Chapter 5 - Nontaxable Income Flashcards
Nontaxable income
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
Scholarship and fellowships
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.
taxable scholarship or fellowship income
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.
When calculating a dependent taxpayer’s standard deduction
taxable scholarships and fellowships not reported on Form W-2 are considered earned income
Long term disability tax free
If a taxpayer retires on disability and paid the premiums with after-tax dollars, then the disability benefits received are tax-free.
Long term disability taxable
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.
Long term disability reported before retirement age
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.
Long term disability reported after retirement age
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.
Reporting disability benefits
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.
Workers compensation
no tax form for workers’ compensation, as it is nontaxable income.
Disability income and earned income credit
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.
Social security income
Social security income, regardless of the age of the recipient, is never reported as wage income, nor is it ever considered earned income.
Social security disability income
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
Alimony
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.
Unemployment compensation
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.
Unemployment compensation overpayment
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.
Other Income
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).
Educator expenses
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).
Eligible educators
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.
Qualified educator expenses
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.
Qualified educator expenses must be reduced if the taxpayer or spouse have any:
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.
Armed Forces, National Guard, and Reservists
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.
Officials Paid on a Fee Basis
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.
Qualified Performing Artists
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.
