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Federal Tax Return Forms

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Federal Tax Return Forms

Federal tax return forms 2. Federal tax return forms   Tax Shelters and Other Reportable Transactions Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Abusive Tax SheltersRules To Curb Abusive Tax Shelters Investor Reporting Penalties Whether To Invest Introduction Investments that yield tax benefits are sometimes called “tax shelters. Federal tax return forms ” In some cases, Congress has concluded that the loss of revenue is an acceptable side effect of special tax provisions designed to encourage taxpayers to make certain types of investments. Federal tax return forms In many cases, however, losses from tax shelters produce little or no benefit to society, or the tax benefits are exaggerated beyond those intended. Federal tax return forms Those cases are called “abusive tax shelters. Federal tax return forms ” An investment that is considered a tax shelter is subject to restrictions, including the requirement that it be disclosed, as discussed later. Federal tax return forms Topics - This chapter discusses: Abusive Tax Shelters , Rules To Curb Abusive Tax Shelters , Investor Reporting , Penalties , and Whether To Invest . Federal tax return forms Useful Items - You may want to see: Publication 538 Accounting Periods and Methods 556 Examination of Returns, Appeal Rights, and Claims for Refund 561 Determining the Value of Donated Property 925 Passive Activity and At-Risk Rules Form (and Instructions) 8275 Disclosure Statement 8275-R Regulation Disclosure Statement 8283 Noncash Charitable Contributions 8886 Reportable Transaction Disclosure Statement See chapter 5, How To Get Tax Help , for information about getting these publications and forms. Federal tax return forms Abusive Tax Shelters Abusive tax shelters are marketing schemes involving artificial transactions with little or no economic reality. Federal tax return forms They often make use of unrealistic allocations, inflated appraisals, losses in connection with nonrecourse loans, mismatching of income and deductions, financing techniques that do not conform to standard commercial business practices, or mischaracterization of the substance of the transaction. Federal tax return forms Despite appearances to the contrary, the taxpayer generally risks little. Federal tax return forms Abusive tax shelters commonly involve package deals designed from the start to generate losses, deductions, or credits that will be far more than present or future investment. Federal tax return forms Or, they may promise investors from the start that future inflated appraisals will enable them, for example, to reap charitable contribution deductions based on those appraisals. Federal tax return forms (But see the appraisal requirements discussed under Rules To Curb Abusive Tax Shelters , later. Federal tax return forms ) They are commonly marketed in terms of the ratio of tax deductions allegedly available to each dollar invested. Federal tax return forms This ratio (or “write-off”) is frequently said to be several times greater than one-to-one. Federal tax return forms Because there are many abusive tax shelters, it is not possible to list all the factors you should consider in determining whether an offering is an abusive tax shelter. Federal tax return forms However, you should ask the following questions, which might provide a clue to the abusive nature of the plan. Federal tax return forms Do the tax benefits far outweigh the economic benefits? Is this a transaction you would seriously consider, apart from the tax benefits, if you hoped to make a profit? Do shelter assets really exist and, if so, are they insured for less than their purchase price? Is there a nontax justification for the way profits and losses are allocated to partners? Do the facts and supporting documents make economic sense? In that connection, are there sales and resales of the tax shelter property at ever increasing prices? Does the investment plan involve a gimmick, device, or sham to hide the economic reality of the transaction? Does the promoter offer to backdate documents after the close of the year? Are you instructed to backdate checks covering your investment? Is your debt a real debt or are you assured by the promoter that you will never have to pay it? Does this transaction involve laundering United States source income through foreign corporations incorporated in a tax haven and owned by United States shareholders? Rules To Curb Abusive Tax Shelters Congress has enacted a series of income tax laws designed to halt the growth of abusive tax shelters. Federal tax return forms These provisions include the following. Federal tax return forms Disclosure of reportable transactions. Federal tax return forms   You must disclose information for each reportable transaction in which you participate. Federal tax return forms See Reportable Transaction Disclosure Statement , later. Federal tax return forms   Material advisors with respect to any reportable transaction must disclose information about the transaction on Form 8918, Material Advisor Disclosure Statement. Federal tax return forms To determine whether you are a material advisor to a transaction, see the Instructions for Form 8918. Federal tax return forms   Material advisors will receive a reportable transaction number for the disclosed reportable transaction. Federal tax return forms They must provide this number to all persons to whom they acted as a material advisor. Federal tax return forms They must provide the number at the time the transaction is entered into. Federal tax return forms If they do not have the number at that time, they must provide it within 60 days from the date the number is mailed to them. Federal tax return forms For information on penalties for failure to disclose and failure to maintain lists, see Internal Revenue Code sections 6707, 6707A, and 6708. Federal tax return forms Requirement to maintain list. Federal tax return forms   Material advisors must maintain a list of persons to whom they provide material aid, assistance, or advice on any reportable transaction. Federal tax return forms The list must be available for inspection by the IRS, and the information required to be included on the list generally must be kept for 7 years. Federal tax return forms See Regulations section 301. Federal tax return forms 6112-1 for more information (including what information is required to be included on the list). Federal tax return forms Confidentiality privilege. Federal tax return forms   The confidentiality privilege between you and a federally authorized tax practitioner does not apply to written communications made after October 21, 2004, regarding the promotion of your direct or indirect participation in any tax shelter. Federal tax return forms Appraisal requirement for donated property. Federal tax return forms   If you claim a deduction of more than $5,000 for an item or group of similar items of donated property, you generally must get a qualified appraisal from a qualified appraiser and complete and attach section B of Form 8283 to your return. Federal tax return forms If you claim a deduction of more than $500,000 for the donated property, you generally must attach the qualified appraisal to your return. Federal tax return forms If you file electronically, see Form 8453, U. Federal tax return forms S. Federal tax return forms Individual Income Tax Transmittal for an IRS e-file Return, and its instructions. Federal tax return forms For more information about appraisals, including exceptions, see Publication 561. Federal tax return forms Passive activity loss and credit limits. Federal tax return forms   The passive activity loss and credit rules limit the amount of losses and credits that can be claimed from passive activities and limit the amount that can offset nonpassive income, such as certain portfolio income from investments. Federal tax return forms For more detailed information about determining and reporting income, losses, and credits from passive activities, see Publication 925. Federal tax return forms Interest on penalties. Federal tax return forms   If you are assessed an accuracy-related or civil fraud penalty (as discussed under Penalties , later), interest will be imposed on the amount of the penalty from the due date of the return (including any extensions) to the date you pay the penalty. Federal tax return forms Accounting method restriction. Federal tax return forms   Tax shelters generally cannot use the cash method of accounting. Federal tax return forms Uniform capitalization rules. Federal tax return forms   The uniform capitalization rules generally apply to producing property or acquiring it for resale. Federal tax return forms Under those rules, the direct cost and part of the indirect cost of the property must be capitalized or included in inventory. Federal tax return forms For more information, see Publication 538. Federal tax return forms Denial of deduction for interest on an underpayment due to a reportable transaction. Federal tax return forms   You cannot deduct any interest you paid or accrued on any part of an underpayment of tax due to an understatement arising from a reportable transaction (discussed later) if the relevant facts affecting the tax treatment of the item are not adequately disclosed. Federal tax return forms This rule applies to reportable transactions entered into in tax years beginning after October 22, 2004. Federal tax return forms Authority for Disallowance of Tax Benefits The IRS has published guidance concluding that the claimed tax benefits of various abusive tax shelters should be disallowed. Federal tax return forms The guidance is the conclusion of the IRS on how the law is applied to a particular set of facts. Federal tax return forms Guidance is published in the Internal Revenue Bulletin for taxpayers' information and also for use by IRS officials. Federal tax return forms So, if your return is examined and an abusive tax shelter is identified and challenged, published guidance dealing with that type of shelter, which disallows certain claimed tax shelter benefits, could serve as the basis for the examining official's challenge of the tax benefits you claimed. Federal tax return forms In such a case, the examiner will not compromise even if you or your representative believes you have authority for the positions taken on your tax return. Federal tax return forms The courts have generally been unsympathetic to taxpayers involved in abusive tax shelter schemes and have ruled in favor of the IRS in the majority of the cases in which these shelters have been challenged. Federal tax return forms Investor Reporting You may be required to file a reportable transaction disclosure statement. Federal tax return forms Reportable Transaction Disclosure Statement Use Form 8886 to disclose information for each reportable transaction (discussed later) in which you participated. Federal tax return forms Generally, you must attach Form 8886 to your return for each tax year in which you participated in the transaction. Federal tax return forms Under certain circumstances, a transaction must be disclosed within 90 days of the transaction being identified as a listed transaction or a transaction of interest (discussed later). Federal tax return forms In addition, for the first year Form 8886 is attached to your return, you must send a copy of the form to: Internal Revenue Service OTSA Mail Stop 4915 1973 North Rulon White Blvd. Federal tax return forms  Ogden, UT 84404 If you file your return electronically, the copy sent to OTSA must show exactly the same information, word for word, provided with the electronically filed return and it must be provided on the official IRS Form 8886 or an exact copy of the form. Federal tax return forms If you use a computer-generated or substitute Form 8886, it must be an exact copy of the official IRS form. Federal tax return forms If you fail to file Form 8886 as required or fail to include any required information on the form, you may have to pay a penalty. Federal tax return forms See Penalty for failure to disclose a reportable transaction , later under Penalties. Federal tax return forms The following discussion briefly describes reportable transactions. Federal tax return forms For more details, see the Instructions for Form 8886. Federal tax return forms Reportable transaction. Federal tax return forms   A reportable transaction is any of the following. Federal tax return forms A listed transaction. Federal tax return forms A confidential transaction. Federal tax return forms A transaction with contractual protection. Federal tax return forms A loss transaction. Federal tax return forms A transaction of interest entered into after November 1, 2006. Federal tax return forms Note. Federal tax return forms Transactions with a brief asset holding period were removed from the definition of reportable transaction for transactions entered into after August 2, 2007. Federal tax return forms Listed transaction. Federal tax return forms   A listed transaction is the same as, or substantially similar to, one of the types of transactions the IRS has determined to be a tax-avoidance transaction. Federal tax return forms These transactions have been identified in notices, regulations, and other published guidance issued by the IRS. Federal tax return forms For a list of existing guidance, see Notice 2009-59 in Internal Revenue Bulletin 2009-31, available at www. Federal tax return forms irs. Federal tax return forms gov/irb/2009-31_IRB/ar07. Federal tax return forms html. Federal tax return forms Confidential transaction. Federal tax return forms   A confidential transaction is offered to you under conditions of confidentiality and for which you have paid an advisor a minimum fee. Federal tax return forms A transaction is offered under conditions of confidentiality if the advisor who is paid the fee places a limit on your disclosure of the tax treatment or tax structure of the transaction and the limit protects the confidentiality of the advisor's tax strategies. Federal tax return forms The transaction is treated as confidential even if the conditions of confidentiality are not legally binding on you. Federal tax return forms Transaction with contractual protection. Federal tax return forms   Generally, a transaction with contractual protection is one in which you or a related party has the right to a full or partial refund of fees if all or part of the intended tax consequences of the transaction are not sustained, or a transaction for which the fees are contingent on your realizing the tax benefits from the transaction. Federal tax return forms For information on exceptions, see Revenue Procedure 2007-20 in Internal Revenue Bulletin 2007-7, available at www. Federal tax return forms irs. Federal tax return forms gov/irb/2007-07_IRB/ar15. Federal tax return forms html. Federal tax return forms Loss transaction. Federal tax return forms   For individuals, a loss transaction is one that results in a deductible loss if the gross amount of the loss is at least $2 million in a single tax year or $4 million in any combination of tax years. Federal tax return forms A loss from a foreign currency transaction under Internal Revenue Code section 988 is a loss transaction if the gross amount of the loss is at least $50,000 in a single tax year, whether or not the loss flows through from an S corporation or partnership. Federal tax return forms   Certain losses (such as losses from casualties, thefts, and condemnations) are excepted from this category and do not have to be reported on Form 8886. Federal tax return forms For information on other exceptions, see Revenue Procedure 2004-66 in Internal Revenue Bulletin 2004-50, as modified and superseded by Revenue Procedure 2013-11, (or future published guidance) available at www. Federal tax return forms irs. Federal tax return forms gov/irb/2004-50_IRB/ar11. Federal tax return forms html. Federal tax return forms Transaction of interest. Federal tax return forms   A transaction of interest is a transaction entered into after November 1, 2006, that is the same as, or substantially similar to, one of the types of transactions that the IRS has identified by notice, regulation, or other form of published guidance as a transaction of interest. Federal tax return forms The IRS has identified the following transactions of interest. Federal tax return forms “Toggling” grantor trusts as described in Notice 2007-73, 2007-36 I. Federal tax return forms R. Federal tax return forms B. Federal tax return forms 545, available at www. Federal tax return forms irs. Federal tax return forms gov/irb/2007-36_IRB/ar20. Federal tax return forms html. Federal tax return forms Certain transactions involving contributions of a successor member interest in a limited liability company as described in Notice 2007-72, 2007-36 I. Federal tax return forms R. Federal tax return forms B. Federal tax return forms 544, available at www. Federal tax return forms irs. Federal tax return forms gov/irb/2007-36_IRB/ar19. Federal tax return forms html. Federal tax return forms Certain transactions involving the sale or other disposition of all interests in a charitable remainder trust and claiming little or no taxable gain as described in Notice 2008-99, 2008-47 I. Federal tax return forms R. Federal tax return forms B. Federal tax return forms 1194, available at www. Federal tax return forms irs. Federal tax return forms gov/irb/2008-47_IRB/ar11. Federal tax return forms html. Federal tax return forms Certain transactions involving a U. Federal tax return forms S. Federal tax return forms taxpayer owning controlled foreign corporations (CFCs) that hold stock of a lower-tier CFC through a domestic partnership to avoid reporting income as described in Notice 2009-7, 2009-3 I. Federal tax return forms R. Federal tax return forms B. Federal tax return forms 312, available at www. Federal tax return forms irs. Federal tax return forms gov/irb/2009-03_IRB/ar10. Federal tax return forms html. Federal tax return forms   For updates to this list, go to www. Federal tax return forms irs. Federal tax return forms gov/Businesses/Corporations/Abusive-Tax-Shelters-and-Transactions. Federal tax return forms Penalties Investing in an abusive tax shelter may lead to substantial expenses. Federal tax return forms First, the promoter generally charges a substantial fee. Federal tax return forms If your return is examined by the IRS and a tax deficiency is determined, you will be faced with payment of more tax, interest on the underpayment, possibly a 20%, 30%, or even 40% accuracy-related penalty, or a 75% civil fraud penalty. Federal tax return forms You may also be subject to the penalty for failure to pay tax. Federal tax return forms These penalties are explained in the following paragraphs. Federal tax return forms Accuracy-related penalties. Federal tax return forms   An accuracy-related penalty of 20% can be imposed for underpayments of tax due to: Negligence or disregard of rules or regulations, Substantial understatement of tax, Substantial valuation misstatement (increased to 40% for gross valuation misstatement), Transaction lacking economic substance (increased to 40% for undisclosed transaction lacking economic substance), or Undisclosed foreign financial asset understatement (40% in all cases). Federal tax return forms Except for a transaction lacking economic substance, this penalty will not be imposed if you can show you had reasonable cause for any understatement of tax and that you acted in good faith. Federal tax return forms Your failure to disclose a reportable transaction is a strong indication that you failed to act in good faith. Federal tax return forms   If you are charged an accuracy-related penalty, interest will be imposed on the amount of the penalty from the due date of the return (including extensions) to the date you pay the penalty. Federal tax return forms   The 20% penalties do not apply to any underpayment attributable to a reportable transaction understatement subject to an accuracy-related penalty (discussed later). Federal tax return forms Negligence or disregard of rules or regulations. Federal tax return forms   The penalty for negligence or disregard of rules or regulations is imposed only on the part of the underpayment due to negligence or disregard of rules or regulations. Federal tax return forms The penalty will not be charged if you can show you had reasonable cause for understating your tax and that you acted in good faith. Federal tax return forms    Negligence includes any failure to make a reasonable attempt to comply with the provisions of the Internal Revenue Code. Federal tax return forms It also includes any failure to keep adequate books and records. Federal tax return forms A return position that has a reasonable basis is not negligence. Federal tax return forms   Disregard includes any careless, reckless, or intentional disregard of rules or regulations. Federal tax return forms   The penalty for disregard of rules and regulations can be avoided if all the following are true. Federal tax return forms You keep adequate books and records. Federal tax return forms You have a reasonable basis for your position on the tax issue. Federal tax return forms You make an adequate disclosure of your position. Federal tax return forms Use Form 8275 to make your disclosure and attach it to your return. Federal tax return forms To disclose a position contrary to a regulation, use Form 8275-R. Federal tax return forms Use Form 8886 to disclose a reportable transaction (discussed earlier). Federal tax return forms Substantial understatement of tax. Federal tax return forms   An understatement is considered to be substantial if it is more than the greater of: 10% of the tax required to be shown on the return, or $5,000. Federal tax return forms An “understatement” is the amount of tax required to be shown on your return for a tax year minus the amount of tax shown on the return, reduced by any rebates. Federal tax return forms The term “rebate” generally means a decrease in the tax shown on your original return as the result of your filing an amended return or claim for refund. Federal tax return forms   For items other than tax shelters, you can file Form 8275 or Form 8275-R to disclose items that could cause a substantial understatement of income tax. Federal tax return forms In that way, you can avoid the substantial understatement penalty if you have a reasonable basis for your position on the tax issue. Federal tax return forms Disclosure of the tax shelter item on a tax return does not reduce the amount of the understatement. Federal tax return forms   Also, the understatement penalty will not be imposed if you can show there was reasonable cause for the underpayment caused by the understatement and that you acted in good faith. Federal tax return forms An important factor in establishing reasonable cause and good faith will be the extent of your effort to determine your proper tax liability under the law. Federal tax return forms Substantial valuation misstatement. Federal tax return forms   In general, you are liable for a 20% penalty for a substantial valuation misstatement if all the following are true. Federal tax return forms The value or adjusted basis of any property claimed on the return is 150% or more of the correct amount. Federal tax return forms You underpaid your tax by more than $5,000 because of the misstatement. Federal tax return forms You cannot establish that you had reasonable cause for the underpayment and that you acted in good faith. Federal tax return forms   You may be assessed a penalty of 40% for a gross valuation misstatement. Federal tax return forms If you misstate the value or the adjusted basis of property by 200% or more of the amount determined to be correct, you will be assessed a penalty of 40%, instead of 20%, of the amount you underpaid because of the gross valuation misstatement. Federal tax return forms The penalty rate is also 40% if the property's correct value or adjusted basis is zero. Federal tax return forms Transaction lacking economic substance. Federal tax return forms   The economic substance doctrine only applies to an individual that entered into a transaction in connection with a trade or business or an activity engaged in for the production of income. Federal tax return forms For transactions entered into after March 30, 2010, a transaction has economic substance for you as an individual taxpayer only if: The transaction changes your economic position in a meaningful way (apart from federal income tax effects), or You have a substantial purpose (apart from federal income tax effects) for entering into the transaction. Federal tax return forms   For purposes of determining whether economic substance exists, a transaction's profit potential will only be taken into account if the present value of the reasonably expected pre-tax profit from the transaction is substantial compared to the present value of the expected net tax benefits that would be allowed if the transaction were respected. Federal tax return forms   If any part of your underpayment is due to any disallowance of claimed tax benefits by reason of a transaction lacking economic substance or failing to meet the requirements of any similar rule of law, that part of your underpayment will be subject to the 20% accuracy-related penalty even if you had a reasonable cause and acted in good faith concerning that part. Federal tax return forms   Additionally, the penalty increases to 40% if you do not adequately disclose on your return or in a statement attached to your return the relevant facts affecting the tax treatment of a transaction that lacks economic substance. Federal tax return forms Relevant facts include any facts affecting the tax treatment of the transaction. Federal tax return forms    Any excessive amount of an erroneous claim for an income tax refund or credit (other than a refund or credit related to the earned income credit) that results from a transaction found to be lacking economic substance will not be treated as having a reasonable basis and could be subject to a 20% penalty. Federal tax return forms Undisclosed foreign financial asset understatement. Federal tax return forms   For tax years beginning after March 18, 2010, you may be liable for a 40% penalty for an understatement of your tax liability due to an undisclosed foreign financial asset. Federal tax return forms An undisclosed foreign financial asset is any asset for which an information return, required to be provided under Internal Revenue Code section 6038, 6038B, 6038D, 6046A, or 6048 for any taxable year, is not provided. Federal tax return forms The penalty applies to any part of an underpayment related to the following undisclosed foreign financial assets. Federal tax return forms Any foreign business you control, reportable on Form 5471, Information Return of U. Federal tax return forms S. Federal tax return forms Persons With Respect To Certain Foreign Corporations, or Form 8865, Return of U. Federal tax return forms S. Federal tax return forms Persons With Respect to Certain Foreign Partnerships. Federal tax return forms Certain transfers of property to a foreign corporation or partnership, reportable on Form 926, Return by a U. Federal tax return forms S. Federal tax return forms Transferor of Property to a Foreign Corporation, or certain distributions to a foreign person, reportable on Form 8865. Federal tax return forms Your ownership interest in certain foreign financial assets, temporarily reportable on Form 8275 or 8275-R. Federal tax return forms    Instead of, or in addition to, Form 8275 or 8275-R, you may have to file Form 8938, Statement of Specified Foreign Financial Assets, with your tax return. Federal tax return forms See the Instructions for Form 8938 for details. Federal tax return forms    Your acquisition, disposition, or substantial change in ownership interest in a foreign partnership, reportable on Form 8865. Federal tax return forms Creation or transfer of money or property to certain foreign trusts, reportable on Form 3520, Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts. Federal tax return forms Penalty for incorrect appraisals. Federal tax return forms   The person who prepares an appraisal of the value of property may have to pay a penalty if: He or she knows, or reasonably should have known, that the appraisal would be used in connection with a return or claim for refund; and The claimed value of the property on a return or claim for refund based on that appraisal results in a substantial valuation misstatement or a gross valuation misstatement as discussed earlier. Federal tax return forms For details on the penalty amount and exceptions, see Publication 561. Federal tax return forms Penalty for failure to disclose a reportable transaction. Federal tax return forms   If you fail to include any required information regarding a reportable transaction (discussed earlier) on a return or statement, you may have to pay a penalty of 75% of the decrease in tax shown on your return as a result of such transaction (or that would have resulted if the transaction were respected for federal tax purposes). Federal tax return forms For an individual, the minimum penalty is $5,000 and the maximum is $10,000 (or $100,000 for a listed transaction). Federal tax return forms This penalty is in addition to any other penalty that may be imposed. Federal tax return forms   The IRS may rescind or abate the penalty for failing to disclose a reportable transaction under certain limited circumstances but cannot rescind the penalty for failing to disclose a listed transaction. Federal tax return forms For information on rescission, see Revenue Procedure 2007-21 in Internal Revenue Bulletin 2007-9 available at www. Federal tax return forms irs. Federal tax return forms gov/irb/2007-09_IRB/ar12. Federal tax return forms html. Federal tax return forms Accuracy-related penalty for a reportable transaction understatement. Federal tax return forms   If you have a reportable transaction understatement, you may have to pay a penalty equal to 20% of the amount of that understatement. Federal tax return forms This applies to any item due to a listed transaction or other reportable transaction with a significant purpose of avoiding or evading federal income tax. Federal tax return forms The penalty is 30% rather than 20% for the part of any reportable transaction understatement if the transaction was not properly disclosed. Federal tax return forms You may not have to pay the 20% penalty if you meet the strengthened reasonable cause and good faith exception. Federal tax return forms The reasonable cause and good faith exception does not apply to any part of a reportable transaction understatement attributable to one or more transactions that lack economic substance. Federal tax return forms   This penalty does not apply to the part of an understatement on which the fraud penalty, gross valuation misstatement penalty, or penalty for nondisclosure of noneconomic substance transactions is imposed. Federal tax return forms Civil fraud penalty. Federal tax return forms   If any underpayment of tax on your return is due to fraud, a penalty of 75% of the underpayment will be added to your tax. Federal tax return forms Joint return. Federal tax return forms   The fraud penalty on a joint return applies to a spouse only if some part of the underpayment is due to the fraud of that spouse. Federal tax return forms Failure to pay tax. Federal tax return forms   If a deficiency is assessed and is not paid within 10 days of the demand for payment, an investor can be penalized with up to a 25% addition to tax if the failure to pay continues. Federal tax return forms Whether To Invest In light of the adverse tax consequences and the substantial amount of penalties and interest that will result if the claimed tax benefits are disallowed, you should consider tax shelter investments carefully and seek competent legal and financial advice. Federal tax return forms Prev  Up  Next   Home   More Online Publications
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Page Last Reviewed or Updated: 05-Feb-2014

The Federal Tax Return Forms

Federal tax return forms 10. Federal tax return forms   Business Bad Debts Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Definition of Business Bad DebtAccrual method. Federal tax return forms Cash method. Federal tax return forms Debt acquired from a decedent. Federal tax return forms Liquidation. Federal tax return forms Types of Business Bad Debts When a Debt Becomes Worthless How To Claim a Business Bad DebtSpecific Charge-Off Method Nonaccrual-Experience Method Recovery of a Bad DebtNet operating loss (NOL) carryover. Federal tax return forms Introduction You have a bad debt if you cannot collect money owed to you. Federal tax return forms A bad debt is either a business bad debt or a nonbusiness bad debt. Federal tax return forms This chapter discusses only business bad debts. Federal tax return forms Generally, a business bad debt is one that comes from operating your trade or business. Federal tax return forms You can deduct business bad debts on Schedule C (Form 1040) or your applicable business income tax return. Federal tax return forms All other bad debts are nonbusiness bad debts and are deductible only as short-term capital losses. Federal tax return forms For more information on nonbusiness bad debts, see Publication 550. Federal tax return forms Topics - This chapter discusses: Definition of business bad debt When a debt becomes worthless How to claim a business bad debt Recovery of a bad debt Useful Items - You may want to see: Publication 525 Taxable and Nontaxable Income 536 Net Operating Losses (NOLs) for Individuals, Estates, and Trusts 544 Sales and Other Dispositions of Assets 550 Investment Income and Expenses 556 Examination of Returns, Appeal Rights, and Claims for Refund Form (and Instructions) Schedule C (Form 1040) Profit or Loss From Business 1040X Amended U. Federal tax return forms S. Federal tax return forms Individual Income Tax Return 1045 Application for Tentative Refund 1139 Corporation Application for Tentative Refund 3115 Application for Change in Accounting Method See chapter 12 for information about getting publications and forms. Federal tax return forms Definition of Business Bad Debt A business bad debt is a loss from the worthlessness of a debt that was either: Created or acquired in your trade or business, or Closely related to your trade or business when it became partly or totally worthless. Federal tax return forms A debt is closely related to your trade or business if your primary motive for incurring the debt is business related. Federal tax return forms Bad debts of a corporation (other than an S corporation) are always business bad debts. Federal tax return forms Credit sales. Federal tax return forms   Business bad debts are mainly the result of credit sales to customers. Federal tax return forms Goods that have been sold, but not yet paid for, and services that have been performed, but not yet paid for, are recorded in your books as either accounts receivable or notes receivable. Federal tax return forms After a reasonable period of time, if you have tried to collect the amount due, but are unable to do so, the uncollectible part becomes a business bad debt. Federal tax return forms   Accounts or notes receivable valued at fair market value (FMV) when received are deductible only at that value, even though the FMV may be less than the face value. Federal tax return forms If you purchased an account receivable for less than its face value, and the receivable subsequently becomes worthless, the most you are allowed to deduct is the amount you paid to acquire it. Federal tax return forms    You can claim a business bad debt deduction only if the amount owed to you was previously included in gross income. Federal tax return forms This applies to amounts owed to you from all sources of taxable income, including sales, services, rents, and interest. Federal tax return forms Accrual method. Federal tax return forms   If you use the accrual method of accounting, you generally report income as you earn it. Federal tax return forms You can only claim a bad debt deduction for an uncollectible receivable if you have previously included the uncollectible amount in income. Federal tax return forms   If you qualify, you can use the nonaccrual-experience method of accounting discussed later. Federal tax return forms Under this method, you do not have to accrue income that, based on your experience, you do not expect to collect. Federal tax return forms Cash method. Federal tax return forms   If you use the cash method of accounting, you generally report income when you receive payment. Federal tax return forms You cannot claim a bad debt deduction for amounts owed to you because you never included those amounts in income. Federal tax return forms For example, a cash basis architect cannot claim a bad debt deduction if a client fails to pay the bill because the architect's fee was never included in income. Federal tax return forms Debts from a former business. Federal tax return forms   If you sell your business but retain its receivables, these debts are business debts because they arose out of your trade or business. Federal tax return forms If any of these receivables subsequently become worthless, the loss is still a business bad debt. Federal tax return forms Debt acquired from a decedent. Federal tax return forms   The character of a loss from debts of a business acquired from a decedent is determined in the same way as debts acquired on the purchase of a business. Federal tax return forms The executor of the decedent's estate treats any loss from the debts as a business bad debt if the debts were closely related to the decedent's trade or business when they became worthless. Federal tax return forms Otherwise, a loss from these debts becomes a nonbusiness bad debt for the decedent's estate. Federal tax return forms Liquidation. Federal tax return forms   If you liquidate your business and some of the accounts receivable that you retain become worthless, they become business bad debts. Federal tax return forms Types of Business Bad Debts Business bad debts may result from the following. Federal tax return forms Loans to clients and suppliers. Federal tax return forms   If you loan money to a client, supplier, employee, or distributor for a business reason and you are unable to collect the loan after attempting to do so, you have a business bad debt. Federal tax return forms Debts owed by political parties. Federal tax return forms   If a political party (or other organization that accepts contributions or spends money to influence elections) owes you money and the debt becomes worthless, you can claim a bad debt deduction only if all of the following requirements are met. Federal tax return forms You use the accrual method of accounting. Federal tax return forms The debt arose from the sale of goods or services in the ordinary course of your trade or business. Federal tax return forms More than 30% of your receivables accrued in the year of the sale were from sales to political parties. Federal tax return forms You made substantial and continuing efforts to collect on the debt. Federal tax return forms Loan or capital contribution. Federal tax return forms   You cannot claim a bad debt deduction for a loan you made to a corporation if, based on the facts and circumstances, the loan is actually a contribution to capital. Federal tax return forms Debts of an insolvent partner. Federal tax return forms   If your business partnership breaks up and one of your former partners becomes insolvent, you may have to pay more than your pro rata share of the partnership's debts. Federal tax return forms If you pay any part of the insolvent partner's share of the debts, you can claim a bad debt deduction for the amount you paid that is attributable to the insolvent partner's share. Federal tax return forms Business loan guarantee. Federal tax return forms   If you guarantee a debt that subsequently becomes worthless, the debt can qualify as a business bad debt if all the following requirements are met. Federal tax return forms You made the guarantee in the course of your trade or business. Federal tax return forms You have a legal duty to pay the debt. Federal tax return forms You made the guarantee before the debt became worthless. Federal tax return forms You meet this requirement if you reasonably expected you would not have to pay the debt without full reimbursement from the borrower. Federal tax return forms You received reasonable consideration for making the guarantee. Federal tax return forms You meet this requirement if you made the guarantee in accord with normal business practice or for a good faith business purpose. Federal tax return forms Example. Federal tax return forms Jane Zayne owns the Zayne Dress Company. Federal tax return forms She guaranteed payment of a $20,000 note for Elegant Fashions, a dress outlet. Federal tax return forms Elegant Fashions is one of Zayne's largest clients. Federal tax return forms Elegant Fashions later defaulted on the loan. Federal tax return forms As a result, Ms. Federal tax return forms Zayne paid the remaining balance of the loan in full to the bank. Federal tax return forms She can claim a business bad debt deduction only for the amount she paid, since her guarantee was made in the course of her trade or business for a good faith business purpose. Federal tax return forms She was motivated by the desire to retain one of her better clients and keep a sales outlet. Federal tax return forms Deductible in the year paid. Federal tax return forms   If you make a payment on a loan you guaranteed, you can deduct it in the year paid, unless you have rights against the borrower. Federal tax return forms Rights against a borrower. Federal tax return forms   When you make payment on a loan you guaranteed, you may have the right to take the place of the lender. Federal tax return forms The debt is then owed to you. Federal tax return forms If you have this right, or some other right to demand payment from the borrower, you cannot claim a bad debt deduction until these rights become partly or totally worthless. Federal tax return forms Joint debtor. Federal tax return forms   If two or more debtors jointly owe you money, your inability to collect from one does not enable you to deduct a proportionate amount as a bad debt. Federal tax return forms Sale of mortgaged property. Federal tax return forms   If mortgaged or pledged property is sold for less than the debt, the unpaid, uncollectible balance of the debt is a bad debt. Federal tax return forms When a Debt Becomes Worthless A debt becomes worthless when there is no longer any chance the amount owed will be paid. Federal tax return forms This may occur when the debt is due or prior to that date. Federal tax return forms To demonstrate worthlessness, you must only show that you have taken reasonable steps to collect the debt but were unable to do so. Federal tax return forms It is not necessary to go to court if you can show that a judgment from the court would be uncollectible. Federal tax return forms Bankruptcy of your debtor is generally good evidence of the worthlessness of at least a part of an unsecured and unpreferred debt. Federal tax return forms Property received for debt. Federal tax return forms   If you receive property in partial settlement of a debt, reduce the debt by the property's FMV, which becomes the property's basis. Federal tax return forms You can deduct the remaining debt as a bad debt if and when it becomes worthless. Federal tax return forms   If you later sell the property for more than its basis, any gain on the sale is due to the appreciation of the property. Federal tax return forms It is not a recovery of a bad debt. Federal tax return forms For information on the sale of an asset, see Publication 544. Federal tax return forms How To Claim a Business Bad Debt There are two methods to claim a business bad debt. Federal tax return forms The specific charge-off method. Federal tax return forms The nonaccrual-experience method. Federal tax return forms Generally, you must use the specific charge-off method. Federal tax return forms However, you may use the nonaccrual-experience method if you meet the requirements discussed later under Nonaccrual-Experience Method . Federal tax return forms Specific Charge-Off Method If you use the specific charge-off method, you can deduct specific business bad debts that become either partly or totally worthless during the tax year. Federal tax return forms However, with respect to partly worthless bad debts, your deduction is limited to the amount you charged off on your books during the year. Federal tax return forms Partly worthless debts. Federal tax return forms   You can deduct specific bad debts that become partly uncollectible during the tax year. Federal tax return forms Your tax deduction is limited to the amount you charge off on your books during the year. Federal tax return forms You do not have to charge off and deduct your partly worthless debts annually. Federal tax return forms You can delay the charge off until a later year. Federal tax return forms However, you cannot deduct any part of a debt after the year it becomes totally worthless. Federal tax return forms Significantly modified debt. Federal tax return forms   An exception to the charge-off rule exists for debt which has been significantly modified and on which the holder recognized gain. Federal tax return forms For more information, see Regulations section 1. Federal tax return forms 166-3(a)(3). Federal tax return forms Deduction disallowed. Federal tax return forms   Generally, you can claim a partial bad debt deduction only in the year you make the charge-off on your books. Federal tax return forms If, under audit, the IRS does not allow your deduction and the debt becomes partly worthless in a later tax year, you can deduct the amount you charged off in that year plus the disallowed amount charged off in the earlier year. Federal tax return forms The charge-off in the earlier year, unless reversed on your books, fulfills the charge-off requirement for the later year. Federal tax return forms Totally worthless debts. Federal tax return forms   If a debt becomes totally worthless in the current tax year, you can deduct the entire amount, less any amount deducted in an earlier tax year when the debt was only partly worthless. Federal tax return forms   You do not have to make an actual charge-off on your books to claim a bad debt deduction for a totally worthless debt. Federal tax return forms However, you may want to do so. Federal tax return forms If you do not and the IRS later rules the debt is only partly worthless, you will not be allowed a deduction for the debt in that tax year because a deduction of a partly worthless bad debt is limited to the amount actually charged off. Federal tax return forms See Partly worthless debts, earlier. Federal tax return forms Filing a claim for refund. Federal tax return forms   If you did not deduct a bad debt on your original return for the year it became worthless, you can file a claim for a credit or refund. Federal tax return forms If the bad debt was totally worthless, you must file the claim by the later of the following dates. Federal tax return forms 7 years from the date your original return was due (not including extensions). Federal tax return forms 2 years from the date you paid the tax. Federal tax return forms   If the claim is for a partly worthless bad debt, you must file the claim by the later of the following dates. Federal tax return forms 3 years from the date you filed your original return. Federal tax return forms 2 years from the date you paid the tax. Federal tax return forms You may have longer to file the claim if you were unable to manage your financial affairs due to a physical or mental impairment. Federal tax return forms Such an impairment requires proof of existence. Federal tax return forms   For details and more information about filing a claim, see Publication 556. Federal tax return forms Use one of the following forms to file a claim. Federal tax return forms For more information, see the instructions for the applicable form. Federal tax return forms Table 10-1. Federal tax return forms Forms Used To File a Claim IF you filed as a. Federal tax return forms . Federal tax return forms . Federal tax return forms THEN file. Federal tax return forms . Federal tax return forms . Federal tax return forms Sole proprietor or farmer Form 1040X Corporation Form 1120X S corporation Form 1120S and check box H(4) Partnership Form 1065X if filing on paper or  Form 1065 and check box G(5) if filing electronically Nonaccrual-Experience Method If you use an accrual method of accounting and qualify under the rules explained in this section, you can use the nonaccrual-experience method for bad debts. Federal tax return forms Under this method, you do not accrue service related income you expect to be uncollectible. Federal tax return forms Because the expected uncollectible amounts are not included in income, these amounts are not later deducted from income. Federal tax return forms Generally, you can use the nonaccrual-experience method for accounts receivable for services you performed only if: The services are provided in the fields of accounting, actuarial science, architecture, consulting, engineering, health, law, or the performing arts, or You meet the $5 million gross receipts test for all prior years. Federal tax return forms Service related income. Federal tax return forms   You can use the nonaccrual-experience method only for amounts earned by performing services. Federal tax return forms You cannot use this method for amounts owed to you from activities such as lending money, selling goods, or acquiring receivables or other rights to receive payment. Federal tax return forms Gross receipts test. Federal tax return forms   To find out if you meet the $5 million gross receipts test for all prior years, you must figure the average annual gross receipts for each prior year. Federal tax return forms If your average annual gross receipts for any year exceeds $5 million, you cannot use the non-accural experience method. Federal tax return forms   The average annual gross receipts for any year is the average of gross receipts from the year in question and the 2 previous years. Federal tax return forms For example, if you were figuring the average annual gross receipts for 2013, you would average your gross receipts for 2011, 2012, and 2013. Federal tax return forms Interest or penalty charged. Federal tax return forms   Generally, you cannot use the nonaccrual-experience method for amounts due on which you charge interest or a late payment penalty. Federal tax return forms However, do not treat a discount offered for early payment as the charging of interest or a penalty if both the following apply. Federal tax return forms You otherwise accrue the full amount due as gross income at the time you provide the services. Federal tax return forms You treat the discount allowed for early payment as an adjustment to gross income in the year of payment. Federal tax return forms Change in accounting method. Federal tax return forms   Generally, you must obtain consent to change to a nonaccrual-experience method (other than one of the safe harbor methods) or to change from one method to another. Federal tax return forms See Form 3115 and the Instructions for Form 3115 for more information. Federal tax return forms Recovery of a Bad Debt If you claim a deduction for a bad debt on your income tax return and later recover (collect) all or part of it, you may have to include all or part of the recovery in gross income. Federal tax return forms The amount you include is limited to the amount you actually deducted. Federal tax return forms However, you can exclude the amount deducted that did not reduce your tax. Federal tax return forms Report the recovery as “Other income” on the appropriate business form or schedule. Federal tax return forms See Recoveries in Publication 525 for more information. Federal tax return forms Net operating loss (NOL) carryover. Federal tax return forms   If a bad debt deduction increases an NOL carryover that has not expired before the beginning of the tax year in which the recovery takes place, you treat the deduction as having reduced your tax. Federal tax return forms A bad debt deduction that contributes to a NOL helps lower taxes in the year to which you carry the NOL. Federal tax return forms For more information about NOLs, see Publication 536. Federal tax return forms Also, see the Instructions for Form 1045, and the Instructions for Form 1139. 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