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taxmap/pubs/p525-004.htm#TXMP5c178d9b Miscellaneous Income(p18)

Income, Miscellaneous

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

taxmap/pubs/p525-004.htm#TXMP0934dba6 Bartering(p18)

Bartering

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

Generally, you report this income on Schedule C or Schedule C-EZ (Form 1040). However, if the barter involves an exchange of something other than services, such as in Example 4 below, you may have to use another form or schedule instead.

taxmap/pubs/p525-004.htm#TXMP495ebeb1
Example 1.(p18)

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

taxmap/pubs/p525-004.htm#TXMP17ce7649
Example 2.(p18)

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

taxmap/pubs/p525-004.htm#TXMP4e9412d5
Example 3.(p18)

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

taxmap/pubs/p525-004.htm#TXMP01d58414
Example 4.(p18)

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

taxmap/pubs/p525-004.htm#TXMP01396f0f Form 1099-B from barter exchange.(p18)

If you exchanged property or services through a barter exchange, Form 1099-B, Proceeds from Broker and Barter Exchange Transactions, or a similar statement from the barter exchange should be sent to you by January 31, 2008. It should show the value of cash, property, services, credits, or scrip you received from exchanges during 2007. The IRS also will receive a copy of Form 1099-B.

taxmap/pubs/p525-004.htm#TXMP6608d3fc Backup withholding.(p18)

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

Under backup withholding, the barter exchange must withhold, as income tax, 28% of the income if:

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

If you join a barter exchange, you must certify under penalties of perjury that your taxpayer identification number is correct and that you are not subject to backup withholding. If you do not make this certification, backup withholding may begin immediately. The barter exchange will give you a Form W-9, Request for Taxpayer Identification Number and Certification, or a similar form, for you to make this certification. The barter exchange will withhold tax only up to the amount of any cash paid to you or deposited in your account and any scrip or credit issued to you (and converted to cash).

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

taxmap/pubs/p525-004.htm#TXMP3b98a9bf Canceled Debts(p18)

Debt Cancellation

Generally, if a debt you owe is canceled or forgiven, other than as a gift or bequest, you must include the canceled amount in your income. You have no income from the canceled debt if it is intended as a gift to you. A debt includes any indebtedness for which you are liable or which attaches to property you hold.

If the debt is a nonbusiness debt, report the canceled amount on Form 1040, line 21. If it is a business debt, report the amount on Schedule C or Schedule C-EZ (Form 1040) (or on Schedule F (Form 1040), Profit or Loss From Farming, if the debt is farm debt and you are a farmer).

taxmap/pubs/p525-004.htm#TXMP66c95ea7 Form 1099-C.(p18)

If a Federal Government agency, financial institution, or credit union cancels or forgives a debt you owe of $600 or more, you will receive a Form 1099-C, Cancellation of Debt. The amount of the canceled debt is shown in box 2.

taxmap/pubs/p525-004.htm#TXMP449a373b Interest included in canceled debt.(p18)

If any interest is forgiven and included in the amount of canceled debt in box 2, the amount of interest also will be shown in box 3. Whether or not you must include the interest portion of the canceled debt in your income depends on whether the interest would be deductible if you paid it. See Deductible debt under Exceptions, later.

If the interest would not be deductible (such as interest on a personal loan), include in your income the amount from Form 1099-C, box 2. If the interest would be deductible (such as on a business loan), include in your income the net amount of the canceled debt (the amount shown in box 2 less the interest amount shown in box 3).

taxmap/pubs/p525-004.htm#TXMP6fbec60b Discounted mortgage loan.(p18)

If your financial institution offers a discount for the early payment of your mortgage loan, the amount of the discount is canceled debt. You must include the canceled amount in your income.

taxmap/pubs/p525-004.htm#TXMP2eeac8cd Mortgage relief upon sale or other disposition.(p19)

If you are personally liable for a mortgage (recourse debt), and you are relieved of the mortgage when you dispose of the property, you may realize gain or loss up to the fair market value of the property. To the extent the mortgage discharge exceeds the fair market value of the property, it is income from discharge of indebtedness unless it qualifies for exclusion under Excluded debt, later. Report any income from discharge of indebtedness on nonbusiness debt that does not qualify for exclusion as other income on Form 1040, line 21.

If you are not personally liable for a mortgage (nonrecourse debt), and you are relieved of the mortgage when you dispose of the property (such as through foreclosure or repossession), that relief is included in the amount you realize. You may have a taxable gain if the amount you realize exceeds your adjusted basis in the property. Report any gain on nonbusiness property as a capital gain.

See Foreclosures and Repossessions in Publication 544 for more information.

taxmap/pubs/p525-004.htm#TXMP146db6fc Stockholder debt.(p19)

If you are a stockholder in a corporation and the corporation cancels or forgives your debt to it, the canceled debt is a constructive distribution that is generally dividend income to you. For more information, see Publication 542, Corporations.

If you are a stockholder in a corporation and you cancel a debt owed to you by the corporation, you generally do not realize income. This is because the canceled debt is considered as a contribution to the capital of the corporation equal to the amount of debt principal that you canceled.

taxmap/pubs/p525-004.htm#TXMP033710b8 Repayment of canceled debt.(p19)

If you included a canceled amount in your income and later pay the debt, you may be able to file a claim for refund for the year the amount was included in income. You can file a claim on Form 1040X if the statute of limitations for filing a claim is still open. The statute of limitations generally does not end until 3 years after the due date of your original return.

taxmap/pubs/p525-004.htm#TXMP4411fc99 Exceptions(p19)

There are several exceptions to the inclusion of canceled debt in income. These are explained next.

taxmap/pubs/p525-004.htm#TXMP63876a73 Student loans.(p19)

Certain student loans contain a provision that all or part of the debt incurred to attend the qualified educational institution will be canceled if you work for a certain period of time in certain professions for any of a broad class of employers.

You do not have income if your student loan is canceled after you agreed to this provision and then performed the services required. To qualify, the loan must have been made by:

1. The Federal Government, a state or local government, or an instrumentality, agency, or subdivision thereof,
2. A tax-exempt public benefit corporation that has assumed control of a state, county, or municipal hospital, and whose employees are considered public employees under state law, or
3. An educational institution:
   1. Under an agreement with an entity described in (1) or (2) that provided the funds to the institution to make the loan, or
   2. As part of a program of the institution designed to encourage students to serve in occupations or areas with unmet needs and under which the services provided are for or under the direction of a governmental unit or a tax-exempt section 501(c)(3) organization (defined later).

A loan to refinance a qualified student loan also will qualify if it was made by an educational institution or a tax-exempt section 501(a) organization under its program designed as described in (3)(b) above.

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

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

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

taxmap/pubs/p525-004.htm#TXMP78233ddb Exception.(p19)

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

taxmap/pubs/p525-004.htm#TXMP6fc7f748 Education loan repayment assistance.(p19)

Education loan repayments made to you by the National Health Service Corps Loan Repayment Program (NHSC Loan Repayment Program) or a state education loan repayment program eligible for funds under the Public Health Service Act are not taxable if you agree to provide primary health services in health professional shortage areas.

taxmap/pubs/p525-004.htm#TXMP53db4778 Deductible debt.(p19)

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

taxmap/pubs/p525-004.htm#TXMP482d9285 Price reduced after purchase.(p19)

Generally, if the seller reduces the amount of debt you owe for property you purchased, you do not have income from the reduction. The reduction of the debt is treated as a purchase price adjustment and reduces your basis in the property.

taxmap/pubs/p525-004.htm#TXMP4a0d6550 Excluded debt.(p19)

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

• The debt is canceled in a bankruptcy case under title 11 of the U.S. Code. See Publication 908, Bankruptcy Tax Guide.
• The debt is canceled when you are insolvent. However, you cannot exclude any amount of canceled debt that is more than the amount by which you are insolvent. See Publication 908.
• The debt is qualified farm debt and is canceled by a qualified person. See chapter 3 of Publication 225, Farmer's Tax Guide.
• The debt is qualified real property business debt. See chapter 5 of Publication 334.
• The cancellation is intended as a gift.

taxmap/pubs/p525-004.htm#TXMP0070ae5e Host or Hostess(p19)

If you host a party at which sales are made, any gift you receive for giving the party is a payment for helping a direct seller make sales. You must report it as income at its fair market value.

Your out-of-pocket party expenses are subject to the 50% limit for meal and entertainment expenses. These expenses are deductible as miscellaneous itemized deductions subject to the 2% of AGI limit on Schedule A (Form 1040), but only up to the amount of income you receive for giving the party.

For more information about the 50% limit for meal and entertainment expenses, see 50% Limit in Publication 463.

taxmap/pubs/p525-004.htm#TXMP0a6bf9e4 Life Insurance Proceeds(p19)

Life Insurance Proceeds

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

taxmap/pubs/p525-004.htm#TXMP44f63854 Proceeds not received in installments.(p19)

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

taxmap/pubs/p525-004.htm#TXMP190543f4 Proceeds received in installments.(p19)

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

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

taxmap/pubs/p525-004.htm#TXMP294c2bc0
Example.(p19)

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

taxmap/pubs/p525-004.htm#TXMP47eba2c4 Installments for life.(p19)

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

taxmap/pubs/p525-004.htm#TXMP12b0762e Surviving spouse.(p20)

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

taxmap/pubs/p525-004.htm#TXMP4dbc69f5 Employer-owned life insurance contract.(p20)

If you are the policyholder of an employer-owned life insurance contract, you must include in income any life insurance proceeds received that are more than the premiums and any other amounts you paid on the policy. You are subject to this rule if you have a trade or business, you own a life insurance contract on the life of your employee, and you (or a related person) are a beneficiary under the contract.

However, you may exclude the full amount of the life insurance proceeds if the following apply.

1. You provided written notice about the insurance to the employee and the employee agreed to be insured.
2. Either:
   1. The employee was your employee within the 12-month period before death, or, at the time the contract was issued, was a director or highly compensated employee, or
   2. The amount is paid to the family or designated beneficiary of the employee.

taxmap/pubs/p525-004.htm#TXMP3b2b0306 Interest option on insurance.(p20)

If an insurance company pays you interest only on proceeds from life insurance left on deposit, 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.

taxmap/pubs/p525-004.htm#TXMP0affb4f0 Surrender of policy for cash.(p20)

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

You should receive a Form 1099-R showing the total proceeds and the taxable part. Report these amounts on lines 16a and 16b of Form 1040 or on lines 12a and 12b of Form 1040A.

For information on when the proceeds are excluded from income, see Accelerated Death Benefits, later.

taxmap/pubs/p525-004.htm#TXMP4ca433b0 Split-dollar life insurance.(p20)

Generally, a split-dollar life insurance arrangement is an arrangement between an owner and a non-owner of a life insurance contract under which either party to the arrangement pays all or part of the premiums, and one of the parties paying the premiums is entitled to recover all or part of those premiums from the proceeds of the contract. There are two mutually exclusive regimes to tax split-dollar life insurance arrangements.

1. Under the economic benefit regime, the owner of the life insurance contract is treated as providing current life insurance protection and other taxable economic benefits to the non-owner of the contract.
2. Under the loan regime, the non-owner of the life insurance contract is treated as loaning premium payments to the owner of the contract.

Only one of these regimes applies to any one policy. For more information, see sections 1.61-22 and 1.7872-15 of the regulations.

taxmap/pubs/p525-004.htm#TXMP12ff58b0 Endowment Contract Proceeds(p20)

Endowment Contract Proceeds

An endowment contract is a policy under which you are paid a specified amount of money on a certain date unless you die before that date, in which case, the money is paid to your designated beneficiary. Endowment proceeds paid in a lump sum to you at maturity are taxable only if the proceeds are more than the cost of the policy. To determine your cost, subtract any amount that you previously received under the contract and excluded from your income from the total premiums (or other consideration) paid for the contract. Include the part of the lump sum payment that is more than your cost in your income.

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

taxmap/pubs/p525-004.htm#TXMP1deaa089 Accelerated Death Benefits(p20)

Accelerated Death Benefits

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

taxmap/pubs/p525-004.htm#TXMP11dbd36b Viatical settlement.(p20)

This is the sale or assignment of any part of the death benefit under a life insurance contract to a viatical settlement provider. A viatical settlement provider is a person who regularly engages in the business of buying or taking assignment of life insurance contracts on the lives of insured individuals who are terminally or chronically ill and who meets the requirements of section 101(g)(2)(B) of the Internal Revenue Code.

taxmap/pubs/p525-004.htm#TXMP4162946f Exclusion for terminal illness.(p20)

Accelerated death benefits are fully excludable if the insured is a terminally ill individual. This is a person who has been certified by a physician as having an illness or physical condition that can reasonably be expected to result in death within 24 months from the date of the certification.

taxmap/pubs/p525-004.htm#TXMP44c80381 Exclusion for chronic illness.(p20)

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

taxmap/pubs/p525-004.htm#TXMP380f24ac Exception.(p20)

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

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

taxmap/pubs/p525-004.htm#TXMP7da167c0 Form 8853.(p20)

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

taxmap/pubs/p525-004.htm#TXMP6cdb4b56 Recoveries(p20)

Recovery

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

taxmap/pubs/p525-004.htm#TXMP6d1358e8 Tax benefit rule.(p20)

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

taxmap/pubs/p525-004.htm#TXMP7fca1390 Federal income tax refund.(p20)

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

taxmap/pubs/p525-004.htm#TXMP795d8d13 State tax refund.(p20)

If you received a state or local income tax refund (or credit or offset) in 2007, 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 January 31, 2008. The IRS also will receive a copy of the Form 1099-G. Use the worksheet in the 2007 Form 1040 instructions for line 10 to figure the amount (if any) to include in your income. See Itemized Deduction Recoveries, later, for when you must use Worksheet 2 on page 23 of this publication.

After 2003, you could choose to deduct for a tax year either:

• State and local income taxes, or
• State and local general sales taxes.

For 2007, the maximum refund that you may have to include in income is limited to the excess of the tax you chose to deduct for that year over the tax you did not choose to deduct for that year.

taxmap/pubs/p525-004.htm#TXMP5d08e2df Example 1.(p21)

For 2006 you can choose an $11,000 state income tax deduction or a $10,000 state general sales tax deduction. You choose to deduct the state income tax. In 2007 you receive a $2,500 state income tax refund. The maximum refund that you may have to include in income is $1,000, since you could have deducted $10,000 in state general sales tax.

taxmap/pubs/p525-004.htm#TXMP4dadaa9b Example 2.(p21)

For 2006 you can choose an $11,500 state general sales tax deduction based on actual expenses or an $11,200 state income tax deduction. You choose to deduct the general sales tax deduction. In 2007 you return an item you had purchased and receive a $500 sales tax refund. In 2007 you also receive a $1,500 state income tax refund. The maximum refund that you may have to include in income is $500, since it is less than the excess of the tax deducted ($11,500) over the tax you did not choose to deduct ($11,200 − $1,500 = $9,700). Since you did not choose to deduct the state income tax, you do not include the state income tax refund in income.

taxmap/pubs/p525-004.htm#TXMP1dddf51b Mortgage interest refund.(p21)

If you received a refund or credit in 2007 of mortgage interest paid in an earlier year, the amount should be shown in box 3 of your Form 1098, Mortgage Interest Statement. Do not subtract the refund amount from the interest you paid in 2007. You may have to include it in your income under the rules explained in the following discussions.

taxmap/pubs/p525-004.htm#TXMP15210453 Interest on recovery.(p21)

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

taxmap/pubs/p525-004.htm#TXMP56721de7 Recovery and expense in same year.(p21)

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

taxmap/pubs/p525-004.htm#TXMP0e0a8e46 Recovery for 2 or more years.(p21)

If you receive a refund or other recovery that is for amounts you paid in 2 or more separate years, you must allocate, on a pro rata basis, the recovered amount between the years in which you paid it. This allocation is necessary to determine the amount of recovery from any earlier years and to determine the amount, if any, of your allowable deduction for this item for the current year.

taxmap/pubs/p525-004.htm#TXMP50d444f6
Example.(p21)

You paid 2006 estimated state income tax of $4,000 in four equal payments. You made your fourth payment in January 2007. You had no state income tax withheld during 2006. In 2007, you received a $400 tax refund based on your 2006 state income tax return. You claimed itemized deductions each year on your federal income tax return.

You must allocate the $400 refund between 2006 and 2007, the years in which you paid the tax on which the refund is based. You paid 75% ($3,000 ÷ $4,000) of the estimated tax in 2006, so 75% of the $400 refund, or $300, is for amounts you paid in 2006 and is a recovery item. If all of the $300 is a taxable recovery item, you will include $300 on Form 1040, line 10, for 2007, and attach a copy of your computation showing why that amount is less than the amount shown on the Form 1099-G you received from the state.

The balance ($100) of the $400 refund is for your January 2007 estimated tax payment. When you figure your deduction for state and local income taxes paid during 2007, you will reduce the $1,000 paid in January by $100. Your deduction for state and local income taxes paid during 2007 will include the January net amount of $900 ($1,000 − $100), plus any estimated state income taxes paid in 2007 for 2007, and any state income tax withheld during 2007.

taxmap/pubs/p525-004.htm#TXMP09d790ba Deductions not itemized.(p21)

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

taxmap/pubs/p525-004.htm#TXMP689366bc
Example.(p21)

You claimed the standard deduction on your 2006 federal income tax return. In 2007 you received a refund of your 2006 state income tax. Do not report any of the refund as income because you did not itemize deductions for 2006.

taxmap/pubs/p525-004.htm#TXMP2f92325b Itemized Deduction Recoveries(p21)

Itemized Deduction, Recovery

The following discussion explains how to determine the amount to include in your income from a recovery of an amount deducted in an earlier year as an itemized deduction. However, you generally do not need to use this discussion if the recovery is for state or local income taxes paid in 2006. Instead, use the worksheet in the 2007 Form 1040 instructions for line 10 to figure the amount (if any) to include in your income.

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

1. The recovery is for a tax year other than 2006.
2. The recovery is for a deducted item other than state or local income taxes, such as a general sales tax or real property tax refund.
3. On your 2006 Form 1040, line 42 was more than line 41.
4. You received a refund of state and local income taxes in 2007 that was more than the excess of your 2006 state and local income tax deduction over the amount you could have deducted for your 2006 state and local general sales tax.
5. You made your last payment of 2006 state or local estimated tax in 2007.
6. You owed alternative minimum tax for 2006.
7. You could not deduct all your tax credits for 2006 because their total was more than the amount of tax shown on your 2006 Form 1040, line 46.
8. You could be claimed as a dependent by someone else in 2006.
9. You had to use the Itemized Deductions Worksheet in the 2006 Schedule A instructions because your 2006 adjusted gross income was over $150,500 ($75,250 if married filing separately) and both of the following apply.
   1. You could not deduct all of the amount on the 2006 Itemized Deductions Worksheet, line 1.
   2. The amount on line 8 of that 2006 worksheet would be more than the amount on line 4 of that worksheet if the amount on line 4 were reduced by 80% of the refund you received in 2007.

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

taxmap/pubs/p525-004.htm#TXMP77f499ca Total recovery included in income.(p21)

If you recover any amount that you deducted in an earlier year on Schedule A (Form 1040), you generally must include the full amount of the recovery in your income in the year you receive it. This rule applies if, for the earlier year, all of the following statements are true.

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

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

taxmap/pubs/p525-004.htm#TXMP6934246f State tax refund.(p21)

In addition to the previous six items, you must include in your income the full amount of a refund of state or local income tax or general sales tax if the excess of the tax you deducted over the tax you did not deduct is more than the refund of the tax deducted.

If the refund is more than the excess, see Total recovery not included in income, later.

taxmap/pubs/p525-004.htm#TXMP1ed9dde4 Where to report.(p22)

Enter your state or local income tax refund on Form 1040, line 10, and the total of all other recoveries as other income on Form 1040, line 21. You cannot use Form 1040A or Form 1040EZ.

taxmap/pubs/p525-004.htm#TXMP12bba58c
Example.(p22)

For 2006, you filed a joint return. Your taxable income was $60,000 and you were not entitled to any tax credits. Your standard deduction was $10,300, and you had itemized deductions of $12,000. In 2007, you received the following recoveries for amounts deducted on your 2006 return:

Medical expenses	$200
State and local income tax refund	400
Refund of mortgage interest	325
Total recoveries	$925

None of the recoveries were more than the deductions taken for 2006. The difference between the state and local income tax you deducted and your local general sales tax was more than $400.

Your total recoveries are less than the amount by which your itemized deductions exceeded the standard deduction ($12,000 − $10,300 = $1,700), so you must include your total recoveries in your income for 2007. Report the state and local income tax refund of $400 on Form 1040, line 10, and the balance of your recoveries, $525, on Form 1040, line 21.

taxmap/pubs/p525-004.htm#TXMP0181f79e Total recovery not included in income.(p22)

If one or more of the six statements listed in the preceding discussion is not true, you may be able to exclude at least part of the recovery from your income. If statements (4), (5), and (6) are true (your itemized deductions were not limited, you had no unused tax credits, and you were not subject to the alternative minimum tax), you can use Worksheet 2 on the next page to determine the part of your recovery to include in your income. You also can use Worksheet 2 to determine the part of a state tax refund (discussed earlier) to include in income.

taxmap/pubs/p525-004.htm#TXMP151752d9 Allocating the included part.(p22)

If you are not required to include all of your recoveries in your income, and you have both a state income tax refund and other itemized deduction recoveries, you must allocate the taxable recoveries between the state income tax refund you report on Form 1040, line 10, and the amount you report as other income on Form 1040, line 21. If you do not use Worksheet 2, make the allocation as follows.

1. Divide your state income tax refund by the total of all your itemized deduction recoveries.
2. Multiply the amount of taxable recoveries by the percentage in (1). This is the amount you report as a state income tax refund.
3. Subtract the result in (2) above from the amount of taxable recoveries. This is the amount you report as other income.

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Example.(p22)

In 2007 you recovered $2,500 of your 2006 itemized deductions, but the recoveries you must include in your 2007 income are only $1,500. Of the $2,500 you recovered, $500 was due to your state income tax refund. Your state income tax was more than your state general sales tax by $600. The amount you report as a state tax refund on Form 1040, line 10, is $300 [($500 ÷ $2,500) × $1,500]. The balance of the taxable recoveries, $1,200, is reported as other income on Form 1040, line 21.

taxmap/pubs/p525-004.htm#TXMP1360c335 Standard deduction limit.(p22)

You generally are allowed to claim the standard deduction if you do not itemize your deductions. Only your itemized deductions that are more than your standard deduction are subject to the recovery rule (unless you are required to itemize your deductions). If your total deductions on the earlier year return were not more than your income for that year, include in your income this year the lesser of:

• Your recoveries, or
• The amount by which your itemized deductions exceeded the standard deduction.

taxmap/pubs/p525-004.htm#w15047d03

Table 3. 2005 Standard Deduction Tables m m m Caution: If you are married filing a separate return and your spouse itemizes deductions, or if you are a dual-status alien, you cannot take the standard deduction even if you were born before January 2, 1941, or you are blind. Table I. Standard Deduction Chart for Most People* IF your filing status is . . . THEN your standard deduction is . . . Single or Married filing separately $5,000 Married filing joint return or Qualifying widow(er) with dependent child 10,000 Head of household n7,300 * DO NOT use this chart if you were born before January 2, 1941, or you are blind, OR if someone else can claim an exemption for you (or your spouse if married filing jointly). Use Table II or III instead. Table II. Standard Deduction Chart for People Who Were Born Before January 2, 1941, or Were Blind* Check the correct number of boxes below. Then go to the chart.       You Born before January 2, 1941m Blind m Your spouse, if claiming spouse's exemption Born before January 2, 1941m Blind m       Total number of boxes you checked mm_____ IF your filing status is . . . AND the number on the line above is . . . THEN your standard deduction is . . . Single 1 2 $n6,250 nn7,500 Married filing joint return or Qualifying widow(er) with dependent child 1 2 3 4 n11,000 n12,000 n13,000 n14,000 Married filing separate return 1 2 3 4 nn6,000 nn7,000 nn8,000 nn9,000 Head of household 1 2 nn8,550 nn9,800 *If someone else can claim an exemption for you (or your spouse if married filing jointly), use Table III instead. Table III. Standard Deduction Worksheet for Dependents* If you were born before January 2, 1941, or you were blind, check the correct number of boxes below. Then go to the worksheet.               You Born before January 2, 1941m   Blind m Your spouse, if claiming spouse's exemption Born before January 2, 1941m   Blind m                   Total number of boxes you checked mm____ 1.   Enter your earned income (defined below). If none, enter -0- 1.              2.   Additional amount 2. $250 3.   Add lines 1 and 2 3.              4.   Minimum standard deduction 4. $800 5.   Enter the larger of line 3 or line 4 5.              6.   Enter the amount shown below for your filing status. Single or Married filing separately—$5,000 Married filing jointly—$10,000 Head of household—$7,300 6.              7. Standard deduction.       a. Enter the smaller of line 5 or line 6. If born after January 1, 1941, and not blind, stop here. This is your standard deduction. Otherwise, go on to line 7b. 7a.                b. If born before January 2, 1941, or blind, multiply $1,250 ($1,000 if married) by the number in the box above. 7b.                c. Add lines 7a and 7b. This is your standard deduction for 2005. 7c.              Earned income includes wages, salaries, tips, professional fees, and other compensation received for personal services you performed. It also includes any amount received as a scholarship that you must include in your income. *Use this worksheet ONLY if someone else can claim an exemption for you (or your spouse if married filing jointly).

taxmap/pubs/p525-004.htm#w15047d05

Table 2. 2006 Standard Deduction Tables m m m Caution: If you are married filing a separate return and your spouse itemizes deductions, or if you are a dual-status alien, you cannot take the standard deduction even if you were born before January 2, 1942, or you are blind. Table I. Standard Deduction Chart for Most People* IF your filing status is . . . THEN your standard deduction is . . . Single or Married filing separately $5,150 Married filing joint return or Qualifying widow(er) with dependent child 10,300 Head of household n7,550 * DO NOT use this chart if you were born before January 2, 1942, or you are blind, OR if someone else can claim an exemption for you (or your spouse if married filing jointly). Use Table II or III instead. Table II. Standard Deduction Chart for People Who Were Born Before January 2, 1942, or Were Blind* Check the correct number of boxes below. Then go to the chart.       You Born before January 2, 1942m Blind m Your spouse, if claiming spouse's exemption Born before January 2, 1942m Blind m       Total number of boxes you checked mm____ IF your filing status is . . . AND the number on the line above is . . . THEN your standard deduction is . . . Single 1 2 $n6,400 nn7,650 Married filing joint return or Qualifying widow(er) with dependent child 1 2 3 4 n11,300 n12,300 n13,300 n14,300 Married filing separate return 1 2 3 4 nn6,150 nn7,150 nn8,150 nn9,150 Head of household 1 2 nn8,800 n10,050 *If someone else can claim an exemption for you (or your spouse if married filing jointly), use Table III instead. Table III. Standard Deduction Worksheet for Dependents* If you were born before January 2, 1942, or you were blind, check the correct number of boxes below. Then go to the worksheet.               You Born before January 2, 1942 m   Blind m Your spouse, if claiming spouse's exemption Born before January 2, 1942 m   Blind m                   Total number of boxes you checked mm____ 1.   Enter your earned income (defined below). If none, enter -0- 1.              2.   Additional amount 2. $300 3.   Add lines 1 and 2 3.              4.