Chapter 5 - Nontaxable Income

Question 1

Nontaxable income

Answer 1

flexible spending accounts, most veterans benefits, workers compensation, life insurance proceeds, federal income tax refunds, welfare benefits, qualified disaster relief payments, cash rebates, child support payments, physical injury or illness settlement, certain foster care payments, most gift and inheritances

Question 2

Scholarship and fellowships

Answer 2

scholarship is a grant of financial aid intended to help fund a student’s college studies. A fellowship is a similar grant, usually designated to help the recipient conduct some form of study or research. Generally, scholarships and fellowships are tax-free to the student if the student is a candidate for a degree at an eligible educational institution and uses the money for qualified education expenses. A taxpayer’s scholarship or fellowship is reported on Form 1098-T, Tuition Statement, box 5.

Question 3

taxable scholarship or fellowship income

Answer 3

Any amount of scholarship or fellowship funds exceeding the degree candidate’s amount of current-year qualified education expenses is taxable income. Qualified education expenses, for this purpose, include tuition, fees, course-required books, supplies, and equipment. Scholarship and fellowship funds used to pay these qualified education expenses are excluded from gross income and are not reported on the taxpayer’s return. The recipient is responsible for determining whether the money was used for qualified education expenses.

Question 4

When calculating a dependent taxpayer’s standard deduction

Answer 4

taxable scholarships and fellowships not reported on Form W-2 are considered earned income

Question 5

Long term disability tax free

Answer 5

If a taxpayer retires on disability and paid the premiums with after-tax dollars, then the disability benefits received are tax-free.

Question 6

Long term disability taxable

Answer 6

If they retire on disability and their employer paid the premiums or they paid the policy themselves with pre-tax dollars, the taxpayer must include any disability benefits received in their income.

Question 7

Long term disability reported before retirement age

Answer 7

Up to and including the day that the taxpayer reaches minimum retirement age, the disability pension payments are reported as wage income (and are considered earned income) on Form 1040, line 1h.

When determining how the taxable disability benefit is reported on the taxpayer’s return, the minimum retirement age for the taxpayer is the age at which the taxpayer could have first received a pension or annuity from the employer if they were not disabled. If the taxpayer does not know if they have reached the minimum retirement age, please refer the taxpayer to their employer’s Human Resources (HR) department or contact the HR department while the taxpayer is with you at the tax desk.

Question 8

Long term disability reported after retirement age

Answer 8

Beginning on the day after the taxpayer reaches minimum retirement age, the disability pension payments are reported as pension income on Form 1040, lines 5a and 5b.

Question 9

Reporting disability benefits

Answer 9

until the taxpayer reaches minimum retirement age, taxable disability pension payments, reported on Form 1099-R, box 2a, Taxable Amount, are entered as wage income on Form 1040, line 1h.
After the taxpayer reaches minimum retirement age, the disability pension payments are treated as pension income.

Question 10

Workers compensation

Answer 10

no tax form for workers’ compensation, as it is nontaxable income.

Question 11

Disability income and earned income credit

Answer 11

There is a very taxpayer-friendly facet to long-term disability benefit income received before the taxpayer reaches minimum retirement age. Remember, such income is treated as wage income. This income may also be considered earned income for purposes of the Earned Income Credit (EIC), a serious benefit for taxpayers. For the long-term disability benefit to be considered earned income, the employer must have paid the premiums or the taxpayer paid the premiums pre-tax. Remember, disability income received from premiums paid pre-tax is included in taxable income when received.

Question 12

Social security income

Answer 12

Social security income, regardless of the age of the recipient, is never reported as wage income, nor is it ever considered earned income.

Question 13

Social security disability income

Answer 13

Social security disability income is reported on the tax return as social security benefits received by the taxpayer, and it is subject to the same rules regarding taxability as other social security benefits. Social security disability income is reported to the recipient on Form SSA-1099

Question 14

Alimony

Answer 14

It is important to note that any prior divorce or separation agreements made before December 31, 2018, will remain taxable income to the recipient spouse in future years. It is only new or modified agreements after December 31, 2018, that will be excluded.
If a taxpayer is receiving taxable alimony, it is included in gross income and reported as taxable income on Schedule 1 (Form 1040), line 2a. The date of the divorce or separation agreement is entered on line 2b.

Question 15

Unemployment compensation

Answer 15

Unemployment compensation is reported to the taxpayer on Form 1099-G, Certain Government Payments, box 1. Unemployment compensation is fully taxable and is entered on Schedule 1 (Form 1040), line 7.
It is important to note that requesting the payer to withhold and remit 10% of the benefit is not required, but it may save the taxpayer from a significant tax liability when their return is filed.

Question 16

Unemployment compensation overpayment

Answer 16

If, during the year, the payer determines that they paid the taxpayer too much in unemployment compensation, the taxpayer is required to pay back the amount of overpayment received. If, during 2023, a taxpayer received an overpayment of unemployment compensation and repaid all or part of it in 2023, the taxpayer is allowed to reduce, dollar for dollar, the amount shown on Form 1099-G, box 1, by the amount repaid. The taxpayer would then enter the net amount on the appropriate line on the tax return and write “Repaid” and the amount repaid in the space to the left of the line.

Question 17

Other Income

Answer 17

Schedule 1 line 8
Cancelled debts
Taxable distributions from a health savings account (HSA) or an Archer medical savings account (MSA) (line 8e)
Jury duty pay - However, if an employee is required to surrender their jury duty pay to their employer in exchange for regular pay, in addition to reporting the jury duty pay as income, the amount surrendered may be deducted as an adjustment to income on Schedule 1 (Form 1040), line 8h.
Prizes and awards for which no services were performed (line 8i). Examples include cash and merchandise won in sweepstakes, in contests, on game shows, etc. These items may be reported on Form 1099-MISC, box 3, shown in the illustration below. If a prize or award is compensation for services performed for an employer, the value should be included in the wages of the recipient.
Hobby income/Activity not engaged in for profit income (line 8j). Income from a hobby is generally taxable. A hobby is an activity in which the taxpayer does not expect to make a profit. This differs from self-employment income, which has a profit motive.
Rental of personal property (line 8l). Income from the rental of personal property if the taxpayer is engaged in the rental for profit, but was not in the business of renting such property (for example, a taxpayer rents his riding lawn mower to his neighbor twice a year for $100).

Question 18

Educator expenses

Answer 18

A taxpayer who is an eligible educator may deduct up to $300 of qualified educator expenses; this is done on Schedule 1 (Form 1040), line 11. If the taxpayer and their spouse are filing a joint return and both individuals are eligible educators, their maximum deduction is $600 ($300 per eligible educator).

Question 19

Eligible educators

Answer 19

include kindergarten through 12th grade instructors, teachers, counselors, principals, or aides who worked in a public or private school for at least 900 hours during the tax year.

Question 20

Qualified educator expenses

Answer 20

are ordinary and necessary expenses for books, equipment, computer software, classroom supplies, and other supplemental instructional materials and services used in the classroom. This includes expenses for disinfectant, personal protective equipment, and other supplies used for the prevention of COVID-19. Ordinary and necessary means common, accepted, helpful, and appropriate in the taxpayer’s educational field. It does not necessarily mean indispensable.
Expenses for professional development courses related to what the educator teaches are also included in qualified expenses as well.

Question 21

Qualified educator expenses must be reduced if the taxpayer or spouse have any:

Answer 21

Reimbursements received that were not included in box 1 of the educator’s Form W-2.
Excludible U.S. Series EE and I Savings Bond interest from Form 8815.
Nontaxable distributions from Coverdell Education Savings Account earnings.
Nontaxable qualified tuition program earnings or distributions.

Question 22

Armed Forces, National Guard, and Reservists

Answer 22

Taxpayers who are a member of the Armed Forces, National Guard, or Reserve Corps and must travel more than 100 miles from their home for services related to the reserves may be able to deduct certain travel expenses.

Question 23

Officials Paid on a Fee Basis

Answer 23

Employees of state or local governments who are paid in whole or in part on a fee basis may be able to deduct their business expenses as an adjustment to income.

Question 24

Qualified Performing Artists

Answer 24

Certain performing artists may qualify to deduct some of their employee business expenses as an adjustment to income. There are specific requirements that must be met for the taxpayer to be able to deduct the expenses.

Question 25

Employees with Impairment-Related Work Expenses

Answer 25

Such expenses would include payment related to special equipment, training, or anything else directly related to an individual’s ability to perform work with an impairment.

Question 26

Health Savings Account (HSA) Deduction

Answer 26

A taxpayer who made after-tax contributions to their HSA, not through their employer, may be entitled to deduct these contributions as an adjustment to income on Form 1040. Generally, HSA contributions made by an employer on the taxpayer’s behalf are excluded from taxable income and are not reported in box 1 of the taxpayer’s Form W-2. This amount, plus any amount contributed by the employee through their employer’s plan, is shown in box 12 with the code W.

Question 27

Flexible Spending Arrangement (FSA)

Answer 27

A flexible spending arrangement (FSA) is another type of medical savings account available through an employer. It is a salary reduction agreement. FSAs share many similarities to HSAs, but are not reported on the tax return. When preparing a return for a taxpayer with a health savings account, be careful to verify that you have the right kind of account! (You can learn more about FSAs in Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans.)

Question 28

Moving Expenses

Answer 28

Prior to 2018, taxpayers who moved within one year of starting a new job may have been eligible to deduct their moving expenses as an adjustment to income on Form 1040. The Tax Cuts and Jobs Act of 2017 (TCJA) eliminated the moving expense adjustment to income for all taxpayers, with the exception of active duty members of the Armed Forces who have a permanent change of station due to a military order.
A qualifying taxpayer is allowed to deduct reasonable moving expenses. Deductible moving expenses generally include actual costs for transportation of household goods, traveling, lodging (not meals), and temporary storage.

Question 29

Deductible Part of Self-Employment Tax

Answer 29

If the taxpayer is self-employed and owes self-employment tax, the taxpayer is allowed to deduct one-half of their self-employment tax calculated on Schedule SE.

Question 30

Self-Employed SEP, SIMPLE, and Qualified Plans

Answer 30

A taxpayer who is self-employed or a partner in a partnership who made SEP, SIMPLE, or other qualified retirement plan contributions for themselves during the year may be able to deduct these contributions.

Question 31

Self-Employed Health Insurance Deduction

Answer 31

A taxpayer who is self-employed, a partner in a partnership, or a shareholder in an S corporation may be eligible to deduct the cost of health insurance for themselves, their spouse, or their dependents. To claim this deduction, the taxpayer must meet specific requirements, which are discussed in the Form 1040 instructions

Question 32

IRA deduction

Answer 32

A taxpayer or spouse who made contributions to a traditional IRA for 2023 may be eligible to deduct the lesser of their total 2023 traditional IRA contributions, or $6,500 ($7,500 if age 50 or older) from their gross income. This adjustment is claimed on Schedule 1 (Form 1040), line 20.
If the taxpayer or their spouse was an active participant in an employer-sponsored retirement plan, their traditional IRA contribution deduction may be reduced or phased out based on their modified adjusted gross income (MAGI). The traditional IRA contribution deduction MAGI phaseout ranges vary based on the taxpayer’s filing status. The traditional IRA contribution is not covered in this chapter, only where to report the deduction, if eligible.

Schedule 1, Line 20

Question 33

Student loan interest deduction

Answer 33

For 2023, a taxpayer may deduct up to $2,500 per return of qualified student loan interest paid during the tax year as an adjustment to income on Schedule 1 (Form 1040), line 21.

taxpayer can claim the student loan interest deduction if the taxpayer meets all of the following requirements.

The taxpayer, or spouse if filing jointly:

Does not use the married filing separately (MFS) filing status.
Is not claimed as a dependent on another taxpayer’s return.
Must be legally obligated to pay interest on a qualified student loan.
Paid interest on a qualified student loan.

Question 34

Student loan interest deduction exception

Answer 34

There is an exception for a taxpayer who is legally obligated to make the payments, as long as they are not a dependent of anyone else. If someone else makes payments on behalf of the taxpayer, the taxpayer is treated as receiving the interest payments from the other taxpayer and then paying the interest themselves.

Question 35

Eligible student

Answer 35

An eligible student is a student who was enrolled at least half-time in a program leading to a degree, certificate, or other recognized educational credential.

Question 36

Qualified education expenses

Answer 36

Qualified education expenses for the student loan interest deduction are the total cost of attending an eligible educational institution, including graduate school. Amounts paid for any of the following are included:

Tuition and fees.
Room and board.
Books, supplies, and equipment.
Other necessary expenses (such as transportation).
The cost of room and board qualifies only to the extent that it is not more than the greater of the following:

The allowance for room and board, as determined by the eligible educational institution, that was included in the cost of attendance for a particular academic period and living arrangement of the student.
The actual amount charged if the student is residing in housing owned or operated by the eligible educational institution.

Question 37

Student loan interest deduction limits

Answer 37

No deduction: MAGI equal to or greater than $185K MFJ or $90K S, HOH, QSS
Limited deduction: MAGI greater than $155K but less than $185K for MFJ or MAGI greater than $75K but less than $90K for S, HOH, QSS
Full deduction: MAGI not more than $155K MFJ or $75K for S, HOH, QSS
No deduction for MFS