In reporting income, the focus should be on what income is taxable and what is not.
The first step is to go through the income information you have collected and pull out those items that are not subject to federal income tax.
Here is a checklist of major types of nontaxable income, including most of the items referred to in Section 4 -- "Income" in the booklet, plus a few others:
Interest on state and local bonds, received either directly or through a mutual fund. In the case of a mutual fund, refer to the fund literature to determine how much is nontaxable.
Disability and other benefits from the armed forces.
Worker's compensation payments for injury or illness.
Gifts or inheritances.
Certain scholarship and fellowship payments.
Life insurance proceeds, except to the extent of any interest component associated with periodic payments.
Benefits from an employer's accident and health plan.
Military allowances and certain cost-of-living allowances for U.S. civilian employees overseas.
Amounts awarded in a civil suit as damages resulting from personal injury.
Some or all of the pay received by U.S. citizens living and working in a foreign country, if they meet certain time and place requirements.
The value of, or reimbursement for, employer-provided child or dependent care services, up to $5,000, pursuant to a written plan.
Dividends on an unmatured life insurance policy, unless the accumulated total exceeds total premiums paid; also dividends from a mutual insurance company that decreases the premiums you paid.
But interest on dividend accumulations must be reported.
Amounts received for living expenses under a casualty insurance policy after a fire or other disaster, except to the extent such payments exceed normal living expenses.
Up to $125,000 of gain on the sale of a principal residence, if you are 55 or older and meet certain other requirements.
Tax may be deferred until a later date on certain types of income.
The principal kinds of tax-deferred income are:
Earnings accumulating in a qualified pension, profit-sharing or stock-bonus plan, including a 401(k) cash or deferred compensation arrangement, whether established by a corporation, individual proprietor or partnership -- the latter two sometimes being referred to as Keogh or H.R. 10 plans.
Earnings accumulated in an individual retirement account (IRA) either by an employee, or by an employer under a simplified employee pension plan (SEP).
Earnings accumulating in many insurance policies.
Interest on Series EE savings bonds, if you have elected to defer the tax liability until the bonds are cashed in or mature.
Gain on the sale of your principal residence if you buy a new, more expensive residence within two years.
Unrealized gain with respect to an investment asset that is exchanged for a "like-kind" asset.
Most other types of income must be included in your tax return. But different categories of income are reported in different ways and different places, sometimes on a special form or schedule.
The accompanying chart, "Reporting Income," lists the principal types of taxable income, tells you where each type is to be reported on Form 1040, and lists the applicable IRS publications.
Form 1040EZ and 1040A filers, having a very limited list of includable items, are not included in the chart.
Here are some special considerations relating to some of the income items listed in the chart:
Wages: Wages reported to you in Box 10 of Form W-2 should be reported on line 7 of Form 1040.
Other items reportable here include certain tips, certain disability payments, strike and lockout benefits paid by a union and employer-paid moving expenses not included in box 10, Form W-2.
Life insurance sales representatives, commission drivers and traveling sales representatives who qualify as "statutory employees," with box 6 of your W-2 checked, should report W-2 income on Schedule C rather than line 7 of Form 1040.
Scholarships and fellowships: If you received a scholarship or fellowship that was granted after Aug. 16, 1986, you may exclude from taxable income the part for tuition, books and course-related supplies and equipment. The balance for room, board, travel and stipend for teaching or research goes on line 7, Form 1040, even though you don't have a W-2. More liberal rules apply to grants made before Aug. 16, 1986.
Interest income: Most interest income that needs to be reported will first be reported to you on Form 1099-INT or 1099-OID. The IRS lists examples in the booklet -- Section 4, line 8a.
If you receive more than $400 of taxable interest, use Schedule B to list the sources and amounts.
If you get a Form 1099 from a broker, list the broker and the Form 1099 amount rather than listing each security on which you received interest.
If you sold your home and took back a mortgage, list the interest income from this mortgage as the first item on line 1.
You may receive a Form 1099 as "nominee," that is, in your name, but belonging in whole or in part to someone else. You may even receive a Form 1099 that includes tax-exempt interest. In either case, include all the Form 1099 interest on line 1 of Schedule B, show a subtotal for all the line 1 interest and just above line 2 put the description "Nominee Distribution" or "Tax-Exempt Interest," as the case may be, and list as a lump sum a negative balance for each of these. Subtract these amounts from the subtotal in arriving at total interest on line 2.
You may also have bought a corporate bond during the year, on a date other than a date on which interest was payable on the bond. Your Form 1099 for interest income from this bond will include all cash payments received while you owned the bond. However, the first interest payment received after you bought the bond will have included interest accrued on the bond prior to when you bought it and this pre-ownership accrued interest, which will have been included in what you paid for the bond, should be treated as nominee interest, as discussed above. The amount to be so treated should be shown on the broker's purchase confirmation slip as "accrued interest purchased."
Regarding Form 1099-OID, the "OID" stands for "original issue discount" -- a reference to interest that is accruing but isn't being paid.
Issuers should give you a Form 1099-OID to tell you how much to report, but you may not be required to report all of the amount shown on this form. Read the booklet instructions and Publication 1212 or ask the issuing company for details.
Tax-exempt interest: Tax-exempt interest from municipal bonds and exempt-interest dividends from a mutual fund should be reported on line 8b of Form 1040. This figure is not included in your taxable income but is used instead in other calculations, such as the calculation of the amount of Social Security income to be included in taxable income.
Dividends: Remember that amounts identified as dividends from mutual savings banks, cooperative banks and credit unions are really interest, and should be reported as such on your return. On the other hand, amounts earned on money market funds and mutual funds, including bond mutual funds that collect interest on the fund's underlying bond investments, are dividend income and are also reportable on your return.
Foreign accounts: If you had a foreign account, an interest in a foreign trust during 1990 or are otherwise required to use Schedule B to report interest or dividends, complete Part III of Schedule B. Note that you should check question 11a "no" if you have foreign accounts worth less than $10,000. See the booklet Section 6, Schedule B, Part III for additional foreign account reporting requirements.
State tax refund: If in 1990 you received a refund of state or local income tax, you are likely to receive a Form 1099-G showing the refund amount.
Line 10 of Form 1040 is used to report taxable refunds, but don't assume that the amount shown on Form 1099-G is necessarily the taxable portion.
Refunds of state and local income taxes are includable in federal gross income in the year received, but only to the extent they reduced a taxpayer's income tax liability, by having been taken as an itemized on Schedule A, in a previous year. Therefore, if a taxpayer took the standard deduction in the previous year rather than itemizing, none of the refund is includable. Similarly, if the taxes were itemized, but total itemized deductions exceed the standard deductions by an amount that is less than the itemized taxes, only that excess amount need be included in income.
Alimony: Generally, payments to or on behalf of a spouse or former spouse, pursuant to a divorce or separation instrument executed after 1984, are "qualifying alimony," taxable to the recipient -- on line 11, Form 1040 -- and deductible by the payer on line 29, Form 1040 if: payment is in cash, the instrument does not specify that the payment is not to be treated as qualifying alimony, the payment is not treated as child support, you were separated under a decree of divorce or separate maintenance and the two of you did not live together when the payment was made, and payments are to cease on the death of the recipient.
A special recapture rule applies to "excess" alimony payments -- that is, a decrease by more than $15,000 in the second or third year alimony is paid. Alimony paid pursuant to pre-1985 decrees generally is includable and deductible if it is "periodic" and isn't considered child support.
Business income: Schedule C is used to report income and claim deductions for a business conducted as a sole proprietorship. If you use Schedule C and reported $400 or more of net income from self-employment, you must also complete and file Schedule SE to determine any liability for self-employment tax, unless you received wages (subject to Social Security tax) of $51,300 or more.
Capital gains and losses: For 1990 returns, capital gains and losses from the sale or exchange of capital assets, reportable on Schedule D as either long term or short term, get no preferential tax treatment.
A capital asset is almost everything you own and use for personal or investment purposes, including stocks and bonds, your house, car, furniture or other personal assets. Excepted items include property used in your trade or business; business inventory; and copyrights, letters and works of art created by you or given to you by the creator.
The sale of any capital asset held for one year or less produces short-term gain or loss; assets held more than one year, long-term gain or loss.
After balancing gains against losses on Schedule D, any net gain is reportable in full as income. However, the amount of capital loss that can be deducted after offsetting capital gains is limited to $3,000 ($1,500 if married filing separately).
A few comments about the capital losses: net capital loss over $3,000 should be carried forward to succeeding tax years until exhausted, retaining its short-term or long-term character.
Information reported to you by brokers and others on Forms 1099-B or 1099-S will not include information about the cost, or basis, of the assets sold. You will have to get this either from your own records or by asking your broker.
Use Form 4797 -- "Sales of Business Property" -- to report the sale of non-capital assets or property used in your trade or business, the reportable amount ends up on line 15, Form 1040.
In reporting the sale of any mutual fund shares, your cost for the shares sold should include the amount of any dividends reinvested.
The gain or loss will depend on the basis of the shares sold, and if you sell just a part of your shares, the question is: which of your shares did you sell and what was their basis? If the shares sold are not specifically identified, you are considered to have sold the earliest shares purchased and their basis is what you paid for them. This actual cost is often less than the cost of subsequent shares, resulting in more capital gain -- or less capital loss.
Capital losses from the sale or exchange of an asset used for personal purposes are not recognizable and generally should not be included on your return. However, capital gain from the sale of a personal asset, such as your car, should be reported on Schedule D.
A loss from any worthless security is recognized only when the security is deemed completely worthless, even though there is no sale or exchange.
If you have made a personal loan to someone other than as part of your trade or business and the debt becomes uncollectible, you have a nonbusiness bad debt, reportable on Schedule D as a short-term capital loss and subject to the $3,000 per year net capital loss limitation.
If you sell your home, you may be able to defer part or all of the gain if, within two years of the sale, you reinvest the sales proceeds in another principal residence. If you are over age 55 and meet certain tests you may also claim a once in a lifetime $125,000 exclusion. See Form 2119 for further details.
Be sure to enter on line 1 of Schedule D, the total amounts received on sales of securities or real estate, as reported on Forms 1099-B and 1099-S. The line 1 entry should equal the total short-term and long-term column (d) sales prices shown on lines 2c and 9c. Attach a reconciliation for any difference. Capital gain transactions for which you don't receive a Form 1099 should be reported on lines 2d and 9d.
If you sold securities in the last few days of last year, intending to defer reporting the transaction until 1991 -- keep in mind that you must use the "trade date" as the date sold and the date acquired for publicly traded stocks and bonds. Accordingly, you may have to report the transaction in 1990 even though you received the sales proceeds in early 1991.
Capital gain distributions reported to you on Form 1099-DIV, box 1c, should be included in the dividends reported on line 5 of Schedule B and also as a lump sum on line 7, Schedule B. If you don't need Schedule D for other capital gains transactions, the line 7, Schedule B amount should be carried over to line 14, Form 1040; otherwise, it should be carried to line 13 of Schedule D.
Retirement income: The rules dealing with taxation of retirement income are complex. There are different rules for different types of distributions, as well as excise taxes regarding certain distributions.
Lines 16 and 17 of Form 1040 are used to report the ordinary income portion of IRA and retirement plan distributions. You should receive Forms 1099-R and W-2P regarding such distributions and the amounts shown there generally will be the amounts to report.
IRA distributions: If you ever made any nondeductible contributions to your IRA, part of your IRA distribution may be nontaxable. You should have a cumulative record of any nondeductible contributions. Use Form 8606 and IRS Publication 590 to figure the taxable part.
If you receive a distribution that in turn is "rolled over," such as transferred, within 60 days and in full from one IRA account to another, report the distribution amount on line 16 and zero on line 16b. Partial rollovers will result in some of the distribution being reportable on line 16b. A direct transfer from one IRA custodian to another is not considered a rollover and need not be reported.
Retirement plan distributions: As with IRAs, if you made nondeductible contributions to your retirement plan, part of your retirement distributions may be nontaxable. The nontaxable portion may be shown on your Form W-2P, if not, you will have to calculate the nontaxable portion using instructions found in Publication 939. However, if your retirement was effective after July 1, 1986, you may be able to use a "simplified" calculation as explained in the booklet.
Using the Simplified General Rule, you divide your contributions to the plan by one of five numbers ranging from 300 to 120, depending on your age at the time of your annuity starting date, and treat the result as the monthly portion of your annuity that is tax-free.
The General Rule applies if you can't use the Simplified General Rule. Calculate a ratio (the "exclusion ratio") between your total contributions to the plan and the total annuity payments expected (the "expected payout"), and apply that ratio to each payment to determine the nontaxable portion. The "expected payout" is determined by using IRS-proffered life expectancy tables.
Note that for retirees after July 1, 1986 it is possible to switch from the General Rule to the Simplified General Rule. See Publication 575 or 721 for details.
Lump-sum distributions: A lump sum distribution is generally a distribution within a single tax year of an employee's entire balance from all of his employer's qualified pension plans or all of his employer's profit-sharing plans, but this doesn't include IRAs. The distribution must be paid because of the employee's death or separation from service, or after the employee reaches age 59 plus. The separation from service condition can't be used for a self-employed person.
As with respect to retirement distributions in general, you may treat an amount equal to your nondeductible contributions as a nontaxable distribution. The balance may be entitled to special tax treatment.
If part of the distribution is attributable to your participation in the plan before 1974 (the "pre-74" portion), this part, shown in box 3 on Form 1099-R, may qualify for capital gains treatment.
More specifically, if you were born before 1936, you can treat all the pre-74 portion as capital gain subject to tax at 20 percent rate. Use Form 4972 to make this election. The balance of the distribution would then be reported in either Part III or IV of Form 4972, using a favorable averaging method to determine the tax.
If you were not born before 1936, you can treat 50 percent of the pre-74 portion as long-term capital gain, reportable on line 9d of Schedule D. Write "lump sum distribution" in column (a) and show 50 percent of the pre-74 portion in column (g). The balance of the distribution would be ordinary income, reported on line 17b. The tax advantage lies in the ability to offset the retirement distribution capital gain with capital losses that would otherwise have to be carried over because of the $3,000 net capital loss limitation.
The other option would be to have rolled over the distribution to either another qualified plan or an IRA.
This would have had to have been done with 60 days of receiving the distribution, so except for some distributions received in late December 1990, this has either already happened or cannot now be done.
If this were done, none of the amount rolled over would be taxable on your 1990 return. For those not born before 1936, this would seem to be the most favorable approach.
Supplemental income and loss: Schedule E, and line 18 of Form 1040, are used to report income from rentals and royalties; partnerships; S corporations; estates and trusts; and REMICS (Real Estate Mortgage Investment Conduits).
We will touch briefly on these, except for the seldom encountered REMICS and preface our remarks with a brief discussion of the passive loss and at-risk rules.
Passive loss rules: For years, so-called tax shelters flourished. Tax shelters were designed to generate positive cash flow while simultaneously generating tax losses, primarily from depreciation. In 1986, Congress passed legislation designed to curb tax shelters, including the passive loss rules.
These rules significantly restrict an investor's ability to deduct passive losses, by prohibiting deductions from passive trade or business activities, to the extent they exceed income from all such passive activities.
Unused, or "suspended," losses are carried forward indefinitely and are deductible against future passive income or when the taxpayer disposes of the passive activity giving rise to the losses.
An activity, such as a trade or business, can be passive with respect to some owners and non-passive with respect to others. A taxpayer's participation is considered to be passive if he or she is not involved in the operations of the activity on a regular, continuous and substantial basis.
By definition, a rental activity is generally deemed to be a passive activity, regardless of whether the taxpayer materially participates.
Also, an individual who holds an interest in a limited partnership is generally considered to own a passive activity unless he can show that he or she materially participates in the partnership activity, though few if any limited partners can do this. There are special phase-in rules for interests in passive activities acquired by a taxpayer before Oct. 22, 1986. For 1990, 10 percent of any losses and credits from these pre-1987 interests will be allowed against non-passive income. For 1991, these special phase-in rules will no longer apply.
Calculate your allowable deduction or credit from passive activities on IRS Forms 8582 and 8582CR, respectively.
At-risk rules: In conjunction with the passive loss rules are the at-risk rules, which generally limit a taxpayer's deductible loss from an activity to the amount that the taxpayer has "at risk" with respect to the activity. Accordingly, loss deductions are limited to the amount of a taxpayer's property and cash contribution to an activity plus any loans for which the taxpayer is personally liable. This rule prevents taxpayers from offsetting trade, business or professional income by losses from investments largely financed by nonrecourse loans for which the taxpayers are not personally liable.
In 1987, real estate activities were added to the list of activities subject to the at-risk rules.
There is a pecking order for applying the various loss limitation rules: first, the at-risk rules; next, the passive loss rules; and finally, any other loss limitation rules, such as the $3,000 capital loss rule. Form 6198 is used to compute any at-risk limitation. Form 8582 is used to compute the passive loss limitation.
Income or loss from rentals: Income or loss from rental properties is reported in Part I, Schedule E. Rental activities, as discussed above, are subject to the passive loss rules, so if you have a net loss on line 22 of Schedule E for any rental property, you need to use Form 8582 to figure how much is deductible.
There is a limited exception to the passive loss rules in the case of losses from rental real estate activities, if an individual taxpayer owns at least 10 percent of the activity and actively participates in making management decisions, such as rental terms, capital improvements or repairs. Up to $25,000 of losses from such an activity are allowed against non-passive income. This $25,000 maximum is reduced, but not below zero, by 50 percent of the amount by which an individual's adjusted gross income exceeds $100,000.
The $25,000 maximum allowance is only $12,500 for marrieds filing separately who live apart the entire year, and there is no allowance for marrieds filing separately who live together at any time during the year. Use Form 8582 to determine this special allowance, unless you meet the three tests discussed in the booklet (Section 6) for line 23, Schedule E. The tests, if met, mean you get all your rental losses without any further calculations.
Finally, the rules for rental real estate get tricky if you mix rental and personal use. If you rent a vacation home for 15 or more days during the year or you use for personal purposes any part of your rental real estate for more than the greater of 14 days or 10 percent of the days it is rented, you are subject to special rules that limit the amount of rental expenses you can deduct. You'll need to allocate your expenses between the rental and personal use, limiting the rental portion of expenses to the amount of rental income and the personal portion to just interest and real estate taxes.
Partnerships: A partnership is not a taxable entity. The income, gains, losses, credits and deductions of a partnership are "passed through" to partners, based on their distributive share of these items, and are reported on partners' individual income tax returns. Partnerships provide each partner with an information return -- a Schedule K-1 -- that shows the partner's distributive share of tax items and how to report them on his or her return. This is an information return only; do not attach it to Form 1040.
If you are a limited partner, the passive loss rules generally apply to you, so you must use Form 8582 to figure your passive activity loss with respect to your partnership interest. If you are a general partner, you need to figure out if you materially participated in the partnership -- see the Form 8582 instructions -- and treat your Schedule K-1 information accordingly.
If your partnership is a "publicly traded partnership," except upon disposition your partnership interest, your passive losses can only be used to offset passive income from that partnership.
If you are a partner of a partnership engaged in rendering personal services, don't worry about the passive loss rules.
Allowable passive loss deductions are transferred from Form 8582 to Part II, Schedule E, column (g). Non-passive losses go in column (i). There are also columns for passive and non-passive income.
S corporations: Like a partnership, an S Corporation -- the reference is to Subchapter S of the Internal Revenue Code -- generally does not pay tax on its income. Instead, its income is "passed through" to shareholders, who receive a Schedule K-1 telling them what to report on their individual returns.
You may only deduct losses from an S corporation to the extent of your "basis" in the corporation's stock plus the amount of any debt the corporation may owe you.
After applying the basis limitation, your losses may be further reduced by the passive loss rules.
Estates and trusts: If you are a beneficiary of an estate or trust, you will receive a Schedule K-1 from the fiduciary showing what to report in Part III, Schedule E. Interest and dividends passed through to beneficiaries go on Schedule B rather than Schedule E.
Social Security benefits: If you receive Social Security benefits, you will receive Form SSA-1099 telling you how much you received.
Some of the Social Security benefits, but never more than half, may be taxable and reportable on line 21, Form 1040. There is a work sheet in the booklet and attached to Form SSA-1099 for determining the taxable portion.
The idea here is that if your "combined income" is above a "base amount," some of your Social Security benefits are taxable. The amount taxable is the lesser of one-half of your Social Security benefits or one-half of the excess of your "combined income" over the "base amount."
Combined income is equal to your adjusted gross income before inclusion of any Social Security benefits, plus tax-exempt interest from line 8b on Form 1040 and one-half of your Social Security benefits.
Your base amount is $32,000 for joint filers; zero for marrieds filing separately who lived together at any time during the year; and $25,000 for single filers and all others.
Social Security recipients can use the simpler Form 1040A, beginning this year.
Other income: Line 22, Form 1040 is used to report any income you can't find another place for on your return. Among the items that often go here are gambling winnings -- report in full; claim gambling losses on Schedule A; jury duty fees; net operating loss carry over; and, in certain cases, the income of your child under 14 years.
Here are a few rules about including your child's income on your return.
"Kiddie" tax: For years, parents could transfer money or income producing property to their child so that the income would be taxed at the child's lower marginal rates, that is, 15 percent rather than up to 33 percent. Recently, new rules were enacted to prevent this practice.
The tax now imposed on the "net unearned income" of a child under 14 years cannot be less than the tax that would be imposed on such income if it were added to the parent's taxable income. "Net unearned income" means basically investment income, less $500, less a $500 standard deduction or investment related itemized deductions, if greater than $500.
If your dependent child under age 14 had income only from interest and dividends and the income aggregated more than $500 but less than $5,000 and the child had no income tax withheld or estimated tax payments for 1990, you may elect to report that child's income on your own return and not file a return for your child.
Form 8814 is used to make the election and determine the amount of income to report on your line 22, Form 1040. The tax on up to the first $500 of the child's investment income is also determined on Form 8814 and is reported on line 38d, Form 1040 and is included as part of the tax entered on line 38, Form 1040.
If your dependent child under age 14 has itemized deductions of more than $500, is blind or otherwise doesn't fit the forgoing criteria, he or she generally must file a separate return. If he or she has investment income of more than $1,000, Form 8615 must be used to compute the tax on the child's net unearned income, using the parent's marginal tax rate. See the instructions for Form 8615 for additional information about having more than one child under age 14 with investment income.