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2012 Tax Forms Online

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2012 Tax Forms Online

2012 tax forms online 7. 2012 tax forms online   Coverdell Education Savings Account (ESA) Table of Contents Introduction What Is a Coverdell ESAQualified Education Expenses ContributionsContribution Limits Additional Tax on Excess Contributions Rollovers and Other TransfersRollovers Changing the Designated Beneficiary Transfer Because of Divorce DistributionsTax-Free Distributions Taxable Distributions When Assets Must Be Distributed Introduction If your modified adjusted gross income (MAGI) is less than $110,000 ($220,000 if filing a joint return), you may be able to establish a Coverdell ESA to finance the qualified education expenses of a designated beneficiary. 2012 tax forms online For most taxpayers, MAGI is the adjusted gross income as figured on their federal income tax return. 2012 tax forms online There is no limit on the number of separate Coverdell ESAs that can be established for a designated beneficiary. 2012 tax forms online However, total contributions for the beneficiary in any year cannot be more than $2,000, no matter how many accounts have been established. 2012 tax forms online See Contributions , later. 2012 tax forms online This benefit applies not only to higher education expenses, but also to elementary and secondary education expenses. 2012 tax forms online What is the tax benefit of the Coverdell ESA. 2012 tax forms online   Contributions to a Coverdell ESA are not deductible, but amounts deposited in the account grow tax free until distributed. 2012 tax forms online   If, for a year, distributions from an account are not more than a designated beneficiary's qualified education expenses at an eligible educational institution, the beneficiary will not owe tax on the distributions. 2012 tax forms online See Tax-Free Distributions , later. 2012 tax forms online    Table 7-1 summarizes the main features of the Coverdell ESA. 2012 tax forms online Table 7-1. 2012 tax forms online Coverdell ESA at a Glance Do not rely on this table alone. 2012 tax forms online It provides only general highlights. 2012 tax forms online See the text for definitions of terms in bold type and for more complete explanations. 2012 tax forms online Question Answer What is a Coverdell ESA? A savings account that is set up to pay the qualified education expenses of a designated beneficiary. 2012 tax forms online Where can it be established? It can be opened in the United States at any bank or other IRS-approved entity that offers Coverdell ESAs. 2012 tax forms online Who can have a Coverdell ESA? Any beneficiary who is under age 18 or is a special needs beneficiary. 2012 tax forms online Who can contribute to a Coverdell ESA? Generally, any individual (including the beneficiary) whose modified adjusted gross income for the year is less than $110,000 ($220,000 in the case of a joint return). 2012 tax forms online Are distributions tax free? Yes, if the distributions are not more than the beneficiary's adjusted qualified education expenses for the year. 2012 tax forms online What Is a Coverdell ESA A Coverdell ESA is a trust or custodial account created or organized in the United States only for the purpose of paying the qualified education expenses of the Designated beneficiary (defined later) of the account. 2012 tax forms online When the account is established, the designated beneficiary must be under age 18 or a special needs beneficiary. 2012 tax forms online To be treated as a Coverdell ESA, the account must be designated as a Coverdell ESA when it is created. 2012 tax forms online The document creating and governing the account must be in writing and must satisfy the following requirements. 2012 tax forms online The trustee or custodian must be a bank or an entity approved by the IRS. 2012 tax forms online The document must provide that the trustee or custodian can only accept a contribution that meets all of the following conditions. 2012 tax forms online The contribution is in cash. 2012 tax forms online The contribution is made before the beneficiary reaches age 18, unless the beneficiary is a special needs beneficiary. 2012 tax forms online The contribution would not result in total contributions for the year (not including rollover contributions) being more than $2,000. 2012 tax forms online Money in the account cannot be invested in life insurance contracts. 2012 tax forms online Money in the account cannot be combined with other property except in a common trust fund or common investment fund. 2012 tax forms online The balance in the account generally must be distributed within 30 days after the earlier of the following events. 2012 tax forms online The beneficiary reaches age 30, unless the beneficiary is a special needs beneficiary. 2012 tax forms online The beneficiary's death. 2012 tax forms online Qualified Education Expenses Generally, these are expenses required for the enrollment or attendance of the designated beneficiary at an eligible educational institution. 2012 tax forms online For purposes of Coverdell ESAs, the expenses can be either qualified higher education expenses or qualified elementary and secondary education expenses. 2012 tax forms online Designated beneficiary. 2012 tax forms online   This is the individual named in the document creating the trust or custodial account to receive the benefit of the funds in the account. 2012 tax forms online Contributions to a qualified tuition program (QTP). 2012 tax forms online   A contribution to a QTP is a qualified education expense if the contribution is on behalf of the designated beneficiary of the Coverdell ESA. 2012 tax forms online In the case of a change in beneficiary, this is a qualified expense only if the new beneficiary is a family member of that designated beneficiary. 2012 tax forms online See chapter 8, Qualified Tuition Program . 2012 tax forms online Eligible Educational Institution For purposes of Coverdell ESAs, an eligible educational institution can be either an eligible postsecondary school or an eligible elementary or secondary school. 2012 tax forms online Eligible postsecondary school. 2012 tax forms online   This is any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the U. 2012 tax forms online S. 2012 tax forms online Department of Education. 2012 tax forms online It includes virtually all accredited public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions. 2012 tax forms online The educational institution should be able to tell you if it is an eligible educational institution. 2012 tax forms online   Certain educational institutions located outside the United States also participate in the U. 2012 tax forms online S. 2012 tax forms online Department of Education's Federal Student Aid (FSA) programs. 2012 tax forms online Eligible elementary or secondary school. 2012 tax forms online   This is any public, private, or religious school that provides elementary or secondary education (kindergarten through grade 12), as determined under state law. 2012 tax forms online Qualified Higher Education Expenses These are expenses related to enrollment or attendance at an eligible postsecondary school. 2012 tax forms online As shown in the following list, to be qualified, some of the expenses must be required by the school and some must be incurred by students who are enrolled at least half-time. 2012 tax forms online The following expenses must be required for enrollment or attendance of a designated beneficiary at an eligible postsecondary school. 2012 tax forms online Tuition and fees. 2012 tax forms online Books, supplies, and equipment. 2012 tax forms online Expenses for special needs services needed by a special needs beneficiary must be incurred in connection with enrollment or attendance at an eligible postsecondary school. 2012 tax forms online Expenses for room and board must be incurred by students who are enrolled at least half-time (defined below). 2012 tax forms online The expense for room and board qualifies only to the extent that it is not more than the greater of the following two amounts. 2012 tax forms online The allowance for room and board, as determined by the school, that was included in the cost of attendance (for federal financial aid purposes) for a particular academic period and living arrangement of the student. 2012 tax forms online The actual amount charged if the student is residing in housing owned or operated by the school. 2012 tax forms online Half-time student. 2012 tax forms online   A student is enrolled “at least half-time” if he or she is enrolled for at least half the full-time academic work load for the course of study the student is pursuing, as determined under the standards of the school where the student is enrolled. 2012 tax forms online Qualified Elementary and Secondary Education Expenses These are expenses related to enrollment or attendance at an eligible elementary or secondary school. 2012 tax forms online As shown in the following list, to be qualified, some of the expenses must be required or provided by the school. 2012 tax forms online There are special rules for computer-related expenses. 2012 tax forms online The following expenses must be incurred by a designated beneficiary in connection with enrollment or attendance at an eligible elementary or secondary school. 2012 tax forms online Tuition and fees. 2012 tax forms online Books, supplies, and equipment. 2012 tax forms online Academic tutoring. 2012 tax forms online Special needs services for a special needs beneficiary. 2012 tax forms online The following expenses must be required or provided by an eligible elementary or secondary school in connection with attendance or enrollment at the school. 2012 tax forms online Room and board. 2012 tax forms online Uniforms. 2012 tax forms online Transportation. 2012 tax forms online Supplementary items and services (including extended day programs). 2012 tax forms online The purchase of computer technology, equipment, or Internet access and related services is a qualified elementary and secondary education expense if it is to be used by the beneficiary and the beneficiary's family during any of the years the beneficiary is in elementary or secondary school. 2012 tax forms online (This does not include expenses for computer software designed for sports, games, or hobbies unless the software is predominantly educational in nature. 2012 tax forms online ) Contributions Any individual (including the designated beneficiary) can contribute to a Coverdell ESA if the individual's MAGI (defined later under Contribution Limits ) for the year is less than $110,000. 2012 tax forms online For individuals filing joint returns, that amount is $220,000. 2012 tax forms online Organizations, such as corporations and trusts, can also contribute to Coverdell ESAs. 2012 tax forms online There is no requirement that an organization's income be below a certain level. 2012 tax forms online Contributions must meet all of the following requirements. 2012 tax forms online They must be in cash. 2012 tax forms online They cannot be made after the beneficiary reaches age 18, unless the beneficiary is a special needs beneficiary. 2012 tax forms online They must be made by the due date of the contributor's tax return (not including extensions). 2012 tax forms online Contributions can be made to one or several Coverdell ESAs for the same designated beneficiary provided that the total contributions are not more than the contribution limits (defined later) for a year. 2012 tax forms online Contributions can be made, without penalty, to both a Coverdell ESA and a QTP in the same year for the same beneficiary. 2012 tax forms online Table 7-2 summarizes many of the features of contributing to a Coverdell ESA. 2012 tax forms online When contributions considered made. 2012 tax forms online   Contributions made to a Coverdell ESA for the preceding tax year are considered to have been made on the last day of the preceding year. 2012 tax forms online They must be made by the due date (not including extensions) for filing your return for the preceding year. 2012 tax forms online   For example, if you make a contribution to a Coverdell ESA in February 2014, and you designate it as a contribution for 2013, you are considered to have made that contribution on December 31, 2013. 2012 tax forms online Contribution Limits There are two yearly limits: One on the total amount that can be contributed for each designated beneficiary in any year, and One on the amount that any individual can contribute for any one designated beneficiary for a year. 2012 tax forms online Limit for each designated beneficiary. 2012 tax forms online   For 2013, the total of all contributions to all Coverdell ESAs set up for the benefit of any one designated beneficiary cannot be more than $2,000. 2012 tax forms online This includes contributions (other than rollovers) to all the beneficiary's Coverdell ESAs from all sources. 2012 tax forms online Rollovers are discussed under Rollovers and Other Transfers , later. 2012 tax forms online Example. 2012 tax forms online When Maria Luna was born in 2012, three separate Coverdell ESAs were set up for her, one by her parents, one by her grandfather, and one by her aunt. 2012 tax forms online In 2013, the total of all contributions to Maria's three Coverdell ESAs cannot be more than $2,000. 2012 tax forms online For example, if her grandfather contributed $2,000 to one of her Coverdell ESAs, no one else could contribute to any of her three accounts. 2012 tax forms online Or, if her parents contributed $1,000 and her aunt $600, her grandfather or someone else could contribute no more than $400. 2012 tax forms online These contributions could be put into any of Maria's Coverdell ESA accounts. 2012 tax forms online Limit for each contributor. 2012 tax forms online   Generally, you can contribute up to $2,000 for each designated beneficiary for 2013. 2012 tax forms online This is the most you can contribute for the benefit of any one beneficiary for the year, regardless of the number of Coverdell ESAs set up for the beneficiary. 2012 tax forms online Example. 2012 tax forms online The facts are the same as in the previous example except that Maria Luna's older brother, Edgar, also has a Coverdell ESA. 2012 tax forms online If their grandfather contributed $2,000 to Maria's Coverdell ESA in 2013, he could also contribute $2,000 to Edgar's Coverdell ESA. 2012 tax forms online Reduced limit. 2012 tax forms online   Your contribution limit may be reduced. 2012 tax forms online If your MAGI (defined on this page) is between $95,000 and $110,000 (between $190,000 and $220,000 if filing a joint return), the $2,000 limit for each designated beneficiary is gradually reduced (see Figuring the limit , later). 2012 tax forms online If your MAGI is $110,000 or more ($220,000 or more if filing a joint return), you cannot contribute to anyone's Coverdell ESA. 2012 tax forms online Table 7-2. 2012 tax forms online Coverdell ESA Contributions at a Glance Do not rely on this table alone. 2012 tax forms online It provides only general highlights. 2012 tax forms online See the text for more complete explanations. 2012 tax forms online Question Answer Are contributions deductible? No. 2012 tax forms online What is the annual contribution limit per designated beneficiary? $2,000 for each designated beneficiary. 2012 tax forms online What if more than one Coverdell ESA has been opened for the same designated beneficiary? The annual contribution limit is $2,000 for each beneficiary, no matter how many Coverdell ESAs are set up for that beneficiary. 2012 tax forms online What if more than one individual makes contributions for the same designated beneficiary? The annual contribution limit is $2,000 per beneficiary, no matter how many individuals contribute. 2012 tax forms online Can contributions other than cash be made to a Coverdell ESA? No. 2012 tax forms online When must contributions stop? No contributions can be made to a beneficiary's Coverdell ESA after he or she reaches age 18, unless the beneficiary is a special needs beneficiary. 2012 tax forms online Modified adjusted gross income (MAGI). 2012 tax forms online   For most taxpayers, MAGI is adjusted gross income (AGI) as figured on their federal income tax return. 2012 tax forms online MAGI when using Form 1040A. 2012 tax forms online   If you file Form 1040A, your MAGI is the AGI on line 22 of that form. 2012 tax forms online MAGI when using Form 1040. 2012 tax forms online   If you file Form 1040, your MAGI is the AGI on line 38 of that form, modified by adding back any: Foreign earned income exclusion, Foreign housing exclusion, Foreign housing deduction, Exclusion of income by bona fide residents of American Samoa, and Exclusion of income by bona fide residents of Puerto Rico. 2012 tax forms online MAGI when using Form 1040NR. 2012 tax forms online   If you file Form 1040NR, your MAGI is the AGI on line 36 of that form. 2012 tax forms online MAGI when using Form 1040NR-EZ. 2012 tax forms online   If you file Form 1040NR-EZ, your MAGI is the AGI on line 10 of that form. 2012 tax forms online   If you have any of these adjustments, you can use Worksheet 7-1. 2012 tax forms online MAGI for a Coverdell ESA , later, to figure your MAGI for Form 1040. 2012 tax forms online Worksheet 7-1. 2012 tax forms online MAGI for a Coverdell ESA 1. 2012 tax forms online Enter your adjusted gross income  (Form 1040, line 38)   1. 2012 tax forms online   2. 2012 tax forms online Enter your foreign earned income exclusion and/or housing exclusion (Form 2555, line 45, or Form 2555-EZ, line 18)   2. 2012 tax forms online       3. 2012 tax forms online Enter your foreign housing deduction (Form 2555, line 50)   3. 2012 tax forms online         4. 2012 tax forms online Enter the amount of income from Puerto Rico you are excluding   4. 2012 tax forms online       5. 2012 tax forms online Enter the amount of income from American Samoa you are excluding (Form 4563, line 15)   5. 2012 tax forms online       6. 2012 tax forms online Add lines 2, 3, 4, and 5   6. 2012 tax forms online   7. 2012 tax forms online Add lines 1 and 6. 2012 tax forms online This is your  modified adjusted gross income   7. 2012 tax forms online   Figuring the limit. 2012 tax forms online    To figure the limit on the amount you can contribute for each designated beneficiary, multiply $2,000 by a fraction. 2012 tax forms online The numerator (top number) is your MAGI minus $95,000 ($190,000 if filing a joint return). 2012 tax forms online The denominator (bottom number) is $15,000 ($30,000 if filing a joint return). 2012 tax forms online Subtract the result from $2,000. 2012 tax forms online This is the amount you can contribute for each beneficiary. 2012 tax forms online You can use Worksheet 7-2. 2012 tax forms online Coverdell ESA Contribution Limit to figure the limit on contributions. 2012 tax forms online    Worksheet 7-2. 2012 tax forms online Coverdell ESA Contribution Limit 1. 2012 tax forms online Maximum contribution   1. 2012 tax forms online $2,000 2. 2012 tax forms online Enter your modified adjusted gross income (MAGI) for purposes of figuring the contribution limit to a Coverdell ESA (see definition or Worksheet 7-1, earlier)   2. 2012 tax forms online   3. 2012 tax forms online Enter $190,000 if married filing jointly; $95,000 for all other filers   3. 2012 tax forms online   4. 2012 tax forms online Subtract line 3 from line 2. 2012 tax forms online If zero or less, enter -0- on line 4, skip lines 5 through 7, and enter $2,000 on line 8   4. 2012 tax forms online   5. 2012 tax forms online Enter $30,000 if married filing jointly; $15,000 for all other filers   5. 2012 tax forms online     Note. 2012 tax forms online If the amount on line 4 is greater than or equal to the amount on line 5, stop here. 2012 tax forms online You are not allowed to contribute to a Coverdell ESA for 2013. 2012 tax forms online       6. 2012 tax forms online Divide line 4 by line 5 and enter the result as a decimal (rounded to at least 3 places)   6. 2012 tax forms online . 2012 tax forms online 7. 2012 tax forms online Multiply line 1 by line 6   7. 2012 tax forms online   8. 2012 tax forms online Subtract line 7 from line 1   8. 2012 tax forms online   Note: The total Coverdell ESA contributions from all sources for the designated beneficiary during the tax year may not exceed $2,000. 2012 tax forms online Example. 2012 tax forms online Paul, who is single, had a MAGI of $96,500 for 2013. 2012 tax forms online Paul can contribute up to $1,800 in 2013 for each beneficiary, as shown in the illustrated Worksheet 7-2, Coverdell ESA Contribution Limit–Illustrated. 2012 tax forms online Worksheet 7-2. 2012 tax forms online Coverdell ESA Contribution Limit—Illustrated 1. 2012 tax forms online Maximum contribution   1. 2012 tax forms online $2,000 2. 2012 tax forms online Enter your modified adjusted gross  income (MAGI) for purposes of figuring the contribution limit to a Coverdell ESA (see definition or Worksheet 7-1, earlier)   2. 2012 tax forms online 96,500 3. 2012 tax forms online Enter $190,000 if married filing jointly; $95,000 for all other filers   3. 2012 tax forms online 95,000 4. 2012 tax forms online Subtract line 3 from line 2. 2012 tax forms online If zero or less, enter -0- on line 4, skip lines 5 through 7, and enter $2,000 on line 8   4. 2012 tax forms online 1,500 5. 2012 tax forms online Enter $30,000 if married filing jointly; $15,000 for all other filers   5. 2012 tax forms online 15,000   Note. 2012 tax forms online If the amount on line 4 is greater than or equal to the amount on line 5,  stop here. 2012 tax forms online You are not allowed to  contribute to a Coverdell ESA for 2013. 2012 tax forms online       6. 2012 tax forms online Divide line 4 by line 5 and enter the result as a decimal (rounded to at least 3 places)   6. 2012 tax forms online . 2012 tax forms online 100 7. 2012 tax forms online Multiply line 1 by line 6   7. 2012 tax forms online 200 8. 2012 tax forms online Subtract line 7 from line 1   8. 2012 tax forms online 1,800 Note: The total Coverdell ESA contributions from all sources for the designated beneficiary during the tax year may not exceed $2,000. 2012 tax forms online Additional Tax on Excess Contributions The beneficiary must pay a 6% excise tax each year on excess contributions that are in a Coverdell ESA at the end of the year. 2012 tax forms online Excess contributions are the total of the following two amounts. 2012 tax forms online Contributions to any designated beneficiary's Coverdell ESA for the year that are more than $2,000 (or, if less, the total of each contributor's limit for the year, as discussed earlier). 2012 tax forms online Excess contributions for the preceding year, reduced by the total of the following two amounts: Distributions (other than those rolled over as discussed later) during the year, and The contribution limit for the current year minus the amount contributed for the current year. 2012 tax forms online Exceptions. 2012 tax forms online   The excise tax does not apply if excess contributions made during 2013 (and any earnings on them) are distributed before the first day of the sixth month of the following tax year (June 1, 2014, for a calendar year taxpayer). 2012 tax forms online   However, you must include the distributed earnings in gross income for the year in which the excess contribution was made. 2012 tax forms online You should receive Form 1099-Q, Payments From Qualified Education Programs, from each institution from which excess contributions were distributed. 2012 tax forms online Box 2 of that form will show the amount of earnings on your excess contributions. 2012 tax forms online Code “2” or “3” entered in the blank box below boxes 5 and 6 indicate the year in which the earnings are taxable. 2012 tax forms online See Instructions for Recipient on the back of copy B of your Form 1099-Q. 2012 tax forms online Enter the amount of earnings on line 21 of Form 1040 (or Form 1040NR) for the applicable tax year. 2012 tax forms online For more information, see Taxable Distributions , later. 2012 tax forms online   The excise tax does not apply to any rollover contribution. 2012 tax forms online Note. 2012 tax forms online Contributions made in one year for the preceding tax year are considered to have been made on the last day of the preceding year. 2012 tax forms online Example. 2012 tax forms online In 2012, Greta's parents and grandparents contributed a total of $2,300 to Greta's Coverdell ESA— an excess contribution of $300. 2012 tax forms online Because Greta did not withdraw the excess before June 1, 2013, she had to pay an additional tax of $18 (6% × $300) when she filed her 2012 tax return. 2012 tax forms online In 2013, excess contributions of $500 were made to Greta's account, however, she withdrew $250 from that account to use for qualified education expenses. 2012 tax forms online Using the steps shown earlier under Additional Tax on Excess Contributions , Greta figures the excess contribution in her account at the end of 2013 as follows. 2012 tax forms online (1)   $500 excess contributions made in 2013     + (2)   $300 excess contributions in ESA at end of 2012     − (2a)   $250 distribution during 2013         $550 excess at end of 2013   × 6%=$33           If Greta limits 2014 contributions to $1,450 ($2,000 maximum allowed − $550 excess contributions from 2013), she will not owe any additional tax in 2014 for excess contributions. 2012 tax forms online Figuring and reporting the additional tax. 2012 tax forms online   You figure this excise tax in Part V of Form 5329. 2012 tax forms online Report the additional tax on Form 1040, line 58 (or Form 1040NR, line 56). 2012 tax forms online Rollovers and Other Transfers Assets can be rolled over from one Coverdell ESA to another or the designated beneficiary can be changed. 2012 tax forms online The beneficiary's interest can be transferred to a spouse or former spouse because of divorce. 2012 tax forms online Rollovers Any amount distributed from a Coverdell ESA is not taxable if it is rolled over to another Coverdell ESA for the benefit of the same beneficiary or a member of the beneficiary's family (including the beneficiary's spouse) who is under age 30. 2012 tax forms online This age limitation does not apply if the new beneficiary is a special needs beneficiary. 2012 tax forms online An amount is rolled over if it is paid to another Coverdell ESA within 60 days after the date of the distribution. 2012 tax forms online Do not report qualifying rollovers (those that meet the above criteria) anywhere on Form 1040 or 1040NR. 2012 tax forms online These are not taxable distributions. 2012 tax forms online Members of the beneficiary's family. 2012 tax forms online   For these purposes, the beneficiary's family includes the beneficiary's spouse and the following other relatives of the beneficiary. 2012 tax forms online Son, daughter, stepchild, foster child, adopted child, or a descendant of any of them. 2012 tax forms online Brother, sister, stepbrother, or stepsister. 2012 tax forms online Father or mother or ancestor of either. 2012 tax forms online Stepfather or stepmother. 2012 tax forms online Son or daughter of a brother or sister. 2012 tax forms online Brother or sister of father or mother. 2012 tax forms online Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law. 2012 tax forms online The spouse of any individual listed above. 2012 tax forms online First cousin. 2012 tax forms online Example. 2012 tax forms online When Aaron graduated from college last year he had $5,000 left in his Coverdell ESA. 2012 tax forms online He wanted to give this money to his younger sister, who was still in high school. 2012 tax forms online In order to avoid paying tax on the distribution of the amount remaining in his account, Aaron contributed the same amount to his sister's Coverdell ESA within 60 days of the distribution. 2012 tax forms online Only one rollover per Coverdell ESA is allowed during the 12-month period ending on the date of the payment or distribution. 2012 tax forms online This rule does not apply to the rollover of a military death gratuity or payment from Servicemembers' Group Life Insurance (SGLI). 2012 tax forms online Military death gratuity. 2012 tax forms online   If you received a military death gratuity or a payment from Servicemembers' Group Life Insurance (SGLI), you may roll over all or part of the amount received to one or more Coverdell ESAs for the benefit of members of the beneficiary's family (see Members of the beneficiary's family , earlier). 2012 tax forms online Such payments are made to an eligible survivor upon the death of a member of the armed forces. 2012 tax forms online The contribution to a Coverdell ESA from survivor benefits received cannot be made later than 1 year after the date on which you receive the gratuity or SGLI payment. 2012 tax forms online   This rollover contribution is not subject to (but is in addition to) the contribution limits discussed earlier under Contribution Limits . 2012 tax forms online The amount you roll over cannot exceed the total survivor benefits you received, reduced by contributions from these benefits to a Roth IRA or other Coverdell ESAs. 2012 tax forms online   The amount contributed from the survivor benefits is treated as part of your basis (cost) in the Coverdell ESA, and will not be taxed when distributed. 2012 tax forms online See Distributions , later. 2012 tax forms online The limit of one rollover per Coverdell ESA during a 12-month period does not apply to a military death gratuity or SGLI payment. 2012 tax forms online Changing the Designated Beneficiary The designated beneficiary can be changed. 2012 tax forms online See Members of the beneficiary's family , earlier. 2012 tax forms online There are no tax consequences if, at the time of the change, the new beneficiary is under age 30 or is a special needs beneficiary. 2012 tax forms online Example. 2012 tax forms online Assume the same situation for Aaron as in the last example (see Rollovers , earlier). 2012 tax forms online Instead of closing his Coverdell ESA and paying the distribution into his sister's Coverdell ESA, Aaron could have instructed the trustee of his account to simply change the name of the beneficiary on his account to that of his sister. 2012 tax forms online Transfer Because of Divorce If a spouse or former spouse receives a Coverdell ESA under a divorce or separation instrument, it is not a taxable transfer. 2012 tax forms online After the transfer, the spouse or former spouse treats the Coverdell ESA as his or her own. 2012 tax forms online Example. 2012 tax forms online In their divorce settlement, Peg received her ex-husband's Coverdell ESA. 2012 tax forms online In this process, the account was transferred into her name. 2012 tax forms online Peg now treats the funds in this Coverdell ESA as if she were the original owner. 2012 tax forms online Distributions The designated beneficiary of a Coverdell ESA can take a distribution at any time. 2012 tax forms online Whether the distributions are tax free depends, in part, on whether the distributions are equal to or less than the amount of Adjusted qualified education expenses (defined later) that the beneficiary has in the same tax year. 2012 tax forms online See Table 7-3, Coverdell ESA Distributions at a Glance, for highlights. 2012 tax forms online Table 7-3. 2012 tax forms online Coverdell ESA Distributions at a Glance Do not rely on this table alone. 2012 tax forms online It provides only general highlights. 2012 tax forms online See the text for definitions of terms in bold type and for more complete explanations. 2012 tax forms online Question Answer Is a distribution from a Coverdell ESA to pay for a designated beneficiary's qualified education expenses tax free? Generally, yes, to the extent the amount of the distribution is not more than the designated beneficiary's adjusted qualified education expenses. 2012 tax forms online After the designated beneficiary completes his or her education at an eligible educational institution, can amounts remaining in the Coverdell ESA be distributed? Yes. 2012 tax forms online Amounts must be distributed when the designated beneficiary reaches age 30, unless he or she is a special needs beneficiary. 2012 tax forms online Also, certain transfers to members of the beneficiary's family are permitted. 2012 tax forms online Does the designated beneficiary need to be enrolled for a minimum number of courses to take a tax-free distribution? No. 2012 tax forms online Adjusted qualified education expenses. 2012 tax forms online   To determine if total distributions for the year are more than the amount of qualified education expenses, reduce total qualified education expenses by any tax-free educational assistance. 2012 tax forms online Tax-free educational assistance includes: The tax-free part of scholarships and fellowships (see Tax-Free Scholarships and Fellowships in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions), Veterans' educational assistance (see Veterans' Benefits in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions), Pell grants (see Pell Grants and Other Title IV Need-Based Education Grants in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions), Employer-provided educational assistance (see chapter 11, Employer-Provided Educational Assistance ), and Any other nontaxable (tax-free) payments (other than gifts or inheritances) received as educational assistance. 2012 tax forms online The amount you get by subtracting tax-free educational assistance from your total qualified education expenses is your adjusted qualified education expenses. 2012 tax forms online Tax-Free Distributions Generally, distributions are tax free if they are not more than the beneficiary's adjusted qualified education expenses for the year. 2012 tax forms online Do not report tax-free distributions (including qualifying rollovers) on your tax return. 2012 tax forms online Taxable Distributions A portion of the distributions is generally taxable to the beneficiary if the total distributions are more than the beneficiary's adjusted qualified education expenses for the year. 2012 tax forms online Excess distribution. 2012 tax forms online   This is the part of the total distribution that is more than the beneficiary's adjusted qualified education expenses for the year. 2012 tax forms online Earnings and basis. 2012 tax forms online   You will receive a Form 1099-Q for each of the Coverdell ESAs from which money was distributed in 2013. 2012 tax forms online The amount of your gross distribution will be shown in box 1. 2012 tax forms online For 2013, instead of dividing the gross distribution between your earnings (box 2) and your basis (already-taxed amount) (box 3), the payer or trustee may report the fair market value (account balance) of the Coverdell ESA as of December 31, 2013. 2012 tax forms online This will be shown in the blank box below boxes 5 and 6. 2012 tax forms online   The amount contributed from survivor benefits (see Military death gratuity , earlier) is treated as part of your basis and will not be taxed when distributed. 2012 tax forms online Figuring the Taxable Portion of a Distribution The taxable portion is the amount of the excess distribution that represents earnings that have accumulated tax free in the account. 2012 tax forms online Figure the taxable portion for 2013 as shown in the following steps. 2012 tax forms online Multiply the total amount distributed by a fraction. 2012 tax forms online The numerator is the basis (contributions not previously distributed) at the end of 2012 plus total contributions for 2013 and the denominator is the value (balance) of the account at the end of 2013 plus the amount distributed during 2013. 2012 tax forms online Subtract the amount figured in (1) from the total amount distributed during 2013. 2012 tax forms online The result is the amount of earnings included in the distribution(s). 2012 tax forms online Multiply the amount of earnings figured in (2) by a fraction. 2012 tax forms online The numerator is the adjusted qualified education expenses paid during 2013 and the denominator is the total amount distributed during 2013. 2012 tax forms online Subtract the amount figured in (3) from the amount figured in (2). 2012 tax forms online The result is the amount the beneficiary must include in income. 2012 tax forms online The taxable amount must be reported on Form 1040 or Form 1040NR, line 21. 2012 tax forms online Example. 2012 tax forms online You received an $850 distribution from your Coverdell ESA, to which $1,500 had been contributed before 2013. 2012 tax forms online There were no contributions in 2013. 2012 tax forms online This is your first distribution from the account, so your basis in the account on December 31, 2012, was $1,500. 2012 tax forms online The value (balance) of your account on December 31, 2013, was $950. 2012 tax forms online You had $700 of adjusted qualified education expenses (AQEE) for the year. 2012 tax forms online Using the steps in Figuring the Taxable Portion of a Distribution , earlier, figure the taxable portion of your distribution as follows. 2012 tax forms online   1. 2012 tax forms online $850 (distribution) × $1,500 basis + $0 contributions  $950 value + $850 distribution       =$708 (basis portion of distribution)     2. 2012 tax forms online $850 (distribution)−$708 (basis portion of distribution)     =$142 (earnings included in distribution)   3. 2012 tax forms online $142 (earnings) × $700 AQEE  $850 distribution           =$117 (tax-free earnings)     4. 2012 tax forms online $142 (earnings)−$117 (tax-free earnings)=$25 (taxable earnings)                 You must include $25 in income as distributed earnings not used for qualified education expenses. 2012 tax forms online Report this amount on Form 1040, line 21, listing the type and amount of income on the dotted line. 2012 tax forms online Worksheet 7-3, Coverdell ESA–Taxable Distributions and Basis , at the end of this chapter, can help you figure your adjusted qualified education expenses, how much of your distribution must be included in income, and the remaining basis in your Coverdell ESA(s). 2012 tax forms online Coordination With American Opportunity and Lifetime Learning Credits The American opportunity or lifetime learning credit can be claimed in the same year the beneficiary takes a tax-free distribution from a Coverdell ESA, as long as the same expenses are not used for both benefits. 2012 tax forms online This means the beneficiary must reduce qualified higher education expenses by tax-free educational assistance, and then further reduce them by any expenses taken into account in determining an American opportunity or lifetime learning credit. 2012 tax forms online Example. 2012 tax forms online Derek Green had $5,800 of qualified higher education expenses for 2013, his first year in college. 2012 tax forms online He paid his college expenses from the following sources. 2012 tax forms online     Partial tuition scholarship (tax free) $1,500     Coverdell ESA distribution 1,000     Gift from parents 2,100     Earnings from part-time job 1,200           Of his $5,800 of qualified higher education expenses, $4,000 was tuition and related expenses that also qualified for an American opportunity credit. 2012 tax forms online Derek's parents claimed a $2,500 American opportunity credit (based on $4,000 expenses) on their tax return. 2012 tax forms online Before Derek can determine the taxable portion of his Coverdell ESA distribution, he must reduce his total qualified higher education expenses. 2012 tax forms online     Total qualified higher education expenses $5,800     Minus: Tax-free educational assistance −1,500     Minus: Expenses taken into account in  figuring American opportunity credit − 4,000     Equals: Adjusted qualified higher education  expenses (AQHEE) $ 300           Since the adjusted qualified higher education expenses ($300) are less than the Coverdell ESA distribution ($1,000), part of the distribution will be taxable. 2012 tax forms online The balance in Derek's account was $1,800 on December 31, 2013. 2012 tax forms online Prior to 2013, $2,100 had been contributed to this account. 2012 tax forms online Contributions for 2013 totaled $400. 2012 tax forms online Using the four steps outlined earlier, Derek figures the taxable portion of his distribution as shown below. 2012 tax forms online   1. 2012 tax forms online $1,000 (distribution) × $2,100 basis + $400 contributions  $1,800 value + $1,000 distribution           =$893 (basis portion of distribution)     2. 2012 tax forms online $1,000 (distribution)−$893 (basis portion of distribution)     = $107 (earnings included in distribution)   3. 2012 tax forms online $107 (earnings) × $300 AQHEE  $1,000 distribution       =$32 (tax-free earnings)     4. 2012 tax forms online $107 (earnings)−$32 (tax-free earnings)=$75 (taxable earnings)                 Derek must include $75 in income (Form 1040, line 21). 2012 tax forms online This is the amount of distributed earnings not used for adjusted qualified higher education expenses. 2012 tax forms online Coordination With Qualified Tuition Program (QTP) Distributions If a designated beneficiary receives distributions from both a Coverdell ESA and a QTP in the same year, and the total distribution is more than the beneficiary's adjusted qualified higher education expenses, those expenses must be allocated between the distribution from the Coverdell ESA and the distribution from the QTP before figuring how much of each distribution is taxable. 2012 tax forms online The following two examples illustrate possible allocations. 2012 tax forms online Example 1. 2012 tax forms online In 2013, Beatrice graduated from high school and began her first semester of college. 2012 tax forms online That year, she had $1,000 of qualified elementary and secondary education expenses (QESEE) for high school and $3,000 of qualified higher education expenses (QHEE) for college. 2012 tax forms online To pay these expenses, Beatrice withdrew $800 from her Coverdell ESA and $4,200 from her QTP. 2012 tax forms online No one claimed Beatrice as a dependent, nor was she eligible for an education credit. 2012 tax forms online She did not receive any tax-free educational assistance in 2013. 2012 tax forms online Beatrice must allocate her total qualified education expenses between the two distributions. 2012 tax forms online Beatrice knows that tax-free treatment will be available if she applies her $800 Coverdell ESA distribution toward her $1,000 of qualified education expenses for high school. 2012 tax forms online The qualified expenses are greater than the distribution, making the $800 Coverdell ESA distribution tax free. 2012 tax forms online Next, Beatrice matches her $4,200 QTP distribution to her $3,000 of QHEE, and finds she has an excess QTP distribution of $1,200 ($4,200 QTP − $3,000 QHEE). 2012 tax forms online She cannot use the extra $200 of high school expenses (from (1) above) against the QTP distribution because those expenses do not qualify a QTP for tax-free treatment. 2012 tax forms online Finally, Beatrice figures the taxable and tax-free portions of her QTP distribution based on her $3,000 of QHEE. 2012 tax forms online (See Figuring the Taxable Portion of a Distribution in chapter 8, Qualified Tuition Program for more information. 2012 tax forms online ) Example 2. 2012 tax forms online Assume the same facts as in Example 1 , except that Beatrice withdrew $1,800 from her Coverdell ESA and $3,200 from her QTP. 2012 tax forms online In this case, she allocates her qualified education expenses as follows. 2012 tax forms online Using the same reasoning as in Example 1, Beatrice matches $1,000 of her Coverdell ESA distribution to her $1,000 of QESEE—she has $800 of her distribution remaining. 2012 tax forms online Because higher education expenses can also qualify a Coverdell ESA distribution for tax-free treatment, Beatrice allocates her $3,000 of QHEE between the remaining $800 Coverdell ESA and the $3,200 QTP distributions ($4,000 total). 2012 tax forms online   $3,000 QHEE × $800 ESA distribution  $4,000 total distribution = $600 QHEE (ESA)     $3,000 QHEE × $3,200 QTP distribution  $4,000 total distribution = $2,400 QHEE (QTP)   Beatrice then figures the taxable part of her: Coverdell ESA distribution based on qualified education expenses of $1,600 ($1,000 QESEE + $600 QHEE). 2012 tax forms online See Figuring the Taxable Portion of a Distribution , earlier, in this chapter. 2012 tax forms online   QTP distribution based on her $2,400 of QHEE (see Figuring the Taxable Portion of a Distribution in chapter 8, Qualified Tuition Program). 2012 tax forms online The above examples show two types of allocation between distributions from a Coverdell ESA and a QTP. 2012 tax forms online However, you do not have to allocate your expenses in the same way. 2012 tax forms online You can use any reasonable method. 2012 tax forms online Losses on Coverdell ESA Investments If you have a loss on your investment in a Coverdell ESA, you may be able to deduct the loss on your income tax return. 2012 tax forms online You can deduct the loss only when all amounts from that account have been distributed and the total distributions are less than your unrecovered basis. 2012 tax forms online Your basis is the total amount of contributions to that Coverdell ESA. 2012 tax forms online You claim the loss as a miscellaneous itemized deduction on Schedule A (Form 1040), line 23 (Schedule A (Form 1040NR), line 9), subject to the 2%-of-adjusted-gross-income limit. 2012 tax forms online If you have distributions from more than one Coverdell ESA account during a year, you must combine the information (amount of distribution, basis, etc. 2012 tax forms online ) from all such accounts in order to determine your taxable earnings for the year. 2012 tax forms online By doing this, the loss from one ESA account reduces the distributed earnings (if any) from any other ESA account. 2012 tax forms online For examples of the calculation, see Losses on QTP Investments in chapter 8, Qualified Tuition Program. 2012 tax forms online Additional Tax on Taxable Distributions Generally, if you receive a taxable distribution, you also must pay a 10% additional tax on the amount included in income. 2012 tax forms online Exceptions. 2012 tax forms online   The 10% additional tax does not apply to distributions: Paid to a beneficiary (or to the estate of the designated beneficiary) on or after the death of the designated beneficiary. 2012 tax forms online Made because the designated beneficiary is disabled. 2012 tax forms online A person is considered to be disabled if he or she shows proof that he or she cannot do any substantial gainful activity because of his or her physical or mental condition. 2012 tax forms online A physician must determine that his or her condition can be expected to result in death or to be of long-continued and indefinite duration. 2012 tax forms online Included in income because the designated beneficiary received: A tax-free scholarship or fellowship (see Tax-Free Scholarships and Fellowships in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions), Veterans' educational assistance (see Veterans' Benefits in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions), Employer-provided educational assistance (see chapter 11, Employer-Provided Educational Assistance ), or Any other nontaxable (tax-free) payments (other than gifts or inheritances) received as educational assistance. 2012 tax forms online Made on account of the attendance of the designated beneficiary at a U. 2012 tax forms online S. 2012 tax forms online military academy (such as the USMA at West Point). 2012 tax forms online This exception applies only to the extent that the amount of the distribution does not exceed the costs of advanced education (as defined in section 2005(d)(3) of title 10 of the U. 2012 tax forms online S. 2012 tax forms online Code) attributable to such attendance. 2012 tax forms online Included in income only because the qualified education expenses were taken into account in determining the American opportunity or lifetime learning credit (see Coordination With American Opportunity and Lifetime Learning Credits , earlier). 2012 tax forms online Made before June 1, 2014, of an excess 2013 contribution (and any earnings on it). 2012 tax forms online The distributed earnings must be included in gross income for the year in which the excess contribution was made. 2012 tax forms online Exception (3) applies only to the extent the distribution is not more than the scholarship, allowance, or payment. 2012 tax forms online Figuring the additional tax. 2012 tax forms online    Use Part II of Form 5329, to figure any additional tax. 2012 tax forms online Report the amount on Form 1040, line 58, or Form 1040NR, line 56. 2012 tax forms online When Assets Must Be Distributed Any assets remaining in a Coverdell ESA must be distributed when either one of the following two events occurs. 2012 tax forms online The designated beneficiary reaches age 30. 2012 tax forms online In this case, the remaining assets must be distributed within 30 days after the beneficiary reaches age 30. 2012 tax forms online However, this rule does not apply if the beneficiary is a special needs beneficiary. 2012 tax forms online The designated beneficiary dies before reaching age 30. 2012 tax forms online In this case, the remaining assets must generally be distributed within 30 days after the date of death. 2012 tax forms online Exception for Transfer to Surviving Spouse or Family Member If a Coverdell ESA is transferred to a surviving spouse or other family member as the result of the death of the designated beneficiary, the Coverdell ESA retains its status. 2012 tax forms online (“Family member” was defined earlier under Rollovers . 2012 tax forms online ) This means the spouse or other family member can treat the Coverdell ESA as his or her own and does not need to withdraw the assets until he or she reaches age 30. 2012 tax forms online This age limitation does not apply if the new beneficiary is a special needs beneficiary. 2012 tax forms online There are no tax consequences as a result of the transfer. 2012 tax forms online How To Figure the Taxable Earnings When a total distribution is made because the designated beneficiary either reached age 30 or died, the earnings that accumulated tax free in the account must be included in taxable income. 2012 tax forms online You determine these earnings as shown in the following two steps. 2012 tax forms online Multiply the amount distributed by a fraction. 2012 tax forms online The numerator is the basis (contributions not previously distributed) at the end of 2012 plus total contributions for 2013 and the denominator is the balance in the account at the end of 2013 plus the amount distributed during 2013. 2012 tax forms online Subtract the amount figured in (1) from the total amount distributed during 2013. 2012 tax forms online The result is the amount of earnings included in the distribution. 2012 tax forms online For an example, see steps (1) and (2) of the Example under Figuring the Taxable Portion of a Distribution, earlier. 2012 tax forms online The beneficiary or other person receiving the distribution must report this amount on Form 1040, line 21, or Form 1040NR, line 21, listing the type and amount of income on the dotted line. 2012 tax forms online Worksheet 7-3 Instructions. 2012 tax forms online Coverdell ESA—Taxable Distributions and Basis Line G. 2012 tax forms online Enter the total distributions received from all Coverdell ESAs during 2013. 2012 tax forms online Do not include amounts rolled over to another ESA within 60 days (only one rollover is allowed during any 12-month period). 2012 tax forms online Also, do not include excess contributions that were distributed with the related earnings (or less any loss) before the first day of the sixth month of the tax year following the year for which the contributions were made. 2012 tax forms online Line 2. 2012 tax forms online Your basis (amount already taxed) in this Coverdell ESA as of December 31, 2012, is the total of:   •All contributions to this Coverdell ESA before 2013 •Minus the tax-free portion of any distributions from this Coverdell ESA before 2013. 2012 tax forms online   If your last distribution from this Coverdell ESA was before 2013, you must start with the basis in your account as of the end of the last year in which you took a distribution. 2012 tax forms online For years before 2002, you can find that amount on the last line of the worksheet in the Instructions for Form 8606, Nondeductible IRAs, that you completed for that year. 2012 tax forms online For years after 2001, you can find that amount by using the ending basis from the worksheet in Publication 970 for that year. 2012 tax forms online You can determine your basis in this Coverdell ESA as of December 31, 2012, by adding to the basis as of the end of that year any contributions made to that account after the year of the distribution and before 2013. 2012 tax forms online Line 4. 2012 tax forms online Enter the total distributions received from this Coverdell ESA in 2013. 2012 tax forms online Do not include amounts rolled over to another Coverdell ESA within 60 days (only one rollover is allowed during any 12-month period). 2012 tax forms online   Also, do not include excess contributions that were distributed with the related earnings (or less any loss) before the first day of the sixth month of the tax year following the year of the contributions. 2012 tax forms online Line 7. 2012 tax forms online Enter the total value of this Coverdell ESA as of December 31, 2013, plus any outstanding rollovers contributed to the account after 2012, but before the end of the 60-day rollover period. 2012 tax forms online A statement should be sent to you by January 31, 2014, for this Coverdell ESA showing the value on December 31, 2013. 2012 tax forms online   A rollover is a tax-free withdrawal from one Coverdell ESA that is contributed to another Coverdell ESA. 2012 tax forms online An outstanding rollover is any amount withdrawn within 60 days before the end of 2013 (November 2 through December 31) that was rolled over after December 31, 2013, but within the 60-day rollover period. 2012 tax forms online Worksheet 7-3. 2012 tax forms online Coverdell ESA—Taxable Distributions and Basis How to complete this worksheet. 2012 tax forms online • • • Complete Part I, lines A through H, on only one worksheet. 2012 tax forms online  Complete a separate Part II, lines 1 through 15, for each of your Coverdell ESAs. 2012 tax forms online  Complete Part III, the Summary (line 16), on only one worksheet. 2012 tax forms online Part I. 2012 tax forms online Qualified Education Expenses (Complete for total expenses)       A. 2012 tax forms online Enter your total qualified education expenses for 2013   A. 2012 tax forms online   B. 2012 tax forms online Enter those qualified education expenses paid for with tax-free educational assistance (for example, tax-free scholarships, veterans' educational benefits, Pell grants, employer-provided educational assistance)   B. 2012 tax forms online         C. 2012 tax forms online Enter those qualified higher education expenses deducted on Schedule C or C-EZ (Form 1040). 2012 tax forms online Schedule F (Form 1040), or as a miscellaneous itemized deduction on Schedule A (Form 1040 or 1040NR)   C. 2012 tax forms online         D. 2012 tax forms online Enter those qualified higher education expenses on which  an American opportunity or lifetime learning credit was based   D. 2012 tax forms online         E. 2012 tax forms online Add lines B, C, and D   D. 2012 tax forms online   F. 2012 tax forms online Subtract line E from line A. 2012 tax forms online This is your adjusted qualified education expense for 2013   E. 2012 tax forms online   G. 2012 tax forms online Enter your total distributions from all Coverdell ESAs during 2013. 2012 tax forms online Do not include rollovers  or the return of excess contributions (see instructions)   F. 2012 tax forms online   H. 2012 tax forms online Divide line F by line G. 2012 tax forms online Enter the result as a decimal (rounded to at least 3 places). 2012 tax forms online If the  result is 1. 2012 tax forms online 000 or more, enter 1. 2012 tax forms online 000   G. 2012 tax forms online . 2012 tax forms online Part II. 2012 tax forms online Taxable Distributions and Basis (Complete separately for each account) 1. 2012 tax forms online Enter the amount contributed to this Coverdell ESA for 2013, including contributions made for 2013 from January 1, 2014, through April 15, 2014. 2012 tax forms online Do not include rollovers or the return of excess contributions   1. 2012 tax forms online   2. 2012 tax forms online Enter your basis in this Coverdell ESA as of December 31, 2012 (see instructions)   2. 2012 tax forms online   3. 2012 tax forms online Add lines 1 and 2   3. 2012 tax forms online   4. 2012 tax forms online Enter the total distributions from this Coverdell ESA during 2013. 2012 tax forms online Do not include rollovers  or the return of excess contributions (see instructions)   4. 2012 tax forms online   5. 2012 tax forms online Multiply line 4 by line H. 2012 tax forms online This is the amount of adjusted qualified  education expense attributable to this Coverdell ESA   5. 2012 tax forms online         6. 2012 tax forms online Subtract line 5 from line 4   6. 2012 tax forms online         7. 2012 tax forms online Enter the total value of this Coverdell ESA as of December 31, 2013,  plus any outstanding rollovers (see instructions)   7. 2012 tax forms online         8. 2012 tax forms online Add lines 4 and 7   8. 2012 tax forms online         9. 2012 tax forms online Divide line 3 by line 8. 2012 tax forms online Enter the result as a decimal (rounded to  at least 3 places). 2012 tax forms online If the result is 1. 2012 tax forms online 000 or more, enter 1. 2012 tax forms online 000   9. 2012 tax forms online . 2012 tax forms online       10. 2012 tax forms online Multiply line 4 by line 9. 2012 tax forms online This is the amount of basis allocated to your  distributions, and is tax free   10. 2012 tax forms online     Note. 2012 tax forms online If line 6 is zero, skip lines 11 through 13, enter -0- on line 14, and go to line 15. 2012 tax forms online       11. 2012 tax forms online Subtract line 10 from line 4   11. 2012 tax forms online   12. 2012 tax forms online Divide line 5 by line 4. 2012 tax forms online Enter the result as a decimal (rounded to  at least 3 places). 2012 tax forms online If the result is 1. 2012 tax forms online 000 or more, enter 1. 2012 tax forms online 000   12. 2012 tax forms online . 2012 tax forms online       13. 2012 tax forms online Multiply line 11 by line 12. 2012 tax forms online This is the amount of qualified education  expenses allocated to your distributions, and is tax free   13. 2012 tax forms online   14. 2012 tax forms online Subtract line 13 from line 11. 2012 tax forms online This is the portion of the distributions from this  Coverdell ESA in 2013 that you must include in income   14. 2012 tax forms online   15. 2012 tax forms online Subtract line 10 from line 3. 2012 tax forms online This is your basis in this Coverdell ESA as of December 31, 2013   15. 2012 tax forms online   Part III. 2012 tax forms online Summary (Complete only once)       16. 2012 tax forms online Taxable amount. 2012 tax forms online Add together all amounts on line 14 for all your Coverdell ESAs. 2012 tax forms online Enter here  and include on Form 1040, line 21, or Form 1040NR, line 21, listing the type and amount of income on the dotted line   16. 2012 tax forms online   Prev  Up  Next   Home   More Online Publications
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Understanding Your CP75 Notice

We’re auditing your tax return and we need documentation to verify the Earned Income Credit (EIC) that you claimed. The Earned Income Credit and/or the Additional Child Tax Credit (ACTC) portion(s) of your refund is being held pending the results of the audit.


What you need to do

  • Read the notice and the enclosed forms carefully. They explain the information you must send to us.
  • Provide copies of the documentation we request to verify the items that we are auditing.
  • Complete the response form by indicating which items your supporting documentation addresses and return the form with the documents you are submitting.

You may want to

  • Review this notice with your tax preparer.
  • Call us for assistance at the toll-free telephone number listed in the top right corner of your notice.
  • Review the rules for claiming the Earned Income Credit and make sure that your child meets the four tests: the Relationship, Age, Residency and Joint Return tests, to qualify for the credit. Read more about the qualifying child rules.
  • Find out if you can claim the Earned Income credit if you do not have a qualifying child. Find the rules for those without a qualifying child here.

Answers to Common Questions

Why was my return selected for audit?
While most returns are accepted as filed, some are selected for examination. The IRS examines (or audits) some federal tax returns to determine if income, expenses, and credits are being reported accurately. The IRS selects returns for examination using various methods which include random sampling, computerized screening, and comparison of information received by the IRS such as Forms W-2 and 1099. Having your return selected for examination does not suggest that you made an error or were dishonest.

Can I claim the Earned Income Credit for my fiancé’s child?
No. You must be married to the child’s parent during the tax year in question to receive the credit.

What do I need to send?
Please refer to the Form 886-H we sent with your notice. There is a separate form for each item being audited that explains what supporting documentation to send.

What if I can’t provide the requested documentation?
We will disallow the items being audited and send you an examination report that shows the proposed changes to your tax return.

What if I did not file a tax return claiming the items you are questioning and someone else is using my name and social security number?
Contact us at the number listed on the top right corner of your notice. You can also refer to the IRS Identity Theft resource page for more information.

Can I file my tax return while I am being audited?
Yes, you should continue to file all required tax returns before the due date to avoid additional penalties and interest.


Tips for next year

Avoid errors that can delay your refund or result in the IRS denying your EIC claim. Find out the most common errors in claiming EITC here.

Page Last Reviewed or Updated: 07-Mar-2014

How to get help

  • Call the 1-800 number listed on the top right corner of your notice.
  • Authorize someone (e.g., accountant) to contact the IRS on your behalf using Form 2848.
  • See if you qualify for help from a Low Income Taxpayer Clinic.
     

The 2012 Tax Forms Online

2012 tax forms online 4. 2012 tax forms online   Interest Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Allocation of InterestOrder of funds spent. 2012 tax forms online Payments from checking accounts. 2012 tax forms online Amounts paid within 30 days. 2012 tax forms online Optional method for determining date of reallocation. 2012 tax forms online Interest on a segregated account. 2012 tax forms online How to report. 2012 tax forms online Interest You Can DeductStatement. 2012 tax forms online Expenses paid to obtain a mortgage. 2012 tax forms online Prepayment penalty. 2012 tax forms online De minimis OID. 2012 tax forms online Constant-yield method. 2012 tax forms online Loan or mortgage ends. 2012 tax forms online Interest You Cannot DeductPenalties. 2012 tax forms online Who is a key person? Exceptions for pre-June 1997 contracts. 2012 tax forms online Interest allocated to unborrowed policy cash value. 2012 tax forms online Capitalization of Interest When To Deduct InterestPrepaid interest. 2012 tax forms online Discounted loan. 2012 tax forms online Refunds of interest. 2012 tax forms online Prepaid interest. 2012 tax forms online Discounted loan. 2012 tax forms online Tax deficiency. 2012 tax forms online Related person. 2012 tax forms online Below-Market LoansLimit on forgone interest for gift loans of $100,000 or less. 2012 tax forms online Introduction This chapter discusses the tax treatment of business interest expense. 2012 tax forms online Business interest expense is an amount charged for the use of money you borrowed for business activities. 2012 tax forms online Topics - This chapter discusses: Allocation of interest Interest you can deduct Interest you cannot deduct Capitalization of interest When to deduct interest Below-market loans Useful Items - You may want to see: Publication 537 Installment Sales 550 Investment Income and Expenses 936 Home Mortgage Interest Deduction Form (and Instructions) Sch A (Form 1040) Itemized Deductions Sch E (Form 1040) Supplemental Income and Loss Sch K-1 (Form 1065) Partner's Share of Income, Deductions, Credits, etc. 2012 tax forms online Sch K-1 (Form 1120S) Shareholder's Share of Income, Deductions, Credits, etc. 2012 tax forms online 1098 Mortgage Interest Statement 3115 Application for Change in Accounting Method 4952 Investment Interest Expense Deduction 8582 Passive Activity Loss Limitations See chapter 12 for information about getting publications and forms. 2012 tax forms online Allocation of Interest The rules for deducting interest vary, depending on whether the loan proceeds are used for business, personal, or investment activities. 2012 tax forms online If you use the proceeds of a loan for more than one type of expense, you must allocate the interest based on the use of the loan's proceeds. 2012 tax forms online Allocate your interest expense to the following categories. 2012 tax forms online Nonpassive trade or business activity interest Passive trade or business activity interest Investment interest Portfolio interest Personal interest In general, you allocate interest on a loan the same way you allocate the loan proceeds. 2012 tax forms online You allocate loan proceeds by tracing disbursements to specific uses. 2012 tax forms online The easiest way to trace disbursements to specific uses is to keep the proceeds of a particular loan separate from any other funds. 2012 tax forms online Secured loan. 2012 tax forms online   The allocation of loan proceeds and the related interest is not generally affected by the use of property that secures the loan. 2012 tax forms online Example. 2012 tax forms online You secure a loan with property used in your business. 2012 tax forms online You use the loan proceeds to buy an automobile for personal use. 2012 tax forms online You must allocate interest expense on the loan to personal use (purchase of the automobile) even though the loan is secured by business property. 2012 tax forms online    If the property that secures the loan is your home, you generally do not allocate the loan proceeds or the related interest. 2012 tax forms online The interest is usually deductible as qualified home mortgage interest, regardless of how the loan proceeds are used. 2012 tax forms online For more information, see Publication 936. 2012 tax forms online Allocation period. 2012 tax forms online   The period for which a loan is allocated to a particular use begins on the date the proceeds are used and ends on the earlier of the following dates. 2012 tax forms online The date the loan is repaid. 2012 tax forms online The date the loan is reallocated to another use. 2012 tax forms online Proceeds not disbursed to borrower. 2012 tax forms online   Even if the lender disburses the loan proceeds to a third party, the allocation of the loan is still based on your use of the funds. 2012 tax forms online This applies whether you pay for property, services, or anything else by incurring a loan, or you take property subject to a debt. 2012 tax forms online Proceeds deposited in borrower's account. 2012 tax forms online   Treat loan proceeds deposited in an account as property held for investment. 2012 tax forms online It does not matter whether the account pays interest. 2012 tax forms online Any interest you pay on the loan is investment interest expense. 2012 tax forms online If you withdraw the proceeds of the loan, you must reallocate the loan based on the use of the funds. 2012 tax forms online Example. 2012 tax forms online Celina, a calendar-year taxpayer, borrows $100,000 on January 4 and immediately uses the proceeds to open a checking account. 2012 tax forms online No other amounts are deposited in the account during the year and no part of the loan principal is repaid during the year. 2012 tax forms online On April 2, Celina uses $20,000 from the checking account for a passive activity expenditure. 2012 tax forms online On September 4, Celina uses an additional $40,000 from the account for personal purposes. 2012 tax forms online Under the interest allocation rules, the entire $100,000 loan is treated as property held for investment for the period from January 4 through April 1. 2012 tax forms online From April 2 through September 3, Celina must treat $20,000 of the loan as used in the passive activity and $80,000 of the loan as property held for investment. 2012 tax forms online From September 4 through December 31, she must treat $40,000 of the loan as used for personal purposes, $20,000 as used in the passive activity, and $40,000 as property held for investment. 2012 tax forms online Order of funds spent. 2012 tax forms online   Generally, you treat loan proceeds deposited in an account as used (spent) before either of the following amounts. 2012 tax forms online Any unborrowed amounts held in the same account. 2012 tax forms online Any amounts deposited after these loan proceeds. 2012 tax forms online Example. 2012 tax forms online On January 9, Olena opened a checking account, depositing $500 of the proceeds of Loan A and $1,000 of unborrowed funds. 2012 tax forms online The following table shows the transactions in her account during the tax year. 2012 tax forms online Date Transaction January 9 $500 proceeds of Loan A and $1,000 unborrowed funds deposited January 14 $500 proceeds of Loan B  deposited February 19 $800 used for personal purposes February 27 $700 used for passive activity June 19 $1,000 proceeds of Loan C  deposited November 20 $800 used for an investment December 18 $600 used for personal purposes Olena treats the $800 used for personal purposes as made from the $500 proceeds of Loan A and $300 of the proceeds of Loan B. 2012 tax forms online She treats the $700 used for a passive activity as made from the remaining $200 proceeds of Loan B and $500 of unborrowed funds. 2012 tax forms online She treats the $800 used for an investment as made entirely from the proceeds of Loan C. 2012 tax forms online She treats the $600 used for personal purposes as made from the remaining $200 proceeds of Loan C and $400 of unborrowed funds. 2012 tax forms online For the periods during which loan proceeds are held in the account, Olena treats them as property held for investment. 2012 tax forms online Payments from checking accounts. 2012 tax forms online   Generally, you treat a payment from a checking or similar account as made at the time the check is written if you mail or deliver it to the payee within a reasonable period after you write it. 2012 tax forms online You can treat checks written on the same day as written in any order. 2012 tax forms online Amounts paid within 30 days. 2012 tax forms online   If you receive loan proceeds in cash or if the loan proceeds are deposited in an account, you can treat any payment (up to the amount of the proceeds) made from any account you own, or from cash, as made from those proceeds. 2012 tax forms online This applies to any payment made within 30 days before or after the proceeds are received in cash or deposited in your account. 2012 tax forms online   If the loan proceeds are deposited in an account, you can apply this rule even if the rules stated earlier under Order of funds spent would otherwise require you to treat the proceeds as used for other purposes. 2012 tax forms online If you apply this rule to any payments, disregard those payments (and the proceeds from which they are made) when applying the rules stated under Order of funds spent. 2012 tax forms online   If you received the loan proceeds in cash, you can treat the payment as made on the date you received the cash instead of the date you actually made the payment. 2012 tax forms online Example. 2012 tax forms online Giovanni gets a loan of $1,000 on August 4 and receives the proceeds in cash. 2012 tax forms online Giovanni deposits $1,500 in an account on August 18 and on August 28 writes a check on the account for a passive activity expense. 2012 tax forms online Also, Giovanni deposits his paycheck, deposits other loan proceeds, and pays his bills during the same period. 2012 tax forms online Regardless of these other transactions, Giovanni can treat $1,000 of the deposit he made on August 18 as being paid on August 4 from the loan proceeds. 2012 tax forms online In addition, Giovanni can treat the passive activity expense he paid on August 28 as made from the $1,000 loan proceeds treated as deposited in the account. 2012 tax forms online Optional method for determining date of reallocation. 2012 tax forms online   You can use the following method to determine the date loan proceeds are reallocated to another use. 2012 tax forms online You can treat all payments from loan proceeds in the account during any month as taking place on the later of the following dates. 2012 tax forms online The first day of that month. 2012 tax forms online The date the loan proceeds are deposited in the account. 2012 tax forms online However, you can use this optional method only if you treat all payments from the account during the same calendar month in the same way. 2012 tax forms online Interest on a segregated account. 2012 tax forms online   If you have an account that contains only loan proceeds and interest earned on the account, you can treat any payment from that account as being made first from the interest. 2012 tax forms online When the interest earned is used up, any remaining payments are from loan proceeds. 2012 tax forms online Example. 2012 tax forms online You borrowed $20,000 and used the proceeds of this loan to open a new savings account. 2012 tax forms online When the account had earned interest of $867, you withdrew $20,000 for personal purposes. 2012 tax forms online You can treat the withdrawal as coming first from the interest earned on the account, $867, and then from the loan proceeds, $19,133 ($20,000 − $867). 2012 tax forms online All the interest charged on the loan from the time it was deposited in the account until the time of the withdrawal is investment interest expense. 2012 tax forms online The interest charged on the part of the proceeds used for personal purposes ($19,133) from the time you withdrew it until you either repay it or reallocate it to another use is personal interest expense. 2012 tax forms online The interest charged on the loan proceeds you left in the account ($867) continues to be investment interest expense until you either repay it or reallocate it to another use. 2012 tax forms online Loan repayment. 2012 tax forms online   When you repay any part of a loan allocated to more than one use, treat it as being repaid in the following order. 2012 tax forms online Personal use. 2012 tax forms online Investments and passive activities (other than those included in (3)). 2012 tax forms online Passive activities in connection with a rental real estate activity in which you actively participate. 2012 tax forms online Former passive activities. 2012 tax forms online Trade or business use and expenses for certain low-income housing projects. 2012 tax forms online Line of credit (continuous borrowings). 2012 tax forms online   The following rules apply if you have a line of credit or similar arrangement. 2012 tax forms online Treat all borrowed funds on which interest accrues at the same fixed or variable rate as a single loan. 2012 tax forms online Treat borrowed funds or parts of borrowed funds on which interest accrues at different fixed or variable rates as different loans. 2012 tax forms online Treat these loans as repaid in the order shown on the loan agreement. 2012 tax forms online Loan refinancing. 2012 tax forms online   Allocate the replacement loan to the same uses to which the repaid loan was allocated. 2012 tax forms online Make the allocation only to the extent you use the proceeds of the new loan to repay any part of the original loan. 2012 tax forms online Debt-financed distribution. 2012 tax forms online   A debt-financed distribution occurs when a partnership or S corporation borrows funds and allocates those funds to distributions made to partners or shareholders. 2012 tax forms online The manner in which you report the interest expense associated with the distributed debt proceeds depends on your use of those proceeds. 2012 tax forms online How to report. 2012 tax forms online   If the proceeds were used in a nonpassive trade or business activity, report the interest on Schedule E (Form 1040), line 28; enter “interest expense” and the name of the partnership or S corporation in column (a) and the amount in column (h). 2012 tax forms online If the proceeds were used in a passive activity, follow the Instructions for Form 8582, Passive Activity Loss Limitations, to determine the amount of interest expense that can be reported on Schedule E (Form 1040), line 28; enter “interest expense” and the name of the partnership in column (a) and the amount in column (f). 2012 tax forms online If the proceeds were used in an investment activity, enter the interest on Form 4952. 2012 tax forms online If the proceeds are used for personal purposes, the interest is generally not deductible. 2012 tax forms online Interest You Can Deduct You can generally deduct as a business expense all interest you pay or accrue during the tax year on debts related to your trade or business. 2012 tax forms online Interest relates to your trade or business if you use the proceeds of the loan for a trade or business expense. 2012 tax forms online It does not matter what type of property secures the loan. 2012 tax forms online You can deduct interest on a debt only if you meet all the following requirements. 2012 tax forms online You are legally liable for that debt. 2012 tax forms online Both you and the lender intend that the debt be repaid. 2012 tax forms online You and the lender have a true debtor-creditor relationship. 2012 tax forms online Partial liability. 2012 tax forms online   If you are liable for part of a business debt, you can deduct only your share of the total interest paid or accrued. 2012 tax forms online Example. 2012 tax forms online You and your brother borrow money. 2012 tax forms online You are liable for 50% of the note. 2012 tax forms online You use your half of the loan in your business, and you make one-half of the loan payments. 2012 tax forms online You can deduct your half of the total interest payments as a business deduction. 2012 tax forms online Mortgage. 2012 tax forms online   Generally, mortgage interest paid or accrued on real estate you own legally or equitably is deductible. 2012 tax forms online However, rather than deducting the interest currently, you may have to add it to the cost basis of the property as explained later under Capitalization of Interest. 2012 tax forms online Statement. 2012 tax forms online   If you paid $600 or more of mortgage interest (including certain points) during the year on any one mortgage, you generally will receive a Form 1098 or a similar statement. 2012 tax forms online You will receive the statement if you pay interest to a person (including a financial institution or a cooperative housing corporation) in the course of that person's trade or business. 2012 tax forms online A governmental unit is a person for purposes of furnishing the statement. 2012 tax forms online   If you receive a refund of interest you overpaid in an earlier year, this amount will be reported in box 3 of Form 1098. 2012 tax forms online You cannot deduct this amount. 2012 tax forms online For information on how to report this refund, see Refunds of interest, later in this chapter. 2012 tax forms online Expenses paid to obtain a mortgage. 2012 tax forms online   Certain expenses you pay to obtain a mortgage cannot be deducted as interest. 2012 tax forms online These expenses, which include mortgage commissions, abstract fees, and recording fees, are capital expenses. 2012 tax forms online If the property mortgaged is business or income-producing property, you can amortize the costs over the life of the mortgage. 2012 tax forms online Prepayment penalty. 2012 tax forms online   If you pay off your mortgage early and pay the lender a penalty for doing this, you can deduct the penalty as interest. 2012 tax forms online Interest on employment tax deficiency. 2012 tax forms online   Interest charged on employment taxes assessed on your business is deductible. 2012 tax forms online Original issue discount (OID). 2012 tax forms online   OID is a form of interest. 2012 tax forms online A loan (mortgage or other debt) generally has OID when its proceeds are less than its principal amount. 2012 tax forms online The OID is the difference between the stated redemption price at maturity and the issue price of the loan. 2012 tax forms online   A loan's stated redemption price at maturity is the sum of all amounts (principal and interest) payable on it other than qualified stated interest. 2012 tax forms online Qualified stated interest is stated interest that is unconditionally payable in cash or property (other than another loan of the issuer) at least annually over the term of the loan at a single fixed rate. 2012 tax forms online You generally deduct OID over the term of the loan. 2012 tax forms online Figure the amount to deduct each year using the constant-yield method, unless the OID on the loan is de minimis. 2012 tax forms online De minimis OID. 2012 tax forms online   The OID is de minimis if it is less than one-fourth of 1% (. 2012 tax forms online 0025) of the stated redemption price of the loan at maturity multiplied by the number of full years from the date of original issue to maturity (the term of the loan). 2012 tax forms online   If the OID is de minimis, you can choose one of the following ways to figure the amount you can deduct each year. 2012 tax forms online On a constant-yield basis over the term of the loan. 2012 tax forms online On a straight-line basis over the term of the loan. 2012 tax forms online In proportion to stated interest payments. 2012 tax forms online In its entirety at maturity of the loan. 2012 tax forms online You make this choice by deducting the OID in a manner consistent with the method chosen on your timely filed tax return for the tax year in which the loan is issued. 2012 tax forms online Example. 2012 tax forms online On January 1, 2013, you took out a $100,000 discounted loan and received $98,500 in proceeds. 2012 tax forms online The loan will mature on January 1, 2023 (a 10-year term), and the $100,000 principal is payable on that date. 2012 tax forms online Interest of $10,000 is payable on January 1 of each year, beginning January 1, 2014. 2012 tax forms online The $1,500 OID on the loan is de minimis because it is less than $2,500 ($100,000 × . 2012 tax forms online 0025 × 10). 2012 tax forms online You choose to deduct the OID on a straight-line basis over the term of the loan. 2012 tax forms online Beginning in 2013, you can deduct $150 each year for 10 years. 2012 tax forms online Constant-yield method. 2012 tax forms online   If the OID is not de minimis, you must use the constant-yield method to figure how much you can deduct each year. 2012 tax forms online You figure your deduction for the first year using the following steps. 2012 tax forms online Determine the issue price of the loan. 2012 tax forms online Generally, this equals the proceeds of the loan. 2012 tax forms online If you paid points on the loan (as discussed later), the issue price generally is the difference between the proceeds and the points. 2012 tax forms online Multiply the result in (1) by the yield to maturity. 2012 tax forms online Subtract any qualified stated interest payments from the result in (2). 2012 tax forms online This is the OID you can deduct in the first year. 2012 tax forms online   To figure your deduction in any subsequent year, follow the above steps, except determine the adjusted issue price in step (1). 2012 tax forms online To get the adjusted issue price, add to the issue price any OID previously deducted. 2012 tax forms online Then follow steps (2) and (3) above. 2012 tax forms online   The yield to maturity is generally shown in the literature you receive from your lender. 2012 tax forms online If you do not have this information, consult your lender or tax advisor. 2012 tax forms online In general, the yield to maturity is the discount rate that, when used in computing the present value of all principal and interest payments, produces an amount equal to the principal amount of the loan. 2012 tax forms online Example. 2012 tax forms online The facts are the same as in the previous example, except that you deduct the OID on a constant yield basis over the term of the loan. 2012 tax forms online The yield to maturity on your loan is 10. 2012 tax forms online 2467%, compounded annually. 2012 tax forms online For 2013, you can deduct $93 [($98,500 × . 2012 tax forms online 102467) − $10,000]. 2012 tax forms online For 2014, you can deduct $103 [($98,593 × . 2012 tax forms online 102467) − $10,000]. 2012 tax forms online Loan or mortgage ends. 2012 tax forms online   If your loan or mortgage ends, you may be able to deduct any remaining OID in the tax year in which the loan or mortgage ends. 2012 tax forms online A loan or mortgage may end due to a refinancing, prepayment, foreclosure, or similar event. 2012 tax forms online If you refinance with the original lender, you generally cannot deduct the remaining OID in the year in which the refinancing occurs, but you may be able to deduct it over the term of the new mortgage or loan. 2012 tax forms online See Interest paid with funds borrowed from original lender under Interest You Cannot Deduct, later. 2012 tax forms online Points. 2012 tax forms online   The term “points” is used to describe certain charges paid, or treated as paid, by a borrower to obtain a loan or a mortgage. 2012 tax forms online These charges are also called loan origination fees, maximum loan charges, discount points, or premium charges. 2012 tax forms online If any of these charges (points) are solely for the use of money, they are interest. 2012 tax forms online   Because points are prepaid interest, you generally cannot deduct the full amount in the year paid. 2012 tax forms online However, you can choose to fully deduct points in the year paid if you meet certain tests. 2012 tax forms online For exceptions to the general rule, see Publication 936. 2012 tax forms online The points reduce the issue price of the loan and result in original issue discount (OID), deductible as explained in the preceding discussion. 2012 tax forms online Partial payments on a nontax debt. 2012 tax forms online   If you make partial payments on a debt (other than a debt owed the IRS), the payments are applied, in general, first to interest and any remainder to principal. 2012 tax forms online You can deduct only the interest. 2012 tax forms online This rule does not apply when it can be inferred that the borrower and lender understood that a different allocation of the payments would be made. 2012 tax forms online Installment purchase. 2012 tax forms online   If you make an installment purchase of business property, the contract between you and the seller generally provides for the payment of interest. 2012 tax forms online If no interest or a low rate of interest is charged under the contract, a portion of the stated principal amount payable under the contract may be recharacterized as interest (unstated interest). 2012 tax forms online The amount recharacterized as interest reduces your basis in the property and increases your interest expense. 2012 tax forms online For more information on installment sales and unstated interest, see Publication 537. 2012 tax forms online Interest You Cannot Deduct Certain interest payments cannot be deducted. 2012 tax forms online In addition, certain other expenses that may seem to be interest but are not, cannot be deducted as interest. 2012 tax forms online You cannot currently deduct interest that must be capitalized, and you generally cannot deduct personal interest. 2012 tax forms online Interest paid with funds borrowed from original lender. 2012 tax forms online   If you use the cash method of accounting, you cannot deduct interest you pay with funds borrowed from the original lender through a second loan, an advance, or any other arrangement similar to a loan. 2012 tax forms online You can deduct the interest expense once you start making payments on the new loan. 2012 tax forms online   When you make a payment on the new loan, you first apply the payment to interest and then to the principal. 2012 tax forms online All amounts you apply to the interest on the first loan are deductible, along with any interest you pay on the second loan, subject to any limits that apply. 2012 tax forms online Capitalized interest. 2012 tax forms online   You cannot currently deduct interest you are required to capitalize under the uniform capitalization rules. 2012 tax forms online See Capitalization of Interest, later. 2012 tax forms online In addition, if you buy property and pay interest owed by the seller (for example, by assuming the debt and any interest accrued on the property), you cannot deduct the interest. 2012 tax forms online Add this interest to the basis of the property. 2012 tax forms online Commitment fees or standby charges. 2012 tax forms online   Fees you incur to have business funds available on a standby basis, but not for the actual use of the funds, are not deductible as interest payments. 2012 tax forms online You may be able to deduct them as business expenses. 2012 tax forms online   If the funds are for inventory or certain property used in your business, the fees are indirect costs and you generally must capitalize them under the uniform capitalization rules. 2012 tax forms online See Capitalization of Interest, later. 2012 tax forms online Interest on income tax. 2012 tax forms online   Interest charged on income tax assessed on your individual income tax return is not a business deduction even though the tax due is related to income from your trade or business. 2012 tax forms online Treat this interest as a business deduction only in figuring a net operating loss deduction. 2012 tax forms online Penalties. 2012 tax forms online   Penalties on underpaid deficiencies and underpaid estimated tax are not interest. 2012 tax forms online You cannot deduct them. 2012 tax forms online Generally, you cannot deduct any fines or penalties. 2012 tax forms online Interest on loans with respect to life insurance policies. 2012 tax forms online   You generally cannot deduct interest on a debt incurred with respect to any life insurance, annuity, or endowment contract that covers any individual unless that individual is a key person. 2012 tax forms online   If the policy or contract covers a key person, you can deduct the interest on up to $50,000 of debt for that person. 2012 tax forms online However, the deduction for any month cannot be more than the interest figured using Moody's Composite Yield on Seasoned Corporate Bonds (formerly known as Moody's Corporate Bond Yield Average-Monthly Average Corporates) (Moody's rate) for that month. 2012 tax forms online Who is a key person?   A key person is an officer or 20% owner. 2012 tax forms online However, the number of individuals you can treat as key persons is limited to the greater of the following. 2012 tax forms online Five individuals. 2012 tax forms online The lesser of 5% of the total officers and employees of the company or 20 individuals. 2012 tax forms online Exceptions for pre-June 1997 contracts. 2012 tax forms online   You can generally deduct the interest if the contract was issued before June 9, 1997, and the covered individual is someone other than an employee, officer, or someone financially interested in your business. 2012 tax forms online If the contract was purchased before June 21, 1986, you can generally deduct the interest no matter who is covered by the contract. 2012 tax forms online Interest allocated to unborrowed policy cash value. 2012 tax forms online   Corporations and partnerships generally cannot deduct any interest expense allocable to unborrowed cash values of life insurance, annuity, or endowment contracts. 2012 tax forms online This rule applies to contracts issued after June 8, 1997, that cover someone other than an officer, director, employee, or 20% owner. 2012 tax forms online For more information, see section 264(f) of the Internal Revenue Code. 2012 tax forms online Capitalization of Interest Under the uniform capitalization rules, you generally must capitalize interest on debt equal to your expenditures to produce real property or certain tangible personal property. 2012 tax forms online The property must be produced by you for use in your trade or business or for sale to customers. 2012 tax forms online You cannot capitalize interest related to property that you acquire in any other manner. 2012 tax forms online Interest you paid or incurred during the production period must be capitalized if the property produced is designated property. 2012 tax forms online Designated property is any of the following. 2012 tax forms online Real property. 2012 tax forms online Tangible personal property with a class life of 20 years or more. 2012 tax forms online Tangible personal property with an estimated production period of more than 2 years. 2012 tax forms online Tangible personal property with an estimated production period of more than 1 year if the estimated cost of production is more than $1 million. 2012 tax forms online Property you produce. 2012 tax forms online   You produce property if you construct, build, install, manufacture, develop, improve, create, raise, or grow it. 2012 tax forms online Treat property produced for you under a contract as produced by you up to the amount you pay or incur for the property. 2012 tax forms online Carrying charges. 2012 tax forms online   Carrying charges include taxes you pay to carry or develop real estate or to carry, transport, or install personal property. 2012 tax forms online You can choose to capitalize carrying charges not subject to the uniform capitalization rules if they are otherwise deductible. 2012 tax forms online For more information, see chapter 7. 2012 tax forms online Capitalized interest. 2012 tax forms online   Treat capitalized interest as a cost of the property produced. 2012 tax forms online You recover your interest when you sell or use the property. 2012 tax forms online If the property is inventory, recover capitalized interest through cost of goods sold. 2012 tax forms online If the property is used in your trade or business, recover capitalized interest through an adjustment to basis, depreciation, amortization, or other method. 2012 tax forms online Partnerships and S corporations. 2012 tax forms online   The interest capitalization rules are applied first at the partnership or S corporation level. 2012 tax forms online The rules are then applied at the partners' or shareholders' level to the extent the partnership or S corporation has insufficient debt to support the production or construction costs. 2012 tax forms online   If you are a partner or a shareholder, you may have to capitalize interest you incur during the tax year for the production costs of the partnership or S corporation. 2012 tax forms online You may also have to capitalize interest incurred by the partnership or S corporation for your own production costs. 2012 tax forms online To properly capitalize interest under these rules, you must be given the required information in an attachment to the Schedule K-1 you receive from the partnership or S corporation. 2012 tax forms online Additional information. 2012 tax forms online   The procedures for applying the uniform capitalization rules are beyond the scope of this publication. 2012 tax forms online For more information, see sections 1. 2012 tax forms online 263A-8 through 1. 2012 tax forms online 263A-15 of the regulations and Notice 88-99. 2012 tax forms online Notice 88-99 is in Cumulative Bulletin 1988-2. 2012 tax forms online When To Deduct Interest If the uniform capitalization rules, discussed under Capitalization of Interest, earlier, do not apply to you, deduct interest as follows. 2012 tax forms online Cash method. 2012 tax forms online   Under the cash method, you can generally deduct only the interest you actually paid during the tax year. 2012 tax forms online You cannot deduct a promissory note you gave as payment because it is a promise to pay and not an actual payment. 2012 tax forms online Prepaid interest. 2012 tax forms online   You generally cannot deduct any interest paid before the year it is due. 2012 tax forms online Interest paid in advance can be deducted only in the tax year in which it is due. 2012 tax forms online Discounted loan. 2012 tax forms online   If interest or a discount is subtracted from your loan proceeds, it is not a payment of interest and you cannot deduct it when you get the loan. 2012 tax forms online For more information, see Original issue discount (OID) under Interest You Can Deduct, earlier. 2012 tax forms online Refunds of interest. 2012 tax forms online   If you pay interest and then receive a refund in the same tax year of any part of the interest, reduce your interest deduction by the refund. 2012 tax forms online If you receive the refund in a later tax year, include the refund in your income to the extent the deduction for the interest reduced your tax. 2012 tax forms online Accrual method. 2012 tax forms online   Under an accrual method, you can deduct only interest that has accrued during the tax year. 2012 tax forms online Prepaid interest. 2012 tax forms online   See Prepaid interest, earlier. 2012 tax forms online Discounted loan. 2012 tax forms online   See Discounted loan, earlier. 2012 tax forms online Tax deficiency. 2012 tax forms online   If you contest a federal income tax deficiency, interest does not accrue until the tax year the final determination of liability is made. 2012 tax forms online If you do not contest the deficiency, then the interest accrues in the year the tax was asserted and agreed to by you. 2012 tax forms online   However, if you contest but pay the proposed tax deficiency and interest, and you do not designate the payment as a cash bond, then the interest is deductible in the year paid. 2012 tax forms online Related person. 2012 tax forms online   If you use an accrual method, you cannot deduct interest owed to a related person who uses the cash method until payment is made and the interest is includible in the gross income of that person. 2012 tax forms online The relationship is determined as of the end of the tax year for which the interest would otherwise be deductible. 2012 tax forms online See section 267 of the Internal Revenue Code for more information. 2012 tax forms online Below-Market Loans If you receive a below-market gift or demand loan and use the proceeds in your trade or business, you may be able to deduct the forgone interest. 2012 tax forms online See Treatment of gift and demand loans, later, in this discussion. 2012 tax forms online A below-market loan is a loan on which no interest is charged or on which interest is charged at a rate below the applicable federal rate. 2012 tax forms online A gift or demand loan that is a below-market loan generally is considered an arm's-length transaction in which you, the borrower, are considered as having received both the following. 2012 tax forms online A loan in exchange for a note that requires the payment of interest at the applicable federal rate. 2012 tax forms online An additional payment in an amount equal to the forgone interest. 2012 tax forms online The additional payment is treated as a gift, dividend, contribution to capital, payment of compensation, or other payment, depending on the substance of the transaction. 2012 tax forms online Forgone interest. 2012 tax forms online   For any period, forgone interest is The interest that would be payable for that period if interest accrued on the loan at the applicable federal rate and was payable annually on December 31, minus Any interest actually payable on the loan for the period. 2012 tax forms online Applicable federal rates are published by the IRS each month in the Internal Revenue Bulletin. 2012 tax forms online Internal Revenue Bulletins are available on the IRS web site at www. 2012 tax forms online irs. 2012 tax forms online gov/irb. 2012 tax forms online You can also contact an IRS office to get these rates. 2012 tax forms online Loans subject to the rules. 2012 tax forms online   The rules for below-market loans apply to the following. 2012 tax forms online Gift loans (below-market loans where the forgone interest is in the nature of a gift). 2012 tax forms online Compensation-related loans (below-market loans between an employer and an employee or between an independent contractor and a person for whom the contractor provides services). 2012 tax forms online Corporation-shareholder loans. 2012 tax forms online Tax avoidance loans (below-market loans where the avoidance of federal tax is one of the main purposes of the interest arrangement). 2012 tax forms online Loans to qualified continuing care facilities under a continuing care contract (made after October 11, 1985). 2012 tax forms online   Except as noted in (5) above, these rules apply to demand loans (loans payable in full at any time upon the lender's demand) outstanding after June 6, 1984, and to term loans (loans that are not demand loans) made after that date. 2012 tax forms online Treatment of gift and demand loans. 2012 tax forms online   If you receive a below-market gift loan or demand loan, you are treated as receiving an additional payment (as a gift, dividend, etc. 2012 tax forms online ) equal to the forgone interest on the loan. 2012 tax forms online You are then treated as transferring this amount back to the lender as interest. 2012 tax forms online These transfers are considered to occur annually, generally on December 31. 2012 tax forms online If you use the loan proceeds in your trade or business, you can deduct the forgone interest each year as a business interest expense. 2012 tax forms online The lender must report it as interest income. 2012 tax forms online Limit on forgone interest for gift loans of $100,000 or less. 2012 tax forms online   For gift loans between individuals, forgone interest treated as transferred back to the lender is limited to the borrower's net investment income for the year. 2012 tax forms online This limit applies if the outstanding loans between the lender and borrower total $100,000 or less. 2012 tax forms online If the borrower's net investment income is $1,000 or less, it is treated as zero. 2012 tax forms online This limit does not apply to a loan if the avoidance of any federal tax is one of the main purposes of the interest arrangement. 2012 tax forms online Treatment of term loans. 2012 tax forms online   If you receive a below-market term loan other than a gift or demand loan, you are treated as receiving an additional cash payment (as a dividend, etc. 2012 tax forms online ) on the date the loan is made. 2012 tax forms online This payment is equal to the loan amount minus the present value, at the applicable federal rate, of all payments due under the loan. 2012 tax forms online The same amount is treated as original issue discount on the loan. 2012 tax forms online See Original issue discount (OID) under Interest You Can Deduct, earlier. 2012 tax forms online Exceptions for loans of $10,000 or less. 2012 tax forms online   The rules for below-market loans do not apply to any day on which the total outstanding loans between the borrower and lender is $10,000 or less. 2012 tax forms online This exception applies only to the following. 2012 tax forms online Gift loans between individuals if the loan is not directly used to buy or carry income-producing assets. 2012 tax forms online Compensation-related loans or corporation-shareholder loans if the avoidance of any federal tax is not a principal purpose of the interest arrangement. 2012 tax forms online This exception does not apply to a term loan described in (2) above that was previously subject to the below-market loan rules. 2012 tax forms online Those rules will continue to apply even if the outstanding balance is reduced to $10,000 or less. 2012 tax forms online Exceptions for loans without significant tax effect. 2012 tax forms online   The following loans are specifically exempted from the rules for below-market loans because their interest arrangements do not have a significant effect on the federal tax liability of the borrower or the lender. 2012 tax forms online Loans made available by lenders to the general public on the same terms and conditions that are consistent with the lender's customary business practices. 2012 tax forms online Loans subsidized by a federal, state, or municipal government that are made available under a program of general application to the public. 2012 tax forms online Certain employee-relocation loans. 2012 tax forms online Certain loans to or from a foreign person, unless the interest income would be effectively connected with the conduct of a U. 2012 tax forms online S. 2012 tax forms online trade or business and not exempt from U. 2012 tax forms online S. 2012 tax forms online tax under an income tax treaty. 2012 tax forms online Any other loan if the taxpayer can show that the interest arrangement has no significant effect on the federal tax liability of the lender or the borrower. 2012 tax forms online Whether an interest arrangement has a significant effect on the federal tax liability of the lender or the borrower will be determined by all the facts and circumstances. 2012 tax forms online Consider all the following factors. 2012 tax forms online Whether items of income and deduction generated by the loan offset each other. 2012 tax forms online The amount of the items. 2012 tax forms online The cost of complying with the below-market loan provisions if they were to apply. 2012 tax forms online Any reasons, other than taxes, for structuring the transaction as a below-market loan. 2012 tax forms online Exception for loans to qualified continuing care facilities. 2012 tax forms online   The below-market interest rules do not apply to a loan owed by a qualified continuing care facility under a continuing care contract if the lender or lender's spouse is age 62 or older by the end of the calendar year. 2012 tax forms online A qualified continuing care facility is one or more facilities (excluding nursing homes) meeting the requirements listed below. 2012 tax forms online Designed to provide services under continuing care contracts (defined below). 2012 tax forms online Includes an independent living unit, and either an assisted living or nursing facility, or both. 2012 tax forms online Substantially all of the independent living unit residents are covered by continuing care contracts. 2012 tax forms online A continuing care contract is a written contract between an individual and a qualified continuing care facility that includes all of the following conditions. 2012 tax forms online The individual or individual's spouse must be entitled to use the facility for the rest of their life or lives. 2012 tax forms online The individual or individual's spouse will be provided with housing, as appropriate for the health of the individual or individual's spouse in an: independent living unit (which has additional available facilities outside the unit for the provision of meals and other personal care), and assisted living or nursing facility available in the continuing care facility. 2012 tax forms online The individual or individual's spouse will be provided with assisted living or nursing care available in the continuing care facility, as required for the health of the individual or the individual's spouse. 2012 tax forms online For more information, see section 7872(h) of the Internal Revenue Code. 2012 tax forms online Sale or exchange of property. 2012 tax forms online   Different rules generally apply to a loan connected with the sale or exchange of property. 2012 tax forms online If the loan does not provide adequate stated interest, part of the principal payment may be considered interest. 2012 tax forms online However, there are exceptions that may require you to apply the below-market interest rate rules to these loans. 2012 tax forms online See Unstated Interest and Original Issue Discount (OID) in Publication 537. 2012 tax forms online More information. 2012 tax forms online   For more information on below-market loans, see section 7872 of the Internal Revenue Code and section 1. 2012 tax forms online 7872-5 of the regulations. 2012 tax forms online Prev  Up  Next   Home   More Online Publications