You generally should not report the following items on your return. However, some of the items are only partly excluded from your income. A discussion of other totally and partly excluded items follows this list.

• Accident and health insurance proceeds
• "Black lung" benefits
• Casualty insurance and other reimbursements (chapter 27)
• Child support payments (chapter 20)
• Compensatory damages awarded for physical injury or physical sickness
• Federal Employees' Compensation Act payments
• Government cost-of-living allowances for civilian employees stationed outside the continental U.S. (or in Alaska)(chapter 6)
• Housing allowance for members of the clergy (chapter 6)
• Interest on state or local government obligations (chapter 8)
• Meals and lodging provided by employer
• Military allowances
• Moving expense reimbursements (chapter 19)
• Scholarship and fellowship grants
• Supplemental security income (SSI)
• Veterans' benefits (chapter 6)
• Welfare benefits
• Workers' compensation

Campaign contributions. These contributions are not income to a candidate unless they are diverted to his or her personal use. To be exempt from tax, the contributions must be spent for campaign purposes or kept in a fund for use in future campaigns. However, interest earned on bank deposits, dividends received on contributed securities, and net gains on sales of contributed securities are taxable and must be reported on Form 1120-POL, U.S. Income Tax Return for Certain Political Organizations. Excess campaign funds transferred to an office account must be included in the officeholder's income on line 21 of Form 1040, in the year transferred.

Cash rebates. A cash rebate you receive from a dealer or manufacturer of an item you buy is not income.

Example. You buy a new car for $9,000 cash and receive a $400 rebate check from the manufacturer. The $400 is not income to you. Your cost is $8,600. This is your basis on which you figure gain or loss if you sell the car, and depreciation if you use it for business.

Employee achievement awards. Exclude from your income employee achievement awards you receive only if your employer can deduct them. To be deducted by your employer and excluded by you, the awards must meet all the following requirements:

1. Be given for length of service or safety achievement,
2. Be tangible personal property other than cash, gift certificates, or equivalent items,
3. Be given under conditions and circumstances that do not create a significant likelihood of the payment of disguised compensation,
4. Be given as part of a meaningful presentation, and
5. Be no more than the specified dollar limits.

Dollar limits. There are limits to the total awards you can exclude in one year. Awards from nonqualified plans are limited to $400, and total awards from both qualified and nonqualified plans are limited to $1,600. The cost to your employer is the determining factor for these limits. Amounts over the limits cannot be deducted by your employer and must be included in your income.

Qualified plan award. A qualified plan award is one you are awarded as part of an established written plan by your employer that does not discriminate in favor of highly compensated employees. An award will not be considered a qualified plan award if the average cost of all employee achievement awards given by your employer during the tax year is more than $400. In determining average cost, awards of nominal value are not taken into account.

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 his income. However, since the $1,750 total value of the awards is more than $1,600, Ben must include $150 ($1,750 - $1,600) in his income.

Energy conservation subsidies. You can exclude from gross income any subsidy provided, either directly or indirectly, by public utilities for the purchase or installation of an energy conservation measure for a dwelling unit.

Energy conservation measure. This includes installations or modifications that are primarily designed to reduce consumption of electricity or natural gas, or improve the management of energy demand.

Dwelling unit. This includes a house, apartment, condominium, mobile home, boat, or similar property. If a building or structure contains both dwelling and other units, any subsidy must be properly allocated.

Foster-care providers. Payments you receive from a state, political subdivision, or tax-exempt child-placement agency for providing foster care to qualified individuals in your home generally are not included in your income. You must include in your income payments received for the care of more than 5 individuals age 19 or older and certain difficulty-of-care payments.

A qualified foster individual is a person who:

1. Is living in a foster family home, and
2. Was placed there by:
   1. An agency of a state or one of its political subdivisions, or
   2. If the individual is under age 19, a tax-exempt child placement agency licensed by a state or one of its political subdivisions.

Difficulty-of-care payments. These are additional payments that are designated by the payer as compensation for providing the additional care which is required for physically, mentally, or emotionally handicapped qualified foster individuals. To be difficulty-of-care payments, a state must determine that the additional compensation is needed and the care for which the payments are made must be provided in your home.

You must include in your income difficulty-of-care payments received for more than:

1. 10 qualified foster individuals under age 19, and
2. 5 qualified foster individuals age 19 or older.

Maintaining space in home. If you are paid by a placement agency to maintain space in your home for foster-care individuals, or if you receive payments that you must include in your income, you are in business as a foster-care provider and you are self-employed. You must include these payments in income.

Get Publication 587, Business Use of Your Home, to help you determine the amount you can deduct for the use of your home.

Gifts and inheritances. Generally, property you receive as a gift, bequest, or inheritance is not included in your income. However, if property you receive this way later produces income such as interest, dividends, or rentals, that income is taxable to you. If property is given to a trust and the income from it is paid, credited, or distributed to you, that also is income to you. If the gift, bequest, or inheritance is the income from the property, that income is taxable to you.

Items given to you as an incentive to enter into a business transaction are not gifts. For example, items such as small appliances or dinnerware given to you by a bank as an incentive to make a deposit are interest income to you and must be reported at their fair market value.

Inherited pension or IRA. If you inherited a pension or an individual retirement arrangement (IRA), you may have to include part of the inherited amount in your income. See chapter 11 if you inherited a pension. See chapter 18 if you inherited an IRA.

Interest on frozen deposits. Generally, you can exclude from your income the amount of interest earned on a frozen deposit. See Interest income on frozen deposits in chapter 8.

Interest on qualified savings bonds. You may be able to exclude from your income all or part of the interest from qualified U.S. savings bonds you redeem if you pay qualified higher educational expenses in the same year. For more information on this exclusion, see Education Savings Bond Program under U.S. Savings Bonds in chapter 8.

Living expenses paid by insurance. Do not include in your income amounts you receive under an insurance policy for additional living expenses you and your family had because you lost the use of your home due to a fire, storm, or other casualty. You exclude from income your actual living expenses of keeping you and your family at the same standard of living you had before the loss minus the normal living expenses you would have had.

Sale of home. You may be able to exclude from income all or part of any gain from the sale or exchange of your principal residence. See chapter 16.

Transporting school children. Do not include in your income a school board mileage allowance for taking children to and from school if you are not in the business of taking children to school. You cannot deduct expenses for providing this transportation.

Utility rebates. If you are a customer of an electric utility company and you participate in the utility's energy conservation program, you may receive on your monthly electric bill either:

1. A reduction in the purchase price of electricity furnished to you (rate reduction), or
2. A nonrefundable credit against the purchase price of the electricity.

The amount of the rate reduction or nonrefundable credit is not included in your income.

Life Insurance Proceeds

Life insurance proceeds paid to you because of the death of the insured person are not taxable unless the policy was turned over to you for a price. This is true even if the proceeds were paid under an accident or health insurance policy or an endowment contract.

Proceeds not received in installments. If death benefits are paid to you in a lump sum or other than at regular intervals, include in your gross income only the benefits that are more than the amount payable to you at the time of the insured person's death. If the benefit payable at death is not specified, you include in your income the benefit payments that are more than the present value of the payments at the time of death.

Proceeds received in installments. If you receive life insurance proceeds in installments, you can exclude part of each installment from your income.

To determine the excluded part, divide the amount held by the insurance company (generally the total lump sum payable at the death of the insured person) by the number of installments to be paid. Include anything over this excluded part in your income as interest.

Surviving spouse. If your spouse died before October 23, 1986, and insurance proceeds are paid to you because of the death of your spouse, and you receive them in installments, you can exclude up to $1,000 a year of the interest included in the installments. If you remarry, you can continue to take the exclusion.

More information. For more information, see Life Insurance Proceeds in Publication 525.

Surrender of policy for cash. If you surrender a life insurance policy for cash, you must include in income any proceeds that are more than the cost of the life insurance policy. In general, your cost (or investment in the contract) is the total premiums that you paid for the life insurance policy, less any refunded premiums, rebates, dividends or unrepaid loans that were not included in your income. This is explained more fully in Publication 575.

You should receive a Form 1099-R. Report these amounts on lines 16a and 16b of Form 1040, or lines 11a and 11b of Form 1040A.

Endowment proceeds. Endowment proceeds paid in a lump sum to you at maturity are taxable only if the proceeds are more than the cost of the policy. To determine your cost, see Endowment proceeds in Publication 525.

Survivor benefits. Generally, payments made by or for an employer because of an employee's death must be included in income. However, if the decedent died before August 21, 1996, the first $5,000 paid to beneficiaries can be excluded from the income of the beneficiaries. The payments need not be made as the result of a contract. The amount excluded for any deceased employee cannot be more than $5,000 regardless of the number of employers or the number of beneficiaries.

See Publication 525 for more information on this exclusion.

Deceased public safety officers. If you are a survivor of a public safety officer who died in the line of duty, you may be able to exclude from income certain amounts you receive.

Bureau of Justice Assistance payments. If you are a surviving dependent of a public safety officer (law enforcement officer or firefighter) who died in the line of duty, do not include in your income the death benefit paid to you by the Bureau of Justice Assistance.

Governmental plan annuity. If you are a surviving child (or former spouse) of a public safety officer who was killed in the line of duty after 1996, you generally do not have to include in income the survivor benefit paid to you. Public safety officers include law enforcement officers, firefighters, rescue squad or ambulance crew. See Publication 525 for more information.

Accelerated Death Benefits

Certain payments received under a life insurance contract on the life of a terminally or chronically ill individual before the individual's death (an accelerated death benefit) can be excluded from income. See the exception later. For a chronically ill individual, the payments must be for costs incurred for qualified long-term care services or made on a periodic basis without regard to the costs.

In addition, if any portion of a death benefit under a life insurance contract on the life of a terminally or chronically ill individual is sold or assigned to a viatical settlement provider, the amount received is also excluded from income. Generally, a viatical settlement provider is one who regularly engages in the business of buying or taking assignment of life insurance contracts on the lives of insured individuals who are terminally or chronically ill.

Terminally or chronically ill defined. A terminally ill person is one who has been certified by a physician as having an illness or physical condition that can reasonably be expected to result in death within 24 months from the date of the certification. A chronically ill person is one who is not terminally ill but has been certified by a licensed health care practitioner as meeting one of the following conditions:

1. Is unable to perform (without substantial help) at least two activities of daily living for a period of 90 days or more because of a loss of functional capacity,
2. Has a level of disability similar to the disability in (1) above, or
3. Requires substantial supervision to protect himself or herself from threats to health and safety due to severe cognitive impairment.

Exception. The exclusion does not apply to any amount paid to a person other than the insured if that other person has an insurable interest in the life of the insured:

• Because the insured is a director, officer, or employee of the other person, or
• Because the insured has a financial interest in the business of the other person.

Limit on exclusion. The amount of accelerated death benefits you may exclude may be limited if:

1. They are paid on account of chronic illness, and
2. They are received as periodic payments.

There is no limit on amounts paid on account of terminal illness.

For 1998, the most you can exclude is $180 per day ($65,700 a year). See Form 8853, Medical Savings Accounts and Long-Term Care Insurance Contracts, for more information.

Long-Term Care Insurance Contracts

Long-term care insurance contracts are generally treated as accident and health insurance contracts. Amounts you receive from them (other than policyholder dividends or premium refunds) generally are excludable from income as amounts received for personal injury or sickness.

A long-term care insurance contract is any insurance contract that only provides coverage of qualified long-term care services. The contract:

1. Must be guaranteed renewable,
2. Must not provide for a cash surrender value or other money that can be paid, assigned, pledged, or borrowed,
3. Must provide that refunds, other than refunds on the death of the insured or complete surrender or cancellation of the contract, and dividends under the contract may be used only to reduce future premiums or increase future benefits, and
4. Generally must not pay or reimburse expenses incurred for services or items that would be reimbursed under Medicare, except where Medicare is a secondary payer or the contract makes per diem or other periodic payments without regard to expenses.

Qualified long-term care services. Qualified long-term care services are:

1. Necessary diagnostic, preventive, therapeutic, curing, treating, mitigating, and rehabilitative services, and
2. Maintenance or personal care services required by a chronically ill individual as prescribed by a licensed health care practitioner.

Chronically ill individual. A chronically ill individual is one who has been certified as one of the following:

1. An individual who, for at least 90 days, is unable to perform at least two activities of daily living without substantial assistance due to loss of functional capacity. Activities of daily living are eating, toileting, transferring, bathing, dressing, and continence, or
2. An individual who requires substantial supervision to be protected from threats to health and safety due to severe cognitive impairment.

The certification must have been made by a licensed health care practitioner within the previous 12 months.

Limit on exclusion. You can generally exclude from gross income up to $185 a day ($65,700 a year) for 1998. The $180 is indexed for inflation after 1998.

Medical Savings Accounts (MSAs)

Do not include in income amounts you withdraw from your MSA if you use the money to pay for qualified medical expenses for you, your spouse, or your dependents. Generally, qualified medical expenses are those you can deduct on Schedule A (Form 1040) Itemized Deductions. You must have paid these expenses yourself. For more information about qualified medical expenses, see Publication 502, Medical and Dental Expenses.

You cannot buy health insurance with distributions from your MSA unless you are receiving unemployment benefits, buying continuation coverage required by Federal law, or buying long-term care insurance.

Taxable distributions and penalty. If you use the money from your MSA for any purpose besides qualified medical expenses, it will be taxable income that you must report on your tax return. In addition to the tax, you will be charged a 15 percent penalty for an early distribution. The penalty will not be charged if you are disabled or age 65.

Table 13-1 Are Your Sickness Benefits and Injury Benefits Taxable?

Welfare and Other Public Assistance Benefits

Do not include in your income the benefit payments from a public welfare fund, such as payments due to blindness. Payments from a state fund for the victims of crime should not be included in the victims' incomes if they are in the nature of welfare payments. Do not deduct medical expenses that are reimbursed by such a fund. You must include in your income any welfare benefits obtained fraudulently.

Alaska residents. Payments the state of Alaska makes to its citizens who meet certain age and residency tests that are not based on need are not welfare benefits. Include them in gross income on line 21 of Form 1040.

Persons with disabilities. If you have a disability, you must include in income compensation you receive for services you perform unless the compensation is otherwise excluded. However, you do not include in income the value of goods, services, and cash that you receive, not in return for your services, but for your training and rehabilitation. Excludable amounts include payments for transportation and attendant care, such as interpreter services for the deaf, reader services for the blind, and services to help mentally retarded persons do their work.

Disaster relief grants. Grants made under the Disaster Relief Act of 1974 to help victims of natural disasters are not included in income. Do not deduct casualty losses or medical expenses that are specifically reimbursed by these disaster relief grants. Disaster unemployment assistance payments under the Act are unemployment benefits that are taxable. See Unemployment compensation in chapter 6.

Mortgage assistance payments. Payments made under section 235 of the National Housing Act for mortgage assistance are not included in the homeowner's gross income.

Interest paid for the homeowner under the mortgage assistance program cannot be deducted.

Payments to reduce cost of winter energy. Payments made by a state to qualified people to reduce their cost of winter energy use are not taxable.

Other Sickness and Injury Benefits

In addition to welfare or insurance benefits, you may receive other payments for sickness or injury. Table 13-1 gives a general overview of some of these payments.

Workers' compensation. Amounts you receive as workers' compensation for an occupational sickness or injury are fully exempt from tax if they are paid under a workers' compensation act or a statute in the nature of a workers' compensation act. The exemption also applies to your survivor(s). The exemption from tax, however, does not apply to retirement benefits you receive based on your age, length of service, or prior contributions to the plan, even if you retired because of occupational sickness or injury.

Note. If part of your workers' compensation reduces your social security or equivalent railroad retirement benefits received, that part is considered social security (or equivalent railroad retirement) benefits and may be taxable. For more information, see Publication 915, Social Security and Equivalent Railroad Retirement Benefits.

Return to work. If you return to work after qualifying for workers' compensation, payments you continue to receive while assigned to light duties are taxable. Report these payments as wages on line 7 of Form 1040 or Form 1040A, or on line 1 of Form 1040EZ.

Federal Employees' Compensation Act (FECA). Payments received under this Act for personal injury or sickness, including payments to beneficiaries in case of death, are not taxable. However, you are taxed on amounts you receive under this Act as "continuation of pay" for up to 45 days while a claim is being decided. Report this income on line 7 of Form 1040 or Form 1040A, or on line 1 of Form 1040EZ. Also, pay for sick leave while a claim is being processed is taxable and must be included in your income as wages.

You can deduct the amount you spend to "buy back" sick leave for an earlier year to be eligible for nontaxable FECA benefits for that period. It is a miscellaneous deduction subject to the 2% limit on Schedule A (Form 1040). If you buy back sick leave in the same year you use it, the amount reduces your taxable sick leave pay. Do not deduct it separately.

Other compensation. Many other amounts you receive as compensation for injury or illness are not taxable. These include:

• Compensatory damages you receive for physical injury or physical illness, whether paid in a lump sum or in periodic payments,
• Benefits you receive under an accident or health insurance policy on which either you paid the premiums or your employer paid the premiums but you had to include them in your gross income,
• Disability benefits you receive for loss of income or earning capacity as a result of injuries under a "no-fault" car insurance policy, and
• Compensation you receive for permanent loss or loss of use of a part or function of your body, or for your permanent disfigurement. This compensation must be based only on the injury and not on the period of your absence from work. These benefits are exempt from tax even if your employer pays for the accident and health plan that provides these benefits.

Reimbursement for medical care. A reimbursement for medical care is generally not taxable. However, this reimbursement may reduce your medical expense deduction. For more information, see chapter 23.

Scholarship and Fellowship Grants

If you receive a scholarship or fellowship grant, you may be able to exclude from income all or part of the amounts you receive.

Qualified scholarships. A candidate for a degree can exclude amounts received as a qualified scholarship. A qualified scholarship is any amount you receive that is for:

1. Tuition and fees to enroll at or attend an educational organization, or
2. Fees, books, supplies, and equipment required for courses at the educational institution.

Amounts used for room and board do not qualify.

Payments for services. Payments you receive for services required as a condition of receiving a scholarship or fellowship grant must be included in income, even if the services are required of all candidates for the degree. This includes amounts received for teaching and research. Include these payments on line 7 of Form 1040 or Form 1040A, or on line 1 of Form 1040EZ. For more information on scholarships and fellowship grants, get Publication 520.

VA payments. Allowances paid by the Department of Veterans Affairs are not included in your gross income. These allowances are not considered scholarship or fellowship grants.

Prizes. Scholarship prizes won in a contest are not scholarships or fellowships if you do not have to use the prizes for educational purposes. You must include these amounts in your gross income on line 21 of Form 1040, whether or not you use the amounts for educational purposes.

Qualified tuition reductions. These reductions are excluded from your income. A qualified tuition reduction is the amount of reduction in tuition for education (below the graduate level) furnished to an employee of an educational institution (or certain other persons) provided certain requirements are met. However, graduate students who engage in teaching or research activities for the educational institution may qualify for this exclusion. For more information, get Publication 520.

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