
because of the loss of your main home. Generally, these expenses include the amounts you pay for the following.
Rent for suitable housing.
Transportation.
Food.
Utilities.
Miscellaneous services.
Normal living expenses consist of these same expenses that you would have incurred but did not because of the casualty or the threat of one.
Example.
As a result of a fire, you vacated your apartment for a month and moved to a motel. You normally pay $525 a month for rent. None was charged for
the month the apartment was vacated. Your motel rent for this month was $1,200. You normally pay $200 a month for food. Your food expenses for the
month you lived in the motel were $400. You received $1,100 from your insurance company to cover your living expenses. You determine the payment you
must include in income as follows.
1)Insurance payment for living
expenses$1,1002)Actual expenses during the month you are unable to use your home because of fire1,6003)Normal living expenses7254)Temporary increase in living
expenses: Subtract line 3
from line 28755)Amount of payment includible
in income: Subtract line 4
from line 1$ 225
Tax year of inclusion.Reimbursement:Tax year of inclusion for insurance reimbursement
You include the taxable part of the insurance payment in income for the year you regain the use of your main home or, if later, for the year you
receive the taxable part of the insurance payment.
Example.
Your main home was destroyed by a tornado in August 2003. You regained use of your home in November 2004. The insurance payments you received in
2003 and 2004 were $1,500 more than the temporary increase in your living expenses during those years. You include this amount in income on your 2004
Form 1040. If, in 2005, you receive further payments to cover the living expenses you had in 2003 and 2004, you must include those payments in income
on your 2005 Form 1040.
Disaster relief.Casualty losses:DisastersDisaster reliefDamage to propertyDisastersDisaster reliefDisaster reliefDisaster relief:Replacement of lost or destroyed propertyEarthquakesDisaster reliefFloodsDisaster reliefHurricanesDisaster reliefPresidentially declared disastersDisaster reliefRelief fundsDisaster reliefStormsDisaster reliefTornadoesDisaster relief
Food, medical supplies, and other forms of assistance you receive do not reduce your casualty loss unless they are replacements for lost or
destroyed property. These items are not taxable income to you.
Qualified disaster relief payments you receive for expenses you incurred as a result of a Presidentially declared disaster, are not taxable income
to you. For more information, see Disaster Area Losses in Publication 547.
Disaster unemployment assistance payments are unemployment benefits that are taxable.
Generally, disaster relief grants and qualified disaster mitigation payments made under the Robert T. Stafford Disaster Relief and Emergency
Assistance Act or the National Flood Insurance Act (as in effect on April 15, 2005) are not includible in your income. See Disaster Area
Losses in Publication 547.
Reimbursement Received After Deducting LossReimbursement:Received after deducting loss
If you figured your casualty or theft loss using your expected reimbursement, you may have to adjust your tax return for the tax year in which you
receive your actual reimbursement. This section explains the adjustment you may have to make.
Actual reimbursement less than expected.
If you later receive less reimbursement than you expected, include that difference as a loss with your other losses (if any) on your return for the
year in which you can reasonably expect no more reimbursement.
Example.
Your personal car had a FMV of $2,000 when it was destroyed in a collision with another car in 2004. The accident was due to the negligence of the
other driver. At the end of 2004, there was a reasonable prospect that the owner of the other car would reimburse you in full. You subtracted the
expected reimbursement when you figured your loss. You did not have a deductible loss in 2004.
In January 2005, the court awarded you a judgment of $2,000. However, in July it became apparent that you will be unable to collect any amount from
the other driver. You can deduct the loss in 2005 subject to the limits discussed later.
Actual reimbursement more than expected.
If you later receive more reimbursement than you expected after you claimed a deduction for the loss, you may have to include the extra
reimbursement in your income for the year you receive it. However, if any part of the original deduction did not reduce your tax for the earlier year,
do not include that part of the reimbursement in your income. You do not refigure your tax for the year you claimed the deduction. For more
information, see Recoveries in chapter 12.
If the total of all the reimbursements you receive is more than your adjusted basis in the destroyed or stolen property, you will have a gain on
the casualty or theft. If you have already taken a deduction for a loss and you receive the reimbursement in a later year, you may have to include the
gain in your income for the later year. Include the gain as ordinary income up to the amount of your deduction that reduced your tax for the earlier
year. See Publication 547 for more information on how to treat a gain from the reimbursement of a casualty or theft.
Actual reimbursement same as expected.
If you receive exactly the reimbursement you expected, you do not have any amount to include in your income or any loss to deduct.
Example.
In December 2005, you had a collision while driving your personal car. Repairs to the car cost $950. You had $100 deductible collision insurance.
Your insurance company agreed to reimburse you for the rest of the damage. Because you expected a reimbursement from the insurance company, you did
not have a casualty loss deduction in 2005.
Due to the $100 rule (discussed later under Deduction Limits), you cannot deduct the $100 deductible you paid. When you receive the $850
from the insurance company in 2006, do not report it as income.
Single Casualty on Multiple PropertiesCasualty losses:Single casualty on multiple propertiesPersonal property.Personal propertyCasualty lossesPersonal propertyTheft ofTheft losses
If a single casualty or theft involves more than one item of personal property, you must figure the loss on each item separately. Then combine the
losses to determine your total loss from that casualty or theft. Personal property is any property that is not real property.
Example.Fires:Casualty loss caused by
A fire in your home destroyed an upholstered chair, an oriental rug, and an antique table. You did not have fire insurance to cover your loss.
(This was the only casualty or theft you had during the year.) You paid $750 for the chair and you established that it had a FMV of $500 just before
the fire. The rug cost $3,000 and had a FMV of $2,500 just before the fire. You bought the table at an auction for $100 before discovering it was an
antique. It had been appraised at $900 before the fire. You figure your loss on each of these items as follows:
ChairRugTable1) Basis (cost) $750 $3,000 $100 2) FMV before fire $500 $2,500 $900 3) FMV after fire –0– –0– –0– 4) Decrease in FMV $500 $2,500 $900 5) Loss (smaller of (1) or
(4)) $500 $2,500 $100 6)Total loss$3,100
Real property.Real estate:Casualty loss
In figuring a casualty loss on personal-use real property, treat the entire property (including any improvements, such as buildings, trees, and
shrubs) as one item. Figure the loss using the smaller of the adjusted basis or the decrease in FMV of the entire property.
Example.
You bought your home a few years ago. You paid $160,000 ($20,000 for the land and $140,000 for the house). You also spent $2,000 for landscaping.
This year a fire destroyed your home. The fire also damaged the shrubbery and trees in your yard. The fire was your only casualty or theft loss this
year. Competent appraisers valued the property as a whole at $200,000 before the fire, but only $30,000 after the fire. (The loss to your household
furnishings is not shown in this example. It would be figured separately on each item, as explained earlier under Personal property.)
Shortly after the fire, the insurance company paid you $155,000 for the loss. You figure your casualty loss as follows:
1) Adjusted basis of the entire property (land, building, and landscaping) $162,000 2) FMV of entire property before fire $200,000 3) FMV of entire property after fire 30,000 4) Decrease in FMV of entire
property $170,000 5) Loss (smaller of (1) or (4)) $162,000 6)Subtract insurance155,0007)Amount of loss after reimbursement$7,000
Deduction LimitsCasualty losses:Deduction limits
After you have figured your casualty or theft loss, you must figure how much of the loss you can deduct. If the loss was to property for your
personal use or your family's use, there are two limits on the amount you can deduct for your casualty or theft loss.
You must reduce each casualty or theft loss by $100 ($100 rule).
You must further reduce the total of all your casualty or theft losses by 10% of your adjusted gross income (10% rule).
You make these reductions on Form 4684.
These rules are explained next and Table 25-1 summarizes how to apply the $100 rule and the 10% rule in various situations. For more
detailed explanations and examples, see Publication 547.
Property used partly for business and partly for personal purposes.Casualty losses:Property used partly for business and partly for personal purposesTheft losses:Property used partly for business and partly for personal purposes
When property is used partly for personal purposes and partly for business or income-producing purposes, the casualty or theft loss deduction must
be figured separately for the personal-use part and for the business or income-producing part. You must figure each loss separately because the $100
rule and the 10% rule apply only to the loss on the personal-use part of the property.
After you have figured your casualty or theft loss on personal-use property, you must reduce that loss by $100. This reduction applies to each
total casualty or theft loss. It does not matter how many pieces of property are involved in an event. Only a single $100 reduction applies.
Example.
A hailstorm damages your home and your car. Determine the amount of loss, as discussed earlier, for each of these items. Since the losses are due
to a single event, you combine the losses and reduce the combined amount by $100.
Single event.
Generally, events closely related in origin cause a single casualty. It is a single casualty when the damage is from two or more closely related
causes, such as wind and flood damage caused by the same storm.
10% Rule
You must reduce the total of all your casualty or theft losses on personal-use property by 10% of your adjusted gross income. Apply this rule after
you reduce each loss by $100. If you have both gains and losses from casualties or thefts, see Gains and losses, later in this discussion.
Example 1.
In June, you discovered that your house had been burglarized. Your loss after insurance reimbursement was $2,000. Your adjusted gross income for
the year you discovered the theft is $29,500. You first apply the $100 rule and then the 10% rule. Figure your theft loss deduction as follows.
1) Loss after insurance$2,000 2) Subtract $100 100 3) Loss after $100 rule $1,900 4) Subtract 10% × $29,500 AGI 2,950 5)Theft loss deduction –0–
You do not have a theft loss deduction because your loss after you apply the $100 rule ($1,900) is less than 10% of your adjusted gross income
($2,950).
Example 2.
In March, you had a car accident that totally destroyed your car. You did not have collision insurance on your car, so you did not receive any
insurance reimbursement. Your loss on the car was $1,200. In November, a fire damaged your basement and totally destroyed the furniture, washer,
dryer, and other items stored there. Your loss on the basement items after reimbursement was $1,700. Your adjusted gross income for the year that the
accident and fire occurred is $25,000. You figure your casualty loss deduction as follows.
Base-Car ment 1) Loss$1,200 $1,700 2) Subtract $100 per incident100 100 3) Loss after $100 rule $1,100 $1,600 4) Total loss $2,700 5) Subtract 10% × $25,000 AGI 2,500 6)Casualty loss deduction $200
Gains and losses.
If you had both gains and losses from casualties or thefts to personal-use property, you must compare your total gains to your total losses. Do
this after you have reduced each loss by any reimbursements and by $100.
Casualty or theft gains do not include gains you choose to postpone. See Publication 547 for information on the postponement of gain.
Losses more than gains.
If your losses are more than your recognized gains, subtract your gains from your losses and reduce the result by 10% of your adjusted gross
income. The rest, if any, is your deductible loss.
Gains more than losses.
If your recognized gains are more than your losses, subtract your losses from your gains. The difference is treated as capital gain and must be
reported on Schedule D (Form 1040). The 10% rule does not apply to your gains.
When To Report
Gains and LossesCasualty losses:Reporting of gain or lossTheft losses:Reporting of gain or loss
If you receive an insurance or other reimbursement that is more than your adjusted basis in the destroyed or stolen property, you have a gain from
the casualty or theft. You must include this gain in your income in the year you receive the reimbursement, unless you choose to postpone reporting
the gain as explained in Publication 547.
If you have a loss, see Table 25-2.
Loss on deposits.Bankruptcy:Financial institution's bankruptcy causing deductible loss:Reporting ofBanks:Losses on deposits, when casualty losses:Reporting ofDeposits:Losses on:Reporting ofGains and losses:Financial institution's bankruptcy causing deductible loss:Reporting ofInsolvency:Financial institution's insolvency causing deductible lossReporting of
If your loss is a loss on deposits in an insolvent or bankrupt financial institution, see Loss on Deposits, earlier.
Casualty loss.Casualty losses:Reporting of gain or loss
Generally, you can deduct a casualty loss only in the tax year in which the casualty occurred. This is true even if you do not repair or replace
the damaged property until a later year.
Theft loss.Theft losses:Reporting of gain or loss
You generally can deduct a theft loss only in the year you discover your property was stolen. You must be able to show that there was a theft, but
you do not have to know when the theft occurred. However, you should show when you discovered that your property was missing.
Disaster Area Loss
If you have a casualty loss from a disaster that occurred in a Presidentially declared disaster area, you can choose to deduct the loss on your tax
return or amended return for either of the following years.
The year the disaster occurred.
The year immediately preceding the year the disaster occurred.
<ROM>Table 25-1. </ROM>How To Apply the Deduction Limits for Personal-Use PropertyCasualty losses:Deduction limits:For personal property (Table 25-1)Tables and figures:Casualty and theft losses:Deduction limits for personal property (Table 25-1)$100 Rule10% RuleGeneral ApplicationYou must reduce each casualty or theft loss by $100 when figuring your deduction. Apply this rule after you have figured the
amount of your loss.You must reduce your total casualty or theft loss by 10% of your adjusted gross income. Apply this rule after you reduce each
loss by $100 (the $100 rule).Single EventApply this rule only once, even if many pieces of property are affected.Apply this rule only once, even if many pieces of property are affected.More Than One EventApply to the loss from each event.Apply to the total of all your losses from all events.More Than One Person—With Loss From the
Same Event
(other than a married couple filing jointly)Apply separately to each person.Apply separately to each person.Married Couple—With Loss From the Same EventFiling JointlyApply as if you were one person.Apply as if you were one person.Filing SeparatelyApply separately to each spouse.Apply separately to each spouse.More Than One Owner(other than a married
couple filing jointly)Apply separately to each owner of jointly owned property.Apply separately to each owner of jointly owned property.
Postponed tax deadlines.Due dates:Disaster areas, postponed deadlinesPostponed tax deadlines:Disaster areas
The IRS may postpone for up to 1 year certain tax deadlines of taxpayers who are affected by a Presidentially declared disaster. The tax deadlines
the IRS may postpone include those for filing income and employment tax returns, paying income and employment taxes, and making contributions to a
traditional IRA or Roth IRA.
If any tax deadline is postponed, the IRS will publicize the postponement in your area by publishing a news release, revenue ruling, revenue
procedure, notice, announcement, or other guidance in the Internal Revenue Bulletin (IRB).
Who is eligible.
If the IRS postpones a tax deadline, the following taxpayers are eligible for the postponement.
Any individual whose main home is located in a covered disaster area (defined next).
Any business entity or sole proprietor whose principal place of business is located in a covered disaster area.
Any relief worker affiliated with a recognized government or philanthropic organization who is assisting in a covered disaster
area.
Any individual, business entity, or sole proprietor whose records are needed to meet a postponed deadline, provided those records are
maintained in a covered disaster area. The main home or principal place of business does not have to be located in the covered disaster
area.
Any estate or trust that has tax records necessary to meet a postponed tax deadline, provided those records are maintained in a covered
disaster area.
The spouse on a joint return with a taxpayer who is eligible for postponements.
Any other person determined by the IRS to be affected by a Presidentially declared disaster.
Covered disaster area.
This is an area of a Presidentially declared disaster area in which the IRS has decided to postpone tax deadlines for up to 1 year.
Abatement of interest and penalties.
The IRS may abate the interest and penalties on underpaid income tax for the length of any postponement of tax deadlines.
More information.
For more information, see Disaster Area Losses in Publication 547.
How To Report
Gains and LossesCasualty losses:Reporting of gain or lossTheft losses:Reporting of gain or loss
Form:4684:Casualty or theft lossUse Form 4684 to report a gain or a deductible loss from a casualty or theft. If you have more
than one casualty or theft, use a separate Form 4684 to determine your gain or loss for each event. Combine the gains and losses on one Form 4684.
Follow the form instructions as to which lines to fill out. In addition, you must use the appropriate schedule to report a gain or loss. The schedule
you use depends on whether you have a gain or loss.
If you have a:Report it on:GainSchedule D (Form 1040)LossSchedule A (Form 1040)
Adjustments to basis.Casualty losses:Adjusted basis in property
If you have a casualty or theft loss, you must decrease your basis in the property by any deductible loss and any insurance or other reimbursement.
Amounts you spend to restore your property after a casualty increase your adjusted basis. See Adjusted Basis in chapter 13 for more
information.
Net operating loss (NOL).Casualty losses:Net operating lossesNet operating losses:Casualty or theft lossesTheft losses:Net operating losses
Casualty lossesTheft lossesIf your casualty or theft loss deduction is more than your income, you may have an NOL. You can use an
NOL to lower your tax in an earlier year, allowing you to get a refund for tax you have already paid. Or, you can use it to lower your tax in a later
year. You do not have to be in business to have an NOL from a casualty or theft loss. For more information, see Publication 536, Net Operating Losses
(NOLs) for Individuals, Estates, and Trusts.
<ROM>Table 25-2. </ROM> When To Deduct a LossCasualty losses:Deductible losses:When to take (Table 25-2)Tables and figures:Casualty and theft losses:Deduction of loss, when to take (Table 25-2)Theft losses:Deduction of loss:When to take (Table 25-2)IF you have a loss...THEN deduct it in the year...from a casualty,the loss occurred.in a Presidentially declared disaster area,the disaster occurred or the year immediately before the disaster.from a theft, the theft was discovered.on a deposit treated as a: • casualty, • a reasonable estimate can be made. • bad debt, • deposits are totally worthless. • ordinary loss, • a reasonable estimate can be made.
Car Expenses and Other Employee Business ExpensesEmployee business expensesCarsEmployeesBusiness expensesEmployee business expensesJobheadings starting with "Employee" or "Employer"What's NewStandard mileage rate.Mileage ratesStandard mileage ratesReimbursement:MileageStandard mileage ratesStandard mileage rates:Business-related milesTravel and transportation expenses:Mileage ratesStandard mileage rates
For 2005, the standard mileage rate for the cost of operating your car for business use is:
40 cents per mile for the period January 1 through August 31, 2005, and
48 cents per mile for the period September 1 through December 31, 2005.
Car expenses and use of the standard mileage rate are explained under Transportation Expenses, later.
Depreciation limits on cars, trucks, and vans.Car expensesDepreciationDepreciation of car
The total section 179 deduction and depreciation you can claim on cars, trucks, and vans you use for business purposes has decreased for vehicles
first placed in service in 2005. See Depreciation limits in chapter 4 of Publication 463.
Employee business expenses:Deductions forYou may be able to deduct the ordinary and necessary business-related expenses you have for:
Travel,
Entertainment,
Gifts, or
Transportation.
An ordinary expense is one that is common and accepted in your field of trade, business, or profession. A necessary expense is one that is
helpful and appropriate for your business. An expense does not have to be required to be considered necessary.
This chapter explains:
What expenses are deductible,
How to report your expenses on your return,
What records you need to prove your expenses, and
How to treat any expense reimbursements you may receive.
Who does not need to use this chapter.Employee business expenses:Deductions for
If you are an employee, you will not need to read this chapter if all of the following are true.
You fully accounted to your employer for your work-related expenses.
You received full reimbursement for your expenses.
Your employer required you to return any excess reimbursement and you did so.
There is no amount shown with a code L in box 12 of your Form W-2, Wage and Tax Statement.
Form:W-2:Box 12 with code LIf you meet all of these conditions, there is no need to show the expenses or the reimbursements on your return. See Reimbursements,
later, if you would like more information on reimbursements and accounting to your employer.
Form:W-2:Reimbursements reported as part of incomeIf you meet these conditions and your employer included reimbursements on
your Form W-2 in error, ask your employer for a corrected Form W-2.
Publication463 Travel, Entertainment, Gift, and Car Expenses535 Business Expenses1542 Per Diem RatesForm (and Instructions)Itemized DeductionsProfit or Loss From BusinessNet Profit From BusinessProfit or Loss From FarmingEmployee Business ExpensesUnreimbursed Employee Business Expenses
Travel ExpensesTravel and transportation expensesBusiness expenses:TravelTravel and transportation expensesDeductions:Transportation expensesTravel and transportation expensesTransportation expensesTravel and transportation expenses
If you temporarily travel away from your tax home, you can use this section to determine if you have deductible travel expenses. This section
discusses:
Traveling away from home,
Tax home,
Temporary assignment or job, and
What travel expenses are deductible.
It also discusses the standard meal allowance, rules for travel inside and outside the United States, and deductible convention expenses.
Travel expenses defined.Travel and transportation expenses:Definition of
For tax purposes, travel expenses are the ordinary and necessary expenses (defined earlier) of traveling away from home for your business,
profession, or job.
You will find examples of deductible travel expenses in Table 26-1.
Traveling Away From Home
You are traveling away from home if:
Your duties require you to be away from the general area of your tax home (defined later) substantially longer than an ordinary day's work,
and
You need to sleep or rest to meet the demands of your work while away from home.
This rest requirement is not satisfied by merely napping in your car. You do not have to be away from your tax home for a whole day or from
dusk to dawn as long as your relief from duty is long enough to get necessary sleep or rest.
Example 1.
You are a railroad conductor. You leave your home terminal on a regularly scheduled round-trip run between two cities and return home 16 hours
later. During the run, you have 6 hours off at your turnaround point where you eat two meals and rent a hotel room to get necessary sleep before
starting the return trip. You are considered to be away from home.
Example 2.
You are a truck driver. You leave your terminal and return to it later the same day. You get an hour off at your turnaround point to eat. Because
you are not off to get necessary sleep and the brief time off is not an adequate rest period, you are not traveling away from home.
Members of the Armed Forces.Armed forces:Permanent duty overseas
If you are a member of the U.S. Armed Forces on a permanent duty assignment overseas, you are not traveling away from home. You cannot deduct your
expenses for meals and lodging. You cannot deduct these expenses even if you have to maintain a home in the United States for your family members who
are not allowed to accompany you overseas. If you are transferred from one permanent duty station to another, you may have deductible moving expenses,
which are explained in Publication 521, Moving Expenses.
Armed forces:Naval officers on permanent duty aboard shipA naval officer assigned to permanent duty aboard a ship that has regular
eating and living facilities has a tax home aboard ship for travel expense purposes.
Travel to family home.Travel and transportation expenses:Going to family home
If you (and your family) do not live at your tax home (defined later), you cannot deduct the cost of traveling between your tax home and your
family home. You also cannot deduct the cost of meals and lodging while at your tax home. See Example 1 that follows.
If you are working temporarily in the same city where you and your family live, you may be considered as traveling away from home. See Example
2, below.
Example 1.
You are a truck driver and you and your family live in Tucson. You are employed by a trucking firm that has its terminal in Phoenix. At the end of
your long runs, you return to your home terminal in Phoenix and spend one night there before returning home. You cannot deduct any expenses you have
for meals and lodging in Phoenix or the cost of traveling from Phoenix to Tucson. This is because Phoenix is your tax home.
Example 2.
Your family home is in Pittsburgh, where you work 12 weeks a year. The rest of the year you work for the same employer in Baltimore. In Baltimore,
you eat in restaurants and sleep in a rooming house. Your salary is the same whether you are in Pittsburgh or Baltimore.
Because you spend most of your working time and earn most of your salary in Baltimore, that city is your tax home. You cannot deduct any expenses
you have for meals and lodging there. However, when you return to work in Pittsburgh, you are away from your tax home even though you stay at your
family home. You can deduct the cost of your round trip between Baltimore and Pittsburgh. You can also deduct your part of your family's living
expenses for meals and lodging while you are living and working in Pittsburgh.
Tax HomeHome:Tax home, determination for travel-related business expensesTravel and transportation expenses:Tax home, determination of
To determine whether you are traveling away from home, you must first determine the location of your tax home.
Generally, your tax home is your regular place of business or post of duty, regardless of where you maintain your family home. It includes the
entire city or general area in which your business or work is located.
If you have more than one regular place of business, your tax home is your main place of business. See Main place of business or work,
later.
If you do not have a regular or a main place of business because of the nature of your work, then your tax home may be the place where you
regularly live. See No main place of business or work, later.
Itinerant workers:Tax home, determination ofTraveling salespersons:Tax home, determination ofIf you do not have a regular place of business or post of duty and there is no place where you
regularly live, you are considered an itinerant (a transient) and your tax home is wherever you work. As an itinerant, you cannot claim a travel
expense deduction because you are never considered to be traveling away from home.
Main place of business or work.
If you have more than one place of business or work, consider the following when determining which one is your main place of business or work.
The total time you ordinarily spend in each place.
The level of your business activity in each place.
Whether your income from each place is significant or insignificant.
Example.
You live in Cincinnati where you have a seasonal job for 8 months each year and earn $40,000. You work the other 4 months in Miami, also at a
seasonal job, and earn $15,000. Cincinnati is your main place of work because you spend most of your time there and earn most of your income there.
No main place of business or work.Travel and transportation expenses:No main place of business or work
You may have a tax home even if you do not have a regular or main place of business or work. Your tax home may be the home where you regularly
live.
Factors used to determine tax home.
If you do not have a regular or main place of business or work, use the following three factors to determine where your tax home is.
You perform part of your business in the area of your main home and use that home for lodging while doing business in the area.
You have living expenses at your main home that you duplicate because your business requires you to be away from that home.
You have not abandoned the area in which both your historical place of lodging and your claimed main home are located; you have a member or
members of your family living at your main home; or you often use that home for lodging.
If you satisfy all three factors, your tax home is the home where you regularly live. If you satisfy only two factors, you may have a tax home
depending on all the facts and circumstances. If you satisfy only one factor, you are an itinerant; your tax home is wherever you work and you cannot
deduct travel expenses.
Example.
You are single and live in Boston in an apartment you rent. You have worked for your employer in Boston for a number of years. Your employer
enrolls you in a 12-month executive training program. You do not expect to return to work in Boston after you complete your training.
During your training, you do not do any work in Boston. Instead, you receive classroom and on-the-job training throughout the United States. You
keep your apartment in Boston and return to it frequently. You use your apartment to conduct your personal business. You also keep up your community
contacts in Boston. When you complete your training, you are transferred to Los Angeles.
You do not satisfy factor (1) because you did not work in Boston. You satisfy factor (2) because you had duplicate living expenses. You also
satisfy factor (3) because you did not abandon your apartment in Boston as your main home, you kept your community contacts, and you frequently
returned to live in your apartment. You have a tax home in Boston.
Temporary Assignment
or JobTemporary job assignments:Travel expensesTravel and transportation expenses:Temporary assignment or job
You may regularly work at your tax home and also work at another location. It may not be practical to return to your tax home from this other
location at the end of each work day.
Temporary assignment vs. indefinite assignment.Travel and transportation expenses:Indefinite assignment
If your assignment or job away from your main place of work is temporary, your tax home does not change. You are considered to be away from home
for the whole period you are away from your main place of work. You can deduct your travel expenses if they otherwise qualify for deduction.
Generally, a temporary assignment in a single location is one that is realistically expected to last (and does in fact last) for one year or less.
However, if your assignment or job is indefinite, the location of the assignment or job becomes your new tax home and you cannot deduct your travel
expenses while there. An assignment or job in a single location is considered indefinite if it is realistically expected to last for more than one
year, whether or not it actually lasts for more than one year.
If your assignment is indefinite, you must include in your income any amounts you receive from your employer for living expenses, even if they are
called travel allowances and you account to your employer for them. You may be able to deduct the cost of relocating to your new tax home as a moving
expense. See Publication 521 for more information.
Exception for federal crime investigations or prosecutions.Criminal prosecutions:Travel expenses for federal staffFederal crime investigations or prosecutions:Travel expensesTravel and transportation expenses:Federal crime investigators or prosecutors
If you are a federal employee participating in a federal crime investigation or prosecution, you are not subject to the one-year rule. This means
you may be able to deduct travel expenses even if you are away from your tax home for more than one year.
For you to qualify, the Attorney General must certify that you are traveling:
For the federal government,
In a temporary duty status, and
To investigate, prosecute, or provide support services for the investigation or prosecution of, a federal crime.
You can deduct your otherwise allowable travel expenses throughout the period of certification.
Determining temporary or indefinite.
You must determine whether your assignment is temporary or indefinite when you start work. If you expect an assignment or job to last for one year
or less, it is temporary unless there are facts and circumstances that indicate otherwise. An assignment or job that is initially temporary may become
indefinite due to changed circumstances. A series of assignments to the same location, all for short periods but that together cover a long period,
may be considered an indefinite assignment.
Going home on days off.Travel and transportation expenses:Going home on days off from temporary assignment
If you go back to your tax home from a temporary assignment on your days off, you are not considered away from home while you are in your hometown.
You cannot deduct the cost of your meals and lodging there. However, you can deduct your travel expenses, including meals and lodging, while traveling
between your temporary place of work and your tax home. You can claim these expenses up to the amount it would have cost you to stay at your temporary
place of work.
If you keep your hotel room during your visit home, you can deduct the cost of your hotel room. In addition, you can deduct your expenses of
returning home up to the amount you would have spent for meals had you stayed at your temporary place of work.
Probationary work period.Probationary work periods:Travel expenses duringTravel and transportation expenses:Probationary work periods
If you take a job that requires you to move, with the understanding that you will keep the job if your work is satisfactory during a probationary
period, the job is indefinite. You cannot deduct any of your expenses for meals and lodging during the probationary period.
What Travel Expenses Are Deductible?Travel and transportation expenses:Deductible expenses
Once you have determined that you are traveling away from your tax home, you can determine what travel expenses are deductible.
You can deduct ordinary and necessary expenses you have when you travel away from home on business. The type of expense you can deduct depends on
the facts and your circumstances.
Table 26-1 summarizes travel expenses you may be able to deduct. You may have other deductible travel expenses that are not covered there,
depending on the facts and your circumstances.
Recordkeeping requirements:Business travel expensesRecordkeeping requirements:Travel expensesTravel and transportation expenses:Recordkeeping requirements
When you travel away from home on business, you should keep records of all the expenses you have and any advances you receive from your employer.
You can use a log, diary, notebook, or any other written record to keep track of your expenses. The types of expenses you need to record, along with
supporting documentation, are described in Table 26-2, later.
Separating costs.Travel and transportation expenses:Allocation of types of costs
If you have one expense that includes the costs of meals, entertainment, and other services (such as lodging or transportation), you must allocate
that expense between the cost of meals and entertainment and the cost of other services. You must have a reasonable basis for making this allocation.
For example, you must allocate your expenses if a hotel includes one or more meals in its room charge.
Travel expenses for another individual.Dependents:Travel expenses forMarried taxpayers:Travel expenses for spouseTravel and transportation expenses:Business travel:Spouse or dependents
If a spouse, dependent, or other individual goes with you (or your employee) on a business trip or to a business convention, you generally cannot
deduct his or her travel expenses.
Employee.Employee business expenses:TravelTravel and transportation expensesTravel and transportation expenses:Business travel:Employees' expenses
You can deduct the travel expenses of someone who goes with you if that person:
Is your employee,
Has a bona fide business purpose for the travel, and
Would otherwise be allowed to deduct the travel expenses.
Business associate.Business associates:Travel expenses of, paying forClients:Travel expenses of, paying forCustomers:Travel expenses of, paying forTravel and transportation expenses:Business associates
If a business associate travels with you and meets the conditions in (2) and (3) above, you can deduct the travel expenses you have for that
person. A business associate is someone with whom you could reasonably expect to actively conduct business. A business associate can be a current or
prospective (likely to become) customer, client, supplier, employee, agent, partner, or professional advisor.
Bona fide business purpose.Bona fide business purpose:Travel expensesTravel and transportation expenses:Bona fide business purpose
A bona fide business purpose exists if you can prove a real business purpose for the individual's presence. Incidental services, such as
typing notes or assisting in entertaining customers, are not enough to make the expenses deductible.
Example.
Jerry drives to Chicago on business and takes his wife, Linda, with him. Linda is not Jerry's employee. Linda occasionally types notes, performs
similar services, and accompanies Jerry to luncheons and dinners. The performance of these services does not establish that her presence on the trip
is necessary to the conduct of Jerry's business. Her expenses are not deductible.
Jerry pays $199 a day for a double room. A single room costs $149 a day. He can deduct the total cost of driving his car to and from Chicago, but
only $149 a day for his hotel room. If he uses public transportation, he can deduct only his fare.
<ROM>Table 26-1.</ROM>
<IMARK> Travel Expenses You Can Deduct
<L><ITL> This chart summarizes expenses you can deduct when you
<L> travel away from home for business purposes.</ITL>Airport transportation:Business-related travel expenseBaggage:Business-related travel expenseBusiness expenses:Meal expensesMeal and lodging expensesCars:Business-related travel expensesDelivery services:Business-related travel expenseDry cleaning:Business-related travel expenseEmployee business expenses:TravelTravel and transportation expensesLaundry:Business-related travel expenseLodgingMeal and lodging expensesM&IE (Meals and incidental expenses)Meal and lodging expensesMeal and lodging expenses:Business-related travel expense includingMeal and lodging expenses:LodgingShipping:Business-related travel expenseTables and figures:Travel and transportation expenses:Examples of deductible expenses (Table 26–1)Taxis:Business-related travel expenseTelephones:Business-related travel expenseTip expense:Business travel expenseTravel and transportation expenses:Business travelTravel and transportation expenses:Deductible expenses:Examples of (Table 26-1)Travel and transportation expenses:Tips
IF you have expenses for...THEN you can deduct the cost of...transportationtravel by airplane, train, bus, or car between your home and your business destination. If you were provided with a ticket or
you are riding free as a result of a frequent traveler or similar program, your cost is zero. If you travel by ship, see Luxury Water
Travel and Cruise ships (under Conventions) in Publication 463 for additional rules and limits.taxi, commuter bus, and airport limousinefares for these and other types of transportation that take you between:
The airport or station and your hotel, and
The hotel and the work location of your customers or clients, your business meeting place, or your temporary work location.
baggage and shippingsending baggage and sample or display material between your regular and temporary work locations.caroperating and maintaining your car when traveling away from home on business. You can deduct actual expenses or the standard
mileage rate as well as business-related tolls and parking. If you rent a car while away from home on business, you can deduct only the business-use
portion of the expenses.lodging and mealsyour lodging and meals if your business trip is overnight or long enough that you need to stop for sleep or rest to properly
perform your duties. Meals include amounts spent for food, beverages, taxes, and related tips. See Meals and incidental expenses for
additional rules and limits.cleaningdry cleaning and laundry.telephonebusiness calls while on your business trip. This includes business communication by fax machine or other communication
devices.tipstips you pay for any expenses in this chart.otherother similar ordinary and necessary expenses related to your business travel. These expenses might include transportation to or
from a business meal, public stenographer's fees, computer rental fees, and operating and maintaining a house trailer.
Meals and Incidental ExpensesMeal and lodging expensesEmployee business expenses:MealsMeal and lodging expensesM&IE (Meals and incidental expenses)Meal and lodging expensesMeal and lodging expenses:Business-related travel expense including
You can deduct the cost of meals in either of the following situations.
It is necessary for you to stop for substantial sleep or rest to properly perform your duties while traveling away from home on
business.
The meal is business-related entertainment.
Business associatesEntertainment expensesBusiness expenses:Entertainment expensesBusiness expenses:Meal expensesMeal and lodging expensesClientsEntertainment expensesCustomersEntertainment expensesDeductions:Entertainment expensesEntertainment expensesMeal and lodging expenses:Business-related entertainment including
Business-related entertainment is discussed under Entertainment Expenses, later. The following discussion deals only with meals (and
incidental expenses) that are not business-related entertainment.
Lavish or extravagant.
You cannot deduct expenses for meals that are lavish or extravagant. An expense is not considered lavish or extravagant if it is reasonable based
on the facts and circumstances. Expenses will not be disallowed merely because they are more than a fixed dollar amount or take place at deluxe
restaurants, hotels, nightclubs, or resorts.
50% limit on meals.Meal and lodging expenses:50% deduction for business-related meals
You can figure your meal expenses using either of the following methods.
Actual cost.
The standard meal allowance.
M&IE (Meals and incidental expenses)Meal and lodging expensesMeal and lodging expenses:Standard meal allowanceStandard meal allowanceBoth of these methods are explained below. But, regardless of the method you use, you generally can deduct only 50% of the unreimbursed cost of
your meals.
If you are reimbursed for the cost of your meals, how you apply the 50% limit depends on whether your employer's reimbursement plan was accountable
or nonaccountable. If you are not reimbursed, the 50% limit applies whether the unreimbursed meal expense is for business travel or business
entertainment. The 50% limit is explained later under Entertainment Expenses. Accountable and nonaccountable plans are discussed later
under Reimbursements.
Actual cost.Meal and lodging expenses:Recordkeeping requirementsRecordkeeping requirements:Meal expenses:Actual cost
You can use the actual cost of your meals to figure the amount of your expense before reimbursement and application of the 50% deduction limit. If
you use this method, you must keep records of your actual cost.
Standard meal allowance.Meal and lodging expenses:Standard meal allowanceRecordkeeping requirements:Meal expenses:Standard meal allowanceStandard meal allowance
Generally, you can use the standard meal allowance method as an alternative to the actual cost method. It allows you to use a set amount for
your daily meals and incidental expenses (M&IE), instead of keeping records of your actual costs. The set amount varies depending on where and
when you travel. In this chapter, standard meal allowance refers to the federal rate for M&IE, discussed later under Amount of
standard meal allowance. If you use the standard meal allowance, you still must keep records to prove the time, place, and business purpose of
your travel. See Recordkeeping, later.
Incidental expenses.Incidental expenses:Travel-relatedM&IE (Meals and incidental expenses)Incidental expensesTravel and transportation expenses:Business travel:Incidental expenses
The term incidental expenses means:
Fees and tips given to porters, baggage carriers, bellhops, hotel maids, stewards or stewardesses and others on ships, and hotel servants in
foreign countries,
Transportation between places of lodging or business and places where meals are taken, if suitable meals can be obtained at the temporary
duty site, and
Mailing costs associated with filing travel vouchers and payment of employer-sponsored charge card billings.
Dry cleaning:Business-related travel expenseLaundry:Business-related travel expenseTip expense:Business travel expenseTravel and transportation expenses:TipsIncidental expenses do not include expenses for laundry, cleaning and pressing of clothing, lodging taxes, or the costs
of telegrams or telephone calls.
Incidental expenses only method.
You can use an optional method (instead of actual cost) for deducting incidental expenses only. The amount of the deduction is $3 a day for
incidental expenses paid or incurred for travel away from home in 2005. You can use this method only if you did not pay or incur any meal expenses.
You cannot use this method on any day that you use the standard meal allowance.
Federal employees should refer to the Federal Travel Regulations at
www.gsa.gov. Click on Per Diem Rates, then on Federal Travel Regulation
(FTR) Overview for changes affecting claims for reimbursement of these expenses.
50% limit may apply.Meal and lodging expenses:50% deduction for business-related meals
If you use the standard meal allowance method for meal expenses and you are not reimbursed or you are reimbursed under a nonaccountable plan, you
can generally deduct only 50% of the standard meal allowance. If you are reimbursed under an accountable plan and you are deducting amounts that are
more than your reimbursements, you can deduct only 50% of the excess amount. The 50% limit is explained later under Entertainment Expenses.
Accountable and nonaccountable plans are discussed later under Reimbursements.
LodgingMeal and lodging expensesMeal and lodging expenses:Lodging
There is no optional standard lodging amount similar to the standard meal allowance. Your allowable lodging expense deduction is your actual cost.
Who can use the standard meal allowance.Meal and lodging expenses:Standard meal allowanceStandard meal allowance
You can use the standard meal allowance whether you are an employee or self-employed, and whether or not you are reimbursed for your traveling
expenses.
Use of the standard meal allowance for other travel.
Medical and dental expenses:Meals and lodging related to receiving medical careYou can use the standard meal allowance to figure your meal expenses
when you travel in connection with investment and other income-producing property. You can also use it to figure your meal expenses when you travel
for qualifying educational purposes. You cannot use the standard meal allowance to figure the cost of your meals when you travel for medical or
charitable purposes.
Amount of standard meal allowance.Meal and lodging expenses:Standard meal allowance:Amount ofStandard meal allowance:Amount of
The standard meal allowance is the federal M&IE rate. For travel in 2005, the rate for most small localities in the United States is $31 a day
from January 1 through September 30, 2005, and $39 a day from October 1 through December 31, 2005.
Most major cities and many other localities in the United States are designated as high-cost areas, qualifying for higher standard meal allowances.
Locations qualifying for these rates are listed in Publication 1542 which is available on the Internet at
www.irs.gov.
You can also find this information on the Internet at
www.gsa.gov. Click on Per Diem Rates, then select 2005 for the period January 1,
2005 — September 30, 2005, and select 2006 for the period October 1, 2005 — December 31, 2005. However, you can apply the rates in
effect before October 1, 2005, for expenses of all travel within the United States for 2005 instead of the updated rates. You must consistently use
either the rates for the first 9 months for all of 2005 or the updated rates for the period of October 1, 2005, through December 31, 2005.
If you travel to more than one location in one day, use the rate in effect for the area where you stop for sleep or rest. If you work in the
transportation industry, however, see Special rate for transportation workers, later.
Standard meal allowance for areas outside the continental United States.Citizens outside U.S.:Business travel outside U.S.:Standard meal allowanceMeal and lodging expenses:Standard meal allowance:Areas outside continental U.S.Standard meal allowance:Areas outside continental U.S.
Alaska:Standard meal allowanceHawaii:Standard meal allowanceThe standard meal allowance rates do not apply to travel in Alaska, Hawaii, or any other locations
outside the continental United States. The federal per diem rates for these locations are published monthly in the Maximum Travel Per Diem
Allowances for Foreign Areas.
Your employer may have these rates available, or you can purchase the publication from the:
Superintendent of Documents
U.S. Government Printing Office
P.O. Box 371954
Pittsburgh, PA 15250-7954
You can also order it by calling the Government Printing Office at 1-202-512-1800 (not a toll-free number).
Special rate for transportation workers.Meal and lodging expenses:Transportation workersTransportation workers:Meal expenses
You can use a special standard meal allowance if you work in the transportation industry. You are in the transportation industry if your work:
Directly involves moving people or goods by airplane, barge, bus, ship, train, or truck, and
Regularly requires you to travel away from home and, during any single trip, usually involves travel to areas eligible for different
standard meal allowance rates.
If this applies to you, you can claim a standard meal allowance of $41 a day ($46 for travel outside the continental United States) from
January 1 through September 30, 2005, and $52 a day ($58 for travel outside the continental United States) from October 1 through December 31, 2005.
Using the special rate for transportation workers eliminates the need for you to determine the standard meal allowance for every area where you
stop for sleep or rest. If you choose to use the special rate for any trip, you must use the special rate (and not use the regular standard meal
allowance rates) for all trips you take that year.
Travel for days you depart and return.
For both the day you depart for and the day you return from a business trip, you must prorate the standard meal allowance (figure a reduced amount
for each day). You can do so by one of two methods.
Method 1: You can claim of the standard meal allowance.
Method 2: You can prorate using any method that you consistently apply and that is in accordance with reasonable business
practice.
Example.
Jen is employed in New Orleans as a convention planner. In March, her employer sent her on a 3-day trip to Washington, DC, to attend a planning
seminar. She left her home in New Orleans at 10 a.m. on Wednesday and arrived in Washington, DC, at 5:30 p.m. After spending two nights there, she
flew back to New Orleans on Friday and arrived back home at 8:00 p.m. Jen's employer gave her a flat amount to cover her expenses and included it with
her wages.
Under Method 1, Jen can claim 2 days of the standard meal allowance for Washington, DC: of the daily rate for
Wednesday and Friday (the days she departed and returned), and the full daily rate for Thursday.
Under Method 2, Jen could also use any method that she applies consistently and that is in accordance with reasonable business practice. For
example, she could claim 3 days of the standard meal allowance even though a federal employee would have to use method 1 and be limited to only 2 days.
Travel in the
United StatesAway-from-home travelTravel and transportation expensesTravel and transportation expenses:Business travel:U.S. travel
The following discussion applies to travel in the United States. For this purpose, the United States includes the 50 states and the District of
Columbia. The treatment of your travel expenses depends on how much of your trip was business related and on how much of your trip occurred within the
United States. See Part of Trip Outside the United States, later.
Trip Primarily for BusinessAway-from-home travelTravel and transportation expensesTravel and transportation expenses:Business travel:Trip primarily for business
You can deduct all your travel expenses if your trip was entirely business related. If your trip was primarily for business and, while at your
business destination, you extended your stay for a vacation, made a personal side trip, or had other personal activities, you can deduct your
business-related travel expenses. These expenses include the travel costs of getting to and from your business destination and any business-related
expenses at your business destination.
Example.
You work in Atlanta and take a business trip to New Orleans. On your way home, you stop in Mobile to visit your parents. You spend $1,070 for the 9
days you are away from home for travel, meals, lodging, and other travel expenses. If you had not stopped in Mobile, you would have been gone only 6
days, and your total cost would have been $920. You can deduct $920 for your trip, including the cost of round-trip transportation to and from New
Orleans. The deduction for your meals is subject to the 50% limit on meals mentioned earlier.
Trip Primarily for
Personal ReasonsTravel and transportation expenses:Business travel:Trip primarily for personal reasons
If your trip was primarily for personal reasons, such as a vacation, the entire cost of the trip is a nondeductible personal expense. However, you
can deduct any expenses you have while at your destination that are directly related to your business.
Cruises:Travel expenses when incidental business activitiesLuxury travel:Travel expenses when incidental business activitiesResorts:Travel expenses when incidental business activitiesTravel and transportation expenses:Resorts or cruise shipsA trip to a resort or on a cruise ship may be a vacation even if the promoter advertises that it is
primarily for business. The scheduling of incidental business activities during a trip, such as viewing videotapes or attending lectures dealing with
general subjects, will not change what is really a vacation into a business trip.
Part of Trip Outside
the United StatesAway-from-home travelTravel and transportation expensesTravel and transportation expenses:Business travel:Trip outside U.S.
If part of your trip is outside the United States, use the rules described later under Travel Outside the United States for that part of
the trip. For the part of your trip that is inside the United States, use the rules for travel in the United States. Travel outside the United States
does not include travel from one point in the United States to another point in the United States. The following discussion can help you determine
whether your trip was entirely within the United States.
Public transportation.
If you travel by public transportation, any place in the United States where that vehicle makes a scheduled stop is a point in the United States.
Once the vehicle leaves the last scheduled stop in the United States on its way to a point outside the United States, you apply the rules under
Travel Outside the United States.
Example.
You fly from New York to Puerto Rico with a scheduled stop in Miami. You return to New York nonstop. The flight from New York to Miami is in the
United States, so only the flight from Miami to Puerto Rico is outside the United States. Because there are no scheduled stops between Puerto Rico and
New York, all of the return trip is outside the United States.
Private car.
Travel by private car in the United States is travel between points in the United States, even when you are on your way to a destination outside
the United States.
Example.
You travel by car from Denver to Mexico City and return. Your travel from Denver to the border and from the border back to Denver is travel in the
United States, and the rules in this section apply. The rules under Travel Outside the United States apply to your trip from the border to
Mexico City and back to the border.
Travel Outside
the United StatesAbroad, citizens traveling or workingCitizens outside U.S.Citizens outside U.S.:Business travel outside U.S.Travel and transportation expenses:Business travel:Trip outside U.S.
If any part of your business travel is outside the United States, some of your deductions for the cost of getting to and from your destination may
be limited. For this purpose, the United States includes the 50 states and the District of Columbia.
How much of your travel expenses you can deduct depends in part upon how much of your trip outside the United States was business related.
See chapter 1 of Publication 463 for information on luxury water travel.
Travel Entirely for Business
or Considered Entirely
for Business
You can deduct all your travel expenses of getting to and from your business destination if your trip is entirely for business or considered
entirely for business.
Travel entirely for business.
If you travel outside the United States and you spend the entire time on business activities, you can deduct all of your travel expenses.
Travel considered entirely for business.
Even if you did not spend your entire time on business activities, your trip is considered entirely for business if you meet at least one of the
following four exceptions.
Exception 1 - No substantial control.
Your trip is considered entirely for business if you did not have substantial control over arranging the trip. The fact that you control the timing
of your trip does not, by itself, mean that you have substantial control over arranging your trip.
You do not have substantial control over your trip if you:
Are an employee who was reimbursed or paid a travel expense allowance,
Are not related to your employer, and
Are not a managing executive.
Related to your employer is defined later in this chapter under Related to employer.
A managing executive is an employee who has the authority and responsibility, without being subject to the veto of another, to decide on the
need for the business travel.
Citizens outside U.S.:Business travel outside U.S.:Self-employed personsSelf-employed persons:Travel outside U.S.A self-employed person generally has substantial control over arranging business trips.
Exception 2 - Outside United States no more than a week.
Your trip is considered entirely for business if you were outside the United States for a week or less, combining business and nonbusiness
activities. One week means seven consecutive days. In counting the days, do not count the day you leave the United States, but do count the day you
return to the United States.
Exception 3 - Less than 25% of time on personal activities.
Your trip is considered entirely for business if:
You were outside the United States for more than a week, and
You spent less than 25% of the total time you were outside the United States on nonbusiness activities.
For this purpose, count both the day your trip began and the day it ended.
Exception 4 - Vacation not a major consideration.
Your trip is considered entirely for business if you can establish that a personal vacation was not a major consideration, even if you have
substantial control over arranging the trip.
Travel Primarily for BusinessAbroad, citizens traveling or workingCitizens outside U.S.Citizens outside U.S.:Business travel outside U.S.Travel and transportation expenses:Business travel:Trip outside U.S.
If you travel outside the United States primarily for business but spend some of your time on nonbusiness activities, you generally cannot deduct
all of your travel expenses. You can only deduct the business portion of your cost of getting to and from your destination. You must allocate the
costs between your business and nonbusiness activities to determine your deductible amount. These travel allocation rules are discussed in chapter 1
of Publication 463.
You do not have to allocate your travel expense deduction if you meet one of the four exceptions listed earlier under Travel considered
entirely for business. In those cases, you can deduct the total cost of getting to and from your destination.
Travel Primarily for Personal ReasonsCitizens outside U.S.:Business travel outside U.S.Travel and transportation expenses:Business travel:Trip outside U.S.
If you travel outside the United States primarily for vacation or for investment purposes, the entire cost of the trip is a nondeductible personal
expense. If you spend some time attending brief professional seminars or a continuing education program, you can deduct your registration fees and
other expenses you have that are directly related to your business.
ConventionsConventions:Travel expensesTravel and transportation expenses:Conventions
You can deduct your travel expenses when you attend a convention if you can show that your attendance benefits your trade or business. You cannot
deduct the travel expenses for your family.
Investments:Classes as travel expensesPolitical conventions:Travel expensesIf the convention is for investment, political, social, or other purposes unrelated to your trade or
business, you cannot deduct the expenses.
Conventions:Delegates:Travel expensesYour appointment or election as a delegate does not, in itself, determine whether you can deduct travel
expenses. You can deduct your travel expenses only if your attendance is connected to your own trade or business.
Convention agenda.
The convention agenda or program generally shows the purpose of the convention. You can show your attendance at the convention benefits your trade
or business by comparing the agenda with the official duties and responsibilities of your position. The agenda does not have to deal specifically with
your official duties and responsibilities; it will be enough if the agenda is so related to your position that it shows your attendance was for
business purposes.
Conventions held outside the North American area.
Travel and transportation expensesSee chapter 1 of Publication 463 for information on conventions held outside the
North American area.
Entertainment ExpensesBusiness associatesEntertainment expensesBusiness expenses:Entertainment expensesClientsEntertainment expensesCustomersEntertainment expensesDeductions:Entertainment expensesEntertainment expenses
You may be able to deduct business-related entertainment expenses you have for entertaining a client, customer, or employee.
You can deduct entertainment expenses only if they are both ordinary and necessary (defined earlier in the Introduction) and meet one of the
following tests.
Directly-related test.
Associated test.
Both of these tests are explained in chapter 2 of Publication 463.
The amount you can deduct for entertainment expenses may be limited. Generally, you can deduct only 50% of your unreimbursed entertainment
expenses. This limit is discussed later under 50% Limit.
Club dues and membership fees.Club dues and membership fees:Entertainment expensesSocial clubs:Dues:Not entertainment expenses
You cannot deduct dues (including initiation fees) for membership in any club organized for:
Business,
Pleasure,
Recreation, or
Other social purpose.
This rule applies to any membership organization if one of its principal purposes is either:
To conduct entertainment activities for members or their guests, or
To provide members or their guests with access to entertainment facilities.
The purposes and activities of a club, not its name, will determine whether or not you can deduct the dues. You cannot deduct dues paid to:
Country clubs,Country clubs:Dues:Entertainment expense deduction not allowed
Golf and athletic clubs, Golf clubsCountry clubs
Airline clubs,Airline club dues:Not entertainment expenses
Hotel clubs, andHotels:Club dues:Not entertainment expenses
Clubs operated to provide meals under circumstances generally considered to be conducive to business discussions.
Entertainment.
Entertainment expenses:Tickets:Face-value as deductible amountTicketsEntertainment expensesEntertainment includes any activity generally considered to provide entertainment, amusement, or recreation.
Examples include entertaining guests at nightclubs; at social, athletic, and sporting clubs; at theaters; at sporting events; on yachts; or on
hunting, fishing, vacation, and similar trips.
You cannot deduct expenses for entertainment that are lavish or extravagant. If you buy a ticket to an entertainment event for a client, you
generally cannot deduct more than the face value of the ticket, even if you paid a higher price.
Gift or entertainment.Entertainment expenses:Business-related gifts vs.Gifts:Business-related expenses
Any item that might be considered either a gift or entertainment generally will be considered entertainment. However, if you give a customer
packaged food or beverages that you intend the customer to use at a later date, treat it as a gift.
Entertainment expenses:Tickets:Gift vs. entertainment deductionIf you give a customer tickets to a theater performance or sporting event and you do
not go with the customer to the performance or event, you have a choice. You can treat the tickets as either a gift or entertainment, whichever is to
your advantage.
If you go with the customer to the event, you must treat the cost of the tickets as an entertainment expense. You cannot choose, in this case, to
treat the tickets as a gift.
Separating costs.Entertainment expenses:Allocation of costs
If you have one expense that includes the costs of entertainment, and other services (such as lodging or transportation), you must allocate that
expense between the cost of entertainment and the cost of other services. You must have a reasonable basis for making this allocation. For example,
you must allocate your expenses if a hotel includes entertainment in its lounge on the same bill with your room charge.
A meal as a form of entertainment.Entertainment expenses:Meal expenses includedMeal and lodging expenses:Business-related entertainment including
Entertainment includes the cost of a meal you provide to a customer or client, whether the meal is a part of other entertainment or by itself. A
meal expense includes the cost of food, beverages, taxes, and tips for the meal. To deduct an entertainment-related meal, you or your employee must be
present when the food or beverages are provided.
You cannot claim the cost of your meal both as an entertainment expense and as a travel expense.
Taking turns paying for meals or entertainment.Entertainment expenses:Taking turns paying for meals or entertainmentMeal and lodging expenses:Taking turns paying for meals or entertainment
If a group of business acquaintances take turns picking up each others' meal or entertainment checks without regard to whether any business
purposes are served, no member of the group can deduct any part of the expense.
Trade association meetings.Trade associations:Meetings and entertainment expenses
Chambers of commerce:Entertainment expenses for attending meetingsProfessionals:Entertainment expenses for attending association meetingsYou can deduct entertainment expenses that are directly related
to, and necessary for, attending business meetings or conventions of certain exempt organizations if the expenses of your attendance are related to
your active trade or business. These organizations include business leagues, chambers of commerce, real estate boards, trade associations, and
professional associations.
Additional information.
For more information on entertainment expenses, including discussions of the directly-related and associated tests, see chapter 2 of Publication
463.
50% LimitEntertainment expenses:50% limitMeal and lodging expenses:50% deduction for business-related meals
In general, you can deduct only 50% of your business-related meal and entertainment expenses. (If you are subject to the Department of
Transportation's hours of service limits, you can deduct a higher percentage. See Individuals subject to hours of service limits,
later.)
The 50% limit applies to employees or their employers, and to self-employed persons (including independent contractors) or their clients, depending
on whether the expenses are reimbursed.
FiguresTables and figuresTables and figures:Entertainment expenses:50% limit (Figure 26-A)Tables and figures:Meal expenses and 50% limit (Figure 26-A)Figure 26-A summarizes the general rules explained in this section.
The 50% limit applies to business meals or entertainment expenses you have while:
Traveling away from home (whether eating alone or with others) on business,
Entertaining customers at your place of business, a restaurant, or other location, or
Attending a business convention or reception, business meeting, or business luncheon at a club.
Included expenses.
Expenses subject to the 50% limit include:
Taxes and tips relating to a business meal or entertainment activity,
Tip expense:Business meal or entertainment activity, 50% deduction limit
Cover charges for admission to a nightclub,
Nightclubs:Cover charges, 50% limit on deduction
Rent paid for a room in which you hold a dinner or cocktail party, and
Amounts paid for parking at a sports arena.
Parking fees:Sports arena, business-related entertainment subject to 50% limitHowever, the cost of transportation to and from a business meal or a business-related entertainment activity is not subject to the 50% limit.
Application of 50% limit.
The 50% limit on meal and entertainment expenses applies if the expense is otherwise deductible and is not covered by one of the exceptions
discussed later in this section.
The 50% limit also applies to certain meal and entertainment expenses that are not business-related. It applies to meal and entertainment expenses
incurred for the production of income, including rental or royalty income. It also applies to the cost of meals included in deductible educational
expenses.
When to apply the 50% limit.
You apply the 50% limit after determining the amount that would otherwise qualify for a deduction. You first have to determine the amount of meal
and entertainment expenses that would be deductible under the other rules discussed in this chapter.
Example 1.
You spend $100 for a business-related meal. If $40 of that amount is not allowable because it is lavish and extravagant, the remaining $60 is
subject to the 50% limit. Your deduction cannot be more than $30 (.50 × $60).
Example 2.
You purchase two tickets to a concert and give them to a client. You purchased the tickets through a ticket agent. You paid $150 for the two
tickets, which had a face value of $60 each ($120 total). Your deduction cannot be more than $60 (.50 × $120).
Exceptions to the 50% Limit
Generally, business-related meal and entertainment expenses are subject to the 50% limit. Figure 26-A can help you determine if the 50% limit
applies to you.
Your meal or entertainment expense is not subject to the 50% limit if the expense meets one of the following exceptions.
Employee's reimbursed expenses.Reimbursement:Employee business expenses
If you are an employee, you are not subject to the 50% limit on expenses for which your employer reimburses you under an accountable plan.
Accountable plans are discussed later under Reimbursements.
Individuals subject to hours of service limits.Meal and lodging expenses:Transportation workers:Deduction limitsTransportation workers:Meal expenses:Deduction limits
You can deduct a higher percentage of your meal expenses while traveling away from your tax home if the meals take place during or incident to any
period subject to the Department of Transportation's hours of service limits. The percentage is 70% for 2005, and it gradually increases to 80%
by the year 2008.
Individuals subject to the Department of Transportation's hours of service limits include the following persons.
Certain air transportation workers (such as pilots, crew, dispatchers, mechanics, and control tower operators) who are under Federal
Aviation Administration regulations.
Interstate truck operators and bus drivers who are under Department of Transportation regulations.
Certain railroad employees (such as engineers, conductors, train crews, dispatchers, and control operations personnel) who are under Federal
Railroad Administration regulations.
Certain merchant mariners who are under Coast Guard regulations.
Meal and lodging expenses
Other exceptions.
There are also exceptions for the self-employed, advertising expenses, selling meals or entertainment, and charitable sports events. These are
discussed in Publication 463.
Entertainment expenses:50% limit:Figure 26-A summary of rulesMeal and lodging expenses:50% deduction for business-related meals:Figure 26-A summary of rulesTables and figures:Entertainment expenses:50% limit (Figure 26-A)Tables and figures:Meal expenses and 50% limit (Figure 26-A)Figure 26-A. Does the 50% Limit Apply to Your Expenses?Summary: This flowchart is used to determine if the 50% limit applies to your expenses and is used by all employees and self-employed people.
The amount you can deduct for entertainment expenses may be limited. Generally, you can deduct only 50% of your unreimbursed entertainment expenses.
There are exceptions to these rules. See Exceptions to the 50% Limit. All employees and self-employed persons can use this chart. For more
information, see 50% Limit.StartThis is the starting of the flowchart.Decision (1)Were your meal and entertainment expenses reimbursed? (Count only reimbursements your employer did not include in box 1 of your Form W-2. If
self-employed, count only reimbursements from clients or customers that are not included on Form 1099-MISC, Miscellaneous Income.)IF Yes Continue To Decision (2)IF No Continue To Process (a)Decision (2)If an employee, did you adequately account to your employer under an accountable plan? If self-employed, did you provide the payer with
adequate records? (See How To Report.)IF Yes Continue To Decision (3)IF No Continue To Process (a)Decision (3)Did your expenses exceed the reimbursement?IF Yes Continue To Decision (4)IF No Continue To Process (b)Decision (4)FOR the amount reimbursed... Continue To Process (b)FOR the excess amount... Continue To Process (a)Process (a)Your meal and entertainment expenses ARE subject to the 50% limit.Continue To End Process (b)Your meal and entertainment expenses are NOT subject to the 50% limit. However, since the reimbursement was not treated as wages or as other
taxable income, you cannot deduct the expenses.Continue To EndEndThis is the ending of the flowchart.Gift ExpensesGifts:Business-related expenses
If you give gifts in the course of your trade or business, you can deduct all or part of the cost. This section explains the limits and rules for
deducting the costs of gifts.
$25 limit.Gifts:$25 limit on business-related expenses
You can deduct no more than $25 for business gifts you give directly or indirectly to any one person during your tax year. A gift to a company that
is intended for the eventual personal use or benefit of a particular person or a limited class of people will be considered an indirect gift to that
particular person or to the individuals within that class of people who receive the gift.
If you give a gift to a member of a customer's family, the gift is generally considered to be an indirect gift to the customer. This rule does not
apply if you have a bona fide, independent business connection with that family member and the gift is not intended for the customer's
eventual use.
If you and your spouse both give gifts, both of you are treated as one taxpayer. It does not matter whether you have separate businesses, are
separately employed, or whether each of you has an independent connection with the recipient. If a partnership gives gifts, the partnership and the
partners are treated as one taxpayer.
Incidental costs.Gifts:Incidental costs of business-related expensesIncidental expenses:Business-related gifts
Incidental costs, such as engraving on jewelry, or packaging, insuring, and mailing, are generally not included in determining the cost of a gift
for purposes of the $25 limit.
A cost is incidental only if it does not add substantial value to the gift. For example, the cost of gift wrapping is an incidental cost. However,
the purchase of an ornamental basket for packaging fruit is not an incidental cost if the value of the basket is substantial compared to the value of
the fruit.
Exceptions.
The following items are not considered gifts for purposes of the $25 limit.
An item that costs $4 or less and:
Has your name clearly and permanently imprinted on the gift, and
Is one of a number of identical items you widely distribute. Examples include pens, desk sets, and plastic bags and cases.
Gifts:$4 or less for business-related expenses
Signs, display racks, or other promotional material to be used on the business premises of the recipient.
Gift or entertainment.Entertainment expenses:Business-related gifts vs.
Any item that might be considered either a gift or entertainment generally will be considered entertainment. However, if you give a customer
packaged food or beverages that you intend the customer to use at a later date, treat it as a gift.
Entertainment expenses:Tickets:Gift vs. entertainment deductionTicketsEntertainment expensesIf you give a customer tickets to a theater performance or sporting event and you do not go with the customer to
the performance or event, you have a choice. You can treat the cost of the tickets as either a gift expense or an entertainment expense, whichever is
to your advantage.
Gifts:Business-related expensesIf you go with the customer to the event, you must treat the cost of the tickets as an
entertainment expense. You cannot choose, in this case, to treat the cost of the tickets as a gift expense.
Transportation ExpensesTravel and transportation expensesBusiness expenses:TravelTravel and transportation expensesDeductions:Transportation expensesTravel and transportation expensesTransportation expensesTravel and transportation expenses
This section discusses expenses you can deduct for business transportation when you are not traveling away from home as defined earlier under
Travel Expenses. These expenses include the cost of transportation by air, rail, bus, taxi, etc., and the cost of driving and maintaining
your car.
Transportation expenses include the ordinary and necessary costs of all of the following.
Getting from one workplace to another in the course of your business or profession when you are traveling within your tax home. (Tax home is
defined earlier under Travel Expenses.)
Visiting clients or customers.
Business associates:Business travel to meetClients:Business travel to meetCustomers:Business travel to meetTravel and transportation expenses:Business travel:Visiting clients or customers
Going to a business meeting away from your regular workplace.
Travel and transportation expenses:Going to business meeting away from regular workplace
Getting from your home to a temporary workplace when you have one or more regular places of work. These temporary workplaces can be either
within the area of your tax home or outside that area.
Travel and transportation expenses:Getting from home to temporary workplace when multiple regular workplacesTransportation expenses do not include expenses you have while traveling away from home overnight. Those expenses are travel expenses, which
are discussed earlier. However, if you use your car while traveling away from home overnight, use the rules in this section to figure your car expense
deduction. See Car Expenses, later.
Illustration of transportation expenses.
Tables and figures:Travel and transportation expenses:Local transportation (Figure 26-B)Travel and transportation expenses:Summary of rules (Figure 26-B)Figure 26-B illustrates the rules for when you can deduct transportation expenses when you
have a regular or main job away from your home. You may want to refer to it when deciding whether you can deduct your transportation expenses.
Temporary work location.Travel and transportation expenses:Temporary work location
If you have one or more regular work locations away from your home and you commute to a temporary work location in the same trade or business, you
can deduct the expenses of the daily round-trip transportation between your home and the temporary location, regardless of distance.
If your employment at a work location is realistically expected to last (and does in fact last) for one year or less, the employment is temporary
unless there are facts and circumstances that would indicate otherwise.
If your employment at a work location is realistically expected to last for more than 1 year or if there is no realistic expectation that the
employment will last for 1 year or less, the employment is not temporary, regardless of whether it actually lasts for more than 1 year.
If employment at a work location initially is realistically expected to last for 1 year or less, but at some later date the employment is
realistically expected to last more than 1 year, that employment will be treated as temporary (unless there are facts and circumstances that would
indicate otherwise) until your expectation changes. It will not be treated as temporary after the date you determine it will last more than 1 year.
If the temporary work location is beyond the general area of your regular place of work and you stay overnight, you are traveling away from home.
You may have deductible travel expenses as discussed earlier in this chapter.
No regular place of work.
If you have no regular place of work but ordinarily work in the metropolitan area where you live, you can deduct daily transportation costs between
home and a temporary work site outside that metropolitan area.
Generally, a metropolitan area includes the area within the city limits and the suburbs that are considered part of that metropolitan area.
You cannot deduct daily transportation costs between your home and temporary work sites within your metropolitan area. These are nondeductible
commuting expenses.
Two places of work.
If you work at two places in one day, whether or not for the same employer, you can deduct the expense of getting from one workplace to the other.
However, if for some personal reason you do not go directly from one location to the other, you cannot deduct more than the amount it would have cost
you to go directly from the first location to the second.
Transportation expenses you have in going between home and a part-time job on a day off from your main job are commuting expenses. You cannot
deduct them.
Armed Forces reservists.Armed forces:ReservistsReservists:Deduction for transportation expense
A meeting of an Armed Forces reserve unit is a second place of business if the meeting is held on a day on which you work at your regular job. You
can deduct the expense of getting from one workplace to the other as just discussed under Two places of work.
You usually cannot deduct the expense if the reserve meeting is held on a day on which you do not work at your regular job. In this case, your
transportation generally is a nondeductible commuting expense. However, you can deduct your transportation expenses if the location of the meeting is
temporary and you have one or more regular places of work.
If you ordinarily work in a particular metropolitan area but not at any specific location and the reserve meeting is held at a temporary location
outside that metropolitan area, you can deduct your transportation expenses.
If you travel away from home overnight to attend a guard or reserve meeting, you can deduct your travel expenses. These expenses are discussed
earlier under Travel Expenses.
If you travel more than 100 miles away from home in connection with your performance of services as a member of the reserves, you may be able to
deduct some of your reserve-related travel costs as an adjustment to income rather than as an itemized deduction. See Armed Forces reservists
traveling more than 100 miles from home under Special Rules, later.
Commuting expenses.Commuting expensesEmployee business expenses:Commuting expensesTravel and transportation expenses:Commuting expenses
You cannot deduct the costs of taking a bus, trolley, subway, or taxi, or of driving a car between your home and your main or regular place of
work. These costs are personal commuting expenses. You cannot deduct commuting expenses no matter how far your home is from your regular place of
work. You cannot deduct commuting expenses even if you work during the commuting trip.
Example.
You had a telephone installed in your car. You sometimes use that telephone to make business calls while commuting to and from work. Sometimes
business associates ride with you to and from work, and you have a business discussion in the car. These activities do not change the trip from
personal to business. You cannot deduct your commuting expenses.
Parking fees.Parking fees:Commuting expenseTravel and transportation expenses:Parking fees:Commuting expense
Fees you pay to park your car at your place of business are nondeductible commuting expenses. You can, however, deduct business-related parking
fees when visiting a customer or client.
Advertising display on car.Cars:Advertising displays on
Putting display material that advertises your business on your car does not change the use of your car from personal use to business use. If you
use this car for commuting or other personal uses, you still cannot deduct your expenses for those uses.
Car pools.Car poolsCars:Car pools
You cannot deduct the cost of using your car in a nonprofit car pool. Do not include payments you receive from the passengers in your income. These
payments are considered reimbursements of your expenses. However, if you operate a car pool for a profit, you must include payments from passengers in
your income. You can then deduct your car expenses (using the rules in this chapter).
Hauling tools or instruments.Cars:Hauling tools or instrumentsEquipmentToolsMachineryToolsTools:Hauling to and from work
Hauling tools or instruments in your car while commuting to and from work does not make your car expenses deductible. However, you can deduct any
additional costs you have for hauling tools or instruments (such as for renting a trailer you tow with your car).
Union members' trips from a union hall.Labor unions:Trips from union hall to place of work
If you get your work assignments at a union hall and then go to your place of work, the costs of getting from the union hall to your place of work
are nondeductible commuting expenses. Although you need the union to get your work assignments, you are employed where you work, not where the union
hall is located.
Office in the home.Home office:Travel to another work location
If you have an office in your home that qualifies as a principal place of business, you can deduct your daily transportation costs between your
home and another work location in the same trade or business. (See chapter 28 for information on determining if your home office qualifies as a
principal place of business.)
Figure 26-B. When Are Transportation Expenses Deductible?Summary: This illustration depicts the rules used to determine if transportation expenses are deductible.Between home and regular or main job, Never deductible.Between home and temporary work location, Deductible if you have a regular or main job at another location.Between home and second job, Never deductible.Between regular or main job and temporary work location, Always deductible.Between regular or main job and second job, Always deductible.Between temporary work location and second job, Always deductible.The image then lists definitions for words used in the graphic:Home: The place where you reside. Transportation expenses between your home and your main or regular place of work are personal commuting
expenses.Regular or main job: Your principal place of business. If you have more than one job, you must determine which one is your regular or main
job. Consider the time you spend at each, the activity you have at each, and the income you earn at each.Temporary work location: A place where your work assignment is realistically expected to last (and does in fact last) one year or less.
Unless you have a regular place of business, you can only deduct your transportation expenses to a temporary work location outside your metropolitan
area.Second job: If you regularly work at two or more places in one day, whether or not for the same employer, you can deduct your transportation
expenses of getting from one workplace to another. You cannot deduct your transportation costs between your home and a second job on a day off from
your main job.Examples of deductible transportation.
The following examples show when you can deduct transportation expenses based on the location of your work and your home.
Example 1.
You regularly work in an office in the city where you live. Your employer sends you to a one-week training session at a different office in the
same city. You travel directly from your home to the training location and return each day. You can deduct the cost of your daily round-trip
transportation between your home and the training location.
Example 2.
Your principal place of business is in your home. You can deduct the cost of round-trip transportation between your qualifying home office and your
client's or customer's place of business.
Example 3.
You have no regular office, and you do not have an office in your home. In this case, the location of your first business contact is considered
your office. Transportation expenses between your home and this first contact are nondeductible commuting expenses. Transportation expenses between
your last business contact and your home are also nondeductible commuting expenses. Although you cannot deduct the costs of these first and last
trips, you can deduct the costs of going from one client or customer to another.
Car ExpensesCars
If you use your car for business purposes, you may be able to deduct car expenses. You generally can use one of the two following methods to figure
your deductible expenses.
If you use actual car expenses to figure your deduction for a car you lease, there are rules that affect the amount of your lease payments that you
can deduct. See Leasing a car under Actual Car Expenses, later.
In this chapter, car includes a van, pickup, or panel truck.
Electric cars:CreditYou may be entitled to a tax credit for an electric vehicle (see chapter 37) or a deduction from gross income for a
part of the cost of a clean-fuel vehicle that you place in service during the year. The vehicle must meet certain requirements, and you do not have to
use it in your business to qualify for the credit or the deduction. For more information, see chapter 12 of Publication 535.
Rural mail carriers.Post office employees:Rural mail carriersRural mail carriersU.S. Postal ServicePost office employees
If you are a rural mail carrier, you may be able to treat the amount of qualified reimbursement you received as the amount of your allowable
expense. Because the qualified reimbursement is treated as paid under an accountable plan, your employer should not include the amount of
reimbursement in your income.
If your vehicle expenses are more than the amount of your reimbursement, you can deduct the unreimbursed expenses as an itemized deduction on
Schedule A (Form 1040). You must complete Form 2106 and attach it to your Form 1040.
A qualified reimbursement is the reimbursement you receive that meets both of the following conditions.
It is given as an equipment maintenance allowance (EMA) to employees of the U.S. Postal Service.
It is at the rate contained in the 1991 collective bargaining agreement. Any later agreement cannot increase the qualified reimbursement
amount by more than the rate of inflation.
See your employer for information on your reimbursement.
If you are a rural mail carrier and received a qualified reimbursement, you cannot use the standard mileage rate.
Standard Mileage RateMileage ratesStandard mileage ratesStandard mileage rates:Business-related milesStandard mileage ratesTravel and transportation expenses:Mileage ratesStandard mileage rates
You may be able to use the standard mileage rate to figure the deductible costs of operating your car for business purposes. For 2005, the standard
mileage rate for each mile of business use is:
40 cents per mile for the period January 1 through August 31, 2005, and
48 cents per mile for the period September 1 through December 31, 2005.
If you use the standard mileage rate for a year, you cannot deduct your actual car expenses for that year, but see Parking fees and
tolls, later.
You generally can use the standard mileage rate whether or not you are reimbursed and whether any reimbursement is more or less than the amount
figured using the standard mileage rate. See Reimbursements under How To Report, later.
Choosing the standard mileage rate.
If you want to use the standard mileage rate for a car you own, you must choose to use it in the first year the car is available for use in your
business. Then in later years, you can choose to use either the standard mileage rate or actual expenses.
If you want to use the standard mileage rate for a car you lease, you must use it for the entire lease period. For leases that began on or before
December 31, 1997, the standard mileage rate must be used for the entire portion of the lease period (including renewals) that is after 1997.
If you choose to use the standard mileage rate, you are considered to have chosen not to use the depreciation methods under the Modified
Accelerated Cost Recovery System (MACRS). This is because the standard mileage rate includes an allowance for depreciation that is not expressed in
terms of years. If you change to the actual expenses method in a later year, but before your car is fully depreciated, you have to estimate the
remaining useful life of the car and use straight line depreciation. For more information about depreciation included in the standard mileage rate,
see the exception in Methods of depreciation under Depreciation Deduction in chapter 4 of Publication 463.
Standard mileage rate not allowed.Standard mileage rates:Not allowed
You cannot use the standard mileage rate if you:
Use the car for hire (such as a taxi),Taxis:Standard mileage rate not allowed
Use five or more cars at the same time (as in fleet operations),Fleet operations:Standard mileage rate not allowed
Claimed a depreciation deduction for the car using any method other than straight line depreciation,
Claimed a section 179 deduction on the car,
Claimed the special depreciation allowance on the car,
Claimed actual car expenses after 1997 for a car you leased, or
Are a rural mail carrier who received a qualified reimbursement. (See Rural mail carriers, earlier.)
Five or more cars.
If you own or lease five or more cars that are used for business at the same time, you cannot use the standard mileage rate for the business use of
any car. However, you may be able to deduct your actual expenses for operating each of the cars in your business. See Actual Car Expenses
in chapter 4 of Publication 463 for information on how to figure your deduction.
You are not using five or more cars for business at the same time if you alternate using (use at different times) the cars for business.
Parking fees and tolls.Cars:ParkingParking feesParking fees:Business-related travelTolls:Business-related travelTravel and transportation expenses:Parking fees:Business-related travel
In addition to using the standard mileage rate, you can deduct any business-related parking fees and tolls. (Parking fees that you pay to park your
car at your place of work are nondeductible commuting expenses.)
Actual Car ExpensesCars:Actual expenses
If you do not use the standard mileage rate, you may be able to deduct your actual car expenses.
If you qualify to use both methods, you may want to figure your deduction both ways to see which gives you a larger deduction.
Business and personal use.Cars:Business and personal use, allocation between
If you use your car for both business and personal purposes, you must divide your expenses between business and personal use. You can divide your
expense based on the miles driven for each purpose.
Example.
You are a contractor and drive your car 20,000 miles during the year: 12,000 miles for business use and 8,000 miles for personal use. You can claim
only 60% (12,000 ÷ 20,000) of the cost of operating your car as a business expense.
Interest on car loans.Interest payments:Car loans
If you are an employee, you cannot deduct any interest paid on a car loan. This interest is treated as personal interest and is not deductible.
However, if you are self-employed and use your car in that business, see chapter 5 of Publication 535.
Home equity loans:Car purchased byIf you use a home equity loan to purchase your car, you may be able to deduct the interest. See chapter 23
for more information.
Taxes paid on your car.Personal propertyTaxesPersonal property taxesPersonal property taxes:Car taxesTaxes:Personal property taxes:Car taxes
If you are an employee, you can deduct personal property taxes paid on your car if you itemize deductions. Enter the amount paid on line 7 of
Schedule A (Form 1040). (See chapter 22 for more information on taxes.) If you are not an employee, see your form instructions for information on how
to deduct personal property taxes paid on your car.
Sales taxes.
Sales tax:Car purchaseTaxes:Sales taxGenerally, sales taxes on your car are part of your car's basis and are recovered through depreciation, discussed
later. However, to the extent the car is not used in your trade or business, you can choose to deduct the nonbusiness part of the sales tax on your
car as part of your state and local sales tax deduction on Schedule A (Form 1040). You can only choose to deduct state and local sales taxes as an
itemized deduction if you choose not to deduct state and local income taxes.
Fines and collateral.Traffic violations:Fines not deductible
You cannot deduct fines you pay and forfeited collateral for traffic violations.
Generally, the cost of a car, plus sales tax and improvements, is a capital expense. Because the benefits last longer than one year, you generally
cannot deduct a capital expense. However, you can recover this cost through the section 179 deduction (the deduction allowed by section 179 of the
Internal Revenue Code), and depreciation deductions. Depreciation allows you to recover the cost over more than one year by deducting part of it each
year. The section 179 deduction, and the depreciation deduction are discussed in more detail in chapter 4 of Publication 463.
Generally, there are limits on these deductions. Special rules apply if you use your car 50% or less in your work or business.
Leasing a car.Cars:Leased vehiclesLeased vehicles:Car expenses
If you lease a car, truck, or van that you use in your business, you can use the standard mileage rate or actual expenses to figure your deductible
car expense.
Deductible payments.
If you choose to use actual expenses, you can deduct the part of each lease payment that is for the use of the car in your business. You cannot
deduct any part of a lease payment that is for personal use of the car, such as commuting.
You must spread any advance payments over the entire lease period. You cannot deduct any payments you make to buy a car, even if the payments are
called lease payments.
If you lease a car for 30 days or more, you may have to reduce your lease payment deduction by an inclusion amount. For information on
reporting lease inclusion amounts, see Leasing a Car in chapter 4 of Publication 463.
Sale, Trade-In, or Other DispositionCars:Sale, trade-in, or other dispositionTrade-in of car
If you sell, trade in, or otherwise dispose of your car, you may have a taxable gain or a deductible loss. This is true whether you used the
standard mileage rate or actual car expenses to deduct the business use of your car. Publication 544 has information on sales of property used in a
trade or business, and details on how to report the disposition.
Travel and transportation expensesRecordkeepingEntertainment expenses:Recordkeeping requirementsGifts:Recordkeeping requirementsMeal and lodging expenses:Recordkeeping requirementsRecordkeeping requirements:Business travel expensesRecordkeeping requirements:Travel expensesTravel and transportation expenses:Recordkeeping requirements
If you deduct travel, entertainment, gift, or transportation expenses, you must be able to prove (substantiate) certain elements of the expense.
This section discusses the records you need to keep to prove these expenses.
If you keep timely and accurate records, you will have support to show the IRS if your tax return is ever examined. You will also have proof of
expenses that your employer may require if you are reimbursed under an accountable plan. These plans are discussed later under
Reimbursements.
How To Prove ExpensesEntertainment expenses:Proof of expensesM&IE (Meals and incidental expenses)Meal and lodging expensesMeal and lodging expenses:Proof of expensesProof of business expenseTravel and transportation expenses:Proof of expenses
Table 26-2 is a summary of records you need to prove each expense discussed in this chapter. You must be able to prove the elements listed across
the top portion of the chart. You prove them by having the information and receipts (where needed) for the expenses listed in the first column.
Estimates:Travel expensesTravel and transportation expenses:Estimates of
You cannot deduct amounts that you approximate or estimate.
You should keep adequate records to prove your expenses or have sufficient evidence that will support your own statement. You must generally
prepare a written record for it to be considered adequate. This is because written evidence is more reliable than oral evidence alone. However, if you
prepare a record in a computer memory device with the aid of a logging program, it is considered an adequate record.
What Are Adequate Records?
You should keep the proof you need in an account book, diary, statement of expense, or similar record. You should also keep documentary evidence
that, together with your records, will support each element of an expense.
You generally must have documentary evidence, such as receipts, canceled checks, or bills, to support your expenses.
Exception.
Documentary evidence is not needed if any of the following conditions apply.
You have meals or lodging expenses while traveling away from home for which you account to your employer under an accountable plan and you
use a per diem allowance method that includes meals and/or lodging. (Accountable plans and per diem allowances are discussed later under
Reimbursements.)
Your expense, other than lodging, is less than $75.Travel and transportation expenses:Business travel:$75 or less
You have a transportation expense for which a receipt is not readily available.Travel and transportation expenses:Business travel:Receipt not readily available to prove
Adequate evidence.
Documentary evidence ordinarily will be considered adequate if it shows the amount, date, place, and essential character of the expense.
For example, a hotel receipt is enough to support expenses for business travel if it has all of the following information.
The name and location of the hotel.
The dates you stayed there.
Separate amounts for charges such as lodging, meals, and telephone calls.
Meal and lodging expenses:Restaurant receiptsA restaurant receipt is enough to prove an expense for a business meal if it has all of the following
information.
The name and location of the restaurant.
The number of people served.
The date and amount of the expense.
If a charge is made for items other than food and beverages, the receipt must show that this is the case.
Canceled check.Checks:Canceled checks as evidence of travel expenses
A canceled check, together with a bill from the payee, ordinarily establishes the cost. However, a canceled check by itself does not prove a
business expense without other evidence to show that it was for a business purpose.
Duplicate information.
You do not have to record information in your account book or other record that duplicates information shown on a receipt as long as your records
and receipts complement each other in an orderly manner.
You do not have to record amounts your employer pays directly for any ticket or other travel item. However, if you charge these items to your
employer, through a credit card or otherwise, you must keep a record of the amounts you spend.
Timely-kept records.
You should record the elements of an expense or of a business use at or near the time of the expense or use and support it with sufficient
documentary evidence. A timely-kept record has more value than a statement prepared later when generally there is a lack of accurate recall.
You do not need to write down the elements of every expense on the day of the expense. If you maintain a log on a weekly basis which accounts for
use during the week, the log is considered a timely-kept record.
If you give your employer, client, or customer an expense account statement, it can also be considered a timely-kept record. This is true if you
copy it from your account book, diary, statement of expense, or similar record.
Proving business purpose.Travel and transportation expenses:Business travel:Proof of business purpose
You must generally provide a written statement of the business purpose of an expense. However, the degree of proof varies according to the
circumstances in each case. If the business purpose of an expense is clear from the surrounding circumstances, then you do not need to give a written
explanation.
Confidential information.Confidential information:Travel expenses andTravel and transportation expenses:Business travel:Confidential information and
You do not need to put confidential information relating to an element of a deductible expense (such as the place, business purpose, or business
relationship) in your account book, diary, or other record. However, you do have to record the information elsewhere at or near the time of the
expense and have it available to fully prove that element of the expense.
What If I Have Incomplete Records?Recordkeeping requirements:Incomplete records
If you do not have complete records to prove an element of an expense, then you must prove the element with:
Your own written or oral statement, containing specific information about the element, and
Other supporting evidence that is sufficient to establish the element.
Destroyed records.Destroyed recordsRecordkeeping requirements:Destroyed records
If you cannot produce a receipt because of reasons beyond your control, you can prove a deduction by reconstructing your records or expenses.
Reasons beyond your control include fire, flood, and other casualty.
Separating and Combining Expenses
This section explains when expenses must be kept separate and when expenses can be combined.
Separating expenses.Cars:Business and personal use, allocation betweenEntertainment expenses:Allocation of costsTravel and transportation expenses:Allocation of types of costs
Each separate payment is generally considered a separate expense. For example, if you entertain a customer or client at dinner and then go to the
theater, the dinner expense and the cost of the theater tickets are two separate expenses. You must record them separately in your records.
Combining items.
You can make one daily entry in your record for reasonable categories of expenses. Examples are taxi fares, telephone calls, or other incidental
travel costs. Meals should be in a separate category. You can include tips for meal-related services with the costs of the meals.
Expenses of a similar nature occurring during the course of a single event are considered a single expense. For example, if during entertainment at
a cocktail lounge, you pay separately for each serving of refreshments, the total expense for the refreshments is treated as a single expense.
Allocating total cost.
If you can prove the total cost of travel or entertainment but you cannot prove how much it cost for each person who participated in the event, you
may have to allocate the total cost among you and your guests on a pro rata basis. An allocation would be needed, for example, if you did not have a
business relationship with all of your guests.
If your return is examined.Audits:Travel expense records
If your return is examined, you may have to provide additional information to the IRS. This information could be needed to clarify or to establish
the accuracy or reliability of information contained in your records, statements, testimony, or documentary evidence before a deduction is allowed.
How Long To Keep
Records and ReceiptsRecordkeeping requirements:Period of retentionRetention of recordsRecordkeeping requirements
You must keep records as long as they may be needed for the administration of any provision of the Internal Revenue Code. Generally, this means you
must keep your records that support your deduction (or an item of income) for 3 years from the date you file the income tax return on which the
deduction is claimed. A return filed early is considered filed on the due date. For a more complete explanation, get Publication 583, Starting a
Business and Keeping Records.
Reimbursed for expenses.
Employees who give their records and documentation to their employers and are reimbursed for their expenses generally do not have to keep copies of
this information. However, you may have to prove your expenses if any of the following conditions apply.
You claim deductions for expenses that are more than reimbursements.
Your expenses are reimbursed under a nonaccountable plan.
Your employer does not use adequate accounting procedures to verify expense accounts.
You are related to your employer, as defined later under Related to employer.
See the next section, How To Report, for a discussion of reimbursements, adequate accounting, and nonaccountable plans.
Additional information.
Chapter 5 of Publication 463 has more information on recordkeeping, including examples.
How To ReportCars:Reporting ofEntertainment expenses:Reporting ofMeal and lodging expenses:Reporting ofTravel and transportation expenses:Reporting of
This section explains where and how to report the expenses discussed in this chapter. It discusses reimbursements and how to treat them under
accountable and nonaccountable plans. It also explains rules for independent contractors and clients, fee-basis officials, certain performing artists,
Armed Forces reservists, and certain disabled employees. This section ends with an illustration of how to report travel, entertainment, gift, and car
expenses on Form 2106-EZ.
Self-employed.
You must report your income and expenses on Schedule C or C-EZ (Form 1040) if you are a sole proprietor, or on Schedule F (Form 1040) if you are a
farmer. You do not use Form 2106 or 2106-EZ. See your form instructions for information on how to complete your tax return. You can also find
information in Publication 535 if you are a sole proprietor, or in Publication 225, Farmer's Tax Guide, if you are a farmer.
Both self-employed and an employee.
Employee business expenses:Deductions for:Form 2106 for deductingForm:1040, Schedule FSelf-employed personsForm:2106:Business-related expensesIf you are both self-employed and an employee, you must keep separate records for each
business activity. Report your business expenses for self-employment on Schedule C, C-EZ, or F (Form 1040), as discussed earlier. Report your business
expenses for your work as an employee on Form 2106 or 2106-EZ, as discussed next.
Employees.
Form:2106:Business-related expensesIf you are an employee, you generally must complete Form 2106 to deduct your travel,
transportation, and entertainment expenses. However, you can use the shorter Form 2106-EZ instead of Form 2106 if you meet all of the following
conditions.
You are an employee deducting expenses attributable to your job.
You were not reimbursed by your employer for your expenses (amounts included in box 1 of your Form W-2 are not considered
reimbursements).
If you claim car expenses, you use the standard mileage rate.
For more information on how to report your expenses on Forms 2106 and 2106-EZ, see Completing Forms 2106 and 2106-EZ, later.
Gifts.Gifts:Reporting of expenses
Form:1040, Schedule AGifts, deduction ofGifts:Schedule A (Form 1040) for deductionIf you did not receive any reimbursements (or the reimbursements were all included in
box 1 of your Form W-2), the only business expense you are claiming is for gifts, and the rules for certain individuals (such as performing artists)
discussed later under Special Rules, do not apply to you, do not complete Form 2106 or 2106-EZ. Instead, claim the amount of your
deductible gifts directly on line 20 of Schedule A (Form 1040).
Statutory employees.Statutory employees
Form:1040, Schedule CStatutory employeesForm:1040, Schedule C-EZStatutory employeesForm:W-2:Statutory employeesIf you received a Form W-2 and the Statutory employee box in box 13 was checked, report your
income and expenses related to that income on Schedule C or C-EZ (Form 1040). Do not complete Form 2106 or 2106-EZ.
Commission drivers:Deduction of expensesHomeworkers:Deduction of expensesIndependent contractors:Homeworkers, deduction of expensesInsurance agents:Deduction of expensesItinerant workers:Deduction of expensesSelf-employed persons:Homeworkers, deduction of expensesTraveling salespersons:Deduction of expenses
Statutory employees include full-time life insurance salespersons, certain agent or commission drivers, traveling salespersons, and certain
homeworkers.
If you are entitled to a reimbursement from your employer but you do not claim it, you cannot claim a deduction for the expenses to which that
unclaimed reimbursement applies.
Reimbursement for personal expenses.Reimbursement:Personal expenses
Form:W-2:Reimbursements reported as part of incomeIf your employer reimburses you for nondeductible personal expenses, such as
for vacation trips, your employer must report the reimbursement as wage income in box 1 of your Form W-2. You cannot deduct personal expenses.
ReimbursementsReimbursement
This section explains what to do when you receive an advance or are reimbursed for any of the employee business expenses discussed in this chapter.
<ROM>Table 26-2.</ROM> How To Prove Certain Business ExpensesEntertainment expenses:Proof of expenses:Table 26-2 summaryGifts:Proof of expenses (Table 26-2 summary)Meal and lodging expenses:Proof of expenses:Table 26-2 summaryProof of business expense:Table 26-2 summaryTables and figures:Entertainment expenses:Proof of (Table 26-2)Tables and figures:Gift expenses:Proof of (Table 26-2)Tables and figures:Travel and transportation expenses:Proof of (Table 26-2)Travel and transportation expenses:Proof of expenses:Summary (Table 26-2)
IF you have expenses for...THEN you must keep records that show details of the following
elements...AmountTimePlace or DescriptionBusiness Purpose and
Business RelationshipTravelCost of each separate expense for travel, lodging, and meals. Incidental expenses may be totaled in reasonable categories such
as taxis, daily meals for traveler, etc.Dates you left and returned for each trip and number of days spent on business.Destination or area of your travel (name of city, town, or other designation).Purpose: Business purpose for the expense or the business benefit gained or expected to be gained.
Relationship: N/AEntertainmentCost of each separate expense. Incidental expenses such as taxis, telephones, etc., may be totaled on a daily basis.Date of entertainment. (Also see Business Purpose.)Name and address or location of place of entertainment. Type of entertainment if not otherwise apparent. (Also see Business
Purpose.)Purpose: Business purpose for the expense or the business benefit gained or expected to be gained. For entertainment, the nature of the
business discussion or activity. If the entertainment was directly before or after a business discussion: the date, place, nature, and duration of the
business discussion, and the identities of the persons who took part in both the business discussion and the entertainment activity.
Relationship: Occupations or other information (such as names, titles, or other designations) about the recipients that shows their business
relationship to you. For entertainment, you must also prove that you or your employee was present if the entertainment was a business
meal.Gifts
Cost of the gift.
Date of the gift.
Description of the gift.
Transportation Cost of each separate expense. For car expenses, the cost of the car and any improvements, the date you started using it for
business, the mileage for each business use, and the total miles for the year.Date of the expense. For car expenses, the date of the use of the car.Your business destination.Purpose: Business purpose for the expense.
Relationship: N/A
If you received an advance, allowance, or reimbursement for your expenses, how you report this amount and your expenses depends on whether the
reimbursement was paid to you under an accountable plan or a nonaccountable plan.
This section explains the two types of plans, how per diem and car allowances simplify proving the amount of your expenses, and the tax treatment
of your reimbursements and expenses.
No reimbursement.
You are not reimbursed or given an allowance for your expenses if you are paid a salary or commission with the understanding that you will pay your
own expenses. In this situation, you have no reimbursement or allowance arrangement, and you do not have to read this section on reimbursements.
Instead, see Completing Forms 2106 and 2106-EZ, later, for information on completing your tax return.
Reimbursement, allowance, or advance.Travel and transportation expenses:Advances
A reimbursement or other expense allowance arrangement is a system or plan that an employer uses to pay, substantiate, and recover the expenses,
advances, reimbursements, and amounts charged to the employer for employee business expenses. Arrangements include per diem and car allowances.
Employee business expenses:ReimbursementsPer diemPer diem:Allowance or reimbursementReimbursementPer diemA per diem allowance is a fixed amount of daily reimbursement your employer gives you for your lodging, meal, and
incidental expenses when you are away from home on business. (The term incidental expenses is defined earlier under Meals and Incidental
Expenses.) A car allowance is an amount your employer gives you for the business use of your car.
Your employer should tell you what method of reimbursement is used and what records you must provide.
Accountable PlansAccountable plans for employee reimbursementsReimbursement:Accountable plans, definition of
To be an accountable plan, your employer's reimbursement or allowance arrangement must include all of the following rules.
Your expenses must have a business connection — that is, you must have paid or incurred deductible expenses while performing services
as an employee of your employer.
You must adequately account to your employer for these expenses within a reasonable period of time.
You must return any excess reimbursement or allowance within a reasonable period of time.
See Adequate Accounting and Returning Excess Reimbursements, later.
An excess reimbursement or allowance is any amount you are paid that is more than the business-related expenses that you adequately accounted for
to your employer.
The definition of reasonable period of time depends on the facts and circumstances of your situation. However, regardless of the facts and
circumstances of your situation, actions that take place within the times specified in the following list will be treated as taking place within a
reasonable period of time.
You receive an advance within 30 days of the time you have an expense.
You adequately account for your expenses within 60 days after they were paid or incurred.
You return any excess reimbursement within 120 days after the expense was paid or incurred.
You are given a periodic statement (at least quarterly) that asks you to either return or adequately account for outstanding advances and
you comply within 120 days of the statement.
Employee meets accountable plan rules.
If you meet the three rules for accountable plans, your employer should not include any reimbursements in your income in box 1 of your Form W-2. If
your expenses equal your reimbursement, you do not complete Form 2106. You have no deduction since your expenses and reimbursement are equal.
Form:W-2:Reimbursements reported as part of incomeIf your employer included reimbursements in box 1 of your Form W-2 and you
meet all the rules for accountable plans, ask your employer for a corrected Form W-2.
Accountable plan rules not met.
Even though you are reimbursed under an accountable plan, some of your expenses may not meet all the rules. Those expenses that fail to meet all
three rules for accountable plans are treated as having been reimbursed under a nonaccountable plan (discussed later).
Reimbursement of nondeductible expenses.
You may be reimbursed under your employer's accountable plan for expenses related to that employer's business, some of which are deductible as
employee business expenses and some of which are not deductible. The reimbursements you receive for the nondeductible expenses do not meet rule (1)
for accountable plans, and they are treated as paid under a nonaccountable plan.
Example.
Your employer's plan reimburses you for travel expenses while away from home on business and also for meals when you work late at the office, even
though you are not away from home. The part of the arrangement that reimburses you for the nondeductible meals when you work late at the office is
treated as paid under a nonaccountable plan.
The employer makes the decision whether to reimburse employees under an accountable plan or a nonaccountable plan. If you are an employee who
receives payments under a nonaccountable plan, you cannot convert these amounts to payments under an accountable plan by voluntarily accounting to
your employer for the expenses and voluntarily returning excess reimbursements to the employer.
Adequate Accounting
One of the rules for an accountable plan is that you must adequately account to your employer for your expenses. You adequately account by giving
your employer a statement of expense, an account book, a diary, or a similar record in which you entered each expense at or near the time you had it,
along with documentary evidence (such as receipts) of your travel, mileage, and other employee business expenses. (See Table 26-2, earlier, for
details you need to enter in your record and documents you need to prove certain expenses.) A per diem or car allowance satisfies the adequate
accounting requirement under certain conditions. See Per Diem and Car Allowances, later.
You must account for all amounts you received from your employer during the year as advances, reimbursements, or allowances. This includes amounts
you charged to your employer by credit card or other method. You must give your employer the same type of records and supporting information that you
would have to give to the IRS if the IRS questioned a deduction on your return. You must pay back the amount of any reimbursement or other expense
allowance for which you do not adequately account or that is more than the amount for which you accounted.
Per Diem and Car AllowancesCars:Allowances from employersEmployee business expenses:ReimbursementsPer diemPer diem:Allowance or reimbursementReimbursementPer diem
If your employer reimburses you for your expenses using a per diem or car allowance, you can generally use the allowance as proof of the amount of
your expenses. A per diem or car allowance satisfies the adequate accounting requirements for the amount of your expenses only if all of the following
conditions apply.
Your employer reasonably limits payments of your expenses to those that are ordinary and necessary in the conduct of the trade or
business.
The allowance is similar in form to and not more than the federal rate (discussed later).
You prove the time (dates), place, and business purpose of your expenses to your employer (as explained in Table 26-2) within a reasonable
period of time.
You are not related to your employer (as defined next). If you are related to your employer, you must be able to prove your expenses to the
IRS even if you have already adequately accounted to your employer and returned any excess reimbursement.
If the IRS finds that an employer's travel allowance practices are not based on reasonably accurate estimates of travel costs (including
recognition of cost differences in different areas for per diem amounts), you will not be considered to have accounted to your employer. In this case,
you must be able to prove your expenses to the IRS.
Related to employer.Family:Standard meal allowance not allowed if related to employer
You are related to your employer if:
Your employer is your brother or sister, half brother or half sister, spouse, ancestor, or lineal descendant,
Accountable plans for employee reimbursementsNonaccountable plans for employee reimbursements
Your employer is a corporation in which you own, directly or indirectly, more than 10% in value of the outstanding stock, or
Certain relationships (such as grantor, fiduciary, or beneficiary) exist between you, a trust, and your employer.
Self-employed persons:Meal allowance not permitted when more than 10% ownership of corporationYou may be considered to indirectly own stock, for purposes of (2), if you have an interest in a corporation, partnership, estate, or trust
that owns the stock or if a member of your family or your partner owns the stock.
The federal rate.Per diem:Federal rate
The federal rate can be figured using any one of the following methods.
For per diem amounts:
The regular federal per diem rate.
The standard meal allowance.
M&IE (Meals and incidental expenses)Meal and lodging expensesMeal and lodging expenses:Standard meal allowanceStandard meal allowance
The high-low rate.
For car expenses:
The standard mileage rate.
A fixed and variable rate (FAVR).
Regular federal per diem rate.
The regular federal per diem rate is the highest amount that the federal government will pay to its employees for lodging, meal, and incidental
expenses (or meal and incidental expenses only) while they are traveling away from home in a particular area. The rates are different for different
locations. Your employer should have these rates available. (Employers can get Publication 1542 on the Internet, which gives the rates in the
continental United States for the current year.)
The standard meal allowance.Meal and lodging expenses:Standard meal allowanceStandard meal allowance
The standard meal allowance (discussed earlier) is the federal rate for meals and incidental expenses (M&IE). The rate for most small
localities in the United States is $31 a day from January 1 through September 30, 2005, and $39 a day from October 1 through December 31, 2005. Most
major cities and many other localities qualify for higher rates. The rates for all localities within the continental United States are listed in
Publication 1542. You can also find this information on the Internet at
www.gsa.gov.
You receive an allowance only for meals and incidental expenses when your employer does one of the following.
Provides you with lodging (furnishes it in kind).
Reimburses you, based on your receipts, for the actual cost of your lodging.
Pays the hotel, motel, etc., directly for your lodging.
Does not have a reasonable belief that you had (or will have) lodging expenses, such as when you stay with friends or relatives or sleep in
the cab of your truck.
Figures the allowance on a basis similar to that used in computing your compensation, such as number of hours worked or miles
traveled.
High-low rate.High-low rate method to compute per diemPer diem:High-low rate method to compute
This is a simplified method of computing the federal per diem rate for travel within the continental United States. It eliminates the need to keep
a current list of the per diem rate for each city.
Under the high-low method, the per diem amount for travel during January through September of 2005 is $204 (including $46 for M&IE) for certain
high-cost locations. All other areas have a per diem amount of $129 (including $36 for M&IE). (Employers can get Publication 1542 which gives the
areas eligible for the $204 per diem amount under the high-low method for all or part of this period.)
Effective October 1, 2005, the per diem rate under this method for certain high-cost locations increased to $226 (including $58 for M&IE). The
rate for all other locations increased to $141 (including $45 for M&IE). However, an employer can continue to use the rates described in the
preceding paragraph for the remainder of 2005 if those rates and locations are used consistently during October, November, and December for all
employees. Employers who did not use the high-low method during the first 9 months of 2005 cannot begin to use it before 2006. See Revenue
Procedure 2005-67 for more information. Also see Publication 1542 on the Internet at
www.irs.gov.
Prorating the standard meal allowance on partial days of travel.Meal and lodging expenses:Standard meal allowance:Prorating on partial days of travelStandard meal allowance:Prorating on partial days of travel
The standard meal allowance is for a full 24-hour day of travel. If you travel for part of a day, such as on the days you depart and return, you
must prorate the full-day M&IE rate. This rule also applies if your employer uses the regular federal per diem rate or the high-low rate.
You can use either of the following methods to figure the federal M&IE for that day.
Method 1:
For the day you depart, add of the standard meal allowance amount for that day.
For the day you return, add of the standard meal allowance amount for the preceding day.
Method 2: Prorate the standard meal allowance using any method that you consistently apply and that is in accordance with
reasonable business practice.
The standard mileage rate.
This is a set rate per mile that you can use to compute your deductible car expenses. For 2005, the standard mileage rate for the cost of operating
your car is:
40 cents per mile for the period January 1 through August 31, 2005, and
48 cents per mile for the period September 1 through December 31, 2005.
Fixed and variable rate (FAVR).Cars:Fixed and variable rate (FAVR)
This is an allowance your employer may use to reimburse your car expenses. Under this method, your employer pays an allowance that includes a
combination of payments covering fixed and variable costs, such as a cents-per-mile rate to cover your variable operating costs (such as gas, oil,
etc.) plus a flat amount to cover your fixed costs (such as depreciation (or lease payments), insurance, etc.). If your employer chooses to use this
method, your employer will request the necessary records from you.
Reporting your expenses with a per diem or car allowance.Employee business expenses:ReimbursementsPer diemPer diem:Allowance or reimbursementReimbursementPer diem
If your reimbursement is in the form of an allowance received under an accountable plan, the following facts affect your reporting.
The federal rate.
Whether the allowance or your actual expenses were more than the federal rate.
The following discussions explain where to report your expenses depending upon how the amount of your allowance compares to the federal rate.
Allowance less than or equal to the federal rate.
If your allowance is less than or equal to the federal rate, the allowance will not be included in box 1 of your Form W-2. You do not need to
report the related expenses or the allowance on your return if your expenses are equal to or less than the allowance.
Form:1040, Schedule ATravel expenses, deduction ofForm:2106:Travel expensesHowever, if your actual expenses are more than your allowance, you can complete Form 2106 and deduct
the excess amount on Schedule A (Form 1040). If you are using actual expenses, you must be able to prove to the IRS the total amount of your expenses
and reimbursements for the entire year. If you are using the standard meal allowance or the standard mileage rate, you do not have to prove that
amount.
Example.
Nicole drives 10,000 miles a year for business (6,500 miles from January 1 through August 31, 2005, and 3,500 miles from September 1 through
December 31, 2005). Under her employer's accountable plan, she accounts for the time (dates), place, and business purpose of each trip. Her employer
pays her a mileage allowance of 25 cents a mile.
Since Nicole's $4,331 expenses computed under the standard mileage rate (6,500 miles × 40 cents ($2,633) + 3,500 miles
× 48 cents ($1,698)) are more than her $2,500 reimbursement (10,000 miles × 25 cents), she itemizes her deductions to
claim the excess expenses. Nicole completes Form 2106 (showing all of her expenses and reimbursements) and enters $1,831 ($4,331 − $2,500) as an
itemized deduction.
Allowance more than the federal rate.
If your allowance is more than the federal rate, your employer must include the allowance amount up to the federal rate in box 12 of your Form W-2.
This amount is not taxable. However, the excess allowance will be included in box 1 of your Form W-2. You must report this part of your allowance as
if it were wage income.
If your actual expenses are less than or equal to the federal rate, you do not complete Form 2106 or claim any of your expenses on your return.
Form:2106:Travel expensesHowever, if your actual expenses are more than the federal rate, you can complete Form 2106 and deduct
those excess expenses. You must report on Form 2106 your reimbursements up to the federal rate (as shown in box 12 of your Form W-2) and all your
expenses. You should be able to prove these amounts to the IRS.
Example.
Joe lives and works in Austin. In May his employer sent him to San Diego for 4 days and paid the hotel directly for Joe's hotel bill. The employer
reimbursed Joe $60 a day for his meals and incidental expenses. The federal rate for San Diego is $51 a day.
Joe can prove that his actual meal expenses totaled $325. His employer's accountable plan will not pay more than $60 a day for travel to San Diego,
so Joe does not give his employer the records that prove that he actually spent $325. However, he does account for the time, place, and business
purpose of the trip. This is Joe's only business trip this year.
Form:W-2:Box 12 with code LJoe was reimbursed $240 ($60 × 4 days), which is $36 more than the federal rate of $204 ($51
× 4 days). His employer includes the $36 as income on Joe's Form W-2 in box 1. His employer also enters $204 in box 12 of Joe's Form W-2.
Joe completes Form 2106 to figure his deductible expenses. He enters the total of his actual expenses for the year ($325) on Form 2106. He also
enters the reimbursements that were not included in his income ($204). His total deductible expense, before the 50% limit, is $121. After he figures
the 50% limit on his unreimbursed meals and entertainment, he will include the balance, $61, as an itemized deduction on Schedule A (Form 1040).
Returning Excess ReimbursementsBusiness expenses:Reimbursements:Returning excess for business expensesEmployee business expenses:Reimbursements:Returning excessExcess reimbursements:Business expense reimbursementsReimbursement:Returning excess for business expenses
Under an accountable plan, you are required to return any excess reimbursement or other expense allowances for your business expenses to the person
paying the reimbursement or allowance. Excess reimbursement means any amount for which you did not adequately account within a reasonable period of
time. For example, if you received a travel advance and you did not spend all the money on business-related expenses, or you do not have proof of all
your expenses, you have an excess reimbursement.
Adequate accounting and reasonable period of time were discussed earlier.
Travel advance.Reimbursement:Travel advancesTravel and transportation expenses:Advances
You receive a travel advance if your employer provides you with an expense allowance before you actually have the expense, and the allowance is
reasonably expected to be no more than your expense. Under an accountable plan, you are required to adequately account to your employer for this
advance and to return any excess within a reasonable period of time.
If you do not adequately account for or do not return any excess advance within a reasonable period of time, the amount you do not account for or
return will be treated as having been paid under a nonaccountable plan (discussed later).
Unproved amounts.Travel and transportation expenses:Business travel:Unproved amounts
If you do not prove that you actually traveled on each day for which you received a per diem or car allowance (proving the elements described in
Table 26-2), you must return this unproved amount of the travel advance within a reasonable period of time. If you do not do this, the unproved amount
will be considered paid under a nonaccountable plan (discussed later).
Per diem allowance more than federal rate.
Form:W-2:Reimbursements reported as part of incomeIf your employer's accountable plan pays you an allowance that is higher than
the federal rate, you do not have to return the difference between the two rates for the period you can prove business-related travel expenses.
However, the difference will be reported as wages on your Form W-2. This excess amount is considered paid under a nonaccountable plan (discussed
later).
Example.
Your employer sends you on a 5-day business trip to Phoenix and gives you a $300 ($60 × 5 days) advance to cover your meals and incidental
expenses. The federal per diem for meals and incidental expenses for Phoenix is $47. Your trip lasts only 3 days. Under your employer's accountable
plan, you must return the $120 ($60 × 2 days) advance for the 2 days you did not travel. You do not have to return the $39 difference between
the allowance you received and the federal rate for Phoenix (($60 − $47) × 3 days). However, the $39 will be reported on your Form W-2 as
wages.
Nonaccountable PlansNonaccountable plans for employee reimbursementsTravel and transportation expenses:Nonaccountable plans, definition of
A nonaccountable plan is a reimbursement or expense allowance arrangement that does not meet one or more of the three rules listed earlier under
Accountable Plans.
In addition, even if your employer has an accountable plan, the following payments will be treated as being paid under a nonaccountable plan.
Excess reimbursements you fail to return to your employer.
Reimbursement of nondeductible expenses related to your employer's business. See Reimbursement of nondeductible expenses earlier
under Accountable Plans.
If you are not sure if the reimbursement or expense allowance arrangement is an accountable or nonaccountable plan, ask your employer.
Reporting your expenses under a nonaccountable plan.
Form:W-2:Reimbursements reported as part of incomeYour employer will combine the amount of any reimbursement or other expense
allowance paid to you under a nonaccountable plan with your wages, salary, or other pay. Your employer will report the total in box 1 of your Form
W-2.
Form:2106:Business-related expensesForm:2106-EZ:Business-related expensesYou must complete Form 2106 or 2106-EZ and itemize your deductions to deduct your expenses
for travel, transportation, meals, or entertainment. Your meal and entertainment expenses will be subject to the 50% limit discussed earlier under
Entertainment Expenses. Also, your total expenses will be subject to the 2%-of-adjusted-gross-income limit that applies to most
miscellaneous itemized deductions on Schedule A (Form 1040).
Example.
Kim's employer gives her $500 a month ($6,000 for the year) for her business expenses. Kim does not have to provide any proof of her expenses to
her employer, and Kim can keep any funds that she does not spend.
Kim is being reimbursed under a nonaccountable plan. Her employer will include the $6,000 on Kim's Form W-2 as if it were wages. If Kim wants to
deduct her business expenses, she must complete Form 2106 or 2106-EZ and itemize her deductions.
Completing Forms
2106 and 2106-EZ
This section briefly describes how employees complete Forms 2106 and 2106-EZ. Table 26-3 explains what the employer reports on Form W-2 and what
the employee reports on Form 2106. The instructions for the forms have more information on completing them.
Form 2106-EZ.
You may be able to use the shorter Form 2106-EZ to claim your employee business expenses. You can use this form if you meet all of the following
conditions.
You are an employee deducting expenses attributable to your job.
You were not reimbursed by your employer for your expenses (amounts included in box 1 of your Form W-2 are not considered
reimbursements).
If you are claiming car expenses, you use the standard mileage rate.
Car expenses.Cars:Form 2106 or 2106-EZ, how to fill out
If you used a car to perform your job as an employee, you may be able to deduct certain car expenses. These are generally figured on Form 2106,
Part II, and then claimed on Form 2106, Part I, line 1, Column A. Car expenses using the standard mileage rate can also be figured on Form 2106-EZ by
completing Part II and Part I, line 1.
Transportation expenses.Travel and transportation expenses:Form 2106 or 2106-EZ, how to fill out
Show your transportation expenses that did not involve overnight travel on Form 2106, line 2, Column A, or on Form 2106-EZ, Part I, line 2. Also
include on this line business expenses you have for parking fees and tolls. Do not include expenses of operating your car or expenses of commuting
between your home and work.
<ROM>Table 26-3. </ROM>
<IMARK>Reporting Travel, Entertainment, Gift, and Car Expenses and ReimbursementsCars:Reporting of:Table 26-3 showing forms to be usedEntertainment expenses:Reporting of:Table 26-3 showing forms to be usedGifts:Reporting of expenses:Table 26-3 showing forms to be usedMeal and lodging expenses:Reporting of:Table 26-3 showing forms to be usedTables and figures:Car expenses, reporting of (Table 26-3)Tables and figures:Entertainment expenses:Reporting of (Table 26-3)Tables and figures:Gift expenses:Reporting of (Table 26-3)Tables and figures:Travel and transportation expenses:Reporting of (Table 26-3)Travel and transportation expenses:Reporting of:Table 26-3 showing forms to be used
IF the type of reimbursement (or other expense allowance) arrangement is under:THEN the employer reports on Form W-2:AND the employee
reports on
Form 2106: *An accountable plan with:Actual expense reimbursement:Adequate accounting made
and excess returned.No amount.No amount.Actual expense reimbursement:Adequate accounting and return of excess both required
but excess not returned.The excess amount as wages in box 1.No amount.Per diem or mileage allowance up to the federal rate:Adequate accounting made
and excess returned.No amount.All expenses and reimbursements only if excess expenses are claimed. Otherwise, form is not filed.Per diem or mileage allowance up to the federal rate:Adequate accounting and return of excess both required
but excess not returned.The excess amount as wages in box 1. The amount up to the federal rate is reported only in box 12—it is not reported in
box 1.No amount.Per diem or mileage allowance exceeds the federal rate:Adequate accounting up to the federal rate only
and excess not returned.The excess amount as wages in box 1. The amount up to the federal rate is reported only in box 12—it is not reported in
box 1.All expenses (and reimbursement reported on Form W-2, box 12) only if expenses in excess of the federal rate are claimed.
Otherwise, form is not required.A nonaccountable plan with:Either adequate accounting or return of excess, or both, not required by planThe entire amount as wages in box 1.All expenses.No reimbursement plan:The entire amount as wages in box 1.All expenses.* You may be able to use Form 2106-EZ. See Completing Forms 2106 and
2106-EZ.
Employee business expenses other than meals and entertainment.
Show your other employee business expenses on Form 2106, lines 3 and 4, Column A, or Form 2106-EZ, lines 3 and 4. Do not include expenses for meals
and entertainment on those lines. Line 4 is for expenses such as gifts, educational expenses (tuition and books), office-in-the-home expenses, and
trade and professional publications.
If line 4 expenses are the only ones you are claiming, you received no reimbursements (or the reimbursements were all included in box 1 of your
Form W-2), and the Special Rules discussed later do not apply to you, do not complete Form 2106 or 2106-EZ. Claim these amounts directly on
Schedule A (Form 1040), line 20. List the type and amount of each expense on the dotted lines and include the total on line 20.
Meal and entertainment expenses.Entertainment expenses:Form 2106 or 2106-EZ, how to fill outMeal and lodging expenses:Form 2106 or 2106-EZ, how to fill out
Show the full amount of your expenses for business-related meals and entertainment on Form 2106, line 5, Column B. Include meals while away from
your tax home overnight and other business meals and entertainment. Enter 50% of the line 8, column B, meal and entertainment expenses on line 9,
Column B.
If you file Form 2106-EZ, enter the full amount of your meals and entertainment on the line to the left of line 5 and multiply the total by 50%.
Enter the result on line 5.
Hours of service limits.Transportation workers:Meal expenses:Form 2106 or 2106-EZ, how to complete
If you are subject to the Department of Transportation's hours of service limits, use 70% instead of 50% for meals while away from your tax
home.
Reimbursements.Reimbursement
Form:W-2:Box 12 with code LEnter on Form 2106, line 7, the amounts your employer (or third party) reimbursed you that were not
included in box 1 of your Form W-2. (You cannot use Form 2106-EZ.) This includes any reimbursement reported under code L in box 12 of Form W-2.
Allocating your reimbursement.Reimbursement:Allocation of
If you were reimbursed under an accountable plan and want to deduct excess expenses that were not reimbursed, you may have to allocate your
reimbursement. This is necessary if your employer pays your reimbursement in the following manner:
Pays you a single amount that covers meals and/or entertainment, as well as other business expenses, and
Does not clearly identify how much is for deductible meals and/or entertainment.
You must allocate that single payment so that you know how much to enter on Form 2106, line 7, Column A and Column B.
Example.
Rob's employer paid him an expense allowance of $5,000 this year under an accountable plan. The $5,000 payment consisted of $2,000 for airfare and
$3,000 for entertainment and car expenses. Rob's employer did not clearly show how much of the $3,000 was for the cost of deductible entertainment.
Rob actually spent $6,500 during the year ($2,000 for airfare, $2,000 for entertainment, and $2,500 for car expenses).
Since the airfare allowance was clearly identified, Rob knows that $2,000 of the payment goes in Column A, line 7 of Form 2106. To allocate the
remaining $3,000, Rob uses the worksheet from the instructions for Form 2106. His completed worksheet follows.
1.Enter the total amount of reimbursements your employer gave you that were not reported to you in box 1 of
Form W-2$3,000 2.Enter the total amount of your expenses for the periods covered by this reimbursement 4,500 3.Of the amount on line 2, enter your total expense for meals and entertainment 2,000 4.Divide line 3 by line 2. Enter the result as a decimal (rounded to at least three places) .444 5.Multiply line 1 by line 4. Enter the result here and in Column B, line 7 1,332 6.Subtract line 5 from line 1. Enter the result here and in Column A, line 7$1,668
On line 7 of Form 2106, Rob enters $3,668 ($2,000 airfare and $1,668 of the $3,000) in Column A and $1,332 (of the $3,000) in Column B.
After you complete the form.
Form:1040, Schedule AEmployee business expense deductionAfter you have completed your Form 2106 or 2106-EZ, follow the directions on that
form to deduct your expenses on the appropriate line of your tax return. For most taxpayers, this is line 20 of Schedule A (Form 1040). However, if
you are a government official paid on a fee basis, a performing artist, an Armed Forces reservist, or a disabled employee with impairment-related work
expenses, see Special Rules, later.
Limits on employee business expenses.
Your employee business expenses may be subject to any of the three limits described next. These limits are figured in the following order on the
specified form.
1. Limit on meals and entertainment.
Meal and lodging expenses:Form 2106 or 2106-EZ, how to fill outCertain meal and entertainment expenses are subject to a 50% limit. If you are an
employee, you figure this limit on line 9 of Form 2106 or line 5 of Form 2106-EZ. See 50% Limit under Entertainment Expenses,
earlier.
2. Limit on miscellaneous itemized deductions.
Form:1040, Schedule AEmployee business expense deductionIf you are an employee, deduct employee business expenses (as figured on Form 2106
or 2106-EZ) on line 20 of Schedule A (Form 1040). Most miscellaneous itemized deductions, including employee business expenses, are subject to a
2%-of-adjusted-gross-income limit. This limit is figured on line 25 of Schedule A (Form 1040).
3. Limit on total itemized deductions.
Adjusted gross income (AGI):Business expenses, limit on deductionIf your adjusted gross income (line 38 of Form 1040) is more than $145,950 ($72,975 if
you are married filing separately), the total of certain itemized deductions, including employee business expenses, may be limited. See chapter 29 for
more information on this limit.
Special RulesDeductions:Fee-basis government officialsFee-basis officials:Business expenses ofState or local governments:Fee-basis officials:Business expenses of
This section discusses special rules that apply to Armed Forces reservists, government officials who are paid on a fee basis, performing artists,
and disabled employees with impairment-related work expenses.
Armed Forces reservists traveling more than 100 miles from home.Armed forces:Reserves
If you are a member of a reserve component of the Armed Forces of the United States and you travel more than 100 miles away from home in connection
with your performance of services as a member of the reserves, you can deduct your travel expenses as an adjustment to gross income rather than as a
miscellaneous itemized deduction. The amount of expenses you can deduct as an adjustment to gross income is limited to the regular federal per diem
rate (for lodging, meals, and incidental expenses) and the standard mileage rate (for car expenses) plus any parking fees, ferry fees, and tolls. The
federal rate is explained earlier under Per Diem and Car Allowances.
Member of a reserve component.
You are a member of a reserve component of the Armed Forces of the United States if you are in the Army, Navy, Marine Corps, Air Force, or Coast
Guard Reserve, the Army National Guard of the United States, the Air National Guard of the United States, or the Reserve Corps of the Public Health
Service.
How to report.
If you have reserve-related travel that takes you more than 100 miles from home, you should first complete Form 2106 or Form 2106-EZ. Then include
your expenses for reserve travel over 100 miles from home, up to the federal rate, from Form 2106, line 10, or Form 2106-EZ, line 6, in the total on
Form 1040, line 24. Subtract this amount from the total on Form 2106, line 10, or Form 2106-EZ, line 6, and deduct the balance as an itemized
deduction on Schedule A (Form 1040), line 20.
You cannot deduct expenses of travel that does not take you more than 100 miles from home as an adjustment to gross income. Instead, you must
complete Form 2106 or 2106-EZ and deduct those expenses as an itemized deduction on Schedule A (Form 1040), line 20.
Officials paid on a fee basis.
Certain fee-basis officials can claim their employee business expenses whether or not they itemize their other deductions on Schedule A (Form
1040).
Fee-basis officials are persons who are employed by a state or local government and who are paid in whole or in part on a fee basis. They can
deduct their business expenses in performing services in that job as an adjustment to gross income rather than as a miscellaneous itemized deduction.
If you are a fee-basis official, include your employee business expenses from Form 2106, line 10, or Form 2106-EZ, line 6, on Form 1040, line 24.
Expenses of certain performing artists.Artists, performingPerforming artistsDeductions:Performing artists' expensesPerforming artists:Business expenses
If you are a performing artist, you may qualify to deduct your employee business expenses as an adjustment to gross income rather than as a
miscellaneous itemized deduction. To qualify, you must meet all of the following requirements.
During the tax year, you perform services in the performing arts as an employee for at least two employers.
You receive at least $200 each from any two of these employers.
Your related performing-arts business expenses are more than 10% of your gross income from the performance of those services.
Your adjusted gross income is not more than $16,000 before deducting these business expenses.
Special rules for married persons.Married taxpayers:Performing artists
If you are married, you must file a joint return unless you lived apart from your spouse at all times during the tax year.
If you file a joint return, you must figure requirements (1), (2), and (3) separately for both you and your spouse. However, requirement (4)
applies to your and your spouse's combined adjusted gross income.
Where to report.
Form:2106:Performing artistsForm:2106-EZ:Performing artistsIf you meet all of the above requirements, you should first complete Form 2106 or 2106-EZ. Then you
include your performing-arts-related expenses from line 10 of Form 2106 or line 6 of Form 2106-EZ in the total on line 24 of Form 1040.
If you do not meet all of the above requirements, you do not qualify to deduct your expenses as an adjustment to gross income. Instead, you must
complete Form 2106 or 2106-EZ and deduct your employee business expenses as an itemized deduction on Schedule A (Form 1040), line 20.
Impairment-related work expenses of disabled employees.Deductions:Impairment-related work expensesDisabilities, persons with:Impairment-related work expenses ofEmployee business expenses:Impairment-related work expenses, deduction forImpairmentDisabilities, persons with
If you are an employee with a physical or mental disability, your impairment-related work expenses are not subject to the
2%-of-adjusted-gross-income limit that applies to most other employee business expenses. After you complete Form 2106 or 2106-EZ, enter your
impairment-related work expenses from Form 2106, line 10, or Form 2106-EZ, line 6, on Schedule A (Form 1040), line 27, and identify the type and
amount of this expense on the dotted line next to line 27. Enter your employee business expenses that are unrelated to your disability from Form 2106,
line 10, or Form 2106-EZ, line 6, on Schedule A, line 20.
Impairment-related work expenses are your allowable expenses for attendant care at your workplace and other expenses you have in connection with
your workplace that are necessary for you to be able to work. For more information, see chapter 21.
Illustrated Example
Bill Wilson is an employee of Fashion Clothing Co. in Manhattan, NY. In a typical week, Bill leaves his home on Long Island on Monday morning and
drives to Albany to exhibit the Fashion line for 3 days to prospective customers. Then he drives to Troy to show Fashion's new line of merchandise to
Town Department Store, an old customer. While in Troy, he talks with Tom Brown, purchasing agent for Town Department Store, to discuss the new line.
He later takes John Smith of Attire Co. out to dinner to discuss Attire Co.'s buying Fashion's new line of clothing.
Bill purchased his car on January 3, 2002. He uses the standard mileage rate for car expense purposes. He records his total mileage, business
mileage, parking fees, and tolls for the year. Bill records his expenses and other pertinent information in a travel expense log (not shown). He
obtains receipts for his expenses for lodging and for any other expenses of $75 or more.
During the year, Bill drove a total of 25,000 miles of which 20,000 miles were for business. Bill drove 14,000 business miles from January 1 to
August 31, 2005, and 6,000 miles from September 1 through the end of the year. He answers all the questions in Part II of Form 2106-EZ and figures his
car expense to be $8,580 (14,000 × 40 cents per mile ($5,670) + 6,000 × 48 cents per mile ($2,910)).
His total employee business expenses are shown in the following table.
Type of Expense Amount Parking fees and tolls $ 325 Car expenses8,580 Meals2,632 Lodging, laundry, dry
cleaning8,975 Entertainment 1,870 Gifts, education, etc. 430 Total$22,812
Bill received an allowance of $6,000 ($500 per month) to help offset his expenses. Bill did not have to account to his employer for the
reimbursement, and the $6,000 was included as income in box 1 of his Form W-2.
Because Bill's reimbursement was included in his income and he is using the standard mileage rate for his car expenses, he files Form 2106-EZ with
his tax return. His filled-in form is shown on the next page.
Form 2106-EZ Unreimbursed Employee Business Expenses 2005Summary: This is a Form 2106-EZ image illustrating the example in the text. The following line items are included:Your name field contains Bill WilsonOccupation in which you incurred expenses field contains SalesSocial security number field contains 555-00-5555Under Part I: Figure Your Expenses:1a. Business miles driven in the period January 1 through August 31 (13,300) multiplied by 40.5 cents. Field contains 5,670.1b. Business miles driven in the period September 1 through December 31 (6,700) multiplied by 48.5 cents. Field contains 2,910.1c. Add lines 1a and 1b. Field contains 8,5802. Parking fees, tolls, and transportation, including train, bus, etc. Field contains 325.3.Travel expenses while away from home overnight, including lodging, airplane, car rental, etc. Field contains 8,975.4. Business expenses not included in lines 1 through 3. Do not include meals and entertainment. Field contains 430.5. Meal and entertainment expenses field contains 4,502 and multiply by 50% (.50) (Employees subject to Department of Transportation hours of
service limits: Multiply meal expenses by 70% (.70) instead of 50%. For details, see instructions) field contains 2,2516. Total expenses. Add lines 1c through 5. Enter here and on line 20 of Schedule A (Form 1040). (Fee-basis state or local government
officials, qualified performing artists, and individuals with disabilities: See the instructions for special rules on where to enter this amount.)
field contains 20,561Under Part II: Information on Your Vehicle:7. When did you place your vehicle in service for business use? (month, day, year) field contains 1/3/02Under 8. Of the total number of miles you drove your vehicle during 2005, enter the number of miles you used your vehicle for:
field:a. Business field contains 20,000b. Commuting field contains 2,600c. Other field contains 2,4009. Do you (or your spouse have another vehicle available for personal use? Yes checkbox is checked10. Was your vehicle available for personal use during off-duty hours? Yes checkbox is checked11a. Do you have evidence to support your deduction? Yes checkbox is checked11b. If Yes, is the evidence written Yes checkbox is checkedEmployee business expenses
Tax Benefits for Work-Related EducationEmployee business expenses:Work-related educationWork-related educationStudents:Work-related educationWork-related educationWhat's NewStandard mileage rate.Mileage deduction for work-related educationStandard mileage rate:Work-related education
Generally, if you claim a business deduction for work-related education and you drive your car to and from school, the amount you can deduct for
miles driven from January 1, 2005, through August 31, 2005, is 40 cents a mile. You can deduct 48 cents a mile for
miles driven from September 1, 2005, through December 31, 2005. This is up from 37 cents a mile in 2004. See Transportation
Expenses under What Expenses Can Be Deducted, for more information.
ReminderLimit on itemized deductions.Adjusted gross income (AGI):Itemized deduction limitItemized deductions:Adjusted gross income limiting
If your adjusted gross income for 2005 is more than $145,950 ($72,975 if you are married filing separately), your itemized deductions may be
limited. See chapter 29 for more information about this limit.
This chapter discusses work-related education expenses that you may be able to deduct as business expenses.
To claim such a deduction, you must:
Be working,
Itemize your deductions on Schedule A (Form 1040) if you are an employee,
File Schedule C (Form 1040) or Schedule F (Form 1040) if you are self-employed, and
Have expenses for education that meet the requirements discussed under Qualifying Work-Related Education.
Work-related education:Business deduction:Tax benefit of
If you are an employee and able to itemize your deductions, you may be able to claim a deduction for the expenses you pay for your work-related
education. Your deduction will be the amount by which your qualifying work-related education expenses plus other job and certain miscellaneous
expenses is greater than 2% of your adjusted gross income. See chapter 28.
If you are self-employed, you deduct your expenses for qualifying work-related education directly from your self-employment income.
Your work-related education expenses may also qualify you for other tax benefits, such as the tuition and fees deduction (see chapter 19) and the
Hope and lifetime learning credits (see chapter 35). You may qualify for these other benefits even if you do not meet the requirements listed earlier.
Also, keep in mind that your work-related education expenses may qualify you to claim more than one tax benefit. Generally, you may claim any
number of benefits as long as you use different expenses to figure each one.
When you figure your taxes, you may want to compare these tax benefits so you can choose the method(s) that give you the lowest tax liability.
First, figure your taxes using the expenses as business deductions. Then, figure your taxes again using any of the other deductions and credits for
which you qualify. You may find that a combination of credit(s) and deduction(s) gives you the lowest tax.
Publication463Travel, Entertainment, Gift, and Car Expenses970Tax Benefits for EducationForm (and Instructions)Employee Business ExpensesUnreimbursed Employee Business ExpensesItemized Deductions
Qualifying Work- Related Education
You can deduct the costs of qualifying work- related education as business expenses. This is education that meets at least one of the following two
tests.
The education is required by your employer or the law to keep your present salary, status, or job. The required education must serve a
bona fide business purpose of your employer.
Bona fide business purpose:Work-related education
The education maintains or improves skills needed in your present work.
However, even if the education meets one or both of the above tests, it is not qualifying work-related education if it:
Is needed to meet the minimum educational requirements of your present trade or business, or
Is part of a program of study that will qualify you for a new trade or business.
You can deduct the costs of qualifying work-related education as a business expense even if the education could lead to a degree.
Use Figure 27-A, later, as a quick check to see if your education qualifies.
Education Required by
Employer or by LawWork-related education:Education required by employer or by law
Once you have met the minimum educational requirements for your job, your employer or the law may require you to get more education. This
additional education is qualifying work-related education if all three of the following requirements are met.
It is required for you to keep your present salary, status, or job,
The requirement serves a business purpose of your employer, and
The education is not part of a program that will qualify you for a new trade or business.
When you get more education than your employer or the law requires, the additional education can be qualifying work-related education only if it
maintains or improves skills required in your present work. See Education To Maintain or Improve Skills.
Example.
You are a teacher who has satisfied the minimum requirements for teaching. Your employer requires you to take an additional college course each
year to keep your teaching job. If the courses will not qualify you for a new trade or business, they are qualifying work-related education even if
you eventually receive a master's degree and an increase in salary because of this extra education.
Education To Maintain
or Improve SkillsWork-related education:Education to maintain or improve skills
If your education is not required by your employer or the law, it can be qualifying work- related education only if it maintains or improves skills
needed in your present work. This could include refresher courses, courses on current developments, and academic or vocational courses.
Example.
You repair televisions, radios, and stereo systems for XYZ Store. To keep up with the latest changes, you take special courses in radio and stereo
service. These courses maintain and improve skills required in your work.
Maintaining skills vs. qualifying for new job.
Education to maintain or improve skills needed in your present work is not qualifying education if it will also qualify you for a new trade or
business.
Temporary absence.Temporary absence from job:Work-related education duringWork-related education:Temporary absence from work
If you stop working for a year or less in order to get education to maintain or improve skills needed in your present work and then return to the
same general type of work, your absence is considered temporary. Education that you get during a temporary absence is qualifying work-related
education if it maintains or improves skills needed in your present work.
Example.
You quit your biology research job to become a full-time biology graduate student for one year. If you return to work in biology research after
completing the courses, the education is related to your present work even if you do not go back to work with the same employer.
Indefinite absence.Indefinite absence from job:Work-related education duringWork-related education:Indefinite absence from work
If you stop work for more than a year, your absence from your job is considered indefinite. Education during an indefinite absence, even if it
maintains or improves skills needed in the work from which you are absent, is considered to qualify you for a new trade or business. Therefore, it is
not qualifying work-related education.
Education To Meet
Minimum RequirementsWork-related education:Education to meet minimum requirements
Education you need to meet the minimum educational requirements for your present trade or business is not qualifying work-related education. The
minimum educational requirements are determined by:
Laws and regulations,
Standards of your profession, trade, or business, and
Your employer.
Once you have met the minimum educational requirements that were in effect when you were hired, you do not have to meet any new minimum educational
requirements. This means that if the minimum requirements change after you were hired, any education you need to meet the new requirements can be
qualifying education.
You have not necessarily met the minimum educational requirements of your trade or business simply because you are already doing the work.
Example 1.
You are a full-time engineering student. Although you have not received your degree or certification, you work part time as an engineer for a firm
that will employ you as a full-time engineer after you finish college. Although your college engineering courses improve your skills in your present
job, they are also needed to meet the minimum job requirements for a full-time engineer. The education is not qualifying work-related education.
Example 2.
You are an accountant and you have met the minimum educational requirements of your employer. Your employer later changes the minimum educational
requirements and requires you to take college courses to keep your job. These additional courses can be qualifying work-related education because you
have already satisfied the minimum requirements that were in effect when you were hired.
Requirements for TeachersTeachers:Work-related educationWork-related education:Teachers
States or school districts usually set the minimum educational requirements for teachers. The requirement is the college degree or the minimum
number of college hours usually required of a person hired for that position.
If there are no requirements, you will have met the minimum educational requirements when you become a faculty member. You generally will be
considered a faculty member when one or more of the following occurs.
You have tenure.
Your years of service count toward obtaining tenure.
You have a vote in faculty decisions.
Your school makes contributions for you to a retirement plan other than social security or a similar program.
Example 1.
The law in your state requires beginning secondary school teachers to have a bachelor's degree, including 10 professional education courses. In
addition, to keep the job, a teacher must complete a fifth year of training within 10 years from the date of hire. If the employing school certifies
to the state Department of Education that qualified teachers cannot be found, the school can hire persons with only 3 years of college. However, to
keep their jobs, these teachers must get a bachelor's degree and the required professional education courses within 3 years.
Under these facts, the bachelor's degree, whether or not it includes the 10 professional education courses, is considered the minimum educational
requirement for qualification as a teacher in your state.
If you have all the required education except the fifth year, you have met the minimum educational requirements. The fifth year of training is
qualifying work-related education unless it is part of a program of study that will qualify you for a new trade or business.
FiguresTables and figuresTables and figures:Work-related education (Figure 27-A)Work-related education:Qualifying education (Figure 27-A)
Figure 27-A. Does Your Work-Related Education Qualify?Summary: This flowchart is used to determine if your work-related education qualifies.StartThis is the starting of the flowchart.Decision (1)Is the education required by your employer or the law to keep your present salary, status, or job?IF Yes Continue To Decision (2)IF No Continue To Decision (3)Decision (2)Does the requirement serve a bona fide business requirement of your employer?IF Yes Continue To Decision (4)IF No Continue To Decision (3)Decision (3)Does the education maintain or improve skills needed in your present work?IF Yes Continue To Decision (4)IF No Continue To Process (a)Decision (4)Is the education needed to meet the minimum educational requirements of your present trade or business?IF Yes Continue To Process (a)IF No Continue To Decision (5)Decision (5)Is the education part of a program of study that will qualify you for a new trade or business?IF Yes Continue To Process (a)IF No Continue To Process (b)Process (a)Your education is not qualifying work-related education.Continue To EndProcess (b)Your education is qualifying work-related education.Continue To End EndThis is the ending of the flowchart.
Example 2.
Assume the same facts as in Example 1 except that you have a bachelor's degree and only six professional education courses. The
additional four education courses can be qualifying work-related education. Although you do not have all the required courses, you have already met
the minimum educational requirements.
Example 3.
Assume the same facts as in Example 1 except that you are hired with only 3 years of college. The courses you take that lead to a
bachelor's degree (including those in education) are not qualifying work-related education. They are needed to meet the minimum educational
requirements for employment as a teacher.
Example 4.
You have a bachelor's degree and you work as a temporary instructor at a university. At the same time, you take graduate courses toward an advanced
degree. The rules of the university state that you can become a faculty member only if you get a graduate degree. Also, you can keep your job as an
instructor only as long as you show satisfactory progress toward getting this degree. You have not met the minimum educational requirements to qualify
you as a faculty member. The graduate courses are not qualifying work-related education.
Certification in a new state.
Once you have met the minimum educational requirements for teachers for your state, you are considered to have met the minimum educational
requirements in all states. This is true even if you must get additional education to be certified in another state. Any additional education you need
is qualifying work-related education. You have already met the minimum requirements for teaching. Teaching in another state is not a new trade or
business.
Example.
You hold a permanent teaching certificate in State A and are employed as a teacher in that state for several years. You move to State B and are
promptly hired as a teacher. You are required, however, to complete certain prescribed courses to get a permanent teaching certificate in State B.
These additional courses are qualifying work-related education because the teaching position in State B involves the same general kind of work for
which you were qualified in State A.
Education That
Qualifies You for a
New Trade or BusinessNew job, trade, or business:Work-related education expensesWork-related education:Education that qualifies for new trade or business
Education that is part of a program of study that will qualify you for a new trade or business is not qualifying work-related education. This is
true even if you do not plan to enter that trade or business.
If you are an employee, a change of duties that involves the same general kind of work is not a new trade or business.
Example 1.
You are an accountant. Your employer requires you to get a law degree at your own expense. You register at a law school for the regular curriculum
that leads to a law degree. Even if you do not intend to become a lawyer, the education is not qualifying because the law degree will qualify you for
a new trade or business.
Example 2.
You are a general practitioner of medicine. You take a 2-week course to review developments in several specialized fields of medicine. The course
does not qualify you for a new profession. It is qualifying work-related education because it maintains or improves skills required in your present
profession.
Example 3.
While working in the private practice of psychiatry, you enter a program to study and train at an accredited psychoanalytic institute. The program
will lead to qualifying you to practice psychoanalysis. The psychoanalytic training does not qualify you for a new profession. It is qualifying
work-related education because it maintains or improves skills required in your present profession.
Bar or CPA Review CourseAccountants:CPA review coursesAttorneys:Bar review coursesBar review coursesCPAsAccountantsState bar associations:Bar review courses
Review courses to prepare for the bar examination or the certified public accountant (CPA) examination are not qualifying work-related education.
They are part of a program of study that can qualify you for a new profession.
Teaching and Related DutiesTeachers:Work-related educationWork-related education:Teachers
All teaching and related duties are considered the same general kind of work. A change in duties in any of the following ways is not considered a
change to a new business.
Elementary school teacher to secondary school teacher.
Teacher of one subject, such as biology, to teacher of another subject, such as art.
Classroom teacher to guidance counselor.
Classroom teacher to school administrator.
What Expenses Can Be DeductedWork-related education:Business deduction:Qualified expensesBusiness expenses:Work-related educationDeductions:Work-related educationQualified education expenses:Work-related education, business deduction
If your education meets the requirements described earlier under Qualifying Work-Related Education, you can generally deduct your
education expenses as business expenses. If you are not self-employed, you can deduct business expenses only if you itemize your deductions.
You cannot deduct expenses related to tax-exempt and excluded income.
Deductible expenses.
The following education expenses can be deducted.
Tuition, books, supplies, lab fees, and similar items.
Certain transportation and travel costs.
Other education expenses, such as costs of research and typing when writing a paper as part of an educational program.
Nondeductible expenses.
You cannot deduct personal or capital expenses. For example, you cannot deduct the dollar value of vacation time or annual leave you take to attend
classes. This amount is a personal expense.
If you do not claim reimbursement that you are entitled to receive from your employer, you cannot deduct the expenses that apply to the
reimbursement.
Example.
Your employer agrees to pay your education expenses if you file a voucher showing your expenses. You do not file a voucher, and you do not get
reimbursed. Because you did not file a voucher, you cannot deduct the expenses on your tax return.
Transportation ExpensesTravel and transportation expenses:Work-related education
If your education qualifies, you can deduct local transportation costs of going directly from work to school. If you are regularly employed and go
to school on a temporary basis, you can also deduct the costs of returning from school to home.
Attendance on a temporary basis.
You go to school on a temporary basis if either of the following situations applies to you.
Your attendance at school is realistically expected to last 1 year or less and does indeed last for 1 year or less.
Initially, your attendance at school is realistically expected to last 1 year or less, but at a later date your attendance is reasonably
expected to last more than 1 year. Your attendance will be considered temporary up to the date you determine it will last more than 1
year.
Note.
If you are in either situation (1) or (2) above, your attendance is not temporary if facts and circumstances indicate otherwise.
Attendance not on a temporary basis.
You do not go to school on a temporary basis if any of the following situations apply to you.
Your attendance at school is realistically expected to last more than 1 year. It does not matter how long you actually attend.
Initially, your attendance at school is realistically expected to last 1 year or less, but at a later date your attendance is reasonably
expected to last more than 1 year. Your attendance is not temporary after the date you determine it will last more than 1 year.
Deductible Transportation Expenses
If you are regularly employed and go directly from home to school on a temporary basis, you can deduct the round-trip costs of transportation
between your home and school. This is true regardless of the location of the school, the distance traveled, or whether you attend school on nonwork
days.
Transportation expenses include the actual costs of bus, subway, cab, or other fares, as well as the costs of using your car. Transportation
expenses do not include amounts spent for travel, meals, or lodging while you are away from home overnight.
Example 1.
You regularly work in a nearby town, and go directly from work to home. You also attend school every work night for 3 months to take a course that
improves your job skills. Since you are attending school on a temporary basis, you can deduct your daily round-trip transportation expenses in going
between home and school. This is true regardless of the distance traveled.
Example 2.
Assume the same facts as in Example 1 except that on certain nights you go directly from work to school and then home. You can deduct
your transportation expenses from your regular work site to school and then home.
Example 3.
Assume the same facts as in Example 1 except that you attend the school for 9 months on Saturdays, nonwork days. Since you are attending
school on a temporary basis, you can deduct your round-trip transportation expenses in going between home and school.
Example 4.
Assume the same facts as in Example 1 except that you attend classes twice a week for 15 months. Since your attendance in school is not
considered temporary, you cannot deduct your transportation expenses in going between home and school. If you go directly from work to school, you can
deduct the one-way transportation expenses of going from work to school. If you go from work to home to school and return home, your transportation
expenses cannot be more than if you had gone directly from work to school.
Using your car.Cars:Work-related education, transportation forStandard mileage rate:Work-related education
If you use your car (whether you own or lease it) for transportation to school, you can deduct your actual expenses or use the standard mileage
rate to figure the amount you can deduct. The standard mileage rate for miles driven from January 1, 2005, through August 31, 2005, is 40 cents a mile. The rate for miles driven from September 1, 2005, through December 31, 2005, is 48 cents a mile. Whichever method
you use, you can also deduct parking fees and tolls. See chapter 26 for information on deducting your actual expenses of using a car.
Travel ExpensesTravel and transportation expenses:Work-related educationWork-related education:Travel expenses for
You can deduct expenses for travel, meals (see 50% Limit on Meals, later), and lodging if:
You travel overnight to obtain qualifying work-related education, and
The main purpose of the trip is to attend a work-related course or seminar.
Travel expenses for qualifying work-related education are treated the same as travel expenses for other employee business purposes. For more
information, see chapter 26.
You cannot deduct expenses for personal activities, such as sightseeing, visiting, or entertaining.
Mainly personal travel.
If your travel away from home is mainly personal, you cannot deduct all of your expenses for travel, meals, and lodging. You can deduct only your
expenses for lodging and 50% of your expenses for meals during the time you attend the qualified educational activities.
Whether a trip's purpose is mainly personal or educational depends upon the facts and circumstances. An important factor is the comparison of time
spent on personal activities with time spent on educational activities. If you spend more time on personal activities, the trip is considered mainly
educational only if you can show a substantial nonpersonal reason for traveling to a particular location.
Example 1.
John works in Newark, New Jersey. He traveled to Chicago to take a deductible 1-week course at the request of his employer. His main reason for
going to Chicago was to take the course.
While there, he took a sightseeing trip, entertained some friends, and took a side trip to Pleasantville for a day.
Since the trip was mainly for business, John can deduct his round-trip airfare to Chicago. He cannot deduct his transportation expenses of going to
Pleasantville. He can deduct only the meals (subject to the 50% limit) and lodging connected with his educational activities.
Example 2.
Sue works in Boston. She went to a university in Michigan to take a course for work. The course is qualifying work-related education.
She took one course, which is one-fourth of a full course load of study. She spent the rest of the time on personal activities. Her reasons for
taking the course in Michigan were all personal.
Sue's trip is mainly personal because three-fourths of her time is considered personal time. She cannot deduct the cost of her round-trip train
ticket to Michigan. She can deduct one-fourth of the meals (subject to the 50% limit) and lodging costs for the time she attended the university.
Example 3.
Dave works in Nashville and recently traveled to California to take a 2-week seminar. The seminar is qualifying work-related education.
While there, he spent an extra 8 weeks on personal activities. The facts, including the extra 8-week stay, show that his main purpose was to take a
vacation.
Dave cannot deduct his round-trip airfare or his meals and lodging for the 8 weeks. He can deduct only his expenses for meals (subject to the 50%
limit) and lodging for the 2 weeks he attended the seminar.
Cruises and conventions.Conventions:Work-related education, deduction of travel expenses for overseas conventionsEducation expenses:Work-related education, deduction of expensesLuxury travel:Work-related education, deduction of expensesCruises:Work-related education, deduction of expenses
Certain cruises and conventions offer seminars or courses as part of their itinerary. Even if the seminars or courses are work related, your
deduction for travel may be limited. This applies to:
Travel by ocean liner, cruise ship, or other form of luxury water transportation, and
Conventions outside the North American area.
For a discussion of the limits on travel expense deductions that apply to cruises and conventions, see Luxury Water Travel and
Conventions in Publication 463.
50% limit on meals.Meal and lodging expenses:50% deduction for business-related meals:Work-related educationWork-related education:Meal expenses
You can deduct only 50% of the cost of your meals while traveling away from home to obtain qualifying work-related education. You cannot have been
reimbursed for the meals.
Employees must use Form 2106 or Form 2106-EZ to apply the 50% limit.
Travel as Education
You cannot deduct the cost of travel as a form of education even if it is directly related to your duties in your work or business.
Example.
You are a French language teacher. While on sabbatical leave granted for travel, you traveled through France to improve your knowledge of the
French language. You chose your itinerary and most of your activities to improve your French language skills. You cannot deduct your travel expenses
as education expenses. This is true even if you spent most of your time learning French by visiting French schools and families, attending movies or
plays, and engaging in similar activities.
No Double Benefit Allowed
You cannot do any of the following.
Deduct work-related education expenses as business expenses if you deduct these expenses under any other provision of the law, for example,
as a tuition and fees deduction. See chapter 19.
Deduct work-related education expenses paid with tax-free scholarship, grant, or employer-provided educational assistance. See
Adjustments to Qualifying Work-Related Education Expenses, next.
Adjustments to Qualifying Work-Related Education Expenses
If you pay qualifying work-related education expenses with certain tax-free funds, you cannot claim a deduction for those amounts. You must reduce
the qualifying expenses by the amount of any tax-free educational assistance you received.
Tax-free educational assistance includes:
The tax-free part of scholarships and fellowships (see chapter 1 of Publication 970),
Pell grants (see chapter 1 of Publication 970),
Employer-provided educational assistance (see chapter 11 of Publication 970),
Veterans' educational assistance (see chapter 1 of Publication 970), and
Any other nontaxable (tax-free) payments (other than gifts or inheritances) received for education assistance.
Do not reduce the qualifying work-related education expenses by amounts paid with funds the student receives as:
Payment for services, such as wages,
A loan,
A gift,
An inheritance, or
A withdrawal from the student's personal savings.
Also, do not reduce the qualifying work-related education expenses by any scholarship or fellowship reported as income on the student's return or
any scholarship which, by its terms, cannot be applied to qualifying work-related education expenses.
How you treat reimbursements depends on the arrangement you have with your employer.
There are two basic types of reimbursement arrangements—accountable plans and nonaccountable plans. You can tell the type of plan you are
reimbursed under by the way the reimbursement is reported on your Form W-2.
For information about how to treat reimbursements under both accountable and nonaccountable plans, see Reimbursements in chapter 26.
Deducting Business Expenses
Self-employed persons and employees report business expenses differently.
The following information explains what forms you must use to deduct the cost of your qualifying education as a business expense.
Form:1040, Schedule CWork-related education expensesForm:1040, Schedule C-EZWork-related education expensesForm:1040, Schedule FWork-related education expensesSelf-employed persons:Work-related education expensesIf you are self-employed, you must report the cost of your qualifying work-related education
on the appropriate form used to report your business income and expenses (generally Schedule C, C-EZ, or F). If your educational expenses include
expenses for a car or truck, travel, or meals, report those expenses the same way you report other business expenses for those items. See the
instructions for the form you file for information on how to complete it.
Employees
If you are an employee, you can deduct the cost of qualifying work-related education only if you:
Did not receive any reimbursement from your employer,
Were reimbursed under a nonaccountable plan (amount is included in box 1 of Form W-2), or
Received reimbursement under an accountable plan, but the amount received was less than your expenses.
If either (1) or (2) applies, you can deduct the total qualifying cost. If (3) applies, you can deduct only the qualifying costs that were more
than your reimbursement.
Employee business expenses:Work-related education
In order to deduct the cost of your qualifying work-related education as a business expense, include the amount with your deduction for any other
employee business expenses on Schedule A (Form 1040), line 20. (Special rules for expenses of certain performing artists and fee-basis officials and
for impairment-related work expenses are explained later.) This deduction is subject to the 2%-of-adjusted-gross-income limit that applies to most
miscellaneous itemized deductions. See chapter 28.
Form 2106 or 2106-EZ.Form:2106:Work-related education expensesForm:2106-EZ:Work-related education expenses
To figure your deduction for employee business expenses, including qualifying work-related education, you generally must complete Form 2106 or Form
2106-EZ.
Form not required.
Do not complete either Form 2106 or Form 2106-EZ if:
All reimbursements, if any, were included in box 1 of your Form W-2, and
You are not claiming travel, transportation, meal, or entertainment expenses.
If you meet both of these requirements, enter the expenses directly on Schedule A (Form 1040), line 20. (Special rules for expenses of certain
performing artists and fee-basis officials and for impairment-related work expenses are explained later.)
Using Form 2106-EZ.
This form is shorter and easier to use than Form 2106. Generally, you can use this form if:
All reimbursements, if any, were included in box 1 of your Form W-2, and
You are using the standard mileage rate if you are claiming vehicle expenses.
If you do not meet both of these requirements, use Form 2106.
Performing Artists and Fee-Basis OfficialsFee-basis officials:Work-related education expensesPerforming artists:Work-related education expensesState or local governments:Fee-basis officials:Work-related education expenses
If you are a qualified performing artist, or a state (or local) government official who is paid in whole or in part on a fee basis, you can deduct
the cost of your qualifying work-related education as an adjustment to gross income rather than as an itemized deduction.
Include the cost of your qualifying work-related education with any other employee business expenses on Form 1040, line 24. You do not have to
itemize your deductions on Schedule A (Form 1040), and, therefore, the deduction is not subject to the 2%-of-adjusted-gross-income limit. You must
complete Form 2106 or 2106-EZ to figure your deduction, even if you meet the requirements described earlier under Form not required.
For more information on qualified performing artists, see Publication 463.
Impairment-Related Work ExpensesDisabilities, persons with:Impairment-related work expenses of:Work-related educationImpairment-related work expenses
If you are disabled and have impairment-related work expenses that are necessary for you to be able to get qualifying work-related education, you
can deduct these expenses on Schedule A (Form 1040), line 27. They are not subject to the 2%-of-adjusted-gross-income limit. To deduct these expenses,
you must complete Form 2106 or 2106-EZ, even if you meet the requirements, described earlier, under Form not required.
For more information on impairment-related work expenses, see Publication 463.
You must keep records as proof of any deduction claimed on your tax return. Generally, you should keep your records for 3 years from the date of
filing the tax return and claiming the deduction.
For specific information about keeping records of business expenses, see Recordkeeping in chapter 26.
Miscellaneous DeductionsMiscellaneous deductionsReminderLimit on itemized deductions.
For 2005, if your adjusted gross income is more than $145,950 ($72,975 if you are married filing separately), you may have to reduce the amount of
certain itemized deductions, including most miscellaneous deductions. See chapter 29 for more information.
This chapter explains which expenses you can claim as miscellaneous itemized deductions on Schedule A (Form 1040). You must reduce the total of
most miscellaneous itemized deductions by 2% of your adjusted gross income. This chapter covers the following topics.
Deductions subject to the 2% limit.
Deductions not subject to the 2% limit.
Expenses you cannot deduct.
You must keep records to verify your deductions. You should keep receipts, canceled checks, financial account statements, and other documentary
evidence. For more information on recordkeeping, get Publication 552, Recordkeeping for Individuals.
Recordkeeping:General requirementsPublication529Miscellaneous Deductions 535Business Expenses 587Business Use of Your Home (Including Use by Daycare Providers) 946How To Depreciate Property Form (and Instructions)Employee Business Expenses Unreimbursed Employee Business Expenses
Deductions Subject
to the 2% LimitLimits:Miscellaneous deductions
You can deduct certain expenses as miscellaneous itemized deductions on Schedule A
(Form 1040). You can claim the amount of expenses that is more than 2% of your adjusted gross income. You figure your deduction on Schedule A by
subtracting 2% of your adjusted gross income from the total amount of these expenses. Your adjusted gross income is the amount on Form 1040, line 38.
Generally, you apply the 2% limit after you apply any other deduction limit. For example, you apply the 50% (or 70%) limit on business-related
meals and entertainment (discussed in chapter 26) before you apply the 2% limit.
Deductions subject to the 2% limit are discussed in the three categories in which you report them on Schedule A.
Unreimbursed employee expenses (line 20).
Tax preparation fees (line 21).
Other expenses (line 22).
Exceptions to 2% limit.Exceptions to 2% limit
The following paragraphs describe certain employee business expenses that are not subject to the 2% limit.
Armed Forces reservists.Armed forces:Reserves
If you are a member of a reserve component of the Armed Forces of the United States, and you travel more than 100 miles away from home in
connection with your performance of services as a member of the reserves, you may be able to deduct some of your reserve-related travel costs as an
adjustment to gross income rather than as an itemized deduction. For more information, see Armed Forces Reservists Traveling More Than 100 Miles
From Home, under Deductions Not Subject to the 2% Limit, later.
Educators.Educators:Expenses
If you were an eligible educator in 2005, you can deduct up to $250 of qualified expenses you paid in 2005 as an adjustment to income rather than
as an itemized deduction. See Educator Expenses in chapter 19.
Impairment-related work expenses.Impairment-related work expenses
If you have a physical or mental disability, certain expenses you incur that allow you to work may not be subject to the 2% limit. See
Impairment-Related Work Expenses under Deductions Not Subject to the 2% Limit, later.
If you are a qualified performing artist, you may be able to deduct your employee business expenses as an adjustment to income rather than as a
miscellaneous itemized deduction. See Special Rules in chapter 26 if you need more information about this exception.
State and local government officials paid on a fee basis.State:OfficialsOfficials:Local governmentStateFee-basis officials
If you performed services as an employee of a state or local government and you were paid in whole or in part on a fee basis, you can claim your
trade or business expenses in performing those services as an adjustment to income, rather than as a miscellaneous deduction. See Officials Paid
on a Fee Basis under Deductions Not Subject to the 2% Limit, later.
You can deduct only unreimbursed employee expenses that are:
Paid or incurred during your tax year,
For carrying on your trade or business of being an employee, and
Ordinary and necessary.
An expense is ordinary if it is common and accepted in your trade, business, or profession. An expense is necessary if it is appropriate and
helpful to your business. An expense does not have to be required to be considered necessary.
Examples of unreimbursed employee expenses are listed next. The list is followed by discussions of additional unreimbursed employee expenses.
Business bad debt of an employee.
Education that is work related. (See chapter 27.)
Legal fees related to your job.
Licenses and regulatory fees.
Malpractice insurance premiums.
Medical examinations required by an employer.
Occupational taxes.
Passport for a business trip.
Subscriptions to professional journals and trade magazines related to your work.
Travel, transportation, entertainment, and gifts related to your work. (See chapter 26.)
Business Liability InsuranceInsurance premiums:Liability
You can deduct insurance premiums you paid for protection against personal liability for wrongful acts on the job.
Damages for Breach of Employment ContractDamagesBreach of contractemployment
If you break an employment contract, you can deduct damages you pay your former employer that are attributable to the pay you received from that
employer.
Depreciation on Computers or Cellular TelephonesEmployee expenses:Home computerEmployee expenses:Cellular telephoneDepreciationCellular telephoneComputerComputerCellular telephone
You can claim a depreciation deduction for a computer or cellular telephone that you use in your work as an employee if its use is:
For the convenience of your employer, and
Required as a condition of your employment.
For more information about the rules and exceptions to the rules affecting the allowable deductions for a home computer or cellular telephone, see
Publication 529.
Dues to Chambers of Commerce and Professional SocietiesDues:Chamber of Commerce
You may be able to deduct dues paid to professional organizations (such as bar associations and medical associations) and to chambers of commerce
and similar organizations, if membership helps you carry out the duties of your job. Similar organizations include:
Boards of trade,
Business leagues,
Civic or public service organizations,
Real estate boards, and
Trade associations.
You cannot deduct dues paid to an organization if one of its main purposes is to:
Conduct entertainment activities for members or their guests, or
Provide members or their guests with access to entertainment facilities.
Dues paid to airline, hotel, and luncheon clubs are not deductible. See Club Dues under Nondeductible Expenses, later.
Lobbying and political activities.
You may not be able to deduct that part of your dues that is for certain lobbying and political activities. See Dues used for lobbying
under Lobbying Expenses, later.
Educator Expenses Over LimitEducators:Excess over limitTeachers:Expenses, deduction of
If you were an educator in 2005 and you had qualified expenses that were more than you can deduct on Form 1040, line 23, you can deduct the rest as
an itemized deduction subject to the 2% limit. See Educator Expenses in chapter 19.
Home OfficeBusiness use of homeHome:Business use ofOfficeOffice, use of home asUse of home in business
If you use a part of your home regularly and exclusively for business purposes, you may be able to deduct a part of the operating expenses and
depreciation of your home.
You can claim this deduction for the business use of a part of your home only if you use that part of your home regularly and exclusively:
As your principal place of business for any trade or business,
As a place to meet or deal with your patients, clients, or customers in the normal course of your trade or business, or
In the case of a separate structure not attached to your home, in connection with your trade or business.
The regular and exclusive business use must be for the convenience of your employer and not just appropriate and helpful in your job. Get
Publication 587 for more detailed information and a worksheet.
Job Search ExpensesNew job, trade, or business:Job search expensesJobSearchExpenses
You can deduct certain expenses you have in looking for a new job in your present occupation, even if you do not get a new job.
You cannot deduct these expenses if:
You are looking for a job in a new occupation,
There was a substantial break between the ending of your last job and your looking for a new one, or
You are looking for a job for the first time.
Employment:Agency feesNew job, trade, or business:Employment agency feesEmployment and outplacement agency fees.
You can deduct employment and outplacement agency fees you pay in looking for a new job in your present occupation.
Employer pays you back.
If, in a later year, your employer pays you back for employment agency fees, you must include the amount you receive in your gross income up to the
amount of your tax benefit in the earlier year. (See Recoveries in chapter 12.)
Employer pays the employment agency.
If your employer pays the fees directly to the employment agency and you are not responsible for them, you do not include them in your gross
income.
Résumé.Employment:Résumé expenses
You can deduct amounts you spend for preparing and mailing copies of a résumé to prospective employers if you are looking for a new
job in your present occupation.
Travel and transportation expenses.New job, trade, or business:Travel expensesTravel and transportation expenses:New employment
If you travel to an area and, while there, you look for a new job in your present occupation, you may be able to deduct travel expenses to and from
the area. You can deduct the travel expenses if the trip is primarily to look for a new job. The amount of time you spend on personal activity
compared to the amount of time you spend in looking for work is important in determining whether the trip is primarily personal or is primarily to
look for a new job.
Even if you cannot deduct the travel expenses to and from an area, you can deduct the expenses of looking for a new job in your present occupation
while in the area.
You can choose to use the standard mileage rate to figure your car expenses. The rate for business use of a vehicle before September 1, 2005, is 40 cents per mile. The rate for business use of a vehicle after August 31, 2005, is 48 cents per mile. See chapter 26 for
more information.
Licenses and Regulatory Fees
You can deduct the amount you pay each year to state or local governments for licenses and regulatory fees for your trade, business, or profession.
Occupational TaxesOccupational taxes
You can deduct an occupational tax charged at a flat rate by a locality for the privilege of working or conducting a business in the locality. If
you are an employee, you can claim occupational taxes only as a miscellaneous deduction subject to the 2% limit; you cannot claim them as a deduction
for taxes elsewhere on your return.
Repayment of Income Aid PaymentIncome aid payment
An income aid payment is one that is received under an employer's plan to aid employees who lose their jobs because of lack of work. If you
repay a lump-sum income aid payment that you received and included in income in an earlier year, you can deduct the repayment.
Research Expenses of a College ProfessorResearch expenses:College professorCollege professor:Research expenses
If you are a college professor, you can deduct research expenses, including travel expenses, for teaching, lecturing, or writing and publishing on
subjects that relate directly to the field of your teaching duties. You must have undertaken the research as a means of carrying out the duties
expected of a professor and without expectation of profit apart from salary. However, you cannot deduct the cost of travel as a form of education.
Tools Used in Your WorkTools
Generally, you can deduct amounts you spend for tools used in your work if the tools wear out and are thrown away within 1 year from the date of
purchase. You can depreciate the cost of tools that have a useful life substantially beyond the tax year. For more information about depreciation, see
Publication 946.
Union Dues and ExpensesDues:UnionUnions:Dues
You can deduct dues and initiation fees you pay for union membership.
You can also deduct assessments
Unions:Assessmentsfor benefit payments to unemployed union members. However, you cannot deduct the part of the assessments or
contributions that provides funds for the payment of sick, accident, or death benefits. Also, you cannot deduct contributions to a pension fund, even
if the union requires you to make the contributions.
You may not be able to deduct amounts you pay to the union that are related to certain lobbying and political activities. See Lobbying
Expenses under Nondeductible Expenses, later.
Work Clothes and UniformsUniformsWork clothesClothing, work
You can deduct the cost and upkeep of work clothes if the following two requirements are met.
You must wear them as a condition of your employment.
The clothes are not suitable for everyday wear.
It is not enough that you wear distinctive clothing. The clothing must be specifically required by your employer. Nor is it enough that you do not,
in fact, wear your work clothes away from work. The clothing must not be suitable for taking the place of your regular clothing.
Examples of workers who may be able to deduct the cost and upkeep of work clothes are: delivery workers, firefighters, health care workers, law
enforcement officers, letter carriers, professional athletes, and transportation workers (air, rail, bus, etc.).
Entertainers and musiciansMusicians and entertainers
Musicians and entertainers can deduct the cost of theatrical clothing and accessories if they are not suitable for everyday wear.
However, work clothing consisting of white cap, white shirt or white jacket, white bib overalls, and standard work shoes, which a painter is
required by his union to wear on the job, is not distinctive in character or in the nature of a uniform. Similarly, the costs of buying and
maintaining blue work clothes worn by a welder at the request of a foreman are not deductible.
Protective clothing.Protective clothing
You can deduct the cost of protective clothing required in your work, such as safety shoes or boots, safety glasses, hard hats, and work gloves.
Examples of workers who may be required to wear safety items are: carpenters, cement workers, chemical workers, electricians, fishing boat crew
members, machinists, oil field workers, pipe fitters, steamfitters, and truck drivers.
Military uniforms.Armed forces:UniformsMilitaryClothing:Military
You generally cannot deduct the cost of your uniforms if you are on full-time active duty in the armed forces. However, if you are an armed forces
reservist, you can deduct the unreimbursed cost of your uniform if military regulations restrict you from wearing it except while on duty as a
reservist. In figuring the deduction, you must reduce the cost by any nontaxable allowance you receive for these expenses.
If local military rules do not allow you to wear fatigue uniforms when you are off duty, you can deduct the amount by which the cost of buying and
keeping up these uniforms is more than the uniform allowance you receive.
You can deduct the cost of your uniforms if you are a civilian faculty or staff member of a military school.
You can usually deduct tax preparation fees in the year you pay them. Thus, on your 2005 return, you can deduct fees paid in 2005 for preparing
your 2004 return. These fees include the cost of tax preparation software programs and tax publications. They also include any fee you paid for
electronic filing of your return. However, if you paid your tax by credit card, you cannot deduct the convenience fee you were charged.
Deduct expenses of preparing tax schedules relating to profit or loss from business (Schedule C or C-EZ), rentals or royalties (Schedule E), or
farm income and expenses (Schedule F) on the appropriate schedule. Deduct the expenses of preparing the remainder of the return on Schedule A (Form
1040), line 21.
Other Expenses (Line 22)Income-producing expenses
You can deduct certain other expenses as miscellaneous itemized deductions subject to the 2%-of-adjusted-gross-income limit. These are expenses you
pay:
To produce or collect income that must be included in your gross income,
To manage, conserve, or maintain property held for producing such income, or
To determine, contest, pay, or claim a refund of any tax.
You can deduct expenses you pay for the purposes in (1) and (2) above only if they are reasonably and closely related to these purposes. Some
of these other expenses are explained in the following discussions.
If the expenses you pay produce income that is only partially taxable, see Tax-Exempt Income Expenses, later, under Nondeductible
Expenses.
Appraisal FeesAppraisal fees
You can deduct appraisal fees if you pay them to figure a casualty loss or the fair market value of donated property.
Certain Casualty and Theft LossesLosses:TheftCasualtyCasualty lossesTheft losses
You can deduct a casualty or theft loss as a miscellaneous itemized deduction subject to the 2% limit if you used the damaged or stolen property in
performing services as an employee. First report the loss in Section B of Form 4684, Casualties and Thefts. You may also have to include the loss on
Form 4797, Sales of Business Property, if you are otherwise required to file that form. To figure your deduction, add all casualty or theft losses
from this type of property included on Form 4684, lines 35 and 41b, or Form 4797, line 18a. For other casualty and theft losses, see chapter 25.
Clerical Help and Office RentClerical help, deductibility ofOffice rent, deductibility of
You can deduct office expenses, such as rent and clerical help, that you have in connection with your investments and collecting the taxable income
on them.
Depreciation on Home ComputerEmployee expenses:Home computerDepreciationHome computer
You can deduct depreciation on your home computer if you use it to produce income (for example, to manage your investments that produce taxable
income). You generally must depreciate the computer using the straight line method over the Alternative Depreciation System (ADS) recovery period. But
if you work as an employee and also use the computer in that work, see Publication 946.
Excess Deductions of an EstateDeductions:Estate
If an estate's total deductions in its last tax year are more than its gross income for that year, the beneficiaries succeeding to the estate's
property can deduct the excess. Do not include deductions for the estate's personal exemption and charitable contributions when figuring the estate's
total deductions. The beneficiaries can claim the deduction only for the tax year in which, or with which, the estate terminates, whether the year of
termination is a normal year or a short tax year. For more information, see Termination of Estate in Publication 559, Survivors, Executors,
and Administrators.
Fees to Collect Interest and DividendsInterest:Fees to collectDividends:Fees to collect
You can deduct fees you pay to a broker, bank, trustee, or similar agent to collect your taxable bond interest or dividends on shares of stock. But
you cannot deduct a fee you pay to a broker to buy investment property, such as stocks or bonds. You must add the fee to the cost of the property.
You cannot deduct the fee you pay to a broker to sell securities. You can use the fee only to figure gain or loss from the sale. See the
instructions for Schedule D (Form 1040), columns (d) and (e), for information on how to report the fee.
Hobby ExpensesHobbies
You can generally deduct hobby expenses, but only up to the amount of hobby income. A hobby is not a business because it is not carried on to make
a profit. See Activity not for profit in chapter 12 under Other Income.
Indirect Deductions of
Pass-Through EntitiesPartners and partnershipsS corporationsPass-through entitiesDeductions:Pass-through entities
Pass-through entities include partnerships, S corporations, and mutual funds that are not publicly offered. Deductions of pass-through entities are
passed through to the partners or shareholders. The partners or shareholders can deduct their share of passed-through deductions for investment
expenses as miscellaneous itemized deductions subject to the 2% limit.
Example.
You are a member of an investment club that is formed solely to invest in securities. The club is treated as a partnership. The partnership's
income is solely from taxable dividends, interest, and gains from sales of securities. In this case, you can deduct your share of the partnership's
operating expenses as miscellaneous itemized deductions subject to the 2% limit. However, if the investment club partnership has investments that also
produce nontaxable income, you cannot deduct your share of the partnership's expenses that produce the nontaxable income.
Publicly offered mutual funds do not pass deductions for investment expenses through to shareholders. A mutual fund is publicly offered if
it is:
Continuously offered pursuant to a public offering,
Regularly traded on an established securities market, or
Held by or for at least 500 persons at all times during the tax year.
A publicly offered mutual fund will send you a Form 1099-DIV, Dividends and Distributions, or a substitute form, showing the net amount of dividend
income (gross dividends minus investment expenses). This net figure is the amount you report on your return as income. You cannot deduct investment
expenses.
Information returns.
You should receive information returns from pass-through entities.
Partnerships and S corporations.
These entities issue Schedule K-1, which lists the items and amounts you must report and identifies the tax return schedules and lines to use.
These funds will send you a Form 1099-DIV, or a substitute form, showing your share of gross income and investment expenses. You can claim the
expenses only as a miscellaneous itemized deduction subject to the 2% limit.
Investment Fees and ExpensesCustodial feesInvestments:Fees
You can deduct investment fees, custodial fees, trust administration fees, and other expenses you paid for managing your investments that produce
taxable income.
Legal ExpensesAttorneys' feesLegal expenses
You can usually deduct legal expenses that you incur in attempting to produce or collect taxable income or that you pay in connection with the
determination, collection, or refund of any tax.
You can also deduct legal expenses that are:
Related to either doing or keeping your job, such as those you paid to defend yourself against criminal charges arising out of your trade or
business,
For tax advice related to a divorce, if the bill specifies how much is for tax advice and it is determined in a reasonable way, or
To collect taxable alimony.
You can deduct expenses of resolving tax issues relating to profit or loss from business (Schedule C or C-EZ), rentals or royalties (Schedule E),
or farm income and expenses (Schedule F) on the appropriate schedule. You deduct expenses of resolving nonbusiness tax issues on Schedule A (Form
1040). See Tax Preparation Fees, earlier.
Unlawful discrimination claims.
You may be able to deduct, as an adjustment to income on Form 1040, line 36, rather than as a miscellaneous itemized deduction, attorney fees and
court costs for actions settled or decided after October 22, 2004, involving a claim of unlawful discrimination, a claim against the U.S. Government,
or a claim made under section 1862(b)(3)(A) of the Social Security Act. However, the amount you can deduct on Form 1040, line 36, is limited to the
amount you included in gross income in 2005 for that claim. The rest of your attorney fees and court costs for this type of claim are deductible as a
miscellaneous itemized deduction subject to the 2% limit. See Publication 525 for more information.
Loss on DepositsDeposits:Loss on
For information on whether, and if so, how, you may deduct a loss on your deposit in a qualified financial institution, see Deposit in
Insolvent or Bankrupt Financial Institution in chapter 14.
Repayments of Income
If you had to repay an amount that you included in income in an earlier year, you may be able to deduct the amount you repaid. If the amount you
had to repay was ordinary income of $3,000 or less, the deduction is subject to the 2% limit. If it was more than $3,000, see Repayments Under
Claim of Right under Deductions Not Subject to the 2% Limit, later.
Repayments of Social Security BenefitsSocial security benefits:Repayments
For information on how to deduct your repayments of certain social security benefits, see Repayments More Than Gross Benefits in chapter
11.
Safe Deposit Box RentSafe deposit box
You can deduct safe deposit box rent if you use the box to store taxable income-producing stocks, bonds, or investment-related papers and
documents. You cannot deduct the rent if you use the box only for jewelry, other personal items, or tax-exempt securities.
Service Charges on Dividend Reinvestment PlansService charges
You can deduct service charges you pay as a subscriber in a dividend reinvestment plan. These service charges include payments for:
Holding shares acquired through a plan,
Collecting and reinvesting cash dividends, and
Keeping individual records and providing detailed statements of accounts.
Trustee's administrative fees that are billed separately and paid by you in connection with your individual retirement arrangement (IRA) are
deductible (if they are ordinary and necessary) as a miscellaneous itemized deduction subject to the 2% limit. For more information about IRAs, see
chapter 17.
Deductions Not Subject to the 2% Limit
You can deduct the items listed below as miscellaneous itemized deductions. They are not subject to the 2% limit. Report these items on Schedule A
(Form 1040), line 27.
List of Deductions
Each of the following items is discussed in detail after the list.
Amortizable premium on taxable bonds.
Casualty and theft losses from income-producing property.
Federal estate tax on income in respect of a decedent.
Gambling losses up to the amount of gambling winnings.
Impairment-related work expenses of persons with disabilities.
Loss from other activities from Schedule K-1 (Form 1065-B), box 2.
Repayments of more than $3,000 under a claim of right.
Unrecovered investment in an annuity.
Amortizable Premium on Taxable BondsBonds:Amortization of premium
In general, if the amount you pay for a bond is greater than its stated principal amount, the excess is bond premium. You can elect to amortize the
premium on taxable bonds. The amortization of the premium is generally an offset to interest income on the bond rather than a separate deduction item.
Part of the premium on some bonds may be a miscellaneous deduction not subject to the 2% limit. For more information, see Amortizable Premium
on Taxable Bonds in Publication 529, and Bond Premium Amortization in chapter 3 of Publication 550, Investment Income and Expenses.
Certain Casualty and Theft LossesLosses:TheftCasualtyCasualty lossesTheft lossesDeductions:Casualty lossesTheft loss
You can deduct a casualty or theft loss as a miscellaneous itemized deduction not subject to the 2% limit if the damaged or stolen property was
income-producing property (property held for investment, such as stocks, notes, bonds, gold, silver, vacant lots, and works of art). First, report the
loss in Form 4684, Section B. You may also have to include the loss on Form 4797 if you are otherwise required to file that form. To figure your
deduction, add all casualty or theft losses from this type of property included on Form 4684, lines 35 and 41b, or Form 4797, line 18a. For more
information on casualty and theft losses, see chapter 25.
Federal Estate Tax on Income in Respect of a DecedentEstatesTax
You can deduct the federal estate tax attributable to income in respect of a decedent that you as a beneficiary include in your gross income.
Income in respect of the decedent is gross income that the decedent would have received had death not occurred and that was not properly includible in
the decedent's final income tax return. See Publication 559 for more information.
Gambling Losses Up to the
Amount of Gambling WinningsGains and losses:GamblingGambling winnings and losses
You must report the full amount of your gambling winnings for the year on Form 1040, line 21. You deduct your gambling losses for the year on
Schedule A (Form 1040), line 27. You cannot deduct gambling losses that are more than your winnings.
You cannot reduce your gambling winnings by your gambling losses and report the difference. You must report the full amount of your winnings as
income and claim your losses (up to the amount of winnings) as an itemized deduction. Therefore, your records should show your winnings separately
from your losses.
Diary of winnings and losses.
Recordkeeping:GamblingYou must keep an accurate diary or similar record of your losses and winnings.
Your diary should contain at least the following information.
The date and type of your specific wager or wagering activity.
The name and address or location of the gambling establishment.
The names of other persons present with you at the gambling establishment.
The amount(s) you won or lost.
See Publication 529 for more information.
Impairment-Related Work ExpensesImpairment-related work expensesDisabilities, persons with:Expenses for
If you have a physical or mental disability that limits your being employed, or substantially limits one or more of your major life activities,
such as performing manual tasks, walking, speaking, breathing, learning, and working, you can deduct your impairment-related work expenses.
Impairment-related work expenses are ordinary and necessary business expenses for attendant care services at your place of work and for other
expenses in connection with your place of work that are necessary for you to be able to work.
Where to report.
If you are an employee, you enter impairment-related work expenses on Form 2106 or Form 2106-EZ. Enter on Schedule A (Form 1040), line 27, that
part of the amount on Form 2106, line 10, or Form 2106-EZ, line 6, that is related to your impairment. Enter the amount that is unrelated to your
impairment on Schedule A (Form 1040), line 20.
Repayments Under Claim of RightRepaymentAmount previously included in income
If you had to repay more than $3,000 that you included in your income in an earlier year because at the time you thought you had an unrestricted
right to it, you may be able to deduct the amount you repaid or take a credit against your tax. See Repayments in chapter 12 for more
information.
Unrecovered Investment in AnnuityPensions:Unrecovered investment inAnnuities:Unrecovered investment
A retiree who contributed to the cost of an annuity can exclude from income a part of each payment received as a tax-free return of the retiree's
investment. If the retiree dies before the entire investment is recovered tax free, any unrecovered investment can be deducted on the retiree's final
income tax return. See chapter 10 for more information about the tax treatment of pensions and annuities.
Loss From Other Activities From Schedule K-1 (Form 1065-B), Box 2
If the amount reported in Schedule K-1 (Form 1065-B), box 2, is a loss, report it on Schedule A (Form 1040), line 27. It is not subject to the
passive activity limitations. See the 2005 Partner's Instructions For Schedule K-1 (Form 1065-B) for more information.
Officials Paid on a Fee BasisState:OfficialsFee-basis officials
If you are a fee-basis official, you can claim your expenses in performing services in that job as an adjustment to income rather than as a
miscellaneous itemized deduction. To qualify as a fee-basis official, you must be employed by a state or local government and be paid in whole or in
part on a fee basis.
Where to report.
If you qualify as a fee-basis official, you should first complete Form 2106 or Form 2106-EZ. Then include your expenses in performing services in
that job (Form 2106, line 10, or Form 2106-EZ, line 6) on Form 1040,
line 24.
Armed Forces Reservists Traveling More Than 100 Miles From HomeArmed forces:Reserves
If you are a member of a reserve component of the Armed Forces of the United States and you travel more than 100 miles away from home in connection
with your performance of services as a member of the reserves, you can deduct your travel expenses as an adjustment to gross income rather than as a
miscellaneous itemized deduction. The amount of expenses you can deduct as an adjustment to gross income is limited to the regular federal per
diem rate (for lodging, meals, and incidental expenses) and the standard mileage rate (for car expenses) plus any parking fees, ferry fees, and
tolls. For more information, see Publication 463.
Member of a reserve component.
You are a member of a reserve component of the Armed Forces of the United States if you are in the Army, Naval, Marine Corps, Air Force, or Coast
Guard Reserve, the Army National Guard of the United States, the Air National Guard of the United States, or the Reserve Corps of the Public Health
Service.
Where to report.
If you have reserve-related travel that takes you more than 100 miles from home, you should first complete Form 2106 or Form 2106-EZ. Then include
your expenses for reserve travel over 100 miles from home, up to the federal rate, from Form 2106, line 10, or Form 2106-EZ, line 6, in the total on
Form 1040, line 24. Subtract this amount from the total on Form 2106, line 10, or Form 2106-EZ, line 6, and deduct the balance as an itemized
deduction on Schedule A (Form 1040), line 20.
You cannot deduct travel expenses that do not take you more than 100 miles from home as an adjustment to gross income. Instead, you must complete
Form 2106 or 2106-EZ and deduct those expenses as an itemized deduction on Schedule A (Form 1040), line 20.
Nondeductible Expenses
Examples of nondeductible expenses are listed next. The list is followed by discussions of additional nondeductible expenses.
List of Nondeductible Expenses
Broker's commissions that you paid in connection with your IRA or other investment property.
Burial or funeral expenses, including the cost of a cemetery lot.
Burial expensesFunerals:Expenses
Capital expenses.
License and similar fees
Fees and licenses, such as car licenses, marriage licenses, and dog tags.
Hobby losses — But see Hobby Expenses, earlier.
Home repairs, insurance, and rent.
Bribes and illegal payments
Illegal bribes and kickbacks—See Bribes and kickbacks in chapter 13 of Publication 535.
Losses from the sale of your home, furniture, personal car, etc.
Personal disability insurance premiums.
Personal, living, or family expenses.
The value of wages never received or lost vacation time.
Adoption Expenses
You cannot deduct the expenses of adopting a child, but you may be able to take a credit for those expenses. See chapter 37.
You cannot deduct campaign expenses of a candidate for any office, even if the candidate is running for reelection to the office. These include
qualification and registration fees for primary elections.
Legal fees.
You cannot deduct legal fees paid to defend charges that arise from participation in a political campaign.
Check-Writing Fees on Personal AccountCheck-writing fees
If you have a personal checking account, you cannot deduct fees charged by the bank for the privilege of writing checks, even if the account pays
interest.
Club DuesDues:Club
Generally, you cannot deduct the cost of membership in any club organized for business, pleasure, recreation, or other social purpose. This
includes business, social, athletic, luncheon, sporting, airline, hotel, golf, and country clubs. For exceptions, see Dues to Chambers of
Commerce and Professional Societies under Unreimbursed Employee Expenses, earlier.
Commuting ExpensesCommuting expenses
You cannot deduct commuting expenses (the cost of transportation between your home and your main or regular place of work). If you haul tools,
instruments, or other items, in your car to and from work, you can deduct only the additional cost of hauling the items such as the rent on a trailer
to carry the items.
Fines or PenaltiesFinesDeductibilityPenalties:Deductibility
You cannot deduct fines or penalties you pay to a governmental unit for violating a law. This includes an amount paid in settlement of your actual
or potential liability for a fine or penalty (civil or criminal). Fines or penalties include parking tickets, tax penalties, and penalties deducted
from teachers' paychecks after an illegal strike.
Health Spa ExpensesHealth Spa
You cannot deduct health spa expenses, even if there is a job requirement to stay in excellent physical condition, such as might be required of a
law enforcement officer.
Home Security SystemHome:Security system
You cannot deduct the cost of a home security system as a miscellaneous deduction. However, you may be able to claim a deduction for a home
security system as a business expense if you have a home office. See Home Office under Unreimbursed Employee Expenses, earlier,
and Security System under Deducting Expenses in Publication 587.
You cannot deduct any expenses for attending a convention, seminar, or similar meeting for investment purposes.
Life Insurance PremiumsInsurance premiums:LifeLife insurance:Premiums
You cannot deduct premiums you pay on your life insurance. You may be able to deduct, as alimony, premiums you pay on life insurance policies
assigned to your former spouse. See chapter 18 for information on alimony.
Lobbying ExpensesLobbying expenses
You generally cannot deduct amounts paid or incurred for lobbying expenses. These include expenses to:
Influence legislation,
Participate or intervene in any political campaign for, or against, any candidate for public office,
Attempt to influence the general public, or segments of the public, about elections, legislative matters, or referendums, or
Communicate directly with covered executive branch officials in any attempt to influence the official actions or positions of those
officials.
Lobbying expenses also include any amounts paid or incurred for research, preparation, planning, or coordination of any of these activities.
Dues used for lobbying.
If a tax-exempt organization notifies you that part of the dues or other amounts you pay to the organization are used to pay nondeductible lobbying
expenses, you cannot deduct that part. See Lobbying Expenses in Publication 529 for information on exceptions.
Lost or Mislaid Cash or PropertyLost property
You cannot deduct a loss based on the mere disappearance of money or property. However, an accidental loss or disappearance of property can qualify
as a casualty if it results from an identifiable event that is sudden, unexpected, or unusual. See chapter 25.
Example.
A car door is accidentally slammed on your hand, breaking the setting of your diamond ring. The diamond falls from the ring and is never found. The
loss of the diamond is a casualty.
Lunches with Coworkers
You cannot deduct the expenses of lunches with co-workers, except while traveling away from home on business. See chapter 26 for information on
deductible expenses while traveling away from home.
Meals While Working Late
You cannot deduct the cost of meals while working late. However, you may be able to claim a deduction if the cost of meals is a deductible
entertainment expense, or if you are traveling away from home. See chapter 26 for information on deductible entertainment expenses and expenses while
traveling away from home.
Personal Legal ExpensesAttorneys' feesLegal expenses
You cannot deduct personal legal expenses such as those for the following.
Custody of children.
Breach of promise to marry suit.
Civil or criminal charges resulting from a personal relationship.
Damages for personal injury.
Preparation of a title (or defense or perfection of a title).
Preparation of a will.
Property claims or property settlement in a divorce.
You cannot deduct these expenses even if a result of the legal proceeding is the loss of income-producing property.
Political ContributionsPolitical campaign expensesContributions:PoliticalPolitical contributionsCampaign contributions
You cannot deduct contributions made to a political candidate, a campaign committee, or a newsletter fund. Advertisements in convention bulletins
and admissions to dinners or programs that benefit a political party or political candidate are not deductible.
Professional Accreditation FeesProfessional license feesFeesProfessional license
You cannot deduct professional accreditation fees such as the following.
Accounting certificate fees paid for the initial right to practice accounting.
Bar exam fees and incidental expenses in securing admission to the bar.
Medical and dental license fees paid to get initial licensing.
Professional ReputationProfessional Reputation
You cannot deduct expenses of radio and TV appearances to increase your personal prestige or establish your professional reputation.
Relief Fund ContributionsRelief fund contributions
You cannot deduct contributions paid to a private plan that pays benefits to any covered employee who cannot work because of any injury or illness
not related to the job.
Residential Telephone ServiceTelephones
You cannot deduct any charge (including taxes) for basic local telephone service for the first telephone line to your residence, even if it is used
in a trade or business.
You cannot deduct transportation and other expenses you pay to attend stockholders' meetings of companies in which you own stock but have no other
interest. You cannot deduct these expenses even if you are attending the meeting to get information that would be useful in making further
investments.
Tax-Exempt Income ExpensesTax-exempt:Income
You cannot deduct expenses to produce tax-exempt income. You cannot deduct interest on a debt incurred or continued to buy or carry
tax-exempt securities.
If you have expenses to produce both taxable and tax-exempt income, but you cannot identify the expenses that produce each type of income, you must
divide the expenses based on the amount of each type of income to determine the amount that you can deduct.
Example.
During the year, you received taxable interest of $4,800 and tax-exempt interest of $1,200. In earning this income, you had total expenses of $500
during the year. You cannot identify the amount of each expense item that is for each income item. Therefore, 80% ($4,800/$6,000) of the expense is
for the taxable interest and 20% ($1,200/$6,000) is for the tax-exempt interest. You can deduct, subject to the 2% limit, expenses of $400 (80% of
$500).
Travel Expenses for Another IndividualTravel and transportation expenses:Expenses paid for others
You generally cannot deduct travel expenses you pay or incur for a spouse, dependent, or other individual who accompanies you (or your employee) on
business travel. See chapter 26 for more information on deductible travel expenses.
Voluntary Unemployment
Benefit Fund ContributionsUnemployment compensation:Voluntary benefit fund contributions
You cannot deduct voluntary unemployment benefit fund contributions you make to a union fund or a private fund. However, you can deduct
contributions as taxes if state law requires you to make them to a state unemployment fund that covers you for the loss of wages from unemployment
caused by business conditions.
WristwatchesWristwatch
You cannot deduct the cost of a wristwatch, even if there is a job requirement that you know the correct time to properly perform your duties.
Limit on Itemized DeductionsLimits:Itemized deductionsItemized deductions:Limits onWhat's NewKatrina Emergency Tax Relief Act of 2005.
This Act provides tax relief for persons affected by Hurricane Katrina. Under the Act, you may be able to treat certain gifts made by cash or check
as qualified contributions not subject to the limit on itemized deductions. See Publication 4492.
This chapter discusses the overall limit on itemized deductions on Schedule A (Form 1040). The topics include:
Who is subject to the limit,
Which itemized deductions are limited, and
How to figure the limit.
Form (and Instructions) Itemized Deductions
Are You Subject
to the Limit?
You are subject to the limit on certain itemized deductions if your adjusted gross income (AGI) is more than $145,950 ($72,975 if you are married
filing separately). Your AGI is the amount on Form 1040, line 38.
Which Itemized Deductions
Are Limited?
The following Schedule A (Form 1040) deductions are subject to the overall limit on itemized deductions.
Taxes—line 9.
Interest—lines 10, 11, and 12.
Gifts to charity—line 18.
Job expenses and most other miscellaneous deductions—line 26.
Other miscellaneous deductions—line 27, excluding gambling and casualty or theft losses.
Which Itemized Deductions
Are Not Limited?
The following Schedule A (Form 1040) deductions are not subject to the overall limit on itemized deductions. However, they are still subject to
other applicable limits.
Medical and dental expenses—line 4.
Investment interest expense—line 13.
Gifts by cash or check made after August 27, 2005, that you elect to treat as qualified contributions—line 15b.
Casualty and theft losses from personal use property—line 19.
Casualty and theft losses from income-producing property—line 27.
Gambling losses—line 27.
How Do You Figure
the Limit?
If your itemized deductions are subject to the limit, the total of all your itemized deductions is reduced by the smaller of:
3% of the amount by which your AGI exceeds $145,950 ($72,975 if married filing separately), or
80% of your itemized deductions that are affected by the limit. See Which Itemized Deductions Are Limited, earlier.
Before you figure the overall limit on itemized deductions, you first must complete Schedule A (Form 1040), lines 1 through 27, including any
related forms (such as Form 2106, Form 4684, etc.).
The overall limit on itemized deductions is figured after you have applied any other limit on the allowance of any itemized deduction. These other
limits include charitable contribution limits (chapter 24), the limit on certain meals and entertainment (chapter 26), and the 2%-of-
adjusted-gross-income limit on certain miscellaneous deductions (chapter 28).
Itemized Deductions Worksheet.
After you have completed Schedule A (Form 1040) through line 27, you can use the Itemized Deductions Worksheet in the Instructions for Schedule A
(Form 1040) to figure your limit. Enter the result on Schedule A (Form 1040), line 28. Keep the worksheet for your records.
You should compare the amount of your standard deduction to the amount of your itemized deductions after applying the limit. Use the greater amount
when completing Form 1040, line 40. See chapter 20 for information on how to figure your standard deduction.
Example
For tax year 2005, Bill and Terry Willow are filing a joint return on Form 1040. Their adjusted gross income on line 38 is $259,600. Their Schedule
A itemized deductions are as follows:
The Willows' investment interest expense deduction ($41,000 from Schedule A (Form 1040), line 13) is not subject to the overall limit on itemized
deductions.
The Willows use the Itemized Deductions Worksheet in the Schedule A (Form 1040) instructions to figure their overall limit. Their completed
worksheet is shown as Table 29-1.
Of their $142,140 total itemized deductions, the Willows can deduct only $138,730 ($142,140 − $3,410). They enter $138,730 on Schedule A
(Form 1040), line 28.
<ROM>Table 29-1.</ROM> Itemized Deductions Worksheet—Line
28 <ITL>Keep for your records</ITL>1.Enter the total of the amounts from Schedule A, lines 4, 9, 14, 18, 19, 26, and 27. 1.142,1402.Enter the total of the amounts from Schedule A, lines 4, 13, 15b, and 19, plus any gambling and
casualty or theft losses included on line 27.2.41,000Be sure your total gambling and casualty or theft losses are clearly identified on the
dotted lines next to line 27.3.Is the amount on line 2 less than the amount on line 1? No.Your deduction is not limited. Enter the amount from line 1 above on Schedule A, line 28.&checkbox; Yes.Subtract line 2 from line 13.101,1404.Multiply line 3 by 80% (.80)4.80,9125.Enter the amount from Form 1040, line 385.259,6006.Enter: $145,950 ($72,975 if married filing separately) 6.145,9507.Is the amount on line 6 less than the amount on line 5? No.Your deduction is not limited. Enter the amount from line 1 above on Schedule A, line 28.&checkbox; Yes.Subtract line 6 from line 57.113,6508.Multiply line 7 by 3% (.03)8.3,4109.Enter the smaller of line 4 or line 89.3,41010.Total itemized deductions. Subtract line 9 from line 1. Enter the result here and on Schedule
A,
line 2810.138,730
Figuring Your Taxes and Credits
The eight chapters in this part explain how to figure your tax and how to figure the tax of certain children who have more than $1,600 of
investment income. They also discuss tax credits that, unlike deductions are subtracted directly from your tax and reduce your tax, dollar for dollar.
Chapter 36 discusses the earned income credit and how you may be able to get part of the credit paid to you in advance throughout the year.
How To Figure Your TaxTaxes:How to figure
After you have figured your income and deductions as explained in Parts One through Five, your next step is to figure your
tax. This chapter discusses:
The general steps you take to figure your tax,
An additional tax you may have to pay called the alternative minimum tax, and
The conditions you must meet if you want the IRS to figure your tax.
Figuring Your TaxFiguring taxes and credits
Your income tax is based on your taxable income. After you figure your income tax and any alternative minimum tax, subtract your tax credits and
add any other taxes you may owe. The result is your total tax. Compare your total tax with your total payments to determine whether you are entitled
to a refund or owe additional tax.
This section provides a general outline of how to figure your tax. You can find step-by-step directions in the instructions for Forms 1040EZ,
1040A, and 1040. If you are unsure of which tax form you should file, see Which Form Should I Use? in chapter 1.
Tax.Taxes
Most taxpayers use either the Tax Table or the Tax Computation Worksheet to figure their income tax. However, there are special methods if your
income includes any of the following items.
A net capital gain. (See chapter 16.)
Qualified dividends taxed at the same rates as a net capital gain. (See chapter 16.)
Lump-sum distributions. (See chapter 10.)
Farming or fishing income. (See Schedule J (Form 1040), Income Averaging for Farmers and Fishermen.)
Investment income over $1,600 for children under age 14. (See chapter 31.)
Credits.Credits
After you figure your income tax and any alternative minimum tax (discussed later), determine your tax credits. This chapter does not explain
whether you are eligible for these credits. You can find that information in chapters 32 through 37 and your form instructions. See the following
table for credits you may be able to subtract from your income tax.
CREDITSFor information on:Seechapter:Adoption37Child and dependent care32Child tax credit34Education35Elderly or disabled33Foreign tax37Mortgage interest 37Prior year minimum tax37Qualified electric vehicle37Qualified retirement savings
contributions37
Some credits (such as the earned income credit) are not listed above because they are treated as payments. See Payments, later.
There are other credits that are not discussed in this publication. These include the following items.
General business creditGeneral business credit, which is made up of several separate business-related credits. These
generally are reported on Form 3800, General Business Credit, and are discussed in chapter 4 of Publication 334, Tax Guide for Small
Business.
Empowerment zoneCredits:Empowerment zone and renewal community employment creditEmpowerment zone and renewal community employment credit,
which is for certain employers who are engaged in a business in an empowerment zone, a renewal community, or the DC zone. See Publication 954, Tax
Incentives for Distressed Communities. Also see the instructions for Form 8844, Empowerment Zone and Renewal Community Employment Credit.
First-time homebuyer credit:District of ColumbiaDistrict of Columbia first-time homebuyer creditDistrict of Columbia first-time homebuyer credit, which is for certain
persons who buy a main home in the District. See the instructions for Form 8859, District of Columbia First-Time Homebuyer Credit.
Credit for alcohol used as fuel. See Form 6478.
Renewable electricity, refined coal, and Indian coal production credit for electricity and refined coal produced at facilities placed in
service after October 22, 2004, and Indian coal produced at facilities placed in service after August 8, 2005. See Form 8835, Section B.
Credits:Fuel from a nonconventional sourceCredit for fuel from a nonconventional source, which is for the person who sold the
fuel or who owned royalty interests and received income from the sale of fuel produced from a nonconventional source. See Form 8907.
Other taxes.Other taxes
After you subtract your tax credits, determine whether there are any other taxes you must pay. This chapter does not explain these other taxes. You
can find that information in other chapters of this publication and your form instructions. See the following table for other taxes you may need to
add to your income tax.
OTHER TAXESFor information on:Seechapter:Additional taxes on qualified retirement plans and IRAs10, 17 Advance earned income credit payments36Household employment taxes32Recapture of an education credit35Social security and Medicare tax on unreported tips6Uncollected social security and Medicare tax on tips6
Another tax you may have to pay, the alternative minimum tax, is discussed later in this chapter.
There are other taxes that are not discussed in this publication. These include the following items.
Self-employment taxSelf-employment tax. You must figure this tax if either of the following applies to you (or
your spouse if you file a joint return).
Your net earnings from self-employment from other than church employee income were $400 or more. The term net earnings from
self-employment may include certain nonemployee compensation and other amounts reported to you on Form 1099-MISC, Miscellaneous Income. If you
received a Form 1099-MISC, see the Instructions to Recipients on the back. Also see the instructions for Schedule SE (Form 1040),
Self-Employment Tax; and Publication 334, Tax Guide for Small Business.
You had church employee income of $108.28 or more.
Recapture:TaxesRecapture taxes. You may have to pay these taxes if you previously claimed an investment credit, a
low-income housing credit, a mortgage interest credit, a new markets credit, a qualified electric vehicle credit, a credit for employer-provided child
care facilities, or an Indian employment credit. For more information, see the instructions for Form 1040, line 63.
Section 72(m)(5)Excess benefits taxSection 72(m)(5)Section 72(m)(5) excess benefits tax. If you are (or were) a 5% owner of a business and you received a
distribution that exceeds the benefits provided for you under the qualified pension or annuity plan formula, you may have to pay this additional tax.
See Tax on Excess Benefits in chapter 4 of Publication 560, Retirement Plans for Small Business (SEP, SIMPLE, and Qualified
Plans).
Social security and Medicare taxesMedicare taxGroup-term life insurance:Uncollected taxUncollected social security and Medicare tax on group-term life insurance. If your former
employer provides you with more than $50,000 of group-term life insurance coverage, you must pay the employee part of social security and Medicare
taxes on those premiums. The amount should be shown in box 12 of your Form W-2 with codes M and N.
Golden parachute payments:Tax onTax on golden parachute payments. This tax applies if you received an excess parachute
payment (EPP) due to a change in a corporation's ownership or control. See the instructions for Form 1040, line 63.
Trusts Trust beneficiariesAccumulation distribution of trusts:Tax onTax on accumulation distribution of trusts. This applies if you are the beneficiary of a trust that
accumulated its income instead of distributing it currently. See the instructions for Form 4970, Tax on Accumulation Distribution of
Trusts.
Medical Savings Accounts (MSAs):Additional tax onAdditional tax on HSAs or MSAs. If amounts contributed to, or distributed from, your health
savings account or medical savings account do not meet the rules for these accounts, you may have to pay additional taxes. See Publication 969, Health
Savings Accounts and Other Tax-Favored Health Plans; Form 8853, Archer MSAs and Long-Term Care Insurance Contracts; Form 8889, Health Savings Accounts
(HSAs); and Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts.
Coverdell ESAs:Additional tax onAdditional tax on Coverdell ESAs. This applies if amounts contributed to, or distributed from,
your Coverdell ESA do not meet the rules for these accounts. See Publication 970, Tax Benefits for Education, and Form 5329.
Qualified tuition programs:Additional tax onAdditional tax on qualified tuition programs. This applies to amounts distributed from
qualified tuition programs that do not meet the rules for these accounts. See Publication 970 and Form 5329.
Insider stock compensation from expatriated corporationTax onTax on insider stock compensation from an expatriated corporation. You may owe a 15% excise tax on the
value of nonstatutory stock options and certain other stock-based compensation held by you or a member of your family from an expatriated corporation
or its expanded affiliated group in which you were an officer, director, or more-than-10% owner. For more information, see the instructions for Form
1040, line 63.
Income from nonqualified deferred compensation plansAdditional tax onAdditional tax on income you received from a nonqualified deferred compensation plan that fails to
meet certain requirements. This income should be shown in Form W-2, box 12, with code Z, or in Form 1099-MISC, box 15b. For more information,
see the instructions for Form 1040, line 63.
Interest on the tax due on installment income from the sale of certain residential lots and timeshares. For more information, see
the instructions for Form 1040, line 63.
Payments.Payments
After you determine your total tax, figure the total payments you have already made for the year. Include credits that are treated as payments.
This chapter does not explain these payments and credits. You can find that information in other chapters of this publication and your form
instructions. See the following table for amounts you can include in your total payments.
PAYMENTSFor information on:Seechapter:Child tax credit (additional)34 Earned income credit36 Estimated tax paid 4 Excess social security
and RRTA tax withheld37 Federal income tax withheld 4 Health coverage tax credit37 Regulated investment company
credit37 Tax paid with extension 1
Another credit that is treated as a payment is the credit for federal excise tax paid on fuels. This credit is for persons who have a nontaxable
use of certain fuels, such as diesel fuel and kerosene. It is claimed on Form 1040, line 70. See Form 4136, Credit for Federal Tax Paid on Fuels.
Refund or balance due.RefundsBalance due
To determine whether you are entitled to a refund or owe additional tax, compare your total payments with your total tax. If you are entitled to a
refund, see your form instructions for information on having it directly deposited into your checking or savings account instead of receiving a paper
check.
Alternative
Minimum TaxAlternative minimum tax (AMT)Taxes:Alternative minimum
This section briefly discusses an additional tax you may have to pay.
The tax law gives special treatment to some kinds of income and allows special deductions and credits for some kinds of expenses. Taxpayers who
benefit from the law in these ways may have to pay at least a minimum amount of tax through an additional tax. This additional tax is called the
alternative minimum tax (AMT).
You may have to pay the alternative minimum tax if your taxable income for regular tax purposes, combined with certain adjustments and tax
preference items, is more than:
$58,000 if your filing status is married filing a joint return (or qualifying widow(er) with dependent child),
$40,250 if your filing status is single or head of household, or
$29,000 if your filing status is married filing a separate return.
Adjustments and tax preference items.
The more common adjustments
Tax preference itemsAdjustmentsand tax preference items include:
Addition of personal exemptions,
Addition of the standard deduction (if claimed),
Addition of itemized deductions claimed for state and local taxes, certain interest, most miscellaneous deductions, and part of medical
expenses,
Subtraction of any refund of state and local taxes included in gross income,
Changes to accelerated depreciation of certain property,
Difference between gain or loss on the sale of property reported for regular tax purposes and AMT purposes,
Addition of certain income from incentive stock options,
Change in certain passive activity loss deductions,
Addition of certain depletion that is more than the adjusted basis of the property,
Addition of part of the deduction for certain intangible drilling costs, and
Addition of tax-exempt interest on certain private activity bonds.
More information.Form:6251
For more information about the alternative minimum tax, see the instructions for Form 1040, line 45, and Form 6251, Alternative Minimum
Tax—Individuals.
Tax Figured by IRSTax figured by IRS
If you file by April 17, 2006, you can have the IRS figure your tax for you on Form 1040EZ, Form 1040A, or Form 1040.
If the IRS figures your tax and you paid too much, you will receive a refund. If you did not pay enough, you will receive a bill for the balance.
To avoid interest or the penalty for late payment, you must pay the bill within 30 days of the date of the bill or by the due date for your return,
whichever is later.
When the IRS cannot figure your tax.
The IRS cannot figure your tax for you if any of the following apply.
You want your refund directly deposited into your account.
You want any part of your refund applied to your 2006 estimated tax.
You had income for the year from sources other than wages, salaries, tips, interest, dividends, taxable social security benefits,
unemployment compensation, IRA distributions, pensions, and annuities.
Your taxable income is $100,000 or more.
You itemize deductions.
You file any of the following forms.
Form 2555, Foreign Earned Income.
Form 2555-EZ, Foreign Earned Income Exclusion.
Form 4137, Social Security and Medicare Tax on Unreported Tip Income.
Form 4970, Tax on Accumulation Distribution of Trusts.
Form 4972, Tax on Lump-Sum Distributions.
Form 6198, At-Risk Limitations.
Form 6251, Alternative Minimum Tax—Individuals.
Form 8606, Nondeductible IRAs.
Form 8615, Tax for Children Under Age 14 With Investment Income of More Than $1,600.
Form 8814, Parents' Election To Report Child's Interest and Dividends.
Form 8839, Qualified Adoption Expenses.
Form 8853, Archer MSAs and Long-Term Care Insurance Contracts.
Form 8889, Health Savings Accounts (HSAs).
Form 8915, Qualified Hurricane Katrina Retirement Plan Distributions and Repayments.
Filing the Return
After you complete the line entries for the tax form you are filing, as discussed next, attach the peel-off label. If you do not have a peel-off
label, fill in your name and address. Enter your social security number in the space provided. If you are married, enter the social security numbers
of you and your spouse. Complete the Third Party Designee area of the return if you would like another person to discuss your return with the
IRS. Sign and date your return and enter your occupation(s). If you are filing a joint return, both you and your spouse must sign it. Enter your
daytime phone number in the space provided.
Attach a copy of each of your Forms W-2 to your return. Also attach any Form 1099-R you received that has withholding tax in box 4.
Mail your return to the Internal Revenue Service Center for the area where you live. A list of Service Center addresses is shown near the end of
this publication.
Form 1040EZ Line EntriesForm:1040EZ
Read lines 1 through 8b and fill in the lines that apply to you. Do not complete lines 9 through 12. If you are filing a joint return, use the
space to the left of line 6 to separately show your taxable income and your spouse's taxable income.
Earned income credit.Earned Income CreditEICEarned Income CreditCredits
If you can take this credit, as discussed in chapter 36, the IRS can figure it for you. Enter EIC in the space to the left of line 8a. Enter
the nontaxable combat pay you elect to include in earned income on line 8b.
If your credit for any year after 1996 was reduced or disallowed by the IRS, you may also have to file Form 8862, Information To Claim Earned
Income Credit After Disallowance, with your return. For details, see the Form 1040EZ instructions.
Form 1040A Line EntriesForm:1040A
Read lines 1 through 27 and fill in the lines that apply to you. If you are filing a joint return, use the space to the left of line 27 to
separately show your taxable income and your spouse's taxable income. Do not complete line 28. Complete lines 29 through 33, 37, and 39 through 42 if
they apply to you. Do not fill in lines 30 and 41a if you want the IRS to figure the credits shown on those lines. Also, enter any write-in
information that applies to you in the space to the left of line 43. Do not complete lines 35, 36, 38, and 43 through 48.
Credit for child and dependent care expenses.Credit for child and dependent care expensesCredits
If you can take this credit, as discussed in chapter 32, complete Schedule 2 and attach it to your return. Enter the amount of the credit on line
29 (Form 1040A). The IRS will not figure this credit.
Credit for the elderly or the disabled.Credit for the elderly or the disabledCredits
If you can take this credit, as discussed in chapter 33, attach Schedule 3 (Form 1040A), Credit for the Elderly or the Disabled for Form 1040A
Filers. Enter CFE next to line 30 (Form 1040A). The IRS will figure this credit for you. On Schedule 3, check the box in Part I for your filing
status and age. Complete Part II and Part III, lines 11 and 13, if they apply.
Earned income credit.Earned Income CreditEICEarned Income CreditCredits
If you can take this credit, as discussed in chapter 36, the IRS will figure it for you. Enter EIC to the left of the entry space for line
41a. Enter the nontaxable combat pay you elect to include in earned income on line 41b. If you have a qualifying child, you must fill in Schedule EIC,
Earned Income Credit, and attach it to your return.
If your credit for any year after 1996 was reduced or disallowed by the IRS, you may also have to file Form 8862, Information To Claim Earned
Income Credit After Disallowance, with your return. For details, see the Form 1040A instructions.
Form 1040 Line EntriesForm:1040
Read lines 1 through 43 and fill in the lines that apply to you. Do not complete line 44.
If you are filing a joint return, use the space under the words Adjusted Gross Income on the front of your return to separately show your
taxable income and your spouse's taxable income.
Read lines 45 through 70. Fill in the lines that apply to you, but do not fill in lines 56, 63, and 71. Also, do not complete line 57 and lines 72
through 76. Do not fill in lines 49 and 66a if you want the IRS to figure the credits shown on those lines.
Fill in any forms or schedules asked for on the lines you completed, and attach them to your return.
Credit for child and dependent care expenses.Credit for child and dependent care expensesCredits
If you can take this credit, as discussed in chapter 32, complete Form 2441 and attach it to your return. Enter the amount of the credit on line
48. The IRS will not figure this credit.
Credit for the elderly or the disabled.Credit for the elderly or the disabledCredits
If you can take this credit, as discussed in chapter 33, attach Schedule R, Credit for the Elderly or the Disabled. Enter CFE on the dotted
line next to Form 1040, line 49. The IRS will figure the credit for you. On Schedule R check the box in Part I for your filing status and age.
Complete Part II and Part III, lines 11 and 13, if they apply.
Earned income credit.Earned Income CreditEICEarned Income CreditCredits
If you can take this credit, as discussed in chapter 36, the IRS will figure it for you. Enter EIC on the dotted line next to Form 1040,
line 66a. Enter the nontaxable combat pay you elect to include in earned income on line 66b. If you have a qualifying child, you must fill in Schedule
EIC and attach it to your return.
If your credit for any year after 1996 was reduced or disallowed by the IRS, you may also have to file Form 8862, Information To Claim Earned
Income Credit After Disallowance, with your return. For details, see the Form 1040 instructions.
Tax on Investment Income of Certain Minor ChildrenChildren:Investment income of child under age 14
Children:Investment income of child under age 14:General rulesThis chapter discusses the following two rules that may affect the tax on certain investment income of a
child under age 14.
If the child's interest and dividend income total less than $8,000, the child's parent may be able to choose to include that income
(including capital gain distributions) on the parent's return rather than file a return for the child. (See Parent's Election To Report Child's
Interest and Dividends, later.)
If the child's interest, dividends, and other investment income total more than $1,600, part of that income may be taxed at the parent's tax
rate instead of the child's tax rate. (See Tax for Children Under Age 14 Who Have Investment Income of More Than $1,600,
later.)
For these rules, the term child includes a legally adopted child and a stepchild. These rules apply whether or not the child is a
dependent.
These rules do not apply if:
The child is not required to file a tax return, or
Neither of the child's parents were living at the end of the tax year.
Publication929Tax Rules for Children and DependentsForm (and Instructions)Tax for Children Under Age 14 With Investment Income of More Than $1,600Parents' Election To Report Child's Interest and Dividends
Which Parent's
Return To UseChildren:Investment income of child under age 14:Parents' election to report on Form 1040
Joint returns:Investment income of child under age 14If a child's parents are married to each other and file a joint return, use the
joint return to figure the tax on the investment income of a child under age 14. The tax rate and other return information from that return are used
to figure the child's tax as explained later under Tax for Children Under Age 14 Who Have Investment Income of More Than $1,600.
Parents Who Do Not File a Joint Return
For parents who do not file a joint return, the following discussions explain which parent's tax return must be used to figure the tax.
Only the parent whose tax return is used can make the election described under Parent's Election To Report Child's Interest and Dividends.
Parents are married.
If the child's parents file separate returns, use the return of the parent with the greater taxable income.
Parents not living together.
If the child's parents are married to each other but not living together, and the parent with whom the child lives (the custodial parent) is
considered unmarried, use the return of the custodial parent. If the custodial parent is not considered unmarried, use the return of the parent with
the greater taxable income.
For an explanation of when a married person living apart from his or her spouse is considered unmarried, see Head of Household in
chapter 2.
Parents are divorced.
If the child's parents are divorced or legally separated, and the parent who had custody of the child for the greater part of the year (the
custodial parent) has not remarried, use the return of the custodial parent.
Custodial parent remarried.
If the custodial parent has remarried, the stepparent (rather than the noncustodial parent) is treated as the child's other parent. Therefore, if
the custodial parent and the stepparent file a joint return, use that joint return. Do not use the return of the noncustodial parent.
If the custodial parent and the stepparent are married, but file separate returns, use the return of the one with the greater taxable income. If
the custodial parent and the stepparent are married but not living together, the earlier discussion under Parents not living together
applies.
Parents never married.
If a child's parents did not marry each other, but lived together all year, use the return of the parent with the greater taxable income. If the
parents did not live together all year, the rules explained earlier under Parents are divorced apply.
Widowed parent remarried.
If a widow or widower remarries, the new spouse is treated as the child's other parent. The rules explained earlier under Custodial parent
remarried apply.
Parent's Election
To Report Child's
Interest and DividendsChildren:Investment income of child under age 14:Parents' election to report on Form 1040
You may be able to elect to include your child's interest and dividend income (including capital gain distributions) on your tax return. If you do,
your child will not have to file a return.
You can make this election for 2005 only if all the following conditions are met.
Your child was under age 14 at the end of 2005. (A child born on January 1,1992, is considered to be age 14 at the end of 2005. You cannot
make the election for this child.)
Your child is required to file a return for 2005, unless you make this election.
Your child had income only from interest and dividends (including capital gain distributions and Alaska Permanent Fund
dividends).
The dividend and interest income was less than $8,000.
No estimated tax payment was made for 2005 and no 2004 overpayment was applied to 2005 under your child's name and social security
number.
No federal income tax was taken out of your child's income under the backup withholding rules.
You are the parent whose return must be used when applying the special tax rules for children under age 14. (See Which Parent's Return
To Use, earlier.)
These conditions are also shown in Figure 31-A.
How to make the election.Form:8814Parents' election to report child's interest and dividends
Make the election by attaching Form 8814 to your Form 1040 or Form 1040NR. (If you make this election, you cannot file Form 1040A or Form 1040EZ.)
Attach a separate Form 8814 for each child for whom you make the election. You can make the election for one or more children and not for others.
Effect of Making the ElectionChildren:Election to use parent's return, effect of makingChildren:Election to use parent's return, effect of making:Inclusion of child's income on parent's return (Figure 31-A)
The federal income tax on your child's income may be more if you make the Form 8814 election.
Rate may be higher.
If your child received qualified dividends or capital gain distributions, you may pay up to $40 more tax if you make this election instead of
filing a separate tax return for the child. This is because the tax rate on the child's income between $800 and $1,600 is 10% if you make this
election. However, if you file a separate return for the child, the tax rate may be as low as 5% because of the preferential tax rates for qualified
dividends and capital gain distributions.
FiguresTables and figuresTables and figures:Children's income:Inclusion on parent's return (Figure 31-A)Deductions you cannot take.
By making the Form 8814 election, you cannot take any of the following deductions that the child would be entitled to on his or her return.
The higher standard deduction for a blind child.
The deduction for a penalty on an early withdrawal of your child's savings.
Itemized deductions (such as your child's investment expenses or charitable contributions).
Reduced deductions or credits.Form:8814Reduced deductions or credits
If you use Form 8814, your increased adjusted gross income may reduce certain deductions or credits on your return including the following.
Deduction for contributions to a traditional individual retirement arrangement (IRA).
Deduction for student loan interest.
Itemized deductions for medical expenses, casualty and theft losses, and certain miscellaneous expenses.
Total itemized deductions.
Personal exemptions.
Credit for child and dependent care expenses.
Child tax credit.
Education tax credits.
Earned income credit.
Penalty for underpayment of estimated tax.Estimated tax:Penalty for underpaymentPenalties:Estimated taxthis heading: Underpayment of estimated taxPenalties:Underpayment of estimated tax
If you make this election for 2005 and did not have enough tax withheld or pay enough estimated tax to cover the tax you owe, you may be subject to
a penalty. If you plan to make this election for 2006, you may need to increase your federal income tax withholding or your estimated tax payments to
avoid the penalty. See chapter 4 for more information.
Figuring Child's IncomeChildren:Income, calculation of
Form:8814Calculation of child's incomeUse Form 8814, Part I, to figure your child's interest and dividend income to report on
your return. Only the amount over $1,600 is added to your income. This amount is shown on Form 8814, line 6. Include this amount on Form 1040 or Form
1040NR, line 21 . Enter Form 8814 in the space next to line 21. If you file more than one Form 8814, include the total amounts from line 6 of
all your Forms 8814 on Form 1040 or Form 1040NR, line 21.
Capital gain distributions and qualified dividends.Capital gains or losses:Child's distributions and dividends, reporting ofChildren:Income, calculation of:Capital gains distributionsForm:8814Capital gains distributions
If your child's dividend income included any capital gain distributions see Capital gain distributions under Figuring Child's
Income in Part 2 of Publication 929. If your child's dividend income included any qualified dividends, see Qualified dividends under
Figuring Child's Income in Part 2 of Publication 929.
Figuring Additional TaxForm:8814Additional tax, figuring of
Use Form 8814, Part II, to figure the tax on the $1,600 of your child's interest and dividends that you do not include in your income. This tax is
added to the tax figured on your income.
This additional tax is the smaller of:
10% × (your child's gross income − $800), or
$80.
Include the amount from line 9 of all your Forms 8814 in the total on Form 1040, line 44, or Form 1040NR, line 41. Check box a on Form 1040, line
44, or Form 1040NR, line 41.
Illustrated Example
David and Linda Parks are married and will file separate tax returns for 2005. Their only child, Philip, is 8. Philip received a Form 1099-INT
showing $1,650 taxable interest income and a Form 1099-DIV showing $1,150 ordinary dividends. All the dividends were qualified dividends. His parents
decide to include that income on one of their returns so they will not have to file a return for Philip.
Figure 31-A. Can You Include Your Child's Income On Your Tax Return?Summary: This flowchart is used to determine if you can include your child's income on your tax return.StartThis is the starting of the flowchart.Decision (1)Was your child under age 14 at the end of 2005?IF Yes Continue To Decision (2)IF No Continue To Process (a)Decision (2)Is your child required to file a tax return for 2005 if you do not make this election?IF Yes Continue To Decision (3)IF No Continue To Process (a)Decision (3)Was the child's only income interest and dividends (including capital gain distributions and Alaska Permanent Fund dividends)?IF Yes Continue To Decision (4)IF No Continue To Process (a)Decision (4)Was the child's income less than $8,000?IF Yes Continue To Decision (5)IF No Continue To Process (a)Decision (5)Did the child make any estimated tax payments for 2005?IF Yes Continue To Process (a)IF No Continue To Decision (6)Decision (6)Did the child have an overpayment of tax on his or her 2004 return applied to the 2005 estimated tax?IF Yes Continue To Process (a)IF No Continue To Decision (7)Decision (7)Was any federal income tax withheld from the child's income (backup withholding)?IF Yes Continue To Process (a)IF No Continue To Decision (8)Decision (8)Are you the parent whose return must be used?Footnote: See Which Parent's Return To UseIF Yes Continue To Process (b)IF No Continue To Process (a)Process (a)You cannot include your child's income on your return.Continue To EndProcess (b)You can include your child's income on your tax return by completing Form 8814 and attaching it to your return. If you do, your child is not
required to file a return.Continue To End EndThis is the ending of the flowchart.
First, David and Linda each figure their taxable income (Form 1040, line 43) without regard to Philip's income. David's taxable income is $56,700
and Linda's is $74,300. Because her taxable income is greater, Linda can elect to include Philip's income on her return. See Which Parent's
Return To Use, earlier.
On Form 8814 (see illustrated form), Linda enters her name and social security number, then Philip's name and social security number. She enters
Philip's taxable interest income, $1,650, on line 1a. Philip had no tax-exempt interest income, so she leaves line 1b blank. She enters Philip's
ordinary dividends, $1,150, on line 2. Philip did not have any capital gain distributions, so she leaves line 3 blank.
Linda adds lines 1a and 2 and enters the result, $2,800, on line 4. Because Philip had qualified dividends, Linda must use the Child's Qualified
Dividends and Capital Gain Distributions Worksheet to figure the amount to enter on line 6, instead of subtracting line 5 from line 4. The amount she
enters on line 6 is $707, the amount from line 11 of the worksheet. On the dotted line next to line 6, she enters QD–$493, the amount
from line 8 of the worksheet. She includes that amount ($493) on lines 9a and 9b of her Form 1040. On the dotted line next to lines 9a and 9b, she
enters Form 8814–$493.
Linda includes $707 in the total on line 21 of her Form 1040 (not illustrated), and in the space next to that line enters Form
8814–$707. Adding that amount, plus the $493 of qualified dividends, to her income increases each of the amounts on lines 22, 37, 38, 41,
and 43 of her Form 1040 by $1,200. Linda is not claiming any deductions or credits that are affected by the increase to her income. Therefore, her
revised taxable income on line 43 is $75,500 ($74,300 + $493 + $707).
On Form 8814, Linda subtracts the $800 shown on line 7 from the $2,800 on line 4 and enters the result, $2,000, on line 8. Because that amount is
not less than $800, she enters $80 on line 9. This is the tax on the first $1,600 of Philip's income, which Linda did not have to add to her income.
She must add this additional tax to the tax figured on her revised taxable income.
The tax on her $75,500 revised taxable income is $16,013. She adds $80, and enters the $16,093 total on line 44 of Form 1040, and checks box a.
Linda attaches Form 8814 to her Form 1040.
Form:8814Sample formForm 8814 2005 Parents' Election To Report Child's Interest and DividendsSummary: This is an example Form 8814 (2005) with items included as described in the text.
<BLD>Child's Qualified Dividends and</BLD>
<L><BLD>Capital Gain Distributions Worksheet</BLD>
<L><BLD>(Keep for your records)</BLD>1.Enter the amount of qualified
dividends included on
Form 8814, line 2$1,1502. Enter the amount from
Form 8814, line 3 03. Enter the amount from
Form 8814, line 4 2,8004. Divide line 1 by line 3. Enter
the result as a decimal
(rounded to at least 3 places).4115.Divide line 2 by line 3. Enter
the result as a decimal
(rounded to at least 3 places).0006. Base amount $ 1,6007. Subtract line 6 from line 3 1,2008. Multiply line 7 by line 4.
Include this amount on Form
1040, lines 9a and 9b, or
Form 1040NR, lines 10a and
10b. On the dotted lines next
to those lines, enter Form
8814 and this amount (unless
you file Schedule B (Form
1040); in that case, follow the
instructions in the Note on
this line). Also, enter QD (for
qualified dividends) and this
amount on the dotted line next
to line 6 of Form 8814.
Note. If this amount plus the
parents' dividends is more
than $1,500, report this
amount on Schedule B
(Form 1040). Show it as
from Form 88144939.Multiply line 7 by line 5.
Include this amount on
Schedule D, line 13;
Form 1040, line 13, or
Form 1040NR, line 14.
Enter Form 8814 and
this amount on the
dotted line next to line 13 of
Schedule D, or in the
space to the left of line 13
of Form 1040 or line 14
of Form 1040NR.
Also, enter CGD (for
capital gain distribution)
and this amount on the
dotted line next to line 6 of
Form 8814.010.Add lines 8 and 949311. Subtract line 10 from line 7.
Enter the result here and on
Form 8814, line 6 707
Tax for Children Under Age 14 Who Have Investment Income of More Than $1,600Form:8615Children under age 14 with more than $1,600 of investment incomeKiddie taxChildren, subheading: Investment income of child under age 14Taxes:Kiddie taxChildren, subheading: Investment income of child under age 14Unearned income of childChildren, subheading: Investment income of child under age 14
Part of a child's 2005 investment income may be subject to tax at the parent's tax rate if all of the following statements are true.
The child was under age 14 at the end of 2005. (A child born on January 1, 1992, is considered to be age 14 at the end of 2005. This child's
investment income is not taxed at the parent's rate.)
The child's investment income was more than $1,600.
The child is required to file a return for 2005.
These conditions are also shown in Figure
31-B .
If neither parent was alive on December 31, 2005, do not use Form 8615. Instead, figure the child's tax in the normal manner.
If the parent does not or cannot choose to include the child's income on the parent's return, use Form 8615 to figure the child's tax. Attach the
completed form to the child's Form 1040, Form 1040A, or Form 1040NR.
The following discussions explain the parental information needed for Form 8615 and the steps to follow in figuring the child's tax. Form 8615 is
illustrated later.
Providing Parental Information
(Form 8615, lines A–C)Children:Investment income of child under age 14:Parental information, providing ofForm:8615Parental information
On Form 8615, lines A and B, enter the parent's name and social security number. (If the parents filed a joint return, enter the name and social
security number listed first on the joint return.) On line C, check the box for the parent's filing status.
Children:Investment income of child under age 14:Form 8615, use of (Figure 31-B)Form:8615Children under age 14 with more than $1,600 of investment incomeTables and figures:Children's income:Investment income more than $1,600, reporting of (Figure 31-B)Figure 31-B. Do You Have To Use Form 8615 To Figure Your Child's Tax?Summary: This flowchart is used to determine if you have to use Form 8615 to figure your child's tax.StartThis is the starting of the flowchart.Decision (1)Was the child under age 14 at the end of 2005?IF Yes Continue To Decision (2)IF No Continue To Process (a)Decision (2)Is the child required to file a tax return for 2005?IF Yes Continue To Decision (3)IF No Continue To Process (a)Decision (3)Was the child's investment income more than $1,600?IF Yes Continue To Process (b)IF No Continue To Process (a)Process (a)Do not use Form 8615 to figure the child's tax.Continue To End Process (b)Use Form 8615 to figure the child's tax. Attach it to the child's return.Note: If the child's parent (see Footnote) chooses to report the child's income by filing Form 8814, the child is not required to file a tax
return. Do not use Form 8615. (See Parent's Election To Report Child's Interest and Dividends.)Footnote: See Which Parent's Return to UseContinue To End EndThis is the ending of the flowchart.
See Which Parent's Return To Use at the beginning of this chapter for information on which parent's return information must be used on
Form 8615.
Parent with different tax year.Form:8615Parental information
If the parent and the child do not have the same tax year, complete Form 8615 using the information on the parent's return for the tax year that
ends in the child's tax year.
Parent's return information not known timely.Form:8615Parental information
If the information needed from the parent's return is not known by the time the child's return is due (usually April 15), you can file the return
using estimates.
You can use any reasonable estimate. This includes using information from last year's return. If you use an estimated amount on Form 8615, enter
Estimated on the line next to the amount.
Form:1040XChild's returnWhen you get the correct information, file an amended return on Form 1040X, Amended U.S. Individual
Income Tax Return.
Instead of using estimates, you can get an automatic 6-month extension of time to file if, by April 17, 2006, you file Form 4868, Application for
Automatic Extension of Time to File U.S. Individual Income Tax Return. Extensions are discussed in chapter 1.
Step 1. Figuring the Child's Net Investment Income
(Form 8615, Part I)Children:Net investment income, figuring ofForm:8615Net investment income
The first step in figuring a child's tax using Form 8615 is to figure the child's net investment income. To do that, use Form 8615, Part I.
Line 1 (investment income).
If the child had no earned income, enter on this line the adjusted gross income shown on the child's return. Adjusted gross income is shown on Form
1040, line 38; Form 1040A, line 22; or Form 1040NR, line 36. Form 1040EZ and Form 1040NR-EZ cannot be used if Form 8615 must be filed.
If the child had earned income, figure the amount to enter on Form 8615, line 1, by using the worksheet in the instructions for the form.
However, if the child has excluded any foreign earned income or deducted either a loss from self-employment or a net operating loss from another
year, use the Alternate Worksheet for Form 8615, line 1, in Publication 929 to figure the amount to enter on Form 8615, line 1.
Investment income defined.Children:Investment income of child under age 14:Investment income definedIncome:Investment income
Investment income is generally all income other than salaries, wages, and other amounts received as pay for work actually done. It includes taxable
interest, dividends, capital gains (including capital gain distributions), the taxable part of social security and pension payments, and certain
distributions from trusts. Investment income includes amounts produced by assets the child obtained with earned income (such as interest on a savings
account into which the child deposited wages).
Nontaxable income.Children:Nontaxable income
For this purpose, investment income includes only amounts that the child must include in total income. Nontaxable investment income, such as
tax-exempt interest and the nontaxable part of social security and pension payments, is not included.
Income from property received as a gift.BequestsGiftsChildren:Gifts toChildren:Property received as gift, income fromGifts:Children, income from property given toInterest income:Children:Gifts to childrenTrusts:Income:Child beneficiary
A child's investment income includes all income produced by property belonging to the child. This is true even if the property was transferred to
the child, regardless of when the property was transferred or purchased or who transferred it.
A child's investment income includes income produced by property given as a gift to the child. This includes gifts to the child from grandparents
or any other person and gifts made under the Uniform Gift to Minors Act.
Example.
Amanda Black, age 13, received the following income.
Dividends — $600
Wages — $2,100
Taxable interest — $1,200
Tax-exempt interest — $100
Net capital gains — $100.
The dividends were qualified dividends on stock given to her by her grandparents.
Amanda's investment income is $1,900. This is the total of the dividends ($600), taxable interest ($1,200), and net capital gains ($100). Her wages
are earned (not investment) income because they are received for work actually done. Her tax-exempt interest is not included because it is nontaxable.
Trust income.Children:Investment income of child under age 14:Trust income
If a child is the beneficiary of a trust, distributions of taxable interest, dividends, capital gains, and other investment income from the trust
are investment income to the child.
Line 2 (deductions).Children:Deductions
If the child does not itemize deductions on Schedule A (Form 1040 or Form 1040NR), enter $1,600 on line 2.
If the child does itemize deductions, enter on line 2 the larger of:
$800 plus the child's itemized deductions that are directly connected with the production of investment income entered on line 1,
or
$1,600.
Directly connected.
Itemized deductions are directly connected with the production of investment income if they are for expenses paid to produce or collect taxable
income or to manage, conserve, or maintain property held for producing income. These expenses include custodian fees and service charges, service fees
to collect taxable interest and dividends, and certain investment counsel fees.
These expenses are added to certain other miscellaneous itemized deductions on Schedule A (Form 1040). Only the amount greater than 2% of the
child's adjusted gross income can be deducted. See chapter 28 for more information.
Example 1.
Roger, age 12, has investment income of $8,000, no other income, no adjustments to income, and itemized deductions of $300 (net of the
2%-of-adjusted-gross-income limit) that are directly connected with his investment income. His adjusted gross income is $8,000, which is entered on
Form 1040, line 38, and on Form 8615, line 1. Line 2 is $1,600 because that is more than the sum of $800 and his directly-connected itemized
deductions of $300.
Example 2.
Eleanor, age 8, has investment income of $16,000 and an early withdrawal penalty of $100. She has no other income. She has itemized deductions of
$1,050 (net of the 2%-of-adjusted-gross-income limit) that are directly connected with the production of her investment income. Her adjusted gross
income, entered on line 1, is $15,900 ($16,000 − $100). The amount on line 2 is $1,850. This is the larger of:
$800 plus the $1,050 of directly connected itemized deductions, or
$1,600.
Line 3.
Subtract line 2 from line 1 and enter the result on this line. If zero or less, do not complete the rest of the form. However, you must still
attach Form 8615 to the child's tax return. Figure the tax on the child's taxable income in the normal manner.
Line 4 (child's taxable income).
Enter on line 4 the child's taxable income from Form 1040, line 43; Form 1040A, line 27; or Form 1040NR, line 40.
Line 5 (net investment income).
A child's net investment income cannot be more than his or her taxable income. Enter on Form 8615, line 5, the smaller of line 3 or line 4. This is
the child's net investment income.
If zero or less, do not complete the rest of the form. However, you must still attach Form 8615 to the child's tax return. Figure the tax on the
child's taxable income in the normal manner.
Step 2. Figuring
Tentative Tax at
the Parent's Tax Rate
(Form 8615, Part II)Children:Tentative tax figured at parent's tax rate
The next step in completing Form 8615 is to figure a tentative tax on the child's net investment income at the parent's tax rate. The tentative tax
at the parent's tax rate is the difference between the tax on the parent's taxable income figured with the child's net investment income (plus the net
investment income of any other child whose Form 8615 includes the tax return information of that parent) and the tax figured without it.
When figuring the tentative tax at the parent's tax rate, do not refigure any of the exclusions, deductions, or credits on the parent's return
because of the child's net investment income. For example, do not refigure the medical expense deduction.
Figure the tentative tax on Form 8615, lines 6 through 13.
Note.
If the child has any capital gains or losses, get Publication 929 for help in completing Form 8615, Part II.
Line 7 (net investment income of other children).
If the tax return information of the parent is also used on any other child's Form 8615, enter on line 7 the total of the amounts from line 5 of
all the other children's Forms 8615. Do not include the amount from line 5 of the Form 8615 being completed.
Example.
Paul and Jane Persimmon have three children, Sharon, Jerry, and Mike, who must attach Form 8615 to their tax returns. The children's net investment
income amounts on line 5 of their Forms 8615 are:
Sharon — $800
Jerry — $600
Mike — $1,000
Line 7 of Sharon's Form 8615 will show $1,600, the total of the amounts on line 5 of Jerry's and Mike's Forms 8615.
Line 7 of Jerry's Form 8615 will show $1,800 ($800 + $1,000).
Line 7 of Mike's Form 8615 will show $1,400 ($800 + $600).
Other children's information not available.
If the net investment income of the other children is not available when the return is due, either file the return using estimates or get an
extension of time to file. See Parent's return information not known timely, earlier.
Line 11 (tentative tax).
Subtract line 10 from line 9 and enter the result on this line. This is the tentative tax.
If line 7 is blank, skip lines 12a and 12b and enter the amount from line 11 on line 13. Also skip the discussion for lines 12a and 12b that
follows.
Lines 12a and 12b (dividing the tentative tax).
If an amount is entered on line 7, divide the tentative tax shown on line 11 among the children according to each child's share of the total net
investment income. This is done on lines 12a, 12b, and 13. Add the amount on line 7 to the amount on line 5 and enter the total on line 12a. Divide
the amount on line 5 by the amount on line 12a and enter the result as a decimal on line 12b.
Example.
In the earlier example under Line 7 (net investment income of other children), Sharon's Form 8615 shows $1,600 on line 7. The amount
entered on line 12a is $2,400, the total of the amounts on lines 5 and 7 ($800 + $1,600). The decimal on line 12b is .333, figured as follows and
rounded to three places.
$800=.333$2,400
Step 3. Figuring
the Child's Tax
(Form 8615, Part III)Children:Child's tax, figuring ofFamilyChildren
The final step in figuring a child's tax using Form 8615 is to determine the larger of:
The total of:
The child's share of the tentative tax based on the parent's tax rate, plus
The tax on the child's taxable income in excess of net investment income, figured at the child's tax rate, or
The tax on the child's taxable income, figured at the child's tax rate.
This is the child's tax. It is figured on Form 8615, lines 14 through 18.
A child may be subject to alternative minimum tax (AMT) if he or she has certain items given preferential treatment under the tax law. See
Alternative Minimum Tax in chapter 30.
Form:6251Alternative minimum taxFor more information on who is liable for AMT and how to figure it, get Form 6251, Alternative
Minimum Tax—Individuals. For information on special limits that apply to a child who files Form 6251, see Alternative Minimum Tax in
Publication 929.
Illustrated Example
The following example includes a completed Form 8615. Form 1040A is not shown.
John and Laura Brown have one child, Sara. She is 13 and has $2,800 taxable interest income and $1,500 earned income. She does not itemize
deductions. John and Laura file a joint return with John's name and social security number listed first. They claim three exemptions, including an
exemption for Sara, on their return.
Because Sara is under age 14 and has more than $1,600 investment income, part of her income may be subject to tax at her parents' rate. A completed
Form 8615 must be attached to her return.
Sara's father, John, fills out Sara's return for her. He completes her Form 1040A through line 27, then begins completing her Form 8615.
John enters his name and social security number on Sara's Form 8615 because his name and number are listed first on the joint return he and Laura
are filing. He checks the box for married filing jointly.
He enters Sara's investment income, $2,800, on line 1. Sara does not itemize deductions, so John enters $1,600 on line 2. He enters $1,200 ($2,800
− $1,600) on line 3.
Sara's taxable income, as shown on her Form 1040A, line 27, is $2,550. This is her total income ($4,300) minus her standard deduction ($1,750). Her
standard deduction is limited to the amount of her earned income plus $250. John enters $2,550 on line 4.
John compares lines 3 and 4 and enters the smaller amount, $1,200, on line 5.
John enters $48,000 on line 6. This is the taxable income from line 43 of John and Laura's joint Form 1040 return. Sara is an only child, so line 7
is blank. He adds line 5 ($1,200), line 6 ($48,000), and line 7 (blank), and enters $49,200 on line 8.
Using the column for married filing jointly in the Tax Table, John finds the tax on $49,200. He enters the tax, $6,654, on line 9. He enters $6,474
on line 10. This is the tax from line 44 of John and Laura's Form 1040. He enters $180 on line 11 ($6,654 − $6,474).
Because line 7 is blank, John skips lines 12a and 12b and enters $180 on line 13.
John subtracts line 5 ($1,200) from line 4 ($2,550) and enters the result, $1,350, on line 14. Using the column for single filing status in the Tax
Table, John finds the tax on $1,350 and enters this tax, $136, on line 15. He adds lines 13 ($180) and 15 ($136) and enters $316 on line 16.
Using the column for single filing status in the Tax Table, John finds the tax on $2,550 (line 4) and enters this tax, $256, on line 17.
John compares lines 16 and 17 and enters the larger amount, $316, on line 18 of Sara's Form 8615. He also enters that amount on line 28 of Sara's
Form 1040A.
Form:8615Sample completed formJohn also completes Schedule 1 (Form 1040A) for Sara.
Form 8615 2005 Tax for Children Under Age 14 With Investment Income of More Than $1,600Summary: This is an example Form 8615 (2005) with items included as described in the text. Additionally, these items were filled out:Child's name shown on return field contains Sara L. BrownChild's social security number field contains 117-00-1111Children:Investment income of child under age 14
Child and Dependent Care CreditChildcare:CreditCredits:Child and dependent careDependent care:Credit forWhat's NewKeeping up home test eliminated.
Generally, you no longer need to pay over half the cost of keeping up a home for a qualifying person. However, the qualifying person must live with
you for more than half of 2005. See Qualifying Person Test for more information.
Qualifying person.
To be your qualifying person, a child generally must be your qualifying child. See Qualifying Person Test, later.
Katrina Emergency Tax Relief Act of 2005.
This Act provides tax relief for persons affected by Hurricane Katrina. Under the Act, the special rule for a spouse who is a full-time student may
still apply if he or she was unable to attend classes because of Hurricane Katrina. See Publication 4492.
RemindersTaxpayer identification number needed for each qualifying person.Taxpayer identification numbers (TINs)
You must include on line 2 of Form 2441 or Schedule 2 (Form 1040A) the name and taxpayer identification number (generally the social security
number) of each qualifying person. See Taxpayer identification number under Qualifying Person Test, later.
Employment taxesSocial security and Medicare taxesYou may have to pay employment taxes.
If you pay someone to come to your home and care for your dependent or spouse, you may be a household employer who has to pay employment taxes.
Usually, you are not a household employer if the person who cares for your dependent or spouse does so at his or her home or place of business. See
Employment Taxes for Household Employers, later.
This chapter discusses the credit for child and dependent care expenses and covers the following topics.
Tests you must meet to claim the credit.
How to figure the credit.
How to claim the credit.
Employment taxes you may have to pay as a household employer.
You may be able to claim the credit if you pay someone to care for your dependent who is under age 13 or for your spouse or dependent who is not
able to care for himself or herself. The credit can be up to 35% of your expenses. To qualify, you must pay these expenses so you can work or look for
work.
This credit should not be confused with the child tax credit discussed in chapter 34.
Dependent care:BenefitsDependent care benefits.
If you received any dependent care benefits from your employer during the year, you may be able to exclude from your income all or part of them.
You must complete Part III of Form 2441 or Schedule 2 (Form 1040A) before you can figure the amount of your credit. See Dependent Care
Benefits under How To Figure the Credit, later.
Publication501Exemptions, Standard Deduction, and Filing Information503 Child and Dependent Care Expenses 926 Household Employer's Tax Guide Form (and Instructions)Child and Dependent Care Expenses Child and Dependent Care Expenses for Form 1040A Filers Household Employment Taxes Application for IRS Individual Taxpayer Identification NumberDependent Care Provider's Identification and Certification
Tests To Claim
the Credit
To be able to claim the credit for child and dependent care expenses, you must file Form 1040 or Form 1040A, not Form 1040EZ, and meet all the
following tests.
The care must be for one or more qualifying persons who are identified on the form you use to claim the credit. (See Qualifying Person
Test.)
You (and your spouse if you are married) must have earned income during the year. (However, see Rule for student-spouse or spouse not
able to care for self under Earned Income Test, later.)
You must pay child and dependent care expenses so you (and your spouse if you are married) can work or look for work. (See Work-Related
Expense Test, later.)
You must make payments for child and dependent care to someone neither you nor your spouse can claim as a dependent. If you make payments to
your child, he or she cannot be your dependent and must be age 19 or older by the end of the year. You cannot make payments to your spouse or to the
parent of your qualifying child who is your qualifying person and is under age 13. (See Payments to Relatives or Dependents under
Work-Related Expense Test, later.)
Your filing status must be single, head of household, qualifying widow(er) with dependent child, or married filing jointly. You must file a
joint return if you are married, unless an exception applies to you. (See Joint Return Test, later.)
You must identify the care provider on your tax return. (See Provider Identification Test, later.)
If you exclude or deduct dependent care benefits provided by a dependent care benefits plan, the total amount you exclude or deduct must be
less than the dollar limit for qualifying expenses (generally, $3,000 if one qualifying person was cared for or $6,000 if two or more qualifying
persons were cared for). (If two or more qualifying persons were cared for, the amount you exclude or deduct will always be less than the dollar
limit, since the amount you can exclude or deduct is limited to $5,000. See Reduced Dollar Limit under How To Figure the Credit,
later.)
These tests are presented in Figure 32-A and are also explained in detail in this chapter.
Figure 32-A. Can You Claim the Credit?Summary: This flowchart is used to determine if a taxpayer can claim the Child and Dependent Care Credit.StartThis is the starting of the flowchart.Decision (1)Was the care for one or more qualifying persons?IF Yes Continue To Decision (2)IF No Continue To Process (a)Decision (2)Did you (see Footnote 1) have earned income during the year?Footnote 1: This also applies to your spouse, unless your spouse was disabled or a full-time student.IF Yes Continue To Decision (3)IF No Continue To Process (a)Decision (3)Did you pay the expenses to allow you (see Footnote 1) to work or look for work?Footnote 1: This also applies to your spouse, unless your spouse was disabled or a full-time student.IF Yes Continue To Decision (4)IF No Continue To Process (a)Decision (4)Were your payments made to someone you or your spouse could claim as a dependent?IF Yes Continue To Process (a)IF No Continue To Decision (5)Decision (5)Were your payments made to your spouse or to the parent of your child who is your qualifying person?IF Yes Continue To Process (a)IF No Continue To Decision (6)Decision (6)Were your payments made to your child who was under the age of 19 at the end of the year?IF Yes Continue To Process (a)IF No Continue To Decision (7)Decision (7)Are you single?IF Yes Continue To Decision (10)IF No Continue To Decision (8)Decision (8)Are you filing a joint return?IF Yes Continue To Decision (10)IF No Continue To Decision (9)Decision (9)Do you meet the requirements to be considered unmarried?IF Yes Continue To Decision (10)IF No Continue To Process (a)Decision (10)Do you know the care provider's name, address, and identifying number?IF Yes Continue To Decision (12)IF No Continue To Decision (11)Decision (11)Did you make a reasonable effort to get this information? (See Due diligence.)IF Yes Continue To Decision (12)IF No Continue To Process (a)Decision (12)Did you have only one qualifying child and exclude or deduct at least $3,000 of dependent care benefits?IF Yes Continue To Process (a)IF No Continue To Process (b)Process (a)You CANNOT claim the child and dependent care credit.Footnote 2: If you had expenses that met the requirements for 2004, except that you did not pay them until 2005, you may be able to claim
those expenses in 2005. See Expenses not paid until the following year under How To Figure the Credit.Continue To End Process (b)You CAN claim the child and dependent care credit. Fill out Form 2441 or Schedule 2 (Form 1040A).Continue To End EndThis is the ending of the flowchart.
Qualifying Person TestQualifying personChild and dependent care creditDisabilities, persons with:Physically or mentally not able to care for oneself.
Your child and dependent care expenses must be for the care of one or more qualifying persons.
A qualifying person is:
Your qualifying child who is your dependent and who was under age 13 when the care was provided,
Your spouse who was physically or mentally not able to care for himself or herself and lived with you for more than half the year,
or
A person who was physically or mentally not able to care for himself or herself, lived with you for more than half the year, and
either:
Was your dependent, or
Would have been your dependent except that (i) he or she received gross income of $3,200 or more, (ii) he or she filed a joint return, or
(iii) you, or your spouse if filing jointly, could be claimed as a dependent on someone else's 2005 return.
If you are divorced or separated, see Child of divorced or separated parents, later, to determine which parent may treat the child as a
qualifying person.
Dependent defined.
A dependent is a person, other than you or your spouse, for whom you can claim an exemption. To be your dependent, a person must be your qualifying
child (or your qualifying relative).
Qualifying child.
To be your qualifying child, a child must live with you for more than half the year and meet other requirements.
More information.
For more information about who is a dependent or a qualifying child, see chapter 3.
Disabilities, persons withPhysically or mentally not able to care for oneself.
Persons who cannot dress, clean, or feed themselves because of physical or mental problems are considered not able to care for themselves. Also,
persons who must have constant attention to prevent them from injuring themselves or others are considered not able to care for themselves.
Person qualifying for part of year.
You determine a person's qualifying status each day. For example, if the person for whom you pay child and dependent care expenses no longer
qualifies on September 16, count only those expenses through September 15. Also see Dollar Limit under How To Figure the Credit,
later.
You must include on your return the name and taxpayer identification number (generally the social security number) of the qualifying person(s). If
the correct information is not shown, the credit may be reduced or disallowed.
Individual taxpayer identification number (ITIN) for aliens.AliensITINs
If your qualifying person is a nonresident or resident alien who does not have and cannot get a social security number (SSN), use that person's
ITIN. To apply for an ITIN, see Form W-7. The ITIN is entered wherever an SSN is requested on a tax return.
An ITIN is for tax use only. It does not entitle the holder to social security benefits or change the holder's employment or immigration status
under U.S. law.
Adoption taxpayer identification number (ATIN).Adoption:Taxpayer identification numbers (TINs)ATIN
If your qualifying person is a child who was placed in your home for adoption and for whom you do not have an SSN, you must get an ATIN for the
child. File Form W-7A, Application for Taxpayer Identification Number for Pending U.S. Adoptions.
Child of divorced or separated parents.Divorced taxpayersChild and dependent care credit
Even if you cannot claim your child as a dependent, he or she is treated as your qualifying person if:
The child was under age 13 or was physically or mentally not able to care for himself or herself,
You were the child's custodial parent (the parent with whom the child lived for the greater part of 2005), and
The noncustodial parent is entitled to claim the child as a dependent under the special rules for a child of divorced or separated
parents.
In that case, the noncustodial parent cannot treat the child as a qualifying person.
To find out when a noncustodial parent is entitled to claim the dependency exemption for a child, see Children of divorced or separated
parents in chapter 3.
Divorced taxpayersChild and dependent care credit
Earned Income Test
To claim the credit, you (and your spouse if you are married) must have earned income during the year.
Earned incomeChild and dependent care creditChild and dependent care creditEarned incomeEarned income.
Earned income includes wages, salaries, tips, other taxable employee compensation, and net earnings from self-employment. A net loss from
self-employment reduces earned income. Earned income also includes strike benefits and any disability pay you report as wages.
Earned income also includes nontaxable employee compensation such as parsonage allowances, meals and lodging furnished for the convenience of the
employer, voluntary salary deferrals, military basic quarters and subsistence allowances and in-kind quarters and subsistence, and military pay earned
in a combat zone.
Members of certain religious faiths opposed to social security.
Certain income earned by persons who are members of certain religious faiths that are opposed to participation in Social Security Act programs and
have an IRS-approved form that exempts certain income from social security and Medicare taxes may not be considered earned income for this purpose.
See Earned Income Test in Publication 503.
Not earned income.
Earned income does not include pensions or annuities, social security payments, workers' compensation, interest, dividends, or unemployment
compensation. It also does not include scholarship or fellowship grants, except amounts paid to you (and reported on Form W-2) for teaching, research,
or other services.
Rule for student-spouse or spouse not able to care for self.Spouse:Disabled, qualifying for dependent care creditSpouse:Student
Your spouse is treated as having earned income for any month that he or she is:
A full-time student, or
Physically or mentally not able to care for himself or herself. (Your spouse also must live with you for more than half the
year.)
Figure the earned income of the nonworking spouse described under (1) or (2) above as explained under Earned Income Limit, later.
This rule applies to only one spouse for any one month. If, in the same month, both you and your spouse do not work and are either full-time
students or physically or mentally not able to care for yourselves, only one of you can be treated as having earned income in that month.
Child and dependent care creditFull-time studentFull-time studentChild and dependent care creditFull-time student.
You are a full-time student if you are enrolled at and attend a school for the number of hours or classes that the school considers full time. You
must have been a student for some part of each of 5 calendar months during the year. (The months need not be consecutive.)
If you enrolled in school before August 25, 2005, you are treated as a full-time student for any month of the enrollment period you were unable to
attend classes because of Hurricane Katrina.
School.
The term school includes elementary schools, junior and senior high schools, colleges, universities, and technical, trade, and mechanical
schools. A school does not include an on-the-job training course, correspondence school, or Internet school.
Work-Related
Expense Test
Child and dependent care expenses must be work-related to qualify for the credit. Expenses are considered work-related only if both of the
following are true.
They allow you (and your spouse if you are married) to work or look for work.
They are for a qualifying person's care.
Working or Looking for Work
To be work-related, your expenses must allow you to work or look for work. If you are married, generally both you and your spouse must work or look
for work. Your spouse is treated as working during any month he or she is a full-time student or is physically or mentally not able to care for
himself or herself.
Your work can be for others or in your own business or partnership. It can be either full time or part time.
Work also includes actively looking for work. However, if you do not find a job and have no earned income for the year, you cannot take this
credit. See Earned Income Test, earlier.
Whether your expenses allow you to work or look for work depends on the facts. For example, the cost of a sitter while you and your spouse go out
to eat is not normally a work-related expense.
An expense is not considered work-related merely because you had it while you were working. The purpose of the expense must be to enable you to
work.
Volunteer work.Volunteer work
For this purpose, you are not considered to be working if you do unpaid volunteer work or volunteer work for a nominal salary.
Work for part of year.
If you work or actively look for work during only part of the period covered by the expenses, then you must figure your expenses for each day. For
example, if you work all year and pay care expenses of $250 a month ($3,000 for the year), all the expenses are work-related. However, if you work or
look for work for only 2 months and 15 days during the year and pay expenses of $250 a month, your work-related expenses are limited to $625 (2 months × $250).
Payments while you are out sick.
Do not count as work-related expenses amounts you pay for child and dependent care while you are off work because of illness. These amounts are not
paid to allow you to work. This applies even if you get sick pay and are still considered an employee.
Care of a Qualifying Person
To be work-related, your expenses must be to provide care for a qualifying person. You do not have to choose the least expensive way of providing
the care.
Expenses are for the care of a qualifying person only if their main purpose is the person's well-being and protection.
Household services
Expenses for household services qualify if part of the services is for the care of qualifying persons. See Household services, later.
Expenses not for care.
Expenses for care do not include amounts you pay for food, clothing, education, and entertainment. However, you can include small amounts paid for
these items if they are incident to and cannot be separated from the cost of caring for the qualifying person.
Education.
Expenses for a child in nursery school, pre-school, or similar programs for children below the level of kindergarten are expenses for care.
Expenses to attend kindergarten or a higher grade are not expenses for care. Do not use these expenses to figure your credit.
Example 1.
You take your 3-year-old child to a nursery school that provides lunch and educational activities as a part of its preschool childcare service. You
can count the total cost when you figure the credit.
Example 2.
You place your 10-year-old child in a boarding school so you can work full time. Only the part of the boarding school expense that is for the care
of your child is a work-related expense. You can count that part of the expense in figuring your credit if it can be separated from the cost of
education. You cannot count any part of the amount you pay the school for your child's education.
Care outside your home.Daycare centersChild and dependent care credit
You can count the cost of care provided outside your home if the care is for your dependent under age 13 or any other qualifying person who
regularly spends at least 8 hours each day in your home.
Dependent care:CenterDependent care center.
You can count care provided outside your home by a dependent care center only if the center complies with all state and local regulations that
apply to these centers.
A dependent care center is a place that provides care for more than six persons (other than persons who live there) and receives a fee, payment, or
grant for providing services for any of those persons, even if the center is not run for profit.
Camp.
The cost of sending your child to an overnight camp is not considered a work-related expense. The cost of sending your child to a day camp may be a
work-related expense, even if the camp specializes in a particular activity, such as computers or soccer.
Transportation.
The cost of getting a qualifying person from your home to the care location and back, or from the care location to school and back, is not
considered a work-related expense. This includes the costs of bus, subway, taxi, or private car. Also, if you pay the transportation cost for the care
provider to come to your home, you cannot count this cost as a work-related expense.
Household servicesEmployment taxesSocial security and Medicare taxesHousehold services.
Expenses you pay for household services meet the work-related expense test if they are at least partly for the well-being and protection of a
qualifying person.
Household services are ordinary and usual services done in and around your home that are necessary to run your home. They include the services of a
housekeeper, maid, or cook. However, they do not include the services of a chauffeur, bartender, or gardener. See Household Services in
Publication 503 for more information.
In this chapter, the term housekeeper refers to any household employee whose services include the care of a qualifying person.
Taxes paid on wages.
The taxes you pay on wages for qualifying child and dependent care services are work-related expenses. See Employment Taxes for Household
Employers, later.
Child and dependent care creditPayments to relativesPayments to Relatives or Dependents
You can count work-related payments you make to relatives who are not your dependents, even if they live in your home. However, do not count any
amounts you pay to:
A dependent for whom you (or your spouse if you are married) can claim an exemption,
Your child who was under age 19 at the end of the year, even if he or she is not your dependent,
Your spouse, or
The parent of your qualifying child who is your qualifying person and is under
age 13.
Joint Return TestMarried taxpayersSpouseChild and dependent care credit
Generally, married couples must file a joint return to take the credit. However, if you are legally separated or living apart from your spouse, you
may be able to file a separate return and still take the credit.
Legally separated.
You are not considered married if you are legally separated from your spouse under a decree of divorce or separate maintenance. You are eligible to
take the credit on a separate return.
Married and living apart.
You are not considered married and are eligible to take the credit if all the following apply.
You file a separate return.
Your home is the home of a qualifying person for more than half the year.
You pay more than half the cost of keeping up your home for the year.
Your spouse does not live in your home for the last 6 months of the year.
Costs of keeping up a home.
The costs of keeping up a home normally include property taxes, mortgage interest, rent, utility charges, home repairs, insurance on the home, and
food eaten at home.
The costs of keeping up a home do not include payments for clothing, education, medical treatment, vacations, life insurance, transportation, or
mortgage principal.
They also do not include the purchase, permanent improvement, or replacement of property. For example, you cannot include the cost of replacing a
water heater. However, you can include the cost of repairing a water heater.
Death of spouse.
If your spouse died during the year and you do not remarry before the end of the year, you generally must file a joint return to take the credit.
If you do remarry before the end of the year, the credit can be claimed on your deceased spouse's separate return.
Provider
Identification TestChildcare:ProviderTaxpayer identification numberTaxpayer identification numbers (TINs):Childcare providerChild and dependent care credit
You must identify all persons or organizations that provide care for your child or dependent. Use Part I of Form 2441 or Schedule 2 (Form 1040A) to
show the information.
Information needed.
To identify the care provider, you must give the provider's:
Name,
Address, and
Taxpayer identification number.
If the care provider is an individual, the taxpayer identification number is his or her social security number or individual taxpayer
identification number. If the care provider is an organization, then it is the employer identification number (EIN).
You do not have to show the taxpayer identification number if the care provider is one of certain tax-exempt organizations (such as a church or
school). In this case, enter Tax-Exempt in the space where the tax form calls for the number.
If you cannot provide all of the information or if the information you provide is incorrect you must be able to show that you used due diligence
(discussed later) in trying to furnish the necessary information.
Getting the information.
You can use
Form:W-10Form W-10 to request the required information from the care provider. If you do not use Form W-10, you can get the
information from:
A copy of the provider's social security card,
A copy of the provider's driver's license (in a state where the license includes the social security number),
A copy of the provider's completed Form W-4 if he or she is your household employee,
A copy of the statement furnished by your employer if the provider is your employer's dependent care plan, or
A letter or invoice from the provider if it shows the information.
You should keep this information with your tax records. Do not send Form W-10 (or other document containing this information) to the Internal
Revenue Service.
Child and dependent care creditDue diligenceDue diligenceChild and dependent care creditDue diligence.
If the care provider information you give is incorrect or incomplete, your credit may not be allowed. However, if you can show that you used due
diligence in trying to supply the information, you can still claim the credit.
You can show due diligence by getting and keeping the provider's completed Form W-10 or one of the other sources of information listed earlier.
Care providers can be penalized if they do not provide this information to you or if they provide incorrect information.
Provider refusal.
If the provider refuses to give you their identifying information, you should report whatever information you have (such as the name and address)
on the form you use to claim the credit. Enter See page 2 in the columns calling for the information you do not have. On the bottom of page 2,
explain that you requested the information from the care provider, but the provider did not give you the information. This statement will show that
you used due diligence in trying to furnish the necessary information.
How To Figure
the Credit
Your credit is a percentage of your work-related expenses. Your expenses are subject to the earned income limit and the dollar limit. The
percentage is based on your adjusted gross income.
Figuring Total
Work-Related Expenses
To figure the credit for 2005 work-related expenses, count only those you paid by December 31, 2005.
Expenses prepaid in an earlier year.
If you pay for services before they are provided, you can count the prepaid expenses only in the year the care is received. Claim the expenses for
the later year as if they were actually paid in that later year.
Expenses not paid until the following year.
Do not count 2004 expenses that you paid in 2005 as work-related expenses for 2005. You may be able to claim an additional credit for them on your
2005 return, but you must figure it separately. See Payments for previous year's expenses under Amount of Credit in Publication
503.
If you had expenses in 2005 that you did not pay until 2006, you cannot count them when figuring your 2005 credit. You may be able to claim a
credit for them on your 2006 return.
Expenses reimbursed.
If a state social services agency pays you a nontaxable amount to reimburse you for some of your child and dependent care expenses, you cannot
count the expenses that are reimbursed as work-related expenses.
Example.
You paid work-related expenses of $3,000. You are reimbursed $2,000 by a state social services agency. You can use only $1,000 to figure your
credit.
Medical expenses.Medical and dental expenses:Work-related
Some expenses for the care of qualifying persons who are not able to care for themselves may qualify as work-related expenses and also as medical
expenses. You can use them either way, but you cannot use the same expenses to claim both a credit and a medical expense deduction.
If you use these expenses to figure the credit and they are more than the earned income limit or the dollar limit, discussed later, you can add the
excess to your medical expenses. However, if you use your total expenses to figure your medical expense deduction, you cannot use any part of them to
figure your credit.
Amounts excluded from your income under your employer's dependent care benefits plan cannot be used to claim a medical expense deduction.
Dependent Care BenefitsDependent care:Benefits
If you receive dependent care benefits, your dollar limit for purposes of the credit may be reduced. See Reduced Dollar Limit, later.
But, even if you cannot take the credit, you may be able to take an exclusion or deduction for the dependent care benefits.
Dependent care benefits.
Dependent care benefits include:
Amounts your employer pays directly to either you or your care provider for the care of your qualifying person while you work,
and
The fair market value of care in a day-care facility provided or sponsored by your employer.
Your salary may have been reduced to pay for these benefits. If you received benefits, they should be shown on your W-2 form. See
Statement for employee, later.
Benefits you received as a partner should be shown in box 13 of your Schedule K-1 (Form 1065) with code O. Enter the amount of these benefits on
Form 2441, line 12.
Exclusion or deduction.
If your employer provides dependent care benefits under a qualified plan, you may be able to exclude these benefits from your income. Your employer
can tell you whether your benefit plan qualifies.
If you are self-employed and receive benefits from a qualified dependent care benefit plan, you are treated as both employer and employee.
Therefore, you would not get an exclusion from wages but instead a deduction on Schedule C (Form 1040), line 14; Schedule E (Form 1040), line 18; or
Schedule F (Form 1040), line 17.
If your plan qualifies, you must complete Part III of either Form 2441 or Schedule 2 (Form 1040A) to claim the exclusion. You cannot use Form
1040EZ. You must use Form 2441 to claim the deduction.
The amount you can exclude or deduct is limited to the smallest of:
The total amount of dependent care benefits you received during the year,
The total amount of qualified expenses you incurred during the year,
Your earned income,
Your spouse's earned income, or
$5,000 ($2,500 if married filing separately).
The definition of earned income for this purpose is not exactly the same as the definition for the credit. See the instructions for Form 2441
or Schedule 2 (Form 1040A).
Statement for employee.
Your employer must give you a Form W-2 (or similar statement) showing in box 10 the total amount of dependent care benefits provided to you during
the year under a qualified plan. Your employer will also include any dependent care benefits over $5,000 in your wages shown on your Form W-2 in box
10.
Effect of exclusion.
If you exclude dependent care benefits from your income, the amount of the excluded benefits:
Is not included in your work-related expenses, and
Reduces the dollar limit, discussed later.
Earned Income Limit
The amount of work-related expenses you use to figure your credit cannot be more than:
Your earned income for the year if you are single at the end of the year, or
The smaller of your or your spouse's earned income for the year if you are married at the end of the year.
Earned income is defined under Earned Income Test, earlier.
For purposes of item (2), use your spouse's earned income for the entire year, even if you were married for only part of the year.
Separated spouse.
If you are legally separated or married and living apart from your spouse (as described under Joint Return Test, earlier), you are not
considered married for purposes of the earned income limit. Use only your income in figuring the earned income limit.
Surviving spouse.
If your spouse died during the year and you file a joint return as a surviving spouse, you are not considered married for purposes of the earned
income limit. Use only your income in figuring the earned income limit.
Community property laws.
You should disregard community property laws when you figure earned income for this credit.
Student-spouse or spouse not able to care for self.
Your spouse who is either a full-time student or not able to care for himself or herself is treated as having earned income. His or her earned
income for each month is considered to be at least $250 if there is one qualifying person in your home, or at least $500 if there are two or more.
Spouse works.
If your spouse works during that month, use the higher of $250 (or $500) or his or her actual earned income for that month.
Spouse qualifies for part of month.
If your spouse is a full-time student or not able to care for himself or herself for only part of a month, the full $250 (or $500) still applies
for that month.
Both spouses qualify.
If, in the same month, both you and your spouse are either full-time students or not able to care for yourselves, only one spouse can be considered
to have this earned income of $250 (or $500) for that month.
Dollar Limit
There is a dollar limit on the amount of your work-related expenses you can use to figure the credit. This limit is $3,000 for one qualifying
person, or $6,000 for two or more qualifying persons.
If you paid work-related expenses for the care of two or more qualifying persons, the $6,000 limit does not need to be divided equally among them.
For example, if your work-related expenses for the care of one qualifying person are $3,200 and your work-related expenses for another qualifying
person are $2,800, you can use the total, $6,000, when figuring the credit.
Yearly limit.
The dollar limit is a yearly limit. The amount of the dollar limit remains the same no matter how long, during the year, you have a qualifying
person in your household. Use the $3,000 limit if you paid work-related expenses for the care of one qualifying person at any time during the year.
Use $6,000 if you paid work-related expenses for the care of more than one qualifying person at any time during the year.
Reduced Dollar Limit
If you received dependent care benefits that you exclude or deduct from your income, you must subtract that amount from the dollar limit that
applies to you. Your reduced dollar limit is figured on lines 28 through 32 of Form 2441 or lines 22 through 26 of Schedule 2 (Form 1040A). See
Dependent Care Benefits, earlier, for information on excluding or deducting these benefits.
Example.
George is a widower with one child and earns $24,000 a year. He pays work-related expenses of $2,900 for the care of his 4-year-old child and
qualifies to claim the credit for child and dependent care expenses. His employer pays an additional $1,000 under a dependent care benefit plan. This
$1,000 is excluded from George's income.
Although the dollar limit for his work-related expenses is $3,000 (one qualifying person), George figures his credit on only $2,000 of the $2,900
work-related expenses he paid. This is because his dollar limit is reduced as shown next.
George's Reduced Dollar Limit1)Maximum allowable expenses for one qualifying person$3,0002)Minus: Dependent care benefits George excludes from income−1,0003)Reduced dollar limit on expenses George can use for the credit$2,000
Amount of Credit
To determine the amount of your credit, multiply your work-related expenses (after applying the earned income and dollar limits) by a percentage.
This percentage depends on your adjusted gross income shown on Form 1040, line 38, or Form 1040A, line 22. The following table shows the percentage to
use based on adjusted gross income.
IF your adjusted gross
income is:THEN
the OverBut not overpercentage is:$ 0$15,00035%15,00017,00034%17,00019,00033%19,00021,00032%21,00023,00031%23,00025,00030%25,00027,00029%27,00029,00028%29,00031,00027%31,00033,00026%33,00035,00025%35,00037,00024%37,00039,00023%39,00041,00022%41,00043,00021%43,000No limit20%
How To Claim
the Credit
To claim the credit, you can file Form 1040 or Form 1040A. You cannot claim the credit on Form 1040EZ.
Form 1040.Form:2441
You must complete Form 2441 and attach it to your Form 1040. Enter the credit on Form 1040, line 48. An example of a filled-in Form 2441 is at the
end of this chapter.
Form 1040A.Schedule:2 of Form 1040A
You must complete Schedule 2 (Form 1040A) and attach it to your Form 1040A. Enter the credit on your Form 1040A, line 29.
Limit on credit.
The amount of credit you can claim is limited to the amount of your regular tax (after reduction by any allowable foreign tax credit) plus your
alternative minimum tax, if any.
Tax credit not refundable.
You cannot get a refund for any part of the credit that is more than this limit.
Recordkeeping. You should keep records of your work-related expenses. Also, if your dependent or spouse is not able to care for himself
or herself, your records should show both the nature and the length of the disability. Other records you should keep to support your claim for the
credit are described earlier under Provider Identification Test.
Employment Taxes
for Household EmployersEmployment taxesSocial security and Medicare taxesHousehold employeesSocial security and Medicare taxes
If you pay someone to come to your home and care for your dependent or spouse, you may be a household employer. If you are a household employer,
you will need an employer identification number (EIN) and you may have to pay employment taxes. If the individuals who work in your home are
self-employed, you are not liable for any of the taxes discussed in this section. Self-employed persons who are in business for themselves are not
household employees. Usually, you are not a household employer if the person who cares for your dependent or spouse does so at his or her home or
place of business.
If you use a placement agency that exercises control over what work is done and how it will be done by a babysitter or companion who works in your
home, that person is not your employee. This control could include providing rules of conduct and appearance and requiring regular reports. In this
case, you do not have to pay employment taxes. But, if an agency merely gives you a list of sitters and you hire one from that list, the sitter may be
your employee.
If you have a household employee you may be subject to:
Social security and Medicare taxes,
Federal unemployment tax, and
Federal income tax withholding.
Social security and Medicare taxes are generally withheld from the employee's pay and matched by the employer. Federal unemployment (FUTA) tax
is paid by the employer only and provides for payments of unemployment compensation to workers who have lost their jobs. Federal income tax is
withheld from the employee's total pay if the employee asks you to do so and you agree.
For more information on a household employer's tax responsibilities, see Publication 926 and Schedule H (Form 1040) and its instructions.
You may also have to pay state unemployment tax. Contact your state unemployment tax office for information. You should also find out whether you
need to pay or collect other state employment taxes or carry workers' compensation insurance. A list of state employment tax agencies, including
addresses and phone numbers, is in Publication 926.
Example
The following example shows how to figure the credit for child and dependent care expenses for two children when employer-provided dependent care
benefits are involved. The filled-in Form 2441 is shown at the end of this chapter.
Illustrated example.
Joan Thomas is divorced and has two children, ages 3 and 9. She works at ACME Computers. Her adjusted gross income (AGI) is $29,000, and the entire
amount is earned income.
Joan's younger child (Susan) stays at her employer's on-site childcare center while she works. The benefits from this childcare center qualify to
be excluded from her income. Her employer reports the value of this service as $3,000 for the year. This $3,000 is shown on her Form W-2 in box 10,
but is not included in taxable wages in box 1.
A neighbor cares for Joan's older child (Seth) after school, on holidays, and during the summer. Joan pays her neighbor $2,400 for this care.
Joan figures her credit on Form 2441 as follows.
1)Work-related expenses Joan paid$2,4002)Dollar limit (2 or more qualified individuals)$6,0003)Minus: Dependent care benefits excluded from Joan's income−3,0004)Reduced dollar limit$3,0005)Lesser of expenses paid ($2,400) or dollar limit ($3,000)$2,4006)Percentage for AGI of $29,000 (28%) .287)Multiply the amount on line 5 by the percentage on line 6 ($2,400 x .28)$ 6728)Enter the amount from Form 1040, line 46$1,2969)Enter the amount from Form 1040, line 47-0-10)Subtract line 9 from line 81,29611)Credit
(Enter the smaller of line 7 or line 10)$672
Form 2441 Child and Dependent Care ExpensesSummary: This is a sample Form 2441 (2005), Page 1 pertaining to the example explained in the text, with additional line item information not
listed in the text.Name(s) shown on Form 1040 field contains Joan ThomasYour social security number field contains 559-00-3436Under Part I: Persons or Organizations Who Provided the Care:1(a) Care provider's name field contains Pat Green and ACME Computers1(b) Address (number, street, apartment number, city, state, and ZIP code) field contains 12 Ash Avenue, Hometown, Texas 75240 and (See
W-2)1(c) Identifying number (Social Security Number or Employer Identification Number) field contains 240-00-38111(d) Amount paid (see instructions) field contains 2,400Under Part II: Credit for Child and Dependent Care Expenses:2(a) Qualifying person's name: First field contains Seth and Susan2(a) Qualifying person's name: Last field contains Thomas and Thomas2(b) Qualifying person's social security number field contains 559-00-1234 and 559-00-56782(c) Qualified expenses you incurred and paid in 2005 for the person listed in column (a) field contains 2,4003. Add the amounts in column (c) of line 2. Do not enter more than $3,000 for one qualifying person or $6,000 for two or more persons. If you
completed Part III, enter the amount from line 26 field contains 2,4004. Enter your earned income field contains 29,0005. If married filing jointly, enter your spouse's earned income (if your spouse was a student or was disabled, see the instructions); all
others, enter the amount from line 4 field contains 29,0006. Enter the smallest of line 3, 4, or 5 field contains 2,4007. Enter the amount from Form 1040, line 38 field contains 29,0008. Enter on line 8 the decimal point shown below that applies to the amount on line 7 field contains .289. Multiply line 6 by the decimal amount on line 8. If you paid 2004 expenses in 2005, see the instructions field contains 67210. Enter the amount from Form 1040, line 46, minus any amount on Form 1040, line 47 field contains 1,29611. Credit for child and dependent care expenses. Enter the smaller of line 9 or line 10 here and on Form 1040, line 48 field contains
672Form 2441 Child and Dependent Care Expenses--Page 2Summary: This is an example of Form 2441 (2005), page 2, as pertains to the text. The completed line items are:Under
Part III: Dependent Care Benefits:12. Enter the total amount of dependent care benefits you received for 2005. This amount should be shown in box 10 of your W-2 form(s). Do not
include amounts that were reported to you as wages in box 1 of Form(s) W-2 field contains 3,00014. Subtract line 13 from line 12 field contains 3,00015. Enter the total amount of qualified expenses incurred in 2005 for the care of the qualifying person(s) field contains
5,40016. Enter the smaller of line 14 or 15 field contains 3,00017. Enter your earned income field contains 29,00018. Enter the amount shown below that applies to you. If married filing jointly, enter your spouse's earned income (if your spouse was a
student or was disabled, see the instructions for line 5); If married filing separately, see the instructions for the amount to enter; All others,
enter the amount from line 17 field contains 29,00019. Enter the smallest of line 16, 17, or 18 field contains 3,00020. Enter the amount from line 12 that you received from your sole proprietorship or partnership. If you did not receive any such amounts,
enter -0-. field contains -0-.21. Subtract line 20 from line 14.. field contains 3,000.22. Enter $5,000 ($2,500 if married filing separately and you were required to enter your spouse's earned income on line 18) field
contains 5,000.23. Deductible benefits. Enter the smallest of line 19, 20, or 22. Also, include this amount on the appropriate line(s) of your return (see
the instructions). Field contains -0-.24. Enter the smaller of line 19 or 22. Field contains 3,000.25. Enter the amount from line 23. Field contains -0-.26. Excluded benefits. Subtract line 25 from line 24. If zero or less, enter -0-. Field contains 3,000.27. Taxable benefits. Subtract line 26 from line 21. If zero or less, enter -0-. Also, include this amount on Form 1040, line 7. On the dotted
line next to line 7, enter DCB Field contains -0-.Under
To claim the child and dependent care credit, complete lines 28–32 below:28. Enter $3,000 ($6,000 if two or more qualifying persons) field contains 6,00029. Add lines 23 and 26 field contains 3,00030. Subtract line 29 from line 28. If zero or less, stop. You cannot take the credit. Exception. If you paid 2004 expenses in 2005, see the
instructions for line 9 field contains 3,00031. Complete line 2 on the front of this form. Do not include in column (c) any benefits shown on line 29 above. Then, add the amounts in
column (c) and enter the total here field contains 2,40032. Enter the smaller of line 30 or 31. Also, enter this amount on line 3 on the front of this form and complete lines 4-11 field
contains 2,400
Credit for the Elderly or the DisabledCredits:For the disabledCredits:For the elderlyDisabilities, persons with:Credit forOlder taxpayers:Credit for the elderly
If you qualify, the law provides a number of credits that can reduce the tax you owe for a year. One of these credits is the credit for the elderly
or the disabled.
This chapter explains:
Who qualifies for the credit for the elderly or the disabled, and
How to figure this credit.
You may be able to take this credit if you are:
Age 65 or older, or
Retired on permanent and total disability.
Publication524 Credit for the Elderly or the Disabled 554 Older Americans' Tax Guide967The IRS Will Figure Your TaxForms (and Instructions)Credit for the Elderly or the Disabled for Form 1040A Filers Credit for the Elderly or the Disabled
Can You Take
the Credit?
You can take the credit for the elderly or the disabled if you meet both of the following requirements.
You are a qualified individual.
Your income is not more than certain limits.
You can use Figure 33-A and Figure 33-B as guides to see if you qualify.
Use Figure 33-A first to see if you are a qualified individual. If you are, go to Figure 33-B to make sure your income is not too high to take the
credit.
You can take the credit only if you file Form 1040 or Form 1040A. You cannot take the credit if you file Form 1040EZ.
Qualified Individual
You are a qualified individual for this credit if you are a U.S. citizen or resident and either of the following applies.
You were age 65 or older at the end of 2005.
You were under age 65 at the end of 2005 and all three of the following statements are true.
You retired on permanent and total disability (explained later).
You received taxable disability income for 2005.
On January 1, 2005, you had not reached mandatory retirement age (defined later under Disability income).
Age 65.
You are considered to be age 65 on the day before your 65th birthday. Therefore, if you were born on January 1, 1941, you are considered to be age
65 at the end of 2005.
U.S. Citizen or Resident
You must be a U.S. citizen or resident (or be treated as a resident) to take the credit. Generally, you cannot take the credit if you were a
nonresident alien at any time during the tax year.
Exceptions.
You may be able to take the credit if you are a nonresident alien who is married to a U.S. citizen or resident at the end of the tax year and you
and your spouse choose to treat you as a U.S. resident. If you make that choice, both you and your spouse are taxed on your worldwide income.
If you were a nonresident alien at the beginning of the year and a resident at the end of the year, and you were married to a U.S. citizen or
resident at the end of the year, you may be able to choose to be treated as a U.S. resident for the entire year. In that case, you may be allowed to
take the credit. For information on these choices, see chapter 1 of Publication 519, U.S. Tax Guide for Aliens.
Married Persons
Generally, if you are married at the end of the tax year, you and your spouse must file a joint return to take the credit. However, if you and your
spouse did not live in the same household at any time during the tax year, you can file either joint or separate returns and still take the credit.
Head of household.
You can file as head of household and qualify to take the credit even if your spouse lived with you during the first 6 months of the year, if you
meet all the tests. See Head of Household in chapter 2 for the tests you must meet.
Under Age 65Qualified individuals:Under age 65 and retired on permanent and total disability
If you are under age 65 at the end of 2005, you can qualify for the credit only if you are retired on permanent and total disability. You are
retired on permanent and total disability if:
You were permanently and totally disabled when you retired, and
You retired on disability before the close of the tax year.
Even if you do not retire formally, you are considered retired on disability when you have stopped working because of your disability.
If you retired on disability before 1977, and were not permanently and totally disabled at the time, you can qualify for the credit if you were
permanently and totally disabled on January 1, 1976, or January 1, 1977.
You are considered to be under age 65 at the end of 2005 if you were born after January 1, 1941.
Permanent and total disability.Disability, permanent and total disabilityPermanent and total disability
Physician certificationYou are permanently and totally disabled if you cannot engage in any substantial gainful activity because
of your physical or mental condition. A physician must certify that the condition has lasted or can be expected to last continuously for 12 months or
more, or that the condition can be expected to result in death. See Physician's statement, later.
Substantial gainful activity is the performance of significant duties over a reasonable period of time while working for pay or profit, or in work
generally done for pay or profit. Full-time work (or part-time work done at your employer's convenience) in a competitive work situation for at least
the minimum wage conclusively shows that you are able to engage in substantial gainful activity.
Substantial gainful activity is not work you do to take care of yourself or your home. It is not unpaid work on hobbies, institutional therapy or
training, school attendance, clubs, social programs, and similar activities. However, doing this kind of work may show that you are able to engage in
substantial gainful activity.
Out of workThe fact that you have not worked for some time is not, of itself, conclusive evidence that you cannot engage in
substantial gainful activity.
Sheltered employment.
Certain work offered at qualified locations to physically or mentally impaired persons is considered sheltered employment. These qualified
locations are in sheltered workshops, hospitals and similar institutions, homebound programs, and Department of Veterans Affairs (VA) sponsored homes.
Compared to commercial employment, pay is lower for sheltered employment. Therefore, one usually does not look for sheltered employment if he or
she can get other employment. The fact that one has accepted sheltered employment is not proof of that person's ability to engage in substantial
gainful activity.
Physician's statementPhysician's statement.
If you are under age 65, you must have your physician complete a statement certifying that you were permanently and totally disabled on the date
you retired. You can use the statement in the instructions for Schedule R (Form 1040) or Schedule 3 (Form 1040A).
Figure 33-A. Are You a Qualified Individual? and Figure 33-B. Income Limits Summary: This flowchart is used to determine if a taxpayer is a qualified individual to take the credit for the elderly or the disabled. The
list that follows the flowchart illustrates the conditions that disqualify an individual from the credit for the elderly or the disabled.StartThis is the starting of the flowchart.Decision (1)Are you a U.S. citizen or resident? (see Footnote 1)Footnote 1: If you were a nonresident alien at any time during the tax year and were married to a U.S. citizen or resident at the end of the
tax year, see U.S. Citizen or Resident under Qualified Individual. If you and your spouse choose to treat you as a U.S. resident, answer
yes to this question.IF Yes Continue To Decision (2)IF No Continue To Process (a)Process (a)You are not a qualified individual and cannot take the credit for the elderly or the disabled.Continue To End Decision (2)Were you 65 or older at the end of the year?IF Yes Continue To Process (b)IF No Continue To Decision (3)Process (b)You are a qualified individual and may be able to take the credit for the elderly or the disabled unless your income exceeds the limits in
Figure 33-B.Continue To End Decision (3)Are you retired on permanent and total disability?IF Yes Continue To Decision (4)IF No Continue To Process (a)Decision (4)Did you reach mandatory retirement age before this year? (see Footnote 2)Footnote 2: Mandatory retirement age is the age set by your employer at which you would have been required to retire, had you not become
disabled.IF Yes Continue To Process (a)IF No Continue To Decision (5)Decision (5)Did you receive taxable disability benefits this year?IF Yes Continue To Process (b)IF No Continue To Process (a)EndThis is the ending of the flowchart.IF your filing status is Single, Head of household, or Qualifying widow(er) with dependent child ... THEN even if you qualify (see Figure
33-A), you CANNOT take the credit if Your Adjusted Gross Income is equal to or more than $17,500 (Footnote: Adjusted Gross Income is the amount on
Form 1040A, line 22, or Form 1040, line 38.) OR the total of your nontaxable social security and other nontaxable pension(s) is equal to or more than
$5,000IF your filing status is Married filing a joint return and both spouses qualify in Figure 33-A ... THEN even if you qualify (see Figure
33-A), you CANNOT take the credit if Your adjusted gross income is equal to or more than $25,000 (Footnote: Adjusted Gross Income is the amount on
Form 1040A, line 22, or Form 1040, line 38.) OR the total of your nontaxable social security and other nontaxable pension(s) is equal to or more than
$7,500IF your filing status is Married filing a joint return and only one spouse qualifies in Figure 33-A ... THEN even if you qualify (see Figure
33-A), you CANNOT take the credit if Your Adjusted Gross Income is equal to or more than $20,000 (Footnote: Adjusted Gross Income is the amount on
Form 1040A, line 22, or Form 1040, line 38.) OR the total of your nontaxable social security and other nontaxable pension(s) is equal to or more than
$5,000IF your filing status is Married filing a separated return and you did not live with your spouse at any time during the year ... THEN even if
you qualify (see Figure 33-A), you CANNOT take the credit if Your adjusted gross income is equal to or more than $12,500 (Footnote: Adjusted Gross
Income is the amount on Form 1040A, line 22, or Form 1040, line 38.) OR the total of your nontaxable social security and other nontaxable pension(s)
is equal to or more than $3,750
You do not have to file this statement with your Form 1040 or Form 1040A, but you must keep it for your records.
Physician's statementVeteransVeterans.
If the Department of Veterans Affairs (VA) certifies that you are permanently and totally disabled, you can substitute VA Form 21-0172,
Certification of Permanent and Total Disability, for the physician's statement you are required to keep. VA Form 21-0172 must be signed by a person
authorized by the VA to do so. You can get this form from your local VA regional office.
Physician's statement obtained in earlier year.
If you got a physician's statement in an earlier year and, due to your continued disabled condition, you were unable to engage in any substantial
gainful activity during 2005, you may not need to get another physician's statement for 2005. For a detailed explanation of the conditions you must
meet, see the instructions for Part II of Schedule R (Form 1040) or Schedule 3 (Form 1040A). If you meet the required conditions, check the box on
line 2 of Part II of Schedule R (Form 1040) or Schedule 3 (Form 1040A).
If you checked box 4, 5, or 6 in Part I of either Schedule R or Schedule 3, enter in the space above the box on line 2 in Part II the first name(s)
of the spouse(s) for whom the box is checked.
Disability income.Disability:Income
If you are under age 65, you can qualify for the credit only if you have taxable disability income. Disability income must meet both of the
following requirements.
It must be paid under your employer's accident or health plan or pension plan.
It must be included in your income as wages (or payments instead of wages) for the time you are absent from work because of permanent and
total disability.
Payments that are not disability income.
Any payment you receive from a plan that does not provide for disability retirement is not disability income. Any lump-sum payment for accrued
annual leave that you receive when you retire on disability is a salary payment and is not disability income.
Mandatory retirement age
For purposes of the credit for the elderly or the disabled, disability income does not include amounts you receive after you reach mandatory
retirement age. Mandatory retirement age is the age set by your employer at which you would have had to retire, had you not become disabled.
Income Limits
To determine if you can claim the credit, you must consider two income limits. The first limit is the amount of your adjusted gross income (AGI).
The second limit is the amount of nontaxable social security and other nontaxable pensions you received. The limits are shown in Figure 33-B, later.
If both your AGI and nontaxable pensions are less than the income limits, you may be able to claim the credit. See Figuring the Credit,
next.
If either your AGI or your nontaxable pensions are equal to or more than the income limits, you cannot take the credit.
Figuring the Credit
You can figure the credit yourself (see the explanation that follows) or the IRS will figure it for you. See Credit Figured for You,
later.
Figuring the credit yourself.Schedule:R of Form 1040Schedule:3 of Form 1040A
If you figure the credit yourself, fill out the front of either Schedule R (if you are filing Form 1040) or Schedule 3 (if you are filing Form
1040A). Next, fill out Part III of either Schedule R or Schedule 3.
<ROM>Table 33-1.</ROM> <BLD>Initial Amounts</BLD>IF your filing status is ...THEN enter on line 10 of Schedule R (Form 1040) or Schedule 3 (Form 1040A)...Single, head of household, or qualifying widow(er) with dependent child and, by the end
of 2005, you were• 65 or older$5,000• under 65 and retired on permanent and total disability
1$5,000Married filing a joint return and by the end of 2005• both of you were 65 or older$7,500• both of you were under 65 and one of you retired on permanent and total disability
1$5,000• both of you were under 65 and both of you retired on permanent and total disability
2$7,500• one of you was 65 or older, and the other was under 65 and retired on permanent and total
disability
3$7,500• one of you was 65 or older, and the other was under 65 and not retired on permanent and total
disability$5,000Married filing a separate return and you did not live with your spouse at any time during the year
and, by the end of 2005, you were• 65 or older$3,750• under 65 and retired on permanent and total disability
1$3,750
1Amount cannot be more than the taxable disability income.2Amount cannot be more than your combined taxable disability income.3Amount is $5,000 plus the taxable disability income of the spouse under age 65, but not more than $7,500.
There are four steps in Part III to determine the amount of your credit:
Determine your initial amount (lines 10–12).
Total any nontaxable social security and certain other nontaxable pensions and disability benefits you received (lines 13a, 13b, and
13c).
Determine your excess adjusted gross income (lines 14–17).
Determine your credit (lines 18–24 of Schedule R or lines 18–22 of Schedule 3).
These steps are discussed in more detail next.
Step 1. Determine Initial Amount
To figure the credit, you must first determine your initial amount. See Table 33-1.
Initial amounts for persons under age 65.
If you are a qualified individual under age 65, your initial amount cannot be more than your taxable disability income.
Step 2. Total Certain Nontaxable Pensions and Benefits
Step 2 is to figure the total amount of nontaxable social security and certain other nontaxable payments you received during the year. (See
Nontaxable payments, later.)
Enter these nontaxable payments on lines 13a or 13b, and total them on line 13c. If you are married filing a joint return, you must enter the
combined amount of nontaxable payments both you and your spouse receive.
Worksheets are provided in the Form 1040 and Form 1040A instructions to help you determine if any part of your social security benefits (or
equivalent railroad retirement benefits) is taxable.
Nontaxable paymentsCredit for the elderly or the disabledCredit for the elderly or the disabledNontaxable paymentsNontaxable payments.
Include the following nontaxable payments in the amounts you enter on lines 13a and 13b.
Nontaxable social security payments. This is the nontaxable part of the amount of benefits shown in box 5 of Form SSA-1099, which includes
disability benefits, before deducting any amounts withheld to pay
premiums on supplementary Medicare insurance, and before any reduction because of receipt of a benefit under workers' compensation.
Do not include a lump-sum death benefit payment you may receive as a surviving spouse, or a surviving child's insurance benefit payments you may
receive as a guardian.
Social security equivalent part of tier 1 railroad retirement pension payments that is not taxed. This is the nontaxable part of the amount
of benefits shown in box 5 of Form RRB-1099.
Nontaxable pension or annuity payments or disability benefits that are paid under a law administered by the Department of Veterans Affairs
(VA).
Do not include amounts received as a pension, annuity, or similar allowance for personal injuries or sickness resulting from active service in the
armed forces of any country or in the National Oceanic and Atmospheric Administration, or the Public Health Service, or as a disability annuity under
section 808 of the Foreign Service Act of 1980.
Pension or annuity payments or disability benefits that are excluded from income under any provision of federal law other than the Internal
Revenue Code.
Do not include amounts that are a return of your cost of a pension or annuity. These amounts do not reduce your initial amount.
You should be sure to take into account all of the nontaxable amounts you receive. These amounts are verified by the IRS through information
supplied by other government agencies.
Step 3. Determine Excess
Adjusted Gross Income
You also must reduce your initial amount by your excess adjusted gross income. Figure your excess adjusted gross income on lines 14–17.
You figure your excess adjusted gross income as follows:
Subtract from your adjusted gross income (Form 1040, line 38 or Form 1040A, line 22) the amount shown for your filing status in the
following list:
$7,500 if you are single, a head of household, or a qualifying widow(er) with a dependent child,
$10,000 if you are married filing a joint return, or
$5,000 if you are married filing a separate return and you and your spouse did not live in the same household at any time during the tax
year.
Divide the result of (1) by 2.
Step 4. Determine Your Credit
To determine if you can take the credit, you must add the amounts you figured in Step 2 and Step 3.
IF the total of Steps 2 and 3 is ...THEN ...equal to or more than the amount in Step 1you cannot take the credit.less than the amount in Step 1you can take the credit.
Figuring the credit.
If you can take the credit, subtract the total of Step 2 and Step 3 from the amount in Step 1 and multiply the result by 15%.
In certain cases, the amount of your credit may be limited. See Limit on credit, later.
Example.
You are 66 years old and your spouse is 64. Your spouse is not disabled. You file a joint return on Form 1040. Your adjusted gross income is
$14,630. Together you received $3,200 from social security, which was nontaxable. You figure the credit as follows:
1)Initial amount$5,000 2)Subtract from line 1 the total of:a) Nontaxable social security and other nontaxable pensions$3,200 b) Excess adjusted gross income
[($14,630 − $10,000) ÷ 2] 2,315 5,5153)Balance (Not less than -0-) -0- 4)Credit-0-
You cannot take the credit because your nontaxable social security (line 2a) plus your excess adjusted gross income (line 2b) is more than your
amount on line 1.
Limit on credit.Limit on credit.
The amount of credit you can claim may be limited.
Figure any limit on your credit on lines 21–24 of Schedule R or lines 21–22 of Schedule 3.
Credit Figured for You
If you choose to have the Internal Revenue Service (IRS) figure the credit for you, read the following discussion for the form you will file (Form
1040 or 1040A). If you want the IRS to figure your tax, see chapter 30.
Form 1040.
If you want the IRS to figure your credit, see Form 1040 Line Entries under Tax Figured by IRS in chapter 30.
Form 1040A.
If you want the IRS to figure your credit, see Form 1040A Line Entries under Tax Figured by IRS in chapter 30.
Example
The following example illustrates the credit for the elderly or the disabled. The initial amount is taken from Table 33-1, shown earlier.
Example.
James Davis is 58 years old, single, and files Form 1040A. In 1998 he retired on permanent and total disability, and he is still permanently and
totally disabled. He got the required physician's statement in 1998, and kept it with his records. His physician signed on line B of the statement.
This year James checks the box in Part II of Schedule 3. He does not need to get another statement for 2005.
James' adjusted gross income is $11,500 ($11,400 + $100). He figures the credit on Schedule 3 as follows:
1)Initial amount$5,000 2)Taxable disability pension11,4003)Smaller of (1) or (2)5,0004)Subtract from line 3 the total of:a) Nontaxable disability benefits (social security)$1,500b) Excess adjusted gross income
[($11,500 − $7,500) ÷ 2] 2,0003,5005)Balance (Not less than -0-)1,5006)Multiply line 5 by 15% (.15)2257)Enter the amount from Form 1040A, line 28.3338)Enter any amounts from Form 1040A, line 29.-0-9)Subtract line 8 from line 733310)Credit
(Enter the smaller of line 6 or line 9)$225
His credit is $225. He enters $225 on line 30 of Form 1040A. The Schedule 3 for James Davis is not shown.
The definition of a qualifying child has changed. See Qualifying Child.
New Form 8901.
If you have a qualifying child who is not your dependent, you must complete and file Form 8901, Information on Qualifying Children Who Are Not
Dependents.
Katrina Emergency Tax Relief Act of 2005.
This Act provides tax relief for persons affected by Hurricane Katrina. Under the Act, if your 2005 earned income is less than your 2004 earned
income, you may be able to use your 2004 earned income in figuring your additional child tax credit for 2005. See Publication 4492.
The child tax credit is a credit that may reduce your tax by as much as $1,000 for each of your qualifying children.
The additional child tax credit is a credit you may be able to take if you are not able to claim the full amount of the child tax credit.
This chapter explains:
Who is a qualifying child.
How much is the credit.
How to claim the credit.
Why you should check your tax withholding.
The child tax credit and the additional child tax credit should not be confused with the child and dependent care credit discussed in
chapter 32.
If you have no tax.
Credits, such as the child tax credit, the adoption credit, or the credit for child and dependent care expenses, are used to reduce tax. If your
tax on Form 1040, line 46, or Form 1040A, line 28, is zero, do not figure the child tax credit because there is no tax to reduce. However, you may
qualify for the additional child tax credit on line 68 (Form 1040) or line 42 (Form 1040A).
Publication972Child Tax CreditForm (and Instructions)Additional Child Tax CreditInformation on Qualifying Children Who Are Not DependentsEmployee's Withholding Allowance Certificate
Qualifying ChildChild tax credit:Qualifying childFoster care:Child tax credit
A qualifying child for purposes of the child tax credit is a child who:
Is your son, daughter, stepchild, foster child, brother, sister, stepbrother, stepsister, or a descendant of any of them (for example, your
grandchild),
Was under age 17 at the end of 2005,
Did not provide over half of his or her own support for 2005,
Lived with you for more than half of 2005 (see Exception to time lived with you condition below), and
Was a U.S. citizen, a U.S. national, or a resident of the United States. If the child was adopted, see Adopted child
below.
For each qualifying child you must either check the box on Form 1040 or Form 1040A, line 6c, column (4), or complete Form 8901 (if the child is not
your dependent).
Form:8901Information on Qualifying Children Who Are Not Dependents
Example.
Your son turned 17 on December 30, 2005. He is a citizen of the United States and you claimed him as a dependent on your return. He is not a
qualifying child for the child tax credit because he was not under age 17 at the end of 2005.
Exceptions to time lived with you condition.
A child is considered to have lived with you for all of 2005 if the child was born or died in 2005 and your home was this child's home for the
entire time he or she was alive. Temporary absences for special circumstances, such as for school, vacation, medical care, military service, or
business, count as time lived at home.
There are also exceptions to the time lived with you condition for kidnapped children and children of divorced or separated parents. For
details, see Residency Test, in chapter 3.
Qualifying child of more than one person.
A special rule applies if your qualifying child is the qualifying child of more than one person. For details, see Special Test for Qualifying
Child of More Than One Person, in chapter 3.
An adopted child is always treated as your own child. An adopted child includes a child lawfully placed with you for legal adoption.
If you are a U.S. citizen or U.S. national and your adopted child lived with you as a member of your household all year, that child meets condition
(5) above to be a qualifying child for the child tax credit.
Amount of CreditChild tax credit:Amount of credit
The maximum amount you can claim for the credit is $1,000 for each qualifying child.
Limits on the CreditChild tax credit:Limits
You must reduce your child tax credit if either (1) or (2) applies.
The amount on Form 1040, line 46 or Form 1040A, line 28 is less than the credit. If this amount is zero, you cannot take this credit because
there is no tax to reduce. But you may be able to take the additional child tax credit. See Additional Child Tax Credit, later.
Your modified adjusted gross income (AGI) is above the amount shown below for your filing status.
Married filing jointly - $110,000.
Single, head of household, or qualifying widow(er) - $75,000.
For purposes of the child tax credit, your modified AGI is your AGI plus the following amounts that may apply to you.
Any amount excluded from income because of the exclusion of income from
Puerto Rico.
Any amount on line 43 or line 48 of Form 2555, Foreign Earned Income.
Any amount on line 18 of Form 2555-EZ, Foreign Earned Income Exclusion.
Any amount on line 15 of Form 4563, Exclusion of Income for Bona Fide Residents of American Samoa.
If you do not have any of the above, your modified AGI is the same as your AGI.
AGI.
Your AGI is the amount on Form 1040, line 38, or Form 1040A, line 22.
Claiming the CreditChild tax credit:Claiming, procedure for
To claim the child tax credit, you must file Form 1040 or Form 1040A. You cannot claim the child tax credit on Form 1040EZ. You must provide the
name and identification number (usually a social security number) on your tax return (or Form 8901) for each qualifying child.
Answer the Questions in your form instructions for Form 1040, line 52 or Form 1040A, line 33 to find out which child tax credit
worksheet you can use to figure the credit.
If you answer Yes to question 1, 2, or 3 in your Form 1040 instructions or question 1 or 2 in your Form 1040A instructions, you must
complete the child tax credit worksheet in Publication 972. Otherwise, you can use the Child Tax Credit Worksheet in your Form 1040 or Form
1040A instructions. (See the filled-in example, later.)
This credit is for certain individuals who get less than the full amount of the child tax credit. The additional child tax credit may give you a
refund even if you do not owe any tax.
How to claim the additional child tax credit.
To claim the additional child tax credit, follow the steps below.
Make sure you figured the amount, if any, of your child tax credit. See Claiming the Credit, earlier.
If you answered Yes on line 4 or line 5 of the Child Tax Credit Worksheet in the Form 1040 or Form 1040A instructions, or
line 13 of the Child Tax Credit Worksheet in Publication 972, use Form 8812 to see if you can take the additional child tax
credit.
If you have an additional child tax credit on line 13 of Form 8812, carry it to Form 1040, line 68 or Form 1040A, line 42.
Checking Your WithholdingChild tax credit:Withholding, checking amountWithholding:Checking amount of
The child tax credit decreases your tax. You can check your tax withholding by using Publication 919, How Do I Adjust My Tax Withholding.
Child tax credit:If you are having too much tax withheld, and you prefer to have the money during the year, you may
be able to decrease your withholding. You do this by completing a new Form W-4 and giving it to your employer.
Example
Amy Brown files as head of household and has two dependent children under age 17. The children are qualifying children for purposes of the child
tax credit. Amy's only income is her salary of $30,350. Amy chooses to itemize her deductions and files Form 1040. Her AGI, shown on line 38 of her
Form 1040, is $30,350. This is her taxable earned income.
Amy does not file Form 2555, 2555-EZ, or 4563. She does not exclude income from Puerto Rico. Her modified AGI is $30,350.
Amy's tax, shown on line 46 of her Form 1040, is $1,334. She claims a $225 credit for child and dependent care expenses on line 48. She claims a
$1,029 earned income credit on line 66a. She has no other credits.
After answering the Questions in the Form 1040 instructions for line 52, she completes the child tax credit worksheet to figure her
child tax credit of $1,109. Amy's completed questions and child tax credit worksheet are shown later.
Amy reads the TIP in the worksheet and finds that she may be able to take the additional child tax credit. See Additional Child Tax
Credit and Amy's completed Form 8812, later.
Filled-in Questions for Amy Brown (Page references are to the Form 1040 instructions.Summary: These are the questions for the taxpayer to use to determine if she should use Pub. 972 to determine the child tax credit she can
claim. They are answered per the example in the text.1. Are you excluding income from Puerto Rico or are you filing any of the following forms? No. Continue checkbox checked2. Is the amount on Form 1040, line 38, more than the amount shown below for your filing status? No. Continue checkbox
checked3. Are you claiming any of the following credits? No. Use the worksheet on page xx to figure your child tax credit. checkbox
checked
Filled-in Child Tax Credit Worksheet--Amy Brown (Page references are to the Form 1040 instructions.)Summary: This is an example of the Child Tax Credit Worksheet with line items completed per the information in the text.1. Number of qualifying child: field contains 2 multiplied by $1,000. Enter the result field contains 2,0002. Enter the amount from Form 1040, line 46. field contains 1,334Under 3. Add the amounts from Form 1040:Line 48: + field contains 225Enter the total. field contains 2254. Are the amounts on lines 2 and 3 the same? No. Subtract line 3 from line 2 checkbox checked and field contains 1,1095. Is the amount on line 1 more than the amount on line 4? Yes. Enter the amount from line 4. Also, you may be able to take the additional
child tax credit. See the TIP below. checkbox checked.This is your child tax credit. Enter this amount on Form 1040, line 52. field contains
1,109Form 8812 Additional Child Tax Credit 2005Summary: This is an example of Form 8812 completed per the information in the text with these line items completed:Name(s) shown on return field contains Amy BrownYour social security number field contains 012-00-5678Under Part I: All Filers:1. Enter the amount from line 1 of your Child Tax Credit Worksheet on page xx of the Form 1040 instructions or page xx of the Form 1040A
instructions. If you used Pub. 972, enter the amount from line 8 of the worksheet on page 4 of the publication field contains 2,0002. Enter the amount from Form 1040, line 52, or Form 1040A, line 33 field contains 1,1093. Subtract line 2 from line 1. If zero, stop; you cannot take this credit field contains 8914. Enter your total taxable earned income. See the instructions on back field contains 30,3505. Is the amount on line 4 more than $11,000? Yes. Subtract $11,000 from the amount on line 4. Enter the result checkbox is checked and field
contains 19,3506. Multiply the amount on line 5 by 15% (.15) and enter the result field contains 2,903Next. Do you have three or more qualifying children? No. If line 6 is zero, stop; you cannot take this credit. Otherwise, skip Part II and
enter the smaller of line 3 or line 6 on line 13 checkbox is checkedUnder Part III Your Additional Child Tax Credit:13. This is your additional child tax credit. Enter this amount on Form 1040, line 68, or Form 1040A, line 42. field contains
891
Education CreditsEducation credits:What's NewKatrina Emergency Tax Relief Act of 2005.
This Act provides tax relief for persons affected by Hurricane Katrina. Under the Act, you may be able to claim an education credit. See
Publication 4492.
Beginning in 2005, the amount of your Hope or lifetime learning credit is gradually reduced (phased out) if your modified adjusted gross income
(MAGI) is between $43,000 and $53,000 ($87,000 and $107,000 if you file a joint return). You cannot claim a credit if your MAGI is $53,000 or more
($107,000 or more if you file a joint return). This is an increase from the 2004 limits of $42,000 and $52,000 ($85,000 and $105,000 if filing a joint
return). For more information, see Effect of the Amount of Your Income on the Amount of Your Credit, later.
This chapter discusses two tax credits (referred to here as education credits) available to persons who pay expenses for higher education. They
are:
The Hope credit, and
The lifetime learning credit.
The chapter will:
Give you general information that applies to both of the credits,
Give you specific information about each of the credits,
Help you choose which of the credits to claim, and
Show you how to figure the credit you choose.
Can you claim both education credits this year.
For each student, you can elect for any year only one of the credits. For example, if you elect to take the Hope credit for a child on your 2005
tax return, you cannot, for that same child, also claim the lifetime learning credit for 2005.
If you are eligible to claim the Hope credit and you are also eligible to claim the lifetime learning credit for the same student in the same year,
you can choose to claim either credit, but not both. For 2005, if the total qualified education expenses for a student are less than $7,500, it will
generally be to your benefit to claim the Hope credit.
If you pay qualified education expenses for more than one student in the same year, you can choose to take credits on a per-student, per-year
basis. This means that, for example, you can claim the Hope credit for one student and the lifetime learning credit for another student in the same
year.
Table 35-1. Comparison of Education Credits
Education credits:Comparison chart (Table 35-1)Hope credit:Comparison with lifetime learning chart (Table 35-1)Lifetime learning credit:Comparison with Hope credit chart (Table 35-1)Tables and figures:Education credits:Comparison chart (Table 35-1)Hope CreditLifetime Learning CreditUp to $1,500 credit per eligible student Up to $2,000 credit per returnAvailable only until the first 2 years of postsecondary education are completed Available for all years of postsecondary
education and for courses to acquire or
improve job skills Available only for 2 years per eligible student Available for an unlimited number of years Student must be pursuing an undergraduate degree or other recognized educational credential Student does not need to be pursuing a degree
or other recognized education credential Student must be enrolled at least half time for at least one academic period beginning during the year
Available for one or more courses No felony drug conviction on student's record Felony drug conviction rule does not apply
Differences between the Hope and lifetime learning credits.
There are several differences between these two credits. For example, you can claim the Hope credit based on the same student's expenses for no
more than 2 years. However, there is no limit on the number of years for which you can claim a lifetime learning credit based on the same student's
expenses. The differences between the two credits are summarized in Table 35-1.
You may be able to take a deduction for your education expenses instead of a credit. Choose the one that will give you the lower tax. See chapter
19 for details about the tuition and fees deduction.
Publication970Tax Benefits for EducationForm (and Instructions)Education Credits (Hope and Lifetime Learning Credits)
Information for Both the Hope and Lifetime Learning Credits
Several rules are common to both education credits. These are discussed below.
Can You Claim a Credit
The following rules will help you determine if you are eligible to claim an education credit on your tax return.
Who Can Claim a CreditEducation credits:General requirements
Generally, you can claim an education credit if all three of the following requirements are met.
You pay qualified education expenses of higher education.
You pay the education expenses for an eligible student.
The eligible student is either yourself, your spouse, or a dependent for whom you claim an exemption on your tax return.
Note.
Qualified education expenses paid by a dependent for whom you claim an exemption, or by a third party for that dependent, are considered paid by
you.
Qualified education expenses are defined below under What Expenses Qualify. Eligible students are defined later under
Who Is an Eligible Student. A dependent for whom you claim an exemption is defined later under Who Can Claim a Dependent's
Expenses
You may find Figure 35-A, later in this chapter, helpful in determining if you can claim an education credit on your tax return.
Who Cannot Claim a CreditEducation credits:Who cannot claim
You cannot claim an education credit for 2005 if any of the following apply.
You are listed as a dependent in the Exemptions section on another person's tax return (such as your parents'). See Who Can
Claim a Dependent's Expenses, later.
Your MAGI is $53,000 or more ($107,000 or more in the case of a joint return). MAGI is explained later under Effect of the Amount of
Your Income on the Amount of Your Credit.
You (or your spouse) were a nonresident alien for any part of 2005 and the nonresident alien did not elect to be treated as a resident alien
for tax purposes. More information on nonresident aliens can be found in Publication 519, U.S. Tax Guide for Aliens.
You claim a tuition and fees deduction for the same student in 2005.
The education credits are based on qualified education expenses you pay for yourself, your spouse, or a dependent for whom you claim an exemption
on your tax return. Generally, a credit is allowed for qualified education expenses paid in 2005 for an academic period beginning in 2005 or in the
first 3 months of 2006.
For example, if you paid $1,500 in December 2005 for qualified tuition for the Spring 2006 semester beginning in January 2006, you may be able to
use that $1,500 in figuring your 2005 credit.
Academic period.Academic periodname of benefitEducation credits:Academic period
An academic period includes a semester, trimester, quarter, or other period of study (such as a summer school session) as reasonably determined by
an educational institution. In the case of an educational institution that uses credit hours or clock hours and does not have academic terms, each
payment period can be treated as an academic period.
Paid with borrowed funds.
You can claim an education credit for qualified education expenses paid with the proceeds of a loan. You use the expenses to figure the education
credit for the year in which the expenses are paid, not the year in which the loan is repaid. Treat loan payments sent directly to the educational
institution as paid on the date the institution credits the student's account.
Student withdraws from class(es).
You can claim an education credit for qualified education expenses not refunded when a student withdraws.
Qualified Education Expenses
For purposes of an education credit, qualified education expenses are tuition and certain related expenses required for enrollment or attendance at
an eligible educational institution.
An eligible educational institution is any college, university, vocational school, or other postsecondary educational institution eligible to
participate in a student aid program administered by the Department of Education. It includes virtually all accredited public, nonprofit, and
proprietary (privately owned profit-making) postsecondary institutions. The educational institution should be able to tell you if it is an eligible
educational institution.
Certain educational institutions located outside the United States also participate in the U.S. Department of Education's Federal Student Aid (FSA)
programs.
Related expenses.
Student-activity fees and expenses for course-related books, supplies, and equipment are included in qualified education expenses only if the fees
and expenses must be paid to the institution as a condition of enrollment or attendance.
In the following examples, assume that each student is an eligible student at an eligible educational institution.
Example 1.
Jackson is a sophomore in University V's degree program in dentistry. This year, in addition to tuition, he is required to pay a fee to the
university for the rental of the dental equipment he will use in this program. Because the equipment rental fee must be paid to University V for
enrollment and attendance, Jackson's equipment rental fee is a qualified expense.
Example 2.
Donna and Charles, both first-year students at College W, are required to have certain books and other reading materials to use in their mandatory
first-year classes. The college has no policy about how students should obtain these materials, but any student who purchases them from College W's
bookstore will receive a bill directly from the college. Charles bought his books from a friend, so what he paid for them is not a qualified education
expense. Donna bought hers at College W's bookstore. Although Donna paid College W directly for her first-year books and materials, her payment is not
a qualified expense because the books and materials are not required to be purchased from College W for enrollment or attendance at the institution.
Example 3.
When Marci enrolled at College X for her freshman year, she had to pay a separate student activity fee in addition to her tuition. This activity
fee is required of all students, and is used solely to fund on-campus organizations and activities run by students, such as the student newspaper and
the student government. No portion of the fee covers personal expenses. Although labeled as a student activity fee, the fee is required for Marci's
enrollment and attendance at College X. Therefore, it is a qualified expense.
No Double Benefit Allowed
You cannot do any of the following.
Deduct higher education expenses on your income tax return (as, for example, a business expense) and also claim an education credit based on
those same expenses.
Claim an education credit in the same year that you are claiming a tuition and fees deduction for the same student.
Claim a Hope credit and a lifetime learning credit based on the same qualified education expenses.
Claim an education credit based on the same expenses used to figure the tax-free portion of a distribution from a Coverdell education
savings account (ESA) or qualified tuition program (QTP).
Claim a credit based on qualified education expenses paid with tax-free scholarship, grant, or employer-provided educational assistance. See
Adjustments to Qualified Education Expenses, next.
Adjustments to Qualified Education Expenses
If you pay qualified education expenses with certain tax-free funds, you cannot claim a credit for those amounts. You must reduce the qualified
education expenses by the amount of any tax-free educational assistance and refund(s) you received.
Tax-free educational assistance.
This includes:
Tax-free parts of scholarships and fellowships (see chapter 12 of this publication and chapter 1 of Publication 970),
Pell grants (see chapter 1 of Publication 970),
Employer-provided educational assistance (see chapter 11 of Publication 970),
Veterans' educational assistance (see chapter 1 of Publication 970), and
Any other nontaxable (tax-free) payments (other than gifts or inheritances) received as educational assistance.
Refunds.Education credits:Refund of expensesRefund of expensesname of benefit
Qualified education expenses do not include expenses for which you, or someone else who paid qualified education expenses on behalf of a student,
receive a refund. For more information, see Refunds in chapters 2 and 3 of Publication 970.
Amounts that do not reduce qualified education expenses.
Do not reduce qualified education expenses by amounts paid with funds the student receives as:
Payment for services, such as wages,
A loan,
A gift,
An inheritance, or
A withdrawal from the student's personal savings.
Do not reduce the qualified education expenses by any scholarship or fellowship reported as income on the student's tax return in the following
situations.
The use of the money is restricted to costs of attendance (such as room and board) other than qualified education expenses.
The use of the money is not restricted and is used to pay education expenses that are not qualified (such as room and board).
Example 1.
In 2005, Jackie paid $3,000 for tuition and $5,000 for room and board at University X. The university did not require her to pay any fees in
addition to her tuition in order to enroll in or attend classes. To help pay these costs, she was awarded a $2,000 scholarship and a $4,000 student
loan.
The terms of the scholarship state that it may be used to pay any of Jackie's college expenses. Because she applied it toward her tuition, the
scholarship is tax free. Therefore, for purposes of figuring an education credit (either Hope or lifetime learning), she must first use the $2,000
scholarship to reduce her tuition (her only qualified education expense). The student loan is not tax-free educational assistance, so she does not use
it to reduce her qualified expenses. Jackie is treated as having paid $1,000 in qualified education expenses ($3,000 tuition – $2,000
scholarship) in 2005.
Example 2.
The facts are the same as in Example 1, except that Jackie uses the $2,000 scholarship to pay room and board, and, therefore, reports
her entire scholarship as income on her tax return. In this case, the scholarship is allocated to expenses other than qualified education expenses.
Jackie is treated as paying the entire $3,000 tuition with other funds and can figure her education credit on the entire $3,000.
Expenses That Do Not Qualify
Qualified education expenses do not include amounts paid for:
Insurance,
Medical expenses (including student health fees),
Room and board,
Transportation, or
Similar personal, living, or family expenses.
This is true even if the amount must be paid to the institution as a condition of enrollment or attendance.
Sports, games, hobbies, and noncredit courses.
Qualified education expenses generally do not include expenses that relate to any course of instruction or other education that involves sports,
games or hobbies, or any noncredit course. However, if the course of instruction or other education is part of the student's degree program, these
expenses can qualify.
Comprehensive or bundled fees.Fees, comprehensive/ bundled
Some eligible educational institutions combine all of their fees for an academic period into one amount. If you do not receive or do not have
access to an allocation showing how much you paid for qualified education expenses and how much you paid for personal expenses, such as those listed
above, contact the institution. The institution is required to make this allocation and provide you with the amount you paid (or were billed) for
qualified education expenses on Form 1098-T, Tuition Statement.
Form:1098-TSee Figuring the Credit, later, for more information about Form 1098-T.
If there are qualified education expenses for your dependent for a year, either you or your dependent, but not both of you, can claim an education
credit for your dependent's expenses for that year.
For you to claim an education credit for your dependent's expenses, you must also claim an exemption for your dependent. You do this by listing
your dependent's name and other required information on Form 1040 (or Form 1040A), line 6c.
IF you...THEN only...claim an exemption on your tax return for a dependent who is an eligible studentyou can claim an education credit based on that dependent's expenses. The dependent cannot claim a credit.do not claim an exemption on your tax return for a dependent who is an eligible student (even if entitled
to the exemption)the dependent can claim an education credit. You cannot claim a credit based on this dependent's
expenses.
Expenses paid by dependent.
If you claim an exemption on your tax return for an eligible student who is your dependent, treat any expenses paid (or deemed paid) by your
dependent as if you had paid them. Include these expenses when figuring the amount of your education credit.
Qualified education expenses paid directly to an eligible educational institution for your dependent under a court-approved divorce decree are
treated as paid by your dependent.
Expenses paid by you.
If you claim an exemption for a dependent who is an eligible student, only you can include any expenses you paid when figuring the amount of an
education credit. If neither you nor anyone else claims an exemption for the dependent, only the dependent can include any expenses you paid when
figuring an education credit.
Expenses paid by others.
Someone other than you, your spouse, or your dependent (such as a relative or former spouse) may make a payment directly to an eligible educational
institution to pay for an eligible student's qualified education expenses. In this case, the student is treated as receiving the payment from the
other person and, in turn, paying the institution. If you claim an exemption on your tax return for the student, you are considered to have paid the
expenses.
Example.
In 2005, Ms. Allen makes a payment directly to an eligible educational institution for her grandson Todd's qualified education expenses. For
purposes of claiming an education credit, Todd is treated as receiving the money as a gift from his grandmother and, in turn, paying his qualified
education expenses himself.
Unless an exemption for Todd is claimed on someone else's return, only Todd can use the payment to claim an education credit.
If anyone, such as Todd's parents, claims an exemption for Todd on his or her tax return, whoever claims the exemption may be able to use the
expenses to claim an education credit. If anyone else claims an exemption for Todd, Todd cannot claim an education credit.
Tuition reduction.
When an eligible educational institution provides a reduction in tuition to an employee of the institution (or spouse or dependent child of an
employee), the amount of the reduction may or may not be taxable. If it is taxable, the employee is treated as receiving a payment of that amount and,
in turn, paying it to the educational institution on behalf of the student. For more information on tuition reductions, see Qualified Tuition
Reduction in chapter 1 of Publication 970.
Dependent's education expenses, claiming:Education creditEducation credits:Dependent's education expenses, claimingEffect of the Amount of Your Income on the Amount of Your CreditEducation credits:Income limitsEducation credits:Phaseout of credit
The amount of your education credit is phased out (gradually reduced) if your MAGI is between $43,000 and $53,000 ($87,000 and $107,000 if you file
a joint return). You cannot claim an education credit if your MAGI is $53,000 or more ($107,000 or more if you file a joint return).
Modified adjusted gross income (MAGI).Education credits:Modified adjusted gross income (MAGI)Hope creditModified adjusted gross income (MAGI)Lifetime learning creditModified adjusted gross income (MAGI)Modified adjusted gross income (MAGI):Education creditsHope creditLifetime learning credit
For most taxpayers, MAGI is adjusted gross income (AGI) as figured on their federal income tax return.
MAGI when using Form 1040A.
If you file Form 1040A, your MAGI is the AGI on line 22 of that form.
MAGI when using Form 1040.
If you file Form 1040, your MAGI is the AGI on line 38 of that form, modified by adding back any:
Foreign earned income exclusion,
Foreign housing exclusion,
Exclusion of income for bona fide residents of American Samoa, and
Exclusion of income from Puerto Rico.
Phaseout.
If your MAGI is within the range of incomes where the credit must be reduced, you will figure your reduced credit using lines 7–13 of Form
8863.
When Must the Credit Be Repaid (Recaptured)Education credits:Recapture of:Timing of
If, after you file your 2005 tax return, you or someone else receives tax-free educational assistance for, or a refund of, an expense you used to
figure an education credit on that return, you may have to repay all or part of the credit. You must refigure your education credit(s) for 2005 as if
the assistance or refund was received in 2005. Subtract the amount of the refigured credit from the amount of the credit you claimed. The result is
the amount you must repay. You add the repayment (recapture) to your tax liability for the year in which you receive the assistance or refund (see the
instructions for your tax return for that year). Your original 2005 tax return does not change.
Figure 35-A. Can You Claim an Education Credit for 2005?Summary: This flowchart is used to determine if you qualify to claim an education credit for 2005.StartThis is the start of the flowchart.Decision (1)Did *you pay qualified education expenses in 2005 for an eligible student?IF YES continue to Decision (2)IF NO continue to Process (a)Decision (2)Did the academic period for which you paid qualified education expenses begin in 2005 or the first 3 months of 2006?IF YES continue to Decision (3)IF NO continue to Process (a)Decision (3)Is the eligible student you, your spouse (if married filing jointly), or your dependent for whom you claim an exemption on your tax
return?IF YES continue to Decision (4)IF NO continue to Process (a)Decision (4)Are you listed as a dependent on another person's tax return?IF YES continue to Process (a)IF NO continue to Decision (5)Decision (5)Is your filing status married filing separately?IF YES continue to Process (a)IF NO continue to Decision (6)Decision (6)Were you (or your spouse) a nonresident alien for any part of 2005 who did not elect to be treated as a resident alien for tax
purposes?IF YES continue to Process (a)IF NO continue to Decision (7)Decision (7)Is your modified adjusted gross income (MAGI) less than $53,000 ($107,000 if married filing jointly)?IF YES continue to Decision (8)IF NO continue to Process (a)Decision (8)Do you have a tax liability (Form 1040, line 46 minus lines 47, 48, and 49) (Form 1040A, line 28 minus lines 29 and 30)?IF YES continue to Decision (9)IF NO continue to Process (a)Decision (9)Did you claim a lifetime learning credit or a tuition and fees deduction for the same student?IF YES continue to Process (a)IF NO continue to Decision (10)Decision (10)Did you use the same expenses to claim a deduction or credit, or to figure the tax-free portion of a Coverdell ESA or QTP
distribution?IF YES continue to Process (a)IF NO continue to Decision (11)Decision (11)Were the same expenses paid with tax-free scholarship, fellowship, grant, or employer-provided educational assistance?IF YES continue to Process (a)IF NO continue to Decision (12)Decision (12)Did you, or someone else who paid these expenses on behalf of a student, receive a refund of all the expenses?IF YES continue to Process (a)IF NO continue to Process (b)Process (a)You cannot claim an education credit for 2005.Continue to EndProcess (b)You can claim an education credit for 2005.Continue to End*Qualified education expenses paid by a dependent for whom you claim an exemption, or by a third party for that dependent, are considered
paid by you.EndThis is the end of the flowchart.Education credits:Can you claim (Figure 35-A)Hope credit:Can you claim (Figure 35-A)Lifetime learning credit:Can you claim (Figure 35-A)Tables and figures:Education credits:Can you claim (Figure 35-A)Information for Only the Hope CreditEducation credits:Hope creditHope credit:TuitionHope credit
You may be able to claim a Hope credit of up to $1,500 for qualified education expenses paid for each eligible student.
Who Is an Eligible StudentHope credit:Eligible studentEligible student:Hope credit
To claim the Hope credit, the student for whom you pay qualified education expenses must be an eligible student. This is a student who meets all of
the following requirements.
The student did not have expenses that were used to figure a Hope credit in any 2 earlier tax years.
The student had not completed the first 2 years of postsecondary education (generally, the freshman and sophomore years of college) before
2005.
For at least one academic period beginning in 2005, the student was enrolled at least half-time in a program leading to a degree,
certificate, or other recognized educational credential.
The student was free of any federal or state felony conviction for possessing or distributing a controlled substance as of the end of
2005.
Completion of first 2 years.
A student who was awarded 2 years of academic credit for postsecondary work completed before 2005 has completed the first 2 years of postsecondary
education. This student generally would not be an eligible student for purposes of the Hope credit.
Exception.
Any academic credit awarded solely on the basis of the student's performance on proficiency examinations is disregarded in determining whether the
student has completed 2 years of postsecondary education.
Enrolled at least half-time.
A student was enrolled at least half-time if the student was taking at least half the normal full-time work load for his or her course of study.
The standard for what is half of the normal full-time work load is determined by each eligible educational institution. However, the standard may
not be lower than any of those established by the Department of Education under the Higher Education Act of 1965.
Example 1.
Marty graduated from high school in June 2004. In September, he enrolled in an undergraduate degree program at College U, and attended full time
for both the 2004 Fall and 2005 Spring semesters. For the 2005 Fall semester, Marty was enrolled less than half-time. Because Marty was enrolled in an
undergraduate degree program on at least a half-time basis for at least one academic period that began during 2004 and at least one academic period
that began during 2005, he is an eligible student for tax years 2004 and 2005 (including the 2005 Fall semester when he enrolled at College U on less
than a half-time basis).
Example 2.
After taking classes at College V on a half-time basis for the 2004 Spring and Fall semesters, Sharon became a full-time student for the 2005
Spring semester. College V classified Sharon as a second-semester sophomore for the 2005 Spring semester and as a first-semester junior for the 2005
Fall semester. Because College V did not classify Sharon as having completed the first two years of postsecondary education as of the beginning of
2005, Sharon is an eligible student for tax year 2005. Therefore, the qualified education expenses paid for the 2005 Spring semester and the 2005 Fall
semester are taken into account in calculating any Hope credit for 2005.
Example 3.
During the 2004 Fall semester, Luis was a high school student who took classes on a half-time basis at College X. Luis was not enrolled as part of
a degree program at College X because College X only admits students to a degree program if they have a high school diploma or equivalent. Because
Luis was not enrolled in a degree program at College X during 2004, Luis was not an eligible student for tax year 2004.
Example 4.
The facts are the same as in Example 3. During the 2005 Spring semester, Luis again attended College X but not as part of a degree
program. Luis graduated from high school in June 2005. For the 2005 Fall semester, Luis enrolled as a full-time student in College X as part of a
degree program, and College X awarded Luis credit for his prior coursework at College X. Because Luis was enrolled in a degree program at College X
for the 2005 Fall term on at least a half-time basis, Luis is an eligible student for all of tax year 2005. Therefore, the qualified education
expenses paid for classes taken at College X during both the 2005 Spring semester (during which Luis was not enrolled in a degree program) and the
2005 Fall semester are taken into account in computing any Hope credit.
Example 5.
Diana graduated from high school in June 2003. In January 2004, Diana enrolled in a one-year postsecondary certificate program on a full-time basis
to obtain a certificate as a travel agent. Diana completed the program in December 2004, and was awarded a certificate. In January 2005, she enrolled
in a one-year postsecondary certificate program on a full-time basis to obtain a certificate as a computer programmer. Diana is an eligible student
for both tax years 2004 and 2005 because she meets the degree requirement, the work load requirement, and the year of study requirement for those
years.
Hope credit:Eligible studentEligible student:Hope creditFiguring the CreditHope credit:Figuring the credit
The amount of the Hope credit (per eligible student) is the sum of:
100% of the first $1,000 of qualified education expenses you paid for the eligible student, and
50% of the next $1,000 of qualified education expenses you paid for that student.
The maximum amount of Hope credit you can claim in 2005 is $1,500 times the number of eligible students. You can claim the full $1,500 for each
eligible student for whom you paid at least $2,000 of qualified education expenses. However, the credit may be reduced based on your MAGI. See
Effect of the Amount of Your Income on the Amount of Your Credit, earlier.
Example.
Jon and Karen Frost are married and file a joint tax return. For 2005, they claim an exemption for their dependent daughter on their tax return.
Their MAGI is $70,000. Their daughter is in her sophomore (second) year of studies at the local university. Jon and Karen paid qualified education
expenses of $4,300 in 2005.
Jon and Karen, their daughter, and the local university meet all of the requirements for the Hope credit. Jon and Karen can claim a $1,500 Hope
credit in 2005. This is 100% of the first $1,000 of qualified education expenses, plus 50% of the next $1,000.
Form 1098-T.Form:1098-T
To help you figure your Hope credit, you should receive Form 1098-T. Generally, an eligible educational institution (such as a college or
university) must send Form 1098-T (or acceptable substitute) to each enrolled student by January 31, 2006.
Claiming the CreditHope credit:Claiming the credit
You claim the Hope credit by completing Parts I and III of Form 8863
Form:8863 and submitting it with your Form 1040 or 1040A. Enter the credit on Form 1040, line 50, or on Form 1040A, line 31. An
illustrated example using Form 8863 appears at the end of this chapter.
Information for Only the Lifetime Learning Credit
You may be able to claim a lifetime learning credit of up to $2,000 for qualified education expenses paid for all students enrolled in eligible
educational institutions.
Who Is an Eligible StudentLifetime learning credit:Eligible studentEligible student:Lifetime learning credit
For purposes of the lifetime learning credit, an eligible student is a student who is enrolled in one or more courses at an eligible educational
institution.
Figuring the CreditLifetime learning credit:Figuring the credit
The amount of the lifetime learning credit is 20% of the first $10,000 of qualified education expenses you paid for all eligible students. The
maximum amount of lifetime learning credit you can claim for 2005 is $2,000 (20% × $10,000). However, that amount may be reduced based on your
MAGI. See Effect of the Amount of Your Income on the Amount of Your Credit, earlier.
Example.
Bruce and Toni are married and file a joint tax return. For 2005, their MAGI is $75,000. Toni is attending a local college (an eligible educational
institution) to earn credits toward a degree in nursing. She already has a bachelor's degree in history and wants to become a nurse. In August 2005,
Toni paid $6,000 of qualified education expenses for her Fall 2005 semester. Bruce and Toni can claim a $1,200 (20% × $6,000) lifetime learning
credit on their 2005 joint tax return.
Form 1098-T.Form:1098-T
To help you figure your lifetime learning credit, you should receive Form 1098-T. Generally, an eligible educational institution (such as a college
or university) must send Form 1098-T (or acceptable substitute) to each enrolled student by January 31, 2006.
Lifetime learning credit:Figuring the creditClaiming the CreditLifetime learning credit:Claiming the credit
You claim the lifetime learning credit by completing Parts II and III of Form 8863
Form:8863and submitting it with your Form 1040 or 1040A. Enter the credit on Form 1040, line 50, or Form 1040A, line 31. An
illustrated example using Form 8863 is shown at the end of this chapter.
Dave and Valerie Jones are married and file a joint tax return. For 2005, they claim exemptions for their two dependent children on their tax
return. Their modified adjusted gross income is $90,000. Their tax, before credits, is $9,956. Their son, Sean, will receive his bachelor's degree in
psychology from the state college in May 2006. Their daughter, Corey, enrolled full-time at that same college in August 2004, to begin working on her
bachelor's degree in physical education. In July 2005, Dave and Valerie paid $2,200 in tuition costs for each child for the Fall 2005 semester. In
December 2005, they also paid $2,600 of tuition for each child for the Spring 2006 semester that begins in January.
Dave and Valerie, their children, and the college meet all of the requirements for the higher education credits. Because Sean is beyond the second
(sophomore) year of his postsecondary education, his expenses do not qualify for the Hope credit. But, amounts paid for Sean's expenses in 2005 for
academic periods beginning in 2005 and the first 3 months of 2006 qualify for the lifetime learning credit. Corey is in her first two (freshman and
sophomore) years of postsecondary education, and expenses paid for her in 2005, for academic periods beginning in 2005 and January 2006, qualify for
the Hope credit.
Education credits:Dave and Valerie figure their tentative education credits for 2005, $2,460, as shown in the
completed Form 8863. They cannot claim the full amount because their modified adjusted gross income is more than $87,000. They carry the amount from
line 19 of Form 8863, $2,091, to line 50 of Form 1040, and they attach the Form 8863 to their return.
Form 8863 Education Credits (Hope and Lifetime Learning Credits) 2005Summary: This is an example of Form 8863 (2005) as pertains to the description in the text. The line items completed are:Name(s) shown on return field contains Dave and Valerie JonesYour social security number field contains 987-00-6543Under
Part I: Hope Credit:1a. Student's name (as shown on page 1 of your tax return:First name field contains CoreyLast name field contains Jones1b. Student's social security number (as shown on page 1 of your tax return) field contains 137-00-96421c. Qualified expenses (see instructions). Do not enter more than $2,000 for each student. field contains 2,0001d. Enter the smaller of the amount in column (c) or $1,000 field contains 1,0001e. Add column (c) and column (d) field contains 3,0001f. Enter one-half of the amount in column (e) field contains 1,5002. Tentative Hope credit. Add the amounts on line 1, column (f). If you are taking the lifetime learning credit for another student, go to
Part II; otherwise, go to Part III field contains 1,500Under
Part II: Lifetime Learning Credit:3a. Student's name (as shown on page 1 of your tax return)First name field contains SeanLast name field contains Jones3b. Student's social security number (as shown on page 1 of your tax return) field contains 246-00-97313c. Qualified expenses (see instructions) field contains 4,8004. Add the amounts on line 3, column (c), and enter the total field contains 4,8005. Enter the smaller of line 4 or $10,000 field contains 4,8006. Tentative lifetime learning credit. Multiply line 5by 20% (.20) and go to Part III field contains
960Under
Part III: Allowable Education Credits:7. Tentative education credits. Add lines 2and 6 field contains 2,4608. Enter: $107,000 if married filing jointly; $53,000 if single, head of household, or qualifying widow(er) field contains
107,0009. Enter the amount from Form 1040, line 38, or Form 1040A, line 22 (Footnote: See Publication 970 for the amount to enter if you are filing
Form 2555, 2555-EZ, or 4563 or you are excluding income from Puerto Rico) field contains 90,00010. Subtract line 9 from line 8. If zero or less, stop; you cannot take any education credits field contains 17,00011. Enter: $20,000 if married filing jointly; $10,000 if single, head of household, or qualifying widow(er) field contains
20,00012. If line 10 is equal to or more than line 11, enter the amount from line 7on line 13 and go to line 14. If line 10 is less than line 11,
divide line 10 by line 11. Enter the result as a decimal (rounded to at least three places) field contains .85013. Multiply line 7 by line 12 field contains 2,09114. Enter the amount from Form 1040, line 46, or Form 1040A, line 28 field contains 9,95615. Enter the total, if any, of your credits from Form 1040, lines 47 through 49, or Form 1040A, lines 29 and 30 field contains
016. Subtract line 15 from line 14. If zero or less, stop; you cannot take any education credits field contains 9,95617. Education credits. Enter the smaller of line 13 or line 16 here and on Form 1040, line 50, or Form 1040A, line 31 field contains
2,091Earned Income CreditCredits:Earned incomeEarned Income CreditWhat's NewQualifying child.
There are some changes to the definition of qualifying child. A qualifying child can include your eligible foster child, your brother, or your
sister, whether or not you care for them as you would your own child. See Rule 8.
If you and someone else have the same qualifying child, only one of you can use that child to claim the following tax benefits: the child's
exemption, the child tax credit, head of household filing status, the credit for child and dependent care expenses, and the EIC. The other person
cannot take any of these five tax benefits unless he or she has a different qualifying child. For details, see Rule 9.
Earned income amount is more.
The maximum amount of income you can earn and still get the credit has increased. You may be able to take the credit if:
You have more than one qualifying child and you earned less than $35,263 ($37,263 if married filing jointly),
You have one qualifying child and you earned less than $31,030 ($33,030 if married filing jointly), or
You do not have a qualifying child and you earned less than $11,750 ($13,750 if married filing jointly).
Your adjusted gross income also must be less than the amount in the above list that applies to you. For details, see Rules 1 and
15.
Katrina Emergency Tax Relief Act of 2005.
This Act provides tax relief for persons affected by Hurricane Katrina. Under the Act, you may be able to figure your 2005 EIC using your 2004
earned income if your 2005 earned income is less than your 2004 earned income.
You may also be able to claim a student as a qualifying child even if he or she was prevented from completing the normal school term. See
Publication 4492.
Investment income amount is more.
The maximum amount of investment income you can have and still get the credit has increased to $2,700. See Rule 6.
Form 8836.Form:8836
If you received Form 8836, Qualifying Children Residency Statement, you have been selected to participate in the EIC certification pilot program.
File the form with the IRS, following the form instructions, to show that your child met the residency test described in Rule 8. If you did
not receive the form, you do not need to get it or file it. You have to file Form 8836 only if it was mailed to you.
RemindersIncreased EIC on certain joint returns.
A married person filing a joint return may get more EIC than someone with the same income but a different filing status. As a result, the EIC table
has different columns for married persons filing jointly than for everyone else. When you look up your EIC in the EIC Table, be sure to use the
correct column for your filing status and the number of children you have.
Advance payment of the earned income credit in your paycheck.
If you expect to qualify for the earned income credit in 2006, you can receive part of it in each paycheck throughout the year. See Advance
Earned Income Credit, later, for more information.
You can use the EITC Assistant at
www.irs.gov/eitc to find out if you are eligible for the
credit. The EITC Assistant is available in English and Spanish.
EIC questioned by IRS.
The IRS may ask you to provide documents to prove you are entitled to claim the EIC. We will tell you what documents to send us. These may include:
birth certificates, school records, medical records, etc. We will also send you a letter with the name, address, and telephone number of the IRS
employee assigned to your case. The process of establishing your eligibility will delay your refund.
The earned income credit (EIC) is a tax credit for certain people who work and have less than $37,263 of earned income. A tax credit usually means
more money in your pocket. It reduces the amount of tax you owe. The EIC may also give you a refund.
How do you get the earned income credit?
To claim the EIC, you must:
Qualify by meeting certain rules, and
File a tax return, even if you:
Do not owe any tax,
Did not earn enough money to file a return, or
Did not have income taxes withheld from your pay.
When you complete your return, you can figure your EIC by using a worksheet in the instructions for Form 1040, Form 1040A, or Form 1040EZ. Or, if
you prefer, you can let the IRS figure the credit for you.
How will this chapter help you?
This chapter will explain the following:
The rules you must meet to qualify for the EIC,
How to figure the EIC, and
How to get advance payment of the EIC in your paycheck.
Publication596Earned Income Credit (EIC)Form (and Instructions)Earned Income Credit (Qualifying Child Information)Earned Income Credit Advance Payment CertificateInformation To Claim Earned Income Credit After Disallowance
Do You Qualify for the Credit?
To qualify to claim the EIC, you must first meet all of the rules explained in Part A, Rules for Everyone. Then you must meet the rules
in Part B, Rules If You Have a Qualifying Child, or Part C, Rules If You Do Not Have a Qualifying Child. There is one final rule
you must meet in Part D, Figuring and Claiming the EIC. You qualify for the credit if you meet all the rules in each part that applies to
you.
If you have a qualifying child, the rules in Parts A, B, and D apply to you.
If you do not have a qualifying child, the rules in Parts A, C, and D apply to you.
Table 36-1, Earned Income Credit in a Nutshell.
Use Table 36-1 as a guide to Parts A, B, C, and D. The table is a summary of all the rules in each part.
Do you have a qualifying child?
You have a qualifying child only if you have a child who meets the three tests described in Rule 8 and illustrated in Figure 36-1.
If Improper Claim
Made in Prior YearForm:8862
If your EIC for any year after 1996 was denied or reduced for any reason other than a math or clerical error, you must attach a completed Form 8862
to your next tax return to claim the EIC. You must also qualify to claim the EIC by meeting the rules described in this chapter.
However, if your EIC was denied or reduced as a result of a math or clerical error, do not attach Form 8862 to your next tax return. For example,
if your arithmetic is incorrect, the IRS can correct it. If you do not provide a correct social security number, the IRS can deny the EIC. These kinds
of errors are called math or clerical errors.
If your EIC for any year after 1996 was denied and it was determined that your error was due to reckless or intentional disregard of the EIC rules,
then you cannot claim the EIC for the next 2 years. If your error was due to fraud, then you cannot claim the EIC for the next 10 years.
More information.
See chapter 5 in Publication 596 for more detailed information about the disallowance period and Form 8862.
Part A. Rules for Everyone
This part of the chapter discusses Rules 1 through 7. You must meet all seven rules to qualify for the earned income credit.
If you do not meet all seven rules, you cannot get the credit and you do not need to read the rest of the chapter.
If you meet all seven rules in this part, then read either Part B or Part C (whichever applies) for more rules you must meet.
Rule 1. Your AGI Must Be Less Than:
$35,263 ($37,263 for married filing jointly) if you have more than one qualifying child,
$31,030 ($33,030 for married filing jointly) if you have one qualifying child, or
$11,750 ($13,750 for married filing jointly) if you do not have a qualifying child.
Adjusted gross income (AGI).
AGI is the amount on line 38 (Form 1040), line 22 (Form 1040A), or line 4 (Form 1040EZ). If your AGI is equal to or more than the applicable limit
listed above, you cannot claim the EIC.
Example.
Your AGI is $32,500, you are single, and you have one qualifying child. You cannot claim the EIC because your AGI is not less than $31,030.
However, if your filing status was married filing jointly, you might be able to claim the EIC because your AGI is less than $33,030.
Community property.
If you are married, but qualify to file as head of household under special rules for married taxpayers living apart (see Rule 3), and
live in a state that has community property laws, your AGI includes that portion of both your and your spouse's wages that you are required to include
in gross income. This is different from the community property rules that apply under Rule 7.
<ROM>Table 36-1.</ROM> Earned Income Credit in a NutshellFirst, you must meet all the rules in this column.Second, you must meet all the rules in one of these columns, whichever
applies.Third, you must meet the rule in this column.Part A.
Rules for EveryonePart B.
Rules If You Have a Qualifying ChildPart C.
Rules If You Do Not Have a Qualifying ChildPart D.
Figuring and Claiming the EIC1. Your adjusted gross income (AGI) must be less than:
•$35,263 ($37,263 for married filing jointly) if you have more than one qualifying child,
•$31,030 ($33,030 for married filing jointly) if you have one qualifying child, or
•$11,750 ($13,750 for married filing jointly) if you do not have a qualifying child.2. You must have a valid social security number.
3. Your filing status cannot be Married filing separately.4. You must be a U.S. citizen or resident alien all year.
5. You cannot file Form 2555 or Form 2555-EZ (relating to foreign earned income).
6. Your investment income must be $2,700 or less.
7. You must have earned income. 8. Your child must meet the relationship, age, and residency tests.
9. Your qualifying child cannot be used by more than one person to claim the EIC.
10. You cannot be a qualifying child of another person. 11. You must be at least age 25 but under age 65.
12. You cannot be the dependent of another person.
13. You cannot be a qualifying child of another person.
14. You must have lived in the United States more than half of the year. 15. Your earned income must be less than:
•$35,263 ($37,263 for married filing jointly) if you have more than one qualifying child,
•$31,030 ($33,030 for married filing jointly) if you have one qualifying child, or
•$11,750 ($13,750 for married filing jointly) if you do not have a qualifying child.
Social Security Numbers (SSNs):Earned Income CreditSocial Security CardRule 2. You Must Have a Valid Social Security Number (SSN)
To claim the EIC, you (and your spouse if filing a joint return) must have a valid SSN issued by the Social Security Administration (SSA). Any
qualifying child listed on Schedule EIC also must have a valid SSN. (See Rule 8 if you have a qualifying child.)
If your social security card (or your spouse's if filing a joint return) says Not valid for employment and your SSN was issued so that you
(or your spouse) could get a federally funded benefit, you cannot get the EIC. An example of a federally funded benefit is Medicaid.
If you have a card with the legend Not valid for employment and your immigration status has changed so that you are now a U.S. citizen or
permanent resident, ask the SSA for a new social security card without the legend.
U. S. citizen.
If you were a U. S. citizen when you received your SSN, you have a valid SSN.
Valid for work only with INS or DHS authorization.
If your social security card reads Valid for work only with INS authorization, or Valid for work only with DHS authorization, you
have a valid SSN.
SSN missing or incorrect.
If an SSN for you or your spouse is missing from your tax return or is incorrect, you may not get the EIC.
Other taxpayer identification number.
You cannot get the EIC if, instead of an SSN, you (or your spouse if filing a joint return) have an individual taxpayer identification number
(ITIN). ITINs are issued by the Internal Revenue Service to noncitizens who cannot get an SSN.
No SSN.
If you do not have a valid SSN, put No next to line 66a (Form 1040), line 41a (Form 1040A), or line 8a (Form 1040EZ). You cannot claim the
EIC.
Form:SS-5Getting an SSN.
If you (or your spouse if filing a joint return) do not have an SSN, you can apply for one by filing Form SS-5, Application for a Social Security
Card, with the Social Security Administration.
Filing deadline approaching and still no SSN.
If the filing deadline is approaching and you still do not have an SSN, you have two choices.
Request an automatic 6-month extension of time to file your return. You can get this extension by filing Form 4868, Application for
Automatic Extension of Time to File U.S. Individual Income Tax Return. For more information, see chapter 1.
File the return on time without claiming the EIC. After receiving the SSN, file an amended return (Form 1040X, Amended U.S. Individual
Income Tax Return) claiming the EIC. Attach a filled-in Schedule EIC if you have a qualifying child.
Rule 3. Your Filing Status Cannot Be Married Filing Separately
If you are married, you usually must file a joint return to claim the EIC. Your filing status cannot be Married filing separately.
Spouse did not live with you.
If you are married and your spouse did not live in your home at any time during the last 6 months of the year, you may be able to file as head of
household, instead of married filing separately. In that case, you may be able to claim the EIC. For detailed information about filing as head of
household, see chapter 2.
Resident aliens:Earned Income CreditU.S. Citizen:Earned Income CreditRule 4. You Must Be a
U.S. Citizen or Resident
Alien All Year
You cannot claim the earned income credit if you are a nonresident alien for any part of the year, unless:
You are married to a U.S. citizen or a resident alien, and
You choose to be treated as a resident for all of 2005 by filing a joint return. If you need more information on making this choice, see
Publication 519, U.S. Tax Guide for Aliens.
Note.
If you make the choice in (2) above, you and your spouse are taxed on your worldwide income. You cannot claim any tax treaty benefits as a resident
of a foreign country during a tax year in which the choice is in effect.
Form:2555Form:2555-EZRule 5. You Cannot File Form 2555 or Form 2555-EZ
You cannot claim the earned income credit if you file Form 2555, Foreign Earned Income, or Form 2555-EZ, Foreign Earned Income Exclusion. You file
these forms to exclude income earned in foreign countries from your gross income, or to deduct or exclude a foreign housing amount. U.S. possessions
are not foreign countries. See Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad, for more detailed information.
Rule 6. Your Investment Income Must Be $2,700 or Less
You cannot claim the earned income credit unless your investment income is $2,700 or less. If your investment income is more than $2,700, you
cannot claim the credit. For most people, investment income is the total of the following amounts.
Taxable interest (line 8a of Form 1040 or 1040A).
Tax-exempt interest (line 8b of Form 1040 or 1040A).
Dividend income (line 9a of Form 1040 or 1040A).
Capital gain net income (line 13 of Form 1040, if more than zero, or line 10 of Form 1040A).
If you file Form 1040EZ, your investment income is the total of the amount of line 2 and the amount of any tax-exempt interest you wrote to the
right of the words Form 1040EZ on line 2.
However, if you are reporting income or loss from the rental of personal property on Form 1040, line 21, or are filing Schedule E (Form 1040), Form
8814, or Form 4797, see Rule 6 in chapter 1 of Publication 596 for more information.
Earned income:EmployeeSelf-employedRule 7. You Must Have Earned Income
This credit is called the earned income credit because, to qualify, you must work and have earned income. If you are married and file a joint
return, you meet this rule if at least one spouse works and has earned income. If you are an employee, earned income includes all the taxable income
you get from your employer. If you are self-employed or a statutory employee, you will figure your earned income on EIC Worksheet B in the
instructions for Form 1040.
Earned Income
Earned income includes all of the following types of income.
Wages, salaries, tips, and other taxable employee pay. Employee pay is earned income only if it is taxable. Nontaxable employee pay, such as
certain dependent care benefits and adoption benefits, is not earned income. But there is an exception for nontaxable combat pay, which you can choose
to include in earned income, as explained below.
Net earnings from self-employment.
Gross income received as a statutory employee.
Wages, salaries, and tips.
Wages, salaries, and tips you receive for working are reported to you on Form W-2, box 1. You should report these on line 1 (Form 1040EZ) or line 7
(Forms 1040A and 1040).
Nontaxable combat pay election.
You can elect to have your nontaxable combat pay included in earned income for the earned income credit. Electing to include nontaxable combat pay
in earned income may increase or decrease your EIC. Figure the credit with and without your nontaxable combat pay before making the election. If you
make the election, you must include in earned income all nontaxable combat pay you received. If you are filing a joint return and both you and your
spouse received nontaxable combat pay, you can each make your own election. The amount of your nontaxable combat pay should be shown on your Form W-2,
in box 12, with code Q.
Self-employed persons and statutory employees.
If you are self-employed or received income as a statutory employee, you must use the Form 1040 instructions to see if you qualify to get the EIC.
Form:4361Form:4029Approved Form 4361 or Form 4029
This section is for persons who have an approved:
Form 4361, Application for Exemption from Self-Employment Tax for Use by Ministers, Members of Religious Orders, and Christian Science
Practitioners, or
Form 4029, Application for Exemption from Social Security and Medicare Taxes and Waiver of Benefits.
Each approved form exempts certain income from social security taxes. Each form is discussed in this section in terms of what is or is not earned
income for purposes of the EIC.
Form 4361.
Even if you have an approved Form 4361, amounts you received for performing ministerial duties as an employee count as earned income. This includes
wages, salaries, tips, and other taxable employee compensation. Amounts you received for performing ministerial duties, but not as an employee, do not
count as earned income. Examples include fees for performing marriages and honoraria for delivering speeches.
Form 4029.
Even if you have an approved Form 4029, all wages, salaries, tips, and other taxable employee compensation count as earned income. However, amounts
you received as a self-employed individual do not count as earned income. Also, in figuring earned income, do not subtract losses on Schedule C, C-EZ,
or F from wages on line 7 of Form 1040.
Disability benefits:Earned Income CreditEarned Income Credit:Disability benefitsDisability Benefits
If you retired on disability, benefits you receive under your employer's disability retirement plan are considered earned income until you reach
minimum retirement age. Minimum retirement age generally is the earliest age at which you could have received a pension or annuity if you were not
disabled. You must report your taxable disability payments on line 7 of either Form 1040 or Form 1040A until you reach minimum retirement age.
Beginning on the day after you reach minimum retirement age, payments you receive are taxable as a pension and are not considered earned income.
Report taxable pension payments on Form 1040, lines 16a and 16b (or Form 1040A, lines 12a and 12b).
Earned Income Credit:Disability insurance paymentsDisability insurance payments:Earned Income CreditDisability insurance payments.
Payments you received from a disability insurance policy that you paid the premiums for are not earned income. It does not matter whether you have
reached minimum retirement age. If this policy is through your employer, the amount may be shown in box 12 of your Form W-2 with code J.
Income That Is Not Earned Income
Examples of items that are not earned income include interest and dividends, pensions and annuities, social security and railroad retirement
benefits (including disability benefits), alimony and child support, welfare benefits, workers' compensation benefits, unemployment compensation
(insurance), nontaxable foster care payments, and veterans' benefits, including VA rehabilitation payments. Do not include any of these items in your
earned income.
Earnings while an inmate.
Amounts received for work performed while an inmate in a penal institution are not earned income when figuring the earned income credit. This
includes amounts for work performed while in a work release program or while in a halfway house.
Workfare payments.
Nontaxable workfare payments are not earned income for the EIC. These are cash payments certain people receive from a state or local agency that
administers public assistance programs funded under the federal Temporary Assistance for Needy Families (TANF) program in return for certain work
activities such as (1) work experience activities (including remodeling or repairing public housing) if sufficient private sector employment is not
available, or (2) community service program activities.
Community property.
If you are married, but qualify to file as head of household under special rules for married taxpayers living apart (see Rule 3), and
live in a state that has community property laws, your earned income for the EIC does not include any amount earned by your spouse that is treated as
belonging to you under those laws. That amount is not earned income for the EIC, even though you must include it in your gross income on your income
tax return. Your earned income includes the entire amount you earned, even if part of it is treated as belonging to your spouse under your state's
community property laws.
Nontaxable military pay.
Nontaxable pay for members of the Armed Forces is not considered earned income for the EIC. Examples of nontaxable military pay are combat pay, the
Basic Allowance for Housing (BAH), and the Basic Allowance for Subsistence (BAS). See Publication 3, Armed Forces' Tax Guide, for more information.
Combat pay. You can elect to have your nontaxable combat pay considered earned income for the EIC. See Nontaxable combat pay
election, earlier.
Part B. Rules
If You Have a Qualifying Child
If you have met all of the rules in Part A, read Part B to see if you have a qualifying child.
Part B discusses Rules 8 through 10. You must meet all three of these rules, in addition to the rules in
Parts A and D, to qualify for the earned income credit with a qualifying child.
Figure 36-1. Test for Qualifying ChildSummary: This figure is an illustrative representation of the relationship, age, and residency tests described in the text that determine if a
dependent is a qualifying child.
You must file Form 1040 or Form 1040A to claim the EIC with a qualifying child. (You cannot file Form 1040EZ). You also must complete Schedule EIC
and attach it to your return. If you meet all the rules in Part A and this part, read Part D to find out what to do next.
If you do not meet Rule 8, you do not have a qualifying child. Read Part C to find out if you can get the earned income
credit without a qualifying child.
Rule 8. Your Child Must Meet the Relationship, Age, and Residency Tests
Your child is a qualifying child if your child meets three tests. The three tests are:
Relationship,
Age, and
Residency.
The three tests are illustrated in Figure 36-1. The paragraphs that follow contain more information about each test.
Relationship Test
To be your qualifying child, a child must be your:
Son, daughter, stepchild, eligible foster child, or a descendant of any of them (for example, your grandchild), or
Brother, sister, half brother, half sister, stepbrother, stepsister, or a descendant of any of them (for example, your niece or
nephew).
The following definitions clarify the relationship test.
Adopted child.Adopted child:Earned Income Credit
An adopted child is always treated as your own child. The term adopted child includes a child who was lawfully placed with you for legal
adoption.
Eligible foster child.Foster child:Earned Income CreditEarned Income Credit:Foster child
For the EIC, a person is your eligible foster child if the child is placed with you by an authorized placement agency or by judgement, decree, or
other order of any court of competent jurisdiction. An authorized placement agency includes a state or local government agency. It also includes a
tax-exempt organization licensed by a state. In addition, it includes an Indian tribal government or an organization authorized by an Indian tribal
government to place Indian children.
Example.
Debbie, who is 12 years old, was placed in your care 2 years ago by an authorized agency responsible for placing children in foster homes. Debbie
is your eligible foster child.
Married child.
If your child was married at the end of the year, he or she does not meet the relationship test unless either of these two situations applies to
you:
You can claim the child's exemption, or
The reason you cannot claim the child's exemption is that you gave that right to your child's other parent under the Special rule for
divorced or separated parents, described later.
Age Test
Your child must be:
Under age 19 at the end of 2005,
A full-time student under age 24 at the end of 2005, or
Permanently and totally disabled at any time during 2005, regardless of age.
The following example and definitions clarify the age test.
Example.
Your son turned 19 on December 10. Unless he was disabled or a full-time student, he is not a qualifying child because, at the end of the year, he
was not under age 19.
Full-time student.
A full-time student is a student who is enrolled for the number of hours or courses the school considers to be full-time attendance.
Student defined.
To qualify as a student, your child must be, during some part of each of any 5 calendar months during the calendar year:
A full-time student at a school that has a regular teaching staff, course of study, and regularly enrolled student body, or
A student taking a full-time, on-farm training course given by a school described in (1), or a state, county, or local
government.
The 5 calendar months need not be consecutive.
School defined.
A school can be an elementary school, junior or senior high school, college, university, or technical, trade, or mechanical school. However,
on-the-job training courses, correspondence schools, and Internet schools do not count as schools for the EIC.
Vocational high school students.
Students who work on co-op jobs in private industry as a part of a school's regular course of classroom and practical training are considered
full-time students.
Permanently and totally disabled.
Your child is permanently and totally disabled if both of the following apply.
He or she cannot engage in any substantial gainful activity because of a physical or mental condition.
A doctor determines the condition has lasted or can be expected to last continuously for at least a year or can lead to death.
Residency Test
Your child must have lived with you in the United States for more than half of 2005. The following definitions clarify the residency test.
United States.
This means the 50 states and the District of Columbia. It does not include Puerto Rico or U.S. possessions such as Guam.
Homeless shelter.
Your home can be any location where you regularly live. You do not need a traditional home. For example, if your child lived with you for more than
half the year in one or more homeless shelters, your child meets the residency test.
Military personnel:Earned Income CreditEarned Income Credit:Military personnelMilitary personnel stationed outside the United States.
U.S. military personnel stationed outside the United States on extended active duty are considered to live in the United States during that duty
period for purposes of the EIC.
Extended active duty.
Extended active duty means you are called or ordered to duty for an indefinite period or for a period of more than 90 days. Once you begin serving
your extended active duty, you are still considered to have been on extended active duty even if you do not serve more than 90 days.
Birth or death of a child.
A child who was born or died in 2005 is treated as having lived with you for all of 2005 if your home was the child's home the entire time he or
she was alive in 2005.
Temporary absences.
Count time that you or your child is away from home on a temporary absence due to a special circumstance as time lived with you. Examples of a
special circumstance include:
Illness,
School attendance,
Detention in a juvenile facility,
Business,
Vacation, and
Military service.
Kidnapped child.
Kidnapped childrenA kidnapped child is treated as living with you for more than half of the year if the child lived with you for
more than half the part of the year before the date of the kidnapping. The child must be presumed by law enforcement authorities to have been
kidnapped by someone who is not a member of your family or your child's family. This treatment applies for all years until the child is returned.
However, the last year this treatment can apply is the earlier of:
The year there is a determination that the child is dead, or
The year the child would have reached age 18.
If your qualifying child has been kidnapped and meets these requirements, enter KC, instead of a number, on line 6 of Schedule EIC.
Social Security Numbers (SSNs): Earned Income CreditEarned Income Credit:Social Security NumberSocial security cardSocial security number.
Your qualifying child must have a valid social security number (SSN) unless the child was born and died in 2005. You cannot claim the EIC on the
basis of a qualifying child if:
Your qualifying child's SSN is missing from your tax return or is incorrect,
Your qualifying child's social security card says Not valid for employment and was issued only for use in getting a federally funded
benefit, or
Instead of an SSN, your qualifying child has:
An individual taxpayer identification number (ITIN), which is issued to a noncitizen who cannot get an SSN, or
An adoption taxpayer identification number (ATIN), which is issued to adopting parents who cannot get an SSN for the child being adopted
until the adoption is final.
If you have two qualifying children and only one has a valid SSN, you can claim the EIC only on the basis of that child. For more information about
SSNs, see Rule 2.
Rule 9. Your Qualifying Child Cannot Be Used By More Than One Person To Claim the EIC
Sometimes a child meets the rules to be a qualifying child of more than one person. However, only one person can treat that child as a qualifying
child and claim the EIC using that child. The paragraphs that follow will help you decide who can claim the EIC when more than one person has the same
qualifying child.
You can choose which person will claim the EIC.
If you and someone else have the same qualifying child, you and the other person(s) can decide which of you, if otherwise eligible, will take all
of the following tax benefits based on the qualifying child.
The child's exemption.
The child tax credit.
Head of household filing status.
The credit for child and dependent care expenses.
The EIC.
The other person cannot take any of these five tax benefits unless he or she has a different qualifying child.
If you and the other person(s) cannot agree and more than one person claims the EIC or the other tax benefits just listed using the same child, the
tie-breaker rule (explained in Table 36-2) applies. However, the tie-breaker rule does not apply if the other person is your spouse and you file a
joint return.
If a child is treated as the qualifying child of the noncustodial parent under the special rule for children of divorced or separated parents,
described next, see Applying Rule 9 to divorced or separated parents, later.
If another person claims the EIC using this child.
If your EIC is denied because your qualifying child is treated under this rule as the qualifying child of another person for 2005, you may be able
to take the EIC using a different qualifying child, but you cannot take the EIC for people who do not have a qualifying child.
If the other person cannot claim the EIC.
If you and someone else have the same qualifying child but the other person cannot claim the EIC because he or she is not eligible or his or her
earned income or AGI is too high, you may be able to treat the child as a qualifying child. See Example 5. But also see You can choose
which person will claim the EIC, earlier.
Example 1 – child lived with parent and grandparent.
You and your 2-year-old son lived with your mother all year. You are 25 years old. Your only income was $9,000 from a part-time job. Your mother's
only income was $20,000 from her job. Your son is a qualifying child of both you and your mother because he meets the relationship, age, and residency
tests for both you and your mother. However, only one of you can treat him as a qualifying child to claim the EIC (and, if that person qualifies, the
other tax benefits listed in You can choose which person will claim the EIC, earlier). You agree to let your mother claim him.
This means, if you do not claim your son as a qualifying child for the EIC or any of the other tax benefits listed in You can choose which
person will claim the EIC, your mother can treat your son as a qualifying child to claim the EIC and any other tax benefit listed for which she
qualifies.
Example 2 – child lived with parent and grandparent.
The facts are the same as in Example 1 except that you and your mother both claim your son as a qualifying child. In this case, you as
the child's parent will be the only one allowed to claim your son as a qualifying child for the EIC and the other tax benefits listed in You can
choose which person will claim the EIC. The IRS will disallow your mother's claim to the EIC and any other tax benefit listed, unless she has
another qualifying child.
Example 3 – three children lived with parent and grandparent.
The facts are the same as in Example 1 except that you also have two other young children who are qualifying children of both you and
your mother. Only one of you can claim each child as a qualifying child. However, you and your mother can split the three qualifying children between
you. For example, you can use one child and your mother can use the other two.
Example 4 – parent is qualifying child of grandparent.
The facts are the same as in Example 1 except that you are only 18 years old. This means you are a qualifying child of your mother.
Because of Rule 10, discussed next, you cannot claim the EIC. Only your mother may be able to treat your son as a qualifying child to claim
the EIC. If your mother meets all the other requirements for claiming the EIC, she can treat both you and your son as qualifying children for the EIC.
Example 5 – parent can claim EIC because grandparent cannot.
The facts are the same as in Example 1 except that your mother earned $50,000 from her job. Because your mother's earned income is too
high for her to claim the EIC, only you can claim the EIC using your son.
Example 6 – separated parents.
You, your husband, and your 10-year-old son lived together until August 1, 2005, when your husband moved out of the household. In August and
September, your son lived with you. For the rest of the year, your son lived with your husband. Your son is a qualifying child of both you and your
husband because your son lived with each of you for more than half the year and because he met the relationship and age tests for both of you. You and
your husband are not divorced, legally separated, or separated under a written separation agreement, so the special rule for divorced or separated
parents does not apply.
You and your husband will file separate returns. Your husband agrees to let you treat your son as a qualifying child. This means, if your husband
does not claim your son as a qualifying child for the EIC or any of the other tax benefits listed in You can choose which person will claim the
EIC, earlier, you can claim him as a qualifying child for the EIC and any other tax benefit listed for which you qualify. However, you cannot
claim head of household filing status because you and your husband did not live apart the last 6 months of the year. As a result, your filing status
is married filing separately, so you cannot claim the EIC or the credit for child and dependent care expenses. See Rule 3.
Example 7 – separated parents.
The facts are the same as in Example 6 except that you and your husband both claim your son as a qualifying child. In this case, only
your husband will be allowed to treat your son as a qualifying child. This is because, during 2005, the boy lived with him longer than with you. You
cannot claim the EIC for persons either with or without a qualifying child. However, because you and your husband did not live apart the last 6 months
of the year your husband cannot claim head of household filing status. As a result, his filing status is married filing separately, so he cannot claim
the EIC or the credit for child and dependent care expenses. See Rule 3.
Example 8 – unmarried parents.
You, your 5-year-old son, and your son's father lived together all year. You and your son's father are not married. Your son is a qualifying child
of both you and his father because he meets the relationship, age, and residency tests for both you and his father. You earned $8,000 and your son's
father earned $18,000. Neither of you had any other income. Your son's father agrees to let you treat the child as a qualifying child. This means, if
your son's father does not claim your son as a qualifying child for the EIC or any of the other tax benefits listed in You can choose which
person will claim the EIC, earlier, you can claim him as a qualifying child for the EIC and any other tax benefit listed for which you qualify.
<ROM>Table 36-2.</ROM>
<IMARK> When More Than One Person Claims EIC Using Same Child (Tie-Breaker Rule)Caution: If a child is treated as the qualifying child of the noncustodial parent under the rules for divorced or separated
parents, described later, see Applying Rule 9 to divorced or separated parents.IF more than one person claims the the same child as a
qualifying child and . . .THEN . . .Only one of the persons is the child's parentOnly the parent can treat the child as a qualifying child.Two of the persons are parents of the child, and they do not file a
joint return togetherOnly the parent with whom the child lived the longest during the year can treat the
child as a qualifying child.Two of the persons are parents of the child, the child lived with each
parent the same amount of time during the year, and the parents do not file a joint return togetherOnly the parent with the highest adjusted gross income (AGI) can treat the child as a
qualifying child.None of the persons are the child's parentOnly the person with the highest AGI can treat the child as a qualifying
child.
Example 9 – unmarried parents.
The facts are the same as in Example 8 except that you and your son's father both claim your son as a qualifying child. In this case,
only your son's father will be allowed to treat your son as a qualifying child. This is because his AGI, $18,000, is more than your AGI, $8,000. You
cannot claim the EIC for persons either with or without a qualifying child.
Example 10 – child did not live with a parent.
You and your 7-year-old niece, your sister's child, lived with your mother all year. You are 25 years old, and your only income was $9,300 from a
part-time job. Your mother's only income was $15,000 from her job. Your niece is a qualifying child of both you and your mother because she meets the
relationship, age, and residency tests for both you and your mother. However, only one of you can treat her as a qualifying child. Your mother agrees
to let you treat the child as a qualifying child. This means, if your mother does not claim her as a qualifying child for the EIC or any of the other
tax benefits listed in You can choose which person will claim the EIC, you can claim your niece as a qualifying child for the EIC and any
other tax benefit listed for which you qualify.
Example 11 – child did not live with a parent.
The facts are the same as in Example 10 except that you and your mother both claim your niece as a qualifying child. In this case, only
your mother will be allowed to treat your niece as a qualifying child. This is because your mother's AGI, $15,000, is more than your AGI, $9,300.
Special rule for divorced or separated parents.Parents, divorced or separatedDivorced parents, special ruleSeparated parents, special rule
A child will be treated as the qualifying child of his or her noncustodial parent (for purposes of claiming an exemption, but not for EIC) if all
of the following apply.
The parents:
Are divorced or legally separated under a decree of divorce or separate maintenance,
Are separated under a written separation agreement, or
Lived apart at all times during the last 6 months of the year.
The child received over half of his or her support for the year from the parents.
The child is in the custody of one or both parents for more than half of the year.
A decree of divorce or separate maintenance or written separation agreement that applies to 2005 provides that the noncustodial parent can
claim the child as a dependent (and, in the case of a pre-1985 agreement, the noncustodial parent provides at least $600 for the support of the child
during the year) or the custodial parent signs a written declaration that he or she will not claim the child as a dependent for the year.
For details, see chapter 3. Also see, Applying Rule 9 to divorced or separated parents, later.
Applying Rule 9 to divorced or separated parents.Parents, divorced or separatedDivorced parentsSeparated parents
If a child is treated as the qualifying child of the noncustodial parent under the special rule for children of divorced or separated parents
described earlier, the noncustodial parent can claim an exemption and the child tax credit for the child but cannot claim the child as a qualifying
child for head of household filing status, the credit for child and dependent care expenses, or the EIC. If the child is the qualifying child of more
than one other person, only one of those persons can claim the child as a qualifying child for head of household filing status, the credit for child
and dependent care expenses, and the EIC. No other person can claim any of these three tax benefits unless he or she has a different qualifying child.
If you and any other person file a return claiming the child as a qualifying child for any of these three tax benefits, the IRS will disallow all but
one of the claims using the tie-breaker rule in Table 36-2.
Rule 10. You Cannot Be a Qualifying Child of Another Person
You are a qualifying child of another person (your parent, guardian, foster parent, etc.) if all of the following statements are true.
You are that person's son, daughter, stepchild, grandchild, or eligible foster child. Or, you are that person's brother, sister, half
brother, half sister, stepbrother, or stepsister (or the child or grandchild of that person's brother, sister, half brother, half sister, stepbrother,
or stepsister).
At the end of the year you were under age 19, or under age 24 and a full-time student, or any age if you were permanently and totally
disabled at any time during the year.
You lived with that person in the United States for more than half of the year.
For more details about the tests to be a qualifying child, see Rule 8.
If you (or your spouse if filing a joint return) are a qualifying child of another person, you cannot claim the EIC. This is true even if the
person for whom you are a qualifying child does not claim the EIC or meet all of the rules to claim the EIC. Put No beside line 66a (Form 1040)
or line 41a (Form 1040A).
Example.
You and your daughter lived with your mother all year. You are 22 years old and attended a trade school full time. You had a part-time job and
earned $5,700. You had no other income. Because you meet the relationship, age, and residency tests, you are a qualifying child of your mother. She
can claim the EIC if she meets all the other requirements. Because you are your mother's qualifying child, you cannot claim the EIC. This is so even
if your mother cannot or does not claim the EIC.
Part C. Rules
If You Do Not Have
a Qualifying Child
Read this part if you:
Do not have a qualifying child, and
Have met all the rules in Part A.
Part C discusses Rules 11 through 14. You must meet all four of these rules, in addition to the rules in
Parts A and D, to qualify for the earned income credit without a qualifying child.
If you have a qualifying child, the rules in this part do not apply to you. You can claim the credit only if you meet all the rules in Parts
A, B, and D. See Rule 8 to find out if you have a qualifying child.
Rule 11. You Must Be at Least Age 25 but Under
Age 65
You must be at least age 25 but under age 65 at the end of 2005. If you are married filing a joint return, either you or your spouse must be at
least age 25 but under age 65 at the end of 2005. It does not matter which spouse meets the age test, as long as one of the spouses does.
If neither you nor your spouse meets the age test, you cannot claim the EIC. Put No next to line 66a (Form 1040), line 41a (Form 1040A), or
line 8a (Form 1040EZ).
Example 1.
You are age 28 and unmarried. You meet the age test.
Example 2.
You are married and filing a joint return. You are age 23 and your spouse is age 27. You meet the age test because your spouse is at least age 25
but under age 65.
Rule 12. You Cannot Be the Dependent of Another Person
If you are not filing a joint return, you meet this rule if:
You checked box 6a on Form 1040 or 1040A, or
You did not check the You box on line 5 of Form 1040EZ, and you entered $8,200 on that line.
If you are filing a joint return, you meet this rule if:
You checked both box 6a and box 6b on Form 1040 or 1040A, or
You and your spouse did not check either the You box or the Spouse box on line 5 of Form 1040EZ, and you entered $16,400 on
that line.
If you are not sure whether someone else can claim you (or your spouse if filing a joint return) as a dependent, read the rules for claiming a
dependent in chapter 3.
If someone else can claim you (or your spouse if filing a joint return) as a dependent on his or her return, but does not, you still cannot claim
the credit.
Example 1.
In 2005, you were age 25, single, and living at home with your parents. You worked and were not a student. You earned $7,500. Your parents cannot
claim you as a dependent. When you file your return, you claim an exemption for yourself by not checking the You box on line 5 of your Form
1040EZ and by entering $8,200 on that line. You meet this rule.
Example 2.
The facts are the same as in Example 1, except that you earned $2,000. Your parents can claim you as a dependent but decide not to. You
do not meet this rule. You cannot claim the credit because your parents could have claimed you as a dependent.
Rule 13. You Cannot Be a Qualifying Child of Another Person
You are a qualifying child of another person (your parent, guardian, foster parent, etc.) if all of the following statements are true.
You are that person's son, daughter, stepchild, grandchild, or eligible foster child. Or, you are that person's brother, sister, half
brother, half sister, stepbrother, or stepsister (or the child or grandchild of that person's brother, sister, half brother, half sister, stepbrother,
or stepsister).
At the end of the year you were under age 19, or under age 24 and a full-time student, or any age if you were permanently and totally
disabled at any time during the year.
You lived with that person in the United States for more than half of the year.
If you (or your spouse if filing a joint return) are a qualifying child of another person, you cannot claim the EIC. This is true even if the
person for whom you are a qualifying child does not claim the EIC or meet all of the rules to claim the EIC. Put No next to line 66a (Form
1040), line 41a (Form 1040A), or line 8a (Form 1040EZ).
Example.
You lived with your mother all year. You are age 26 and permanently and totally disabled. Your only income was from a community center where you
went three days a week to answer telephones. You earned $3,400 for the year and provided more than half of your own support. Because you meet the
relationship, age, and residency tests, you are a qualifying child of your mother for the EIC. She can claim the EIC if she meets all the other
requirements. Because you are a qualifying child of your mother, you cannot claim the EIC. This is so even if your mother cannot or does not claim the
EIC.
Rule 14. You Must Have Lived in the United States More Than Half of the Year
Your home (and your spouse's, if filing a joint return) must have been in the United States for more than half the year.
If it was not, put No next to line 66a (Form 1040), line 41a (Form 1040A), or line 8a (Form 1040EZ).
United States.
This means the 50 states and the District of Columbia. It does not include Puerto Rico or U.S. possessions such as Guam.
Homeless shelter.
Your home can be any location where you regularly live. You do not need a traditional home. If you lived in one or more homeless shelters in the
United States for more than half the year, you meet this rule.
Military personnel stationed outside the United States.
U.S. military personnel stationed outside the United States on extended active duty (defined in Rule 8) are considered to live in the
United States during that duty period for purposes of the EIC.
Part D. Figuring and Claiming the EIC
Read this part if you have met all the rules in Parts A and B, or all the rules in Parts A and C.
Part D discusses Rule 15. You must meet this rule, in addition to the rules in Parts A and B, or
Parts A and C, to qualify for the earned income credit.
This part of the chapter also explains how to figure the amount of your credit. You have two choices.
Have the IRS figure the EIC for you. If you want to do this, see IRS Will Figure the EIC for You.
Figure the EIC yourself. If you want to do this, see How To Figure the EIC Yourself.
Rule 15. Your Earned Income Must Be Less Than:
$35,263 ($37,263 for married filing jointly) if you have more than one qualifying child,
$31,030 ($33,030 for married filing jointly) if you have one qualifying child, or
$11,750 ($13,750 for married filing jointly) if you do not have a qualifying child.
Earned income generally means wages, salaries, tips, other taxable employee pay, and net earnings from self-employment. Employee pay is earned
income only if it is taxable. Nontaxable employee pay, such as certain dependent care benefits and adoption benefits, is not earned income. But there
is an exception for nontaxable combat pay, which you can choose to include in earned income. Earned income is explained in detail in Rule
7.
Earned income
Figuring earned income.
If you are self-employed, a statutory employee, or a member of the clergy or church employee who files Schedule SE (Form 1040), you will figure
your earned income when you fill out Part 4 of EIC Worksheet B in the Form 1040 instructions.
Otherwise, figure your earned income by using the worksheet in Step 5 of the Form 1040 instructions for lines 66a and 66b or the Form
1040A instructions for lines 41a and 41b, or the worksheet in Step 2 of the Form 1040EZ instructions for lines 8a and 8b.
When using one of those worksheets to figure your earned income, you will start with the amount on line 7 (Form 1040 or Form 1040A) or line 1 (Form
1040EZ). You will then reduce that amount by any amount included on that line and described in the following list.
Scholarship or fellowship grants not reported on a Form W-2. A scholarship or fellowship grant that was not reported to you on a
Form W-2 is not considered earned income for the earned income credit.
Inmates. Amounts received for work performed while an inmate in a penal institution are not earned income for the earned income
credit. This includes amounts received for work performed while in a work release program or while in a halfway house. If you received any amount for
work done while an inmate in a penal institution and that amount is included in the total on line 7 (Form 1040 or Form 1040A) or line 1 (Form 1040EZ),
put PRI and the amount on the dotted line next to line 7 (Form 1040), in the space to the left of the entry space for line 7 (Form 1040A), or
in the space to the left of line 1 (Form 1040EZ).
Deferred compensation plans. A pension or annuity from a nonqualified deferred compensation plan or a nongovernmental section 457
plan is not considered earned income for the earned income credit. If you received such an amount and it was included in the total on line 7 (Form
1040 or Form 1040A) or line 1 (Form 1040EZ), put DFC and the amount on the dotted line next to line 7 (Form 1040), in the space to the left of
the entry space for line 7 (Form 1040A), or in the space to the left of line 1 (Form 1040EZ). This amount may be reported in box 11 of your Form W-2.
If you received such an amount but box 11 is blank, contact your employer for the amount received as a pension or annuity.
Clergy.
If you are a member of the clergy who files Schedule SE and the amount on line 2 of that schedule includes an amount that was also reported on line
7 (Form 1040), subtract that amount from the amount on line 7 (Form 1040) and enter the result in the first space of the worksheet in Step
5 of the Form 1040 instructions for lines 66a and 66b. Put Clergy on the dotted line next to line 66a (Form 1040).
Church employees.
A church employee means an employee (other than a minister or member of a religious order) of a church or qualified church-controlled organization
that is exempt from employer social security and Medicare taxes. If you received wages as a church employee and included any amount on both line 5a of
Schedule SE and line 7 (Form 1040), subtract that amount from the amount on line 7 (Form 1040) and enter the result in the first space of the
worksheet in Step 5 of the Form 1040 instructions for lines 66a and 66b.
IRS Will Figure
the EIC for You
The IRS will figure the amount of your EIC for you if you follow the steps explained in this section.
Please do not ask the IRS to figure your EIC unless you are eligible for it. Read the rules in Parts A, B, C, and D to see if
you qualify.
If you want the IRS to also figure the amount of your income tax, see chapter 30.
Form 1040
If you file Form 1040 and want the IRS to figure your credit for you, follow these steps.
Put EIC on the dotted line next to line 66a. Then, if you have any of the types of income described earlier under Inmates,
Deferred compensation plans, or Clergy, follow the instructions given there.
If you received nontaxable combat pay and are electing to include it in your earned income for the EIC, enter the amount on line 66b (Form
1040). For details, see Nontaxable combat pay election in Rule 7.
Complete all other parts of your return that apply to you (including line 61), but do not fill in lines 71, 72, 73a, and 75. If you do not
have a qualifying child, stop here.
If you have a qualifying child, complete Schedule EIC according to its instructions. Be sure to enter the child's social security number on
line 2 of that schedule. If you do not, your credit may be reduced or disallowed. Attach Schedule EIC to your return.
Form 1040A
If you file Form 1040A and want the IRS to figure your credit for you, follow these steps.
Put EIC to the left of the entry space for line 41a. Then, if you have any of the types of income described earlier under
Inmates or Deferred compensation plans, follow the instructions given there.
If you received nontaxable combat pay and are electing to include it in your earned income for the EIC, enter the amount on line 41b (Form
1040A). For details, see Nontaxable combat pay election in Rule 7.
Complete all other parts of your return that apply to you (including line 37), but do not fill in lines 43, 44, 45a, and 47. If you do not
have a qualifying child, stop here.
If you have a qualifying child, complete Schedule EIC according to its instructions. Be sure to enter the child's social security number on
line 2 of that schedule. If you do not, your credit may be reduced or disallowed. Attach Schedule EIC to your return.
Form 1040EZ
If you file Form 1040EZ and want the IRS to figure your credit for you, follow these steps.
Put EIC in the space to the left of line 8a. Then if you have any of the types of income described earlier under Inmates
or Deferred compensation plans, follow the instructions given there.
If you received nontaxable combat pay and are electing to include it in your earned income for the EIC, enter the amount on line 8b (Form
1040EZ). For details, see Nontaxable combat pay election in Rule 7.
Complete all other parts of your return that apply to you, but do not fill in lines 9, 11a, or 12.
How To Figure the
EIC Yourself
To figure the EIC yourself use the EIC Worksheet in the instructions for the form you are using (Form 1040, Form 1040A, or Form 1040EZ).
Form 1040 and EIC Worksheet.
If you file Form 1040 and want to figure the credit yourself, follow these steps.
Go to your form instruction booklet and turn to the instructions for lines 66a and 66b, and look for Worksheet A or Worksheet B.
Complete the EIC Worksheet that applies to your situation according to its instructions. Complete Worksheet B if you were self-employed, a
member of the clergy or a church employee who files Schedule SE, or a statutory employee filing Schedule C or C-EZ. Find the amount of your credit in
the EIC Table in your instruction booklet.
Enter the amount of your earned income credit from Worksheet A or B on Form 1040, line 66a.
Keep the EIC Worksheet for your records. Do not attach it to your income tax return. If you do not have a qualifying child, stop
here.
If you have a qualifying child, complete Schedule EIC according to its instructions. Be sure to enter the child's social security number on
line 2 of that schedule. If you do not, your credit may be reduced or disallowed. Attach Schedule EIC to your return.
Form 1040A and EIC Worksheet.
If you file Form 1040A and want to figure the credit yourself, follow these steps.
Go to your form instruction booklet and turn to the instructions for lines 41a and 41b, and look for the EIC Worksheet.
Complete the EIC Worksheet according to its instructions. Find the amount of your credit in the EIC Table in your form instruction
booklet.
Enter the amount of your earned income credit from line 6 of the EIC Worksheet on Form 1040A, line 41a.
Keep the EIC Worksheet for your records. Do not attach it to your income tax return. If you do not have a qualifying child, stop
here.
If you have a qualifying child, complete Schedule EIC according to its instructions. Be sure to enter the child's social security number on
line 2 of that schedule. If you do not, your credit may be reduced or disallowed. Attach Schedule EIC to your return.
Form 1040EZ and EIC Worksheet.
If you file Form 1040EZ and want to figure the credit yourself, follow these steps.
Go to your form instruction booklet and turn to the instructions for lines 8a and 8b and look for the EIC Worksheet.
Complete the EIC Worksheet according to its instructions. Find the amount of your credit in the EIC Table in your form instruction
booklet.
Enter the amount of your earned income credit from line 6 of the EIC Worksheet on Form 1040EZ, line 8a.
Keep the EIC Worksheet for your records. Do not attach it to your income tax return.
Examples
The following two comprehensive examples (complete with filled-in forms) may be helpful.
John and Janet Smith, a married couple with one qualifying child and using Form 1040A.
Kelly Green, age 30, a student, with no qualifying child and using Form 1040EZ.
Example 1. John and Janet Smith (Form 1040A)
John and Janet Smith are married and will file a joint return. They have one child, Amy, who is 3 years old. Amy lived with John and Janet for all
of 2005. John worked and earned $9,500. Janet worked part of the year and earned $1,500. Their earned income and AGI are $11,000. John and Janet
qualify for the earned income credit and fill out the EIC Worksheet and Schedule EIC. The Smiths will attach Schedule EIC to Form 1040A when they send
their completed return to the IRS.
They took the following steps to complete Schedule EIC and the EIC Worksheet.
Completing Schedule EIC
The Smiths complete Schedule EIC because they have a qualifying child. They enter John and Janet Smith and John's SSN (the SSN that appears
first on their Form 1040A) on the line at the top of Schedule EIC. The Smiths then fill out Qualifying Child Information (lines
1–6).
Line 1.
The Smiths enter Amy's first name and last name in the column Child 1.
Line 2.
They enter Amy's SSN.
Line 3.
They enter Amy's year of birth (2002).
Lines 4a and 4b.
The Smiths skip lines 4a and 4b because Amy was born after 1986.
Line 5.
The Smiths enter Daughter. This line shows Amy's relationship to John and Janet.
Line 6.
The Smiths enter 12. This is how many months Amy lived with them in 2005.
Completing the EIC Worksheet
Next, the Smiths will complete the EIC Worksheet to figure their earned income credit.
Line 1.
The Smiths enter $11,000 (their earned income).
Line 2.
The Smiths go to the Earned Income Credit Table in the Form 1040A instructions. The Smiths find their income of $11,000 within the range of $11,000
to $11,050. They follow this line across to the column that describes their filing status and number of children and find $2,662. They enter $2,662 on
line 2.
Line 3.
The Smiths enter their AGI of $11,000.
Line 4.
The Smiths check the Yes box because lines 1 and 3 are the same ($11,000). They skip line 5 and enter the amount from line 2 ($2,662) on
line 6.
Line 6.
The Smiths' EIC is $2,662.
Example 2. Kelly Green (Form 1040EZ)
Kelly Green is age 30 and a full-time student. She lived with her parents in the United States for all of 2005. She had a part-time job and earned
$6,240. She earned $20 interest on a savings account. She is not eligible to be claimed as a dependent on her parents' return. Although she lived with
her parents, she is not their qualifying child because she does not meet the age test. She does not have any children.
Kelly qualifies for the earned income credit. Kelly will file Form 1040EZ and complete the EIC Worksheet.
Completing the EIC Worksheet
Kelly figures the amount of her earned income credit on the EIC Worksheet as follows.
Line 1.
She enters $6,240 (her earned income).
Line 2.
Kelly goes to the Earned Income Credit Table in the forms instruction booklet. She finds her earned income of $6,240 in the range of $6,200 to
$6,250. Kelly follows this line across to the column that describes her filing status and number of children and finds $399. She enters $399 on line
2.
Line 3.
Kelly enters $6,260 (her AGI).
Line 4.
Kelly checks the No box because lines 1 and 3 are not the same.
Line 5.
Kelly checks the Yes box because the amount on line 3 ($6,260) is less than $6,550. She leaves line 5 blank and enters the amount from line
2, $399, on line 6.
Line 6.
She enters $399 here and on Form 1040EZ, line 8a. Kelly's earned income credit is $399.
Advance Earned Income CreditAdvance earned income creditForm:W-5
Do you expect to be eligible for the EIC this year (2006) and to have a qualifying child? If so, you can choose to get payments of the EIC in your
paycheck now instead of waiting to get your EIC all at once in 2007 when you file your tax return for the year 2006. These payments are called advance
EIC payments. This chapter explains how you may be able to get them this year and how to report them on your tax return.
Who can get the advance payment of the earned income credit?
To get part of the earned income credit paid to you throughout the year in your paycheck, you must meet all the following rules.
You must expect that your earned income and AGI will each be less than $32,001 ($34,001 if you expect to file married filing
jointly).
You must expect to have a qualifying child.
You must expect to meet all the rules in Parts A, B, and D of this chapter or in the instructions for Form
W-5.
Persons who are not entitled to receive advance payments.
Under certain circumstances, even if you meet these rules, you may not be entitled to get EIC. If your wages are not subject to federal income
tax, social security tax, or Medicare tax withholding, you cannot get the advance payment of the earned income credit. If you are a farm worker paid
on a daily basis, your employer is not required to pay you the advance amount of the credit.
How To Get Advance
Payments for 2006
If you meet the rules stated above under Who can get the advance payment of the earned income credit, give your employer a Form W-5,
Earned Income Credit Advance Payment Certificate, for 2006.
After you have read the instructions and completed
Form:W-5Form W-5, give the lower part of the form to your employer. Keep the top part for your records.
More than one employer.
If you have more than one employer, give a certificate to only one of them. If you are married and both you and your spouse are employed and expect
to qualify for the credit, you may give a Form W-5 to your employer and your spouse may give one to his or her employer.
If you receive advance payments of EIC in 2006, you must file a 2006 tax return (even if you would not otherwise have to file) to report the
payments and claim any additional EIC. Box 9 of your Form W-2 will show the amount you received. See the instructions for Form 1040 or Form 1040A for
the line number on which you report advance payments of EIC.
Receipt of advance payments you do not qualify for.
If you receive advance payments of EIC in 2006, and later find out that you are not eligible for some or all of them, you still must report them on
your tax return.
You cannot use Form 1040EZ to report your advance payments. You must file Form 1040 or Form 1040A.
When to give your employer a new Form W-5.
The 2006 Form W-5 you give to your employer is valid until December 31, 2006. If you expect to be eligible for EIC in 2007 and you want to receive
advance payments, you must give your employer a new Form W-5 in 2007. Do this each year you expect to be eligible for the EIC.
If you no longer want to get advance payments or if your situation changes and you no longer qualify for the earned income credit, you must give
your employer a new Form W-5. Check the No box on line 1 of the new form.
If your spouse files a Form W-5 with his or her employer, you must file a new Form W-5 with your employer. Check the Yes box on line 3.
Advance Payments
Received in 2005
If you received advance payments of EIC in 2005, you must file Form 1040 or Form 1040A to report the payments. Your Form W-2, box 9, will show the
amount you received. Report the amount on line 61 (Form 1040) or line 37 (Form 1040A).
You cannot use Form 1040EZ to report your advance payments.
Filled-in Schedule EIC--John and Janet Smith (Page references are to the Schedule Earned Income Credit Instructions.)Summary: This is a sample of Schedule EIC with items included as described in the text.Filled-in Earned Income Credit Worksheet--John and Janet Smith (Page references are to the Form 1040A Instructions.)Summary: This is a sample Earned Income Credit Worksheet--Lines 41a and 41b with items included as described in the
text.Filled-in Earned Income Credit Worksheet--Kelly Green (Page references are to the Form 1040EZ Instructions)Summary: This is a sample Earned Income Credit Worksheet--Lines 8a and 8b with items included as described in the
text.
EIC Eligibility ChecklistYou may claim the EIC if you answer Yes to all the
following questions.*YesNo1.Is your AGI less than:
$11,750 ($13,750 if married filing jointly) if you do not have a qualifying child,
$31,030 ($33,030 if married filing jointly) if you have one qualifying child, or
$35,263 ($37,263 if married filing jointly) if you have more than one qualifying child?
(See Rule 1.)
□□2.Do you, your spouse, and your qualifying child each have a valid SSN? (See Rule 2.)
□□3.Is your filing status married filing jointly, head of household, qualifying widow(er), or single? (See Rule
3.)
Caution: If you are a nonresident alien, answer Yes only if your filing status is married filing jointly and you are
married to a U.S. citizen or resident alien. (See Rule 4.)
□□4.Answer Yes if you are not filing Form 2555 or Form 2555-EZ. Otherwise, answer
No. (See Rule 5.)
□□5.Is your investment income $2,700 or less? (See Rule 6.)
□□6.Is your total earned income at least $1 but less than:
$11,750 ($13,750 if married filing jointly) if you do not have a qualifying child,
$31,030 ($33,030 if married filing jointly) if you have one qualifying child, or
$35,263 ($37,263 if married filing jointly) if you have more than one qualifying child?
(See Rules 7 and 15.)
□□7.Answer Yes if you (and your spouse if filing a joint return) are not a qualifying child of
another person. Otherwise, answer No. (See Rules 10 and 13.)
□□STOP:If you have a qualifying child, answer questions 8 and 9 and skip 10–12. If you do not have a
qualifying child, skip questions 8 and 9 and answer 10–12.*
8.Does your child meet the age, residency, and relationship tests for a qualifying child? (See Rule 8.)
□□9.Is your child a qualifying child only for you? Answer Yes if your qualifying child also meets
the tests to be a qualifying child of another person, but the other person is not claiming any child-related tax benefits using that child. Answer
No if you do not know whether the other person is claiming any child-related tax benefits using that child.
□□10.Were you (or your spouse if filing a joint return) at least age 25 but under 65 at the end of 2005? (See Rule
11.)
□□11.Answer Yes if you (and your spouse if filing a joint return) cannot be claimed as a dependent on
anyone else's return. Answer No if you (or your spouse if filing a joint return) can be claimed as a dependent on someone else's
return. (See Rule 12.)
□□12.Was your main home (and your spouse's if filing a joint return) in the United States for more than half the year?
(See Rule 14.)
□□*PERSONS WITH A QUALIFYING CHILD: If you answered Yes to questions 1 through 9, you
can claim the EIC. Remember to fill out Schedule EIC and attach it to your Form 1040 or Form 1040A. You cannot use Form 1040EZ. If you answered
Yes to questions 1 through 8 and No to question 9, see Rule 9 to help you determine whether you can
claim the EIC. If you answered Yes to questions 1 through 7 and No to question 8, answer questions 10 through 12
to see if you can claim the EIC without a qualifying child.
PERSONS WITHOUT A QUALIFYING CHILD: If you answered Yes to questions 1 through 7, and
10 through 12, you can claim the EIC.
If you answered No to any question that applies to you: You cannot claim the
EIC.
Other CreditsWhat's New for 2005Adoption credit.Adoption:CreditsFamilyAdoption creditAdoption
The maximum adoption credit increases to $10,630. See Adoption Credit, for more information.
Excess withholding of social security tax and railroad retirement tax.Credits:Excess withholding of social security and railroad retirement taxExcess withholding creditExcess withholding creditRailroad retirement benefitsExcess withholding creditRailroad retirement tax (RRTA)Excess withholding creditRRTA taxExcess withholding creditSocial security and Medicare taxesExcess withholding credit
Social security and tier 1 railroad retirement tax (RRTA) are both withheld at a rate of 6.2% of wages. The maximum wages subject to this tax
increased to $90,000 in 2005. The withholding rate of tier 2 RRTA decreased to 4.4% of wages in 2005. The maximum wages subject to this tax increased
to $66,900 in 2005. If you had too much social security or RRTA tax withheld during 2005, you may be entitled to a credit of the excess withholding.
For more information about the credit, see Credit for Excess Social Security Tax or Railroad Retirement Tax Withheld under Refundable
Credits, later.
What's New for 2006Residential energy credit.
You may be able to take a residential energy credit for expenses paid in 2006 to have qualified energy saving items installed in your main home.
See Publication 553 for more information.
Alternative motor vehicle credit.
You may be able to take a credit if you place an energy efficient motor vehicle or alternative fuel vehicle refueling property in service in 2006.
See Publication 553 for more information.
Qualified electric vehicle credit.
The qualified electric vehicle credit is reduced by 75% for qualified vehicles placed in service in 2006.
This chapter discusses the following credits.
Adoption credit.
Foreign tax credit.
Mortgage interest credit.
Retirement savings contributions credit.
Credit for prior year minimum tax.
Qualified electric vehicle credit.
Credit for excess social security tax or railroad retirement tax withheld.
Credit for tax on undistributed capital gain.
Health coverage tax credit.
Several other credits are discussed in other chapters in this publication.
Child and dependent care credit (chapter 32).
Credit for the elderly or the disabled (chapter 33).
The first part of this chapter, Nonrefundable Credits, covers six credits that you subtract from your tax. These credits may reduce your
tax to zero. If these credits are more than your tax, the excess is not refunded to you.
The second part of this chapter, Refundable Credits, covers three credits that are treated as payments and are refundable to you. These
credits are added to the federal income tax withheld and any estimated tax payments you made. If this total is more than your total tax, the excess
will be refunded to you.
Publication502Medical and Dental Expenses514Foreign Tax Credit for
Individuals530Tax Information for First-Time Homeowners535Business Expenses590Individual Retirement Arrangements (IRAs)Form (and Instructions)Foreign Tax Credit (Individual, Estate, or Trust)Notice to Shareholder of Undistributed Long-Term Capital GainsMortgage Interest CreditCredit For Prior Year Minimum Tax — Individuals, Estates, and TrustsRecapture of Federal Mortgage SubsidyQualified Electric Vehicle CreditQualified Adoption ExpensesCredit for Qualified Retirement Savings ContributionsHealth Coverage Tax Credit
Nonrefundable CreditsNonrefundable credits
The credits discussed in this part of the chapter can reduce your tax. However, if the total of these credits is more than your tax, the excess is
not refunded to you.
Adoption CreditAdoption:Credits
You may be able to take a tax credit of up to $10,630 for qualifying expenses paid to adopt an eligible child. The credit may be allowed for the
adoption of a child with special needs even if you do not have any qualifying expenses.
If your modified adjusted gross income (AGI) is more than $159,450, your credit is reduced. If your modified AGI is $199,450 or more, you cannot
take the credit.
Qualifying expenses.
Qualifying adoption expenses are reasonable and necessary expenses directly related to, and whose principal purpose is for, the legal adoption of
an eligible child. These expenses include:
Adoption fees,
Court costs,
Attorney fees,
Traveling expenses (including amounts spent for meals and lodging) while away from home, and
Re-adoption expenses to adopt a foreign child.
.
Nonqualifying expenses.
Qualifying adoption expenses do not include expenses:
That violate state or federal law,
For carrying out any surrogate parenting arrangement,
For the adoption of your spouse's child,
For which you received funds under any federal, state, or local program,
Allowed as a credit or deduction under any other federal income tax rule, or
Paid or reimbursed by your employer or any other person or organization.
Eligible child.
The term eligible child means any individual:
Under 18 years old, or
Physically or mentally incapable of caring for himself or herself.
Child with special needs.Adoption:Credit Employer's assistance programSpecial needs children:Adoption credit
An eligible child is a child with special needs if all three of the following apply.
He or she is a citizen or resident of the United States (including U.S. possessions).
A state (including the District of Columbia) determines that the child cannot or should not be returned to his or her parents'
home.
The state has determined that the child will not be adopted unless assistance is provided to the adoptive parents. Factors used by the state
to make this determination include:
The child's ethnic background,
The child's age,
Whether the child is a member of a minority or sibling group, or
Whether the child has a medical condition or physical, mental, or emotional handicap.
When to take the credit.Adoption:Credits:Taking
Generally, until the adoption becomes final, you take the credit in the year after your qualified expenses are paid or incurred. See the
instructions for Form 8839 for more specific information on when to take the credit.
If the child is not a U.S. citizen or resident at the time the adoption process began, you cannot take the credit unless the adoption becomes
final. You treat all adoption expenses paid or incurred in years before the adoption becomes final as paid or incurred in the year it becomes final.
How to take the credit.Form:1040Adoption expensesForm:1040AAdoption expensesForm:8839Qualified adoption expenses
To take the credit, you must complete Form 8839 and attach it to your Form 1040 or Form 1040A. Enter the credit on Form 1040, line 53, or Form
1040A, line 34.
You generally can choose to take income taxes you paid or accrued during the year to a foreign country or U.S. possession as a credit against your
U.S. income tax. Or, you can deduct them as an itemized deduction (see chapter 22).
You cannot take a credit (or deduction) for foreign income taxes paid on income that you exclude from U.S. tax under any of the following.
Foreign earned income exclusion.
Foreign housing exclusion.
Income from Puerto Rico exempt from U.S. tax.
Possession exclusion.
Extraterritorial income exclusion.
Limit on the credit.Foreign tax credit:Limit on
Unless you can elect not to file Form 1116 (see Exception, later), your foreign tax credit cannot be more than your U.S. tax liability
(Form 1040, line 44), multiplied by a fraction. The numerator of the fraction is your taxable income from sources outside the United States. The
denominator is your total taxable income from U.S. and foreign sources. See Publication 514 for more information.
How to take the credit.Foreign tax credit:How to takeForm:1040Foreign tax creditForm:1116Foreign tax credit
Complete Form 1116 and attach it to your Form 1040. Enter the credit on Form 1040, line 47.
Exception.Exemption from foreign tax credit limit
You do not have to complete Form 1116 to take the credit if all five of the following apply.
All of your gross foreign source income was from interest and dividends and all of that income and the foreign tax paid on it were reported
to you on Form 1099-INT, Form 1099-DIV, or Schedule K-1 (or substitute statement).
If you had dividend income from shares of stock, you held those shares for at least 16 days.
You are not filing Form 4563 or excluding income from sources within Puerto Rico.
The total of your foreign taxes was not more than $300 (not more than $600 if married filing jointly).
All of your foreign taxes were:
Legally owed and not eligible for a refund, and
Paid to countries that are recognized by the United States and do not support terrorism.
For more details on these requirements, see the instructions for Form 1116.
The mortgage interest credit is intended to help lower-income individuals own a home. If you qualify, you can take the credit each year for part of
the home mortgage interest you pay.
Who qualifies.
You may be eligible for the credit if you were issued a mortgage credit certificate (MCC)
Certificate, mortgage creditMCC (Mortgage credit certificate)Mortgage credit certificate (MCC)from your state or local government. Generally, an MCC is issued only in connection with a new
mortgage for the purchase of your main home.
Amount of credit.
Figure your credit on Form 8396. If your mortgage is equal to (or smaller than) the certified indebtedness amount (loan) shown on your MCC, enter
on Form 8396, line 1, all the interest you paid on your mortgage during the year.
If your mortgage loan amount is larger than the certified indebtedness amount shown on your MCC, you can figure the credit on only part of the
interest you paid. To find the amount to enter on line 1, multiply the total interest you paid during the year on your mortgage by the following
fraction.
Certified indebtedness amount on your MCCOriginal amount of your mortgage
If two or more persons (other than a married couple filing a joint return) hold an interest in the home to which the MCC relates, the credit must
be divided based on the interest held by each person. See Publication 530 for more information.
If the certificate credit rate is more than 20%, the credit you are allowed cannot be more than $2,000.
If your allowable credit is reduced because of the limit based on your tax, you can carry forward the unused portion of the credit to the next 3
years or until used, whichever comes first.
If you are subject to the $2,000 limit because your certificate credit rate is more than 20%, you cannot carry forward any amount more than $2,000
(or your share of the $2,000 if you must divide the credit).
How to take the credit.Mortgage interest credit:How to takeMortgages:Interest creditMortgage interest credit
Form:1040Mortgage interest creditForm:8396Mortgage interest creditFigure your 2005 credit and any carryforward to 2006 on Form 8396, and attach it to your Form
1040. Be sure to include any credit carryforward from 2002, 2003, and 2004.
Include the credit in your total for Form 1040, line 54, and check box a.
If you itemize your deductions on Schedule A (Form 1040), you must reduce your home mortgage interest deduction by the amount of the mortgage
interest credit shown on Form 8396, line 3. You must do this even if part of that amount is to be carried forward to 2006. For more information about
the home mortgage interest deduction, see chapter 23.
Recapture of federal mortgage subsidy.Mortgage interest credit:RecaptureMortgages:Federally subsidized mortgage, recapture of tax paid on home purchased with
If you received an MCC with your mortgage loan, you may have to recapture (pay back) all or part of the benefit you received from that program. The
recapture may be required if you sell or dispose of your home at a gain during the first 9 years after the date you closed your mortgage loan. See
Publication 523, Selling Your Home, for more information.
You may be able to take this credit if you, or your spouse if filing jointly, made:
Contributions to a traditional or Roth IRA,
Elective deferrals to a 401(k), 403(b), governmental 457, SEP, or SIMPLE plan,
Voluntary employee contributions to a qualified retirement plan (including the federal Thrift Savings Plan), or
Contributions to a 501(c)(18)(D) plan.
However, you cannot take the credit if either of the following applies.
The amount on Form 1040, line 38, or Form 1040A, line 22, is more than $25,000 ($37,500 if head of household; $50,000 if married filing
jointly).
The person(s) who made the qualified contribution or elective deferral (a) was born after January 1, 1988, (b) is claimed as a dependent on
someone else's 2005 tax return or (c) was a student (defined next).
Student.
You were a student if during any 5 months of 2005 you:
Were enrolled as a full-time student at a school, or
Took a full-time, on-farm training course given by a school or a state, county, or local government agency.
School.
A school includes a technical, trade, or mechanical school. It does not include an on-the-job training course, correspondence school, or internet
school.
How to take the credit.Form:8880Credit for Qualified Retirement Savings Contributions
Figure the credit on Form 8880. Enter the credit on your Form 1040, line 51, or your Form 1040A, line 32, and attach Form 8880 to your return.
Credit for Prior Year Minimum TaxAlternative minimum tax (AMT):Credit for prior year taxCredits:Alternative minimum tax, credit for prior year tax
The tax laws give special treatment to some kinds of income and allow special deductions and credits for some kinds of expenses. If you benefit
from these laws, you may have to pay at least a minimum amount of tax in addition to any other tax on these items. This is called the alternative
minimum tax.
The special treatment of some items of income and expenses only allows you to postpone paying tax until a later year. If in prior years you paid
alternative minimum tax because of these tax postponement items, you may be able to take a credit for prior year minimum tax against your current
year's regular tax. The amount of the credit cannot reduce your current year's tax below your current year's tentative alternative minimum tax.
You may be able to take a credit against your regular tax if for 2004 you had:
An alternative minimum tax liability and adjustments or preferences other than exclusion items,
A minimum tax credit that you are carrying forward to 2005, or
An unallowed nonconventional source fuel credit or qualified electric vehicle credit.
How to take the credit.Alternative minimum tax (AMT):Credit for prior year taxCredits:Alternative minimum tax, credit for prior year taxForm:1040Alternative minimum tax, Credit for prior year tax
Form:8801Alternative minimum taxFigure your 2005 credit and any carryforward to 2006 on Form 8801, and attach it to your Form
1040. Include the credit in your total for Form 1040, line 55, and check box b. You can carry forward any unused credit for prior year minimum tax to
later years until it is completely used.
For more information about the credit, see the instructions for Form 8801.
Qualified Electric Vehicle CreditCredits:Electric vehiclesElectric carsElectric cars:Credits
You may be allowed a tax credit if you placed a qualified electric vehicle in service during the year.
Qualified electric vehicle.Electric cars:Credits:Qualified electric vehicle
Generally, this is a vehicle that:
Has at least four wheels and is manufactured primarily for use on public streets, roads, and highways,
Is powered primarily by an electric motor drawing current from rechargeable batteries, fuel cells, or other portable sources of electrical
current,
Is originally used by you,
Is acquired for your own use, not for resale,
Has never been used as a nonelectric vehicle, and
Is used predominately in the United States.
Amount of credit.Electric cars:Credits:Amount of
If you placed a qualified electric vehicle in service during 2005, the credit is generally 10% of the cost of the vehicle. However, if the vehicle
is a depreciable business asset, you must reduce the cost of the vehicle by any section 179 deduction before figuring the credit. See Publication 463,
Travel, Entertainment, Gift, and Car Expenses, for information on the section 179 deduction.
The credit is limited to $4,000 for each vehicle placed in service in 2005.
Recapture.
Electric cars:Credits:Recapture ofRecapture:CreditsThe credit will be subject to recapture if, within 3 years after the date you place the vehicle in service, the
vehicle is used predominately outside the United States or is modified (or its use is modified) so that it is no longer eligible for the credit. You
recapture the credit by adding part or all of it to your income tax for the year in which the recapture event occurs. See Publication 535, chapter 12,
for more information.
How to take the credit.Electric cars:Credits:How to takeForm:1040Electric vehicle creditForm:8834Electric vehicle credit
To take the credit, complete Form 8834 and attach it to your Form 1040. Include the credit in your total for Form 1040, line 55. Check box c, and
enter 8834 on the line next to box c.
Do not confuse this credit with the deduction for clean-fuel vehicles which is discussed in Publication 535, chapter 12.
The credits discussed in this part of the chapter are treated as payments of tax. If the total of these credits, withheld federal income tax, and
estimated tax payments is more than your total tax, the excess can be refunded to you.
Credit for Excess Social Security Tax or Railroad Retirement Tax WithheldExcess withholding credit
Most employers must withhold social security tax from your wages. If you work for a railroad employer, that employer must withhold tier 1 railroad
retirement (RRTA) tax and tier 2 RRTA tax.
If you worked for two or more employers in 2005, you may have had too much social security or RRTA tax withheld from your pay. You can claim the
excess social security or RRTA tier 1 tax as a credit against your income tax. The following table shows the maximum amount of wages subject to tax
and the maximum amount of tax that should have been withheld in 2005.
Type of taxMaximum
wages
subject to taxMaximum tax
that should
have been
withheldSocial security or
RRTA tier 1$90,000$5,580.00RRTA tier 2$66,900$2,943.60
All wages are subject to Medicare tax withholding.
Form:843Claim for refund and request for abatementUse Form 843, Claim for Refund and Request for Abatement, to claim a refund
of excess RRTA tier 2 tax. See Publication 505, Tax Withholding and Estimated Tax, for details.
If any one employer withheld too much social security or RRTA tax, you cannot take the excess as a credit against your income tax. The employer
should adjust the tax for you. If the employer does not adjust the overcollection, you can file a claim for refund using Form 843.
Joint return.Joint returns:Excess social security/railroad retirement tax withholding credit
If you are filing a joint return, you cannot add the social security or RRTA tax withheld from your spouse's wages to the amount withheld from your
wages. Figure the credit separately for you and your spouse to determine if either of you has excess withholding.
How to figure the credit if you did not work for a railroad.Figuring taxes and creditsWorksheetsWorksheets:Excess withholding credit
If you did not work for a railroad during 2005, figure the credit as follows:
1. Add all social security tax withheld (but not more than $5,580.00 for each employer). Enter the total
here2. Enter any uncollected social security tax on tips or group-term life insurance included in the total on
Form 1040, line 63 3. Add lines 1 and 2. If $5,580.00 or less, stop here. You cannot take
the credit 4. Social security tax limit 5,580.005. Credit. Subtract line 4 from line 3. Enter the result here and on Form 1040, line 67 (or Form 1040A, line
43)
Example.
You are married and file a joint return with your spouse who had no gross income in 2005. During 2005, you worked for the Brown Shoe Company and
earned $52,000 in wages. Social security tax of $3,224 was withheld. You also worked for another employer in 2005 and earned $40,200 in wages.
$2,492.40 of social security tax was withheld from these wages. Because you worked for more than one employer and your total wages were more than
$90,000, you can take a credit of $136.40 for the excess social security tax withheld.
1. Add all social security tax withheld (but not more than $5,580.00 for each employer). Enter the total
here$5,716.402. Enter any uncollected social security tax on tips or group-term life insurance included in the total on
Form 1040, line 63 -0- 3. Add lines 1 and 2. If $5,580.00 or less, stop here. You cannot take the credit 5,716.404. Social security tax limit 5,580.005. Credit. Subtract line 4 from line 3. Enter the result here and on Form 1040, line 67 (or Form 1040A, line
43) $136.40
How to figure the credit if you worked for a railroad.
If you were a railroad employee during 2005, figure the credit as follows:
1. Add all social security and tier 1 RRTA tax withheld (but not more than $5,580.00 for each employer). Enter
the total here 2. Enter any uncollected social security and tier 1 RRTA tax on
tips or group-term life insurance
included in the total on Form 1040,
line 633. Add lines 1 and 2. If $5,580.00 or less, stop here. You cannot take
the credit4. Social security and tier 1 RRTA
tax limit5,580.005. Credit. Subtract line 4 from line 3. Enter the result here and on Form 1040, line 67 (or Form 1040A, line
43)
How to take the credit.Excess withholding credit:How to takeForm:1040Excess withholding creditForm:1040AExcess withholding credit
Enter the credit on Form 1040, line 67, or Form 1040A, line 43.
Credit for Tax on Undistributed Capital GainCapital gains or losses:Undistributed gains:Credit for tax onCredits:Capital gains, undistributed, credit for tax onMutual funds:Undistributed capital gains:Credit for tax onReal estate investment trusts (REITs):Undistributed capital gains:Credit for tax onRegulated investment companies:Undistributed capital gains, credit for tax onUndistributed capital gains
You must include in your income any amounts that regulated investment companies (commonly called mutual funds) or real estate investment trusts
(REITs) allocated to you as capital gain distributions, even if you did not actually receive them. If the mutual fund or REIT paid a tax on the
capital gain, you are allowed a credit for the tax since it is considered paid by you. The mutual fund or REIT will send you Form 2439, Notice to
Shareholder of Undistributed Long-Term Capital Gains, showing the undistributed capital gains and the tax paid, if any. Take the credit for the tax
paid by entering the amount on Form 1040, line 70, and checking box a. Attach Copy B of Form 2439 to your return. See Capital Gain Distributions
in chapter 8 for more information on undistributed capital gains.
Form:1040Undistributed long-term capital gainsForm:2439Notice to shareholder on undistributed long-term capital gainsHealth Coverage Tax CreditHealth coverage tax creditMedical and dental expenses:Health insurance credit
You may be able to take this credit only if, for any month in 2005, all of the following apply.
You were an eligible trade adjustment assistance (TAA) recipient, alternative TAA recipient, or Pension Benefit Guaranty Corporation (PBGC)
pension recipient (defined later).
You were covered by a qualified health insurance plan for which you paid the premiums.
You were not entitled to Medicare Part A or enrolled in Medicare Part B.
You were not enrolled in Medicaid or State Children's Health Insurance Program (SCHIP).
You were not enrolled in the Federal Employees Health Benefits Program or eligible to receive benefits under the U.S. military health system
(TRICARE).
You were not imprisoned under federal, state, or local authority.
But, you cannot take the credit if you can be claimed as a dependent on someone else's 2005 tax return. If you meet all of these conditions,
you may be able to take a credit of up to 65% of the amount you paid for qualified health insurance coverage. The amount you paid for qualified health
insurance coverage must be reduced by any (a) Archer MSA and health savings account distributions used to pay for the coverage, and (b) National
Emergency Grants you received for health insurance in 2005.
You can take this credit on your tax return or have it paid on your behalf in advance to your insurance company. If the credit is paid on your
behalf in advance, that amount will reduce the amount of the credit you can take on your tax return.
For definitions and special rules including those relating to qualified health insurance plans and employer-sponsored health insurance plans, see
Publication 502 and the instructions for Form 8885.
TAA Recipient
You were an eligible TAA recipient on the first day of the month if, for any day in that month or the prior month, you:
Received a trade readjustment allowance, or
Would have been entitled to receive such an allowance except that you had not exhausted all rights to any unemployment insurance (except
additional compensation that is funded by a state and is not reimbursed from any federal funds) to which you were entitled (or would be entitled if
you applied).
Example.
You received a trade adjustment allowance for January 2005. You were an eligible TAA recipient on the first day of January and February.
Alternative TAA Recipient
You were an eligible alternative TAA recipient on the first day of the month if, for that month or the prior month, you received benefits under an
alternative trade adjustment assistance program for older workers established by the Department of Labor.
Example.
You received benefits under an alternative trade adjustment assistance program for older workers for October 2005. The program was established by
the Department of Labor. You were an eligible alternative TAA recipient on the first day of October and November.
PBGC Pension Recipient
You were an eligible PBGC pension recipient on the first day of the month, if both of the following apply.
You were age 55 or older on the first day of the month.
You received a benefit for that month that was paid by the PBGC under title IV of the Employee Retirement Income Security Act of 1974
(ERISA).
If you received a lump-sum payment from the PBGC after August 5, 2002, you meet item (2) above for any month that you would have received a
PBGC benefit if you had not received the lump-sum payment.
How To Take the CreditForm:1040Health insurance creditForm:8885Health insurance credit
To take the credit, complete Form 8885 and attach it to your Form 1040. Include your credit in the total for Form 1040, line 70, and check box c.
You must attach invoices and proof of payment for any amounts you include on Form 8885, line 2, for which you did not receive an advance payment.
For details, see Publication 502 or Form 8885.
2005 Tax Table with ExampleSummary: This is the tax table used to determine 2005 taxes based on taxable income and filing status for Form 1040 filers. This portion of
the table lists from
At least--$0 to
But less than--5,000. A small sample table illustrates the data mentioned in the example text. The data in row
At least 25,300 But less than 25,350 and column
Married Filing Jointly, is 3,069. This number is circled.2005 Tax Table with Example--ContinuedSummary: This is the tax table used to determine 2005 taxes based on taxable income and filing status for Form 1040 filers. This portion of
the table lists from
At least--$5,000 to
But less than--14,000.2005 Tax Table with Example--ContinuedSummary: This is the tax table used to determine 2005 taxes based on taxable income and filing status for Form 1040 filers. This portion of
the table lists from
At least--$14,000 to
But less than--23,000.2005 Tax Table with Example--ContinuedSummary: This is the tax table used to determine 2005 taxes based on taxable income and filing status for Form 1040 filers. This portion of
the table lists from
At least--$23,000 to
But less than--32,000.2005 Tax Table with Example--ContinuedSummary: This is the tax table used to determine 2005 taxes based on taxable income and filing status for Form 1040 filers. This portion of
the table lists from
At least--$32,000 to
But less than--41,000.2005 Tax Table with Example--ContinuedSummary: This is the tax table used to determine 2005 taxes based on taxable income and filing status for Form 1040 filers. This portion of
the table lists from
At least--$41,000 to
But less than--50,000.2005 Tax Table with Example--ContinuedSummary: This is the tax table used to determine 2005 taxes based on taxable income and filing status for Form 1040 filers. This portion of
the table lists from
At least--$50,000 to
But less than--59,000.2005 Tax Table with Example--ContinuedSummary: This is the tax table used to determine 2005 taxes based on taxable income and filing status for Form 1040 filers. This portion of
the table lists from
At least--$59,000 to
But less than--68,000.2005 Tax Table with Example--ContinuedSummary: This is the tax table used to determine 2005 taxes based on taxable income and filing status for Form 1040 filers. This portion of
the table lists from
At least--$68,000 to
But less than--77,000.2005 Tax Table with Example--ContinuedSummary: This is the tax table used to determine 2005 taxes based on taxable income and filing status for Form 1040 filers. This portion of
the table lists from
At least--$77,000 to
But less than--86,000.2005 Tax Table with Example--ContinuedSummary: This is the tax table used to determine 2005 taxes based on taxable income and filing status for Form 1040 filers. This portion of
the table lists from
At least--$86,000 to
But less than--95,000.2005 Tax Table with Example--ContinuedSummary: This is the tax table used to determine 2005 taxes based on taxable income and filing status for Form 1040 filers. This portion of
the table lists from
At least--$95,000 to
But less than--100,000. There is a note that states: $100,000 or over--use the Tax Rate
Schedules.
2005 Tax Rate SchedulesSummary: These are the Tax Rate Schedules used to determine your 2005 taxes if your income is $100,000 or more.Schedule X--Use if your filing status is Single.
If the amount on Form 1040, line 43, is: Over—
But not over--
The tax on Form 1040, line 44 is:
of the amount over—
$0
$7,300
10% of the amount over $0
7,300
29,700
$730.00 plus 15% of the amount over 7,300
29,700
71,950
4,090.00 plus 25% of the amount over 29,700
71,950
150,150
14,652.50 plus 28% of the amount over 71,950
150,150
326,450
36,548.50 plus 33% of the amount over 150,150
326,450
no limit
94,727.50 plus 35% of the amount over 326,450
Schedule Y-1--Use if your filing status is Married filing jointly or Qualifying widow(er).
If the amount on Form 1040, line 43, is: Over—
But not over--
The tax on Form 1040, line 44 is:
of the amount over—
$0
14,600
10% of the amount over $0
14,600
59,400
$1,460.00 plus 15% of the amount over 14,600
59,400
119,950
8,180.00 plus 25% of the amount over 59,400
119,950
182,800
23,317.50 plus 28% of the amount over 119,950
182,800
326,450
40,915.50 plus 33% of the amount over 182,800
326,450
no limit
88,320.00 plus 35% of the amount over 326,450
Schedule Y-2--Use if your filing status is Married filing separately.
If the amount on Form 1040, line 43, is: Over—
But not over--
The tax on Form 1040, line 44 is:
of the amount over—
$0
7,300
10% of the amount over $0
7,300
29,700
$730.00 plus 15% of the amount over 7,300
29,700
59,975
4,090.00 plus 25% of the amount over 29,700
59,975
91,400
11,658.75 plus 28% of the amount over 59,975
91,400
163,225
20,457.75 plus 33% of the amount over 91,400
163,225
no limit
44,160.00 plus 35% of the amount over 163,225
Schedule Z--Use if your filing status is Head of household.
If the amount on Form 1040, line 43, is: Over—
But not over--
The tax on Form 1040, line 44 is:
of the amount over—
$0
10,450
10% of the amount over $0
10,450
39,800
$1,045.00 plus 15% of the amount over 10,450
39,800
102,800
5,447.50 plus 25% of the amount over 39,800
102,800
166,450
21,197.50 plus 28% of the amount over 102,800
166,450
326,450
39,019.50 plus 33% of the amount over 166,450
326,450
no limit
91,819.50 plus 35% of the amount over 326,450
2005 Tax Computation Worksheet—Line 44See the instructions for line 44 in the instructions for Form 1040 to see if you can use the
worksheet below to figure your tax.Note. If you are required to use this worksheet to figure the tax on an amount from another
form or worksheet, such as the Qualified Dividends and Capital Gain Tax Worksheet, the Schedule D Tax Worksheet, Schedule J, or Form 8615, enter the
amount from that form or worksheet in column (a) of the row that applies to the amount you are looking up. Enter the result on the appropriate line of
the form or worksheet that you are completing.
Section A—<ROM>Use if your filing status is</ROM> Single. <ROM>Complete the row below that applies to you.</ROM>Taxable Income.If line 43 is—(a)Enter the amount from line 43(b)Multiplication amount (c)Multiply
(a) by (b)(d) Subtraction
amountTax.Subtract (d) from (c).
Enter the result here and
on Form 1040, line 44At least $100,000 but not over $150,150 $ × 28% (.28) $ $ 5,493.50 $Over $150,150 but not over $326,450 $ × 33% (.33) $ $ 13,001.00 $Over $326,450 $ × 35% (.35) $ $ 19,530.00 $
Section B—<ROM>Use if your filing status is</ROM> Married filing jointly <ROM>or</ROM> qualifying widow(er).<ROM>Complete the row below
that applies to you.</ROM> Taxable Income.If line 43 is—(a)Enter the amount from line 43(b)Multiplication amount(c)Multiply
(a) by (b)(d) Subtraction
amountTax.Subtract (d) from (c).
Enter the result here and
on Form 1040, line 44At least $100,000 but not over $119,950 $ × 25% (.25) $ $ 6,670.00 $Over $119,950 but not over $182,800 $ × 28% (.28) $ $ 10,268.50 $Over $182,800 but not over $326,450 $ × 33% (.33) $ $ 19,408.50 $Over $326,450 $ × 35% (.35) $ $ 25,937.50 $
Section C—<ROM>Use if your filing status is</ROM> Married filing separately. <ROM>Complete the row below that applies to
you.</ROM>Taxable Income.If line 43 is—(a)Enter the amount from line 43(b)Multiplication amount(c)Multiply
(a) by (b)(d) Subtraction
amountTax.Subtract (d) from (c).
Enter the result here and
on Form 1040, line 44At least $100,000 but not over $163,225 $ × 33% (.33) $ $ 9,704.25 $Over $163,225 $ × 35% (.35) $ $ 12,968.75 $
Section D—<ROM>Use if your filing status is </ROM>Head of household. <ROM>Complete the row below that applies to you.</ROM>Taxable Income.If line 43 is—(a)Enter the amount from line 43(b)Multiplication amount(c)Multiply
(a) by (b)(d) Subtraction
amountTax.Subtract (d) from (c).
Enter the result here and
on Form 1040, line 44At least $100,000 but not over $102,800 $ × 25% (.25) $ $ 4,502.50 $Over $102,800 but not over $166,450 $ × 28% (.28) $ $ 7,586.50 $Over $166,450 but not over $326,450 $ × 33% (.33) $ $ 15,909.00 $Over $326,450 $ × 35% (.35) $ $ 22,438.00 $
Your Rights as a Taxpayer
This section explains some of your most important rights as a taxpayer including the examination, appeal, collection, and refund processes.
Declaration of Taxpayer RightsProtection of your rights.
IRS employees will explain and protect your rights as a taxpayer throughout your contact with us.
Privacy and confidentiality.
The IRS will not disclose to anyone the information you give us, except as authorized by law. You have the right to know why we are asking you for
information, how we will use it, and what will happen if you do not provide requested information.
Professional and courteous service.
If you believe that an IRS employee has not treated you in a professional, fair, and courteous manner, you should tell that employee's supervisor.
If the supervisor's response is not satisfactory, you should write to the IRS director for your area or the center where you filed your return.
Representation.
You may either represent yourself or, with proper written authorization, have someone else represent you in your place. Your representative must be
a person allowed to practice before the IRS, such as an attorney, certified public accountant, or enrolled agent. If you are in an interview and ask
to consult such a person, then we must stop and reschedule the interview in most cases.
You can have someone accompany you at an interview. You may make sound recordings of any meetings with our examination, appeal, or collection
personnel, provided you tell us in writing 10 days before the meeting.
Payment of only the correct amount of tax.
You are responsible for paying only the correct amount of tax due under the law—no more, no less. If you cannot pay all of your tax when it
is due, you may be able to make monthly installment payments.
Help with unresolved tax problems.
The Taxpayer Advocate Service can help you if you have tried unsuccessfully to resolve a problem with the IRS. Your local Taxpayer Advocate can
offer you special help if you have a significant hardship as a result of a tax problem. For more information, see Contacting your Taxpayer
Advocate under How To Get Tax Help.
Appeals and judicial review.
If you disagree with us about the amount of your tax liability or certain collection actions, you have the right to ask the Appeals Office to
review your case. You may also ask a court to review your case.
Relief from certain penalties and interest.
The IRS will waive penalties when allowed by law if you can show you acted reasonably and in good faith or relied on the incorrect advice of an IRS
employee. We will waive interest that is the result of certain errors or delays caused by an IRS employee.
Examinations (Audits)
We accept most taxpayers' returns as filed. If we inquire about your return or select it for examination, it does not suggest that you are
dishonest. The inquiry or examination may or may not result in more tax. We may close your case without change; or, you may receive a refund.
The process of selecting a return for examination usually begins in one of two ways. First, we use computer programs to identify returns that may
have incorrect amounts. These programs may be based on information returns, such as Forms 1099 and W-2, on studies of past examinations, or on certain
issues identified by compliance projects. Second, we use information from outside sources that indicates that a return may have incorrect amounts.
These sources may include newspapers, public records, and individuals. If we determine that the information is accurate and reliable, we may use it to
select a return for examination.
Publication 556, Examination of Returns, Appeal Rights, and Claims for Refund, explains the rules and procedures that we follow in examinations.
The following sections give an overview of how we conduct examinations.
By mail.
We handle many examinations and inquiries by mail. We will send you a letter with either a request for more information or a reason why we believe
a change to your return may be needed. You can respond by mail or you can request a personal interview with an examiner. If you mail us the requested
information or provide an explanation, we may or may not agree with you, and we will explain the reasons for any changes. Please do not hesitate to
write to us about anything you do not understand.
By interview.
If we notify you that we will conduct your examination through a personal interview, or you request such an interview, you have the right to ask
that the examination take place at a reasonable time and place that is convenient for both you and the IRS. If our examiner proposes any changes to
your return, he or she will explain the reasons for the changes. If you do not agree with these changes, you can meet with the examiner's supervisor.
Repeat examinations.
If we examined your return for the same items in either of the 2 previous years and proposed no change to your tax liability, please contact us as
soon as possible so we can see if we should discontinue the examination.
Appeals
If you do not agree with the examiner's proposed changes, you can appeal them to the Appeals Office of IRS. Most differences can be settled without
expensive and time-consuming court trials. Your appeal rights are explained in detail in both Publication 5, Your Appeal Rights and How To Prepare a
Protest If You Don't Agree, and Publication 556, Examination of Returns, Appeal Rights, and Claims for Refund.
If you do not wish to use the Appeals Office or disagree with its findings, you may be able to take your case to the U.S. Tax Court, U.S. Court of
Federal Claims, or the U.S. District Court where you live. If you take your case to court, the IRS will have the burden of proving certain facts if
you kept adequate records to show your tax liability, cooperated with the IRS, and meet certain other conditions. If the court agrees with you on most
issues in your case and finds that our position was largely unjustified, you may be able to recover some of your administrative and litigation costs.
You will not be eligible to recover these costs unless you tried to resolve your case administratively, including going through the appeals system,
and you gave us the information necessary to resolve the case.
Collections
Publication 594, The IRS Collection Process, explains your rights and responsibilities regarding payment of federal taxes. It describes:
What to do when you owe taxes. It describes what to do if you get a tax bill and what to do if you think your bill is wrong. It also covers
making installment payments, delaying collection action, and submitting an offer in compromise.
IRS collection actions. It covers liens, releasing a lien, levies, releasing a levy, seizures and sales, and release of
property.
Your collection appeal rights are explained in detail in Publication 1660, Collection Appeal Rights.
Innocent spouse relief.
Generally, both you and your spouse are each responsible for paying the full amount of any tax, interest, and penalties due on your joint return.
However, if you qualify for innocent spouse relief, you may be relieved of all or part of the joint liability. To request relief, you must file Form
8857, Request for Innocent Spouse Relief no later than 2 years after the date on which the IRS first attempted to collect the tax from you. For
example, the two-year period for filing your claim may start if the IRS applies your tax refund from one year to the taxes that you and your spouse
owe for another year. For more information on innocent spouse relief, see Publication 971, Innocent Spouse Relief, and Form 8857.
Potential Third Party Contacts
Generally, the IRS will deal directly with you or your duly authorized representative. However, we sometimes talk with other persons if we need
information that you have been unable to provide, or to verify information we have received. If we do contact other persons, such as a neighbor, bank,
employer, or employees, we will generally need to tell them limited information, such as your name. The law prohibits us from disclosing any more
information than is necessary to obtain or verify the information we are seeking. Our need to contact other persons may continue as long as there is
activity in your case. If we do contact other persons, you have a right to request a list of those contacted.
Refunds
You may file a claim for refund if you think you paid too much tax. You must generally file the claim within 3 years from the date you filed your
original return or 2 years from the date you paid the tax, whichever is later. The law generally provides for interest on your refund if it is not
paid within 45 days of the date you filed your return or claim for refund. Publication 556, Examination of Returns, Appeal Rights, and Claims for
Refund, has more information on refunds.
If you were due a refund but you did not file a return, you generally must file within 3 years from the date the return was due (including
extensions) to get that refund.
How To Get Tax HelpMore informationTax helpFree tax servicesTax helpHelpTax helpPublicationsTax helpTTY/TDD information
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.
Contacting your Taxpayer Advocate.Taxpayer Advocate
If you have attempted to deal with an IRS problem unsuccessfully, you should contact your Taxpayer Advocate.
The Taxpayer Advocate independently represents your interests and concerns within the IRS by protecting your rights and resolving problems that
have not been fixed through normal channels. While Taxpayer Advocates cannot change the tax law or make a technical tax decision, they can clear up
problems that resulted from previous contacts and ensure that your case is given a complete and impartial review.
To contact your Taxpayer Advocate:
Call the Taxpayer Advocate toll free at
1-877-777-4778.
Call, write, or fax the Taxpayer Advocate office in your area.
For more information, see Publication 1546, How To Get Help With Unresolved Tax Problems (now available in Chinese, Korean, Russian, and
Vietnamese, in addition to English and Spanish).
Free tax services.
To find out what services are available, get Publication 910, IRS Guide to Free Tax Services. It contains a list of free tax publications and an
index of tax topics. It also describes other free tax information services, including tax education and assistance programs and a list of TeleTax
topics.
Internet. You can access the IRS website 24 hours a day, 7 days a week, at
www.irs.gov to:
E-file your return. Find out about commercial tax preparation and e-file services available free to eligible
taxpayers.
Check the status of your 2005 refund. Click on Where's My Refund. Be sure to wait at least 6 weeks from the date you filed your
return (3 weeks if you filed electronically). Have your 2005 tax return available because you will need to know your social security number, your
filing status, and the exact whole dollar amount of your refund.
Download forms, instructions, and publications.
Order IRS products online.
Research your tax questions online.
Search publications online by topic or keyword.
View Internal Revenue Bulletins (IRBs) published in the last few years.
Figure your withholding allowances using our Form W-4 calculator.
Sign up to receive local and national tax news by email.
Get information on starting and operating a small business.
Phone. Many services are available by phone.
Ordering forms, instructions, and publications. Call 1-800-829-3676 to order current-year forms, instructions, and publications
and prior-year forms and instructions. You should receive your order within 10 days.
Asking tax questions. Call the IRS with your tax questions at 1-800-829-1040.
Solving problems. You can get face-to-face help solving tax problems every business day in IRS Taxpayer Assistance Centers. 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.
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.
TeleTax topics. Call 1-800-829-4477 and press 2 to listen to pre-recorded messages covering various tax topics.
Refund information. If you would like to check the status of your 2005 refund, call 1-800-829-4477 and press 1 for automated
refund information or call 1-800-829-1954. Be sure to wait at least 6 weeks from the date you filed your return (3 weeks if you filed electronically).
Have your 2005 tax return available because you will need to know your social security number, your filing status, and the exact whole dollar amount
of your refund.
Evaluating the quality of our telephone services. To ensure that 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 sometimes listen in on or
record telephone calls. Another is to ask some callers to complete a short survey at the end of the call.
Walk-in. Many products and services are available on a walk-in basis.
Products. You can walk in to many post offices, libraries, and IRS offices to pick up certain forms, instructions, and
publications. Some IRS offices, libraries, grocery stores, copy centers, city and county government offices, credit unions, and office supply stores
have a collection of products available to print from a CD-ROM or 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.
Services. You can walk in to your local Taxpayer Assistance Center every business day 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're more comfortable talking with someone in person, visit your
local Taxpayer Assistance Center where you can spread out your records and talk with an IRS representative face-to-face. No appointment is necessary,
but if you prefer, you can call your local Center and leave a message requesting an appointment to resolve a tax account issue. A representative will
call you back within 2 business days to schedule an in-person appointment at your convenience. To find the number, go to
www.irs.gov/localcontacts or
look in the phone book under United States Government, Internal Revenue Service.
Mail. You can send your order for forms, instructions, and publications to the address below and receive a response within 10 business
days after your request is received.
National Distribution Center
P.O. Box 8903
Bloomington, IL 61702-8903
CD-ROM for tax products. You can order Publication 1796, IRS Tax Products CD-ROM, and obtain:
A CD that is released twice so you have the latest products. The first release ships in late December and the final release ships in late
February.
Current-year forms, instructions, and publications.
Prior-year forms, instructions, and publications.
Tax Map: an electronic research tool and finding aid.
Tax law frequently asked questions (FAQs).
Tax Topics from the IRS telephone response system.
Fill-in, print, and save features for most tax forms.
Internal Revenue Bulletins.
Toll-free and email technical support.
Buy the CD-ROM from National Technical Information Service (NTIS) at
www.irs.gov/cdorders for $25 (no handling fee) or call 1-877-233-6767 toll free to buy the CD-ROM for $25 (plus a $5 handling fee).
CD-ROM for small businesses. Publication 3207, The Small Business Resource Guide CD-ROM for 2005, has a new look and enhanced navigation
features. This year's CD includes:
Helpful information, such as how to prepare a business plan, find financing for your business, and much more.
All the business tax forms, instructions, and publications needed to successfully manage a business.
Tax law changes for 2005.
IRS Tax Map to help you find forms, instructions, and publications by searching on a keyword or topic.
Web links to various government agencies, business associations, and IRS organizations.
Rate the Product survey—your opportunity to suggest changes for future editions.
An updated version of this CD is available each year in early April. You can get a free copy by calling 1-800-829-3676 or by visiting
www.irs.gov/smallbiz.
Where To FileNote. Use this table only if you are an individual taxpayer filing your own return.AND use the zip code below according to the form you are filing and
whether you are enclosing paymentForm 1040Form 1040AForm 1040EZIF you live in...THEN send your return to...No payment enclosedPayment enclosedNo payment enclosedPayment enclosedNo payment enclosedPayment enclosedAlabama, Delaware, Florida, Georgia, North Carolina, Rhode Island, South Carolina, VirginiaInternal Revenue Service Center
Atlanta, GA39901–000239901–010239901–001539901–011539901–001439901–0114Alaska, Arizona, California, Hawaii, Idaho, Montana, Nevada, Oregon, Washington, Colorado, Nebraska, New Mexico, South Dakota, Utah,
WyomingInternal Revenue Service Center
Fresno, CA93888–000293888–010293888–001593888–011593888–001493888–0114Arkansas, Kansas, Kentucky, Louisiana, Mississippi, Oklahoma, Tennessee, Texas, West VirginiaInternal Revenue Service Center
Austin, TX73301–000273301–010273301–001573301–011573301–001473301–0114New Jersey, PennsylvaniaInternal Revenue Service Center
Philadelphia, PA19255–000219255–010219255–001519255–011519255–001419255–0114Connecticut, Illinois, Indiana, Iowa, Michigan, Minnesota, Missouri, Ohio, North Dakota, WisconsinInternal Revenue Service Center
Kansas City, MO64999–000264999–010264999–001564999–011564999–001464999–0114District of Columbia, Maine, Maryland, Massachusetts, New Hampshire, New York, VermontInternal Revenue Service Center
Andover, MA05501–000205501–010205501–001505501–011505501–001405501–0114American Samoa, nonpermanent residents of Guam* or the Virgin Islands**, Puerto Rico (or if excluding income under Internal Revenue Code
section 933), dual status aliens, non-resident aliens, and anyone filing Form 4563Internal Revenue Service Center
Philadelphia, PA , USA19255–021519255–0215All APO and FPO addresses, U.S. citizens or tax residents in a foreign country, and anyone filing Form 2555 or 2555EZInternal Revenue Service Center
Austin, TX, USA73301–021573301–0102* Permanent residents of Guam should use:
Department of Revenue and Taxation
Government of Guam, P.O. Box 23607
GMF, GU 96921
**Permanent residents of the Virgin Islands should use:
V.I. Bureau of Internal Revenue
9601 Estate Thomas
Charlotte Amalie, St. Thomas VI 00802
Tax Publications for Individual Taxpayers and Commonly Used Tax FormsSummary: This is a listing of tax publications and commonly used tax forms. The text states:Tax Publications for Individual TaxpayersSee How to Get Tax Help for a variety of ways to get publications, including by computer, phone, and mail.General Guides1--Your Rights as a Taxpayer17--Your Federal Income Tax (For Individuals)334--Tax Guide for Small Business (For Individuals Who Use Schedule C or C-EZ)509--Tax Calendars for 2003553--Highlights of 2002 Tax Changes910--Guide to Free Tax ServicesSpecialized Publications3--Armed Forces' Tax Guide54--Tax Guide for United States Citizens and Residents Aliens Abroad225--Farmer's Tax Guide378--Fuel Tax Credits and Refunds463--Travel, Entertainment, Gift, and Car Expenses501--Exemptions, Standard Deduction, and Filing Information502--Medical and Dental Expenses503--Child and Dependent Care Expenses504--Divorced or Separated Individuals505--Tax Withholding and Estimated Tax508--Tax Benefits for Work-Related Education514--Foreign Tax Credit for Individuals516--United States Government Civilian Employees Stationed Abroad517--Social Security and Other Information for Members of the Clergy and Religious Workers519--United States Tax Guide for Aliens520--Scholarships and Fellowships521--Moving Expenses523--Selling Your Home524--Credit for the Elderly or the Disabled525--Taxable and Nontaxable Income526--Charitable Contributions527--Residential Rental Property529--Miscellaneous Deductions530--Tax Information for First-Time Homeowners531--Reporting Tip Income533--Self-Employment Tax534--Depreciating Property Placed in Service Before 1987536--Net Operating Losses for Individuals, Estates, and Trusts537--Installment Sales541--Partnerships544--Sales and Other Dispositions of Assets547--Casualties, Disasters, and Thefts550--Investment Income and Expenses551--Basis of Assets552--Recordkeeping for Individuals554--Older Americans' Tax Guide555--Community Property556--Examination of Returns, Appeal Rights, and Claims for Refund559--Survivors, Executors, and Administrators561--Determining the Value of Donated Property564--Mutual Fund Distributions570--Tax Guide for Individuals With Income From United States Possessions571--Tax-Sheltered Annuity Plans (403(b) Plans)575--Pension and Annuity Income584--Casualty, Disaster, and Theft Loss Workbook (Personal-Use Property)587--Business Use of Your Home (Including Use by Day-Care Providers)590--Individual Retirement Arrangements593--Tax Highlights for United States Citizens and Residents Going Abroad594--The Internal Revenue Service Collection Process595--Tax Highlights for Commercial Fishermen596--Earned Income Credit721--Tax Guide to United States Civil Service Retirement Benefits901--United States Tax Treaties907--Tax Highlights for Persons with Disabilities908--Bankruptcy Tax Guide911--Direct Sellers915--Social Security and Equivalent Railroad Retirement Benefits919--How Do I Adjust My Tax Withholding?925--Passive Activity and At-Risk Rules926--Household Employer's Tax Guide929--Tax Rules for Children and Dependents936--Home Mortgage Interest Deduction946--How to Depreciate Property947--Practice Before the Internal Revenue Service and Power of Attorney950--Introduction to Estate and Gift Taxes967--Internal Revenue Service Will Figure Your Tax968--Tax Benefits for Adoption969--Medical Savings Accounts970--Tax Benefits for Education971--Innocent Spouse Relief972--Child Tax Credit (For Individuals Sent Here From the Form 1040 or 1040A Instructions)1542--Per Diem Rates1544--Reporting Cash Payments of Over $10,0001546--The Taxpayer Advocate Service of the Internal Revenue ServiceSpanish Language Publications1SP--Derechos del Contribuyente579SP Cómo Preparar la Declaración de Impuesto Federal594SP Comprendiendo el Proceso de Cobro596SP Crédito por Ingreso del Trabajo850 English-Spanish Glossary of Words and Phrases Used in Publications Issued by the Internal Revenue Service1544SP Informe de Pagos en Efectivo en Exceso de $10,000 (Recibidos en una Ocupación o Negocio)Commonly Used Tax FormsSee How To Get Tax Help for a variety of ways to get forms, including by computer, fax, phone, and mail. For fax orders only, use the catalog
number when ordering.
Form Number and Title
Catalog Number
1040--United States Individual Income Tax Return
11320
Schedule A&B--Itemized Deductions & Interest and Ordinary Dividends
11330
Schedule C--Profit or Loss From Business
11334
Schedule C-EZ--Net Profit From Business
14374
Schedule D--Capital Gains and Losses
11338
Schedule D-1--Continuation Sheet for Schedule D
10424
Schedule E--Supplemental Income and Loss
11344
Schedule EIC--Earned Income Credit
13339
Schedule F--Profit or Loss From Farming
11346
Schedule H--Household Employment Taxes
12187
Schedule J--Farm Income Averaging
25513
Schedule R--Credit for the Elderly or the Disabled
11359
Schedule SE--Self-Employment Tax
11358
1040A--United States Individual Income Tax Return
11327
Schedule 1--Interest and Ordinary Dividends for Form 1040A Filers
12075
Schedule 2--Child and Dependent Care Expenses for Form 1040A Filers
10749
Schedule 3--Credit for the Elderly or the Disabled for Form 1040A Filers
12064
1040EZ--Income Tax Return for Single and Joint Filers With No Dependents
11329
1040-ES--Estimated Tax for Individuals
11340
1040X--Amended United States Individual Income Tax Return
11360
2106--Employee Business Expenses
11700
2106-EZ--Unreimbursed Employee Business Expenses
20604
2210--Underpayment of Estimated Tax by Individuals, Estates, and Trusts
11744
2441--Child and Dependent Care Expenses
11862
2848--Power of Attorney and Declaration of Representative
11980
3903--Moving Expenses
12490
4562--Depreciation and Amortization
12906
4868--Application for Automatic Extension of Time To File United States Individual Income Tax Return
13141
4952--Investment Interest Expense Deduction
13177
5329--Additional Taxes on Qualified Plans (including Individual Retirement Arrangements) and Other Tax-Favored Accounts
Order Blank for Forms and PublicationsSummary: This is an example of an order blank a taxpayer can use to request forms and publications. It lists instructions on how to use the
order blank, where to mail the order form depending on where the taxpayer lives, shipping information, and a section where the taxpayer circles the
forms and/or publications they wish to receive.
