Table of Contents
- Topics - This chapter discusses:
- Useful Items - You may want to see:
- General Information
- SSN for joint account.
- Custodian account for your child.
- Penalty for failure to supply SSN.
- Certification.
- Underreported interest and dividends.
- How to stop backup withholding due to underreporting.
- How to stop backup withholding due to an incorrect identification number.
- Reporting backup withholding.
- Nonresident aliens.
- Penalties.
- Savings account with parent as trustee.
- Interest Income
- Discount on Debt Instruments
- When To Report Interest Income
- How To Report Interest Income
- Dividends and Other Corporate Distributions
- How To Report Dividend Income
- Stripped Preferred Stock
- REMICs, FASITs, and Other CDOs
- S Corporations
- Investment Clubs
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Interest income,
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Dividends and other corporate distributions,
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Real estate mortgage investment conduits (REMICs), financial asset securitization investment trusts (FASITs), and other collateralized debt obligations (CDOs),
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S corporations, and
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Investment clubs.
Publication
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525 Taxable and Nontaxable Income
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537 Installment Sales
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564 Mutual Fund Distributions
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590 Individual Retirement Arrangements (IRAs)
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925 Passive Activity and At-Risk Rules
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1212 Guide to Original Issue Discount (OID) Instruments
Form (and Instructions)
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Schedule B (Form 1040) Interest and Ordinary Dividends
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Schedule 1 (Form 1040A) Interest and Ordinary Dividends for Form 1040A Filers
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1099 General Instructions for Forms 1099, 1098, 5498, and W-2G
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3115 Application for Change in Accounting Method
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6251 Alternative Minimum Tax — Individuals
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8582 Passive Activity Loss Limitations
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8615 Tax for Certain Children Who Have Investment Income of More Than $1,800
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8814 Parents' Election To Report Child's Interest and Dividends
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8815 Exclusion of Interest From Series EE and I U.S. Savings Bonds Issued After 1989
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8818 Optional Form To Record Redemption of Series EE and I U.S. Savings Bonds Issued After 1989
See Ordering forms and publications above for information about getting these publications and forms.
A few items of general interest are covered here.
Recordkeeping.You should keep a list showing sources and amounts of investment income that you receive during the year. Also, keep the forms you receive that show your investment income (Forms 1099-INT, Interest Income, and 1099-DIV, Dividends and Distributions, for example) as an important part of your records.-
The child had more than $1,800 of investment income.
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The child is required to file a tax return.
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The child was:
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Under age 18 at the end of 2008,
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Age 18 at the end of 2008 and did not have earned income that was more than half of the child's support, or
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A full-time student over age 18 and under age 24 at the end of 2008 and did not have earned income that was more than half of the child's support.
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At least one of the child's parents was alive at the end of 2008.
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The child does not file a joint return for 2008.
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Include your SSN on any return, statement, or other document,
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Give your SSN to another person who has to include it on any return, statement, or other document, or
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Include the SSN of another person on any return, statement, or other document.
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You do not give the payer your identification number (either a social security number or an employer identification number) in the required manner,
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The Internal Revenue Service (IRS) notifies the payer that you gave an incorrect identification number,
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The IRS notifies the payer that you are subject to backup withholding on interest or dividends because you have underreported interest or dividends on your income tax return, or
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You are required, but fail, to certify that you are not subject to backup withholding for the reason described in (3).
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You failed to include any part of a reportable interest or dividend payment required to be shown on your return, or
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You were required to file a return and to include a reportable interest or dividend payment on that return, but you failed to file the return.
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No underreporting occurred.
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You have a bona fide dispute with the IRS about whether underreporting occurred.
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Backup withholding will cause or is causing an undue hardship, and it is unlikely that you will underreport interest and dividends in the future.
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You have corrected the underreporting by filing a return if you did not previously file one and by paying all taxes, penalties, and interest due for any underreported interest or dividend payments.
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The savings account legally belongs to the child.
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The parents are not legally permitted to use any of the funds to support the child.
Table 1-1.Where To Report Common Types of Investment Income
(For detailed information about reporting investment income, see the rest of this publication, especially How To Report Interest Income and How To Report Dividend Income in chapter 1.)
|
Type of Income | If you file Form 1040, report on ... | If you can file Form 1040A, report on ... | If you can file Form 1040EZ, report on ... |
Taxable interest that totals $1,500 or less | Line 8a (You may need to file Schedule B as well.) | Line 8a (You may need to file Schedule 1 as well.) | Line 2 |
Taxable interest that totals more than $1,500 | Line 8a; also use Schedule B | Line 8a; also use Schedule 1 | |
Savings bond interest you will exclude because of higher education expenses | Schedule B; also use Form 8815 | Schedule 1; also use Form 8815 | |
Ordinary dividends that total $1,500 or less | Line 9a (You may need to file Schedule B as well.) | Line 9a (You may need to file Schedule 1 as well.) | |
Ordinary dividends that total more than $1,500 | Line 9a; also use Schedule B | Line 9a; also use Schedule 1 | |
Qualified dividends (if you do not have to file Schedule D) | Line 9b; also use the Qualified Dividends and Capital Gain Tax Worksheet | Line 9b; also use the Qualified Dividends and Capital Gain Tax Worksheet | |
Qualified dividends (if you have to file Schedule D) | Line 9b; also use the Qualified Dividends and Capital Gain Tax Worksheet or the Schedule D Tax Worksheet | You cannot use Form 1040A. | You cannot use Form 1040EZ |
Capital gain distributions (if you do not have to file Schedule D) | Line 13; also use the Qualified Dividends and Capital Gain Tax Worksheet | Line 10; also use the Qualified Dividends and Capital Gain Tax Worksheet | |
Capital gain distributions (if you have to file Schedule D) | Schedule D, line 13; also use the Qualified Dividends and Capital Gain Tax Worksheet or the Schedule D Tax Worksheet | ||
Gain or loss from sales of stocks or bonds | Line 13; also use Schedule D and the Qualified Dividends and Capital Gain Tax Worksheet or the Schedule D Tax Worksheet | You cannot use Form 1040A | |
Gain or loss from exchanges of like-kind investment property | Line 13; also use Schedule D, Form 8824, and the Qualified Dividends and Capital Gain Tax Worksheet or the Schedule D Tax Worksheet |
This section discusses the tax treatment of different types of interest income.
In general, any interest that you receive or that is credited to your account and can be withdrawn is taxable income. (It does not have to be entered in your passbook.) Exceptions to this rule are discussed later.
Note.
Exempt-interest dividends paid from specified private activity bonds may be subject to the alternative minimum tax. The exempt-interest dividends subject to the alternative minimum tax are shown in box 9 of Form 1099-INT. See Form 6251 and its instructions for more information about this tax. (private activity bonds are discussed later under State or Local Government Obligations.)
Taxable interest includes interest you receive from bank accounts, loans you make to others, and other sources. The following are some sources of taxable interest.
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Cooperative banks,
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Credit unions,
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Domestic building and loan associations,
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Domestic savings and loan associations,
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Federal savings and loan associations, and
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Mutual savings banks.
Example.
You deposited $5,000 with a bank and borrowed $5,000 from the bank to make up the $10,000 minimum deposit required to buy a 6-month certificate of deposit. The certificate earned $575 at maturity in 2008, but you received only $265, which represented the $575 you earned minus $310 interest charged on your $5,000 loan. The bank gives you a Form 1099-INT for 2008 showing the $575 interest you earned. The bank also gives you a statement showing that you paid $310 interest for 2008. You must include the $575 in your income. If you itemize your deductions on Schedule A (Form 1040), you can deduct $310, subject to the net investment income limit.
Example.
You open a savings account at your local bank and deposit $800. The account earns $20 interest. You also receive a $15 calculator. If no other interest is credited to your account during the year, the Form 1099-INT you receive will show $35 interest for the year. You must report $35 interest income on your tax return.
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The financial institution is bankrupt or insolvent, or
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The state in which the institution is located has placed limits on withdrawals because other financial institutions in the state are bankrupt or insolvent.
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The net amount you withdrew from these deposits during the year, and
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The amount you could have withdrawn as of the end of the year (not reduced by any penalty for premature withdrawals of a time deposit).
Example.
$100 of interest was credited on your frozen deposit during the year. You withdrew $80 but could not withdraw any more as of the end of the year. You must include $80 in your income and exclude $20 from your income for the year. You must include the $20 in your income for the year you can withdraw it.
If you make a below-market gift or demand loan, you must report as interest income any forgone interest (defined later) from that loan. The below-market loan rules and exceptions are described in this section. For more information, see section 7872 of the Internal Revenue Code and its regulations.
If you receive a below-market loan, you may be able to deduct the forgone interest as well as any interest that you actually paid, but not if it is personal interest.
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Gift loans,
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Pay-related loans,
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Corporation-shareholder loans,
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Tax avoidance loans, and
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Certain loans made to qualified continuing care facilities under a continuing care contract.
A pay-related loan is any below-market loan between an employer and an employee or between an independent contractor and a person for whom the contractor provides services.
A tax avoidance loan is any below-market loan where the avoidance of federal tax is one of the main purposes of the interest arrangement.
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The amount of interest that would be payable for that period if interest accrued on the loan at the applicable federal rate and was payable annually on December 31, minus
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Any interest actually payable on the loan for the period.
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A loan to the borrower in exchange for a note that requires the payment of interest at the applicable federal rate, and
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An additional payment to the borrower in an amount equal to the forgone interest.
These transfers are considered to occur annually, generally on December 31.
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Gift loans between individuals if the gift loan is not directly used to buy or carry income-producing assets, and
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Pay-related loans or corporation-shareholder loans if the avoidance of federal tax is not a principal purpose of the interest arrangement.
This exception does not apply to a term loan described in (2) above that previously has been subject to the below-market loan rules. Those rules will continue to apply even if the outstanding balance is reduced to $10,000 or less.
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Loans made available by the lender to the general public on the same terms and conditions that are consistent with the lender's customary business practice,
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Loans subsidized by a federal, state, or municipal government that are made available under a program of general application to the public,
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Certain employee-relocation loans,
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Certain loans from a foreign person, unless the interest income would be effectively connected with the conduct of a U.S. trade or business and would not be exempt from U.S. tax under an income tax treaty,
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Gift loans to a charitable organization, contributions to which are deductible, if the total outstanding amount of loans between the organization and lender is $250,000 or less at all times during the tax year, and
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Other loans on which the interest arrangement can be shown to have no significant effect on the federal tax liability of the lender or the borrower.
For a loan described in (6) above, all the facts and circumstances are used to determine if the interest arrangement has a significant effect on the federal tax liability of the lender or borrower. Some factors to be considered are:
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Whether items of income and deduction generated by the loan offset each other,
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The amount of these items,
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The cost to you of complying with the below-market loan rules, if they were to apply, and
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Any reasons other than taxes for structuring the transaction as a below-market loan.
If you structure a transaction to meet this exception, and one of the principal purposes of structuring the transaction in that way is the avoidance of federal tax, the loan will be considered a tax-avoidance loan and this exception will not apply.
This section provides tax information on U.S. savings bonds. It explains how to report the interest income on these bonds and how to treat transfers of these bonds.
U.S. savings bonds currently offered to individuals are the following.
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Series EE bonds
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Series I bonds
For other information on U.S. savings bonds, write to:
For Series HH/H:
Bureau of the Public Debt
Division of Customer Assistance
P.O. Box 2186
Parkersburg, WV 26106-2186.
For Series EE and I
Bureau of the Public Debt
Division of Customer Assistance
P.O. Box 7012
Parkersburg, WV 26106-7012.
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Method 1. Postpone reporting the interest until the earlier of the year you cash or dispose of the bonds or the year in which they mature. (However, see Savings bonds traded , later.)
Note. Series E bonds issued in 1978 matured in 2008. If you have used method 1, you generally must report the interest on these bonds on your 2008 return. -
Method 2. Choose to report the increase in redemption value as interest each year.
You must use the same method for all series EE, series E, and series I bonds you own. If you do not choose method 2 by reporting the increase in redemption value as interest each year, you must use method 1.
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You have typed or printed the following number at the top: “131”.
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It includes your name and social security number under the label in (1).
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It includes the year of change (both the beginning and ending dates).
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It identifies the savings bonds for which you are requesting this change.
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It includes your agreement to:
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Report all interest on any bonds acquired during or after the year of change when the interest is realized upon disposition, redemption, or final maturity, whichever is earliest, and
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Report all interest on the bonds acquired before the year of change when the interest is realized upon disposition, redemption, or final maturity, whichever is earliest, with the exception of the interest reported in prior tax years.
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Internal Revenue Service
Attention: CC:IT&A (Automatic Rulings Branch)
P.O. Box 7604
Benjamin Franklin Station
Washington, DC 20044
Internal Revenue Service
Attention: CC:IT&A
(Automatic Rulings Branch) Room 5336
1111 Constitution Avenue, NW
Washington, DC 20224
Example.
You bought series EE bonds entirely with your own funds. You did not choose to report the accrued interest each year. Later, you transfer the bonds to your former spouse under a divorce agreement. You must include the deferred accrued interest, from the date of the original issue of the bonds to the date of transfer, in your income in the year of transfer. Your former spouse includes in income the interest on the bonds from the date of transfer to the date of redemption.
IF ... | THEN the interest must be reported by ... |
you buy a bond in your name and the name of another person as co-owners, using only your own funds | you. |
you buy a bond in the name of another person, who is the sole owner of the bond | the person for whom you bought the bond. |
you and another person buy a bond as co-owners, each contributing part of the purchase price | both you and the other co-owner, in proportion to the amount each paid for the bond. |
you and your spouse, who live in a community property state, buy a bond that is community property | you and your spouse. If you file separate returns, both you and your spouse generally report one-half of the interest. |
Example 1.
You and your spouse each spent an equal amount to buy a $1,000 series EE savings bond. The bond was issued to you and your spouse as co-owners. You both postpone reporting interest on the bond. You later have the bond reissued as two $500 bonds, one in your name and one in your spouse's name. At that time neither you nor your spouse has to report the interest earned to the date of reissue.
Example 2.
You bought a $1,000 series EE savings bond entirely with your own funds. The bond was issued to you and your spouse as co-owners. You both postponed reporting interest on the bond. You later have the bond reissued as two $500 bonds, one in your name and one in your spouse's name. You must report half the interest earned to the date of reissue.
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The surviving spouse or personal representative (executor, administrator, etc.) who files the final income tax return of the decedent can choose to include on that return all of the interest earned on the bonds before the decedent's death. The person who acquires the bonds then includes in income only interest earned after the date of death.
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If the choice in (1) is not made, the interest earned up to the date of death is income in respect of the decedent. It should not be included in the decedent's final return. All of the interest earned both before and after the decedent's death (except any part reported by the estate on its income tax return) is income to the person who acquires the bonds. If that person uses the cash method and does not choose to report the interest each year, he or she can postpone reporting it until the year the bonds are cashed or disposed of or the year they mature, whichever is earlier. In the year that person reports the interest, he or she can claim a deduction for any federal estate tax that was paid on the part of the interest included in the decedent's estate.
Example 1.
Your uncle, a cash method taxpayer, died and left you a $1,000 series EE bond. He had bought the bond for $500 and had not chosen to report the interest each year. At the date of death, interest of $200 had accrued on the bond and its value of $700 was included in your uncle's estate. Your uncle's executor chose not to include the $200 accrued interest in your uncle's final income tax return. The $200 is income in respect of the decedent.
You are a cash method taxpayer and do not choose to report the interest each year as it is earned. If you cash the bond when it reaches maturity value of $1,000, you report $500 interest income—the difference between maturity value of $1,000 and the original cost of $500. For that year, you can deduct (as a miscellaneous itemized deduction not subject to the 2%-of-adjusted-gross-income limit) any federal estate tax paid because the $200 interest was included in your uncle's estate.
Example 2.
If, in Example 1, the executor had chosen to include the $200 accrued interest in your uncle's final return, you would report only $300 as interest when you cashed the bond at maturity. $300 is the interest earned after your uncle's death.
Example 3.
If, in Example 1, you make or have made the choice to report the increase in redemption value as interest each year, you include in gross income for the year you acquire the bond all of the unreported increase in value of all series E, series EE, and series I bonds you hold, including the $200 on the bond you inherited from your uncle.
Example 4.
When your aunt died, she owned series H bonds that she had acquired in a trade for series E bonds. You were the beneficiary of these bonds. Your aunt used the cash method and did not choose to report the interest on the series E bonds each year as it accrued. Your aunt's executor chose not to include any interest earned before your aunt's death on her final return.
The income in respect of the decedent is the sum of the unreported interest on the series E bonds and the interest, if any, payable on the series H bonds but not received as of the date of your aunt's death. You must report any interest received during the year as income on your return. The part of the interest that was payable but not received before your aunt's death is income in respect of the decedent and may qualify for the estate tax deduction. For information on when to report the interest on the series E bonds traded, see Savings bonds traded, later.
Example.
In 2004, you traded series EE bonds (on which you postponed reporting the interest) for $2,500 in series HH bonds and $223 in cash. You reported the $223 as taxable income in 2004, the year of the trade. At the time of the trade, the series EE bonds had accrued interest of $523 and a redemption value of $2,723. You hold the series HH bonds until maturity, when you receive $2,500. You must report $300 as interest income in the year of maturity. This is the difference between their redemption value, $2,500, and your cost, $2,200 (the amount you paid for the series EE bonds). (It is also the difference between the accrued interest of $523 on the series EE bonds and the $223 cash received on the trade.)
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You chose to report the increase in the redemption value of the bond each year. The interest shown on your Form 1099-INT will not be reduced by amounts previously included in income.
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You received the bond from a decedent. The interest shown on your Form 1099-INT will not be reduced by any interest reported by the decedent before death, or on the decedent's final return, or by the estate on the estate's income tax return.
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Ownership of the bond was transferred. The interest shown on your Form 1099-INT will not be reduced by interest that accrued before the transfer.
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You were named as a co-owner and the other co-owner contributed funds to buy the bond. The interest shown on your Form 1099-INT will not be reduced by the amount you received as nominee for the other co-owner. (See Co-owners , earlier in this section, for more information about the reporting requirements.)
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You received the bond in a taxable distribution from a retirement or profit-sharing plan. The interest shown on your Form 1099-INT will not be reduced by the interest portion of the amount taxable as a distribution from the plan and not taxable as interest. (This amount is generally shown on Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., for the year of distribution.)
You may be able to exclude from income all or part of the interest you receive on the redemption of qualified U.S. savings bonds during the year if you pay qualified higher educational expenses during the same year. This exclusion is known as the Education Savings Bond Program.
You do not qualify for this exclusion if your filing status is married filing separately.
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Tax-free part of scholarships and fellowships.
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Expenses used to figure the tax-free portion of distributions from a Coverdell ESA.
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Expenses used to figure the tax-free portion of distributions from a qualified tuition program.
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Any tax-free payments (other than gifts or inheritances) received as educational assistance, such as:
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Veterans' educational assistance benefits,
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Qualified tuition reductions, or
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Employer-provided educational assistance.
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Any expense used in figuring the Hope and lifetime learning credits.
Example.
In February 2008, Mark and Joan, a married couple, cashed a qualified series EE U.S. savings bond they bought in April 1996. They received proceeds of $7,816, representing principal of $5,000 and interest of $2,816. In 2008, they paid $4,000 of their daughter's college tuition. They are not claiming an education credit for that amount, and their daughter does not have any tax-free educational assistance. They can exclude $1,441 ($2,816 × ($4,000 ÷ $7,816)) of interest in 2008. They must pay tax on the remaining $1,375 ($2,816 − $1,441) interest.
Alternate Line 6 Worksheet | ||
1. | Enter the amount from Form 8815, line 5 | |
2. | Enter the face value of all post-1989 paper series EE bonds cashed in 2008 | |
3. | Multiply line 2 above by 50% (.50) | |
4. | Enter the face value of all electronic series EE bonds (including post-1989 series EE bonds converted from paper to electronic format) and all series I bonds cashed in 2008 | |
5. | Add lines 3 and 4 | |
6. | Subtract line 5 from line 1 | |
7. | Enter the amount of interest reported as income in previous years | |
8. | Subtract line 7 from line 6. Enter the result here and on Form 8815, line 6 |
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$67,100 to $82,100 for taxpayers filing single or head of household, and
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$100,650 to $130,650 for married taxpayers filing jointly, or for a qualifying widow(er) with dependent child.
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Foreign earned income exclusion,
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Foreign housing exclusion and deduction,
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Exclusion of income for bona fide residents of American Samoa,
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Exclusion for income from Puerto Rico,
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Exclusion for adoption benefits received under an employer's adoption assistance program,
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Deduction for tuition and fees,
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Deduction for student loan interest, and
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Deduction for domestic production activities.
Treasury bills, notes, and bonds are direct debts (obligations) of the U.S. Government.
Bureau of The Public Debt
P.O. Box 7015
Parkersburg, WV 26106-7015
If you sell a bond between interest payment dates, part of the sales price represents interest accrued to the date of sale. You must report that part of the sales price as interest income for the year of sale.
If you buy a bond between interest payment dates, part of the purchase price represents interest accrued before the date of purchase. When that interest is paid to you, treat it as a return of your capital investment, rather than interest income, by reducing your basis in the bond. See Accrued interest on bonds under How To Report Interest Income, later in this chapter, for information on reporting the payment.
Life insurance proceeds paid to you as beneficiary of the insured person are usually not taxable. But if you receive the proceeds in installments, you must usually report part of each installment payment as interest income.
For more information about insurance proceeds received in installments, see Publication 525.
Interest you receive on an obligation issued by a state or local government is generally not taxable. The issuer should be able to tell you whether the interest is taxable. The issuer should also give you a periodic (or year-end) statement showing the tax treatment of the obligation. If you invested in the obligation through a trust, a fund, or other organization, that organization should give you this information.
Even if interest on the obligation is not subject to income tax, you may have to report capital gain or loss when you sell it. Estate, gift, or generation-skipping tax may apply to other dispositions of the obligation.Interest on a bond used to finance government operations generally is not taxable if the bond is issued by a state, the District of Columbia, a U.S. possession, or any of their political subdivisions. Political subdivisions include:
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Port authorities,
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Toll road commissions,
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Utility services authorities,
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Community redevelopment agencies, and
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Qualified volunteer fire departments (for certain obligations issued after 1980).
There are other requirements for tax-exempt bonds. Contact the issuing state or local government agency or see sections 103 and 141 through 150 of the Internal Revenue Code and the related regulations.
Obligations that are not bonds. Interest on a state or local government obligation may be tax exempt even if the obligation is not a bond. For example, interest on a debt evidenced only by an ordinary written agreement of purchase and sale may be tax exempt. Also, interest paid by an insurer on default by the state or political subdivision may be tax exempt.Interest on some state or local obligations is taxable.
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Bonneville Power Authority (if the guarantee was under the Northwest Power Act as in effect on July 18, 1984).
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Department of Veterans Affairs.
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Federal home loan banks. (The guarantee must be made after July 30, 2008, in connection with the original bond issue during the period beginning on July 30, 2008, and ending on December 31, 2010, and the bank must meet safety and soundness requirements.)
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Federal Home Loan Mortgage Corporation.
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Federal Housing Administration.
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Federal National Mortgage Association.
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Government National Mortgage Corporation.
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Resolution Funding Corporation.
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Student Loan Marketing Association.
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More than 10% of the proceeds of the issue is to be used for a private business use.
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More than 10% of the payment of the principal or interest is:
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Secured by an interest in property to be used for a private business use (or payments for this property), or
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Derived from payments for property (or borrowed money) used for a private business use.
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Qualified 501(c)(3) bonds.
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New York Liberty bonds.
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Gulf Opportunity Zone bonds.
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Midwestern disaster area bonds.
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Hurricane Ike disaster area bonds.
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Exempt facility bonds issued after July 30, 2008.
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Qualified mortgage bonds issued after July 30, 2008.
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Qualified veterans' mortgage bonds issued after July 30, 2008.
In general, a debt instrument, such as a bond, note, debenture, or other evidence of indebtedness, that bears no interest or bears interest at a lower than current market rate will usually be issued at less than its face amount. This discount is, in effect, additional interest income. The following are some of the types of discounted debt instruments.
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U.S. Treasury bonds.
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Corporate bonds.
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Municipal bonds.
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Certificates of deposit.
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Notes between individuals.
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Stripped bonds and coupons.
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Collateralized debt obligations (CDOs).
The discount on these instruments (except municipal bonds) is taxable in most instances. The discount on municipal bonds generally is not taxable (but see State or Local Government Obligations , earlier, for exceptions). See also REMICs, FASITs, and Other CDOs , later, for information about applying the rules discussed in this section to the regular interest holder of a real estate mortgage investment conduit, a financial asset securitization investment trust, or other CDO.
OID is a form of interest. You generally include OID in your income as it accrues over the term of the debt instrument, whether or not you receive any payments from the issuer.
A debt instrument generally has OID when the instrument is issued for a price that is less than its stated redemption price at maturity. OID is the difference between the stated redemption price at maturity and the issue price.
All debt instruments that pay no interest before maturity are presumed to be issued at a discount. Zero coupon bonds are one example of these instruments.
The OID accrual rules generally do not apply to short-term obligations (those with a fixed maturity date of 1 year or less from date of issue). See Discount on Short-Term Obligations , later.
For information about the sale of a debt instrument with OID, see chapter 4.
Example 1.
You bought a 10-year bond with a stated redemption price at maturity of $1,000, issued at $980 with OID of $20. One-fourth of 1% of $1,000 (stated redemption price) times 10 (the number of full years from the date of original issue to maturity) equals $25. Because the $20 discount is less than $25, the OID is treated as zero. (If you hold the bond at maturity, you will recognize $20 ($1,000 − $980) of capital gain.)
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Tax-exempt obligations. (However, see Stripped tax-exempt obligations , later.)
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U.S. savings bonds.
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Short-term debt instruments (those with a fixed maturity date of not more than 1 year from the date of issue).
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Obligations issued by an individual before March 2, 1984.
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Loans between individuals, if all the following are true.
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The lender is not in the business of lending money.
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The amount of the loan, plus the amount of any outstanding prior loans between the same individuals, is $10,000 or less.
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Avoiding any federal tax is not one of the principal purposes of the loan.
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The issuer of the debt instrument (or your broker, if you held the instrument through a broker) should give you Form 1099-OID, Original Issue Discount, or a similar statement, if the total OID for the calendar year is $10 or more. Form 1099-OID will show, in box 1, the amount of OID for the part of the year that you held the bond. It also will show, in box 2, the stated interest that you must include in your income. A copy of Form 1099-OID will be sent to the IRS. Do not file your copy with your return. Keep it for your records.
In most cases, you must report the entire amount in boxes 1 and 2 of Form 1099-OID as interest income. But see Refiguring OID shown on Form 1099-OID , later in this discussion, and also Original issue discount (OID) adjustment under How To Report Interest Income, later in this chapter, for more information.
-
You bought the debt instrument after its original issue and paid a premium or an acquisition premium.
-
The debt instrument is a stripped bond or a stripped coupon (including certain zero coupon instruments). See Figuring OID under Stripped Bonds and Coupons, later in this chapter.
See Original issue discount (OID) adjustment under How To Report Interest Income, later in this chapter, for information about reporting the correct amount of OID.
-
You did not pay a premium.
-
The instrument's adjusted basis immediately after purchase (including purchase at original issue) was greater than its adjusted issue price. This is the issue price plus the OID previously accrued, minus any payment previously made on the instrument other than qualified stated interest.
Acquisition premium reduces the amount of OID includible in your income. For information about figuring the correct amount of OID to include in your income, see Figuring OID on Long-Term Debt Instruments in Publication 1212.
The rules for reporting OID depend on the date the long-term debt instrument was issued.
Number of full months | Original | |||
you held the instrument | × | Issue | ||
Number of full months from date of | Discount | |||
original issue to date of maturity |
If you buy a CD with a maturity of more than 1 year, you must include in income each year a part of the total interest due and report it in the same manner as other OID.
This also applies to similar deposit arrangements with banks, building and loan associations, etc., including:
-
Time deposits,
-
Bonus plans,
-
Savings certificates,
-
Deferred income certificates,
-
Bonus savings certificates, and
-
Growth savings certificates.
These certificates are subject to the OID rules. They are a form of endowment contracts issued by insurance or investment companies for either a lump-sum payment or periodic payments, with the face amount becoming payable on the maturity date of the certificate.
In general, the difference between the face amount and the amount you paid for the contract is OID. You must include a part of the OID in your income over the term of the certificate.
The issuer must give you a statement on Form 1099-OID indicating the amount you must include in your income each year.
If you hold an inflation-indexed debt instrument (other than a series I U.S. savings bond), you must report as OID any increase in the inflation-adjusted principal amount of the instrument that occurs while you held the instrument during the year. In general, an inflation-indexed debt instrument is a debt instrument on which the payments are adjusted for inflation and deflation (such as Treasury Inflation-Protected Securities). You should receive Form 1099-OID from the payer showing the amount you must report as OID and any qualified stated interest paid to you during the year. For more information, see Publication 1212.
If you strip one or more coupons from a bond and sell the bond or the coupons, the bond and coupons are treated as separate debt instruments issued with OID.
The holder of a stripped bond has the right to receive the principal (redemption price) payment. The holder of a stripped coupon has the right to receive interest on the bond.
Stripped bonds and stripped coupons include:
-
Zero coupon instruments available through the Department of the Treasury's Separate Trading of Registered Interest and Principal of Securities (STRIPS) program and government-sponsored enterprises such as the Resolution Funding Corporation and the Financing Corporation, and
-
Instruments backed by U.S. Treasury securities that represent ownership interests in those securities, such as obligations backed by U.S. Treasury bonds that are offered primarily by brokerage firms.
A market discount bond is any bond having market discount except:
-
Short-term obligations (those with fixed maturity dates of up to 1 year from the date of issue),
-
Tax-exempt obligations that you bought before May 1, 1993,
-
U.S. savings bonds, and
-
Certain installment obligations.
Market discount arises when the value of a debt obligation decreases after its issue date, generally because of an increase in interest rates. If you buy a bond on the secondary market, it may have market discount.
When you buy a market discount bond, you can choose to accrue the market discount over the period you own the bond and include it in your income currently as interest income. If you do not make this choice, the following rules generally apply.
-
You must treat any gain when you dispose of the bond as ordinary interest income, up to the amount of the accrued market discount. See Discounted Debt Instruments under Capital Gains and Losses in chapter 4.
-
You must treat any partial payment of principal on the bond as ordinary interest income, up to the amount of the accrued market discount. See Partial principal payments , later in this discussion.
-
If you borrow money to buy or carry the bond, your deduction for interest paid on the debt is limited. See Limit on interest deduction for market discount bonds under When To Deduct Investment Interest in chapter 3.
-
Your cost basis in the bond is less than the bond's issue price.
-
The bond is issued in exchange for a market discount bond under a plan of reorganization. (This does not apply if the bond is issued in exchange for a market discount bond issued before July 19, 1984, and the terms and interest rates of both bonds are the same.)
-
State that you have included market discount in your gross income for the year under section 1278(b) of the Internal Revenue Code, and
-
Describe the method you used to figure the accrued market discount for the year.
-
On the basis of the constant yield method, described earlier,
-
In proportion to the accrual of OID for any accrual period, if the debt instrument has OID, or
-
In proportion to the amount of stated interest paid in the accrual period, if the debt instrument has no OID.
When you buy a short-term obligation (one with a fixed maturity date of 1 year or less from the date of issue), other than a tax-exempt obligation, you can generally choose to include any discount and interest payable on the obligation in income currently. If you do not make this choice, the following rules generally apply.
-
You must treat any gain when you sell, exchange, or redeem the obligation as ordinary income, up to the amount of the ratable share of the discount. See Discounted Debt Instruments under Capital Gains and Losses in chapter 4.
-
If you borrow money to buy or carry the obligation, your deduction for interest paid on the debt is limited. See Limit on interest deduction for short-term obligations under When To Deduct Investment Interest in chapter 3.
-
Held by an accrual-basis taxpayer,
-
Held primarily for sale to customers in the ordinary course of your trade or business,
-
Held by a bank, regulated investment company, or common trust fund,
-
Held by certain pass-through entities,
-
Identified as part of a hedging transaction, or
-
A stripped bond or stripped coupon held by the person who stripped the bond or coupon (or by any other person whose basis in the obligation is determined by reference to the basis in the hands of that person).
-
Your name, address, and social security number,
-
The choice you are making and that it is being made under section 1283(c)(2) of the Internal Revenue Code,
-
The period for which the choice is being made and the obligation to which it applies, and
-
Any other information necessary to show you are entitled to make this choice.
Generally, you can elect to treat all interest on a debt instrument acquired during the tax year as OID and include it in income currently. For purposes of this election, interest includes stated interest, acquisition discount, OID, de minimis OID, market discount, de minimis market discount, and unstated interest as adjusted by any amortizable bond premium or acquisition premium. See Regulations section 1.1272-3.
When to report your interest income depends on whether you use the cash method or an accrual method to report income.
Example.
On September 1, 2006, you loaned another individual $2,000 at 12% compounded annually. You are not in the business of lending money. The note stated that principal and interest would be due on August 31, 2008. In 2008, you received $2,508.80 ($2,000 principal and $508.80 interest). If you use the cash method, you must include in income on your 2008 return the $508.80 interest you received in that year.
-
Make withdrawals in multiples of even amounts,
-
Give a notice to withdraw before making the withdrawal,
-
Withdraw all or part of the account to withdraw the earnings, or
-
Pay a penalty on early withdrawals, unless the interest you are to receive on an early withdrawal or redemption is substantially less than the interest payable at maturity.
Generally, you report all of your taxable interest income on Form 1040, line 8a; Form 1040A, line 8a; or Form 1040EZ, line 2.
You cannot use Form 1040EZ if your interest income is more than $1,500. Instead, you must use Form 1040A or Form 1040.
In addition, you cannot use Form 1040EZ if you must use Form 1040, as described later, or if any of the statements listed under Schedule B , later, are true.
-
Your taxable interest income is more than $1,500.
-
You are claiming the interest exclusion under the Education Savings Bond Program (discussed earlier).
-
You received interest from a seller-financed mortgage, and the buyer used the property as a home.
-
You received a Form 1099-INT for U.S. savings bond interest that includes amounts you reported before 2008.
-
You received, as a nominee, interest that actually belongs to someone else.
-
You received a Form 1099-INT for interest on frozen deposits.
-
You forfeited interest income because of the early withdrawal of a time deposit,
-
You received or paid accrued interest on securities transferred between interest payment dates,
-
You had a financial account in a foreign country, unless the combined value of all foreign accounts was $10,000 or less during all of 2008 or the accounts were with certain U.S. military banking facilities,
-
You acquired taxable bonds after 1987 and choose to reduce interest income from the bonds by any amortizable bond premium (discussed in chapter 3 under Bond Premium Amortization ),
-
You are reporting OID in an amount more or less than the amount shown on Form 1099-OID, or
-
You received tax-exempt interest from private activity bonds issued after August 7, 1986.
-
Your taxable interest income is more than $1,500.
-
You are claiming the interest exclusion under the Education Savings Bond Program (discussed earlier).
-
You had a foreign account or you received a distribution from, or were a granter of, or transferor to, a foreign trust.
-
You received interest from a seller-financed mortgage, and the buyer used the property as a home.
-
You received a Form 1099-INT for U.S. savings bond interest that includes amounts you reported before 2008.
-
You received, as a nominee, interest that actually belongs to someone else.
-
You received a Form 1099-INT for interest on frozen deposits.
-
You received a Form 1099-INT for interest on a bond that you bought between interest payment dates.
-
Statement (4) or (5) in the preceding list is true.
If you forfeited interest income because of the early withdrawal of a time deposit, the deductible amount will be shown on Form 1099-INT, in box 2. See Penalty on early withdrawal of savings , later. Box 3 of Form 1099-INT shows the amount of interest income you received from U.S. savings bonds, Treasury bills, Treasury notes, and Treasury bonds. Add the amount shown in box 3 to any other taxable interest income you received, unless part of the amount in box 3 was previously included in your interest income. If part of the amount shown in box 3 was previously included in your interest income, see U.S. savings bond interest previously reported , later. If you redeemed U.S. savings bonds you bought after 1989 and you paid qualified educational expenses, see Interest excluded under the Education Savings Bond Program , later. Box 4 (federal income tax withheld) of Form 1099-INT will contain an amount if you were subject to backup withholding. Report the amount from box 4 on Form 1040EZ, line 7; on Form 1040A, line 38; or on Form 1040, line 62. Box 5 of Form 1099-INT shows investment expenses you may be able to deduct as an itemized deduction. Chapter 3 discusses investment expenses. If there are entries in boxes 6 and 7 of Form 1099-INT, you must file Form 1040. You may be able to take a credit for the amount shown in box 6 (foreign tax paid) unless you deduct this amount on Schedule A of Form 1040 as “Other taxes.” To take the credit, you may have to file Form 1116, Foreign Tax Credit. For more information, see Publication 514, Foreign Tax Credit for Individuals.
-
Several lines above line 2, enter a subtotal of all interest listed on line 1.
-
Below the subtotal enter “U.S. Savings Bond Interest Previously Reported” and enter amounts previously reported or interest accrued before you received the bond.
-
Subtract these amounts from the subtotal and enter the result on line 2.
Example 1.
Your parents bought U.S. savings bonds for you when you were a child. The bonds were issued in your name, and the interest on the bonds was reported each year as it accrued. (See Choice to report interest each year under U.S. Savings Bonds, earlier.)
In March 2008, you redeemed one of the bonds — a $1,000 series EE bond. The bond was originally issued in March 1989. When you redeemed the bond, you received $1,341.20 for it.
The Form 1099-INT you received shows interest income of $841.20. However, since the interest on your savings bonds was reported yearly, you need only include the $26.00 interest that accrued from January 2008 to March 2008.
You received no other taxable interest for 2008. You file Form 1040A.
On Schedule 1 (Form 1040A), Part I, line 1, enter your interest income as shown on Form 1099-INT — $841.20. (If you had other taxable interest income, you would enter it next and then enter a subtotal, as described earlier, before going to the next step.) Several lines above line 2, enter “U.S. Savings Bond Interest Previously Reported” and enter $815.20 ($841.20 − $26.00). Subtract $815.20 from $841.20 and enter $26.00 on line 2. Enter $26.00 on Schedule 1, line 4, and on Form 1040A, line 8a.
Example 2.
Your uncle died and left you a $1,000 series EE bond. You redeem the bond when it reaches maturity.
Your uncle paid $500 for the bond, so $500 of the amount you receive upon redemption is interest income. Your uncle's executor included in your uncle's final return $200 of the interest that had accrued at the time of your uncle's death. You have to include only $300 in your income.
The bank where you redeem the bond gives you a Form 1099-INT showing interest income of $500. You also receive a Form 1099-INT showing taxable interest income of $300 from your savings account.
You file Form 1040 and you complete Schedule B. On line 1 of Schedule B, you list the $500 and $300 interest amounts shown on your Forms 1099. Several lines above line 2, you put a subtotal of $800. Below this subtotal, enter “U.S. Savings Bond Interest Previously Reported” and enter the $200 interest included in your uncle's final return. Subtract the $200 from the subtotal and enter $600 on line 2. You then complete the rest of the form.
A. | Enter the amount of cash received upon redemption of the bond | |
B. | Enter the value of the bond at the time of distribution by the plan | |
C. | Subtract the amount on line B from the amount on line A. This is the amount of interest accrued on the bond since it was distributed by the plan | |
D. | Enter the amount of interest shown on your Form 1099-INT | |
E. | Subtract the amount on line C from the amount on line D. This is the amount you include in “U.S. Savings Bond Interest Previously Reported” |
Your employer should tell you the value of each bond on the date it was distributed.
Example.
You received a distribution of series EE U.S. savings bonds in December 2005 from your company's profit-sharing plan.
In March 2008, you redeemed a $100 series EE bond that was part of the distribution you received in 2005. You received $116.76 for the bond the company bought in May 1992. The value of the bond at the time of distribution in 2005 was $107.88. (This is the amount you included on your 2005 return.) The bank gave you a Form 1099-INT that shows $66.76 interest (the total interest from the date the bond was purchased to the date of redemption). Since a part of the interest was included in your income in 2005, you need to include in your 2008 income only the interest that accrued after the bond was distributed to you.
On Schedule B (Form 1040), line 1, include all the interest shown on your Form 1099-INT as well as any other taxable interest income you received. Several lines above line 2, put a subtotal of all interest listed on line 1. Below this subtotal enter “U.S. Savings Bond Interest Previously Reported” and enter the amount figured on the worksheet below.
A. | Enter the amount of cash received upon redemption of the bond | $116.76 |
B. | Enter the value of the bond at the time of distribution by the plan | 107.88 |
C. | Subtract the amount on line B from the amount on line A. This is the amount of interest accrued on the bond since it was distributed by the plan | $8.88 |
D. | Enter the amount of interest shown on your Form 1099-INT | $66.76 |
E. | Subtract the amount on line C from the amount on line D. This is the amount you include in “U.S. Savings Bond Interest Previously Reported” | $57.88 |
Subtract $57.88 from the subtotal and enter the result on Schedule B, line 2. You then complete the rest of the form.
Example.
You and your sister have a joint savings account that paid $1,500 interest for 2008. Your sister deposited 30% of the funds in this account, and you and she have agreed to share the yearly interest income in proportion to the amount that each of you has invested. Because your social security number was given to the bank, you received a Form 1099-INT for 2008 that includes the interest income earned belonging to your sister. This amount is $450, or 30% of the total interest of $1,500.
You must give your sister a Form 1099-INT by February 2, 2009, showing $450 of interest income that she earned for 2008. You must also send a copy of the nominee Form 1099-INT, along with Form 1096, to the Internal Revenue Service Center by March 2, 2009 (March 31, 2009, if you file Form 1099-INT electronically). Show your own name, address, and social security number as that of the “Payer” on the Form 1099-INT. Show your sister's name, address, and social security number in the blocks provided for identification of the “Recipient.”
When you prepare your own federal income tax return, report the total amount of interest income, $1,500, on Schedule 1 (Form 1040A), Part I, line 1, or Schedule B (Form 1040), Part I, line 1, and identify the name of the bank that paid this interest. Show the amount belonging to your sister, $450, as a subtraction from a subtotal of all interest on Schedule 1 (or Schedule B) and identify this subtraction as a “Nominee Distribution.” (Your sister will report the $450 of interest income on her own tax return, if she has to file a return, and identify you as the payer of that amount.)
Dividends are distributions of money, stock, or other property paid to you by a corporation. You also may receive dividends through a partnership, an estate, a trust, or an association that is taxed as a corporation. However, some amounts you receive that are called dividends are actually interest income. (See Dividends that are actually interest under Taxable Interest — General, earlier.)
The most common kinds of distributions are:
-
Ordinary dividends,
-
Capital gain distributions, and
-
Nondividend distributions.
Most distributions are paid in cash (check). However, distributions can consist of more stock, stock rights, other property, or services.
Ordinary (taxable) dividends are the most common type of distribution from a corporation. They are paid out of the earnings and profits of a corporation and are ordinary income to you. This means they are not capital gains. You can assume that any dividend you receive on common or preferred stock is an ordinary dividend unless the paying corporation tells you otherwise. Ordinary dividends will be shown in box 1a of the Form 1099-DIV you receive.
Qualified dividends are the ordinary dividends that are subject to the same 0% or 15% maximum tax rate that applies to net capital gain. They should be shown in box 1b of the Form 1099-DIV you receive.
Qualified dividends are subject to the 15% rate if the regular tax rate that would apply is 25% or higher. If the regular tax rate that would apply is lower than 25%, qualified dividends are subject to the 0% rate.
To qualify for the 0% or 15% maximum rate, all of the following requirements must be met.
-
The dividends must have been paid by a U.S. corporation or a qualified foreign corporation. (See Qualified foreign corporation later.)
-
The dividends are not of the type listed later under Dividends that are not qualified dividends .
-
You meet the holding period (discussed next).
Example 1.
You bought 5,000 shares of XYZ Corp. common stock on July 1, 2008. XYZ Corp. paid a cash dividend of 10 cents per share. The ex-dividend date was July 9, 2008. Your Form 1099-DIV from XYZ Corp. shows $500 in box 1a (ordinary dividends) and in box 1b (qualified dividends). However, you sold the 5,000 shares on August 4, 2008. You held your shares of XYZ Corp. for only 34 days of the 121-day period (from July 2, 2008, through August 4, 2008). The 121-day period began on May 10, 2008 (60 days before the ex-dividend date), and ended on September 7, 2008. You have no qualified dividends from XYZ Corp. because you held the XYZ stock for less than 61 days.
Example 2.
Assume the same facts as in Example 1 except that you bought the stock on July 8, 2008 (the day before the ex-dividend date), and you sold the stock on September 9, 2008. You held the stock for 63 days (from July 9, 2008, through September 9, 2008). The $500 of qualified dividends shown in box 1b of your Form 1099-DIV are all qualified dividends because you held the stock for 61 days of the 121-day period (from July 9, 2008, through September 7, 2008).
Example 3.
You bought 10,000 shares of ABC Mutual Fund common stock on July 1, 2008. ABC Mutual Fund paid a cash dividend of 10 cents per share. The ex-dividend date was July 9, 2008. The ABC Mutual Fund advises you that the portion of the dividend eligible to be treated as qualified dividends equals 2 cents per share. Your Form 1099-DIV from ABC Mutual Fund shows total ordinary dividends of $1,000 and qualified dividends of $200. However, you sold the 10,000 shares on August 4, 2008. You have no qualified dividends from ABC Mutual Fund because you held the ABC Mutual Fund stock for less than 61 days.
-
You had an option to sell, were under a contractual obligation to sell, or had made (and not closed) a short sale of substantially identical stock or securities.
-
You were grantor (writer) of an option to buy substantially identical stock or securities.
-
Your risk of loss is diminished by holding one or more other positions in substantially similar or related property.
-
The corporation is incorporated in a U.S. possession.
-
The corporation is eligible for the benefits of a comprehensive income tax treaty with the United States that the Treasury Department determines is satisfactory for this purpose and that includes an exchange of information program. For a list of those treaties, see Table 1-3.
-
The corporation does not meet (1) or (2) above, but the stock for which the dividend is paid is readily tradable on an established securities market in the United States. See Readily tradable stock , later.
Table 1-3. Income Tax Treaties
Income tax treaties that the United States has with the following countries satisfy requirement (2) under Qualified foreign corporation. | ||
Australia | Indonesia | Romania |
Austria | Ireland | Russian |
Bangladesh1 | Israel | Federation |
Barbados2 | Italy | Slovak |
Belgium | Jamaica | Republic |
Canada | Japan | Slovenia |
China | Kazakhstan | South Africa |
Cyprus | Korea | Spain |
Czech | Latvia | Sri Lanka3 |
Republic | Lithuania | Sweden |
Denmark | Luxembourg | Switzerland |
Egypt | Mexico | Thailand |
Estonia | Morocco | Trinidad and |
Finland | Netherlands | Tobago |
France | New Zealand | Tunisia |
Germany | Norway | Turkey |
Greece | Pakistan | Ukraine |
Hungary | Philippines | United |
Iceland | Poland | Kingdom |
India | Portugal | Venezuela |
1Effective for dividends paid after August 6, 2006. 2Effective for dividends paid after December 19, 2004. 3Effective for dividends paid after July 11, 2004. |
-
Capital gain distributions.
-
Dividends paid on deposits with mutual savings banks, cooperative banks, credit unions, U.S. building and loan associations, U.S. savings and loan associations, federal savings and loan associations, and similar financial institutions. (Report these amounts as interest income.)
-
Dividends from a corporation that is a tax-exempt organization or farmer's cooperative during the corporation's tax year in which the dividends were paid or during the corporation's previous tax year.
-
Dividends paid by a corporation on employer securities which are held on the date of record by an employee stock ownership plan (ESOP) maintained by that corporation.
-
Dividends on any share of stock to the extent that you are obligated (whether under a short sale or otherwise) to make related payments for positions in substantially similar or related property.
-
Payments in lieu of dividends, but only if you know or have reason to know that the payments are not qualified dividends.
-
Payments shown in Form 1099-DIV, box 1b, from a foreign corporation to the extent you know or have reason to know the payments are not qualified dividends.
The corporation in which you own stock may have a dividend reinvestment plan. This plan lets you choose to use your dividends to buy (through an agent) more shares of stock in the corporation instead of receiving the dividends in cash. If you are a member of this type of plan and you use your dividends to buy more stock at a price equal to its fair market value, you still must report the dividends as income.
If you are a member of a dividend reinvestment plan that lets you buy more stock at a price less than its fair market value, you must report as dividend income the fair market value of the additional stock on the dividend payment date.
You also must report as dividend income any service charge subtracted from your cash dividends before the dividends are used to buy the additional stock. But you may be able to deduct the service charge. See Expenses of Producing Income in chapter 3.
In some dividend reinvestment plans, you can invest more cash to buy shares of stock at a price less than fair market value. If you choose to do this, you must report as dividend income the difference between the cash you invest and the fair market value of the stock you buy. When figuring this amount, use the fair market value of the stock on the dividend payment date.
Capital gain distributions (also called capital gain dividends) are paid to you or credited to your account by mutual funds (or other regulated investment companies) and real estate investment trusts (REITs). They will be shown in box 2a of the Form 1099-DIV you receive from the mutual fund or REIT.
Report capital gain distributions as long-term capital gains, regardless of how long you owned your shares in the mutual fund or REIT. See Capital gain distributions under How To Report Dividend Income, later in this chapter.
-
Unrecaptured section 1250 gain (box 1b),
-
Gain from qualified small business stock (section 1202 gain, box 1c), or
-
Collectibles (28%) gain (box 1d).
A nondividend distribution is a distribution that is not paid out of the earnings and profits of a corporation. You should receive a Form 1099-DIV or other statement from the corporation showing you the nondividend distribution. On Form 1099-DIV, a nondividend distribution will be shown in box 3. If you do not receive such a statement, you report the distribution as an ordinary dividend.
Example.
You bought stock in 1996 for $100. In 1999, you received a nondividend distribution of $80. You did not include this amount in your income, but you reduced the basis of your stock to $20. You received a nondividend distribution of $30 in 2008. The first $20 of this amount reduced your basis to zero. You report the other $10 as a long-term capital gain for 2008. You must report as a long-term capital gain any nondividend distribution you receive on this stock in later years.
Liquidating distributions, sometimes called liquidating dividends, are distributions you receive during a partial or complete liquidation of a corporation. These distributions are, at least in part, one form of a return of capital. They may be paid in one or more installments. You will receive Form 1099-DIV from the corporation showing you the amount of the liquidating distribution in box 8 or 9.
Any liquidating distribution you receive is not taxable to you until you have recovered the basis of your stock. After the basis of your stock has been reduced to zero, you must report the liquidating distribution as a capital gain. Whether you report the gain as a long-term or short-term capital gain depends on how long you have held the stock. See Holding Period in chapter 4.
Distributions by a corporation of its own stock are commonly known as stock dividends. Stock rights (also known as “stock options”) are distributions by a corporation of rights to acquire the corporation's stock. Generally, stock dividends and stock rights are not taxable to you, and you do not report them on your return.
-
You or any other shareholder has the choice to receive cash or other property instead of stock or stock rights.
-
The distribution gives cash or other property to some shareholders and an increase in the percentage interest in the corporation's assets or earnings and profits to other shareholders.
-
The distribution is in convertible preferred stock and has the same result as in (2).
-
The distribution gives preferred stock to some common stock shareholders and common stock to other common stock shareholders.
-
The distribution is on preferred stock. (The distribution, however, is not taxable if it is an increase in the conversion ratio of convertible preferred stock made solely to take into account a stock dividend, stock split, or similar event that would otherwise result in reducing the conversion right.)
If you receive taxable stock dividends or stock rights, include their fair market value at the time of the distribution in your income.
For stock issued before October 10, 1990, you include the redemption premium in your income ratably over the period during which the stock cannot be redeemed. For stock issued after October 9, 1990, you include the redemption premium on the basis of its economic accrual over the period during which the stock cannot be redeemed, as if it were original issue discount on a debt instrument. See Original Issue Discount (OID) , earlier in this chapter.
The redemption premium is not a constructive distribution, and therefore is not taxable, in the following situations.
-
The stock was issued before October 10, 1990 (before December 20, 1995, if redeemable solely at the option of the issuer), and the redemption premium is “reasonable.” (For stock issued before October 10, 1990, only the part of the redemption premium that is not “reasonable” is a constructive distribution.) The redemption premium is reasonable if it is not more than 10% of the issue price on stock not redeemable for 5 years from the issue date or is in the nature of a penalty for making a premature redemption.
-
The stock was issued after October 9, 1990 (after December 19, 1995, if redeemable solely at the option of the issuer), and the redemption premium is “ de minimis.” The redemption premium is de minimis if it is less than one-fourth of 1% (.0025) of the redemption price multiplied by the number of full years from the date of issue to the date redeemable.
-
The stock was issued after October 9, 1990, and must be redeemed at a specified time or is redeemable at your option, but the redemption is unlikely because it is subject to a contingency outside your control (not including the possibility of default, insolvency, etc.).
-
The stock was issued after December 19, 1995, and is redeemable solely at the option of the issuer, but the redemption premium is in the nature of a penalty for premature redemption or redemption is not more likely than not to occur. The redemption will be treated under a “safe harbor” as not more likely than not to occur if all of the following are true.
-
You and the issuer are not related under the rules discussed in chapter 4 under Losses on Sales or Trades of Property , substituting “20%” for “50%.”
-
There are no plans, arrangements, or agreements that effectively require or are intended to compel the issuer to redeem the stock.
-
The redemption would not reduce the stock's yield.
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Example.
You own one share of common stock that you bought on January 3, 2000, for $100. The corporation declared a common stock dividend of 5% on June 30, 2008. The fair market value of the stock at the time the stock dividend was declared was $200. You were paid $10 for the fractional-share stock dividend under a plan described in the above paragraph. You figure your gain or loss as follows:
Fair market value of old stock | $200.00 |
Fair market value of stock dividend (cash received) |
+ 10.00 |
Fair market value of old stock and stock dividend | $210.00 |
Basis (cost) of old stock after the stock dividend (($200 ÷ $210) × $100) |
$95.24 |
Basis (cost) of stock dividend (($10 ÷ $210) × $100) |
+ 4.76 |
Total | $100.00 |
Cash received | $10.00 |
Basis (cost) of stock dividend | − 4.76 |
Gain | $5.24 |
Because you had held the share of stock for more than 1 year at the time the stock dividend was declared, your gain on the stock dividend is a long-term capital gain.
You may receive any of the following distributions during the year.
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Property bought for your personal use, or
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Capital assets or depreciable property bought for use in your business. But you must reduce the basis (cost) of the items bought. If the dividend is more than the adjusted basis of the assets, you must report the excess as income.
Generally, you can use either Form 1040 or Form 1040A to report your dividend income. Report the total of your ordinary dividends on line 9a of Form 1040 or Form 1040A. Report qualified dividends on line 9b.
If you receive capital gain distributions, you may be able to use Form 1040A or you may have to use Form 1040. See Capital gain distributions , later. If you receive nondividend distributions required to be reported as capital gains, you must use Form 1040. You cannot use Form 1040EZ if you receive any dividend income.
See Form 1099-DIV for more information on how to report dividend income.
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Your ordinary dividends (Form 1099-DIV, box 1a) are more than $1,500, or
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You received, as a nominee, dividends that actually belong to someone else.
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Your ordinary dividends (Form 1099-DIV, box 1a) are more than $1,500, or
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You received, as a nominee, dividends that actually belong to someone else.
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Qualified dividends you received as a nominee. See Nominees , later.
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Dividends on stock for which you did not meet the holding period. See Holding period , earlier under Qualified Dividends.
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Dividends on any share of stock to the extent that you are obligated (whether under a short sale or otherwise) to make related payments for positions in substantially similar or related property.
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Payments in lieu of dividends, but only if you know or have reason to know that the payments are not qualified dividends.
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Payments shown in Form 1099-DIV, box 1b, from a foreign corporation to the extent you know or have reason to know the payments are not qualified dividends.
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Unrecaptured section 1250 gain (box 2b), or
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Section 1202 gain (box 2c).
If the dividend rights are stripped from certain preferred stock, the holder of the stripped preferred stock may have to include amounts in income equal to the amounts that would have been included if the stock were a bond with original issue discount (OID).
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There has been a separation in ownership between the stock and any dividend on the stock that has not become payable.
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The stock:
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Is limited and preferred as to dividends,
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Does not participate in corporate growth to any significant extent, and
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Has a fixed redemption price.
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Was issued on the purchase date of the stock, and
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Has OID equal to:
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The redemption price for the stock, minus
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The price at which you bought the stock.
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Holders of interests in real estate mortgage investment conduits (REMICs), financial asset securitization investment trusts (FASITs), and other collateralized debt obligations (CDOs) must follow special rules for reporting income and any expenses from these investment products.
A real estate mortgage investment conduit (REMIC) is an entity that is formed for the purpose of holding a fixed pool of mortgages secured by interests in real property. A REMIC issues regular and residual interests to investors. For tax purposes, a REMIC is generally treated as a partnership with the residual interest holders treated as the partners. The regular interests are treated as debt instruments.
REMIC income or loss is not income or loss from a passive activity.
For more information about the qualifications and the tax treatment that apply to a REMIC and the interests of investors in a REMIC, see sections 860A through 860G of the Internal Revenue Code, and the regulations under those sections.
A REMIC can have several classes (also known as “tranches”) of regular interests. A regular interest unconditionally entitles the holder to receive a specified principal amount (or other similar amount).
A REMIC regular interest is treated as a debt instrument for income tax purposes. Accordingly, the OID, market discount, and income reporting rules that apply to bonds and other debt instruments as described earlier in this publication under Discount on Debt Instruments apply, with certain modifications discussed below.
Generally, you report your income from a regular interest on Form 1040, line 8a. For more information on how to report interest and OID, see How To Report Interest Income , earlier.
You may not get a Form 1099.
Corporations and other persons specified in Regulations section 1.6049-7(c) will not receive Forms 1099. These persons and fiscal year taxpayers may obtain tax information by contacting the REMIC or the issuer of the CDO, if they hold their interest directly from the REMIC or issuer of the CDO. Publication 938, Real Estate Mortgage Investment Conduits (REMICs) Reporting Information, explains how to request this information.
If you hold a regular interest or CDO through a nominee (rather than directly), you can request the information from the nominee.
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The amount that would have been included in your income if the yield to maturity on the regular interest had been 110% of the applicable federal rate at the beginning of your holding period, minus
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The amount you included in your income.
A residual interest is an interest in a REMIC that is not a regular interest. It is designated as a residual interest by the REMIC.
If you acquire a residual interest in a REMIC, you must take into account, on a quarterly basis, your daily portion of the taxable income or net loss of the REMIC for each day during the tax year that you hold the residual interest. You must report these amounts as ordinary income or loss.
A collateralized debt obligation (CDO) is a debt instrument, other than a REMIC regular interest, that is secured by a pool of mortgages or other evidence of debt and that has principal payments that are subject to acceleration. (Note: While REMIC regular interests are collateralized debt obligations, they have unique rules that do not apply to CDOs issued before 1987.) CDOs, also known as “pay-through bonds,” are commonly divided into different classes (also called “tranches”).
CDOs can be secured by a pool of mortgages, automobile loans, equipment leases, or credit card receivables.
For more information about the qualifications and the tax treatment that apply to an issuer of a CDO, see section 1272(a)(6) of the Internal Revenue Code and the regulations under that section.
The OID, market discount, and income-reporting rules that apply to bonds and other debt instruments, as described earlier in this chapter under Discount on Debt Instruments , also apply to a CDO.
You must include interest income from your CDO in your gross income under your regular method of accounting. Also include any OID accrued on your CDO during the tax year.
Generally, you report your income from a CDO on Form 1040, line 8a. For more information about reporting these amounts on your return, see How To Report Interest Income , earlier.
A financial asset securitization investment trust (FASIT) is an entity that securitizes debt obligations such as credit card receivables, home equity loans, and automobile loans.
A regular interest in a FASIT is treated as a debt instrument. The rules described under Collateralized Debt Obligations (CDOs), earlier, apply to a regular interest in a FASIT, except that a holder of a regular interest in a FASIT must use an accrual method of accounting to report OID and interest income.
For more information about FASITs, see sections 860H through 860L of the Internal Revenue Code.
Beginning January 1, 2005, the special rules for FASITs are repealed. However, the special rules still apply to any FASIT in existence on October 22, 2004, to the extent that regular interests issued by the FASIT before that date continue to remain outstanding in accordance with the original terms of issuance.In general, an S corporation does not pay a tax on its income. Instead, its income and expenses are passed through to the shareholders, who then report these items on their own income tax returns.
If you are an S corporation shareholder, your share of the corporation's current year income or loss and other tax items are taxed to you whether or not you receive any amount. Generally, those items increase or decrease the basis of your S corporation stock as appropriate. For more information on basis adjustments for S corporation stock, see Stocks and Bonds under Basis of Investment Property in chapter 4.
Generally, S corporation distributions, except dividend distributions, are considered a return of capital and reduce your basis in the stock of the corporation. The part of any distribution that is more than your basis is treated as a gain from the sale or exchange of property. The corporation's distributions may be in the form of cash or property.
S corporation distributions are not treated as dividends except in certain cases in which the corporation has accumulated earnings and profits from years before it became an S corporation.
An investment club is formed when a group of friends, neighbors, business associates, or others pool their money to invest in stock or other securities. The club may or may not have a written agreement, a charter, or bylaws.
Usually the group operates informally with members pledging to pay a regular amount into the club monthly. Some clubs have a committee that gathers information on securities, selects the most promising securities, and recommends that the club invest in them. Other clubs rotate these responsibilities among all their members. Most clubs require all members to vote for or against all investments, sales, trades, and other transactions.
Generally, an investment club is treated as a partnership for federal tax purposes unless it chooses otherwise. In some situations, however, it is taxed as a corporation or a trust.
If your club is not taxed as a corporation or a trust, it will be treated as a partnership.
An investment club formed after 1996 is taxed as a corporation if:
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It is formed under a federal or state law that refers to it as incorporated or as a corporation, body corporate, or body politic,
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It is formed under a state law that refers to it as a joint-stock company or joint-stock association, or
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It chooses to be taxed as a corporation.
In a few cases, an investment club is taxed as a trust. In general, a trust is an arrangement through which trustees take title to property for the purpose of protecting or conserving it for the beneficiaries under the ordinary rules applied in chancery or probate courts. An arrangement is treated as a trust for tax purposes if its purpose is to vest in trustees responsibility for protecting and conserving property for beneficiaries who cannot share in that responsibility and so are not associates in a joint enterprise for the conduct of business for profit. If you need more information about trusts, see Regulations section 301.7701-4.
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