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Form 1040x

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Form 1040x

Form 1040x 8. Form 1040x   Gains and Losses Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Sales and ExchangesDetermining Gain or Loss Like-Kind Exchanges Transfer to Spouse Ordinary or Capital Gain or LossCapital Assets Noncapital Assets Hedging (Commodity Futures) Livestock Converted Wetland and Highly Erodible Cropland Timber Sale of a Farm Foreclosure or Repossession Abandonment Introduction This chapter explains how to figure, and report on your tax return, your gain or loss on the disposition of your property or debt and whether such gain or loss is ordinary or capital. Form 1040x Ordinary gain is taxed at the same rates as wages and interest income while capital gain is generally taxed at lower rates. Form 1040x Dispositions discussed in this chapter include sales, exchanges, foreclosures, repossessions, canceled debts, hedging transactions, and elections to treat cutting of timber as a sale or exchange. Form 1040x Topics - This chapter discusses: Sales and exchanges Ordinary or capital gain or loss Useful Items - You may want to see: Publication 334 Tax Guide for Small Business 523 Selling Your Home 544 Sales and Other Dispositions of Assets 550 Investment Income and Expenses 908 Bankruptcy Tax Guide Form (and Instructions) 982 Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment) Sch D (Form 1040) Capital Gains and Losses Sch F (Form 1040) Profit or Loss From Farming 1099-A Acquisition or Abandonment of Secured Property 1099-C Cancellation of Debt 4797 Sales of Business Property 8949 Sales and Other Dispositions of Capital Assets See chapter 16 for information about getting publications and forms. Form 1040x Sales and Exchanges If you sell, exchange, or otherwise dispose of your property, you usually have a gain or a loss. Form 1040x This section explains certain rules for determining whether any gain you have is taxable, and whether any loss you have is deductible. Form 1040x A sale is a transfer of property for money or a mortgage, note, or other promise to pay money. Form 1040x An exchange is a transfer of property for other property or services. Form 1040x Determining Gain or Loss You usually realize a gain or loss when you sell or exchange property. Form 1040x If the amount you realize from a sale or exchange of property is more than its adjusted basis, you will have a gain. Form 1040x If the adjusted basis of the property is more than the amount you realize, you will have a loss. Form 1040x Basis and adjusted basis. Form 1040x   The basis of property you buy is usually its cost. Form 1040x The adjusted basis of property is basis plus certain additions and minus certain deductions. Form 1040x See chapter 6 for more information about basis and adjusted basis. Form 1040x Amount realized. Form 1040x   The amount you realize from a sale or exchange is the total of all money you receive plus the fair market value (FMV) (defined in chapter 6) of all property or services you receive. Form 1040x The amount you realize also includes any of your liabilities assumed by the buyer and any liabilities to which the property you transferred is subject, such as real estate taxes or a mortgage. Form 1040x   If the liabilities relate to an exchange of multiple properties, see Multiple Property Exchanges in chapter 1 of Publication 544. Form 1040x Amount recognized. Form 1040x   Your gain or loss realized from a sale or exchange of certain property is usually a recognized gain or loss for tax purposes. Form 1040x A recognized gain is a gain you must include in gross income and report on your income tax return. Form 1040x A recognized loss is a loss you deduct from gross income. Form 1040x However, your gain or loss realized from the exchange of certain property may not be recognized for tax purposes. Form 1040x See Like-Kind Exchanges next. Form 1040x Also, a loss from the disposition of property held for personal use is not deductible. Form 1040x Like-Kind Exchanges Certain exchanges of property are not taxable. Form 1040x This means any gain from the exchange is not recognized, and any loss cannot be deducted. Form 1040x Your gain or loss will not be recognized until you sell or otherwise dispose of the property you receive. Form 1040x The exchange of property for the same kind of property is the most common type of nontaxable exchange. Form 1040x To qualify for treatment as a like-kind exchange, the property traded and the property received must be both of the following. Form 1040x Qualifying property. Form 1040x Like-kind property. Form 1040x These two requirements are discussed later. Form 1040x Multiple-party transactions. Form 1040x   The like-kind exchange rules also apply to property exchanges that involve three and four-party transactions. Form 1040x Any part of these multiple-party transactions can qualify as a like-kind exchange if it meets all the requirements described in this section. Form 1040x Receipt of title from third party. Form 1040x   If you receive property in a like-kind exchange and the other party who transfers the property to you does not give you the title, but a third party does, you can still treat this transaction as a like-kind exchange if it meets all the requirements. Form 1040x Basis of property received. Form 1040x   If you receive property in a like-kind exchange, the basis of the property will be the same as the basis of the property you gave up. Form 1040x See chapter 6 for more information. Form 1040x Money paid. Form 1040x   If, in addition to giving up like-kind property, you pay money in a like-kind exchange, you still have no recognized gain or loss. Form 1040x The basis of the property received is the basis of the property given up, increased by the money paid. Form 1040x Example. Form 1040x You traded an old tractor with an adjusted basis of $15,000 for a new one. Form 1040x The new tractor costs $300,000. Form 1040x You were allowed $80,000 for the old tractor and paid $220,000 cash. Form 1040x You have no recognized gain or loss on the transaction regardless of the adjusted basis of your old tractor and the basis of the new tractor is $235,000, the adjusted basis of the old tractor plus the cash paid ($15,000 + $220,000). Form 1040x If you had sold the old tractor to a third party for $80,000 and bought a new one, you would have a recognized gain or loss on the sale of your old tractor equal to the difference between the amount realized and the adjusted basis of the old tractor. Form 1040x In this case, the taxable gain would be $65,000 ($80,000 − $15,000) and the basis of the new tractor would be $300,000. Form 1040x Reporting the exchange. Form 1040x   Report the exchange of like-kind property, even though no gain or loss is recognized, on Form 8824, Like-Kind Exchanges. Form 1040x The Instructions for Form 8824 explain how to report the details of the exchange. Form 1040x   If you have any recognized gain because you received money or unlike property, report it on Schedule D (Form 1040) or Form 4797, whichever applies. Form 1040x You may also have to report the recognized gain as ordinary income because of depreciation recapture on Form 4797. Form 1040x See chapter 9 for more information. Form 1040x Qualifying property. Form 1040x   In a like-kind exchange, both the property you give up and the property you receive must be held by you for investment or for productive use in your trade or business. Form 1040x Machinery, buildings, land, trucks, breeding livestock, rental houses, and certain mutual ditch, reservoir, or irrigation company stock are examples of property that may qualify. Form 1040x Nonqualifying property. Form 1040x   The rules for like-kind exchanges do not apply to exchanges of the following property. Form 1040x Property you use for personal purposes, such as your home and family car. Form 1040x Stock in trade or other property held primarily for sale, such as crops and produce. Form 1040x Stocks, bonds, or notes. Form 1040x However, see Qualifying property above. Form 1040x Other securities or evidences of indebtedness, such as accounts receivable. Form 1040x Partnership interests. Form 1040x However, you may have a nontaxable exchange under other rules. Form 1040x See Other Nontaxable Exchanges in chapter 1 of Publication 544. Form 1040x Like-kind property. Form 1040x   To qualify as a nontaxable exchange, the properties exchanged must be of like kind. Form 1040x Like-kind properties are properties of the same nature or character, even if they differ in grade or quality. Form 1040x Generally, real property exchanged for real property qualifies as an exchange of like-kind property. Form 1040x For example, an exchange of city property for farm property or improved property for unimproved property is a like-kind exchange. Form 1040x   An exchange of a tractor for a new tractor is an exchange of like-kind property, and so is an exchange of timber land for crop acreage. Form 1040x An exchange of a tractor for acreage, however, is not an exchange of like-kind property. Form 1040x The exchange of livestock of one sex for livestock of the other sex is not a like-kind exchange. Form 1040x For example, the exchange of a bull for a cow is not a like-kind exchange. Form 1040x An exchange of the assets of a business for the assets of a similar business cannot be treated as an exchange of one property for another property. Form 1040x    Note. Form 1040x Whether you engaged in a like-kind exchange depends on an analysis of each asset involved in the exchange. Form 1040x Personal property. Form 1040x   Depreciable tangible personal property can be either like kind or like class to qualify for nontaxable exchange treatment. Form 1040x Like-class properties are depreciable tangible personal properties within the same General Asset Class or Product Class. Form 1040x Property classified in any General Asset Class may not be classified within a Product Class. Form 1040x Assets that are not in the same class will qualify as like-kind property if they are of the same nature or character. Form 1040x General Asset Classes. Form 1040x   General Asset Classes describe the types of property frequently used in many businesses. Form 1040x They include, but are not limited to, the following property. Form 1040x Office furniture, fixtures, and equipment (asset class 00. Form 1040x 11). Form 1040x Information systems, such as computers and peripheral equipment (asset class 00. Form 1040x 12). Form 1040x Data handling equipment except computers (asset class 00. Form 1040x 13). Form 1040x Automobiles and taxis (asset class 00. Form 1040x 22). Form 1040x Light general purpose trucks (asset class 00. Form 1040x 241). Form 1040x Heavy general purpose trucks (asset class 00. Form 1040x 242). Form 1040x Tractor units for use over-the-road (asset class 00. Form 1040x 26). Form 1040x Trailers and trailer-mounted containers (asset class 00. Form 1040x 27). Form 1040x Industrial steam and electric generation and/or distribution systems (asset class 00. Form 1040x 4). Form 1040x Product Classes. Form 1040x   Product Classes include property listed in a 6-digit product class in sectors 31 through 33 of the North American Industry Classification System (NAICS) of the Executive Office of the President, Office of Management and Budget, United States, (NAICS Manual). Form 1040x The latest version of the manual can be accessed at www. Form 1040x census. Form 1040x gov/eos/www/naics/. Form 1040x Copies of the printed manual may be purchased from the National Technical Information Service (NTIS) at  www. Form 1040x ntis. Form 1040x gov/products/naics. Form 1040x aspx or by calling 1-800-553-NTIS (1-800-553-6847) or (703) 605-6000. Form 1040x A CD-ROM version with search and retrieval software is also available from NTIS. Form 1040x    NAICS class 333111, Farm Machinery and Equipment Manufacturing, includes most machinery and equipment used in a farming business. Form 1040x Partially nontaxable exchange. Form 1040x   If, in addition to like-kind property, you receive money or unlike property in an exchange on which you realize gain, you have a partially nontaxable exchange. Form 1040x You are taxed on the gain you realize, but only to the extent of the money and the FMV of the unlike property you receive. Form 1040x A loss is not deductible. Form 1040x Example 1. Form 1040x You trade farmland that cost $30,000 for $10,000 cash and other land to be used in farming with a FMV of $50,000. Form 1040x You have a realized gain of $30,000 ($50,000 FMV of new land + $10,000 cash − $30,000 basis of old farmland = $30,000 realized gain). Form 1040x However, only $10,000, the cash received, is recognized (included in income). Form 1040x Example 2. Form 1040x Assume the same facts as in Example 1, except that, instead of money, you received a tractor with a FMV of $10,000. Form 1040x Your recognized gain is still limited to $10,000, the value of the tractor (the unlike property). Form 1040x Example 3. Form 1040x Assume in Example 1 that the FMV of the land you received was only $15,000. Form 1040x Your $5,000 loss is not recognized. Form 1040x Unlike property given up. Form 1040x   If, in addition to like-kind property, you give up unlike property, you must recognize gain or loss on the unlike property you give up. Form 1040x The gain or loss is the difference between the FMV of the unlike property and the adjusted basis of the unlike property. Form 1040x Like-kind exchanges between related persons. Form 1040x   Special rules apply to like-kind exchanges between related persons. Form 1040x These rules affect both direct and indirect exchanges. Form 1040x Under these rules, if either person disposes of the property within 2 years after the exchange, the exchange is disqualified from nonrecognition treatment. Form 1040x The gain or loss on the original exchange must be recognized as of the date of the later disposition. Form 1040x The 2-year holding period begins on the date of the last transfer of property that was part of the like-kind exchange. Form 1040x Related persons. Form 1040x   Under these rules, related persons include, for example, you and a member of your family (spouse, brother, sister, parent, child, etc. Form 1040x ), you and a corporation in which you have more than 50% ownership, you and a partnership in which you directly or indirectly own more than a 50% interest of the capital or profits, and two partnerships in which you directly or indirectly own more than 50% of the capital interests or profits. Form 1040x   For the complete list of related persons, see Related persons in chapter 2 of Publication 544. Form 1040x Example. Form 1040x You used a grey pickup truck in your farming business. Form 1040x Your sister used a red pickup truck in her landscaping business. Form 1040x In December 2012, you exchanged your grey pickup truck, plus $200, for your sister's red pickup truck. Form 1040x At that time, the FMV of the grey pickup truck was $7,000 and its adjusted basis was $6,000. Form 1040x The FMV of the red pickup truck was $7,200 and its adjusted basis was $1,000. Form 1040x You realized a gain of $1,000 (the $7,200 FMV of the red pickup truck, minus the grey pickup truck's $6,000 adjusted basis, minus the $200 you paid). Form 1040x Your sister realized a gain of $6,200 (the $7,000 FMV of the grey pickup truck plus the $200 you paid, minus the $1,000 adjusted basis of the red pickup truck). Form 1040x However, because this was a like-kind exchange, you recognized no gain. Form 1040x Your basis in the red pickup truck was $6,200 (the $6,000 adjusted basis of the grey pickup truck plus the $200 you paid). Form 1040x She recognized gain only to the extent of the money she received, $200. Form 1040x Her basis in the grey pickup truck was $1,000 (the $1,000 adjusted basis of the red pickup truck minus the $200 received, plus the $200 gain recognized). Form 1040x In 2013, you sold the red pickup truck to a third party for $7,000. Form 1040x Because you sold it within 2 years after the exchange, the exchange is disqualified from nonrecognition treatment. Form 1040x On your tax return for 2013, you must report your $1,000 gain on the 2012 exchange. Form 1040x You also report a loss on the sale as $200 (the adjusted basis of the red pickup truck, $7,200 (its $6,200 basis plus the $1,000 gain recognized), minus the $7,000 realized from the sale). Form 1040x In addition, your sister must report on her tax return for 2013 the $6,000 balance of her gain on the 2012 exchange. Form 1040x Her adjusted basis in the grey pickup truck is increased to $7,000 (its $1,000 basis plus the $6,000 gain recognized). Form 1040x Exceptions to the rules for related persons. Form 1040x   The following property dispositions are excluded from these rules. Form 1040x Dispositions due to the death of either related person. Form 1040x Involuntary conversions. Form 1040x Dispositions where it is established to the satisfaction of the IRS that neither the exchange nor the disposition has, as a main purpose, the avoidance of federal income tax. Form 1040x Multiple property exchanges. Form 1040x   Under the like-kind exchange rules, you must generally make a property-by-property comparison to figure your recognized gain and the basis of the property you receive in the exchange. Form 1040x However, for exchanges of multiple properties, you do not make a property-by-property comparison if you do either of the following. Form 1040x Transfer and receive properties in two or more exchange groups. Form 1040x Transfer or receive more than one property within a single exchange group. Form 1040x   For more information, see Multiple Property Exchanges in chapter 1 of Publication 544. Form 1040x Deferred exchange. Form 1040x   A deferred exchange for like-kind property may qualify for nonrecognition of gain or loss. Form 1040x A deferred exchange is an exchange in which you transfer property you use in business or hold for investment and later receive like-kind property you will use in business or hold for investment. Form 1040x The property you receive is replacement property. Form 1040x The transaction must be an exchange of property for property rather than a transfer of property for money used to buy replacement property. Form 1040x In addition, the replacement property will not be treated as like-kind property unless certain identification and receipt requirements are met. Form 1040x   For more information see Deferred Exchanges in chapter 1 of Publication 544. Form 1040x Transfer to Spouse No gain or loss is recognized on a transfer of property from an individual to (or in trust for the benefit of) a spouse, or a former spouse if incident to divorce. Form 1040x This rule does not apply if the recipient is a nonresident alien. Form 1040x Nor does this rule apply to a transfer in trust to the extent the liabilities assumed and the liabilities on the property are more than the property's adjusted basis. Form 1040x Any transfer of property to a spouse or former spouse on which gain or loss is not recognized is not considered a sale or exchange. Form 1040x The recipient's basis in the property will be the same as the adjusted basis of the giver immediately before the transfer. Form 1040x This carryover basis rule applies whether the adjusted basis of the transferred property is less than, equal to, or greater than either its FMV at the time of transfer or any consideration paid by the recipient. Form 1040x This rule applies for determining loss as well as gain. Form 1040x Any gain recognized on a transfer in trust increases the basis. Form 1040x For more information on transfers of property incident to divorce, see Property Settlements in Publication 504, Divorced or Separated Individuals. Form 1040x Ordinary or Capital Gain or Loss Generally, you will have a capital gain or loss if you sell or exchange a capital asset (defined below). Form 1040x You may also have a capital gain if your section 1231 transactions result in a net gain. Form 1040x See Section 1231 Gains and Losses in  chapter 9. Form 1040x To figure your net capital gain or loss, you must classify your gains and losses as either ordinary or capital (and your capital gains or losses as either short-term or long-term). Form 1040x Your net capital gains may be taxed at a lower tax rate than ordinary income. Form 1040x See Capital Gains Tax Rates , later. Form 1040x Your deduction for a net capital loss may be limited. Form 1040x See Treatment of Capital Losses , later. Form 1040x Capital Assets Almost everything you own and use for personal purposes or investment is a capital asset. Form 1040x The following items are examples of capital assets. Form 1040x A home owned and occupied by you and your family. Form 1040x Household furnishings. Form 1040x A car used for pleasure. Form 1040x If your car is used both for pleasure and for farm business, it is partly a capital asset and partly a noncapital asset, defined later. Form 1040x Stocks and bonds. Form 1040x However, there are special rules for gains on qualified small business stock. Form 1040x For more information on this subject, see Gains on Qualified Small Business Stock and Losses on Section 1244 (Small Business) Stock in chapter 4 of Publication 550. Form 1040x Personal-use property. Form 1040x   Gain from a sale or exchange of personal-use property is a capital gain and is taxable. Form 1040x Loss from the sale or exchange of personal-use property is not deductible. Form 1040x You can deduct a loss relating to personal-use property only if it results from a casualty or theft. Form 1040x For information on casualties and thefts, see chapter 11. Form 1040x Long and Short Term Where you report a capital gain or loss depends on how long you own the asset before you sell or exchange it. Form 1040x The time you own an asset before disposing of it is the holding period. Form 1040x If you hold a capital asset 1 year or less, the gain or loss resulting from its disposition is short term. Form 1040x Report it in Part I of Schedule D (Form 1040). Form 1040x If you hold a capital asset longer than 1 year, the gain or loss resulting from its disposition is long term. Form 1040x Report it in Part II of Schedule D (Form 1040). Form 1040x Holding period. Form 1040x   To figure if you held property longer than 1 year, start counting on the day after the day you acquired the property. Form 1040x The day you disposed of the property is part of your holding period. Form 1040x Example. Form 1040x If you bought an asset on June 19, 2012, you should start counting on June 20, 2012. Form 1040x If you sold the asset on June 19, 2013, your holding period is not longer than 1 year, but if you sold it on June 20, 2013, your holding period is longer than 1 year. Form 1040x Inherited property. Form 1040x   If you inherit property, you are considered to have held the property longer than 1 year, regardless of how long you actually held it. Form 1040x This rule does not apply to livestock used in a farm business. Form 1040x See Holding period under Livestock , later. Form 1040x Nonbusiness bad debt. Form 1040x   A nonbusiness bad debt is a short-term capital loss, deductible in the year the debt becomes worthless. Form 1040x See chapter 4 of Publication 550. Form 1040x Nontaxable exchange. Form 1040x   If you acquire an asset in exchange for another asset and your basis for the new asset is figured, in whole or in part, by using your basis in the old property, the holding period of the new property includes the holding period of the old property. Form 1040x That is, it begins on the same day as your holding period for the old property. Form 1040x Gift. Form 1040x   If you receive a gift of property and your basis in it is figured using the donor's basis, your holding period includes the donor's holding period. Form 1040x Real property. Form 1040x   To figure how long you held real property, start counting on the day after you received title to it or, if earlier, on the day after you took possession of it and assumed the burdens and privileges of ownership. Form 1040x   However, taking possession of real property under an option agreement is not enough to start the holding period. Form 1040x The holding period cannot start until there is an actual contract of sale. Form 1040x The holding period of the seller cannot end before that time. Form 1040x Figuring Net Gain or Loss The totals for short-term capital gains and losses and the totals for long-term capital gains and losses must be figured separately. Form 1040x Net short-term capital gain or loss. Form 1040x   Combine your short-term capital gains and losses. Form 1040x Do this by adding all of your short-term capital gains. Form 1040x Then add all of your short-term capital losses. Form 1040x Subtract the lesser total from the greater. Form 1040x The difference is your net short-term capital gain or loss. Form 1040x Net long-term capital gain or loss. Form 1040x   Follow the same steps to combine your long-term capital gains and losses. Form 1040x The result is your net long-term capital gain or loss. Form 1040x Net gain. Form 1040x   If the total of your capital gains is more than the total of your capital losses, the difference is taxable. Form 1040x However, part of your gain (but not more than your net capital gain) may be taxed at a lower rate than the rate of tax on your ordinary income. Form 1040x See Capital Gains Tax Rates , later. Form 1040x Net loss. Form 1040x   If the total of your capital losses is more than the total of your capital gains, the difference is deductible. Form 1040x But there are limits on how much loss you can deduct and when you can deduct it. Form 1040x See Treatment of Capital Losses next. Form 1040x Treatment of Capital Losses If your capital losses are more than your capital gains, you must claim the difference even if you do not have ordinary income to offset it. Form 1040x For taxpayers other than corporations, the yearly limit on the capital loss you can deduct is $3,000 ($1,500 if you are married and file a separate return). Form 1040x If your other income is low, you may not be able to use the full $3,000. Form 1040x The part of the $3,000 you cannot use becomes part of your capital loss carryover (discussed next). Form 1040x Capital loss carryover. Form 1040x   Generally, you have a capital loss carryover if either of the following situations applies to you. Form 1040x Your net loss on Schedule D (Form 1040), is more than the yearly limit. Form 1040x Your taxable income without your deduction for exemptions is less than zero. Form 1040x If either of these situations applies to you for 2013, see Capital Losses under Reporting Capital Gains and Losses in chapter 4 of Publication 550 to figure the amount you can carry over to 2014. Form 1040x    To figure your capital loss carryover from 2013 to 2014, you will need a copy of your 2013 Form 1040 and Schedule D (Form 1040). Form 1040x Capital Gains Tax Rates The tax rates that apply to a net capital gain are generally lower than the tax rates that apply to other income. Form 1040x These lower rates are called the maximum capital gains rates. Form 1040x The term “net capital gain” means the amount by which your net long-term capital gain for the year is more than your net short-term capital loss. Form 1040x See Schedule D (Form 1040) and the Instructions for Schedule D (Form 1040). Form 1040x Also see Publication 550. Form 1040x Noncapital Assets Noncapital assets include property such as inventory and depreciable property used in a trade or business. Form 1040x A list of properties that are not capital assets is provided in the Instructions for Schedule D (Form 1040). Form 1040x Property held for sale in the ordinary course of your farm business. Form 1040x   Property you hold mainly for sale to customers, such as livestock, poultry, livestock products, and crops, is a noncapital asset. Form 1040x Gain or loss from sales or other dispositions of this property is reported on Schedule F (Form 1040) (not on Schedule D (Form 1040) or Form 4797). Form 1040x The treatment of this property is discussed in chapter 3. Form 1040x Land and depreciable properties. Form 1040x   Land and depreciable property you use in farming are not capital assets. Form 1040x Noncapital assets also include livestock held for draft, breeding, dairy, or sporting purposes. Form 1040x However, your gains and losses from sales and exchanges of your farmland and depreciable properties must be considered together with certain other transactions to determine whether the gains and losses are treated as capital or ordinary gains and losses. Form 1040x The sales of these business assets are reported on Form 4797. Form 1040x See chapter 9 for more information. Form 1040x Hedging (Commodity Futures) Hedging transactions are transactions that you enter into in the normal course of business primarily to manage the risk of interest rate or price changes, or currency fluctuations, with respect to borrowings, ordinary property, or ordinary obligations. Form 1040x Ordinary property or obligations are those that cannot produce capital gain or loss if sold or exchanged. Form 1040x A commodity futures contract is a standardized, exchange-traded contract for the sale or purchase of a fixed amount of a commodity at a future date for a fixed price. Form 1040x The holder of an option on a futures contract has the right (but not the obligation) for a specified period of time to enter into a futures contract to buy or sell at a particular price. Form 1040x A forward contract is generally similar to a futures contract except that the terms are not standardized and the contract is not exchange traded. Form 1040x Businesses may enter into commodity futures contracts or forward contracts and may acquire options on commodity futures contracts as either of the following. Form 1040x Hedging transactions. Form 1040x Transactions that are not hedging transactions. Form 1040x Futures transactions with exchange-traded commodity futures contracts that are not hedging transactions, generally, result in capital gain or loss and are subject to the mark-to-market rules discussed in Publication 550. Form 1040x There is a limit on the amount of capital losses you can deduct each year. Form 1040x Hedging transactions are not subject to the mark-to-market rules. Form 1040x If, as a farmer-producer, to protect yourself from the risk of unfavorable price fluctuations, you enter into commodity forward contracts, futures contracts, or options on futures contracts and the contracts cover an amount of the commodity within your range of production, the transactions are generally considered hedging transactions. Form 1040x They can take place at any time you have the commodity under production, have it on hand for sale, or reasonably expect to have it on hand. Form 1040x The gain or loss on the termination of these hedges is generally ordinary gain or loss. Form 1040x Farmers who file their income tax returns on the cash method report any profit or loss on the hedging transaction on Schedule F, line 8. Form 1040x Gains or losses from hedging transactions that hedge supplies of a type regularly used or consumed in the ordinary course of your trade or business may be ordinary gains or losses. Form 1040x Examples include fuel and feed. Form 1040x If you have numerous transactions in the commodity futures market during the year, you must be able to show which transactions are hedging transactions. Form 1040x Clearly identify a hedging transaction on your books and records before the end of the day you entered into the transaction. Form 1040x It may be helpful to have separate brokerage accounts for your hedging and speculation transactions. Form 1040x Retain the identification of each hedging transaction with your books and records. Form 1040x Also, identify the item(s) or aggregate risk that is being hedged in your records. Form 1040x Although the identification of the hedging transaction must be made before the end of the day it was entered into, you have 35 days after entering into the transaction to identify the hedged item(s) or risk. Form 1040x For more information on the tax treatment of futures and options contracts, see Commodity Futures and Section 1256 Contracts Marked to Market in Publication 550. Form 1040x Accounting methods for hedging transactions. Form 1040x   The accounting method you use for a hedging transaction must clearly reflect income. Form 1040x This means that your accounting method must reasonably match the timing of income, deduction, gain, or loss from a hedging transaction with the timing of income, deduction, gain, or loss from the item or items being hedged. Form 1040x There are requirements and limits on the method you can use for certain hedging transactions. Form 1040x See Regulations section 1. Form 1040x 446-4(e) for those requirements and limits. Form 1040x   Hedging transactions must be accounted for under the rules stated above unless the transaction is subject to mark-to-market accounting under section 475 or you use an accounting method other than the following methods. Form 1040x Cash method. Form 1040x Farm-price method. Form 1040x Unit-livestock-price method. Form 1040x   Once you adopt a method, you must apply it consistently and must have IRS approval before changing it. Form 1040x   Your books and records must describe the accounting method used for each type of hedging transaction. Form 1040x They must also contain any additional identification necessary to verify the application of the accounting method you used for the transaction. Form 1040x You must make the additional identification no more than 35 days after entering into the hedging transaction. Form 1040x Example of a hedging transaction. Form 1040x   You file your income tax returns on the cash method. Form 1040x On July 2 you anticipate a yield of 50,000 bushels of corn this year. Form 1040x The December futures price is $5. Form 1040x 75 a bushel, but there are indications that by harvest time the price will drop. Form 1040x To protect yourself against a drop in the price, you enter into the following hedging transaction. Form 1040x You sell ten December futures contracts of 5,000 bushels each for a total of 50,000 bushels of corn at $5. Form 1040x 75 a bushel. Form 1040x   The price did not drop as anticipated but rose to $6 a bushel. Form 1040x In November, you sell your crop at a local elevator for $6 a bushel. Form 1040x You also close out your futures position by buying ten December contracts for $6 a bushel. Form 1040x You paid a broker's commission of $1,400 ($70 per contract) for the complete in and out position in the futures market. Form 1040x   The result is that the price of corn rose 25 cents a bushel and the actual selling price is $6 a bushel. Form 1040x Your loss on the hedge is 25 cents a bushel. Form 1040x In effect, the net selling price of your corn is $5. Form 1040x 75 a bushel. Form 1040x   Report the results of your futures transactions and your sale of corn separately on Schedule F. Form 1040x See the instructions for the 2013 Schedule F (Form 1040). Form 1040x   The loss on your futures transactions is $13,900, figured as follows. Form 1040x July 2 - Sold December corn futures (50,000 bu. Form 1040x @$5. Form 1040x 75) $287,500 November 6 - Bought December corn futures (50,000 bu. Form 1040x @$6 plus $1,400 broker's commission) 301,400 Futures loss ($13,900) This loss is reported as a negative figure on Schedule F, Part I, line 8, as other income. Form 1040x   The proceeds from your corn sale at the local elevator are $300,000 (50,000 bu. Form 1040x × $6). Form 1040x Report it on Schedule F, Part I, line 2, as income from sales of products you raised. Form 1040x   Assume you were right and the price went down 25 cents a bushel. Form 1040x In effect, you would still net $5. Form 1040x 75 a bushel, figured as follows. Form 1040x Sold cash corn, per bushel $5. Form 1040x 50 Gain on hedge, per bushel . Form 1040x 25 Net price, per bushel $5. Form 1040x 75       The gain on your futures transactions would have been $11,100, figured as follows. Form 1040x July 2 - Sold December corn futures (50,000 bu. Form 1040x @$5. Form 1040x 75) $287,500 November 6 - Bought December corn futures (50,000 bu. Form 1040x @$5. Form 1040x 50 plus $1,400 broker's commission) 276,400 Futures gain $11,100 The $11,100 is reported on Schedule F, Part I, line 8, as other income. Form 1040x   The proceeds from the sale of your corn at the local elevator, $275,000, are reported on Schedule F, Part I, line 2, as income from sales of products you raised. Form 1040x Livestock This part discusses the sale or exchange of livestock used in your farm business. Form 1040x Gain or loss from the sale or exchange of this livestock may qualify as a section 1231 gain or loss. Form 1040x However, any part of the gain that is ordinary income from the recapture of depreciation is not included as section 1231 gain. Form 1040x See chapter 9 for more information on section 1231 gains and losses and the recapture of depreciation under section 1245. Form 1040x The rules discussed here do not apply to the sale of livestock held primarily for sale to customers. Form 1040x The sale of this livestock is reported on Schedule F. Form 1040x See chapter 3. Form 1040x Also, special rules apply to sales or exchanges caused by weather-related conditions. Form 1040x See chapter 3. Form 1040x Holding period. Form 1040x   The sale or exchange of livestock used in your farm business (defined below) qualifies as a section 1231 transaction if you held the livestock for 12 months or more (24 months or more for horses and cattle). Form 1040x Livestock. Form 1040x   For section 1231 transactions, livestock includes cattle, hogs, horses, mules, donkeys, sheep, goats, fur-bearing animals, and other mammals. Form 1040x Also, for section 1231 transactions, livestock does not include chickens, turkeys, pigeons, geese, emus, ostriches, rheas, or other birds, fish, frogs, reptiles, etc. Form 1040x Livestock used in farm business. Form 1040x   If livestock is held primarily for draft, breeding, dairy, or sporting purposes, it is used in your farm business. Form 1040x The purpose for which an animal is held ordinarily is determined by a farmer's actual use of the animal. Form 1040x An animal is not held for draft, breeding, dairy, or sporting purposes merely because it is suitable for that purpose, or because it is held for sale to other persons for use by them for that purpose. Form 1040x However, a draft, breeding, or sporting purpose may be present if an animal is disposed of within a reasonable time after it is prevented from its intended use or made undesirable as a result of an accident, disease, drought, or unfitness of the animal. Form 1040x Example 1. Form 1040x You discover an animal that you intend to use for breeding purposes is sterile. Form 1040x You dispose of it within a reasonable time. Form 1040x This animal was held for breeding purposes. Form 1040x Example 2. Form 1040x You retire and sell your entire herd, including young animals that you would have used for breeding or dairy purposes had you remained in business. Form 1040x These young animals were held for breeding or dairy purposes. Form 1040x Also, if you sell young animals to reduce your breeding or dairy herd because of drought, these animals are treated as having been held for breeding or dairy purposes. Form 1040x See Sales Caused by Weather-Related Conditions in chapter 3. Form 1040x Example 3. Form 1040x You are in the business of raising hogs for slaughter. Form 1040x Customarily, before selling your sows, you obtain a single litter of pigs that you will raise for sale. Form 1040x You sell the brood sows after obtaining the litter. Form 1040x Even though you hold these brood sows for ultimate sale to customers in the ordinary course of your business, they are considered to be held for breeding purposes. Form 1040x Example 4. Form 1040x You are in the business of raising registered cattle for sale to others for use as breeding cattle. Form 1040x The business practice is to breed the cattle before sale to establish their fitness as registered breeding cattle. Form 1040x Your use of the young cattle for breeding purposes is ordinary and necessary for selling them as registered breeding cattle. Form 1040x Such use does not demonstrate that you are holding the cattle for breeding purposes. Form 1040x However, those cattle you held as additions or replacements to your own breeding herd to produce calves are considered to be held for breeding purposes, even though they may not actually have produced calves. Form 1040x The same applies to hog and sheep breeders. Form 1040x Example 5. Form 1040x You breed, raise, and train horses for racing purposes. Form 1040x Every year you cull horses from your racing stable. Form 1040x In 2013, you decided that to prevent your racing stable from getting too large to be effectively operated, you must cull six horses that had been raced at public tracks in 2012. Form 1040x These horses are all considered held for sporting purposes. Form 1040x Figuring gain or loss on the cash method. Form 1040x   Farmers or ranchers who use the cash method of accounting figure their gain or loss on the sale of livestock used in their farming business as follows. Form 1040x Raised livestock. Form 1040x   Gain on the sale of raised livestock is generally the gross sales price reduced by any expenses of the sale. Form 1040x Expenses of sale include sales commissions, freight or hauling from farm to commission company, and other similar expenses. Form 1040x The basis of the animal sold is zero if the costs of raising it were deducted during the years the animal was being raised. Form 1040x However, see Uniform Capitalization Rules in chapter 6. Form 1040x Purchased livestock. Form 1040x   The gross sales price minus your adjusted basis and any expenses of sale is the gain or loss. Form 1040x Example. Form 1040x A farmer sold a breeding cow on January 8, 2013, for $1,250. Form 1040x Expenses of the sale were $125. Form 1040x The cow was bought July 2, 2009, for $1,300. Form 1040x Depreciation (not less than the amount allowable) was $867. Form 1040x Gross sales price $1,250 Cost (basis) $1,300   Minus: Depreciation deduction 867   Unrecovered cost (adjusted basis) $ 433   Expense of sale 125 558 Gain realized $ 692 Converted Wetland and Highly Erodible Cropland Special rules apply to dispositions of land converted to farming use after March 1, 1986. Form 1040x Any gain realized on the disposition of converted wetland or highly erodible cropland is treated as ordinary income. Form 1040x Any loss on the disposition of such property is treated as a long-term capital loss. Form 1040x Converted wetland. Form 1040x   This is generally land that was drained or filled to make the production of agricultural commodities possible. Form 1040x It includes converted wetland held by the person who originally converted it or held by any other person who used the converted wetland at any time after conversion for farming. Form 1040x   A wetland (before conversion) is land that meets all the following conditions. Form 1040x It is mostly soil that, in its undrained condition, is saturated, flooded, or ponded long enough during a growing season to develop an oxygen-deficient state that supports the growth and regeneration of plants growing in water. Form 1040x It is saturated by surface or groundwater at a frequency and duration sufficient to support mostly plants that are adapted for life in saturated soil. Form 1040x It supports, under normal circumstances, mostly plants that grow in saturated soil. Form 1040x Highly erodible cropland. Form 1040x   This is cropland subject to erosion that you used at any time for farming purposes other than grazing animals. Form 1040x Generally, highly erodible cropland is land currently classified by the Department of Agriculture as Class IV, VI, VII, or VIII under its classification system. Form 1040x Highly erodible cropland also includes land that would have an excessive average annual erosion rate in relation to the soil loss tolerance level, as determined by the Department of Agriculture. Form 1040x Successor. Form 1040x   Converted wetland or highly erodible cropland is also land held by any person whose basis in the land is figured by reference to the adjusted basis of a person in whose hands the property was converted wetland or highly erodible cropland. Form 1040x Timber Standing timber you held as investment property is a capital asset. Form 1040x Gain or loss from its sale is capital gain or loss reported on Form 8949 and Schedule D (Form 1040), as applicable. Form 1040x If you held the timber primarily for sale to customers, it is not a capital asset. Form 1040x Gain or loss on its sale is ordinary business income or loss. Form 1040x It is reported on Schedule F, line 1 (purchased timber) or line 2 (raised timber). Form 1040x See the Instructions for Schedule F (Form 1040). Form 1040x Farmers who cut timber on their land and sell it as logs, firewood, or pulpwood usually have no cost or other basis for that timber. Form 1040x Amounts realized from these sales, and the expenses incurred in cutting, hauling, etc. Form 1040x , are ordinary farm income and expenses reported on Schedule F. Form 1040x Different rules apply if you owned the timber longer than 1 year and elect to treat timber cutting as a sale or exchange or you enter into a cutting contract, discussed below. Form 1040x Timber considered cut. Form 1040x   Timber is considered cut on the date when, in the ordinary course of business, the quantity of felled timber is first definitely determined. Form 1040x This is true whether the timber is cut under contract or whether you cut it yourself. Form 1040x Christmas trees. Form 1040x   Evergreen trees, such as Christmas trees, that are more than 6 years old when severed from their roots and sold for ornamental purposes are included in the term timber. Form 1040x They qualify for both rules discussed below. Form 1040x Election to treat cutting as a sale or exchange. Form 1040x   Under the general rule, the cutting of timber results in no gain or loss. Form 1040x It is not until a sale or exchange occurs that gain or loss is realized. Form 1040x But if you owned or had a contractual right to cut timber, you can elect to treat the cutting of timber as a section 1231 transaction in the year it is cut. Form 1040x Even though the cut timber is not actually sold or exchanged, you report your gain or loss on the cutting for the year the timber is cut. Form 1040x Any later sale results in ordinary business income or loss. Form 1040x See the example below. Form 1040x   To elect this treatment, you must: Own or hold a contractual right to cut the timber for a period of more than 1 year before it is cut, and Cut the timber for sale or use in your trade or business. Form 1040x Making the election. Form 1040x   You make the election on your return for the year the cutting takes place by including in income the gain or loss on the cutting and including a computation of your gain or loss. Form 1040x You do not have to make the election in the first year you cut the timber. Form 1040x You can make it in any year to which the election would apply. Form 1040x If the timber is partnership property, the election is made on the partnership return. Form 1040x This election cannot be made on an amended return. Form 1040x   Once you have made the election, it remains in effect for all later years unless you revoke it. Form 1040x Election under section 631(a) may be revoked. Form 1040x   If you previously elected for any tax year ending before October 23, 2004, to treat the cutting of timber as a sale or exchange under section 631(a), you may revoke this election without the consent of the IRS for any tax year ending after October 22, 2004. Form 1040x The prior election (and revocation) is disregarded for purposes of making a subsequent election. Form 1040x See Form T (Timber), Forest Activities Schedule, for more information. Form 1040x Gain or loss. Form 1040x   Your gain or loss on the cutting of standing timber is the difference between its adjusted basis for depletion and its FMV on the first day of your tax year in which it is cut. Form 1040x   Your adjusted basis for depletion of cut timber is based on the number of units (board feet, log scale, or other units) of timber cut during the tax year and considered to be sold or exchanged. Form 1040x Your adjusted basis for depletion is also based on the depletion unit of timber in the account used for the cut timber, and should be figured in the same manner as shown in section 611 and Regulations section 1. Form 1040x 611-3. Form 1040x   Depletion of timber is discussed in chapter 7. Form 1040x Example. Form 1040x   In April 2013, you owned 4,000 MBF (1,000 board feet) of standing timber longer than 1 year. Form 1040x It had an adjusted basis for depletion of $40 per MBF. Form 1040x You are a calendar year taxpayer. Form 1040x On January 1, 2013, the timber had a FMV of $350 per MBF. Form 1040x It was cut in April for sale. Form 1040x On your 2013 tax return, you elect to treat the cutting of the timber as a sale or exchange. Form 1040x You report the difference between the FMV and your adjusted basis for depletion as a gain. Form 1040x This amount is reported on Form 4797 along with your other section 1231 gains and losses to figure whether it is treated as a capital gain or as ordinary gain. Form 1040x You figure your gain as follows. Form 1040x FMV of timber January 1, 2013 $1,400,000 Minus: Adjusted basis for depletion 160,000 Section 1231 gain $1,240,000   The FMV becomes your basis in the cut timber, and a later sale of the cut timber, including any by-product or tree tops, will result in ordinary business income or loss. Form 1040x Outright sales of timber. Form 1040x   Outright sales of timber by landowners qualify for capital gains treatment using rules similar to the rules for certain disposal of timber under a contract with retained economic interest (defined later). Form 1040x However, for outright sales, the date of disposal is not deemed to be the date the timber is cut because the landowner can elect to treat the payment date as the date of disposal (see Date of disposal below). Form 1040x Cutting contract. Form 1040x   You must treat the disposal of standing timber under a cutting contract as a section 1231 transaction if all the following apply to you. Form 1040x You are the owner of the timber. Form 1040x You held the timber longer than 1 year before its disposal. Form 1040x You kept an economic interest in the timber. Form 1040x   You have kept an economic interest in standing timber if, under the cutting contract, the expected return on your investment is conditioned on the cutting of the timber. Form 1040x   The difference between the amount realized from the disposal of the timber and its adjusted basis for depletion is treated as gain or loss on its sale. Form 1040x Include this amount on Form 4797 along with your other section 1231 gains or losses. Form 1040x Date of disposal. Form 1040x   The date of disposal is the date the timber is cut. Form 1040x However, for outright sales by landowners or if you receive payment under the contract before the timber is cut, you can elect to treat the date of payment as the date of disposal. Form 1040x   This election applies only to figure the holding period of the timber. Form 1040x It has no effect on the time for reporting gain or loss (generally when the timber is sold or exchanged). Form 1040x   To make this election, attach a statement to the tax return filed by the due date (including extensions) for the year payment is received. Form 1040x The statement must identify the advance payments subject to the election and the contract under which they were made. Form 1040x   If you timely filed your return for the year you received payment without making the election, you can still make the election by filing an amended return within 6 months after the due date for that year's return (excluding extensions). Form 1040x Attach the statement to the amended return and write “Filed pursuant to section 301. Form 1040x 9100-2” at the top of the statement. Form 1040x File the amended return at the same address the original return was filed. Form 1040x Owner. Form 1040x   An owner is any person who owns an interest in the timber, including a sublessor and the holder of a contract to cut the timber. Form 1040x You own an interest in timber if you have the right to cut it for sale on your own account or for use in your business. Form 1040x Tree stumps. Form 1040x   Tree stumps are a capital asset if they are on land held by an investor who is not in the timber or stump business as a buyer, seller, or processor. Form 1040x Gain from the sale of stumps sold in one lot by such a holder is taxed as a capital gain. Form 1040x However, tree stumps held by timber operators after the saleable standing timber was cut and removed from the land are considered by-products. Form 1040x Gain from the sale of stumps in lots or tonnage by such operators is taxed as ordinary income. Form 1040x   See Form T (Timber) and its separate instructions for more information about dispositions of timber. Form 1040x Sale of a Farm The sale of your farm will usually involve the sale of both nonbusiness property (your home) and business property (the land and buildings used in the farm operation and perhaps machinery and livestock). Form 1040x If you have a gain from the sale, you may be allowed to exclude the gain on your home. Form 1040x For more information, see Publication 523, Selling Your Home. Form 1040x The gain on the sale of your business property is taxable. Form 1040x A loss on the sale of your business property to an unrelated person is deducted as an ordinary loss. Form 1040x Your taxable gain or loss on the sale of property used in your farm business is taxed under the rules for section 1231 transactions. Form 1040x See chapter 9. Form 1040x Losses from personal-use property, other than casualty or theft losses, are not deductible. Form 1040x If you receive payments for your farm in installments, your gain is taxed over the period of years the payments are received, unless you elect not to use the installment method of reporting the gain. Form 1040x See chapter 10 for information about installment sales. Form 1040x When you sell your farm, the gain or loss on each asset is figured separately. Form 1040x The tax treatment of gain or loss on the sale of each asset is determined by the classification of the asset. Form 1040x Each of the assets sold must be classified as one of the following. Form 1040x Capital asset held 1 year or less. Form 1040x Capital asset held longer than 1 year. Form 1040x Property (including real estate) used in your business and held 1 year or less (including draft, breeding, dairy, and sporting animals held less than the holding periods discussed earlier under Livestock ). Form 1040x Property (including real estate) used in your business and held longer than 1 year (including only draft, breeding, dairy, and sporting animals held for the holding periods discussed earlier). Form 1040x Property held primarily for sale or which is of the kind that would be included in inventory if on hand at the end of your tax year. Form 1040x Allocation of consideration paid for a farm. Form 1040x   The sale of a farm for a lump sum is considered a sale of each individual asset rather than a single asset. Form 1040x The residual method is required only if the group of assets sold constitutes a trade or business. Form 1040x This method determines gain or loss from the transfer of each asset. Form 1040x It also determines the buyer's basis in the business assets. Form 1040x For more information, see Sale of a Business in chapter 2 of Publication 544. Form 1040x Property used in farm operation. Form 1040x   The rules for excluding the gain on the sale of your home, described later under Sale of your home , do not apply to the property used for your farming business. Form 1040x Recognized gains and losses on business property must be reported on your return for the year of the sale. Form 1040x If the property was held longer than 1 year, it may qualify for section 1231 treatment (see chapter 9). Form 1040x Example. Form 1040x You sell your farm, including your main home, which you have owned since December 2001. Form 1040x You realize gain on the sale as follows. Form 1040x   Farm   Farm   With Home Without   Home Only Home Selling price $382,000 $158,000 $224,000 Cost (or other basis) 240,000 110,000 130,000 Gain $142,000 $48,000 $94,000 You must report the $94,000 gain from the sale of the property used in your farm business. Form 1040x All or a part of that gain may have to be reported as ordinary income from the recapture of depreciation or soil and water conservation expenses. Form 1040x Treat the balance as section 1231 gain. Form 1040x The $48,000 gain from the sale of your home is not taxable as long as you meet the requirements explained later under Sale of your home . Form 1040x Partial sale. Form 1040x   If you sell only part of your farm, you must report any recognized gain or loss on the sale of that part on your tax return for the year of the sale. Form 1040x You cannot wait until you have sold enough of the farm to recover its entire cost before reporting gain or loss. Form 1040x For a detailed discussion on installment sales, see Publication 544. Form 1040x Adjusted basis of the part sold. Form 1040x   This is the properly allocated part of your original cost or other basis of the entire farm plus or minus necessary adjustments for improvements, depreciation, etc. Form 1040x , on the part sold. Form 1040x If your home is on the farm, you must properly adjust the basis to exclude those costs from your farm asset costs, as discussed below under Sale of your home . Form 1040x Example. Form 1040x You bought a 600-acre farm for $700,000. Form 1040x The farm included land and buildings. Form 1040x The purchase contract designated $600,000 of the purchase price to the land. Form 1040x You later sold 60 acres of land on which you had installed a fence. Form 1040x Your adjusted basis for the part of your farm sold is $60,000 (1/10 of $600,000), plus any unrecovered cost (cost not depreciated) of the fence on the 60 acres at the time of sale. Form 1040x Use this amount to determine your gain or loss on the sale of the 60 acres. Form 1040x Assessed values for local property taxes. Form 1040x   If you paid a flat sum for the entire farm and no other facts are available for properly allocating your original cost or other basis between the land and the buildings, you can use the assessed values for local property taxes for the year of purchase to allocate the costs. Form 1040x Example. Form 1040x Assume that in the preceding example there was no breakdown of the $700,000 purchase price between land and buildings. Form 1040x However, in the year of purchase, local taxes on the entire property were based on assessed valuations of $420,000 for land and $140,000 for improvements, or a total of $560,000. Form 1040x The assessed valuation of the land is 3/4 (75%) of the total assessed valuation. Form 1040x Multiply the $700,000 total purchase price by 75% to figure basis of $525,000 for the 600 acres of land. Form 1040x The unadjusted basis of the 60 acres you sold would then be $52,500 (1/10 of $525,000). Form 1040x Sale of your home. Form 1040x   Your home is a capital asset and not property used in the trade or business of farming. Form 1040x If you sell a farm that includes a house you and your family occupy, you must determine the part of the selling price and the part of the cost or other basis allocable to your home. Form 1040x Your home includes the immediate surroundings and outbuildings relating to it that are not used for business purposes. Form 1040x   If you use part of your home for business, you must make an appropriate adjustment to the basis for depreciation allowed or allowable. Form 1040x For more information on basis, see chapter 6. Form 1040x More information. Form 1040x   For more information on selling your home, see Publication 523. Form 1040x Gain from condemnation. Form 1040x   If you have a gain from a condemnation or sale under threat of condemnation, you may use the preceding rules for excluding the gain, rather than the rules discussed under Postponing Gain in chapter 11. Form 1040x However, any gain that cannot be excluded (because it is more than the limit) may be postponed under the rules discussed under Postponing Gain in chapter 11. Form 1040x Foreclosure or Repossession If you do not make payments you owe on a loan secured by property, the lender may foreclose on the loan or repossess the property. Form 1040x The foreclosure or repossession is treated as a sale or exchange from which you may realize gain or loss. Form 1040x This is true even if you voluntarily return the property to the lender. Form 1040x You may also realize ordinary income from cancellation of debt if the loan balance is more than the FMV of the property. Form 1040x Buyer's (borrower's) gain or loss. Form 1040x   You figure and report gain or loss from a foreclosure or repossession in the same way as gain or loss from a sale or exchange. Form 1040x The gain or loss is the difference between your adjusted basis in the transferred property and the amount realized. Form 1040x See Determining Gain or Loss , earlier. Form 1040x Worksheet 8-1. Form 1040x Worksheet for Foreclosures andRepossessions Part 1. Form 1040x Use Part 1 to figure your ordinary income from the cancellation of debt upon foreclosure or repossession. Form 1040x Complete this part only if you were personally liable for the debt. Form 1040x Otherwise, go to Part 2. Form 1040x   1. Form 1040x Enter the amount of outstanding debt immediately before the transfer of property reduced by any amount for which you remain personally liable after the transfer of property   2. Form 1040x Enter the Fair Market Value of the transferred property   3. Form 1040x Ordinary income from cancellation of debt upon foreclosure or repossession. Form 1040x * Subtract line 2 from line 1. Form 1040x If zero or less, enter -0-   Part 2. Form 1040x Figure your gain or loss from foreclosure or repossession. Form 1040x   4. Form 1040x If you completed Part 1, enter the smaller of line 1 or line 2. Form 1040x If you did not complete Part 1, enter the outstanding debt immediately before the transfer of property   5. Form 1040x Enter any proceeds you received from the foreclosure sale   6. Form 1040x Add lines 4 and 5   7. Form 1040x Enter the adjusted basis of the transferred property   8. Form 1040x Gain or loss from foreclosure or repossession. Form 1040x Subtract line 7  from line 6   * The income may not be taxable. Form 1040x See Cancellation of debt . Form 1040x    You can use Worksheet 8-1 to figure your gain or loss from a foreclosure or repossession. Form 1040x Amount realized on a nonrecourse debt. Form 1040x   If you are not personally liable for repaying the debt (nonrecourse debt) secured by the transferred property, the amount you realize includes the full amount of the debt canceled by the transfer. Form 1040x The full canceled debt is included in the amount realized even if the fair market value of the property is less than the canceled debt. Form 1040x Example 1. Form 1040x Ann paid $200,000 for land used in her farming business. Form 1040x She paid $15,000 down and borrowed the remaining $185,000 from a bank. Form 1040x Ann is not personally liable for the loan (nonrecourse debt), but pledges the land as security. Form 1040x The bank foreclosed on the loan 2 years after Ann stopped making payments. Form 1040x When the bank foreclosed, the balance due on the loan was $180,000 and the FMV of the land was $170,000. Form 1040x The amount Ann realized on the foreclosure was $180,000, the debt canceled by the foreclosure. Form 1040x She figures her gain or loss on Form 4797, Part I, by comparing the amount realized ($180,000) with her adjusted basis ($200,000). Form 1040x She has a $20,000 deductible loss. Form 1040x Example 2. Form 1040x Assume the same facts as in Example 1 except the FMV of the land was $210,000. Form 1040x The result is the same. Form 1040x The amount Ann realized on the foreclosure is $180,000, the debt canceled by the foreclosure. Form 1040x Because her adjusted basis is $200,000, she has a deductible loss of $20,000, which she reports on Form 4797, Part I. Form 1040x Amount realized on a recourse debt. Form 1040x   If you are personally liable for the debt (recourse debt), the amount realized on the foreclosure or repossession includes the lesser of: The outstanding debt immediately before the transfer reduced by any amount for which you remain personally liable immediately after the transfer, or The fair market value of the transferred property. Form 1040x   You are treated as receiving ordinary income from the canceled debt for the part of the debt that is more than the fair market value. Form 1040x The amount realized does not include the canceled debt that is your income from cancellation of debt. Form 1040x See Cancellation of debt , later. Form 1040x Example 3. Form 1040x Assume the same facts as in Example 1 above except Ann is personally liable for the loan (recourse debt). Form 1040x In this case, the amount she realizes is $170,000. Form 1040x This is the canceled debt ($180,000) up to the FMV of the land ($170,000). Form 1040x Ann figures her gain or loss on the foreclosure by comparing the amount realized ($170,000) with her adjusted basis ($200,000). Form 1040x She has a $30,000 deductible loss, which she figures on Form 4797, Part I. Form 1040x She is also treated as receiving ordinary income from cancellation of debt. Form 1040x That income is $10,000 ($180,000 − $170,000). Form 1040x This is the part of the canceled debt not included in the amount realized. Form 1040x She reports this as other income on Schedule F, line 8. Form 1040x Seller's (lender's) gain or loss on repossession. Form 1040x   If you finance a buyer's purchase of property and later acquire an interest in it through foreclosure or repossession, you may have a gain or loss on the acquisition. Form 1040x For more information, see Repossession in Publication 537, Installment Sales. Form 1040x Cancellation of debt. Form 1040x   If property that is repossessed or foreclosed upon secures a debt for which you are personally liable (recourse debt), you generally must report as ordinary income the amount by which the canceled debt is more than the FMV of the property. Form 1040x This income is separate from any gain or loss realized from the foreclosure or repossession. Form 1040x Report the income from cancellation of a business debt on Schedule F, line 8. Form 1040x Report the income from cancellation of a nonbusiness debt as miscellaneous income on Form 1040. Form 1040x    You can use Worksheet 8-1 to figure your income from cancellation of debt. Form 1040x   However, income from cancellation of debt is not taxed if any of the following apply. Form 1040x The cancellation is intended as a gift. Form 1040x The debt is qualified farm debt (see chapter 3). Form 1040x The debt is qualified real property business debt (see chapter 5 of Publication 334). Form 1040x You are insolvent or bankrupt (see  chapter 3). Form 1040x The debt is qualified principal residence indebtedness (see chapter 3). Form 1040x   Use Form 982 to report the income exclusion. Form 1040x Abandonment The abandonment of property is a disposition of property. Form 1040x You abandon property when you voluntarily and permanently give up possession and use of the property with the intention of ending your ownership, but without passing it on to anyone else. Form 1040x Business or investment property. Form 1040x   Loss from abandonment of business or investment property is deductible as a loss. Form 1040x Loss from abandonment of business or investment property that is not treated as a sale or exchange generally is an ordinary loss. Form 1040x If your adjusted basis is more than the amount you realize (if any), then you have a loss. Form 1040x If the amount you realize (if any) is more than your adjusted basis, then you have a gain. Form 1040x This rule also applies to leasehold improvements the lessor made for the lessee. Form 1040x However, if the property is foreclosed on or repossessed in lieu of abandonment, gain or loss is figured as discussed earlier under Foreclosure or Repossession . Form 1040x   If the abandoned property is secured by debt, special rules apply. Form 1040x The tax consequences of abandonment of property that secures a debt depend on whether you are personally liable for the debt (recourse debt) or were not personally liable for the debt (nonrecourse debt). Form 1040x For more information, see chapter 3 of Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments (for Individuals). Form 1040x The abandonment loss is deducted in the tax year in which the loss is sustained. Form 1040x Report the loss on Form 4797, Part II, line 10. Form 1040x Personal-use property. Form 1040x   You cannot deduct any loss from abandonment of your home or other property held for personal use. Form 1040x Canceled debt. Form 1040x   If the abandoned property secures a debt for which you are personally liable and the debt is canceled, you will realize ordinary income equal to the canceled debt. Form 1040x This income is separate from any loss realized from abandonment of the property. Form 1040x Report income from cancellation of a debt related to a business or rental activity as business or rental income. Form 1040x Report income from cancellation of a nonbusiness debt as miscellaneous income on Form 1040. Form 1040x   However, income from cancellation of debt is not taxed in certain circumstances. Form 1040x See Cancellation of debt earlier under Foreclosure or Repossession . Form 1040x Forms 1099-A and 1099-C. Form 1040x   A lender who acquires an interest in your property in a foreclosure, repossession, or abandonment should send you Form 1099-A showing the information you need to figure your loss from the foreclosure, repossession, or abandonment. Form 1040x However, if the lender cancels part of your debt and the lender must file Form 1099-C, the lender may include the information about the foreclosure, repossession, or abandonment on that form instead of Form 1099-A. Form 1040x The lender must file Form 1099-C and send you a copy if the canceled debt is $600 or more and the lender is a financial institution, credit union, federal government agency, or any organization that has a significant trade or business of lending money. Form 1040x For foreclosures, repossessions, abandonments of property, and debt cancellations occurring in 2013, these forms should be sent to you by January 31, 2014. Form 1040x Prev  Up  Next   Home   More Online Publications
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The Form 1040x

Form 1040x 4. Form 1040x   Qualified Plans Table of Contents Topics - This chapter discusses: Useful Items - You may want to see: Kinds of PlansDefined Contribution Plan Defined Benefit Plan Qualification RulesEarly retirement. Form 1040x Loan secured by benefits. Form 1040x Waiver of survivor benefits. Form 1040x Waiver of 30-day waiting period before annuity starting date. Form 1040x Involuntary cash-out of benefits not more than dollar limit. Form 1040x Exception for certain loans. Form 1040x Exception for QDRO. Form 1040x SIMPLE and safe harbor 401(k) plan exception. Form 1040x Setting Up a Qualified PlanAdopting a Written Plan Investing Plan Assets Minimum Funding RequirementDue dates. Form 1040x Installment percentage. Form 1040x Extended period for making contributions. Form 1040x ContributionsEmployer Contributions Employee Contributions When Contributions Are Considered Made Employer DeductionDeduction Limits Deduction Limit for Self-Employed Individuals Where To Deduct Contributions Carryover of Excess Contributions Excise Tax for Nondeductible (Excess) Contributions Elective Deferrals (401(k) Plans)Limit on Elective Deferrals Automatic Enrollment Treatment of Excess Deferrals Qualified Roth Contribution ProgramElective Deferrals Qualified Distributions Reporting Requirements DistributionsRequired Distributions Distributions From 401(k) Plans Tax Treatment of Distributions Tax on Early Distributions Tax on Excess Benefits Excise Tax on Reversion of Plan Assets Notification of Significant Benefit Accrual Reduction Prohibited TransactionsTax on Prohibited Transactions Reporting RequirementsOne-participant plan. Form 1040x Caution: Form 5500-EZ not required. Form 1040x Form 5500. Form 1040x Electronic filing of Forms 5500 and 5500-SF. Form 1040x Topics - This chapter discusses: Kinds of plans Qualification rules Setting up a qualified plan Minimum funding requirement Contributions Employer deduction Elective deferrals (401(k) plans) Qualified Roth contribution program Distributions Prohibited transactions Reporting requirements Useful Items - You may want to see: Publications 575 Pension and Annuity Income 590 Individual Retirement Arrangements (IRAs) 3066 Have you had your Check-up this year? for Retirement Plans 3998 Choosing A Retirement Solution for Your Small Business 4222 401(k) Plans for Small Businesses 4530 Designated Roth Accounts under a 401(k), 403(b), or governmental 457(b) plans 4531 401(k) Plan Checklist 4674 Automatic Enrollment 401(k) Plans for Small Businesses 4806 Profit Sharing Plans for Small Businesses Forms (and Instructions) www. Form 1040x dol. Form 1040x gov/ebsa/pdf/2013-5500. Form 1040x pdf www. Form 1040x dol. Form 1040x gov/ebsa/pdf/2013-5500-SF. Form 1040x pdf W-2 Wage and Tax Statement Schedule K-1 (Form 1065) Partner's Share of Income, Deductions, Credits, etc. Form 1040x 1099-R Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. Form 1040x 1040 U. Form 1040x S. Form 1040x Individual Income Tax Return Schedule C (Form 1040) Profit or Loss From Business Schedule F (Form 1040) Profit or Loss From Farming 5300 Application for Determination for Employee Benefit Plan 5310 Application for Determination for Terminating Plan 5329 Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts 5330 Return of Excise Taxes Related to Employee Benefit Plans 5500 Annual Return/Report of Employee Benefit Plan. Form 1040x For copies of this form, go to: 5500-EZ Annual Return of One-Participant (Owners and Their Spouses) Retirement Plan 5500-SF Short Form Annual Return/Report of Small Employee Benefit Plan. Form 1040x For copies of this form, go to: 8717 User Fee for Employee Plan Determination Letter Request 8880 Credit for Qualified Retirement Savings Contributions 8881 Credit for Small Employer Pension Plan Startup Costs 8955-SSA Annual Registration Statement Identifying Separated Participants With Deferred Vested Benefits These qualified retirement plans set up by self-employed individuals are sometimes called Keogh or H. Form 1040x R. Form 1040x 10 plans. Form 1040x A sole proprietor or a partnership can set up one of these plans. Form 1040x A common-law employee or a partner cannot set up one of these plans. Form 1040x The plans described here can also be set up and maintained by employers that are corporations. Form 1040x All the rules discussed here apply to corporations except where specifically limited to the self-employed. Form 1040x The plan must be for the exclusive benefit of employees or their beneficiaries. Form 1040x These qualified plans can include coverage for a self-employed individual. Form 1040x As an employer, you can usually deduct, subject to limits, contributions you make to a qualified plan, including those made for your own retirement. Form 1040x The contributions (and earnings and gains on them) are generally tax free until distributed by the plan. Form 1040x Kinds of Plans There are two basic kinds of qualified plans—defined contribution plans and defined benefit plans—and different rules apply to each. Form 1040x You can have more than one qualified plan, but your contributions to all the plans must not total more than the overall limits discussed under Contributions and Employer Deduction, later. Form 1040x Defined Contribution Plan A defined contribution plan provides an individual account for each participant in the plan. Form 1040x It provides benefits to a participant largely based on the amount contributed to that participant's account. Form 1040x Benefits are also affected by any income, expenses, gains, losses, and forfeitures of other accounts that may be allocated to an account. Form 1040x A defined contribution plan can be either a profit-sharing plan or a money purchase pension plan. Form 1040x Profit-sharing plan. Form 1040x   Although it is called a “profit-sharing plan,” you do not actually have to make a business profit for the year in order to make a contribution (except for yourself if you are self-employed as discussed under Self-employed Individual, later). Form 1040x A profit-sharing plan can be set up to allow for discretionary employer contributions, meaning the amount contributed each year to the plan is not fixed. Form 1040x An employer may even make no contribution to the plan for a given year. Form 1040x   The plan must provide a definite formula for allocating the contribution among the participants and for distributing the accumulated funds to the employees after they reach a certain age, after a fixed number of years, or upon certain other occurrences. Form 1040x   In general, you can be more flexible in making contributions to a profit-sharing plan than to a money purchase pension plan (discussed next) or a defined benefit plan (discussed later). Form 1040x Money purchase pension plan. Form 1040x   Contributions to a money purchase pension plan are fixed and are not based on your business profits. Form 1040x For example, if the plan requires that contributions be 10% of the participants' compensation without regard to whether you have profits (or the self-employed person has earned income), the plan is a money purchase pension plan. Form 1040x This applies even though the compensation of a self-employed individual as a participant is based on earned income derived from business profits. Form 1040x Defined Benefit Plan A defined benefit plan is any plan that is not a defined contribution plan. Form 1040x Contributions to a defined benefit plan are based on what is needed to provide definitely determinable benefits to plan participants. Form 1040x Actuarial assumptions and computations are required to figure these contributions. Form 1040x Generally, you will need continuing professional help to have a defined benefit plan. Form 1040x Qualification Rules To qualify for the tax benefits available to qualified plans, a plan must meet certain requirements (qualification rules) of the tax law. Form 1040x Generally, unless you write your own plan, the financial institution that provided your plan will take the continuing responsibility for meeting qualification rules that are later changed. Form 1040x The following is a brief overview of important qualification rules that generally have not yet been discussed. Form 1040x It is not intended to be all-inclusive. Form 1040x See Setting Up a Qualified Plan , later. Form 1040x Generally, the following qualification rules also apply to a SIMPLE 401(k) retirement plan. Form 1040x A SIMPLE 401(k) plan is, however, not subject to the top-heavy plan rules and nondiscrimination rules if the plan satisfies the provisions discussed in chapter 3 under SIMPLE 401(k) Plan. Form 1040x Plan assets must not be diverted. Form 1040x   Your plan must make it impossible for its assets to be used for, or diverted to, purposes other than the benefit of employees and their beneficiaries. Form 1040x As a general rule, the assets cannot be diverted to the employer. Form 1040x Minimum coverage requirement must be met. Form 1040x   To be a qualified plan, a defined benefit plan must benefit at least the lesser of the following. Form 1040x 50 employees, or The greater of: 40% of all employees, or Two employees. Form 1040x If there is only one employee, the plan must benefit that employee. Form 1040x Contributions or benefits must not discriminate. Form 1040x   Under the plan, contributions or benefits to be provided must not discriminate in favor of highly compensated employees. Form 1040x Contributions and benefits must not be more than certain limits. Form 1040x   Your plan must not provide for contributions or benefits that are more than certain limits. Form 1040x The limits apply to the annual contributions and other additions to the account of a participant in a defined contribution plan and to the annual benefit payable to a participant in a defined benefit plan. Form 1040x These limits are discussed later in this chapter under Contributions. Form 1040x Minimum vesting standard must be met. Form 1040x   Your plan must satisfy certain requirements regarding when benefits vest. Form 1040x A benefit is vested (you have a fixed right to it) when it becomes nonforfeitable. Form 1040x A benefit is nonforfeitable if it cannot be lost upon the happening, or failure to happen, of any event. Form 1040x Special rules apply to forfeited benefit amounts. Form 1040x In defined contribution plans, forfeitures can be allocated to the accounts of remaining participants in a nondiscriminatory way, or they can be used to reduce your contributions. Form 1040x   Forfeitures under a defined benefit plan cannot be used to increase the benefits any employee would otherwise receive under the plan. Form 1040x Forfeitures must be used instead to reduce employer contributions. Form 1040x Participation. Form 1040x   In general, an employee must be allowed to participate in your plan if he or she meets both the following requirements. Form 1040x Has reached age 21. Form 1040x Has at least 1 year of service (2 years if the plan is not a 401(k) plan and provides that after not more than 2 years of service the employee has a nonforfeitable right to all his or her accrued benefit). Form 1040x A plan cannot exclude an employee because he or she has reached a specified age. Form 1040x Leased employee. Form 1040x   A leased employee, defined in chapter 1, who performs services for you (recipient of the services) is treated as your employee for certain plan qualification rules. Form 1040x These rules include those in all the following areas. Form 1040x Nondiscrimination in coverage, contributions, and benefits. Form 1040x Minimum age and service requirements. Form 1040x Vesting. Form 1040x Limits on contributions and benefits. Form 1040x Top-heavy plan requirements. Form 1040x Contributions or benefits provided by the leasing organization for services performed for you are treated as provided by you. Form 1040x Benefit payment must begin when required. Form 1040x   Your plan must provide that, unless the participant chooses otherwise, the payment of benefits to the participant must begin within 60 days after the close of the latest of the following periods. Form 1040x The plan year in which the participant reaches the earlier of age 65 or the normal retirement age specified in the plan. Form 1040x The plan year in which the 10th anniversary of the year in which the participant began participating in the plan occurs. Form 1040x The plan year in which the participant separates from service. Form 1040x Early retirement. Form 1040x   Your plan can provide for payment of retirement benefits before the normal retirement age. Form 1040x If your plan offers an early retirement benefit, a participant who separates from service before satisfying the early retirement age requirement is entitled to that benefit if he or she meets both the following requirements. Form 1040x Satisfies the service requirement for the early retirement benefit. Form 1040x Separates from service with a nonforfeitable right to an accrued benefit. Form 1040x The benefit, which may be actuarially reduced, is payable when the early retirement age requirement is met. Form 1040x Required minimum distributions. Form 1040x   Special rules require minimum annual distributions from qualified plans, generally beginning after age  70½. Form 1040x See Required Distributions , under Distributions, later. Form 1040x Survivor benefits. Form 1040x   Defined benefit and money purchase pension plans must provide automatic survivor benefits in both the following forms. Form 1040x A qualified joint and survivor annuity for a vested participant who does not die before the annuity starting date. Form 1040x A qualified pre-retirement survivor annuity for a vested participant who dies before the annuity starting date and who has a surviving spouse. Form 1040x   The automatic survivor benefit also applies to any participant under a profit-sharing plan unless all the following conditions are met. Form 1040x The participant does not choose benefits in the form of a life annuity. Form 1040x The plan pays the full vested account balance to the participant's surviving spouse (or other beneficiary if the surviving spouse consents or if there is no surviving spouse) if the participant dies. Form 1040x The plan is not a direct or indirect transferee of a plan that must provide automatic survivor benefits. Form 1040x Loan secured by benefits. Form 1040x   If automatic survivor benefits are required for a spouse under a plan, he or she must consent to a loan that uses as security the accrued benefits in the plan. Form 1040x Waiver of survivor benefits. Form 1040x   Each plan participant may be permitted to waive the joint and survivor annuity or the pre-retirement survivor annuity (or both), but only if the participant has the written consent of the spouse. Form 1040x The plan also must allow the participant to withdraw the waiver. Form 1040x The spouse's consent must be witnessed by a plan representative or notary public. Form 1040x Waiver of 30-day waiting period before annuity starting date. Form 1040x    A plan may permit a participant to waive (with spousal consent) the 30-day minimum waiting period after a written explanation of the terms and conditions of a joint and survivor annuity is provided to each participant. Form 1040x   The waiver is allowed only if the distribution begins more than 7 days after the written explanation is provided. Form 1040x Involuntary cash-out of benefits not more than dollar limit. Form 1040x   A plan may provide for the immediate distribution of the participant's benefit under the plan if the present value of the benefit is not greater than $5,000. Form 1040x   However, the distribution cannot be made after the annuity starting date unless the participant and the spouse or surviving spouse of a participant who died (if automatic survivor benefits are required for a spouse under the plan) consents in writing to the distribution. Form 1040x If the present value is greater than $5,000, the plan must have the written consent of the participant and the spouse or surviving spouse (if automatic survivor benefits are required for a spouse under the plan) for any immediate distribution of the benefit. Form 1040x   Benefits attributable to rollover contributions and earnings on them can be ignored in determining the present value of these benefits. Form 1040x   A plan must provide for the automatic rollover of any cash-out distribution of more than $1,000 to an individual retirement account or annuity, unless the participant chooses otherwise. Form 1040x A section 402(f) notice must be sent prior to an involuntary cash-out of an eligible rollover distribution. Form 1040x See Section 402(f) Notice under Distributions, later, for more details. Form 1040x Consolidation, merger, or transfer of assets or liabilities. Form 1040x   Your plan must provide that, in the case of any merger or consolidation with, or transfer of assets or liabilities to, any other plan, each participant would (if the plan then terminated) receive a benefit equal to or more than the benefit he or she would have been entitled to just before the merger, etc. Form 1040x (if the plan had then terminated). Form 1040x Benefits must not be assigned or alienated. Form 1040x   Your plan must provide that a participant's or beneficiary's benefits under the plan cannot be taken away by any legal or equitable proceeding except as provided below or pursuant to certain judgements or settlements against the participant for violations of plan rules. Form 1040x Exception for certain loans. Form 1040x   A loan from the plan (not from a third party) to a participant or beneficiary is not treated as an assignment or alienation if the loan is secured by the participant's accrued nonforfeitable benefit and is exempt from the tax on prohibited transactions under section 4975(d)(1) or would be exempt if the participant were a disqualified person. Form 1040x A disqualified person is defined later in this chapter under Prohibited Transactions. Form 1040x Exception for QDRO. Form 1040x   Compliance with a QDRO (qualified domestic relations order) does not result in a prohibited assignment or alienation of benefits. Form 1040x   Payments to an alternate payee under a QDRO before the participant attains age 59½ are not subject to the 10% additional tax that would otherwise apply under certain circumstances. Form 1040x Benefits distributed to an alternate payee under a QDRO can be rolled over tax free to an individual retirement account or to an individual retirement annuity. Form 1040x No benefit reduction for social security increases. Form 1040x   Your plan must not permit a benefit reduction for a post-separation increase in the social security benefit level or wage base for any participant or beneficiary who is receiving benefits under your plan, or who is separated from service and has nonforfeitable rights to benefits. Form 1040x This rule also applies to plans supplementing the benefits provided by other federal or state laws. Form 1040x Elective deferrals must be limited. Form 1040x   If your plan provides for elective deferrals, it must limit those deferrals to the amount in effect for that particular year. Form 1040x See Limit on Elective Deferrals later in this chapter. Form 1040x Top-heavy plan requirements. Form 1040x   A top-heavy plan is one that mainly favors partners, sole proprietors, and other key employees. Form 1040x   A plan is top-heavy for a plan year if, for the preceding plan year, the total value of accrued benefits or account balances of key employees is more than 60% of the total value of accrued benefits or account balances of all employees. Form 1040x Additional requirements apply to a top-heavy plan primarily to provide minimum benefits or contributions for non-key employees covered by the plan. Form 1040x   Most qualified plans, whether or not top-heavy, must contain provisions that meet the top-heavy requirements and will take effect in plan years in which the plans are top-heavy. Form 1040x These qualification requirements for top-heavy plans are explained in section 416 and its regulations. Form 1040x SIMPLE and safe harbor 401(k) plan exception. Form 1040x   The top-heavy plan requirements do not apply to SIMPLE 401(k) plans, discussed earlier in chapter 3, or to safe harbor 401(k) plans that consist solely of safe harbor contributions, discussed later in this chapter. Form 1040x QACAs (discussed later) also are not subject to top-heavy requirements. Form 1040x Setting Up a Qualified Plan There are two basic steps in setting up a qualified plan. Form 1040x First you adopt a written plan. Form 1040x Then you invest the plan assets. Form 1040x You, the employer, are responsible for setting up and maintaining the plan. Form 1040x If you are self-employed, it is not necessary to have employees besides yourself to sponsor and set up a qualified plan. Form 1040x If you have employees, see Participation, under Qualification Rules, earlier. Form 1040x Set-up deadline. Form 1040x   To take a deduction for contributions for a tax year, your plan must be set up (adopted) by the last day of that year (December 31 for calendar-year employers). Form 1040x Credit for startup costs. Form 1040x   You may be able to claim a tax credit for part of the ordinary and necessary costs of starting a qualified plan that first became effective in 2013. Form 1040x For more information, see Credit for startup costs under Reminders, earlier. Form 1040x Adopting a Written Plan You must adopt a written plan. Form 1040x The plan can be an IRS-approved master or prototype plan offered by a sponsoring organization. Form 1040x Or it can be an individually designed plan. Form 1040x Written plan requirement. Form 1040x   To qualify, the plan you set up must be in writing and must be communicated to your employees. Form 1040x The plan's provisions must be stated in the plan. Form 1040x It is not sufficient for the plan to merely refer to a requirement of the Internal Revenue Code. Form 1040x Master or prototype plans. Form 1040x   Most qualified plans follow a standard form of plan (a master or prototype plan) approved by the IRS. Form 1040x Master and prototype plans are plans made available by plan providers for adoption by employers (including self-employed individuals). Form 1040x Under a master plan, a single trust or custodial account is established, as part of the plan, for the joint use of all adopting employers. Form 1040x Under a prototype plan, a separate trust or custodial account is established for each employer. Form 1040x Plan providers. Form 1040x   The following organizations generally can provide IRS-approved master or prototype plans. Form 1040x Banks (including some savings and loan associations and federally insured credit unions). Form 1040x Trade or professional organizations. Form 1040x Insurance companies. Form 1040x Mutual funds. Form 1040x Individually designed plan. Form 1040x   If you prefer, you can set up an individually designed plan to meet specific needs. Form 1040x Although advance IRS approval is not required, you can apply for approval by paying a fee and requesting a determination letter. Form 1040x You may need professional help for this. Form 1040x See Rev. Form 1040x Proc. Form 1040x 2014-6, 2014-1 I. Form 1040x R. Form 1040x B. Form 1040x 198, available at www. Form 1040x irs. Form 1040x gov/irb/2014-1_IRB/ar10. Form 1040x html, as annually updated, that may help you decide whether to apply for approval. Form 1040x Internal Revenue Bulletins are available on the IRS website at IRS. Form 1040x gov They are also available at most IRS offices and at certain libraries. Form 1040x User fee. Form 1040x   The fee mentioned earlier for requesting a determination letter does not apply to employers who have 100 or fewer employees who received at least $5,000 of compensation from the employer for the preceding year. Form 1040x At least one of them must be a non-highly compensated employee participating in the plan. Form 1040x The fee does not apply to requests made by the later of the following dates. Form 1040x The end of the 5th plan year the plan is in effect. Form 1040x The end of any remedial amendment period for the plan that begins within the first 5 plan years. Form 1040x The request cannot be made by the sponsor of a prototype or similar plan the sponsor intends to market to participating employers. Form 1040x   For more information about whether the user fee applies, see Rev. Form 1040x Proc. Form 1040x 2014-8, 2014-1 I. Form 1040x R. Form 1040x B. Form 1040x 242, available at www. Form 1040x irs. Form 1040x gov/irb/2014-1_IRB/ar12. Form 1040x html, as may be annually updated; Notice 2003-49, 2003-32 I. Form 1040x R. Form 1040x B. Form 1040x 294, available at www. Form 1040x irs. Form 1040x gov/irb/2003-32_IRB/ar13. Form 1040x html; and Notice 2011-86, 2011-45 I. Form 1040x R. Form 1040x B. Form 1040x 698, available at www. Form 1040x irs. Form 1040x gov/irb/2011-45_IRB/ar11. Form 1040x html. Form 1040x Investing Plan Assets In setting up a qualified plan, you arrange how the plan's funds will be used to build its assets. Form 1040x You can establish a trust or custodial account to invest the funds. Form 1040x You, the trust, or the custodial account can buy an annuity contract from an insurance company. Form 1040x Life insurance can be included only if it is incidental to the retirement benefits. Form 1040x You set up a trust by a legal instrument (written document). Form 1040x You may need professional help to do this. Form 1040x You can set up a custodial account with a bank, savings and loan association, credit union, or other person who can act as the plan trustee. Form 1040x You do not need a trust or custodial account, although you can have one, to invest the plan's funds in annuity contracts or face-amount certificates. Form 1040x If anyone other than a trustee holds them, however, the contracts or certificates must state they are not transferable. Form 1040x Other plan requirements. Form 1040x   For information on other important plan requirements, see Qualification Rules , earlier in this chapter. Form 1040x Minimum Funding Requirement In general, if your plan is a money purchase pension plan or a defined benefit plan, you must actually pay enough into the plan to satisfy the minimum funding standard for each year. Form 1040x Determining the amount needed to satisfy the minimum funding standard for a defined benefit plan is complicated, and you should seek professional help in order to meet these contribution requirements. Form 1040x For information on this funding requirement, see section 412 and its regulations. Form 1040x Quarterly installments of required contributions. Form 1040x   If your plan is a defined benefit plan subject to the minimum funding requirements, you generally must make quarterly installment payments of the required contributions. Form 1040x If you do not pay the full installments timely, you may have to pay interest on any underpayment for the period of the underpayment. Form 1040x Due dates. Form 1040x   The due dates for the installments are 15 days after the end of each quarter. Form 1040x For a calendar-year plan, the installments are due April 15, July 15, October 15, and January 15 (of the following year). Form 1040x Installment percentage. Form 1040x   Each quarterly installment must be 25% of the required annual payment. Form 1040x Extended period for making contributions. Form 1040x   Additional contributions required to satisfy the minimum funding requirement for a plan year will be considered timely if made by 8½ months after the end of that year. Form 1040x Contributions A qualified plan is generally funded by your contributions. Form 1040x However, employees participating in the plan may be permitted to make contributions, and you may be permitted to make contributions on your own behalf. Form 1040x See Employee Contributions and Elective Deferrals later. Form 1040x Contributions deadline. Form 1040x   You can make deductible contributions for a tax year up to the due date of your return (plus extensions) for that year. Form 1040x Self-employed individual. Form 1040x   You can make contributions on behalf of yourself only if you have net earnings (compensation) from self-employment in the trade or business for which the plan was set up. Form 1040x Your net earnings must be from your personal services, not from your investments. Form 1040x If you have a net loss from self-employment, you cannot make contributions for yourself for the year, even if you can contribute for common-law employees based on their compensation. Form 1040x Employer Contributions There are certain limits on the contributions and other annual additions you can make each year for plan participants. Form 1040x There are also limits on the amount you can deduct. Form 1040x See Deduction Limits , later. Form 1040x Limits on Contributions and Benefits Your plan must provide that contributions or benefits cannot exceed certain limits. Form 1040x The limits differ depending on whether your plan is a defined contribution plan or a defined benefit plan. Form 1040x Defined benefit plan. Form 1040x   For 2013, the annual benefit for a participant under a defined benefit plan cannot exceed the lesser of the following amounts. Form 1040x 100% of the participant's average compensation for his or her highest 3 consecutive calendar years. Form 1040x $205,000 ($210,000 for 2014). Form 1040x Defined contribution plan. Form 1040x   For 2013, a defined contribution plan's annual contributions and other additions (excluding earnings) to the account of a participant cannot exceed the lesser of the following amounts. Form 1040x 100% of the participant's compensation. Form 1040x $51,000 ($52,000 for 2014). Form 1040x   Catch-up contributions (discussed later under Limit on Elective Deferrals) are not subject to the above limit. Form 1040x Employee Contributions Participants may be permitted to make nondeductible contributions to a plan in addition to your contributions. Form 1040x Even though these employee contributions are not deductible, the earnings on them are tax free until distributed in later years. Form 1040x Also, these contributions must satisfy the actual contribution percentage (ACP) test of section 401(m)(2), a nondiscrimination test that applies to employee contributions and matching contributions. Form 1040x See Regulations sections 1. Form 1040x 401(k)-2 and 1. Form 1040x 401(m)-2 for further guidance relating to the nondiscrimination rules under sections 401(k) and 401(m). Form 1040x When Contributions Are Considered Made You generally apply your plan contributions to the year in which you make them. Form 1040x But you can apply them to the previous year if all the following requirements are met. Form 1040x You make them by the due date of your tax return for the previous year (plus extensions). Form 1040x The plan was established by the end of the previous year. Form 1040x The plan treats the contributions as though it had received them on the last day of the previous year. Form 1040x You do either of the following. Form 1040x You specify in writing to the plan administrator or trustee that the contributions apply to the previous year. Form 1040x You deduct the contributions on your tax return for the previous year. Form 1040x A partnership shows contributions for partners on Form 1065. Form 1040x Employer's promissory note. Form 1040x   Your promissory note made out to the plan is not a payment that qualifies for the deduction. Form 1040x Also, issuing this note is a prohibited transaction subject to tax. Form 1040x See Prohibited Transactions , later. Form 1040x Employer Deduction You can usually deduct, subject to limits, contributions you make to a qualified plan, including those made for your own retirement. Form 1040x The contributions (and earnings and gains on them) are generally tax free until distributed by the plan. Form 1040x Deduction Limits The deduction limit for your contributions to a qualified plan depends on the kind of plan you have. Form 1040x Defined contribution plans. Form 1040x   The deduction for contributions to a defined contribution plan (profit-sharing plan or money purchase pension plan) cannot be more than 25% of the compensation paid (or accrued) during the year to your eligible employees participating in the plan. Form 1040x If you are self-employed, you must reduce this limit in figuring the deduction for contributions you make for your own account. Form 1040x See Deduction Limit for Self-Employed Individuals , later. Form 1040x   When figuring the deduction limit, the following rules apply. Form 1040x Elective deferrals (discussed later) are not subject to the limit. Form 1040x Compensation includes elective deferrals. Form 1040x The maximum compensation that can be taken into account for each employee in 2013 is $255,000 ($260,000 for 2014). Form 1040x Defined benefit plans. Form 1040x   The deduction for contributions to a defined benefit plan is based on actuarial assumptions and computations. Form 1040x Consequently, an actuary must figure your deduction limit. Form 1040x    In figuring the deduction for contributions, you cannot take into account any contributions or benefits that are more than the limits discussed earlier under Limits on Contributions and Benefits, earlier. Form 1040x Table 4–1. Form 1040x Carryover of Excess Contributions Illustrated—Profit-Sharing Plan (000's omitted) Year Participants' compensation Participants' share of required contribution (10% of annual profit) Deductible  limit for current year (25% of compensation) Contribution Excess contribution carryover used1 Total  deduction including carryovers Excess contribution carryover available at end of year 2010 $1,000 $100 $250 $100 $ 0 $100 $ 0 2011 400 165 100 165 0 100 65 2012 500 100 125 100 25 125 40 2013 600 100 150 100 40 140 0  1There were no carryovers from years before 2010. Form 1040x Deduction Limit for Self-Employed Individuals If you make contributions for yourself, you need to make a special computation to figure your maximum deduction for these contributions. Form 1040x Compensation is your net earnings from self-employment, defined in chapter 1. Form 1040x This definition takes into account both the following items. Form 1040x The deduction for the deductible part of your self-employment tax. Form 1040x The deduction for contributions on your behalf to the plan. Form 1040x The deduction for your own contributions and your net earnings depend on each other. Form 1040x For this reason, you determine the deduction for your own contributions indirectly by reducing the contribution rate called for in your plan. Form 1040x To do this, use either the Rate Table for Self-Employed or the Rate Worksheet for Self-Employed in chapter 5. Form 1040x Then figure your maximum deduction by using the Deduction Worksheet for Self-Employed in chapter 5. Form 1040x Where To Deduct Contributions Deduct the contributions you make for your common-law employees on your tax return. Form 1040x For example, sole proprietors deduct them on Schedule C (Form 1040) or Schedule F (Form 1040); partnerships deduct them on Form 1065; and corporations deduct them on Form 1120, or Form 1120S. Form 1040x Sole proprietors and partners deduct contributions for themselves on line 28 of Form 1040. Form 1040x (If you are a partner, contributions for yourself are shown on the Schedule K-1 (Form 1065) you get from the partnership. Form 1040x ) Carryover of Excess Contributions If you contribute more to the plans than you can deduct for the year, you can carry over and deduct the difference in later years, combined with your contributions for those years. Form 1040x Your combined deduction in a later year is limited to 25% of the participating employees' compensation for that year. Form 1040x For purposes of this limit, a SEP is treated as a profit-sharing (defined contribution) plan. Form 1040x However, this percentage limit must be reduced to figure your maximum deduction for contributions you make for yourself. Form 1040x See Deduction Limit for Self-Employed Individuals, earlier. Form 1040x The amount you carry over and deduct may be subject to the excise tax discussed next. Form 1040x Table 4-1, earlier, illustrates the carryover of excess contributions to a profit-sharing plan. Form 1040x Excise Tax for Nondeductible (Excess) Contributions If you contribute more than your deduction limit to a retirement plan, you have made nondeductible contributions and you may be liable for an excise tax. Form 1040x In general, a 10% excise tax applies to nondeductible contributions made to qualified pension and profit-sharing plans and to SEPs. Form 1040x Special rule for self-employed individuals. Form 1040x   The 10% excise tax does not apply to any contribution made to meet the minimum funding requirements in a money purchase pension plan or a defined benefit plan. Form 1040x Even if that contribution is more than your earned income from the trade or business for which the plan is set up, the difference is not subject to this excise tax. Form 1040x See Minimum Funding Requirement , earlier. Form 1040x Reporting the tax. Form 1040x   You must report the tax on your nondeductible contributions on Form 5330. Form 1040x Form 5330 includes a computation of the tax. Form 1040x See the separate instructions for completing the form. Form 1040x Elective Deferrals (401(k) Plans) Your qualified plan can include a cash or deferred arrangement under which participants can choose to have you contribute part of their before-tax compensation to the plan rather than receive the compensation in cash. Form 1040x A plan with this type of arrangement is popularly known as a “401(k) plan. Form 1040x ” (As a self-employed individual participating in the plan, you can contribute part of your before-tax net earnings from the business. Form 1040x ) This contribution is called an “elective deferral” because participants choose (elect) to defer receipt of the money. Form 1040x In general, a qualified plan can include a cash or deferred arrangement only if the qualified plan is one of the following plans. Form 1040x A profit-sharing plan. Form 1040x A money purchase pension plan in existence on June 27, 1974, that included a salary reduction arrangement on that date. Form 1040x Partnership. Form 1040x   A partnership can have a 401(k) plan. Form 1040x Restriction on conditions of participation. Form 1040x   The plan cannot require, as a condition of participation, that an employee complete more than 1 year of service. Form 1040x Matching contributions. Form 1040x   If your plan permits, you can make matching contributions for an employee who makes an elective deferral to your 401(k) plan. Form 1040x For example, the plan might provide that you will contribute 50 cents for each dollar your participating employees choose to defer under your 401(k) plan. Form 1040x Matching contributions are generally subject to the ACP test discussed earlier under Employee Contributions. Form 1040x Nonelective contributions. Form 1040x   You can also make contributions (other than matching contributions) for your participating employees without giving them the choice to take cash instead. Form 1040x These are called nonelective contributions. Form 1040x Employee compensation limit. Form 1040x   No more than $255,000 of the employee's compensation can be taken into account when figuring contributions other than elective deferrals in 2013. Form 1040x This limit is $260,000 in 2014. Form 1040x SIMPLE 401(k) plan. Form 1040x   If you had 100 or fewer employees who earned $5,000 or more in compensation during the preceding year, you may be able to set up a SIMPLE 401(k) plan. Form 1040x A SIMPLE 401(k) plan is not subject to the nondiscrimination and top-heavy plan requirements discussed earlier under Qualification Rules. Form 1040x For details about SIMPLE 401(k) plans, see SIMPLE 401(k) Plan in chapter 3. Form 1040x Distributions. Form 1040x   Certain rules apply to distributions from 401(k) plans. Form 1040x See Distributions From 401(k) Plans , later. Form 1040x Limit on Elective Deferrals There is a limit on the amount an employee can defer each year under these plans. Form 1040x This limit applies without regard to community property laws. Form 1040x Your plan must provide that your employees cannot defer more than the limit that applies for a particular year. Form 1040x For 2013 and 2014, the basic limit on elective deferrals is $17,500. Form 1040x This limit applies to all salary reduction contributions and elective deferrals. Form 1040x If, in conjunction with other plans, the deferral limit is exceeded, the difference is included in the employee's gross income. Form 1040x Catch-up contributions. Form 1040x   A 401(k) plan can permit participants who are age 50 or over at the end of the calendar year to also make catch-up contributions. Form 1040x The catch-up contribution limit for 2013 and 2014 is $5,500. Form 1040x Elective deferrals are not treated as catch-up contributions for 2013 until they exceed the $17,500 limit, the actual deferral percentage (ADP) test limit of section 401(k)(3), or the plan limit (if any). Form 1040x However, the catch-up contribution a participant can make for a year cannot exceed the lesser of the following amounts. Form 1040x The catch-up contribution limit. Form 1040x The excess of the participant's compensation over the elective deferrals that are not catch-up contributions. Form 1040x Treatment of contributions. Form 1040x   Your contributions to your own 401(k) plan are generally deductible by you for the year they are contributed to the plan. Form 1040x Matching or nonelective contributions made to the plan are also deductible by you in the year of contribution. Form 1040x Your employees' elective deferrals other than designated Roth contributions are tax free until distributed from the plan. Form 1040x Elective deferrals are included in wages for social security, Medicare, and federal unemployment (FUTA) tax. Form 1040x Forfeiture. Form 1040x   Employees have a nonforfeitable right at all times to their accrued benefit attributable to elective deferrals. Form 1040x Reporting on Form W-2. Form 1040x   Do not include elective deferrals in the “Wages, tips, other compensation” box of Form W-2. Form 1040x You must, however, include them in the “Social security wages” and “Medicare wages and tips” boxes. Form 1040x You must also include them in box 12. Form 1040x Mark the “Retirement plan” checkbox in box 13. Form 1040x For more information, see the Form W-2 instructions. Form 1040x Automatic Enrollment Your 401(k) plan can have an automatic enrollment feature. Form 1040x Under this feature, you can automatically reduce an employee's pay by a fixed percentage and contribute that amount to the 401(k) plan on his or her behalf unless the employee affirmatively chooses not to have his or her pay reduced or chooses to have it reduced by a different percentage. Form 1040x These contributions are elective deferrals. Form 1040x An automatic enrollment feature will encourage employees' saving for retirement and will help your plan pass nondiscrimination testing (if applicable). Form 1040x For more information, see Publication 4674, Automatic Enrollment 401(k) Plans for Small Businesses. Form 1040x Eligible automatic contribution arrangement. Form 1040x   Under an eligible automatic contribution arrangement (EACA), a participant is treated as having elected to have the employer make contributions in an amount equal to a uniform percentage of compensation. Form 1040x This automatic election will remain in place until the participant specifically elects not to have such deferral percentage made (or elects a different percentage). Form 1040x There is no required deferral percentage. Form 1040x Withdrawals. Form 1040x   Under an EACA, you may allow participants to withdraw their automatic contributions to the plan if certain conditions are met. Form 1040x The participant must elect the withdrawal no later than 90 days after the date of the first elective contributions under the EACA. Form 1040x The participant must withdraw the entire amount of EACA default contributions, including any earnings thereon. Form 1040x   If the plan allows withdrawals under the EACA, the amount of the withdrawal other than the amount of any designated Roth contributions must be included in the employee's gross income for the tax year in which the distribution is made. Form 1040x The additional 10% tax on early distributions will not apply to the distribution. Form 1040x Notice requirement. Form 1040x   Under an EACA, employees must be given written notice of the terms of the EACA within a reasonable period of time before each plan year. Form 1040x The notice must be written in a manner calculated to be understood by the average employee and be sufficiently accurate and comprehensive in order to apprise the employee of his or her rights and obligations under the EACA. Form 1040x The notice must include an explanation of the employee's right to elect not to have elective contributions made on his or her behalf, or to elect a different percentage, and the employee must be given a reasonable period of time after receipt of the notice before the first elective contribution is made. Form 1040x The notice also must explain how contributions will be invested in the absence of an investment election by the employee. Form 1040x Qualified automatic contribution arrangement. Form 1040x    A qualified automatic contribution arrangement (QACA) is a type of safe harbor plan. Form 1040x It contains an automatic enrollment feature, and mandatory employer contributions are required. Form 1040x If your plan includes a QACA, it will not be subject to the ADP test (discussed later) nor the top-heavy requirements (discussed earlier). Form 1040x Additionally, your plan will not be subject to the actual contribution percentage (ACP) test if certain additional requirements are met. Form 1040x Under a QACA, each employee who is eligible to participate in the plan will be treated as having elected to make elective deferral contributions equal to a certain default percentage of compensation. Form 1040x In order to not have default elective deferrals made, an employee must make an affirmative election specifying a deferral percentage (including zero, if desired). Form 1040x If an employee does not make an affirmative election, the default deferral percentage must meet the following conditions. Form 1040x It must be applied uniformly. Form 1040x It must not exceed 10%. Form 1040x It must be at least 3% in the first plan year it applies to an employee and through the end of the following year. Form 1040x It must increase to at least 4% in the following plan year. Form 1040x It must increase to at least 5% in the following plan year. Form 1040x It must increase to at least 6% in subsequent plan years. Form 1040x Matching or nonelective contributions. Form 1040x   Under the terms of the QACA, you must make either matching or nonelective contributions according to the following terms. Form 1040x Matching contributions. Form 1040x You must make matching contributions on behalf of each non-highly compensated employee in the following amounts. Form 1040x An amount equal to 100% of elective deferrals, up to 1% of compensation. Form 1040x An amount equal to 50% of elective deferrals, from 1% up to 6% of compensation. Form 1040x Other formulas may be used as long as they are at least as favorable to non-highly compensated employees. Form 1040x The rate of matching contributions for highly compensated employees, including yourself, must not exceed the rates for non-highly compensated employees. Form 1040x Nonelective contributions. Form 1040x You must make nonelective contributions on behalf of every non-highly compensated employee eligible to participate in the plan, regardless of whether they elected to participate, in an amount equal to at least 3% of their compensation. Form 1040x Vesting requirements. Form 1040x   All accrued benefits attributed to matching or nonelective contributions under the QACA must be 100% vested for all employees who complete 2 years of service. Form 1040x These contributions are subject to special withdrawal restrictions, discussed later. Form 1040x Notice requirements. Form 1040x   Each employee eligible to participate in the QACA must receive written notice of their rights and obligations under the QACA, within a reasonable period before each plan year. Form 1040x The notice must be written in a manner calculated to be understood by the average employee, and it must be accurate and comprehensive. Form 1040x The notice must explain their right to elect not to have elective contributions made on their behalf, or to have contributions made at a different percentage than the default percentage. Form 1040x Additionally, the notice must explain how contributions will be invested in the absence of any investment election by the employee. Form 1040x The employee must have a reasonable period of time after receiving the notice to make such contribution and investment elections prior to the first contributions under the QACA. Form 1040x Treatment of Excess Deferrals If the total of an employee's deferrals is more than the limit for 2013, the employee can have the difference (called an excess deferral) paid out of any of the plans that permit these distributions. Form 1040x He or she must notify the plan by April 15, 2014 (or an earlier date specified in the plan), of the amount to be paid from each plan. Form 1040x The plan must then pay the employee that amount, plus earnings on the amount through the end of 2013, by April 15, 2014. Form 1040x Excess withdrawn by April 15. Form 1040x   If the employee takes out the excess deferral by April 15, 2014, it is not reported again by including it in the employee's gross income for 2014. Form 1040x However, any income earned in 2013 on the excess deferral taken out is taxable in the tax year in which it is taken out. Form 1040x The distribution is not subject to the additional 10% tax on early distributions. Form 1040x   If the employee takes out part of the excess deferral and the income on it, the distribution is treated as made proportionately from the excess deferral and the income. Form 1040x   Even if the employee takes out the excess deferral by April 15, the amount will be considered for purposes of nondiscrimination testing requirements of the plan, unless the distributed amount is for a non-highly compensated employee who participates in only one employer's 401(k) plan or plans. Form 1040x Excess not withdrawn by April 15. Form 1040x   If the employee does not take out the excess deferral by April 15, 2014, the excess, though taxable in 2013, is not included in the employee's cost basis in figuring the taxable amount of any eventual distributions under the plan. Form 1040x In effect, an excess deferral left in the plan is taxed twice, once when contributed and again when distributed. Form 1040x Also, if the employee's excess deferral is allowed to stay in the plan and the employee participates in no other employer's plan, the plan can be disqualified. Form 1040x Reporting corrective distributions on Form 1099-R. Form 1040x   Report corrective distributions of excess deferrals (including any earnings) on Form 1099-R. Form 1040x For specific information about reporting corrective distributions, see the Instructions for Forms 1099-R and 5498. Form 1040x Tax on excess contributions of highly compensated employees. Form 1040x   The law provides tests to detect discrimination in a plan. Form 1040x If tests, such as the actual deferral percentage test (ADP test) (see section 401(k)(3)) and the actual contribution percentage test (ACP test) (see section 401(m)(2)), show that contributions for highly compensated employees are more than the test limits for these contributions, the employer may have to pay a 10% excise tax. Form 1040x Report the tax on Form 5330. Form 1040x The ADP test does not apply to a safe harbor 401(k) plan (discussed next) nor to a QACA. Form 1040x Also, the ACP test does not apply to these plans if certain additional requirements are met. Form 1040x   The tax for the year is 10% of the excess contributions for the plan year ending in your tax year. Form 1040x Excess contributions are elective deferrals, employee contributions, or employer matching or nonelective contributions that are more than the amount permitted under the ADP test or the ACP test. Form 1040x   See Regulations sections 1. Form 1040x 401(k)-2 and 1. Form 1040x 401(m)-2 for further guidance relating to the nondiscrimination rules under sections 401(k) and 401(m). Form 1040x    If the plan fails the ADP or ACP testing, and the failure is not corrected by the end of the next plan year, the plan can be disqualified. Form 1040x Safe harbor 401(k) plan. Form 1040x If you meet the requirements for a safe harbor 401(k) plan, you do not have to satisfy the ADP test, nor the ACP test, if certain additional requirements are met. Form 1040x For your plan to be a safe harbor plan, you must meet the following conditions. Form 1040x Matching or nonelective contributions. Form 1040x You must make matching or nonelective contributions according to one of the following formulas. Form 1040x Matching contributions. Form 1040x You must make matching contributions according to the following rules. Form 1040x You must contribute an amount equal to 100% of each non-highly compensated employee's elective deferrals, up to 3% of compensation. Form 1040x You must contribute an amount equal to 50% of each non-highly compensated employee's elective deferrals, from 3% up to 5% of compensation. Form 1040x The rate of matching contributions for highly compensated employees, including yourself, must not exceed the rates for non-highly compensated employees. Form 1040x Nonelective contributions. Form 1040x You must make nonelective contributions, without regard to whether the employee made elective deferrals, on behalf of all non-highly compensated employees eligible to participate in the plan, equal to at least 3% of the employee's compensation. Form 1040x These mandatory matching and nonelective contributions must be immediately 100% vested and are subject to special withdrawal restrictions. Form 1040x Notice requirement. Form 1040x You must give eligible employees written notice of their rights and obligations with regard to contributions under the plan, within a reasonable period before the plan year. Form 1040x The other requirements for a 401(k) plan, including withdrawal and vesting rules, must also be met for your plan to qualify as a safe harbor 401(k) plan. Form 1040x Qualified Roth Contribution Program Under this program an eligible employee can designate all or a portion of his or her elective deferrals as after-tax Roth contributions. Form 1040x Elective deferrals designated as Roth contributions must be maintained in a separate Roth account. Form 1040x However, unlike other elective deferrals, designated Roth contributions are not excluded from employees' gross income, but qualified distributions from a Roth account are excluded from employees' gross income. Form 1040x Elective Deferrals Under a qualified Roth contribution program, the amount of elective deferrals that an employee may designate as a Roth contribution is limited to the maximum amount of elective deferrals excludable from gross income for the year (for 2013 and 2014, $17,500 if under age 50 and $23,000 if age 50 or over) less the total amount of the employee's elective deferrals not designated as Roth contributions. Form 1040x Designated Roth deferrals are treated the same as pre-tax elective deferrals for most purposes, including: The annual individual elective deferral limit (total of all designated Roth contributions and traditional, pre-tax elective deferrals) of $17,500 for 2013 and 2014, with an additional $5,500 if age 50 or over for 2013 and 2014, Determining the maximum employee and employer annual contributions of the lesser of 100% of compensation or $51,000 for 2013 ($52,000 for 2014), Nondiscrimination testing, Required distributions, and Elective deferrals not taken into account for purposes of deduction limits. Form 1040x Qualified Distributions A qualified distribution is a distribution that is made after the employee's nonexclusion period and: On or after the employee attains age   59½, On account of the employee's being disabled, or On or after the employee's death. Form 1040x An employee's nonexclusion period for a plan is the 5-tax-year period beginning with the earlier of the following tax years. Form 1040x The first tax year in which the employee made a contribution to his or her Roth account in the plan, or If a rollover contribution was made to the employee's designated Roth account from a designated Roth account previously established for the employee under another plan, then the first tax year the employee made a designated Roth contribution to the previously established account. Form 1040x Rollover. Form 1040x   Beginning September 28, 2010, a rollover from another account can be made to a designated Roth account in the same plan. Form 1040x For additional information on these in-plan Roth rollovers, see Notice 2010-84, 2010-51 I. Form 1040x R. Form 1040x B. Form 1040x 872, available at www. Form 1040x irs. Form 1040x gov/irb/2010-51_IRB/ar11. Form 1040x html, and Notice 2013-74. Form 1040x A distribution from a designated Roth account can only be rolled over to another designated Roth account or a Roth IRA. Form 1040x Rollover amounts do not apply toward the annual deferral limit. Form 1040x Reporting Requirements You must report a contribution to a Roth account on Form W-2 and a distribution from a Roth account on Form 1099-R. Form 1040x See the Form W-2 and 1099-R instructions for detailed information. Form 1040x Distributions Amounts paid to plan participants from a qualified plan are called distributions. Form 1040x Distributions may be nonperiodic, such as lump-sum distributions, or periodic, such as annuity payments. Form 1040x Also, certain loans may be treated as distributions. Form 1040x See Loans Treated as Distributions in Publication 575. Form 1040x Required Distributions A qualified plan must provide that each participant will either: Receive his or her entire interest (benefits) in the plan by the required beginning date (defined later), or Begin receiving regular periodic distributions by the required beginning date in annual amounts calculated to distribute the participant's entire interest (benefits) over his or her life expectancy or over the joint life expectancy of the participant and the designated beneficiary (or over a shorter period). Form 1040x These distribution rules apply individually to each qualified plan. Form 1040x You cannot satisfy the requirement for one plan by taking a distribution from another. Form 1040x The plan must provide that these rules override any inconsistent distribution options previously offered. Form 1040x Minimum distribution. Form 1040x   If the account balance of a qualified plan participant is to be distributed (other than as an annuity), the plan administrator must figure the minimum amount required to be distributed each distribution calendar year. Form 1040x This minimum is figured by dividing the account balance by the applicable life expectancy. Form 1040x The plan administrator can use the life expectancy tables in Appendix C of Publication 590 for this purpose. Form 1040x For more information on figuring the minimum distribution, see Tax on Excess Accumulation in Publication 575. Form 1040x Required beginning date. Form 1040x   Generally, each participant must receive his or her entire benefits in the plan or begin to receive periodic distributions of benefits from the plan by the required beginning date. Form 1040x   A participant must begin to receive distributions from his or her qualified retirement plan by April 1 of the first year after the later of the following years. Form 1040x Calendar year in which he or she reaches age 70½. Form 1040x Calendar year in which he or she retires from employment with the employer maintaining the plan. Form 1040x However, the plan may require the participant to begin receiving distributions by April 1 of the year after the participant reaches age 70½ even if the participant has not retired. Form 1040x   If the participant is a 5% owner of the employer maintaining the plan, the participant must begin receiving distributions by April 1 of the first year after the calendar year in which the participant reached age 70½. Form 1040x For more information, see Tax on Excess Accumulation in Publication 575. Form 1040x Distributions after the starting year. Form 1040x   The distribution required to be made by April 1 is treated as a distribution for the starting year. Form 1040x (The starting year is the year in which the participant meets (1) or (2) above, whichever applies. Form 1040x ) After the starting year, the participant must receive the required distribution for each year by December 31 of that year. Form 1040x If no distribution is made in the starting year, required distributions for 2 years must be made in the next year (one by April 1 and one by December 31). Form 1040x Distributions after participant's death. Form 1040x   See Publication 575 for the special rules covering distributions made after the death of a participant. Form 1040x Distributions From 401(k) Plans Generally, distributions cannot be made until one of the following occurs. Form 1040x The employee retires, dies, becomes disabled, or otherwise severs employment. Form 1040x The plan ends and no other defined contribution plan is established or continued. Form 1040x In the case of a 401(k) plan that is part of a profit-sharing plan, the employee reaches age 59½ or suffers financial hardship. Form 1040x For the rules on hardship distributions, including the limits on them, see Regulations section 1. Form 1040x 401(k)-1(d). Form 1040x The employee becomes eligible for a qualified reservist distribution (defined next). Form 1040x Certain distributions listed above may be subject to the tax on early distributions discussed later. Form 1040x Qualified reservist distributions. Form 1040x   A qualified reservist distribution is a distribution from an IRA or an elective deferral account made after September 11, 2001, to a military reservist or a member of the National Guard who has been called to active duty for at least 180 days or for an indefinite period. Form 1040x All or part of a qualified reservist distribution can be recontributed to an IRA. Form 1040x The additional 10% tax on early distributions does not apply to a qualified reservist distribution. Form 1040x Tax Treatment of Distributions Distributions from a qualified plan minus a prorated part of any cost basis are subject to income tax in the year they are distributed. Form 1040x Since most recipients have no cost basis, a distribution is generally fully taxable. Form 1040x An exception is a distribution that is properly rolled over as discussed under Rollover, next. Form 1040x The tax treatment of distributions depends on whether they are made periodically over several years or life (periodic distributions) or are nonperiodic distributions. Form 1040x See Taxation of Periodic Payments and Taxation of Nonperiodic Payments in Publication 575 for a detailed description of how distributions are taxed, including the 10-year tax option or capital gain treatment of a lump-sum distribution. Form 1040x Note. Form 1040x A recipient of a distribution from a designated Roth account will have a cost basis since designated Roth contributions are made on an after-tax basis. Form 1040x Also, a distribution from a designated Roth account is entirely tax-free if certain conditions are met. Form 1040x See Qualified distributions under Qualified Roth Contribution Program, earlier. Form 1040x Rollover. Form 1040x   The recipient of an eligible rollover distribution from a qualified plan can defer the tax on it by rolling it over into a traditional IRA or another eligible retirement plan. Form 1040x However, it may be subject to withholding as discussed under Withholding requirement, later. Form 1040x A rollover can also be made to a Roth IRA, in which case, any previously untaxed amounts are includible in gross income unless the rollover is from a designated Roth account. Form 1040x Eligible rollover distribution. Form 1040x   This is a distribution of all or any part of an employee's balance in a qualified retirement plan that is not any of the following. Form 1040x A required minimum distribution. Form 1040x See Required Distributions , earlier. Form 1040x Any of a series of substantially equal payments made at least once a year over any of the following periods. Form 1040x The employee's life or life expectancy. Form 1040x The joint lives or life expectancies of the employee and beneficiary. Form 1040x A period of 10 years or longer. Form 1040x A hardship distribution. Form 1040x The portion of a distribution that represents the return of an employee's nondeductible contributions to the plan. Form 1040x See Employee Contributions , earlier, and Rollover of nontaxable amounts, next. Form 1040x Loans treated as distributions. Form 1040x Dividends on employer securities. Form 1040x The cost of any life insurance coverage provided under a qualified retirement plan. Form 1040x Similar items designated by the IRS in published guidance. Form 1040x See, for example, the Instructions for Forms 1099-R and 5498. Form 1040x Rollover of nontaxable amounts. Form 1040x   You may be able to roll over the nontaxable part of a distribution to another qualified retirement plan or a section 403(b) plan, or to an IRA. Form 1040x If the rollover is to a qualified retirement plan or a section 403(b) plan that separately accounts for the taxable and nontaxable parts of the rollover, the transfer must be made through a direct (trustee-to-trustee) rollover. Form 1040x If the rollover is to an IRA, the transfer can be made by any rollover method. Form 1040x Note. Form 1040x A distribution from a designated Roth account can be rolled over to another designated Roth account or to a Roth IRA. Form 1040x If the rollover is to a Roth IRA, it can be rolled over by any rollover method, but if the rollover is to another designated Roth account, it must be rolled over directly (trustee-to-trustee). Form 1040x More information. Form 1040x   For more information about rollovers, see Rollovers in Pubs. Form 1040x 575 and 590. Form 1040x Withholding requirement. Form 1040x   If, during a year, a qualified plan pays to a participant one or more eligible rollover distributions (defined earlier) that are reasonably expected to total $200 or more, the payor must withhold 20% of the taxable portion of each distribution for federal income tax. Form 1040x Exceptions. Form 1040x   If, instead of having the distribution paid to him or her, the participant chooses to have the plan pay it directly to an IRA or another eligible retirement plan (a direct rollover), no withholding is required. Form 1040x   If the distribution is not an eligible rollover distribution, defined earlier, the 20% withholding requirement does not apply. Form 1040x Other withholding rules apply to distributions that are not eligible rollover distributions, such as long-term periodic distributions and required distributions (periodic or nonperiodic). Form 1040x However, the participant can choose not to have tax withheld from these distributions. Form 1040x If the participant does not make this choice, the following withholding rules apply. Form 1040x For periodic distributions, withholding is based on their treatment as wages. Form 1040x For nonperiodic distributions, 10% of the taxable part is withheld. Form 1040x Estimated tax payments. Form 1040x   If no income tax is withheld or not enough tax is withheld, the recipient of a distribution may have to make estimated tax payments. Form 1040x For more information, see Withholding Tax and Estimated Tax in Publication 575. Form 1040x Section 402(f) Notice. Form 1040x   If a distribution is an eligible rollover distribution, as defined earlier, you must provide a written notice to the recipient that explains the following rules regarding such distributions. Form 1040x That the distribution may be directly transferred to an eligible retirement plan and information about which distributions are eligible for this direct transfer. Form 1040x That tax will be withheld from the distribution if it is not directly transferred to an eligible retirement plan. Form 1040x That the distribution will not be subject to tax if transferred to an eligible retirement plan within 60 days after the date the recipient receives the distribution. Form 1040x Certain other rules that may be applicable. Form 1040x   Notice 2009-68, 2009-39 I. Form 1040x R. Form 1040x B. Form 1040x 423, available at www. Form 1040x irs. Form 1040x gov/irb/2009-39_IRB/ar14. Form 1040x html, contains two updated safe harbor section 402(f) notices that plan administrators may provide recipients of eligible rollover distributions. Form 1040x If the plan allows in-plan Roth rollovers, the 402(f) notice must be amended to reflect this. Form 1040x Notice 2010-84 contains guidance on how to modify a 402(f) notice for in-plan Roth rollovers. Form 1040x Timing of notice. Form 1040x   The notice generally must be provided no less than 30 days and no more than 180 days before the date of a distribution. Form 1040x Method of notice. Form 1040x   The written notice must be provided individually to each distributee of an eligible rollover distribution. Form 1040x Posting of the notice is not sufficient. Form 1040x However, the written requirement may be satisfied through the use of electronic media if certain additional conditions are met. Form 1040x See Regulations section 1. Form 1040x 401(a)-21. Form 1040x Tax on failure to give notice. Form 1040x   Failure to give a 402(f) notice will result in a tax of $100 for each failure, with a total not exceeding $50,000 per calendar year. Form 1040x The tax will not be imposed if it is shown that such failure is due to reasonable cause and not to willful neglect. Form 1040x Tax on Early Distributions If a distribution is made to an employee under the plan before he or she reaches age 59½, the employee may have to pay a 10% additional tax on the distribution. Form 1040x This tax applies to the amount received that the employee must include in income. Form 1040x Exceptions. Form 1040x   The 10% tax will not apply if distributions before age 59½ are made in any of the following circumstances. Form 1040x Made to a beneficiary (or to the estate of the employee) on or after the death of the employee. Form 1040x Made due to the employee having a qualifying disability. Form 1040x Made as part of a series of substantially equal periodic payments beginning after separation from service and made at least annually for the life or life expectancy of the employee or the joint lives or life expectancies of the employee and his or her designated beneficiary. Form 1040x (The payments under this exception, except in the case of death or disability, must continue for at least 5 years or until the employee reaches age 59½, whichever is the longer period. Form 1040x ) Made to an employee after separation from service if the separation occurred during o