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Frequently Asked Questions - Taxable and Non-Taxable Income

Q: Do I pay taxes on child support?

A: Child support payments are not taxable. Receipt of alimony payments is taxable.

Q: I am a 62-year-old widow receiving pension from the Department of Veterans Affairs. I have no other source of income except this pension. I am not sure if I should file or not. I didn't receive Form 1099-R.

A: Amounts received from the Department of Veterans Affairs are not taxable income and need not be reported. That is why you did not receive a 1099-R.

Q: My company paid my travel expenses. When I received my form W-2, the company had combined my wages and travel expenses. How do I separate these on my return so that I won't have to pay taxes?

A: If by "combined," you mean that your employer added the amount of reimbursed travel expenses to Box 1 (labeled "Wages, tips, other compensation"), then you cannot separate the two. An employer should only be adding reimbursed travel to Wages if the employer's plan is a non-accountable plan. If this is the case, then you are allowed to deduct those expenses added to Wages using Form 1040, Schedule A, Miscellaneous Itemized Deductions. See Form 2106 and its instructions for more information.

Q: We took a 401(k) distribution. When this was taken, I was over the age of 67. Can the taxable portion be reduced through the simplified method?

A: The simplified method is only used for qualified retirement plans in which you have a cost basis. It is highly likely that you do not have a cost basis, as most 401(k) plans are funded by employees' pre-tax and employers' pre-tax contributions. Any earnings in the account are also pre-tax. Usually, if you have a cost basis because the employer allowed you to make after-tax contributions, the plan administrator would know that and already reflect the non-taxable portion using the simplified method on your 1099-R.

Q: I received a workers' comp settlement of $37,000. Is this taxable income?

A: Workers' compensation benefits are almost always not taxable. However, your workers' compensation may be indirectly subject to tax on your tax return. The part of your workers' compensation that reduces your Social Security benefits (or equivalent Railroad Retirement benefits) is considered a Social Security benefit and may be taxable on your tax return under the rules for those types of income.

Q: If I made less than $1,500 in interest and less than $1,500 in ordinary dividends, it says on schedule 1, I don't have to fill it out. Does that mean I don't have to report any amounts less than that?

A: It means that you do not have to file Schedule 1 with your 1040A. You still must report the income on your 1040A.

Q: Do you pay tax yearly on the interest on CDs or when the CDs are cashed?

A: You report interest income received on Certificates of Deposit (CDs) in the year the interest is credited to your account. Each January, the financial institution that holds the CD will send to you a Form 1099-INT, which  shows the interest income you must report.

Q: If I received a state-tax refund last year, do I have to claim it this year on my federal?

A: If you receive a state or local income-tax refund (or credit or offset), you generally must include it in income if you deducted the tax in an earlier year. The payer should send Form 1099-G, Certain Government Payments, to you by Jan. 31. The IRS also receives a copy of your Form 1099-G.

You must report the refund or recovery only if you got some tax benefit from it in a previous year. You only have to report recoveries of items to the extent that they helped your itemized deductions to exceed the standard deduction for the year in question.

Taxpayers who itemized their deductions for the year to which the recovery applies, but had their deductions limited because they were high-income taxpayers, must go through some special calculations to determine how much of the recovery they must report. Basically, the calculations help determine how much of a deduction the taxpayers would have been able to claim for the item if it had been reported accurately. This result is compared with the amount the taxpayers actually were able to claim for the item, taking the limitation into account.

Use the worksheet in the Form 1040, instructions for Line 10, to figure the amount (if any) of the refund to include in your income.

Q: My mother, who is deceased, left savings bonds to go to her children and grandchildren. Hers was the only name on the bonds. My dad cashed the bonds and passed out the cash and interest to the children.
Does my dad have to pay taxes on the interest from those bonds, or can the cash be declared "gifts"? No one person got over $3,000.

A: Assuming that these were the type of savings bonds that had interest accruing and your mother did not elect to declare the interest in every tax year, then the owner of the bonds at the time they are cashed must declare the interest income as taxable income.

If your mother's will specifically bequeathed these bonds to the children and grandchildren, then each of them would have to declare the interest income. (They would not include any principal in income.) The fact that your dad was the one who cashed the bonds has no relevance for reporting of interest income, as he was merely acting as his children's and grandchildren's agent.

If, on the other hand, the will did not explicitly state that the children inherited the bonds, and the bonds were part of her estate that went to your dad, then your dad reports and pays tax on the interest from the bonds. The distributions to the children are "gifts" with no tax consequences for the children.

Q: Are "cash liquidation distributions," as shown on a 1099-DIV (Box 8) taxable income?

A: "Liquidating distributions," sometimes called "liquidating dividends," are distributions you receive during a partial or complete liquidation of a corporation. These distributions are one form of a return of capital. You will receive a Form 1099-DIV from the corporation showing the amount of the liquidating distribution in Box 8 or 9. Partial liquidating distributions are not taxable income. As long as you still have a cost basis in your original investment, they are used to reduce that basis.

If and when distributions exceed your cost basis, the excess is a capital gain. If, when the distributions are ended and the corporation has been completely liquidated, the distributions were less than your basis, the difference is a capital loss.

Q: My dad is 70 years old and still working. His employer is still taking out for income tax. Should they have to stop?

A: Employers are obligated to withhold income tax and other payroll taxes from an employee's pay based on a table provided by the IRS. If your father believes that he will not have a tax liability or that his withholding will be excessive, he should file IRS Form W-4 with his employer. This form is used to modify an employee's withholding.

Q: I am a teacher on disability retirement. I have heard that disability income may be fully or partially exempt from paying federal income tax. Is that correct?

A: Generally, if you retire on disability, you must report your pension or annuity as income. The rule is that disability insurance is not taxable only to the extent that you paid the premiums yourself out of after-tax money or you are receiving disability payments for physical injury.

Some disability payments, such as military or government pensions, may not taxable. See Sickness & Injury Benefits in Chapter 5 of Publication 17 from the IRS website.

Q: We refinanced our home from an FHA loan to a conventional loan. We got a refund check from our escrow account. Do we need to claim this refund amount on our taxes?

A: No. They have just returned your money, which would have been used to pay taxes, insurance, and the like, if you had not refinanced.

Q: I am thinking about retiring early. I will be 52 years old and will receive a monthly pension plan amount from the company I worked for during the past 27 years. This income is not from a 401(k) or IRA plan. It is the company-sponsored pension plan, paid to all employees, regardless of other retirement savings, such as 401(k)s and the like. Is this income taxed as "regular" income?

Also, I have money in a 401(k) plan. Because I am younger than 55 or 59.5, if some of this 401(k) savings is taken out as a monthly income for me, will the money be subject to the 10-percent penalty?

A: Yes the pension is taxed as ordinary income.

The tax rate will depend on the amount of the pension and all your other income and deductions.

If you withdraw 401(k) money as an annuity consisting of substantially equal periodic payments over your lifetime, per an approved IRS method, the distribution would only be subject to ordinary income tax.

Any other type of distribution would be subject to the 10-percent early withdrawal penalty.

Q: I won $2,000 at a slot machine last year. Do I put that under "Other Income," then add it to my taxable income?

A: The 2,000 is entered on Line 21, "Other Income," of Form 1040 along with a brief description. If you have proof of gambling losses, they can be deducted (up to the amount of winnings) on Schedule A.

Q: I received an out-of-court settlement from the insurance carrier representing local county government. I received $51,500 from my attorney, and he kept $23,500.00 as contingency fee. The actual settlement amount was $75,000.00. Do I show the full $75,000 as income and claim $23,500 as legal fees, or can I claim actual amount I received ($51,500) and not claim any legal fees?

A: You need to report $75,000 as "Other Income" on Form 1040 and deduct $23,500 on Line 22 of Schedule A.

A word of caution. You should seek some professional tax advice, as Miscellaneous Itemized Deductions (Line 22 of Schedule A) are not allowed when computing Alternative Minimum Tax. It is quite possible that you are subject to the AMT.

Q: Please tell me if dividends on a money market account should be reported on a federal tax return. They are "reinvested."

A: Dividends on a money market account are taxable income. You should have received a 1099-INT or 1099-DIV from the financial organization in January. That form determines on which line of your tax form it gets reported.

Q: I am 63 and on Social Security. I also babysit for extra income. Do I have to file a tax return or pay any taxes on babysitting monies?

A: As an independent contractor providing babysitting services, you must file a tax return (Form 1040) if your net earnings (income less your business expenses) is at least $400. In addition, if your net earnings exceed $433.12, you will have to pay self-employment taxes (those are Social Security and Medicare) on your net income, even though you may not owe any income tax. See IRS Pub 334, Tax Guide for Small Business, for more information.

Q: My husband died this year, and I received his life-insurance payment. Do I need to pay taxes on it? Do I need to fill out any special forms?

A: You do not need to report as income the life-insurance proceeds you received on your husband's policy. You may file a joint tax return with your deceased husband for the year of death. Put his name, the word "deceased," and the date of death across the top of the tax form and sign, "Filing as surviving spouse" in his signature area.

Q: My wife inherited $20,000 from her deceased uncle. We are both on Social Security. Is the money she received taxable?

A: If she received the cash from the estate, it is not taxable. If, on the other hand, she was the beneficiary of a pension, annuity, or some other type of retirement plan, then the payment would be taxable to your wife in the same manner it would have been taxed if the decedent had taken a distribution.

Q: I have not reached my full retirement age. I receive a pension, interest, dividends, and early Social Security benefits. Is any of this other income considered "earned income"? Is my Social Security subject to recapture?

A: "Earned income" is compensation you receive in the form of wages, salary, tips, bonuses, and the like—all of which is reflected in Box 1 of the W-2 you receive from your employer. "Earned income" also includes your net earnings from any business you own or operate or from any self-employment. Pensions, annuities, interest, dividends, and capital gains are not earned income.

Q: I hold a mortgage for my daughter on her home. Are there any forms I must file with the IRS to report this interest?

A: There are no IRS Information Forms that are required to be filed between a parent and a child. You are required to report the interest income you receive from your daughter. She can deduct the mortgage interest paid only if the loan is secured debt. If it is just a personal loan, the interest is not deductible.

A secured debt is one in which you sign an instrument (such as a mortgage, deed of trust, or land contract) that makes your ownership in a qualified home security for payment of the debt; the instrument provides that in case of default, your home could satisfy the debt. The instrument is recorded or is otherwise perfected under any state or local law that applies.

In other words, your mortgage is a secured debt if you put your home up as collateral to protect the interests of the lender. If you cannot pay the debt, your home can then serve as payment to the lender to satisfy (or pay) the debt.

Q: I received a gift of $5,000 from my grandfather. Is it reportable? And, if yes, where on the 1040 Form?

A: A bona fide gift from another individual to you is not taxable income. There is nothing for you to report.

Q: I received payments from someone as a result of an out-of-court settlement to the lawsuit I filed. Part of these payments are principal on money owed me that I have already paid income tax on. The other part (about $7,000) is interest income. I probably will not receive a 1099-INT from the individual. Where do I report this interest income on the Form 1040?

A: You report the interest as "taxable interest" on Form 1040, Schedule B. The question of whether or not you receive a 1099-INT from the individual is not germane.

Q: My daughter, who lives with me, is 19 and a full-time student at one of our state colleges. She is my qualifying child and I claim her as my dependent. She received a variety of scholarship grants that came to $2,000. She spent some of that for school supplies and books. Is any part of those grants taxable income to me, and if yes, how do I report it?

A: The grants were received by your daughter. As such, any amount that may be taxable income would be reported on your daughter's tax return.

As she is a full-time student at an accredited college pursuing a degree, the only taxable part of her grant is that part not spent on qualified educational expenses. "Qualified educational expenses" are explained in IRS Publication 970.

If some part of your daughter's grant is taxable, it should be reported on her own tax return. Report the taxable amount on Line 7 of the 1040 or 1040A, and write the word SCH on that line.

Q: I have a W-2 from an insurance company. The Form reflects payments in Box 1 for disability benefits I received. Is this subject to federal income tax?

A: Yes it is taxable. It gets added to any other wages you received and is entered on Line 7 of Form 1040. Presumably this is from a disability policy paid for by your employer, not you.

Q: My spouse died in 2008. I neglected to take his name off various accounts and investments that we owned jointly with his name and Social Security number listed first. Information for 2008 is going to go to the IRS using his Social Security number. How do I resolve this problem for filing my tax return?

A: Include all the income on your return, and don't worry about it. In the unlikely event you hear from the IRS, simply explain it to them. This happens all the time. Make sure you change the title on all the accounts and on any real property you owned jointly.

Q: Is pay for Jury Duty taxable?

A: Jury Duty income must be reported on Line 21, "Other Income," of Form 1040.

Q: The IRS says that I don't need to attach a copy of my SSA-1099 to my tax return. I had voluntary income tax withheld from each check. How do I prove to the IRS that this amount was withheld?

A: You do not have to prove it. The SSA has already reported the amount of income tax withheld to the IRS. Just be sure to note the amount withheld on your tax return.

Q: What is the difference between "ordinary dividends" and "qualified dividends"? My 1099 dividend statements were marked by the companies as both.

A: "Qualified dividends" are ordinary dividends paid out of the profits of the company. "Qualified dividends" are subject to the same tax rate that applies to net capital gains. The amount of ordinary dividends identified as qualified dividends goes on Line 9b of Form 1040. The tax-instruction booklet contains a worksheet on qualified dividends and capital gains taxes, which you can use to compute your tax. Using the worksheet will tax the qualified dividends at the capital gains rate.