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Chapter 13. Other Income

Introduction

This chapter discusses many kinds of income and explains whether they are
taxable or nontaxable.

∙  Income that is taxable must be reported on your tax return and is subject
   to tax.

∙  Income that is nontaxable may have to be shown on your tax return but is
   not subject to tax.

You must include on your return all income you receive in the form of money,
property, and services unless the tax law states that you do not include them.
Some items, however, are only partly excluded from income. They are listed and
discussed briefly in this chapter.

Related publications.

This chapter refers to several publications that you may need. For more
information, you may want to order the following:

    Publication 501, Exemptions, Standard Deduction, and Filing Information

    Publication 520, Scholarships and Fellowships

    Publication 525, Taxable and Nontaxable Income

    Publication 544, Sales and Other Dispositions of Assets

    Publication 550, Investment Income and Expenses

Miscellaneous Taxable Income

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

    Bartering

    Recoveries (including state income tax refunds)

    Repayments

    Royalties

Note. When you report miscellaneous taxable income on line 22 of Form 1040,
write a brief description of the income on the dotted line next to line 22.

Activity not for profit. You must include on your return income from an
activity not for profit. An example of this type of activity would be a hobby
or a farm you operate mostly for recreation and pleasure. Deductions for
expenses related to the activity are limited, 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 Publication 535, Business
Expenses, for information on whether an activity is considered carried on
for a profit.

Alaska oil royalties. If you were a resident of Alaska and qualified to
receive a payment from Alaska's mineral income fund (Alaska Permanent Fund
dividends), you must report this amount on line 22, Form 1040. The state of
Alaska will send you a Form 1099─MISC which shows this amount. The IRS will
receive a copy of the Form 1099.

Alimony. Include in your income on line 11, Form 1040, any alimony payments
you receive. Amounts you receive for child support are not income to you.
Alimony and child support payments are discussed in Chapter 19.

Allowances and reimbursements. If you receive travel, transportation, or
other business expense allowances or reimbursements from your employer,
see Chapter 28. If you are reimbursed for the business use of your car, see
Chapter 28, and if you are reimbursed for moving expenses, see Chapter 27.

Canceled debt. A canceled debt, or a debt paid for you by another person,
is generally income to you and must be reported on line 22, Form 1040.

A discount offered by a financial institution for the prepayment of a mortgage
loan is income from the cancellation of a debt. However, you have no income
from the cancellation of a debt if the cancellation, or the payment by another
person, is intended by the other person as a gift to you.

If your debt is canceled in a bankruptcy case (title 11) or when you are
insolvent, do not include the canceled debt in your gross income. Get
Publication 908, Bankruptcy and Other Debt Cancellation.

Cancellation of student loan. You do not have income if your student loan
is canceled because you agreed to certain conditions to obtain the loan and
then performed the services required. Under the terms of the loan you must be
required to work for a specified period of time in certain professions for one
of a broad class of employers. 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.

3)  An educational organization under an agreement with an entity described
    in (1) or (2) that provided the funds to the institution to make the
    loan.

Cancellations of student loans under section 465 of the Higher Education Act
of 1965 also are not income.

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.

3)  Punitive damages awarded in cases not involving physical injury or
    sickness. Report this income on line 22, Form 1040.

4)  Amounts received in settlement of pension rights (if you did not
    contribute to the plan).

5)  Damages for:

    a)  Patent or copyright infringement.

    b)  Breach of contract.

    c)  Interference with business operations.

Do not include as your income compensatory damages for the following:

1)  Personal injury or sickness (whether received in a lump sum or
    installments).

2)  Damage to your character.

3)  Alienation of affection.

4)  Surrender of custody of a minor child.

Get Publication 525 for additional information.

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
are taxed on your share of its income. However, there is never a double tax.
Estates and trusts file their returns on Form 1041, U.S. Fiduciary Income Tax
Return, and report your share of the income on Schedule K─1 of Form 1041.

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

Current income not required to be distributed. If you are the beneficiary of
an estate or trust and the fiduciary has the choice of whether to distribute
all or part of the current income, you must report all income that is required
to be distributed to you, whether or not it is actually distributed, plus all
other amounts actually paid or credited to you, to the extent of your share
of distributable net income.

How to report estate and trust income. Each item of income is treated the
same for you as for the estate or trust. If it is dividend income for the
trust, it is the same for you.

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 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. This rule applies if the property put into the trust will
revert (be returned) to the grantor or the grantor's spouse. Generally, for
transfers after March 1, 1986, 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. For transfers in trust made before March 2,
1986, a trust was a grantor trust if it was expected that the property would
revert to the grantor within 10 years.

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

1)  A corporate director.

2)  An executor or administrator of an estate.

3)  A notary public.

4)  An election precinct official.

If these payments total $600 or more for the year, the payer must report these
fees to the IRS on Form 1099─MISC. You will receive a copy of Form 1099─MISC.
Report these payments on Schedule C (Form 1040) as self-employment income. You
may be able to use Schedule C-EZ instead of Schedule C. See the instructions
for Schedule C-EZ.

If you receive a Form W─2 showing corporate director fees, report these
fees on line 7 of Form 1040 or Form 1040A, or on line 1 of Form 1040EZ.

Free tour. A free tour you receive from a travel agency for organizing a group
of tourists must be included in your income on line 22, Form 1040, or on
Schedule C (Form 1040) at the fair market value of the tour. You cannot deduct
your expenses in serving as the voluntary leader of the group at the group's
request.

Gambling winnings. You must include your gambling winnings in income on line
22, 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.

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

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

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.

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

Illegal income, such as stolen or embezzled funds, must be included in your
gross income on line 22, Form 1040, or on Schedule C (Form 1040).

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.

Investment clubs. An investment club is a group of friends, neighbors,
business associates, or others who pool limited or stated amounts of funds to
invest in stock or other securities. The club may or may not have a written
agreement, charter, or by-laws. Usually the group operates informally with
members pledging a regular amount to be paid into the club monthly. Some clubs
have a committee that gathers information on securities, selects the most
promising, and recommends that the club invest in them. Other clubs rotate
the investigatory responsibilities among all their members. Most require all
members to vote for or against all investments, sales, exchanges, or other
transactions.

How the income from an investment club is reported on your tax return depends
on how the club operates. Most clubs operate as partnerships and are treated
as such for federal tax purposes. Others operate as corporations, trusts, or
associations taxed as corporations.

For more information about investment clubs, get Publication 550.

Jury duty pay you receive must be included in your income. If you are required
to give the pay to your employer because your employer continues to pay your
salary while you serve on the jury, you can deduct the amount turned over to
your employer as an adjustment to your income. Include the amount you repay
your employer on line 30, Form 1040, and write "Jury pay" and the amount on
the dotted line next to line 30.

Kickbacks. You must include in your income on line 22, Form 1040, or on
Schedule C (Form 1040), kickbacks, side commissions, push money, or similar
payments you receive.

Example. You are a car salesperson 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.

Note received for services. If your employer gives you a note as payment for
your services, you must include the fair market value (usually the discount
value) of the note in your income as wages for the year you receive it. When
you later receive payments on the note, part of each payment is a recovery
of the fair market value that you previously included in your income. Do not
include that part in your income again. Include the rest of the payment in
your income in the year of payment.

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 22, Form 1040.

Employee cash awards or bonuses. Cash awards or bonuses given to you by
your employer for good work or suggestions must be included in your income.
However, certain employee awards can be excluded from your income. See
Employee achievement awards, later.

Prizes and awards in goods or services must be included in income at their
fair market value. If you refuse to accept a prize, do not include it in
your income.

Pulitzer, Nobel, and other prizes awarded in recognition of past
accomplishments - in religious, charitable, scientific, artistic, educational,
literary, or civic fields - are not included in your income if all of the
following requirements are met:

1)  You were selected without any action on your part to enter the contest
    or proceeding.

2)  You are not required to perform substantial future services as a
    condition to receiving the prize or award.

3)  The prize or award is transferred directly to a governmental unit or
    tax-exempt charitable organization as designated by you.

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

Property purchased from employer. If you buy shares of stock or other property
from your employer for less than fair market value, you ordinarily must
include in your income, as wages, the difference between their fair market
value at the time you bought them and the amount you paid. You also must
include in your income the fair market value of any stock you received
free from your employer. See Property received for services in Chapter 6.

Sale of personal items. If you sell an item that you owned for personal use,
such as a car, refrigerator, furniture, stereo, jewelry, or silverware, a gain
is taxable as a capital gain reported on Schedule D (Form 1040). A loss is
not deductible.

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

Bartering

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

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

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

Report this income on Schedule C (Form 1040) and complete Part VII of Schedule
D (Form 1040) if you received one or more Forms 1099─B, Proceeds From Broker
and Barter Exchange Transactions, or a similar statement reporting these
amounts.

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

Barter exchange. If you exchanged property or services through a barter
exchange, you may receive a statement from the barter exchange (Form 1099─B
or a similar statement). You should receive the statement by January 31, 1993,
and it will generally show the value of cash, property, services, credits, or
scrip you received from exchanges during the year. The IRS will get a copy
of Form 1099─B.

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

If you join a barter exchange, you must certify under penalties of perjury
that your social security or employer 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. For
more information, see Backup Withholding in Chapter 5.

Reporting the tax withheld. If tax is withheld from your barter income, the
barter exchange must give you a Form 1099─B, or similar statement, that
indicates the amount of tax withheld.

Partnership Income

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

The partnership must file a return on Form 1065, U.S. Partnership Return of
Income, and send Schedule K─1 to each partner. In addition, the partnership
will send each partner a copy of the Partner's Instructions for Schedule K─1
(Form 1065), to help each partner report his or her share of the partnership's
income, credits, deductions, and tax preference items. Do not attach Schedule
K─1 (Form 1065) to your Form 1040 (unless you are required to file it with
Form 8271). Keep it for your records.

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

S Corporation Income

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

An S corporation must file a return on Form 1120S, U.S. Income Tax Return
for an S Corporation, and send Schedule K─1 (Form 1120S) to each shareholder.
In addition, the S corporation will send each shareholder a copy of the
Shareholder's Instructions for Schedule K─1 (Form 1120S) to help each
shareholder report his or her share of the S corporation's income, credits,
and deductions. Do not attach Schedule K─1 (Form 1120S) to your Form 1040
(unless you are required to file it with Form 8271). Keep it for your records.

For more information on S corporations and their shareholders, get
Publication 589, Tax Information on S Corporations.

Recoveries

A recovery is a return of an amount you deducted or took a credit for in
an earlier year. Generally, you must include all or part of the recovered
amounts in your income in the year the recovery is received. The most common
recoveries are refunds, reimbursements, and rebates of deductions itemized on
Schedule A (Form 1040). Non-itemized deduction recoveries include such items
as payments you receive on previously deducted bad debts, reimbursements not
included on your Form W─2 for an employee business expense deducted before
1987, and recoveries on items for which you previously claimed a tax credit.

If you receive recoveries from items that were deducted in 2 or more years,
the amount of the recoveries to include in your income must be figured
separately for each year.

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

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

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

Recovery attributable to 2 or more years. If you receive a refund or other
recovery from one item, such as a real estate tax rebate, that is for amounts
you paid in two or more separate years, you must allocate, on a pro rata
basis, the recovered amount between the years in which it was paid.

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

Tax benefit rule. If you did not derive a tax benefit from your prior year
deduction, you do not have to include the amount you received this year in
income. This could happen if you were subject to the alternative minimum tax
or had credits that reduced your tax liability to zero. For more information,
get Publication 525.

Itemized Deduction Recoveries

If you recover any amount that you deducted in an earlier year on Schedule A
(Form 1040), you must determine how much, if any, of the recovery to include
in your income.

Due to changes in the tax law, different computations are needed for the
recovery of items deducted after 1986 or before 1987. The discussions in
this section apply to recoveries from any year, unless otherwise noted.

Standard deduction. To determine if amounts deducted in 1991 and recovered in
1992 must be included in your income, you must know the standard deduction
for your filing status in 1991. Standard deduction amounts for 1991 are in
Publication 525.

Form 1099─G. If you received a state or local income tax refund in 1992, you
may receive a statement, Form 1099-G, Certain Government Payments, from the
payer of the refund (or credit or offset) by January 31, 1993. The IRS will
receive a copy of the Form 1099-G.

No earlier year deduction. If you did not itemize deductions in the year for
which you received the recovery, do not include any of the recovery amount in
your income.

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 1991 you paid $1,200 for medical expenses. From this amount
you subtracted $1,000, which was 7.5% of your adjusted gross income. Your
taxable income for 1991 was $9,000. Your actual medical expense deduction was
$200. In 1992, you received a $500 reimbursement from your medical insurance
for your 1991 expenses. The only amount of the $500 reimbursement that must
be included in your income in 1992 is $200 - the amount actually deducted.

Total recoveries included in income. The total amount recovered in 1992 is
included in your income if certain requirements are met. These requirements
are different for amounts deducted after 1986 and amounts deducted before
1987. The recoveries included in your income will not be more than the
amount deducted. See Tax benefit rule, earlier.

Amounts deducted after 1986 will be included in your income if:

1)  The recoveries are equal to or less than the amount by which your
    itemized deductions exceeded the standard deduction for your
    filing status in the earlier year, and

2)  Your taxable income in the earlier year was 0 or more.

Amounts deducted before 1987 will be included in your income if:

1)  The recoveries are equal to or less than the earlier year's excess
    itemized deductions, and

2)  Your taxable income in the earlier year was not less than your zero
    bracket amount.

Enter your state and local income tax refund on line 10, Form 1040, and the
total of all other recoveries as other income on line 22, Form 1040.

Example. In 1991, you filed a joint return. Your taxable income was $20,000.
The standard deduction for your filing status was $5,700, and you had itemized
deductions of $7,000. In 1992, you received the following recoveries for
amounts deducted in 1991:

     Medical expenses ..............................    $200
     State and local income tax refund .............     400
     Real estate tax rebate ........................     325
                                                     __________
     Total recoveries ..........................        $925
                                                     ==========

None of the recoveries were more than the deductions taken in 1991.

Because your total recoveries are less than the amount your itemized
deductions exceeded the standard deduction ($7,000 - 5,700 = $1,300), and your
1991 taxable income was $20,000, you must include your total recoveries in
your income in 1992. Report the state and local income tax refund of $400 on
line 10, Form 1040, and the balance of your recoveries, $525, on line 22,
Form 1040.

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

After 1986, 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. Therefore,
include in your income the smaller of:

1)  Your recoveries, or

2)  The amount by which your itemized deductions exceeded the standard
    deduction.

Example. You filed a joint return in 1991. Your itemized deductions were
$7,000. The standard deduction that you could have claimed was $5,700. In 1992
you recover $2,400 of your 1991 itemized deductions. None of the recoveries
were more than the actual deductions in 1991. Include $1,300 of the recoveries
in your 1992 income. This is the smaller of your recoveries ($2,400) or the
amount your itemized deductions exceeded the standard deduction ($7,000 -
5,700 = $1,300).

Before 1987. Because only excess itemized deductions before 1987 could reduce
tax, the recovered amount of these deductions required to be included in your
income in 1992 is not more than the excess of your itemized deductions over
your zero bracket amount (excess itemized deductions).

The zero bracket amount was not taxed. Therefore, if your taxable income was
zero or more, but less than your zero bracket amount, only part of your excess
itemized deductions reduced the tax. To figure that part, reduce the excess
itemized deductions by the difference between your zero bracket amount and
your taxable income. You are not required to include the recovery in your
income to the extent that it is more than the reduced excess itemized
deductions.

See Recoveries in Publication 525 if:

1)  You recover in 1992 amounts deducted before 1987.

2)  You had a negative taxable income in the prior year.

3)  You have recoveries from items other than itemized deductions.

4)  You were required to itemize deductions in the prior year for which
    you received the recovery.

5)  You received a recovery for an item for which you claimed a tax credit
    (other than investment credit or foreign tax credit) in a prior year.

6)  You were subject to the alternative minimum tax, or you had credits
    that reduced your tax liability to zero, in the year the deduction was
    claimed.

7)  Your last payment of 1991 estimated state income tax was made in 1992.

Repayments

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

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

Repayment $3,000 or less. If the amount you repaid was $3,000 or less, deduct
it from your income (in the year you repaid it) on the same form or schedule
on which you previously reported it. For example, if you reported it as a
capital gain, deduct it on Schedule D (Form 1040). If you reported it as
wages or other ordinary income, enter it on line 20, Schedule A (Form 1040).

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

1)  Figure your tax for 1992 claiming a deduction for the repaid amount.

2)  Figure your tax for 1992 without deducting the amount you repaid. Then,

    a)   Refigure your tax from the earlier year without including in income
         the amount you repaid in 1992.

    b)   Subtract the tax in (a) from the tax shown on your return for the
         earlier year.

    c)   Then subtract the answer in (b) from the tax for 1992 figured
         without the deduction.

How you treat the repayment on your 1992 return depends on which answer
above results in less tax.

∙  If the answer in Step (1) is less tax, deduct the amount repaid on the
   same form or schedule on which you previously reported it. For example,
   if you reported it as self-employment income, deduct it on Schedule C
   (Form 1040), or if you reported it as wages, deduct it on line 25 of
   Schedule A (Form 1040).

∙  If the answer in Step (2) is less tax, claim a credit on line 59, Form
   1040, and write "I.R.C. 1341" on the dotted line next to line 59.

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

Royalties

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

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

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

You can recover your cost or other basis through depreciation deductions
over the life of the copyright or patent. If a patent or copyright becomes
worthless in any year before it expires, you can deduct your unrecovered cost
or other basis in the year it becomes worthless.

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

Depletion. If you are the owner of an economic interest in mineral deposits
or oil and gas wells, you can recover your investment through the depletion
allowance. For information on this subject, see Chapter 11 of Publication
535, Business Expenses.

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

Interest in the property sold. If you sell your complete interest in the oil,
gas, or mineral rights, the amount you receive is considered payment for the
sale of your property, not royalty income. Under certain circumstances, the
sale is subject to capital gain or loss treatment on Schedule D (Form 1040).
For information on capital gain or loss, see Chapter 15.

Also, you can report the sale as an installment sale if you are to receive at
least one payment after the tax year in which the sale took place. For more
information, get Publication 537, Installment Sales.

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

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

Your payments for the buyer's share of the proceeds are treated as a loan
repayment. The buyer will treat the share as a return of capital that is not
included in your income or subject to a depletion allowance. Any interest
factor received by the buyer will be treated as ordinary income not subject
to the allowance for depletion.

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

Income Not Taxed

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

     Accident and health insurance proceeds

    "Black lung" benefits

    Casualty insurance and other reimbursements (Chapter 26)

    Child support payments (Chapter 19)

    Damages awarded for physical injury or sickness

    Employment agency fees (Chapter 30)

    Federal Employees' Compensation Act payments

    Government cost-of-living allowances (Chapter 6)

    Interest on state or local government obligations (Chapter 8)

    Meals and lodging (Chapter 6)

    Members of the clergy housing allowance (Chapter 6)

    Military allowances (Chapter 6)

    Scholarship and fellowship grants

    Social security benefits and equivalent railroad retirement benefits
    (Chapter 12)

    Supplemental security income

    Veterans' benefits (Chapter 6)

    Workers' compensation

Campaign contributions are not income to a candidate unless they are diverted
to his or her personal use. To be exempt from tax, the contributions must be
spent for campaign purposes or kept in a fund for use in future campaigns.
However, interest earned on bank deposits, dividends received on contributed
securities, and net gains on sales of contributed securities are taxable
and must be reported on Form 1120─POL, U.S. Income Tax Return for Certain
Political Organizations. Excess campaign funds transferred to an office
account must be included in the officeholder's income on line 22, Form 1040,
in the year transferred.

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

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

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

1)  Be given for length of service or safety achievement.

2)  Be tangible personal property other than cash, gift certificates,
    or equivalent items.

3)  Be given under conditions and circumstances that do not create a
    significant likelihood of the payment of disguised compensation.

4)  Be given as part of a meaningful presentation.

5)  Be no more than the specified dollar limits.

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

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

Example. Ben Green received three employee achievement awards during 1992: a
nonqualified plan award of a watch valued at $250, and two qualified plan
awards of a stereo valued at $1,000 and a set of golf clubs valued at $500.
Assuming that the requirements for qualified plan awards are otherwise
satisfied, each award by itself would be excluded from his income. However,
since the total value of the awards is more than $1,600, Ben must include the
excess of $150 ($1,750 - $1,600) in his income.

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. Add any amounts that you
previously received under the contract and excluded from your income to the
lump-sum payment to find how much of the total is a return of your cost and
how much is an excess over your cost. Include any excess 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
as explained in Publication 575, Pension and Annuity Income (Including
Simplified General Rule). 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 became payable to you.

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

A qualified foster individual is a person who:

1)  Is living in a foster family home, and

2)  Was placed there by:

    a)  An agency of a state or one of its political subdivisions, or

    b)  A tax-exempt child placement agency licensed by a state, if the
        individual is under age 19.

Difficulty-of-care payments are not included in your income. These are
additional payments made to foster-care providers of physically, mentally,
or emotionally handicapped individuals by a state, political subdivision, or
tax-exempt child placement agency that are designated as difficulty-of-care
payments. A state must determine the additional compensation is needed. You
must include in your income difficulty-of-care payments received for more
than:

1)  10 children under age 19, and

2)  5 individuals age 19 and older.

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

Report the income and expenses on Schedule C and net business income on
Schedule SE (Form 1040). See Home Office in Chapter 30.

For more information on foster care, get Publication 501.

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

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

Interest on frozen deposits. In general, you can 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.

The amount of interest you can 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).

In the year the interest becomes withdrawable, you must include in your income
the part of the interest that was excluded.

Example. For tax year 1992, Bill and Joan Smith had interest income of $1,500
credited to their account. The account is with a bank that has been insolvent
since 1985. The Smiths were not able to withdraw any money from this frozen
account. They can exclude the $1,500 of interest credited to this account from
their 1992 gross income.

Interest on qualified savings bonds. You can exclude from your 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 savings bond issued after December 31, 1989,
to an individual 24 years of age or older. For more information on this
exclusion, see Chapter 8.

Living expenses paid by insurance. Do not include in income amounts you
receive under an insurance policy for additional living expenses you and your
family had because you lost the use of your home by fire, storm, or other
casualty. The amount you exclude from income is limited to your extra living
expenses that are more than the normal expenses you would have had. Extra
living expenses, for this purpose, include only those to keep you and your
family at the same standard of living you had before the loss.

Sale of home. If you are 55 or older and sell your main home, you can choose
to exclude from income, under certain conditions, all or part of any gain
from the sale. See Chapter 16.

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

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

1)  A reduction in the purchase price of electricity furnished to you (rate
    reduction), or

2)  A nonrefundable credit against the purchase price of the electricity.

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

Life Insurance Proceeds

Life insurance proceeds paid to you because of the death of the insured person
are not taxable unless the policy was turned over to you for a price. This
applies 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 them in your gross income
only to the extent they 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 the benefit payments in your income to the extent they 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, you must 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. For more information,
get Publication 525.

Surviving spouse. If your spouse died before October 23, 1986, and insurance
proceeds are payable to you because of the death of your spouse, and you
receive them in installments, you can exclude up to $1,000 a year of the
interest included in the installments. This is in addition to the part of
each installment that is excluded as a recovery of the lump sum payable at
death. If you remarry, you can continue to take the exclusion.

If your spouse died after October 22, 1986, you cannot exclude any interest
payments included in the installment payments.

See Insurance Received in Installments in Chapter 8.

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

If your spouse died before October 23, 1986, and 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.

Payments to beneficiaries of deceased employees (death benefit exclusion). The
first $5,000 of payments made by or for an employer because of an employee's
death can be excluded from the income of the beneficiaries. The payments need
not be made as the result of a contract. The amount excluded for any deceased
employee cannot be more than $5,000 regardless of the number of employers or
the number of beneficiaries.

This exclusion also covers payments of the balance to the credit of a deceased
employee under a stock bonus, pension, or profit-sharing plan, as long as they
are received during one tax year of the beneficiary.

Example. William Smith was an officer of a corporation at the time of his
death last year. The board of directors voted to pay Mr. Smith's salary to his
widow for the remainder of the year for his past services. During the year the
corporation made payments of $18,000 to the widow. She can exclude from her
income the first $5,000 she received, but must include the remaining $13,000
on line 22, of her Form 1040.

Self-employed individuals. The death benefit exclusion also applies to
lump-sum distributions paid on behalf of self-employed individuals, if
paid under a qualified pension, profit-sharing, or stock bonus plan.

Payments not qualifying. Any amount the deceased employee (or self-employed
individual) had a guaranteed right to receive had death not occurred cannot be
excluded as a tax-free death benefit. If the deceased employee was receiving a
retirement annuity, and the beneficiary continues to receive payments under a
joint and survivor annuity option, these payments do not qualify for the death
benefit exclusion. However, if the deceased employee had retired on disability
and at the time of death had not reached minimum retirement age, payments
to the beneficiary may qualify for the death benefit exclusion. Minimum
retirement age generally is the age at which an individual can receive
a pension or annuity were that individual not disabled.

Death benefits paid in installments over a period of years are annuity
payments. If you are the beneficiary of an employee who died while still
employed, the pension or annuity you receive may qualify for the death benefit
exclusion. This exclusion is limited to $5,000 and generally applies to the
amount by which the present value of the annuity (explained in Publication
575), figured as of the date of the employee's death, is more than the larger
of:

1)  The employee's contributions to the plan, or

2)  The amount the employee had a guaranteed right to receive.

If you are eligible for the exclusion, add it to the cost or unrecovered cost
of the annuity in figuring, at the annuity starting date, the investment in
the contract.

Treatment of annuity payments to beneficiaries of employees and the death
benefit exclusion are discussed in Chapter 11.

Deceased public safety officers. 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 payable to you by
the Bureau of Justice Assistance.

Welfare and Other Public Assistance Benefits

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

Payments for age and residency. If the state of Alaska makes payments to its
citizens who meet certain age and residency tests, and the payments are not
based on need, the payments are not welfare benefits. Include them in gross
income on line 22, Form 1040.

Handicapped persons employed in community service activities under the
Employment Opportunities for Handicapped Individuals Act do not include in
income the wages, allowances, or reimbursements paid to them under the Act.

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

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

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

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

Other Sickness and Injury Benefits

In addition to welfare or insurance benefits, you may receive other payments
for sickness and injury.

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

If part of your workers' compensation reduces your social security or
equivalent railroad retirement benefits received, you may have to include part
of the workers' compensation in income. For more information, see Publication
915, Social Security Benefits and Equivalent Railroad Retirement Benefits.

If you return to work after qualifying for workers' compensation, payments you
continue to receive while assigned to light duties are taxable.

Federal Employees' Compensation Act (FECA) payments for personal injury or
sickness, including payments to beneficiaries in case of death, are not
taxable. However, amounts are taxable that are received under this Act as
"continuation of pay" for up to 45 days while a claim is being decided.
Also, pay for sick leave while a claim is being processed is taxable and
must be included in your income as wages.

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

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

Compensatory damages received for injury or illness (however, punitive damages
in cases not involving physical injury or sickness are taxable),

Benefits received under an accident or health insurance policy attributable
to premiums you paid,

Disability benefits received for loss of income or earning capacity as a
result of injuries under a "no-fault" automobile policy, and

Compensation received for permanent loss or loss of use of a part or function
of your body, or for your permanent disfigurement. This compensation must be
figured only on the injury and not on the period of your absence from work.
These benefits are exempt from tax even though your employer pays for the
accident and health plan that provides these benefits.

Reimbursement for medical care is generally not taxable. However, this
reimbursement may reduce your medical expense deduction. For more information,
see Chapter 22.

Scholarship and Fellowship Grants

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

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

1)  Tuition and fees to enroll at or attend an educational organization, or

2)  Fees, books, supplies, and equipment required for courses at the
    educational institution.

Amounts used for room and board do not qualify.

All payments you receive for services must be included in income, even if
the services are a condition of receiving the grant and are required of all
candidates for the degree. This includes amounts received for teaching and
research. Get Publication 520 for information on how to report the taxable
portion of scholarships and fellowship grants.

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

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 22, Form 1040, whether or not you use the
amounts for educational purposes.

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