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 Previous Page: Publication 525 - Taxable and Nontaxable Income - Sickness and Injury Benefits Next Page: Publication 525 - Taxable and Nontaxable Income - RepaymentsUse to find additional instances of index items. |
Taxmap/pubs/p525-004.htm#TXMP5c178d9b |
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This section discusses various types of income. You may have taxable income from certain transactions even if no money changes hands. For example, you may have taxable income if you lend money at a below-market interest rate or have a debt you owe cancelled.
Taxmap/pubs/p525-004.htm#TXMP0934dba6 |
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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.
Generally, you report this income on Schedule C or Schedule C-EZ (Form 1040). However, if the barter involves an exchange of something other than services, such as in Example 4 below, you may have to use another form or schedule instead.
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.
You are a self-employed accountant. You and a house painter are members of a barter club. Members get in touch with each other directly and bargain for the value of the services to be performed. In return for accounting services you provided, the house painter painted your home. You must report as your income on Schedule C or Schedule C-EZ (Form 1040) the fair market value of the house painting services you received. The house painter must include in income the fair market value of the accounting services you provided.
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.
You own a small apartment building. In return for 6 months rent-free use of an apartment, an artist gives you a work of art she created. You must report as rental income on Schedule E (Form 1040) the fair market value of the artwork, and the artist must report as income on Schedule C or Schedule C-EZ (Form 1040) the fair rental value of the apartment.
Taxmap/pubs/p525-004.htm#TXMP01396f0f |
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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, 2005. It should show the value of cash, property, services, credits, or scrip you received from exchanges during 2004. The IRS will also receive a copy of Form 1099-B.
Taxmap/pubs/p525-004.htm#TXMP6608d3fc |
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The income you receive from bartering generally is not subject to regular income tax withholding. However, backup withholding will apply in certain circumstances to ensure that income tax is collected on this income.
Under backup withholding, the barter exchange must withhold, as income tax, 28% of the income if:
The barter exchange will withhold tax only up to the amount of any cash paid to you or deposited in your account and any scrip or credit issued to you (and converted to cash).
 | If tax is withheld from your barter income, the barter exchange will report the amount of tax withheld on Form 1099-B, or similar statement. |
Taxmap/pubs/p525-004.htm#TXMP3b98a9bf |
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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.
If the debt is a nonbusiness debt, report the canceled amount on Form 1040, line 21. If it is a business debt, report the amount on Schedule C or Schedule C-EZ (Form 1040) (or on Schedule F (Form 1040), Profit or Loss From Farming, if the debt is farm debt and you are a farmer).
Taxmap/pubs/p525-004.htm#TXMP66c95ea7 |
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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.
Taxmap/pubs/p525-004.htm#TXMP449a373b Interest included in canceled debt. |
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If any interest is forgiven and included in the amount of canceled debt in box 2, the amount of interest also will 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).
Taxmap/pubs/p525-004.htm#TXMP6fbec60b |
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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.
Taxmap/pubs/p525-004.htm#TXMP2eeac8cd |
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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.
Taxmap/pubs/p525-004.htm#TXMP146db6fc |
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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.
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.
Taxmap/pubs/p525-004.htm#TXMP4411fc99 |
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There are several exceptions to the inclusion of canceled debt in income. These are explained next.
Taxmap/pubs/p525-004.htm#TXMP63876a73 |
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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:
A loan to refinance a qualified student loan will also qualify if it was made by an educational institution or a tax-exempt section 501(a) organization under its program designed as described in (3)(b) above.
An educational institution is an organization with a regular faculty and curriculum and a regularly enrolled body of students in attendance at the place where the educational activities are carried on.
A section 501(c)(3) organization is any corporation, community chest, fund, or foundation organized and operated exclusively for one or more of the following purposes.
Taxmap/pubs/p525-004.htm#TXMP36df7670 Exception. |
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You do have income if your student loan was made by an educational institution and is canceled because of services you performed for the institution or other organization that provided the funds.
Taxmap/pubs/p525-004.htm#TXMP53db4778 |
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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.
Taxmap/pubs/p525-004.htm#TXMP482d9285 |
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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.
Taxmap/pubs/p525-004.htm#TXMP4a0d6550 |
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Do not include a canceled debt in your gross income in the following situations.
Taxmap/pubs/p525-004.htm#TXMP629a3b27 |
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Beginning in 2004, 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.
Taxmap/pubs/p525-004.htm#TXMP0a6bf9e4 |
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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.
Taxmap/pubs/p525-004.htm#TXMP44f63854 |
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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.
Taxmap/pubs/p525-004.htm#TXMP190543f4 |
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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.
The face amount of the policy is $75,000 and, as beneficiary, you choose to receive 120 monthly installments of $1,000 each. The excluded part of each installment is $625 ($75,000 ÷ 120), or $7,500 for an entire year. The rest of each payment, $375 a month (or $4,500 for an entire year), is interest income to you.
Taxmap/pubs/p525-004.htm#TXMP47eba2c4 Installments for life. |
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If, as the beneficiary under an insurance contract, you are entitled to receive the proceeds in installments for the rest of your life without a refund or period-certain guarantee, you figure the excluded part of each installment by dividing the amount held by the insurance company by your life expectancy. If there is a refund or period-certain guarantee, the amount held by the insurance company for this purpose is reduced by the actuarial value of the guarantee.
Taxmap/pubs/p525-004.htm#TXMP12b0762e Surviving spouse. |
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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.
Taxmap/pubs/p525-004.htm#TXMP3b2b0306 |
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If an insurance company pays you interest only on proceeds from life insurance left on deposit, the interest you are paid is taxable.
If your spouse died before October 23, 1986, and you chose to receive only the interest from your insurance proceeds, the $1,000 interest exclusion for a surviving spouse does not apply. If you later decide to receive the proceeds from the policy in installments, you can take the interest exclusion from the time you begin to receive the installments.
Taxmap/pubs/p525-004.htm#TXMP0affb4f0 |
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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.
You 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 on lines 12a and 12b of Form 1040A.
| For information on when the proceeds are excluded from income, see Accelerated Death Benefits, later. |
Taxmap/pubs/p525-004.htm#TXMP4ca433b0 |
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Generally, a split-dollar life insurance arrangement is an arrangement between an owner and a non-owner of a life insurance contract under which either party to the arrangement pays all or part of the premiums, and one of the parties paying the premiums is entitled to recover all or part of those premiums from the proceeds of the contract. There are two mutually exclusive regimes to tax split-dollar life insurance arrangements.
Taxmap/pubs/p525-004.htm#TXMP12ff58b0 |
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An endowment contract is a policy under which you are paid a specified amount of money on a certain date unless you die before that date, in which case, the money is paid to your designated beneficiary. Endowment proceeds paid in a lump sum to you at maturity are taxable only if the proceeds are more than the cost of the policy. To determine your cost, subtract any amount that you previously received under the contract and excluded from your income from the total premiums (or other consideration) paid for the contract. Include the part of the lump sum payment that is more than your cost in your income.
Endowment proceeds that you choose to receive in installments instead of a lump-sum payment at the maturity of the policy are taxed as an annuity. This is explained in Publication 575. For this treatment to apply, you must choose to receive the proceeds in installments before receiving any part of the lump sum. This election must be made within 60 days after the lump-sum payment first becomes payable to you.
Taxmap/pubs/p525-004.htm#TXMP1deaa089 |
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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.
Taxmap/pubs/p525-004.htm#TXMP11dbd36b |
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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.
Taxmap/pubs/p525-004.htm#TXMP4162946f |
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Accelerated 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.
Taxmap/pubs/p525-004.htm#TXMP44c80381 |
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If 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, earlier.
Taxmap/pubs/p525-004.htm#TXMP41aaf4e1 |
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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:
Taxmap/pubs/p525-004.htm#TXMP7da167c0 |
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To claim an exclusion for accelerated death benefits made on a per diem or other periodic basis, you must file Form 8853 with your return. You do not have to file Form 8853 to exclude accelerated death benefits paid on the basis of actual expenses incurred.
Taxmap/pubs/p525-004.htm#TXMP6cdb4b56 |
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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.
Taxmap/pubs/p525-004.htm#TXMP6d1358e8 |
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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.
Taxmap/pubs/p525-004.htm#TXMP7fca1390 |
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Refunds of federal income taxes are not included in your income because they are never allowed as a deduction from income.
Taxmap/pubs/p525-004.htm#TXMP6512a7c3 |
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If you received a state or local income tax refund (or credit or offset) in 2004, 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, 2005. The IRS also will receive a copy of the Form 1099-G. Use the worksheet in the 2004 Form 1040 instructions for line 10 to figure the amount (if any) to include in your income.
Taxmap/pubs/p525-004.htm#TXMP1dddf51b |
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If you received a refund or credit in 2004 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 2004. You may have to include it in your income under the rules explained in the following discussions.
Taxmap/pubs/p525-004.htm#TXMP15210453 |
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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.
Taxmap/pubs/p525-004.htm#TXMP56721de7 |
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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.
Taxmap/pubs/p525-004.htm#TXMP0e0a8e46 |
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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.
You paid 2003 estimated state income tax of $4,000 in four equal payments. You made your fourth payment in January 2004. You had no state income tax withheld during 2003. In 2004, you received a $400 tax refund based on your 2003 state income tax return. You claimed itemized deductions each year on your federal income tax return.
You must allocate the $400 refund between 2003 and 2004, the years in which you paid the tax on which the refund is based. You paid 75% ($3,000 ÷ $4,000) of the estimated tax in 2003, so 75% of the $400 refund, or $300, is for amounts you paid in 2003 and is a recovery item. If all of the $300 is a taxable recovery item, you will include $300 on Form 1040, line 10, for 2004, and attach a copy of your computation showing why that amount is less than the amount shown on the Form 1099-G you received from the state.
The balance ($100) of the $400 refund is for your January 2004 estimated tax payment. When you figure your deduction for state and local income taxes paid during 2004, you will reduce the $1,000 paid in January by $100. Your deduction for state and local income taxes paid during 2004 will include the January net amount of $900 ($1,000 − $100), plus any estimated state income taxes paid in 2004 for 2004, and any state income tax withheld during 2004.
Taxmap/pubs/p525-004.htm#TXMP09d790ba |
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If you did not itemize deductions for the year for which you received the recovery of an expense that was deductible only if you itemized, do not include any of the recovery amount in your income.
You claimed the standard deduction on your 2003 federal income tax return. In 2004 you received a refund of your 2003 state income tax. Do not report any of the refund as income because you did not itemize deductions for 2003.
Taxmap/pubs/p525-004.htm#TXMP2f92325b |
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The following discussion explains how to determine the amount to include in your income from a recovery of an amount deducted in an earlier year as an itemized deduction. However, you generally do not need to use this discussion if the recovery is for state or local income taxes paid in 2003. Instead, use the worksheet in the 2004 Form 1040 instructions for line 10 to figure the amount (if any) to include in your income.
You cannot use the Form 1040 worksheet and must use this discussion if any of the following statements is true.
 | If you also recovered an amount deducted as a non-itemized deduction, figure the amount of that recovery to include in your income and add it to your adjusted gross income before applying the rules explained here. See Non-Itemized Deduction Recoveries, later. |
Taxmap/pubs/p525-004.htm#TXMP0f771666 |
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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. This rule applies if, for the earlier year, all of the following statements are true.
If any of the above statements is not true, see Total recovery not included in income, later.
Taxmap/pubs/p525-004.htm#TXMP1ed9dde4 Where to report. |
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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.
For 2003, you filed a joint return. Your taxable income was $60,000 and you were not entitled to any tax credits. Your standard deduction was $9,500, and you had itemized deductions of $11,000. In 2004, you received the following recoveries for amounts deducted on your 2003 return:
| Medical expenses | $200 |
| State and local income tax refund | 400 |
| Refund of mortgage interest | 325 |
| Total recoveries | $925 |
Your total recoveries are less than the amount by which your itemized deductions exceeded the standard deduction ($11,000 − $9,500 = $1,500), so you must include your total recoveries in your income for 2004. 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.
Taxmap/pubs/p525-004.htm#TXMP4665f508 |
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If one or more of the six statements listed in the preceding discussion is not true, you may be able to exclude at least part of the recovery from your income. If statements (4), (5), and (6) are true (your itemized deductions were not limited, you had no unused tax credits, and you were not subject to the alternative minimum tax), you can use Worksheet 2 to determine the part of your recovery to include in your income.
| To determine whether you should complete this worksheet to figure the part of a recovery amount to include in income on your 2004 Form 1040, see Total recovery not included in income under Itemized Deduction Recoveries. If you recovered amounts from more than one year, such as a state income tax refund from 2003 and a casualty loss reimbursement from 2002, complete a separate worksheet for each year. Use information from Schedule A (Form 1040) for the year the expense was deducted. A recovery is included in income only to the extent of the deduction amount that reduced your tax in the prior year (year of the deduction). If you were subject to the alternative minimum tax or your tax credits reduced your tax to zero, see Unused tax credits and Subject to alternative minimum tax under Itemized Deduction Recoveries. If your recovery was for an itemized deduction that was limited, you should read Itemized deductions limited under Itemized Deduction Recoveries. | ||||||
| 1. | State/local income tax refund or credit 1 | 1. | ||||
| 2. | Enter the total of all other Schedule A refunds or reimbursements (excluding the amount you entered on line 1) 1 | 2. | ||||
| 3. | Add lines 1 and 2 | 3. | ||||
| 4. | Itemized deductions for the prior year (for example, line 28 of Schedule A for 2003) | 4. | ||||
| 5. | Enter any amount previously refunded to you (do not enter an amount from line 1 or line 2) | 5. | ||||
| 6. | Subtract line 5 from line 4 | 6. | ||||
| 7. | Standard deduction for the prior year. (The standard deduction amounts for 2003, 2002, and 2001 are shown in Tables 2, 3, and 4.) | 7. | ||||
| 8. | Subtract line 7 from line 6. If the result is zero or less, stop here. The amounts on lines 1 and 2 are not taxable | 8. | ||||
| 9. | Enter the smaller of line 3 or line 8 | 9. | ||||
| 10. | Taxable income for prior year 2 (for example, line 41, Form 1040 for 2003) | 10. | ||||
| 11. | Amount to include in income for 2004:
| 11. | ||||
| If line 11 equals line 3 - Enter the amount from line 1 on line 10, Form 1040. Enter the amount from line 2 on line 21, Form 1040. | ||||||
| If line 11 is less than line 3 and either line 1 or line 2 is zero - If there is an amount on line 1, enter the amount from line 11 on line 10, Form 1040. If there is an amount on line 2, enter the amount from line 11 on line 21, Form 1040. | ||||||
| If line 11 is less than line 3, and there are amounts on both lines 1 and 2, complete the following worksheet. | ||||||
| A. | Divide the amount on line 1 by the amount on line 3. Enter the percentage | A. | ||||
| B. | Multiply the amount on line 11 by the percentage on line A. Enter the result here and on line 10, Form 1040 | B. | ||||
| C. | Subtract the amount on line B from the amount on line 11. Enter the result here and on line 21, Form 1040 | C. | ||||
| 1 Do not enter more than the amount deducted for the prior year. | |
| 2 If taxable income is a negative amount, enter that amount in brackets. Do not enter zero unless your taxable income is exactly zero. Taxable income will have to be adjusted for any net operating loss carryover. For more information, see Publication 536, Net Operating Losses (NOLs) for Individuals, Estates, and Trusts. | |
| 3 For example, $700 + ($400) = $300. |
Table 2. 2003 Standard Deduction Tables
Table 4 – 2002 standard deduction Table 2 – 2001 standard deduction Taxmap/pubs/p525-004.htm#TXMP151752d9 Allocating the included part. |
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If you are not required to include all of your recoveries in your income, and you have both a state income tax refund and other itemized deduction recoveries, you must allocate the taxable recoveries between the state tax refund you report on Form 1040, line 10, and the amount you report as other income on Form 1040, line 21. If you do not use Worksheet 2, make the allocation as follows.
Taxmap/pubs/p525-004.htm#TXMP549daa20 |
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In 2004 you recovered $2,500 of your 2003 itemized deductions, but the recoveries you must include in your 2004 income are only $1,500. Of the $2,500 you recovered, $500 was due to your state income tax refund. The amount you report as a state tax refund on Form 1040, line 10, is $300 [($500 ÷ $2,500) × $1,500]. The balance of the taxable recoveries, $1,200, is reported as other income on Form 1040, line 21.
Taxmap/pubs/p525-004.htm#TXMP1360c335 |
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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:
Taxmap/pubs/p525-004.htm#TXMP72ae9959 Standard deduction for earlier years. |
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To determine if amounts recovered in 2004 must be included in your income, you must know the standard deduction for your filing status for the year the deduction was claimed. The standard deduction tables for 2003, 2002, and 2001 are shown in Tables 2, 3, and 4. If you need the standard deduction amounts for years before 2001, see the copy of your return for that year.
You filed a joint return for 2003 with taxable income of $45,000. Your itemized deductions were $10,350. The standard deduction that you could have claimed was $9,500. In 2004, you recovered $2,400 of your 2003 itemized deductions. None of the recoveries were more than the actual deductions for 2003. Include $850 of the recoveries in your 2004 income. This is the smaller of your recoveries ($2,400) or the amount by which your itemized deductions were more than the standard deduction ($10,350 − $9,500 = $850).
Taxmap/pubs/p525-004.htm#TXMP2417fe4c |
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If your taxable income was a negative amount, reduce the recovery you must otherwise include in your income by the negative amount.
The facts are the same as in the previous example except you had a negative taxable income of $200 in 2003. You must include $650 in your 2004 income, rather than $850.
Taxmap/pubs/p525-004.htm#TXMP0797f5eb |
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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:
During 2003, 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 2004, you received a $500 reimbursement from your medical insurance for your 2003 expenses. The only amount of the $500 reimbursement that must be included in your income for 2004 is $200—the amount actually deducted.
Taxmap/pubs/p525-004.htm#TXMP196804db |
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You were subject to the limit on itemized deductions in the earlier year if your adjusted gross income (AGI) was more than a base amount. For example, this amount was:
If the amount you recovered was deducted in a year in which your itemized deductions were limited, you must include it in income up to the difference between the amount of itemized deductions actually allowed that year and the amount you would have been allowed (the greater of your itemized deductions or your standard deduction) if you had figured your deductions using only the net amount of the recovery item.
To determine the part of the recovery you must include in income, follow the two steps below.
If you had unused tax credits in the earlier year, see Unused tax credits on page 24.
For more information on this computation, see Revenue Ruling 93-75. This ruling is in Cumulative Bulletin 1993-2.
Eileen Martin is single. She had an AGI of $1,137,300 and itemized her deductions on her federal income tax return for 2003. She was not subject to alternative minimum tax and was not entitled to any credit against income tax. Her only allowable deduction was $40,000 of state income taxes. However, Eileen deducted only $10,000 in 2003 because her otherwise allowable deductions of $40,000 were reduced by $30,000. In 2004, she received a $5,000 refund of her state income taxes for 2003.
The following shows how Eileen figured the $30,000 reduction and other amounts from the Itemized Deduction Worksheet in the 2003 Schedule A (Form 1040) instructions. These amounts are needed to figure the part of the $5,000 refund that Eileen must include in her income for 2004.
| AGI for 2003 | $1,137,300 |
| State income taxes paid in 2003 | $40,000 |
| 3% reduction (amount on 2003 Itemized Deduction Worksheet, line 8), [($1,137,300 - $137,300) × 3%] | $30,000 |
| 80% reduction not applied (amount on 2003 Itemized Deduction Worksheet, line 4) ($40,000 × 80%) | $32,000 |
| 2003 deduction (amount on 2003 Itemized Deduction Worksheet, line 10) ($40,000 - $30,000) | $10,000 |
| Refund received in 2004 of 2003 state income tax | $5,000 |
| Net amount of 2003 state income tax ($40,000 - $5,000) | $35,000 |
If Eileen had used the $35,000 net amount of state income tax to figure her itemized deductions for 2003, the deduction allowed would have been $7,000. This is her otherwise allowable deduction of $35,000 reduced by $28,000 ($35,000 × 80%). By deducting the full $10,000 paid in 2003, she derived a tax benefit of $3,000 ($10,000 − $7,000). Therefore, only $3,000 of the $5,000 refund is included in her income for 2004.
Taxmap/pubs/p525-004.htm#TXMP35e0715f |
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If you recover an item deducted in an earlier year in which you had unused tax credits, you must refigure the earlier year's tax to determine if you must include the recovery in your income. To do this, add the amount of the recovery to your earlier year's taxable income and refigure the tax and the credits on the recomputed amount. If the recomputed tax, after application of the credits, is more than the actual tax in the earlier year, include the recovery in your income up to the amount of the deduction that reduced the tax in the earlier year. For this purpose, any increase to a credit carried over to the current year that resulted from deducting the recovered credit in the earlier year is considered to have reduced your tax in the earlier year. If the recovery is for an itemized deduction claimed in a year in which the deductions were limited, see Itemized deductions limited, earlier.
If your tax, after application of the credits, does not change, you did not have a tax benefit from the deduction. Do not include the recovery in your income.
In 2003, Jean Black filed as head of household and itemized her deductions. Her taxable income was $5,260 and her tax was $528. She claimed a child care credit of $1,200. The credit reduced her tax to zero and she had an unused tax credit of $672 ($1,200 − $528). In 2004, Jean recovered $1,000 of her itemized deductions. She reduces her 2003 itemized deductions by $1,000 and recomputes that year's tax on taxable income of $6,260. However, the child care credit exceeds the recomputed tax of $628. Jean's tax liability for 2003 is not changed by reducing her deductions by the recovery. She did not have a tax benefit from the recovered deduction and does not include any of the recovery in her income for 2004.
Taxmap/pubs/p525-004.htm#TXMP4c35a922 |
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If you were subject to the alternative minimum tax in the year of the deduction, you will have to recompute your tax for the earlier year to determine if the recovery must be included in your income. This will require a recomputation of your regular tax, as shown in the preceding example, and a recomputation of your alternative minimum tax. If inclusion of the recovery does not change your total tax, you do not include the recovery in your income. However, if your total tax increases by any amount, you received a tax benefit from the deduction and you must include the recovery in your income up to the amount of the deduction that reduced your tax in the earlier year.
Taxmap/pubs/p525-004.htm#TXMP668d9cdd |
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This section discusses recovery of deductions other than those deducted on Schedule A (Form 1040).
Taxmap/pubs/p525-004.htm#TXMP74f359db |
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If you recover an amount that you deducted in an earlier year in figuring your adjusted gross income, you must generally include the full amount of the recovery in your income in the year received.
Taxmap/pubs/p525-004.htm#TXMP4b4dbffb |
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If any part of the deduction you took for the recovered amount did not reduce your tax, you may be able to exclude at least part of the recovery from your income. You must include the recovery in your income only up to the amount of the deduction that reduced your tax in the year of the deduction. (See Tax benefit rule, earlier.)
Taxmap/pubs/p525-004.htm#TXMP0a56ae2f |
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If your taxable income was a negative amount, reduce the recovery by that negative amount. Include this reduced recovery in your income.
Taxmap/pubs/p525-004.htm#TXMP7b666a7e |
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If you recover an item deducted in an earlier year in which you had unused tax credits, you must refigure the earlier year's tax to determine if you must include the recovery in your income. To do this, add the amount of the recovery to your earlier year's taxable income and refigure the tax and the credits on the recomputed amount. If the recomputed tax, after application of the credits, is more than the actual tax in the earlier year, include the recovery in your income up to the amount of the deduction that reduced the tax in the earlier year. For this purpose, any increase to an amount carried over to the current year that resulted from deducting the recovered amount in the earlier year is considered to have reduced your tax in the earlier year.
If your tax, after application of the credits, does not change, you did not have a tax benefit from the deduction. Do not include the recovery in your income.
Taxmap/pubs/p525-004.htm#TXMP3cbfbde4 |
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If you received a recovery in 2004 for an item for which you claimed a tax credit in an earlier year, you must increase your 2004 tax by the amount of the recovery, up to the amount by which the credit reduced your tax in the earlier year. You had a recovery if there was a downward price adjustment or similar adjustment on the item for which you claimed a credit.
This rule does not apply to the investment credit or the foreign tax credit. Recoveries of these credits are covered by other provisions of the law. See Publication 514, Foreign Tax Credit for Individuals, or Form 4255, Recapture of Investment Credit, for details.
Taxmap/pubs/p525-004.htm#TXMP7229e9cd |
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Generally, payments made by or for an employer because of an employee's death must be included in income. The following discussions explain the tax treatment of certain payments made to survivors. For additional information, see Publication 559.
Taxmap/pubs/p525-004.htm#TXMP5256a519 |
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Lump-sum payments you receive from a decedent's employer as the surviving spouse or beneficiary may be accrued salary payments; distributions from employee profit-sharing, pension, annuity, or stock bonus plans; or other items that should be treated separately for tax purposes. The tax treatment of these lump-sum payments depends on the type of payment.
Taxmap/pubs/p525-004.htm#TXMP0c39971e Salary or wages. |
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Salary or wages received after the death of the employee are usually ordinary income to you.
Taxmap/pubs/p525-004.htm#TXMP14b13d19 Qualified employee retirement plans. |
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Lump-sum distributions from qualified employee retirement plans are subject to special tax treatment. For information on these distributions, see Publication 575 (or Publication 721 if you are the survivor of a federal employee or retiree).
Taxmap/pubs/p525-004.htm#TXMP5cbec34a |
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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. For 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.
Taxmap/pubs/p525-004.htm#TXMP2715504a |
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The tax treatment of unemployment benefits you receive depends on the type of program paying the benefits.
Taxmap/pubs/p525-004.htm#TXMP6aaf5356 |
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You must include in your income all unemployment compensation you receive. You should receive a Form 1099-G 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.
Taxmap/pubs/p525-004.htm#TXMP50832ae6 Types of unemployment compensation. |
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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.
Taxmap/pubs/p525-004.htm#TXMP04fca69b Governmental program. |
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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.
Taxmap/pubs/p525-004.htm#TXMP7e7f7fa2 Repayment of unemployment compensation. |
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If you repaid in 2004 unemployment compensation you received in 2004, 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 2004 that you included in your 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, later.
Taxmap/pubs/p525-004.htm#TXMP30e376ce Tax withholding. |
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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.
| If 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 Publication 505, Tax Withholding and Estimated Tax. |
Taxmap/pubs/p525-004.htm#TXMP0b4cf78a |
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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 Publication 15-A, section 5, Employer's Supplemental Tax Guide. Report these payments on line 7 of Form 1040 or Form 1040A or on line 1 of Form 1040EZ.
Taxmap/pubs/p525-004.htm#TXMP5bb72a91 Repayment of benefits. |
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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 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 35, and enter "Sub-Pay TRA" and the amount on the dotted line next to line 35. 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 information on this, see Repayments, later.
Taxmap/pubs/p525-004.htm#TXMP31a1b348 |
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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.
Taxmap/pubs/p525-004.htm#TXMP7312de11 |
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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.
Taxmap/pubs/p525-004.htm#TXMP4712286b |
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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.
Taxmap/pubs/p525-004.htm#TXMP6375a34a |
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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.
Taxmap/pubs/p525-004.htm#TXMP2d1e62d1 |
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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.
Taxmap/pubs/p525-004.htm#TXMP31ae4bde |
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Payments you receive from a state welfare agency for taking part in a work-training program are not included in your income, as long as the payments (exclusive of extra allowances for transportation or other costs) do not total more than the public welfare benefits you would have received otherwise. If the payments are more than the welfare benefits you would have received, the entire amount must be included in your income as wages.
Taxmap/pubs/p525-004.htm#TXMP3c18cf3c |
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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.
Taxmap/pubs/p525-004.htm#TXMP438ecf95 |
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Do 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.
Taxmap/pubs/p525-004.htm#TXMP17e70b6c |
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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:
A qualified disaster is:
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.
Taxmap/pubs/p525-004.htm#TXMP4fd5e565 |
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Payments made under section 235 of the Nati
