This section discusses various types of income. You may have to include income from certain transactions even if no money changes hands. For example, if you lend money at a below-market interest rate or have a debt you owe cancelled, you may have to include an amount in income.

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 an exchange of something other than services, such as in Example 4 below, 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 the fair market value of the shares in your income on Schedule C or Schedule C-EZ (Form 1040) in the year you receive them.

Example 2. You are a self-employed accountant. You and a house painter are members of a barter club. Members get in touch with each other directly and bargain for the value of the services to be performed. In return for accounting services you provided, the house painter painted your home. You must report as your income on Schedule C or Schedule C-EZ (Form 1040) the fair market value of the house painting services you received. The house painter must include in income the fair market value of the accounting services you provided.

Example 3. 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 or 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 your income the value of the 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 4. 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 she created. You must report as rental income on Schedule E (Form 1040) the fair market value of the artwork, 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, Proceeds from Broker and Barter Exchange Transactions, or a similar statement from the barter exchange by January 31, 2001. 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.

Backup withholding. The income you receive from bartering is generally not subject to regular income tax withholding. However, backup withholding will apply in certain circumstances to ensure that income tax is collected on this income.

Under backup withholding, the barter exchange must withhold, as income tax, 31% of the income if:

1. You do not give the barter exchange your taxpayer identification number (generally a social security number or an employer identification number), or
2. The IRS notifies the barter exchange that you gave it an incorrect identification number.

If you join a barter exchange, you must certify under penalties of perjury that your taxpayer identification number is correct and that you are not subject to backup withholding. If you do not make this certification, backup withholding may begin immediately. The barter exchange will give you a Form W-9, Request for Taxpayer Identification Number and Certification, or a similar form, for you to make this certification.

The barter exchange will withhold tax only to the extent of any cash paid to you or deposited in your account or any scrip or credit issued to you (and converted to cash).

If tax is withheld from your barter income, the barter exchange will report the amount of tax withheld on Form 1099-B, or similar statement.

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 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 the debt is a nonbusiness debt, report the canceled amount on line 21 of Form 1040. If it is a business debt, report the amount on Schedule C or C-EZ (Form 1040) (or on Schedule F (Form 1040), Profit or Loss From Farming, 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 income depends on whether the interest would be deductible if you paid it. See Deductible debt under Exceptions, later.

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 (the amount shown in box 2 less the interest amount shown in box 3).

Discounted 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 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

There are several exceptions to the inclusion of canceled debt in income. These 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 a nonrecourse debt is canceled or forgiven in conjunction with the foreclosure or repossession 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 designed 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 to refinance a qualified student loan will also qualify if it was made by an educational institution or a tax-exempt section 501(a) organization under its program designed as described in (3)(b) above.

An educational institution is an organization with a regular faculty and curriculum and a regularly enrolled body of students in attendance at the place where the educational activities are carried on.

A section 501(c)(3) organization is any corporation, community chest, fund, or foundation organized and operated exclusively for one or more of the following purposes.

• Charitable.
• Religious.
• Educational.
• Scientific.
• Literary.
• Testing for public safety.
• Fostering national or international amateur sports competition (but only if none of the organization's activities involve providing athletic facilities or equipment).
• Preventing cruelty to children or animals.

Exception. You do have income if your student loan was made by an educational institution and is canceled because of services you performed for the institution or other organization that provided the funds.

Deductible debt. You do not have income from the cancellation of a debt if your payment of the debt would be deductible. This exception applies only if you use the cash method of accounting. For more information, see chapter 5 of Publication 334.

Price reduced after purchase. Generally, if the seller reduces the amount of debt 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.

Excluded debt. Do not include a canceled debt in your gross income in the following situations.

1. The debt is canceled in a bankruptcy case under title 11 of the U.S. Code. See Publication 908, Bankruptcy Tax Guide.
2. The debt is canceled when you are insolvent. However, this does not apply to the extent the debt exceeds the amount by which you are insolvent. See Publication 908.
3. The debt is qualified farm debt and is canceled by a qualified person. See chapter 4 of Publication 225, Farmer's Tax Guide.
4. The debt is qualified real property business debt. See chapter 5 of Publication 334.

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 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.

Example. The face amount of the policy is $75,000 and, as beneficiary, you choose to receive 120 monthly installments of $1,000 each. The excluded part of each installment is $625 ($75,000 x 120), or $7,500 for an entire year. The rest of each payment, $375 a month (or $4,500 for an entire year), is interest income to you.

Installments for life. If, as the beneficiary under an insurance contract, you are entitled to receive the proceeds in installments for the rest of your life without a refund or period-certain guarantee, you figure the excluded part of each installment by dividing the amount held by the insurance company by your life expectancy. If there is a refund or period-certain guarantee, the amount held by the insurance company for this purpose is reduced by the actuarial value of the guarantee.

Surviving spouse. If your spouse died before October 23, 1986, and insurance proceeds paid to you because of the death of your spouse are received 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.

Interest option on insurance. If an insurance company pays you interest only on proceeds from life insurance left on deposit, the interest you are paid is taxable.

If you chose to receive only the interest from your insurance proceeds, the $1,000 interest exclusion for a surviving spouse does not apply. If you later decide to receive the proceeds from the policy in installments, you can take the interest exclusion from the time you begin to receive the installments.

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 of 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.

You should receive a Form 1099-R showing the total proceeds and the taxable part. Report these amounts on lines 16a and 16b of Form 1040, or on lines 12a and 12b 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, add the aggregate amount of premiums (or other consideration) paid for the contract and subtract any amount that you previously received under the contract and excluded from your income. Include any amount of the lump sum payment over your cost in your income.

Endowment proceeds that you choose to receive in installments instead of a lump-sum payment at the maturity of the policy are taxed as an annuity. This is explained in Publication 575. For this treatment to apply, you must choose to receive the proceeds in installments before receiving any part of the lump sum. This election must be made within 60 days after the lump-sum payment first becomes payable to you.

Accelerated Death Benefits

Certain amounts paid as accelerated death benefits under a life insurance contract or viatical settlement before the insured's death are excluded from income if the insured is terminally or chronically ill.

Viatical settlement. This is the sale or assignment of any part of the death benefit under a life insurance contract to a viatical settlement provider. A viatical settlement provider is a person 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 and who meets the requirements of section 101(g)(2)(B) of the Internal Revenue Code.

Exclusion for terminal illness. Accelerated death benefits are fully excludable if the insured is a terminally ill individual. This is a person 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.

Exclusion for chronic illness. If the insured is a chronically ill individual who is not terminally ill, accelerated death benefits paid on the basis of costs incurred for qualified long-term care services are fully excludable. Accelerated death benefits paid on a per diem or other periodic basis are excludable up to a limit. This limit applies to the total of the accelerated death benefits and any periodic payments received from long-term care insurance contracts. For information on the limit and the definitions of "chronically ill individual," "qualified long-term care services," and "long-term care insurance contracts," see Long-Term Care Insurance Contracts under Sickness and Injury Benefits, earlier.

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

• Is a director, officer, or employee of the person, or
• Has a financial interest in the person's business.

Form 8853. To claim an exclusion for accelerated death benefits made on a per diem or other periodic basis, you must file Form 8853 with your return. You do not have to file Form 8853 to exclude accelerated death benefits paid on the basis of actual expenses incurred.

Recoveries

A recovery is a return of an amount you deducted or took a credit for in an earlier year. The most common recoveries are refunds, reimbursements, and rebates of deductions itemized on Schedule A (Form 1040). You may also have recoveries of non-itemized deductions (such as payments on previously deducted bad debts) and recoveries of items for which you previously claimed a tax credit.

Table 1 - Post '86 Worksheet

Table 2 - 1999 Standard Deduction

Table 3 - 1998 Standard Deduction

Table 4 - 1997 Standard Deduction

Tax benefit rule. You must include a recovery in your income in the year you receive it to the extent that the deduction or credit you took for the recovered amount reduced your tax in the earlier year. For this purpose, any increase to an amount carried over to the current year that resulted from the deduction or credit is considered to have reduced your tax in the earlier year.

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.

State income tax refund. If you received a state or local income tax refund (or credit or offset) in 2000, you must include it in income if you deducted the tax in an earlier year. You should receive Form 1099-G, Certain Government and Qualified State Tuition Program Payments, from the payer by January 31, 2001. The IRS will also receive a copy of the Form 1099-G.

Mortgage interest refund. If you received a refund or credit in 2000 of mortgage interest paid in an earlier year, the amount should be shown in box 3 of your Form 1098, Mortgage Interest Statement. Do not subtract the refund amount from the interest you paid in 2000. You may have to include it in your income under the rules explained in the following discussions.

Interest on recovery. Interest on any of the amounts you recover must be reported as interest income in the year received. For example, report any interest you received on state or local income tax refunds on line 8a of Form 1040.

Recovery and expense in same year. If the refund or other recovery and the expense occur in the same year, the recovery reduces the deduction or credit 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 you paid it.

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.

Example. You paid 1999 estimated state income tax of $4,000 in four equal payments. You made your fourth payment in January 2000. You had no state income tax withheld during 1999. In 2000, you received a $400 tax refund based on your 1999 state income tax return. You claimed itemized deductions each year on your federal income tax return.

You must allocate the $400 refund between 1999 and 2000, the years in which you paid the tax on which the refund is based. Since you paid 75% ($3,000 x $4,000) of the estimated tax in 1999, 75% of the $400 refund, or $300, is for amounts you paid in 1999 and is a recovery item. If all of the $300 is a taxable recovery item, you will include $300 on line 10, Form 1040, for 2000, and attach a copy of your computation showing why that amount is less than the amount shown on the Form 1099-G you received from the state.

The balance ($100) of the $400 refund is for your January 2000 estimated tax payment. When you figure your deduction for state and local income taxes paid during 2000, you will reduce the $1,000 paid in January by $100. Your deduction for state and local income taxes paid during 2000 will include the January net amount of $900 ($1,000 - $100), plus any estimated state income taxes paid in 2000 for 2000, and any state income tax withheld during 2000.

Deductions not itemized. If you did not itemize deductions for the year for which you received the recovery of an expense that was deductible only if you itemized, do not include any of the recovery amount in your income.

Example. You filed your 1999 federal income tax return on Form 1040A. In 2000 you received a refund of your 1999 state income tax. Do not report any of the refund as income because you did not itemize deductions for 1999.

Itemized Deduction Recoveries

The following discussion explains how to determine the amount to include in your income from a recovery of an amount deducted in an earlier year as an itemized deduction. However, you generally do not need to use this discussion if the recovery is for state or local income taxes paid in 1999. Instead, use the worksheet in the 2000 Form 1040 instructions for line 10 to figure the amount (if any) to include in your income.

You cannot use the Form 1040 worksheet and must use this discussion if any of the following statements is true.

• The recovery is for a tax year other than 1999.
• The recovery is for a deducted item other than state or local income taxes, such as real property taxes.
• Your 1999 taxable income was zero.
• You made your last payment of 1999 state or local estimated tax in 2000.
• You owed alternative minimum tax for 1999.
• You could not deduct all your tax credits for 1999 because their total was more than the tax shown on line 40 of your 1999 Form 1040.

If you also recovered an amount deducted as a non-itemized deduction, figure the amount of that recovery to include in your income and add it to your adjusted gross income before applying the rules explained here. See Non-Itemized Deduction Recoveries, later.

Total recovery included in income. 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 recovery in your income in the year you receive it. This rule applies if, for the earlier year, all of the following statements are true.

1. Your itemized deductions exceeded the standard deduction by at least the amount of the recovery. (If your itemized deductions did not exceed the standard deduction by at least the amount of the recovery, see Standard deduction limit, later.)
2. You had taxable income. (If you had no taxable income, see Negative taxable income, later.)
3. Your deduction for the item recovered equals or exceeds the amount recovered. (If your deduction was less than the amount recovered, see Recovery limited to deduction, later.)
4. Your itemized deductions were not subject to the limit on itemized deductions. (If your deductions were limited, see Itemized deductions limited, later.)
5. You had no unused tax credits. (If you had unused tax credits, see Unused tax credits, later.)
6. You were not subject to alternative minimum tax. (If you were subject to alternative minimum tax, see Subject to alternative minimum tax, later.)

If any of the above statements is not true, see Total recovery not included in income, later.

Where to report. Enter your state or 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 1999, you filed a joint return. Your taxable income was $20,000 and you were not entitled to any tax credits. Your standard deduction was $7,200, and you had itemized deductions of $9,000. In 2000, you received the following recoveries for amounts deducted on your 1999 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 1999.

Because your total recoveries are less than the amount by which your itemized deductions exceeded the standard deduction ($9,000 - $7,200 = $1,800), you must include your total recoveries in your income for 2000. 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.

Total recovery not included in income. If one or more of the six statements listed in the preceding discussion is not true, you may be able to exclude at least part of the recovery from your income. If statements (4), (5), and (6) are true (your itemized deductions were not limited, you had no unused tax credits, and you were not subject to the alternative minimum tax), you can use Table 1 to determine the amount of your recovery of amounts deducted after 1986 to include in your income.

Allocation of recoveries to be included. If you are not required to include all of your recoveries in your income, and you have both a state income tax refund and other itemized deduction recoveries, you must allocate part of the taxable recoveries to report as a state tax refund on line 10 of Form 1040. The balance of your taxable recoveries is reported as other income on line 21 of Form 1040. You can use Table 1 to figure the part to report as a state tax refund, or you can figure that part as follows.

1. Divide your state income tax refund by the total of all your itemized deduction recoveries. The result is the percentage of the total recoveries that the state income tax refund represents.
2. Multiply the amount of taxable recoveries by the percentage in (1).

Example. In 2000 you recovered $2,500 of your 1999 itemized deductions, but the recoveries you must include in your 2000 income are only $1,500. Of the $2,500 you recovered, $500 was due to your state income tax refund. The amount you report as a tax refund on line 10 of Form 1040 is $300 [($500 x $2,500) x $1,500]. The balance of the taxable recoveries, $1,200, is reported as other income on line 21 of Form 1040.

Standard deduction limit. 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.

Standard deduction for earlier years. To determine if amounts recovered in 2000 must be included in your income, you must know the standard deduction for your filing status for the year the deduction was claimed. The standard deduction tables for 1999, 1998, and 1997 are shown in Tables 2, 3, and 4. If you need the standard deduction amounts for years before 1997, see the copy of your return for that year.

Example. You filed a joint return for 1999 with a taxable income of $25,000. Your itemized deductions were $8,700. The standard deduction that you could have claimed was $7,200. In 2000, you recover $2,400 of your 1999 itemized deductions. None of the recoveries were more than the actual deductions for 1999. Include $1,500 of the recoveries in your 2000 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 - $7,200 = $1,500).

Negative taxable income. If your taxable income was a negative amount, reduce the recovery you must otherwise include in your income by the negative amount.

Example. The facts are the same as in the previous example except you had a negative taxable income of $200 in 1999. You would include $1,300 in your 2000 income, rather than $1,500.

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 1999, 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 2000, you received a $500 reimbursement from your medical insurance for your 1999 expenses. The only amount of the $500 reimbursement that must be included in your income for 2000 is $200 -- the amount actually deducted.

Itemized deductions limited. You were subject to the limit on itemized deductions in the earlier year if your adjusted gross income (AGI) was more than a base amount. For example, this amount was:

• For 1999, $126,600 ($63,300 if married filing separately),
• For 1998, $124,500 ($62,250 if married filing separately),
• For 1997, $121,200 ($60,600 if married filing separately), and

If the limit applied, your itemized deductions were reduced by the smaller of the following amounts.

1. 3% of the amount by which your AGI exceeded the base amount.
2. 80% of your otherwise allowable deductions other than medical and dental expenses, investment interest expense, nonbusiness casualty and theft losses, and gambling losses.

If the amount you recovered was deducted in a year in which your itemized deductions were limited, you must include it in income up to the difference between the amount of itemized deductions actually allowed that year and the amount you would have been allowed (the greater of your itemized deductions or your standard deduction) if you had figured your deductions using only the net amount of the recovery item.

To determine the portion of the recovery you must include in income, follow the four steps below. If your earlier tax year does not involve negative taxable income or an unused tax credit, skip steps 1 and 2 and start with step 3.

1. If your taxable income for the earlier year was a negative amount, reduce your recovery by the negative amount.
2. If your tax for the earlier year was reduced to zero by a tax credit that was not fully used in that year, and if reducing your deduction for that year by the recovery would result in tax for that year, reduce your recovery to an amount equal to your recovery multiplied by the following fraction:
   1. Your tax for the earlier year, determined after reducing your deductions by the recovery and applying the credit, over
   2. The total increase in your tax for the earlier year, determined by subtracting your actual tax before applying the credit from the tax in (a) before applying the credit.
3. Figure the greater of:
   1. The standard deduction for the earlier year, or
   2. The amount of itemized deductions you would have been allowed for the earlier year (after taking into account the limit on itemized deductions) if you had figured them using only the net amount of the recovery item. The net amount is the amount you actually paid reduced by the recovery amount (as reduced in steps 1 and 2, if they apply).

   Note. If you were required to itemize your deductions in the earlier year, use step 3(b) and not step 3(a).

4. Subtract the amount in step 3 from the amount of itemized deductions actually allowed in the earlier year after applying the limit on itemized deductions.

The result of step 4 is the amount of the recovery to include in your income for the year you receive the recovery.

For more information on this computation, see Revenue Ruling 93-75. This ruling is in Cumulative Bulletin 1993-2.

Example. Eileen Martin is single. She had an AGI of $1,126,600 and itemized her deductions on her federal income tax return for 1999. She was not subject to alternative minimum tax and was not entitled to any credit against income tax. Her only allowable deduction was $40,000 of state income taxes. However, Eileen deducted only $10,000 in 1999 because her otherwise allowable deductions of $40,000 were reduced by $30,000. In 2000, she received a $5,000 refund of her state income taxes for 1999.

The following table shows how Eileen figured the $30,000 reduction and other amounts from the Itemized Deduction Worksheet in the 1999 Schedule A (Form 1040) instructions. These amounts are needed to figure the portion of the $5,000 refund that Eileen must include in her income for 2000.

AGI for 1999	$1,126,600
State income taxes paid in 1999	$40,000
3% reduction (amount on line 8 of  1999 Itemized Deduction Worksheet)   [($1,126,600 - $126,600) x 3%]	$30,000
80% reduction not applied (amount  on line 4 of 1999 Itemized Deduction  Worksheet) ($40,000 x 80%)	$32,000
1999 deduction (amount on line 10 of  1999 Itemized Deduction Worksheet)  ($40,000 - $30,000)	$10,000
Refund received in 2000 of 1999 state  income tax	$5,000
Net amount of 1999 state income  tax ($40,000 - $5,000)	$35,000

If Eileen had used the $35,000 net amount of state income tax to figure her itemized deductions for 1999, the deduction allowed would have been $7,000. This is her otherwise allowable deduction of $35,000 reduced by $28,000 ($35,000 x 80%). By deducting the full $10,000 paid in 1999, she derived a tax benefit of $3,000 ($10,000 - $7,000). Therefore, only $3,000 of the $5,000 refund is included in her income for 2000.

Unused tax credits. If you recover an item deducted in an earlier year in which you had unused tax credits, you must refigure the earlier year's tax to determine if you must include the recovery in your income. To do this, add the amount of the recovery to your earlier year's taxable income and refigure the tax and the credits on the recomputed amount. If the recomputed tax, after application of the credits, is more than the actual tax in the earlier year, include the recovery in your income to the extent it reduced the tax in the earlier year. For this purpose, any increase to an amount carried over to the current year that resulted from deducting the recovered amount in the earlier year is considered to have reduced your tax in the earlier year. If the recovery is for an itemized deduction claimed in a year in which the deductions were limited, see Itemized deductions limited, earlier.

If your tax, after application of the credits, does not change, you did not have a tax benefit from the deduction. Do not include the recovery in your income.

Example. In 1999, Jean Black filed as head of household and itemized her deductions. Her taxable income was $5,260 and her tax was $791. She claimed a child care credit of $1,200. The credit reduced her tax to zero and she had an unused tax credit of $409 ($1,200 - $791). In 2000, Jean recovered $1,000 of her itemized deductions. She reduces her 1999 itemized deductions by $1,000 and recomputes that year's tax on taxable income of $6,260. However, the child care credit exceeds the recomputed tax of $941. Jean's tax liability for 1999 is not changed by reducing her deductions by the recovery. She did not have a tax benefit from the recovered deduction and does not include any of the recovery in her income for 2000.

Subject to alternative minimum tax. If you were subject to the alternative minimum tax in the year of the deduction, you will have to recompute your tax for the earlier year to determine if the recovery must be included in your income. This will require a recomputation of your regular tax, as shown in the preceding example, and a recomputation of your alternative minimum tax. If inclusion of the recovery does not change your total tax, you do not include the recovery in your income. However, if your total tax increases by any amount, you received a tax benefit from the deduction and you must include the recovery in your income to the extent the deduction reduced your tax in the earlier year.

Non-Itemized Deduction Recoveries

This section discusses recovery of deductions other than those deducted on Schedule A (Form 1040).

Total recovery included in income. If you recover an amount that you deducted in an earlier year in figuring your adjusted gross income, you must generally include the full amount of the recovery in your income in the year received.

Total recovery not included in income. If any part of the deduction you took for the recovered amount did not reduce your tax, you may be able to exclude at least part of the recovery from your income. You must include the recovery in your income only to the extent the deduction reduced your tax in the year of the deduction. (See Tax benefit rule, earlier.)

Negative taxable income. If your taxable income was a negative amount, reduce the recovery by that negative amount. Include this reduced recovery in your income.

Amounts Recovered for Credits

If you received a recovery in 2000 for an item for which you claimed a tax credit in an earlier year, you must increase your 2000 tax to the extent the credit reduced your tax in the earlier year. You have a recovery if there is a downward price adjustment or similar adjustment on the item for which you claimed a credit.

This rule does not apply to the investment credit or the foreign tax credit. Recoveries of these credits are covered by other provisions of the law. See Publication 514, Foreign Tax Credit for Individuals, or Form 4255, Recapture of Investment Credit, for details.

Survivor Benefits

Generally, payments made by or for an employer because of an employee's death must be included in income. The following discussions explain the tax treatment of certain payments made to survivors. For additional information, see Publication 559, Survivors, Executors, and Administrators.

Lump-sum payments. Lump-sum payments you receive from a decedent's employer as the surviving spouse or beneficiary may be accrued salary payments; distributions from employee profit-sharing, pension, annuity, or stock bonus plans; or other items that should be treated separately for tax purposes. The tax treatment of these lump-sum payments depends on the type of payment.

Salary or wages. Salary or wages received after the death of the employee are usually ordinary income to you.

Qualified employee retirement plans. Lump-sum distributions from qualified employee retirement plans are subject to special tax treatment. For information on these distributions, get Publication 575 (or Publication 721 if you are the survivor of a federal employee or retiree).

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 receive a survivor annuity as the child or spouse (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 it in income. The annuity is excluded to the extent it is based on the officer's service as a public safety officer.

For this purpose, the term "public safety officer" includes police and law enforcement officers, firefighters and rescue squad and ambulance crew members.

The exclusion does not apply in situations involving intentional misconduct, intent to commit suicide, voluntary intoxication, or gross negligence. Nor does it apply to payments made to anyone who substantially contributed to the death of the officer.

Unemployment Benefits

The tax treatment of unemployment benefits you receive depends on the type of program paying the benefits.

Unemployment compensation. You must include in your income all unemployment compensation you receive. You should receive a Form 1099-G, Certain Government and Qualified State Tuition Program Payments, showing the amount paid to you. Generally, you enter unemployment compensation on line 19 of Form 1040, line 13 of Form 1040A, or line 3 of Form 1040EZ.

Types of unemployment compensation. Unemployment compensation generally includes any amount received under an unemployment compensation law of the United States or of a state. It includes the following benefits.

1. Benefits paid by a state or the District of Columbia from the Federal Unemployment Trust Fund.
2. State unemployment insurance benefits.
3. Railroad unemployment compensation benefits.
4. Disability payments from a government program paid as a substitute for unemployment compensation. (Amounts received as workers' compensation for injuries or illness are not unemployment compensation. See Workers' Compensation under Sickness and Injury Benefits, earlier.)
5. Trade readjustment allowances under the Trade Act of 1974.
6. Benefits under the Airline Deregulation Act of 1978.
7. Unemployment assistance under the Disaster Relief Act Amendments of 1974.

Governmental program. If you contribute to a governmental unemployment compensation program and your contributions are not deductible, amounts you receive under the program are not included as unemployment compensation until you recover your contributions.

Repayment of unemployment compensation. If you repaid in 2000 unemployment compensation you received in 2000, subtract the amount you repaid from the total amount you received and enter the difference on line 19 of Form 1040, line 13 of Form 1040A, or line 3 of Form 1040EZ. On the dotted line next to your entry, write "Repaid" and the amount you repaid. If you repaid unemployment compensation in 2000 that you included in your income in an earlier year, you can deduct the amount repaid on Schedule A (Form 1040) if you itemize deductions. See Repayments, later.

Tax withholding. You can choose to have federal income tax withheld from your unemployment compensation. To make this choice, complete Form W-4V, Voluntary Withholding Request, and give it to the paying office. Tax will be withheld at 15% of your payment.

If you do not choose to have tax withheld from your unemployment compensation, you may be liable for estimated tax. For more information on estimated tax, get Publication 505, Tax Withholding and Estimated Tax.

Supplemental unemployment benefits. Benefits received from an employer-financed fund (to which the employees did not contribute) are not unemployment compensation. They are taxable as wages and are subject to withholding for income tax and social security and Medicare taxes. Report these payments on line 7 of Form 1040 or Form 1040A or on line 1 of Form 1040EZ.

Repayment of benefits. You may have to repay some of your supplemental unemployment benefits to qualify for trade readjustment allowances under the Trade Act of 1974. If you repay supplemental unemployment benefits in the same year you receive them, reduce the total benefits by the amount you repay. If you repay the benefits in a later year, you must include the full amount of the benefits in your income for the year you received them.

Deduct the repayment in the later year as an adjustment to gross income on Form 1040. (You cannot use Form 1040A or Form 1040EZ.) Include the repayment on line 32 of Form 1040, and write "Sub-Pay TRA" and the amount on the dotted line next to line 32. If the amount you repay in a later year is more than $3,000, you may be able to take a credit against your tax for the later year instead of deducting the amount repaid. For information on this, see Repayments, later.

Private unemployment fund. Unemployment benefit payments from a private fund to which you voluntarily contribute are taxable only if the amounts you receive are more than your total payments into the fund. Report the taxable amount on line 21 of Form 1040.

Payments by a union. Benefits paid to you as an unemployed member of a union from regular union dues are included in your gross income on line 21 of Form 1040.

Guaranteed annual wage. Payments you receive from your employer during periods of unemployment, under a union agreement that guarantees you full pay during the year, are taxable as wages. Include them on line 7 of Form 1040 or Form 1040A or on line 1 of Form 1040EZ.

State employees. Payments similar to a state's unemployment compensation may be made by the state to its employees who are not covered by the state's unemployment compensation law. Although the payments are fully taxable, do not report them as unemployment compensation. Report these payments on line 21 of Form 1040.

Welfare and Other Public Assistance Benefits

Do not include in your income 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 payments 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.

Work-training program. Payments you receive from a state welfare agency for taking part in a work-training program are not included in your income, as long as the payments (exclusive of extra allowances for transportation, etc.) do not total more than the public welfare benefits you would have received otherwise. If the amount you receive (minus the extra allowances) is more than the welfare benefits you would have received, the entire amount must be included in your income as wages.

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 because you have a disability. 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. Unemployment assistance payments under the Act are taxable unemployment compensation. See Unemployment compensation under Unemployment Benefits, earlier.

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

Nutrition Program for the Elderly. Food benefits you receive under the Nutrition Program for the Elderly are not taxable. If you prepare and serve free meals for the program, include in your income as wages the cash pay you receive, even if you are also eligible for food benefits.

Other Income

The following brief discussions are arranged in alphabetical order. Income items that are discussed in greater detail in another publication include a reference to that publication.

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 is 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), report it as income on line 21 of Form 1040, line 13 of Form 1040A, or line 3 of Form 1040EZ. The state of Alaska sends each recipient a document that shows the amount of the payment with the check. The amount is also reported to IRS.

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. For complete information, get Publication 504, Divorced or Separated Individuals.

Below-market loans. A below-market loan is a loan on which no interest is charged or on which the interest is charged at a rate below the applicable federal rate. If you make a below-market gift or demand loan, you must include the forgone interest (at the federal rate) from the loan as interest income on your return. These loans are considered a transaction in which you, the lender, are treated as having made:

1. A loan to the borrower in exchange for a note that requires the payment of interest at the applicable federal rate, and
2. An additional payment to the borrower, which the borrower transfers back to you as interest.

Depending on the transaction, the additional payment to the borrower is treated as a:

1. Gift,
2. Dividend,
3. Contribution to capital,
4. Payment of compensation, or
5. Another type of payment.

The borrower may have to report this payment as income, depending on its classification.

For more information on below-market loans, see chapter 1 of Publication 550.

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 realized 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.

Canceled sales contract. If you sell property (such as land or a residence) under a contract, but the contract is canceled and you return the buyer's money in the same tax year as the original sale, you have no income from the sale. If the contract is canceled and you return the buyer's money in a later tax year, you must include your gain in your income for the year of the sale. When you return the money and take back the property in the later year, you treat the transaction as a purchase that gives you a new basis in the property equal to the funds you return to the buyer.

Special rules apply to the reacquisition of real property where a secured indebtedness (mortgage) to the original seller is involved. For further information, see Repossession in Publication 537, Installment Sales.

Car pools. Do not include in your income amounts you receive from the passengers for driving a car in a car pool to and from work. These amounts are considered reimbursement for your expenses. However, this rule does not apply if you have developed car pool arrangements into a profit-making business of transporting workers for hire.

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.

Casualty insurance and other reimbursements. You generally should not report these reimbursements on your return. Get Publication 547, Casualties, Disasters, and Thefts (Business and Nonbusiness), for more information.

Charitable gift annuities. If you are the beneficiary of a charitable gift annuity, you are required to report the yearly annuity or fixed percentage payment in gross income.

The payer will report the types of income you received on Form 1099-R. Report the gross distribution from box 1 on Form 1040, line 16a, and the portion taxed as ordinary income (box 2a minus box 3) on Form 1040, line 16b. Report the portion taxed as capital gain on Schedule D, line 8, in column (f), and identify it in column (a).

Child support payments. You should not report these payments on your return. Get Publication 504 for more information.

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 in this discussion.
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. Damages you receive for emotional distress due to a physical injury or sickness are treated as received for the physical injury or sickness. Do not include them in your income. If the emotional distress is due to a personal injury that is unrelated to a physical injury or sickness (for example, employment discrimination or injury to reputation), you must include the damages in your income, except for any damages you receive for medical care due to that emotional distress. 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.

Pre-existing agreement. If you receive damages under a written binding agreement, court decree, or mediation award that was in effect (or issued on or before) September 13, 1995, you do not have to include in income any of those damages received on account of personal injuries or sickness.

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.

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. If the property is not a dwelling unit (nonresidential property), you can exclude 50% of the subsidy, but only for amounts received under a written contract in effect on September 13, 1995, and at all times thereafter.

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.

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 (Form 1041), Beneficiary's Share of Income, Deductions, Credits, etc.

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 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. Treat each item of income the same way that the estate or trust would treat it. For example, if a trust's dividend income is distributed to you, 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 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.

If you are not an employee and the fees for your services from the same payer total $600 or more for the year, you may receive a Form 1099-MISC.

Corporate director. Corporate director fees are self-employment income. Report these payments on Schedule C (Form 1040) or Schedule C-EZ (Form 1040).

Executor or administrator of an estate. 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), report these fees on line 21 of Form 1040. If you provide the services as a trade or business, report them as self-employment income on Schedule C (Form 1040) or Schedule C-EZ (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.

Food program payments to day care providers. If you operate a day care service and receive payments under the Child Care Food Program administered by the Department of Agriculture that are not for your services, do not include the payments in your gross income to the extent you use them to provide food to children eligible for help under the program.

Foster-care providers. Payments you receive from a state, political subdivision, or tax-exempt child-placement agency for providing care to qualified foster 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 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 that is required for physically, mentally, or emotionally handicapped qualified foster individuals. 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, or
2. 5 qualified foster individuals age 19 or older.

Maintaining space in home. If you are paid to maintain space in your home for emergency foster-care, you must include the payment in your income.

Reporting taxable payments. 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. Report the payments on Schedule C or Schedule C-EZ (Form 1040). Get Publication 587, Business Use of Your Home (Including Use by Day-Care Providers), to help you determine the amount you can deduct for the use of your home.

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 if you are not in the trade or business of organizing tours. You cannot deduct your expenses in serving as the voluntary leader of the group at the group's request. If you organize tours as a trade or business, report the tour's value on Schedule C (Form 1040) or Schedule C-EZ (Form 1040).

Gambling winnings. You must include your gambling winnings in your 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.

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.

Installment payments. Generally, if you win a state lottery prize payable in installments, you must include in your gross income the annual payments and any amounts you receive designated as "interest" on the unpaid installments. If you sell future lottery payments for a lump sum, you must report the amount you receive from the sale as ordinary income (line 21, Form 1040) in the year you receive it.

Form W-2G. You may have received a Form W-2G, Certain Gambling Winnings, 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 58 of Form 1040.

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 rents, 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 income is also taxable to you. If the gift, bequest, or inheritance is the income from the property, that income is taxable to you.

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 Survivors and Beneficiaries in Publication 575 if you inherited a pension. See Inherited IRAs in Publication 590, Individual Retirement Arrangements (IRAs) (Including Roth IRAs and Education IRAs), if you inherited an IRA.

Expected inheritance. If you sell an interest in an expected inheritance from a living person, include the entire amount you receive in gross income on line 21 of Form 1040.

Bequest for services. If you receive cash or other property as a bequest for services you performed while the decedent was alive, the value is taxable compensation.

Historic preservation grants. Do not include in your income any payment you receive under the National Historic Preservation Act to preserve a historically significant property.

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, in this discussion.

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. However, if you sell items from your collection at a loss, you cannot deduct the 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.

Interest on frozen deposits. In general, you exclude from your income the amount of interest earned on a frozen deposit. A deposit is frozen if, at the end of the calendar year, you cannot withdraw any part of the deposit because:

1. The financial institution is bankrupt or insolvent, or
2. The state where the institution is located has placed limits on withdrawals because other financial institutions in the state are bankrupt or insolvent.

Excludable amount. The amount of interest you exclude from gross income for the year is the interest that was credited on the frozen deposit for that tax year minus the sum of:

1. The net amount withdrawn from the deposit during that year, and
2. The amount that could have been withdrawn at the end of that tax year (not reduced by any penalty for premature withdrawals of a time deposit).

The excluded part of the interest is included in your gross income in the tax year it becomes withdrawable.

Interest on qualified savings bonds. You may be able to exclude from income the interest from qualified U.S. savings bonds you redeem if you pay qualified higher educational expenses in the same year. "Qualified higher educational expenses" are those you pay for tuition and required fees at an eligible educational institution for you, your spouse, or your dependent. A "qualified U.S. savings bond" is a series EE bond issued after 1989 or a series I bond. The bond must have been issued to you when you were 24 years of age or older. For more information on this exclusion, see Education Savings Bond Program in chapter 1 of Publication 550.

Interest on state and local government obligations. This interest is usually exempt from federal tax. However, you must show the amount of any tax-exempt interest on your federal income tax return. For more information, see State or Local Government Obligations in chapter 1 of Publication 550.

Job interview expenses. If a prospective employer asks you to appear for an interview and either pays you an allowance or reimburses you for your transportation and other travel expenses, the amount you receive is generally not taxable. You include in income only the amount you receive that is more than your actual expenses.

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 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 kickbacks, side commissions, push money, or similar payments you receive in your income on line 21 of Form 1040, or on Schedule C or Schedule C-EZ (Form 1040) if from your self-employment activity.

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.

Manufacturer incentive payments. You must include as other income on Form 1040, line 21 (or Schedule C or C-EZ if you are self-employed) incentive payments from a manufacturer that you receive as a salesperson. This is true whether you receive the payment directly from the manufacturer or through your employer.

Example. You sell cars for an automobile dealership and receive incentive payments from the automobile manufacturer every time you sell a particular model of car. You report the incentive payments on line 21 of Form 1040.

Medical savings accounts (MSAs). You do not generally include in income amounts you withdraw from your MSA or Medicare+Choice MSA if you use the money to pay for qualified medical expenses. Generally, qualified medical expenses are those you can deduct on Schedule A (Form 1040). For more information about MSAs or Medicare+Choice MSAs, see Publication 969, Medical Savings Accounts (MSAs).

Moving expense reimbursements. You generally should not report these benefits on your return. Get Publication 521 for more information.

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.

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

Employee 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 noncash employee achievement awards can be excluded from income. See Bonuses and awards under Miscellaneous Compensation, earlier.

Prize points. If you are a salesperson and receive "prize points" redeemable for merchandise, which are awarded by a distributor to employees of dealers, you must include their fair market value in your income. The "prize points" are taxable in the year they are paid or made available to you, rather than in the year you redeem them for merchandise.

Pulitzer, Nobel, and similar prizes. If you were awarded a 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 your income. However, you 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 for 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. The following conditions apply to the transfer.
   1. You cannot use the prize or award before it is transferred.
   2. You should provide the designation before the prize or award is presented to prevent a disqualifying use. The designation should contain:
      1. The purpose of the designation by making a reference to section 74(b)(3) of the Internal Revenue Code,
      2. A description of the prize or award,
      3. The name and address of the organization to receive the prize or award,
      4. Your name, address, and taxpayer identification number, and
      5. Your signature and the date signed.
   3. In the case of an unexpected presentation, you must return the prize or award before using it (or spending, depositing, investing it, etc., in the case of money) and then prepare the statement as described in (b).
   4. After the transfer, you should receive from the payer a written response stating when and to whom the designated amounts were transferred.

These rules do not apply to scholarship or fellowship awards. See Scholarships and Fellowships, later.

Railroad retirement annuities. The following types of payments are treated as pension or annuity income and are taxable under the rules explained in Publication 575.

1. Tier 1 railroad retirement benefits that are more than the "social security equivalent benefit."
2. Tier 2 benefits.
3. Vested dual benefits.

Sale of home. You may be able to exclude from income all or part of any gain from the sale or exchange of a personal residence. Get Publication 523, Selling Your Home.

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. Report it 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.

Scholarships and fellowships. A candidate for a degree can exclude amounts received as a qualified scholarship or fellowship. A qualified scholarship or fellowship 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. Get Publication 520 for more information on qualified scholarships and fellowship grants.

Payments for services. Payments you receive for services required as a condition of receiving a scholarship or fellowship grant must be included in your 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 information about the exclusion for a qualified tuition reduction provided to employees and their families by an educational institution, see 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.

Social security and equivalent railroad retirement benefits. Social security or equivalent railroad retirement benefits, if taxable, must be included in the income of the person who has the legal right to receive the benefits. Whether any of your benefits are taxable, and the amount that is taxable, depends on the amount of the benefits and your other income.

Social security benefits include any monthly benefit under Title II of the Social Security Act and any part of a tier I railroad retirement benefit treated as a social security benefit. Social security benefits do not include any supplemental security income (SSI) payments.

Form SSA-1099. If you received social security benefits during the year, you will receive Form SSA-1099, Social Security Benefit Statement. An IRS Notice 703 will be enclosed with your Form SSA-1099. This notice includes a worksheet you can use to figure whether any of your benefits are taxable.

For an explanation of the information found on your Form SSA-1099, get Publication 915, Social Security and Equivalent Railroad Retirement Benefits.

Form RRB-1099. If you received equivalent railroad retirement or special guaranty benefits during the year, you will receive Form RRB-1099, Payments by the Railroad Retirement Board.

For an explanation of the information found on your Form RRB-1099, get Publication 915.

If you received other railroad retirement benefits, see Railroad retirement annuities, earlier.

Joint return. If you are married and file a joint return, you and your spouse must combine your incomes and your social security and equivalent railroad retirement benefits when figuring if any of your combined benefits are taxable. Even if your spouse did not receive any benefits, you must add your spouse's income to yours when figuring if any of your benefits are taxable.

Taxable amount. Use the worksheet in the Form 1040 or Form 1040A instruction package to determine the amount of your benefits to include in your income. Publication 915 also has worksheets you can use. However, you must use the worksheets in Publication 915 if any of the following situations applies.

• You received a lump-sum benefit payment during the year that is for one or more earlier years.
• You exclude qualified adoption expenses, interest from qualified U.S. savings bonds, or interest paid on a student loan.
• You take the foreign earned income exclusion, the foreign housing exclusion or deduction, the exclusion of income from U.S. possessions, or the exclusion of income from Puerto Rico by bona fide residents of Puerto Rico.

Benefits may affect your IRA deduction. You must use the special worksheets in Appendix B of Publication 590 to figure your taxable benefits and your IRA deduction if all of the following conditions apply.

1. You receive social security or equivalent railroad retirement benefits.
2. You have taxable compensation.
3. You contribute to your IRA.
4. You or your spouse is covered by a retirement plan at work.

How to report. If any of your benefits are taxable, you must use either Form 1040 or Form 1040A to report the taxable part. You cannot use Form 1040EZ. Report your net benefits (the amount in box 5 of your Forms SSA-1099 and RRB-1099) on line 20a of Form 1040, or line 14a of Form 1040A. Report the taxable part (from the last line of the worksheet) on line 20b of Form 1040, or on line 14b of Form 1040A.

State tuition programs. If you receive distributions from a qualified state tuition program, only the amount that is more than the amount contributed to the program is taxable.

A qualified state tuition program is one that is established and maintained by a state or agency and that:

1. Allows a person to:
   1. Buy tuition credits or certificates for a designated beneficiary who would then be entitled to a waiver or payment of qualified higher educational expenses, or
   2. Make contributions to an account that is set up to meet the qualified higher educational expenses of a designated beneficiary of the account,
2. Requires all purchases or contributions to be made only in cash,
3. Prohibits the contributor and the beneficiary from directing the amount invested,
4. Allows a rollover or a change of beneficiary to be made only between members of the same family, and
5. Imposes a penalty on any refund of earnings that does not meet at least one of the following conditions.
   1. It is used for qualified higher educational expenses of the beneficiary.
   2. It is made because of the death or disability of the beneficiary.
   3. It is made because of (and it is not more than) a scholarship, veteran's educational assistance allowance, or another nontaxable payment (other than a gift, bequest, or inheritance) received by the beneficiary for educational expenses.

For information on a specific program, contact the state or agency that established and maintains it.

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.

Union benefits and dues. Amounts deducted from your pay for union dues, assessments, contributions, or other payments to a union cannot be excluded from your income.

You may be able to deduct some of these payments as a miscellaneous deduction subject to the 2% limit if they are related to your job and if you itemize deductions on Schedule A (Form 1040). For more information, get Publication 529, Miscellaneous Deductions.

Strike and lockout benefits. Benefits paid to you by a union as strike or lockout benefits, including both cash and the fair market value of other property, are usually included in your income as compensation. You can exclude these benefits from your income only when the facts clearly show that the union intended them as gifts to you.

Reimbursed union convention expenses. If you are a delegate of your local union chapter and you attend the annual convention of the international union, do not include in your income amounts you receive from the international union to reimburse you for expenses of traveling away from home to attend the convention. You cannot deduct the reimbursed expenses, even if you are reimbursed in a later year. If you are reimbursed for lost salary, you must include that reimbursement in your income.

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.

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