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Form 1040 X

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Form 1040 X

Form 1040 x Publication 538 - Main Content Table of Contents Accounting PeriodsCalendar Year Fiscal Year Short Tax Year Improper Tax Year Change in Tax Year Individuals Partnerships, S Corporations, and Personal Service Corporations (PSCs) Corporations (Other Than S Corporations and PSCs) Accounting MethodsSpecial methods. Form 1040 x Hybrid method. Form 1040 x Cash Method Accrual Method Inventories Change in Accounting Method How To Get Tax HelpLow Income Taxpayer Clinics (LITCs). Form 1040 x Accounting Periods You must use a tax year to figure your taxable income. Form 1040 x A tax year is an annual accounting period for keeping records and reporting income and expenses. Form 1040 x An annual accounting period does not include a short tax year (discussed later). Form 1040 x You can use the following tax years: A calendar year; or A fiscal year (including a 52-53-week tax year). Form 1040 x Unless you have a required tax year, you adopt a tax year by filing your first income tax return using that tax year. Form 1040 x A required tax year is a tax year required under the Internal Revenue Code or the Income Tax Regulations. Form 1040 x You cannot adopt a tax year by merely: Filing an application for an extension of time to file an income tax return; Filing an application for an employer identification number (Form SS-4); or Paying estimated taxes. Form 1040 x This section discusses: A calendar year. Form 1040 x A fiscal year (including a period of 52 or 53 weeks). Form 1040 x A short tax year. Form 1040 x An improper tax year. Form 1040 x A change in tax year. Form 1040 x Special situations that apply to individuals. Form 1040 x Restrictions that apply to the accounting period of a partnership, S corporation, or personal service corporation. Form 1040 x Special situations that apply to corporations. Form 1040 x Calendar Year A calendar year is 12 consecutive months beginning on January 1st and ending on December 31st. Form 1040 x If you adopt the calendar year, you must maintain your books and records and report your income and expenses from January 1st through December 31st of each year. Form 1040 x If you file your first tax return using the calendar tax year and you later begin business as a sole proprietor, become a partner in a partnership, or become a shareholder in an S corporation, you must continue to use the calendar year unless you obtain approval from the IRS to change it, or are otherwise allowed to change it without IRS approval. Form 1040 x See Change in Tax Year, later. Form 1040 x Generally, anyone can adopt the calendar year. Form 1040 x However, you must adopt the calendar year if: You keep no books or records; You have no annual accounting period; Your present tax year does not qualify as a fiscal year; or You are required to use a calendar year by a provision in the Internal Revenue Code or the Income Tax Regulations. Form 1040 x Fiscal Year A fiscal year is 12 consecutive months ending on the last day of any month except December 31st. Form 1040 x If you are allowed to adopt a fiscal year, you must consistently maintain your books and records and report your income and expenses using the time period adopted. Form 1040 x 52-53-Week Tax Year You can elect to use a 52-53-week tax year if you keep your books and records and report your income and expenses on that basis. Form 1040 x If you make this election, your 52-53-week tax year must always end on the same day of the week. Form 1040 x Your 52-53-week tax year must always end on: Whatever date this same day of the week last occurs in a calendar month, or Whatever date this same day of the week falls that is nearest to the last day of the calendar month. Form 1040 x For example, if you elect a tax year that always ends on the last Monday in March, your 2012 tax year will end on March 25, 2013. Form 1040 x Election. Form 1040 x   To make the election for the 52-53-week tax year, attach a statement with the following information to your tax return. Form 1040 x The month in which the new 52-53-week tax year ends. Form 1040 x The day of the week on which the tax year always ends. Form 1040 x The date the tax year ends. Form 1040 x It can be either of the following dates on which the chosen day: Last occurs in the month in (1), above, or Occurs nearest to the last day of the month in (1), above. Form 1040 x   When you figure depreciation or amortization, a 52-53-week tax year is generally considered a year of 12 calendar months. Form 1040 x   To determine an effective date (or apply provisions of any law) expressed in terms of tax years beginning, including, or ending on the first or last day of a specified calendar month, a 52-53-week tax year is considered to: Begin on the first day of the calendar month beginning nearest to the first day of the 52-53-week tax year, and End on the last day of the calendar month ending nearest to the last day of the 52-53-week tax year. Form 1040 x Example. Form 1040 x Assume a tax provision applies to tax years beginning on or after July 1, 2012, which happens to be a Sunday. Form 1040 x For this purpose, a 52-53-week tax year that begins on the last Tuesday of June, which falls on June 26, 2012, is treated as beginning on July 1, 2012. Form 1040 x Short Tax Year A short tax year is a tax year of less than 12 months. Form 1040 x A short period tax return may be required when you (as a taxable entity): Are not in existence for an entire tax year, or Change your accounting period. Form 1040 x Tax on a short period tax return is figured differently for each situation. Form 1040 x Not in Existence Entire Year Even if a taxable entity was not in existence for the entire year, a tax return is required for the time it was in existence. Form 1040 x Requirements for filing the return and figuring the tax are generally the same as the requirements for a return for a full tax year (12 months) ending on the last day of the short tax year. Form 1040 x Example 1. Form 1040 x XYZ Corporation was organized on July 1, 2012. Form 1040 x It elected the calendar year as its tax year. Form 1040 x Therefore, its first tax return was due March 15, 2013. Form 1040 x This short period return will cover the period from July 1, 2012, through December 31, 2012. Form 1040 x Example 2. Form 1040 x A calendar year corporation dissolved on July 23, 2012. Form 1040 x Its final return is due by October 15, 2012. Form 1040 x It will cover the short period from January 1, 2012, through July 23, 2012. Form 1040 x Death of individual. Form 1040 x   When an individual dies, a tax return must be filed for the decedent by the 15th day of the 4th month after the close of the individual's regular tax year. Form 1040 x The decedent's final return will be a short period tax return that begins on January 1st, and ends on the date of death. Form 1040 x In the case of a decedent who dies on December 31st, the last day of the regular tax year, a full calendar-year tax return is required. Form 1040 x Example. Form 1040 x   Agnes Green was a single, calendar year taxpayer. Form 1040 x She died on March 6, 2012. Form 1040 x Her final income tax return must be filed by April 15, 2013. Form 1040 x It will cover the short period from January 1, 2012, to March 6, 2012. Form 1040 x Figuring Tax for Short Year If the IRS approves a change in your tax year or you are required to change your tax year, you must figure the tax and file your return for the short tax period. Form 1040 x The short tax period begins on the first day after the close of your old tax year and ends on the day before the first day of your new tax year. Form 1040 x Figure tax for a short year under the general rule, explained below. Form 1040 x You may then be able to use a relief procedure, explained later, and claim a refund of part of the tax you paid. Form 1040 x General rule. Form 1040 x   Income tax for a short tax year must be annualized. Form 1040 x However, self-employment tax is figured on the actual self-employment income for the short period. Form 1040 x Individuals. Form 1040 x   An individual must figure income tax for the short tax year as follows. Form 1040 x Determine your adjusted gross income (AGI) for the short tax year and then subtract your actual itemized deductions for the short tax year. Form 1040 x You must itemize deductions when you file a short period tax return. Form 1040 x Multiply the dollar amount of your exemptions by the number of months in the short tax year and divide the result by 12. Form 1040 x Subtract the amount in (2) from the amount in (1). Form 1040 x The result is your modified taxable income. Form 1040 x Multiply the modified taxable income in (3) by 12, then divide the result by the number of months in the short tax year. Form 1040 x The result is your annualized income. Form 1040 x Figure the total tax on your annualized income using the appropriate tax rate schedule. Form 1040 x Multiply the total tax by the number of months in the short tax year and divide the result by 12. Form 1040 x The result is your tax for the short tax year. Form 1040 x Relief procedure. Form 1040 x   Individuals and corporations can use a relief procedure to figure the tax for the short tax year. Form 1040 x It may result in less tax. Form 1040 x Under this procedure, the tax is figured by two separate methods. Form 1040 x If the tax figured under both methods is less than the tax figured under the general rule, you can file a claim for a refund of part of the tax you paid. Form 1040 x For more information, see section 443(b)(2) of the Internal Revenue Code. Form 1040 x Alternative minimum tax. Form 1040 x   To figure the alternative minimum tax (AMT) due for a short tax year: Figure the annualized alternative minimum taxable income (AMTI) for the short tax period by completing the following steps. Form 1040 x Multiply the AMTI by 12. Form 1040 x Divide the result by the number of months in the short tax year. Form 1040 x Multiply the annualized AMTI by the appropriate rate of tax under section 55(b)(1) of the Internal Revenue Code. Form 1040 x The result is the annualized AMT. Form 1040 x Multiply the annualized AMT by the number of months in the short tax year and divide the result by 12. Form 1040 x   For information on the AMT for individuals, see the Instructions for Form 6251, Alternative Minimum Tax–Individuals. Form 1040 x For information on the AMT for corporations, see the Instructions to Form 4626, Alternative Minimum Tax–Corporations. Form 1040 x Tax withheld from wages. Form 1040 x   You can claim a credit against your income tax liability for federal income tax withheld from your wages. Form 1040 x Federal income tax is withheld on a calendar year basis. Form 1040 x The amount withheld in any calendar year is allowed as a credit for the tax year beginning in the calendar year. Form 1040 x Improper Tax Year Taxpayers that have adopted an improper tax year must change to a proper tax year. Form 1040 x For example, if a taxpayer began business on March 15 and adopted a tax year ending on March 14 (a period of exactly 12 months), this would be an improper tax year. Form 1040 x See Accounting Periods, earlier, for a description of permissible tax years. Form 1040 x To change to a proper tax year, you must do one of the following. Form 1040 x If you are requesting a change to a calendar tax year, file an amended income tax return based on a calendar tax year that corrects the most recently filed tax return that was filed on the basis of an improper tax year. Form 1040 x Attach a completed Form 1128 to the amended tax return. Form 1040 x Write “FILED UNDER REV. Form 1040 x PROC. Form 1040 x 85-15” at the top of Form 1128 and file the forms with the Internal Revenue Service Center where you filed your original return. Form 1040 x If you are requesting a change to a fiscal tax year, file Form 1128 in accordance with the form instructions to request IRS approval for the change. Form 1040 x Change in Tax Year Generally, you must file Form 1128 to request IRS approval to change your tax year. Form 1040 x See the Instructions for Form 1128 for exceptions. Form 1040 x If you qualify for an automatic approval request, a user fee is not required. Form 1040 x Individuals Generally, individuals must adopt the calendar year as their tax year. Form 1040 x An individual can adopt a fiscal year provided that the individual maintains his or her books and records on the basis of the adopted fiscal year. Form 1040 x Partnerships, S Corporations, and Personal Service Corporations (PSCs) Generally, partnerships, S corporations (including electing S corporations), and PSCs must use a required tax year. Form 1040 x A required tax year is a tax year that is required under the Internal Revenue Code and Income Tax Regulations. Form 1040 x The entity does not have to use the required tax year if it receives IRS approval to use another permitted tax year or makes an election under section 444 of the Internal Revenue Code (discussed later). Form 1040 x The following discussions provide the rules for partnerships, S corporations, and PSCs. Form 1040 x Partnership A partnership must conform its tax year to its partners' tax years unless any of the following apply. Form 1040 x The partnership makes an election under section 444 of the Internal Revenue Code to have a tax year other than a required tax year by filing Form 8716. Form 1040 x The partnership elects to use a 52-53-week tax year that ends with reference to either its required tax year or a tax year elected under section 444. Form 1040 x The partnership can establish a business purpose for a different tax year. Form 1040 x The rules for the required tax year for partnerships are as follows. Form 1040 x If one or more partners having the same tax year own a majority interest (more than 50%) in partnership profits and capital, the partnership must use the tax year of those partners. Form 1040 x If there is no majority interest tax year, the partnership must use the tax year of all its principal partners. Form 1040 x A principal partner is one who has a 5% or more interest in the profits or capital of the partnership. Form 1040 x If there is no majority interest tax year and the principal partners do not have the same tax year, the partnership generally must use a tax year that results in the least aggregate deferral of income to the partners. Form 1040 x If a partnership changes to a required tax year because of these rules, it can get automatic approval by filing Form 1128. Form 1040 x Least aggregate deferral of income. Form 1040 x   The tax year that results in the least aggregate deferral of income is determined as follows. Form 1040 x Figure the number of months of deferral for each partner using one partner's tax year. Form 1040 x Find the months of deferral by counting the months from the end of that tax year forward to the end of each other partner's tax year. Form 1040 x Multiply each partner's months of deferral figured in step (1) by that partner's share of interest in the partnership profits for the year used in step (1). Form 1040 x Add the amounts in step (2) to get the aggregate (total) deferral for the tax year used in step (1). Form 1040 x Repeat steps (1) through (3) for each partner's tax year that is different from the other partners' years. Form 1040 x   The partner's tax year that results in the lowest aggregate (total) number is the tax year that must be used by the partnership. Form 1040 x If the calculation results in more than one tax year qualifying as the tax year with the least aggregate deferral, the partnership can choose any one of those tax years as its tax year. Form 1040 x However, if one of the tax years that qualifies is the partnership's existing tax year, the partnership must retain that tax year. Form 1040 x Example. Form 1040 x A and B each have a 50% interest in partnership P, which uses a fiscal year ending June 30. Form 1040 x A uses the calendar year and B uses a fiscal year ending November 30. Form 1040 x P must change its tax year to a fiscal year ending November 30 because this results in the least aggregate deferral of income to the partners, as shown in the following table. Form 1040 x Year End 12/31: Year End Profits Interest Months of Deferral Interest × Deferral A 12/31 0. Form 1040 x 5 -0- -0- B 11/30 0. Form 1040 x 5 11 5. Form 1040 x 5 Total Deferral 5. Form 1040 x 5 Year End 11/30: Year End Profits Interest Months of Deferral Interest × Deferral A 12/31 0. Form 1040 x 5 1 0. Form 1040 x 5 B 11/30 0. Form 1040 x 5 -0- -0- Total Deferral 0. Form 1040 x 5 When determination is made. Form 1040 x   The determination of the tax year under the least aggregate deferral rules must generally be made at the beginning of the partnership's current tax year. Form 1040 x However, the IRS can require the partnership to use another day or period that will more accurately reflect the ownership of the partnership. Form 1040 x This could occur, for example, if a partnership interest was transferred for the purpose of qualifying for a particular tax year. Form 1040 x Short period return. Form 1040 x   When a partnership changes its tax year, a short period return must be filed. Form 1040 x The short period return covers the months between the end of the partnership's prior tax year and the beginning of its new tax year. Form 1040 x   If a partnership changes to the tax year resulting in the least aggregate deferral, it must file a Form 1128 with the short period return showing the computations used to determine that tax year. Form 1040 x The short period return must indicate at the top of page 1, “FILED UNDER SECTION 1. Form 1040 x 706-1. Form 1040 x ” More information. Form 1040 x   For more information about changing a partnership's tax year, and information about ruling requests, see the Instructions for Form 1128. Form 1040 x S Corporation All S corporations, regardless of when they became an S corporation, must use a permitted tax year. Form 1040 x A permitted tax year is any of the following. Form 1040 x The calendar year. Form 1040 x A tax year elected under section 444 of the Internal Revenue Code. Form 1040 x See Section 444 Election, below for details. Form 1040 x A 52-53-week tax year ending with reference to the calendar year or a tax year elected under section 444. Form 1040 x Any other tax year for which the corporation establishes a business purpose. Form 1040 x If an electing S corporation wishes to adopt a tax year other than a calendar year, it must request IRS approval using Form 2553, instead of filing Form 1128. Form 1040 x For information about changing an S corporation's tax year and information about ruling requests, see the Instructions for Form 1128. Form 1040 x Personal Service Corporation (PSC) A PSC must use a calendar tax year unless any of the following apply. Form 1040 x The corporation makes an election under section 444 of the Internal Revenue Code. Form 1040 x See Section 444 Election, below for details. Form 1040 x The corporation elects to use a 52-53-week tax year ending with reference to the calendar year or a tax year elected under section 444. Form 1040 x The corporation establishes a business purpose for a fiscal year. Form 1040 x See the Instructions for Form 1120 for general information about PSCs. Form 1040 x For information on adopting or changing tax years for PSCs and information about ruling requests, see the Instructions for Form 1128. Form 1040 x Section 444 Election A partnership, S corporation, electing S corporation, or PSC can elect under section 444 of the Internal Revenue Code to use a tax year other than its required tax year. Form 1040 x Certain restrictions apply to the election. Form 1040 x A partnership or an S corporation that makes a section 444 election must make certain required payments and a PSC must make certain distributions (discussed later). Form 1040 x The section 444 election does not apply to any partnership, S corporation, or PSC that establishes a business purpose for a different period, explained later. Form 1040 x A partnership, S corporation, or PSC can make a section 444 election if it meets all the following requirements. Form 1040 x It is not a member of a tiered structure (defined in section 1. Form 1040 x 444-2T of the regulations). Form 1040 x It has not previously had a section 444 election in effect. Form 1040 x It elects a year that meets the deferral period requirement. Form 1040 x Deferral period. Form 1040 x   The determination of the deferral period depends on whether the partnership, S corporation, or PSC is retaining its tax year or adopting or changing its tax year with a section 444 election. Form 1040 x Retaining tax year. Form 1040 x   Generally, a partnership, S corporation, or PSC can make a section 444 election to retain its tax year only if the deferral period of the new tax year is 3 months or less. Form 1040 x This deferral period is the number of months between the beginning of the retained year and the close of the first required tax year. Form 1040 x Adopting or changing tax year. Form 1040 x   If the partnership, S corporation, or PSC is adopting or changing to a tax year other than its required year, the deferral period is the number of months from the end of the new tax year to the end of the required tax year. Form 1040 x The IRS will allow a section 444 election only if the deferral period of the new tax year is less than the shorter of: Three months, or The deferral period of the tax year being changed. Form 1040 x This is the tax year immediately preceding the year for which the partnership, S corporation, or PSC wishes to make the section 444 election. Form 1040 x If the partnership, S corporation, or PSC's tax year is the same as its required tax year, the deferral period is zero. Form 1040 x Example 1. Form 1040 x BD Partnership uses a calendar year, which is also its required tax year. Form 1040 x BD cannot make a section 444 election because the deferral period is zero. Form 1040 x Example 2. Form 1040 x E, a newly formed partnership, began operations on December 1. Form 1040 x E is owned by calendar year partners. Form 1040 x E wants to make a section 444 election to adopt a September 30 tax year. Form 1040 x E's deferral period for the tax year beginning December 1 is 3 months, the number of months between September 30 and December 31. Form 1040 x Making the election. Form 1040 x   Make a section 444 election by filing Form 8716 with the Internal Revenue Service Center where the entity will file its tax return. Form 1040 x Form 8716 must be filed by the earlier of: The due date (not including extensions) of the income tax return for the tax year resulting from the section 444 election, or The 15th day of the 6th month of the tax year for which the election will be effective. Form 1040 x For this purpose, count the month in which the tax year begins, even if it begins after the first day of that month. Form 1040 x Note. Form 1040 x If the due date falls on a Saturday, Sunday, or legal holiday, file on the next business day. Form 1040 x   Attach a copy of Form 8716 to Form 1065, Form 1120S, or Form 1120 for the first tax year for which the election is made. Form 1040 x Example 1. Form 1040 x AB, a partnership, begins operations on September 13, 2012, and is qualified to make a section 444 election to use a September 30 tax year for its tax year beginning September 13, 2012. Form 1040 x AB must file Form 8716 by January 15, 2013, which is the due date of the partnership's tax return for the period from September 13, 2012, to September 30, 2012. Form 1040 x Example 2. Form 1040 x The facts are the same as in Example 1 except that AB begins operations on October 21, 2012. Form 1040 x AB must file Form 8716 by March 17, 2013. Form 1040 x Example 3. Form 1040 x B is a corporation that first becomes a PSC for its tax year beginning September 1, 2012. Form 1040 x B qualifies to make a section 444 election to use a September 30 tax year for its tax year beginning September 1, 2012. Form 1040 x B must file Form 8716 by December 17, 2012, the due date of the income tax return for the short period from September 1, 2012, to September 30, 2012. Form 1040 x Note. Form 1040 x The due dates in Examples 2 and 3 are adjusted because the dates fall on a Saturday, Sunday or legal holiday. Form 1040 x Extension of time for filing. Form 1040 x   There is an automatic extension of 12 months to make this election. Form 1040 x See the Form 8716 instructions for more information. Form 1040 x Terminating the election. Form 1040 x   The section 444 election remains in effect until it is terminated. Form 1040 x If the election is terminated, another section 444 election cannot be made for any tax year. Form 1040 x   The election ends when any of the following applies to the partnership, S corporation, or PSC. Form 1040 x The entity changes to its required tax year. Form 1040 x The entity liquidates. Form 1040 x The entity becomes a member of a tiered structure. Form 1040 x The IRS determines that the entity willfully failed to comply with the required payments or distributions. Form 1040 x   The election will also end if either of the following events occur. Form 1040 x An S corporation's S election is terminated. Form 1040 x However, if the S corporation immediately becomes a PSC, the PSC can continue the section 444 election of the S corporation. Form 1040 x A PSC ceases to be a PSC. Form 1040 x If the PSC elects to be an S corporation, the S corporation can continue the election of the PSC. Form 1040 x Required payment for partnership or S corporation. Form 1040 x   A partnership or an S corporation must make a required payment for any tax year: The section 444 election is in effect. Form 1040 x The required payment for that year (or any preceding tax year) is more than $500. Form 1040 x    This payment represents the value of the tax deferral the owners receive by using a tax year different from the required tax year. Form 1040 x   Form 8752, Required Payment or Refund Under Section 7519, must be filed each year the section 444 election is in effect, even if no payment is due. Form 1040 x If the required payment is more than $500 (or the required payment for any prior year was more than $500), the payment must be made when Form 8752 is filed. Form 1040 x If the required payment is $500 or less and no payment was required in a prior year, Form 8752 must be filed showing a zero amount. Form 1040 x Applicable election year. Form 1040 x   Any tax year a section 444 election is in effect, including the first year, is called an applicable election year. Form 1040 x Form 8752 must be filed and the required payment made (or zero amount reported) by May 15th of the calendar year following the calendar year in which the applicable election year begins. Form 1040 x Required distribution for PSC. Form 1040 x   A PSC with a section 444 election in effect must distribute certain amounts to employee-owners by December 31 of each applicable year. Form 1040 x If it fails to make these distributions, it may be required to defer certain deductions for amounts paid to owner-employees. Form 1040 x The amount deferred is treated as paid or incurred in the following tax year. Form 1040 x   For information on the minimum distribution, see the instructions for Part I of Schedule H (Form 1120), Section 280H Limitations for a Personal Service Corporation (PSC). Form 1040 x Back-up election. Form 1040 x   A partnership, S corporation, or PSC can file a back-up section 444 election if it requests (or plans to request) permission to use a business purpose tax year, discussed later. Form 1040 x If the request is denied, the back-up section 444 election must be activated (if the partnership, S corporation, or PSC otherwise qualifies). Form 1040 x Making back-up election. Form 1040 x   The general rules for making a section 444 election, as discussed earlier, apply. Form 1040 x When filing Form 8716, type or print “BACK-UP ELECTION” at the top of the form. Form 1040 x However, if Form 8716 is filed on or after the date Form 1128 (or Form 2553) is filed, type or print “FORM 1128 (or FORM 2553) BACK-UP ELECTION” at the top of Form 8716. Form 1040 x Activating election. Form 1040 x   A partnership or S corporation activates its back-up election by filing the return required and making the required payment with Form 8752. Form 1040 x The due date for filing Form 8752 and making the payment is the later of the following dates. Form 1040 x May 15 of the calendar year following the calendar year in which the applicable election year begins. Form 1040 x 60 days after the partnership or S corporation has been notified by the IRS that the business year request has been denied. Form 1040 x   A PSC activates its back-up election by filing Form 8716 with its original or amended income tax return for the tax year in which the election is first effective and printing on the top of the income tax return, “ACTIVATING BACK-UP ELECTION. Form 1040 x ” 52-53-Week Tax Year A partnership, S corporation, or PSC can use a tax year other than its required tax year if it elects a 52-53-week tax year (discussed earlier) that ends with reference to either its required tax year or a tax year elected under section 444 (discussed earlier). Form 1040 x A newly formed partnership, S corporation, or PSC can adopt a 52-53-week tax year ending with reference to either its required tax year or a tax year elected under section 444 without IRS approval. Form 1040 x However, if the entity wishes to change to a 52-53-week tax year or change from a 52-53-week tax year that references a particular month to a non-52-53-week tax year that ends on the last day of that month, it must request IRS approval by filing Form 1128. Form 1040 x Business Purpose Tax Year A partnership, S corporation, or PSC establishes the business purpose for a tax year by filing Form 1128. Form 1040 x See the Instructions for Form 1128 for details. Form 1040 x Corporations (Other Than S Corporations and PSCs) A new corporation establishes its tax year when it files its first tax return. Form 1040 x A newly reactivated corporation that has been inactive for a number of years is treated as a new taxpayer for the purpose of adopting a tax year. Form 1040 x An S corporation or a PSC must use the required tax year rules, discussed earlier, to establish a tax year. Form 1040 x Generally, a corporation that wants to change its tax year must obtain approval from the IRS under either the: (a) automatic approval procedures; or (b) ruling request procedures. Form 1040 x See the Instructions for Form 1128 for details. Form 1040 x Accounting Methods An accounting method is a set of rules used to determine when income and expenses are reported on your tax return. Form 1040 x Your accounting method includes not only your overall method of accounting, but also the accounting treatment you use for any material item. Form 1040 x You choose an accounting method when you file your first tax return. Form 1040 x If you later want to change your accounting method, you must get IRS approval. Form 1040 x See Change in Accounting Method, later. Form 1040 x No single accounting method is required of all taxpayers. Form 1040 x You must use a system that clearly reflects your income and expenses and you must maintain records that will enable you to file a correct return. Form 1040 x In addition to your permanent accounting books, you must keep any other records necessary to support the entries on your books and tax returns. Form 1040 x You must use the same accounting method from year to year. Form 1040 x An accounting method clearly reflects income only if all items of gross income and expenses are treated the same from year to year. Form 1040 x If you do not regularly use an accounting method that clearly reflects your income, your income will be refigured under the method that, in the opinion of the IRS, does clearly reflect income. Form 1040 x Methods you can use. Form 1040 x   In general, you can compute your taxable income under any of the following accounting methods. Form 1040 x Cash method. Form 1040 x Accrual method. Form 1040 x Special methods of accounting for certain items of income and expenses. Form 1040 x A hybrid method which combines elements of two or more of the above accounting methods. Form 1040 x The cash and accrual methods of accounting are explained later. Form 1040 x Special methods. Form 1040 x   This publication does not discuss special methods of accounting for certain items of income or expenses. Form 1040 x For information on reporting income using one of the long-term contract methods, see section 460 of the Internal Revenue Code and the related regulations. Form 1040 x The following publications also discuss special methods of reporting income or expenses. Form 1040 x Publication 225, Farmer's Tax Guide. Form 1040 x Publication 535, Business Expenses. Form 1040 x Publication 537, Installment Sales. Form 1040 x Publication 946, How To Depreciate Property. Form 1040 x Hybrid method. Form 1040 x   Generally, you can use any combination of cash, accrual, and special methods of accounting if the combination clearly reflects your income and you use it consistently. Form 1040 x However, the following restrictions apply. Form 1040 x If an inventory is necessary to account for your income, you must use an accrual method for purchases and sales. Form 1040 x See Exceptions under Inventories, later. Form 1040 x Generally, you can use the cash method for all other items of income and expenses. Form 1040 x See Inventories, later. Form 1040 x If you use the cash method for reporting your income, you must use the cash method for reporting your expenses. Form 1040 x If you use an accrual method for reporting your expenses, you must use an accrual method for figuring your income. Form 1040 x Any combination that includes the cash method is treated as the cash method for purposes of section 448 of the Internal Revenue Code. Form 1040 x Business and personal items. Form 1040 x   You can account for business and personal items using different accounting methods. Form 1040 x For example, you can determine your business income and expenses under an accrual method, even if you use the cash method to figure personal items. Form 1040 x Two or more businesses. Form 1040 x   If you operate two or more separate and distinct businesses, you can use a different accounting method for each business. Form 1040 x No business is separate and distinct, unless a complete and separate set of books and records is maintained for each business. Form 1040 x Note. Form 1040 x If you use different accounting methods to create or shift profits or losses between businesses (for example, through inventory adjustments, sales, purchases, or expenses) so that income is not clearly reflected, the businesses will not be considered separate and distinct. Form 1040 x Cash Method Most individuals and many small businesses use the cash method of accounting. Form 1040 x Generally, if you produce, purchase, or sell merchandise, you must keep an inventory and use an accrual method for sales and purchases of merchandise. Form 1040 x See Inventories, later, for exceptions to this rule. Form 1040 x Income Under the cash method, you include in your gross income all items of income you actually or constructively receive during the tax year. Form 1040 x If you receive property and services, you must include their fair market value (FMV) in income. Form 1040 x Constructive receipt. Form 1040 x   Income is constructively received when an amount is credited to your account or made available to you without restriction. Form 1040 x You need not have possession of it. Form 1040 x If you authorize someone to be your agent and receive income for you, you are considered to have received it when your agent receives it. Form 1040 x Income is not constructively received if your control of its receipt is subject to substantial restrictions or limitations. Form 1040 x Example. Form 1040 x You are a calendar year taxpayer. Form 1040 x Your bank credited, and made available, interest to your bank account in December 2012. Form 1040 x You did not withdraw it or enter it into your books until 2013. Form 1040 x You must include the amount in gross income for 2012, the year you constructively received it. Form 1040 x You cannot hold checks or postpone taking possession of similar property from one tax year to another to postpone paying tax on the income. Form 1040 x You must report the income in the year the property is received or made available to you without restriction. Form 1040 x Expenses Under the cash method, generally, you deduct expenses in the tax year in which you actually pay them. Form 1040 x This includes business expenses for which you contest liability. Form 1040 x However, you may not be able to deduct an expense paid in advance. Form 1040 x Instead, you may be required to capitalize certain costs, as explained later under Uniform Capitalization Rules. Form 1040 x Expense paid in advance. Form 1040 x   An expense you pay in advance is deductible only in the year to which it applies, unless the expense qualifies for the 12-month rule. Form 1040 x   Under the 12-month rule, a taxpayer is not required to capitalize amounts paid to create certain rights or benefits for the taxpayer that do not extend beyond the earlier of the following. Form 1040 x 12 months after the right or benefit begins, or The end of the tax year after the tax year in which payment is made. Form 1040 x   If you have not been applying the general rule (an expense paid in advance is deductible only in the year to which it applies) and/or the 12-month rule to the expenses you paid in advance, you must obtain approval from the IRS before using the general rule and/or the 12-month rule. Form 1040 x See Change in Accounting Method, later. Form 1040 x Example 1. Form 1040 x You are a calendar year taxpayer and pay $3,000 in 2012 for a business insurance policy that is effective for three years (36 months), beginning on July 1, 2012. Form 1040 x The general rule that an expense paid in advance is deductible only in the year to which it applies is applicable to this payment because the payment does not qualify for the 12-month rule. Form 1040 x Therefore, only $500 (6/36 x $3,000) is deductible in 2012, $1,000 (12/36 x $3,000) is deductible in 2013, $1,000 (12/36 x $3,000) is deductible in 2014, and the remaining $500 is deductible in 2015. Form 1040 x Example 2. Form 1040 x You are a calendar year taxpayer and pay $10,000 on July 1, 2012, for a business insurance policy that is effective for only one year beginning on July 1, 2012. Form 1040 x The 12-month rule applies. Form 1040 x Therefore, the full $10,000 is deductible in 2012. Form 1040 x Excluded Entities The following entities cannot use the cash method, including any combination of methods that includes the cash method. Form 1040 x (See Special rules for farming businesses, later. Form 1040 x ) A corporation (other than an S corporation) with average annual gross receipts exceeding $5 million. Form 1040 x See Gross receipts test, below. Form 1040 x A partnership with a corporation (other than an S corporation) as a partner, and with the partnership having average annual gross receipts exceeding $5 million. Form 1040 x See Gross receipts test, below. Form 1040 x A tax shelter. Form 1040 x Exceptions The following entities are not prohibited from using the cash method of accounting. Form 1040 x Any corporation or partnership, other than a tax shelter, that meets the gross receipts test for all tax years after 1985. Form 1040 x A qualified personal service corporation (PSC). Form 1040 x Gross receipts test. Form 1040 x   A corporation or partnership, other than a tax shelter, that meets the gross receipts test can generally use the cash method. Form 1040 x A corporation or a partnership meets the test if, for each prior tax year beginning after 1985, its average annual gross receipts are $5 million or less. Form 1040 x    An entity's average annual gross receipts for a prior tax year is determined by: Adding the gross receipts for that tax year and the 2 preceding tax years; and Dividing the total by 3. Form 1040 x See Gross receipts test for qualifying taxpayers, for more information. Form 1040 x Generally, a partnership applies the test at the partnership level. Form 1040 x Gross receipts for a short tax year are annualized. Form 1040 x Aggregation rules. Form 1040 x   Organizations that are members of an affiliated service group or a controlled group of corporations treated as a single employer for tax purposes are required to aggregate their gross receipts to determine whether the gross receipts test is met. Form 1040 x Change to accrual method. Form 1040 x   A corporation or partnership that fails to meet the gross receipts test for any tax year is prohibited from using the cash method and must change to an accrual method of accounting, effective for the tax year in which the entity fails to meet this test. Form 1040 x Special rules for farming businesses. Form 1040 x   Generally, a taxpayer engaged in the trade or business of farming is allowed to use the cash method for its farming business. Form 1040 x However, certain corporations (other than S corporations) and partnerships that have a partner that is a corporation must use an accrual method for their farming business. Form 1040 x For this purpose, farming does not include the operation of a nursery or sod farm or the raising or harvesting of trees (other than fruit and nut trees). Form 1040 x   There is an exception to the requirement to use an accrual method for corporations with gross receipts of $1 million or less for each prior tax year after 1975. Form 1040 x For family corporations engaged in farming, the exception applies if gross receipts were $25 million or less for each prior tax year after 1985. Form 1040 x See chapter 2 of Publication 225, Farmer's Tax Guide, for more information. Form 1040 x Qualified PSC. Form 1040 x   A PSC that meets the following function and ownership tests can use the cash method. Form 1040 x Function test. Form 1040 x   A corporation meets the function test if at least 95% of its activities are in the performance of services in the fields of health, veterinary services, law, engineering (including surveying and mapping), architecture, accounting, actuarial science, performing arts, or consulting. Form 1040 x Ownership test. Form 1040 x   A corporation meets the ownership test if at least 95% of its stock is owned, directly or indirectly, at all times during the year by one or more of the following. Form 1040 x Employees performing services for the corporation in a field qualifying under the function test. Form 1040 x Retired employees who had performed services in those fields. Form 1040 x The estate of an employee described in (1) or (2). Form 1040 x Any other person who acquired the stock by reason of the death of an employee referred to in (1) or (2), but only for the 2-year period beginning on the date of death. Form 1040 x   Indirect ownership is generally taken into account if the stock is owned indirectly through one or more partnerships, S corporations, or qualified PSCs. Form 1040 x Stock owned by one of these entities is considered owned by the entity's owners in proportion to their ownership interest in that entity. Form 1040 x Other forms of indirect stock ownership, such as stock owned by family members, are generally not considered when determining if the ownership test is met. Form 1040 x   For purposes of the ownership test, a person is not considered an employee of a corporation unless that person performs more than minimal services for the corporation. Form 1040 x Change to accrual method. Form 1040 x   A corporation that fails to meet the function test for any tax year; or fails to meet the ownership test at any time during any tax year must change to an accrual method of accounting, effective for the year in which the corporation fails to meet either test. Form 1040 x A corporation that fails to meet the function test or the ownership test is not treated as a qualified PSC for any part of that tax year. Form 1040 x Accrual Method Under the accrual method of accounting, generally you report income in the year it is earned and deduct or capitalize expenses in the year incurred. Form 1040 x The purpose of an accrual method of accounting is to match income and expenses in the correct year. Form 1040 x Income Generally, you include an amount in gross income for the tax year in which all events that fix your right to receive the income have occurred and you can determine the amount with reasonable accuracy. Form 1040 x Under this rule, you report an amount in your gross income on the earliest of the following dates. Form 1040 x When you receive payment. Form 1040 x When the income amount is due to you. Form 1040 x When you earn the income. Form 1040 x When title has passed. Form 1040 x Estimated income. Form 1040 x   If you include a reasonably estimated amount in gross income and later determine the exact amount is different, take the difference into account in the tax year you make that determination. Form 1040 x Change in payment schedule. Form 1040 x   If you perform services for a basic rate specified in a contract, you must accrue the income at the basic rate, even if you agree to receive payments at a reduced rate. Form 1040 x Continue this procedure until you complete the services, then account for the difference. Form 1040 x Advance Payment for Services Generally, you report an advance payment for services to be performed in a later tax year as income in the year you receive the payment. Form 1040 x However, if you receive an advance payment for services you agree to perform by the end of the next tax year, you can elect to postpone including the advance payment in income until the next tax year. Form 1040 x However, you cannot postpone including any payment beyond that tax year. Form 1040 x Service agreement. Form 1040 x   You can postpone reporting income from an advance payment you receive for a service agreement on property you sell, lease, build, install, or construct. Form 1040 x This includes an agreement providing for incidental replacement of parts or materials. Form 1040 x However, this applies only if you offer the property without a service agreement in the normal course of business. Form 1040 x Postponement not allowed. Form 1040 x   Generally, one cannot postpone including an advance payment in income for services if either of the following applies. Form 1040 x You are to perform any part of the service after the end of the tax year immediately following the year you receive the advance payment. Form 1040 x You are to perform any part of the service at any unspecified future date that may be after the end of the tax year immediately following the year you receive the advance payment. Form 1040 x Examples. Form 1040 x   In each of the following examples, assume the tax year is a calendar year and that the accrual method of accounting is used. Form 1040 x Example 1. Form 1040 x You manufacture, sell, and service computers. Form 1040 x You received payment in 2012 for a one-year contingent service contract on a computer you sold. Form 1040 x You can postpone including in income the part of the payment you did not earn in 2012 if, in the normal course of your business, you offer computers for sale without a contingent service contract. Form 1040 x Example 2. Form 1040 x You are in the television repair business. Form 1040 x You received payments in 2012 for one-year contracts under which you agree to repair or replace certain parts that fail to function properly in television sets manufactured and sold by unrelated parties. Form 1040 x You include the payments in gross income as you earn them. Form 1040 x Example 3. Form 1040 x You own a dance studio. Form 1040 x On October 1, 2012, you receive payment for a one-year contract for 48 one-hour lessons beginning on that date. Form 1040 x You give eight lessons in 2012. Form 1040 x Under this method of including advance payments, you must include one-sixth (8/48) of the payment in income for 2012, and five-sixths (40/48) of the payment in 2013, even if you do not give all the lessons by the end of 2013. Form 1040 x Example 4. Form 1040 x Assume the same facts as in Example 3, except the payment is for a two-year contract for 96 lessons. Form 1040 x You must include the entire payment in income in 2012 since part of the services may be performed after the following year. Form 1040 x Guarantee or warranty. Form 1040 x   Generally, you cannot postpone reporting income you receive under a guarantee or warranty contract. Form 1040 x Prepaid rent. Form 1040 x   You cannot postpone reporting income from prepaid rent. Form 1040 x Prepaid rent does not include payment for the use of a room or other space when significant service is also provided for the occupant. Form 1040 x You provide significant service when you supply space in a hotel, boarding house, tourist home, motor court, motel, or apartment house that furnishes hotel services. Form 1040 x Books and records. Form 1040 x   Any advance payment you include in gross receipts on your tax return for the year you receive payment must not be less than the payment you include in income for financial reports under the method of accounting used for those reports. Form 1040 x Financial reports include reports to shareholders, partners, beneficiaries, and other proprietors for credit purposes and consolidated financial statements. Form 1040 x IRS approval. Form 1040 x   You must file Form 3115 to obtain IRS approval to change your method of accounting for advance payment for services. Form 1040 x Advance Payment for Sales Special rules apply to including income from advance payments on agreements for future sales or other dispositions of goods held primarily for sale to customers in the ordinary course of your trade or business. Form 1040 x However, the rules do not apply to a payment (or part of a payment) for services that are not an integral part of the main activities covered under the agreement. Form 1040 x An agreement includes a gift certificate that can be redeemed for goods. Form 1040 x Amounts due and payable are considered received. Form 1040 x How to report payments. Form 1040 x   Generally, include an advance payment in income in the year in which you receive it. Form 1040 x However, you can use the alternative method, discussed next. Form 1040 x Alternative method of reporting. Form 1040 x   Under the alternative method, generally include an advance payment in income in the earlier tax year in which you: Include advance payments in gross receipts under the method of accounting you use for tax purposes, or Include any part of advance payments in income for financial reports under the method of accounting used for those reports. Form 1040 x Financial reports include reports to shareholders, partners, beneficiaries, and other proprietors for credit purposes and consolidated financial statements. Form 1040 x Example 1. Form 1040 x You are a retailer. Form 1040 x You use an accrual method of accounting and account for the sale of goods when you ship the goods. Form 1040 x You use this method for both tax and financial reporting purposes. Form 1040 x You can include advance payments in gross receipts for tax purposes in either: (a) the tax year in which you receive the payments; or (b) the tax year in which you ship the goods. Form 1040 x However, see Exception for inventory goods, later. Form 1040 x Example 2. Form 1040 x You are a calendar year taxpayer. Form 1040 x You manufacture household furniture and use an accrual method of accounting. Form 1040 x Under this method, you accrue income for your financial reports when you ship the furniture. Form 1040 x For tax purposes, you do not accrue income until the furniture has been delivered and accepted. Form 1040 x In 2012, you received an advance payment of $8,000 for an order of furniture to be manufactured for a total price of $20,000. Form 1040 x You shipped the furniture to the customer in December 2012, but it was not delivered and accepted until January 2013. Form 1040 x For tax purposes, you include the $8,000 advance payment in gross income for 2012; and include the remaining $12,000 of the contract price in gross income for 2013. Form 1040 x Information schedule. Form 1040 x   If you use the alternative method of reporting advance payments, you must attach a statement with the following information to your tax return each year. Form 1040 x Total advance payments received in the current tax year. Form 1040 x Total advance payments received in earlier tax years and not included in income before the current tax year. Form 1040 x Total payments received in earlier tax years included in income for the current tax year. Form 1040 x Exception for inventory goods. Form 1040 x   If you have an agreement to sell goods properly included in inventory, you can postpone including the advance payment in income until the end of the second tax year following the year you receive an advance payment if, on the last day of the tax year, you meet the following requirements. Form 1040 x You account for the advance payment under the alternative method (discussed earlier). Form 1040 x You have received a substantial advance payment on the agreement (discussed next). Form 1040 x You have enough substantially similar goods on hand, or available through your normal source of supply, to satisfy the agreement. Form 1040 x These rules also apply to an agreement, such as a gift certificate, that can be satisfied with goods that cannot be identified in the tax year you receive an advance payment. Form 1040 x   If you meet these conditions, all advance payments you receive by the end of the second tax year, including payments received in prior years but not reported, must be included in income by the second tax year following the tax year of receipt of substantial advance payments. Form 1040 x You must also deduct in that second year all actual or estimated costs for the goods required to satisfy the agreement. Form 1040 x If you estimated the cost, you must take into account any difference between the estimate and the actual cost when the goods are delivered. Form 1040 x Note. Form 1040 x You must report any advance payments you receive after the second year in the year received. Form 1040 x No further deferral is allowed. Form 1040 x Substantial advance payments. Form 1040 x   Under an agreement for a future sale, you have substantial advance payments if, by the end of the tax year, the total advance payments received during that year and preceding tax years are equal to or more than the total costs reasonably estimated to be includible in inventory because of the agreement. Form 1040 x Example. Form 1040 x You are a calendar year, accrual method taxpayer who accounts for advance payments under the alternative method. Form 1040 x In 2008, you entered into a contract for the sale of goods properly includible in your inventory. Form 1040 x The total contract price is $50,000 and you estimate that your total inventoriable costs for the goods will be $25,000. Form 1040 x You receive the following advance payments under the contract. Form 1040 x 2009 $17,500 2010 10,000 2011 7,500 2012 5,000 2013 5,000 2014 5,000 Total contract price $50,000   Your customer asked you to deliver the goods in 2015. Form 1040 x In your 2010 closing inventory, you had on hand enough of the type of goods specified in the contract to satisfy the contract. Form 1040 x Since the advance payments you had received by the end of 2010 were more than the costs you estimated, the payments are substantial advance payments. Form 1040 x   For 2012, include in income all payments you received by the end of 2012, the second tax year following the tax year in which you received substantial advance payments. Form 1040 x You must include $40,000 in sales for 2012 (the total amounts received from 2009 through 2012) and include in inventory the cost of the goods (or similar goods) on hand. Form 1040 x If no such goods are on hand, then estimate the cost necessary to satisfy the contract. Form 1040 x   No further deferral is allowed. Form 1040 x You must include in gross income the advance payment you receive each remaining year of the contract. Form 1040 x Take into account the difference between any estimated cost of goods sold and the actual cost when you deliver the goods in 2015. Form 1040 x IRS approval. Form 1040 x   You must file Form 3115 to obtain IRS approval to change your method of accounting for advance payments for sales. Form 1040 x Expenses Under an accrual method of accounting, you generally deduct or capitalize a business expense when both the following apply. Form 1040 x The all-events test has been met. Form 1040 x The test is met when: All events have occurred that fix the fact of liability, and The liability can be determined with reasonable accuracy. Form 1040 x Economic performance has occurred. Form 1040 x Economic Performance Generally, you cannot deduct or capitalize a business expense until economic performance occurs. Form 1040 x If your expense is for property or services provided to you, or for your use of property, economic performance occurs as the property or services are provided or the property is used. Form 1040 x If your expense is for property or services you provide to others, economic performance occurs as you provide the property or services. Form 1040 x Example. Form 1040 x You are a calendar year taxpayer. Form 1040 x You buy office supplies in December 2012. Form 1040 x You receive the supplies and the bill in December, but you pay the bill in January 2013. Form 1040 x You can deduct the expense in 2012 because all events have occurred to fix the liability, the amount of the liability can be determined, and economic performance occurred in 2012. Form 1040 x Your office supplies may qualify as a recurring item, discussed later. Form 1040 x If so, you can deduct them in 2012, even if the supplies are not delivered until 2013 (when economic performance occurs). Form 1040 x Workers' compensation and tort liability. Form 1040 x   If you are required to make payments under workers' compensation laws or in satisfaction of any tort liability, economic performance occurs as you make the payments. Form 1040 x If you are required to make payments to a special designated settlement fund established by court order for a tort liability, economic performance occurs as you make the payments. Form 1040 x Taxes. Form 1040 x   Economic performance generally occurs as estimated income tax, property taxes, employment taxes, etc. Form 1040 x are paid. Form 1040 x However, you can elect to treat taxes as a recurring item, discussed later. Form 1040 x You can also elect to ratably accrue real estate taxes. Form 1040 x See chapter 5 of Publication 535 for information about real estate taxes. Form 1040 x Other liabilities. Form 1040 x   Other liabilities for which economic performance occurs as you make payments include liabilities for breach of contract (to the extent of incidental, consequential, and liquidated damages), violation of law, rebates and refunds, awards, prizes, jackpots, insurance, and warranty and service contracts. Form 1040 x Interest. Form 1040 x   Economic performance occurs with the passage of time (as the borrower uses, and the lender forgoes use of, the lender's money) rather than as payments are made. Form 1040 x Compensation for services. Form 1040 x   Generally, economic performance occurs as an employee renders service to the employer. Form 1040 x However, deductions for compensation or other benefits paid to an employee in a year subsequent to economic performance are subject to the rules governing deferred compensation, deferred benefits, and funded welfare benefit plans. Form 1040 x For information on employee benefit programs, see Publication 15-B, Employer's Tax Guide to Fringe Benefits. Form 1040 x Vacation pay. Form 1040 x   You can take a current deduction for vacation pay earned by your employees if you pay it during the year or, if the amount is vested, within 2½ months after the end of the year. Form 1040 x If you pay it later than this, you must deduct it in the year actually paid. Form 1040 x An amount is vested if your right to it cannot be nullified or cancelled. Form 1040 x Exception for recurring items. Form 1040 x   An exception to the economic performance rule allows certain recurring items to be treated as incurred during the tax year even though economic performance has not occurred. Form 1040 x The exception applies if all the following requirements are met. Form 1040 x The all-events test, discussed earlier, is met. Form 1040 x Economic performance occurs by the earlier of the following dates. Form 1040 x 8½ months after the close of the year. Form 1040 x The date you file a timely return (including extensions) for the year. Form 1040 x The item is recurring in nature and you consistently treat similar items as incurred in the tax year in which the all-events test is met. Form 1040 x Either: The item is not material, or Accruing the item in the year in which the all-events test is met results in a better match against income than accruing the item in the year of economic performance. Form 1040 x This exception does not apply to workers' compensation or tort liabilities. Form 1040 x Amended return. Form 1040 x   You may be able to file an amended return and treat a liability as incurred under the recurring item exception. Form 1040 x You can do so if economic performance for the liability occurs after you file your tax return for the year, but within 8½ months after the close of the tax year. Form 1040 x Recurrence and consistency. Form 1040 x   To determine whether an item is recurring and consistently reported, consider the frequency with which the item and similar items are incurred (or expected to be incurred) and how you report these items for tax purposes. Form 1040 x A new expense or an expense not incurred every year can be treated as recurring if it is reasonable to expect that it will be incurred regularly in the future. Form 1040 x Materiality. Form 1040 x   Factors to consider in determining the materiality of a recurring item include the size of the item (both in absolute terms and in relation to your income and other expenses) and the treatment of the item on your financial statements. Form 1040 x   An item considered material for financial statement purposes is also considered material for tax purposes. Form 1040 x However, in certain situations an immaterial item for financial accounting purposes is treated as material for purposes of economic performance. Form 1040 x Matching expenses with income. Form 1040 x   Costs directly associated with the revenue of a period are properly allocable to that period. Form 1040 x To determine whether the accrual of an expense in a particular year results in a better match with the income to which it relates, generally accepted accounting principles (GAAP; visit www. Form 1040 x fasab. Form 1040 x gov/accepted. Form 1040 x html) are an important factor. Form 1040 x   For example, if you report sales income in the year of sale, but you do not ship the goods until the following year, the shipping costs are more properly matched to income in the year of sale than the year the goods are shipped. Form 1040 x Expenses that cannot be practically associated with income of a particular period, such as advertising costs, should be assigned to the period the costs are incurred. Form 1040 x However, the matching requirement is considered met for certain types of expenses. Form 1040 x These expenses include taxes, payments under insurance, warranty, and service contracts, rebates, refunds, awards, prizes, and jackpots. Form 1040 x Expenses Paid in Advance An expense you pay in advance is deductible only in the year to which it applies, unless the expense qualifies for the 12-month rule. Form 1040 x Under the 12-month rule, a taxpayer is not required to capitalize amounts paid to create certain rights or benefits for the taxpayer that do not extend beyond the earlier of the following. Form 1040 x 12 months after the right or benefit begins, or The end of the tax year after the tax year in which payment is made. Form 1040 x If you have not been applying the general rule (an expense paid in advance is deductible only in the year to which it applies) and/or the 12-month rule to the expenses you paid in advance, you must get IRS approval before using the general rule and/or the 12-month rule. Form 1040 x See Change in Accounting Method, later, for information on how to get IRS approval. Form 1040 x See Expense paid in advance under Cash Method, earlier, for examples illustrating the application of the general and 12-month rules. Form 1040 x Related Persons Business expenses and interest owed to a related person who uses the cash method of accounting are not deductible until you make the payment and the corresponding amount is includible in the related person's gross income. Form 1040 x Determine the relationship for this rule as of the end of the tax year for which the expense or interest would otherwise be deductible. Form 1040 x See section 267 of the Internal Revenue Code and Publication 542, Corporations, for the definition of related person. Form 1040 x Inventories An inventory is necessary to clearly show income when the production, purchase, or sale of merchandise is an income-producing factor. Form 1040 x If you must account for an inventory in your business, you must use an accrual method of accounting for your purchases and sales. Form 1040 x However, see Exceptions, next. Form 1040 x See also Accrual Method, earlier. Form 1040 x To figure taxable income, you must value your inventory at the beginning and end of each tax year. Form 1040 x To determine the value, you need a method for identifying the items in your inventory and a method for valuing these items. Form 1040 x See Identifying Cost and Valuing Inventory, later. Form 1040 x The rules for valuing inventory are not the same for all businesses. Form 1040 x The method you use must conform to generally accepted accounting principles for similar businesses and must clearly reflect income. Form 1040 x Your inventory practices must be consistent from year to year. Form 1040 x The rules discussed here apply only if they do not conflict with the uniform capitalization rules of section 263A and the mark-to-market rules of section 475. Form 1040 x Exceptions The following taxpayers can use the cash method of accounting even if they produce, purchase, or sell merchandise. Form 1040 x These taxpayers can also account for inventoriable items as materials and supplies that are not incidental (discussed later). Form 1040 x A qualifying taxpayer under Revenue Procedure 2001-10 on page 272 of Internal Revenue Bulletin 2001-2, available at www. Form 1040 x irs. Form 1040 x gov/pub/irs-irbs/irb01–02. Form 1040 x pdf. Form 1040 x A qualifying small business taxpayer under Revenue Procedure 2002-28, on page 815 of Internal Revenue Bulletin 2002-18, available at www. Form 1040 x irs. Form 1040 x gov/pub/irs-irbs/irb02–18. Form 1040 x pdf. Form 1040 x In addition to the information provided in this publication, you should see the revenue procedures referenced in the list, above, and the instructions for Form 3115 for information you will need to adopt or change to these accounting methods (see Changing methods, later). Form 1040 x Qualifying taxpayer. Form 1040 x   You are a qualifying taxpayer under Revenue Procedure 2001-10 only if: You satisfy the gross receipts test for each prior tax year ending on or after December 17, 1998 (see Gross receipts test for qualifying taxpayers, next). Form 1040 x Your average annual gross receipts for each test year (explained in Step 1, listed next) must be $1 million or less. Form 1040 x You are not a tax shelter as defined under section 448(d)(3) of the Internal Revenue Code. Form 1040 x Gross receipts test for qualifying taxpayers. Form 1040 x   To determine if you meet the gross receipts test for qualifying taxpayers, use the following steps: Step 1. Form 1040 x List each of the test years. Form 1040 x For qualifying taxpayers under Revenue Procedure 2001-10, the test years are each prior tax year ending on or after December 17, 1998. Form 1040 x Step 2. Form 1040 x Determine your average annual gross receipts for each test year listed in Step 1. Form 1040 x Your average annual gross receipts for a tax year is determined by adding the gross receipts for that tax year and the 2 preceding tax years and dividing the total by 3. Form 1040 x Step 3. Form 1040 x You meet the gross receipts test for qualifying taxpayers if your average annual gross receipts for each test year listed in Step 1 is $1 million or less. Form 1040 x Qualifying small business taxpayer. Form 1040 x   You are a qualifying small business taxpayer under Revenue Procedure 2002-28 only if: You satisfy the gross receipts test for each prior tax year ending on or after December 31, 2000 (see Gross receipts test for qualifying small business taxpayers, next). Form 1040 x Your average annual gross receipts for each test year (explained in Step 1, listed next) must be $10 million or less. Form 1040 x You are not prohibited from using the cash method under section 448 of the Internal Revenue Code. Form 1040 x Your principle business activity is an eligible business. Form 1040 x See Eligible business, later. Form 1040 x You have not changed (or have not been required to change) from the cash method because you became ineligible to use the cash method under Revenue Procedure 2002-28. Form 1040 x Note. Form 1040 x Revenue Procedure 2002-28 does not apply to a farming business of a qualifying small business taxpayer. Form 1040 x A taxpayer engaged in the trade or business of farming generally is allowed to use the cash method for any farming business. Form 1040 x See Special rules for farming businesses under Cash Method, earlier. Form 1040 x Gross receipts test for qualifying small business taxpayers. Form 1040 x   To determine if you meet the gross receipts test for qualifying small business taxpayers, use the following steps: Step 1. Form 1040 x List each of the test years. Form 1040 x For qualifying small business taxpayers under Revenue Procedure 2002-28, the test years are each prior tax year ending on or after December 31, 2000. Form 1040 x Step 2. Form 1040 x Determine your average annual gross receipts for each test year listed in Step 1. Form 1040 x Your average annual gross receipts for a tax year is determined by adding the gross receipts for that tax year and the 2 preceding tax years and dividing the total by 3. Form 1040 x Step 3. Form 1040 x You meet the gross receipts test for qualifying small business taxpayers if your average annual gross receipts for each test year listed in Step 1 is $10 million or less. Form 1040 x Eligible business. Form 1040 x   An eligible business is any business for which a qualified small business taxpayer can use the cash method and choose to not keep an inventory. Form 1040 x You have an eligible business if you meet any of the following requirements. Form 1040 x Your principal business activity is described in a North American Industry Classification System (NAICS) code other than any of the following NAICS subsector codes: NAICS codes 211 and 212 (mining activities). Form 1040 x NAICS codes 31-33 (manufacturing). Form 1040 x NAICS code 42 (wholesale trade). Form 1040 x NAICS codes 44-45 (retail trade). Form 1040 x NAICS codes 5111 and 5122 (information industries). Form 1040 x Your principal business activity is the provision of services, including the provision of property incident to those services. Form 1040 x Your principal business activity is the fabrication or modification of tangible personal property upon demand in accordance with customer design or specifications. Form 1040 x   Information about the NAICS codes can be found at http://www. Form 1040 x census. Form 1040 x gov/naics or in the instructions for your federal income tax return. Form 1040 x Gross receipts. Form 1040 x   In general, gross receipts must include all receipts from all your trades or businesses that must be recognized under the method of accounting you used for that tax year for federal income tax purposes. Form 1040 x See the definit
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Defense Finance and Accounting Services (DFAS)

The Defense Finance and Accounting Services oversees payments to Department of Defense servicemembers, employees, vendors and contractors. The Defense Finance and Accounting Services also provides Department of Defense decision makers with business intelligence, finance and accounting information.

Contact the Agency or Department

Website: Defense Finance and Accounting Services (DFAS)

Address: Crystal Mall 3
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Arlington, VA 22240-5291

Phone Number: (703)607-2616

Toll-free: (888)332-7411

The Form 1040 X

Form 1040 x 2. Form 1040 x   Taxable and Nontaxable Income Table of Contents Compensation for Services Retirement Plan DistributionsIndividual Retirement Arrangements (IRAs) Pensions and Annuities Social Security and Equivalent Railroad Retirement BenefitsAre Any of Your Benefits Taxable? How Much Is Taxable? How To Report Your Benefits Lump-Sum Election Repayments More Than Gross Benefits Sickness and Injury BenefitsDisability Pensions Long-Term Care Insurance Contracts Workers' Compensation Other Sickness and Injury Benefits Life Insurance ProceedsInstallments for life. Form 1040 x Surviving spouse. Form 1040 x Endowment Contract Proceeds Accelerated Death Benefits Sale of HomeMaximum Amount of Exclusion Ownership and Use Tests Married Persons Business Use or Rental of Home Reporting the Sale Reverse Mortgages Other ItemsWelfare benefits. Form 1040 x Payments from a state fund for victims of crime. Form 1040 x Home Affordable Modification Program (HAMP). Form 1040 x Mortgage assistance payments. Form 1040 x Payments to reduce cost of winter energy use. Form 1040 x Nutrition Program for the Elderly. Form 1040 x Reemployment Trade Adjustment Assistance (RTAA). Form 1040 x Generally, income is taxable unless it is specifically exempt (not taxed) by law. Form 1040 x Your taxable income may include compensation for services, interest, dividends, rents, royalties, income from partnerships, estate or trust income, gain from sales or exchanges of property, and business income of all kinds. Form 1040 x Under special provisions of the law, certain items are partially or fully exempt from tax. Form 1040 x Provisions that are of special interest to older taxpayers are discussed in this chapter. Form 1040 x Compensation for Services Generally, you must include in gross income everything you receive in payment for personal services. Form 1040 x In addition to wages, salaries, commissions, fees, and tips, this includes other forms of compensation such as fringe benefits and stock options. Form 1040 x You need not receive the compensation in cash for it to be taxable. Form 1040 x Payments you receive in the form of goods or services generally must be included in gross income at their fair market value. Form 1040 x Volunteer work. Form 1040 x   Do not include in your gross income amounts you receive for supportive services or reimbursements for out-of-pocket expenses under any of the following volunteer programs. Form 1040 x Retired Senior Volunteer Program (RSVP). Form 1040 x Foster Grandparent Program. Form 1040 x Senior Companion Program. Form 1040 x Service Corps of Retired Executives (SCORE). Form 1040 x Unemployment compensation. Form 1040 x   You must include in income all unemployment compensation you or your spouse (if married filing jointly) received. Form 1040 x More information. Form 1040 x   See Publication 525, Taxable and Nontaxable Income, for more detailed information on specific types of income. Form 1040 x Retirement Plan Distributions This section summarizes the tax treatment of amounts you receive from traditional individual retirement arrangements (IRA), employee pensions or annuities, and disability pensions or annuities. Form 1040 x A traditional IRA is any IRA that is not a Roth or SIMPLE IRA. Form 1040 x A Roth IRA is an individual retirement plan that can be either an account or an annuity and features nondeductible contributions and tax-free distributions. Form 1040 x A SIMPLE IRA is a tax-favored retirement plan that certain small employers (including self-employed individuals) can set up for the benefit of their employees. Form 1040 x More detailed information can be found in Publication 590, Individual Retirement Arrangements (IRAs), and Publication 575, Pension and Annuity Income. Form 1040 x Individual Retirement Arrangements (IRAs) In general, distributions from a traditional IRA are taxable in the year you receive them. Form 1040 x Exceptions to the general rule are rollovers, tax-free withdrawals of contributions, and the return of nondeductible contributions. Form 1040 x These are discussed in Publication 590. Form 1040 x If you made nondeductible contributions to a traditional IRA, you must file Form 8606, Nondeductible IRAs. Form 1040 x If you do not file Form 8606 with your return, you may have to pay a $50 penalty. Form 1040 x Also, when you receive distributions from your traditional IRA, the amounts will be taxed unless you can show, with satisfactory evidence, that nondeductible contributions were made. Form 1040 x Early distributions. Form 1040 x   Generally, early distributions are amounts distributed from your traditional IRA account or annuity before you are age 59½, or amounts you receive when you cash in retirement bonds before you are age  59½. Form 1040 x You must include early distributions of taxable amounts in your gross income. Form 1040 x These taxable amounts are also subject to an additional 10% tax unless the distribution qualifies for an exception. Form 1040 x For purposes of the additional 10% tax, an IRA is a qualified retirement plan. Form 1040 x For more information about this tax, see Tax on Early Distributions under Pensions and Annuities, later. Form 1040 x After age 59½ and before age 70½. Form 1040 x   After you reach age 59½, you can receive distributions from your traditional IRA without having to pay the 10% additional tax. Form 1040 x Even though you can receive distributions after you reach age 59½, distributions are not required until you reach  age 70½. Form 1040 x Required distributions. Form 1040 x   If you are the owner of a traditional IRA, you generally must receive the entire balance in your IRA or start receiving periodic distributions from your IRA by April 1 of the year following the year in which you reach age 70½. Form 1040 x See When Must You Withdraw Assets? (Required Minimum Distributions) in Publication 590. Form 1040 x If distributions from your traditional IRA(s) are less than the required minimum distribution for the year, you may have to pay a 50% excise tax for that year on the amount not distributed as required. Form 1040 x For purposes of the 50% excise tax, an IRA is a qualified retirement plan. Form 1040 x For more information about this tax, see Tax on Excess Accumulation under Pensions and Annuities, later. Form 1040 x See also Excess Accumulations (Insufficient Distributions) in Publication 590. Form 1040 x Pensions and Annuities Generally, if you did not pay any part of the cost of your employee pension or annuity, and your employer did not withhold part of the cost of the contract from your pay while you worked, the amounts you receive each year are fully taxable. Form 1040 x However, see Insurance Premiums for Retired Public Safety Officers , later. Form 1040 x If you paid part of the cost of your pension or annuity plan (see Cost , later), you can exclude part of each annuity payment from income as a recovery of your cost (investment in the contract). Form 1040 x 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. Form 1040 x The rest of each payment is taxable. Form 1040 x However, see Insurance Premiums for Retired Public Safety Officers , later. Form 1040 x You figure the tax-free part of the payment using one of the following methods. Form 1040 x Simplified Method. Form 1040 x 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). Form 1040 x You cannot use this method if your annuity is paid under a nonqualified plan. Form 1040 x General Rule. Form 1040 x You must use this method if your annuity is paid under a nonqualified plan. Form 1040 x You generally cannot use this method if your annuity is paid under a qualified plan. Form 1040 x Contact your employer or plan administrator to find out if your pension or annuity is paid under a qualified or nonqualified plan. Form 1040 x 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. Form 1040 x Exclusion limit. Form 1040 x   If your annuity starting date is after 1986, the total amount of annuity income you can exclude over the years as a recovery of the cost cannot exceed your total cost. Form 1040 x 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. Form 1040 x This deduction is not subject to the 2%-of-adjusted-gross-income limit on miscellaneous deductions. Form 1040 x   If you contributed to your pension or annuity and your annuity starting date is before 1987, you can continue to take your monthly exclusion for as long as you receive your annuity. Form 1040 x 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. Form 1040 x The total exclusion may be more than your cost. Form 1040 x Cost. Form 1040 x   Before you can figure how much, if any, of your pension or annuity benefits are taxable, you must determine your cost in the plan (your investment in the contract). Form 1040 x Your total cost in the plan includes everything that you paid. Form 1040 x It also includes amounts your employer contributed that were taxable to you when paid. Form 1040 x However, see Foreign employment contributions , later. Form 1040 x   From this total cost, subtract any refunded premiums, rebates, dividends, unrepaid loans, or other tax-free amounts you received by the later of the annuity starting date or the date on which you received your first payment. Form 1040 x   The annuity starting date is the later of the first day of the first period for which you received a payment from the plan or the date on which the plan's obligations became fixed. Form 1040 x    The amount of your contributions to the plan may be shown in box 9b of any Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. Form 1040 x , that you receive. Form 1040 x Foreign employment contributions. Form 1040 x   If you worked abroad, certain amounts your employer paid into your retirement plan that were not includible in your gross income may be considered part of your cost. Form 1040 x For details, see Foreign employment contributions in Publication 575. Form 1040 x Withholding. Form 1040 x   The payer of your pension, profit-sharing, stock bonus, annuity, or deferred compensation plan will withhold income tax on the taxable part of amounts paid to you. Form 1040 x However, you can choose not to have tax withheld on the payments you receive, unless they are eligible rollover distributions. Form 1040 x (These are distributions that are eligible for rollover treatment but are not paid directly to another qualified retirement plan or to a traditional IRA. Form 1040 x ) See Withholding Tax and Estimated Tax and Rollovers in Publication 575 for more information. Form 1040 x   For payments other than eligible rollover distributions, you can tell the payer how much to withhold by filing a Form W-4P, Withholding Certificate for Pension or Annuity Payments. Form 1040 x Simplified Method. Form 1040 x   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. Form 1040 x For an annuity that is payable over the lives of the annuitants, this number is based on the annuitants' ages on the annuity starting date and is determined from a table. Form 1040 x For any other annuity, this number is the number of monthly annuity payments under the contract. Form 1040 x Who must use the Simplified Method. Form 1040 x   You must use the Simplified Method if your annuity starting date is after November 18, 1996, and you receive your pension or annuity payments from a qualified plan or annuity, unless you were at least 75 years old and entitled to at least 5 years of guaranteed payments (defined next). Form 1040 x   In addition, if your annuity starting date is after July 1, 1986, and before November 19, 1996, you could have chosen to use the Simplified Method for payments from a qualified plan, unless you were at least 75 years old and entitled to at least 5 years of guaranteed payments. Form 1040 x If you chose to use the Simplified Method, you must continue to use it each year that you recover part of your cost. Form 1040 x Guaranteed payments. Form 1040 x   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. Form 1040 x 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. Form 1040 x Who cannot use the Simplified Method. Form 1040 x   You cannot use the Simplified Method and 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 you are entitled to at least 5 years of guaranteed payments (defined above). Form 1040 x   In addition, you had to use the General Rule for either circumstance described above if your annuity starting date is after July 1, 1986, and before November 19, 1996. Form 1040 x If you did not have to use the General Rule, you could have chosen to use it. Form 1040 x You also had to use the General Rule for payments from a qualified plan if your annuity starting date is before July 2, 1986, and you did not qualify to use the Three-Year Rule. Form 1040 x   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. Form 1040 x   Unless your annuity starting date was before 1987, once you have recovered all of your non-taxable investment, all of each remaining payment you receive is fully taxable. Form 1040 x Once your remaining payments are fully taxable, there is no longer a concern with the General Rule or Simplified Method. Form 1040 x   Complete information on the General Rule, including the actuarial tables you need, is contained in Publication 939, General Rule for Pensions and Annuities. Form 1040 x How to use the Simplified Method. Form 1040 x   Complete the Simplified Method Worksheet in the Form 1040, Form 1040A, or Form 1040NR instructions or in Publication 575 to figure your taxable annuity for 2013. Form 1040 x Be sure to keep the completed worksheet; it will help you figure your taxable annuity next year. Form 1040 x   To complete line 3 of the worksheet, you must determine the total number of expected monthly payments for your annuity. Form 1040 x How you do this depends on whether the annuity is for a single life, multiple lives, or a fixed period. Form 1040 x 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. Form 1040 x    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. Form 1040 x Instead, enter the amount from line 4 of last year's worksheet on line 4 of this year's worksheet. Form 1040 x Single-life annuity. Form 1040 x   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. Form 1040 x Enter on line 3 the number shown for your age on your annuity starting date. Form 1040 x This number will differ depending on whether your annuity starting date is before November 19, 1996, or after November 18, 1996. Form 1040 x Multiple-lives annuity. Form 1040 x   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. Form 1040 x Enter on line 3 the number shown for the annuitants' combined ages on the annuity starting date. Form 1040 x 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. Form 1040 x 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. Form 1040 x Do not treat as a survivor annuitant anyone whose entitlement to payments depends on an event other than the primary annuitant's death. Form 1040 x   However, if your annuity starting date is before 1998, do not use Table 2 and do not combine the annuitants' ages. Form 1040 x 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. Form 1040 x This number will differ depending on whether your annuity starting date is before November 19, 1996, or after November 18, 1996. Form 1040 x Fixed-period annuities. Form 1040 x   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. Form 1040 x Line 6. Form 1040 x   The amount on line 6 should include all amounts that could have been recovered in prior years. Form 1040 x If you did not recover an amount in a prior year, you may be able to amend your returns for the affected years. Form 1040 x    Be sure to keep a copy of the completed worksheet; it will help you figure your taxable annuity in later years. Form 1040 x Example. Form 1040 x Bill Smith, age 65, began receiving retirement benefits in 2013, under a joint and survivor annuity. Form 1040 x Bill's annuity starting date is January 1, 2013. Form 1040 x The benefits are to be paid over the joint lives of Bill and his wife, Kathy, age 65. Form 1040 x Bill had contributed $31,000 to a qualified plan and had received no distributions before the annuity starting date. Form 1040 x 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. Form 1040 x 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. Form 1040 x See the illustrated Worksheet 2-A, Simplified Method Worksheet, later. Form 1040 x You can find a blank version of this worksheet in Publication 575. Form 1040 x (The references in the illustrated worksheet are to sections in Publication 575). Form 1040 x His annuity is payable over the lives of more than one annuitant, so Bill uses his and Kathy's combined ages, 130 (65 + 65), and Table 2 at the bottom of the worksheet in completing line 3 of the worksheet and finds the line 3 amount to be 310. Form 1040 x Bill's tax-free monthly amount is $100 ($31,000 ÷ 310 as shown on line 4 of the worksheet). Form 1040 x Upon Bill's death, if Bill has not recovered the full $31,000 investment, Kathy will also exclude $100 from her $600 monthly payment. Form 1040 x The full amount of any annuity payments received after 310 payments are paid must generally be included in gross income. Form 1040 x 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. Form 1040 x This deduction is not subject to the 2%-of-adjusted-gross-income limit. Form 1040 x Worksheet 2-A. Form 1040 x Simplified Method Worksheet—Illustrated 1. Form 1040 x Enter the total pension or annuity payments received this year. Form 1040 x Also, add this amount to the total for Form 1040, line 16a; Form 1040A, line 12a; or Form 1040NR, line 17a 1. Form 1040 x $ 14,400 2. Form 1040 x Enter your cost in the plan (contract) at the annuity starting date plus any death benefit exclusion* See Cost (Investment in the Contract), earlier 2. Form 1040 x 31,000   Note. Form 1040 x 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). Form 1040 x Otherwise, go to line 3. Form 1040 x     3. Form 1040 x Enter the appropriate number from Table 1 below. Form 1040 x 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. Form 1040 x 310 4. Form 1040 x Divide line 2 by the number on line 3 4. Form 1040 x 100 5. Form 1040 x Multiply line 4 by the number of months for which this year's payments were made. Form 1040 x If your annuity starting date was before 1987, enter this amount on line 8 below and skip lines 6, 7, 10, and 11. Form 1040 x Otherwise, go to line 6 5. Form 1040 x 1,200 6. Form 1040 x Enter any amount previously recovered tax free in years after 1986. Form 1040 x This is the amount shown on line 10 of your worksheet for last year 6. Form 1040 x 0 7. Form 1040 x Subtract line 6 from line 2 7. Form 1040 x 31,000 8. Form 1040 x Enter the smaller of line 5 or line 7 8. Form 1040 x 1,200 9. Form 1040 x Taxable amount for year. Form 1040 x Subtract line 8 from line 1. Form 1040 x Enter the result, but not less than zero. Form 1040 x Also, add this amount to the total for Form 1040, line 16b; Form 1040A, line 12b; or Form 1040NR, line 17b. Form 1040 x Note. Form 1040 x If your Form 1099-R shows a larger taxable amount, use the amount figured on this line instead. Form 1040 x 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. Form 1040 x 9. Form 1040 x $ 13,200 10. Form 1040 x Was your annuity starting date before 1987? □ Yes. Form 1040 x STOP. Form 1040 x Do not complete the rest of this worksheet. Form 1040 x  ☑ No. Form 1040 x Add lines 6 and 8. Form 1040 x This is the amount you have recovered tax free through 2013. Form 1040 x You will need this number if you need to fill out this worksheet next year. Form 1040 x 10. Form 1040 x 1,200 11. Form 1040 x Balance of cost to be recovered. Form 1040 x Subtract line 10 from line 2. Form 1040 x If zero, you will not have to complete this worksheet next year. Form 1040 x The payments you receive next year will generally be fully taxable 11. Form 1040 x $ 29,800 * A death benefit exclusion (up to $5,000) applied to certain benefits received by employees who died before August 21, 1996. Form 1040 x   Table 1 for Line 3 Above       AND your annuity starting date was—   IF your age on your annuity starting date was . Form 1040 x . Form 1040 x . Form 1040 x   BEFORE November 19, 1996, enter on line 3 . Form 1040 x . Form 1040 x . Form 1040 x AFTER November 18, 1996, enter on line 3 . Form 1040 x . Form 1040 x . Form 1040 x   55 or under 300 360   56-60 260 310   61-65 240 260   66-70 170 210   71 or over 120 160 Table 2 for Line 3 Above   IF the annuitants' combined ages on your annuity starting date were . Form 1040 x . Form 1040 x . Form 1040 x   THEN enter on line 3 . Form 1040 x . Form 1040 x . Form 1040 x         110 or under   410         111-120   360         121-130   310         131-140   260         141 or over   210       Survivors of retirees. Form 1040 x   Benefits paid to you as a survivor under a joint and survivor annuity must be included in your gross income in the same way the retiree would have included them in gross income. Form 1040 x   If you receive a survivor annuity because of the death of a retiree who had reported the annuity under the Three-Year Rule, include the total received in your income. Form 1040 x The retiree's cost has already been recovered tax free. Form 1040 x   If the retiree was reporting the annuity payments under the General Rule, you must apply the same exclusion percentage the retiree used to your initial payment called for in the contract. Form 1040 x The resulting tax-free amount will then remain fixed. Form 1040 x Any increases in the survivor annuity are fully taxable. Form 1040 x   If the retiree was reporting the annuity payments under the Simplified Method, the part of each payment that is tax free is the same as the tax-free amount figured by the retiree at the annuity starting date. Form 1040 x See Simplified Method , earlier. Form 1040 x How to report. Form 1040 x   If you file Form 1040, report your total annuity on line 16a, and the taxable part on line 16b. Form 1040 x If your pension or annuity is fully taxable, enter it on line 16b. Form 1040 x Do not make an entry on line 16a. Form 1040 x   If you file Form 1040A, report your total annuity on line 12a, and the taxable part on line 12b. Form 1040 x If your pension or annuity is fully taxable, enter it on line 12b. Form 1040 x Do not make an entry on line 12a. Form 1040 x   If you file Form 1040NR, report your total annuity on line 17a, and the taxable part on line 17b. Form 1040 x If your pension or annuity is fully taxable, enter it on line 17b. Form 1040 x Do not make an entry on line 17a. Form 1040 x Example. Form 1040 x You are a Form 1040 filer and you received monthly payments totaling $1,200 (12 months x $100) during 2013 from a pension plan that was completely financed by your employer. Form 1040 x You had paid no tax on the payments that your employer made to the plan, and the payments were not used to pay for accident, health, or long-term care insurance premiums (as discussed later under Insurance Premiums for Retired Public Safety Officers ). Form 1040 x The entire $1,200 is taxable. Form 1040 x You include $1,200 only on Form 1040, line 16b. Form 1040 x Joint return. Form 1040 x   If you file a joint return and you and your spouse each receive one or more pensions or annuities, report the total of the pensions and annuities on line 16a of Form 1040, line 12a of Form 1040A, or line 17a of Form 1040NR. Form 1040 x Report the total of the taxable parts on line 16b of Form 1040, line 12b of Form 1040A, or line 17b of Form 1040NR. Form 1040 x Form 1099-R. Form 1040 x   You should receive a Form 1099-R for your pension or annuity. Form 1040 x Form 1099-R shows your pension or annuity for the year and any income tax withheld. Form 1040 x You should receive a Form W-2 if you receive distributions from certain nonqualified plans. Form 1040 x You must attach Forms 1099-R or Forms W-2 to your 2013 tax return if federal income tax was withheld. Form 1040 x Generally, you should be sent these forms by January 31, 2014. Form 1040 x Nonperiodic Distributions If you receive a nonperiodic distribution from your retirement plan, you may be able to exclude all or part of it from your income as a recovery of your cost. Form 1040 x Nonperiodic distributions include cash withdrawals, distributions of current earnings (dividends) on your investment, and certain loans. Form 1040 x For information on how to figure the taxable amount of a nonperiodic distribution, see Taxation of Nonperiodic Payments in Publication 575. Form 1040 x The taxable part of a nonperiodic distribution may be subject to an additional 10% tax. Form 1040 x See Tax on Early Distributions, later. Form 1040 x Lump-sum distributions. Form 1040 x   If you receive a lump-sum distribution from a qualified employee plan or qualified employee annuity and the plan participant was born before January 2, 1936, you may be able to elect optional methods of figuring the tax on the distribution. Form 1040 x The part from active participation in the plan before 1974 may qualify as capital gain subject to a 20% tax rate. Form 1040 x The part from participation after 1973 (and any part from participation before 1974 that you do not report as capital gain) is ordinary income. Form 1040 x You may be able to use the 10-year tax option to figure tax on the ordinary income part. Form 1040 x Form 1099-R. Form 1040 x   If you receive a total distribution from a plan, you should receive a Form 1099-R. Form 1040 x If the distribution qualifies as a lump-sum distribution, box 3 shows the capital gain part of the distribution. Form 1040 x The amount in box 2a, Taxable amount, minus the amount in box 3, Capital gain, is the ordinary income part. Form 1040 x More information. Form 1040 x   For more detailed information on lump-sum distributions, see Publication 575 or Form 4972, Tax on Lump-Sum Distributions. Form 1040 x Tax on Early Distributions Most distributions you receive from your qualified retirement plan and nonqualified annuity contracts before you reach age 59½ are subject to an additional tax of 10%. Form 1040 x The tax applies to the taxable part of the distribution. Form 1040 x For this purpose, a qualified retirement plan is: A qualified employee plan (including a qualified cash or deferred arrangement (CODA) under Internal Revenue Code section 401(k)), A qualified employee annuity plan, A tax-sheltered annuity plan (403(b) plan), or An eligible state or local government section 457 deferred compensation plan (to the extent that any distribution is attributable to amounts the plan received in a direct transfer or rollover from one of the other plans listed here or an IRA). Form 1040 x  An IRA is also a qualified retirement plan for purposes of this tax. Form 1040 x General exceptions to tax. Form 1040 x   The early distribution tax does not apply to any distributions that are: Made as part of a series of substantially equal periodic payments (made at least annually) for your life (or life expectancy) or the joint lives (or joint life expectancies) of you and your designated beneficiary (if from a qualified retirement plan, the payments must begin after separation from service), Made because you are totally and permanently disabled, or Made on or after the death of the plan participant or contract holder. Form 1040 x Additional exceptions. Form 1040 x   There are additional exceptions to the early distribution tax for certain distributions from qualified retirement plans and nonqualified annuity contracts. Form 1040 x See Publication 575 for details. Form 1040 x Reporting tax. Form 1040 x   If you owe only the tax on early distributions and distribution code 1 (early distribution, no known exception) is correctly shown in Form 1099-R, box 7, multiply the taxable part of the early distribution by 10% (. Form 1040 x 10) and enter the result on Form 1040, line 58, or Form 1040NR, line 56. Form 1040 x See the instructions for line 58 of Form 1040 or line 56 of Form 1040NR for more information about reporting the early distribution tax. Form 1040 x Tax on Excess Accumulation To make sure that most of your retirement benefits are paid to you during your lifetime, rather than to your beneficiaries after your death, the payments that you receive from qualified retirement plans must begin no later than your required beginning date. Form 1040 x Unless the rule for 5% owners applies, this is generally April 1 of the year that follows the later of: The calendar year in which you reach age 70½, or The calendar year in which you retire from employment with the employer maintaining the plan. Form 1040 x However, your plan may require you to begin to receive payments by April 1 of the year that follows the year in which you reach 70½, even if you have not retired. Form 1040 x For this purpose, a qualified retirement plan includes: A qualified employee plan, A qualified employee annuity plan, An eligible section 457 deferred compensation plan, or A tax-sheltered annuity plan (403(b) plan) (for benefits accruing after 1986). Form 1040 x  An IRA is also a qualified retirement plan for purposes of this tax. Form 1040 x An excess accumulation is the undistributed remainder of the required minimum distribution that was left in your qualified retirement plan. Form 1040 x 5% owners. Form 1040 x   If you own (or are considered to own under section 318 of the Internal Revenue Code) more than 5% of the company maintaining your qualified retirement plan, you must begin to receive distributions from the plan by April 1 of the year after the calendar year in which you reach age 70½. Form 1040 x See Publication 575 for more information. Form 1040 x Amount of tax. Form 1040 x   If you do not receive the required minimum distribution, you are subject to an additional tax. Form 1040 x The tax equals 50% of the difference between the amount that must be distributed and the amount that was distributed during the tax year. Form 1040 x You can get this excise tax excused if you establish that the shortfall in distributions was due to reasonable error and that you are taking reasonable steps to remedy the shortfall. Form 1040 x Form 5329. Form 1040 x   You must file a Form 5329 if you owe a tax because you did not receive a minimum required distribution from your qualified retirement plan. Form 1040 x Additional information. Form 1040 x   For more detailed information on the tax on excess accumulation, see Publication 575. Form 1040 x 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. Form 1040 x The premiums can be for coverage for you, your spouse, or dependent(s). Form 1040 x The distribution must be made directly from the plan to the insurance provider. Form 1040 x You can exclude from income the smaller of the amount of the insurance premiums or $3,000. Form 1040 x You can only make this election for amounts that would otherwise be included in your income. Form 1040 x The amount excluded from your income cannot be used to claim a medical expense deduction. Form 1040 x An eligible retirement plan is a governmental plan that is a: Qualified trust, Section 403(a) plan, Section 403(b) annuity, or Section 457(b) plan. Form 1040 x If you make this election, reduce the otherwise taxable amount of your pension or annuity by the amount excluded. Form 1040 x The taxable amount shown in box 2a of any Form 1099-R that you receive does not reflect the exclusion. Form 1040 x Report your total distributions on Form 1040, line 16a; Form 1040A, line 12a; or Form 1040NR, line 17a. Form 1040 x Report the taxable amount on Form 1040, line 16b; Form 1040A, line 12b; or Form 1040NR, line 17b. Form 1040 x Enter “PSO” next to the appropriate line on which you report the taxable amount. Form 1040 x Railroad Retirement Benefits Benefits paid under the Railroad Retirement Act fall into two categories. Form 1040 x These categories are treated differently for income tax purposes. Form 1040 x Social security equivalent benefits. Form 1040 x   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. Form 1040 x This part of the tier 1 benefit is the social security equivalent benefit (SSEB) and is treated for tax purposes like social security benefits. Form 1040 x (See Social Security and Equivalent Railroad Retirement Benefits , later. Form 1040 x ) Non-social security equivalent benefits. Form 1040 x   The second category contains the rest of the tier 1 benefits, called the non-social security equivalent benefit (NSSEB). Form 1040 x It also contains any tier 2 benefit, vested dual benefit (VDB), and supplemental annuity benefit. Form 1040 x This category of benefits is treated as an amount received from a qualified employee plan. Form 1040 x 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. Form 1040 x Vested dual benefits and supplemental annuity benefits are non-contributory pensions and are fully taxable. Form 1040 x More information. Form 1040 x   For more information about railroad retirement benefits, see Publication 575. Form 1040 x Military Retirement Pay Military retirement pay based on age or length of service is taxable and must be included in income as a pension on Form 1040, lines 16a and 16b; on Form 1040A, lines 12a and 12b; or on Form 1040NR, lines 17a and 17b. Form 1040 x But, certain military and government disability pensions that are based on a percentage of disability from active service in the Armed Forces of any country generally are not taxable. Form 1040 x For more information, including information about veterans' benefits and insurance, see Publication 525. Form 1040 x Social Security and Equivalent Railroad Retirement Benefits This discussion explains the federal income tax rules for social security benefits and equivalent tier 1 railroad retirement benefits. Form 1040 x Social security benefits include monthly retirement, survivor, and disability benefits. Form 1040 x They do not include supplemental security income (SSI) payments, which are not taxable. Form 1040 x Equivalent tier 1 railroad retirement benefits are the part of tier 1 benefits that a railroad employee or beneficiary would have been entitled to receive under the social security system. Form 1040 x They commonly are called the social security equivalent benefit (SSEB) portion of tier 1 benefits. Form 1040 x If you received these benefits during 2013, you should have received a Form SSA-1099 or Form RRB-1099 (Form SSA-1042S or Form RRB-1042S if you are a nonresident alien), showing the amount of the benefits. Form 1040 x Are Any of Your Benefits Taxable? Note. Form 1040 x When the term “benefits” is used in this section, it applies to both social security benefits and the SSEB portion of tier 1 railroad retirement benefits. Form 1040 x  To find out whether any of your benefits may be taxable, compare the base amount for your filing status (explained later) with the total of: One-half of your benefits, plus All your other income, including tax-exempt interest. Form 1040 x When making this comparison, do not reduce your other income by any exclusions for: Interest from qualified U. Form 1040 x S. Form 1040 x savings bonds, Employer-provided adoption benefits, Foreign earned income or foreign housing, or Income earned in American Samoa or Puerto Rico by bona fide residents. Form 1040 x Figuring total income. Form 1040 x   To figure the total of one-half of your benefits plus your other income, use Worksheet 2-B. Form 1040 x If that total amount is more than your base amount, part of your benefits may be taxable. Form 1040 x If you are married and file a joint return for 2013, you and your spouse must combine your incomes and your benefits to figure whether any of your combined benefits are taxable. Form 1040 x Even if your spouse did not receive any benefits, you must add your spouse's income to yours to figure whether any of your benefits are taxable. Form 1040 x If the only income you received during 2013 was your social security or the SSEB portion of tier 1 railroad retirement benefits, your benefits generally are not taxable and you probably do not have to file a return. Form 1040 x If you have income in addition to your benefits, you may have to file a return even if none of your benefits are taxable. Form 1040 x Worksheet 2-B. Form 1040 x A Quick Way To Check if Your Benefits May Be Taxable A. Form 1040 x Enter the amount from box 5 of all your Forms SSA-1099 and RRB-1099. Form 1040 x Include  the full amount of any lump-sum benefit payments received in 2013, for 2013 and  earlier years. Form 1040 x (If you received more than one form, combine the amounts from box 5  and enter the total. Form 1040 x ) A. Form 1040 x     Note. Form 1040 x If the amount on line A is zero or less, stop here; none of your benefits are  taxable this year. Form 1040 x     B. Form 1040 x Enter one-half of the amount on line A B. Form 1040 x   C. Form 1040 x Enter your taxable pensions, wages, interest, dividends, and other taxable income C. Form 1040 x   D. Form 1040 x Enter any tax-exempt interest income (such as interest on municipal bonds) plus any exclusions from income for: •Interest from qualified U. Form 1040 x S. Form 1040 x savings bonds, •Employer-provided adoption benefits, •Foreign earned income or foreign housing, or •Income earned in American Samoa or Puerto Rico by bona fide residents D. Form 1040 x   E. Form 1040 x Add lines B, C, and D and enter the total E. Form 1040 x   F. Form 1040 x If you are: •Married filing jointly, enter $32,000 •Single, head of household, qualifying widow(er), or married filing separately and you  lived apart from your spouse for all of 2013, enter $25,000 •Married filing separately and you lived with your spouse at any time during 2013,  enter -0- F. Form 1040 x   G. Form 1040 x Is the amount on line F less than or equal to the amount on line E? □ No. Form 1040 x None of your benefits are taxable this year. Form 1040 x  □ Yes. Form 1040 x Some of your benefits may be taxable. Form 1040 x To figure how much of your benefits  are taxable, see Which worksheet to use under How Much Is Taxable. Form 1040 x     Base Amount Your base amount is: $25,000 if you are single, head of household, or qualifying widow(er) with dependent child, $25,000 if you are married filing separately and lived apart from your spouse for all of 2013, $32,000 if you are married filing jointly, or $0 if you are married filing separately and lived with your spouse at any time during 2013. Form 1040 x Repayment of Benefits Any repayment of benefits you made during 2013 must be subtracted from the gross benefits you received in 2013. Form 1040 x It does not matter whether the repayment was for a benefit you received in 2013 or in an earlier year. Form 1040 x If you repaid more than the gross benefits you received in 2013, see Repayments More Than Gross Benefits , later. Form 1040 x Your gross benefits are shown in box 3 of Form SSA-1099 or Form RRB-1099. Form 1040 x Your repayments are shown in box 4. Form 1040 x The amount in box 5 shows your net benefits for 2013 (box 3 minus box 4). Form 1040 x Use the amount in box 5 to figure whether any of your benefits are taxable. Form 1040 x Tax Withholding and Estimated Tax You can choose to have federal income tax withheld from your social security and/or the SSEB portion of your tier 1 railroad retirement benefits. Form 1040 x If you choose to do this, you must complete a Form W-4V, Voluntary Withholding Request. Form 1040 x If you do not choose to have income tax withheld, you may have to request additional withholding from other income, or pay estimated tax during the year. Form 1040 x For details, see Publication 505, Tax Withholding and Estimated Tax, or the instructions for Form 1040-ES, Estimated Tax for Individuals. Form 1040 x How Much Is Taxable? If part of your benefits is taxable, how much is taxable depends on the total amount of your benefits and other income. Form 1040 x Generally, the higher that total amount, the greater the taxable part of your benefits. Form 1040 x Maximum taxable part. Form 1040 x   The taxable part of your benefits usually cannot be more than 50%. Form 1040 x However, up to 85% of your benefits can be taxable if either of the following situations applies to you. Form 1040 x The total of one-half of your benefits and all your other income is more than $34,000 ($44,000 if you are married filing jointly). Form 1040 x You are married filing separately and lived with your spouse at any time during 2013. Form 1040 x   If you are a nonresident alien, 85% of your benefits are taxable. Form 1040 x However, this income is exempt under some tax treaties. Form 1040 x Which worksheet to use. Form 1040 x   A worksheet to figure your taxable benefits is in the instructions for your Form 1040 or 1040A. Form 1040 x However, you will need to use a different worksheet(s) if any of the following situations applies to you. Form 1040 x You contributed to a traditional individual retirement arrangement (IRA) and you or your spouse were covered by a retirement plan at work. Form 1040 x In this situation, you must use the special worksheets in Appendix B of Publication 590 to figure both your IRA deduction and your taxable benefits. Form 1040 x Situation (1) does not apply and you take one or more of the following exclusions. Form 1040 x Interest from qualified U. Form 1040 x S. Form 1040 x savings bonds (Form 8815). Form 1040 x Employer-provided adoption benefits (Form 8839). Form 1040 x Foreign earned income or housing (Form 2555 or Form 2555-EZ). Form 1040 x Income earned in American Samoa (Form 4563) or Puerto Rico by bona fide residents. Form 1040 x In these situations, you must use Worksheet 1 in Publication 915, Social Security and Equivalent Railroad Retirement Benefits, to figure your taxable benefits. Form 1040 x You received a lump-sum payment for an earlier year. Form 1040 x In this situation, also complete Worksheet 2 or 3 and Worksheet 4 in Publication 915. Form 1040 x See Lump-Sum Election , later. Form 1040 x How To Report Your Benefits If part of your benefits are taxable, you must use Form 1040, Form 1040A, or Form 1040NR. Form 1040 x You cannot use Form 1040EZ. Form 1040 x Reporting on Form 1040. Form 1040 x   Report your net benefits (the amount in box 5 of your Form SSA-1099 or Form RRB-1099) on line 20a and the taxable part on line 20b. Form 1040 x If you are married filing separately and you lived apart from your spouse for all of 2013, also enter “D” to the right of the word “benefits” on line 20a. Form 1040 x Reporting on Form 1040A. Form 1040 x   Report your net benefits (the amount in box 5 of your Form SSA-1099 or Form RRB-1099) on line 14a and the taxable part on line 14b. Form 1040 x If you are married filing separately and you lived apart from your spouse for all of 2013, also enter “D” to the right of the word “benefits” on line 14a. Form 1040 x Reporting on Form 1040NR. Form 1040 x   Report 85% of the total amount of your benefits (box 5 of your Form SSA-1042S or Form RRB-1042S) in the appropriate column of Form 1040NR, Schedule NEC, line 8. Form 1040 x Benefits not taxable. Form 1040 x   If you are filing Form 1040EZ, do not report any benefits on your tax return. Form 1040 x If you are filing Form 1040 or Form 1040A, report your net benefits (the amount in box 5 of your Form SSA-1099 or Form RRB-1099) on Form 1040, line 20a, or Form 1040A, line 14a. Form 1040 x Enter -0- on Form 1040, line 20b, or Form 1040A, line 14b. Form 1040 x If you are married filing separately and you lived apart from your spouse for all of 2013, also enter “D” to the right of the word “benefits” on Form 1040, line 20a, or Form 1040A, line 14a. Form 1040 x Lump-Sum Election You must include the taxable part of a lump-sum (retroactive) payment of benefits received in 2013 in your 2013 income, even if the payment includes benefits for an earlier year. Form 1040 x This type of lump-sum benefit payment should not be confused with the lump-sum death benefit that both the SSA and RRB pay to many of their beneficiaries. Form 1040 x No part of the lump-sum death benefit is subject to tax. Form 1040 x For more information about the lump-sum death benefit, visit the Social Security Administration website at www. Form 1040 x SSA. Form 1040 x gov, and use keyword: death benefit. Form 1040 x Generally, you use your 2013 income to figure the taxable part of the total benefits received in 2013. Form 1040 x However, you may be able to figure the taxable part of a lump-sum payment for an earlier year separately, using your income for the earlier year. Form 1040 x You can elect this method if it lowers your taxable benefits. Form 1040 x See Publication 915 for more information. Form 1040 x Repayments More Than Gross Benefits In some situations, your Form SSA-1099 or Form RRB-1099 will show that the total benefits you repaid (box 4) are more than the gross benefits (box 3) you received. Form 1040 x If this occurred, your net benefits in box 5 will be a negative figure (a figure in parentheses) and none of your benefits will be taxable. Form 1040 x If you receive more than one form, a negative figure in box 5 of one form is used to offset a positive figure in box 5 of another form for that same year. Form 1040 x If you have any questions about this negative figure, contact your local Social Security Administration office or your local U. Form 1040 x S. Form 1040 x Railroad Retirement Board field office. Form 1040 x Joint return. Form 1040 x   If you and your spouse file a joint return, and your Form SSA-1099 or RRB-1099 has a negative figure in box 5 but your spouse's does not, subtract the box 5 amount on your form from the box 5 amount on your spouse's form. Form 1040 x You do this to get your net benefits when figuring if your combined benefits are taxable. Form 1040 x Repayment of benefits received in an earlier year. Form 1040 x   If the total amount shown in box 5 of all of your Forms SSA-1099 and RRB-1099 is a negative figure, you can take an itemized deduction for the part of this negative figure that represents benefits you included in gross income in an earlier year. Form 1040 x   If this deduction is $3,000 or less, it is subject to the 2%-of-adjusted-gross-income limit that applies to certain miscellaneous itemized deductions. Form 1040 x Claim it on Schedule A (Form 1040), line 23. Form 1040 x   If this deduction is more than $3,000, you have to follow some special instructions. Form 1040 x See Publication 915 for those instructions. Form 1040 x Sickness and Injury Benefits Generally, you must report as income any amount you receive for personal injury or sickness through an accident or health plan that is paid for by your employer. Form 1040 x If both you and your employer pay for the plan, only the amount you receive that is due to your employer's payments is reported as income. Form 1040 x However, certain payments may not be taxable to you. Form 1040 x Some of these payments are discussed later in this section. Form 1040 x Also, see Military and Government Disability Pensions and Other Sickness and Injury Benefits in Publication 525. Form 1040 x Cost paid by you. Form 1040 x   If you pay the entire cost of an accident or health plan, do not include any amounts you receive from the plan for personal injury or sickness as income on your tax return. Form 1040 x If your plan reimbursed you for medical expenses you deducted in an earlier year, you may have to include some, or all, of the reimbursement in your income. Form 1040 x Disability Pensions If you retired on disability, you must include in income any disability pension you receive under a plan that is paid for by your employer. Form 1040 x 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. Form 1040 x Minimum retirement age generally is the age at which you can first receive a pension or annuity if you are not disabled. Form 1040 x If you were 65 or older by the end of 2013 or you were retired on permanent and total disability and received taxable disability income, you may be able to claim the credit for the elderly or the disabled. Form 1040 x See Credit for the Elderly or the Disabled, later. Form 1040 x For more information on this credit, see Publication 524, Credit for the Elderly or the Disabled. Form 1040 x Beginning on the day after you reach minimum retirement age, payments you receive are taxable as a pension or annuity. Form 1040 x Report the payments on lines 16a and 16b of Form 1040, on lines 12a and 12b of Form 1040A, or on lines 17a and 17b of Form 1040NR. Form 1040 x For more information on pensions and annuities, see Publication 575. Form 1040 x Retirement and profit-sharing plans. Form 1040 x   If you receive payments from a retirement or profit-sharing plan that does not provide for disability retirement, do not treat the payments as a disability pension. Form 1040 x The payments must be reported as a pension or annuity. Form 1040 x Accrued leave payment. Form 1040 x   If you retire on disability, any lump-sum payment you receive for accrued annual leave is a salary payment. Form 1040 x The payment is not a disability payment. Form 1040 x Include it in your income in the tax year you receive it. Form 1040 x Long-Term Care Insurance Contracts In most cases, long-term care insurance contracts generally are treated as accident and health insurance contracts. Form 1040 x Amounts you receive from them (other than policyholder dividends or premium refunds) generally are excludable from income as amounts received for personal injury or sickness. Form 1040 x However, the amount you can exclude may be limited. Form 1040 x Long-term care insurance contracts are discussed in more detail in Publication 525. Form 1040 x Workers' Compensation Amounts you receive as workers' compensation for an occupational sickness or injury are fully exempt from tax if they are paid under a workers' compensation act or a statute in the nature of a workers' compensation act. Form 1040 x The exemption also applies to your survivors. Form 1040 x The exemption, however, does not apply to retirement plan benefits you receive based on your age, length of service, or prior contributions to the plan, even if you retired because of an occupational sickness or injury. Form 1040 x If part of your workers' compensation reduces your social security or equivalent railroad retirement benefits, that part is considered social security (or equivalent railroad retirement) benefits and may be taxable. Form 1040 x For a discussion of the taxability of these benefits, see Social Security and Equivalent Railroad Retirement Benefits, earlier. Form 1040 x Return to work. Form 1040 x   If you return to work after qualifying for workers' compensation, salary payments you receive for performing light duties are taxable as wages. Form 1040 x Other Sickness and Injury Benefits In addition to disability pensions and annuities, you may receive other payments for sickness or injury. Form 1040 x Federal Employees' Compensation Act (FECA). Form 1040 x   Payments received under this Act for personal injury or sickness, including payments to beneficiaries in case of death, are not taxable. Form 1040 x However, you are taxed on amounts you receive under this Act as continuation of pay for up to 45 days while a claim is being decided. Form 1040 x Report this income on Form 1040, line 7; Form 1040A, line 7; on Form 1040EZ, line 1; or Form 1040NR, line 8. Form 1040 x Also, pay for sick leave while a claim is being processed is taxable and must be included in your income as wages. Form 1040 x    If part of the payments you receive under FECA reduces your social security or equivalent railroad retirement benefits, that part is considered social security (or equivalent railroad retirement) benefits and may be taxable. Form 1040 x For a discussion of the taxability of these benefits, see Social Security and Equivalent Railroad Retirement Benefits, earlier. Form 1040 x Other compensation. Form 1040 x   Many other amounts you receive as compensation for sickness or injury are not taxable. Form 1040 x These include the following amounts. Form 1040 x Benefits you receive under an accident or health insurance policy on which either you paid the premiums or your employer paid the premiums but you had to include them in your income. Form 1040 x Disability benefits you receive for loss of income or earning capacity as a result of injuries under a no-fault car insurance policy. Form 1040 x Compensation you receive for permanent loss or loss of use of a part or function of your body, for your permanent disfigurement, or for such loss or disfigurement suffered by your spouse or dependent(s). Form 1040 x This compensation must be based only on the injury and not on the period of your absence from work. Form 1040 x These benefits are not taxable even if your employer pays for the accident and health plan that provides these benefits. Form 1040 x Life Insurance Proceeds Life insurance proceeds paid to you because of the death of the insured person are not taxable unless the policy was turned over to you for a price. Form 1040 x This is true even if the proceeds were paid under an accident or health insurance policy or an endowment contract. Form 1040 x Proceeds not received in installments. Form 1040 x   If death benefits are paid to you in a lump sum or other than at regular intervals, include in your income only the benefits that are more than the amount payable to you at the time of the insured person's death. Form 1040 x If the benefit payable at death is not specified, you include in your income the benefit payments that are more than the present value of the payments at the time of death. Form 1040 x Proceeds received in installments. Form 1040 x   If you receive life insurance proceeds in installments, you can exclude part of each installment from your income. Form 1040 x   To determine the excluded part, divide the amount held by the insurance company (generally the total lump sum payable at the death of the insured person) by the number of installments to be paid. Form 1040 x Include anything over this excluded part in your income as interest. Form 1040 x Installments for life. Form 1040 x   If, as the beneficiary under an insurance contract, you are entitled to receive the proceeds in installments for the rest of your life without a refund or period-certain guarantee, you figure the excluded part of each installment by dividing the amount held by the insurance company by your life expectancy. Form 1040 x If there is a refund or period-certain guarantee, the amount held by the insurance company for this purpose is reduced by the actuarial value of the guarantee. Form 1040 x Surviving spouse. Form 1040 x   If your spouse died before October 23, 1986, and insurance proceeds paid to you because of the death of your spouse are received in installments, you can exclude, in any year, up to $1,000 of the interest included in the installments. Form 1040 x If you remarry, you can continue to take the exclusion. Form 1040 x Surrender of policy for cash. Form 1040 x   If you surrender a life insurance policy for cash, you must include in income any proceeds that are more than the cost of the life insurance policy. Form 1040 x In general, your cost (or investment in the contract) is the total of premiums that you paid for the life insurance policy, less any refunded premiums, rebates, dividends, or unrepaid loans that were not included in your income. Form 1040 x You should receive a Form 1099-R showing the total proceeds and the taxable part. Form 1040 x Report these amounts on Form 1040, lines 16a and 16b; Form 1040A, lines 12a and 12b; or Form 1040NR, lines 17a and 17b. Form 1040 x Endowment Contract Proceeds An endowment contract is a policy that pays over to you a specified amount of money on a certain date unless you die before that date, in which case, the money is paid to your designated beneficiary. Form 1040 x Endowment proceeds paid in a lump sum to you at maturity are taxable only if the proceeds are more than the cost of the policy. Form 1040 x To determine your cost, subtract from the total premiums (or other consideration) paid for the contract any amount that you previously received under the contract and excluded from your income. Form 1040 x Include in your income the part of the lump-sum payment that is more than your cost. Form 1040 x Endowment proceeds that you choose to receive in installments instead of a lump-sum payment at the maturity of the policy are taxed as an annuity. Form 1040 x The tax treatment of an annuity is explained in Publication 575. Form 1040 x For this treatment to apply, you must choose to receive the proceeds in installments before receiving any part of the lump sum. Form 1040 x This election must be made within 60 days after the lump-sum payment first becomes payable to you. Form 1040 x Accelerated Death Benefits Certain amounts paid as accelerated death benefits under a life insurance contract or viatical settlement before the insured's death are generally excluded from income if the insured is terminally or chronically ill. Form 1040 x However, see Exception , later. Form 1040 x For a chronically ill individual, accelerated death benefits paid on the basis of costs incurred for qualified long-term care services are fully excludable. Form 1040 x Accelerated death benefits paid on a per diem or other periodic basis without regard to the costs are excludable up to a limit. Form 1040 x In addition, if any portion of a death benefit under a life insurance contract on the life of a terminally or chronically ill individual is sold or assigned to a viatical settlement provider, the amount received also is excluded from income. Form 1040 x Generally, a viatical settlement provider is one who regularly engages in the business of buying or taking assignment of life insurance contracts on the lives of insured individuals who are terminally or chronically ill. Form 1040 x To report taxable accelerated death benefits made on a per diem or other periodic basis, you must file Form 8853, Archer MSAs and Long-Term Care Insurance Contracts, with your return. Form 1040 x Terminally or chronically ill defined. Form 1040 x   A terminally ill person is one who has been certified by a physician as having an illness or physical condition that reasonably can be expected to result in death within 24 months from the date of the certification. Form 1040 x A chronically ill person is one who is not terminally ill but has been certified (within the previous 12 months) by a licensed health care practitioner as meeting either of the following conditions. Form 1040 x The person is unable to perform (without substantial help) at least two activities of daily living (eating, toileting, transferring, bathing, dressing, and continence) for a period of 90 days or more because of a loss of functional capacity. Form 1040 x The person requires substantial supervision to protect himself or herself from threats to health and safety due to severe cognitive impairment. Form 1040 x Exception. Form 1040 x   The exclusion does not apply to any amount paid to a person other than the insured if that other person has an insurable interest in the life of the insured because the insured: Is a director, officer, or employee of the other person, or Has a financial interest in the business of the other person. Form 1040 x Sale of Home You may be able to exclude from income any gain up to $250,000 ($500,000 on a joint return in most cases) on the sale of your main home. Form 1040 x Generally, if you can exclude all of the gain, you do not need to report the sale on your tax return. Form 1040 x You can choose not to take the exclusion by including the gain from the sale in your gross income on your tax return for the year of the sale. Form 1040 x Main home. Form 1040 x   Usually, your main home is the home you live in most of the time and can be a: House, Houseboat, Mobile home, Cooperative apartment, or Condominium. Form 1040 x Repaying the first-time homebuyer credit because you sold your home. Form 1040 x   If you claimed a first-time homebuyer credit for your main home and you sell it, you may have to repay the credit. Form 1040 x For a home purchased in 2008 and used as your main home until sold in 2013, you must file Form 5405 and repay the balance of the unpaid credit on your 2013 tax return. Form 1040 x   For a home purchased after 2008, you generally must repay the entire credit if the home was sold (or otherwise ceased to be your main home) within 36 months of the purchase date. Form 1040 x If you purchased your home in 2009 and used it as your main home until sold in 2013, you do not have to repay the credit or file Form 5405. Form 1040 x If you purchased your home in 2010 and used it as your main home until sold in 2013, you may have to file Form 5405 and repay the entire credit on your 2013 tax return. Form 1040 x   See the Instructions for Form 5405 for more information about repaying the credit and exceptions to repayment that may apply to you. Form 1040 x Maximum Amount of Exclusion You can generally exclude up to $250,000 of the gain (other than gain allocated to periods of nonqualified use) on the sale of your main home if all of the following are true. Form 1040 x You meet the ownership test. Form 1040 x You meet the use test. Form 1040 x During the 2-year period ending on the date of the sale, you did not exclude gain from the sale of another home. Form 1040 x You may be able to exclude up to $500,000 of the gain (other than gain allocated to periods of nonqualified use) on the sale of your main home if you are married and file a joint return and meet the requirements listed in the discussion of the special rules for joint returns, later, under Married Persons . Form 1040 x Ownership and Use Tests To claim the exclusion, you must meet the ownership and use tests. Form 1040 x This means that during the 5-year period ending on the date of the sale, you must have: Owned the home for at least 2 years (the ownership test), and Lived in the home as your main home for at least 2 years (the use test). Form 1040 x Exception to ownership and use tests. Form 1040 x   If you owned and lived in the property as your main home for less than 2 years, you still can claim an exclusion in some cases. Form 1040 x Generally, you must have sold the home due to a change in place of employment, health, or unforeseen circumstances. Form 1040 x The maximum amount you can exclude will be reduced. Form 1040 x See Publication 523, Selling Your Home, for more information. Form 1040 x Exception to use test for individuals with a disability. Form 1040 x   There is an exception to the use test if, during the 5-year period before the sale of your home: You become physically or mentally unable to care for yourself, and You owned and lived in your home as your main home for a total of at least 1 year. Form 1040 x Under this exception, you are considered to live in your home during any time that you own the home and live in a facility (including a nursing home) that is licensed by a state or political subdivision to care for persons in your condition. Form 1040 x   If you meet this exception to the use test, you still have to meet the 2-out-of-5-year ownership test to claim the exclusion. Form 1040 x Exception to ownership test for property acquired in a like-kind exchange. Form 1040 x   You must have owned your main home for at least 5 years to qualify for the exclusion if you acquired your main home in a like-kind exchange. Form 1040 x This special 5-year ownership rule continues to apply to a home you acquired in a like-kind exchange and gave to another person. Form 1040 x A like-kind exchange is an exchange of property held for productive use in a trade or business or for investment. Form 1040 x See Publication 523 for more information. Form 1040 x Period of nonqualified use. Form 1040 x   Generally, the gain from the sale or exchange of your main home will not qualify for the exclusion to the extent that the gain is allocated to periods of nonqualified use. Form 1040 x Nonqualified use is any period after December 31, 2008, during which the property is not used as the main home. Form 1040 x See Publication 523 for more information. Form 1040 x Married Persons In the special situations discussed below, if you and your spouse file a joint return for the year of sale and one spouse meets the ownership and use test, you can exclude up to $250,000 of gain. Form 1040 x However, see Special rules for joint returns , next. Form 1040 x Special rules for joint returns. Form 1040 x   You can exclude up to $500,000 of the gain on the sale of your main home if all of the following are true. Form 1040 x You are married and file a joint return for the year. Form 1040 x Either you or your spouse meets the ownership test. Form 1040 x Both you and your spouse meet the use test. Form 1040 x During the 2-year period ending on the date of the sale, neither you nor your spouse exclude gain from the sale of another home. Form 1040 x Sale of home by surviving spouse. Form 1040 x   If your spouse died and you did not remarry before the date of sale, you are considered to have owned and lived in the property as your main home during any period of time when your spouse owned and lived in it as a main home. Form 1040 x   If you meet all of the following requirements, you may qualify to exclude up to $500,000 of any gain from the sale or exchange of your main home in 2013. Form 1040 x The sale or exchange took place no more than 2 years after the date of death of your spouse. Form 1040 x You have not remarried. Form 1040 x You and your spouse met the use test at the time of your spouse's death. Form 1040 x You or your spouse met the ownership test at the time of your spouse's death. Form 1040 x Neither you nor your spouse excluded gain from the sale of another home during the last 2 years. Form 1040 x Home transferred from spouse. Form 1040 x   If your home was transferred to you by your spouse (or former spouse if the transfer was incident to divorce), you are considered to have owned it during any period of time when your spouse owned it. Form 1040 x Use of home after divorce. Form 1040 x   You are considered to have used property as your main home during any period when: You owned it, and Your spouse or former spouse is allowed to live in it under a divorce or separation instrument and uses it as his or her main home. Form 1040 x Business Use or Rental of Home You may be able to exclude gain from the sale of a home that you have used for business or to produce rental income. Form 1040 x However, you must meet the ownership and use tests. Form 1040 x See Publication 523 for more information. Form 1040 x Depreciation after May 6, 1997. Form 1040 x   If you were entitled to take depreciation deductions because you used your home for business purposes or as rental property, you cannot exclude the part of your gain equal to any depreciation allowed or allowable as a deduction for periods after May 6, 1997. Form 1040 x See Publication 523 for more information. Form 1040 x Reporting the Sale Do not report the 2013 sale of your main home on your tax return unless: You have a gain and you do not qualify to exclude all of it, You have a gain and you choose not to exclude it, or You received Form 1099-S. Form 1040 x If you have a gain that you cannot or choose not to exclude, if you received a Form 1099-S, or if you have a deductible loss, report the sale on your tax return. Form 1040 x Report the sale on Part I or Part II of Form 8949 as a short-term or long-term transaction, depending on how long you owned the home. Form 1040 x If you used your home for business or to produce rental income, you may have to use Form 4797, Sales of Business Property, to report the sale of the business or rental part. Form 1040 x See Publication 523 for more information. Form 1040 x Reverse Mortgages A revers