Your income tax is based primarily on the amount of your income for the year. However, not all income is subject to tax; and the various kinds of taxable income are handled differently.
Today's column explains briefly the different kinds of income and tells how to report each. For those items where the rules are quite complex or may not be of general interest, the pertinent IRS publication is cited. Nontaxable Income
Here is a handy checklist of income not subject to tax and not reportable on your federal tax return. (State rules vary in some instances, so be sure to review Sunday's article carefully before completing your state tax return.).
Social security benefits.
Veterans Administration payments to veterans and their families or survivors.
Lump-sum insurance benefits received by a beneficiary on the death of the insured (although these payments may be subject to estate tax).
TAX TIP: Life insurance proceeds received in the form of periodic payments payments generally include some interest in addition to the insurance portion. The interest component is taxable income to the recipient.
Gifts or bequests (but there may be a liability for gift or estate tax).
Interest earned on state or municipal bonds, and specified dividends from tax-free mutual funds.
Scholarship grants (with limitations).
Military allowances and certain cost-of-living allowances for U.S. civilian employees overseas.
Workmen's compensation or Federal Employee's Compensation Act payments for injury or illness.
Payments made by certain employers (primarily public school systems) on your behalf to a qualified tax-deferred annuity retirement plan.
The value of a parsonage provided to a clergyman, or a rental allowance paid in lieu of a home.
Campaign contributions received (unless diverted to a personal use).
Payments received by foster parents for care of a child in their home, except any amount in excess of actual expenses.
Reimbursement from your employer for out-of-pocket costs of business travel not in excess of actual expenses, including flat-fee reimbursement not exceeding $44 a day in per diem or 17 cents a mile for travel (if you accounted for the travel to your employer). Wages or Salary
By Jan. 31 your employer should have provided you with a Form W-2, in several copies, on which the employes has entered the amount of wages, salary, or commissions paid to you, and the total federal and state income tax and social security contributions withheld from your pay during 1977.
If the information is correct, you need only transfer the figures for wages and income tax withheld to the appropriate lines of Form 1040 or 1040A and attached Copy B of the Form W-2 to your return.
If your employer provided you with meals and lodging as a matter of your choice rather than his, then their fair market value must be included as part of your wages or salary.
But if you are required to use the living quarters provided or to eat at the employer's place of business as a condition of employment or for the convenience of the employer, these do not constitute reportable income. (See Publication 525 for a detailed explanation). Tips
Cash tips received in the course of your employment are subject to income tax, and in addition may be counted towards social security benefits. If you regularly receive tips, get a copy of Publication 531 for reporting instructions. Income from Self-Employment
If you operated a business or profession, either full-or part-time, use Schedule C to report gross income and expenses. As noted earlier, the free IRS book "Tax Guide for Small Business" provides much useful information on record-keeping and taxation.
A legitimate loss from a business may be deducted from income from other sources, thus reducing your net tax liability. To qualify, the business must have been conducted with the expectation of producing income, rather than as a hobby.
TAX TIP: The IRS generally applies a "two-of-five" rule to determine profit-making intent.That is, you must have shown a profit in two of the last five years to qualify as a bona fide business. It you don't meet this test, you may cite special circumstances; and application of the test may be deferred for a new business.
In addition to Schedule C, if your income from self-employment was $400 or more you must complete Schedule SE to determine the amount of any social security tax due on those earnings. Tax Limit on Earned Income
The maximum tax on earned income (wages, salary, tips, professional fees, etc.) for 1977 cannot exceed 50 per cent regardless of the amount of earnings.
TAX TIP: A recent change in the law expands the definition of "earned income" to include all income from "personal services" - specifically retirement pay, employment-related taxable pensions and annuities, and various forms of deferred compensation.
Income from the investment of capital (rents and royalties, capital gains, interest and dividends) is not protected by this ceiling and may be subject to the maximum individual tax rate of 70 percent.
If the normal method of computing [SOURCE OMITTED FROM SOURCE]
TAX TIP: You should check this provision if you are single and your taxable earned income for 1977 exceeded $40,200; or was greater than $55,200 if you are married and filing a joint return. Interest Income
Report as income any interest earned on bank, credit union, and savings and loan accounts; on loans, notes, and mortgages; on insurance dividends left on deposit (but not the dividends themselves); and on corporate bonds (but not state or municipal bonds or notes).
Also report interest on U.S. savings bonds cashed during the year, if not previously reported; on Series E bonds still held if you have elected to report the interest annually; on other U.S. obligations such as Series H bonds, Treasury bills, etc.; and on any tax refunds from the IRS or your state received during 1977 for overpayments or erros in previous years.
TAX TIP: If you converted Series E to Series H bonds during the year, you need not report interest on the Series E bonds until the Series H bonds mature or are disposed of (except to the extent of any cash you received on the exchange).
Interest must be reported as income whether actually received by you in cash or "constructively" received - that is, credited to your account or otherwise made available. Interest credited to your account at a savings institution on Dec. 31 must be reported as 1977 income even if not entered in your passbook until some time in 1978.
If you redeemed a certificate of deposit from a savings institution before the expiration date, a substantial interest penalty was imposed by law (unless redemption was due to the death or disability of the certificate owner).
However, the savings institution is required to show the full amount of interest earned by the CD on the Form 1099-INT issued to you for your tax records. The amount of any penalty is shown separately on the same form.
Do not balance on against the other to get the net amount. Instead, you must include as interest income the gross interest earned; then deduct the amount of forfeited interest by entering it on line 26 of Form 1040. (If you have a CD penalty you may not use Form 1040A.)
Thus your adjusted gross income includes only the net amount of interest received - but you get there by entering both the gross interest and the penalty or forfeiture in two different places on your return.
If total interest received during the year is $400 or less, simply show the total on either Form 1040 or 1040A. If more than $400, you must use Form 1040 and itemize the amount of interest from each source on Schedule B. Dividends
Like interest income, ordinary dividends totalling $400 or less, earned on corporate stocks and mutual fund shares, need only be entered in total on either tax form. If the total is more than $400, you must use the 1040; show the dividend from each separate source on Schedule B.
In either case, subtract from the total any capital gains or nontaxable dividends received, plus up to $100 for qualifying dividends received from U.S. corporations
This exclusion increases to $200 on a joint return if each spouse had dividend income of at least $100 or if the securities are held in joint ownership. Only the balance, if any, after subtracting the exclusion is taxable.
Dividends identified as "non-qualifying" by the payer are not eligible for and may not be reduced by this $100 or $200 exclusion.
A dividend which is a return of capital is normally not taxable as income, but must be used instead to reduce the cost basis of the stock.
Similarly, a stock dividend is usually not taxable; but the original cost must be spread over the total number of shares owned after the dividend.
Capital gains dividends, usually received from mutual funds, are normally reported on Schedule D rather than as dividends. But if Schedule D is not otherwise needed, you may simply enter half of the total capital gains dividends on line 15 of Form 1040. (If you have capital gains of any kind you may not use 1040A.).
TAX TIP: "Tax-free" mutual funds may now pass through to shareholders nontaxable interest earned by the fund. Watch for such a pass-through on the Form 1099 issued by your fund, and do not report tax-free interest on your federal return. But capital gains from portfolio transactions are taxable even if derived from the sale of municiple bonds.
If you have a share account in a savings and loan assocation, "dividends" received on your shares are really interest payments and should be reported as such.
"Dividends" on life insurance policies are not true dividends, but rather refunds of previously paid premiums. These should not be reported as income unless the accumulated total of dividends received exceeds the total net premiums paid (a rare case). Pensions and Annuities
Taxable income from pensionsto which you did not contribute (including military retirement pay) should be reported on line 18 of Form 1040.
Federal civil service retirees and others covered by retirement plans to which both employer and employee contributed, and in which the employe's total contribution is recoverable within three years, may exclude annuity payments from income until an amount equal to that contribution has been received.
If your pension payments qualify for exclusion under this "three-year rule," a statement should have been issued to you when you retired specifying the number of dollars you had contributed during your working years.
Income from qualifying contributory plans from which your total contribution had not yet been recovered is reported in Part I of Schedule E. But if you had recovered your entire cost before Jan. 1, 1977, then the entire amount received in 1977 is taxable and should be reported on line 18 of the 1040.
If you received annuity or retirement payments from a contributory plan not covered by the three-year rule, then a portion of each payment is nontaxable, based on total cost and your life expectancy at the time of the first payment.
TAX TIP: Once established at retirement, the ration of taxable to nontaxable income doesn't change (even though the dollar amounts might), so you don't have to recompute the percentage each year.
Disability retirement pay from the armed forces is nontaxable and should not be reported; normally it is not included on the Form W-2 provided by the service. Similarly, disability pensions from the Veterans Administration are not taxable income.
The exclusion as "sick pay" of up to $5,200 of the taxable part of disability pay is not authorized unless you are under 65 and were either 100 per cent disabled at retirement or were eligible for disability retirement in any degree and were 100 per cent disabled on Jan. 1, 1976 or Jan. 1, 1977.
If you qualify for the sick pay exclusion under these new rules, the amount allowed must be reduced, dollar for dollar, by the excess over $15,000 of adjusted gross income. (Use Form 2440 for the exclusion.:
TAX TIP: The sick pay exclusion was originally restricted for 1976; but in 1977 the Congress changed the effective date to Jan. 1, 1977. If you were eligible under the old rules but didn't claim the exclusion on your 1976 return, you may now file an amended return (using IRS Form 1040X) to claim the exclusion and refund. Income from Rental Property
Rental income is reported in Part II of Schedule E (unless you're in the realty business). If you need more space for listing expenses, use the more convenient Form 4831 and carry the totals to the corresponding lines and columns of Schedule E.
If you own property which you rent for part of the time and use yourself at other times, there are restrictions on the deductions allowed for expenses.
If the property was rented for less than 15 days, you need not report the income; but only taxes, interest, and casualty losses are deductible, and only if you itemize (on Schedule A). Do not use Schedule E in this case.
If the property was rented for 15 days or more, use Schedule E to report income and expenses. In that case:
(a)If the property was used by you or any relative for 15 days or more or for ten per cent or more of the total number of days it was rented (whichever is greater), you may deduct all interest, taxes, and casualty losses; but you may only claim other expenses up to the amount of income remaining after those items are subtracted.
(b) If the amount of personal use was less than these ceilings, you may claim all operating expenses including depreciation without an income limitation. Sale of Property
Profit or loss from the sale of property such as real estate, stocks, or bonds (other than property used in a business) is called a capital gain or loss, and is normally accounted for on Schedule D.
If you sold property in 1977 which you had owned for nine months or less, any gain is considered "short-term" and is counted in full as taxable income. The sale of property owned for more than nine months may result in "long-term" profit; generally, only half of a long-term gain is considered on your tax return. (But see "tax-preference" income below.)
The same nine-month period is applied in the consideration of capital losses. All of a short-term loss but only half of a long-term loss may be used to reduce taxable income.
If you have a net loss after consolidating all capital fains and losses, you may deduct a maximum of $2,000 from other income. Because of the 50 per cent rule, it takes two dollars of net long-term loss for each one dollar deduction.
Any excess over $2,000 may be carried forward to subsequent years until used up. If you have a capital loss balance to carry to 1978 and the loss was originally incurred after 1969, compute the carryover on page 2 of your 1977 Schedule D. If any part of the loss originated in 1969 or earlier, use page 2 of Form 4798 for this computation.
If you had a capital loss carryover from 1976 to 1977 from a post-1969 transaction, you should have computed the balance last year on the 1976 Form 4798 and entered the amount on page 2 of the 1976 Schedule D.
In that case, no additional 1977 form is required; simply enter the amount on line 4 (short-term) or line 12 (long-term) of Schedule D.
But if the carryover from 1976 to 1977 included a loss which originated in 1969 or earlier, you must now complete a 1977 Form 4798 to calculate the amount; attach the Form 4798 to your 1977 Form 1040.
TAX TIP: For the 1978 tax year the holding period to differentiate between short-term and long-term gains and losses is increased to twelve months, and the maximum annual deduction goes up to $3,000.
A non-business loan which became uncollectible during 1977 - a personal "bad debt" - is treated as a short-term capital loss. But it must represent an actual out-of pocket loss; you may not claim as a bad debt a payment you didn't receive which was due you for services.
If you owned securities which became worthless during the year, they are considered to have been sold for "zero" dollars on Dec. 31, 1977 for purposes of determining whether your loss is short-term or long-term.
TAX TIP: If you received property as a gift or bequest, the cost basis for determining gain or loss may not be the actual cost. See IRS Publication 551 for instructions. Sale of Your Home
Profit on the sale of your personal residence is a capital gain; but a loss is never deductible. The amount of gain can be reduced by adding to the original purchase price certain of the closing costs on purchase and cost of any permanent (capital) improvements; and by deducting selling expenses from the sales price.
The tax on any gain must be deferred if you buy another personal residence costing at least as much as the selling price of the old home, and Ocupy it within 18 months before or after the sale.
If you build a new home, construction must begin before the sale or within 18 months after the sale, and you must occupy the new home as your principal residence within 24 months.
If you were 65 or over on the date of the sale, part or all of the gain may be excludable from income. In the case of a jointly-owned residence, this tax savings is available if either co-owner had reached the age of 65.
TAX TIP: In the event of a divorce or separation and the concurrent sale of a jointly-owned residence, either owner may qualify independently for the tax deferral if he or she bought a new principal residence. The amount of gain on which tax is deferred is based on his or her share of the proceeds from the sale of the old home. Other Income
Here's a checklist of other types of reportable income, and where each goes on your tax return:
Alimony or separate maintenance payments (but not child support): line 12, Form 1040.
State income tax refunds (but only if you claimed the tax paid as an itermized deduction in a prior year): line 11, Form 1040.
Gross gambling winnings> lottery and bingo prizes: line 20, Form 1040. Gambling losses may be deducted on Schedule A if you itemize, but only up to the amount of winnings reported as income.
Farm income or loss: Schedule F.
Fees, but not travel expenses, for jury duty: line 20, Form 1040.
Income from a partnership, estate, or trust: Part III of Schedule E. Tax-Preference Income
A minimum tax is imposed on selected forms of income which would otherwise escape taxation. The minimum tax is 15 per cent on net tax-preference income after the application of specified exclusions.
Tax-preference items include stock options; certain types of accelerated depreciation, depletion, and amortization; half of net long-term capital gains; and itemized deductions (excluding medical expenses and casualty losses) in excess of 60 per cent; but not over 100 per cent, of adjusted gross income.
TAX TIP: Capital gain on sale of your residence is included with other capital gains as tax-preference income - but not if tax on the gain is deferred because of the purchase of a new home.
If you had tax-preference income of $10,000 or more ($5,000 if married filing separately), you must complete Form 4625 to determine if there is any tax due. Form 4625 must be filed with your return to show the calculations even if no tax liability results.