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Free income tax help Publication 575 - Main Content Table of Contents General InformationPension. Free income tax help Annuity. Free income tax help Qualified employee plan. Free income tax help Qualified employee annuity. Free income tax help Designated Roth account. Free income tax help Tax-sheltered annuity plan. Free income tax help Fixed-period annuities. Free income tax help Annuities for a single life. Free income tax help Joint and survivor annuities. Free income tax help Variable annuities. Free income tax help Disability pensions. Free income tax help Variable Annuities Section 457 Deferred Compensation Plans Disability Pensions Insurance Premiums for Retired Public Safety Officers Railroad Retirement Benefits Withholding Tax and Estimated Tax Cost (Investment in the Contract)Foreign employment contributions while a nonresident alien. Free income tax help Taxation of Periodic PaymentsPeriod of participation. Free income tax help Fully Taxable Payments Partly Taxable Payments Taxation of Nonperiodic PaymentsFiguring the Taxable Amount Loans Treated as Distributions Transfers of Annuity Contracts Lump-Sum Distributions RolloversExceptions. Free income tax help No tax withheld. Free income tax help Partial rollovers. Free income tax help Frozen deposits. Free income tax help Reasonable period of time. Free income tax help 20% Mandatory withholding. Free income tax help How to report. Free income tax help How to report. Free income tax help Special rule for Roth IRAs and designated Roth accounts. Free income tax help Special Additional TaxesTax on Early Distributions Tax on Excess Accumulation Survivors and BeneficiariesGuaranteed payments. Free income tax help How To Get Tax HelpLow Income Taxpayer Clinics General Information Definitions. Free income tax help   Some of the terms used in this publication are defined in the following paragraphs. Free income tax help Pension. Free income tax help   A pension is generally a series of definitely determinable payments made to you after you retire from work. Free income tax help Pension payments are made regularly and are based on such factors as years of service and prior compensation. Free income tax help Annuity. Free income tax help   An annuity is a series of payments under a contract made at regular intervals over a period of more than one full year. Free income tax help They can be either fixed (under which you receive a definite amount) or variable (not fixed). Free income tax help You can buy the contract alone or with the help of your employer. Free income tax help Qualified employee plan. Free income tax help   A qualified employee plan is an employer's stock bonus, pension, or profit-sharing plan that is for the exclusive benefit of employees or their beneficiaries and that meets Internal Revenue Code requirements. Free income tax help It qualifies for special tax benefits, such as tax deferral for employer contributions and capital gain treatment or the 10-year tax option for lump-sum distributions (if participants qualify). Free income tax help To determine whether your plan is a qualified plan, check with your employer or the plan administrator. Free income tax help Qualified employee annuity. Free income tax help   A qualified employee annuity is a retirement annuity purchased by an employer for an employee under a plan that meets Internal Revenue Code requirements. Free income tax help Designated Roth account. Free income tax help   A designated Roth account is a separate account created under a qualified Roth contribution program to which participants may elect to have part or all of their elective deferrals to a 401(k), 403(b), or 457(b) plan designated as Roth contributions. Free income tax help Elective deferrals that are designated as Roth contributions are included in your income. Free income tax help However, qualified distributions (explained later) are not included in your income. Free income tax help You should check with your plan administrator to determine if your plan will accept designated Roth contributions. Free income tax help Tax-sheltered annuity plan. Free income tax help   A tax-sheltered annuity plan (often referred to as a 403(b) plan or a tax-deferred annuity plan) is a retirement plan for employees of public schools and certain tax-exempt organizations. Free income tax help Generally, a tax-sheltered annuity plan provides retirement benefits by purchasing annuity contracts for its participants. Free income tax help Types of pensions and annuities. Free income tax help   Pensions and annuities include the following types. Free income tax help Fixed-period annuities. Free income tax help   You receive definite amounts at regular intervals for a specified length of time. Free income tax help Annuities for a single life. Free income tax help   You receive definite amounts at regular intervals for life. Free income tax help The payments end at death. Free income tax help Joint and survivor annuities. Free income tax help   The first annuitant receives a definite amount at regular intervals for life. Free income tax help After he or she dies, a second annuitant receives a definite amount at regular intervals for life. Free income tax help The amount paid to the second annuitant may or may not differ from the amount paid to the first annuitant. Free income tax help Variable annuities. Free income tax help   You receive payments that may vary in amount for a specified length of time or for life. Free income tax help The amounts you receive may depend upon such variables as profits earned by the pension or annuity funds, cost-of-living indexes, or earnings from a mutual fund. Free income tax help Disability pensions. Free income tax help   You receive disability payments because you retired on disability and have not reached minimum retirement age. Free income tax help More than one program. Free income tax help   You may receive employee plan benefits from more than one program under a single trust or plan of your employer. Free income tax help If you participate in more than one program, you may have to treat each as a separate pension or annuity contract, depending upon the facts in each case. Free income tax help Also, you may be considered to have received more than one pension or annuity. Free income tax help Your former employer or the plan administrator should be able to tell you if you have more than one contract. Free income tax help Example. Free income tax help Your employer set up a noncontributory profit-sharing plan for its employees. Free income tax help The plan provides that the amount held in the account of each participant will be paid when that participant retires. Free income tax help Your employer also set up a contributory defined benefit pension plan for its employees providing for the payment of a lifetime pension to each participant after retirement. Free income tax help The amount of any distribution from the profit-sharing plan depends on the contributions (including allocated forfeitures) made for the participant and the earnings from those contributions. Free income tax help Under the pension plan, however, a formula determines the amount of the pension benefits. Free income tax help The amount of contributions is the amount necessary to provide that pension. Free income tax help Each plan is a separate program and a separate contract. Free income tax help If you get benefits from these plans, you must account for each separately, even though the benefits from both may be included in the same check. Free income tax help Distributions from a designated Roth account are treated separately from other distributions from the plan. Free income tax help Qualified domestic relations order (QDRO). Free income tax help   A QDRO is a judgment, decree, or order relating to payment of child support, alimony, or marital property rights to a spouse, former spouse, child, or other dependent of a participant in a retirement plan. Free income tax help The QDRO must contain certain specific information, such as the name and last known mailing address of the participant and each alternate payee, and the amount or percentage of the participant's benefits to be paid to each alternate payee. Free income tax help A QDRO may not award an amount or form of benefit that is not available under the plan. Free income tax help   A spouse or former spouse who receives part of the benefits from a retirement plan under a QDRO reports the payments received as if he or she were a plan participant. Free income tax help The spouse or former spouse is allocated a share of the participant's cost (investment in the contract) equal to the cost times a fraction. Free income tax help The numerator of the fraction is the present value of the benefits payable to the spouse or former spouse. Free income tax help The denominator is the present value of all benefits payable to the participant. Free income tax help   A distribution that is paid to a child or other dependent under a QDRO is taxed to the plan participant. Free income tax help Variable Annuities The tax rules in this publication apply both to annuities that provide fixed payments and to annuities that provide payments that vary in amount based on investment results or other factors. Free income tax help For example, they apply to commercial variable annuity contracts, whether bought by an employee retirement plan for its participants or bought directly from the issuer by an individual investor. Free income tax help Under these contracts, the owner can generally allocate the purchase payments among several types of investment portfolios or mutual funds and the contract value is determined by the performance of those investments. Free income tax help The earnings are not taxed until distributed either in a withdrawal or in annuity payments. Free income tax help The taxable part of a distribution is treated as ordinary income. Free income tax help Net investment income tax. Free income tax help   Beginning in 2013, annuities under a nonqualified plan are included in calculating your net investment income for the net investment income tax (NIIT). Free income tax help For information see the Instructions for Form 8960, Net Investment Income Tax — Individuals, Estates and Trusts. Free income tax help For information on the tax treatment of a transfer or exchange of a variable annuity contract, see Transfers of Annuity Contracts under Taxation of Nonperiodic Payments, later. Free income tax help Withdrawals. Free income tax help   If you withdraw funds before your annuity starting date and your annuity is under a qualified retirement plan, a ratable part of the amount withdrawn is tax free. Free income tax help The tax-free part is based on the ratio of your cost (investment in the contract) to your account balance under the plan. Free income tax help   If your annuity is under a nonqualified plan (including a contract you bought directly from the issuer), the amount withdrawn is allocated first to earnings (the taxable part) and then to your cost (the tax-free part). Free income tax help However, if you bought your annuity contract before August 14, 1982, a different allocation applies to the investment before that date and the earnings on that investment. Free income tax help To the extent the amount withdrawn does not exceed that investment and earnings, it is allocated first to your cost (the tax-free part) and then to earnings (the taxable part). Free income tax help   If you withdraw funds (other than as an annuity) on or after your annuity starting date, the entire amount withdrawn is generally taxable. Free income tax help   The amount you receive in a full surrender of your annuity contract at any time is tax free to the extent of any cost that you have not previously recovered tax free. Free income tax help The rest is taxable. Free income tax help   For more information on the tax treatment of withdrawals, see Taxation of Nonperiodic Payments , later. Free income tax help If you withdraw funds from your annuity before you reach age 59½, also see Tax on Early Distributions under Special Additional Taxes, later. Free income tax help Annuity payments. Free income tax help   If you receive annuity payments under a variable annuity plan or contract, you recover your cost tax free under either the Simplified Method or the General Rule, as explained under Taxation of Periodic Payments , later. Free income tax help For a variable annuity paid under a qualified plan, you generally must use the Simplified Method. Free income tax help For a variable annuity paid under a nonqualified plan (including a contract you bought directly from the issuer), you must use a special computation under the General Rule. Free income tax help For more information, see Variable annuities in Publication 939 under Computation Under the General Rule. Free income tax help Death benefits. Free income tax help    If you receive a single-sum distribution from a variable annuity contract because of the death of the owner or annuitant, the distribution is generally taxable only to the extent it is more than the unrecovered cost of the contract. Free income tax help If you choose to receive an annuity, the payments are subject to tax as described above. Free income tax help If the contract provides a joint and survivor annuity and the primary annuitant had received annuity payments before death, you figure the tax-free part of annuity payments you receive as the survivor in the same way the primary annuitant did. Free income tax help See Survivors and Beneficiaries , later. Free income tax help Section 457 Deferred Compensation Plans If you work for a state or local government or for a tax-exempt organization, you may be able to participate in a section 457 deferred compensation plan. Free income tax help If your plan is an eligible plan, you are not taxed currently on pay that is deferred under the plan or on any earnings from the plan's investment of the deferred pay. Free income tax help You are generally taxed on amounts deferred in an eligible state or local government plan only when they are distributed from the plan. Free income tax help You are taxed on amounts deferred in an eligible tax-exempt organization plan when they are distributed or otherwise made available to you. Free income tax help Your 457(b) plan may have a designated Roth account option. Free income tax help If so, you may be able to roll over amounts to the designated Roth account or make contributions. Free income tax help Elective deferrals to a designated Roth account are included in your income. Free income tax help Qualified distributions (explained later) are not included in your income. Free income tax help See the Designated Roth accounts discussion under Taxation of Periodic Payments, later. Free income tax help This publication covers the tax treatment of benefits under eligible section 457 plans, but it does not cover the treatment of deferrals. Free income tax help For information on deferrals under section 457 plans, see Retirement Plan Contributions under Employee Compensation in Publication 525. Free income tax help Is your plan eligible?   To find out if your plan is an eligible plan, check with your employer. Free income tax help Plans that are not eligible section 457 plans include the following: Bona fide vacation leave, sick leave, compensatory time, severance pay, disability pay, or death benefit plans. Free income tax help Nonelective deferred compensation plans for nonemployees (independent contractors). Free income tax help Deferred compensation plans maintained by churches. Free income tax help Length of service award plans for bona fide volunteer firefighters and emergency medical personnel. Free income tax help An exception applies if the total amount paid to a volunteer exceeds $3,000 for any year of service. Free income tax help Disability Pensions If you retired on disability, you generally must include in income any disability pension you receive under a plan that is paid for by your employer. Free income tax help You must report your taxable disability payments as wages on line 7 of Form 1040 or Form 1040A or on line 8 of Form 1040NR until you reach minimum retirement age. Free income tax help Minimum retirement age generally is the age at which you can first receive a pension or annuity if you are not disabled. Free income tax help You may be entitled to a tax credit if you were permanently and totally disabled when you retired. Free income tax help For information on this credit, see Publication 524. Free income tax help Beginning on the day after you reach minimum retirement age, payments you receive are taxable as a pension or annuity. Free income tax help Report the payments on Form 1040, lines 16a and 16b; Form 1040A, lines 12a and 12b; or on Form 1040NR, lines 17a and 17b. Free income tax help Disability payments for injuries incurred as a direct result of a terrorist attack directed against the United States (or its allies) are not included in income. Free income tax help For more information about payments to survivors of terrorist attacks, see Publication 3920, Tax Relief for Victims of Terrorist Attacks. Free income tax help Insurance Premiums for Retired Public Safety Officers If you are an eligible retired public safety officer (law enforcement officer, firefighter, chaplain, or member of a rescue squad or ambulance crew), you can elect to exclude from income distributions made from your eligible retirement plan that are used to pay the premiums for accident or health insurance or long-term care insurance. Free income tax help The premiums can be for coverage for you, your spouse, or dependents. Free income tax help The distribution must be made directly from the plan to the insurance provider. Free income tax help You can exclude from income the smaller of the amount of the insurance premiums or $3,000. Free income tax help You can only make this election for amounts that would otherwise be included in your income. Free income tax help The amount excluded from your income cannot be used to claim a medical expense deduction. Free income tax help An eligible retirement plan is a governmental plan that is: a qualified trust, a section 403(a) plan, a section 403(b) annuity, or a section 457(b) plan. Free income tax help If you make this election, reduce the otherwise taxable amount of your pension or annuity by the amount excluded. Free income tax help The amount shown in box 2a of Form 1099-R does not reflect this exclusion. Free income tax help Report your total distributions on Form 1040, line 16a; Form 1040A, line 12a; or Form 1040NR, line 17a. Free income tax help Report the taxable amount on Form 1040, line 16b; Form 1040A, line 12b; or Form 1040NR, line 17b. Free income tax help Enter “PSO” next to the appropriate line on which you report the taxable amount. Free income tax help If you are retired on disability and reporting your disability pension on line 7 of Form 1040 or Form 1040A, or line 8 of Form 1040NR, include only the taxable amount on that line and enter “PSO” and the amount excluded on the dotted line next to the applicable line. Free income tax help Railroad Retirement Benefits Benefits paid under the Railroad Retirement Act fall into two categories. Free income tax help These categories are treated differently for income tax purposes. Free income tax help The first category is the amount of tier 1 railroad retirement benefits that equals the social security benefit that a railroad employee or beneficiary would have been entitled to receive under the social security system. Free income tax help This part of the tier 1 benefit is the social security equivalent benefit (SSEB) and you treat it for tax purposes like social security benefits. Free income tax help If you received, repaid, or had tax withheld from the SSEB portion of tier 1 benefits during 2013, you will receive Form RRB-1099, Payments by the Railroad Retirement Board (or Form RRB-1042S, Statement for Nonresident Alien Recipients of Payments by the Railroad Retirement Board, if you are a nonresident alien) from the U. Free income tax help S. Free income tax help Railroad Retirement Board (RRB). Free income tax help For more information about the tax treatment of the SSEB portion of tier 1 benefits and Forms RRB-1099 and RRB-1042S, see Publication 915. Free income tax help The second category contains the rest of the tier 1 railroad retirement benefits, called the non-social security equivalent benefit (NSSEB). Free income tax help It also contains any tier 2 benefit, vested dual benefit (VDB), and supplemental annuity benefit. Free income tax help Treat this category of benefits, shown on Form RRB-1099-R, as an amount received from a qualified employee plan. Free income tax help This allows for the tax-free (nontaxable) recovery of employee contributions from the tier 2 benefits and the NSSEB part of the tier 1 benefits. Free income tax help (The NSSEB and tier 2 benefits, less certain repayments, are combined into one amount called the Contributory Amount Paid on Form RRB-1099-R. Free income tax help ) Vested dual benefits and supplemental annuity benefits are non-contributory pensions and are fully taxable. Free income tax help See Taxation of Periodic Payments , later, for information on how to report your benefits and how to recover the employee contributions tax free. Free income tax help Form RRB-1099-R is used for U. Free income tax help S. Free income tax help citizens, resident aliens, and nonresident aliens. Free income tax help Nonresident aliens. Free income tax help   A nonresident alien is an individual who is not a citizen or a resident alien of the United States. Free income tax help Nonresident aliens are subject to mandatory U. Free income tax help S. Free income tax help tax withholding unless exempt under a tax treaty between the United States and their country of legal residency. Free income tax help A tax treaty exemption may reduce or eliminate tax withholding from railroad retirement benefits. Free income tax help See Tax withholding next for more information. Free income tax help   If you are a nonresident alien and your tax withholding rate changed or your country of legal residence changed during the year, you may receive more than one Form RRB-1042S or Form RRB-1099-R. Free income tax help To determine your total benefits paid or repaid and total tax withheld for the year, you should add the amounts shown on all forms you received for that year. Free income tax help For information on filing requirements for aliens, see Publication 519, U. Free income tax help S. Free income tax help Tax Guide for Aliens. Free income tax help For information on tax treaties between the United States and other countries that may reduce or eliminate U. Free income tax help S. Free income tax help tax on your benefits, see Publication 901, U. Free income tax help S. Free income tax help Tax Treaties. Free income tax help Tax withholding. Free income tax help   To request or change your income tax withholding from SSEB payments, U. Free income tax help S. Free income tax help citizens should contact the IRS for Form W-4V, Voluntary Withholding Request, and file it with the RRB. Free income tax help To elect, revoke, or change your income tax withholding from NSSEB, tier 2, VDB, and supplemental annuity payments received, use Form RRB W-4P, Withholding Certificate for Railroad Retirement Payments. Free income tax help If you are a nonresident alien or a U. Free income tax help S. Free income tax help citizen living abroad, you should provide Form RRB-1001, Nonresident Questionnaire, to the RRB to furnish citizenship and residency information and to claim any treaty exemption from U. Free income tax help S. Free income tax help tax withholding. Free income tax help Nonresident U. Free income tax help S. Free income tax help citizens cannot elect to be exempt from withholding on payments delivered outside of the U. Free income tax help S. Free income tax help Help from the RRB. Free income tax help   To request an RRB form or to get help with questions about an RRB benefit, you should contact your nearest RRB field office if you reside in the United States (call 1-877-772-5772 for the nearest field office) or U. Free income tax help S. Free income tax help consulate/Embassy if you reside outside the United States. Free income tax help You can visit the RRB on the Internet at www. Free income tax help rrb. Free income tax help gov. Free income tax help Form RRB-1099-R. Free income tax help   The following discussion explains the items shown on Form RRB-1099-R. Free income tax help The amounts shown on this form are before any deduction for: Federal income tax withholding, Medicare premiums, Legal process garnishment payments, Recovery of a prior year overpayment of an NSSEB, tier 2 benefit, VDB, or supplemental annuity benefit, or Recovery of Railroad Unemployment Insurance Act benefits received while awaiting payment of your railroad retirement annuity. Free income tax help   The amounts shown on this form are after any offset for: Social Security benefits, Age reduction, Public Service pensions or public disability benefits, Dual railroad retirement entitlement under another RRB claim number, Work deductions, Legal process partition deductions, Actuarial adjustment, Annuity waiver, or Recovery of a current-year overpayment of NSSEB, tier 2, VDB, or supplemental annuity benefits. Free income tax help   The amounts shown on Form RRB-1099-R do not reflect any special rules, such as capital gain treatment or the special 10-year tax option for lump-sum payments, or tax-free rollovers. Free income tax help To determine if any of these rules apply to your benefits, see the discussions about them later. Free income tax help   Generally, amounts shown on your Form RRB-1099-R are considered a normal distribution. Free income tax help Use distribution code “7” if you are asked for a distribution code. Free income tax help Distribution codes are not shown on Form RRB-1099-R. Free income tax help   There are three copies of this form. Free income tax help Copy B is to be included with your income tax return if federal income tax is withheld. Free income tax help Copy C is for your own records. Free income tax help Copy 2 is filed with your state, city, or local income tax return, when required. Free income tax help See the illustrated Copy B (Form RRB-1099-R) above. Free income tax help       Each beneficiary will receive his or her own Form RRB-1099-R. Free income tax help If you receive benefits on more than one railroad retirement record, you may get more than one Form RRB-1099-R. Free income tax help So that you get your form timely, make sure the RRB always has your current mailing address. Free income tax help Please click here for the text description of the image. Free income tax help Form RRB-1099-R Box 1—Claim Number and Payee Code. Free income tax help   Your claim number is a six- or nine-digit number preceded by an alphabetical prefix. Free income tax help This is the number under which the RRB paid your benefits. Free income tax help Your payee code follows your claim number and is the last number in this box. Free income tax help It is used by the RRB to identify you under your claim number. Free income tax help In all your correspondence with the RRB, be sure to use the claim number and payee code shown in this box. Free income tax help Box 2—Recipient's Identification Number. Free income tax help   This is the recipient's U. Free income tax help S. Free income tax help taxpayer identification number. Free income tax help It is the social security number (SSN), individual taxpayer identification number (ITIN), or employer identification number (EIN), if known, for the person or estate listed as the recipient. Free income tax help If you are a resident or nonresident alien who must furnish a taxpayer identification number to the IRS and are not eligible to obtain an SSN, use Form W-7, Application for IRS Individual Taxpayer Identification Number, to apply for an ITIN. Free income tax help The Instructions for Form W-7 explain how and when to apply. Free income tax help Box 3—Employee Contributions. Free income tax help   This is the amount of taxes withheld from the railroad employee's earnings that exceeds the amount of taxes that would have been withheld had the earnings been covered under the social security system. Free income tax help This amount is the employee's cost that you use to figure the tax-free part of the NSSEB and tier 2 benefit you received (the amount shown in box 4). Free income tax help (For information on how to figure the tax-free part, see Partly Taxable Payments under Taxation of Periodic Payments, later. Free income tax help ) The amount shown is the total employee contribution amount, not reduced by any amounts that the RRB calculated as previously recovered. Free income tax help It is the latest amount reported for 2013 and may have increased or decreased from a previous Form RRB-1099-R. Free income tax help If this amount has changed, the change is retroactive. Free income tax help You may need to refigure the tax-free part of your NSSEB/tier 2 benefit for 2013 and prior tax years. Free income tax help If this box is blank, it means that the amount of your NSSEB and tier 2 payments shown in box 4 is fully taxable. Free income tax help    If you had a previous annuity entitlement that ended and you are figuring the tax-free part of your NSSEB/tier 2 benefit for your current annuity entitlement, you should contact the RRB for confirmation of your correct employee contribution amount. Free income tax help Box 4—Contributory Amount Paid. Free income tax help   This is the gross amount of the NSSEB and tier 2 benefit you received in 2013, less any 2013 benefits you repaid in 2013. Free income tax help (Any benefits you repaid in 2013 for an earlier year or for an unknown year are shown in box 8. Free income tax help ) This amount is the total contributory pension paid in 2013. Free income tax help It may be partly taxable and partly tax free or fully taxable. Free income tax help If you determine you are eligible to compute a tax-free part as explained later in Partly Taxable Payments under Taxation of Periodic Payments, use the latest reported employee contribution amount shown in box 3 as the cost. Free income tax help Box 5—Vested Dual Benefit. Free income tax help   This is the gross amount of vested dual benefit (VDB) payments paid in 2013, less any 2013 VDB payments you repaid in 2013. Free income tax help It is fully taxable. Free income tax help VDB payments you repaid in 2013 for an earlier year or for an unknown year are shown in box 8. Free income tax help Note. Free income tax help The amounts shown in boxes 4 and 5 may represent payments for 2013 and/or other years after 1983. Free income tax help Box 6—Supplemental Annuity. Free income tax help   This is the gross amount of supplemental annuity benefits paid in 2013, less any 2013 supplemental annuity benefits you repaid in 2013. Free income tax help It is fully taxable. Free income tax help Supplemental annuity benefits you repaid in 2013 for an earlier year or for an unknown year are shown in box 8. Free income tax help Box 7—Total Gross Paid. Free income tax help   This is the sum of boxes 4, 5, and 6. Free income tax help The amount represents the total pension paid in 2013. Free income tax help Include this amount on Form 1040, line 16a; Form 1040A, line 12a; or Form 1040NR, line 17a. Free income tax help Box 8—Repayments. Free income tax help   This amount represents any NSSEB, tier 2 benefit, VDB, and supplemental annuity benefit you repaid to the RRB in 2013 for years before 2013 or for unknown years. Free income tax help The amount shown in this box has not been deducted from the amounts shown in boxes 4, 5, and 6. Free income tax help It only includes repayments of benefits that were taxable to you. Free income tax help This means it only includes repayments in 2013 of NSSEB benefits paid after 1985, tier 2 and VDB benefits paid after 1983, and supplemental annuity benefits paid in any year. Free income tax help If you included the benefits in your income in the year you received them, you may be able to deduct the repaid amount. Free income tax help For more information about repayments, see Repayment of benefits received in an earlier year , later. Free income tax help    You may have repaid an overpayment of benefits by returning a payment, by making a payment, or by having an amount withheld from your railroad retirement annuity payment. Free income tax help Box 9—Federal Income Tax Withheld. Free income tax help   This is the total federal income tax withheld from your NSSEB, tier 2 benefit, VDB, and supplemental annuity benefit. Free income tax help Include this on your income tax return as tax withheld. Free income tax help If you are a nonresident alien and your tax withholding rate and/or country of legal residence changed during 2013, you will receive more than one Form RRB-1099-R for 2013. Free income tax help Determine the total amount of U. Free income tax help S. Free income tax help federal income tax withheld from your 2013 RRB NSSEB, tier 2, VDB, and supplemental annuity payments by adding the amounts in box 9 of all original 2013 Forms RRB-1099-R, or the latest corrected or duplicate Forms RRB-1099-R you receive. Free income tax help Box 10—Rate of Tax. Free income tax help   If you are taxed as a U. Free income tax help S. Free income tax help citizen or resident alien, this box does not apply to you. Free income tax help If you are a nonresident alien, an entry in this box indicates the rate at which tax was withheld on the NSSEB, tier 2, VDB, and supplemental annuity payments that were paid to you in 2013. Free income tax help If you are a nonresident alien whose tax was withheld at more than one rate during 2013, you will receive a separate Form RRB-1099-R for each rate change during 2013. Free income tax help Box 11—Country. Free income tax help   If you are taxed as a U. Free income tax help S. Free income tax help citizen or resident alien, this box does not apply to you. Free income tax help If you are a nonresident alien, an entry in this box indicates the country of which you were a resident for tax purposes at the time you received railroad retirement payments in 2013. Free income tax help If you are a nonresident alien who was a resident of more than one country during 2013, you will receive a separate Form RRB-1099-R for each country of residence during 2013. Free income tax help Box 12—Medicare Premium Total. Free income tax help   This is for information purposes only. Free income tax help The amount shown in this box represents the total amount of Part B Medicare premiums deducted from your railroad retirement annuity payments in 2013. Free income tax help Medicare premium refunds are not included in the Medicare total. Free income tax help The Medicare total is normally shown on Form RRB-1099 (if you are a citizen or resident alien of the United States) or Form RRB-1042S (if you are a nonresident alien). Free income tax help However, if Form RRB-1099 or Form RRB-1042S is not required for 2013, then this total will be shown on Form RRB-1099-R. Free income tax help If your Medicare premiums were deducted from your social security benefits, paid by a third party, refunded to you, and/or you paid the premiums by direct billing, your Medicare total will not be shown in this box. Free income tax help Repayment of benefits received in an earlier year. Free income tax help   If you had to repay any railroad retirement benefits that you had included in your income in an earlier year because at that time you thought you had an unrestricted right to it, you can deduct the amount you repaid in the year in which you repaid it. Free income tax help   If you repaid $3,000 or less in 2013, deduct it on Schedule A (Form 1040), line 23. Free income tax help The 2%-of-adjusted-gross-income limit applies to this deduction. Free income tax help You cannot take this deduction if you file Form 1040A. Free income tax help    If you repaid more than $3,000 in 2013, you can either take a deduction for the amount repaid on Schedule A (Form 1040), line 28 or you can take a credit against your tax. Free income tax help For more information, see Repayments in Publication 525. Free income tax help Withholding Tax and Estimated Tax Your retirement plan distributions are subject to federal income tax withholding. Free income tax help However, you can choose not to have tax withheld on payments you receive unless they are eligible rollover distributions. Free income tax help (These are distributions, described later under Rollovers, that are eligible for rollover treatment but are not paid directly to another qualified retirement plan or to a traditional IRA. Free income tax help ) If you choose not to have tax withheld or if you do not have enough tax withheld, you may have to make estimated tax payments. Free income tax help See Estimated tax , later. Free income tax help The withholding rules apply to the taxable part of payments you receive from: An employer pension, annuity, profit-sharing, or stock bonus plan, Any other deferred compensation plan, A traditional individual retirement arrangement (IRA), or A commercial annuity. Free income tax help For this purpose, a commercial annuity means an annuity, endowment, or life insurance contract issued by an insurance company. Free income tax help There will be no withholding on any part of a distribution where it is reasonable to believe that it will not be includible in gross income. Free income tax help Choosing no withholding. Free income tax help   You can choose not to have income tax withheld from retirement plan payments unless they are eligible rollover distributions. Free income tax help You can make this choice on Form W-4P for periodic and nonperiodic payments. Free income tax help This choice generally remains in effect until you revoke it. Free income tax help   The payer will ignore your choice not to have tax withheld if: You do not give the payer your social security number (in the required manner), or The IRS notifies the payer, before the payment is made, that you gave an incorrect social security number. Free income tax help   To choose not to have tax withheld, a U. Free income tax help S. Free income tax help citizen or resident alien must give the payer a home address in the United States or its possessions. Free income tax help Without that address, the payer must withhold tax. Free income tax help For example, the payer has to withhold tax if the recipient has provided a U. Free income tax help S. Free income tax help address for a nominee, trustee, or agent to whom the benefits are delivered, but has not provided his or her own U. Free income tax help S. Free income tax help home address. Free income tax help   If you do not give the payer a home address in the United States or its possessions, you can choose not to have tax withheld only if you certify to the payer that you are not a U. Free income tax help S. Free income tax help citizen, a U. Free income tax help S. Free income tax help resident alien, or someone who left the country to avoid tax. Free income tax help But if you so certify, you may be subject to the 30% flat rate withholding that applies to nonresident aliens. Free income tax help This 30% rate will not apply if you are exempt or subject to a reduced rate by treaty. Free income tax help For details, get Publication 519. Free income tax help Periodic payments. Free income tax help   Unless you choose no withholding, your annuity or similar periodic payments (other than eligible rollover distributions) will be treated like wages for withholding purposes. Free income tax help Periodic payments are amounts paid at regular intervals (such as weekly, monthly, or yearly) for a period of time greater than one year (such as for 15 years or for life). Free income tax help You should give the payer a completed withholding certificate (Form W-4P or a similar form provided by the payer). Free income tax help If you do not, tax will be withheld as if you were married and claiming three withholding allowances. Free income tax help   Tax will be withheld as if you were single and were claiming no withholding allowances if: You do not give the payer your social security number (in the required manner), or The IRS notifies the payer (before any payment is made) that you gave an incorrect social security number. Free income tax help   You must file a new withholding certificate to change the amount of withholding. Free income tax help Nonperiodic distributions. Free income tax help    Unless you choose no withholding, the withholding rate for a nonperiodic distribution (a payment other than a periodic payment) that is not an eligible rollover distribution is 10% of the distribution. Free income tax help You can also ask the payer to withhold an additional amount using Form W-4P. Free income tax help The part of any loan treated as a distribution (except an offset amount to repay the loan), explained later, is subject to withholding under this rule. Free income tax help Eligible rollover distribution. Free income tax help    If you receive an eligible rollover distribution, 20% of it generally will be withheld for income tax. Free income tax help You cannot choose not to have tax withheld from an eligible rollover distribution. Free income tax help However, tax will not be withheld if you have the plan administrator pay the eligible rollover distribution directly to another qualified plan or an IRA in a direct rollover. Free income tax help For more information about eligible rollover distributions, see Rollovers , later. Free income tax help Estimated tax. Free income tax help   Your estimated tax is the total of your expected income tax, self-employment tax, and certain other taxes for the year, minus your expected credits and withheld tax. Free income tax help Generally, you must make estimated tax payments for 2014 if you expect to owe at least $1,000 in tax (after subtracting your withholding and credits) and you expect your withholding and credits to be less than the smaller of: 90% of the tax to be shown on your 2014 return, or 100% of the tax shown on your 2013 return. Free income tax help If your adjusted gross income for 2013 was more than $150,000 ($75,000 if your filing status for 2014 is married filing separately), substitute 110% for 100% in (2) above. Free income tax help For more information, get Publication 505, Tax Withholding and Estimated Tax. Free income tax help In figuring your withholding or estimated tax, remember that a part of your monthly social security or equivalent tier 1 railroad retirement benefits may be taxable. Free income tax help See Publication 915. Free income tax help You can choose to have income tax withheld from those benefits. Free income tax help Use Form W-4V to make this choice. Free income tax help Cost (Investment in the Contract) Distributions from your pension or annuity plan may include amounts treated as a recovery of your cost (investment in the contract). Free income tax help If any part of a distribution is treated as a recovery of your cost under the rules explained in this publication, that part is tax free. Free income tax help Therefore, the first step in figuring how much of a distribution is taxable is to determine the cost of your pension or annuity. Free income tax help In general, your cost is your net investment in the contract as of the annuity starting date (or the date of the distribution, if earlier). Free income tax help To find this amount, you must first figure the total premiums, contributions, or other amounts you paid. Free income tax help This includes the amounts your employer contributed that were taxable to you when paid. Free income tax help (However, see Foreign employment contributions , later. Free income tax help ) It does not include amounts withheld from your pay on a tax-deferred basis (money that was taken out of your gross pay before taxes were deducted). Free income tax help It also does not include amounts you contributed for health and accident benefits (including any additional premiums paid for double indemnity or disability benefits). Free income tax help From this total cost you must subtract the following amounts. Free income tax help Any refunded premiums, rebates, dividends, or unrepaid loans that were not included in your income and that you received by the later of the annuity starting date or the date on which you received your first payment. Free income tax help Any other tax-free amounts you received under the contract or plan by the later of the dates in (1). Free income tax help If you must use the Simplified Method for your annuity payments, the tax-free part of any single-sum payment received in connection with the start of the annuity payments, regardless of when you received it. Free income tax help (See Simplified Method , later, for information on its required use. Free income tax help ) If you use the General Rule for your annuity payments, the value of the refund feature in your annuity contract. Free income tax help (See General Rule , later, for information on its use. Free income tax help ) Your annuity contract has a refund feature if the annuity payments are for your life (or the lives of you and your survivor) and payments in the nature of a refund of the annuity's cost will be made to your beneficiary or estate if all annuitants die before a stated amount or a stated number of payments are made. Free income tax help For more information, see Publication 939. Free income tax help The tax treatment of the items described in (1) through (3) is discussed later under Taxation of Nonperiodic Payments . Free income tax help Form 1099-R. Free income tax help If you began receiving periodic payments of a life annuity in 2013, the payer should show your total contributions to the plan in box 9b of your 2013 Form 1099-R. Free income tax help Annuity starting date defined. Free income tax help   Your annuity starting date is the later of the first day of the first period for which you received a payment or the date the plan's obligations became fixed. Free income tax help Example. Free income tax help On January 1, you completed all your payments required under an annuity contract providing for monthly payments starting on August 1 for the period beginning July 1. Free income tax help The annuity starting date is July 1. Free income tax help This is the date you use in figuring the cost of the contract and selecting the appropriate number from Table 1 for line 3 of the Simplified Method Worksheet. Free income tax help Designated Roth accounts. Free income tax help   Your cost in these accounts is your designated Roth contributions that were included in your income as wages subject to applicable withholding requirements. Free income tax help Your cost will also include any in-plan Roth rollovers you included in income. Free income tax help Foreign employment contributions. Free income tax help   If you worked abroad, your cost may include contributions by your employer to the retirement plan, but only if those contributions would be excludible from your gross income had they been paid directly to you as compensation. Free income tax help The contributions that apply are: Contributions before 1963 by your employer, Contributions after 1962 by your employer if the contributions would be excludible from your gross income (not including the foreign earned income exclusion) had they been paid directly to you, or Contributions after 1996 by your employer if you performed the services of a foreign missionary (a duly ordained, commissioned, or licensed minister of a church or a lay person) but only if the contributions would be excludible from your gross income had they been paid directly to you. Free income tax help Foreign employment contributions while a nonresident alien. Free income tax help   In determining your cost, special rules apply if you are a U. Free income tax help S. Free income tax help citizen or resident alien who received distributions in 2013 from a plan to which contributions were made while you were a nonresident alien. Free income tax help Your contributions and your employer's contributions are not included in your cost if the contribution: Was made based on compensation which was for services performed outside the United States while you were a nonresident alien, and Was not subject to income tax under the laws of the United States or any foreign country, but only if the contribution would have been subject to income tax if paid as cash compensation when the services were performed. Free income tax help Taxation of Periodic Payments This section explains how the periodic payments you receive from a pension or annuity plan are taxed. Free income tax help Periodic payments are amounts paid at regular intervals (such as weekly, monthly, or yearly) for a period of time greater than one year (such as for 15 years or for life). Free income tax help These payments are also known as amounts received as an annuity. Free income tax help If you receive an amount from your plan that is not a periodic payment, see Taxation of Nonperiodic Payments , later. Free income tax help In general, you can recover the cost of your pension or annuity tax free over the period you are to receive the payments. Free income tax help The amount of each payment that is more than the part that represents your cost is taxable (however, see Insurance Premiums for Retired Public Safety Officers , earlier). Free income tax help Designated Roth accounts. Free income tax help   If you receive a qualified distribution from a designated Roth account, the distribution is not included in your gross income. Free income tax help This applies to both your cost in the account and income earned on that account. Free income tax help A qualified distribution is generally a distribution that is: Made after a 5-tax-year period of participation, and Made on or after the date you reach age 59½, made to a beneficiary or your estate on or after your death, or attributable to your being disabled. Free income tax help   If the distribution is not a qualified distribution, the rules discussed in this section apply. Free income tax help The designated Roth account is treated as a separate contract. Free income tax help Period of participation. Free income tax help   The 5-tax-year period of participation is the 5-tax-year period beginning with the first tax year for which the participant made a designated Roth contribution to the plan. Free income tax help Therefore, for designated Roth contributions made for 2013, the first year for which a qualified distribution can be made is 2018. Free income tax help   However, if a direct rollover is made to the plan from a designated Roth account under another plan, the 5-tax-year period for the recipient plan begins with the first tax year for which the participant first had designated Roth contributions made to the other plan. Free income tax help   Your 401(k), 403(b), or 457(b) plan may permit you to roll over amounts from those plans to a designated Roth account within the same plan. Free income tax help This is known as an in-plan Roth rollover. Free income tax help For more details, see In-plan Roth rollovers , later. Free income tax help Fully Taxable Payments The pension or annuity payments that you receive are fully taxable if you have no cost in the contract because any of the following situations applies to you (however, see Insurance Premiums for Retired Public Safety Officers , earlier). Free income tax help You did not pay anything or are not considered to have paid anything for your pension or annuity. Free income tax help Amounts withheld from your pay on a tax-deferred basis are not considered part of the cost of the pension or annuity payment. Free income tax help Your employer did not withhold contributions from your salary. Free income tax help You got back all of your contributions tax free in prior years (however, see Exclusion not limited to cost under Partly Taxable Payments, later). Free income tax help Report the total amount you got on Form 1040, line 16b; Form 1040A, line 12b; or on Form 1040NR, line 17b. Free income tax help You should make no entry on Form 1040, line 16a; Form 1040A, line 12a; or Form 1040NR, line 17a. Free income tax help Deductible voluntary employee contributions. Free income tax help   Distributions you receive that are based on your accumulated deductible voluntary employee contributions are generally fully taxable in the year distributed to you. Free income tax help Accumulated deductible voluntary employee contributions include net earnings on the contributions. Free income tax help If distributed as part of a lump sum, they do not qualify for the 10-year tax option or capital gain treatment, explained later. Free income tax help Partly Taxable Payments If you have a cost to recover from your pension or annuity plan (see Cost (Investment in the Contract) , earlier), you can exclude part of each annuity payment from income as a recovery of your cost. Free income tax help This tax-free part of the payment is figured when your annuity starts and remains the same each year, even if the amount of the payment changes. Free income tax help The rest of each payment is taxable (however, see Insurance Premiums for Retired Public Safety Officers , earlier). Free income tax help You figure the tax-free part of the payment using one of the following methods. Free income tax help Simplified Method. Free income tax help You generally must use this method if your annuity is paid under a qualified plan (a qualified employee plan, a qualified employee annuity, or a tax-sheltered annuity plan or contract). Free income tax help You cannot use this method if your annuity is paid under a nonqualified plan. Free income tax help General Rule. Free income tax help You must use this method if your annuity is paid under a nonqualified plan. Free income tax help You generally cannot use this method if your annuity is paid under a qualified plan. Free income tax help You determine which method to use when you first begin receiving your annuity, and you continue using it each year that you recover part of your cost. Free income tax help If you had more than one partly taxable pension or annuity, figure the tax-free part and the taxable part of each separately. Free income tax help Qualified plan annuity starting before November 19, 1996. Free income tax help   If your annuity is paid under a qualified plan and your annuity starting date (defined earlier under Cost (Investment in the Contract) ) is after July 1, 1986, and before November 19, 1996, you could have chosen to use either the Simplified Method or the General Rule. Free income tax help If your annuity starting date is before July 2, 1986, you use the General Rule unless your annuity qualified for the Three-Year Rule. Free income tax help If you used the Three-Year Rule (which was repealed for annuities starting after July 1, 1986), your annuity payments are generally now fully taxable. Free income tax help Exclusion limit. Free income tax help   Your annuity starting date determines the total amount of annuity payments that you can exclude from income over the years. Free income tax help Once your annuity starting date is determined, it does not change. Free income tax help If you calculate the taxable portion of your annuity payments using the simplified method worksheet, the annuity starting date determines the recovery period for your cost. Free income tax help That recovery period begins on your annuity starting date and is not affected by the date you first complete the worksheet. Free income tax help Exclusion limited to cost. Free income tax help   If your annuity starting date is after 1986, the total amount of annuity income that you can exclude over the years as a recovery of the cost cannot exceed your total cost. Free income tax help Any unrecovered cost at your (or the last annuitant's) death is allowed as a miscellaneous itemized deduction on the final return of the decedent. Free income tax help This deduction is not subject to the 2%-of-adjusted-gross-income limit. Free income tax help Example 1. Free income tax help Your annuity starting date is after 1986, and you exclude $100 a month ($1,200 a year) under the Simplified Method. Free income tax help The total cost of your annuity is $12,000. Free income tax help Your exclusion ends when you have recovered your cost tax free, that is, after 10 years (120 months). Free income tax help After that, your annuity payments are generally fully taxable. Free income tax help Example 2. Free income tax help The facts are the same as in Example 1, except you die (with no surviving annuitant) after the eighth year of retirement. Free income tax help You have recovered tax free only $9,600 (8 × $1,200) of your cost. Free income tax help An itemized deduction for your unrecovered cost of $2,400 ($12,000 – $9,600) can be taken on your final return. Free income tax help Exclusion not limited to cost. Free income tax help   If your annuity starting date is before 1987, you can continue to take your monthly exclusion for as long as you receive your annuity. Free income tax help If you chose a joint and survivor annuity, your survivor can continue to take the survivor's exclusion figured as of the annuity starting date. Free income tax help The total exclusion may be more than your cost. Free income tax help Simplified Method Under the Simplified Method, you figure the tax-free part of each annuity payment by dividing your cost by the total number of anticipated monthly payments. Free income tax help For an annuity that is payable for the lives of the annuitants, this number is based on the annuitants' ages on the annuity starting date and is determined from a table. Free income tax help For any other annuity, this number is the number of monthly annuity payments under the contract. Free income tax help Who must use the Simplified Method. Free income tax help   You must use the Simplified Method if your annuity starting date is after November 18, 1996, and you meet both of the following conditions. Free income tax help You receive your pension or annuity payments from any of the following plans. Free income tax help A qualified employee plan. Free income tax help A qualified employee annuity. Free income tax help A tax-sheltered annuity plan (403(b) plan). Free income tax help On your annuity starting date, at least one of the following conditions applies to you. Free income tax help You are under age 75. Free income tax help You are entitled to less than 5 years of guaranteed payments. Free income tax help Guaranteed payments. Free income tax help   Your annuity contract provides guaranteed payments if a minimum number of payments or a minimum amount (for example, the amount of your investment) is payable even if you and any survivor annuitant do not live to receive the minimum. Free income tax help If the minimum amount is less than the total amount of the payments you are to receive, barring death, during the first 5 years after payments begin (figured by ignoring any payment increases), you are entitled to less than 5 years of guaranteed payments. Free income tax help Annuity starting before November 19, 1996. Free income tax help   If your annuity starting date is after July 1, 1986, and before November 19, 1996, and you chose to use the Simplified Method, you must continue to use it each year that you recover part of your cost. Free income tax help You could have chosen to use the Simplified Method if your annuity is payable for your life (or the lives of you and your survivor annuitant) and you met both of the conditions listed earlier under Who must use the Simplified Method . Free income tax help Who cannot use the Simplified Method. Free income tax help   You cannot use the Simplified Method if you receive your pension or annuity from a nonqualified plan or otherwise do not meet the conditions described in the preceding discussion. Free income tax help See General Rule , later. Free income tax help How to use the Simplified Method. Free income tax help    Complete Worksheet A in the back of this publication to figure your taxable annuity for 2013. Free income tax help Be sure to keep the completed worksheet; it will help you figure your taxable annuity next year. Free income tax help   To complete line 3 of the worksheet, you must determine the total number of expected monthly payments for your annuity. Free income tax help How you do this depends on whether the annuity is for a single life, multiple lives, or a fixed period. Free income tax help For this purpose, treat an annuity that is payable over the life of an annuitant as payable for that annuitant's life even if the annuity has a fixed-period feature or also provides a temporary annuity payable to the annuitant's child under age 25. Free income tax help    You do not need to complete line 3 of the worksheet or make the computation on line 4 if you received annuity payments last year and used last year's worksheet to figure your taxable annuity. Free income tax help Instead, enter the amount from line 4 of last year's worksheet on line 4 of this year's worksheet. Free income tax help Single-life annuity. Free income tax help   If your annuity is payable for your life alone, use Table 1 at the bottom of the worksheet to determine the total number of expected monthly payments. Free income tax help Enter on line 3 the number shown for your age on your annuity starting date. Free income tax help This number will differ depending on whether your annuity starting date is before November 19, 1996, or after November 18, 1996. Free income tax help Multiple-lives annuity. Free income tax help   If your annuity is payable for the lives of more than one annuitant, use Table 2 at the bottom of the worksheet to determine the total number of expected monthly payments. Free income tax help Enter on line 3 the number shown for the annuitants' combined ages on the annuity starting date. Free income tax help For an annuity payable to you as the primary annuitant and to more than one survivor annuitant, combine your age and the age of the youngest survivor annuitant. Free income tax help For an annuity that has no primary annuitant and is payable to you and others as survivor annuitants, combine the ages of the oldest and youngest annuitants. Free income tax help Do not treat as a survivor annuitant anyone whose entitlement to payments depends on an event other than the primary annuitant's death. Free income tax help   However, if your annuity starting date is before 1998, do not use Table 2 and do not combine the annuitants' ages. Free income tax help Instead, you must use Table 1 at the bottom of the worksheet and enter on line 3 the number shown for the primary annuitant's age on the annuity starting date. Free income tax help This number will differ depending on whether your annuity starting date is before November 19, 1996, or after November 18, 1996. Free income tax help Fixed-period annuity. Free income tax help   If your annuity does not depend in whole or in part on anyone's life expectancy, the total number of expected monthly payments to enter on line 3 of the worksheet is the number of monthly annuity payments under the contract. Free income tax help Line 6. Free income tax help   The amount on line 6 should include all amounts that could have been recovered in prior years. Free income tax help If you did not recover an amount in a prior year, you may be able to amend your returns for the affected years. Free income tax help Example. Free income tax help Bill Smith, age 65, began receiving retirement benefits in 2013 under a joint and survivor annuity. Free income tax help Bill's annuity starting date is January 1, 2013. Free income tax help The benefits are to be paid for the joint lives of Bill and his wife, Kathy, age 65. Free income tax help Bill had contributed $31,000 to a qualified plan and had received no distributions before the annuity starting date. Free income tax help Bill is to receive a retirement benefit of $1,200 a month, and Kathy is to receive a monthly survivor benefit of $600 upon Bill's death. Free income tax help Bill must use the Simplified Method to figure his taxable annuity because his payments are from a qualified plan and he is under age 75. Free income tax help Because his annuity is payable over the lives of more than one annuitant, he uses his and Kathy's combined ages and Table 2 at the bottom of Worksheet A in completing line 3 of the worksheet. Free income tax help His completed worksheet is shown later. Free income tax help Bill's tax-free monthly amount is $100 ($31,000 ÷ 310) as shown on line 4 of the worksheet. Free income tax help Upon Bill's death, if Bill has not recovered the full $31,000 investment, Kathy will also exclude $100 from her $600 monthly payment. Free income tax help The full amount of any annuity payments received after 310 payments are paid must be included in gross income. Free income tax help If Bill and Kathy die before 310 payments are made, a miscellaneous itemized deduction will be allowed for the unrecovered cost on the final income tax return of the last to die. Free income tax help This deduction is not subject to the 2%-of-adjusted-gross-income limit. Free income tax help Worksheet A. Free income tax help Simplified Method Worksheet for Bill Smith 1. Free income tax help Enter the total pension or annuity payments received this year. Free income tax help Also, add this amount to the total for Form 1040, line 16a; Form 1040A, line 12a; or Form 1040NR, line 17a 1. Free income tax help $14,400 2. Free income tax help Enter your cost in the plan (contract) at the annuity starting date plus any death benefit exclusion. Free income tax help * See Cost (Investment in the Contract) , earlier 2. Free income tax help 31,000   Note. Free income tax help If your annuity starting date was before this year and you completed this worksheet last year, skip line 3 and enter the amount from line 4 of last year's worksheet on line 4 below (even if the amount of your pension or annuity has changed). Free income tax help Otherwise, go to line 3. Free income tax help     3. Free income tax help Enter the appropriate number from Table 1 below. Free income tax help But if your annuity starting date was after 1997 and the payments are for your life and that of your beneficiary, enter the appropriate number from Table 2 below 3. Free income tax help 310 4. Free income tax help Divide line 2 by the number on line 3 4. Free income tax help 100 5. Free income tax help Multiply line 4 by the number of months for which this year's payments were made. Free income tax help If your annuity starting date was before 1987, enter this amount on line 8 below and skip lines 6, 7, 10, and 11. Free income tax help Otherwise, go to line 6 5. Free income tax help 1,200 6. Free income tax help Enter any amount previously recovered tax free in years after 1986. Free income tax help This is the amount shown on line 10 of your worksheet for last year 6. Free income tax help -0- 7. Free income tax help Subtract line 6 from line 2 7. Free income tax help 31,000 8. Free income tax help Enter the smaller of line 5 or line 7 8. Free income tax help 1,200 9. Free income tax help Taxable amount for year. Free income tax help Subtract line 8 from line 1. Free income tax help Enter the result, but not less than zero. Free income tax help Also, add this amount to the total for Form 1040, line 16b; Form 1040A, line 12b; or Form 1040NR, line 17b. Free income tax help Note: If your Form 1099-R shows a larger taxable amount, use the amount figured on this line instead. Free income tax help If you are a retired public safety officer, see Insurance Premiums for Retired Public Safety Officers , earlier, before entering an amount on your tax return 9. Free income tax help $13,200 10. Free income tax help Was your annuity starting date before 1987? □ Yes. Free income tax help STOP. Free income tax help Do not complete the rest of this worksheet. Free income tax help  ☑ No. Free income tax help Add lines 6 and 8. Free income tax help This is the amount you have recovered tax free through 2013. Free income tax help You will need this number if you need to fill out this worksheet next year 10. Free income tax help 1,200 11. Free income tax help Balance of cost to be recovered. Free income tax help Subtract line 10 from line 2. Free income tax help If zero, you will not have to complete this worksheet next year. Free income tax help The payments you receive next year will generally be fully taxable 11. Free income tax help $29,800         * A death benefit exclusion (up to $5,000) applied to certain benefits received by employees who died before August 21, 1996. Free income tax help           Table 1 for Line 3 Above       AND your annuity starting date was—     IF the age at annuity starting date was. Free income tax help . Free income tax help . Free income tax help BEFORE November 19, 1996, enter on line 3. Free income tax help . Free income tax help . Free income tax help AFTER November 18, 1996, enter on line 3. Free income tax help . Free income tax help . Free income tax help     55 or under 300 360     56-60 260 310     61-65 240 260     66-70 170 210     71 or older 120 160     Table 2 for Line 3 Above     IF the combined ages at  annuity starting date were. Free income tax help . Free income tax help . Free income tax help THEN enter on line 3. Free income tax help . Free income tax help . Free income tax help     110 or under   410     111-120   360     121-130   310     131-140   260     141 or older   210   Multiple annuitants. Free income tax help   If you and one or more other annuitants receive payments at the same time, you exclude from each annuity payment a pro rata share of the monthly tax-free amount. Free income tax help Figure your share by taking the following steps. Free income tax help Complete your worksheet through line 4 to figure the monthly tax-free amount. Free income tax help Divide the amount of your monthly payment by the total amount of the monthly payments to all annuitants. Free income tax help Multiply the amount on line 4 of your worksheet by the amount figured in (2) above. Free income tax help The result is your share of the monthly tax-free amount. Free income tax help   Replace the amount on line 4 of the worksheet with the result in (3) above. Free income tax help Enter that amount on line 4 of your worksheet each year. Free income tax help General Rule Under the General Rule, you determine the tax-free part of each annuity payment based on the ratio of the cost of the contract to the total expected return. Free income tax help Expected return is the total amount you and other eligible annuitants can expect to receive under the contract. Free income tax help To figure it, you must use life expectancy (actuarial) tables prescribed by the IRS. Free income tax help Who must use the General Rule. Free income tax help   You must use the General Rule if you receive pension or annuity payments from: A nonqualified plan (such as a private annuity, a purchased commercial annuity, or a nonqualified employee plan), or A qualified plan if you are age 75 or older on your annuity starting date and your annuity payments are guaranteed for at least 5 years. Free income tax help Annuity starting before November 19, 1996. Free income tax help   If your annuity starting date is after July 1, 1986, and before November 19, 1996, you had to use the General Rule for either circumstance just described. Free income tax help You also had to use it for any fixed-period annuity. Free income tax help If you did not have to use the General Rule, you could have chosen to use it. Free income tax help If your annuity starting date is before July 2, 1986, you had to use the General Rule unless you could use the Three-Year Rule. Free income tax help   If you had to use the General Rule (or chose to use it), you must continue to use it each year that you recover your cost. Free income tax help Who cannot use the General Rule. Free income tax help   You cannot use the General Rule if you receive your pension or annuity from a qualified plan and none of the circumstances described in the preceding discussions apply to you. Free income tax help See Simplified Method , earlier. Free income tax help More information. Free income tax help   For complete information on using the General Rule, including the actuarial tables you need, see Publication 939. Free income tax help Taxation of Nonperiodic Payments This section of the publication explains how any nonperiodic distributions you receive under a pension or annuity plan are taxed. Free income tax help Nonperiodic distributions are also known as amounts not received as an annuity. Free income tax help They include all payments other than periodic payments and corrective distributions. Free income tax help For example, the following items are treated as nonperiodic distributions. Free income tax help Cash withdrawals. Free income tax help Distributions of current earnings (dividends) on your investment. Free income tax help However, do not include these distributions in your income to the extent the insurer keeps them to pay premiums or other consideration for the contract. Free income tax help Certain loans. Free income tax help See Loans Treated as Distributions , later. Free income tax help The value of annuity contracts transferred without full and adequate consideration. Free income tax help See Transfers of Annuity Contracts , later. Free income tax help Corrective distributions of excess plan contributions. Free income tax help   Generally, if the contributions made for you during the year to certain retirement plans exceed certain limits, the excess is taxable to you. Free income tax help To correct an excess, your plan may distribute it to you (along with any income earned on the excess). Free income tax help Although the plan reports the corrective distributions on Form 1099-R, the distribution is not treated as a nonperiodic distribution from the plan. Free income tax help It is not subject to the allocation rules explained in the following discussion, it cannot be rolled over into another plan, and it is not subject to the additional tax on early distributions. Free income tax help    If your retirement plan made a corrective distribution of excess amounts (excess deferrals, excess contributions, or excess annual additions), your Form 1099-R should have the code “8,” “B,” “P,” or “E” in box 7. Free income tax help   For information on plan contribution limits and how to report corrective distributions of excess contributions, see Retirement Plan Contributions under Employee Compensation in Publication 525. Free income tax help Figuring the Taxable Amount How you figure the taxable amount of a nonperiodic distribution depends on whether it is made before the annuity starting date, or on or after the annuity starting date. Free income tax help If it is made before the annuity starting date, its tax treatment also depends on whether it is made under a qualified or nonqualified plan. Free income tax help If it is made under a nonqualified plan, its tax treatment depends on whether it fully discharges the contract, is received under certain life insurance or endowment contracts, or is allocable to an investment you made before August 14, 1982. Free income tax help You may be able to roll over the taxable amount of a nonperiodic distribution from a qualified retirement plan into another qualified retirement plan or a traditional IRA tax free. Free income tax help See Rollovers, later. Free income tax help If you do not make a tax-free rollover and the distribution qualifies as a lump-sum distribution, you may be able to elect an optional method of figuring the tax on the taxable amount. Free income tax help See Lump-Sum Distributions, later. Free income tax help Annuity starting date. Free income tax help   The annuity starting date is either the first day of the first period for which you receive an annuity payment under the contract or the date on which the obligation under the contract becomes fixed, whichever is later. Free income tax help Distributions of employer securities. Free income tax help    If you receive a distribution of employer securities from a qualified retirement plan, you may be able to defer the tax on the net unrealized appreciation (NUA) in the securities. Free income tax help The NUA is the net increase in the securities' value while they were in the trust. Free income tax help This tax deferral applies to distributions of the employer corporation's stocks, bonds, registered debentures, and debentures with interest coupons attached. Free income tax help   If the distribution is a lump-sum distribution, tax is deferred on all of the NUA unless you choose to include it in your income for the year of the distribution. Free income tax help    A lump-sum distribution for this purpose is the distribution or payment of a plan participant's entire balance (within a single tax year) from all of the employer's qualified plans of one kind (pension, profit-sharing, or stock bonus plans), but only if paid: Because of the plan participant's death, After the participant reaches age 59½, Because the participant, if an employee, separates from service, or After the participant, if a self-employed individual, becomes totally and permanently disabled. Free income tax help    If you choose to include NUA in your income for the year of the distribution and the participant was born before January 2, 1936, you may be able to figure the tax on the NUA using the optional methods described und
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Free income tax help 4. Free income tax help   Interest Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Allocation of InterestOrder of funds spent. Free income tax help Payments from checking accounts. Free income tax help Amounts paid within 30 days. Free income tax help Optional method for determining date of reallocation. Free income tax help Interest on a segregated account. Free income tax help How to report. Free income tax help Interest You Can DeductStatement. Free income tax help Expenses paid to obtain a mortgage. Free income tax help Prepayment penalty. Free income tax help De minimis OID. Free income tax help Constant-yield method. Free income tax help Loan or mortgage ends. Free income tax help Interest You Cannot DeductPenalties. Free income tax help Who is a key person? Exceptions for pre-June 1997 contracts. Free income tax help Interest allocated to unborrowed policy cash value. Free income tax help Capitalization of Interest When To Deduct InterestPrepaid interest. Free income tax help Discounted loan. Free income tax help Refunds of interest. Free income tax help Prepaid interest. Free income tax help Discounted loan. Free income tax help Tax deficiency. Free income tax help Related person. Free income tax help Below-Market LoansLimit on forgone interest for gift loans of $100,000 or less. Free income tax help Introduction This chapter discusses the tax treatment of business interest expense. Free income tax help Business interest expense is an amount charged for the use of money you borrowed for business activities. Free income tax help Topics - This chapter discusses: Allocation of interest Interest you can deduct Interest you cannot deduct Capitalization of interest When to deduct interest Below-market loans Useful Items - You may want to see: Publication 537 Installment Sales 550 Investment Income and Expenses 936 Home Mortgage Interest Deduction Form (and Instructions) Sch A (Form 1040) Itemized Deductions Sch E (Form 1040) Supplemental Income and Loss Sch K-1 (Form 1065) Partner's Share of Income, Deductions, Credits, etc. Free income tax help Sch K-1 (Form 1120S) Shareholder's Share of Income, Deductions, Credits, etc. Free income tax help 1098 Mortgage Interest Statement 3115 Application for Change in Accounting Method 4952 Investment Interest Expense Deduction 8582 Passive Activity Loss Limitations See chapter 12 for information about getting publications and forms. Free income tax help Allocation of Interest The rules for deducting interest vary, depending on whether the loan proceeds are used for business, personal, or investment activities. Free income tax help If you use the proceeds of a loan for more than one type of expense, you must allocate the interest based on the use of the loan's proceeds. Free income tax help Allocate your interest expense to the following categories. Free income tax help Nonpassive trade or business activity interest Passive trade or business activity interest Investment interest Portfolio interest Personal interest In general, you allocate interest on a loan the same way you allocate the loan proceeds. Free income tax help You allocate loan proceeds by tracing disbursements to specific uses. Free income tax help The easiest way to trace disbursements to specific uses is to keep the proceeds of a particular loan separate from any other funds. Free income tax help Secured loan. Free income tax help   The allocation of loan proceeds and the related interest is not generally affected by the use of property that secures the loan. Free income tax help Example. Free income tax help You secure a loan with property used in your business. Free income tax help You use the loan proceeds to buy an automobile for personal use. Free income tax help You must allocate interest expense on the loan to personal use (purchase of the automobile) even though the loan is secured by business property. Free income tax help    If the property that secures the loan is your home, you generally do not allocate the loan proceeds or the related interest. Free income tax help The interest is usually deductible as qualified home mortgage interest, regardless of how the loan proceeds are used. Free income tax help For more information, see Publication 936. Free income tax help Allocation period. Free income tax help   The period for which a loan is allocated to a particular use begins on the date the proceeds are used and ends on the earlier of the following dates. Free income tax help The date the loan is repaid. Free income tax help The date the loan is reallocated to another use. Free income tax help Proceeds not disbursed to borrower. Free income tax help   Even if the lender disburses the loan proceeds to a third party, the allocation of the loan is still based on your use of the funds. Free income tax help This applies whether you pay for property, services, or anything else by incurring a loan, or you take property subject to a debt. Free income tax help Proceeds deposited in borrower's account. Free income tax help   Treat loan proceeds deposited in an account as property held for investment. Free income tax help It does not matter whether the account pays interest. Free income tax help Any interest you pay on the loan is investment interest expense. Free income tax help If you withdraw the proceeds of the loan, you must reallocate the loan based on the use of the funds. Free income tax help Example. Free income tax help Celina, a calendar-year taxpayer, borrows $100,000 on January 4 and immediately uses the proceeds to open a checking account. Free income tax help No other amounts are deposited in the account during the year and no part of the loan principal is repaid during the year. Free income tax help On April 2, Celina uses $20,000 from the checking account for a passive activity expenditure. Free income tax help On September 4, Celina uses an additional $40,000 from the account for personal purposes. Free income tax help Under the interest allocation rules, the entire $100,000 loan is treated as property held for investment for the period from January 4 through April 1. Free income tax help From April 2 through September 3, Celina must treat $20,000 of the loan as used in the passive activity and $80,000 of the loan as property held for investment. Free income tax help From September 4 through December 31, she must treat $40,000 of the loan as used for personal purposes, $20,000 as used in the passive activity, and $40,000 as property held for investment. Free income tax help Order of funds spent. Free income tax help   Generally, you treat loan proceeds deposited in an account as used (spent) before either of the following amounts. Free income tax help Any unborrowed amounts held in the same account. Free income tax help Any amounts deposited after these loan proceeds. Free income tax help Example. Free income tax help On January 9, Olena opened a checking account, depositing $500 of the proceeds of Loan A and $1,000 of unborrowed funds. Free income tax help The following table shows the transactions in her account during the tax year. Free income tax help Date Transaction January 9 $500 proceeds of Loan A and $1,000 unborrowed funds deposited January 14 $500 proceeds of Loan B  deposited February 19 $800 used for personal purposes February 27 $700 used for passive activity June 19 $1,000 proceeds of Loan C  deposited November 20 $800 used for an investment December 18 $600 used for personal purposes Olena treats the $800 used for personal purposes as made from the $500 proceeds of Loan A and $300 of the proceeds of Loan B. Free income tax help She treats the $700 used for a passive activity as made from the remaining $200 proceeds of Loan B and $500 of unborrowed funds. Free income tax help She treats the $800 used for an investment as made entirely from the proceeds of Loan C. Free income tax help She treats the $600 used for personal purposes as made from the remaining $200 proceeds of Loan C and $400 of unborrowed funds. Free income tax help For the periods during which loan proceeds are held in the account, Olena treats them as property held for investment. Free income tax help Payments from checking accounts. Free income tax help   Generally, you treat a payment from a checking or similar account as made at the time the check is written if you mail or deliver it to the payee within a reasonable period after you write it. Free income tax help You can treat checks written on the same day as written in any order. Free income tax help Amounts paid within 30 days. Free income tax help   If you receive loan proceeds in cash or if the loan proceeds are deposited in an account, you can treat any payment (up to the amount of the proceeds) made from any account you own, or from cash, as made from those proceeds. Free income tax help This applies to any payment made within 30 days before or after the proceeds are received in cash or deposited in your account. Free income tax help   If the loan proceeds are deposited in an account, you can apply this rule even if the rules stated earlier under Order of funds spent would otherwise require you to treat the proceeds as used for other purposes. Free income tax help If you apply this rule to any payments, disregard those payments (and the proceeds from which they are made) when applying the rules stated under Order of funds spent. Free income tax help   If you received the loan proceeds in cash, you can treat the payment as made on the date you received the cash instead of the date you actually made the payment. Free income tax help Example. Free income tax help Giovanni gets a loan of $1,000 on August 4 and receives the proceeds in cash. Free income tax help Giovanni deposits $1,500 in an account on August 18 and on August 28 writes a check on the account for a passive activity expense. Free income tax help Also, Giovanni deposits his paycheck, deposits other loan proceeds, and pays his bills during the same period. Free income tax help Regardless of these other transactions, Giovanni can treat $1,000 of the deposit he made on August 18 as being paid on August 4 from the loan proceeds. Free income tax help In addition, Giovanni can treat the passive activity expense he paid on August 28 as made from the $1,000 loan proceeds treated as deposited in the account. Free income tax help Optional method for determining date of reallocation. Free income tax help   You can use the following method to determine the date loan proceeds are reallocated to another use. Free income tax help You can treat all payments from loan proceeds in the account during any month as taking place on the later of the following dates. Free income tax help The first day of that month. Free income tax help The date the loan proceeds are deposited in the account. Free income tax help However, you can use this optional method only if you treat all payments from the account during the same calendar month in the same way. Free income tax help Interest on a segregated account. Free income tax help   If you have an account that contains only loan proceeds and interest earned on the account, you can treat any payment from that account as being made first from the interest. Free income tax help When the interest earned is used up, any remaining payments are from loan proceeds. Free income tax help Example. Free income tax help You borrowed $20,000 and used the proceeds of this loan to open a new savings account. Free income tax help When the account had earned interest of $867, you withdrew $20,000 for personal purposes. Free income tax help You can treat the withdrawal as coming first from the interest earned on the account, $867, and then from the loan proceeds, $19,133 ($20,000 − $867). Free income tax help All the interest charged on the loan from the time it was deposited in the account until the time of the withdrawal is investment interest expense. Free income tax help The interest charged on the part of the proceeds used for personal purposes ($19,133) from the time you withdrew it until you either repay it or reallocate it to another use is personal interest expense. Free income tax help The interest charged on the loan proceeds you left in the account ($867) continues to be investment interest expense until you either repay it or reallocate it to another use. Free income tax help Loan repayment. Free income tax help   When you repay any part of a loan allocated to more than one use, treat it as being repaid in the following order. Free income tax help Personal use. Free income tax help Investments and passive activities (other than those included in (3)). Free income tax help Passive activities in connection with a rental real estate activity in which you actively participate. Free income tax help Former passive activities. Free income tax help Trade or business use and expenses for certain low-income housing projects. Free income tax help Line of credit (continuous borrowings). Free income tax help   The following rules apply if you have a line of credit or similar arrangement. Free income tax help Treat all borrowed funds on which interest accrues at the same fixed or variable rate as a single loan. Free income tax help Treat borrowed funds or parts of borrowed funds on which interest accrues at different fixed or variable rates as different loans. Free income tax help Treat these loans as repaid in the order shown on the loan agreement. Free income tax help Loan refinancing. Free income tax help   Allocate the replacement loan to the same uses to which the repaid loan was allocated. Free income tax help Make the allocation only to the extent you use the proceeds of the new loan to repay any part of the original loan. Free income tax help Debt-financed distribution. Free income tax help   A debt-financed distribution occurs when a partnership or S corporation borrows funds and allocates those funds to distributions made to partners or shareholders. Free income tax help The manner in which you report the interest expense associated with the distributed debt proceeds depends on your use of those proceeds. Free income tax help How to report. Free income tax help   If the proceeds were used in a nonpassive trade or business activity, report the interest on Schedule E (Form 1040), line 28; enter “interest expense” and the name of the partnership or S corporation in column (a) and the amount in column (h). Free income tax help If the proceeds were used in a passive activity, follow the Instructions for Form 8582, Passive Activity Loss Limitations, to determine the amount of interest expense that can be reported on Schedule E (Form 1040), line 28; enter “interest expense” and the name of the partnership in column (a) and the amount in column (f). Free income tax help If the proceeds were used in an investment activity, enter the interest on Form 4952. Free income tax help If the proceeds are used for personal purposes, the interest is generally not deductible. Free income tax help Interest You Can Deduct You can generally deduct as a business expense all interest you pay or accrue during the tax year on debts related to your trade or business. Free income tax help Interest relates to your trade or business if you use the proceeds of the loan for a trade or business expense. Free income tax help It does not matter what type of property secures the loan. Free income tax help You can deduct interest on a debt only if you meet all the following requirements. Free income tax help You are legally liable for that debt. Free income tax help Both you and the lender intend that the debt be repaid. Free income tax help You and the lender have a true debtor-creditor relationship. Free income tax help Partial liability. Free income tax help   If you are liable for part of a business debt, you can deduct only your share of the total interest paid or accrued. Free income tax help Example. Free income tax help You and your brother borrow money. Free income tax help You are liable for 50% of the note. Free income tax help You use your half of the loan in your business, and you make one-half of the loan payments. Free income tax help You can deduct your half of the total interest payments as a business deduction. Free income tax help Mortgage. Free income tax help   Generally, mortgage interest paid or accrued on real estate you own legally or equitably is deductible. Free income tax help However, rather than deducting the interest currently, you may have to add it to the cost basis of the property as explained later under Capitalization of Interest. Free income tax help Statement. Free income tax help   If you paid $600 or more of mortgage interest (including certain points) during the year on any one mortgage, you generally will receive a Form 1098 or a similar statement. Free income tax help You will receive the statement if you pay interest to a person (including a financial institution or a cooperative housing corporation) in the course of that person's trade or business. Free income tax help A governmental unit is a person for purposes of furnishing the statement. Free income tax help   If you receive a refund of interest you overpaid in an earlier year, this amount will be reported in box 3 of Form 1098. Free income tax help You cannot deduct this amount. Free income tax help For information on how to report this refund, see Refunds of interest, later in this chapter. Free income tax help Expenses paid to obtain a mortgage. Free income tax help   Certain expenses you pay to obtain a mortgage cannot be deducted as interest. Free income tax help These expenses, which include mortgage commissions, abstract fees, and recording fees, are capital expenses. Free income tax help If the property mortgaged is business or income-producing property, you can amortize the costs over the life of the mortgage. Free income tax help Prepayment penalty. Free income tax help   If you pay off your mortgage early and pay the lender a penalty for doing this, you can deduct the penalty as interest. Free income tax help Interest on employment tax deficiency. Free income tax help   Interest charged on employment taxes assessed on your business is deductible. Free income tax help Original issue discount (OID). Free income tax help   OID is a form of interest. Free income tax help A loan (mortgage or other debt) generally has OID when its proceeds are less than its principal amount. Free income tax help The OID is the difference between the stated redemption price at maturity and the issue price of the loan. Free income tax help   A loan's stated redemption price at maturity is the sum of all amounts (principal and interest) payable on it other than qualified stated interest. Free income tax help Qualified stated interest is stated interest that is unconditionally payable in cash or property (other than another loan of the issuer) at least annually over the term of the loan at a single fixed rate. Free income tax help You generally deduct OID over the term of the loan. Free income tax help Figure the amount to deduct each year using the constant-yield method, unless the OID on the loan is de minimis. Free income tax help De minimis OID. Free income tax help   The OID is de minimis if it is less than one-fourth of 1% (. Free income tax help 0025) of the stated redemption price of the loan at maturity multiplied by the number of full years from the date of original issue to maturity (the term of the loan). Free income tax help   If the OID is de minimis, you can choose one of the following ways to figure the amount you can deduct each year. Free income tax help On a constant-yield basis over the term of the loan. Free income tax help On a straight-line basis over the term of the loan. Free income tax help In proportion to stated interest payments. Free income tax help In its entirety at maturity of the loan. Free income tax help You make this choice by deducting the OID in a manner consistent with the method chosen on your timely filed tax return for the tax year in which the loan is issued. Free income tax help Example. Free income tax help On January 1, 2013, you took out a $100,000 discounted loan and received $98,500 in proceeds. Free income tax help The loan will mature on January 1, 2023 (a 10-year term), and the $100,000 principal is payable on that date. Free income tax help Interest of $10,000 is payable on January 1 of each year, beginning January 1, 2014. Free income tax help The $1,500 OID on the loan is de minimis because it is less than $2,500 ($100,000 × . Free income tax help 0025 × 10). Free income tax help You choose to deduct the OID on a straight-line basis over the term of the loan. Free income tax help Beginning in 2013, you can deduct $150 each year for 10 years. Free income tax help Constant-yield method. Free income tax help   If the OID is not de minimis, you must use the constant-yield method to figure how much you can deduct each year. Free income tax help You figure your deduction for the first year using the following steps. Free income tax help Determine the issue price of the loan. Free income tax help Generally, this equals the proceeds of the loan. Free income tax help If you paid points on the loan (as discussed later), the issue price generally is the difference between the proceeds and the points. Free income tax help Multiply the result in (1) by the yield to maturity. Free income tax help Subtract any qualified stated interest payments from the result in (2). Free income tax help This is the OID you can deduct in the first year. Free income tax help   To figure your deduction in any subsequent year, follow the above steps, except determine the adjusted issue price in step (1). Free income tax help To get the adjusted issue price, add to the issue price any OID previously deducted. Free income tax help Then follow steps (2) and (3) above. Free income tax help   The yield to maturity is generally shown in the literature you receive from your lender. Free income tax help If you do not have this information, consult your lender or tax advisor. Free income tax help In general, the yield to maturity is the discount rate that, when used in computing the present value of all principal and interest payments, produces an amount equal to the principal amount of the loan. Free income tax help Example. Free income tax help The facts are the same as in the previous example, except that you deduct the OID on a constant yield basis over the term of the loan. Free income tax help The yield to maturity on your loan is 10. Free income tax help 2467%, compounded annually. Free income tax help For 2013, you can deduct $93 [($98,500 × . Free income tax help 102467) − $10,000]. Free income tax help For 2014, you can deduct $103 [($98,593 × . Free income tax help 102467) − $10,000]. Free income tax help Loan or mortgage ends. Free income tax help   If your loan or mortgage ends, you may be able to deduct any remaining OID in the tax year in which the loan or mortgage ends. Free income tax help A loan or mortgage may end due to a refinancing, prepayment, foreclosure, or similar event. Free income tax help If you refinance with the original lender, you generally cannot deduct the remaining OID in the year in which the refinancing occurs, but you may be able to deduct it over the term of the new mortgage or loan. Free income tax help See Interest paid with funds borrowed from original lender under Interest You Cannot Deduct, later. Free income tax help Points. Free income tax help   The term “points” is used to describe certain charges paid, or treated as paid, by a borrower to obtain a loan or a mortgage. Free income tax help These charges are also called loan origination fees, maximum loan charges, discount points, or premium charges. Free income tax help If any of these charges (points) are solely for the use of money, they are interest. Free income tax help   Because points are prepaid interest, you generally cannot deduct the full amount in the year paid. Free income tax help However, you can choose to fully deduct points in the year paid if you meet certain tests. Free income tax help For exceptions to the general rule, see Publication 936. Free income tax help The points reduce the issue price of the loan and result in original issue discount (OID), deductible as explained in the preceding discussion. Free income tax help Partial payments on a nontax debt. Free income tax help   If you make partial payments on a debt (other than a debt owed the IRS), the payments are applied, in general, first to interest and any remainder to principal. Free income tax help You can deduct only the interest. Free income tax help This rule does not apply when it can be inferred that the borrower and lender understood that a different allocation of the payments would be made. Free income tax help Installment purchase. Free income tax help   If you make an installment purchase of business property, the contract between you and the seller generally provides for the payment of interest. Free income tax help If no interest or a low rate of interest is charged under the contract, a portion of the stated principal amount payable under the contract may be recharacterized as interest (unstated interest). Free income tax help The amount recharacterized as interest reduces your basis in the property and increases your interest expense. Free income tax help For more information on installment sales and unstated interest, see Publication 537. Free income tax help Interest You Cannot Deduct Certain interest payments cannot be deducted. Free income tax help In addition, certain other expenses that may seem to be interest but are not, cannot be deducted as interest. Free income tax help You cannot currently deduct interest that must be capitalized, and you generally cannot deduct personal interest. Free income tax help Interest paid with funds borrowed from original lender. Free income tax help   If you use the cash method of accounting, you cannot deduct interest you pay with funds borrowed from the original lender through a second loan, an advance, or any other arrangement similar to a loan. Free income tax help You can deduct the interest expense once you start making payments on the new loan. Free income tax help   When you make a payment on the new loan, you first apply the payment to interest and then to the principal. Free income tax help All amounts you apply to the interest on the first loan are deductible, along with any interest you pay on the second loan, subject to any limits that apply. Free income tax help Capitalized interest. Free income tax help   You cannot currently deduct interest you are required to capitalize under the uniform capitalization rules. Free income tax help See Capitalization of Interest, later. Free income tax help In addition, if you buy property and pay interest owed by the seller (for example, by assuming the debt and any interest accrued on the property), you cannot deduct the interest. Free income tax help Add this interest to the basis of the property. Free income tax help Commitment fees or standby charges. Free income tax help   Fees you incur to have business funds available on a standby basis, but not for the actual use of the funds, are not deductible as interest payments. Free income tax help You may be able to deduct them as business expenses. Free income tax help   If the funds are for inventory or certain property used in your business, the fees are indirect costs and you generally must capitalize them under the uniform capitalization rules. Free income tax help See Capitalization of Interest, later. Free income tax help Interest on income tax. Free income tax help   Interest charged on income tax assessed on your individual income tax return is not a business deduction even though the tax due is related to income from your trade or business. Free income tax help Treat this interest as a business deduction only in figuring a net operating loss deduction. Free income tax help Penalties. Free income tax help   Penalties on underpaid deficiencies and underpaid estimated tax are not interest. Free income tax help You cannot deduct them. Free income tax help Generally, you cannot deduct any fines or penalties. Free income tax help Interest on loans with respect to life insurance policies. Free income tax help   You generally cannot deduct interest on a debt incurred with respect to any life insurance, annuity, or endowment contract that covers any individual unless that individual is a key person. Free income tax help   If the policy or contract covers a key person, you can deduct the interest on up to $50,000 of debt for that person. Free income tax help However, the deduction for any month cannot be more than the interest figured using Moody's Composite Yield on Seasoned Corporate Bonds (formerly known as Moody's Corporate Bond Yield Average-Monthly Average Corporates) (Moody's rate) for that month. Free income tax help Who is a key person?   A key person is an officer or 20% owner. Free income tax help However, the number of individuals you can treat as key persons is limited to the greater of the following. Free income tax help Five individuals. Free income tax help The lesser of 5% of the total officers and employees of the company or 20 individuals. Free income tax help Exceptions for pre-June 1997 contracts. Free income tax help   You can generally deduct the interest if the contract was issued before June 9, 1997, and the covered individual is someone other than an employee, officer, or someone financially interested in your business. Free income tax help If the contract was purchased before June 21, 1986, you can generally deduct the interest no matter who is covered by the contract. Free income tax help Interest allocated to unborrowed policy cash value. Free income tax help   Corporations and partnerships generally cannot deduct any interest expense allocable to unborrowed cash values of life insurance, annuity, or endowment contracts. Free income tax help This rule applies to contracts issued after June 8, 1997, that cover someone other than an officer, director, employee, or 20% owner. Free income tax help For more information, see section 264(f) of the Internal Revenue Code. Free income tax help Capitalization of Interest Under the uniform capitalization rules, you generally must capitalize interest on debt equal to your expenditures to produce real property or certain tangible personal property. Free income tax help The property must be produced by you for use in your trade or business or for sale to customers. Free income tax help You cannot capitalize interest related to property that you acquire in any other manner. Free income tax help Interest you paid or incurred during the production period must be capitalized if the property produced is designated property. Free income tax help Designated property is any of the following. Free income tax help Real property. Free income tax help Tangible personal property with a class life of 20 years or more. Free income tax help Tangible personal property with an estimated production period of more than 2 years. Free income tax help Tangible personal property with an estimated production period of more than 1 year if the estimated cost of production is more than $1 million. Free income tax help Property you produce. Free income tax help   You produce property if you construct, build, install, manufacture, develop, improve, create, raise, or grow it. Free income tax help Treat property produced for you under a contract as produced by you up to the amount you pay or incur for the property. Free income tax help Carrying charges. Free income tax help   Carrying charges include taxes you pay to carry or develop real estate or to carry, transport, or install personal property. Free income tax help You can choose to capitalize carrying charges not subject to the uniform capitalization rules if they are otherwise deductible. Free income tax help For more information, see chapter 7. Free income tax help Capitalized interest. Free income tax help   Treat capitalized interest as a cost of the property produced. Free income tax help You recover your interest when you sell or use the property. Free income tax help If the property is inventory, recover capitalized interest through cost of goods sold. Free income tax help If the property is used in your trade or business, recover capitalized interest through an adjustment to basis, depreciation, amortization, or other method. Free income tax help Partnerships and S corporations. Free income tax help   The interest capitalization rules are applied first at the partnership or S corporation level. Free income tax help The rules are then applied at the partners' or shareholders' level to the extent the partnership or S corporation has insufficient debt to support the production or construction costs. Free income tax help   If you are a partner or a shareholder, you may have to capitalize interest you incur during the tax year for the production costs of the partnership or S corporation. Free income tax help You may also have to capitalize interest incurred by the partnership or S corporation for your own production costs. Free income tax help To properly capitalize interest under these rules, you must be given the required information in an attachment to the Schedule K-1 you receive from the partnership or S corporation. Free income tax help Additional information. Free income tax help   The procedures for applying the uniform capitalization rules are beyond the scope of this publication. Free income tax help For more information, see sections 1. Free income tax help 263A-8 through 1. Free income tax help 263A-15 of the regulations and Notice 88-99. Free income tax help Notice 88-99 is in Cumulative Bulletin 1988-2. Free income tax help When To Deduct Interest If the uniform capitalization rules, discussed under Capitalization of Interest, earlier, do not apply to you, deduct interest as follows. Free income tax help Cash method. Free income tax help   Under the cash method, you can generally deduct only the interest you actually paid during the tax year. Free income tax help You cannot deduct a promissory note you gave as payment because it is a promise to pay and not an actual payment. Free income tax help Prepaid interest. Free income tax help   You generally cannot deduct any interest paid before the year it is due. Free income tax help Interest paid in advance can be deducted only in the tax year in which it is due. Free income tax help Discounted loan. Free income tax help   If interest or a discount is subtracted from your loan proceeds, it is not a payment of interest and you cannot deduct it when you get the loan. Free income tax help For more information, see Original issue discount (OID) under Interest You Can Deduct, earlier. Free income tax help Refunds of interest. Free income tax help   If you pay interest and then receive a refund in the same tax year of any part of the interest, reduce your interest deduction by the refund. Free income tax help If you receive the refund in a later tax year, include the refund in your income to the extent the deduction for the interest reduced your tax. Free income tax help Accrual method. Free income tax help   Under an accrual method, you can deduct only interest that has accrued during the tax year. Free income tax help Prepaid interest. Free income tax help   See Prepaid interest, earlier. Free income tax help Discounted loan. Free income tax help   See Discounted loan, earlier. Free income tax help Tax deficiency. Free income tax help   If you contest a federal income tax deficiency, interest does not accrue until the tax year the final determination of liability is made. Free income tax help If you do not contest the deficiency, then the interest accrues in the year the tax was asserted and agreed to by you. Free income tax help   However, if you contest but pay the proposed tax deficiency and interest, and you do not designate the payment as a cash bond, then the interest is deductible in the year paid. Free income tax help Related person. Free income tax help   If you use an accrual method, you cannot deduct interest owed to a related person who uses the cash method until payment is made and the interest is includible in the gross income of that person. Free income tax help The relationship is determined as of the end of the tax year for which the interest would otherwise be deductible. Free income tax help See section 267 of the Internal Revenue Code for more information. Free income tax help Below-Market Loans If you receive a below-market gift or demand loan and use the proceeds in your trade or business, you may be able to deduct the forgone interest. Free income tax help See Treatment of gift and demand loans, later, in this discussion. Free income tax help A below-market loan is a loan on which no interest is charged or on which interest is charged at a rate below the applicable federal rate. Free income tax help A gift or demand loan that is a below-market loan generally is considered an arm's-length transaction in which you, the borrower, are considered as having received both the following. Free income tax help A loan in exchange for a note that requires the payment of interest at the applicable federal rate. Free income tax help An additional payment in an amount equal to the forgone interest. Free income tax help The additional payment is treated as a gift, dividend, contribution to capital, payment of compensation, or other payment, depending on the substance of the transaction. Free income tax help Forgone interest. Free income tax help   For any period, forgone interest is The 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 Any interest actually payable on the loan for the period. Free income tax help Applicable federal rates are published by the IRS each month in the Internal Revenue Bulletin. Free income tax help Internal Revenue Bulletins are available on the IRS web site at www. Free income tax help irs. Free income tax help gov/irb. Free income tax help You can also contact an IRS office to get these rates. Free income tax help Loans subject to the rules. Free income tax help   The rules for below-market loans apply to the following. Free income tax help Gift loans (below-market loans where the forgone interest is in the nature of a gift). Free income tax help Compensation-related loans (below-market loans between an employer and an employee or between an independent contractor and a person for whom the contractor provides services). Free income tax help Corporation-shareholder loans. Free income tax help Tax avoidance loans (below-market loans where the avoidance of federal tax is one of the main purposes of the interest arrangement). Free income tax help Loans to qualified continuing care facilities under a continuing care contract (made after October 11, 1985). Free income tax help   Except as noted in (5) above, these rules apply to demand loans (loans payable in full at any time upon the lender's demand) outstanding after June 6, 1984, and to term loans (loans that are not demand loans) made after that date. Free income tax help Treatment of gift and demand loans. Free income tax help   If you receive a below-market gift loan or demand loan, you are treated as receiving an additional payment (as a gift, dividend, etc. Free income tax help ) equal to the forgone interest on the loan. Free income tax help You are then treated as transferring this amount back to the lender as interest. Free income tax help These transfers are considered to occur annually, generally on December 31. Free income tax help If you use the loan proceeds in your trade or business, you can deduct the forgone interest each year as a business interest expense. Free income tax help The lender must report it as interest income. Free income tax help Limit on forgone interest for gift loans of $100,000 or less. Free income tax help   For gift loans between individuals, forgone interest treated as transferred back to the lender is limited to the borrower's net investment income for the year. Free income tax help This limit applies if the outstanding loans between the lender and borrower total $100,000 or less. Free income tax help If the borrower's net investment income is $1,000 or less, it is treated as zero. Free income tax help This limit does not apply to a loan if the avoidance of any federal tax is one of the main purposes of the interest arrangement. Free income tax help Treatment of term loans. Free income tax help   If you receive a below-market term loan other than a gift or demand loan, you are treated as receiving an additional cash payment (as a dividend, etc. Free income tax help ) on the date the loan is made. Free income tax help This payment is equal to the loan amount minus the present value, at the applicable federal rate, of all payments due under the loan. Free income tax help The same amount is treated as original issue discount on the loan. Free income tax help See Original issue discount (OID) under Interest You Can Deduct, earlier. Free income tax help Exceptions for loans of $10,000 or less. Free income tax help   The rules for below-market loans do not apply to any day on which the total outstanding loans between the borrower and lender is $10,000 or less. Free income tax help This exception applies only to the following. Free income tax help Gift loans between individuals if the loan is not directly used to buy or carry income-producing assets. Free income tax help Compensation-related loans or corporation-shareholder loans if the avoidance of any federal tax is not a principal purpose of the interest arrangement. Free income tax help This exception does not apply to a term loan described in (2) above that was previously subject to the below-market loan rules. Free income tax help Those rules will continue to apply even if the outstanding balance is reduced to $10,000 or less. Free income tax help Exceptions for loans without significant tax effect. Free income tax help   The following loans are specifically exempted from the rules for below-market loans because their interest arrangements do not have a significant effect on the federal tax liability of the borrower or the lender. Free income tax help Loans made available by lenders to the general public on the same terms and conditions that are consistent with the lender's customary business practices. Free income tax help Loans subsidized by a federal, state, or municipal government that are made available under a program of general application to the public. Free income tax help Certain employee-relocation loans. Free income tax help Certain loans to or from a foreign person, unless the interest income would be effectively connected with the conduct of a U. Free income tax help S. Free income tax help trade or business and not exempt from U. Free income tax help S. Free income tax help tax under an income tax treaty. Free income tax help Any other loan if the taxpayer can show that the interest arrangement has no significant effect on the federal tax liability of the lender or the borrower. Free income tax help Whether an interest arrangement has a significant effect on the federal tax liability of the lender or the borrower will be determined by all the facts and circumstances. Free income tax help Consider all the following factors. Free income tax help Whether items of income and deduction generated by the loan offset each other. Free income tax help The amount of the items. Free income tax help The cost of complying with the below-market loan provisions if they were to apply. Free income tax help Any reasons, other than taxes, for structuring the transaction as a below-market loan. Free income tax help Exception for loans to qualified continuing care facilities. Free income tax help   The below-market interest rules do not apply to a loan owed by a qualified continuing care facility under a continuing care contract if the lender or lender's spouse is age 62 or older by the end of the calendar year. Free income tax help A qualified continuing care facility is one or more facilities (excluding nursing homes) meeting the requirements listed below. Free income tax help Designed to provide services under continuing care contracts (defined below). Free income tax help Includes an independent living unit, and either an assisted living or nursing facility, or both. Free income tax help Substantially all of the independent living unit residents are covered by continuing care contracts. Free income tax help A continuing care contract is a written contract between an individual and a qualified continuing care facility that includes all of the following conditions. Free income tax help The individual or individual's spouse must be entitled to use the facility for the rest of their life or lives. Free income tax help The individual or individual's spouse will be provided with housing, as appropriate for the health of the individual or individual's spouse in an: independent living unit (which has additional available facilities outside the unit for the provision of meals and other personal care), and assisted living or nursing facility available in the continuing care facility. Free income tax help The individual or individual's spouse will be provided with assisted living or nursing care available in the continuing care facility, as required for the health of the individual or the individual's spouse. Free income tax help For more information, see section 7872(h) of the Internal Revenue Code. Free income tax help Sale or exchange of property. Free income tax help   Different rules generally apply to a loan connected with the sale or exchange of property. Free income tax help If the loan does not provide adequate stated interest, part of the principal payment may be considered interest. Free income tax help However, there are exceptions that may require you to apply the below-market interest rate rules to these loans. Free income tax help See Unstated Interest and Original Issue Discount (OID) in Publication 537. Free income tax help More information. Free income tax help   For more information on below-market loans, see section 7872 of the Internal Revenue Code and section 1. Free income tax help 7872-5 of the regulations. Free income tax help Prev  Up  Next   Home   More Online Publications