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1040 Tax Form

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1040 Tax Form

1040 tax form Publication 537 - Main Content Table of Contents What Is an Installment Sale?Special rule. 1040 tax form General RulesFiguring Installment Sale Income Reporting Installment Sale Income Other RulesElecting Out of the Installment Method Payments Received or Considered Received Escrow Account Depreciation Recapture Income Sale to a Related Person Like-Kind Exchange Contingent Payment Sale Single Sale of Several Assets Sale of a Business Unstated Interest and Original Issue Discount (OID) Disposition of an Installment Obligation Repossession Interest on Deferred Tax Reporting an Installment SaleRelated person. 1040 tax form Several assets. 1040 tax form Special situations. 1040 tax form Schedule D (Form 1040). 1040 tax form Form 4797. 1040 tax form How To Get Tax Help What Is an Installment Sale? An installment sale is a sale of property where you receive at least one payment after the tax year of the sale. 1040 tax form The rules for installment sales do not apply if you elect not to use the installment method (see Electing Out of the Installment Method under Other Rules, later) or the transaction is one for which the installment method may not apply. 1040 tax form The installment sales method cannot be used for the following. 1040 tax form Sale of inventory. 1040 tax form   The regular sale of inventory of personal property does not qualify as an installment sale even if you receive a payment after the year of sale. 1040 tax form See Sale of a Business under Other Rules, later. 1040 tax form Dealer sales. 1040 tax form   Sales of personal property by a person who regularly sells or otherwise disposes of the same type of personal property on the installment plan are not installment sales. 1040 tax form This rule also applies to real property held for sale to customers in the ordinary course of a trade or business. 1040 tax form However, the rule does not apply to an installment sale of property used or produced in farming. 1040 tax form Special rule. 1040 tax form   Dealers of time-shares and residential lots can treat certain sales as installment sales and report them under the installment method if they elect to pay a special interest charge. 1040 tax form For more information, see section 453(l). 1040 tax form Stock or securities. 1040 tax form   You cannot use the installment method to report gain from the sale of stock or securities traded on an established securities market. 1040 tax form You must report the entire gain on the sale in the year in which the trade date falls. 1040 tax form Installment obligation. 1040 tax form   The buyer's obligation to make future payments to you can be in the form of a deed of trust, note, land contract, mortgage, or other evidence of the buyer's debt to you. 1040 tax form General Rules If a sale qualifies as an installment sale, the gain must be reported under the installment method unless you elect out of using the installment method. 1040 tax form See Electing Out of the Installment Method under Other Rules, later, for information on recognizing the entire gain in the year of sale. 1040 tax form Sale at a loss. 1040 tax form   If your sale results in a loss, you cannot use the installment method. 1040 tax form If the loss is on an installment sale of business or investment property, you can deduct it only in the tax year of sale. 1040 tax form Unstated interest. 1040 tax form   If your sale calls for payments in a later year and the sales contract provides for little or no interest, you may have to figure unstated interest, even if you have a loss. 1040 tax form See Unstated Interest and Original Issue Discount (OID) under Other Rules, later. 1040 tax form Figuring Installment Sale Income You can use the following discussions or Form 6252 to help you determine gross profit, contract price, gross profit percentage, and installment sale income. 1040 tax form Each payment on an installment sale usually consists of the following three parts. 1040 tax form Interest income. 1040 tax form Return of your adjusted basis in the property. 1040 tax form Gain on the sale. 1040 tax form In each year you receive a payment, you must include in income both the interest part and the part that is your gain on the sale. 1040 tax form You do not include in income the part that is the return of your basis in the property. 1040 tax form Basis is the amount of your investment in the property for installment sale purposes. 1040 tax form Interest Income You must report interest as ordinary income. 1040 tax form Interest is generally not included in a down payment. 1040 tax form However, you may have to treat part of each later payment as interest, even if it is not called interest in your agreement with the buyer. 1040 tax form Interest provided in the agreement is called stated interest. 1040 tax form If the agreement does not provide for enough stated interest, there may be unstated interest or original issue discount. 1040 tax form See Unstated Interest and Original Issue Discount (OID) under Other Rules, later. 1040 tax form Adjusted Basis and Installment Sale Income (Gain on Sale) After you have determined how much of each payment to treat as interest, you treat the rest of each payment as if it were made up of two parts. 1040 tax form A tax-free return of your adjusted basis in the property, and Your gain (referred to as installment sale income on Form 6252). 1040 tax form Figuring adjusted basis for installment sale purposes. 1040 tax form   You can use Worksheet A to figure your adjusted basis in the property for installment sale purposes. 1040 tax form When you have completed the worksheet, you will also have determined the gross profit percentage necessary to figure your installment sale income (gain) for this year. 1040 tax form Worksheet A. 1040 tax form Figuring Adjusted Basis and Gross Profit Percentage 1. 1040 tax form Enter the selling price for the property   2. 1040 tax form Enter your adjusted basis for the property     3. 1040 tax form Enter your selling expenses     4. 1040 tax form Enter any depreciation recapture     5. 1040 tax form Add lines 2, 3, and 4. 1040 tax form  This is your adjusted basis for installment sale purposes   6. 1040 tax form Subtract line 5 from line 1. 1040 tax form If zero or less, enter -0-. 1040 tax form  This is your gross profit     If the amount entered on line 6 is zero, stop here. 1040 tax form You cannot use the installment method. 1040 tax form   7. 1040 tax form Enter the contract price for the property   8. 1040 tax form Divide line 6 by line 7. 1040 tax form This is your gross profit percentage   Selling price. 1040 tax form   The selling price is the total cost of the property to the buyer and includes any of the following. 1040 tax form Any money you are to receive. 1040 tax form The fair market value (FMV) of any property you are to receive (FMV is discussed in Property Used As a Payment under Other Rules, later). 1040 tax form Any existing mortgage or other debt the buyer pays, assumes, or takes (a note, mortgage, or any other liability, such as a lien, accrued interest, or taxes you owe on the property). 1040 tax form Any of your selling expenses the buyer pays. 1040 tax form   Do not include stated interest, unstated interest, any amount recomputed or recharacterized as interest, or original issue discount. 1040 tax form Adjusted basis for installment sale purposes. 1040 tax form   Your adjusted basis is the total of the following three items. 1040 tax form Adjusted basis. 1040 tax form Selling expenses. 1040 tax form Depreciation recapture. 1040 tax form Adjusted basis. 1040 tax form   Basis is your investment in the property for installment sale purposes. 1040 tax form The way you figure basis depends on how you acquire the property. 1040 tax form The basis of property you buy is generally its cost. 1040 tax form The basis of property you inherit, receive as a gift, build yourself, or receive in a tax-free exchange is figured differently. 1040 tax form   While you own property, various events may change your original basis. 1040 tax form Some events, such as adding rooms or making permanent improvements, increase basis. 1040 tax form Others, such as deductible casualty losses or depreciation previously allowed or allowable, decrease basis. 1040 tax form The result is adjusted basis. 1040 tax form   For more information on how to figure basis and adjusted basis, see Publication 551. 1040 tax form For more information regarding your basis in property you inherited from someone who died in 2010 and whose executor filed Form 8939, Allocation of Increase In Basis for Property Acquired From a Decedent, see Publication 4895. 1040 tax form Selling expenses. 1040 tax form   Selling expenses relate to the sale of the property. 1040 tax form They include commissions, attorney fees, and any other expenses paid on the sale. 1040 tax form Selling expenses are added to the basis of the sold property. 1040 tax form Depreciation recapture. 1040 tax form   If the property you sold was depreciable property, you may need to recapture part of the gain on the sale as ordinary income. 1040 tax form See Depreciation Recapture Income under Other Rules, later. 1040 tax form Gross profit. 1040 tax form   Gross profit is the total gain you report on the installment method. 1040 tax form   To figure your gross profit, subtract your adjusted basis for installment sale purposes from the selling price. 1040 tax form If the property you sold was your home, subtract from the gross profit any gain you can exclude. 1040 tax form See Sale of Your Home , later, under Reporting Installment Sale Income. 1040 tax form Contract price. 1040 tax form   Contract price equals: The selling price, minus The mortgages, debts, and other liabilities assumed or taken by the buyer, plus The amount by which the mortgages, debts, and other liabilities assumed or taken by the buyer exceed your adjusted basis for installment sale purposes. 1040 tax form Gross profit percentage. 1040 tax form   A certain percentage of each payment (after subtracting interest) is reported as installment sale income. 1040 tax form This percentage is called the gross profit percentage and is figured by dividing your gross profit from the sale by the contract price. 1040 tax form   The gross profit percentage generally remains the same for each payment you receive. 1040 tax form However, see the Example under Selling Price Reduced, later, for a situation where the gross profit percentage changes. 1040 tax form Example. 1040 tax form You sell property at a contract price of $6,000 and your gross profit is $1,500. 1040 tax form Your gross profit percentage is 25% ($1,500 ÷ $6,000). 1040 tax form After subtracting interest, you report 25% of each payment, including the down payment, as installment sale income from the sale for the tax year you receive the payment. 1040 tax form The remainder (balance) of each payment is the tax-free return of your adjusted basis. 1040 tax form Amount to report as installment sale income. 1040 tax form   Multiply the payments you receive each year (less interest) by the gross profit percentage. 1040 tax form The result is your installment sale income for the tax year. 1040 tax form In certain circumstances, you may be treated as having received a payment, even though you received nothing directly. 1040 tax form A receipt of property or the assumption of a mortgage on the property sold may be treated as a payment. 1040 tax form For a detailed discussion, see Payments Received or Considered Received under Other Rules, later. 1040 tax form Selling Price Reduced If the selling price is reduced at a later date, the gross profit on the sale also will change. 1040 tax form You then must refigure the gross profit percentage for the remaining payments. 1040 tax form Refigure your gross profit using Worksheet B. 1040 tax form You will spread any remaining gain over future installments. 1040 tax form Worksheet B. 1040 tax form New Gross Profit Percentage — Selling Price Reduced 1. 1040 tax form Enter the reduced selling  price for the property   2. 1040 tax form Enter your adjusted  basis for the  property     3. 1040 tax form Enter your selling  expenses     4. 1040 tax form Enter any depreciation  recapture     5. 1040 tax form Add lines 2, 3, and 4. 1040 tax form   6. 1040 tax form Subtract line 5 from line 1. 1040 tax form  This is your adjusted  gross profit   7. 1040 tax form Enter any installment sale  income reported in  prior year(s)   8. 1040 tax form Subtract line 7 from line 6   9. 1040 tax form Future installments   10. 1040 tax form Divide line 8 by line 9. 1040 tax form  This is your new gross profit percentage*   * Apply this percentage to all future payments to determine how much of each of those payments is installment sale income. 1040 tax form Example. 1040 tax form In 2011, you sold land with a basis of $40,000 for $100,000. 1040 tax form Your gross profit was $60,000. 1040 tax form You received a $20,000 down payment and the buyer's note for $80,000. 1040 tax form The note provides for four annual payments of $20,000 each, plus 8% interest, beginning in 2012. 1040 tax form Your gross profit percentage is 60%. 1040 tax form You reported a gain of $12,000 on each payment received in 2011 and 2012. 1040 tax form In 2013, you and the buyer agreed to reduce the purchase price to $85,000 and payments during 2013, 2014, and 2015 are reduced to $15,000 for each year. 1040 tax form The new gross profit percentage, 46. 1040 tax form 67%, is figured on Example—Worksheet B. 1040 tax form You will report a gain of $7,000 (46. 1040 tax form 67% of $15,000) on each of the $15,000 installments due in 2013, 2014, and 2015. 1040 tax form Example — Worksheet B. 1040 tax form New Gross Profit Percentage — Selling Price Reduced 1. 1040 tax form Enter the reduced selling  price for the property 85,000 2. 1040 tax form Enter your adjusted  basis for the  property 40,000   3. 1040 tax form Enter your selling  expenses -0-   4. 1040 tax form Enter any depreciation  recapture -0-   5. 1040 tax form Add lines 2, 3, and 4. 1040 tax form 40,000 6. 1040 tax form Subtract line 5 from line 1. 1040 tax form  This is your adjusted  gross profit 45,000 7. 1040 tax form Enter any installment sale  income reported in  prior year(s) 24,000 8. 1040 tax form Subtract line 7 from line 6 21,000 9. 1040 tax form Future installments 45,000 10. 1040 tax form Divide line 8 by line 9. 1040 tax form  This is your new gross profit percentage* 46. 1040 tax form 67% * Apply this percentage to all future payments to determine how much of each of those payments is installment sale income. 1040 tax form Reporting Installment Sale Income Generally, you will use Form 6252 to report installment sale income from casual sales of real or personal property during the tax year. 1040 tax form You also will have to report the installment sale income on Schedule D (Form 1040), Capital Gains and Losses, or Form 4797, or both. 1040 tax form See Schedule D (Form 1040) and Form 4797 , later. 1040 tax form If the property was your main home, you may be able to exclude part or all of the gain. 1040 tax form See Sale of Your Home , later. 1040 tax form Form 6252 Use Form 6252 to report an installment sale in the year it takes place and to report payments received, or considered received because of related party resales, in later years. 1040 tax form Attach it to your tax return for each year. 1040 tax form Form 6252 will help you determine the gross profit, contract price, gross profit percentage, and installment sale income. 1040 tax form Which parts to complete. 1040 tax form   Which part to complete depends on whether you are filing the form for the year of sale or a later year. 1040 tax form Year of sale. 1040 tax form   Complete lines 1 through 4, Part I, and Part II. 1040 tax form If you sold property to a related party during the year, also complete Part III. 1040 tax form Later years. 1040 tax form   Complete lines 1 through 4 and Part II for any year in which you receive a payment from an installment sale. 1040 tax form   If you sold a marketable security to a related party after May 14, 1980, and before January 1, 1987, complete Form 6252 for each year of the installment agreement, even if you did not receive a payment. 1040 tax form (After December 31, 1986, the installment method is not available for the sale of marketable securities. 1040 tax form ) Complete lines 1 through 4 and Part II for any year in which you receive a payment from the sale. 1040 tax form Complete Part III unless you received the final payment during the tax year. 1040 tax form   If you sold property other than a marketable security to a related party after May 14, 1980, complete Form 6252 for the year of sale and for 2 years after the year of sale, even if you did not receive a payment. 1040 tax form Complete lines 1 through 4 and Part II for any year during this 2-year period in which you receive a payment from the sale. 1040 tax form Complete Part III for the 2 years after the year of sale unless you received the final payment during the tax year. 1040 tax form Schedule D (Form 1040) Enter the gain figured on Form 6252 (line 26) for personal-use property (capital assets) on Schedule D (Form 1040), as a short-term gain (line 4) or long-term gain (line 11). 1040 tax form If your gain from the installment sale qualifies for long-term capital gain treatment in the year of sale, it will continue to qualify in later tax years. 1040 tax form Your gain is long-term if you owned the property for more than 1 year when you sold it. 1040 tax form Form 4797 An installment sale of property used in your business or that earns rent or royalty income may result in a capital gain, an ordinary gain, or both. 1040 tax form All or part of any gain from the disposition of the property may be ordinary gain from depreciation recapture. 1040 tax form For trade or business property held for more than 1 year, enter the amount from line 26 of Form 6252 on Form 4797, line 4. 1040 tax form If the property was held 1 year or less or you have an ordinary gain from the sale of a noncapital asset (even if the holding period is more than 1 year), enter this amount on Form 4797, line 10, and write “From Form 6252. 1040 tax form ” Sale of Your Home If you sell your home, you may be able to exclude all or part of the gain on the sale. 1040 tax form See Publication 523 for information about excluding the gain. 1040 tax form If the sale is an installment sale, any gain you exclude is not included in gross profit when figuring your gross profit percentage. 1040 tax form Seller-financed mortgage. 1040 tax form   If you finance the sale of your home to an individual, both you and the buyer may have to follow special reporting procedures. 1040 tax form   When you report interest income received from a buyer who uses the property as a personal residence, write the buyer's name, address, and social security number (SSN) on line 1 of Schedule B (Form 1040A or 1040), Interest and Ordinary Dividends. 1040 tax form   When deducting the mortgage interest, the buyer must write your name, address, and SSN on line 11 of Schedule A (Form 1040), Itemized Deductions. 1040 tax form   If either person fails to include the other person's SSN, a $50 penalty will be assessed. 1040 tax form Other Rules The rules discussed in this part of the publication apply only in certain circumstances or to certain types of property. 1040 tax form The following topics are discussed. 1040 tax form Electing out of the installment method. 1040 tax form Payments received or considered received. 1040 tax form Escrow account. 1040 tax form Depreciation recapture income. 1040 tax form Sale to a related person. 1040 tax form Like-kind exchange. 1040 tax form Contingent payment sale. 1040 tax form Single sale of several assets. 1040 tax form Sale of a business. 1040 tax form Unstated interest and original issue discount. 1040 tax form Disposition of an installment obligation. 1040 tax form Repossession. 1040 tax form Interest on deferred tax. 1040 tax form Electing Out of the Installment Method If you elect not to use the installment method, you generally report the entire gain in the year of sale, even though you do not receive all the sale proceeds in that year. 1040 tax form To figure the amount of gain to report, use the fair market value (FMV) of the buyer's installment obligation that represents the buyer's debt to you. 1040 tax form Notes, mortgages, and land contracts are examples of obligations that are included at FMV. 1040 tax form You must figure the FMV of the buyer's installment obligation, whether or not you would actually be able to sell it. 1040 tax form If you use the cash method of accounting, the FMV of the obligation will never be considered to be less than the FMV of the property sold (minus any other consideration received). 1040 tax form Example. 1040 tax form You sold a parcel of land for $50,000. 1040 tax form You received a $10,000 down payment and will receive the balance over the next 10 years at $4,000 a year, plus 8% interest. 1040 tax form The buyer gave you a note for $40,000. 1040 tax form The note had an FMV of $40,000. 1040 tax form You paid a commission of 6%, or $3,000, to a broker for negotiating the sale. 1040 tax form The land cost $25,000, and you owned it for more than one year. 1040 tax form You decide to elect out of the installment method and report the entire gain in the year of sale. 1040 tax form Gain realized:     Selling price $50,000 Minus: Property's adj. 1040 tax form basis $25,000     Commission 3,000 28,000 Gain realized $22,000 Gain recognized in year of sale:   Cash $10,000 Market value of note 40,000 Total realized in year of sale $50,000 Minus: Property's adj. 1040 tax form basis $25,000     Commission 3,000 28,000 Gain recognized $22,000 The recognized gain of $22,000 is long-term capital gain. 1040 tax form You include the entire gain in income in the year of sale, so you do not include in income any principal payments you receive in later tax years. 1040 tax form The interest on the note is ordinary income and is reported as interest income each year. 1040 tax form How to elect out. 1040 tax form   To make this election, do not report your sale on Form 6252. 1040 tax form Instead, report it on Form 8949, Sales and Other Dispositions of Capital Assets, Form 4797, or both. 1040 tax form When to elect out. 1040 tax form   Make this election by the due date, including extensions, for filing your tax return for the year the sale takes place. 1040 tax form Automatic six-month extension. 1040 tax form   If you timely file your tax return without making the election, you still can make the election by filing an amended return within 6 months of the due date of your return (excluding extensions). 1040 tax form Write “Filed pursuant to section 301. 1040 tax form 9100-2” at the top of the amended return and file it where the original return was filed. 1040 tax form Revoking the election. 1040 tax form   Once made, the election can be revoked only with IRS approval. 1040 tax form A revocation is retroactive. 1040 tax form You will not be allowed to revoke the election if either of the following applies. 1040 tax form One of the purposes is to avoid federal income tax. 1040 tax form The tax year in which any payment was received has closed. 1040 tax form Payments Received or Considered Received You must figure your gain each year on the payments you receive, or are treated as receiving, from an installment sale. 1040 tax form In certain situations, you are considered to have received a payment, even though the buyer does not pay you directly. 1040 tax form These situations occur when the buyer assumes or pays any of your debts, such as a loan, or pays any of your expenses, such as a sales commission. 1040 tax form However, as discussed later, the buyer's assumption of your debt is treated as a recovery of your basis rather than as a payment in many cases. 1040 tax form Buyer Pays Seller's Expenses If the buyer pays any of your expenses related to the sale of your property, it is considered a payment to you in the year of sale. 1040 tax form Include these expenses in the selling and contract prices when figuring the gross profit percentage. 1040 tax form Buyer Assumes Mortgage If the buyer assumes or pays off your mortgage, or otherwise takes the property subject to the mortgage, the following rules apply. 1040 tax form Mortgage not more than basis. 1040 tax form   If the buyer assumes a mortgage that is not more than your installment sale basis in the property, it is not considered a payment to you. 1040 tax form It is considered a recovery of your basis. 1040 tax form The contract price is the selling price minus the mortgage. 1040 tax form Example. 1040 tax form You sell property with an adjusted basis of $19,000. 1040 tax form You have selling expenses of $1,000. 1040 tax form The buyer assumes your existing mortgage of $15,000 and agrees to pay you $10,000 (a cash down payment of $2,000 and $2,000 (plus 12% interest) in each of the next 4 years). 1040 tax form The selling price is $25,000 ($15,000 + $10,000). 1040 tax form Your gross profit is $5,000 ($25,000 − $20,000 installment sale basis). 1040 tax form The contract price is $10,000 ($25,000 − $15,000 mortgage). 1040 tax form Your gross profit percentage is 50% ($5,000 ÷ $10,000). 1040 tax form You report half of each $2,000 payment received as gain from the sale. 1040 tax form You also report all interest you receive as ordinary income. 1040 tax form Mortgage more than basis. 1040 tax form   If the buyer assumes a mortgage that is more than your installment sale basis in the property, you recover your entire basis. 1040 tax form The part of the mortgage greater than your basis is treated as a payment received in the year of sale. 1040 tax form   To figure the contract price, subtract the mortgage from the selling price. 1040 tax form This is the total amount (other than interest) you will receive directly from the buyer. 1040 tax form Add to this amount the payment you are considered to have received (the difference between the mortgage and your installment sale basis). 1040 tax form The contract price is then the same as your gross profit from the sale. 1040 tax form    If the mortgage the buyer assumes is equal to or more than your installment sale basis, the gross profit percentage always will be 100%. 1040 tax form Example. 1040 tax form The selling price for your property is $9,000. 1040 tax form The buyer will pay you $1,000 annually (plus 8% interest) over the next 3 years and assume an existing mortgage of $6,000. 1040 tax form Your adjusted basis in the property is $4,400. 1040 tax form You have selling expenses of $600, for a total installment sale basis of $5,000. 1040 tax form The part of the mortgage that is more than your installment sale basis is $1,000 ($6,000 − $5,000). 1040 tax form This amount is included in the contract price and treated as a payment received in the year of sale. 1040 tax form The contract price is $4,000: Selling price $9,000 Minus: Mortgage (6,000) Amount actually received $3,000 Add difference:   Mortgage $6,000   Minus: Installment sale basis 5,000 1,000 Contract price $4,000       Your gross profit on the sale is also $4,000: Selling price $9,000 Minus: Installment sale basis (5,000) Gross profit $4,000 Your gross profit percentage is 100%. 1040 tax form Report 100% of each payment (less interest) as gain from the sale. 1040 tax form Treat the $1,000 difference between the mortgage and your installment sale basis as a payment and report 100% of it as gain in the year of sale. 1040 tax form Mortgage Canceled If the buyer of your property is the person who holds the mortgage on it, your debt is canceled, not assumed. 1040 tax form You are considered to receive a payment equal to the outstanding canceled debt. 1040 tax form Example. 1040 tax form Mary Jones loaned you $45,000 in 2009 in exchange for a note and a mortgage in a tract of land you owned. 1040 tax form On April 4, 2013, she bought the land for $70,000. 1040 tax form At that time, $30,000 of her loan to you was outstanding. 1040 tax form She agreed to forgive this $30,000 debt and to pay you $20,000 (plus interest) on August 1, 2013, and $20,000 on August 1, 2014. 1040 tax form She did not assume an existing mortgage. 1040 tax form She canceled the $30,000 debt you owed her. 1040 tax form You are considered to have received a $30,000 payment at the time of the sale. 1040 tax form Buyer Assumes Other Debts If the buyer assumes any other debts, such as a loan or back taxes, it may be considered a payment to you in the year of sale. 1040 tax form If the buyer assumes the debt instead of paying it off, only part of it may have to be treated as a payment. 1040 tax form Compare the debt to your installment sale basis in the property being sold. 1040 tax form If the debt is less than your installment sale basis, none of it is treated as a payment. 1040 tax form If it is more, only the difference is treated as a payment. 1040 tax form If the buyer assumes more than one debt, any part of the total that is more than your installment sale basis is considered a payment. 1040 tax form These rules are the same as the rules discussed earlier under Buyer Assumes Mortgage . 1040 tax form However, they apply only to the following types of debt the buyer assumes. 1040 tax form Those acquired from ownership of the property you are selling, such as a mortgage, lien, overdue interest, or back taxes. 1040 tax form Those acquired in the ordinary course of your business, such as a balance due for inventory you purchased. 1040 tax form If the buyer assumes any other type of debt, such as a personal loan or your legal fees relating to the sale, it is treated as if the buyer had paid off the debt at the time of the sale. 1040 tax form The value of the assumed debt is then considered a payment to you in the year of sale. 1040 tax form Property Used As a Payment If you receive property other than money from the buyer, it is still considered a payment in the year received. 1040 tax form However, see Like-Kind Exchange , later. 1040 tax form Generally, the amount of the payment is the property's FMV on the date you receive it. 1040 tax form Exception. 1040 tax form   If the property the buyer gives you is payable on demand or readily tradable, the amount you should consider as payment in the year received is: The FMV of the property on the date you receive it if you use the cash method of accounting, The face amount of the obligation on the date you receive it if you use the accrual method of accounting, or The stated redemption price at maturity less any original issue discount (OID) or, if there is no OID, the stated redemption price at maturity appropriately discounted to reflect total unstated interest. 1040 tax form See Unstated Interest and Original Issue Discount (OID) , later. 1040 tax form Debt not payable on demand. 1040 tax form   Any evidence of debt you receive from the buyer not payable on demand is not considered a payment. 1040 tax form This is true even if the debt is guaranteed by a third party, including a government agency. 1040 tax form Fair market value (FMV). 1040 tax form   This is the price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having a reasonable knowledge of all the necessary facts. 1040 tax form Third-party note. 1040 tax form   If the property the buyer gives you is a third-party note (or other obligation of a third party), you are considered to have received a payment equal to the note's FMV. 1040 tax form Because the FMV of the note is itself a payment on your installment sale, any payments you later receive from the third party are not considered payments on the sale. 1040 tax form The excess of the note's face value over its FMV is interest. 1040 tax form Exclude this interest in determining the selling price of the property. 1040 tax form However, see Exception under Property Used As a Payment, earlier. 1040 tax form Example. 1040 tax form You sold real estate in an installment sale. 1040 tax form As part of the down payment, the buyer assigned to you a $50,000, 8% interest third-party note. 1040 tax form The FMV of the third-party note at the time of the sale was $30,000. 1040 tax form This amount, not $50,000, is a payment to you in the year of sale. 1040 tax form The third-party note had an FMV equal to 60% of its face value ($30,000 ÷ $50,000), so 60% of each principal payment you receive on this note is a nontaxable return of capital. 1040 tax form The remaining 40% is interest taxed as ordinary income. 1040 tax form Bond. 1040 tax form   A bond or other evidence of debt you receive from the buyer that is payable on demand or readily tradable in an established securities market is treated as a payment in the year you receive it. 1040 tax form For more information on the amount you should treat as a payment, see Exception under Property Used As a Payment, earlier. 1040 tax form    If you receive a government or corporate bond for a sale before October 22, 2004, and the bond has interest coupons attached or can be readily traded in an established securities market, you are considered to have received payment equal to the bond's FMV. 1040 tax form However, see Exception under Property Used As a Payment, earlier. 1040 tax form Buyer's note. 1040 tax form   The buyer's note (unless payable on demand) is not considered payment on the sale. 1040 tax form However, its full face value is included when figuring the selling price and the contract price. 1040 tax form Payments you receive on the note are used to figure your gain in the year received. 1040 tax form Installment Obligation Used as Security (Pledge Rule) If you use an installment obligation to secure any debt, the net proceeds from the debt may be treated as a payment on the installment obligation. 1040 tax form This is known as the pledge rule, and it applies if the selling price of the property is over $150,000. 1040 tax form It does not apply to the following dispositions. 1040 tax form Sales of property used or produced in farming. 1040 tax form Sales of personal-use property. 1040 tax form Qualifying sales of time-shares and residential lots. 1040 tax form The net debt proceeds are the gross debt minus the direct expenses of getting the debt. 1040 tax form The amount treated as a payment is considered received on the later of the following dates. 1040 tax form The date the debt becomes secured. 1040 tax form The date you receive the debt proceeds. 1040 tax form A debt is secured by an installment obligation to the extent that payment of principal or interest on the debt is directly secured (under the terms of the loan or any underlying arrangement) by any interest in the installment obligation. 1040 tax form For sales after December 16, 1999, payment on a debt is treated as directly secured by an interest in an installment obligation to the extent an arrangement allows you to satisfy all or part of the debt with the installment obligation. 1040 tax form Limit. 1040 tax form   The net debt proceeds treated as a payment on the pledged installment obligation cannot be more than the excess of item (1) over item (2), below. 1040 tax form The total contract price on the installment sale. 1040 tax form Any payments received on the installment obligation before the date the net debt proceeds are treated as a payment. 1040 tax form Installment payments. 1040 tax form   The pledge rule accelerates the reporting of the installment obligation payments. 1040 tax form Do not report payments received on the obligation after it has been pledged until the payments received exceed the amount reported under the pledge rule. 1040 tax form Exception. 1040 tax form   The pledge rule does not apply to pledges made after December 17, 1987, to refinance a debt under the following circumstances. 1040 tax form The debt was outstanding on December 17, 1987. 1040 tax form The debt was secured by that installment sale obligation on that date and at all times thereafter until the refinancing occurred. 1040 tax form   A refinancing as a result of the creditor's calling of the debt is treated as a continuation of the original debt so long as a person other than the creditor or a person related to the creditor provides the refinancing. 1040 tax form   This exception applies only to refinancing that does not exceed the principal of the original debt immediately before the refinancing. 1040 tax form Any excess is treated as a payment on the installment obligation. 1040 tax form Escrow Account In some cases, the sales agreement or a later agreement may call for the buyer to establish an irrevocable escrow account from which the remaining installment payments (including interest) are to be made. 1040 tax form These sales cannot be reported on the installment method. 1040 tax form The buyer's obligation is paid in full when the balance of the purchase price is deposited into the escrow account. 1040 tax form When an escrow account is established, you no longer rely on the buyer for the rest of the payments, but on the escrow arrangement. 1040 tax form Example. 1040 tax form You sell property for $100,000. 1040 tax form The sales agreement calls for a down payment of $10,000 and payment of $15,000 in each of the next 6 years to be made from an irrevocable escrow account containing the balance of the purchase price plus interest. 1040 tax form You cannot report the sale on the installment method because the full purchase price is considered received in the year of sale. 1040 tax form You report the entire gain in the year of sale. 1040 tax form Escrow established in a later year. 1040 tax form   If you make an installment sale and in a later year an irrevocable escrow account is established to pay the remaining installments plus interest, the amount placed in the escrow account represents payment of the balance of the installment obligation. 1040 tax form Substantial restriction. 1040 tax form   If an escrow arrangement imposes a substantial restriction on your right to receive the sale proceeds, the sale can be reported on the installment method, provided it otherwise qualifies. 1040 tax form For an escrow arrangement to impose a substantial restriction, it must serve a bona fide purpose of the buyer, that is, a real and definite restriction placed on the seller or a specific economic benefit conferred on the buyer. 1040 tax form Depreciation Recapture Income If you sell property for which you claimed or could have claimed a depreciation deduction, you must report any depreciation recapture income in the year of sale, whether or not an installment payment was received that year. 1040 tax form Figure your depreciation recapture income (including the section 179 deduction and the section 179A deduction recapture) in Part III of Form 4797. 1040 tax form Report the recapture income in Part II of Form 4797 as ordinary income in the year of sale. 1040 tax form The recapture income is also included in Part I of Form 6252. 1040 tax form However, the gain equal to the recapture income is reported in full in the year of the sale. 1040 tax form Only the gain greater than the recapture income is reported on the installment method. 1040 tax form For more information on depreciation recapture, see chapter 3 in Publication 544. 1040 tax form The recapture income reported in the year of sale is included in your installment sale basis in determining your gross profit on the installment sale. 1040 tax form Determining gross profit is discussed under General Rules , earlier. 1040 tax form Sale to a Related Person If you sell depreciable property to a related person and the sale is an installment sale, you may not be able to report the sale using the installment method. 1040 tax form If you sell property to a related person and the related person disposes of the property before you receive all payments with respect to the sale, you may have to treat the amount realized by the related person as received by you when the related person disposes of the property. 1040 tax form These rules are explained under Sale of Depreciable Property and under Sale and Later Disposition , later. 1040 tax form Sale of Depreciable Property If you sell depreciable property to certain related persons, you generally cannot report the sale using the installment method. 1040 tax form Instead, all payments to be received are considered received in the year of sale. 1040 tax form However, see Exception , below. 1040 tax form Depreciable property for this rule is any property the purchaser can depreciate. 1040 tax form Payments to be received include the total of all noncontingent payments and the FMV of any payments contingent as to amount. 1040 tax form In the case of contingent payments for which the FMV cannot be reasonably determined, your basis in the property is recovered proportionately. 1040 tax form The purchaser cannot increase the basis of the property acquired in the sale before the seller includes a like amount in income. 1040 tax form Exception. 1040 tax form   You can use the installment method to report a sale of depreciable property to a related person if no significant tax deferral benefit will be derived from the sale. 1040 tax form You must show to the satisfaction of the IRS that avoidance of federal income tax was not one of the principal purposes of the sale. 1040 tax form Related person. 1040 tax form   Related persons include the following. 1040 tax form A person and all controlled entities with respect to that person. 1040 tax form A taxpayer and any trust in which such taxpayer (or his spouse) is a beneficiary, unless that beneficiary's interest in the trust is a remote contingent interest. 1040 tax form Except in the case of a sale or exchange in satisfaction of a pecuniary bequest, an executor of an estate and a beneficiary of that estate. 1040 tax form Two or more partnerships in which the same person owns, directly or indirectly, more than 50% of the capital interests or the profits interests. 1040 tax form   For information about which entities are controlled entities, see section 1239(c). 1040 tax form Sale and Later Disposition Generally, a special rule applies if you sell or exchange property to a related person on the installment method (first disposition) who then sells, exchanges, or gives away the property (second disposition) under the following circumstances. 1040 tax form The related person makes the second disposition before making all payments on the first disposition. 1040 tax form The related person disposes of the property within 2 years of the first disposition. 1040 tax form This rule does not apply if the property involved is marketable securities. 1040 tax form Under this rule, you treat part or all of the amount the related person realizes (or the FMV if the disposed property is not sold or exchanged) from the second disposition as if you received it at the time of the second disposition. 1040 tax form See Exception , later. 1040 tax form Related person. 1040 tax form   Related persons include the following. 1040 tax form Members of a family, including only brothers and sisters (either whole or half), husband and wife, ancestors, and lineal descendants. 1040 tax form A partnership or estate and a partner or beneficiary. 1040 tax form A trust (other than a section 401(a) employees trust) and a beneficiary. 1040 tax form A trust and an owner of the trust. 1040 tax form Two corporations that are members of the same controlled group as defined in section 267(f). 1040 tax form The fiduciaries of two different trusts, and the fiduciary and beneficiary of two different trusts, if the same person is the grantor of both trusts. 1040 tax form A tax-exempt educational or charitable organization and a person (if an individual, including members of the individual's family) who directly or indirectly controls such an organization. 1040 tax form An individual and a corporation when the individual owns, directly or indirectly, more than 50% of the value of the outstanding stock of the corporation. 1040 tax form A fiduciary of a trust and a corporation when the trust or the grantor of the trust owns, directly or indirectly, more than 50% in value of the outstanding stock of the corporation. 1040 tax form The grantor and fiduciary, and the fiduciary and beneficiary, of any trust. 1040 tax form Any two S corporations if the same persons own more than 50% in value of the outstanding stock of each corporation. 1040 tax form An S corporation and a corporation that is not an S corporation if the same persons own more than 50% in value of the outstanding stock of each corporation. 1040 tax form A corporation and a partnership if the same persons own more than 50% in value of the outstanding stock of the corporation and more than 50% of the capital or profits interest in the partnership. 1040 tax form An executor and a beneficiary of an estate unless the sale is in satisfaction of a pecuniary bequest. 1040 tax form Example 1. 1040 tax form In 2012, Harvey Green sold farm land to his son Bob for $500,000, which was to be paid in five equal payments over 5 years, plus adequate stated interest on the balance due. 1040 tax form His installment sale basis for the farm land was $250,000 and the property was not subject to any outstanding liens or mortgages. 1040 tax form His gross profit percentage is 50% (gross profit of $250,000 ÷ contract price of $500,000). 1040 tax form He received $100,000 in 2012 and included $50,000 in income for that year ($100,000 × 0. 1040 tax form 50). 1040 tax form Bob made no improvements to the property and sold it to Alfalfa Inc. 1040 tax form , in 2013 for $600,000 after making the payment for that year. 1040 tax form The amount realized from the second disposition is $600,000. 1040 tax form Harvey figures his installment sale income for 2013 as follows: Lesser of: 1) Amount realized on second disposition, or 2) Contract price on first disposition $500,000 Subtract: Sum of payments from Bob in 2012 and 2013 - 200,000 Amount treated as received because of second disposition $300,000 Add: Payment from Bob in 2013 + 100,000 Total payments received and treated as received for 2013 $400,000 Multiply by gross profit % × . 1040 tax form 50 Installment sale income for 2013 $200,000 Harvey will not include in his installment sale income any principal payments he receives on the installment obligation for 2014, 2015, and 2016 because he has already reported the total payments of $500,000 from the first disposition ($100,000 in 2012 and $400,000 in 2013). 1040 tax form Example 2. 1040 tax form Assume the facts are the same as Example 1 except that Bob sells the property for only $400,000. 1040 tax form The gain for 2013 is figured as follows: Lesser of: 1) Amount realized on second disposition, or 2) Contract price on first disposition $400,000 Subtract: Sum of payments from Bob in 2012 and 2013 − 200,000 Amount treated as received because of second disposition $200,000 Add: Payment from Bob in 2013 + 100,000 Total payments received and treated as received for 2013 $300,000 Multiply by gross profit % × . 1040 tax form 50 Installment sale income for 2013 $150,000     Harvey receives a $100,000 payment in 2014 and another in 2015. 1040 tax form They are not taxed because he treated the $200,000 from the disposition in 2013 as a payment received and paid tax on the installment sale income. 1040 tax form In 2016, he receives the final $100,000 payment. 1040 tax form He figures the installment sale income he must recognize in 2016 as follows: Total payments from the first disposition received by the end of 2016 $500,000 Minus the sum of:     Payment from 2012 $100,000   Payment from 2013 100,000   Amount treated as received in 2013 200,000   Total on which gain was previously recognized  − 400,000 Payment on which gain is recognized for 2016  $100,000 Multiply by gross profit % × . 1040 tax form 50 Installment sale income for 2016 $ 50,000 Exception. 1040 tax form   This rule does not apply to a second disposition, and any later transfer, if you can show to the satisfaction of the IRS that neither the first disposition (to the related person) nor the second disposition had as one of its principal purposes the avoidance of federal income tax. 1040 tax form Generally, an involuntary second disposition will qualify under the nontax avoidance exception, such as when a creditor of the related person forecloses on the property or the related person declares bankruptcy. 1040 tax form   The nontax avoidance exception also applies to a second disposition that is also an installment sale if the terms of payment under the installment resale are substantially equal to or longer than those for the first installment sale. 1040 tax form However, the exception does not apply if the resale terms permit significant deferral of recognition of gain from the first sale. 1040 tax form   In addition, any sale or exchange of stock to the issuing corporation is not treated as a first disposition. 1040 tax form An involuntary conversion is not treated as a second disposition if the first disposition occurred before the threat of conversion. 1040 tax form A transfer after the death of the person making the first disposition or the related person's death, whichever is earlier, is not treated as a second disposition. 1040 tax form Like-Kind Exchange If you trade business or investment property solely for the same kind of property to be held as business or investment property, you can postpone reporting the gain. 1040 tax form These trades are known as like-kind exchanges. 1040 tax form The property you receive in a like-kind exchange is treated as if it were a continuation of the property you gave up. 1040 tax form You do not have to report any part of your gain if you receive only like-kind property. 1040 tax form However, if you also receive money or other property (boot) in the exchange, you must report your gain to the extent of the money and the FMV of the other property received. 1040 tax form For more information on like-kind exchanges, see Like-Kind Exchanges in chapter 1 of Publication 544. 1040 tax form Installment payments. 1040 tax form   If, in addition to like-kind property, you receive an installment obligation in the exchange, the following rules apply to determine the installment sale income each year. 1040 tax form The contract price is reduced by the FMV of the like-kind property received in the trade. 1040 tax form The gross profit is reduced by any gain on the trade that can be postponed. 1040 tax form Like-kind property received in the trade is not considered payment on the installment obligation. 1040 tax form Example. 1040 tax form In 2013, George Brown trades personal property with an installment sale basis of $400,000 for like-kind property having an FMV of $200,000. 1040 tax form He also receives an installment note for $800,000 in the trade. 1040 tax form Under the terms of the note, he is to receive $100,000 (plus interest) in 2014 and the balance of $700,000 (plus interest) in 2015. 1040 tax form George's selling price is $1,000,000 ($800,000 installment note + $200,000 FMV of like-kind property received). 1040 tax form His gross profit is $600,000 ($1,000,000 − $400,000 installment sale basis). 1040 tax form The contract price is $800,000 ($1,000,000 − $200,000). 1040 tax form The gross profit percentage is 75% ($600,000 ÷ $800,000). 1040 tax form He reports no gain in 2013 because the like-kind property he receives is not treated as a payment for figuring gain. 1040 tax form He reports $75,000 gain for 2014 (75% of $100,000 payment received) and $525,000 gain for 2015 (75% of $700,000 payment received). 1040 tax form Deferred exchanges. 1040 tax form   A deferred exchange is one in which you transfer property you use in business or hold for investment and receive like-kind property later that you will use in business or hold for investment. 1040 tax form Under this type of exchange, the person receiving your property may be required to place funds in an escrow account or trust. 1040 tax form If certain rules are met, these funds will not be considered a payment until you have the right to receive the funds or, if earlier, the end of the exchange period. 1040 tax form See Regulations section 1. 1040 tax form 1031(k)-1(j)(2) for these rules. 1040 tax form Contingent Payment Sale A contingent payment sale is one in which the total selling price cannot be determined by the end of the tax year of sale. 1040 tax form This happens, for example, if you sell your business and the selling price includes a percentage of its profits in future years. 1040 tax form If the selling price cannot be determined by the end of the tax year, you must use different rules to figure the contract price and the gross profit percentage than those you use for an installment sale with a fixed selling price. 1040 tax form For rules on using the installment method for a contingent payment sale, see Regulations section 15a. 1040 tax form 453-1(c). 1040 tax form Single Sale of Several Assets If you sell different types of assets in a single sale, you must identify each asset to determine whether you can use the installment method to report the sale of that asset. 1040 tax form You also have to allocate part of the selling price to each asset. 1040 tax form If you sell assets that constitute a trade or business, see Sale of a Business , later. 1040 tax form Unless an allocation of the selling price has been agreed to by both parties in an arm's-length transaction, you must allocate the selling price to an asset based on its FMV. 1040 tax form If the buyer assumes a debt, or takes the property subject to a debt, you must reduce the FMV of the property by the debt. 1040 tax form This becomes the net FMV. 1040 tax form A sale of separate and unrelated assets of the same type under a single contract is reported as one transaction for the installment method. 1040 tax form However, if an asset is sold at a loss, its disposition cannot be reported on the installment method. 1040 tax form It must be reported separately. 1040 tax form The remaining assets sold at a gain are reported together. 1040 tax form Example. 1040 tax form You sold three separate and unrelated parcels of real property (A, B, and C) under a single contract calling for a total selling price of $130,000. 1040 tax form The total selling price consisted of a cash payment of $20,000, the buyer's assumption of a $30,000 mortgage on parcel B, and an installment obligation of $80,000 payable in eight annual installments, plus interest at 8% a year. 1040 tax form Your installment sale basis for each parcel was $15,000. 1040 tax form Your net gain was $85,000 ($130,000 − $45,000). 1040 tax form You report the gain on the installment method. 1040 tax form The sales contract did not allocate the selling price or the cash payment received in the year of sale among the individual parcels. 1040 tax form The FMV of parcels A, B, and C were $60,000, $60,000, and $10,000, respectively. 1040 tax form The installment sale basis for parcel C was more than its FMV, so it was sold at a loss and must be treated separately. 1040 tax form You must allocate the total selling price and the amounts received in the year of sale between parcel C and the remaining parcels. 1040 tax form Of the total $130,000 selling price, you must allocate $120,000 to parcels A and B together and $10,000 to parcel C. 1040 tax form You should allocate the cash payment of $20,000 received in the year of sale and the note receivable on the basis of their proportionate net FMV. 1040 tax form The allocation is figured as follows:   Parcels   A and B Parcel C FMV $120,000 $10,000 Minus: Mortgage assumed 30,000 -0- Net FMV $ 90,000 $10,000 Proportionate net FMV:     Percentage of total 90% 10% Payments in year of sale:     $20,000 × 90% $18,000   $20,000 × 10%   $2,000 Excess of parcel B mortgage over installment sale basis 15,000 -0- Allocation of payments  received (or considered  received) in year of sale $ 33,000 $ 2,000 You cannot report the sale of parcel C on the installment method because the sale results in a loss. 1040 tax form You report this loss of $5,000 ($10,000 selling price − $15,000 installment sale basis) in the year of sale. 1040 tax form However, if parcel C was held for personal use, the loss is not deductible. 1040 tax form You allocate the installment obligation of $80,000 to the properties sold based on their proportionate net FMVs (90% to parcels A and B, 10% to parcel C). 1040 tax form Sale of a Business The installment sale of an entire business for one overall price under a single contract is not the sale of a single asset. 1040 tax form Allocation of Selling Price To determine whether any of the gain on the sale of the business can be reported on the installment method, you must allocate the total selling price and the payments received in the year of sale between each of the following classes of assets. 1040 tax form Assets sold at a loss. 1040 tax form Real and personal property eligible for the installment method. 1040 tax form Real and personal property ineligible for the installment method, including: Inventory, Dealer property, and Stocks and securities. 1040 tax form Inventory. 1040 tax form   The sale of inventories of personal property cannot be reported on the installment method. 1040 tax form All gain or loss on their sale must be reported in the year of sale, even if you receive payment in later years. 1040 tax form   If inventory items are included in an installment sale, you may have an agreement stating which payments are for inventory and which are for the other assets being sold. 1040 tax form If you do not, each payment must be allocated between the inventory and the other assets sold. 1040 tax form   Report the amount you receive (or will receive) on the sale of inventory items as ordinary business income. 1040 tax form Use your basis in the inventory to figure the cost of goods sold. 1040 tax form Deduct the part of the selling expenses allocated to inventory as an ordinary business expense. 1040 tax form Residual method. 1040 tax form   Except for assets exchanged under the like-kind exchange rules, both the buyer and seller of a business must use the residual method to allocate the sale price to each business asset sold. 1040 tax form This method determines gain or loss from the transfer of each asset and the buyer's basis in the assets. 1040 tax form   The residual method must be used for any transfer of a group of assets that constitutes a trade or business and for which the buyer's basis is determined only by the amount paid for the assets. 1040 tax form This applies to both direct and indirect transfers, such as the sale of a business or the sale of a partnership interest in which the basis of the buyer's share of the partnership assets is adjusted for the amount paid under section 743(b). 1040 tax form   A group of assets constitutes a trade or business if goodwill or going concern value could, under any circumstances, attach to the assets or if the use of the assets would constitute an active trade or business under section 355. 1040 tax form   The residual method provides for the consideration to be reduced first by cash and general deposit accounts (including checking and savings accounts but excluding certificates of deposit). 1040 tax form The consideration remaining after this reduction must be allocated among the various business assets in a certain order. 1040 tax form   For asset acquisitions occurring after March 15, 2001, make the allocation among the following assets in proportion to (but not more than) their fair market value on the purchase date in the following order. 1040 tax form Certificates of deposit, U. 1040 tax form S. 1040 tax form Government securities, foreign currency, and actively traded personal property, including stock and securities. 1040 tax form Accounts receivable, other debt instruments, and assets that you mark to market at least annually for federal income tax purposes. 1040 tax form However, see Regulations section 1. 1040 tax form 338-6(b)(2)(iii) for exceptions that apply to debt instruments issued by persons related to a target corporation, contingent debt instruments, and debt instruments convertible into stock or other property. 1040 tax form Property of a kind that would properly be included in inventory if on hand at the end of the tax year or property held by the taxpayer primarily for sale to customers in the ordinary course of business. 1040 tax form All other assets except section 197 intangibles. 1040 tax form Section 197 intangibles except goodwill and going concern value. 1040 tax form Goodwill and going concern value (whether or not they qualify as section 197 intangibles). 1040 tax form   If an asset described in (1) through (6) is includible in more than one category, include it in the lower number category. 1040 tax form For example, if an asset is described in both (4) and (6), include it in (4). 1040 tax form Agreement. 1040 tax form   The buyer and seller may enter into a written agreement as to the allocation of any consideration or the fair market value of any of the assets. 1040 tax form This agreement is binding on both parties unless the IRS determines the amounts are not appropriate. 1040 tax form Reporting requirement. 1040 tax form   Both the buyer and seller involved in the sale of business assets must report to the IRS the allocation of the sales price among section 197 intangibles and the other business assets. 1040 tax form Use Form 8594, Asset Acquisition Statement Under Section 1060, to provide this information. 1040 tax form The buyer and seller should each attach Form 8594 to their federal income tax return for the year in which the sale occurred. 1040 tax form Sale of Partnership Interest A partner who sells a partnership interest at a gain may be able to report the sale on the installment method. 1040 tax form The sale of a partnership interest is treated as the sale of a single capital asset. 1040 tax form The part of any gain or loss from unrealized receivables or inventory items will be treated as ordinary income. 1040 tax form (The term “unrealized receivables” includes depreciation recapture income, discussed earlier. 1040 tax form ) The gain allocated to the unrealized receivables and the inventory cannot be reported under the installment method. 1040 tax form The gain allocated to the other assets can be reported under the installment method. 1040 tax form For more information on the treatment of unrealized receivables and inventory, see Publication 541. 1040 tax form Example — Sale of a Business On June 4, 2013, you sold the machine shop you had operated since 2005. 1040 tax form You received a $100,000 down payment and the buyer's note for $120,000. 1040 tax form The note payments are $15,000 each, plus 10% interest, due every July 1 and January 1, beginning in 2014. 1040 tax form The total selling price is $220,000. 1040 tax form Your selling expenses are $11,000. 1040 tax form The selling expenses are divided among all the assets sold, including inventory. 1040 tax form Your selling expense for each asset is 5% of the asset's selling price ($11,000 selling expense ÷ $220,000 total selling price). 1040 tax form The FMV, adjusted basis, and depreciation claimed on each asset sold are as follows:     Depre- ciation Adj. 1040 tax form Asset FMV Claimed Basis Inventory $ 10,000 -0- $ 8,000 Land 42,000 -0- 15,000 Building 48,000 $9,000 36,000 Machine A 71,000 27,200 63,800 Machine B 24,000 12,960 22,040 Truck 6,500 18,624 5,376   $201,500 $67,784 $150,216         Under the residual method, you allocate the selling price to each of the assets based on their FMV ($201,500). 1040 tax form The remaining $18,500 ($220,000 - $201,500) is allocated to your section 197 intangible, goodwill. 1040 tax form The assets included in the sale, their selling prices based on their FMVs, the selling expense allocated to each asset, the adjusted basis, and the gain for each asset are shown in the following chart. 1040 tax form   Sale  Price Sale   Exp. 1040 tax form Adj. 1040 tax form   Basis Gain Inventory $ 10,000 $ 500 $ 8,000 $ 1,500 Land 42,000 2,100 15,000 24,900 Building 48,000 2,400 36,000 9,600 Mch. 1040 tax form A 71,000 3,550 63,800 3,650 Mch. 1040 tax form B 24,000 1,200 22,040 760 Truck 6,500 325 5,376 799 Goodwill 18,500 925 -0- 17,575   $220,000 $11,000 $150,216 $58,784 The building was acquired in 2005, the year the business began, and it is section 1250 property. 1040 tax form There is no depreciation recapture income because the building was depreciated using the straight line method. 1040 tax form All gain on the truck, machine A, and machine B is depreciation recapture income since it is the lesser of the depreciation claimed or the gain on the sale. 1040 tax form Figure depreciation recapture in Part III of Form 4797. 1040 tax form The total depreciation recapture income reported in Part II of Form 4797 is $5,209. 1040 tax form This consists of $3,650 on machine A, $799 on the truck, and $760 on machine B (the gain on each item because it was less than the depreciation claimed). 1040 tax form These gains are reported in full in the year of sale and are not included in the installment sale computation. 1040 tax form Of the $220,000 total selling price, the $10,000 for inventory assets cannot be reported using the installment method. 1040 tax form The selling prices of the truck and machines are also removed from the total selling price because gain on these items is reported in full in the year of sale. 1040 tax form The selling price equals the contract price for the installment sale ($108,500). 1040 tax form The assets included in the installment sale, their selling price, and their installment sale bases are shown in the following chart. 1040 tax form   Selling  Price Install- ment  Sale  Basis Gross  Profit Land $ 42,000 $17,100 $24,900 Building 48,000 38,400 9,600 Goodwill 18,500 925 17,575 Total $108,500 $56,425 $52,075         The gross profit percentage (gross profit ÷ contract price) for the installment sale is 48% ($52,075 ÷ $108,500). 1040 tax form The gross profit percentage for each asset is figured as follows: Percentage Land— $24,900 ÷ $108,500 22. 1040 tax form 95 Building— $9,600 ÷ $108,500 8. 1040 tax form 85 Goodwill— $17,575 ÷ $108,500 16. 1040 tax form 20 Total 48. 1040 tax form 00 The sale includes assets sold on the installment method and assets for which the gain is reported in full in the year of sale, so payments must be allocated between the installment part of the sale and the part reported in the year of sale. 1040 tax form The selling price for the installment sale is $108,500. 1040 tax form This is 49. 1040 tax form 3% of the total selling price of $220,000 ($108,500 ÷ $220,000). 1040 tax form The selling price of assets not reported on the installment method is $111,500. 1040 tax form This is 50. 1040 tax form 7% ($111,500 ÷ $220,000) of the total selling price. 1040 tax form Multiply principal payments by 49. 1040 tax form 3% to determine the part of the payment for the installment sale. 1040 tax form The balance, 50. 1040 tax form 7%, is for the part reported in the year of the sale. 1040 tax form The gain on the sale of the inventory, machines, and truck is reported in full in the year of sale. 1040 tax form When you receive principal payments in later years, no part of the payment for the sale of these assets is included in gross income. 1040 tax form Only the part for the installment sale (49. 1040 tax form 3%) is used in the installment sale computation. 1040 tax form The only payment received in 2013 is the down payment of $100,000. 1040 tax form The part of the payment for the installment sale is $49,300 ($100,000 × 49. 1040 tax form 3%). 1040 tax form This amount is used in the installment sale computation. 1040 tax form Installment income for 2013. 1040 tax form   Your installment income for each asset is the gross profit percentage for that asset times $49,300, the installment income received in 2013. 1040 tax form Income Land—22. 1040 tax form 95% of $49,300 $11,314 Building—8. 1040 tax form 85% of $49,300 4,363 Goodwill—16. 1040 tax form 2% of $49,300 7,987 Total installment income for 2013 $23,664 Installment income after 2013. 1040 tax form   You figure installment income for years after 2013 by applying the same gross profit percentages to 49. 1040 tax form 3% of the total payments you receive on the buyer's note during the year. 1040 tax form Unstated Interest and Original Issue Discount (OID) An installment sale contract may provide that each deferred payment on the sale will include interest or that there will be an interest payment in addition to the principal payment. 1040 tax form Interest provided in the contract is called stated interest. 1040 tax form If an installment sale contract does not provide for adequate stated interest, part of the stated principal amount of the contract may be recharacterized as interest. 1040 tax form If section 483 applies to the contract, this interest is called unstated interest. 1040 tax form If section 1274 applies to the contract, this interest is called original issue discount (OID). 1040 tax form An installment sale contract does not provide for adequate stated interest if the stated interest rate is lower than the test rate (defined later). 1040 tax form Treatment of unstated interest and OID. 1040 tax form   Generally, if a buyer gives a debt in consideration for personal use property, the unstated interest rules do not apply. 1040 tax form As a result, the buyer cannot deduct the unstated interest. 1040 tax form The seller must report the unstated interest as income. 1040 tax form   Personal-use property is any property in which substantially all of its use by the buyer is not in connection with a trade or business or an investment activity. 1040 tax form   If the debt is subject to the section 483 rules and is also subject to the below-market loan rules, such as a gift loan, compensation-related loan, or corporation-shareholder loan, then both parties are subject to the below-market loan rules rather than the unstated interest rules. 1040 tax form Rules for the seller. 1040 tax form   If either section 1274 or section 483 applies to the installment sale contract, you must treat part of the installment sale price as interest, even though interest is not called for in the sales agreement. 1040 tax form If either section applies, you must reduce the stated selling price of the property and increase your interest income by this unstated interest. 1040 tax form   Include the unstated interest in income based on your regular method of accounting. 1040 tax form Include OID in income over the term of the contract. 1040 tax form   The OID includible in income each year is based on the constant yield method described in section 1272. 1040 tax form (In some cases, the OID on an installment sale contract also may include all or part of the stated interest, especially if the stated interest is not paid at least annually. 1040 tax form )   If you do not use the installment method to report the sale, report the entire gain under your method of accounting in the year of sale. 1040 tax form Reduce the selling price by any stated principal treated as interest to determine the gain. 1040 tax form   Report unstated interest or OID on your tax return, in addition to stated interest. 1040 tax form Rules for the buyer. 1040 tax form   Any part of the stated selling price of an installment sale contract treated by the buyer as interest reduces the buyer's basis in the property and increases the buyer's interest expense. 1040 tax form These rules do not apply to personal-use property (for example, property not used in a trade or business). 1040 tax form Adequate stated interest. 1040 tax form   An installment sale contract generally provides for adequate stated interest if the contract's stated principal amount is at least equal to the sum of the present values of all principal and interest payments called for under the contract. 1040 tax form The present value of a payment is determined based on the test rate of interest, defined next. 1040 tax form (If section 483 applies to the contract, payments due within six months after the sale are taken into account at face value. 1040 tax form ) In general, an installment sale contract provides for adequate stated interest if the stated interest rate (based on an appropriate compounding period) is at least equal to the test rate of interest. 1040 tax form Test rate of interest. 1040 tax form   The test rate of interest for a contract is the 3-month rate. 1040 tax form The 3-month rate is the lower of the following applicable federal rates (AFRs). 1040 tax form The lowest AFR (based on the appropriate compounding period) in effect during the 3-month period ending with the first month in which there is a binding written contract that substantially provides the terms under which the sale or exchange is ultimately completed. 1040 tax form The lowest AFR (based on the appropriate compounding period) in effect during the 3-month period ending with the month in which the sale or exchange occurs. 1040 tax form Applicable federal rate (AFR). 1040 tax form   The AFR depends on the month the binding
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The 1040 Tax Form

1040 tax form Publication 575 - Main Content Table of Contents General InformationPension. 1040 tax form Annuity. 1040 tax form Qualified employee plan. 1040 tax form Qualified employee annuity. 1040 tax form Designated Roth account. 1040 tax form Tax-sheltered annuity plan. 1040 tax form Fixed-period annuities. 1040 tax form Annuities for a single life. 1040 tax form Joint and survivor annuities. 1040 tax form Variable annuities. 1040 tax form Disability pensions. 1040 tax form Variable Annuities Section 457 Deferred Compensation Plans Disability Pensions Insurance Premiums for Retired Public Safety Officers Railroad Retirement Benefits Withholding Tax and Estimated Tax Cost (Investment in the Contract)Foreign employment contributions while a nonresident alien. 1040 tax form Taxation of Periodic PaymentsPeriod of participation. 1040 tax form Fully Taxable Payments Partly Taxable Payments Taxation of Nonperiodic PaymentsFiguring the Taxable Amount Loans Treated as Distributions Transfers of Annuity Contracts Lump-Sum Distributions RolloversExceptions. 1040 tax form No tax withheld. 1040 tax form Partial rollovers. 1040 tax form Frozen deposits. 1040 tax form Reasonable period of time. 1040 tax form 20% Mandatory withholding. 1040 tax form How to report. 1040 tax form How to report. 1040 tax form Special rule for Roth IRAs and designated Roth accounts. 1040 tax form Special Additional TaxesTax on Early Distributions Tax on Excess Accumulation Survivors and BeneficiariesGuaranteed payments. 1040 tax form How To Get Tax HelpLow Income Taxpayer Clinics General Information Definitions. 1040 tax form   Some of the terms used in this publication are defined in the following paragraphs. 1040 tax form Pension. 1040 tax form   A pension is generally a series of definitely determinable payments made to you after you retire from work. 1040 tax form Pension payments are made regularly and are based on such factors as years of service and prior compensation. 1040 tax form Annuity. 1040 tax form   An annuity is a series of payments under a contract made at regular intervals over a period of more than one full year. 1040 tax form They can be either fixed (under which you receive a definite amount) or variable (not fixed). 1040 tax form You can buy the contract alone or with the help of your employer. 1040 tax form Qualified employee plan. 1040 tax form   A qualified employee plan is an employer's stock bonus, pension, or profit-sharing plan that is for the exclusive benefit of employees or their beneficiaries and that meets Internal Revenue Code requirements. 1040 tax form It qualifies for special tax benefits, such as tax deferral for employer contributions and capital gain treatment or the 10-year tax option for lump-sum distributions (if participants qualify). 1040 tax form To determine whether your plan is a qualified plan, check with your employer or the plan administrator. 1040 tax form Qualified employee annuity. 1040 tax form   A qualified employee annuity is a retirement annuity purchased by an employer for an employee under a plan that meets Internal Revenue Code requirements. 1040 tax form Designated Roth account. 1040 tax form   A designated Roth account is a separate account created under a qualified Roth contribution program to which participants may elect to have part or all of their elective deferrals to a 401(k), 403(b), or 457(b) plan designated as Roth contributions. 1040 tax form Elective deferrals that are designated as Roth contributions are included in your income. 1040 tax form However, qualified distributions (explained later) are not included in your income. 1040 tax form You should check with your plan administrator to determine if your plan will accept designated Roth contributions. 1040 tax form Tax-sheltered annuity plan. 1040 tax form   A tax-sheltered annuity plan (often referred to as a 403(b) plan or a tax-deferred annuity plan) is a retirement plan for employees of public schools and certain tax-exempt organizations. 1040 tax form Generally, a tax-sheltered annuity plan provides retirement benefits by purchasing annuity contracts for its participants. 1040 tax form Types of pensions and annuities. 1040 tax form   Pensions and annuities include the following types. 1040 tax form Fixed-period annuities. 1040 tax form   You receive definite amounts at regular intervals for a specified length of time. 1040 tax form Annuities for a single life. 1040 tax form   You receive definite amounts at regular intervals for life. 1040 tax form The payments end at death. 1040 tax form Joint and survivor annuities. 1040 tax form   The first annuitant receives a definite amount at regular intervals for life. 1040 tax form After he or she dies, a second annuitant receives a definite amount at regular intervals for life. 1040 tax form The amount paid to the second annuitant may or may not differ from the amount paid to the first annuitant. 1040 tax form Variable annuities. 1040 tax form   You receive payments that may vary in amount for a specified length of time or for life. 1040 tax form The amounts you receive may depend upon such variables as profits earned by the pension or annuity funds, cost-of-living indexes, or earnings from a mutual fund. 1040 tax form Disability pensions. 1040 tax form   You receive disability payments because you retired on disability and have not reached minimum retirement age. 1040 tax form More than one program. 1040 tax form   You may receive employee plan benefits from more than one program under a single trust or plan of your employer. 1040 tax form If you participate in more than one program, you may have to treat each as a separate pension or annuity contract, depending upon the facts in each case. 1040 tax form Also, you may be considered to have received more than one pension or annuity. 1040 tax form Your former employer or the plan administrator should be able to tell you if you have more than one contract. 1040 tax form Example. 1040 tax form Your employer set up a noncontributory profit-sharing plan for its employees. 1040 tax form The plan provides that the amount held in the account of each participant will be paid when that participant retires. 1040 tax form Your employer also set up a contributory defined benefit pension plan for its employees providing for the payment of a lifetime pension to each participant after retirement. 1040 tax form The amount of any distribution from the profit-sharing plan depends on the contributions (including allocated forfeitures) made for the participant and the earnings from those contributions. 1040 tax form Under the pension plan, however, a formula determines the amount of the pension benefits. 1040 tax form The amount of contributions is the amount necessary to provide that pension. 1040 tax form Each plan is a separate program and a separate contract. 1040 tax form If you get benefits from these plans, you must account for each separately, even though the benefits from both may be included in the same check. 1040 tax form Distributions from a designated Roth account are treated separately from other distributions from the plan. 1040 tax form Qualified domestic relations order (QDRO). 1040 tax form   A QDRO is a judgment, decree, or order relating to payment of child support, alimony, or marital property rights to a spouse, former spouse, child, or other dependent of a participant in a retirement plan. 1040 tax form The QDRO must contain certain specific information, such as the name and last known mailing address of the participant and each alternate payee, and the amount or percentage of the participant's benefits to be paid to each alternate payee. 1040 tax form A QDRO may not award an amount or form of benefit that is not available under the plan. 1040 tax form   A spouse or former spouse who receives part of the benefits from a retirement plan under a QDRO reports the payments received as if he or she were a plan participant. 1040 tax form The spouse or former spouse is allocated a share of the participant's cost (investment in the contract) equal to the cost times a fraction. 1040 tax form The numerator of the fraction is the present value of the benefits payable to the spouse or former spouse. 1040 tax form The denominator is the present value of all benefits payable to the participant. 1040 tax form   A distribution that is paid to a child or other dependent under a QDRO is taxed to the plan participant. 1040 tax form Variable Annuities The tax rules in this publication apply both to annuities that provide fixed payments and to annuities that provide payments that vary in amount based on investment results or other factors. 1040 tax form For example, they apply to commercial variable annuity contracts, whether bought by an employee retirement plan for its participants or bought directly from the issuer by an individual investor. 1040 tax form Under these contracts, the owner can generally allocate the purchase payments among several types of investment portfolios or mutual funds and the contract value is determined by the performance of those investments. 1040 tax form The earnings are not taxed until distributed either in a withdrawal or in annuity payments. 1040 tax form The taxable part of a distribution is treated as ordinary income. 1040 tax form Net investment income tax. 1040 tax form   Beginning in 2013, annuities under a nonqualified plan are included in calculating your net investment income for the net investment income tax (NIIT). 1040 tax form For information see the Instructions for Form 8960, Net Investment Income Tax — Individuals, Estates and Trusts. 1040 tax form For information on the tax treatment of a transfer or exchange of a variable annuity contract, see Transfers of Annuity Contracts under Taxation of Nonperiodic Payments, later. 1040 tax form Withdrawals. 1040 tax form   If you withdraw funds before your annuity starting date and your annuity is under a qualified retirement plan, a ratable part of the amount withdrawn is tax free. 1040 tax form The tax-free part is based on the ratio of your cost (investment in the contract) to your account balance under the plan. 1040 tax form   If your annuity is under a nonqualified plan (including a contract you bought directly from the issuer), the amount withdrawn is allocated first to earnings (the taxable part) and then to your cost (the tax-free part). 1040 tax form However, if you bought your annuity contract before August 14, 1982, a different allocation applies to the investment before that date and the earnings on that investment. 1040 tax form To the extent the amount withdrawn does not exceed that investment and earnings, it is allocated first to your cost (the tax-free part) and then to earnings (the taxable part). 1040 tax form   If you withdraw funds (other than as an annuity) on or after your annuity starting date, the entire amount withdrawn is generally taxable. 1040 tax form   The amount you receive in a full surrender of your annuity contract at any time is tax free to the extent of any cost that you have not previously recovered tax free. 1040 tax form The rest is taxable. 1040 tax form   For more information on the tax treatment of withdrawals, see Taxation of Nonperiodic Payments , later. 1040 tax form If you withdraw funds from your annuity before you reach age 59½, also see Tax on Early Distributions under Special Additional Taxes, later. 1040 tax form Annuity payments. 1040 tax form   If you receive annuity payments under a variable annuity plan or contract, you recover your cost tax free under either the Simplified Method or the General Rule, as explained under Taxation of Periodic Payments , later. 1040 tax form For a variable annuity paid under a qualified plan, you generally must use the Simplified Method. 1040 tax form For a variable annuity paid under a nonqualified plan (including a contract you bought directly from the issuer), you must use a special computation under the General Rule. 1040 tax form For more information, see Variable annuities in Publication 939 under Computation Under the General Rule. 1040 tax form Death benefits. 1040 tax form    If you receive a single-sum distribution from a variable annuity contract because of the death of the owner or annuitant, the distribution is generally taxable only to the extent it is more than the unrecovered cost of the contract. 1040 tax form If you choose to receive an annuity, the payments are subject to tax as described above. 1040 tax form If the contract provides a joint and survivor annuity and the primary annuitant had received annuity payments before death, you figure the tax-free part of annuity payments you receive as the survivor in the same way the primary annuitant did. 1040 tax form See Survivors and Beneficiaries , later. 1040 tax form Section 457 Deferred Compensation Plans If you work for a state or local government or for a tax-exempt organization, you may be able to participate in a section 457 deferred compensation plan. 1040 tax form If your plan is an eligible plan, you are not taxed currently on pay that is deferred under the plan or on any earnings from the plan's investment of the deferred pay. 1040 tax form You are generally taxed on amounts deferred in an eligible state or local government plan only when they are distributed from the plan. 1040 tax form You are taxed on amounts deferred in an eligible tax-exempt organization plan when they are distributed or otherwise made available to you. 1040 tax form Your 457(b) plan may have a designated Roth account option. 1040 tax form If so, you may be able to roll over amounts to the designated Roth account or make contributions. 1040 tax form Elective deferrals to a designated Roth account are included in your income. 1040 tax form Qualified distributions (explained later) are not included in your income. 1040 tax form See the Designated Roth accounts discussion under Taxation of Periodic Payments, later. 1040 tax form This publication covers the tax treatment of benefits under eligible section 457 plans, but it does not cover the treatment of deferrals. 1040 tax form For information on deferrals under section 457 plans, see Retirement Plan Contributions under Employee Compensation in Publication 525. 1040 tax form Is your plan eligible?   To find out if your plan is an eligible plan, check with your employer. 1040 tax form Plans that are not eligible section 457 plans include the following: Bona fide vacation leave, sick leave, compensatory time, severance pay, disability pay, or death benefit plans. 1040 tax form Nonelective deferred compensation plans for nonemployees (independent contractors). 1040 tax form Deferred compensation plans maintained by churches. 1040 tax form Length of service award plans for bona fide volunteer firefighters and emergency medical personnel. 1040 tax form An exception applies if the total amount paid to a volunteer exceeds $3,000 for any year of service. 1040 tax form Disability Pensions If you retired on disability, you generally must include in income any disability pension you receive under a plan that is paid for by your employer. 1040 tax form You must report your taxable disability payments as wages on line 7 of Form 1040 or Form 1040A or on line 8 of Form 1040NR until you reach minimum retirement age. 1040 tax form Minimum retirement age generally is the age at which you can first receive a pension or annuity if you are not disabled. 1040 tax form You may be entitled to a tax credit if you were permanently and totally disabled when you retired. 1040 tax form For information on this credit, see Publication 524. 1040 tax form Beginning on the day after you reach minimum retirement age, payments you receive are taxable as a pension or annuity. 1040 tax form Report the payments on Form 1040, lines 16a and 16b; Form 1040A, lines 12a and 12b; or on Form 1040NR, lines 17a and 17b. 1040 tax form Disability payments for injuries incurred as a direct result of a terrorist attack directed against the United States (or its allies) are not included in income. 1040 tax form For more information about payments to survivors of terrorist attacks, see Publication 3920, Tax Relief for Victims of Terrorist Attacks. 1040 tax form Insurance Premiums for Retired Public Safety Officers If you are an eligible retired public safety officer (law enforcement officer, firefighter, chaplain, or member of a rescue squad or ambulance crew), you can elect to exclude from income distributions made from your eligible retirement plan that are used to pay the premiums for accident or health insurance or long-term care insurance. 1040 tax form The premiums can be for coverage for you, your spouse, or dependents. 1040 tax form The distribution must be made directly from the plan to the insurance provider. 1040 tax form You can exclude from income the smaller of the amount of the insurance premiums or $3,000. 1040 tax form You can only make this election for amounts that would otherwise be included in your income. 1040 tax form The amount excluded from your income cannot be used to claim a medical expense deduction. 1040 tax form An eligible retirement plan is a governmental plan that is: a qualified trust, a section 403(a) plan, a section 403(b) annuity, or a section 457(b) plan. 1040 tax form If you make this election, reduce the otherwise taxable amount of your pension or annuity by the amount excluded. 1040 tax form The amount shown in box 2a of Form 1099-R does not reflect this exclusion. 1040 tax form Report your total distributions on Form 1040, line 16a; Form 1040A, line 12a; or Form 1040NR, line 17a. 1040 tax form Report the taxable amount on Form 1040, line 16b; Form 1040A, line 12b; or Form 1040NR, line 17b. 1040 tax form Enter “PSO” next to the appropriate line on which you report the taxable amount. 1040 tax form If you are retired on disability and reporting your disability pension on line 7 of Form 1040 or Form 1040A, or line 8 of Form 1040NR, include only the taxable amount on that line and enter “PSO” and the amount excluded on the dotted line next to the applicable line. 1040 tax form Railroad Retirement Benefits Benefits paid under the Railroad Retirement Act fall into two categories. 1040 tax form These categories are treated differently for income tax purposes. 1040 tax form The first category is the amount of tier 1 railroad retirement benefits that equals the social security benefit that a railroad employee or beneficiary would have been entitled to receive under the social security system. 1040 tax form This part of the tier 1 benefit is the social security equivalent benefit (SSEB) and you treat it for tax purposes like social security benefits. 1040 tax form If you received, repaid, or had tax withheld from the SSEB portion of tier 1 benefits during 2013, you will receive Form RRB-1099, Payments by the Railroad Retirement Board (or Form RRB-1042S, Statement for Nonresident Alien Recipients of Payments by the Railroad Retirement Board, if you are a nonresident alien) from the U. 1040 tax form S. 1040 tax form Railroad Retirement Board (RRB). 1040 tax form For more information about the tax treatment of the SSEB portion of tier 1 benefits and Forms RRB-1099 and RRB-1042S, see Publication 915. 1040 tax form The second category contains the rest of the tier 1 railroad retirement benefits, called the non-social security equivalent benefit (NSSEB). 1040 tax form It also contains any tier 2 benefit, vested dual benefit (VDB), and supplemental annuity benefit. 1040 tax form Treat this category of benefits, shown on Form RRB-1099-R, as an amount received from a qualified employee plan. 1040 tax form This allows for the tax-free (nontaxable) recovery of employee contributions from the tier 2 benefits and the NSSEB part of the tier 1 benefits. 1040 tax form (The NSSEB and tier 2 benefits, less certain repayments, are combined into one amount called the Contributory Amount Paid on Form RRB-1099-R. 1040 tax form ) Vested dual benefits and supplemental annuity benefits are non-contributory pensions and are fully taxable. 1040 tax form See Taxation of Periodic Payments , later, for information on how to report your benefits and how to recover the employee contributions tax free. 1040 tax form Form RRB-1099-R is used for U. 1040 tax form S. 1040 tax form citizens, resident aliens, and nonresident aliens. 1040 tax form Nonresident aliens. 1040 tax form   A nonresident alien is an individual who is not a citizen or a resident alien of the United States. 1040 tax form Nonresident aliens are subject to mandatory U. 1040 tax form S. 1040 tax form tax withholding unless exempt under a tax treaty between the United States and their country of legal residency. 1040 tax form A tax treaty exemption may reduce or eliminate tax withholding from railroad retirement benefits. 1040 tax form See Tax withholding next for more information. 1040 tax form   If you are a nonresident alien and your tax withholding rate changed or your country of legal residence changed during the year, you may receive more than one Form RRB-1042S or Form RRB-1099-R. 1040 tax form To determine your total benefits paid or repaid and total tax withheld for the year, you should add the amounts shown on all forms you received for that year. 1040 tax form For information on filing requirements for aliens, see Publication 519, U. 1040 tax form S. 1040 tax form Tax Guide for Aliens. 1040 tax form For information on tax treaties between the United States and other countries that may reduce or eliminate U. 1040 tax form S. 1040 tax form tax on your benefits, see Publication 901, U. 1040 tax form S. 1040 tax form Tax Treaties. 1040 tax form Tax withholding. 1040 tax form   To request or change your income tax withholding from SSEB payments, U. 1040 tax form S. 1040 tax form citizens should contact the IRS for Form W-4V, Voluntary Withholding Request, and file it with the RRB. 1040 tax form To elect, revoke, or change your income tax withholding from NSSEB, tier 2, VDB, and supplemental annuity payments received, use Form RRB W-4P, Withholding Certificate for Railroad Retirement Payments. 1040 tax form If you are a nonresident alien or a U. 1040 tax form S. 1040 tax form citizen living abroad, you should provide Form RRB-1001, Nonresident Questionnaire, to the RRB to furnish citizenship and residency information and to claim any treaty exemption from U. 1040 tax form S. 1040 tax form tax withholding. 1040 tax form Nonresident U. 1040 tax form S. 1040 tax form citizens cannot elect to be exempt from withholding on payments delivered outside of the U. 1040 tax form S. 1040 tax form Help from the RRB. 1040 tax form   To request an RRB form or to get help with questions about an RRB benefit, you should contact your nearest RRB field office if you reside in the United States (call 1-877-772-5772 for the nearest field office) or U. 1040 tax form S. 1040 tax form consulate/Embassy if you reside outside the United States. 1040 tax form You can visit the RRB on the Internet at www. 1040 tax form rrb. 1040 tax form gov. 1040 tax form Form RRB-1099-R. 1040 tax form   The following discussion explains the items shown on Form RRB-1099-R. 1040 tax form The amounts shown on this form are before any deduction for: Federal income tax withholding, Medicare premiums, Legal process garnishment payments, Recovery of a prior year overpayment of an NSSEB, tier 2 benefit, VDB, or supplemental annuity benefit, or Recovery of Railroad Unemployment Insurance Act benefits received while awaiting payment of your railroad retirement annuity. 1040 tax form   The amounts shown on this form are after any offset for: Social Security benefits, Age reduction, Public Service pensions or public disability benefits, Dual railroad retirement entitlement under another RRB claim number, Work deductions, Legal process partition deductions, Actuarial adjustment, Annuity waiver, or Recovery of a current-year overpayment of NSSEB, tier 2, VDB, or supplemental annuity benefits. 1040 tax form   The amounts shown on Form RRB-1099-R do not reflect any special rules, such as capital gain treatment or the special 10-year tax option for lump-sum payments, or tax-free rollovers. 1040 tax form To determine if any of these rules apply to your benefits, see the discussions about them later. 1040 tax form   Generally, amounts shown on your Form RRB-1099-R are considered a normal distribution. 1040 tax form Use distribution code “7” if you are asked for a distribution code. 1040 tax form Distribution codes are not shown on Form RRB-1099-R. 1040 tax form   There are three copies of this form. 1040 tax form Copy B is to be included with your income tax return if federal income tax is withheld. 1040 tax form Copy C is for your own records. 1040 tax form Copy 2 is filed with your state, city, or local income tax return, when required. 1040 tax form See the illustrated Copy B (Form RRB-1099-R) above. 1040 tax form       Each beneficiary will receive his or her own Form RRB-1099-R. 1040 tax form If you receive benefits on more than one railroad retirement record, you may get more than one Form RRB-1099-R. 1040 tax form So that you get your form timely, make sure the RRB always has your current mailing address. 1040 tax form Please click here for the text description of the image. 1040 tax form Form RRB-1099-R Box 1—Claim Number and Payee Code. 1040 tax form   Your claim number is a six- or nine-digit number preceded by an alphabetical prefix. 1040 tax form This is the number under which the RRB paid your benefits. 1040 tax form Your payee code follows your claim number and is the last number in this box. 1040 tax form It is used by the RRB to identify you under your claim number. 1040 tax form In all your correspondence with the RRB, be sure to use the claim number and payee code shown in this box. 1040 tax form Box 2—Recipient's Identification Number. 1040 tax form   This is the recipient's U. 1040 tax form S. 1040 tax form taxpayer identification number. 1040 tax form It is the social security number (SSN), individual taxpayer identification number (ITIN), or employer identification number (EIN), if known, for the person or estate listed as the recipient. 1040 tax form If you are a resident or nonresident alien who must furnish a taxpayer identification number to the IRS and are not eligible to obtain an SSN, use Form W-7, Application for IRS Individual Taxpayer Identification Number, to apply for an ITIN. 1040 tax form The Instructions for Form W-7 explain how and when to apply. 1040 tax form Box 3—Employee Contributions. 1040 tax form   This is the amount of taxes withheld from the railroad employee's earnings that exceeds the amount of taxes that would have been withheld had the earnings been covered under the social security system. 1040 tax form This amount is the employee's cost that you use to figure the tax-free part of the NSSEB and tier 2 benefit you received (the amount shown in box 4). 1040 tax form (For information on how to figure the tax-free part, see Partly Taxable Payments under Taxation of Periodic Payments, later. 1040 tax form ) The amount shown is the total employee contribution amount, not reduced by any amounts that the RRB calculated as previously recovered. 1040 tax form It is the latest amount reported for 2013 and may have increased or decreased from a previous Form RRB-1099-R. 1040 tax form If this amount has changed, the change is retroactive. 1040 tax form You may need to refigure the tax-free part of your NSSEB/tier 2 benefit for 2013 and prior tax years. 1040 tax form If this box is blank, it means that the amount of your NSSEB and tier 2 payments shown in box 4 is fully taxable. 1040 tax form    If you had a previous annuity entitlement that ended and you are figuring the tax-free part of your NSSEB/tier 2 benefit for your current annuity entitlement, you should contact the RRB for confirmation of your correct employee contribution amount. 1040 tax form Box 4—Contributory Amount Paid. 1040 tax form   This is the gross amount of the NSSEB and tier 2 benefit you received in 2013, less any 2013 benefits you repaid in 2013. 1040 tax form (Any benefits you repaid in 2013 for an earlier year or for an unknown year are shown in box 8. 1040 tax form ) This amount is the total contributory pension paid in 2013. 1040 tax form It may be partly taxable and partly tax free or fully taxable. 1040 tax form If you determine you are eligible to compute a tax-free part as explained later in Partly Taxable Payments under Taxation of Periodic Payments, use the latest reported employee contribution amount shown in box 3 as the cost. 1040 tax form Box 5—Vested Dual Benefit. 1040 tax form   This is the gross amount of vested dual benefit (VDB) payments paid in 2013, less any 2013 VDB payments you repaid in 2013. 1040 tax form It is fully taxable. 1040 tax form VDB payments you repaid in 2013 for an earlier year or for an unknown year are shown in box 8. 1040 tax form Note. 1040 tax form The amounts shown in boxes 4 and 5 may represent payments for 2013 and/or other years after 1983. 1040 tax form Box 6—Supplemental Annuity. 1040 tax form   This is the gross amount of supplemental annuity benefits paid in 2013, less any 2013 supplemental annuity benefits you repaid in 2013. 1040 tax form It is fully taxable. 1040 tax form Supplemental annuity benefits you repaid in 2013 for an earlier year or for an unknown year are shown in box 8. 1040 tax form Box 7—Total Gross Paid. 1040 tax form   This is the sum of boxes 4, 5, and 6. 1040 tax form The amount represents the total pension paid in 2013. 1040 tax form Include this amount on Form 1040, line 16a; Form 1040A, line 12a; or Form 1040NR, line 17a. 1040 tax form Box 8—Repayments. 1040 tax form   This amount represents any NSSEB, tier 2 benefit, VDB, and supplemental annuity benefit you repaid to the RRB in 2013 for years before 2013 or for unknown years. 1040 tax form The amount shown in this box has not been deducted from the amounts shown in boxes 4, 5, and 6. 1040 tax form It only includes repayments of benefits that were taxable to you. 1040 tax form This means it only includes repayments in 2013 of NSSEB benefits paid after 1985, tier 2 and VDB benefits paid after 1983, and supplemental annuity benefits paid in any year. 1040 tax form If you included the benefits in your income in the year you received them, you may be able to deduct the repaid amount. 1040 tax form For more information about repayments, see Repayment of benefits received in an earlier year , later. 1040 tax form    You may have repaid an overpayment of benefits by returning a payment, by making a payment, or by having an amount withheld from your railroad retirement annuity payment. 1040 tax form Box 9—Federal Income Tax Withheld. 1040 tax form   This is the total federal income tax withheld from your NSSEB, tier 2 benefit, VDB, and supplemental annuity benefit. 1040 tax form Include this on your income tax return as tax withheld. 1040 tax form If you are a nonresident alien and your tax withholding rate and/or country of legal residence changed during 2013, you will receive more than one Form RRB-1099-R for 2013. 1040 tax form Determine the total amount of U. 1040 tax form S. 1040 tax form federal income tax withheld from your 2013 RRB NSSEB, tier 2, VDB, and supplemental annuity payments by adding the amounts in box 9 of all original 2013 Forms RRB-1099-R, or the latest corrected or duplicate Forms RRB-1099-R you receive. 1040 tax form Box 10—Rate of Tax. 1040 tax form   If you are taxed as a U. 1040 tax form S. 1040 tax form citizen or resident alien, this box does not apply to you. 1040 tax form If you are a nonresident alien, an entry in this box indicates the rate at which tax was withheld on the NSSEB, tier 2, VDB, and supplemental annuity payments that were paid to you in 2013. 1040 tax form If you are a nonresident alien whose tax was withheld at more than one rate during 2013, you will receive a separate Form RRB-1099-R for each rate change during 2013. 1040 tax form Box 11—Country. 1040 tax form   If you are taxed as a U. 1040 tax form S. 1040 tax form citizen or resident alien, this box does not apply to you. 1040 tax form If you are a nonresident alien, an entry in this box indicates the country of which you were a resident for tax purposes at the time you received railroad retirement payments in 2013. 1040 tax form If you are a nonresident alien who was a resident of more than one country during 2013, you will receive a separate Form RRB-1099-R for each country of residence during 2013. 1040 tax form Box 12—Medicare Premium Total. 1040 tax form   This is for information purposes only. 1040 tax form The amount shown in this box represents the total amount of Part B Medicare premiums deducted from your railroad retirement annuity payments in 2013. 1040 tax form Medicare premium refunds are not included in the Medicare total. 1040 tax form The Medicare total is normally shown on Form RRB-1099 (if you are a citizen or resident alien of the United States) or Form RRB-1042S (if you are a nonresident alien). 1040 tax form However, if Form RRB-1099 or Form RRB-1042S is not required for 2013, then this total will be shown on Form RRB-1099-R. 1040 tax form If your Medicare premiums were deducted from your social security benefits, paid by a third party, refunded to you, and/or you paid the premiums by direct billing, your Medicare total will not be shown in this box. 1040 tax form Repayment of benefits received in an earlier year. 1040 tax form   If you had to repay any railroad retirement benefits that you had included in your income in an earlier year because at that time you thought you had an unrestricted right to it, you can deduct the amount you repaid in the year in which you repaid it. 1040 tax form   If you repaid $3,000 or less in 2013, deduct it on Schedule A (Form 1040), line 23. 1040 tax form The 2%-of-adjusted-gross-income limit applies to this deduction. 1040 tax form You cannot take this deduction if you file Form 1040A. 1040 tax form    If you repaid more than $3,000 in 2013, you can either take a deduction for the amount repaid on Schedule A (Form 1040), line 28 or you can take a credit against your tax. 1040 tax form For more information, see Repayments in Publication 525. 1040 tax form Withholding Tax and Estimated Tax Your retirement plan distributions are subject to federal income tax withholding. 1040 tax form However, you can choose not to have tax withheld on payments you receive unless they are eligible rollover distributions. 1040 tax form (These are distributions, described later under Rollovers, that are eligible for rollover treatment but are not paid directly to another qualified retirement plan or to a traditional IRA. 1040 tax form ) If you choose not to have tax withheld or if you do not have enough tax withheld, you may have to make estimated tax payments. 1040 tax form See Estimated tax , later. 1040 tax form The withholding rules apply to the taxable part of payments you receive from: An employer pension, annuity, profit-sharing, or stock bonus plan, Any other deferred compensation plan, A traditional individual retirement arrangement (IRA), or A commercial annuity. 1040 tax form For this purpose, a commercial annuity means an annuity, endowment, or life insurance contract issued by an insurance company. 1040 tax form There will be no withholding on any part of a distribution where it is reasonable to believe that it will not be includible in gross income. 1040 tax form Choosing no withholding. 1040 tax form   You can choose not to have income tax withheld from retirement plan payments unless they are eligible rollover distributions. 1040 tax form You can make this choice on Form W-4P for periodic and nonperiodic payments. 1040 tax form This choice generally remains in effect until you revoke it. 1040 tax form   The payer will ignore your choice not to have tax withheld if: You do not give the payer your social security number (in the required manner), or The IRS notifies the payer, before the payment is made, that you gave an incorrect social security number. 1040 tax form   To choose not to have tax withheld, a U. 1040 tax form S. 1040 tax form citizen or resident alien must give the payer a home address in the United States or its possessions. 1040 tax form Without that address, the payer must withhold tax. 1040 tax form For example, the payer has to withhold tax if the recipient has provided a U. 1040 tax form S. 1040 tax form address for a nominee, trustee, or agent to whom the benefits are delivered, but has not provided his or her own U. 1040 tax form S. 1040 tax form home address. 1040 tax form   If you do not give the payer a home address in the United States or its possessions, you can choose not to have tax withheld only if you certify to the payer that you are not a U. 1040 tax form S. 1040 tax form citizen, a U. 1040 tax form S. 1040 tax form resident alien, or someone who left the country to avoid tax. 1040 tax form But if you so certify, you may be subject to the 30% flat rate withholding that applies to nonresident aliens. 1040 tax form This 30% rate will not apply if you are exempt or subject to a reduced rate by treaty. 1040 tax form For details, get Publication 519. 1040 tax form Periodic payments. 1040 tax form   Unless you choose no withholding, your annuity or similar periodic payments (other than eligible rollover distributions) will be treated like wages for withholding purposes. 1040 tax form Periodic payments are amounts paid at regular intervals (such as weekly, monthly, or yearly) for a period of time greater than one year (such as for 15 years or for life). 1040 tax form You should give the payer a completed withholding certificate (Form W-4P or a similar form provided by the payer). 1040 tax form If you do not, tax will be withheld as if you were married and claiming three withholding allowances. 1040 tax form   Tax will be withheld as if you were single and were claiming no withholding allowances if: You do not give the payer your social security number (in the required manner), or The IRS notifies the payer (before any payment is made) that you gave an incorrect social security number. 1040 tax form   You must file a new withholding certificate to change the amount of withholding. 1040 tax form Nonperiodic distributions. 1040 tax form    Unless you choose no withholding, the withholding rate for a nonperiodic distribution (a payment other than a periodic payment) that is not an eligible rollover distribution is 10% of the distribution. 1040 tax form You can also ask the payer to withhold an additional amount using Form W-4P. 1040 tax form The part of any loan treated as a distribution (except an offset amount to repay the loan), explained later, is subject to withholding under this rule. 1040 tax form Eligible rollover distribution. 1040 tax form    If you receive an eligible rollover distribution, 20% of it generally will be withheld for income tax. 1040 tax form You cannot choose not to have tax withheld from an eligible rollover distribution. 1040 tax form However, tax will not be withheld if you have the plan administrator pay the eligible rollover distribution directly to another qualified plan or an IRA in a direct rollover. 1040 tax form For more information about eligible rollover distributions, see Rollovers , later. 1040 tax form Estimated tax. 1040 tax form   Your estimated tax is the total of your expected income tax, self-employment tax, and certain other taxes for the year, minus your expected credits and withheld tax. 1040 tax form Generally, you must make estimated tax payments for 2014 if you expect to owe at least $1,000 in tax (after subtracting your withholding and credits) and you expect your withholding and credits to be less than the smaller of: 90% of the tax to be shown on your 2014 return, or 100% of the tax shown on your 2013 return. 1040 tax form If your adjusted gross income for 2013 was more than $150,000 ($75,000 if your filing status for 2014 is married filing separately), substitute 110% for 100% in (2) above. 1040 tax form For more information, get Publication 505, Tax Withholding and Estimated Tax. 1040 tax form In figuring your withholding or estimated tax, remember that a part of your monthly social security or equivalent tier 1 railroad retirement benefits may be taxable. 1040 tax form See Publication 915. 1040 tax form You can choose to have income tax withheld from those benefits. 1040 tax form Use Form W-4V to make this choice. 1040 tax form Cost (Investment in the Contract) Distributions from your pension or annuity plan may include amounts treated as a recovery of your cost (investment in the contract). 1040 tax form If any part of a distribution is treated as a recovery of your cost under the rules explained in this publication, that part is tax free. 1040 tax form Therefore, the first step in figuring how much of a distribution is taxable is to determine the cost of your pension or annuity. 1040 tax form In general, your cost is your net investment in the contract as of the annuity starting date (or the date of the distribution, if earlier). 1040 tax form To find this amount, you must first figure the total premiums, contributions, or other amounts you paid. 1040 tax form This includes the amounts your employer contributed that were taxable to you when paid. 1040 tax form (However, see Foreign employment contributions , later. 1040 tax form ) It does not include amounts withheld from your pay on a tax-deferred basis (money that was taken out of your gross pay before taxes were deducted). 1040 tax form It also does not include amounts you contributed for health and accident benefits (including any additional premiums paid for double indemnity or disability benefits). 1040 tax form From this total cost you must subtract the following amounts. 1040 tax form Any refunded premiums, rebates, dividends, or unrepaid loans that were not included in your income and that you received by the later of the annuity starting date or the date on which you received your first payment. 1040 tax form Any other tax-free amounts you received under the contract or plan by the later of the dates in (1). 1040 tax form If you must use the Simplified Method for your annuity payments, the tax-free part of any single-sum payment received in connection with the start of the annuity payments, regardless of when you received it. 1040 tax form (See Simplified Method , later, for information on its required use. 1040 tax form ) If you use the General Rule for your annuity payments, the value of the refund feature in your annuity contract. 1040 tax form (See General Rule , later, for information on its use. 1040 tax form ) Your annuity contract has a refund feature if the annuity payments are for your life (or the lives of you and your survivor) and payments in the nature of a refund of the annuity's cost will be made to your beneficiary or estate if all annuitants die before a stated amount or a stated number of payments are made. 1040 tax form For more information, see Publication 939. 1040 tax form The tax treatment of the items described in (1) through (3) is discussed later under Taxation of Nonperiodic Payments . 1040 tax form Form 1099-R. 1040 tax form If you began receiving periodic payments of a life annuity in 2013, the payer should show your total contributions to the plan in box 9b of your 2013 Form 1099-R. 1040 tax form Annuity starting date defined. 1040 tax form   Your annuity starting date is the later of the first day of the first period for which you received a payment or the date the plan's obligations became fixed. 1040 tax form Example. 1040 tax form On January 1, you completed all your payments required under an annuity contract providing for monthly payments starting on August 1 for the period beginning July 1. 1040 tax form The annuity starting date is July 1. 1040 tax form This is the date you use in figuring the cost of the contract and selecting the appropriate number from Table 1 for line 3 of the Simplified Method Worksheet. 1040 tax form Designated Roth accounts. 1040 tax form   Your cost in these accounts is your designated Roth contributions that were included in your income as wages subject to applicable withholding requirements. 1040 tax form Your cost will also include any in-plan Roth rollovers you included in income. 1040 tax form Foreign employment contributions. 1040 tax form   If you worked abroad, your cost may include contributions by your employer to the retirement plan, but only if those contributions would be excludible from your gross income had they been paid directly to you as compensation. 1040 tax form The contributions that apply are: Contributions before 1963 by your employer, Contributions after 1962 by your employer if the contributions would be excludible from your gross income (not including the foreign earned income exclusion) had they been paid directly to you, or Contributions after 1996 by your employer if you performed the services of a foreign missionary (a duly ordained, commissioned, or licensed minister of a church or a lay person) but only if the contributions would be excludible from your gross income had they been paid directly to you. 1040 tax form Foreign employment contributions while a nonresident alien. 1040 tax form   In determining your cost, special rules apply if you are a U. 1040 tax form S. 1040 tax form citizen or resident alien who received distributions in 2013 from a plan to which contributions were made while you were a nonresident alien. 1040 tax form Your contributions and your employer's contributions are not included in your cost if the contribution: Was made based on compensation which was for services performed outside the United States while you were a nonresident alien, and Was not subject to income tax under the laws of the United States or any foreign country, but only if the contribution would have been subject to income tax if paid as cash compensation when the services were performed. 1040 tax form Taxation of Periodic Payments This section explains how the periodic payments you receive from a pension or annuity plan are taxed. 1040 tax form Periodic payments are amounts paid at regular intervals (such as weekly, monthly, or yearly) for a period of time greater than one year (such as for 15 years or for life). 1040 tax form These payments are also known as amounts received as an annuity. 1040 tax form If you receive an amount from your plan that is not a periodic payment, see Taxation of Nonperiodic Payments , later. 1040 tax form In general, you can recover the cost of your pension or annuity tax free over the period you are to receive the payments. 1040 tax form The amount of each payment that is more than the part that represents your cost is taxable (however, see Insurance Premiums for Retired Public Safety Officers , earlier). 1040 tax form Designated Roth accounts. 1040 tax form   If you receive a qualified distribution from a designated Roth account, the distribution is not included in your gross income. 1040 tax form This applies to both your cost in the account and income earned on that account. 1040 tax form A qualified distribution is generally a distribution that is: Made after a 5-tax-year period of participation, and Made on or after the date you reach age 59½, made to a beneficiary or your estate on or after your death, or attributable to your being disabled. 1040 tax form   If the distribution is not a qualified distribution, the rules discussed in this section apply. 1040 tax form The designated Roth account is treated as a separate contract. 1040 tax form Period of participation. 1040 tax form   The 5-tax-year period of participation is the 5-tax-year period beginning with the first tax year for which the participant made a designated Roth contribution to the plan. 1040 tax form Therefore, for designated Roth contributions made for 2013, the first year for which a qualified distribution can be made is 2018. 1040 tax form   However, if a direct rollover is made to the plan from a designated Roth account under another plan, the 5-tax-year period for the recipient plan begins with the first tax year for which the participant first had designated Roth contributions made to the other plan. 1040 tax form   Your 401(k), 403(b), or 457(b) plan may permit you to roll over amounts from those plans to a designated Roth account within the same plan. 1040 tax form This is known as an in-plan Roth rollover. 1040 tax form For more details, see In-plan Roth rollovers , later. 1040 tax form Fully Taxable Payments The pension or annuity payments that you receive are fully taxable if you have no cost in the contract because any of the following situations applies to you (however, see Insurance Premiums for Retired Public Safety Officers , earlier). 1040 tax form You did not pay anything or are not considered to have paid anything for your pension or annuity. 1040 tax form Amounts withheld from your pay on a tax-deferred basis are not considered part of the cost of the pension or annuity payment. 1040 tax form Your employer did not withhold contributions from your salary. 1040 tax form You got back all of your contributions tax free in prior years (however, see Exclusion not limited to cost under Partly Taxable Payments, later). 1040 tax form Report the total amount you got on Form 1040, line 16b; Form 1040A, line 12b; or on Form 1040NR, line 17b. 1040 tax form You should make no entry on Form 1040, line 16a; Form 1040A, line 12a; or Form 1040NR, line 17a. 1040 tax form Deductible voluntary employee contributions. 1040 tax form   Distributions you receive that are based on your accumulated deductible voluntary employee contributions are generally fully taxable in the year distributed to you. 1040 tax form Accumulated deductible voluntary employee contributions include net earnings on the contributions. 1040 tax form If distributed as part of a lump sum, they do not qualify for the 10-year tax option or capital gain treatment, explained later. 1040 tax form Partly Taxable Payments If you have a cost to recover from your pension or annuity plan (see Cost (Investment in the Contract) , earlier), you can exclude part of each annuity payment from income as a recovery of your cost. 1040 tax form This tax-free part of the payment is figured when your annuity starts and remains the same each year, even if the amount of the payment changes. 1040 tax form The rest of each payment is taxable (however, see Insurance Premiums for Retired Public Safety Officers , earlier). 1040 tax form You figure the tax-free part of the payment using one of the following methods. 1040 tax form Simplified Method. 1040 tax form You generally must use this method if your annuity is paid under a qualified plan (a qualified employee plan, a qualified employee annuity, or a tax-sheltered annuity plan or contract). 1040 tax form You cannot use this method if your annuity is paid under a nonqualified plan. 1040 tax form General Rule. 1040 tax form You must use this method if your annuity is paid under a nonqualified plan. 1040 tax form You generally cannot use this method if your annuity is paid under a qualified plan. 1040 tax form You determine which method to use when you first begin receiving your annuity, and you continue using it each year that you recover part of your cost. 1040 tax form If you had more than one partly taxable pension or annuity, figure the tax-free part and the taxable part of each separately. 1040 tax form Qualified plan annuity starting before November 19, 1996. 1040 tax form   If your annuity is paid under a qualified plan and your annuity starting date (defined earlier under Cost (Investment in the Contract) ) is after July 1, 1986, and before November 19, 1996, you could have chosen to use either the Simplified Method or the General Rule. 1040 tax form If your annuity starting date is before July 2, 1986, you use the General Rule unless your annuity qualified for the Three-Year Rule. 1040 tax form If you used the Three-Year Rule (which was repealed for annuities starting after July 1, 1986), your annuity payments are generally now fully taxable. 1040 tax form Exclusion limit. 1040 tax form   Your annuity starting date determines the total amount of annuity payments that you can exclude from income over the years. 1040 tax form Once your annuity starting date is determined, it does not change. 1040 tax form If you calculate the taxable portion of your annuity payments using the simplified method worksheet, the annuity starting date determines the recovery period for your cost. 1040 tax form That recovery period begins on your annuity starting date and is not affected by the date you first complete the worksheet. 1040 tax form Exclusion limited to cost. 1040 tax form   If your annuity starting date is after 1986, the total amount of annuity income that you can exclude over the years as a recovery of the cost cannot exceed your total cost. 1040 tax form Any unrecovered cost at your (or the last annuitant's) death is allowed as a miscellaneous itemized deduction on the final return of the decedent. 1040 tax form This deduction is not subject to the 2%-of-adjusted-gross-income limit. 1040 tax form Example 1. 1040 tax form Your annuity starting date is after 1986, and you exclude $100 a month ($1,200 a year) under the Simplified Method. 1040 tax form The total cost of your annuity is $12,000. 1040 tax form Your exclusion ends when you have recovered your cost tax free, that is, after 10 years (120 months). 1040 tax form After that, your annuity payments are generally fully taxable. 1040 tax form Example 2. 1040 tax form The facts are the same as in Example 1, except you die (with no surviving annuitant) after the eighth year of retirement. 1040 tax form You have recovered tax free only $9,600 (8 × $1,200) of your cost. 1040 tax form An itemized deduction for your unrecovered cost of $2,400 ($12,000 – $9,600) can be taken on your final return. 1040 tax form Exclusion not limited to cost. 1040 tax form   If your annuity starting date is before 1987, you can continue to take your monthly exclusion for as long as you receive your annuity. 1040 tax form If you chose a joint and survivor annuity, your survivor can continue to take the survivor's exclusion figured as of the annuity starting date. 1040 tax form The total exclusion may be more than your cost. 1040 tax form Simplified Method Under the Simplified Method, you figure the tax-free part of each annuity payment by dividing your cost by the total number of anticipated monthly payments. 1040 tax form For an annuity that is payable for the lives of the annuitants, this number is based on the annuitants' ages on the annuity starting date and is determined from a table. 1040 tax form For any other annuity, this number is the number of monthly annuity payments under the contract. 1040 tax form Who must use the Simplified Method. 1040 tax form   You must use the Simplified Method if your annuity starting date is after November 18, 1996, and you meet both of the following conditions. 1040 tax form You receive your pension or annuity payments from any of the following plans. 1040 tax form A qualified employee plan. 1040 tax form A qualified employee annuity. 1040 tax form A tax-sheltered annuity plan (403(b) plan). 1040 tax form On your annuity starting date, at least one of the following conditions applies to you. 1040 tax form You are under age 75. 1040 tax form You are entitled to less than 5 years of guaranteed payments. 1040 tax form Guaranteed payments. 1040 tax form   Your annuity contract provides guaranteed payments if a minimum number of payments or a minimum amount (for example, the amount of your investment) is payable even if you and any survivor annuitant do not live to receive the minimum. 1040 tax form If the minimum amount is less than the total amount of the payments you are to receive, barring death, during the first 5 years after payments begin (figured by ignoring any payment increases), you are entitled to less than 5 years of guaranteed payments. 1040 tax form Annuity starting before November 19, 1996. 1040 tax form   If your annuity starting date is after July 1, 1986, and before November 19, 1996, and you chose to use the Simplified Method, you must continue to use it each year that you recover part of your cost. 1040 tax form You could have chosen to use the Simplified Method if your annuity is payable for your life (or the lives of you and your survivor annuitant) and you met both of the conditions listed earlier under Who must use the Simplified Method . 1040 tax form Who cannot use the Simplified Method. 1040 tax form   You cannot use the Simplified Method if you receive your pension or annuity from a nonqualified plan or otherwise do not meet the conditions described in the preceding discussion. 1040 tax form See General Rule , later. 1040 tax form How to use the Simplified Method. 1040 tax form    Complete Worksheet A in the back of this publication to figure your taxable annuity for 2013. 1040 tax form Be sure to keep the completed worksheet; it will help you figure your taxable annuity next year. 1040 tax form   To complete line 3 of the worksheet, you must determine the total number of expected monthly payments for your annuity. 1040 tax form How you do this depends on whether the annuity is for a single life, multiple lives, or a fixed period. 1040 tax form For this purpose, treat an annuity that is payable over the life of an annuitant as payable for that annuitant's life even if the annuity has a fixed-period feature or also provides a temporary annuity payable to the annuitant's child under age 25. 1040 tax form    You do not need to complete line 3 of the worksheet or make the computation on line 4 if you received annuity payments last year and used last year's worksheet to figure your taxable annuity. 1040 tax form Instead, enter the amount from line 4 of last year's worksheet on line 4 of this year's worksheet. 1040 tax form Single-life annuity. 1040 tax form   If your annuity is payable for your life alone, use Table 1 at the bottom of the worksheet to determine the total number of expected monthly payments. 1040 tax form Enter on line 3 the number shown for your age on your annuity starting date. 1040 tax form This number will differ depending on whether your annuity starting date is before November 19, 1996, or after November 18, 1996. 1040 tax form Multiple-lives annuity. 1040 tax form   If your annuity is payable for the lives of more than one annuitant, use Table 2 at the bottom of the worksheet to determine the total number of expected monthly payments. 1040 tax form Enter on line 3 the number shown for the annuitants' combined ages on the annuity starting date. 1040 tax form For an annuity payable to you as the primary annuitant and to more than one survivor annuitant, combine your age and the age of the youngest survivor annuitant. 1040 tax form For an annuity that has no primary annuitant and is payable to you and others as survivor annuitants, combine the ages of the oldest and youngest annuitants. 1040 tax form Do not treat as a survivor annuitant anyone whose entitlement to payments depends on an event other than the primary annuitant's death. 1040 tax form   However, if your annuity starting date is before 1998, do not use Table 2 and do not combine the annuitants' ages. 1040 tax form Instead, you must use Table 1 at the bottom of the worksheet and enter on line 3 the number shown for the primary annuitant's age on the annuity starting date. 1040 tax form This number will differ depending on whether your annuity starting date is before November 19, 1996, or after November 18, 1996. 1040 tax form Fixed-period annuity. 1040 tax form   If your annuity does not depend in whole or in part on anyone's life expectancy, the total number of expected monthly payments to enter on line 3 of the worksheet is the number of monthly annuity payments under the contract. 1040 tax form Line 6. 1040 tax form   The amount on line 6 should include all amounts that could have been recovered in prior years. 1040 tax form If you did not recover an amount in a prior year, you may be able to amend your returns for the affected years. 1040 tax form Example. 1040 tax form Bill Smith, age 65, began receiving retirement benefits in 2013 under a joint and survivor annuity. 1040 tax form Bill's annuity starting date is January 1, 2013. 1040 tax form The benefits are to be paid for the joint lives of Bill and his wife, Kathy, age 65. 1040 tax form Bill had contributed $31,000 to a qualified plan and had received no distributions before the annuity starting date. 1040 tax form Bill is to receive a retirement benefit of $1,200 a month, and Kathy is to receive a monthly survivor benefit of $600 upon Bill's death. 1040 tax form Bill must use the Simplified Method to figure his taxable annuity because his payments are from a qualified plan and he is under age 75. 1040 tax form Because his annuity is payable over the lives of more than one annuitant, he uses his and Kathy's combined ages and Table 2 at the bottom of Worksheet A in completing line 3 of the worksheet. 1040 tax form His completed worksheet is shown later. 1040 tax form Bill's tax-free monthly amount is $100 ($31,000 ÷ 310) as shown on line 4 of the worksheet. 1040 tax form Upon Bill's death, if Bill has not recovered the full $31,000 investment, Kathy will also exclude $100 from her $600 monthly payment. 1040 tax form The full amount of any annuity payments received after 310 payments are paid must be included in gross income. 1040 tax form If Bill and Kathy die before 310 payments are made, a miscellaneous itemized deduction will be allowed for the unrecovered cost on the final income tax return of the last to die. 1040 tax form This deduction is not subject to the 2%-of-adjusted-gross-income limit. 1040 tax form Worksheet A. 1040 tax form Simplified Method Worksheet for Bill Smith 1. 1040 tax form Enter the total pension or annuity payments received this year. 1040 tax form Also, add this amount to the total for Form 1040, line 16a; Form 1040A, line 12a; or Form 1040NR, line 17a 1. 1040 tax form $14,400 2. 1040 tax form Enter your cost in the plan (contract) at the annuity starting date plus any death benefit exclusion. 1040 tax form * See Cost (Investment in the Contract) , earlier 2. 1040 tax form 31,000   Note. 1040 tax form If your annuity starting date was before this year and you completed this worksheet last year, skip line 3 and enter the amount from line 4 of last year's worksheet on line 4 below (even if the amount of your pension or annuity has changed). 1040 tax form Otherwise, go to line 3. 1040 tax form     3. 1040 tax form Enter the appropriate number from Table 1 below. 1040 tax form But if your annuity starting date was after 1997 and the payments are for your life and that of your beneficiary, enter the appropriate number from Table 2 below 3. 1040 tax form 310 4. 1040 tax form Divide line 2 by the number on line 3 4. 1040 tax form 100 5. 1040 tax form Multiply line 4 by the number of months for which this year's payments were made. 1040 tax form If your annuity starting date was before 1987, enter this amount on line 8 below and skip lines 6, 7, 10, and 11. 1040 tax form Otherwise, go to line 6 5. 1040 tax form 1,200 6. 1040 tax form Enter any amount previously recovered tax free in years after 1986. 1040 tax form This is the amount shown on line 10 of your worksheet for last year 6. 1040 tax form -0- 7. 1040 tax form Subtract line 6 from line 2 7. 1040 tax form 31,000 8. 1040 tax form Enter the smaller of line 5 or line 7 8. 1040 tax form 1,200 9. 1040 tax form Taxable amount for year. 1040 tax form Subtract line 8 from line 1. 1040 tax form Enter the result, but not less than zero. 1040 tax form Also, add this amount to the total for Form 1040, line 16b; Form 1040A, line 12b; or Form 1040NR, line 17b. 1040 tax form Note: If your Form 1099-R shows a larger taxable amount, use the amount figured on this line instead. 1040 tax form If you are a retired public safety officer, see Insurance Premiums for Retired Public Safety Officers , earlier, before entering an amount on your tax return 9. 1040 tax form $13,200 10. 1040 tax form Was your annuity starting date before 1987? □ Yes. 1040 tax form STOP. 1040 tax form Do not complete the rest of this worksheet. 1040 tax form  ☑ No. 1040 tax form Add lines 6 and 8. 1040 tax form This is the amount you have recovered tax free through 2013. 1040 tax form You will need this number if you need to fill out this worksheet next year 10. 1040 tax form 1,200 11. 1040 tax form Balance of cost to be recovered. 1040 tax form Subtract line 10 from line 2. 1040 tax form If zero, you will not have to complete this worksheet next year. 1040 tax form The payments you receive next year will generally be fully taxable 11. 1040 tax form $29,800         * A death benefit exclusion (up to $5,000) applied to certain benefits received by employees who died before August 21, 1996. 1040 tax form           Table 1 for Line 3 Above       AND your annuity starting date was—     IF the age at annuity starting date was. 1040 tax form . 1040 tax form . 1040 tax form BEFORE November 19, 1996, enter on line 3. 1040 tax form . 1040 tax form . 1040 tax form AFTER November 18, 1996, enter on line 3. 1040 tax form . 1040 tax form . 1040 tax form     55 or under 300 360     56-60 260 310     61-65 240 260     66-70 170 210     71 or older 120 160     Table 2 for Line 3 Above     IF the combined ages at  annuity starting date were. 1040 tax form . 1040 tax form . 1040 tax form THEN enter on line 3. 1040 tax form . 1040 tax form . 1040 tax form     110 or under   410     111-120   360     121-130   310     131-140   260     141 or older   210   Multiple annuitants. 1040 tax form   If you and one or more other annuitants receive payments at the same time, you exclude from each annuity payment a pro rata share of the monthly tax-free amount. 1040 tax form Figure your share by taking the following steps. 1040 tax form Complete your worksheet through line 4 to figure the monthly tax-free amount. 1040 tax form Divide the amount of your monthly payment by the total amount of the monthly payments to all annuitants. 1040 tax form Multiply the amount on line 4 of your worksheet by the amount figured in (2) above. 1040 tax form The result is your share of the monthly tax-free amount. 1040 tax form   Replace the amount on line 4 of the worksheet with the result in (3) above. 1040 tax form Enter that amount on line 4 of your worksheet each year. 1040 tax form General Rule Under the General Rule, you determine the tax-free part of each annuity payment based on the ratio of the cost of the contract to the total expected return. 1040 tax form Expected return is the total amount you and other eligible annuitants can expect to receive under the contract. 1040 tax form To figure it, you must use life expectancy (actuarial) tables prescribed by the IRS. 1040 tax form Who must use the General Rule. 1040 tax form   You must use the General Rule if you receive pension or annuity payments from: A nonqualified plan (such as a private annuity, a purchased commercial annuity, or a nonqualified employee plan), or A qualified plan if you are age 75 or older on your annuity starting date and your annuity payments are guaranteed for at least 5 years. 1040 tax form Annuity starting before November 19, 1996. 1040 tax form   If your annuity starting date is after July 1, 1986, and before November 19, 1996, you had to use the General Rule for either circumstance just described. 1040 tax form You also had to use it for any fixed-period annuity. 1040 tax form If you did not have to use the General Rule, you could have chosen to use it. 1040 tax form If your annuity starting date is before July 2, 1986, you had to use the General Rule unless you could use the Three-Year Rule. 1040 tax form   If you had to use the General Rule (or chose to use it), you must continue to use it each year that you recover your cost. 1040 tax form Who cannot use the General Rule. 1040 tax form   You cannot use the General Rule if you receive your pension or annuity from a qualified plan and none of the circumstances described in the preceding discussions apply to you. 1040 tax form See Simplified Method , earlier. 1040 tax form More information. 1040 tax form   For complete information on using the General Rule, including the actuarial tables you need, see Publication 939. 1040 tax form Taxation of Nonperiodic Payments This section of the publication explains how any nonperiodic distributions you receive under a pension or annuity plan are taxed. 1040 tax form Nonperiodic distributions are also known as amounts not received as an annuity. 1040 tax form They include all payments other than periodic payments and corrective distributions. 1040 tax form For example, the following items are treated as nonperiodic distributions. 1040 tax form Cash withdrawals. 1040 tax form Distributions of current earnings (dividends) on your investment. 1040 tax form However, do not include these distributions in your income to the extent the insurer keeps them to pay premiums or other consideration for the contract. 1040 tax form Certain loans. 1040 tax form See Loans Treated as Distributions , later. 1040 tax form The value of annuity contracts transferred without full and adequate consideration. 1040 tax form See Transfers of Annuity Contracts , later. 1040 tax form Corrective distributions of excess plan contributions. 1040 tax form   Generally, if the contributions made for you during the year to certain retirement plans exceed certain limits, the excess is taxable to you. 1040 tax form To correct an excess, your plan may distribute it to you (along with any income earned on the excess). 1040 tax form Although the plan reports the corrective distributions on Form 1099-R, the distribution is not treated as a nonperiodic distribution from the plan. 1040 tax form It is not subject to the allocation rules explained in the following discussion, it cannot be rolled over into another plan, and it is not subject to the additional tax on early distributions. 1040 tax form    If your retirement plan made a corrective distribution of excess amounts (excess deferrals, excess contributions, or excess annual additions), your Form 1099-R should have the code “8,” “B,” “P,” or “E” in box 7. 1040 tax form   For information on plan contribution limits and how to report corrective distributions of excess contributions, see Retirement Plan Contributions under Employee Compensation in Publication 525. 1040 tax form Figuring the Taxable Amount How you figure the taxable amount of a nonperiodic distribution depends on whether it is made before the annuity starting date, or on or after the annuity starting date. 1040 tax form If it is made before the annuity starting date, its tax treatment also depends on whether it is made under a qualified or nonqualified plan. 1040 tax form If it is made under a nonqualified plan, its tax treatment depends on whether it fully discharges the contract, is received under certain life insurance or endowment contracts, or is allocable to an investment you made before August 14, 1982. 1040 tax form You may be able to roll over the taxable amount of a nonperiodic distribution from a qualified retirement plan into another qualified retirement plan or a traditional IRA tax free. 1040 tax form See Rollovers, later. 1040 tax form If you do not make a tax-free rollover and the distribution qualifies as a lump-sum distribution, you may be able to elect an optional method of figuring the tax on the taxable amount. 1040 tax form See Lump-Sum Distributions, later. 1040 tax form Annuity starting date. 1040 tax form   The annuity starting date is either the first day of the first period for which you receive an annuity payment under the contract or the date on which the obligation under the contract becomes fixed, whichever is later. 1040 tax form Distributions of employer securities. 1040 tax form    If you receive a distribution of employer securities from a qualified retirement plan, you may be able to defer the tax on the net unrealized appreciation (NUA) in the securities. 1040 tax form The NUA is the net increase in the securities' value while they were in the trust. 1040 tax form This tax deferral applies to distributions of the employer corporation's stocks, bonds, registered debentures, and debentures with interest coupons attached. 1040 tax form   If the distribution is a lump-sum distribution, tax is deferred on all of the NUA unless you choose to include it in your income for the year of the distribution. 1040 tax form    A lump-sum distribution for this purpose is the distribution or payment of a plan participant's entire balance (within a single tax year) from all of the employer's qualified plans of one kind (pension, profit-sharing, or stock bonus plans), but only if paid: Because of the plan participant's death, After the participant reaches age 59½, Because the participant, if an employee, separates from service, or After the participant, if a self-employed individual, becomes totally and permanently disabled. 1040 tax form    If you choose to include NUA in your income for the year of the distribution and the participant was born before January 2, 1936, you may be able to figure the tax on the NUA using the optional methods described und