Elective
deferrals. The limit on the
amount of your wages you can
elect to defer into certain
retirement plans (such as
section 401(k) plans) increases
each year through 2006. If you
are age 50 or older, you may be
able to make additional catch-up
elective deferrals. See
Elective deferrals
in
Retirement Plan Contributions
under Employee Compensation.
Reminder
Foreign
income. If you are a U.S. citizen or
resident alien, you must report
income from sources outside the
United States (foreign income)
on your tax return unless it is
exempt by U.S. law. This is true
whether you reside inside or
outside the United States and
whether or not you receive a
Form W-2, Wage and Tax
Statement, or Form 1099 from the
foreign payer. This applies to
earned income (such as wages and
tips) as well as unearned income
(such as interest, dividends,
capital gains, pensions, rents,
and royalties). If you reside
outside the United States, you
may be able to exclude part or
all of your foreign source
earned income. For details, see
Publication 54, Tax Guide for
U.S. Citizens and Resident
Aliens Abroad.
Introduction
This chapter discusses
compensation received for
services as an employee, such as
wages, salaries, and fringe
benefits. The topics include:
Bonuses and awards,
Special rules for
certain employees, and
Sickness and injury
benefits.
The chapter explains what
income is included in the
employee's gross income and what
is not included.
Useful Items - You
may want to see:
Publication
463
Travel, Entertainment,
Gift, and Car Expenses
503
Child and Dependent Care
Expenses
505
Tax Withholding and
Estimated Tax
525
Taxable and Nontaxable
Income
Employee
Compensation
This section discusses
various types of employee
compensation including fringe
benefits, retirement plan
contributions, stock options,
and restricted property.
Form W-2.If you are an employee,
you should receive Form W-2
from your employer showing
the pay you received for
your services. Include your
pay on line 7 of Form 1040
or Form 1040A, or on line 1
of Form 1040EZ, even if you
do not receive a Form W-2.
Child care
providers.If you provide
childcare, either in the
child's home or in your home
or other place of business,
the pay you receive must be
included in your income. If
you are not an employee, you
are probably self-employed
and must include payments
for your services on
Schedule C (Form 1040),
Profit or Loss From
Business, or Schedule C-EZ
(Form 1040), Net Profit From
Business. You are generally
not an employee unless you
are subject to the will and
control of the person who
employs you as to what you
are to do and how you are to
do it.
Baby-sitting.
If you baby-sit for
relatives or neighborhood
children, whether on a
regular basis or only
periodically, the rules for
childcare providers apply to
you.
Miscellaneous
Compensation
This section discusses
different types of employee
compensation.
Advance
commissions and other
earnings.
If you receive advance
commissions or other
amounts for services to
be performed in the
future and you are a
cash-method taxpayer,
you must include these
amounts in your income
in the year you receive
them.
If you repay
unearned commissions or
other amounts in the
same year you receive
them, reduce the amount
included in your income
by the repayment. If you
repay them in a later
tax year, you can deduct
the repayment as an
itemized deduction on
your Schedule A (Form
1040), or you may be
able to take a credit
for that year. See
Repayments in chapter 13.
Allowances and
reimbursements.If you receive
travel, transportation,
or other business
expense allowances or
reimbursements from your
employer, see
Publication 463. If you
are reimbursed for
moving expenses, see
Publication 521, Moving
Expenses.
Back
pay awards.Include in income
amounts you are awarded
in a settlement or
judgment for back pay.
These include payments
made to you for damages,
unpaid life insurance
premiums, and unpaid
health insurance
premiums. They should be
reported to you by your
employer on Form W-2.
Bonuses
and awards.
Bonuses or awards you
receive for outstanding
work are included in
your income and should
be shown on your Form
W-2. These include
prizes such as vacation
trips for meeting sales
goals. If the prize or
award you receive is
goods or services, you
must include the fair
market value of the
goods or services in
your income. However, if
your employer merely
promises to pay you a
bonus or award at some
future time, it is not
taxable until you
receive it or it is made
available to you.
Employee achievement
award.
If you receive
tangible personal
property (other than
cash, a gift
certificate, or an
equivalent item) as an
award for length of
service or safety
achievement, you can
generally exclude its
value from your income.
However, the amount you
can exclude is limited
to your employer's cost
and cannot be more than
$1,600 ($400 for awards
that are not qualified
plan awards) for all
such awards you receive
during the year. Your
employer can tell you
whether your award is a
qualified plan award.
Your employer must make
the award as part of a
meaningful presentation,
under conditions and
circumstances that do
not create a significant
likelihood of it being
disguised pay.
However, the exclusion
does not apply to the
following awards.
A
length-of-service
award if you
received it for
less than 5
years of service
or if you
received another
length-of-service
award during the
year or the
previous 4
years.
A safety
achievement
award if you are
a manager,
administrator,
clerical
employee, or
other
professional
employee or if
more than 10% of
eligible
employees
previously
received safety
achievement
awards during
the year.
Example.
Ben Green received
three employee
achievement awards
during the year: a
nonqualified plan award
of a watch valued at
$250, and two qualified
plan awards of a stereo
valued at $1,000 and a
set of golf clubs valued
at $500. Assuming that
the requirements for
qualified plan awards
are otherwise satisfied,
each award by itself
would be excluded from
income. However, because
the $1,750 total value
of the awards is more
than $1,600, Ben must
include $150 ($1,750 –
$1,600) in his income.
Government
cost-of-living
allowances.
Cost-of-living
allowances generally are
included in your income.
However, they are not
included in your income
if you are a federal
civilian employee or a
federal court employee
who is stationed in
Alaska, Hawaii, or
outside the United
States.
Allowances and
differentials that
increase your basic pay
as an incentive for
taking a less desirable
post of duty are part of
your compensation and
must be included in
income. For example,
your compensation
includes Foreign Post,
Foreign Service, and
Overseas Tropical
differentials. For more
information, see
Publication 516, U.S.
Government Civilian
Employees Stationed
Abroad.
Note
received for services.If your employer
gives you a secured note
as payment for your
services, you must
include the fair market
value (usually the
discount value) of the
note in your income for
the year you receive it.
When you later receive
payments on the note, a
proportionate part of
each payment is the
recovery of the fair
market value that you
previously included in
your income. Do not
include that part again
in your income. Include
the rest of the payment
in your income in the
year of payment.
If your employer gives
you a nonnegotiable
unsecured note as
payment for your
services, payments on
the note that are
credited toward the
principal amount of the
note are compensation
income when you receive
them.
Severance pay.
Amounts you receive as
severance pay are
taxable. A lump-sum
payment for cancellation
of your employment
contract must be
included in your income
in the tax year you
receive it.
Accrued leave payment.If you are a federal
employee and receive a
lump-sum payment for
accrued annual leave
when you retire or
resign, this amount will
be included as wages on
your Form W-2.
If you resign from one
agency and are
reemployed by another
agency, you may have to
repay part of your
lump-sum annual leave
payment to the second
agency. You can reduce
gross wages by the
amount you repaid in the
same tax year in which
you received it. Attach
to your tax return a
copy of the receipt or
statement given to you
by the agency you repaid
to explain the
difference between the
wages on the return and
the wages on your Forms
W-2.
Outplacement services.
If you choose to
accept a reduced amount
of severance pay so that
you can receive
outplacement services
(such as training in
résumé writing and
interview techniques),
you must include the
unreduced amount of the
severance pay in income.
However, you can
deduct the value of
these outplacement
services (up to the
difference between the
severance pay included
in income and the amount
actually received) as a
miscellaneous deduction
(subject to the 2%
limit) on Schedule A
(Form 1040).
Sick
pay.
Pay you receive from
your employer while you
are sick or injured is
part of your salary or
wages. In addition, you
must include in your
income sick pay benefits
received from any of the
following payers.
A welfare
fund.
A state
sickness or
disability fund.
An
association of
employers or
employees.
An insurance
company, if your
employer paid
for the plan.
However, if you paid the
premiums on an accident
or health insurance
policy, the benefits you
receive under the policy
are not taxable.
Social
security and Medicare
taxes paid by employer.
If you and your
employer have an
agreement that your
employer pays your
social security and
Medicare taxes without
deducting them from your
gross wages, you must
report the amount of tax
paid for you as taxable
wages on your tax
return. The payment is
also treated as wages
for figuring your social
security and Medicare
taxes and your social
security and Medicare
benefits. However, these
payments are not treated
as social security and
Medicare wages if you
are a household worker
or a farm worker.
Stock
appreciation rights.
Do not include a stock
appreciation right
granted by your employer
in income until you
exercise (use) the
right. When you use the
right, you are entitled
to a cash payment equal
to the fair market value
of the corporation's
stock on the date of use
minus the fair market
value on the date the
right was granted. You
include the cash payment
in your income in the
year you use the right.
Fringe
Benefits
Fringe benefits received
in connection with the
performance of your services
are included in your income
as compensation unless you
pay fair market value for
them or they are
specifically excluded by
law. Abstaining from the
performance of services (for
example, under a covenant
not to compete) is treated
as the performance of
services for purposes of
these rules.
Accounting period.
You must use the same
accounting period your
employer uses to report
your taxable noncash
fringe benefits. Your
employer has the option
to report taxable
noncash fringe benefits
by using either of the
following rules.
The general
rule: benefits
are reported for
a full calendar
year (January 1–
December 31).
The special
accounting
period rule:
benefits
provided during
the last 2
months of the
calendar year
(or any shorter
period) are
treated as paid
during the
following
calendar year.
For example,
each year your
employer reports
the value of
benefits
provided during
the last 2
months of the
prior year and
the first 10
months of the
current year.
Your employer does not
have to use the same
accounting period for
each fringe benefit, but
must use the same period
for all employees who
receive a particular
benefit.
You must use the same
accounting period that
you use to report the
benefit to claim an
employee business
deduction (for use of a
car, for example).
Form
W-2.
Your employer reports
your taxable fringe
benefits in box 1
(Wages, tips, other
compensation) of Form
W-2. The total value of
your fringe benefits may
also be noted in box 12.
The value of your fringe
benefits may be added to
your other compensation
on one Form W-2, or you
may receive a separate
Form W-2 showing just
the value of your fringe
benefits in box 1 with a
notation in box 12.
Accident or
Health Plan
Generally, the value
of accident or health
plan coverage provided
to you by your employer
is not included in your
income. Benefits you
receive from the plan
may be taxable, as
explained later under
Sickness and Injury
Benefits.
Long-term care
coverage.Contributions by
your employer to
provide coverage for
long-term care
services are
generally not
included in your
income. However,
contributions made
through a flexible
spending or similar
arrangement (such as
a cafeteria plan)
must be included in
your income. This
amount will be
reported as wages in
box 1 of your Form
W-2.
Contributions you
make to the plan are
discussed in
Publication 502,
Medical and Dental
Expenses.
Archer MSA
contributions.Contributions by
your employer to
your Archer MSA
generally are not
included in your
income. Their total
will be reported in
box 12 of Form W-2
with code R. You
must report this
amount on Form 8853,
Archer MSAs and
Long-Term Care
Insurance Contracts.
File the form with
your return.
If your employer
does not make
contributions to
your MSA, you can
make your own
contributions to
your MSA. These
contributions are
discussed in
Publication 969,
Health Savings
Accounts and Other
Tax-Favored Health
Plans. Also, see
Form 8853.
Health flexible
spending arrangement
(health FSA).
If your employer
provides a health
FSA that qualifies
as an accident or
health plan, the
amount of your
salary reduction,
and reimbursements
of your medical care
expenses and those
of your spouse and
dependents, are
generally not
included in your
income.
Health reimbursement
arrangement (HRA).
If your employer
provides an HRA that
qualifies as an
accident or health
plan, coverage and
reimbursements of
your medical care
expenses and those
of your spouse and
dependents are
generally not
included in your
income.
See also
Reimbursement
for medical care
under
Other Sickness
and Injury Benefits,
later.
Adoption
Assistance
You may be able to
exclude from your income
amounts paid or expenses
incurred by your
employer for qualified
adoption expenses in
connection with your
adoption of an eligible
child. See Publication
968, Tax Benefits for
Adoption, for more
information.
Adoption benefits
are reported by your
employer in box 12 of
Form W-2 with code T.
They are also included
as social security and
Medicare wages in boxes
3 and 5. However, they
are not included as
wages in box 1. To
determine the taxable
and nontaxable amounts,
you must complete Part
III of Form 8839,
Qualified Adoption
Expenses. File the form
with your return.
De Minimis
(Minimal)
Benefits
If your employer
provides you with a
product or service and
the cost of it is so
small that it would be
unreasonable for the
employer to account for
it, the value is not
included in your income.
Generally, the value of
benefits such as
discounts at company
cafeterias, cab fares
home when working
overtime, and company
picnics are not included
in your income.
Holiday gifts.
If your employer
gives you a turkey,
ham, or other item
of nominal value at
Christmas or other
holidays, do not
include the value of
the gift in your
income. However, if
your employer gives
you cash, a gift
certificate, or a
similar item that
you can easily
exchange for cash,
you include the
value of that gift
as extra salary or
wages regardless of
the amount involved.
Educational
Assistance
You can exclude from
your income up to $5,250
of qualified
employer-provided
educational assistance.
The exclusion applies to
undergraduate and
graduate-level courses.
For more information,
see Publication 970, Tax
Benefits for Education.
Employer-Provided
Vehicles
If your employer
provides a car (or other
highway motor vehicle)
to you, your personal
use of the car is
usually a taxable
noncash fringe benefit.
Your employer must
determine the actual
value of this fringe
benefit to include in
your income.
Certain
employer-provided
transportation can be
excluded from gross
income. See the
discussion on
Transportation, later.
Group-Term
Life
Insurance
Generally, the cost
of up to $50,000 of
group-term life
insurance coverage
provided to you by your
employer (or former
employer) is not
included in your income.
However, you must
include in income the
cost of
employer-provided
insurance that is more
than the cost of $50,000
of coverage.
If your employer
provided more than
$50,000 of coverage, the
amount included in your
income is reported as
part of your wages in
box 1 of your Form W-2.
It is also shown
separately in box 12
with code C.
Group-term life
insurance.
This insurance is
term life insurance
protection
(insurance for a
fixed period of
time) that:
Provides
a general
death
benefit,
Is
provided to
a group of
employees,
Is
provided
under a
policy
carried by
the
employer,
and
Provides
an amount of
insurance to
each
employee
based on a
formula that
prevents
individual
selection.
Permanent
benefits.
If your group-term
life insurance
policy includes
permanent benefits,
such as a paid-up or
cash surrender
value, you must
include in your
income, as wages,
the cost of the
permanent benefits
minus the amount you
pay for them. Your
employer should be
able to tell you the
amount to include in
your income.
Accidental death
benefits.
Insurance that
provides accidental
or other death
benefits but does
not provide general
death benefits
(travel insurance,
for example) is not
group-term life
insurance.
Former employer.
If your former
employer provides
more than $50,000 of
group-term life
insurance coverage
during the year, the
amount included in
your income is
reported as wages in
box 1 of Form W-2.
Also, it is shown
separately in box 12
with code C. Box 12
also will show the
amount of
uncollected social
security and
Medicare taxes on
the excess coverage,
with codes M and N.
You must pay these
taxes with your
income tax return.
Include them in your
total tax on line
62, Form 1040, and
enter “UT”
and the amount of
the taxes on the
dotted line next to
line 62.
Two
or more employers.
Your exclusion for
employer-provided
group-term life
insurance coverage
cannot exceed the
cost of $50,000 of
coverage, whether
the insurance is
provided by a single
employer or multiple
employers. If two or
more employers
provide insurance
coverage that totals
more than $50,000,
the amounts reported
as wages on your
Forms W-2 will not
be correct. You must
figure how much to
include in your
income. Reduce the
amount you figure by
any amount reported
with code C in box
12 of your Forms
W-2, add the result
to the wages
reported in box 1,
and report the total
on your return.
Figuring the taxable
cost.
Use the following
worksheet to figure
the amount to
include in your
income.
Worksheet
6-1.
Figuring
the
Cost
of
Group-Term
Life
Insurance
To
Include
in
Income
1.
Enter
the
total
amount
of
your
insurance
coverage
from
your
employers
1.
2.
Limit
on
exclusion
for
employer-provided
group-term
life
insurance
coverage
2.
50,000
3.
Subtract
line
2
from
line
1
3.
4.
Divide
line
3 by
$1,000.
Figure
to
the
nearest
tenth
4.
5.
Go
to
Table
6-1.
Using
your
age
on
the
last
day
of
the
tax
year,
find
your
age
group
in
the
left
column,
and
enter
the
cost
from
the
column
on
the
right
for
your
age
group
5.
6.
Multiply
line
4 by
line
5
6.
7.
Enter
the
number
of
full
months
of
coverage
at
this
cost.
7.
8.
Multiply
line
6 by
line
7
8.
9.
Enter
the
premiums
you
paid
per
month
9.
10.
Enter
the
number
of
months
you
paid
the
premiums
10.
11.
Multiply
line
9 by
line
10.
11.
12.
Subtract
line
11
from
line
8.
Include
this
amount
in
your
income
as
wages
12.
Example.
You are 51 years
old and work for
employers A and B.
Both employers
provide group-term
life insurance
coverage for you for
the entire year.
Your coverage is
$35,000 with
employer A and
$45,000 with
employer B. You pay
premiums of $4.15 a
month under the
employer B group
plan. You figure the
amount to include in
your income as
follows.
Worksheet
6-1.
Figuring
the
Cost
of
Group-Term
Life
Insurance
to
Include
in
Income—Illustrated
1.
Enter
the
total
amount
of
your
insurance
coverage
from
your
employers
1.
80,000
2.
Limit
on
exclusion
for
employer-provided
group-term
life
insurance
coverage
2.
50,000
3.
Subtract
line
2
from
line
1
3.
30,000
4.
Divide
line
3 by
$1,000.
Figure
to
the
nearest
tenth
4.
30.0
5.
Go
to
Table
6-1.
Using
your
age
on
the
last
day
of
the
tax
year,
find
your
age
group
in
the
left
column,
and
enter
the
cost
from
the
column
on
the
right
for
your
age
group
5.
.23
6.
Multiply
line
4 by
line
5
6.
6.90
7.
Enter
the
number
of
full
months
of
coverage
at
this
cost.
7.
12
8.
Multiply
line
6 by
line
7
8.
82.80
9.
Enter
the
premiums
you
paid
per
month
9.
4.15
10.
Enter
the
number
of
months
you
paid
the
premiums
10.
12
11.
Multiply
line
9 by
line
10.
11.
49.80
12.
Subtract
line
11
from
line
8.
Include
this
amount
in
your
income
as
wages
12.
33.00
Age
Cost
Under 25
$.05
25 through
29
.06
30 through
34
.08
35 through
39
.09
40 through
44
.10
45 through
49
.15
50 through
54
.23
55 through
59
.43
60 through
64
.66
65 through
69
1.27
70 and older
2.06
Entire cost
excluded.
You are not taxed
on the cost of
group-term life
insurance if any of
the following
circumstances apply.
You are
permanently
and totally
disabled and
have ended
your
employment.
Your
employer is
the
beneficiary
of the
policy for
the entire
period the
insurance is
in force
during the
tax year.
A
charitable
organization
(defined in
chapter 26)
to which
contributions
are
deductible
is the only
beneficiary
of the
policy for
the entire
period the
insurance is
in force
during the
tax year.
(You are not
entitled to
a deduction
for a
charitable
contribution
for naming a
charitable
organization
as the
beneficiary
of your
policy.)
The plan
existed on
January 1,
1984, and:
You
retired
before
January
2,
1984,
and
were
covered
by
the
plan
when
you
retired,
or
You
reached
age
55
before
January
2,
1984,
and
were
employed
by
the
employer
or
its
predecessor
in
1983.
Entire cost taxed.
You are taxed on
the entire cost of
group-term life
insurance if either
of the following
circumstances apply.
The
insurance is
provided by
your
employer
through a
qualified
employees'
trust, such
as a pension
trust or a
qualified
annuity
plan.
You are
a key
employee and
your
employer's
plan
discriminates
in favor of
key
employees.
Retirement
Planning
Services
If your employer has
a qualified retirement
plan, qualified
retirement planning
services provided to you
(and your spouse) by
your employer are not
included in your income.
Qualified services
include retirement
planning advice,
information about your
employer's retirement
plan, and information
about how the plan may
fit into your overall
individual retirement
income plan. You cannot
exclude the value of any
tax preparation,
accounting, legal, or
brokerage services
provided by your
employer.
Transportation
If your employer
provides you with a
qualified transportation
fringe benefit, it can
be excluded from your
income, up to certain
limits. A qualified
transportation fringe
benefit is:
Transportation
in a commuter
highway vehicle
(such as a van)
between your
home and work
place,
A transit
pass, or
Qualified
parking.
Cash reimbursement by
your employer for these
expenses under a
bona fide
reimbursement
arrangement is also
excludable. However,
cash reimbursement for a
transit pass is
excludable only if a
voucher or similar item
that can be exchanged
only for a transit pass
is not readily available
for direct distribution
to you.
Exclusion limit.
The exclusion for
commuter highway
vehicle
transportation and
transit pass fringe
benefits cannot be
more than a total of
$100 a month.
The exclusion for
the qualified
parking fringe
benefit cannot be
more than $195 a
month.
If the benefits
have a value that is
more than these
limits, the excess
must be included in
your income.
Commuter highway
vehicle.
This is a highway
vehicle that seats
at least six adults
(not including the
driver). At least
80% of the vehicle's
mileage must
reasonably be
expected to be:
For
transporting
employees
between
their homes
and work
place, and
On trips
during which
employees
occupy at
least half
of the
vehicle's
adult
seating
capacity
(not
including
the driver).
Transit pass.
This is any pass,
token, farecard,
voucher, or similar
item entitling a
person to ride mass
transit (whether
public or private)
free or at a reduced
rate or to ride in a
commuter highway
vehicle operated by
a person in the
business of
transporting persons
for compensation.
Qualified
parking.
This is parking
provided to an
employee at or near
the employer's place
of business. It also
includes parking
provided on or near
a location from
which the employee
commutes to work by
mass transit, in a
commuter highway
vehicle, or by
carpool. It does not
include parking at
or near the
employee's home.
Retirement
Plan
Contributions
Your employer's
contributions to a qualified
retirement plan for you are
not included in income at
the time contributed. (Your
employer can tell you
whether your retirement plan
is qualified.) However, the
cost of life insurance
coverage included in the
plan may have to be
included. See
Group-Term Life Insurance,
earlier, under
Fringe Benefits.
If your employer pays
into a nonqualified plan for
you, you generally must
include the contributions in
your income as wages for the
tax year in which the
contributions are made.
However, if your interest in
the plan is not transferable
or is subject to a
substantial risk of
forfeiture (you have a good
chance of losing it) at the
time of the contribution,
you do not have to include
the value of your interest
in your income until it is
transferable or is no longer
subject to a substantial
risk of forfeiture.
Elective deferrals.
If you are covered by
certain kinds of
retirement plans, you
can choose to have part
of your compensation
contributed by your
employer to a retirement
fund, rather than have
it paid to you. The
amount you set aside
(called an elective
deferral) is treated as
an employer contribution
to a qualified plan. It
is not included in wages
subject to income tax at
the time contributed.
However, it is included
in wages subject to
social security and
Medicare taxes.
Elective deferrals
include elective
contributions to the
following retirement
plans.
Cash or
deferred
arrangements
(section 401(k)
plans).
Savings
incentive match
plans for
employees
(SIMPLE plans).
Tax-sheltered
annuity plans
(403(b) plans).
Section
501(c)(18)(D)
plans.
Section 457
plans.
Overall limit on
deferrals.
For 2004, you
generally should not
have deferred more than
a total of $13,000 of
contributions to the
plans listed in (1)
through (6) above. You
should not have deferred
more than the lesser of
your includible
compensation or $13,000
of contributions to the
plan listed in (7) above
(section 457 plan).
Excess deferrals.
Your employer or plan
administrator should
apply the proper annual
limit when figuring your
plan contributions.
However, you are
responsible for
monitoring the total you
defer to ensure that the
deferrals are not more
than the overall limit.
If you set aside more
than the limit, the
excess generally must be
included in your income
for that year. See
Publication 525 for a
discussion of the tax
treatment of excess
deferrals.
Catch-up contributions.
You may be allowed
catch-up contributions
(additional elective
deferral) if you are age
50 or older by the end
of your tax year.
Stock
Options
If you receive a
nonstatutory option to buy
or sell stock or other
property as payment for your
services, you usually will
have income when you receive
the option, when you
exercise the option (use it
to buy or sell the stock or
other property), or when you
sell or otherwise dispose of
the option. However, if your
option is a statutory stock
option, you will not have
any income until you sell or
exchange your stock. Your
employer can tell you which
kind of option you hold. For
details, get Publication
525.
Restricted
Property
Generally, if you receive
property for your services,
you must include its fair
market value in your income
in the year you receive the
property. However, if you
receive stock or other
property that has certain
restrictions that affect its
value, you do not include
the value of the property in
your income until it has
substantially vested. (You
can choose to include the
value of the property in
your income in the year it
is transferred to you.) For
details, see
Restricted Property in Publication 525.
Dividends received on
restricted stock.
Dividends you receive
on restricted stock are
treated as compensation
and not as dividend
income. Your employer
should include these
payments on your Form
W-2.
Stock you chose to
include in income.
Dividends you receive
on restricted stock you
chose to include in your
income in the year
transferred are treated
the same as any other
dividends. Report them
on your return as
dividends. For a
discussion of dividends,
see chapter 9.
For information on
how to treat dividends
reported on both your
Form W-2 and Form
1099-DIV, see
Dividends received
on restricted stock in Publication
525.
Special Rules for
Certain Employees
This section deals with
special rules for people in
certain types of employment:
members of the clergy, members
of religious orders, people
working for foreign employers,
military personnel, and
volunteers.
Clergy
If you are a member of
the clergy, you must include
in your income offerings and
fees you receive for
marriages, baptisms,
funerals, masses, etc., in
addition to your salary. If
the offering is made to the
religious institution, it is
not taxable to you.
If you are a member of a
religious organization and
you give your outside
earnings to the
organization, you still must
include the earnings in your
income. However, you may be
entitled to a charitable
contribution deduction for
the amount paid to the
organization. See chapter
26.
Housing.Special rules for
housing apply to members
of the clergy. Under
these rules, you do not
include in your income
the rental value of a
home (including
utilities) or a
designated housing
allowance provided to
you as part of your pay.
However, the exclusion
cannot be more than the
reasonable pay for your
service. If you pay for
the utilities, you can
exclude any allowance
designated for utility
cost, up to your actual
cost. The home or
allowance must be
provided as compensation
for your services as an
ordained, licensed, or
commissioned minister.
However, you must
include the rental value
of the home or the
housing allowance as
earnings from
self-employment on
Schedule SE (Form 1040)
if you are subject to
the self-employment tax.
For more information,
see Publication 517,
Social Security and
Other Information for
Members of the Clergy
and Religious Workers.
Pension.A pension or
retirement pay for a
member of the clergy is
usually treated as any
other pension or
annuity. It must be
reported on lines 16a
and 16b of Form 1040 or
on lines 12a and 12b of
Form 1040A.
Members of
Religious Orders
If you are a member of a
religious order who has
taken a vow of poverty, how
you treat earnings that you
renounce and turn over to
the order depends on whether
your services are performed
for the order.
Services performed for
the order. If you
are performing the
services as an agent of
the order in the
exercise of duties
required by the order,
do not include in your
income the amounts
turned over to the
order.
If your order directs
you to perform services
for another agency of
the supervising church
or an associated
institution, you are
considered to be
performing the services
as an agent of the
order. Any wages you
earn as an agent of an
order that you turn over
to the order are not
included in your income.
Example.
You are a member
of a church order
and have taken a vow
of poverty. You
renounce any claims
to your earnings and
turn over to the
order any salaries
or wages you earn.
You are a registered
nurse, so your order
assigns you to work
in a hospital that
is an associated
institution of the
church. However, you
remain under the
general direction
and control of the
order. You are
considered to be an
agent of the order
and any wages you
earn at the hospital
that you turn over
to your order are
not included in your
income.
Services performed
outside the order.
If you are directed to
work outside the order,
your services are not an
exercise of duties
required by the order
unless they meet both of
the following
requirements.
They are the
kind of services
that are
ordinarily the
duties of
members of the
order.
They are
part of the
duties that you
must exercise
for, or on
behalf of, the
religious order
as its agent.
If you are an employee
of a third party, the
services you perform for
the third party will not
be considered directed
or required of you by
the order. Amounts you
receive for these
services are included in
your income, even if you
have taken a vow of
poverty.
Example.
Mark Brown is a
member of a
religious order and
has taken a vow of
poverty. He
renounces all claims
to his earnings and
turns over his
earnings to the
order.
Mark is a
schoolteacher. He
was instructed by
the superiors of the
order to get a job
with a private
tax-exempt school.
Mark became an
employee of the
school, and, at his
request, the school
made the salary
payments directly to
the order.
Because Mark is
an employee of the
school, he is
performing services
for the school
rather than as an
agent of the order.
The wages Mark earns
working for the
school are included
in his income.
Foreign
Employer
Special rules apply if
you work for a foreign
employer.
U.S.
citizen.
If you are a U.S.
citizen who works in the
United States for a
foreign government, an
international
organization, a foreign
embassy, or any foreign
employer, you must
include your salary in
your income.
Social security and
Medicare taxes.
You are exempt from
social security and
Medicare employee taxes
if you are employed in
the United States by an
international
organization or a
foreign government.
However, you must pay
self-employment tax on
your earnings from
services performed in
the United States, even
though you are not
self-employed. This rule
also applies if you are
an employee of a
qualifying wholly owned
instrumentality of a
foreign government.
Employees of
international
organizations or foreign
governments.
Your compensation for
official services to an
international
organization is exempt
from federal income tax
if you are not a citizen
of the United States or
you are a citizen of the
Philippines (whether or
not you are a citizen of
the United States).
Your compensation for
official services to a
foreign government is
exempt from federal
income tax if all of the
following are true.
You are not
a citizen of the
United States or
you are a
citizen of the
Philippines
(whether or not
you are a
citizen of the
United States).
Your work is
like the work
done by
employees of the
United States in
foreign
countries.
The foreign
government gives
an equal
exemption to
employees of the
United States in
its country.
Waiver of alien status.
If you are an alien
who works for a foreign
government or
international
organization and you
file a waiver under
section 247(b) of the
Immigration and
Nationality Act to keep
your immigrant status,
different rules may
apply. See
Foreign Employer
in
Publication 525.
Employment abroad.
For information on
income earned abroad,
see Publication 54.
Military
Payments you receive as
a member of a military
service generally are taxed
as wages except for
retirement pay, which is
taxed as a pension.
Allowances generally are not
taxed. For more information
on the tax treatment of
military allowances and
benefits, see Publication 3,
Armed Forces' Tax Guide.
Military retirement pay.
If your retirement pay
is based on age or
length of service, it is
taxable and must be
included in your income
as a pension on lines
16a and 16b of Form 1040
or on lines 12a and 12b
of Form 1040A. Do not
include in your income
the amount of any
reduction in retirement
or retainer pay to
provide a survivor
annuity for your spouse
or children under the
Retired Serviceman's
Family Protection Plan
or the Survivor Benefit
Plan.
For more information
on survivor annuities,
see chapter 11.
Disability.
If you are retired on
disability, see
Military and
Government Disability
Pensions
under
Sickness and Injury
Benefits,
later.
Veterans' benefits.
Do not include in your
income any veterans'
benefits paid under any
law, regulation, or
administrative practice
administered by the
Department of Veterans
Affairs (VA). The
following amounts paid
to veterans or their
families are not
taxable.
Education,
training, and
subsistence
allowances.
Disability
compensation and
pension payments
for disabilities
paid either to
veterans or
their families.
Grants for
homes designed
for wheelchair
living.
Grants for
motor vehicles
for veterans who
lost their sight
or the use of
their limbs.
Veterans'
insurance
proceeds and
dividends paid
either to
veterans or
their
beneficiaries,
including the
proceeds of a
veteran's
endowment policy
paid before
death.
Interest on
insurance
dividends you
leave on deposit
with the VA.
Benefits
under a
dependent-care
assistance
program.
The death
gratuity paid to
a survivor of a
member of the
Armed Forces who
died after
September 10,
2001.
Rehabilitative program
payments.
VA payments to
hospital patients and
resident veterans for
their services under the
VA's therapeutic or
rehabilitative programs
are not treated as
nontaxable veterans'
benefits. Report these
payments as income on
line 21 of Form 1040.
Volunteers
The tax treatment of
amounts you receive as a
volunteer worker for the
Peace Corps or similar
agency is covered in the
following discussions.
Peace
Corps.
Living allowances you
receive as a Peace Corps
volunteer or volunteer
leader for housing,
utilities, household
supplies, food, and
clothing are exempt from
tax.
Taxable allowances.
The following
allowances must be
included in your income
and reported as wages.
Allowances
paid to your
spouse and minor
children while
you are a
volunteer leader
training in the
United States.
Living
allowances
designated by
the Director of
the Peace Corps
as basic
compensation.
These are
allowances for
personal items
such as domestic
help, laundry
and clothing
maintenance,
entertainment
and recreation,
transportation,
and other
miscellaneous
expenses.
Leave
allowances.
Readjustment
allowances or
termination
payments. These
are considered
received by you
when credited to
your account.
Example.
Gary Carpenter, a
Peace Corps
volunteer, gets $175
a month as a
readjustment
allowance during his
period of service,
to be paid to him in
a lump sum at the
end of his tour of
duty. Although the
allowance is not
available to him
until the end of his
service, Gary must
include it in his
income on a monthly
basis as it is
credited to his
account.
Volunteers in Service to
America (VISTA).
If you are a VISTA
volunteer, you must
include meal and lodging
allowances paid to you
in your income as wages.
National Senior Services
Corps programs. Do
not include in your
income amounts you
receive for supportive
services or
reimbursements for
out-of-pocket expenses
from the following
programs.
Retired
Senior Volunteer
Program (RSVP).
Foster
Grandparent
Program.
Senior
Companion
Program.
Service
Corps of Retired
Executives (SCORE).
If you receive amounts
for supportive services
or reimbursements for
out-of-pocket expenses
from SCORE, do not
include these amounts in
income.
Volunteer tax
counseling.
Do not include in your
income any
reimbursements you
receive for
transportation, meals,
and other expenses you
have in training for, or
actually providing,
volunteer federal income
tax counseling for the
elderly (TCE).
You can deduct as a
charitable contribution
your unreimbursed
out-of-pocket expenses
in taking part in the
volunteer income tax
assistance (VITA)
program. See chapter 26.
Sickness and Injury
Benefits
This section discusses
sickness and injury benefits
including disability pensions,
long-term care insurance
contracts, workers'
compensation, and other
benefits.
Disability
Pensions
Generally, if you retire
on disability, you must
report your pension or
annuity as income.
There is a tax credit
for people who are
permanently and totally
disabled. For information on
this credit and the
definition of permanent and
total disability, see
chapter 35.
For information on
disability payments from a
governmental program
provided as a substitute for
unemployment compensation,
see chapter 13.
Disability income.
Generally, you must
report as income any
amount you receive for
personal injury or
sickness through an
accident or health plan
that is paid for by your
employer. If both you
and your employer pay
for the plan, only the
amount you receive that
is due to your
employer's payments is
reported as income.
However, certain
payments may not be
taxable to you. Your
employer should be able
to give you specific
details about your
pension plan and tell
you the amount you paid
for your disability
pension. In addition to
disability pensions and
annuities, you may be
receiving other payments
for sickness and injury.
Do not report as
income any amounts paid to
reimburse you for medical
expenses you incurred after
the plan was established.
Cost
paid by you.
If you pay the entire
cost of a health or
accident insurance plan,
do not include any
amounts you receive from
the plan for personal
injury or sickness as
income on your tax
return. If your plan
reimbursed you for
medical expenses you
deducted in an earlier
year, you may have to
include some, or all, of
the reimbursement in
your income. See
Reimbursement in a
later year
in chapter 23.
Cafeteria plans.
Generally, if you are
covered by an accident
or health insurance plan
through a cafeteria
plan, and the amount of
the insurance premiums
was not included in your
income, you are not
considered to have paid
the premiums and you
must include any
benefits you receive in
your income. If the
amount of the premiums
was included in your
income, you are
considered to have paid
the premiums, and any
benefits you receive are
not taxable.
Retirement and
profit-sharing plans.
If you receive
payments from a
retirement or
profit-sharing plan that
does not provide for
disability retirement,
do not treat the
payments as a disability
pension. The payments
must be reported as a
pension or annuity. For
more information on
pensions, see chapter
11.
Accrued
leave payment.
If you retire on
disability, any lump-sum
payment you receive for
accrued annual leave is
a salary payment. The
payment is not a
disability payment.
Include it in your
income in the tax year
you receive it.
How to
report.If you retired on
disability, you must
include in income any
disability pension you
receive under a plan
that is paid for by your
employer. You must
report your taxable
disability payments as
wages on line 7 of Form
1040 or Form 1040A,
until you reach minimum
retirement age. Minimum
retirement age generally
is the age at which you
can first receive a
pension or annuity if
you are not disabled.
Beginning on the day
after you reach minimum
retirement age, payments
you receive are taxable
as a pension or annuity.
Report the payments on
lines 16a and 16b of
Form 1040 or on lines
12a and 12b of Form
1040A. The rules for
reporting pensions are
explained in
How To Report in chapter 11.
Military and
Government
Disability
Pensions
Certain military and
government disability
pensions are not
taxable.
Service-connected
disability.
You may be able to
exclude from income
amounts you receive
as a pension,
annuity, or similar
allowance for
personal injury or
sickness resulting
from active service
in one of the
following government
services.
The
armed forces
of any
country.
The
National
Oceanic and
Atmospheric
Administration.
The
Public
Health
Service.
The
Foreign
Service.
Conditions for
exclusion.
Do not include the
disability payments
in your income if
any of the following
conditions apply.
You were
entitled to
receive a
disability
payment
before
September
25, 1975.
You were
a member of
a listed
government
service or
its reserve
component,
or were
under a
binding
written
commitment
to become a
member, on
September
24, 1975.
You
receive the
disability
payments for
a
combat-related
injury. This
is a
personal
injury or
sickness
that:
Results
directly
from
armed
conflict,
Takes
place
while
you
are
engaged
in
extra-hazardous
service,
Takes
place
under
conditions
simulating
war,
including
training
exercises
such
as
maneuvers,
or
Is
caused
by
an
instrumentality
of
war.
You
would be
entitled to
receive
disability
compensation
from the
Department
of Veterans
Affairs (VA)
if you filed
an
application
for it. Your
exclusion
under this
condition is
equal to the
amount you
would be
entitled to
receive from
the VA.
Pension based on
years of service.
If you receive a
disability pension
based on years of
service, you
generally must
include it in your
income. However, if
the pension
qualifies for the
exclusion for a
service-connected
disability
(discussed earlier),
do not include in
income the part of
your pension that
you would have
received if the
pension had been
based on a
percentage of
disability. You must
include the rest of
your pension in your
income.
Retroactive VA
determination.
If you retire from
the armed services
based on years of
service and are
later given a
retroactive
service-connected
disability rating by
the VA, your
retirement pay for
the retroactive
period is excluded
from income up to
the amount of VA
disability benefits
you would have been
entitled to receive.
You can claim a
refund of any tax
paid on the
excludable amount
(subject to the
statute of
limitations) by
filing an amended
return on Form 1040X
for each previous
year during the
retroactive period.
If you receive a
lump-sum disability
severance payment
and are later
awarded VA
disability benefits,
exclude 100% of the
severance benefit
from your income.
However, you must
include in your
income any lump-sum
readjustment or
other nondisability
severance payment
you received on
release from active
duty, even if you
are later given a
retroactive
disability rating by
the VA.
Terrorist attack or
military action.
Do not include in
your income
disability payments
you receive for
injuries resulting
directly from a
terrorist or
military action.
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.
To claim an exclusion for
payments made on a
per diem or
other periodic basis under a
long-term care insurance
contract, you must file Form
8853 with your return.
A long-term care
insurance contract is an
insurance contract that only
provides coverage for
qualified long-term care
services. The contract must:
Be guaranteed
renewable,
Not provide for
a cash surrender
value or other money
that can be paid,
assigned, pledged,
or borrowed,
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
Generally 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:
Necessary
diagnostic,
preventive,
therapeutic,
curing,
treating,
mitigating, and
rehabilitative
services, and
maintenance and
personal care
services, and
Required by
a chronically
ill individual
and provided
pursuant to a
plan of care as
prescribed by a
licensed health
care
practitioner.
Chronically ill
individual.
A chronically ill
individual is one who
has been certified by a
licensed health care
practitioner within the
previous 12 months as
one of the following.
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.
An
individual who
requires
substantial
supervision to
be protected
from threats to
health and
safety due to
severe cognitive
impairment.
Limit
on exclusion.
You can generally
exclude from gross
income up to $230 a day
for 2004. See
Limit on exclusion,
under
Long-Term Care
Insurance Contracts,
under
Sickness and Injury
Benefits in
Publication 525 for more
information.
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 survivors. The
exemption, however, does not
apply to retirement plan
benefits you receive based
on your age, length of
service, or prior
contributions to the plan,
even if you retired because
of an occupational sickness
or injury.
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, salary
payments you receive for
performing light duties
are taxable as wages.
Other
Sickness and
Injury Benefits
In addition to disability
pensions and annuities, you
may receive other payments
for sickness or injury.
Railroad sick pay.Payments you receive
as sick pay under the
Railroad Unemployment
Insurance Act are
taxable and you must
include them in your
income. However, do not
include them in your
income if they are for
an on-the-job injury.
If you received income
because of a disability,
see
Disability Pensions,
earlier.
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.
If part of the
payments you receive
under FECA 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 a
discussion of the
taxability of these
benefits, see Social
security and equivalent
railroad retirement
benefits under Other
Income, in Publication
525.
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 used it, the
amount reduces your
taxable sick leave pay.
Do not deduct it
separately.
Other
compensation.
Many other amounts you
receive as compensation
for sickness or injury
are not taxable. These
include the following
amounts.
Compensatory
damages you
receive for
physical injury
or physical
sickness,
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
income.
Disability
benefits you
receive for loss
of income or
earning capacity
as a result of
injuries under a
no-fault car
insurance
policy.
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 not
taxable 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, it may reduce
your medical expense
deduction. For more
information, see chapter
23.
