Income – Wages, Interest, Etc.
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Income – Wages, Interest, Etc.
Introduction
This is the rst of nine lessons covering the Income section of the
taxpayer’s return. A critical component of completing the taxpayer’s return
is distinguishing between taxable and nontaxable income and knowing
where to report the dierent types of income on Form 1040.
What do I need?
□ Form 13614-C
□ Publication 4012
□ Publication 17
Optional:
□ Form 1040 Instructions
□ Form 1099-PATR
□ Schedule B
□ Publication 531
□ Publication 550
□ Publication 926
□ Publication 970
Objectives
At the end of this lesson, using your resource materials, you will be able to:
• Compute taxable and nontaxable income
• Distinguish between earned and unearned income
• Report income correctly on Form 1040
The following chart will help you select the appropriate topic for your
certication course.
Certication Course
Basic Advanced Military International
Wages & Reported Tips
Unreported Tip Income
Scholarship and Fellowship Income
Interest Income
Dividend Income
Taxable Refunds
Alimony Received
Business Income
Capital Gain/Loss
Other Gains/Losses N/A N/A N/A N/A
IRA Distributions*
Pensions/Annuities*
Rental Income
Schedule K-1 Distributions
Farm Income N/A N/A N/A N/A
Unemployment Compensation
Social Security Benets
Other Income
Foreign Earned Income
Military Income
*Basic only if the taxable amount is already determined.
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How do I determine taxable and nontaxable income?
The Income Quick Reference Guide in the Volunteer Resource Guide, Tab D, Income, includes examples of
taxable and nontaxable income.
Gross income is all income received in the form of money, goods, property, and services that is not exempt
from tax. It includes income from sources outside the U.S. or from the sale of a primary residence, even
if part or all of that income can be excluded. Gross income may include part of Social Security benets
received and certain scholarship and fellowship grants.
• Income that is taxable must be reported on a taxpayer’s return and is subject to tax.
• Income that is nontaxable may have to be shown on a taxpayer’s return but is exempt from tax.
What are types of taxable income?
Form 1040 and its associated schedules are used to report earned and unearned taxable income.
• Earned income – any income received for work, such as wages or business/self-employment income
• Unearned income – any income not earned from work, such as unemployment income or income
produced by investments, such as interest on savings, dividends on stocks, or rental income
What are examples of nontaxable or exempt income?
Some nontaxable income such as gifts and inheritances are excludable and not shown on the return.
Exempt income includes such things as interest income produced from certain types of investments.
There are some instances when exempt income is shown on the return but not included in the income tax
computation, for example, tax-exempt municipal bond interest income.
Under the Victims of Terrorism Tax Relief Act of 2001, the following amounts are not included in income:
• Certain disability payments received in tax years ending after September 10, 2001, for injuries
sustained in a terrorist attack
• Payments from the September 11th Victim Compensation Fund of 2001
• Qualied disaster relief payments made after September 10, 2001, to cover personal, family, living, or
funeral expenses incurred because of a terrorist attack
• Death benets paid by an employer to the survivor of an employee if the benets are paid because the
employee died as a result of a terrorist attack
The Act also provides that the federal income tax liability of those who died as a result of the following
attacks is forgiven for certain tax years:
• The September 11, 2001 attacks on the World Trade Center, the Pentagon, and United Airlines Flight
93 in Somerset County, Pennsylvania
• Terrorist attacks involving anthrax occurring after September 10, 2001, and before January 1, 2002
• The April 19, 1995 attack on the Alfred P. Murrah Federal Building
For additional details, see Publication 3920, Tax Relief for Victims of Terrorist Attacks.
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How do I get started?
To determine a taxpayer’s income, discuss and review the Income section of the intake and interview sheet
with the taxpayer.
Income is reported on a variety of forms depending on its source. Ask taxpayers to show you all Forms W-2,
Forms 1099, and other statements reporting income. Also ask taxpayers if they received income that was
not reported on a tax form, such as odd jobs or tips from customers. (Do not confuse Form 1099 with Form
1098. Generally, Form 1098 reports expenses the taxpayers have paid, not income they have received.)
Tax Software Hint: After you have collected all the income statements, review the pages on income
documents and How/Where to Enter Income in the Volunteer Resource Guide, Tab D, Income. These pages
will show you where to correctly report income items.
Taxpayers who can check no to the virtual currency question on Form 1040 are in scope. Taxpayers are
instructed to check no if they held no virtual currency for the year or if the taxpayer’s only transactions involving virtual
currency during the year were purchases of virtual currency with real currency. Identify these situations as early in the
interview as possible.
How do I report wages, salaries, tips, etc.?
What is Form W-2?
Employers must report wages and other employee compensation on Form W-2. Employers are not required
to mail Forms W-2, but they must make them available to employees by January 31. Employees may need
to pick up Form W-2 from their employers or obtain it electronically. Most employers issue a standardized
version of Form W-2, Wage and Tax Statement. Go to https://www.irs.gov to view Form W-2.
Additional Medicare Tax applies to an individual’s wages, Railroad Retirement Tax Act compensation, and self-
employment income that exceeds a threshold amount based on the individual’s ling status. This topic is out of scope
for the VITA/TCE programs. Taxpayers aected by the Additional Medicare Tax should be referred to a professional
tax preparer. Additional information can be found on
https://www.irs.gov
A Form W-2 with code Q in Box 12, indicating combat pay, requires Military certication to complete the return.
Tax Software Hint: Refer to the Volunteer Resource Guide, Tab D, Income, for instructions on
entering income. Once you enter all Forms W-2 into the software, it carries the total to Form 1040 and
transfers necessary information for credits, deductions, withholding, etc., to other sections of the tax return.
What if the taxpayer does not receive Form W-2 by January 31?
Taxpayers who do not receive Form W-2 by January 31 should rst contact the employer and nd out if, or
when, the form was mailed, or if it can be picked up or accessed online.
If Form W-2 is still not received after allowing a reasonable amount of time for the employer to issue or reissue
it, then the taxpayer should contact the IRS for assistance after February 15.
If taxpayers do not receive Form W-2 before the ling deadline, they should le their tax return with Form
4852, Substitute for Form W-2, Wage and Tax Statement, or Form 1099-R, Distributions From Pensions,
Annuities, Retirement or Prot-Sharing Plans, IRAs, Insurance Contracts, etc. Taxpayers will need to
provide the information required to complete Form 4852, such as the last paycheck stub. Taxpayers should
keep a copy of Form 4852 for their records. Your site coordinator may need to determine whether Form
4852 can be led with a state return as well.
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If the taxpayer eventually receives the employer’s Form W-2, and the numbers dier from those on Form 4852,
the taxpayer will need to amend the return to report the correct amounts.
If the earnings reported on Form 4852 are not reected on the taxpayer’s Social Security Statement, the
taxpayer should contact the Social Security Administration at the number shown on the statement. See
Publication 5396-A: Job Aid for VITA/TCE Volunteers: Using Form 4852 when Missing the Form W-2 or
1099-R (PDF) for help completing the form.
What if the taxpayer has an ITIN, but a Form W-2 is showing a dierent SSN?
Use the taxpayer’s ITIN when starting the return. Enter the Social Security number as shown on the Form
W-2 when prompted by the tax software. Refer to the Volunteer Resource Guide, Tab D, Income, for
instructions.
What is Box 10, Dependent Care Benets?
Box 10 is used by employers to report dependent care benets paid to the taxpayer or incurred on behalf
of the taxpayer. Complete Form 2441, Child and Dependent Care Expenses, to determine if any part of this
benet is taxable to the taxpayer and the allowable amount of dependent care credit. Some employer plans
provide a carryover or forfeiture of benets that are not used by year end. This may require part III of Form
2441 to be completed.
What do Box 12 codes mean?
There are numerous code letters that the employer can use to designate certain items, such as employee
contributions to the company retirement plan. Refer to the list of codes in the Volunteer Resource Guide,
Tab D, Income.
The tax software will automatically transfer qualied voluntary retirement contributions to Form 8880, Credit
for Qualied Retirement Savings Contributions, for the retirement savings credit. Refer to the Volunteer
Resource Guide, Tab G, Nonrefundable Credits, for instructions on how to enter these amounts. Also see
the Miscellaneous Credits lesson.
Code FF in Box 12 of a Form W-2 indicates a Qualied Small Employer Health Reimbursement Arrangement
(QSEHRA) and is out of scope for the VITA/TCE programs.
Other W-2 Income
Can a disability pension be treated as wages?
An individual who has not reached their employer’s minimum retirement age and is receiving a disability
pension may report the disability pension as wages for tax purposes, such as the earned income credit.
This is discussed in the Retirement Income lesson.
What about income received by household employees?
The term “household employee” refers to an individual who works in someone’s home performing
household duties such as caring for children, cleaning, or cooking. Generally, an employer is not required to
provide Form W-2 to a household employee who earns less than the threshold amount for that year.
example
During the tax year, Tina earned income from both a full-time and a part-time job. She received two
Forms W-2, each listing dierent employers. Her return will list her wages as the total of the amounts
in Box 1, but each Form W-2 must be entered into the tax software separately.
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In this situation, neither the employer nor the employee will owe Social Security or Medicare tax on those
wages. However, employers who withhold federal income taxes from their employee’s wages must issue
Form W-2. Regardless of whether Form W-2 is issued, the income must be included on Form 1040.
For further information and a denition of who is a household employee, see Publication 926, Household
Employer’s Tax Guide.
What about Qualied Medicaid Waiver Payments?
Qualied Medicaid waiver payments, as dened in IRS Notice 2014-7, may be excluded from gross income.
Qualied Medicaid waiver payments may be excluded from gross income only when the care provider
and the care recipient reside in the same home. When the care provider and the care recipient do not live
together in the same home, the Medicaid waiver payments may not be excluded from gross income.
A taxpayer may choose to include qualied Medicaid waiver payments in the calculation of earned income
for the Earned Income Credit (EIC) and Additional Child Tax Credit (ACTC). The taxpayer may include
qualied Medicaid waiver payments in earned income even if the taxpayer chooses to exclude those
payments from gross income.
• A taxpayer may not choose to include or exclude only a portion of qualied Medicaid waiver payments.
Either include all or none of the qualied Medicaid waiver payments for the taxable year in earned
income.
• If the taxpayer chooses to include qualied Medicaid waiver payments in earned income, that amount
will be included in the calculation for both the EIC and the ACTC.
Taxpayers who excluded qualied Medicaid waiver payments from gross income in prior tax years may
amend a return for any open tax years to include Medicaid waiver payments in earned income for the EIC
and ACTC.
For more information, refer to the Volunteer Resource Guide, Tab D, Income, Entering Medicaid Waiver
Payments.
Tip Income
Self-employed taxpayers who receive tips, such as hair stylists and manicurists, should include their tips in
gross receipts on Schedule C.
If taxpayers have jobs in which tips are normally received (e.g., waiter/waitress, bellhop, or motel/hotel
housekeeper), be sure to ask about any tips they may have received. All tip income is taxable, whether or
not it is reported to the employer.
If individuals receive more than $20 per month in tips at one job and report their tip income to their
employer, the tips will be included in Boxes 1 and 7 on Form W-2.
What are allocated tips?
To ensure that everyone reports their fair share of income from tips, some employers have tip allocation
programs. These programs are approved by the IRS. If an employee reports tips to the employer that were
less than the designated share based on the employer’s formula, the employer reports the dierence as
“allocated tips” and includes it on the employee’s Form W-2.
Allocated tips are shown separately in Form W-2, Box 8. Social Security and Medicare taxes are not
withheld on allocated tips. Allocated tips are not included in the amount in Form W-2, Box 1. Explain to
the taxpayers that unless they kept a written and reliable record of tips actually received at that job, the
allocated tips must be included in Form 1040 as wages.
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Tax Software Hint: When allocated tips are reported on Form W-2, the software automatically adds
them to Form 1040 and also completes Form 4137, Social Security and Medicare Tax on Unreported Tip
Income. Refer to the Volunteer Resource Guide for instructions to enter the taxpayer’s actual amount of tips
according to their tip log.
What about unreported tips?
An individual is not required to report tip income to their employer if it is $20 or less per month. Since these
tips are subject to federal income tax, ask taxpayers if they have any tip income that was not reported to
their employer.
Other Tips
• Noncash tips (e.g., tickets or passes) do not have to be reported to the employer, but must be included
as taxable income at their fair market value.
• Tips of less than $20 per month or noncash tips are not subject to Social Security and Medicare taxes.
• If tips of more than $20 a month were not reported to the employer, the taxpayer must also pay Social
Security and Medicare taxes. Complete Form 4137 if the taxpayer received tips that were not reported
to the employer. This form calculates the appropriate income, Social Security, and Medicare taxes.
Tax Software Hint: If the taxpayer has unreported tip income, enter the income on Form W-2,
unreported tip income box. This will initiate Form 4137. Refer to the Volunteer Resource Guide, Tab D,
Income, for instructions on how to enter tip income.
For more information about tip income, see Publication 531, Reporting Tip Income.
What is penal income (or prisoner income)?
An individual may be compensated while in a penal institution, a work-release program, or in a halfway
house. The compensation will be reported on Form W-2 but it is not treated as earned income for most tax
benets, such as the earned income credit. The amount is reported as wages on Form 1040 and is shown
as “PRI” on the dotted line next to the wages line. Refer to the Volunteer Resource Guide, Tab D, Income,
for instructions on how to identify and enter penal income, also known as prisoner income.
Scholarship and Fellowship Income (Form W-2 and Form 1098-T)
Are scholarships and fellowships taxable income?
Scholarships and fellowships may be fully or partially taxable, or nontaxable. Taxable amounts include:
• Payment for services
• Money used for personal living expenses, such as room and board
If the taxpayer received Form W-2 for the scholarship or fellowship it is considered earned income. Include
the amount on Form 1040 as wages just as you would any other Form W-2.
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Form 1098-T lists qualied tuition and related expenses paid to the school. Verify that these amounts have
been paid by reviewing the student’s detailed nancial account transcript which lists scholarship and grant
money the student received. If scholarships or grants exceed the qualied educational costs, some of the
grant or scholarship may be taxable.
In certain situations, the student may choose to include all or part of certain scholarships or grants in
income in order to increase an education credit. This is explained in the education credits lesson, and
examples can be found in the Form 8863 Instructions and Publication 970, Tax Benets for Education.
Tax Software Hint: Taxable scholarships are entered into the software in the Income>Less Common
Income>Other compensation> Scholarships and Grants section, but are shown as part of Wages on the tax
return with “SCH” printed on the line. Refer to the Volunteer Resource Guide for specic entries.
What about higher education emergency nancial aid grants?
Emergency nancial aid grants under the CARES Act for unexpected expenses, unmet nancial need,
or expenses related to the disruption of campus operations due to the COVID-19 pandemic, such as
unexpected expenses for food, housing, course materials, technology, health care, or childcare, are
qualied disaster relief payments under section 139 of the Internal Revenue Code. This grant is not
includible in gross income.
What about loan repayment assistance programs (LRAPs) for health care professionals?
Education loan repayments are not taxable if they are made to taxpayers by:
• The National Health Service Corps Loan Repayment Program
• A state education loan repayment program eligible for funds under the Public Health Service Act, or
• Any other state loan repayment or loan forgiveness program that promotes increased availability of
health professionals/services in underserved areas
The taxpayer should not receive a tax form because the amount is not taxable. If there is any question, the
taxpayer should contact the repayment agency.
What about ministers or other members of the clergy?
The ministry profession presents unique issues, such as the parsonage/housing allowance, whether
earnings are covered under FICA or SECA (self employment tax), and the rules for being exempt.
Publication 517, Social Security and Other Information for Members of the Clergy and Religious Workers,
covers this topic. This information is provided for awareness only and is out of scope for the VITA/TCE
programs. Taxpayers who have these issues should be referred to a professional tax preparer.
What interest is taxable?
Common sources of taxable interest income are checking and savings accounts, certicates of deposit
(CDs), savings certicates, U.S. government bonds, interest on insurance proceeds, and loans that
the taxpayer makes to others. Some savings and loans, credit unions, and banks call their distributions
“dividends.” These distributions are really interest and are reported correctly as interest on Form 1099-INT.
If a taxpayer received less than $10 in interest, the nancial institution might not issue Form 1099-INT. Even
if the taxpayer did not receive Form 1099-INT, they must still report all of their taxable interest income. The interest
amount for the year will typically be shown on the December statement.
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If the FATCA (Foreign Account Tax Compliance Act) ling requirement box is checked on Forms 1099-INT,
1099-DIV, or any other income reporting document, the taxpayer may have a FATCA ling requirement. Refer these
taxpayers to a professional tax preparer.
Where do I get interest income information?
There are many sources of information about interest income. Ask the taxpayer to supply all Form(s) 1099-
INT from institutions that pay interest. Some institutions issue a year-end summary statement with the title
“In lieu of Form 1099-INT or Form 1099-DIV” rather than preparing multiple documents for each account.
Original Issue Discount (OID) is a form of interest income. A debt instrument generally has OID when issued
for an amount that is less than its stated redemption price at maturity. The issuer of the debt instrument will
report the amount of OID that is currently taxable on Form 1099-OID, Original Issue Discount, or a similar
statement.
Entries in Boxes 10,11,12 and 13 of Form 1099-INT, and Boxes 5 and 10 of Form 1099-OID are in scope.
Enter the information just as it appears on the information reporting documents (type what you see) and
TaxSlayer software will complete the calculations.
If the amount reported in Box 11 exceeds the amount reported in Box 1, the return is out of scope.
If the amount reported in Box 12 exceeds the amount reported in Box 3, or if the amount reported in Box 13 exceeds
the amount reported in Box 8, the return is also out of scope.
If the taxpayers cashed in Series EE or Series I bonds, they should have received a Form 1099-INT. Most
taxpayers report the total interest when they cash in the bonds. Few taxpayers elect to report savings
bond interest as it accrues each year. This method is out of scope for the volunteer program and taxpayers
should be referred to a professional tax preparer.
Interest on qualied U.S. Series EE and Series I savings bonds that are used to pay for higher education
expenses may be eligible for exclusion from income using Form 8815, Exclusion of Interest From Series EE and
Series I U.S. Savings Bonds Issued After 1989. Form 8815 is out of scope for the VITA/TCE programs.
A Net Investment Income Tax applies to individuals, estates and trusts that have certain investment income
above certain threshold amounts. This topic is out of scope for the VITA/TCE programs. Taxpayers aected by the
Net Investment Income Tax should be referred to a professional tax preparer. Additional information can be found in
Publication 17 or on
https://www.irs.gov
If a U.S. savings bond is issued in the names of co-owners, such as the taxpayer and child, or the
taxpayer and spouse, interest on the bond is generally taxable to the co-owner who purchased the bond.
To determine who is responsible for paying the tax on the interest from the redemption of a bond, see
Publication 17, Interest Income.
• Taxpayers with Series HH bonds receive interest twice a year.
• Ask the taxpayer for all tax statements reporting the interest received.
• Ask if the taxpayer holds any loans or seller-nanced mortgages.
The taxpayer will likely not receive a tax form for interest received from a private borrower. The name,
Social Security number, and address of the payer (the buyer) of interest on a seller-nanced mortgage is
required to e-le a return.
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The manner of reporting interest income on Series E, Series EE, or Series I U.S. savings bonds, after the
death of the owner (decedent), depends on the accounting and income-reporting methods previously used by the
decedent. See Publication 550, Investment Income and Expenses, for additional information.
Interest from U.S. government obligations is not taxable by any state. Refer to the Volunteer Resource Guide,
Tab D, Income, for the entries needed to identify the interest that is not taxable for state purposes.
What interest income is tax-exempt?
Certain types of interest are exempt from federal income tax. However, they may be taxable on the state
tax return, and sometimes the reverse is true; the interest may be taxable on the federal return and exempt
from state income tax.
Interest from bonds issued by the following are exempt from federal income tax:
• State and political subdivisions (county or city)
• District of Columbia
• U.S. possessions and political subdivisions
• Port authorities
• Toll-road commissions
• Utility service authorities
• Community redevelopment agencies
• Qualied volunteer re departments
• Amounts indicated on broker statements as tax-exempt interest or tax-exempt dividends
Read the taxpayer’s Form(s) 1099-INT carefully; both taxable and tax-exempt interest may be listed.
Specic software entries are needed based on the source of the municipal interest income. Consult with
your Site Coordinator if you have any questions.
Municipal mutual funds report the exempt interest as dividends on Form 1099-DIV. This income is interest
income and while you may enter the amounts as “exempt interest dividends” in the software, they will
appear on the interest income line of Form 1040.
Interest from Private Activity Bonds (PAB) may be shown on the interest statement. It is a subset of
tax-exempt interest and may aect the Alternative Minimum Tax. Taxpayers who are subject to the
Alternative Minimum Tax should be referred to a professional tax preparer. Although tax-exempt interest
is not taxable, it must be reported on Form 1040. Tax-exempt interest is used in calculating the taxability of
some income items, such as Social Security benets.
example
Bob holds a promissory note for a cash loan that he made to his brother-in-law, Stan. Stan pays Bob
principal and interest each month. Even though Bob does not receive a Form 1099-INT, he reports
that interest on Schedule B of his tax return.
example
Hazel has four savings accounts in four dierent banks. The total amount of interest earned from the
accounts is $3,000. Hazel will receive four Forms 1099-INT. She will list each payer and amount on
Schedule B and le it with her tax return.
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What if a bond is sold between interest payment dates?
If a bond is sold between interest payment dates, part of the sales price represents interest accrued to the
date of the sale. This amount is taxable to the seller and must be reported as interest income for that tax
year, even if the seller does not receive a Form 1099-INT. The buyers of the bond may receive a 1099-INT
reecting the accrued interest and will treat this amount as a return of capital investment, reducing their
basis in the bond. Payers and brokers will report the correct amount of interest on the Form 1099-INT/OID
for all covered securities. Taxpayers who sell noncovered bonds between interest payment dates should
be referred to a professional tax preparer. If taxpayers would like additional information, refer them to
Publication 550, Investment Income and Expenses.
Tax Software Hint: To review information related to the software, go to the Volunteer Resource
Guide, Tab D, Income, Interest Income entries.
What about the interest on an IRA?
Generally, interest on a Roth IRA is not taxable. However, if the criteria for distribution are not followed, the
interest is taxable.
Interest on a traditional IRA is tax-deferred. Do not include that interest in taxable income until the taxpayer
receives distributions from the IRA, which will be reported on Form 1099-R. See the Retirement Income
lesson, Publication 17, and Publication 590-B, Distributions from Individual Retirement Arrangements, for
more information on IRA distributions.
How do I report interest income?
Interest income is entered on Form 1040. Amounts labeled Interest income and Interest on U.S. Savings
Bonds and Treasury obligations on Form 1099-INT are reported as taxable interest. Be sure to enter any
tax-exempt interest as directed in the software.
If the taxpayer receives Form 1099-OID, ensure that all the amounts included on Forms 1099-INT and
1099-OID are entered in their proper places in the software and on Form 1040. These will be discussed
in later lessons. For example, amounts shown in the early withdrawal penalty box will appear in the
Adjustments section and any federal income tax withheld is shown in the Payments section. Entries shown
in the foreign tax paid and foreign country boxes will be discussed in the Foreign Tax Credit lesson.
If taxpayers indicate there are adjustments needed for any of the amounts listed on Form 1099-OID, or
if they have income from original issue discount but did not receive a Form 1099-OID, refer them to a
professional tax preparer to ensure the correct amount is reported.
Tax Software Hint: Refer to the Volunteer Resource Guide, Tab D, Income, for instructions on
entering interest income. The software will le Schedule B if required.
example
Mike makes contributions to a traditional IRA each year. Throughout the year, he gets statements
listing the interest earned. Because it is tax-deferred, he does not report any of the interest income
from his traditional IRA on his tax return.
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SAMPLE INTERVIEW
VOLUNTEER SAYS… BARBARA RESPONDS…
Now we will complete the income section of your
return. I believe you told me that you work at the post
oce?
Yes. Here is my W-2.
Are you employed by anyone else? No way, they keep me busy enough at the
post oce!
Did you have any disability income? No, I’m not disabled.
Now, let’s go on to interest income. Did you earn any
interest on checking accounts, savings accounts, or
a certicate of deposit?
Yes, I have a savings account that earns
interest. Here is the 1099-INT.
What about U.S. savings bonds? I know that a lot of
postal employees buy them at work
Yes, I do, every pay period.
Are they for educational purposes, or just an
investment?
No, they aren’t educational. I don’t have
any information about my bonds with me.
Why would I need that?
Some people report the interest as it accrues every
year. You have to make this decision in the rst year
after you buy the bonds. Have you ever declared
accrued interest from your savings bonds on your
federal tax return?
Oh, no, never.
Well, did you redeem any bonds, or did any of them
mature during this tax year?
No to both questions. I’ve been buying
them for 15 years and they don’t become
fully mature for 30 years.
Okay, then it sounds like your only interest income is
from the savings account.
Taxpayer Interview and Tax Law Application
Barbara Smith is a clerk with the United States Postal Service. She has one Form W-2.
How do I handle dividends?
The corporate distributions that volunteer tax preparers may handle are:
• Ordinary dividends
• Section 199A dividends
• Qualied dividends
• Capital gain distributions
• Nondividend distributions
These are all reported on Form 1099-DIV.
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What are ordinary dividends?
Ordinary dividends are corporate distributions paid out of the earnings and prots of a corporation. Any
dividend received on common or preferred stock is an ordinary dividend unless the paying corporation
states otherwise. Ordinary dividends are reported on Form 1099-DIV.
What are Section 199A dividends?
A subset of ordinary dividends is called Section 199A dividends, which are eligible for the qualied business
income deduction. See the Standard Deduction lesson for this deduction and the Volunteer Resource
Guide, Tab D, Income, for software entries.
What are qualied dividends?
Qualied dividends are ordinary dividends that qualify for lower, long-term capital gains tax rates. See
Publication 550, Investment Income, for a detailed denition of qualied dividends.
Taxpayers who have questions about why a dividend is qualied or not qualied should contact the
company that paid the dividend.
What are capital gain distributions?
Capital gain distributions are also called capital gain dividends. They come from mutual funds and real
estate investment trusts (REITs). They are taxed at the lower long-term capital gains rate, regardless of how
long the taxpayer holds the shares. Capital gain distributions are reported to the taxpayer on Form 1099-DIV.
While you may enter these distributions in the dividend section of the software, these distributions will appear
as long-term capital gains on Form 1040 and on Schedule D if required.
Capital gains are not the same as capital gain distributions. A capital gain distribution is the owner’s portion of
the capital gains that were realized when the mutual fund or REIT sold assets. A volunteer with a Basic certication
can prepare a return with this type of income.
A capital gain occurs when the owner of a mutual fund or other capital asset sells the asset for more than its cost. A
volunteer must have Advanced certication to prepare a return for taxpayers who actually sold mutual fund shares, or
other shares of stock.
What are nondividend distributions?
Form 1099-DIV also shows nondividend distributions, which is the part of a distribution that is nontaxable
because it is a return of the taxpayer’s cost or other basis in a stock or security. Brokers will keep track of
these and other basis adjustments for covered securities. Otherwise, taxpayers should keep this information
with their tax records in order to calculate the adjusted basis of the stock when it is sold.
example
Olivia held both common stock and preferred stock in several U.S. corporations. Several of them paid
dividends during the tax year. The following January she received Forms 1099-DIV listing these as
ordinary dividends.
example
During the tax year, Olivia owned shares in a mutual fund and in a real estate investment trust. Both
made capital gain distributions that year. The following January she received Forms 1099-DIV listing
these capital gain distributions.
Income – Wages, Interest, Etc.
8-13
Where do I get dividend information?
Taxpayers that hold their securities in a brokerage account will receive Form 1099-DIV from their broker. For
stocks held directly, corporations use Form 1099-DIV to report dividend distributions to each shareholder.
Ask the taxpayer for any Form(s) 1099-DIV. If the taxpayers did not receive a Form 1099-DIV for a dividend,
they should contact the payer or their broker to get the needed forms.
What about Patronage dividends on Form 1099-PATR?
Form 1099-PATR, Box 1, shows patronage dividends paid to the taxpayer during the year in cash, qualied
written notices of allocation (at stated dollar value), or other property (not including nonqualied allocations).
Any dividends paid on property bought for personal use are not taxable. Ask the taxpayer if the patronage
dividends are only for personal consumption of goods. Only when the dividends are not taxable are they in
scope. In this case, it is not necessary to enter the dividend into the software.
How do I report dividend information?
Generally, all dividend income is reported on Form 1040. Schedule B may be needed if the taxpayer’s
ordinary dividends exceed a specied amount, or if the taxpayer was the nominee for dividends that actually
belong to someone else. On Form 1099-DIV, amounts included in boxes labeled Unrecap. Sec. 1250 gain,
Section 1202 gain, Cash liquidation distributions, and Noncash liquidation distributions are out of scope for
the VITA/TCE programs. Refer taxpayers with amounts in these boxes to a professional tax preparer.
Any federal income tax withheld shown on a Form 1099-DIV is reported on the federal income tax withheld
line of the return. Foreign tax paid will be covered in the Foreign Tax Credit lesson.
Tax Software Hint: Review the Volunteer Resource Guide, Tab D, Income, for guidance for entering
dividend income. If the taxpayer has multiple accounts, the software will add all the dividends for you,
preventing math errors.
Taxpayer Interview and Tax Law Application
Leonard and Gloria are ling a joint return. Leonard and the volunteer are discussing dividend income.
SAMPLE INTERVIEW
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . .
VOLUNTEER SAYS… LEONARD RESPONDS…
Do you and your wife own shares of stock, mutual
funds, or bond funds?
Yes, I have an IRA and I own shares in
several mutual funds and a bond fund. My
wife has an IRA. Here are the statements.
The earnings on the IRAs are tax deferred until you
take a distribution. These 1099-DIVs are what we
want right now. Are these the only Forms 1099-DIV
that you received?
Yes
We will enter the information from each of these in
the tax software. It will add everything up and display
it properly on your tax return
Income – Wages, Interest, Etc.
8-14
How do I report a refund of state or local income taxes?
Taxpayers who receive a refund of state or local income taxes may receive Form 1099-G reporting their
refund amount(s). Only taxpayers who itemized and received a federal income tax benet for deducting
their state or local income taxes have to include their state/local tax refunds in income. Not everyone must
include the refund in their taxable income.
• Taxpayers who claimed the standard deduction on the tax return for the year they received a refund of
state or local income taxes do not have to include the refund in their taxable income.
• Taxpayers who itemized and deducted the state sales tax instead of the state income tax withheld or
paid do not have to include the refund in their taxable income.
• Some taxpayers could not deduct all their state income taxes because of the annual cap on state and
local taxes deduction. Refer to the Volunteer Resource Guide, Tab D, Income, for the State and Local
Refund Worksheet in the software to determine the amount, if any, of the refund that is taxable.
Refer taxpayers who received a state or local income tax refund for a year other than the previous tax year to a
professional tax preparer.
What is alimony?
Alimony is a payment to or for a spouse or former spouse under a separation or divorce instrument. It may
include payments on behalf of the spouse or former spouse, such as medical bills, housing costs, and other
expenses. It does not include child support or voluntary payments outside the instrument.
Post-1984 and Pre-2019 Divorces
The person receiving alimony must include it as income. The person paying alimony can subtract it as
an adjustment to income. Both items are reported on Form 1040, Schedule 1. The date of divorce or
separation agreement must also be provided.
If the taxpayer is unsure whether a payment is alimony or child support, ask if the payments will stop once the
child is grown.
Alimony income received under a pre-2019 divorce or separation instrument is unearned income. However, it
is considered compensation, which may allow the taxpayer receiving alimony income to make a deductible traditional
IRA or nondeductible Roth IRA contribution.
If the agreement was executed before 1985, refer the taxpayer to a professional tax preparer.
example
Nancy itemized her deductions on last year’s federal return. She included the income taxes paid to her
state on Schedule A. During the current tax year, she received a state refund on the overpaid portion
of those taxes. When ling her current year tax return, she must use the state tax refund worksheet to
see how much of the refund to include in her federal taxable income.
Income – Wages, Interest, Etc.
8-15
Where do I get alimony information?
Ask if the taxpayer received alimony under a divorce or separation instrument. If so, explain that you need
the exact amount, since it may also be reported as a deduction by the payor, and the two amounts must
agree.
How do I report alimony income?
Tax Software Hint: Enter any alimony income on the alimony received screen. The Social Security
number of the person paying the alimony is not needed.
Post-2018 Divorces
The Tax Cuts and Jobs Act provides that alimony and separate maintenance payments are not deductible
by the payor spouse and repeals the code provisions that specify that alimony and separate maintenance
payments are included in income by the recipient of the payments.
This treatment is eective for any divorce or separation instrument executed after December 31, 2018, or
for any divorce or separation instrument executed on or before December 31, 2018, and modied after
that date, if the modication expressly provides that the amendments made by the Tax Cuts and Jobs Act,
Section 11051, apply to such modication.
Summary
This lesson covered income reported on Form 1040, including how to dierentiate taxable and nontaxable
income, and earned or unearned income.
• Earned income is any income received for work, such as wages or business/self-employment income.
• Unearned income is any income produced by investments, such as interest on savings, dividends on
stocks, or rental income.
• The Form 1040 wages, salaries, tips, etc. line includes wages, salaries, tips, and scholarships usually
reported to the taxpayer on Form W-2. Taxable scholarships or household employee income are shown
on the same line even when not shown on a Form W-2.
• Common sources of taxable interest income are checking and savings accounts, certicates of deposit
(CDs), savings certicates, or U.S. government bonds. This interest is reported by the payer on Form
1099-INT and included in the taxpayer’s income on Form 1040.
• Interest on certain bonds, such as from state political subdivisions, District of Columbia, or port
authorities, are exempt from federal income tax but must be reported on Form 1040.
• Dividends are reported to the taxpayer on Form 1099-DIV. Ordinary dividends are corporate
distributions paid out of the earnings and prots of a corporation. Qualied dividends are ordinary
dividends that qualify for lower, long-term capital gains tax rates. Capital gain distributions are reported
on Form 1040 and Schedule D, if required.
• Taxpayers who itemized deductions in the previous year and received a tax benet from deducting
state or local income taxes may have to report part or all of their refund as income. Taxpayers generally
receive Form 1099-G reporting their state or local tax refund.
• Alimony is income received from a spouse or former spouse under a separation or divorce instrument.
If the alimony was paid pursuant to a divorce or separation instrument executed on or before December
31, 2018, it is taxable income and included on Form 1040, Schedule 1.
Income – Wages, Interest, Etc.
8-16
What situations are out of scope for the VITA/TCE programs?
The following are out of scope for this lesson. While this list may not be all inclusive, it is provided for your
awareness only.
• Taxpayers with income from the following sources:
○ Other gains/losses
○ Farm income
• Taxpayers who must check “yes” to the virtual currency question on Form 1040.
• Taxpayers subject to the Additional Medicare Tax, the Net Investment Income Tax, or the Alternative
Minimum Tax
• Taxpayers who use the accrual method for reporting income
• Taxpayers who buy or sell noncovered bonds between interest payment dates
• Form 1099-INT amounts reported in the box labeled Specied private activity bond interest if AMT
applies
• Form 1099-INT premium amount is greater than the respective amount of interest reported.
• Form 1099-DIV amounts reported in the boxes labeled Unrecap. Sec. 1250 gain, Section 1202 gain,
Cash liquidation distributions, and Noncash liquidation distributions
• Adjustments needed for any of the amounts reported on Form 1099-OID, or if the taxpayer should have
received Form 1099-OID but did not receive one
• State or local income tax refunds received during the current tax year for a year other than the previous
tax year
• Alimony/divorce agreements executed before 1985
• Tax returns for ministers and members of the clergy because of unique tax issues
TAX LAW APPLICATION
To gain a better understanding of the tax law, complete the practice return(s) for your course of study
using the Practice Lab on L<.
