| Pub. 525, Taxable and Nontaxable Income |
2004 Tax Year |
Main Contents
This is archived information that pertains only to the 2004 Tax Year. If you
are looking for information for the current tax year, go to the Tax Prep Help Area.
Generally, you must include in gross income everything you receive in payment for personal services. In addition to wages,
salaries, commissions,
fees, and tips, this includes other forms of compensation such as fringe benefits and stock options.
You should receive a Form W-2, Wage and Tax Statement, from your employer showing the pay you
received for your services. Include your pay on line 7 of Form 1040 or Form 1040A or on line 1 of Form 1040EZ, even if you
do not receive a Form W-2.
Childcare providers.
If you provide child care, either in the child's home or in your home or other place of business, the pay you receive
must be included in your
income. If you are not an employee, you are probably self-employed and must include payments for your services on Schedule
C (Form 1040), Profit or
Loss From Business, or Schedule C-EZ (Form 1040), Net Profit From Business. You generally are not an employee unless you are
subject to the will and
control of the person who employs you as to what you are to do and how you are to do it.
Baby-sitting.
If you baby-sit for relatives or neighborhood children, whether on a regular basis or only periodically, the rules
for childcare providers apply to
you.
Miscellaneous Compensation
This section discusses many types of employee compensation. The subjects are arranged in alphabetical order.
Advance commissions and other earnings.
If you receive advance commissions or other amounts for services to be performed in the future and you are a cash-method
taxpayer, you must include
these amounts in your income in the year you receive them.
If you repay unearned commissions or other amounts in the same year you receive
them, reduce the amount included in your income by the repayment. If you repay them in a later tax year, you can deduct the
repayment as an itemized
deduction on your Schedule A (Form 1040), or you may be able to take a credit for that year. See Repayments, later.
Allowances and reimbursements.
If you receive travel, transportation, or other business expense allowances or reimbursements from your
employer, see Publication 463, Travel, Entertainment, Gift, and Car Expenses. If you are reimbursed for moving expenses, see
Publication 521, Moving
Expenses.
Back pay awards.
Include in income amounts you are awarded in a settlement or judgment for back pay. These include payments made to
you for damages, unpaid life
insurance premiums, and unpaid health insurance premiums. They should be reported to you by your employer on Form W-2.
Bonuses and awards.
Bonuses or awards you receive for outstanding work are included in your income and should be shown on your
Form W-2. These include prizes such as vacation trips for meeting sales goals. If the prize or award you receive is goods
or services, you must
include the fair market value of the goods or services in your income. However, if your employer merely promises to pay you
a bonus or award at some
future time, it is not taxable until you receive it or it is made available to you.
Employee achievement award.
If you receive tangible personal property (other than cash, a gift certificate, or an equivalent item) as an award
for length-of-service or safety
achievement, you generally can exclude its value from your income. However, the amount you can exclude is limited to your
employer's cost and cannot
be more than $1,600 ($400 for awards that are not qualified plan awards) for all such awards you receive during the year.
Your employer can tell you
whether your award is a qualified plan award. Your employer must make the award as part of a meaningful presentation, under
conditions and
circumstances that do not create a significant likelihood of it being disguised pay.
However, the exclusion does not apply to the following awards.
-
A length-of-service award if you received it for less than 5 years of service or if you received another length-of-service
award during the
year or the previous 4 years.
-
A safety achievement award if you are a manager, administrator, clerical employee, or other professional employee or if more
than 10% of
eligible employees previously received safety achievement awards during the year.
Example.
Ben Green received three employee achievement awards during the year: a nonqualified plan award of a watch valued at $250,
and two qualified plan
awards of a stereo valued at $1,000 and a set of golf clubs valued at $500. Assuming that the requirements for qualified plan
awards are otherwise
satisfied, each award by itself would be excluded from income. However, because the $1,750 total value of the awards is more
than $1,600, Ben must
include $150 ($1,750 - $1,600) in his income.
Government cost-of-living allowances.
Cost-of-living allowances generally are included in your income. However, they are not included in your income if
you are a federal civilian
employee or a federal court employee who is stationed in Alaska, Hawaii, or outside the United States.
Allowances and differentials that increase your basic pay as an incentive for taking a less desirable post of duty
are part of your compensation
and must be included in income. For example, your compensation includes Foreign Post, Foreign Service, and Overseas Tropical
differentials. For more
information, see Publication 516, U.S. Government Civilian Employees Stationed Abroad.
Note received for services.
If your employer gives you a secured note as payment for your services, you must include the fair market value (usually
the discount value) of the
note in your income for the year you receive it. When you later receive payments on the note, a proportionate part of each
payment is the recovery of
the fair market value that you previously included in your income. Do not include that part again in your income. Include
the rest of the payment in
your income in the year of payment.
If your employer gives you a nonnegotiable unsecured note as payment for your services, payments on the note that
are credited toward the principal
amount of the note are compensation income when you receive them.
Severance pay.
Amounts you receive as severance pay are taxable. A lump-sum payment for cancellation of your employment contract
must be included in your income
in the tax year you receive it.
Accrued leave payment.
If you are a federal employee and receive a lump-sum payment for accrued annual leave when you retire or resign, this
amount will be included as
wages on your Form W-2.
If you resign from one agency and are reemployed by another agency, you may have to repay part of your lump-sum annual
leave payment to the second
agency. You can reduce gross wages by the amount you repaid in the same tax year in which you received it. Attach to your
tax return a copy of the
receipt or statement given to you by the agency you repaid to explain the difference between the wages on your return and
the wages on your Forms W-2.
Outplacement services.
If you choose to accept a reduced amount of severance pay so that you can receive outplacement services (such as training
in résumé
writing and interview techniques), you must include the unreduced amount of the severance pay in income.
However, you can deduct the value of these outplacement services (up to the difference
between the severance pay included in income and the amount actually received) as a miscellaneous deduction (subject to the
2% limit) on Schedule A
(Form 1040).
Sick pay.
Pay you receive from your employer while you are sick or injured is part of your salary or wages. In addition, you
must include in your income sick
pay benefits received from any of the following payers.
-
A welfare fund.
-
A state sickness or disability fund.
-
An association of employers or employees.
-
An insurance company, if your employer paid for the plan.
However, if you paid the premiums on an accident or health insurance policy, the benefits you receive under the policy are
not taxable. For
more information, see Other Sickness and Injury Benefits under Sickness and Injury Benefits, later.
Social security and Medicare taxes paid by employer.
If you and your employer have an agreement that your employer pays your social security and Medicare taxes without
deducting them from your gross
wages, you must report the amount of tax paid for you as taxable wages on your tax return. The payment is also treated as
wages for figuring your
social security and Medicare taxes and your social security and Medicare benefits. However, these payments are not treated
as social security and
Medicare wages if you are a household worker or a farm worker.
Stock appreciation rights.
Do not include a stock appreciation right granted by your employer in income until you exercise (use) the right. When
you use the right, you are
entitled to a cash payment equal to the fair market value of the corporation's stock on the date of use, minus the fair market
value on the date the
right was granted. You include the cash payment in income in the year you use the right.
Fringe benefits received in connection with the performance of your services are included in your income as compensation unless
you pay fair market
value for them or they are specifically excluded by law. Abstaining from the performance of services (for example, under a
covenant not to compete) is
treated as the performance of services for purposes of these rules.
See Valuation of Fringe Benefits, later in this discussion, for information on how to determine the amount to include in income.
Recipient of fringe benefit.
You are the recipient of a fringe benefit if you perform the services for which the fringe benefit is provided. You
are considered to be the
recipient even if it is given to another person, such as a member of your family. An example is a car your employer gives
to your spouse for services
you perform. The car is considered to have been provided to you and not to your spouse.
You do not have to be an employee of the provider to be a recipient of a fringe benefit. If you are a partner, director,
or independent contractor,
you can also be the recipient of a fringe benefit.
Provider of benefit.
Your employer or another person for whom you perform services is the provider of a fringe benefit regardless of whether
that person actually
provides the fringe benefit to you. The provider can be a client or customer of an independent contractor.
Accounting period.
You must use the same accounting period your employer uses to report your taxable noncash fringe benefits. Your employer
has the option to report
taxable noncash fringe benefits by using either of the following rules.
-
The general rule: benefits are reported for a full calendar year (January 1 – December 31).
-
The special accounting period rule: benefits provided during the last 2 months of the calendar year (or any shorter period)
are treated as
paid during the following calendar year. For example, each year your employer reports the value of benefits provided during
the last 2 months of the
prior year and the first 10 months of the current year.
Your employer does not have to use the same accounting period for each fringe benefit, but must use the same period for all
employees who
receive a particular benefit.
You must use the same accounting period that you use to report the benefit to claim an employee business deduction
(for use of a car, for example).
Form W-2.
Your employer reports your taxable fringe benefits in box 1 (Wages, tips, other compensation) of Form W-2. The total
value of your fringe benefits
may also be noted in box 12. The value of your fringe benefits may be added to your other compensation on one Form W-2, or
you may receive a separate
Form W-2 showing just the value of your fringe benefits in box 1 with a notation in box 12.
Generally, the value of accident or health plan coverage provided to you by your employer is not included in your income.
Benefits you receive from
the plan may be taxable, as explained, later, under Sickness and Injury Benefits.
Long-term care coverage.
Contributions by your employer to provide coverage for long-term care services generally are not included in your
income. However, contributions
made through a flexible spending or similar arrangement (such as a cafeteria plan) must be included in your income. This amount
will be reported as
wages in box 1 of your Form W-2.
Archer MSA contributions.
Contributions by your employer to your Archer MSA generally are not
included in your income. Their total will be reported in box 12 of Form W-2, with code R. You must report this amount on Form
8853, Archer MSAs and
Long-Term Care Insurance Contracts. File the form with your return.
Health flexible spending arrangement (health FSA).
If your employer provides a health FSA that qualifies as an accident or health plan, the amount of your salary reduction,
and reimbursements of
your medical care expenses and those of your spouse and dependents, generally are not included in your income.
Health reimbursement arrangement (HRA).
If your employer provides an HRA that qualifies as an accident or health plan, coverage and reimbursements of your
medical care expenses and those
of your spouse and dependents generally are not included in your income.
See also Reimbursement for medical care under Other Sickness and Injury Benefits, later.
You may be able to exclude from your income amounts paid or expenses incurred by your employer for qualified adoption expenses
in connection with
your adoption of an eligible child. See Publication 968, Tax Benefits for Adoption, for more information.
Adoption benefits are reported by your employer in box 12 of Form W-2 with code T. They also are
included as social security and Medicare wages in boxes 3 and 5. However, they are not included as wages in box 1. To determine
the taxable and
nontaxable amounts, you must complete Part III of Form 8839, Qualified Adoption Expenses. File the form with your return.
If your employer provides you with the free or low-cost use of an employer-operated gym or other athletic club on your employer's
premises, the
value is not included in your compensation. The gym must be used primarily by employees, their spouses, and their dependent
children.
If your employer pays for a fitness program provided to you at an off-site resort hotel or athletic club, the value of the
program is included in
your compensation.
De Minimis (Minimal) Benefits
If your employer provides you with a product or service and the cost of it is so small that it would be unreasonable for the
employer to account
for it, the value is not included in your income. Generally, the value of benefits such as discounts at company cafeterias,
cab fares home when
working overtime, and company picnics are not included in your income. Also see Employee Discounts, later.
Holiday gifts.
If your employer gives you a turkey, ham, or other item of nominal value at Christmas or other holidays, do not include
the value of the gift in
your income. However, if your employer gives you cash, a gift certificate, or a similar item that you can easily exchange
for cash, you include the
value of that gift as extra salary or wages regardless of the amount involved.
If your employer provides dependent care benefits under a qualified plan, you may be able to exclude these benefits from your
income. Dependent
care benefits include:
-
Amounts your employer pays directly to either you or your care provider for the care of your qualifying person while you work,
and
-
The fair market value of care in a daycare facility provided or sponsored by your employer.
The amount you can exclude is limited to the lesser of:
-
The total amount of dependent care benefits you received during the year,
-
The total amount of qualified expenses you incurred during the year,
-
Your earned income,
-
Your spouse's earned income, or
-
$5,000 ($2,500 if married filing separately).
Your employer must show the total amount of dependent care benefits provided to you during the year under a qualified plan
in box 10 of your Form
W-2. Your employer also will include any dependent care benefits over $5,000 in your wages shown in box 1 of your Form W-2.
To claim the exclusion, you must complete either Part III of Form 2441, Child and
Dependent Care Expenses, or Part III of Schedule 2 (Form 1040A), Child and Dependent Care Expenses for Form 1040A Filers.
(You cannot use Form
1040EZ.)
See the instructions for Form 2441 or Schedule 2 (Form 1040A) for more information.
You can exclude from your income up to $5,250 of qualified employer-provided educational assistance. The exclusion applies
to undergraduate and
graduate-level courses. For more information, see Publication 970.
If your employer sells you property or services at a discount, you may be able to exclude the amount of the discount from
your income. The
exclusion applies to discounts on property or services offered to customers in the ordinary course of the line of business
in which you work. However,
it does not apply to discounts on real property or property commonly held for investment (such as stocks or bonds).
The exclusion is limited to the price charged nonemployee customers multiplied by the following percentage.
-
For a discount on property, your employer's gross profit percentage (gross profit divided by gross sales) on all property
sold during the
employer's previous tax year. (Ask your employer for this percentage.)
-
For a discount on services, 20%.
Financial Counseling Fees
Financial counseling fees paid for you by your employer are included in your income and must be
reported as part of wages. If the fees are for tax or investment counseling, they can be deducted on Schedule A (Form 1040)
as a miscellaneous
deduction (subject to the 2% limit).
Qualified retirement planning services paid for you by your employer may be excluded from your
income. For more information, see Retirement Planning Services, later.
Group-Term Life Insurance
Generally, the cost of up to $50,000 of group-term life insurance coverage provided to you by your employer (or former employer)
is not included in
your income. However, you must include in income the cost of employer-provided insurance that is more than the cost of $50,000
of coverage reduced by
any amount you pay toward the purchase of the insurance.
For exceptions to this rule, see Entire cost excluded, and Entire cost taxed, later.
If your employer provided more than $50,000 of coverage, the amount included in your income is reported as part of your wages
in box 1 of your Form
W-2. It is also shown separately in box 12 with code C.
Group-term life insurance.
This insurance is term life insurance protection (insurance for a fixed period of time) that:
-
Provides a general death benefit,
-
Is provided to a group of employees,
-
Is provided under a policy carried by the employer, and
-
Provides an amount of insurance to each employee based on a formula that prevents individual selection.
Permanent benefits.
If your group-term life insurance policy includes permanent benefits, such as a paid-up or cash surrender value, you
must include in your income,
as wages, the cost of the permanent benefits minus the amount you pay for them. Your employer should be able to tell you the
amount to include in your
income.
Accidental death benefits.
Insurance that provides accidental or other death benefits but does not provide general death benefits (travel insurance,
for example) is not
group-term life insurance.
Former employer.
If your former employer provides more than $50,000 of group-term life insurance coverage during the year, the amount
included in your income is
reported as wages in box 1 of Form W-2. Also, it is shown separately in box 12 with code C. Box 12 also will show the amount
of uncollected social
security and Medicare taxes on the excess coverage, with codes M and N. You must pay these taxes with your income tax return.
Include them in your
total tax on line 62, Form 1040, and enter “ UT” and the amount of the taxes on the dotted line next to line 62.
Two or more employers.
Your exclusion for employer-provided group-term life insurance coverage cannot exceed the cost of $50,000 of coverage,
whether the insurance is
provided by a single employer or multiple employers. If two or more employers provide insurance coverage that totals more
than $50,000, the amounts
reported as wages on your Forms W-2 will not be correct. You must figure how much to include in your income. Reduce the amount
you figure by any
amount reported with code C in box 12 of your Forms W-2, add the result to the wages reported in box 1, and report the total
on your return.
Figuring the taxable cost.
Use the following worksheet to figure the amount to include in your income.
Worksheet 1. Figuring the Cost of Group-Term Life Insurance To Include in Income
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1.
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Enter the total amount of your insurance coverage from your employer(s)
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1.
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2.
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Limit on exclusion for employer-provided group-term life insurance coverage
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2.
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50,000 |
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3.
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Subtract line 2 from line 1
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3.
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4.
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Divide line 3 by $1,000. Figure to the nearest tenth
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4.
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5.
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Go to Table 1. Using your age on the last day of the tax year, find your age group in the left
column, and enter the cost from the column on the right for your age group
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5.
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6.
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Multiply line 4 by line 5
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6.
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| |
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7.
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Enter the number of full months of coverage at this cost
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7.
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8.
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Multiply line 6 by line 7
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8.
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9.
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Enter the premiums you paid per month
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9.
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10.
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Enter the number of months you paid the premiums
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10.
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11.
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Multiply line 9 by line 10.
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11.
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12.
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Subtract line 11 from line 8. Include this amount in your income as wages |
12.
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If you pay any part of the cost of the insurance, your entire payment reduces, dollar for dollar, the amount you would otherwise
include in your
income. However, you cannot reduce the amount to include in your income by:
-
Payments for coverage in a different tax year,
-
Payments for coverage through a cafeteria plan, unless the payments are after-tax contributions, or
-
Payments for coverage not taxed to you because of the exceptions discussed later under Entire cost excluded.
Example.
You are 51 years old and work for employers A and B. Both employers provide group-term life insurance coverage for you for
the entire year. Your
coverage is $35,000 with employer A and $45,000 with employer B. You pay premiums of $4.15 a month under the employer B group
plan. You figure the
amount to include in your income as follows.
Worksheet 1. Figuring the Cost of Group-Term Life Insurance To Include in Income—Illustrated
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1.
|
Enter the total amount of your insurance coverage from your employer(s)
|
1.
|
80,000
|
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2.
|
Limit on exclusion for employer-provided group-term life insurance coverage
|
2.
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50,000 |
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3.
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Subtract line 2 from line 1
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3.
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30,000
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4.
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Divide line 3 by $1,000. Figure to the nearest tenth
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4.
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30.0
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5.
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Go to Table 1. Using your age on the last day of the tax year, find your age group in the left
column, and enter the cost from the column on the right for your age group
|
5.
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.23
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6.
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Multiply line 4 by line 5
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6.
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6.90
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7.
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Enter the number of full months of coverage at this cost.
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7.
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12
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8.
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Multiply line 6 by line 7
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8.
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82.80
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9.
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Enter the premiums you paid per month
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9.
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4.15
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10.
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Enter the number of months you paid the premiums
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10.
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12
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11.
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Multiply line 9 by line 10.
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11.
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49.80
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12.
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Subtract line 11 from line 8. Include this amount in your income as wages |
12.
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33.00
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The total amount to include in income for the cost of excess group-term life insurance is $33. Neither employer provided over
$50,000 insurance
coverage, so the wages shown on your Forms W-2 do not include any part of that $33. You must add it to the wages shown on
your Forms W-2 and include
the total on your return.
Entire cost excluded.
You are not taxed on the cost of group-term life insurance if any of the following circumstances apply.
-
You are permanently and totally disabled and have ended your employment.
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Your employer is the beneficiary of the policy for the entire period the insurance is in force during the tax year.
-
A charitable organization to which contributions are deductible is the only beneficiary of the policy for the entire period
the insurance is
in force during the tax year. (You are not entitled to a deduction for a charitable contribution for naming a charitable organization
as the
beneficiary of your policy.)
-
The plan existed on January 1, 1984, and:
-
You retired before January 2, 1984, and were covered by the plan when you retired, or
-
You reached age 55 before January 2, 1984, and were employed by the employer or its predecessor in 1983.
Entire cost taxed.
You are taxed on the entire cost of group-term life insurance if either of the following circumstances apply.
-
The insurance is provided by your employer through a qualified employees' trust, such as a pension trust or a qualified annuity
plan.
-
You are a key employee and your employer's plan discriminates in favor of key employees.
You do not include in your income the value of meals and lodging provided to you and your family by your employer at no charge
if the following
conditions are met.
-
The meals are:
-
Furnished on the business premises of your employer, and
-
Furnished for the convenience of your employer.
-
The lodging is:
-
Furnished on the business premises of your employer,
-
Furnished for the convenience of your employer, and
-
A condition of your employment. (You must accept it in order to be able to properly perform your duties.)
You also do not include in your income the value of meals or meal money that qualifies as a de
minimis fringe benefit. See De Minimis (Minimal) Benefits, earlier.
Faculty lodging.
If you are an employee of an educational institution or an academic health center and you are provided with lodging
that does not meet the three
conditions above, you still may not have to include the value of the lodging in income. However, the lodging must be qualified
campus lodging, and you
must pay an adequate rent.
Academic health center.
This is an organization that meets the following conditions.
-
Its principal purpose or function is to provide medical or hospital care or medical education or research.
-
It receives payments for graduate medical education under the Social Security Act.
-
One of its principal purposes or functions is to provide and teach basic and clinical medical science and research using its
own
faculty.
Qualified campus lodging.
Qualified campus lodging is lodging furnished to you, your spouse, or one of your dependents by, or on behalf of,
the institution or center for use
as a home. The lodging must be located on or near a campus of the educational institution or academic health center.
Adequate rent.
The amount of rent you pay for the year for qualified campus lodging is considered adequate if it is at least equal
to the lesser of:
-
5% of the appraised value of the lodging, or
-
The average of rentals paid by individuals (other than employees or students) for comparable lodging held for rent by the
educational
institution.
If the amount you pay is less than the lesser of these amounts, you must include the difference in your income.
The lodging must be appraised by an independent appraiser and the appraisal must be reviewed on an annual basis.
Example.
Carl Johnson, a sociology professor for State University, rents a home from the university that is qualified campus lodging.
The house is appraised
at $100,000. The average rent paid for comparable university lodging by persons other than employees or students is $7,000
a year. Carl pays an annual
rent of $5,500. Carl does not include in his income any rental value because the rent he pays equals at least 5% of the appraised
value of the house
(5% × $100,000 = $5,000). If Carl paid annual rent of only $4,000, he would have to include $1,000 in his income ($5,000 -
$4,000).
Moving Expense Reimbursements
Generally, if your employer pays for your moving expenses (either directly or indirectly) and the expenses would have been
deductible if you paid
them yourself, the value is not included in your income. See Publication 521 for more information.
No-Additional-Cost Services
The value of services you receive from your employer for free, at cost, or for a reduced price is not included in your income
if your employer:
-
Offers the same service for sale to customers in the ordinary course of the line of business in which you work, and
-
Does not have a substantial additional cost (including any sales income given up) to provide you with the service (regardless
of what you
paid for the service).
Generally, no-additional-cost services are excess capacity services, such as airline, bus, or train tickets, hotel rooms,
and telephone services.
Example.
You are employed as a flight attendant for a company that owns both an airline and a hotel chain. Your employer allows you
to take personal flights
(if there is an unoccupied seat) and stay in any one of their hotels (if there is an unoccupied room) at no cost to you. The
value of the personal
flight is not included in your income. However, the value of the hotel room is included in your income because you do not
work in the hotel business.
Retirement Planning Services
If your employer has a qualified retirement plan, qualified retirement planning services provided to you (and your spouse)
by your employer are not
included in your income. Qualified services include retirement planning advice, information about your employer's retirement
plan, and information
about how the plan may fit into your overall individual retirement income plan. You cannot exclude the value of any tax preparation,
accounting,
legal, or brokerage services provided by your employer. Also, see Financial Counseling Fees, earlier.
If your employer provides you with a qualified transportation fringe benefit, it can be excluded from your income, up to certain
limits. A
qualified transportation fringe benefit is:
Cash reimbursement by your employer for these expenses under a bona fide reimbursement arrangement is also excludable. However,
cash
reimbursement for a transit pass is excludable only if a voucher or similar item that can be exchanged only for a transit
pass is not readily
available for direct distribution to you.
Exclusion limit.
The exclusion for commuter highway vehicle transportation and transit pass fringe benefits cannot be more than a total
of $100 a month.
The exclusion for the qualified parking fringe benefit cannot be more than $195 a month.
If the benefits have a value that is more than these limits, the excess must be included in your income.
Commuter highway vehicle.
This is a highway vehicle that seats at least six adults (not including the driver). At least 80% of the vehicle's
mileage must reasonably be
expected to be:
-
For transporting employees between their homes and work place, and
-
On trips during which employees occupy at least half of the vehicle's adult seating capacity (not including the driver).
Transit pass.
This is any pass, token, farecard, voucher, or similar item entitling a person to ride mass transit (whether public
or private) free or at a
reduced rate or to ride in a commuter highway vehicle operated by a person in the business of transporting persons for compensation.
Qualified parking.
This is parking provided to an employee at or near the employer's place of business. It also includes parking provided
on or near a location from
which the employee commutes to work by mass transit, in a commuter highway vehicle, or by carpool. It does not include parking
at or near the
employee's home.
You can exclude a qualified tuition reduction from your income. This is the amount of a reduction in tuition:
-
For education (below graduate level) furnished by an educational institution to an employee, former employee who retired or
became disabled,
or his or her spouse and dependent children.
-
For education furnished to a graduate student at an educational institution if the graduate student is engaged in teaching
or research
activities for that institution.
-
Representing payment for teaching, research, or other services if you receive the amount under the National Health Service
Corps Scholarship
Program or the Armed Forces Health Professions Scholarship and Financial Assistance Program.
For more information, see Publication 970.
Working Condition Benefits
If your employer provides you with a product or service and the cost of it would have been allowable as a business or depreciation
deduction if you
paid for it yourself, the cost is not included in your income.
Example.
You work as an engineer and your employer provides you with a subscription to an engineering trade magazine. The cost of the
subscription is not
included in your income because the cost would have been allowable to you as a business deduction if you had paid for the
subscription yourself.
Valuation of Fringe Benefits
If a fringe benefit is included in your income, the amount included is generally its value determined under the general valuation
rule or under the
special valuation rules. For an exception, see Group-Term Life Insurance, earlier.
General valuation rule.
You must include in your income the amount by which the fair market value of the fringe benefit is more than the sum
of:
-
The amount, if any, you paid for the benefit, plus
-
The amount, if any, specifically excluded from your income by law.
If you pay fair market value for a fringe benefit, no amount is included in your income.
Fair market value.
The fair market value of a fringe benefit is determined by all the facts and circumstances. It is the amount you would
have to pay a third party to
buy or lease the benefit. This is determined without regard to:
Employer-provided vehicles.
If your employer provides a car (or other highway motor vehicle) to you, your personal use of the car is usually a
taxable noncash fringe benefit.
Under the general valuation rules, the value of an employer-provided vehicle is the amount you would have to pay a
third party to lease the same or
a similar vehicle on the same or comparable terms in the same geographic area where you use the vehicle. An example of a comparable
lease term is the
amount of time the vehicle is available for your use, such as a 1-year period. The value cannot be determined by multiplying
a cents-per-mile rate
times the number of miles driven unless you prove the vehicle could have been leased on a cents-per-mile basis.
Flights on employer-provided aircraft.
Under the general valuation rules, if your flight on an employer-provided piloted aircraft is primarily personal and
you control the use of the
aircraft for the flight, the value is the amount it would cost to charter the flight from a third party.
If there is more than one employee on the flight, the cost to charter the aircraft must be divided among those employees.
The division must be
based on all the facts, including which employee or employees control the use of the aircraft.
Special valuation rules.
You generally can use a special valuation rule for a fringe benefit only if your employer uses the rule. If your employer
uses a special valuation
rule, you cannot use a different special rule to value that benefit. You always can use the general valuation rule discussed
earlier, based on facts
and circumstances, even if your employer uses a special rule.
If you and your employer use a special valuation rule, you must include in your income the amount your employer determines
under the special rule
minus the sum of:
-
Any amount you repaid your employer, plus
-
Any amount specifically excluded from income by law.
The special valuation rules are the following.
-
The automobile lease rule.
-
The vehicle cents-per-mile rule.
-
The commuting rule.
-
The unsafe conditions commuting rule.
-
The employer-operated eating-facility rule.
For more information on these rules, see Publication 15-B, Employer's Tax Guide to Fringe Benefits.
For information on the non-commercial flight and commercial flight valuation rules, see sections 1.61-21(g)
and 1.61-21(h) of the regulations.
Retirement Plan Contributions
Your employer's contributions to a qualified retirement plan for you are not included in income at the time contributed. (Your
employer can tell
you whether your retirement plan is qualified.) However, the cost of life insurance coverage included in the plan may have
to be included. See
Group-Term Life Insurance, earlier, under Fringe Benefits.
If your employer pays into a nonqualified plan for you, you generally must include the contributions in your income as wages
for the tax year in
which the contributions are made. However, if your interest in the plan is not transferable or is subject to a substantial
risk of forfeiture (you
have a good chance of losing it) at the time of the contribution, you do not have to include the value of your interest in
your income until it is
transferable or is no longer subject to a substantial risk of forfeiture.
If you are covered by certain kinds of retirement plans, you can choose to have part of your compensation contributed by your
employer to a
retirement fund, rather than have it paid to you. The amount you set aside (called an elective deferral) is treated as an
employer contribution to a
qualified plan. It is not included in wages subject to income tax at the time contributed. However, it is included in wages
subject to social security
and Medicare taxes.
Elective deferrals include elective contributions to the following retirement plans.
-
Cash or deferred arrangements (section 401(k) plans).
-
The Thrift Savings Plan for federal employees.
-
Salary reduction simplified employee pension plans (SARSEP).
-
Savings incentive match plans for employees (SIMPLE plans).
-
Tax-sheltered annuity plans (403(b) plans).
-
Section 501(c)(18)(D) plans. (But see Reporting by employer, later.)
-
Section 457 plans.
Overall limit on deferrals.
For 2004, you generally should not have deferred more than a total of $13,000 of contributions to the plans listed
in (1) through (6) above. You
should not have deferred more than the lesser of your includible compensation (defined later) or $13,000 of contributions
to the plan listed in (7)
above (section 457 plan).
Your employer or plan administrator should apply the proper annual limit when figuring your plan contributions. However,
you are responsible for
monitoring the total you defer to ensure that the deferrals are not more than the overall limit.
Catch-up contributions.
You may be allowed catch-up contributions (additional elective deferrals) if you are age 50 or older by the end of
your tax year. For more
information about catch-up contributions to 403(b) plans, see chapter 6 of Publication 571, Tax Sheltered Annuity Plans (403(b)
Plans).
For more information about additional elective deferrals to:
-
SEPs (SARSEPs), see Salary Reduction Simplified Employee Pension in Publication 560, Retirement Plans for Small
Business.
-
SIMPLE plans, see How Much Can Be Contributed on Your Behalf in chapter 3 of Publication 590, Individual Retirement Arrangements
(IRAs).
-
Section 457 plans, see Limit for deferrals under section 457 plans, later.
Limit for deferrals under SIMPLE plans.
If you are a participant in a SIMPLE plan, you generally should not have deferred more than $9,000 in 2004. Amounts
you defer under a SIMPLE plan
count toward the overall limit ($13,000 for 2004) and may affect the amount you can defer under other elective deferral plans.
Limit for deferrals under section 457 plans.
If you are a participant in a section 457 plan (a deferred compensation plan for employees of state or local governments
or tax-exempt
organizations), you should have deferred no more than the lesser of your includible compensation or $13,000. However, if you
are within 3 years of
normal retirement age, you may be allowed an increased limit if the plan allows it. See Increased limit, later.
Includible compensation.
This is the pay you received for the year from the employer who maintained the section 457 plan. It generally includes
all the following payments.
-
Wages and salaries.
-
Fees for professional services.
-
The value of any employer-provided qualified transportation fringe benefit (defined under Transportation, earlier) that is not
included in your income.
-
Other amounts received (cash or noncash) for personal services you performed, including, but not limited to, the following
items.
-
Commissions and tips.
-
Fringe benefits.
-
Bonuses.
-
Employer contributions (elective deferrals) to:
-
The section 457 plan.
-
Qualified cash or deferred arrangements (section 401(k) plans) that are not included in your income.
-
A salary reduction simplified employee pension (SARSEP).
-
A tax-sheltered annuity (section 403(b) plan).
-
A savings incentive match plan for employees (SIMPLE plan).
-
A section 125 cafeteria plan.
Instead of using the amounts listed above to determine your includible compensation, your employer can use any of
the following amounts.
-
Your wages as defined for income tax withholding purposes.
-
Your wages as reported in box 1 of Form W-2, Wage and Tax Statement.
-
Your wages that are subject to social security withholding (including elective deferrals).
Increased limit.
During any, or all, of the last 3 years ending before you reach normal retirement age under the plan, your plan may
provide that your limit is the
lesser of:
-
Twice the dollar limit for the year, or
-
The limit for prior years minus the amount you deferred in prior years plus the lesser of:
-
Your includible compensation for the current year, or
-
The dollar limit for the current year.
Catch-up contributions.
You generally can have additional elective deferrals made to your governmental section 457 plan if:
-
You reached age 50 by the end of the year, and
-
No other elective deferrals can be made for you to the plan for the year because of limits or restrictions.
If you qualify, your limit can be the lesser of your includible compensation or $13,000 ($14,000 for 2005), plus $3,000 ($4,000
for 2005).
However, if you are within 3 years of retirement age and your plan provides the increased limit earlier, that limit may be
higher.
Limit for tax-sheltered annuities.
If you are a participant in a tax-sheltered annuity plan (403(b) plan), the limit on elective deferrals for 2004 generally
is $13,000 ($14,000 for
2005). However, if you have at least 15 years of service with a public school system, a hospital, a home health service agency,
a health and welfare
service agency, a church, or a convention or association of churches (or associated organization), the limit on elective deferrals
is increased by the
least of the following amounts.
-
$3,000.
-
$15,000, reduced by increases to the overall limit that you were allowed in earlier years because of this years-of-service
rule.
-
$5,000 times your number of years of service for the organization, minus the total elective deferrals under the plan for earlier
years.
For more information, see Publication 571, Tax-Sheltered Annuity Plans (403(b) Plans).
Reporting by employer.
Your employer generally should not include elective deferrals in your wages in box 1 of Form W-2. Instead, your employer
should mark the Retirement
plan checkbox in box 13 and show the total amount deferred in box 12.
Section 501(c)(18)(D) contributions.
Wages shown in box 1 of your Form W-2 should not have been reduced for contributions you made to a section 501(c)(18)(D)
retirement plan. The
amount you contributed should be identified with code “ H” in box 12. You may deduct the amount deferred subject to the limits that apply. Include
your deduction in the total on Form 1040, line 35. Enter the amount and “ 501(c)(18)(D)” on the dotted line next to line 35.
Excess deferrals.
If your deferrals exceed the limit, you must notify your plan by the date required by the plan. If the plan permits,
the excess amount will be
distributed to you. If you participate in more than one plan, you can have the excess paid out of any of the plans that permit
these distributions.
You must notify each plan by the date required by that plan of the amount to be paid from that particular plan. The plan must
then pay you the amount
of the excess, along with any income earned on that amount, by April 15 of the following year.
You must include the excess deferral in your income for the year of the deferral. File Form 1040 to add the excess
deferral amount to your wages on
line 7. Do not use Form 1040A or Form 1040EZ to report excess deferral amounts.
Excess not distributed.
If you do not take out the excess amount, you cannot include it in the cost of the contract even though you included
it in your income. Therefore,
you are taxed twice on the excess deferral left in the plan—once when you contribute it, and again when you receive it as
a distribution.
Excess distributed to you.
If you take out the excess after the year of the deferral and you receive the corrective distribution by April 15
of the following year, do not
include it in income again in the year you receive it. If you receive it later, you must include it in income in both the
year of the deferral and the
year you receive it. Any income on the excess deferral taken out is taxable in the tax year in which you take it out. If you
take out part of the
excess deferral and the income on it, allocate the distribution proportionately between the excess deferral and the income.
You should receive a Form 1099-R, Distributions From Pensions, Annuities, Retirement or
Profit-Sharing Plans, IRAs, Insurance Contracts, etc., for the year in which the excess deferral is distributed to you. Use
the following rules to
report a corrective distribution shown on Form 1099-R for 2004.
-
If the distribution was for a 2004 excess deferral, your Form 1099-R should have the code “8” in box 7. Add the excess deferral amount
to your wages on your 2004 tax return.
-
If the distribution was for a 2003 excess deferral, your Form 1099-R should have the code “P” in box 7. If you did not add the excess
deferral amount to your wages on your 2003 tax return, you must file an amended return on Form 1040X, Amended U.S. Individual
Income Tax Return. If
you did not receive the distribution by April 15, 2004, you also must add it to your wages on your 2004 tax return.
-
If the distribution was for a 2002 excess deferral, your Form 1099-R should have the code “D” in box 7. If you did not add the excess
deferral amount to your wages on your 2002 tax return, you must file an amended return on Form 1040X. You also must add it
to your wages on your 2004
income tax return.
-
If the distribution was for the income earned on an excess deferral, your Form 1099-R should have the code “8” in box 7. Add the income
amount to your wages on your 2004 income tax return, regardless of when the excess deferral was made.
Report a loss on a corrective distribution of an excess deferral in the year the excess amount (reduced by the loss) is distributed
to you.
Include the loss as a negative amount on Form 1040, line 21 and identify it as “ Loss on Excess Deferral Distribution.”
Even though a corrective distribution of excess deferrals is reported on Form 1099-R, it is not otherwise treated as a distribution
from the plan.
It cannot be rolled over into another plan, and it is not subject to the additional tax on early distributions.
If you are a highly compensated employee, the total of your elective deferrals and other contributions made for you for any
year under a section
401(k) plan or SARSEP can be, as a percentage of pay, no more than 125% of the average deferral percentage (ADP) of all eligible
non-highly
compensated employees.
If the total contributed to the plan is more than the amount allowed under the
ADP test, the excess contributions must be either distributed to you or recharacterized as after-tax employee contributions
by treating them as
distributed to you and then contributed by you to the plan. You must include the excess contributions in your income as wages
on Form 1040, line 7.
You cannot use Form 1040A or Form 1040EZ to report excess contribution amounts.
If you receive excess contributions from a 401(k) plan and any income earned on the contributions within 2½ months after the
close
of the plan year, you must include them in your income in the year of the contribution. If you receive them later, or receive
less than $100 excess
contributions, include the excess contributions and earnings in your income in the year distributed. If the excess contributions
are recharacterized,
you must include them in income in the year a corrective distribution would have occurred. For a SARSEP, the employer must
notify you by March 15
following the year in which excess contributions are made that you must withdraw the excess and earnings. You must include
the excess contributions in
your income in the year of the contribution (or the year of the notification if less than $100) and include the earnings in
your income in the year
withdrawn.
You should receive a Form 1099-R for the year in which the excess contributions are distributed
to you (or are recharacterized). Add excess contributions or earnings shown on Form 1099-R for 2004 to your wages on your
2004 tax return if code
“8” is in box 7. If code “P” or “D” is in box 7, you may have to file an amended 2003 or 2002 return on Form 1040X to add the excess
contributions or earnings to your wages in the year of the contribution.
Even though a corrective distribution of excess contributions is reported on Form 1099-R, it is not otherwise treated as a
distribution from the
plan. It cannot be rolled over into another plan, and it is not subject to the additional tax on early distributions.
The amount contributed in 2004 to a defined contribution plan is generally limited to the lesser of 100% of your compensation
or $40,000. Under
certain circumstances, contributions that exceed these limits (excess annual additions) may be corrected by a distribution
of your elective deferrals
or a return of your after-tax contributions and earnings from these contributions.
A corrective payment of excess annual additions consisting of elective deferrals or earnings from your after-tax contributions
is fully taxable in
the year paid. A corrective payment consisting of your after-tax contributions is not taxable.
If you received a corrective payment of excess annual additions, you should receive a separate Form
1099-R for the year of the payment with the code “E” in box 7. Report the total payment shown in box 1 of Form 1099-R on line 16a of Form 1040 or
line 12a of Form 1040A. Report the taxable amount shown in box 2a of Form 1099-R on line 16b of Form 1040 or line 12b of Form
1040A.
Even though a corrective distribution of excess annual additions is reported on Form 1099-R, it is not
otherwise treated as a distribution from the plan. It cannot be rolled over into another plan, and it is not subject to the
additional tax on early
distributions.
If you receive a nonstatutory option to buy or sell stock or other property as payment for your services, you usually will
have income when you
receive the option, when you exercise the option (use it to buy or sell the stock or other property), or when you sell or
otherwise dispose of the
option. However, if your option is a statutory stock option (defined later), you will not have any income until you sell or
exchange your stock. Your
employer can tell you which kind of option you hold.
Nonstatutory Stock Options
If you are granted a nonstatutory stock option, the amount of income to include and the time to
include it depend on whether the fair market value of the option can be readily determined. The fair market value of an option
can be readily
determined if it is actively traded on an established market.
The fair market value of an option that is not traded on an established market can be readily determined only
if all of the following conditions exist.
-
You can transfer the option.
-
You can exercise the option immediately in full.
-
The option or the property subject to the option is not subject to any condition or restriction (other than a condition to
secure payment of
the purchase price) that has a significant effect on the fair market value of the option.
-
The fair market value of the option privilege can be readily determined.
The option privilege for an option to buy is the opportunity to benefit during the option's exercise period from any increase
in the value of
property subject to the option without risking any capital. For example, if during the exercise period the fair market value
of stock subject to an
option is greater than the option's exercise price, a profit may be realized by exercising the option and immediately selling
the stock at its higher
value. The option privilege for an option to sell is the opportunity to benefit during the exercise period from a decrease
in the value of the
property subject to the option.
If you or a member of your family is an officer, director, or more-than-10% owner of an expatriated corporation, you may owe
an excise tax on the
value of nonstatutory options and other stock-based compensation from that corporation. For more information on the excise
tax, see Internal Revenue
Code section 4985.
Option with readily determined value.
If you receive a nonstatutory stock option that has a readily determined fair market value at the time it is granted
to you, the option is treated
like other property received as compensation. See Restricted Property, later, for rules on how much income to include and when to include
it. However, the rule described in that discussion for choosing to include the value of property in your income for the year
of the transfer does not
apply to a nonstatutory option.
Option without readily determined value.
If the fair market value of the option is not readily determined at the time it is granted to you (even if it is determined
later), you do not have
income until you transfer or exercise the option. When you exercise this kind of option, the restricted property rules apply
to the property received.
The amount to include in your income is the difference between the amount you pay for the property and its fair market value
when it becomes
substantially vested. Your basis in the property you acquire under the option is the amount you pay for it plus any amount
you must include in your
gross income under this rule. For more information on restricted property, see Restricted Property, later.
Unrelated person.
If you transferred this kind of option in an arm's-length transaction to an unrelated person, you must include in
your income the money or other
property you received for the transfer, as if you had exercised the option.
Related person.
If you transferred this kind of option in an arm's-length transaction to a related person after July
1, 2003, the option is not treated as exercised or closed at that time, and you do not include in your income the money or
other property you received
for the transfer at that time. See Temporary Regulations section 1.83-7T for the definition of a related person.
Recourse note in satisfaction of the exercise price of an option.
If you are an employee, and you issue a recourse note to your employer in satisfaction of the exercise price of an
option to acquire your
employer's stock, and your employer and you subsequently agree to reduce the stated principal amount of the note, you generally
recognize compensation
income at the time and in the amount of the reduction.
Tax form.
If you receive compensation from employer-provided nonstatutory stock options, it is reported in box 1 of Form W-2.
It is also reported in box 12
using code “ V.”
If you are a nonemployee spouse and you exercise nonstatutory stock options you
received incident to a divorce, the income is reported to you on Form 1099-MISC, Miscellaneous Income, in box 3.
There are two kinds of statutory stock options.
For either kind of option, you must be an employee of the company granting the option, or a related company, at all times
beginning with the date
the option is granted, until 3 months before you exercise the option (for an incentive stock option, 1 year before if you
are disabled). Also, the
option must be nontransferable except at death. If you do not meet the employment requirements, or you receive a transferable
option, your option is a
nonstatutory stock option. See Nonstatutory Stock Options, earlier in this discussion.
If you receive a statutory stock option, do not include any amount in your income either when the option is granted or when
you exercise it. You
have taxable income or a deductible loss when you sell the stock that you bought by exercising the option. Your income or
loss is the difference
between the amount you paid for the stock (the option price) and the amount you receive when you sell it. You generally treat
this amount as capital
gain or loss and report it on Schedule D (Form 1040), Capital Gains and Losses, for the year of the sale.
However, you may have ordinary income for the year that you sell or otherwise dispose of the stock in either of the following
situations.
-
You do not meet the holding period requirement. This situation generally applies if you sell the stock within 1 year after
its transfer to
you or within 2 years after the option was granted. However, you are considered to meet the holding period requirement for
certain sales after October
22, 2004, to comply with conflict-of-interest requirements.
-
You meet the conditions described under Option granted at a discount, under Employee stock purchase plan,
later.
Report your ordinary income as wages on Form 1040, line 7, for the year of the sale.
Incentive stock options (ISOs).
If you sell stock acquired by exercising an ISO and meet the holding period requirement, your
gain or loss from the sale is capital gain or loss.
If you do not meet the holding period requirement and you have a gain from the sale, the gain is ordinary income up
to the amount by which the
stock's fair market value when you exercised the option exceeded the option price. Any excess gain is capital gain. If you
have a loss from the sale,
it is a capital loss and you do not have any ordinary income.
Example.
Your employer, X Corporation, granted you an ISO on March 11, 2002, to buy 100 shares of X Corporation stock at $10 a share,
its fair market value
at the time. You exercised the option on January 17, 2003, when the stock was selling on the open market for $12 a share.
On January 24, 2004, you
sold the stock for $15 a share. Although you held the stock for more than a year, less than 2 years had passed from the time
you were granted the
option. In 2004, you must report the difference between the option price ($10) and the value of the stock when you exercised
the option ($12) as
wages. The rest of your gain is capital gain, figured as follows:
Alternative minimum tax (AMT).
For the AMT, you must treat stock acquired through the exercise of an ISO as if no special treatment
applied. This means that, when your rights in the stock are transferable or no longer subject to a substantial risk of forfeiture,
you must include as
an adjustment in figuring alternative minimum taxable income the amount by which the fair market value of the stock exceeds
the option price. Enter
this adjustment on Form 6251, line 13, Alternative Minimum Tax—Individuals. Increase your AMT basis in any stock you acquire
by exercising the
ISO by the amount of the adjustment. However, no adjustment is required if you dispose of the stock in the same year you exercise
the option.
See Restricted Property, later, for more information.
Your AMT basis in stock acquired through an ISO is likely to differ from your regular tax basis. Therefore, keep adequate
records for both the AMT
and regular tax so that you can figure your adjusted gain or loss.
Example.
The facts are the same as in the previous example. On January 17, 2004, when the stock was selling on the open market for
$14 a share, your rights
to the stock first became transferable. You include $400 ($1,400 value when your rights first became transferable minus $1,000
purchase price) as an
adjustment on Form 6251, line 13.
Employee stock purchase plan.
If you sold stock acquired by exercising an option granted under an employee stock purchase plan, determine your ordinary
income and your capital
gain or loss as follows.
Option granted at a discount.
If at the time the option was granted, the option price per share was less than 100% (but not less than 85%) of the
fair market value of the share,
and you dispose of the share after meeting the holding period requirement, or you die while owning the share, you must include
in your income as
compensation, the lesser of:
-
The amount, if any, by which the price paid under the option was exceeded by the fair market value of the share at the time
the option was
granted, or
-
The amount, if any, by which the price paid under the option was exceeded by the fair market value of the share at the time
of the
disposition or death.
For this purpose, if the option price was not fixed or determinable at the time the option was granted, the option price is
figured as if the
option had been exercised at the time it was granted.
Any excess gain is capital gain. If you have a loss from the sale, it is a capital loss,
and you do not have any ordinary income.
Example.
Your employer, Y Corporation, granted you an option under its employee stock purchase plan to buy 100 shares of stock of Y
Corporation for $20 a
share at a time when the stock had a value of $22 a share. Eighteen months later, when the value of the stock was $23 a share,
you exercised the
option, and 14 months after that you sold your stock for $30 a share. In the year of sale, you must report as wages the difference
between the option
price ($20) and the value at the time the option was granted ($22). The rest of your gain ($8 per share) is capital gain,
figured as follows:
Holding period requirement not met.
If you do not meet the holding period requirement, your ordinary income is the amount by which the stock's fair market
value when you exercised the
option exceeded the option price. This ordinary income is not limited to your gain from the sale of the stock. Increase your
basis in the stock by the
amount of this ordinary income. The difference between your increased basis and the selling price of the stock is a capital
gain or loss.
Example.
The facts are the same as in the previous example, except that you sold the stock only 6 months after you exercised
the option. You did not hold the stock long enough, so you must report $300 as wages and $700 as capital gain, figured as
follows:
Generally, if you receive property for your services, you must include its fair market value in your income in the year you
receive the property.
However, if you receive stock or other property that has certain restrictions that affect its value, you do not include the
value of the property in
your income until it has been substantially vested. (You can choose to include the value of the property in your income in
the year it is transferred
to you, as discussed later, rather than the year it is substantially vested.)
Until the property becomes substantially vested, it is owned by the person who makes the transfer to you, usually your employer.
However, any
income from the property, or the right to use the property, is included in your income as additional compensation in the year
you receive the income
or have the right to use the property.
When the property becomes substantially vested, you must include its fair market value, minus any amount you paid for it,
in your income for that
year.
Example.
Your employer, the RST Corporation, sells you 100 shares of its stock at $10 a share. At the time of the sale the fair market
value of the stock is
$100 a share. Under the terms of the sale, the stock is under a substantial risk of forfeiture (you have a good chance of
losing it) for a 5-year
period. Your stock is not substantially vested when it is transferred, so you do not include any amount in your income in
the year you buy it. At the
end of the 5-year period, the fair market value of the stock is $200 a share. You must include $19,000 in your income [100
shares × ($200 fair
market value - $10 you paid)]. Dividends paid by the RST Corporation on your 100 shares of stock are taxable to you as additional
compensation
during the period the stock can be forfeited.
Substantially vested.
Property is substantially vested when:
Transferable property.
Property is transferable if you can sell, assign, or pledge your interest in the property to any person (other than
the transferor), and if the
person receiving your interest in the property is not required to give up the property, or its value, if the substantial risk
of forfeiture occurs.
Substantial risk of forfeiture.
A substantial risk of forfeiture exists if the rights in the property transferred depend on performing (or not performing)
substantial services, or
on a condition related to the transfer, and the possibility of forfeiture is substantial if the condition is not satisfied.
Example.
The Spin Corporation transfers to you as compensation for services 100 shares of its corporate stock for $100 a share. Under
the terms of the
transfer, you must resell the stock to the corporation at $100 a share if you leave your job for any reason within 3 years
from the date of transfer.
You must perform substantial services over a period of time and you must resell the stock to the corporation at $100 a share
(regardless of its value)
if you do not perform the services, so your rights to the stock are subject to a substantial risk of forfeiture.
Choosing to include in income for year of transfer.
You can choose to include the value of restricted property at the time of transfer (minus any amount you paid for
the property) in your income for
the year it is transferred. If you make this choice, the substantial vesting rules do not apply and, generally, any later
appreciation in value is not
included in your compensation when the property becomes substantially vested. Your basis for figuring gain or loss when you
sell the property is the
amount you paid for it plus the amount you included in income as compensation.
If you make this choice, you cannot revoke it without the consent of the Internal Revenue Service. Consent will be given only
if you were under a
mistake of fact as to the underlying transaction.
If you forfeit the property after you have included its value in income, your loss is the amount you paid for the
property minus any amount you
realized on the forfeiture.
You cannot make this choice for a nonstatutory stock option.
How to make the choice.
You make the choice by filing a written statement with the Internal Revenue Service Center where you file your return.
You must file this statement
no later than 30 days after the date the property was transferred. A copy of the statement must be attached to your tax return
for the year the
property was transferred. You also must give a copy of this statement to the person for whom you performed the services and,
if someone other than you
received the property, to that person.
You must sign the statement and indicate on it that you are making the choice under section 83(b) of the Internal
Revenue Code. The statement must contain all of the following information.
-
Your name, address, and taxpayer identification number.
-
A description of each property for which you are making the choice.
-
The date or dates on which the property was transferred and the tax year for which you are making the choice.
-
The nature of any restrictions on the property.
-
The fair market value at the time of transfer (ignoring restrictions except those that will never lapse) of each property
for which you are
making the choice.
-
Any amount that you paid for the property.
-
A statement that you have provided copies to the appropriate persons.
Dividends received on restricted stock.
Dividends you receive on restricted stock are treated as compensation and not as dividend income. Your employer should
include these payments on
your Form W-2. If they are also reported on a Form 1099-DIV, Dividends and Distributions, you should list them on Schedule
B (Form 1040) or Schedule 1
(Form 1040A), Interest and Ordinary Dividends for Form 1040A Filers, with a statement that you have included them as wages.
Do not include them in the
total dividends received.
Stock you chose to include in your income.
Dividends you receive on restricted stock you chose to include in your income in the year transferred are treated
the same as any other dividends.
You should receive a Form 1099-DIV showing these dividends. Do not include the dividends in your wages on your return. Report
them as dividends.
Sale of property not substantially vested.
These rules apply to the sale or other disposition of property that you did not choose to include in your income in
the year transferred and that
is not substantially vested.
If you sell or otherwise dispose of the property in an arm's-length transaction, include in your income as compensation
for the year of sale the
amount realized minus the amount you paid for the property. If you exchange the property in an arm's-length transaction for
other property that is not
substantially vested, treat the new property as if it were substituted for the exchanged property.
The sale or other disposition of a nonstatutory stock option to a related person after July 1, 2003, is not considered
an arm's-length transaction.
See Temporary Regulations section 1.83-7T for the definition of a related person.
If you sell the property in a transaction that is not at arm's length, include in your income as compensation for
the year of sale the total of any
money you received and the fair market value of any substantially vested property you received on the sale. In addition, you
will have to report
income when the original property becomes substantially vested, as if you still held it. Report as compensation its fair market
value minus the total
of the amount you paid for the property and the amount included in your income from the earlier sale.
Example.
In 2001, you paid your employer $50 for a share of stock that had a fair market value of $100 and was subject to forfeiture
until 2004. In 2003,
you sold the stock to your spouse for $10 in a transaction not at arm's length. You had compensation of $10 from this transaction.
In 2004, when the
stock had a fair market value of $120, it became substantially vested. For 2004, you must report additional compensation of
$60, figured as follows:
|
Fair market value of stock at time of substantial vesting
|
|
$120
|
|
Minus: Amount paid for stock
|
$50
|
|
|
Minus: Compensation previously included in income from sale to spouse
|
10
|
-60
|
| Additional income |
|
$60
|
Inherited property not substantially vested.
If you inherit property not substantially vested at the time of the decedent's death, any income you receive
from the property is considered income in respect of a decedent and is taxed according to the rules for restricted property
received for services. For
information about income in respect of a decedent, see Publication 559.
Special Rules for Certain Employees
This part of the publication deals with special rules for people in certain types of employment: members of the clergy, members
of religious
orders, people working for foreign employers, military personnel, and volunteers.
If you are a member of the clergy, you must include in your income offerings and fees you receive for marriages, baptisms,
funerals, masses, etc.,
in addition to your salary. If the offering is made to the religious institution, it is not taxable to you.
If you are a member of a religious organization and you give your outside earnings to the organization, you still must include
the earnings in your
income. However, you may be entitled to a charitable contribution deduction for the amount paid to the organization. See Publication
526, Charitable
Contributions. Also, see Members of Religious Orders, later.
Pension.
A pension or retirement pay for a member of the clergy usually is treated as any other pension or annuity. It must
be reported on lines 16a and 16b
of Form 1040 or on lines 12a and 12b of Form 1040A.
Special rules for housing apply to members of the clergy. Under these rules, you do not include in your income the rental
value of a home
(including utilities) or a designated housing allowance provided to you as part of your pay. However, the exc |
