Table of Contents
- What's New
- Introduction
- Useful Items - You may want to see:
- Bartering
- Canceled Debts
- Host or Hostess
- Life Insurance Proceeds
- Partnership Income
- S Corporation Income
- Recoveries
- Rents from Personal Property
- Repayments
- Royalties
- Unemployment Benefits
- Welfare and Other Public Assistance Benefits
- Other Income
- Emotional distress.
- Deduction for costs involved in unlawful discrimination suits.
- Energy conservation measure.
- Dwelling unit.
- Current income required to be distributed.
- Current income not required to be distributed.
- How to report.
- Losses.
- Grantor trust.
- Nonemployee compensation.
- Corporate director.
- Personal representatives.
- Manager of trade or business for bankruptcy estate.
- Notary public.
- Election precinct official.
- Difficulty-of-care payments.
- Maintaining space in home.
- Reporting taxable payments.
- Lotteries and raffles.
- Form W-2G.
- Inherited pension or IRA.
- Employee awards or bonuses.
- Pulitzer, Nobel, and similar prizes.
- Payment for services.
- VA payments.
- Prizes.
- Strike and lockout benefits.
Qualified joint venture. . A qualified joint venture conducted by you and your spouse may not be treated as a partnership if you file a joint return for the tax year. See Partnership Income, later.
Expiration of relief granted for Hurricane Katrina. The exclusion from income for the discharge of certain nonbusiness debt as a result of Hurricane Katrina expired.
You must include on your return all income you receive in the form of money, property, and services unless the tax law states that you do not include them. Some items, however, are only partly excluded from income. This chapter discusses many kinds of income and explains whether they are taxable or nontaxable.
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Income that is taxable must be reported on your tax return and is subject to tax.
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Income that is nontaxable may have to be shown on your tax return but is not taxable.
This chapter begins with discussions of the following income items.
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Bartering.
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Canceled debts.
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Host or hostess.
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Life insurance proceeds.
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Partnership income.
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S Corporation income.
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Recoveries (including state income tax refunds).
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Rents from personal property.
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Repayments.
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Royalties.
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Unemployment benefits.
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Welfare and other public assistance benefits.
These discussions are followed by brief discussions of other income items arranged in alphabetical order.
Publication
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525 Taxable and Nontaxable Income
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544 Sales and Other Dispositions of Assets
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550 Investment Income and Expenses
Bartering is an exchange of property or services. You must include in your income, at the time received, the fair market value of property or services you receive in bartering. If you exchange services with another person and you both have agreed ahead of time as to the value of the services, that value will be accepted as fair market value unless the value can be shown to be otherwise.
Generally, you report this income on Schedule C, Profit or Loss From Business, or Schedule C-EZ, Net Profit From Business (Form 1040). However, if the barter involves an exchange of something other than services, such as in Example 3 below, you may have to use another form or schedule instead.
Example 1.
You are a self-employed attorney who performs legal services for a client, a small corporation. The corporation gives you shares of its stock as payment for your services. You must include the fair market value of the shares in your income on Schedule C or Schedule C-EZ (Form 1040) in the year you receive them.
Example 2.
You are self-employed and a member of a barter club. The club uses “credit units” as a means of exchange. It adds credit units to your account for goods or services you provide to members, which you can use to purchase goods or services offered by other members of the barter club. The club subtracts credit units from your account when you receive goods or services from other members. You must include in your income the value of the credit units that are added to your account, even though you may not actually receive goods or services from other members until a later tax year.
Example 3.
You own a small apartment building. In return for 6 months rent-free use of an apartment, an artist gives you a work of art she created. You must report as rental income on Schedule E, Supplemental Income and Loss (Form 1040), the fair market value of the artwork, and the artist must report as income on Schedule C or Schedule C-EZ (Form 1040) the fair rental value of the apartment.
Generally, if a debt you owe is canceled or forgiven, other than as a gift or bequest, you must include the canceled amount in your income. You have no income from the canceled debt if it is intended as a gift to you. A debt includes any indebtedness for which you are liable or which attaches to property you hold.
If the debt is a nonbusiness debt, report the canceled amount on Form 1040, line 21. If it is a business debt, report the amount on Schedule C or Schedule C-EZ (Form 1040) (or on Schedule F, Profit or Loss From Farming (Form 1040), if the debt is farm debt and you are a farmer).
There are several exceptions to the inclusion of canceled debt in income. These are explained next.
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The Federal Government, a state or local government, or an instrumentality, agency, or subdivision thereof,
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A tax-exempt public benefit corporation that has assumed control of a state, county, or municipal hospital, and whose employees are considered public employees under state law, or
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An educational institution
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Under an agreement with an entity described in (1) or (2) that provided the funds to the institution to make the loan, or
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As part of a program of the institution designed to encourage students to serve in occupations or areas with unmet needs and under which the services provided are for or under the direction of a governmental unit or a tax-exempt section 501(c)(3) organization.
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The debt is canceled in a bankruptcy case under title 11 of the U.S. Code. See Publication 908, Bankruptcy Tax Guide.
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The debt is canceled when you are insolvent. However, you cannot exclude any amount of canceled debt that is more than the amount by which you are insolvent. See Publication 908.
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The debt is qualified farm debt and is canceled by a qualified person. See chapter 3 of Publication 225, Farmer's Tax Guide.
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The debt is qualified real property business debt. See chapter 5 of Publication 334.
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The cancellation is intended as a gift.
If you host a party at which sales are made, any gift you receive for giving the party is a payment for helping a direct seller make sales. You must report it as income at its fair market value.
Your out-of-pocket party expenses are subject to the 50% limit for meal and entertainment expenses. These expenses are deductible as miscellaneous itemized deductions subject to the 2% of AGI limit on Schedule A (Form 1040), but only up to the amount of income you receive for giving the party.
For more information about the 50% limit for meal and entertainment expenses, see 50% Limit in Publication 463, Travel, Entertainment, Gift, and Car Expenses.
Life insurance proceeds paid to you because of the death of the insured person are not taxable unless the policy was turned over to you for a price. This is true even if the proceeds were paid under an accident or health insurance policy or an endowment contract.
An endowment contract is a policy under which you are paid a specified amount of money on a certain date unless you die before that date, in which case, the money is paid to your designated beneficiary. Endowment proceeds paid in a lump sum to you at maturity are taxable only if the proceeds are more than the cost of the policy. To determine your cost, subtract any amount that you previously received under the contract and excluded from your income from the total premiums (or other consideration) paid for the contract. Include the part of the lump sum payment that is more than your cost in your income.
Certain amounts paid as accelerated death benefits under a life insurance contract or viatical settlement before the insured's death are excluded from income if the insured is terminally or chronically ill.
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Is a director, officer, or employee of the person, or
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Has a financial interest in the person's business.
If you are a survivor of a public safety officer who was killed in the line of duty, you may be able to exclude from income certain amounts you receive.
For this purpose, the term public safety officer includes law enforcement officers, firefighters, chaplains, and rescue squad and ambulance crew members. For more information, see Publication 559, Survivors, Executors, and Administrators.
A partnership generally is not a taxable entity. The income, gains, losses, deductions, and credits of a partnership are passed through to the partners based on each partner's distributive share of these items.
Keep Schedule K-1 (Form 1065) for your records. Do not attach it to your Form 1040.
For more information on partnerships, see Publication 541, Partnerships.
In general, an S corporation does not pay tax on its income. Instead, the income, losses, deductions, and credits of the corporation are passed through to the shareholders based on each shareholder's pro rata share.
Keep Schedule K-1 (Form 1120S) for your records. Do not attach it to your Form 1040.
For more information on S corporations and their shareholders, see Instructions for Form 1120S.
A recovery is a return of an amount you deducted or took a credit for in an earlier year. The most common recoveries are refunds, reimbursements, and rebates of deductions itemized on Schedule A (Form 1040). You also may have recoveries of non-itemized deductions (such as payments on previously deducted bad debts) and recoveries of items for which you previously claimed a tax credit.
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State and local income taxes, or
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State and local general sales taxes.
If you recover any amount that you deducted in an earlier year on Schedule A (Form 1040), you generally must include the full amount of the recovery in your income in the year you receive it.
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Your recoveries, or
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The amount by which your itemized deductions exceeded the standard deduction.
Example.
For 2006, you filed a joint return. Your taxable income was $60,000 and you were not entitled to any tax credits. Your standard deduction was $10,300, and you had itemized deductions of $12,000. In 2007, you received the following recoveries for amounts deducted on your 2006 return:
Medical expenses | $200 | |
State and local income tax refund | 400 | |
Refund of mortgage interest | 325 | |
Total recoveries | $925 |
None of the recoveries were more than the deductions taken for 2006. The difference between the state and local income tax you deducted and your local general sales tax was more than $400.
Your total recoveries are less than the amount by which your itemized deductions exceeded the standard deduction ($12,000 − 10,300 = $1,700), so you must include your total recoveries in your income for 2007. Report the state and local income tax refund of $400 on Form 1040, line 10, and the balance of your recoveries, $525, on Form 1040, line 21.
Example.
You filed a joint return for 2006 with taxable income of $45,000. Your itemized deductions were $10,650. The standard deduction that you could have claimed was $10,300. In 2007, you recovered $2,100 of your 2006 itemized deductions. None of the recoveries were more than the actual deductions for 2006. Include $350 of the recoveries in your 2007 income. This is the smaller of your recoveries ($2,100) or the amount by which your itemized deductions were more than the standard deduction ($10,650 − 10,300 = $350).
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The amount deducted on Schedule A (Form 1040), or
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The amount recovered.
Example.
During 2006 you paid $1,700 for medical expenses. From this amount you subtracted $1,500, which was 7.5% of your adjusted gross income. Your actual medical expense deduction was $200. In 2007, you received a $500 reimbursement from your medical insurance for your 2006 expenses. The only amount of the $500 reimbursement that must be included in your income for 2007 is $200—the amount actually deducted.
If you rent out personal property, such as equipment or vehicles, how you report your income and expenses is generally determined by:
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Whether or not the rental activity is a business, and
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Whether or not the rental activity is conducted for profit.
Generally, if your primary purpose is income or profit and you are involved in the rental activity with continuity and regularity, your rental activity is a business. See Publication 535, Business Expenses, for details on deducting expenses for both business and not-for-profit activities.
If you had to repay an amount that you included in your income in an earlier year, you may be able to deduct the amount repaid from your income for the year in which you repaid it. Or, if the amount you repaid is more than $3,000, you may be able to take a credit against your tax for the year in which you repaid it. Generally, you can claim a deduction or credit only if the repayment qualifies as an expense or loss incurred in your trade or business or in a for-profit transaction.
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Figure your tax for 2007 without deducting the repaid amount.
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Refigure your tax from the earlier year without including in income the amount you repaid in 2007.
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Subtract the tax in (2) from the tax shown on your return for the earlier year. This is the credit.
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Subtract the answer in (3) from the tax for 2007 figured without the deduction (Step 1).
Royalties from copyrights, patents, and oil, gas, and mineral properties are taxable as ordinary income.
You generally report royalties in Part I of Schedule E (Form 1040). However, if you hold an operating oil, gas, or mineral interest or are in business as a self-employed writer, inventor, artist, etc., report your income and expenses on Schedule C or Schedule C-EZ (Form 1040).
The tax treatment of unemployment benefits you receive depends on the type of program paying the benefits.
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Benefits paid by a state or the District of Columbia from the Federal Unemployment Trust Fund.
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State unemployment insurance benefits.
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Railroad unemployment compensation benefits.
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Disability payments from a government program paid as a substitute for unemployment compensation. (Amounts received as workers' compensation for injuries or illness are not unemployment compensation. See chapter 5 for more information.)
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Trade readjustment allowances under the Trade Act of 1974.
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Unemployment assistance under the Disaster Relief and Emergency Assistance Act.
Do not include in your income governmental benefit payments from a public welfare fund based upon need, such as payments due to blindness. Payments from a state fund for the victims of crime should not be included in the victims' incomes if they are in the nature of welfare payments. Do not deduct medical expenses that are reimbursed by such a fund. You must include in your income any welfare payments that are compensation for services or that are obtained fraudulently.
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To reimburse or pay reasonable and necessary personal, family, living, or funeral expenses that result from a qualified disaster,
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To reimburse or pay reasonable and necessary expenses incurred for the repair or rehabilitation of your home or repair or replacement of its contents to the extent it is due to a qualified disaster,
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By a person engaged in the furnishing or sale of transportation as a common carrier because of the death or personal physical injuries incurred as a result of a qualified disaster, or
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By a federal, state, or local government, or agency, or instrumentality in connection with a qualified disaster in order to promote the general welfare.
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A disaster which results from a terrorist or military action,
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A Presidentially declared disaster, or
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A disaster which results from an accident involving a common carrier, or from any other event, which is determined to be catastrophic by the Secretary of the Treasury or his or her delegate.
The following brief discussions are arranged in alphabetical order. Income items that are discussed in greater detail in another publication include a reference to that publication.
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Interest on any award.
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Compensation for lost wages or lost profits in most cases.
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Punitive damages, in most cases. It does not matter if they relate to a physical injury or physical sickness.
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Amounts received in settlement of pension rights (if you did not contribute to the plan).
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Damages for
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Back pay and damages for emotional distress received to satisfy a claim under Title VII of the Civil Rights Act of 1964.
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Attorney fees and costs (including contingent fees) where the underlying recovery is included in gross income.
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All income that is required to be distributed to you, whether or not it is actually distributed, plus
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All other amounts actually paid or credited to you,
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A corporate director,
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An executor, administrator, or personal representative of an estate,
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A manager of a trade or business you operated before declaring Chapter 11 bankruptcy,
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A notary public, or
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An election precinct official.
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Is living in a foster family home, and
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Was placed there by
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An agency of a state or one of its political subdivisions, or
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A qualified foster care placement agency.
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10 qualified foster individuals under age 19, or
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5 qualified foster individuals age 19 or older.
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You were selected without any action on your part to enter the contest or proceeding.
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You are not required to perform substantial future services as a condition to receiving the prize or award.
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The prize or award is transferred by the payer directly to a governmental unit or tax-exempt charitable organization as designated by you.
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Tuition and fees to enroll at or attend an educational institution, or
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Fees, books, supplies, and equipment required for courses at the educational institution.
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