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Www irs gov freefile Publication 537 - Main Content Table of Contents What Is an Installment Sale?Special rule. Www irs gov freefile General RulesFiguring Installment Sale Income Reporting Installment Sale Income Other RulesElecting Out of the Installment Method Payments Received or Considered Received Escrow Account Depreciation Recapture Income Sale to a Related Person Like-Kind Exchange Contingent Payment Sale Single Sale of Several Assets Sale of a Business Unstated Interest and Original Issue Discount (OID) Disposition of an Installment Obligation Repossession Interest on Deferred Tax Reporting an Installment SaleRelated person. Www irs gov freefile Several assets. Www irs gov freefile Special situations. Www irs gov freefile Schedule D (Form 1040). Www irs gov freefile Form 4797. Www irs gov freefile How To Get Tax Help What Is an Installment Sale? An installment sale is a sale of property where you receive at least one payment after the tax year of the sale. Www irs gov freefile The rules for installment sales do not apply if you elect not to use the installment method (see Electing Out of the Installment Method under Other Rules, later) or the transaction is one for which the installment method may not apply. Www irs gov freefile The installment sales method cannot be used for the following. Www irs gov freefile Sale of inventory. Www irs gov freefile   The regular sale of inventory of personal property does not qualify as an installment sale even if you receive a payment after the year of sale. Www irs gov freefile See Sale of a Business under Other Rules, later. Www irs gov freefile Dealer sales. Www irs gov freefile   Sales of personal property by a person who regularly sells or otherwise disposes of the same type of personal property on the installment plan are not installment sales. Www irs gov freefile This rule also applies to real property held for sale to customers in the ordinary course of a trade or business. Www irs gov freefile However, the rule does not apply to an installment sale of property used or produced in farming. Www irs gov freefile Special rule. Www irs gov freefile   Dealers of time-shares and residential lots can treat certain sales as installment sales and report them under the installment method if they elect to pay a special interest charge. Www irs gov freefile For more information, see section 453(l). Www irs gov freefile Stock or securities. Www irs gov freefile   You cannot use the installment method to report gain from the sale of stock or securities traded on an established securities market. Www irs gov freefile You must report the entire gain on the sale in the year in which the trade date falls. Www irs gov freefile Installment obligation. Www irs gov freefile   The buyer's obligation to make future payments to you can be in the form of a deed of trust, note, land contract, mortgage, or other evidence of the buyer's debt to you. Www irs gov freefile General Rules If a sale qualifies as an installment sale, the gain must be reported under the installment method unless you elect out of using the installment method. Www irs gov freefile See Electing Out of the Installment Method under Other Rules, later, for information on recognizing the entire gain in the year of sale. Www irs gov freefile Sale at a loss. Www irs gov freefile   If your sale results in a loss, you cannot use the installment method. Www irs gov freefile If the loss is on an installment sale of business or investment property, you can deduct it only in the tax year of sale. Www irs gov freefile Unstated interest. Www irs gov freefile   If your sale calls for payments in a later year and the sales contract provides for little or no interest, you may have to figure unstated interest, even if you have a loss. Www irs gov freefile See Unstated Interest and Original Issue Discount (OID) under Other Rules, later. Www irs gov freefile Figuring Installment Sale Income You can use the following discussions or Form 6252 to help you determine gross profit, contract price, gross profit percentage, and installment sale income. Www irs gov freefile Each payment on an installment sale usually consists of the following three parts. Www irs gov freefile Interest income. Www irs gov freefile Return of your adjusted basis in the property. Www irs gov freefile Gain on the sale. Www irs gov freefile In each year you receive a payment, you must include in income both the interest part and the part that is your gain on the sale. Www irs gov freefile You do not include in income the part that is the return of your basis in the property. Www irs gov freefile Basis is the amount of your investment in the property for installment sale purposes. Www irs gov freefile Interest Income You must report interest as ordinary income. Www irs gov freefile Interest is generally not included in a down payment. Www irs gov freefile However, you may have to treat part of each later payment as interest, even if it is not called interest in your agreement with the buyer. Www irs gov freefile Interest provided in the agreement is called stated interest. Www irs gov freefile If the agreement does not provide for enough stated interest, there may be unstated interest or original issue discount. Www irs gov freefile See Unstated Interest and Original Issue Discount (OID) under Other Rules, later. Www irs gov freefile Adjusted Basis and Installment Sale Income (Gain on Sale) After you have determined how much of each payment to treat as interest, you treat the rest of each payment as if it were made up of two parts. Www irs gov freefile A tax-free return of your adjusted basis in the property, and Your gain (referred to as installment sale income on Form 6252). Www irs gov freefile Figuring adjusted basis for installment sale purposes. Www irs gov freefile   You can use Worksheet A to figure your adjusted basis in the property for installment sale purposes. Www irs gov freefile When you have completed the worksheet, you will also have determined the gross profit percentage necessary to figure your installment sale income (gain) for this year. Www irs gov freefile Worksheet A. Www irs gov freefile Figuring Adjusted Basis and Gross Profit Percentage 1. Www irs gov freefile Enter the selling price for the property   2. Www irs gov freefile Enter your adjusted basis for the property     3. Www irs gov freefile Enter your selling expenses     4. Www irs gov freefile Enter any depreciation recapture     5. Www irs gov freefile Add lines 2, 3, and 4. Www irs gov freefile  This is your adjusted basis for installment sale purposes   6. Www irs gov freefile Subtract line 5 from line 1. Www irs gov freefile If zero or less, enter -0-. Www irs gov freefile  This is your gross profit     If the amount entered on line 6 is zero, stop here. Www irs gov freefile You cannot use the installment method. Www irs gov freefile   7. Www irs gov freefile Enter the contract price for the property   8. Www irs gov freefile Divide line 6 by line 7. Www irs gov freefile This is your gross profit percentage   Selling price. Www irs gov freefile   The selling price is the total cost of the property to the buyer and includes any of the following. Www irs gov freefile Any money you are to receive. Www irs gov freefile The fair market value (FMV) of any property you are to receive (FMV is discussed in Property Used As a Payment under Other Rules, later). Www irs gov freefile Any existing mortgage or other debt the buyer pays, assumes, or takes (a note, mortgage, or any other liability, such as a lien, accrued interest, or taxes you owe on the property). Www irs gov freefile Any of your selling expenses the buyer pays. Www irs gov freefile   Do not include stated interest, unstated interest, any amount recomputed or recharacterized as interest, or original issue discount. Www irs gov freefile Adjusted basis for installment sale purposes. Www irs gov freefile   Your adjusted basis is the total of the following three items. Www irs gov freefile Adjusted basis. Www irs gov freefile Selling expenses. Www irs gov freefile Depreciation recapture. Www irs gov freefile Adjusted basis. Www irs gov freefile   Basis is your investment in the property for installment sale purposes. Www irs gov freefile The way you figure basis depends on how you acquire the property. Www irs gov freefile The basis of property you buy is generally its cost. Www irs gov freefile The basis of property you inherit, receive as a gift, build yourself, or receive in a tax-free exchange is figured differently. Www irs gov freefile   While you own property, various events may change your original basis. Www irs gov freefile Some events, such as adding rooms or making permanent improvements, increase basis. Www irs gov freefile Others, such as deductible casualty losses or depreciation previously allowed or allowable, decrease basis. Www irs gov freefile The result is adjusted basis. Www irs gov freefile   For more information on how to figure basis and adjusted basis, see Publication 551. Www irs gov freefile For more information regarding your basis in property you inherited from someone who died in 2010 and whose executor filed Form 8939, Allocation of Increase In Basis for Property Acquired From a Decedent, see Publication 4895. Www irs gov freefile Selling expenses. Www irs gov freefile   Selling expenses relate to the sale of the property. Www irs gov freefile They include commissions, attorney fees, and any other expenses paid on the sale. Www irs gov freefile Selling expenses are added to the basis of the sold property. Www irs gov freefile Depreciation recapture. Www irs gov freefile   If the property you sold was depreciable property, you may need to recapture part of the gain on the sale as ordinary income. Www irs gov freefile See Depreciation Recapture Income under Other Rules, later. Www irs gov freefile Gross profit. Www irs gov freefile   Gross profit is the total gain you report on the installment method. Www irs gov freefile   To figure your gross profit, subtract your adjusted basis for installment sale purposes from the selling price. Www irs gov freefile If the property you sold was your home, subtract from the gross profit any gain you can exclude. Www irs gov freefile See Sale of Your Home , later, under Reporting Installment Sale Income. Www irs gov freefile Contract price. Www irs gov freefile   Contract price equals: The selling price, minus The mortgages, debts, and other liabilities assumed or taken by the buyer, plus The amount by which the mortgages, debts, and other liabilities assumed or taken by the buyer exceed your adjusted basis for installment sale purposes. Www irs gov freefile Gross profit percentage. Www irs gov freefile   A certain percentage of each payment (after subtracting interest) is reported as installment sale income. Www irs gov freefile This percentage is called the gross profit percentage and is figured by dividing your gross profit from the sale by the contract price. Www irs gov freefile   The gross profit percentage generally remains the same for each payment you receive. Www irs gov freefile However, see the Example under Selling Price Reduced, later, for a situation where the gross profit percentage changes. Www irs gov freefile Example. Www irs gov freefile You sell property at a contract price of $6,000 and your gross profit is $1,500. Www irs gov freefile Your gross profit percentage is 25% ($1,500 ÷ $6,000). Www irs gov freefile After subtracting interest, you report 25% of each payment, including the down payment, as installment sale income from the sale for the tax year you receive the payment. Www irs gov freefile The remainder (balance) of each payment is the tax-free return of your adjusted basis. Www irs gov freefile Amount to report as installment sale income. Www irs gov freefile   Multiply the payments you receive each year (less interest) by the gross profit percentage. Www irs gov freefile The result is your installment sale income for the tax year. Www irs gov freefile In certain circumstances, you may be treated as having received a payment, even though you received nothing directly. Www irs gov freefile A receipt of property or the assumption of a mortgage on the property sold may be treated as a payment. Www irs gov freefile For a detailed discussion, see Payments Received or Considered Received under Other Rules, later. Www irs gov freefile Selling Price Reduced If the selling price is reduced at a later date, the gross profit on the sale also will change. Www irs gov freefile You then must refigure the gross profit percentage for the remaining payments. Www irs gov freefile Refigure your gross profit using Worksheet B. Www irs gov freefile You will spread any remaining gain over future installments. Www irs gov freefile Worksheet B. Www irs gov freefile New Gross Profit Percentage — Selling Price Reduced 1. Www irs gov freefile Enter the reduced selling  price for the property   2. Www irs gov freefile Enter your adjusted  basis for the  property     3. Www irs gov freefile Enter your selling  expenses     4. Www irs gov freefile Enter any depreciation  recapture     5. Www irs gov freefile Add lines 2, 3, and 4. Www irs gov freefile   6. Www irs gov freefile Subtract line 5 from line 1. Www irs gov freefile  This is your adjusted  gross profit   7. Www irs gov freefile Enter any installment sale  income reported in  prior year(s)   8. Www irs gov freefile Subtract line 7 from line 6   9. Www irs gov freefile Future installments   10. Www irs gov freefile Divide line 8 by line 9. Www irs gov freefile  This is your new gross profit percentage*   * Apply this percentage to all future payments to determine how much of each of those payments is installment sale income. Www irs gov freefile Example. Www irs gov freefile In 2011, you sold land with a basis of $40,000 for $100,000. Www irs gov freefile Your gross profit was $60,000. Www irs gov freefile You received a $20,000 down payment and the buyer's note for $80,000. Www irs gov freefile The note provides for four annual payments of $20,000 each, plus 8% interest, beginning in 2012. Www irs gov freefile Your gross profit percentage is 60%. Www irs gov freefile You reported a gain of $12,000 on each payment received in 2011 and 2012. Www irs gov freefile In 2013, you and the buyer agreed to reduce the purchase price to $85,000 and payments during 2013, 2014, and 2015 are reduced to $15,000 for each year. Www irs gov freefile The new gross profit percentage, 46. Www irs gov freefile 67%, is figured on Example—Worksheet B. Www irs gov freefile You will report a gain of $7,000 (46. Www irs gov freefile 67% of $15,000) on each of the $15,000 installments due in 2013, 2014, and 2015. Www irs gov freefile Example — Worksheet B. Www irs gov freefile New Gross Profit Percentage — Selling Price Reduced 1. Www irs gov freefile Enter the reduced selling  price for the property 85,000 2. Www irs gov freefile Enter your adjusted  basis for the  property 40,000   3. Www irs gov freefile Enter your selling  expenses -0-   4. Www irs gov freefile Enter any depreciation  recapture -0-   5. Www irs gov freefile Add lines 2, 3, and 4. Www irs gov freefile 40,000 6. Www irs gov freefile Subtract line 5 from line 1. Www irs gov freefile  This is your adjusted  gross profit 45,000 7. Www irs gov freefile Enter any installment sale  income reported in  prior year(s) 24,000 8. Www irs gov freefile Subtract line 7 from line 6 21,000 9. Www irs gov freefile Future installments 45,000 10. Www irs gov freefile Divide line 8 by line 9. Www irs gov freefile  This is your new gross profit percentage* 46. Www irs gov freefile 67% * Apply this percentage to all future payments to determine how much of each of those payments is installment sale income. Www irs gov freefile Reporting Installment Sale Income Generally, you will use Form 6252 to report installment sale income from casual sales of real or personal property during the tax year. Www irs gov freefile You also will have to report the installment sale income on Schedule D (Form 1040), Capital Gains and Losses, or Form 4797, or both. Www irs gov freefile See Schedule D (Form 1040) and Form 4797 , later. Www irs gov freefile If the property was your main home, you may be able to exclude part or all of the gain. Www irs gov freefile See Sale of Your Home , later. Www irs gov freefile Form 6252 Use Form 6252 to report an installment sale in the year it takes place and to report payments received, or considered received because of related party resales, in later years. Www irs gov freefile Attach it to your tax return for each year. Www irs gov freefile Form 6252 will help you determine the gross profit, contract price, gross profit percentage, and installment sale income. Www irs gov freefile Which parts to complete. Www irs gov freefile   Which part to complete depends on whether you are filing the form for the year of sale or a later year. Www irs gov freefile Year of sale. Www irs gov freefile   Complete lines 1 through 4, Part I, and Part II. Www irs gov freefile If you sold property to a related party during the year, also complete Part III. Www irs gov freefile Later years. Www irs gov freefile   Complete lines 1 through 4 and Part II for any year in which you receive a payment from an installment sale. Www irs gov freefile   If you sold a marketable security to a related party after May 14, 1980, and before January 1, 1987, complete Form 6252 for each year of the installment agreement, even if you did not receive a payment. Www irs gov freefile (After December 31, 1986, the installment method is not available for the sale of marketable securities. Www irs gov freefile ) Complete lines 1 through 4 and Part II for any year in which you receive a payment from the sale. Www irs gov freefile Complete Part III unless you received the final payment during the tax year. Www irs gov freefile   If you sold property other than a marketable security to a related party after May 14, 1980, complete Form 6252 for the year of sale and for 2 years after the year of sale, even if you did not receive a payment. Www irs gov freefile Complete lines 1 through 4 and Part II for any year during this 2-year period in which you receive a payment from the sale. Www irs gov freefile Complete Part III for the 2 years after the year of sale unless you received the final payment during the tax year. Www irs gov freefile Schedule D (Form 1040) Enter the gain figured on Form 6252 (line 26) for personal-use property (capital assets) on Schedule D (Form 1040), as a short-term gain (line 4) or long-term gain (line 11). Www irs gov freefile If your gain from the installment sale qualifies for long-term capital gain treatment in the year of sale, it will continue to qualify in later tax years. Www irs gov freefile Your gain is long-term if you owned the property for more than 1 year when you sold it. Www irs gov freefile Form 4797 An installment sale of property used in your business or that earns rent or royalty income may result in a capital gain, an ordinary gain, or both. Www irs gov freefile All or part of any gain from the disposition of the property may be ordinary gain from depreciation recapture. Www irs gov freefile For trade or business property held for more than 1 year, enter the amount from line 26 of Form 6252 on Form 4797, line 4. Www irs gov freefile If the property was held 1 year or less or you have an ordinary gain from the sale of a noncapital asset (even if the holding period is more than 1 year), enter this amount on Form 4797, line 10, and write “From Form 6252. Www irs gov freefile ” Sale of Your Home If you sell your home, you may be able to exclude all or part of the gain on the sale. Www irs gov freefile See Publication 523 for information about excluding the gain. Www irs gov freefile If the sale is an installment sale, any gain you exclude is not included in gross profit when figuring your gross profit percentage. Www irs gov freefile Seller-financed mortgage. Www irs gov freefile   If you finance the sale of your home to an individual, both you and the buyer may have to follow special reporting procedures. Www irs gov freefile   When you report interest income received from a buyer who uses the property as a personal residence, write the buyer's name, address, and social security number (SSN) on line 1 of Schedule B (Form 1040A or 1040), Interest and Ordinary Dividends. Www irs gov freefile   When deducting the mortgage interest, the buyer must write your name, address, and SSN on line 11 of Schedule A (Form 1040), Itemized Deductions. Www irs gov freefile   If either person fails to include the other person's SSN, a $50 penalty will be assessed. Www irs gov freefile Other Rules The rules discussed in this part of the publication apply only in certain circumstances or to certain types of property. Www irs gov freefile The following topics are discussed. Www irs gov freefile Electing out of the installment method. Www irs gov freefile Payments received or considered received. Www irs gov freefile Escrow account. Www irs gov freefile Depreciation recapture income. Www irs gov freefile Sale to a related person. Www irs gov freefile Like-kind exchange. Www irs gov freefile Contingent payment sale. Www irs gov freefile Single sale of several assets. Www irs gov freefile Sale of a business. Www irs gov freefile Unstated interest and original issue discount. Www irs gov freefile Disposition of an installment obligation. Www irs gov freefile Repossession. Www irs gov freefile Interest on deferred tax. Www irs gov freefile Electing Out of the Installment Method If you elect not to use the installment method, you generally report the entire gain in the year of sale, even though you do not receive all the sale proceeds in that year. Www irs gov freefile To figure the amount of gain to report, use the fair market value (FMV) of the buyer's installment obligation that represents the buyer's debt to you. Www irs gov freefile Notes, mortgages, and land contracts are examples of obligations that are included at FMV. Www irs gov freefile You must figure the FMV of the buyer's installment obligation, whether or not you would actually be able to sell it. Www irs gov freefile If you use the cash method of accounting, the FMV of the obligation will never be considered to be less than the FMV of the property sold (minus any other consideration received). Www irs gov freefile Example. Www irs gov freefile You sold a parcel of land for $50,000. Www irs gov freefile You received a $10,000 down payment and will receive the balance over the next 10 years at $4,000 a year, plus 8% interest. Www irs gov freefile The buyer gave you a note for $40,000. Www irs gov freefile The note had an FMV of $40,000. Www irs gov freefile You paid a commission of 6%, or $3,000, to a broker for negotiating the sale. Www irs gov freefile The land cost $25,000, and you owned it for more than one year. Www irs gov freefile You decide to elect out of the installment method and report the entire gain in the year of sale. Www irs gov freefile Gain realized:     Selling price $50,000 Minus: Property's adj. Www irs gov freefile basis $25,000     Commission 3,000 28,000 Gain realized $22,000 Gain recognized in year of sale:   Cash $10,000 Market value of note 40,000 Total realized in year of sale $50,000 Minus: Property's adj. Www irs gov freefile basis $25,000     Commission 3,000 28,000 Gain recognized $22,000 The recognized gain of $22,000 is long-term capital gain. Www irs gov freefile You include the entire gain in income in the year of sale, so you do not include in income any principal payments you receive in later tax years. Www irs gov freefile The interest on the note is ordinary income and is reported as interest income each year. Www irs gov freefile How to elect out. Www irs gov freefile   To make this election, do not report your sale on Form 6252. Www irs gov freefile Instead, report it on Form 8949, Sales and Other Dispositions of Capital Assets, Form 4797, or both. Www irs gov freefile When to elect out. Www irs gov freefile   Make this election by the due date, including extensions, for filing your tax return for the year the sale takes place. Www irs gov freefile Automatic six-month extension. Www irs gov freefile   If you timely file your tax return without making the election, you still can make the election by filing an amended return within 6 months of the due date of your return (excluding extensions). Www irs gov freefile Write “Filed pursuant to section 301. Www irs gov freefile 9100-2” at the top of the amended return and file it where the original return was filed. Www irs gov freefile Revoking the election. Www irs gov freefile   Once made, the election can be revoked only with IRS approval. Www irs gov freefile A revocation is retroactive. Www irs gov freefile You will not be allowed to revoke the election if either of the following applies. Www irs gov freefile One of the purposes is to avoid federal income tax. Www irs gov freefile The tax year in which any payment was received has closed. Www irs gov freefile Payments Received or Considered Received You must figure your gain each year on the payments you receive, or are treated as receiving, from an installment sale. Www irs gov freefile In certain situations, you are considered to have received a payment, even though the buyer does not pay you directly. Www irs gov freefile These situations occur when the buyer assumes or pays any of your debts, such as a loan, or pays any of your expenses, such as a sales commission. Www irs gov freefile However, as discussed later, the buyer's assumption of your debt is treated as a recovery of your basis rather than as a payment in many cases. Www irs gov freefile Buyer Pays Seller's Expenses If the buyer pays any of your expenses related to the sale of your property, it is considered a payment to you in the year of sale. Www irs gov freefile Include these expenses in the selling and contract prices when figuring the gross profit percentage. Www irs gov freefile Buyer Assumes Mortgage If the buyer assumes or pays off your mortgage, or otherwise takes the property subject to the mortgage, the following rules apply. Www irs gov freefile Mortgage not more than basis. Www irs gov freefile   If the buyer assumes a mortgage that is not more than your installment sale basis in the property, it is not considered a payment to you. Www irs gov freefile It is considered a recovery of your basis. Www irs gov freefile The contract price is the selling price minus the mortgage. Www irs gov freefile Example. Www irs gov freefile You sell property with an adjusted basis of $19,000. Www irs gov freefile You have selling expenses of $1,000. Www irs gov freefile The buyer assumes your existing mortgage of $15,000 and agrees to pay you $10,000 (a cash down payment of $2,000 and $2,000 (plus 12% interest) in each of the next 4 years). Www irs gov freefile The selling price is $25,000 ($15,000 + $10,000). Www irs gov freefile Your gross profit is $5,000 ($25,000 − $20,000 installment sale basis). Www irs gov freefile The contract price is $10,000 ($25,000 − $15,000 mortgage). Www irs gov freefile Your gross profit percentage is 50% ($5,000 ÷ $10,000). Www irs gov freefile You report half of each $2,000 payment received as gain from the sale. Www irs gov freefile You also report all interest you receive as ordinary income. Www irs gov freefile Mortgage more than basis. Www irs gov freefile   If the buyer assumes a mortgage that is more than your installment sale basis in the property, you recover your entire basis. Www irs gov freefile The part of the mortgage greater than your basis is treated as a payment received in the year of sale. Www irs gov freefile   To figure the contract price, subtract the mortgage from the selling price. Www irs gov freefile This is the total amount (other than interest) you will receive directly from the buyer. Www irs gov freefile Add to this amount the payment you are considered to have received (the difference between the mortgage and your installment sale basis). Www irs gov freefile The contract price is then the same as your gross profit from the sale. Www irs gov freefile    If the mortgage the buyer assumes is equal to or more than your installment sale basis, the gross profit percentage always will be 100%. Www irs gov freefile Example. Www irs gov freefile The selling price for your property is $9,000. Www irs gov freefile The buyer will pay you $1,000 annually (plus 8% interest) over the next 3 years and assume an existing mortgage of $6,000. Www irs gov freefile Your adjusted basis in the property is $4,400. Www irs gov freefile You have selling expenses of $600, for a total installment sale basis of $5,000. Www irs gov freefile The part of the mortgage that is more than your installment sale basis is $1,000 ($6,000 − $5,000). Www irs gov freefile This amount is included in the contract price and treated as a payment received in the year of sale. Www irs gov freefile The contract price is $4,000: Selling price $9,000 Minus: Mortgage (6,000) Amount actually received $3,000 Add difference:   Mortgage $6,000   Minus: Installment sale basis 5,000 1,000 Contract price $4,000       Your gross profit on the sale is also $4,000: Selling price $9,000 Minus: Installment sale basis (5,000) Gross profit $4,000 Your gross profit percentage is 100%. Www irs gov freefile Report 100% of each payment (less interest) as gain from the sale. Www irs gov freefile Treat the $1,000 difference between the mortgage and your installment sale basis as a payment and report 100% of it as gain in the year of sale. Www irs gov freefile Mortgage Canceled If the buyer of your property is the person who holds the mortgage on it, your debt is canceled, not assumed. Www irs gov freefile You are considered to receive a payment equal to the outstanding canceled debt. Www irs gov freefile Example. Www irs gov freefile Mary Jones loaned you $45,000 in 2009 in exchange for a note and a mortgage in a tract of land you owned. Www irs gov freefile On April 4, 2013, she bought the land for $70,000. Www irs gov freefile At that time, $30,000 of her loan to you was outstanding. Www irs gov freefile She agreed to forgive this $30,000 debt and to pay you $20,000 (plus interest) on August 1, 2013, and $20,000 on August 1, 2014. Www irs gov freefile She did not assume an existing mortgage. Www irs gov freefile She canceled the $30,000 debt you owed her. Www irs gov freefile You are considered to have received a $30,000 payment at the time of the sale. Www irs gov freefile Buyer Assumes Other Debts If the buyer assumes any other debts, such as a loan or back taxes, it may be considered a payment to you in the year of sale. Www irs gov freefile If the buyer assumes the debt instead of paying it off, only part of it may have to be treated as a payment. Www irs gov freefile Compare the debt to your installment sale basis in the property being sold. Www irs gov freefile If the debt is less than your installment sale basis, none of it is treated as a payment. Www irs gov freefile If it is more, only the difference is treated as a payment. Www irs gov freefile If the buyer assumes more than one debt, any part of the total that is more than your installment sale basis is considered a payment. Www irs gov freefile These rules are the same as the rules discussed earlier under Buyer Assumes Mortgage . Www irs gov freefile However, they apply only to the following types of debt the buyer assumes. Www irs gov freefile Those acquired from ownership of the property you are selling, such as a mortgage, lien, overdue interest, or back taxes. Www irs gov freefile Those acquired in the ordinary course of your business, such as a balance due for inventory you purchased. Www irs gov freefile If the buyer assumes any other type of debt, such as a personal loan or your legal fees relating to the sale, it is treated as if the buyer had paid off the debt at the time of the sale. Www irs gov freefile The value of the assumed debt is then considered a payment to you in the year of sale. Www irs gov freefile Property Used As a Payment If you receive property other than money from the buyer, it is still considered a payment in the year received. Www irs gov freefile However, see Like-Kind Exchange , later. Www irs gov freefile Generally, the amount of the payment is the property's FMV on the date you receive it. Www irs gov freefile Exception. Www irs gov freefile   If the property the buyer gives you is payable on demand or readily tradable, the amount you should consider as payment in the year received is: The FMV of the property on the date you receive it if you use the cash method of accounting, The face amount of the obligation on the date you receive it if you use the accrual method of accounting, or The stated redemption price at maturity less any original issue discount (OID) or, if there is no OID, the stated redemption price at maturity appropriately discounted to reflect total unstated interest. Www irs gov freefile See Unstated Interest and Original Issue Discount (OID) , later. Www irs gov freefile Debt not payable on demand. Www irs gov freefile   Any evidence of debt you receive from the buyer not payable on demand is not considered a payment. Www irs gov freefile This is true even if the debt is guaranteed by a third party, including a government agency. Www irs gov freefile Fair market value (FMV). Www irs gov freefile   This is the price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having a reasonable knowledge of all the necessary facts. Www irs gov freefile Third-party note. Www irs gov freefile   If the property the buyer gives you is a third-party note (or other obligation of a third party), you are considered to have received a payment equal to the note's FMV. Www irs gov freefile Because the FMV of the note is itself a payment on your installment sale, any payments you later receive from the third party are not considered payments on the sale. Www irs gov freefile The excess of the note's face value over its FMV is interest. Www irs gov freefile Exclude this interest in determining the selling price of the property. Www irs gov freefile However, see Exception under Property Used As a Payment, earlier. Www irs gov freefile Example. Www irs gov freefile You sold real estate in an installment sale. Www irs gov freefile As part of the down payment, the buyer assigned to you a $50,000, 8% interest third-party note. Www irs gov freefile The FMV of the third-party note at the time of the sale was $30,000. Www irs gov freefile This amount, not $50,000, is a payment to you in the year of sale. Www irs gov freefile The third-party note had an FMV equal to 60% of its face value ($30,000 ÷ $50,000), so 60% of each principal payment you receive on this note is a nontaxable return of capital. Www irs gov freefile The remaining 40% is interest taxed as ordinary income. Www irs gov freefile Bond. Www irs gov freefile   A bond or other evidence of debt you receive from the buyer that is payable on demand or readily tradable in an established securities market is treated as a payment in the year you receive it. Www irs gov freefile For more information on the amount you should treat as a payment, see Exception under Property Used As a Payment, earlier. Www irs gov freefile    If you receive a government or corporate bond for a sale before October 22, 2004, and the bond has interest coupons attached or can be readily traded in an established securities market, you are considered to have received payment equal to the bond's FMV. Www irs gov freefile However, see Exception under Property Used As a Payment, earlier. Www irs gov freefile Buyer's note. Www irs gov freefile   The buyer's note (unless payable on demand) is not considered payment on the sale. Www irs gov freefile However, its full face value is included when figuring the selling price and the contract price. Www irs gov freefile Payments you receive on the note are used to figure your gain in the year received. Www irs gov freefile Installment Obligation Used as Security (Pledge Rule) If you use an installment obligation to secure any debt, the net proceeds from the debt may be treated as a payment on the installment obligation. Www irs gov freefile This is known as the pledge rule, and it applies if the selling price of the property is over $150,000. Www irs gov freefile It does not apply to the following dispositions. Www irs gov freefile Sales of property used or produced in farming. Www irs gov freefile Sales of personal-use property. Www irs gov freefile Qualifying sales of time-shares and residential lots. Www irs gov freefile The net debt proceeds are the gross debt minus the direct expenses of getting the debt. Www irs gov freefile The amount treated as a payment is considered received on the later of the following dates. Www irs gov freefile The date the debt becomes secured. Www irs gov freefile The date you receive the debt proceeds. Www irs gov freefile A debt is secured by an installment obligation to the extent that payment of principal or interest on the debt is directly secured (under the terms of the loan or any underlying arrangement) by any interest in the installment obligation. Www irs gov freefile For sales after December 16, 1999, payment on a debt is treated as directly secured by an interest in an installment obligation to the extent an arrangement allows you to satisfy all or part of the debt with the installment obligation. Www irs gov freefile Limit. Www irs gov freefile   The net debt proceeds treated as a payment on the pledged installment obligation cannot be more than the excess of item (1) over item (2), below. Www irs gov freefile The total contract price on the installment sale. Www irs gov freefile Any payments received on the installment obligation before the date the net debt proceeds are treated as a payment. Www irs gov freefile Installment payments. Www irs gov freefile   The pledge rule accelerates the reporting of the installment obligation payments. Www irs gov freefile Do not report payments received on the obligation after it has been pledged until the payments received exceed the amount reported under the pledge rule. Www irs gov freefile Exception. Www irs gov freefile   The pledge rule does not apply to pledges made after December 17, 1987, to refinance a debt under the following circumstances. Www irs gov freefile The debt was outstanding on December 17, 1987. Www irs gov freefile The debt was secured by that installment sale obligation on that date and at all times thereafter until the refinancing occurred. Www irs gov freefile   A refinancing as a result of the creditor's calling of the debt is treated as a continuation of the original debt so long as a person other than the creditor or a person related to the creditor provides the refinancing. Www irs gov freefile   This exception applies only to refinancing that does not exceed the principal of the original debt immediately before the refinancing. Www irs gov freefile Any excess is treated as a payment on the installment obligation. Www irs gov freefile Escrow Account In some cases, the sales agreement or a later agreement may call for the buyer to establish an irrevocable escrow account from which the remaining installment payments (including interest) are to be made. Www irs gov freefile These sales cannot be reported on the installment method. Www irs gov freefile The buyer's obligation is paid in full when the balance of the purchase price is deposited into the escrow account. Www irs gov freefile When an escrow account is established, you no longer rely on the buyer for the rest of the payments, but on the escrow arrangement. Www irs gov freefile Example. Www irs gov freefile You sell property for $100,000. Www irs gov freefile The sales agreement calls for a down payment of $10,000 and payment of $15,000 in each of the next 6 years to be made from an irrevocable escrow account containing the balance of the purchase price plus interest. Www irs gov freefile You cannot report the sale on the installment method because the full purchase price is considered received in the year of sale. Www irs gov freefile You report the entire gain in the year of sale. Www irs gov freefile Escrow established in a later year. Www irs gov freefile   If you make an installment sale and in a later year an irrevocable escrow account is established to pay the remaining installments plus interest, the amount placed in the escrow account represents payment of the balance of the installment obligation. Www irs gov freefile Substantial restriction. Www irs gov freefile   If an escrow arrangement imposes a substantial restriction on your right to receive the sale proceeds, the sale can be reported on the installment method, provided it otherwise qualifies. Www irs gov freefile For an escrow arrangement to impose a substantial restriction, it must serve a bona fide purpose of the buyer, that is, a real and definite restriction placed on the seller or a specific economic benefit conferred on the buyer. Www irs gov freefile Depreciation Recapture Income If you sell property for which you claimed or could have claimed a depreciation deduction, you must report any depreciation recapture income in the year of sale, whether or not an installment payment was received that year. Www irs gov freefile Figure your depreciation recapture income (including the section 179 deduction and the section 179A deduction recapture) in Part III of Form 4797. Www irs gov freefile Report the recapture income in Part II of Form 4797 as ordinary income in the year of sale. Www irs gov freefile The recapture income is also included in Part I of Form 6252. Www irs gov freefile However, the gain equal to the recapture income is reported in full in the year of the sale. Www irs gov freefile Only the gain greater than the recapture income is reported on the installment method. Www irs gov freefile For more information on depreciation recapture, see chapter 3 in Publication 544. Www irs gov freefile The recapture income reported in the year of sale is included in your installment sale basis in determining your gross profit on the installment sale. Www irs gov freefile Determining gross profit is discussed under General Rules , earlier. Www irs gov freefile Sale to a Related Person If you sell depreciable property to a related person and the sale is an installment sale, you may not be able to report the sale using the installment method. Www irs gov freefile If you sell property to a related person and the related person disposes of the property before you receive all payments with respect to the sale, you may have to treat the amount realized by the related person as received by you when the related person disposes of the property. Www irs gov freefile These rules are explained under Sale of Depreciable Property and under Sale and Later Disposition , later. Www irs gov freefile Sale of Depreciable Property If you sell depreciable property to certain related persons, you generally cannot report the sale using the installment method. Www irs gov freefile Instead, all payments to be received are considered received in the year of sale. Www irs gov freefile However, see Exception , below. Www irs gov freefile Depreciable property for this rule is any property the purchaser can depreciate. Www irs gov freefile Payments to be received include the total of all noncontingent payments and the FMV of any payments contingent as to amount. Www irs gov freefile In the case of contingent payments for which the FMV cannot be reasonably determined, your basis in the property is recovered proportionately. Www irs gov freefile The purchaser cannot increase the basis of the property acquired in the sale before the seller includes a like amount in income. Www irs gov freefile Exception. Www irs gov freefile   You can use the installment method to report a sale of depreciable property to a related person if no significant tax deferral benefit will be derived from the sale. Www irs gov freefile You must show to the satisfaction of the IRS that avoidance of federal income tax was not one of the principal purposes of the sale. Www irs gov freefile Related person. Www irs gov freefile   Related persons include the following. Www irs gov freefile A person and all controlled entities with respect to that person. Www irs gov freefile A taxpayer and any trust in which such taxpayer (or his spouse) is a beneficiary, unless that beneficiary's interest in the trust is a remote contingent interest. Www irs gov freefile Except in the case of a sale or exchange in satisfaction of a pecuniary bequest, an executor of an estate and a beneficiary of that estate. Www irs gov freefile Two or more partnerships in which the same person owns, directly or indirectly, more than 50% of the capital interests or the profits interests. Www irs gov freefile   For information about which entities are controlled entities, see section 1239(c). Www irs gov freefile Sale and Later Disposition Generally, a special rule applies if you sell or exchange property to a related person on the installment method (first disposition) who then sells, exchanges, or gives away the property (second disposition) under the following circumstances. Www irs gov freefile The related person makes the second disposition before making all payments on the first disposition. Www irs gov freefile The related person disposes of the property within 2 years of the first disposition. Www irs gov freefile This rule does not apply if the property involved is marketable securities. Www irs gov freefile Under this rule, you treat part or all of the amount the related person realizes (or the FMV if the disposed property is not sold or exchanged) from the second disposition as if you received it at the time of the second disposition. Www irs gov freefile See Exception , later. Www irs gov freefile Related person. Www irs gov freefile   Related persons include the following. Www irs gov freefile Members of a family, including only brothers and sisters (either whole or half), husband and wife, ancestors, and lineal descendants. Www irs gov freefile A partnership or estate and a partner or beneficiary. Www irs gov freefile A trust (other than a section 401(a) employees trust) and a beneficiary. Www irs gov freefile A trust and an owner of the trust. Www irs gov freefile Two corporations that are members of the same controlled group as defined in section 267(f). Www irs gov freefile The fiduciaries of two different trusts, and the fiduciary and beneficiary of two different trusts, if the same person is the grantor of both trusts. Www irs gov freefile A tax-exempt educational or charitable organization and a person (if an individual, including members of the individual's family) who directly or indirectly controls such an organization. Www irs gov freefile An individual and a corporation when the individual owns, directly or indirectly, more than 50% of the value of the outstanding stock of the corporation. Www irs gov freefile A fiduciary of a trust and a corporation when the trust or the grantor of the trust owns, directly or indirectly, more than 50% in value of the outstanding stock of the corporation. Www irs gov freefile The grantor and fiduciary, and the fiduciary and beneficiary, of any trust. Www irs gov freefile Any two S corporations if the same persons own more than 50% in value of the outstanding stock of each corporation. Www irs gov freefile An S corporation and a corporation that is not an S corporation if the same persons own more than 50% in value of the outstanding stock of each corporation. Www irs gov freefile A corporation and a partnership if the same persons own more than 50% in value of the outstanding stock of the corporation and more than 50% of the capital or profits interest in the partnership. Www irs gov freefile An executor and a beneficiary of an estate unless the sale is in satisfaction of a pecuniary bequest. Www irs gov freefile Example 1. Www irs gov freefile In 2012, Harvey Green sold farm land to his son Bob for $500,000, which was to be paid in five equal payments over 5 years, plus adequate stated interest on the balance due. Www irs gov freefile His installment sale basis for the farm land was $250,000 and the property was not subject to any outstanding liens or mortgages. Www irs gov freefile His gross profit percentage is 50% (gross profit of $250,000 ÷ contract price of $500,000). Www irs gov freefile He received $100,000 in 2012 and included $50,000 in income for that year ($100,000 × 0. Www irs gov freefile 50). Www irs gov freefile Bob made no improvements to the property and sold it to Alfalfa Inc. Www irs gov freefile , in 2013 for $600,000 after making the payment for that year. Www irs gov freefile The amount realized from the second disposition is $600,000. Www irs gov freefile Harvey figures his installment sale income for 2013 as follows: Lesser of: 1) Amount realized on second disposition, or 2) Contract price on first disposition $500,000 Subtract: Sum of payments from Bob in 2012 and 2013 - 200,000 Amount treated as received because of second disposition $300,000 Add: Payment from Bob in 2013 + 100,000 Total payments received and treated as received for 2013 $400,000 Multiply by gross profit % × . Www irs gov freefile 50 Installment sale income for 2013 $200,000 Harvey will not include in his installment sale income any principal payments he receives on the installment obligation for 2014, 2015, and 2016 because he has already reported the total payments of $500,000 from the first disposition ($100,000 in 2012 and $400,000 in 2013). Www irs gov freefile Example 2. Www irs gov freefile Assume the facts are the same as Example 1 except that Bob sells the property for only $400,000. Www irs gov freefile The gain for 2013 is figured as follows: Lesser of: 1) Amount realized on second disposition, or 2) Contract price on first disposition $400,000 Subtract: Sum of payments from Bob in 2012 and 2013 − 200,000 Amount treated as received because of second disposition $200,000 Add: Payment from Bob in 2013 + 100,000 Total payments received and treated as received for 2013 $300,000 Multiply by gross profit % × . Www irs gov freefile 50 Installment sale income for 2013 $150,000     Harvey receives a $100,000 payment in 2014 and another in 2015. Www irs gov freefile They are not taxed because he treated the $200,000 from the disposition in 2013 as a payment received and paid tax on the installment sale income. Www irs gov freefile In 2016, he receives the final $100,000 payment. Www irs gov freefile He figures the installment sale income he must recognize in 2016 as follows: Total payments from the first disposition received by the end of 2016 $500,000 Minus the sum of:     Payment from 2012 $100,000   Payment from 2013 100,000   Amount treated as received in 2013 200,000   Total on which gain was previously recognized  − 400,000 Payment on which gain is recognized for 2016  $100,000 Multiply by gross profit % × . Www irs gov freefile 50 Installment sale income for 2016 $ 50,000 Exception. Www irs gov freefile   This rule does not apply to a second disposition, and any later transfer, if you can show to the satisfaction of the IRS that neither the first disposition (to the related person) nor the second disposition had as one of its principal purposes the avoidance of federal income tax. Www irs gov freefile Generally, an involuntary second disposition will qualify under the nontax avoidance exception, such as when a creditor of the related person forecloses on the property or the related person declares bankruptcy. Www irs gov freefile   The nontax avoidance exception also applies to a second disposition that is also an installment sale if the terms of payment under the installment resale are substantially equal to or longer than those for the first installment sale. Www irs gov freefile However, the exception does not apply if the resale terms permit significant deferral of recognition of gain from the first sale. Www irs gov freefile   In addition, any sale or exchange of stock to the issuing corporation is not treated as a first disposition. Www irs gov freefile An involuntary conversion is not treated as a second disposition if the first disposition occurred before the threat of conversion. Www irs gov freefile A transfer after the death of the person making the first disposition or the related person's death, whichever is earlier, is not treated as a second disposition. Www irs gov freefile Like-Kind Exchange If you trade business or investment property solely for the same kind of property to be held as business or investment property, you can postpone reporting the gain. Www irs gov freefile These trades are known as like-kind exchanges. Www irs gov freefile The property you receive in a like-kind exchange is treated as if it were a continuation of the property you gave up. Www irs gov freefile You do not have to report any part of your gain if you receive only like-kind property. Www irs gov freefile However, if you also receive money or other property (boot) in the exchange, you must report your gain to the extent of the money and the FMV of the other property received. Www irs gov freefile For more information on like-kind exchanges, see Like-Kind Exchanges in chapter 1 of Publication 544. Www irs gov freefile Installment payments. Www irs gov freefile   If, in addition to like-kind property, you receive an installment obligation in the exchange, the following rules apply to determine the installment sale income each year. Www irs gov freefile The contract price is reduced by the FMV of the like-kind property received in the trade. Www irs gov freefile The gross profit is reduced by any gain on the trade that can be postponed. Www irs gov freefile Like-kind property received in the trade is not considered payment on the installment obligation. Www irs gov freefile Example. Www irs gov freefile In 2013, George Brown trades personal property with an installment sale basis of $400,000 for like-kind property having an FMV of $200,000. Www irs gov freefile He also receives an installment note for $800,000 in the trade. Www irs gov freefile Under the terms of the note, he is to receive $100,000 (plus interest) in 2014 and the balance of $700,000 (plus interest) in 2015. Www irs gov freefile George's selling price is $1,000,000 ($800,000 installment note + $200,000 FMV of like-kind property received). Www irs gov freefile His gross profit is $600,000 ($1,000,000 − $400,000 installment sale basis). Www irs gov freefile The contract price is $800,000 ($1,000,000 − $200,000). Www irs gov freefile The gross profit percentage is 75% ($600,000 ÷ $800,000). Www irs gov freefile He reports no gain in 2013 because the like-kind property he receives is not treated as a payment for figuring gain. Www irs gov freefile He reports $75,000 gain for 2014 (75% of $100,000 payment received) and $525,000 gain for 2015 (75% of $700,000 payment received). Www irs gov freefile Deferred exchanges. Www irs gov freefile   A deferred exchange is one in which you transfer property you use in business or hold for investment and receive like-kind property later that you will use in business or hold for investment. Www irs gov freefile Under this type of exchange, the person receiving your property may be required to place funds in an escrow account or trust. Www irs gov freefile If certain rules are met, these funds will not be considered a payment until you have the right to receive the funds or, if earlier, the end of the exchange period. Www irs gov freefile See Regulations section 1. Www irs gov freefile 1031(k)-1(j)(2) for these rules. Www irs gov freefile Contingent Payment Sale A contingent payment sale is one in which the total selling price cannot be determined by the end of the tax year of sale. Www irs gov freefile This happens, for example, if you sell your business and the selling price includes a percentage of its profits in future years. Www irs gov freefile If the selling price cannot be determined by the end of the tax year, you must use different rules to figure the contract price and the gross profit percentage than those you use for an installment sale with a fixed selling price. Www irs gov freefile For rules on using the installment method for a contingent payment sale, see Regulations section 15a. Www irs gov freefile 453-1(c). Www irs gov freefile Single Sale of Several Assets If you sell different types of assets in a single sale, you must identify each asset to determine whether you can use the installment method to report the sale of that asset. Www irs gov freefile You also have to allocate part of the selling price to each asset. Www irs gov freefile If you sell assets that constitute a trade or business, see Sale of a Business , later. Www irs gov freefile Unless an allocation of the selling price has been agreed to by both parties in an arm's-length transaction, you must allocate the selling price to an asset based on its FMV. Www irs gov freefile If the buyer assumes a debt, or takes the property subject to a debt, you must reduce the FMV of the property by the debt. Www irs gov freefile This becomes the net FMV. Www irs gov freefile A sale of separate and unrelated assets of the same type under a single contract is reported as one transaction for the installment method. Www irs gov freefile However, if an asset is sold at a loss, its disposition cannot be reported on the installment method. Www irs gov freefile It must be reported separately. Www irs gov freefile The remaining assets sold at a gain are reported together. Www irs gov freefile Example. Www irs gov freefile You sold three separate and unrelated parcels of real property (A, B, and C) under a single contract calling for a total selling price of $130,000. Www irs gov freefile The total selling price consisted of a cash payment of $20,000, the buyer's assumption of a $30,000 mortgage on parcel B, and an installment obligation of $80,000 payable in eight annual installments, plus interest at 8% a year. Www irs gov freefile Your installment sale basis for each parcel was $15,000. Www irs gov freefile Your net gain was $85,000 ($130,000 − $45,000). Www irs gov freefile You report the gain on the installment method. Www irs gov freefile The sales contract did not allocate the selling price or the cash payment received in the year of sale among the individual parcels. Www irs gov freefile The FMV of parcels A, B, and C were $60,000, $60,000, and $10,000, respectively. Www irs gov freefile The installment sale basis for parcel C was more than its FMV, so it was sold at a loss and must be treated separately. Www irs gov freefile You must allocate the total selling price and the amounts received in the year of sale between parcel C and the remaining parcels. Www irs gov freefile Of the total $130,000 selling price, you must allocate $120,000 to parcels A and B together and $10,000 to parcel C. Www irs gov freefile You should allocate the cash payment of $20,000 received in the year of sale and the note receivable on the basis of their proportionate net FMV. Www irs gov freefile The allocation is figured as follows:   Parcels   A and B Parcel C FMV $120,000 $10,000 Minus: Mortgage assumed 30,000 -0- Net FMV $ 90,000 $10,000 Proportionate net FMV:     Percentage of total 90% 10% Payments in year of sale:     $20,000 × 90% $18,000   $20,000 × 10%   $2,000 Excess of parcel B mortgage over installment sale basis 15,000 -0- Allocation of payments  received (or considered  received) in year of sale $ 33,000 $ 2,000 You cannot report the sale of parcel C on the installment method because the sale results in a loss. Www irs gov freefile You report this loss of $5,000 ($10,000 selling price − $15,000 installment sale basis) in the year of sale. Www irs gov freefile However, if parcel C was held for personal use, the loss is not deductible. Www irs gov freefile You allocate the installment obligation of $80,000 to the properties sold based on their proportionate net FMVs (90% to parcels A and B, 10% to parcel C). Www irs gov freefile Sale of a Business The installment sale of an entire business for one overall price under a single contract is not the sale of a single asset. Www irs gov freefile Allocation of Selling Price To determine whether any of the gain on the sale of the business can be reported on the installment method, you must allocate the total selling price and the payments received in the year of sale between each of the following classes of assets. Www irs gov freefile Assets sold at a loss. Www irs gov freefile Real and personal property eligible for the installment method. Www irs gov freefile Real and personal property ineligible for the installment method, including: Inventory, Dealer property, and Stocks and securities. Www irs gov freefile Inventory. Www irs gov freefile   The sale of inventories of personal property cannot be reported on the installment method. Www irs gov freefile All gain or loss on their sale must be reported in the year of sale, even if you receive payment in later years. Www irs gov freefile   If inventory items are included in an installment sale, you may have an agreement stating which payments are for inventory and which are for the other assets being sold. Www irs gov freefile If you do not, each payment must be allocated between the inventory and the other assets sold. Www irs gov freefile   Report the amount you receive (or will receive) on the sale of inventory items as ordinary business income. Www irs gov freefile Use your basis in the inventory to figure the cost of goods sold. Www irs gov freefile Deduct the part of the selling expenses allocated to inventory as an ordinary business expense. Www irs gov freefile Residual method. Www irs gov freefile   Except for assets exchanged under the like-kind exchange rules, both the buyer and seller of a business must use the residual method to allocate the sale price to each business asset sold. Www irs gov freefile This method determines gain or loss from the transfer of each asset and the buyer's basis in the assets. Www irs gov freefile   The residual method must be used for any transfer of a group of assets that constitutes a trade or business and for which the buyer's basis is determined only by the amount paid for the assets. Www irs gov freefile This applies to both direct and indirect transfers, such as the sale of a business or the sale of a partnership interest in which the basis of the buyer's share of the partnership assets is adjusted for the amount paid under section 743(b). Www irs gov freefile   A group of assets constitutes a trade or business if goodwill or going concern value could, under any circumstances, attach to the assets or if the use of the assets would constitute an active trade or business under section 355. Www irs gov freefile   The residual method provides for the consideration to be reduced first by cash and general deposit accounts (including checking and savings accounts but excluding certificates of deposit). Www irs gov freefile The consideration remaining after this reduction must be allocated among the various business assets in a certain order. Www irs gov freefile   For asset acquisitions occurring after March 15, 2001, make the allocation among the following assets in proportion to (but not more than) their fair market value on the purchase date in the following order. Www irs gov freefile Certificates of deposit, U. Www irs gov freefile S. Www irs gov freefile Government securities, foreign currency, and actively traded personal property, including stock and securities. Www irs gov freefile Accounts receivable, other debt instruments, and assets that you mark to market at least annually for federal income tax purposes. Www irs gov freefile However, see Regulations section 1. Www irs gov freefile 338-6(b)(2)(iii) for exceptions that apply to debt instruments issued by persons related to a target corporation, contingent debt instruments, and debt instruments convertible into stock or other property. Www irs gov freefile Property of a kind that would properly be included in inventory if on hand at the end of the tax year or property held by the taxpayer primarily for sale to customers in the ordinary course of business. Www irs gov freefile All other assets except section 197 intangibles. Www irs gov freefile Section 197 intangibles except goodwill and going concern value. Www irs gov freefile Goodwill and going concern value (whether or not they qualify as section 197 intangibles). Www irs gov freefile   If an asset described in (1) through (6) is includible in more than one category, include it in the lower number category. Www irs gov freefile For example, if an asset is described in both (4) and (6), include it in (4). Www irs gov freefile Agreement. Www irs gov freefile   The buyer and seller may enter into a written agreement as to the allocation of any consideration or the fair market value of any of the assets. Www irs gov freefile This agreement is binding on both parties unless the IRS determines the amounts are not appropriate. Www irs gov freefile Reporting requirement. Www irs gov freefile   Both the buyer and seller involved in the sale of business assets must report to the IRS the allocation of the sales price among section 197 intangibles and the other business assets. Www irs gov freefile Use Form 8594, Asset Acquisition Statement Under Section 1060, to provide this information. Www irs gov freefile The buyer and seller should each attach Form 8594 to their federal income tax return for the year in which the sale occurred. Www irs gov freefile Sale of Partnership Interest A partner who sells a partnership interest at a gain may be able to report the sale on the installment method. Www irs gov freefile The sale of a partnership interest is treated as the sale of a single capital asset. Www irs gov freefile The part of any gain or loss from unrealized receivables or inventory items will be treated as ordinary income. Www irs gov freefile (The term “unrealized receivables” includes depreciation recapture income, discussed earlier. Www irs gov freefile ) The gain allocated to the unrealized receivables and the inventory cannot be reported under the installment method. Www irs gov freefile The gain allocated to the other assets can be reported under the installment method. Www irs gov freefile For more information on the treatment of unrealized receivables and inventory, see Publication 541. Www irs gov freefile Example — Sale of a Business On June 4, 2013, you sold the machine shop you had operated since 2005. Www irs gov freefile You received a $100,000 down payment and the buyer's note for $120,000. Www irs gov freefile The note payments are $15,000 each, plus 10% interest, due every July 1 and January 1, beginning in 2014. Www irs gov freefile The total selling price is $220,000. Www irs gov freefile Your selling expenses are $11,000. Www irs gov freefile The selling expenses are divided among all the assets sold, including inventory. Www irs gov freefile Your selling expense for each asset is 5% of the asset's selling price ($11,000 selling expense ÷ $220,000 total selling price). Www irs gov freefile The FMV, adjusted basis, and depreciation claimed on each asset sold are as follows:     Depre- ciation Adj. Www irs gov freefile Asset FMV Claimed Basis Inventory $ 10,000 -0- $ 8,000 Land 42,000 -0- 15,000 Building 48,000 $9,000 36,000 Machine A 71,000 27,200 63,800 Machine B 24,000 12,960 22,040 Truck 6,500 18,624 5,376   $201,500 $67,784 $150,216         Under the residual method, you allocate the selling price to each of the assets based on their FMV ($201,500). Www irs gov freefile The remaining $18,500 ($220,000 - $201,500) is allocated to your section 197 intangible, goodwill. Www irs gov freefile The assets included in the sale, their selling prices based on their FMVs, the selling expense allocated to each asset, the adjusted basis, and the gain for each asset are shown in the following chart. Www irs gov freefile   Sale  Price Sale   Exp. Www irs gov freefile Adj. Www irs gov freefile   Basis Gain Inventory $ 10,000 $ 500 $ 8,000 $ 1,500 Land 42,000 2,100 15,000 24,900 Building 48,000 2,400 36,000 9,600 Mch. Www irs gov freefile A 71,000 3,550 63,800 3,650 Mch. Www irs gov freefile B 24,000 1,200 22,040 760 Truck 6,500 325 5,376 799 Goodwill 18,500 925 -0- 17,575   $220,000 $11,000 $150,216 $58,784 The building was acquired in 2005, the year the business began, and it is section 1250 property. Www irs gov freefile There is no depreciation recapture income because the building was depreciated using the straight line method. Www irs gov freefile All gain on the truck, machine A, and machine B is depreciation recapture income since it is the lesser of the depreciation claimed or the gain on the sale. Www irs gov freefile Figure depreciation recapture in Part III of Form 4797. Www irs gov freefile The total depreciation recapture income reported in Part II of Form 4797 is $5,209. Www irs gov freefile This consists of $3,650 on machine A, $799 on the truck, and $760 on machine B (the gain on each item because it was less than the depreciation claimed). Www irs gov freefile These gains are reported in full in the year of sale and are not included in the installment sale computation. Www irs gov freefile Of the $220,000 total selling price, the $10,000 for inventory assets cannot be reported using the installment method. Www irs gov freefile The selling prices of the truck and machines are also removed from the total selling price because gain on these items is reported in full in the year of sale. Www irs gov freefile The selling price equals the contract price for the installment sale ($108,500). Www irs gov freefile The assets included in the installment sale, their selling price, and their installment sale bases are shown in the following chart. Www irs gov freefile   Selling  Price Install- ment  Sale  Basis Gross  Profit Land $ 42,000 $17,100 $24,900 Building 48,000 38,400 9,600 Goodwill 18,500 925 17,575 Total $108,500 $56,425 $52,075         The gross profit percentage (gross profit ÷ contract price) for the installment sale is 48% ($52,075 ÷ $108,500). Www irs gov freefile The gross profit percentage for each asset is figured as follows: Percentage Land— $24,900 ÷ $108,500 22. Www irs gov freefile 95 Building— $9,600 ÷ $108,500 8. Www irs gov freefile 85 Goodwill— $17,575 ÷ $108,500 16. Www irs gov freefile 20 Total 48. Www irs gov freefile 00 The sale includes assets sold on the installment method and assets for which the gain is reported in full in the year of sale, so payments must be allocated between the installment part of the sale and the part reported in the year of sale. Www irs gov freefile The selling price for the installment sale is $108,500. Www irs gov freefile This is 49. Www irs gov freefile 3% of the total selling price of $220,000 ($108,500 ÷ $220,000). Www irs gov freefile The selling price of assets not reported on the installment method is $111,500. Www irs gov freefile This is 50. Www irs gov freefile 7% ($111,500 ÷ $220,000) of the total selling price. Www irs gov freefile Multiply principal payments by 49. Www irs gov freefile 3% to determine the part of the payment for the installment sale. Www irs gov freefile The balance, 50. Www irs gov freefile 7%, is for the part reported in the year of the sale. Www irs gov freefile The gain on the sale of the inventory, machines, and truck is reported in full in the year of sale. Www irs gov freefile When you receive principal payments in later years, no part of the payment for the sale of these assets is included in gross income. Www irs gov freefile Only the part for the installment sale (49. Www irs gov freefile 3%) is used in the installment sale computation. Www irs gov freefile The only payment received in 2013 is the down payment of $100,000. Www irs gov freefile The part of the payment for the installment sale is $49,300 ($100,000 × 49. Www irs gov freefile 3%). Www irs gov freefile This amount is used in the installment sale computation. Www irs gov freefile Installment income for 2013. Www irs gov freefile   Your installment income for each asset is the gross profit percentage for that asset times $49,300, the installment income received in 2013. Www irs gov freefile Income Land—22. Www irs gov freefile 95% of $49,300 $11,314 Building—8. Www irs gov freefile 85% of $49,300 4,363 Goodwill—16. Www irs gov freefile 2% of $49,300 7,987 Total installment income for 2013 $23,664 Installment income after 2013. Www irs gov freefile   You figure installment income for years after 2013 by applying the same gross profit percentages to 49. Www irs gov freefile 3% of the total payments you receive on the buyer's note during the year. Www irs gov freefile Unstated Interest and Original Issue Discount (OID) An installment sale contract may provide that each deferred payment on the sale will include interest or that there will be an interest payment in addition to the principal payment. Www irs gov freefile Interest provided in the contract is called stated interest. Www irs gov freefile If an installment sale contract does not provide for adequate stated interest, part of the stated principal amount of the contract may be recharacterized as interest. Www irs gov freefile If section 483 applies to the contract, this interest is called unstated interest. Www irs gov freefile If section 1274 applies to the contract, this interest is called original issue discount (OID). Www irs gov freefile An installment sale contract does not provide for adequate stated interest if the stated interest rate is lower than the test rate (defined later). Www irs gov freefile Treatment of unstated interest and OID. Www irs gov freefile   Generally, if a buyer gives a debt in consideration for personal use property, the unstated interest rules do not apply. Www irs gov freefile As a result, the buyer cannot deduct the unstated interest. Www irs gov freefile The seller must report the unstated interest as income. Www irs gov freefile   Personal-use property is any property in which substantially all of its use by the buyer is not in connection with a trade or business or an investment activity. Www irs gov freefile   If the debt is subject to the section 483 rules and is also subject to the below-market loan rules, such as a gift loan, compensation-related loan, or corporation-shareholder loan, then both parties are subject to the below-market loan rules rather than the unstated interest rules. Www irs gov freefile Rules for the seller. Www irs gov freefile   If either section 1274 or section 483 applies to the installment sale contract, you must treat part of the installment sale price as interest, even though interest is not called for in the sales agreement. Www irs gov freefile If either section applies, you must reduce the stated selling price of the property and increase your interest income by this unstated interest. Www irs gov freefile   Include the unstated interest in income based on your regular method of accounting. Www irs gov freefile Include OID in income over the term of the contract. Www irs gov freefile   The OID includible in income each year is based on the constant yield method described in section 1272. Www irs gov freefile (In some cases, the OID on an installment sale contract also may include all or part of the stated interest, especially if the stated interest is not paid at least annually. Www irs gov freefile )   If you do not use the installment method to report the sale, report the entire gain under your method of accounting in the year of sale. Www irs gov freefile Reduce the selling price by any stated principal treated as interest to determine the gain. Www irs gov freefile   Report unstated interest or OID on your tax return, in addition to stated interest. Www irs gov freefile Rules for the buyer. Www irs gov freefile   Any part of the stated selling price of an installment sale contract treated by the buyer as interest reduces the buyer's basis in the property and increases the buyer's interest expense. Www irs gov freefile These rules do not apply to personal-use property (for example, property not used in a trade or business). Www irs gov freefile Adequate stated interest. Www irs gov freefile   An installment sale contract generally provides for adequate stated interest if the contract's stated principal amount is at least equal to the sum of the present values of all principal and interest payments called for under the contract. Www irs gov freefile The present value of a payment is determined based on the test rate of interest, defined next. Www irs gov freefile (If section 483 applies to the contract, payments due within six months after the sale are taken into account at face value. Www irs gov freefile ) In general, an installment sale contract provides for adequate stated interest if the stated interest rate (based on an appropriate compounding period) is at least equal to the test rate of interest. Www irs gov freefile Test rate of interest. Www irs gov freefile   The test rate of interest for a contract is the 3-month rate. Www irs gov freefile The 3-month rate is the lower of the following applicable federal rates (AFRs). Www irs gov freefile The lowest AFR (based on the appropriate compounding period) in effect during the 3-month period ending with the first month in which there is a binding written contract that substantially provides the terms under which the sale or exchange is ultimately completed. Www irs gov freefile The lowest AFR (based on the appropriate compounding period) in effect during the 3-month period ending with the month in which the sale or exchange occurs. Www irs gov freefile Applicable federal rate (AFR). Www irs gov freefile   The AFR depends on the month the binding
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Www irs gov freefile 5. Www irs gov freefile   Excise Taxes Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Prohibited Tax Shelter TransactionsEntity Level Tax Excess Benefit TransactionsTax on Disqualified Persons Tax on Organization Managers Excess Benefit Transaction Excess Business Holdings Taxable Distributions of Sponsoring Organizations Exception. Www irs gov freefile A donor advised fund does not include: Taxes on Prohibited Benefits Resulting From Donor Advised Fund Distributions Excise Taxes on Private Foundations Excise Taxes on Black Lung Benefit Trusts Excise Tax on Failure to Meet the Community Health Needs Assessment Requirements Introduction An excise tax may be imposed on certain tax-exempt organizations. Www irs gov freefile Topics - This chapter discusses: Prohibited tax shelter transactions Excess benefit transactions Excess business holdings Taxable distributions of sponsoring organizations Taxes on prohibited benefits distributed from donor advised funds Excise taxes on private foundations Excise taxes on 501(c)(21) black lung benefit trusts Excise Tax on Failure to Meet the Community Health Needs Assessment Requirements of Hospitals Useful Items - You may want to see: Forms (and Instructions) 4720 Return of Certain Excise Taxes Under Chapters 41 and 42 of the Internal Revenue Code See chapter 6 for more information about getting Form 4720. Www irs gov freefile Prohibited Tax Shelter Transactions Section 4965 imposes an excise tax on: Certain tax-exempt entities that are party to prohibited tax shelter transactions, and Any entity manager who approves or otherwise causes the entity to be a party to a prohibited tax shelter transaction and knows or has reason to know that the transaction is a prohibited tax shelter transaction. Www irs gov freefile  Additionally, section 6033 provides new disclosure requirements on a tax-exempt entity that is a party to a prohibited tax shelter transaction. Www irs gov freefile Tax-exempt entities. Www irs gov freefile   Tax-exempt entities that are subject to section 4965 include: Entities described in section 501(c), including but not limited to the following common types of entities: Instrumentalities of the United States described in section 501(c)(1); Churches, hospitals, museums, schools, scientific research organizations, and other charities described in section 501(c)(3); Civic leagues, social welfare organizations, and local associations of employees described in section 501(c)(4); Labor, agricultural, or horticultural organizations described in section 501(c)(5); Business leagues, chambers of commerce, trade associations, and other organizations described in section 501(c)(6); Voluntary employees' beneficiary associations (VEBAs) described in section 501(c)(9); Credit unions described in section 501(c)(14); Insurance companies described in section 501(c)(15); and Veterans' organizations described in section 501(c)(19). Www irs gov freefile Religious or apostolic associations or corporations described in section 501(d). Www irs gov freefile Entities described in section 170(c), including states, possessions of the United States, the District of Columbia, political subdivisions of states and political subdivisions of possessions of the United States (but not including the United States). Www irs gov freefile Indian tribal governments within the meaning of section 7701(a)(40). Www irs gov freefile Entity manager. Www irs gov freefile    An entity manager is any person with authority or responsibility similar to that exercised by an officer, director, or trustee, and, for any act, the person that has authority or responsibility with respect to the prohibited transaction. Www irs gov freefile Prohibited tax shelter transaction. Www irs gov freefile   A prohibited tax shelter transaction is any listed transaction, within the meaning of section 6707A(c)(2), and any prohibited reportable transactions. Www irs gov freefile A prohibited reportable transaction is a confidential transaction within the meaning of Regulations section 1. Www irs gov freefile 6011-4(b)(3), and a transaction with contractual protection within the meaning of Regulations section 1. Www irs gov freefile 6011-4(b)(4). Www irs gov freefile See the Instructions for Form 8886 for more information on listed transactions and prohibited reportable transactions. Www irs gov freefile Subsequently listed transaction. Www irs gov freefile   Any transaction to which the tax-exempt entity is a party and is later determined to be a listed transaction after the entity has become a party to it, is a subsequently listed transaction. Www irs gov freefile Entity Level Tax Section 4965(a)(1) imposes an entity level excise tax on any tax-exempt entity described in 1, 2, 3, or 4 above that becomes a party to a prohibited tax shelter transaction or is a party to a subsequently listed transaction (defined earlier). Www irs gov freefile The excise tax imposed on a tax-exempt entity applies to tax years in which the entity becomes a party to the prohibited tax shelter transaction and any subsequent tax years. Www irs gov freefile The amount of the excise tax depends on whether the tax-exempt entity knew or had reason to know that the transaction was a prohibited tax shelter transaction at the time it became a party to the transaction. Www irs gov freefile To figure and report the excise tax imposed on a tax-exempt entity for being a party to a prohibited tax shelter transaction, file Form 4720. Www irs gov freefile For more information about this excise tax, including information about how it is figured, see the Instructions for Form 4720. Www irs gov freefile Manager Level Tax Section 4965(a)(2) imposes an excise tax on any tax-exempt entity manager who approves or otherwise causes the entity to be a party to a prohibited tax shelter transaction and knows (or has reason to know) that the transaction is a prohibited tax shelter transaction. Www irs gov freefile The excise tax, in the amount of $20,000, is assessed for each approval or other act causing the organization to be a party to the prohibited tax shelter transaction. Www irs gov freefile To report this tax, file Form 4720. Www irs gov freefile Excess Benefit Transactions Excise tax on excess benefit transactions. Www irs gov freefile   A disqualified person who benefits from an excess benefit transaction, such as compensation, fringe benefits, or contract payments from certain section 501(c)(3), 501(c)(4), or 501(c)(29) organizations, must correct the transaction and may have to pay an excise tax under section 4958. Www irs gov freefile A manager of the organization may also have to pay an excise tax under section 4958. Www irs gov freefile These taxes are reported on Form 4720. Www irs gov freefile   The excise taxes are imposed if an applicable tax-exempt organization provides an excess benefit to a disqualified person and that benefit exceeds the value of the benefit received in exchange. Www irs gov freefile   There are three taxes under section 4958. Www irs gov freefile Disqualified persons are liable for the first two taxes and certain organization managers are liable for the third tax. Www irs gov freefile    Taxes imposed on excess benefit transactions do not apply to a transaction under a written contract that was binding on September 13, 1995, and at all times thereafter before the transaction occurred. Www irs gov freefile Tax on Disqualified Persons An excise tax equal to 25% of the excess benefit is imposed on each excess benefit transaction between an applicable tax-exempt organization and a disqualified person. Www irs gov freefile The disqualified person who benefited from the transaction is liable for the tax. Www irs gov freefile See definition of Disqualified person, later at Disqualified person. Www irs gov freefile Additional tax on the disqualified person. Www irs gov freefile   If the 25% tax is imposed and the excess benefit transaction is not corrected within the taxable period, an additional excise tax equal to 200% of the excess benefit is imposed on any disqualified person involved. Www irs gov freefile   If a disqualified person makes a payment of less than the full correction amount, the 200% tax is imposed only on the unpaid portion of the correction amount. Www irs gov freefile If more than one disqualified person received an excess benefit from an excess benefit transaction, all such disqualified persons are jointly and severally liable for the taxes. Www irs gov freefile   To avoid the 200% tax, a disqualified person must correct the excess benefit transaction during the taxable period. Www irs gov freefile The 200% tax is abated (refunded if collected) if the excess benefit transaction is corrected within a 90-day correction period beginning on the date a statutory notice of deficiency is issued. Www irs gov freefile Taxable period. Www irs gov freefile   The taxable period means the period beginning with the date on which the excess benefit transaction occurs and ending on the earlier of: The date a notice of deficiency was mailed to the disqualified person for the initial tax on the excess benefit transaction, or The date on which the initial tax on the excess benefit transaction for the disqualified person is assessed. Www irs gov freefile Tax on Organization Managers If tax is imposed on a disqualified person for any excess benefit transaction, an excise tax equal to 10% of the excess benefit is imposed on an organization manager who knowingly participated in an excess benefit transaction, unless such participation was not willful and was due to reasonable cause. Www irs gov freefile This tax cannot exceed $20,000 ($10,000 for transactions entered in a tax year beginning before August 18, 2006), for each transaction. Www irs gov freefile There is also joint and several liability for this tax. Www irs gov freefile A person can be liable for both the tax paid by the disqualified person and the organization manager tax for a particular excess benefit transaction. Www irs gov freefile Organization Manager. Www irs gov freefile   An organization manager is any officer, director, or trustee of an applicable tax-exempt organization, or any individual having powers or responsibilities similar to officers, directors, or trustees of the organization, regardless of title. Www irs gov freefile An organization manager is not considered to have participated in an excess benefit transaction where the manager has opposed the transaction in a manner consistent with the fulfillment of the manager's responsibilities to the organization. Www irs gov freefile For example, a director who votes against giving an excess benefit would ordinarily not be subject to the 10% tax. Www irs gov freefile A person participates in a transaction knowingly if the person: Has actual knowledge of sufficient facts so that, based solely upon those facts, such transaction would be an excess benefit transaction; Is aware that such a transaction under these circumstances may violate the provisions of federal tax law governing excess benefit transactions; and Negligently fails to make reasonable attempts to ascertain whether the transaction is an excess benefit transaction, or the manager is in fact aware that it is such a transaction. Www irs gov freefile Knowing does not mean having reason to know. Www irs gov freefile The organization manager ordinarily will not be considered knowing if, after full disclosure of the factual situation to an appropriate professional, the organization manager relied on the professional's reasoned written opinion on matters within the professional's expertise or if the manager relied on the fact that the requirements for the rebuttable presumption of reasonableness have been satisfied. Www irs gov freefile Participation by an organization manager is willful if it is voluntary, conscious, and intentional. Www irs gov freefile An organization manager's participation is due to reasonable cause if the manager has exercised responsibility on behalf of the organization with ordinary business care and prudence. Www irs gov freefile Excess Benefit Transaction An excess benefit transaction is a transaction in which an economic benefit is provided by an applicable tax-exempt organization, directly or indirectly, to or for the use of any disqualified person, and the value of the economic benefit provided by the organization exceeds the value of the consideration (including the performance of services) received for providing such benefit. Www irs gov freefile The excess benefit transaction rules apply to all transactions with disqualified persons, regardless of whether the amount of the benefit provided is determined in whole or in part by the revenues of one or more activities of the organization. Www irs gov freefile To determine whether an excess benefit transaction has occurred, all consideration and benefits exchanged between a disqualified person and the applicable tax-exempt organization, and all entities it controls, are taken into account. Www irs gov freefile For purposes of determining the value of economic benefits, the value of property, including the right to use property, is the fair market value. Www irs gov freefile Fair market value is the price at which property, or the right to use property, would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy, sell, or transfer property or the right to use property, and both having reasonable knowledge of relevant facts. Www irs gov freefile Donor advised fund transactions occurring after August 17, 2006. Www irs gov freefile   For a donor advised fund, an excess benefit transaction includes a grant, loan, compensation, or other similar payment from the fund to a: Donor or donor advisor, Family member of a donor, or donor advisor, 35% controlled entity of a donor, or donor advisor, or 35% controlled entity of a family member of a donor, or donor advisor. Www irs gov freefile   The excess benefit in this transaction is the amount of the grant, loan, compensation, or other similar payment. Www irs gov freefile For additional information, see the Instructions for Form 4720. Www irs gov freefile Supporting organization transactions occurring after July 25, 2006. Www irs gov freefile   For any supporting organization, defined in section 509(a)(3), an excess benefit transaction includes grants, loans, compensation, or other similar payment provided by the supporting organization to a: Substantial contributor, Family member of a substantial contributor, 35% controlled entity of a substantial contributor, or 35% controlled entity of a family member of a substantial contributor. Www irs gov freefile   Additionally, an excess benefit transaction includes any loans provided by the supporting organization to a disqualified person (other than an organization described in section 509(a)(1), (2), or (4)). Www irs gov freefile   The excess benefit for substantial contributors and parties related to those contributors includes the amount of the grant, loan, compensation, or other similar payment. Www irs gov freefile For additional information, see the Instructions for Form 4720. Www irs gov freefile   Excess benefit transaction rules generally do not apply to transactions between a supporting organization and its supported organization described in section 501(c)(4), (5), or (6) in furtherance of charitable purposes. Www irs gov freefile Date of Occurrence An excess benefit transaction occurs on the date the disqualified person receives the economic benefit from the organization for federal income tax purposes. Www irs gov freefile However, when a single contractual arrangement provides for a series of compensation or other payments to or for the use of a disqualified person during the disqualified person's tax year, any excess benefit transaction with respect to these payments occurs on the last day of the taxpayer's tax year. Www irs gov freefile In the case of benefits provided to a qualified pension, profit-sharing, or stock bonus plan, the transaction occurs on the date the benefit is vested. Www irs gov freefile In the case of the transfer of property subject to a substantial risk of forfeiture, or in the case of rights to future compensation or property, the transaction occurs on the date the property, or the rights to future compensation or property, is not subject to a substantial risk of forfeiture. Www irs gov freefile Where the disqualified person elects to include an amount in gross income in the tax year of transfer under section 83(b), the excess benefit transaction occurs on the date the disqualified person receives the economic benefit for federal income tax purposes. Www irs gov freefile Correcting the excess benefit. Www irs gov freefile   An excess benefit transaction is corrected by undoing the excess benefit to the extent possible, and by taking any additional measures necessary to place the organization in a financial position not worse than what it would have been if the disqualified person were dealing under the highest fiduciary standards. Www irs gov freefile   A disqualified person corrects an excess benefit by making a payment in cash or cash equivalents, excluding payment by a promissory note, equal to the correction amount to the applicable tax-exempt organization. Www irs gov freefile The correction amount equals the excess benefit plus the interest on the excess benefit. Www irs gov freefile The interest rate can be no lower than the applicable federal rate, compounded annually, for the month the transaction occurred. Www irs gov freefile   A disqualified person can, with the agreement of the applicable tax-exempt organization, make a payment by returning the specific property previously transferred in the excess transaction. Www irs gov freefile In this case, the disqualified person is treated as making a payment equal to the lesser of: The fair market value of the property on the date the property is returned to the organization, or The fair market value of the property on the date the excess benefit transaction occurred. Www irs gov freefile   If the payment resulting from the return of property is less than the correction amount, the disqualified person must make an additional cash payment to the organization equal to the difference. Www irs gov freefile   If the payment resulting from the return of the property exceeds the correction amount described above, the organization can make a cash payment to the disqualified person equal to the difference. Www irs gov freefile Exception. Www irs gov freefile   For a correction of an excess benefit transaction (discussed earlier), no amount repaid in a manner prescribed by the Secretary can be held in a donor advised fund. Www irs gov freefile Applicable Tax-Exempt Organization An applicable tax-exempt organization is a section 501(c)(3), 501(c)(4), or 501(c)(29) organization that is tax-exempt under section 501(a), or was such an organization at any time during a 5-year period ending on the day of the excess benefit transaction. Www irs gov freefile An applicable tax-exempt organization does not include: A private foundation as defined in section 509(a), A governmental entity that is: Exempt from (or not subject to) taxation without regard to section 501(a), or Not required to file an annual return, or A foreign organization, recognized by the IRS or by treaty, that receives substantially all of its support (other than gross investment income) from sources outside the United States. Www irs gov freefile An organization is not treated as a section 501(c)(3), 501(c)(4), or 501(c)(29) organization for any period covered by a final determination that the organization was not tax-exempt under section 501(a), but only if the determination was not based on private inurement or one or more excess benefit transactions. Www irs gov freefile Disqualified Person A disqualified person is: Any person (at any time during the 5-year period ending on the date of the transaction) in a position to exercise substantial influence over the affairs of the organization, A family member of an individual described in 1, and A 35% controlled entity. Www irs gov freefile For donor advised funds, sponsoring organizations, and certain supporting organizations occurring after August 17, 2006. Www irs gov freefile   The following persons will be considered disqualified persons along with certain family members and 35% controlled entities associated with them. Www irs gov freefile Donors of donor advised funds, Investment advisors of sponsoring organizations, and Disqualified persons of a section 509(a)(3) supporting organization that supports the applicable tax-exempt organization. Www irs gov freefile For certain supporting organization transactions occurring after July 25, 2006. Www irs gov freefile   Substantial contributors to supporting organizations will also be considered disqualified persons with respect to the supporting organizations, along with their family members and 35% controlled entities. Www irs gov freefile Investment advisor. Www irs gov freefile   Investment advisor means for any sponsoring organization, any person compensated by such organization (but not an employee of such organization) for managing the investment of, or providing investment advice for, assets maintained in donor advised funds owned by such sponsoring organization. Www irs gov freefile Substantial contributor. Www irs gov freefile   In general, a substantial contributor means any person who contributed or bequeathed an aggregate of more than $5,000 to the organization, if that amount is more than 2% of the total contributions and bequests received by the end of the organization's tax year in which the contribution or bequest is received. Www irs gov freefile A substantial contributor includes the grantor of a trust. Www irs gov freefile Family members. Www irs gov freefile   Family members of a disqualified person include a disqualified person's spouse, brothers or sisters (whether by whole or half-blood), spouses of brothers or sisters (whether by whole or half-blood), ancestors, children (including a legally adopted child), grandchildren, great grandchildren, and spouses of children, grandchildren, and great grandchildren (whether by whole or half-blood). Www irs gov freefile 35% controlled entity. Www irs gov freefile   A 35% controlled entity is: A corporation in which disqualified persons own more than 35% of the total combined voting power, A partnership in which such persons own more than 35% of the profits interest, or A trust or estate in which such persons own more than 35% of the beneficial interest. Www irs gov freefile   In determining the holdings of a business enterprise, any stock or other interest owned directly or indirectly shall apply. Www irs gov freefile Persons having substantial influence. Www irs gov freefile   Among those who are in a position to exercise substantial influence over the affairs of the organization are, for example, voting members of the governing body, and persons holding the power of: Presidents, chief executives, or chief operating officers. Www irs gov freefile Treasurers and chief financial officers. Www irs gov freefile Persons with a material financial interest in a provider-sponsored organization. Www irs gov freefile Persons not considered to have substantial influence. Www irs gov freefile   Persons who are not considered to be in a position to exercise substantial influence over the affairs of an organization include: An employee who receives benefits that total less than the highly compensated amount in section 414(q)(1)(B)(i) and who does not hold the executive or voting powers mentioned earlier in the discussion on Disqualified Person, is not a family member of a disqualified person, and is not a substantial contributor, Tax-exempt organizations described in section 501(c)(3), and Section 501(c)(4) organizations with respect to transactions engaged in with other section 501(c)(4) organizations. Www irs gov freefile Facts and circumstances. Www irs gov freefile   The determination of whether a person has substantial influence over the affairs of an organization is based on all the facts and circumstances. Www irs gov freefile Facts and circumstances that tend to show a person has substantial influence over the affairs of an organization include, but are not limited to, the following. Www irs gov freefile The person founded the organization. Www irs gov freefile The person is a substantial contributor to the organization under the section 507(d)(2)(A) definition, only taking into account contributions to the organization for the past 5 years. Www irs gov freefile The person's compensation is primarily based on revenues derived from activities of the organization that the person controls. Www irs gov freefile The person has or shares authority to control or determine a substantial portion of the organization's capital expenditures, operating budget, or compensation for employees. Www irs gov freefile The person manages a discrete segment or activity of the organization that represents a substantial portion of the activities, assets, income, or expenses of the organization, as compared to the organization as a whole. Www irs gov freefile The person owns a controlling interest (measured by either vote or value) in a corporation, partnership, or trust that is a disqualified person. Www irs gov freefile The person is a nonstock organization controlled directly or indirectly by one or more disqualified persons. Www irs gov freefile   Facts and circumstances tending to show that a person does not have substantial influence over the affairs of an organization include, but are not limited to, the following. Www irs gov freefile The person has taken a bona fide vow of poverty as an employee or agent of a religious organization or on its behalf. Www irs gov freefile The person is an independent contractor whose sole relationship to the organization is providing professional advice (without having decision-making authority) with respect to transactions from which the independent contractor will not economically benefit either directly or indirectly aside from customary fees received for the professional advice rendered. Www irs gov freefile Any preferential treatment the person receives based on the size of the person's donation is also offered to others making comparable widely solicited donations. Www irs gov freefile The direct supervisor of the person is not a disqualified person. Www irs gov freefile The person does not participate in any management decisions affecting the organization as a whole or a discrete segment of the organization that represents a substantial portion of the activities, assets, income, or expenses of the organization, as compared to the organization as a whole. Www irs gov freefile   In the case of multiple organizations affiliated by common control or governing documents, the determination of whether a person does or does not have substantial influence is made separately for each applicable tax-exempt organization. Www irs gov freefile A person may be a disqualified person with respect to transactions with more than one organization. Www irs gov freefile Reasonable Compensation. Www irs gov freefile    Reasonable compensation is the value that would ordinarily be paid for like services by like enterprises under like circumstances. Www irs gov freefile The section 162 standard will apply in determining the reasonableness of compensation. Www irs gov freefile The fact that a bonus or revenue-sharing arrangement is subject to a cap is a relevant factor in determining reasonableness of compensation. Www irs gov freefile   To determine the reasonableness of compensation, all items of compensation provided by an applicable tax-exempt organization in exchange for performance of services are taken into account in determining the value of compensation (except for economic benefits that are disregarded under the discussion Disregarded benefits , later). Www irs gov freefile Items of compensation include: All forms of cash and noncash compensation, including salary, fees, bonuses, severance payments, and deferred noncash compensation, The payment of liability insurance premiums for, or the payment or reimbursement by the organization of penalties, taxes, or certain expenses under section 4958, unless excludable from income as a de minimis fringe benefit under section 132(a)(4), All other compensatory benefits, whether or not included in gross income for income tax purposes, Taxable and nontaxable fringe benefits, except fringe benefits described in section 132, and Foregone interest on loans. Www irs gov freefile    Intent to treat benefits as compensation. Www irs gov freefile An economic benefit is not treated as consideration for the performance of services unless the organization providing the benefit clearly indicates its intent to treat the benefit as compensation when the benefit is paid. Www irs gov freefile   An applicable tax-exempt organization (or entity that it controls) is treated as clearly indicating its intent to provide an economic benefit as compensation for services only if the organization provides written substantiation that is contemporaneous with the transfer of the economic benefits under consideration. Www irs gov freefile Ways to provide contemporaneous written substantiation of its intent to provide an economic benefit as compensation include: The organization produces a signed written employment contract, The organization reports the benefit as compensation on an original Form W-2, Form 1099, or Form 990, or on an amended form filed before starting an IRS examination, or The disqualified person reports the benefit as income on the person's original Form 1040, or on an amended form filed before starting an IRS examination. Www irs gov freefile Exception. Www irs gov freefile   If the economic benefit is excluded from the disqualified person's gross income for income tax purposes, the applicable tax-exempt organization is not required to indicate its intent to provide an economic benefit as compensation for services. Www irs gov freefile Rebuttable presumption that a transaction is not an excess benefit transaction. Www irs gov freefile   Payments under a compensation arrangement are presumed to be reasonable and the transfer of property (or right to use property) is presumed to be at fair market value, if the following three conditions are met. Www irs gov freefile The transaction is approved in advance by an authorized body of the organization (or an entity it controls) which is composed of individuals who do not have a conflict of interest concerning the transaction. Www irs gov freefile Before making its determination, the authorized body obtained and relied upon appropriate data as to comparability. Www irs gov freefile (There is a special safe harbor for small organizations. Www irs gov freefile If the organization has gross receipts of less than $1 million, appropriate comparability data includes data on compensation paid by three comparable organizations in the same or similar communities for similar services. Www irs gov freefile ) The authorized body adequately documents the basis for its determination concurrently with making that determination. Www irs gov freefile The documentation should include: The terms of the approved transaction and the date approved, The members of the authorized body who were present during debate on the transaction that was approved and those who voted on it, The comparability data obtained and relied upon by the authorized body and how the data was obtained, Any actions by a member of the authorized body having conflict of interest, and Documentation of the basis of the determination before the later of the next meeting of the authorized body or 60 days after the final actions of the authorized body are taken, and approval of records as reasonable, accurate, and complete within a reasonable time thereafter. Www irs gov freefile Disregarded benefits. Www irs gov freefile   The following economic benefits are disregarded for section 4958 purposes. Www irs gov freefile Nontaxable fringe benefits that are excluded from income under section 132. Www irs gov freefile Benefits provided to a volunteer for the organization if the benefit is provided to the general public in exchange for a membership fee or contribution of $75 or less. Www irs gov freefile Benefits provided to a member of an organization due to the payment of a membership fee or to a donor as a result of a deductible contribution, if a significant number of disqualified persons make similar payments or contributions and are offered a similar economic benefit. Www irs gov freefile Benefits provided to a person solely as a member of a charitable class that the applicable tax-exempt organization intends to benefit as part of the accomplishment of its exempt purpose. Www irs gov freefile A transfer of an economic benefit to or for the use of a governmental unit, as defined in section 170(c)(1), if exclusively for public purposes. Www irs gov freefile Special Exception for Initial Contracts      Section 4958 does not apply to any fixed payment made to a person under an initial contract. Www irs gov freefile   A fixed payment is an amount of cash or other property specified in the contract, or determined by a fixed formula that is specified in the contract, which is to be paid or transferred in exchange for the provision of specified services or property. Www irs gov freefile   A fixed formula can, generally, incorporate an amount that depends upon future specified events or contingencies, as long as no one has discretion when calculating the amount of a payment or deciding whether to make a payment (such as a bonus). Www irs gov freefile   An initial contract is a binding written contract between an applicable tax-exempt organization and a person who was not a disqualified person immediately before entering into the contract. Www irs gov freefile   A binding written contract, providing it can be terminated or canceled by the applicable tax-exempt organization without the other party's consent (except as a result of substantial nonperformance) and without substantial penalty, is treated as a new contract, as of the earliest date any termination or cancellation would be effective. Www irs gov freefile Also, if the parties make a material change to a contract, which includes an extension or renewal of the contract (except for an extension or renewal resulting from the exercise of an option by the disqualified person), or a more than incidental change to the amount payable under the contract, it is treated as a new contract as of the effective date of the material change. Www irs gov freefile More information. Www irs gov freefile   For more information, see the Instructions to Forms 990 and 4720. Www irs gov freefile Excess Business Holdings Private foundations are generally not permitted to hold more than a 20% interest in an unrelated business enterprise. Www irs gov freefile They may be subject to an excise tax on the amount of any excess business holdings. Www irs gov freefile For purposes of section 4943, for tax years beginning after August 17, 2006, donor advised funds and certain supporting organizations are considered private foundations. Www irs gov freefile Donor advised fund. Www irs gov freefile   In general, a donor advised fund is a fund or account separately identified by reference to contributions of a donor or donors that is owned and controlled by a sponsoring organization and for which the donor has or expects to have advisory privileges concerning the distribution or investment of the funds. Www irs gov freefile Supporting organizations. Www irs gov freefile   Only certain supporting organizations are subject to the excess business holdings tax under section 4943. Www irs gov freefile These include (1) Type III supporting organizations that are not functionally integrated and (2) Type II supporting organizations that accept any gift or contribution from a person who by himself or in connection with a related party controls the supported organization that the Type II supporting organization supports. Www irs gov freefile Taxes. Www irs gov freefile   A private foundation that has excess holdings in a business enterprise may become liable for an excise tax based on the amount of holdings. Www irs gov freefile The initial tax is 10% (5% for tax years beginning before August 18, 2006) of the value of the excess holdings and is imposed on the last day of each tax year that ends during the taxable period. Www irs gov freefile The excess holdings are determined on the day during the tax year when they were the largest. Www irs gov freefile   A foundation that fails to correct the excess business holdings becomes liable for an additional tax of 200% of the remaining excess business holdings as of the earlier of tax assessment or mailing of a notice of deficiency. Www irs gov freefile   For more information on the tax on excess business holdings, see the Instructions for Form 4720. Www irs gov freefile Taxable Distributions of Sponsoring Organizations An excise tax is imposed on a sponsoring organization for each taxable distribution it makes from a donor advised fund. Www irs gov freefile An excise tax is also imposed on any fund manager of the sponsoring organization who agreed to the making of a distribution, knowing that it is a taxable distribution. Www irs gov freefile Taxable distribution. Www irs gov freefile   A taxable distribution is any distribution from a donor advised fund to any natural person or to any other person if: The distribution is for any purpose other than one specified in section 170(c)(2)(B), or The sponsoring organization maintaining the donor advised fund does not exercise expenditure responsibility with respect to the distribution in accordance with section 4945(h). Www irs gov freefile    However, a taxable distribution does not include a distribution from a donor advised fund to: Any organization described in section 170(b)(1)(A) (other than a disqualified supporting organization), The sponsoring organization of the donor advised fund, or Any other donor advised fund. Www irs gov freefile The tax on taxable distributions applies to distributions occurring in tax years beginning after August 17, 2006. Www irs gov freefile Sponsoring organization. Www irs gov freefile   A sponsoring organization is a section 170(c) organization that is neither a government organization (as referred to in section 170(c)(1) and (2)(A)) nor a private foundation. Www irs gov freefile Donor advised fund. Www irs gov freefile    A donor advised fund is a fund or account: Which is separately identified by reference to contributions of a donor or donors, Which is owned and controlled by a sponsoring organization, and For which the donor (or any person appointed or designated by the donor) has or expects to have advisory privileges concerning the distribution or investment of the funds held in the donor advised funds or accounts because of the donor's status as a donor. Www irs gov freefile Exception. Www irs gov freefile A donor advised fund does not include:    A fund or account that makes distributions only to a single identified organization or governmental entity, or Any fund or account for a person described in 3 above that gives advice about which individuals receive grants for travel, study, or similar purposes, if the following three requirements are met: The person's advisory privileges are performed exclusively by such person in their capacity as a committee member of which all the committee members are appointed by the sponsoring organization, No combination of persons with advisory privileges, described in 3 above, or persons related to those in 3 above directly or indirectly control the committee, and All grants from the fund or account are awarded on an objective and nondiscriminatory basis according to a procedure approved in advance by the board of directors of the sponsoring organization. Www irs gov freefile The procedure must be designed to ensure that all grants meet the requirements of section 4945(g)(1), (2), or (3). Www irs gov freefile Disqualified supporting organization. Www irs gov freefile   A disqualified supporting organization includes (1) a Type III supporting organization that is not functionally integrated and (2) any supporting organization where the donor or donor advisor (and any related parties) directly or indirectly controls a supported organization of the supporting organization. Www irs gov freefile Tax on sponsoring organization. Www irs gov freefile   A tax of 20% of the amount of each taxable distribution is imposed on the sponsoring organization. Www irs gov freefile Tax on fund manager. Www irs gov freefile   If a tax is imposed on a taxable distribution of the sponsoring organization, a tax of 5% of the distribution will be imposed on any fund manager who agreed to the distribution knowing that it was a taxable distribution. Www irs gov freefile Any fund manager who took part in the distribution and is liable for the tax must pay the tax. Www irs gov freefile The maximum amount of tax on all fund managers for any one taxable distribution is $10,000. Www irs gov freefile If more than one fund manager is liable for tax on a taxable distribution, all such managers are jointly and severally liable for the tax. Www irs gov freefile   For more information on the tax on taxable distributions of sponsoring organizations, see the Instructions for Form 4720. Www irs gov freefile Taxes on Prohibited Benefits Resulting From Donor Advised Fund Distributions Prohibited benefit. Www irs gov freefile   If any donor, donor advisor, or related party advises the sponsoring organization about making a distribution which results in a donor, donor advisor, or related party receiving (either directly or indirectly) a more than incidental benefit, then such benefit is a prohibited benefit. Www irs gov freefile The tax on prohibited benefits applies to distributions occurring in tax years beginning after August 17, 2006. Www irs gov freefile Donor advisor. Www irs gov freefile   A donor advisor is any person appointed or designated by a donor to advise a sponsoring organization on the distribution or investment of amounts held in the donor's fund or account. Www irs gov freefile Related party. Www irs gov freefile   A related party includes any family member or 35% controlled entity. Www irs gov freefile See the definition of those terms under Disqualified Person , earlier. Www irs gov freefile Tax on donor, donor advisor, or related person. Www irs gov freefile    A tax of 125% of the benefit resulting from the distribution is imposed on both the party who advised as to the distribution (which might be a donor, donor advisor, or related party) and the party who received such benefit (which might be a donor, donor advisor, or related party). Www irs gov freefile The advisor and the party who received the benefit are jointly and severally liable for the tax. Www irs gov freefile Tax on fund managers. Www irs gov freefile   If a tax is imposed on a prohibited benefit received by a donor, donor advisor, or related person, a tax of 10% of the amount of the prohibited benefit is imposed on any fund manager who agreed to the distribution knowing that it would confer a prohibited benefit. Www irs gov freefile Any fund manager who took part in the distribution and is liable for the tax must pay the tax. Www irs gov freefile The maximum amount of tax on all fund managers for any one taxable distribution is $10,000. Www irs gov freefile If more than one fund manager is liable for tax on a taxable distribution, all such managers are jointly and severally liable for the tax. Www irs gov freefile Exception. Www irs gov freefile   If a person engaged in an excess benefit transaction and received a prohibited benefit for the same transaction, the person is taxed under section 4958, and no tax is imposed under section 4967 for a prohibited benefit. Www irs gov freefile   For more information on taxes on prohibited benefits distributed from donor advised funds, see the Instructions for Form 4720. Www irs gov freefile Excise Taxes on Private Foundations There is an excise tax on the net investment income of most domestic private foundations. Www irs gov freefile Capital gains from appreciation are included in the tax base on private foundation net investment income. Www irs gov freefile This tax must be reported on Form 990-PF and must be paid annually at the time for filing that return or in quarterly estimated tax payments if the total tax for the year (section 4940 tax minus credits) is $500 or more. Www irs gov freefile Form 990-W is used to calculate the estimated tax. Www irs gov freefile In addition, there are several other rules that apply to excise taxes on private foundations. Www irs gov freefile These include: Restrictions on self-dealing between private foundations and their substantial contributors and other disqualified persons, Requirements that the foundation annually distribute income for charitable purposes, Limits on their holdings in any business enterprise (see Excess Business Holdings, earlier), Provisions that investments must not jeopardize the carrying out of exempt purposes, and Provisions to assure that expenditures further the organization's exempt purposes. Www irs gov freefile Violations of these provisions give rise to taxes and penalties against the private foundation and, in some cases, its managers, its substantial contributors, and certain related persons. Www irs gov freefile For more information on the excise taxes imposed on private foundations, see the Instructions for Form 4720 and the Instructions for Form 990-PF. Www irs gov freefile Excise Taxes on Black Lung Benefit Trusts A black lung benefit trust that makes any expenditures, payments, or investments other than those described in chapter 4 under 501(c)(21) - Black Lung Benefit Trusts must pay a tax equal to 10% of the amount of such expenditures. Www irs gov freefile If there are any acts of self-dealing between the trust and a disqualified person, a tax equal to 10% of the amount involved is imposed on the disqualified person. Www irs gov freefile Both of these excise taxes are reported on Schedule A (Form 990-BL). Www irs gov freefile See the Form 990-BL instructions for more information on these taxes and what has to be filed, even if the trust is excepted from filing. Www irs gov freefile Excise Tax on Failure to Meet the Community Health Needs Assessment Requirements For tax years beginning after March 23, 2012, new section 4959 imposes an excise tax on hospital organizations which fail to meet certain section 501(r) requirements for each of their hospital facilities. Www irs gov freefile These entities must meet section 501(r)(3) requirements at all times during their tax year. Www irs gov freefile Section 501(r)(3) requirements pertain to a hospital organization preparing a community health needs assessment (CHNA). Www irs gov freefile See Schedule H, Hospitals (Form 990), for details. Www irs gov freefile Prev  Up  Next   Home   More Online Publications