This section begins with brief discussions of many income items arranged in alphabetical order. These discussions are followed by discussions of other taxable income items which are discussed in greater detail as follows:

• Bartering
• Canceled debts
• Recoveries (including state income tax refunds)
• Rental of personal property
• Repayments
• Royalties

When you report miscellaneous taxable income on line 21 of Form 1040, write a brief description of the income on the dotted line next to line 21.

Activity not for profit. You must include on your return income from an activity from which you do not expect to make a profit. An example of this type of activity would be a hobby or a farm you operate mostly for recreation and pleasure. Enter this income on line 21 of Form 1040. Deductions for expenses related to the activity are limited. They cannot total more than the income you report, and can be taken only if you itemize deductions on Schedule A (Form 1040). See Not-for-Profit Activities in chapter 1 of Publication 535, Business Expenses, for information on whether an activity is considered carried on for a profit.

Alaska Permanent Fund dividend income. If you received a payment from Alaska's mineral income fund (Alaska Permanent Fund dividend), you should report this amount on line 21 of Form 1040. The state of Alaska sends each recipient a document that shows this amount with the check. The amount is also reported to IRS.

If you otherwise qualify to use Form 1040A or 1040EZ, you can report the Alaska Permanent Fund dividend on line 12 of Form 1040A or line 3 of Form 1040EZ. See your form instructions.

Alimony. Include in your income on line 11 of Form 1040 any alimony payments you receive. Amounts you receive for child support are not income to you. Alimony and child support payments are discussed in chapter 20.

Allowances and reimbursements. If you receive travel, transportation, or other business expense allowances or reimbursements from your employer, see chapter 28. If you are reimbursed for moving expenses, see chapter 19.

Court awards and damages. To determine if settlement amounts you receive by compromise or judgment must be included in your income, you must consider the item that the settlement replaces. Include the following as ordinary income.

1. Interest on any award.
2. Compensation for lost wages or lost profits in most cases.
3. Punitive damages. See Punitive damages, later.
4. Amounts received in settlement of pension rights (if you did not contribute to the plan).
5. Damages for:
1. Patent or copyright infringement,
2. Breach of contract, or
3. Interference with business operations.
6. Back pay and damages for emotional distress received to satisfy a claim under Title VII of the Civil Rights Act of 1964.

Do not include in your income compensatory damages for personal physical injury or physical sickness (whether received in a lump sum or installments).

Emotional distress. If emotional distress is due to physical injuries or physical sickness, the damages you receive for medical care due to that emotional distress are not taxable. Emotional distress includes physical symptoms that result from emotional distress, such as headaches, insomnia, and stomach disorders.

Punitive damages. Punitive damages generally are taxable. It does not matter if they relate to a physical injury or physical sickness. This rule does not create any inference about punitive damages under prior law.

For more information on punitive damages, get Publication 525.

Credit card insurance. Generally, if you receive benefits under a credit card disability or unemployment insurance plan, the benefits are taxable to you. These plans make the minimum monthly payment on your credit card account if you cannot make the payment due to injury, illness, disability, or unemployment. Report on line 21 of Form 1040 the amount of benefits you receive during the year that is more than the amount of the premiums you paid during the year.

Estate and trust income. An estate or trust, unlike a partnership, may have to pay federal income tax. If you are a beneficiary of an estate or trust, you may be taxed on your share of its income distributed or required to be distributed to you. However, there is never a double tax. Estates and trusts file their returns on Form 1041, U.S. Income Tax Return for Estates and Trusts, and your share of the income is reported to you on Schedule K-1 of Form 1041.

Current income required to be distributed. If you are the beneficiary of a trust that must distribute all of its current income, you must report your share of the distributable net income whether or not you have actually received it.

Current income not required to be distributed. If you are the beneficiary of an estate or trust and the fiduciary has the choice of whether to distribute all or part of the current income, you must report:

1. All income that is required to be distributed to you, whether or not it is actually distributed, plus
2. All other amounts actually paid or credited to you,

up to the amount of your share of distributable net income.

How to report. Each item of income is treated the same for you as for the estate or trust. For example, if dividend income is distributed to you from a trust, you report the distribution as dividend income on your return. The same rule applies to distributions of tax-exempt interest and capital gains.

The fiduciary of the estate or trust must tell you the type of items making up your share of the estate or trust income and any credits you are allowed on your individual income tax return.

Losses. Losses of estates and trusts generally are not deductible by the beneficiaries.

Grantor trust. Income earned by a grantor trust is taxable to the grantor, not the beneficiary, if the grantor keeps certain control over the trust. This rule applies if the property (or income from the property) put into the trust will or may revert (be returned) to the grantor or the grantor's spouse. The grantor is the one who transferred property to the trust.

Generally, a trust is a grantor trust if the grantor has a reversionary interest valued (at the date of transfer) at more than 5% of the value of the transferred property.

Fees for services. Include all fees for your services in your gross income. Examples of these fees are amounts you receive for services you perform as:

1. A corporate director,
2. An executor or administrator of an estate,
3. A notary public, or
4. An election precinct official.

Corporate director. If you received (or should have received) a Form W-2 showing corporate director fees, report these fees on line 7 of Form 1040 or Form 1040A, or on line 1 of Form 1040EZ.

Otherwise, report these payments on Schedule C (Form 1040) or Schedule C-EZ (Form 1040) as self-employment income.

Executor or administrator of an estate. If these payments total $600 or more for the year, you may receive a Form 1099-MISC. Report these payments on Schedule C (Form 1040) or Schedule C-EZ (Form 1040) as self-employment income. Exception: If you are not in the trade or business of being an executor (for instance, you are the executor of a friend's or relative's estate), do not include these amounts on Schedule C or Schedule C-EZ. Report them on line 21 of Form 1040.

Notary public. Report payments for these services on Schedule C (Form 1040) or Schedule C-EZ (Form 1040). These payments are not subject to self-employment tax.

Election precinct official. You should receive a Form W-2 showing payments for services performed as an election official or election worker. Report these payments on line 7 of Form 1040 or Form 1040A, or on line 1 of Form 1040EZ.

Free tour. If you received a free tour from a travel agency for organizing a group of tourists, you must include its value in your income. Report the fair market value of the tour on line 21 of Form 1040, or on Schedule C or Schedule C-EZ (Form 1040). You cannot deduct your expenses in serving as the voluntary leader of the group at the group's request.

Gambling winnings. You must include your gambling winnings in income on line 21 of Form 1040. If you itemize your deductions on Schedule A (Form 1040), you can deduct gambling losses you had during the year, but only up to the amount of your winnings. See Publication 529, Miscellaneous Deductions, for information on recordkeeping.

Lotteries and raffles. Winnings from lotteries and raffles are gambling winnings. In addition to cash winnings, you must include in your income the fair market value of bonds, cars, houses, and other noncash prizes.

If you win a state lottery prize payable in installments, you must include in your gross income the annual payments and any amount you receive designated as "interest" on the unpaid installments.

Form W-2G. You may have received a Form W-2G showing the amount of your gambling winnings and any tax taken out of them. Include the amount from box 1 on line 21 of Form 1040. Be sure to include any amount from box 2 on line 57 of Form 1040.

Hobby losses. Losses from a hobby are not deductible from other income. A hobby is an activity from which you do not expect to make a profit. See Activity not for profit, earlier.

If you collect stamps, coins, or other items as a hobby for recreation and pleasure, and you sell any of the items, your gain is taxable as a capital gain. (See chapter 17.) However, if you sell items from your collection at a loss, you cannot deduct a net loss.

Illegal income. Illegal income, such as stolen or embezzled funds, must be included in your gross income on line 21 of Form 1040, or on Schedule C or Schedule C-EZ (Form 1040) if from your self-employment activity.

Indian fishing rights. If you are a member of a qualified Indian tribe that has fishing rights secured by treaty, executive order, or an Act of Congress as of March 17, 1988, do not include in your income amounts you receive from activities related to those fishing rights. The income is not subject to income tax, self-employment tax, or employment taxes.

Jury duty. Jury duty pay you receive must be included in your income on line 21 of Form 1040. If you must give the pay to your employer because your employer continues to pay your salary while you serve on the jury, you can deduct the amount turned over to your employer as an adjustment to your income. Include the amount you repay your employer on line 32 of Form 1040. Write "Jury Pay" and the amount on the dotted line next to line 32.

Kickbacks. You must include in your income on line 21 of Form 1040, or on Schedule C or Schedule C-EZ (Form 1040), kickbacks, side commissions, push money, or similar payments you receive.

Example. You sell cars and help arrange car insurance for buyers. Insurance brokers pay back part of their commissions to you for referring customers to them. You must include the kickbacks in your income.

Prizes and awards. If you win a prize in a lucky number drawing, television or radio quiz program, beauty contest, or other event, you must include it in your income. For example, if you win a $50 prize in a photography contest, you must report this income on line 21 of Form 1040. If you refuse to accept a prize, do not include its value in your income.

Employee cash awards or bonuses. Cash awards or bonuses given to you by your employer for good work or suggestions generally must be included in your income as wages. However, certain employee awards can be excluded from your income. See Employee achievement awards under Income Not Taxed, later.

Goods or services. Prizes and awards in goods or services must be included in your income at their fair market value.

Pulitzer, Nobel, and other prizes. If you were awarded a Pulitzer, Nobel, or other prize in recognition of past accomplishments (in religious, charitable, scientific, artistic, educational, literary, or civic fields), you generally must include the value of the prize in income. However, do not include this prize in your income if you meet all of the following requirements.

1. You were selected without any action on your part to enter the contest or proceeding.
2. You are not required to perform substantial future services as a condition to receiving the prize or award.
3. The prize or award is transferred by the payer directly to a governmental unit or tax-exempt charitable organization as designated by you.

See Publication 525 for more information about the conditions that apply to the transfer.

State tuition programs. Distributions from a qualified state tuition program are taxable only to the extent they are more than the amount contributed to the program.

Qualified state tuition programs are defined in Publication 525. For more information on a specific program, contact the state or agency that established and maintains it.

Sale of personal items. If you sold an item you owned for personal use, such as a car, refrigerator, furniture, stereo, jewelry, or silverware, your gain is taxable as a capital gain that you report on Schedule D (Form 1040). You cannot deduct a loss.

However, if you sold an item you held for investment, such as gold or silver bullion, coins, or gems, any gain is taxable as a capital gain and any loss is deductible as a capital loss.

Bartering

Bartering is an exchange of property or services. You must include in your income, at the time received, the fair market value of property or services you receive in bartering. If you exchange services with another person and you both have agreed ahead of time as to the value of the services, that value will be accepted as fair market value unless the value can be shown to be otherwise.

Generally, you report this income on Schedule C or Schedule C-EZ (Form 1040). But if the barter involves exchange of something other than services, you may have to use another form or schedule instead.

Example 1. You are a self-employed attorney who performs legal services for a client, a small corporation. The corporation gives you shares of its stock as payment for your services. You must include in income the fair market value of the shares on Schedule C or Schedule C-EZ (Form 1040) in the year that you receive them.

Example 2. You are self-employed and a member of a barter club. The club uses "credit units" as a means of exchange. It adds credit units to your account for goods or services you provide to members, which you can use to purchase goods and services offered by other members of the barter club. The club subtracts credit units from your account when you receive goods or services from other members. You must include in income the value of credit units that are added to your account, even though you may not actually receive goods or services from other members until a later tax year.

Example 3. You own a small apartment building. In return for 6 months' rent-free use of an apartment, an artist gives you a work of art that she created. You must report as rental income on Schedule E (Form 1040) the fair market value of the art work, and the artist must report as income on Schedule C or Schedule C-EZ (Form 1040) the fair rental value of the apartment.

Form 1099-B from barter exchange. If you exchanged property or services through a barter exchange, you should receive Form 1099-B or a similar statement from the barter exchange. You should receive the statement by February 1, 1999, and it should show the value of cash, property, services, credits, or scrip you received from exchanges during the year. The IRS will also receive a copy of Form 1099-B.

Canceled Debts

Generally, if a debt you owe is canceled or forgiven, other than as a gift or bequest, you must include the canceled amount in your gross income. You have no income from the canceled debt if it is intended as a gift to you. A debt includes any indebtedness for which you are liable or which attaches to property you hold.

If you are not self-employed, report the amount on line 21 of Form 1040. If you are self-employed, report the amount on Schedule C or C-EZ (Form 1040) if you are a sole proprietor or on Schedule F (Form 1040) if you are a farmer.

Form 1099-C. If a federal government agency, financial institution, or credit union cancels or forgives a debt you owe of $600 or more, you will receive a Form 1099-C, Cancellation of Debt. The amount of the canceled debt is shown in box 2.

Interest included in canceled debt. If any interest is forgiven and included in the amount of canceled debt in box 2, the amount of interest will also be shown in box 3. Whether or not you must include the interest portion of the canceled debt in your gross income depends on whether the interest would be deductible if you paid it.

If the interest would not be deductible (such as interest on a personal loan), include in your income the amount from box 2 of Form 1099-C. If the interest would be deductible (such as on a business loan), include in your income the net amount of the canceled debt (shown in box 2) less the interest amount (shown in box 3).

Mortgage loan. If your financial institution offers a discount for the early payment of your mortgage loan, the amount of the discount is canceled debt. You must include the canceled amount in your gross income.

Stockholder debt. If you are a stockholder in a corporation and the corporation cancels or forgives your debt to it, the canceled debt is dividend income to you.

If you are a stockholder in a corporation and you cancel a debt owed to you by the corporation, you generally do not realize income. This is because the canceled debt is considered as a contribution to the capital of the corporation equal to the amount of debt principal that you canceled.

Exceptions and Exclusions

There are several exceptions and exclusions to the inclusion of canceled debt in income. Some of the more common ones are explained next.

Nonrecourse debt. If you are not personally liable for the debt (nonrecourse debt), different rules apply. You may have a gain or loss if nonrecourse debt is canceled or forgiven in conjunction with the sale or foreclosure of property to which the debt attaches. See Publication 544 for more information.

Student loans. Certain student loans contain a provision that all or part of the debt incurred to attend the qualified educational institution will be canceled if you work for a certain period of time in certain professions for any of a broad class of employers.

You do not have income if your student loan is canceled after you agreed to this provision and then performed the services required. To qualify, the loan must have been made by:

1. The government--federal, state, or local, or an instrumentality, agency, or subdivision thereof,
2. A tax-exempt public benefit corporation that has assumed control of a state, county, or municipal hospital, and whose employees are considered public employees under state law, or
3. An educational institution
1. Under an agreement with an entity described in (1) or (2) that provided the funds to the institution to make the loan, or
2. As part of a program of the institution to encourage students to serve in occupations or areas with unmet needs and under which the services provided are for or under the direction of a governmental unit or a tax-exempt section 501(c)(3) organization.

A loan will also qualify if it was made by an educational institution or a tax-exempt 501(c)(3) organization to refinance any loan to assist the individual in attending the institution that meets the requirements above.

Section 501(c)(3) organizations are defined in Publication 525.

Deductible debt. If a debt that qualified for a tax deduction is canceled, you do not realize income from the canceled debt. However, whether or not you must include the canceled debt in your gross income depends on whether you use the cash or an accrual method of accounting. If you use the cash method, you do not include it in income. If you use an accrual method, you do include it in income. For more information, see chapter 5 of Publication 334, Tax Guide for Small Business.

Price reduced after purchase. Generally, if the seller reduces the amount you owe for property you purchased, you do not have income from the reduction. The reduction of the debt is treated as a purchase price adjustment and reduces your basis in the property.

Bankruptcy exclusion. If your debt is canceled in a bankruptcy case under title 11 of the United States Code, do not include the canceled debt in your gross income. However, you must reduce your tax attributes (but not below zero) by the canceled amount that is not included in your income. See Publication 908, Bankruptcy Tax Guide, for more information.

Insolvency exclusion. If your debt is canceled when you are insolvent, you do not include the canceled debt (up to a certain limit) in your gross income. However, you must reduce your tax attributes (but not below zero) by the canceled amount that is not included in your income. This exclusion applies only to the amount by which you are insolvent. See Publication 908 for more information.

Partnership Income

A partnership is not a taxable entity. The income, gains, losses, credits, and deductions of a partnership are "passed through" to the partners based on each partner's distributive share of these items.

The partnership must file an information return on Form 1065, U.S. Partnership Return of Income, and send Schedule K-1 (Form 1065) to each partner. In addition, the partnership will send each partner a copy of the Partner's Instructions for Schedule K-1 (Form 1065) to help each partner report his or her share of the partnership's income, credits, deductions, and tax preference items.

Retain Schedule K-1 (Form 1065) for your records. Do not attach it to your Form 1040.

For more information on partnerships, get Publication 541, Partnerships.

S Corporation Income

In general, an S corporation does not pay tax on its income. Instead, the income and expenses of the corporation are "passed through" to the shareholders.

An S corporation must file a return on Form 1120S, U.S. Income Tax Return for an S Corporation, and send Schedule K-1 (Form 1120S) to each shareholder. In addition, the S corporation will send each shareholder a copy of the Shareholder's Instructions for Schedule K-1 (Form 1120S) to help each shareholder report his or her share of the S corporation's income, credits, and deductions.

Do not attach Schedule K-1 (Form 1120S) to your Form 1040. Keep it for your records.

For more information on S corporations and their shareholders, see the instructions for Form 1120S.

Recoveries

A recovery is a return of an amount you deducted or took a credit for in an earlier year. Generally, you must include all or part of the recovered amounts in your income in the year the recovery is received. The most common recoveries are refunds, reimbursements, and rebates of deductions itemized on Schedule A (Form 1040). Non-itemized deduction recoveries include such items as payments you receive on previously deducted bad debts and recoveries of items for which you previously claimed a tax credit.

Federal income tax refund. Refunds of federal income taxes are not included in your income because they are never allowed as a deduction from income.

Form 1099-G. If you received a state or local income tax refund in 1998, you may receive a statement, Form 1099-G, Certain Government Payments, from the payer of the refund (or credit or offset) by February 1, 1999. The IRS will also receive a copy of the Form 1099-G.

Interest. Interest on any of the amounts you recover must be reported as interest income in the year received.

Recovery and expense in same year. If the refund or other recovery and the deductible expense occur in the same year, the recovery reduces the deduction and is not reported as income.

Recovery for 2 or more years. If you receive a refund or other recovery that is for amounts you paid in 2 or more separate years, you must allocate, on a pro rata basis, the recovered amount between the years in which it was paid.

This allocation is necessary to determine the amount of recovery from any earlier years and to determine the amount, if any, of your allowable deduction for this item for the current year. For information on how to compute the allocation, see Recoveries in Publication 525.

Tax benefit rule. If you recover an amount that you deducted or took a credit for in an earlier year, include the recovery in your income only up to the amount the deduction or credit reduced your tax in the earlier year. For more information, get Publication 525.

Itemized Deduction Recoveries

If you recover any amount that you deducted in an earlier year on Schedule A (Form 1040), you must generally include the full amount of the refund or recovery in your income in the year you receive it.

Where to report. Enter your state and local income tax refund on line 10 of Form 1040, and the total of all other recoveries as other income on line 21 of Form 1040. You cannot use Form 1040A or Form 1040EZ.

Example. For 1997, you filed a joint return. Your taxable income was $20,000. Your standard deduction was $6,900, and you had itemized deductions of $8,000. In 1998, you received the following recoveries for amounts deducted on your 1997 return:

Medical expenses                                    $200

State and local income tax refund             400

Refund of mortgage interest                     325

Total recoveries                                      $925

None of the recoveries were more than the deductions taken for 1997.

Because your total recoveries are less than the amount by which your itemized deductions exceeded the standard deduction ($8,000 - 6,900 = $1,100), you must include your total recoveries in your income for 1998. Report the state and local income tax refund of $400 on line 10 of Form 1040 and the balance of your recoveries, $525, on line 21 of Form 1040.

Standard deduction for earlier years. To determine if amounts recovered in 1998 must be included in your income, you must know the standard deduction for your filing status for the year the deduction was claimed. Standard deduction amounts for 1997, 1996, and 1995 are in Publication 525.

Total recoveries not included in income. The total recovery that must be included in your income is limited to the itemized deduction amount that reduced your tax for the earlier year. (See Tax benefit rule, earlier.)

You are generally allowed to claim the standard deduction if you do not itemize your deductions. Only your itemized deductions that are more than your standard deduction are subject to the recovery rule (unless you are required to itemize your deductions). If your total deductions on the earlier year return were not more than your income for that year, include in your income this year the smaller of:

1. Your recoveries, or
2. The amount by which your itemized deductions exceeded the standard deduction.

Example. You filed a joint return for 1997 with taxable income of $25,000. Your itemized deductions were $8,700. The standard deduction that you could have claimed was $6,900. In 1998 you recover $2,400 of your 1997 itemized deductions. None of the recoveries were more than the actual deductions for 1997. Include $1,800 of the recoveries in your 1998 income. This is the smaller of your recoveries ($2,400) or the amount by which your itemized deductions were more than the standard deduction ($8,700 - 6,900 = $1,800).

Recovery limited to deduction. You do not include in your income any amount of your recovery that is more than the amount you deducted in the earlier year. The amount you include in your income is limited to the smaller of:

1. The amount deducted on Schedule A (Form 1040), or
2. The amount recovered.

Example. During 1997 you paid $1,700 for medical expenses. From this amount you subtracted $1,500, which was 7.5% of your adjusted gross income. Your actual medical expense deduction was $200. In 1998, you received a $500 reimbursement from your medical insurance for your 1997 expenses. The only amount of the $500 reimbursement that must be included in your income in 1998 is $200--the amount actually deducted.

Other recoveries. See Recoveries in Publication 525 if:

1. You have recoveries of items other than itemized deductions, or
2. You received a recovery for an item for which you claimed a tax credit (other than investment credit or foreign tax credit) in a prior year.

Rental of Personal Property

If you rent out personal property, such as equipment or vehicles, how you report your income and expenses is generally determined by:

1. Whether or not the rental activity is a business, and
2. Whether or not the rental activity is conducted for profit.

Generally, if your primary purpose is income or profit and you are involved in the rental activity with continuity and regularity, your rental activity is a business. See Publication 535 for details on deducting expenses for both business and not-for-profit activities.

Reporting business income and expenses. If you are in the business of renting personal property, report your income and expenses on Schedule C or C-EZ. The form instructions have information on how to complete them.

Reporting nonbusiness income. If you are not in the business of renting personal property, report your rental income on line 21 of Form 1040. List the type and amount of the income on the dotted line to the left of the amount you report on line 21.

Reporting nonbusiness expenses. If you rent personal property for a profit, report your rental expenses on line 32 of Form 1040. Enter the amount and "PPR" on the dotted line to the left and include the amount of your deductible expenses in the total amount you enter on line 32.

If you do not rent personal property for a profit, your deductions are limited and you cannot report a loss to offset other income. You report these rental expenses on Schedule A (Form 1040).

Repayments

If you had to repay an amount that you had included in your income in an earlier year because at that time you thought you had an unrestricted right to it, you can deduct the amount repaid from your income in the year in which you repay it.

Type of deduction. The type of deduction you are allowed in the year of repayment depends on the type of income you included in the earlier year. For instance, if you repay an amount that you previously reported as a capital gain, deduct the repayment as a capital loss.

Repayment $3,000 or less. If the amount you repaid was $3,000 or less, deduct it from your income in the year you repaid it. If you reported it as wages, unemployment compensation, or other ordinary income, enter it on line 22 of Schedule A (Form 1040). If you reported it as a capital gain, deduct it on Schedule D (Form 1040).

Repayment over $3,000. If the amount you repaid was more than $3,000, you can take a deduction for the amount repaid or you can take a credit against your tax. Follow the steps below and compare the results. Use the method that results in less tax.

1. Figure your tax for 1998 claiming a deduction for the repaid amount.
2. Figure your tax for 1998 without deducting the repaid amount. Then,
1. Refigure your tax from the earlier year without including in income the amount you repaid in 1998.
2. Subtract the tax in (a) from the tax shown on your return for the earlier year.
3. Then subtract the answer in (b) from the tax for 1998 figured without the deduction.

How you treat the repayment on your 1998 return depends on which answer above results in less tax.

If the answer in Step (1) is less tax, deduct the amount repaid on the same form or schedule on which you previously reported it. For example, if you reported it as self-employment income, deduct it as a business deduction on Schedule C or Schedule C-EZ (Form 1040). If you reported it as wages, deduct it as an individual deduction on line 27 of Schedule A (Form 1040).

If the answer in Step (2) is less tax, claim a credit on line 63 of Form 1040, and write "I.R.C. 1341" next to line 63.

An example of this computation can be found in Publication 525.

Repaid social security benefits. If you repaid social security benefits, see Repayment of benefits in chapter 12.

Royalties

Royalties from copyrights, patents, and oil, gas, and mineral properties are taxable as ordinary income.

You generally report royalties on Part I of Schedule E (Form 1040). However, if you hold an operating oil, gas, or mineral interest or are in business as a self-employed writer, inventor, artist, etc., report your gross income and expenses on Schedule C or Schedule C-EZ (Form 1040).

Copyrights and patents. Royalties from copyrights on literary, musical, or artistic works, and similar property, or from patents on inventions, are amounts paid to you for the right to use your work over a specified period of time. Royalties are generally based on the number of units sold, such as the number of books, tickets to a performance, or machines sold.

Oil, gas, and minerals. Royalty income from oil, gas, and mineral properties is the amount you receive when natural resources are extracted from your property. The royalties are based on units, such as barrels, tons, etc., and are paid to you by a person or company who leases the property from you.

Depletion. If you are the owner of an economic interest in mineral deposits or oil and gas wells, you can recover your investment through the depletion allowance. For information on this subject, see chapter 13 of Publication 535.

Coal and iron ore. Under certain circumstances, you can treat amounts you receive from the disposal of coal and iron ore as payments from the sale of a capital asset, rather than as royalty income. For information about gain or loss from the sale of coal and iron ore, get Publication 544, Sales and Other Dispositions of Assets.

Interest in the property sold. If you sell your complete interest in the oil, gas, or mineral rights, the amount you receive is considered payment for the sale of your property, not royalty income. Under certain circumstances, the sale is subject to capital gain or loss treatment on Schedule D (Form 1040).

Part of future production sold. If you own mineral property but sell part of the future production, you generally treat the money you receive from the buyer at the time of the sale as a loan from the buyer. Do not include it in your income or take depletion based on it.

When production begins, you include all the proceeds in your income, deduct all the production expenses, and deduct depletion from that amount to arrive at your taxable income from the property.

Retained interest. If you retain a royalty, an overriding royalty, or a net profit interest in a mineral property for the life of the property, you have made a lease or a sublease, and any cash you receive for the assignment is ordinary income subject to a depletion allowance.

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