Unearned Income

Unearned Income - An individual's income derived from means other than the provision of personal efforts (Salaries), such as that derived as dividend, interest, or rent. Pensions and royalties, however, are not considered unearned income.

Examples of unearned income include interest from a saving account, bond interest, tips, alimony, and dividends from stock. As long as this income is "realized" then it is taxable.

Interest

Interest is money paid or received for the use of money. Banks pay interest on money their customers deposit; governments and corporations pay interest on bonds they issue; insurance companies pay interest on money left on deposit. The sources of interest income are almost unlimited. Most of the interest we received is taxable, but some is not. See  Form 1099-INT.

Payers of interest of $10 or more to any one person during the year generally required to report such payments to the IRS and furnish the recipient with a statement of total interest received for the tax year. If less than $10 interest was received from any payer, that interest is also taxable to the taxpayer, even though a reporting form is not required from the payer. In some cases, especially with loans or contracts, the taxpayer must determine the amount received from his own records (for example, from an amortization schedule).

When the taxpayer receives taxable interest totaling more than $400, it must be listed on either Form 1040A, Schedule 1, or Form 1040, Schedule B. Interest totaling $400 or less can be listed in the Interest Income section of the Income Compilation Worksheet.

If a taxpayer sells his home to a buyer who uses the home as his residence, and the seller finances part or all of the mortgage, the seller must report the interest he receives each year on Schedule B, Form 1040, or Schedule 1, Form 1040A. Additionally, the seller must report the buyer's name, address, and social security number on Schedule B or Schedule 1. The seller is also required to provide the buyer with his name, address, and social security number.  

EDUCATION SAVING BOND PROGRAM

Treasury Bills, notes and bonds are direct obligations of the Treasury. T.Bills mature in one year or less, and are taxed at maturity . Most other treasury obligations are taxed as the interest is earned.

If a Treasury obligation is redeemed before maturity, the taxpayer may be forced to forfeit some of the interest earned.

By federal law, interest from U.S. Treasury obligations is never subject to state or local income taxes.

Educational Saving Bond Program

Some taxpayers can avoid paying tax on certain bond interest when they use the funds to pay for college expenses. If a taxpayer cashes qualified Series EE or Series I bonds and uses the money, or an equivalent amount from other sources, to pay qualified higher education costs for himself, his spouse, or his dependents, the interest will escape taxation, provided the taxpayer's income doesn't exceed certain levels. The exclusion is phased out for higher-income taxpayers. Qualified tuition and fees must be reduced by the amount of any nontaxable scholarships or fellowships used by the student.

To qualify for the exclusion, the bonds must be issued after 1989 and must have been purchased by an individual who was at least 24 years old on or before the bond's issue date. Gift bonds, however, don't qualify. For example, if the taxpayer purchases the bonds and puts them in his child's name, the exclusion is lost even if the child later redeems the bonds to pay college tuition. The same is true if the child's grandparents, for example, purchase the bonds and give them to the child's parents.

Example: Adriano Yosores, a grandfather, purchased Series EE bonds and gave them to her daughter on the condition that the proceeds of the bonds be used for her granddaughter college education. These bonds would not qualify for the exclusion. Adriano would be wiser to give the money to her daughter and have her daughter purchase the bonds, thus making them eligible for the exclusion when the granddaughter goes to college, assuming all other qualifications are met.Note: Adriano's granddaughter may, if she owns the bonds and if she qualifies, elect to report the interest income annually, as discussed earlier. This strategy may reduce or eliminate his overall tax burden regarding bonds. 

Exclusion - Specific condition, circumstance, or situation usually listed in a contract as being not covered. All contracts (including insurance policies and construction contracts) contain exclusions, expressly or by implication.

Who May Take the Exclusion

You may take the exclusion if all four of the following apply:

1. You cashed qualified U.S. savings bonds in 1999 that were issued after 1989
2. You paid qualified higher education expenses in 1999 for yourself, your spouse, or your dependents.
3. Your filing status is any status except married filing separately.
4. Your modified AGI (adjusted gross income) is less tha: $68,100 if single or head of household; $109,650 if married filing jointly or qualifying widow(er).

Note: The amount above subject to change (that is only example for 1999 tax year). It depend the amount of current year.

U.S. Savings Bonds That Qualify for Exclusion

To qualify for the exclusion, the bonds must be series EE or I U.S. savings bonds issued after 1989 in your name, or, if you are married, they may be issued in your name and your spouse's name. Also, you must have been age 24 or older before the bonds were issued. A bond bought by a parent and issued in the name of his or her child under age 24 does not qualify for the exclusion by the parent or child.

Gross Income

Record-keeping Requirements

Keep the following to verify the amount of interest you excluded.

• Bill, receipts, canceled checks, or other documents showing you paid qualified higher education expenses in 1999.
• A written record of each post-1989 series EE or I bond that you cash. Your record must include the serial number, issued date, face exceeds these levels. It also isn't available for taxpayers using the married filing separately status. 

MODIFIED ADJUSTED GROSS INCOME

Modified adjusted gross income is an employee's adjusted gross income for a tax year, plus any tax exempt interest they have earned.The taxpayer's adjusted gross income, and is then modified for each individual purpose.

MAGI, for purposes of the U.S. Savings Bonds exclusion, is usually computed in the same manner as the regular AGI. However, the amount of interest included in MAGI is the amount before any qualified bond exclusion has been subtracted. Any student loan interest deduction shown Form 1040, must be added back, and any employer-provided adoption benefits which were excluded from income must be added in. Also, certain taxpayers must add back the foreign earned income exclusion, the foreign housing exclusion or deduction, the exclusion for income from certain U.S. possessions, and the exclusion for income from sources within Puerto Rico.

Other Interest Income

Municipal bonds are generally issued by state and local government to fund capital improvement projects. Local government include countries, cities, school district, and other administrative divisions of the states that have been granted the authority to issue bonds. The federal government does not tax municipal bond interest.

Some state and local governments do not tax interest from any municipal bonds. Others tax interest from municipal bonds issued by state or local governments other than their own. Other states tax interest from all municipal bonds, including their own.

Tax-exempt interest is reported on Forms 1040A and 1040, but must be kept separate from taxable interest so it is not included in taxable income. Tax-exempt interest is reported on line 8b, Form 1040A or Form 1040.

If the taxpayer received a Form 1099-INT for ta-exempt interest, include the tax-exempt interest with other interest items.

Interest Penalty on Early Withdrawal of Savings

If money in a time savings (such as a certificate of deposit) is withdrawn before maturity, interest may revert to a lower rate for the year of withdrawal and there may also be a period when no interest is paid. The difference (the amount of interest forfeited) will be reported as an early withdrawal penalty in Box 2 on Form 1099-INT or similar statement. It's possible that the penalty could be more than the gross amount of interest reported in Box 1.

The interest penalty is entered on line 30, Form 1040, ans is subtracted from total income. Form 1040A cannot be used. The interest reported on Form 1099-INT is the amount that was received for the tax year up to the date of withdrawal.

Form 1099-INT-Interest Income

RECIPIENTS identification number is the social security number of the owner of the account.

Box 1. This box includes amounts that are paid or credited to the taxpayer's account by savings and loan associations, building and loan associations, cooperative banks, homestead associations, credit unions, and similar organizations.

It includes interest on bank deposits, corporate bonds, debentures, notes, certificate, stockholder's accounts, and any interest paid in the course of trade or business totaling $600 or more to any one individual.

Box 2. The early withdrawal penalty is the interest penalty due to an early withdrawal of time deposits. It is entered on line 30, Form 1040. It does not affect the entry of interest income from Box 1.

Box 3. Interest from U.S. Savings Bonds and Treasury obligations is entered here Generally, this income is taxable on the federal return, but nontaxable on state returns. Box-3 amounts are entered on the federal return in the same manner as Box-1 amounts.

Box 4. Usually, tax isn't withheld from interest payments. However, if the taxpayer has failed to provide the payer with this social security or other identifying number, the payer is required to withhold 31 percent of the interest paid. Any amount withheld is entered in Box 4.

Box 5. Any amount shown in this box is the taxpayer's share of investment expenses from a real estate mortgage investment conduit (REMIC). A REMIC is a corporation similar to a mutual fund that invests in mortgage. If the taxpayer itemizes, he may deduct this amount as an itemized deduction.

Box 6. Foreign tax paid is any foreign tax withheld from the interest income. The taxpayer mat take a dollar-for-dollar credit for this tax, or deduct it from his taxable income as an itemized deduction.

Box 7. Foreign country or U.S. possession is the country or possession to which  the foreign tax was paid.

DIVIDENDS

Dividends are paid to shareholders (people who own stock) of corporations. They represent the shareholder's portion of the corporation's profits. In this section you'll learn about the various kinds of dividends shareholder may receive, and their tax treatment. 

Note: Certain distributions commonly referred to as dividends are actually interest. These so-called "dividends" must be reported as interest. The most common example is "dividends" paid by credit unions.

Payers of dividends of $10 or more to any one person during the year required to report such payments to the IRS and furnish the recipient with a statement of total dividends receives for the tax year. Form 1099-DIV

The three most common types of distributions are:

1. Ordinary dividends (Box 1);
2. Capital gain distributions (Box 2a); and
3. Nontaxable distributions (Box 3).

Ordinary dividends are the most common type of distribution and are the portion of a corporation's profits paid to the shareholders. Ordinary dividends are fully taxable. 

Capital gain distributions are paid by mutual funds, regulated investment companies, and real estate investment trusts. They represent the shareholder's portion of gain from the sale of securities owned by these investment companies. There are two treatments of capital gain distributions. Both types of capital gain distributions are taxable for the year constructively received.

• Distributed capital gains are paid in cash to the shareholders or reinvested in additional shares at the shareholders' request.
• Undistributed capital gains are retained by the investment company, which pays the tax on them. These gains are reinvested automatically in additional shares and reported to the taxpayer of Form 2439 rather than on Form 1099-DIV. An individual who receives Form 2439 may have a credit to be entered on line 63, Form 1040, for tax paid by the investment company.

Nontaxable distributions are a return of the shareholder's capital (original investment), generally made because an excess amount of capital has been accumulated by the corporation. Nontaxable distributions may be received in cash or reinvested at the shareholder's request to acquire additional shares. The basis (usually the cost) of the stock must be reduced by the amount of the distribution. Amounts received are not taxable until the remaining basis is reduced to zero.

CAPITAL GAIN TAX COMPUTATION

Capital gain distributions (those found in Box 2a, Form 1099-DIV) are treated as long-term capital gains regardless of the period of time the shareholder owned an interest in the fund. Long-term capital gains are generally taxed at different rates than short-term gains and other ordinary income, and the several types of capital gain (such as those found in Boxes 2b, 2c, and 2d on Form 1099-DIV) are themselves taxed at different tax rates.

ALIMONY

Alimony is a payment made to a person by court decree as a result of divorce or separation. If the taxpayer is receiving taxable alimony, it's included in income on line 11, Form 1040. Payment of taxable alimony is deducted by the payer as an adjustment to income on line 31a, Form 1040. Enter the recipient's social security number in the space provided next to line 31a.

Qualifications

If alimony is deductible by the person who pays it, it is taxable income to the person who receives it. The rules governing whether alimony is deductible by the payer and taxable to the recipient depend on when the divorce or separation agreement was established. The rules discussed here apply to divorce and separation agreements established after 1984. If you ever need to know the rules for agreements established prior to 1985, you'll need to do some research.

COMMUNITY PROPERTY STATES

In community property states, payments to a separated spouse (as opposed to a divorced spouse) are deductible only when the amount exceeds the spouse's share of the community property income; for example, if the spouse's share of community property income is $20,000, and the alimony received and the remaining $20,000 is reported as other gross income. Only $2,000 is deductible by the spouse paying the alimony.

Payments That Are Not Alimony

The term alimony may be used in a decree to describe payments that do not meet the tax deductible requirements of alimony. Property settlements, payments not required by the decree or agreements, and payments not arising from the marital relationship (for example, a bona fide loan from one spouse to the other spouse)

CHILD SUPPORT

Payments that are specifically designated in the decree or agreement as support for minor children are child support and not alimony. These payments are neither deductible by the payer nor taxable to the recipient.

Sometimes amounts not specifically stated in the decree to be child support will nonetheless be treated as child support. This happens when payments are reduced or eliminated upon the occurrence of a contingency relating to the child, or at a time that is clearly associated with the contingency.

Example: Peter Simson's divorce decree states he will pay his ex-wife $500 per month until their son reaches age 21. Although the divorce decree does not specifically state that the $500 per month is child support, it will be so treated because it will cease upon the contingency of the son's 21st birthday.

When the divorce decree does not set a specific amount for child support, and no child-related contingencies are involved, the entire payment is alimony.

Example: Rolly and Gina Martin are divorced. Gina has custody of the couple's two children. Their divorce decree states only that Rolly will pay Gina $1,500 per month. Because the decree does not stipulate a specific amount as child support, and no child-related contingencies are involved, the entire amount is considered alimony.

When alimony and child support payments are both required by a decree, child support is always considered to be paid first.

Example: A taxpayer is required to make payments of $900 per month until the death or remarriage of his spouse. The decreed designates $600 pf this amount as alimony and $300 as child support. The taxpayer sends only $9,000 in total payments for the year. The alimony deduction for that year is $5,400 because the $3,600 designated as child support by the decree is considered to be paid first.

On occasion, alimony may include the payment of expenses of a personal residence, such as real estate taxes, insurance, interest, and utilities. The facts in each situation determine the amount deductible by one spouse and taxable to the other spouse.

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MISCELLANEOUS INCOME

MISCELLANEOUS INCOME

Miscellaneous income includes various types of income that do not have specific lines of entry on Form 1040. Such income is generally reported on line 21, Form 1040, as "other income" Form 1040A or 1040EZ can not be used to report these types of income. Some common examples are gambling winnings, prizes, awards, jury duty fees, fees paid to election judges, and feespaid to nonprofessional executors of trusts and estates.

Some employers require their employees to surrender any jury duty pay they receive in exchange for their regular wages. Always ask a taxpayer imposes this requirement on its employees.

Employees in this situation must report their jury duty pay as income on line 21, Form 1040, in the usual manner. They may then back it out as a write-in adjustment to income on line 32, Form 1040.

Gambling Winnings

The gross amount of a taxpayer's gambling winning is taxable. Gambling losses may not be "netted out" of the gross winnings. Gambling losses may be deducted only as an itemized deduction on schedule A and only to the extent of winnings.

Withholding of income tax from certain gambling winnings is required. If a taxpayer had gambling winnings from which tax was withheld, he will have a Form W-2g which should be attached to, and filed with, Form 1040. Winnings are reported on line 21, Form 1040. The tax withheld is included with taxes withheld from Form W-2 on line 57, Form 1040. 

Hobby Income

Gross income from a hobby is taxable and is reported on line 21, Form 1040. Expenses to the extent of hobby income, are deductible as a miscellaneous itemized deduction on Schedule A.

Barter Income

Barter income (the value of property or services a taxpayer receives in exchange for property or services rendered) and kickbacks (amounts received for referrals) are taxable miscellaneous income or may be self-emplyment income.

NONTAXABLE INCOME

Only income that is specifically exempt from tax is nontaxable. Income that is specifically exempt includes welfare benefits, gifts, most bequests and inheritances, workers compensation, and most veterans' benefits.

Scholarship and Fellowships

Some scholarships are nontaxable. But first, we'll those scholarships that are taxable.

A degree candidate will follow this same procedure of reporting any scholarship income spent for, or designated for, room and board. However, he does not need to report scholarship money spent for tuition, fees, and course-required books, supplies, and equipment. These amounts are excludable from gross income. The recipient is responsible for determining whether the grant from gross income. The recipient is responsible for determining whether the grant was used for qualified tuition and related expenses.