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Freestatetaxreturn 7. Freestatetaxreturn   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. Freestatetaxreturn For most taxpayers, MAGI is the adjusted gross income as figured on their federal income tax return. Freestatetaxreturn There is no limit on the number of separate Coverdell ESAs that can be established for a designated beneficiary. Freestatetaxreturn However, total contributions for the beneficiary in any year cannot be more than $2,000, no matter how many accounts have been established. Freestatetaxreturn See Contributions , later. Freestatetaxreturn This benefit applies not only to higher education expenses, but also to elementary and secondary education expenses. Freestatetaxreturn What is the tax benefit of the Coverdell ESA. Freestatetaxreturn   Contributions to a Coverdell ESA are not deductible, but amounts deposited in the account grow tax free until distributed. Freestatetaxreturn   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. Freestatetaxreturn See Tax-Free Distributions , later. Freestatetaxreturn    Table 7-1 summarizes the main features of the Coverdell ESA. Freestatetaxreturn Table 7-1. Freestatetaxreturn Coverdell ESA at a Glance Do not rely on this table alone. Freestatetaxreturn It provides only general highlights. Freestatetaxreturn See the text for definitions of terms in bold type and for more complete explanations. Freestatetaxreturn Question Answer What is a Coverdell ESA? A savings account that is set up to pay the qualified education expenses of a designated beneficiary. Freestatetaxreturn 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. Freestatetaxreturn Who can have a Coverdell ESA? Any beneficiary who is under age 18 or is a special needs beneficiary. Freestatetaxreturn 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). Freestatetaxreturn Are distributions tax free? Yes, if the distributions are not more than the beneficiary's adjusted qualified education expenses for the year. Freestatetaxreturn 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. Freestatetaxreturn When the account is established, the designated beneficiary must be under age 18 or a special needs beneficiary. Freestatetaxreturn To be treated as a Coverdell ESA, the account must be designated as a Coverdell ESA when it is created. Freestatetaxreturn The document creating and governing the account must be in writing and must satisfy the following requirements. Freestatetaxreturn The trustee or custodian must be a bank or an entity approved by the IRS. Freestatetaxreturn The document must provide that the trustee or custodian can only accept a contribution that meets all of the following conditions. Freestatetaxreturn The contribution is in cash. Freestatetaxreturn The contribution is made before the beneficiary reaches age 18, unless the beneficiary is a special needs beneficiary. Freestatetaxreturn The contribution would not result in total contributions for the year (not including rollover contributions) being more than $2,000. Freestatetaxreturn Money in the account cannot be invested in life insurance contracts. Freestatetaxreturn Money in the account cannot be combined with other property except in a common trust fund or common investment fund. Freestatetaxreturn The balance in the account generally must be distributed within 30 days after the earlier of the following events. Freestatetaxreturn The beneficiary reaches age 30, unless the beneficiary is a special needs beneficiary. Freestatetaxreturn The beneficiary's death. Freestatetaxreturn Qualified Education Expenses Generally, these are expenses required for the enrollment or attendance of the designated beneficiary at an eligible educational institution. Freestatetaxreturn For purposes of Coverdell ESAs, the expenses can be either qualified higher education expenses or qualified elementary and secondary education expenses. Freestatetaxreturn Designated beneficiary. Freestatetaxreturn   This is the individual named in the document creating the trust or custodial account to receive the benefit of the funds in the account. Freestatetaxreturn Contributions to a qualified tuition program (QTP). Freestatetaxreturn   A contribution to a QTP is a qualified education expense if the contribution is on behalf of the designated beneficiary of the Coverdell ESA. Freestatetaxreturn 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. Freestatetaxreturn See chapter 8, Qualified Tuition Program . Freestatetaxreturn 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. Freestatetaxreturn Eligible postsecondary school. Freestatetaxreturn   This is any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the U. Freestatetaxreturn S. Freestatetaxreturn Department of Education. Freestatetaxreturn It includes virtually all accredited public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions. Freestatetaxreturn The educational institution should be able to tell you if it is an eligible educational institution. Freestatetaxreturn   Certain educational institutions located outside the United States also participate in the U. Freestatetaxreturn S. Freestatetaxreturn Department of Education's Federal Student Aid (FSA) programs. Freestatetaxreturn Eligible elementary or secondary school. Freestatetaxreturn   This is any public, private, or religious school that provides elementary or secondary education (kindergarten through grade 12), as determined under state law. Freestatetaxreturn Qualified Higher Education Expenses These are expenses related to enrollment or attendance at an eligible postsecondary school. Freestatetaxreturn 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. Freestatetaxreturn The following expenses must be required for enrollment or attendance of a designated beneficiary at an eligible postsecondary school. Freestatetaxreturn Tuition and fees. Freestatetaxreturn Books, supplies, and equipment. Freestatetaxreturn 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. Freestatetaxreturn Expenses for room and board must be incurred by students who are enrolled at least half-time (defined below). Freestatetaxreturn The expense for room and board qualifies only to the extent that it is not more than the greater of the following two amounts. Freestatetaxreturn 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. Freestatetaxreturn The actual amount charged if the student is residing in housing owned or operated by the school. Freestatetaxreturn Half-time student. Freestatetaxreturn   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. Freestatetaxreturn Qualified Elementary and Secondary Education Expenses These are expenses related to enrollment or attendance at an eligible elementary or secondary school. Freestatetaxreturn As shown in the following list, to be qualified, some of the expenses must be required or provided by the school. Freestatetaxreturn There are special rules for computer-related expenses. Freestatetaxreturn The following expenses must be incurred by a designated beneficiary in connection with enrollment or attendance at an eligible elementary or secondary school. Freestatetaxreturn Tuition and fees. Freestatetaxreturn Books, supplies, and equipment. Freestatetaxreturn Academic tutoring. Freestatetaxreturn Special needs services for a special needs beneficiary. Freestatetaxreturn The following expenses must be required or provided by an eligible elementary or secondary school in connection with attendance or enrollment at the school. Freestatetaxreturn Room and board. Freestatetaxreturn Uniforms. Freestatetaxreturn Transportation. Freestatetaxreturn Supplementary items and services (including extended day programs). Freestatetaxreturn 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. Freestatetaxreturn (This does not include expenses for computer software designed for sports, games, or hobbies unless the software is predominantly educational in nature. Freestatetaxreturn ) 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. Freestatetaxreturn For individuals filing joint returns, that amount is $220,000. Freestatetaxreturn Organizations, such as corporations and trusts, can also contribute to Coverdell ESAs. Freestatetaxreturn There is no requirement that an organization's income be below a certain level. Freestatetaxreturn Contributions must meet all of the following requirements. Freestatetaxreturn They must be in cash. Freestatetaxreturn They cannot be made after the beneficiary reaches age 18, unless the beneficiary is a special needs beneficiary. Freestatetaxreturn They must be made by the due date of the contributor's tax return (not including extensions). Freestatetaxreturn 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. Freestatetaxreturn Contributions can be made, without penalty, to both a Coverdell ESA and a QTP in the same year for the same beneficiary. Freestatetaxreturn Table 7-2 summarizes many of the features of contributing to a Coverdell ESA. Freestatetaxreturn When contributions considered made. Freestatetaxreturn   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. Freestatetaxreturn They must be made by the due date (not including extensions) for filing your return for the preceding year. Freestatetaxreturn   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. Freestatetaxreturn 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. Freestatetaxreturn Limit for each designated beneficiary. Freestatetaxreturn   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. Freestatetaxreturn This includes contributions (other than rollovers) to all the beneficiary's Coverdell ESAs from all sources. Freestatetaxreturn Rollovers are discussed under Rollovers and Other Transfers , later. Freestatetaxreturn Example. Freestatetaxreturn 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. Freestatetaxreturn In 2013, the total of all contributions to Maria's three Coverdell ESAs cannot be more than $2,000. Freestatetaxreturn 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. Freestatetaxreturn Or, if her parents contributed $1,000 and her aunt $600, her grandfather or someone else could contribute no more than $400. Freestatetaxreturn These contributions could be put into any of Maria's Coverdell ESA accounts. Freestatetaxreturn Limit for each contributor. Freestatetaxreturn   Generally, you can contribute up to $2,000 for each designated beneficiary for 2013. Freestatetaxreturn 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. Freestatetaxreturn Example. Freestatetaxreturn The facts are the same as in the previous example except that Maria Luna's older brother, Edgar, also has a Coverdell ESA. Freestatetaxreturn If their grandfather contributed $2,000 to Maria's Coverdell ESA in 2013, he could also contribute $2,000 to Edgar's Coverdell ESA. Freestatetaxreturn Reduced limit. Freestatetaxreturn   Your contribution limit may be reduced. Freestatetaxreturn 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). Freestatetaxreturn 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. Freestatetaxreturn Table 7-2. Freestatetaxreturn Coverdell ESA Contributions at a Glance Do not rely on this table alone. Freestatetaxreturn It provides only general highlights. Freestatetaxreturn See the text for more complete explanations. Freestatetaxreturn Question Answer Are contributions deductible? No. Freestatetaxreturn What is the annual contribution limit per designated beneficiary? $2,000 for each designated beneficiary. Freestatetaxreturn 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. Freestatetaxreturn 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. Freestatetaxreturn Can contributions other than cash be made to a Coverdell ESA? No. Freestatetaxreturn 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. Freestatetaxreturn Modified adjusted gross income (MAGI). Freestatetaxreturn   For most taxpayers, MAGI is adjusted gross income (AGI) as figured on their federal income tax return. Freestatetaxreturn MAGI when using Form 1040A. Freestatetaxreturn   If you file Form 1040A, your MAGI is the AGI on line 22 of that form. Freestatetaxreturn MAGI when using Form 1040. Freestatetaxreturn   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. Freestatetaxreturn MAGI when using Form 1040NR. Freestatetaxreturn   If you file Form 1040NR, your MAGI is the AGI on line 36 of that form. Freestatetaxreturn MAGI when using Form 1040NR-EZ. Freestatetaxreturn   If you file Form 1040NR-EZ, your MAGI is the AGI on line 10 of that form. Freestatetaxreturn   If you have any of these adjustments, you can use Worksheet 7-1. Freestatetaxreturn MAGI for a Coverdell ESA , later, to figure your MAGI for Form 1040. Freestatetaxreturn Worksheet 7-1. Freestatetaxreturn MAGI for a Coverdell ESA 1. Freestatetaxreturn Enter your adjusted gross income  (Form 1040, line 38)   1. Freestatetaxreturn   2. Freestatetaxreturn Enter your foreign earned income exclusion and/or housing exclusion (Form 2555, line 45, or Form 2555-EZ, line 18)   2. Freestatetaxreturn       3. Freestatetaxreturn Enter your foreign housing deduction (Form 2555, line 50)   3. Freestatetaxreturn         4. Freestatetaxreturn Enter the amount of income from Puerto Rico you are excluding   4. Freestatetaxreturn       5. Freestatetaxreturn Enter the amount of income from American Samoa you are excluding (Form 4563, line 15)   5. Freestatetaxreturn       6. Freestatetaxreturn Add lines 2, 3, 4, and 5   6. Freestatetaxreturn   7. Freestatetaxreturn Add lines 1 and 6. Freestatetaxreturn This is your  modified adjusted gross income   7. Freestatetaxreturn   Figuring the limit. Freestatetaxreturn    To figure the limit on the amount you can contribute for each designated beneficiary, multiply $2,000 by a fraction. Freestatetaxreturn The numerator (top number) is your MAGI minus $95,000 ($190,000 if filing a joint return). Freestatetaxreturn The denominator (bottom number) is $15,000 ($30,000 if filing a joint return). Freestatetaxreturn Subtract the result from $2,000. Freestatetaxreturn This is the amount you can contribute for each beneficiary. Freestatetaxreturn You can use Worksheet 7-2. Freestatetaxreturn Coverdell ESA Contribution Limit to figure the limit on contributions. Freestatetaxreturn    Worksheet 7-2. Freestatetaxreturn Coverdell ESA Contribution Limit 1. Freestatetaxreturn Maximum contribution   1. Freestatetaxreturn $2,000 2. Freestatetaxreturn 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. Freestatetaxreturn   3. Freestatetaxreturn Enter $190,000 if married filing jointly; $95,000 for all other filers   3. Freestatetaxreturn   4. Freestatetaxreturn Subtract line 3 from line 2. Freestatetaxreturn If zero or less, enter -0- on line 4, skip lines 5 through 7, and enter $2,000 on line 8   4. Freestatetaxreturn   5. Freestatetaxreturn Enter $30,000 if married filing jointly; $15,000 for all other filers   5. Freestatetaxreturn     Note. Freestatetaxreturn If the amount on line 4 is greater than or equal to the amount on line 5, stop here. Freestatetaxreturn You are not allowed to contribute to a Coverdell ESA for 2013. Freestatetaxreturn       6. Freestatetaxreturn Divide line 4 by line 5 and enter the result as a decimal (rounded to at least 3 places)   6. Freestatetaxreturn . Freestatetaxreturn 7. Freestatetaxreturn Multiply line 1 by line 6   7. Freestatetaxreturn   8. Freestatetaxreturn Subtract line 7 from line 1   8. Freestatetaxreturn   Note: The total Coverdell ESA contributions from all sources for the designated beneficiary during the tax year may not exceed $2,000. Freestatetaxreturn Example. Freestatetaxreturn Paul, who is single, had a MAGI of $96,500 for 2013. Freestatetaxreturn 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. Freestatetaxreturn Worksheet 7-2. Freestatetaxreturn Coverdell ESA Contribution Limit—Illustrated 1. Freestatetaxreturn Maximum contribution   1. Freestatetaxreturn $2,000 2. Freestatetaxreturn 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. Freestatetaxreturn 96,500 3. Freestatetaxreturn Enter $190,000 if married filing jointly; $95,000 for all other filers   3. Freestatetaxreturn 95,000 4. Freestatetaxreturn Subtract line 3 from line 2. Freestatetaxreturn If zero or less, enter -0- on line 4, skip lines 5 through 7, and enter $2,000 on line 8   4. Freestatetaxreturn 1,500 5. Freestatetaxreturn Enter $30,000 if married filing jointly; $15,000 for all other filers   5. Freestatetaxreturn 15,000   Note. Freestatetaxreturn If the amount on line 4 is greater than or equal to the amount on line 5,  stop here. Freestatetaxreturn You are not allowed to  contribute to a Coverdell ESA for 2013. Freestatetaxreturn       6. Freestatetaxreturn Divide line 4 by line 5 and enter the result as a decimal (rounded to at least 3 places)   6. Freestatetaxreturn . Freestatetaxreturn 100 7. Freestatetaxreturn Multiply line 1 by line 6   7. Freestatetaxreturn 200 8. Freestatetaxreturn Subtract line 7 from line 1   8. Freestatetaxreturn 1,800 Note: The total Coverdell ESA contributions from all sources for the designated beneficiary during the tax year may not exceed $2,000. Freestatetaxreturn 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. Freestatetaxreturn Excess contributions are the total of the following two amounts. Freestatetaxreturn 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). Freestatetaxreturn 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. Freestatetaxreturn Exceptions. Freestatetaxreturn   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). Freestatetaxreturn   However, you must include the distributed earnings in gross income for the year in which the excess contribution was made. Freestatetaxreturn You should receive Form 1099-Q, Payments From Qualified Education Programs, from each institution from which excess contributions were distributed. Freestatetaxreturn Box 2 of that form will show the amount of earnings on your excess contributions. Freestatetaxreturn Code “2” or “3” entered in the blank box below boxes 5 and 6 indicate the year in which the earnings are taxable. Freestatetaxreturn See Instructions for Recipient on the back of copy B of your Form 1099-Q. Freestatetaxreturn Enter the amount of earnings on line 21 of Form 1040 (or Form 1040NR) for the applicable tax year. Freestatetaxreturn For more information, see Taxable Distributions , later. Freestatetaxreturn   The excise tax does not apply to any rollover contribution. Freestatetaxreturn Note. Freestatetaxreturn Contributions made in one year for the preceding tax year are considered to have been made on the last day of the preceding year. Freestatetaxreturn Example. Freestatetaxreturn In 2012, Greta's parents and grandparents contributed a total of $2,300 to Greta's Coverdell ESA— an excess contribution of $300. Freestatetaxreturn 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. Freestatetaxreturn 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. Freestatetaxreturn 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. Freestatetaxreturn (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. Freestatetaxreturn Figuring and reporting the additional tax. Freestatetaxreturn   You figure this excise tax in Part V of Form 5329. Freestatetaxreturn Report the additional tax on Form 1040, line 58 (or Form 1040NR, line 56). Freestatetaxreturn Rollovers and Other Transfers Assets can be rolled over from one Coverdell ESA to another or the designated beneficiary can be changed. Freestatetaxreturn The beneficiary's interest can be transferred to a spouse or former spouse because of divorce. Freestatetaxreturn 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. Freestatetaxreturn This age limitation does not apply if the new beneficiary is a special needs beneficiary. Freestatetaxreturn An amount is rolled over if it is paid to another Coverdell ESA within 60 days after the date of the distribution. Freestatetaxreturn Do not report qualifying rollovers (those that meet the above criteria) anywhere on Form 1040 or 1040NR. Freestatetaxreturn These are not taxable distributions. Freestatetaxreturn Members of the beneficiary's family. Freestatetaxreturn   For these purposes, the beneficiary's family includes the beneficiary's spouse and the following other relatives of the beneficiary. Freestatetaxreturn Son, daughter, stepchild, foster child, adopted child, or a descendant of any of them. Freestatetaxreturn Brother, sister, stepbrother, or stepsister. Freestatetaxreturn Father or mother or ancestor of either. Freestatetaxreturn Stepfather or stepmother. Freestatetaxreturn Son or daughter of a brother or sister. Freestatetaxreturn Brother or sister of father or mother. Freestatetaxreturn Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law. Freestatetaxreturn The spouse of any individual listed above. Freestatetaxreturn First cousin. Freestatetaxreturn Example. Freestatetaxreturn When Aaron graduated from college last year he had $5,000 left in his Coverdell ESA. Freestatetaxreturn He wanted to give this money to his younger sister, who was still in high school. Freestatetaxreturn 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. Freestatetaxreturn Only one rollover per Coverdell ESA is allowed during the 12-month period ending on the date of the payment or distribution. Freestatetaxreturn This rule does not apply to the rollover of a military death gratuity or payment from Servicemembers' Group Life Insurance (SGLI). Freestatetaxreturn Military death gratuity. Freestatetaxreturn   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). Freestatetaxreturn Such payments are made to an eligible survivor upon the death of a member of the armed forces. Freestatetaxreturn 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. Freestatetaxreturn   This rollover contribution is not subject to (but is in addition to) the contribution limits discussed earlier under Contribution Limits . Freestatetaxreturn 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. Freestatetaxreturn   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. Freestatetaxreturn See Distributions , later. Freestatetaxreturn The limit of one rollover per Coverdell ESA during a 12-month period does not apply to a military death gratuity or SGLI payment. Freestatetaxreturn Changing the Designated Beneficiary The designated beneficiary can be changed. Freestatetaxreturn See Members of the beneficiary's family , earlier. Freestatetaxreturn 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. Freestatetaxreturn Example. Freestatetaxreturn Assume the same situation for Aaron as in the last example (see Rollovers , earlier). Freestatetaxreturn 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. Freestatetaxreturn 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. Freestatetaxreturn After the transfer, the spouse or former spouse treats the Coverdell ESA as his or her own. Freestatetaxreturn Example. Freestatetaxreturn In their divorce settlement, Peg received her ex-husband's Coverdell ESA. Freestatetaxreturn In this process, the account was transferred into her name. Freestatetaxreturn Peg now treats the funds in this Coverdell ESA as if she were the original owner. Freestatetaxreturn Distributions The designated beneficiary of a Coverdell ESA can take a distribution at any time. Freestatetaxreturn 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. Freestatetaxreturn See Table 7-3, Coverdell ESA Distributions at a Glance, for highlights. Freestatetaxreturn Table 7-3. Freestatetaxreturn Coverdell ESA Distributions at a Glance Do not rely on this table alone. Freestatetaxreturn It provides only general highlights. Freestatetaxreturn See the text for definitions of terms in bold type and for more complete explanations. Freestatetaxreturn 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. Freestatetaxreturn After the designated beneficiary completes his or her education at an eligible educational institution, can amounts remaining in the Coverdell ESA be distributed? Yes. Freestatetaxreturn Amounts must be distributed when the designated beneficiary reaches age 30, unless he or she is a special needs beneficiary. Freestatetaxreturn Also, certain transfers to members of the beneficiary's family are permitted. Freestatetaxreturn Does the designated beneficiary need to be enrolled for a minimum number of courses to take a tax-free distribution? No. Freestatetaxreturn Adjusted qualified education expenses. Freestatetaxreturn   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. Freestatetaxreturn 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. Freestatetaxreturn The amount you get by subtracting tax-free educational assistance from your total qualified education expenses is your adjusted qualified education expenses. Freestatetaxreturn Tax-Free Distributions Generally, distributions are tax free if they are not more than the beneficiary's adjusted qualified education expenses for the year. Freestatetaxreturn Do not report tax-free distributions (including qualifying rollovers) on your tax return. Freestatetaxreturn 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. Freestatetaxreturn Excess distribution. Freestatetaxreturn   This is the part of the total distribution that is more than the beneficiary's adjusted qualified education expenses for the year. Freestatetaxreturn Earnings and basis. Freestatetaxreturn   You will receive a Form 1099-Q for each of the Coverdell ESAs from which money was distributed in 2013. Freestatetaxreturn The amount of your gross distribution will be shown in box 1. Freestatetaxreturn 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. Freestatetaxreturn This will be shown in the blank box below boxes 5 and 6. Freestatetaxreturn   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. Freestatetaxreturn 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. Freestatetaxreturn Figure the taxable portion for 2013 as shown in the following steps. Freestatetaxreturn Multiply the total amount distributed by a fraction. Freestatetaxreturn 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. Freestatetaxreturn Subtract the amount figured in (1) from the total amount distributed during 2013. Freestatetaxreturn The result is the amount of earnings included in the distribution(s). Freestatetaxreturn Multiply the amount of earnings figured in (2) by a fraction. Freestatetaxreturn The numerator is the adjusted qualified education expenses paid during 2013 and the denominator is the total amount distributed during 2013. Freestatetaxreturn Subtract the amount figured in (3) from the amount figured in (2). Freestatetaxreturn The result is the amount the beneficiary must include in income. Freestatetaxreturn The taxable amount must be reported on Form 1040 or Form 1040NR, line 21. Freestatetaxreturn Example. Freestatetaxreturn You received an $850 distribution from your Coverdell ESA, to which $1,500 had been contributed before 2013. Freestatetaxreturn There were no contributions in 2013. Freestatetaxreturn This is your first distribution from the account, so your basis in the account on December 31, 2012, was $1,500. Freestatetaxreturn The value (balance) of your account on December 31, 2013, was $950. Freestatetaxreturn You had $700 of adjusted qualified education expenses (AQEE) for the year. Freestatetaxreturn Using the steps in Figuring the Taxable Portion of a Distribution , earlier, figure the taxable portion of your distribution as follows. Freestatetaxreturn   1. Freestatetaxreturn $850 (distribution) × $1,500 basis + $0 contributions  $950 value + $850 distribution       =$708 (basis portion of distribution)     2. Freestatetaxreturn $850 (distribution)−$708 (basis portion of distribution)     =$142 (earnings included in distribution)   3. Freestatetaxreturn $142 (earnings) × $700 AQEE  $850 distribution           =$117 (tax-free earnings)     4. Freestatetaxreturn $142 (earnings)−$117 (tax-free earnings)=$25 (taxable earnings)                 You must include $25 in income as distributed earnings not used for qualified education expenses. Freestatetaxreturn Report this amount on Form 1040, line 21, listing the type and amount of income on the dotted line. Freestatetaxreturn 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). Freestatetaxreturn 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. Freestatetaxreturn 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. Freestatetaxreturn Example. Freestatetaxreturn Derek Green had $5,800 of qualified higher education expenses for 2013, his first year in college. Freestatetaxreturn He paid his college expenses from the following sources. Freestatetaxreturn     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. Freestatetaxreturn Derek's parents claimed a $2,500 American opportunity credit (based on $4,000 expenses) on their tax return. Freestatetaxreturn Before Derek can determine the taxable portion of his Coverdell ESA distribution, he must reduce his total qualified higher education expenses. Freestatetaxreturn     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. Freestatetaxreturn The balance in Derek's account was $1,800 on December 31, 2013. Freestatetaxreturn Prior to 2013, $2,100 had been contributed to this account. Freestatetaxreturn Contributions for 2013 totaled $400. Freestatetaxreturn Using the four steps outlined earlier, Derek figures the taxable portion of his distribution as shown below. Freestatetaxreturn   1. Freestatetaxreturn $1,000 (distribution) × $2,100 basis + $400 contributions  $1,800 value + $1,000 distribution           =$893 (basis portion of distribution)     2. Freestatetaxreturn $1,000 (distribution)−$893 (basis portion of distribution)     = $107 (earnings included in distribution)   3. Freestatetaxreturn $107 (earnings) × $300 AQHEE  $1,000 distribution       =$32 (tax-free earnings)     4. Freestatetaxreturn $107 (earnings)−$32 (tax-free earnings)=$75 (taxable earnings)                 Derek must include $75 in income (Form 1040, line 21). Freestatetaxreturn This is the amount of distributed earnings not used for adjusted qualified higher education expenses. Freestatetaxreturn 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. Freestatetaxreturn The following two examples illustrate possible allocations. Freestatetaxreturn Example 1. Freestatetaxreturn In 2013, Beatrice graduated from high school and began her first semester of college. Freestatetaxreturn 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. Freestatetaxreturn To pay these expenses, Beatrice withdrew $800 from her Coverdell ESA and $4,200 from her QTP. Freestatetaxreturn No one claimed Beatrice as a dependent, nor was she eligible for an education credit. Freestatetaxreturn She did not receive any tax-free educational assistance in 2013. Freestatetaxreturn Beatrice must allocate her total qualified education expenses between the two distributions. Freestatetaxreturn 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. Freestatetaxreturn The qualified expenses are greater than the distribution, making the $800 Coverdell ESA distribution tax free. Freestatetaxreturn 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). Freestatetaxreturn 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. Freestatetaxreturn Finally, Beatrice figures the taxable and tax-free portions of her QTP distribution based on her $3,000 of QHEE. Freestatetaxreturn (See Figuring the Taxable Portion of a Distribution in chapter 8, Qualified Tuition Program for more information. Freestatetaxreturn ) Example 2. Freestatetaxreturn Assume the same facts as in Example 1 , except that Beatrice withdrew $1,800 from her Coverdell ESA and $3,200 from her QTP. Freestatetaxreturn In this case, she allocates her qualified education expenses as follows. Freestatetaxreturn 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. Freestatetaxreturn 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). Freestatetaxreturn   $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). Freestatetaxreturn See Figuring the Taxable Portion of a Distribution , earlier, in this chapter. Freestatetaxreturn   QTP distribution based on her $2,400 of QHEE (see Figuring the Taxable Portion of a Distribution in chapter 8, Qualified Tuition Program). Freestatetaxreturn The above examples show two types of allocation between distributions from a Coverdell ESA and a QTP. Freestatetaxreturn However, you do not have to allocate your expenses in the same way. Freestatetaxreturn You can use any reasonable method. Freestatetaxreturn 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. Freestatetaxreturn 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. Freestatetaxreturn Your basis is the total amount of contributions to that Coverdell ESA. Freestatetaxreturn 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. Freestatetaxreturn If you have distributions from more than one Coverdell ESA account during a year, you must combine the information (amount of distribution, basis, etc. Freestatetaxreturn ) from all such accounts in order to determine your taxable earnings for the year. Freestatetaxreturn By doing this, the loss from one ESA account reduces the distributed earnings (if any) from any other ESA account. Freestatetaxreturn For examples of the calculation, see Losses on QTP Investments in chapter 8, Qualified Tuition Program. Freestatetaxreturn 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. Freestatetaxreturn Exceptions. Freestatetaxreturn   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. Freestatetaxreturn Made because the designated beneficiary is disabled. Freestatetaxreturn 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. Freestatetaxreturn 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. Freestatetaxreturn 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. Freestatetaxreturn Made on account of the attendance of the designated beneficiary at a U. Freestatetaxreturn S. Freestatetaxreturn military academy (such as the USMA at West Point). Freestatetaxreturn 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. Freestatetaxreturn S. Freestatetaxreturn Code) attributable to such attendance. Freestatetaxreturn 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). Freestatetaxreturn Made before June 1, 2014, of an excess 2013 contribution (and any earnings on it). Freestatetaxreturn The distributed earnings must be included in gross income for the year in which the excess contribution was made. Freestatetaxreturn Exception (3) applies only to the extent the distribution is not more than the scholarship, allowance, or payment. Freestatetaxreturn Figuring the additional tax. Freestatetaxreturn    Use Part II of Form 5329, to figure any additional tax. Freestatetaxreturn Report the amount on Form 1040, line 58, or Form 1040NR, line 56. Freestatetaxreturn When Assets Must Be Distributed Any assets remaining in a Coverdell ESA must be distributed when either one of the following two events occurs. Freestatetaxreturn The designated beneficiary reaches age 30. Freestatetaxreturn In this case, the remaining assets must be distributed within 30 days after the beneficiary reaches age 30. Freestatetaxreturn However, this rule does not apply if the beneficiary is a special needs beneficiary. Freestatetaxreturn The designated beneficiary dies before reaching age 30. Freestatetaxreturn In this case, the remaining assets must generally be distributed within 30 days after the date of death. Freestatetaxreturn 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. Freestatetaxreturn (“Family member” was defined earlier under Rollovers . Freestatetaxreturn ) 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. Freestatetaxreturn This age limitation does not apply if the new beneficiary is a special needs beneficiary. Freestatetaxreturn There are no tax consequences as a result of the transfer. Freestatetaxreturn 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. Freestatetaxreturn You determine these earnings as shown in the following two steps. Freestatetaxreturn Multiply the amount distributed by a fraction. Freestatetaxreturn 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. Freestatetaxreturn Subtract the amount figured in (1) from the total amount distributed during 2013. Freestatetaxreturn The result is the amount of earnings included in the distribution. Freestatetaxreturn For an example, see steps (1) and (2) of the Example under Figuring the Taxable Portion of a Distribution, earlier. Freestatetaxreturn 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. Freestatetaxreturn Worksheet 7-3 Instructions. Freestatetaxreturn Coverdell ESA—Taxable Distributions and Basis Line G. Freestatetaxreturn Enter the total distributions received from all Coverdell ESAs during 2013. Freestatetaxreturn Do not include amounts rolled over to another ESA within 60 days (only one rollover is allowed during any 12-month period). Freestatetaxreturn 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. Freestatetaxreturn Line 2. Freestatetaxreturn 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. Freestatetaxreturn   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. Freestatetaxreturn 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. Freestatetaxreturn For years after 2001, you can find that amount by using the ending basis from the worksheet in Publication 970 for that year. Freestatetaxreturn 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. Freestatetaxreturn Line 4. Freestatetaxreturn Enter the total distributions received from this Coverdell ESA in 2013. Freestatetaxreturn Do not include amounts rolled over to another Coverdell ESA within 60 days (only one rollover is allowed during any 12-month period). Freestatetaxreturn   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. Freestatetaxreturn Line 7. Freestatetaxreturn 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. Freestatetaxreturn A statement should be sent to you by January 31, 2014, for this Coverdell ESA showing the value on December 31, 2013. Freestatetaxreturn   A rollover is a tax-free withdrawal from one Coverdell ESA that is contributed to another Coverdell ESA. Freestatetaxreturn 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. Freestatetaxreturn Worksheet 7-3. Freestatetaxreturn Coverdell ESA—Taxable Distributions and Basis How to complete this worksheet. Freestatetaxreturn • • • Complete Part I, lines A through H, on only one worksheet. Freestatetaxreturn  Complete a separate Part II, lines 1 through 15, for each of your Coverdell ESAs. Freestatetaxreturn  Complete Part III, the Summary (line 16), on only one worksheet. Freestatetaxreturn Part I. Freestatetaxreturn Qualified Education Expenses (Complete for total expenses)       A. Freestatetaxreturn Enter your total qualified education expenses for 2013   A. Freestatetaxreturn   B. Freestatetaxreturn 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. Freestatetaxreturn         C. Freestatetaxreturn Enter those qualified higher education expenses deducted on Schedule C or C-EZ (Form 1040). Freestatetaxreturn Schedule F (Form 1040), or as a miscellaneous itemized deduction on Schedule A (Form 1040 or 1040NR)   C. Freestatetaxreturn         D. Freestatetaxreturn Enter those qualified higher education expenses on which  an American opportunity or lifetime learning credit was based   D. Freestatetaxreturn         E. Freestatetaxreturn Add lines B, C, and D   D. Freestatetaxreturn   F. Freestatetaxreturn Subtract line E from line A. Freestatetaxreturn This is your adjusted qualified education expense for 2013   E. Freestatetaxreturn   G. Freestatetaxreturn Enter your total distributions from all Coverdell ESAs during 2013. Freestatetaxreturn Do not include rollovers  or the return of excess contributions (see instructions)   F. Freestatetaxreturn   H. Freestatetaxreturn Divide line F by line G. Freestatetaxreturn Enter the result as a decimal (rounded to at least 3 places). Freestatetaxreturn If the  result is 1. Freestatetaxreturn 000 or more, enter 1. Freestatetaxreturn 000   G. Freestatetaxreturn . Freestatetaxreturn Part II. Freestatetaxreturn Taxable Distributions and Basis (Complete separately for each account) 1. Freestatetaxreturn Enter the amount contributed to this Coverdell ESA for 2013, including contributions made for 2013 from January 1, 2014, through April 15, 2014. Freestatetaxreturn Do not include rollovers or the return of excess contributions   1. Freestatetaxreturn   2. Freestatetaxreturn Enter your basis in this Coverdell ESA as of December 31, 2012 (see instructions)   2. Freestatetaxreturn   3. Freestatetaxreturn Add lines 1 and 2   3. Freestatetaxreturn   4. Freestatetaxreturn Enter the total distributions from this Coverdell ESA during 2013. Freestatetaxreturn Do not include rollovers  or the return of excess contributions (see instructions)   4. Freestatetaxreturn   5. Freestatetaxreturn Multiply line 4 by line H. Freestatetaxreturn This is the amount of adjusted qualified  education expense attributable to this Coverdell ESA   5. Freestatetaxreturn         6. Freestatetaxreturn Subtract line 5 from line 4   6. Freestatetaxreturn         7. Freestatetaxreturn Enter the total value of this Coverdell ESA as of December 31, 2013,  plus any outstanding rollovers (see instructions)   7. Freestatetaxreturn         8. Freestatetaxreturn Add lines 4 and 7   8. Freestatetaxreturn         9. Freestatetaxreturn Divide line 3 by line 8. Freestatetaxreturn Enter the result as a decimal (rounded to  at least 3 places). Freestatetaxreturn If the result is 1. Freestatetaxreturn 000 or more, enter 1. Freestatetaxreturn 000   9. Freestatetaxreturn . Freestatetaxreturn       10. Freestatetaxreturn Multiply line 4 by line 9. Freestatetaxreturn This is the amount of basis allocated to your  distributions, and is tax free   10. Freestatetaxreturn     Note. Freestatetaxreturn If line 6 is zero, skip lines 11 through 13, enter -0- on line 14, and go to line 15. Freestatetaxreturn       11. Freestatetaxreturn Subtract line 10 from line 4   11. Freestatetaxreturn   12. Freestatetaxreturn Divide line 5 by line 4. Freestatetaxreturn Enter the result as a decimal (rounded to  at least 3 places). Freestatetaxreturn If the result is 1. Freestatetaxreturn 000 or more, enter 1. Freestatetaxreturn 000   12. Freestatetaxreturn . Freestatetaxreturn       13. Freestatetaxreturn Multiply line 11 by line 12. Freestatetaxreturn This is the amount of qualified education  expenses allocated to your distributions, and is tax free   13. Freestatetaxreturn   14. Freestatetaxreturn Subtract line 13 from line 11. Freestatetaxreturn This is the portion of the distributions from this  Coverdell ESA in 2013 that you must include in income   14. Freestatetaxreturn   15. Freestatetaxreturn Subtract line 10 from line 3. Freestatetaxreturn This is your basis in this Coverdell ESA as of December 31, 2013   15. Freestatetaxreturn   Part III. Freestatetaxreturn Summary (Complete only once)       16. Freestatetaxreturn Taxable amount. Freestatetaxreturn Add together all amounts on line 14 for all your Coverdell ESAs. Freestatetaxreturn 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. Freestatetaxreturn   Prev  Up  Next   Home   More Online Publications
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The Freestatetaxreturn

Freestatetaxreturn 8. Freestatetaxreturn   Business Expenses Table of Contents Introduction Useful Items - You may want to see: Bad DebtsAccrual method. Freestatetaxreturn Cash method. Freestatetaxreturn Car and Truck ExpensesOffice in the home. Freestatetaxreturn Methods for Deducting Car and Truck Expenses Reimbursing Your Employees for Expenses Depreciation Employees' PayFringe benefits. Freestatetaxreturn InsuranceHow to figure the deduction. Freestatetaxreturn Interest Legal and Professional FeesTax preparation fees. Freestatetaxreturn Pension Plans Rent Expense Taxes Travel, Meals, and EntertainmentTransportation. Freestatetaxreturn Taxi, commuter bus, and limousine. Freestatetaxreturn Baggage and shipping. Freestatetaxreturn Car or truck. Freestatetaxreturn Meals and lodging. Freestatetaxreturn Cleaning. Freestatetaxreturn Telephone. Freestatetaxreturn Tips. Freestatetaxreturn More information. Freestatetaxreturn Business Use of Your HomeExceptions to exclusive use. Freestatetaxreturn Other Expenses You Can Deduct Expenses You Cannot Deduct Introduction You can deduct the costs of operating your business. Freestatetaxreturn These costs are known as business expenses. Freestatetaxreturn These are costs you do not have to capitalize or include in the cost of goods sold but can deduct in the current year. Freestatetaxreturn To be deductible, a business expense must be both ordinary and necessary. Freestatetaxreturn An ordinary expense is one that is common and accepted in your field of business. Freestatetaxreturn A necessary expense is one that is helpful and appropriate for your business. Freestatetaxreturn An expense does not have to be indispensable to be considered necessary. Freestatetaxreturn For more information about the general rules for deducting business expenses, see chapter 1 in Publication 535, Business Expenses. Freestatetaxreturn If you have an expense that is partly for business and partly personal, separate the personal part from the business part. Freestatetaxreturn The personal part is not deductible. Freestatetaxreturn Useful Items - You may want to see: Publication 463 Travel, Entertainment, Gift, and Car Expenses 535 Business Expenses 946 How To Depreciate Property See chapter 12 for information about getting publications and forms. Freestatetaxreturn Bad Debts If someone owes you money you cannot collect, you have a bad debt. Freestatetaxreturn There are two kinds of bad debts, business bad debts and nonbusiness bad debts. Freestatetaxreturn A business bad debt is generally one that comes from operating your trade or business. Freestatetaxreturn You may be able to deduct business bad debts as an expense on your business tax return. Freestatetaxreturn Business bad debt. Freestatetaxreturn   A business bad debt is a loss from the worthlessness of a debt that was either of the following. Freestatetaxreturn Created or acquired in your business. Freestatetaxreturn Closely related to your business when it became partly or totally worthless. Freestatetaxreturn A debt is closely related to your business if your primary motive for incurring the debt is a business reason. Freestatetaxreturn   Business bad debts are mainly the result of credit sales to customers. Freestatetaxreturn They can also be the result of loans to suppliers, clients, employees, or distributors. Freestatetaxreturn Goods and services customers have not paid for are shown in your books as either accounts receivable or notes receivable. Freestatetaxreturn If you are unable to collect any part of these accounts or notes receivable, the uncollectible part is a business bad debt. Freestatetaxreturn    You can take a bad debt deduction for these accounts and notes receivable only if the amount you were owed was included in your gross income either for the year the deduction is claimed or for a prior year. Freestatetaxreturn Accrual method. Freestatetaxreturn   If you use an accrual method of accounting, you normally report income as you earn it. Freestatetaxreturn You can take a bad debt deduction for an uncollectible receivable if you have included the uncollectible amount in income. Freestatetaxreturn Cash method. Freestatetaxreturn   If you use the cash method of accounting, you normally report income when you receive payment. Freestatetaxreturn You cannot take a bad debt deduction for amounts owed to you that you have not received and cannot collect if you never included those amounts in income. Freestatetaxreturn More information. Freestatetaxreturn   For more information about business bad debts, see chapter 10 in Publication 535. Freestatetaxreturn Nonbusiness bad debts. Freestatetaxreturn   All other bad debts are nonbusiness bad debts and are deductible as short-term capital losses on Form 8949 and Schedule D (Form 1040). Freestatetaxreturn For more information on nonbusiness bad debts, see Publication 550, Investment Income and Expenses. Freestatetaxreturn Car and Truck Expenses If you use your car or truck in your business, you may be able to deduct the costs of operating and maintaining your vehicle. Freestatetaxreturn You also may be able to deduct other costs of local transportation and traveling away from home overnight on business. Freestatetaxreturn You may qualify for a tax credit for qualified plug-in electric vehicles, qualified plug-in electric drive motor vehicles, and alternative motor vehicles you place in service during the year. Freestatetaxreturn See Form 8936 and Form 8910 for more information. Freestatetaxreturn Local transportation expenses. Freestatetaxreturn   Local transportation expenses include the ordinary and necessary costs of all the following. Freestatetaxreturn Getting from one workplace to another in the course of your business or profession when you are traveling within the city or general area that is your tax home. Freestatetaxreturn Tax home is defined later. Freestatetaxreturn Visiting clients or customers. Freestatetaxreturn Going to a business meeting away from your regular workplace. Freestatetaxreturn Getting from your home to a temporary workplace when you have one or more regular places of work. Freestatetaxreturn These temporary workplaces can be either within the area of your tax home or outside that area. Freestatetaxreturn Local business transportation does not include expenses you have while traveling away from home overnight. Freestatetaxreturn Those expenses are deductible as travel expenses and are discussed later under Travel, Meals, and Entertainment. Freestatetaxreturn However, if you use your car while traveling away from home overnight, use the rules in this section to figure your car expense deduction. Freestatetaxreturn   Generally, your tax home is your regular place of business, regardless of where you maintain your family home. Freestatetaxreturn It includes the entire city or general area in which your business or work is located. Freestatetaxreturn Example. Freestatetaxreturn You operate a printing business out of rented office space. Freestatetaxreturn You use your van to deliver completed jobs to your customers. Freestatetaxreturn You can deduct the cost of round-trip transportation between your customers and your print shop. Freestatetaxreturn    You cannot deduct the costs of driving your car or truck between your home and your main or regular workplace. Freestatetaxreturn These costs are personal commuting expenses. Freestatetaxreturn Office in the home. Freestatetaxreturn   Your workplace can be your home if you have an office in your home that qualifies as your principal place of business. Freestatetaxreturn For more information, see Business Use of Your Home, later. Freestatetaxreturn Example. Freestatetaxreturn You are a graphics designer. Freestatetaxreturn You operate your business out of your home. Freestatetaxreturn Your home qualifies as your principal place of business. Freestatetaxreturn You occasionally have to drive to your clients to deliver your completed work. Freestatetaxreturn You can deduct the cost of the round-trip transportation between your home and your clients. Freestatetaxreturn Methods for Deducting Car and Truck Expenses For local transportation or overnight travel by car or truck, you generally can use one of the following methods to figure your expenses. Freestatetaxreturn Standard mileage rate. Freestatetaxreturn Actual expenses. Freestatetaxreturn Standard mileage rate. Freestatetaxreturn   You may be able to use the standard mileage rate to figure the deductible costs of operating your car, van, pickup, or panel truck for business purposes. Freestatetaxreturn For 2013, the standard mileage rate is 56. Freestatetaxreturn 5 cents per mile. Freestatetaxreturn    If you choose to use the standard mileage rate for a year, you cannot deduct your actual expenses for that year except for business-related parking fees and tolls. Freestatetaxreturn Choosing the standard mileage rate. Freestatetaxreturn   If you want to use the standard mileage rate for a car or truck you own, you must choose to use it in the first year the car is available for use in your business. Freestatetaxreturn In later years, you can choose to use either the standard mileage rate or actual expenses. Freestatetaxreturn   If you use the standard mileage rate for a car you lease, you must choose to use it for the entire lease period (including renewals). Freestatetaxreturn Standard mileage rate not allowed. Freestatetaxreturn   You cannot use the standard mileage rate if you: Operate five or more cars at the same time, Claimed a depreciation deduction using any method other than straight line, for example, ACRS or MACRS, Claimed a section 179 deduction on the car, Claimed the special depreciation allowance on the car, Claimed actual car expenses for a car you leased, or Are a rural mail carrier who received a qualified reimbursement. Freestatetaxreturn Parking fees and tolls. Freestatetaxreturn   In addition to using the standard mileage rate, you can deduct any business-related parking fees and tolls. Freestatetaxreturn (Parking fees you pay to park your car at your place of work are nondeductible commuting expenses. Freestatetaxreturn ) Actual expenses. Freestatetaxreturn   If you do not choose to use the standard mileage rate, you may be able to deduct your actual car or truck expenses. Freestatetaxreturn    If you qualify to use both methods, figure your deduction both ways to see which gives you a larger deduction. Freestatetaxreturn   Actual car expenses include the costs of the following items. Freestatetaxreturn Depreciation Lease payments Registration Garage rent Licenses Repairs Gas Oil Tires Insurance Parking fees Tolls   If you use your vehicle for both business and personal purposes, you must divide your expenses between business and personal use. Freestatetaxreturn You can divide your expenses based on the miles driven for each purpose. Freestatetaxreturn Example. Freestatetaxreturn You are the sole proprietor of a flower shop. Freestatetaxreturn You drove your van 20,000 miles during the year. Freestatetaxreturn 16,000 miles were for delivering flowers to customers and 4,000 miles were for personal use (including commuting miles). Freestatetaxreturn You can claim only 80% (16,000 ÷ 20,000) of the cost of operating your van as a business expense. Freestatetaxreturn More information. Freestatetaxreturn   For more information about the rules for claiming car and truck expenses, see Publication 463. Freestatetaxreturn Reimbursing Your Employees for Expenses You generally can deduct the amount you reimburse your employees for car and truck expenses. Freestatetaxreturn The reimbursement you deduct and the manner in which you deduct it depend in part on whether you reimburse the expenses under an accountable plan or a nonaccountable plan. Freestatetaxreturn For details, see chapter 11 in Publication 535. Freestatetaxreturn That chapter explains accountable and nonaccountable plans and tells you whether to report the reimbursement on your employee's Form W-2, Wage and Tax Statement. Freestatetaxreturn Depreciation If property you acquire to use in your business is expected to last more than 1 year, you generally cannot deduct the entire cost as a business expense in the year you acquire it. Freestatetaxreturn You must spread the cost over more than 1 tax year and deduct part of it each year on Schedule C. Freestatetaxreturn This method of deducting the cost of business property is called depreciation. Freestatetaxreturn The discussion here is brief. Freestatetaxreturn You will find more information about depreciation in Publication 946. Freestatetaxreturn What property can be depreciated?   You can depreciate property if it meets all the following requirements. Freestatetaxreturn It must be property you own. Freestatetaxreturn It must be used in business or held to produce income. Freestatetaxreturn You never can depreciate inventory (explained in chapter 2) because it is not held for use in your business. Freestatetaxreturn It must have a useful life that extends substantially beyond the year it is placed in service. Freestatetaxreturn It must have a determinable useful life, which means that it must be something that wears out, decays, gets used up, becomes obsolete, or loses its value from natural causes. Freestatetaxreturn You never can depreciate the cost of land because land does not wear out, become obsolete, or get used up. Freestatetaxreturn It must not be excepted property. Freestatetaxreturn This includes property placed in service and disposed of in the same year. Freestatetaxreturn Repairs. Freestatetaxreturn    You cannot depreciate repairs and replacements that do not increase the value of your property, make it more useful, or lengthen its useful life. Freestatetaxreturn You can deduct these amounts on line 21 of Schedule C or line 2 of Schedule C-EZ. Freestatetaxreturn Depreciation method. Freestatetaxreturn   The method for depreciating most business and investment property placed in service after 1986 is called the Modified Accelerated Cost Recovery System (MACRS). Freestatetaxreturn MACRS is discussed in detail in Publication 946. Freestatetaxreturn Section 179 deduction. Freestatetaxreturn   You can elect to deduct a limited amount of the cost of certain depreciable property in the year you place the property in service. Freestatetaxreturn This deduction is known as the “section 179 deduction. Freestatetaxreturn ” The maximum amount you can elect to deduct during 2013 is generally $500,000 (higher limits apply to certain property). Freestatetaxreturn See IRC 179(e). Freestatetaxreturn   This limit is generally reduced by the amount by which the cost of the property placed in service during the tax year exceeds $2 million. Freestatetaxreturn The total amount of depreciation (including the section 179 deduction) you can take for a passenger automobile you use in your business and first place in service in 2013 is $3,160 ($11,160 if you take the special depreciation allowance for qualified passenger automobiles placed in service in 2013). Freestatetaxreturn Special rules apply to trucks and vans. Freestatetaxreturn For more information, see Publication 946. Freestatetaxreturn It explains what property qualifies for the deduction, what limits apply to the deduction, and when and how to recapture the deduction. Freestatetaxreturn    Your section 179 election for the cost of any sport utility vehicle (SUV) and certain other vehicles is limited to $25,000. Freestatetaxreturn For more information, see the Instructions for Form 4562 or Publication 946. Freestatetaxreturn Listed property. Freestatetaxreturn   You must follow special rules and recordkeeping requirements when depreciating listed property. Freestatetaxreturn Listed property is any of the following. Freestatetaxreturn Most passenger automobiles. Freestatetaxreturn Most other property used for transportation. Freestatetaxreturn Any property of a type generally used for entertainment, recreation, or amusement. Freestatetaxreturn Certain computers and related peripheral equipment. Freestatetaxreturn   For more information about listed property, see Publication 946. Freestatetaxreturn Form 4562. Freestatetaxreturn   Use Form 4562, Depreciation and Amortization, if you are claiming any of the following. Freestatetaxreturn Depreciation on property placed in service during the current tax year. Freestatetaxreturn A section 179 deduction. Freestatetaxreturn Depreciation on any listed property (regardless of when it was placed in service). Freestatetaxreturn    If you have to use Form 4562, you must file Schedule C. Freestatetaxreturn You cannot use Schedule C-EZ. Freestatetaxreturn   Employees' Pay You can generally deduct on Schedule C the pay you give your employees for the services they perform for your business. Freestatetaxreturn The pay may be in cash, property, or services. Freestatetaxreturn To be deductible, your employees' pay must be an ordinary and necessary expense and you must pay or incur it in the tax year. Freestatetaxreturn In addition, the pay must meet both the following tests. Freestatetaxreturn The pay must be reasonable. Freestatetaxreturn The pay must be for services performed. Freestatetaxreturn Chapter 2 in Publication 535 explains and defines these requirements. Freestatetaxreturn You cannot deduct your own salary or any personal withdrawals you make from your business. Freestatetaxreturn As a sole proprietor, you are not an employee of the business. Freestatetaxreturn If you had employees during the year, you must use Schedule C. Freestatetaxreturn You cannot use Schedule C-EZ. Freestatetaxreturn Kinds of pay. Freestatetaxreturn   Some of the ways you may provide pay to your employees are listed below. Freestatetaxreturn For an explanation of each of these items, see chapter 2 in Publication 535. Freestatetaxreturn Awards. Freestatetaxreturn Bonuses. Freestatetaxreturn Education expenses. Freestatetaxreturn Fringe benefits (discussed later). Freestatetaxreturn Loans or advances you do not expect the employee to repay if they are for personal services actually performed. Freestatetaxreturn Property you transfer to an employee as payment for services. Freestatetaxreturn Reimbursements for employee business expenses. Freestatetaxreturn Sick pay. Freestatetaxreturn Vacation pay. Freestatetaxreturn Fringe benefits. Freestatetaxreturn   A fringe benefit is a form of pay for the performance of services. Freestatetaxreturn The following are examples of fringe benefits. Freestatetaxreturn Benefits under qualified employee benefit programs. Freestatetaxreturn Meals and lodging. Freestatetaxreturn The use of a car. Freestatetaxreturn Flights on airplanes. Freestatetaxreturn Discounts on property or services. Freestatetaxreturn Memberships in country clubs or other social clubs. Freestatetaxreturn Tickets to entertainment or sporting events. Freestatetaxreturn   Employee benefit programs include the following. Freestatetaxreturn Accident and health plans. Freestatetaxreturn Adoption assistance. Freestatetaxreturn Cafeteria plans. Freestatetaxreturn Dependent care assistance. Freestatetaxreturn Educational assistance. Freestatetaxreturn Group-term life insurance coverage. Freestatetaxreturn Welfare benefit funds. Freestatetaxreturn   You can generally deduct the cost of fringe benefits you provide on your Schedule C in whatever category the cost falls. Freestatetaxreturn For example, if you allow an employee to use a car or other property you lease, deduct the cost of the lease as a rent or lease expense. Freestatetaxreturn If you own the property, include your deduction for its cost or other basis as a section 179 deduction or a depreciation deduction. Freestatetaxreturn    You may be able to exclude all or part of the fringe benefits you provide from your employees' wages. Freestatetaxreturn For more information about fringe benefits and the exclusion of benefits, see Publication 15-B, Employer's Tax Guide to Fringe Benefits. Freestatetaxreturn Insurance You can generally deduct premiums you pay for the following kinds of insurance related to your business. Freestatetaxreturn Fire, theft, flood, or similar insurance. Freestatetaxreturn Credit insurance that covers losses from business bad debts. Freestatetaxreturn Group hospitalization and medical insurance for employees, including long-term care insurance. Freestatetaxreturn Liability insurance. Freestatetaxreturn Malpractice insurance that covers your personal liability for professional negligence resulting in injury or damage to patients or clients. Freestatetaxreturn Workers' compensation insurance set by state law that covers any claims for bodily injuries or job-related diseases suffered by employees in your business, regardless of fault. Freestatetaxreturn Contributions to a state unemployment insurance fund are deductible as taxes if they are considered taxes under state law. Freestatetaxreturn Overhead insurance that pays for business overhead expenses you have during long periods of disability caused by your injury or sickness. Freestatetaxreturn Car and other vehicle insurance that covers vehicles used in your business for liability, damages, and other losses. Freestatetaxreturn If you operate a vehicle partly for personal use, deduct only the part of the insurance premium that applies to the business use of the vehicle. Freestatetaxreturn If you use the standard mileage rate to figure your car expenses, you cannot deduct any car insurance premiums. Freestatetaxreturn Life insurance covering your employees if you are not directly or indirectly the beneficiary under the contract. Freestatetaxreturn Business interruption insurance that pays for lost profits if your business is shut down due to a fire or other cause. Freestatetaxreturn Nondeductible premiums. Freestatetaxreturn   You cannot deduct premiums on the following kinds of insurance. Freestatetaxreturn Self-insurance reserve funds. Freestatetaxreturn You cannot deduct amounts credited to a reserve set up for self-insurance. Freestatetaxreturn This applies even if you cannot get business insurance coverage for certain business risks. Freestatetaxreturn However, your actual losses may be deductible. Freestatetaxreturn For more information, see Publication 547, Casualties, Disasters, and Thefts. Freestatetaxreturn Loss of earnings. Freestatetaxreturn You cannot deduct premiums for a policy that pays for your lost earnings due to sickness or disability. Freestatetaxreturn However, see item (8) in the previous list. Freestatetaxreturn Certain life insurance and annuities. Freestatetaxreturn For contracts issued before June 9, 1997, you cannot deduct the premiums on a life insurance policy covering you, an employee, or any person with a financial interest in your business if you are directly or indirectly a beneficiary of the policy. Freestatetaxreturn You are included among possible beneficiaries of the policy if the policy owner is obligated to repay a loan from you using the proceeds of the policy. Freestatetaxreturn A person has a financial interest in your business if the person is an owner or part owner of the business or has lent money to the business. Freestatetaxreturn For contracts issued after June 8, 1997, you generally cannot deduct the premiums on any life insurance policy, endowment contract, or annuity contract if you are directly or indirectly a beneficiary. Freestatetaxreturn The disallowance applies without regard to whom the policy covers. Freestatetaxreturn Insurance to secure a loan. Freestatetaxreturn If you take out a policy on your life or on the life of another person with a financial interest in your business to get or protect a business loan, you cannot deduct the premiums as a business expense. Freestatetaxreturn Nor can you deduct the premiums as interest on business loans or as an expense of financing loans. Freestatetaxreturn In the event of death, the proceeds of the policy are not taxed as income even if they are used to liquidate the debt. Freestatetaxreturn Self-employed health insurance deduction. Freestatetaxreturn   You may be able to deduct the amount you paid for medical and dental insurance and qualified long-term care insurance for you and your family. Freestatetaxreturn How to figure the deduction. Freestatetaxreturn   Generally, you can use the worksheet in the Form 1040 instructions to figure your deduction. Freestatetaxreturn However, if any of the following apply, you must use the worksheet in chapter 6 of Publication 535. Freestatetaxreturn You have more than one source of income subject to self-employment tax. Freestatetaxreturn You file Form 2555 or Form 2555-EZ (relating to foreign earned income). Freestatetaxreturn You are using amounts paid for qualified long-term care insurance to figure the deduction. Freestatetaxreturn Prepayment. Freestatetaxreturn   You cannot deduct expenses in advance, even if you pay them in advance. Freestatetaxreturn This rule applies to any expense paid far enough in advance to, in effect, create an asset with a useful life extending substantially beyond the end of the current tax year. Freestatetaxreturn Example. Freestatetaxreturn In 2013, you signed a 3-year insurance contract. Freestatetaxreturn Even though you paid the premiums for 2013, 2014, and 2015 when you signed the contract, you can only deduct the premium for 2013 on your 2013 tax return. Freestatetaxreturn You can deduct in 2014 and 2015 the premium allocable to those years. Freestatetaxreturn More information. Freestatetaxreturn   For more information about deducting insurance, see chapter 6 in Publication 535. Freestatetaxreturn Interest You can generally deduct as a business expense all interest you pay or accrue during the tax year on debts related to your business. Freestatetaxreturn Interest relates to your business if you use the proceeds of the loan for a business expense. Freestatetaxreturn It does not matter what type of property secures the loan. Freestatetaxreturn You can deduct interest on a debt only if you meet all of the following requirements. Freestatetaxreturn You are legally liable for that debt. Freestatetaxreturn Both you and the lender intend that the debt be repaid. Freestatetaxreturn You and the lender have a true debtor-creditor relationship. Freestatetaxreturn You cannot deduct on Schedule C or C-EZ the interest you paid on personal loans. Freestatetaxreturn If a loan is part business and part personal, you must divide the interest between the personal part and the business part. Freestatetaxreturn Example. Freestatetaxreturn In 2013, you paid $600 interest on a car loan. Freestatetaxreturn During 2013, you used the car 60% for business and 40% for personal purposes. Freestatetaxreturn You are claiming actual expenses on the car. Freestatetaxreturn You can only deduct $360 (60% × $600) for 2013 on Schedule C or C-EZ. Freestatetaxreturn The remaining interest of $240 is a nondeductible personal expense. Freestatetaxreturn More information. Freestatetaxreturn   For more information about deducting interest, see chapter 4 in Publication 535. Freestatetaxreturn That chapter explains the following items. Freestatetaxreturn Interest you can deduct. Freestatetaxreturn Interest you cannot deduct. Freestatetaxreturn How to allocate interest between personal and business use. Freestatetaxreturn When to deduct interest. Freestatetaxreturn The rules for a below-market interest rate loan. Freestatetaxreturn (This is generally a loan on which no interest is charged or on which interest is charged at a rate below the applicable federal rate. Freestatetaxreturn ) Legal and Professional Fees Legal and professional fees, such as fees charged by accountants, that are ordinary and necessary expenses directly related to operating your business are deductible on Schedule C or C-EZ. Freestatetaxreturn However, you usually cannot deduct legal fees you pay to acquire business assets. Freestatetaxreturn Add them to the basis of the property. Freestatetaxreturn If the fees include payments for work of a personal nature (such as making a will), you can take a business deduction only for the part of the fee related to your business. Freestatetaxreturn The personal part of legal fees for producing or collecting taxable income, doing or keeping your job, or for tax advice may be deductible on Schedule A (Form 1040) if you itemize deductions. Freestatetaxreturn For more information, see Publication 529, Miscellaneous Deductions. Freestatetaxreturn Tax preparation fees. Freestatetaxreturn   You can deduct on Schedule C or C-EZ the cost of preparing that part of your tax return relating to your business as a sole proprietor or statutory employee. Freestatetaxreturn You can deduct the remaining cost on Schedule A (Form 1040) if you itemize your deductions. Freestatetaxreturn   You can also deduct on Schedule C or C-EZ the amount you pay or incur in resolving asserted tax deficiencies for your business as a sole proprietor or statutory employee. Freestatetaxreturn Pension Plans You can set up and maintain the following small business retirement plans for yourself and your employees. Freestatetaxreturn SEP (Simplified Employee Pension) plans. Freestatetaxreturn SIMPLE (Savings Incentive Match Plan for Employees) plans. Freestatetaxreturn Qualified plans (including Keogh or H. Freestatetaxreturn R. Freestatetaxreturn 10 plans). Freestatetaxreturn SEP, SIMPLE, and qualified plans offer you and your employees a tax favored way to save for retirement. Freestatetaxreturn You can deduct contributions you make to the plan for your employees on line 19 of Schedule C. Freestatetaxreturn If you are a sole proprietor, you can deduct contributions you make to the plan for yourself on line 28 of Form 1040. Freestatetaxreturn You can also deduct trustees' fees if contributions to the plan do not cover them. Freestatetaxreturn Earnings on the contributions are generally tax free until you or your employees receive distributions from the plan. Freestatetaxreturn You may also be able to claim a tax credit of 50% of the first $1,000 of qualified startup costs if you begin a new qualified defined benefit or defined contribution plan (including a 401(k) plan), SIMPLE plan, or simplified employee pension. Freestatetaxreturn Under certain plans, employees can have you contribute limited amounts of their before-tax pay to a plan. Freestatetaxreturn These amounts (and earnings on them) are generally tax free until your employees receive distributions from the plan. Freestatetaxreturn For more information on retirement plans for small business, see Publication 560, Retirement Plans for Small Business (SEP, SIMPLE, and Qualified Plans). Freestatetaxreturn Publication 590, Individual Retirement Arrangements (IRAs), discusses other tax favored ways to save for retirement. Freestatetaxreturn Rent Expense Rent is any amount you pay for the use of property you do not own. Freestatetaxreturn In general, you can deduct rent as a business expense only if the rent is for property you use in your business. Freestatetaxreturn If you have or will receive equity in or title to the property, you cannot deduct the rent. Freestatetaxreturn Unreasonable rent. Freestatetaxreturn   You cannot take a rental deduction for unreasonable rents. Freestatetaxreturn Ordinarily, the issue of reasonableness arises only if you and the lessor are related. Freestatetaxreturn Rent paid to a related person is reasonable if it is the same amount you would pay to a stranger for use of the same property. Freestatetaxreturn Rent is not unreasonable just because it is figured as a percentage of gross receipts. Freestatetaxreturn   Related persons include members of your immediate family, including only brothers and sisters (either whole or half), your spouse, ancestors, and lineal descendants. Freestatetaxreturn For a list of the other related persons, see section 267 of the Internal Revenue Code. Freestatetaxreturn Rent on your home. Freestatetaxreturn   If you rent your home and use part of it as your place of business, you may be able to deduct the rent you pay for that part. Freestatetaxreturn You must meet the requirements for business use of your home. Freestatetaxreturn For more information, see Business Use of Your Home , later. Freestatetaxreturn Rent paid in advance. Freestatetaxreturn   Generally, rent paid in your business is deductible in the year paid or accrued. Freestatetaxreturn If you pay rent in advance, you can deduct only the amount that applies to your use of the rented property during the tax year. Freestatetaxreturn You can deduct the rest of your payment only over the period to which it applies. Freestatetaxreturn More information. Freestatetaxreturn   For more information about rent, see chapter 3 in Publication 535. Freestatetaxreturn Taxes You can deduct on Schedule C or C-EZ various federal, state, local, and foreign taxes directly attributable to your business. Freestatetaxreturn Income taxes. Freestatetaxreturn   You can deduct on Schedule C or C-EZ a state tax on gross income (as distinguished from net income) directly attributable to your business. Freestatetaxreturn You can deduct other state and local income taxes on Schedule A (Form 1040) if you itemize your deductions. Freestatetaxreturn Do not deduct federal income tax. Freestatetaxreturn Employment taxes. Freestatetaxreturn   You can deduct the social security, Medicare, and federal unemployment (FUTA) taxes you paid out of your own funds as an employer. Freestatetaxreturn Employment taxes are discussed briefly in chapter 1. Freestatetaxreturn You can also deduct payments you made as an employer to a state unemployment compensation fund or to a state disability benefit fund. Freestatetaxreturn Deduct these payments as taxes. Freestatetaxreturn Self-employment tax. Freestatetaxreturn   You can deduct one-half of your self-employment tax on line 27 of Form 1040. Freestatetaxreturn Self-employment tax is discussed in chapters 1 and 10. Freestatetaxreturn Personal property tax. Freestatetaxreturn   You can deduct on Schedule C or C-EZ any tax imposed by a state or local government on personal property used in your business. Freestatetaxreturn   You can also deduct registration fees for the right to use property within a state or local area. Freestatetaxreturn Example. Freestatetaxreturn May and Julius Winter drove their car 7,000 business miles out of a total of 10,000 miles. Freestatetaxreturn They had to pay $25 for their annual state license tags and $20 for their city registration sticker. Freestatetaxreturn They also paid $235 in city personal property tax on the car, for a total of $280. Freestatetaxreturn They are claiming their actual car expenses. Freestatetaxreturn Because they used the car 70% for business, they can deduct 70% of the $280, or $196, as a business expense. Freestatetaxreturn Real estate taxes. Freestatetaxreturn   You can deduct on Schedule C or C-EZ the real estate taxes you pay on your business property. Freestatetaxreturn Deductible real estate taxes are any state, local, or foreign taxes on real estate levied for the general public welfare. Freestatetaxreturn The taxing authority must base the taxes on the assessed value of the real estate and charge them uniformly against all property under its jurisdiction. Freestatetaxreturn   For more information about real estate taxes, see chapter 5 in Publication 535. Freestatetaxreturn That chapter explains special rules for deducting the following items. Freestatetaxreturn Taxes for local benefits, such as those for sidewalks, streets, water mains, and sewer lines. Freestatetaxreturn Real estate taxes when you buy or sell property during the year. Freestatetaxreturn Real estate taxes if you use an accrual method of accounting and choose to accrue real estate tax related to a definite period ratably over that period. Freestatetaxreturn Sales tax. Freestatetaxreturn   Treat any sales tax you pay on a service or on the purchase or use of property as part of the cost of the service or property. Freestatetaxreturn If the service or the cost or use of the property is a deductible business expense, you can deduct the tax as part of that service or cost. Freestatetaxreturn If the property is merchandise bought for resale, the sales tax is part of the cost of the merchandise. Freestatetaxreturn If the property is depreciable, add the sales tax to the basis for depreciation. Freestatetaxreturn For information on the basis of property, see Publication 551, Basis of Assets. Freestatetaxreturn    Do not deduct state and local sales taxes imposed on the buyer that you must collect and pay over to the state or local government. Freestatetaxreturn Do not include these taxes in gross receipts or sales. Freestatetaxreturn Excise taxes. Freestatetaxreturn   You can deduct on Schedule C or C-EZ all excise taxes that are ordinary and necessary expenses of carrying on your business. Freestatetaxreturn Excise taxes are discussed briefly in chapter 1. Freestatetaxreturn Fuel taxes. Freestatetaxreturn   Taxes on gasoline, diesel fuel, and other motor fuels you use in your business are usually included as part of the cost of the fuel. Freestatetaxreturn Do not deduct these taxes as a separate item. Freestatetaxreturn   You may be entitled to a credit or refund for federal excise tax you paid on fuels used for certain purposes. Freestatetaxreturn For more information, see Publication 510, Excise Taxes. Freestatetaxreturn Travel, Meals, and Entertainment This section briefly explains the kinds of travel and entertainment expenses you can deduct on Schedule C or C-EZ. Freestatetaxreturn Table 8-1. Freestatetaxreturn When Are Entertainment Expenses Deductible? (Note. Freestatetaxreturn The following is a summary of the rules for deducting entertainment expenses. Freestatetaxreturn For more details about these rules, see Publication 463. Freestatetaxreturn ) General rule You can deduct ordinary and necessary expenses to entertain a client, customer, or employee if the expenses meet the directly-related test or the associated test. Freestatetaxreturn Definitions Entertainment includes any activity generally considered to provide entertainment, amusement, or recreation, and includes meals provided to a customer or client. Freestatetaxreturn An ordinary expense is one that is common and accepted in your field of business, trade, or profession. Freestatetaxreturn A necessary expense is one that is helpful and appropriate, although not necessarily required, for your business. Freestatetaxreturn Tests to be met Directly-related test Entertainment took place in a clear business setting, or Main purpose of entertainment was the active conduct of business, and You did engage in business with the person during the entertainment period, and You had more than a general expectation of getting income or some other specific business benefit. Freestatetaxreturn   Associated test Entertainment is associated with your trade or business, and Entertainment directly precedes or follows a substantial business discussion. Freestatetaxreturn Other rules You cannot deduct the cost of your meal as an entertainment expense if you are claiming the meal as a travel expense. Freestatetaxreturn You cannot deduct expenses that are lavish or extravagant under the circumstances. Freestatetaxreturn You generally can deduct only 50% of your unreimbursed entertainment expenses. Freestatetaxreturn Travel expenses. Freestatetaxreturn   These are the ordinary and necessary expenses of traveling away from home for your business. Freestatetaxreturn You are traveling away from home if both the following conditions are met. Freestatetaxreturn Your duties require you to be away from the general area of your tax home (defined later) substantially longer than an ordinary day's work. Freestatetaxreturn You need to get sleep or rest to meet the demands of your work while away from home. Freestatetaxreturn Generally, your tax home is your regular place of business, regardless of where you maintain your family home. Freestatetaxreturn It includes the entire city or general area in which your business is located. Freestatetaxreturn See Publication 463 for more information. Freestatetaxreturn   The following is a brief discussion of the expenses you can deduct. Freestatetaxreturn Transportation. Freestatetaxreturn   You can deduct the cost of travel by airplane, train, bus, or car between your home and your business destination. Freestatetaxreturn Taxi, commuter bus, and limousine. Freestatetaxreturn   You can deduct fares for these and other types of transportation between the airport or station and your hotel, or between the hotel and your work location away from home. Freestatetaxreturn Baggage and shipping. Freestatetaxreturn   You can deduct the cost of sending baggage and sample or display material between your regular and temporary work locations. Freestatetaxreturn Car or truck. Freestatetaxreturn   You can deduct the costs of operating and maintaining your vehicle when traveling away from home on business. Freestatetaxreturn You can deduct actual expenses or the standard mileage rate (discussed earlier under Car and Truck Expenses), as well as business-related tolls and parking. Freestatetaxreturn If you rent a car while away from home on business, you can deduct only the business-use portion of the expenses. Freestatetaxreturn Meals and lodging. Freestatetaxreturn   You can deduct the cost of meals and lodging if your business trip is overnight or long enough that you need to stop for sleep or rest to properly perform your duties. Freestatetaxreturn In most cases, you can deduct only 50% of your meal expenses. Freestatetaxreturn Cleaning. Freestatetaxreturn   You can deduct the costs of dry cleaning and laundry while on your business trip. Freestatetaxreturn Telephone. Freestatetaxreturn   You can deduct the cost of business calls while on your business trip, including business communication by fax machine or other communication devices. Freestatetaxreturn Tips. Freestatetaxreturn   You can deduct the tips you pay for any expense in this list. Freestatetaxreturn More information. Freestatetaxreturn   For more information about travel expenses, see Publication 463. Freestatetaxreturn Entertainment expenses. Freestatetaxreturn   You may be able to deduct business-related entertainment expenses for entertaining a client, customer, or employee. Freestatetaxreturn In most cases, you can deduct only 50% of these expenses. Freestatetaxreturn   The following are examples of entertainment expenses. Freestatetaxreturn Entertaining guests at nightclubs, athletic clubs, theaters, or sporting events. Freestatetaxreturn Providing meals, a hotel suite, or a car to business customers or their families. Freestatetaxreturn To be deductible, the expenses must meet the rules listed in Table 8-1. Freestatetaxreturn For details about these rules, see Publication 463. Freestatetaxreturn Reimbursing your employees for expenses. Freestatetaxreturn   You generally can deduct the amount you reimburse your employees for travel and entertainment expenses. Freestatetaxreturn The reimbursement you deduct and the manner in which you deduct it depend in part on whether you reimburse the expenses under an accountable plan or a nonaccountable plan. Freestatetaxreturn For details, see chapter 11 in Publication 535. Freestatetaxreturn That chapter explains accountable and nonaccountable plans and tells you whether to report the reimbursement on your employee's Form W-2, Wage and Tax Statement. Freestatetaxreturn Business Use of Your Home To deduct expenses related to the part of your home used for business, you must meet specific requirements. Freestatetaxreturn Even then, your deduction may be limited. Freestatetaxreturn To qualify to claim expenses for business use of your home, you must meet the following tests. Freestatetaxreturn Your use of the business part of your home must be: Exclusive (however, see Exceptions to exclusive use , later), Regular, For your business, and The business part of your home must be one of the following: Your principal place of business (defined later), A place where you meet or deal with patients, clients, or customers in the normal course of your business, or A separate structure (not attached to your home) you use in connection with your business. Freestatetaxreturn Exclusive use. Freestatetaxreturn   To qualify under the exclusive use test, you must use a specific area of your home only for your trade or business. Freestatetaxreturn The area used for business can be a room or other separately identifiable space. Freestatetaxreturn The space does not need to be marked off by a permanent partition. Freestatetaxreturn   You do not meet the requirements of the exclusive use test if you use the area in question both for business and for personal purposes. Freestatetaxreturn Example. Freestatetaxreturn You are an attorney and use a den in your home to write legal briefs and prepare clients' tax returns. Freestatetaxreturn Your family also uses the den for recreation. Freestatetaxreturn The den is not used exclusively in your profession, so you cannot claim a business deduction for its use. Freestatetaxreturn Exceptions to exclusive use. Freestatetaxreturn   You do not have to meet the exclusive use test if you use part of your home in either of the following ways. Freestatetaxreturn For the storage of inventory or product samples. Freestatetaxreturn As a daycare facility. Freestatetaxreturn For an explanation of these exceptions, see Publication 587, Business Use of Your Home (Including Use by Daycare Providers). Freestatetaxreturn Regular use. Freestatetaxreturn   To qualify under the regular use test, you must use a specific area of your home for business on a continuing basis. Freestatetaxreturn You do not meet the test if your business use of the area is only occasional or incidental, even if you do not use that area for any other purpose. Freestatetaxreturn Principal place of business. Freestatetaxreturn   You can have more than one business location, including your home, for a single trade or business. Freestatetaxreturn To qualify to deduct the expenses for the business use of your home under the principal place of business test, your home must be your principal place of business for that business. Freestatetaxreturn To determine your principal place of business, you must consider all the facts and circumstances. Freestatetaxreturn   Your home office will qualify as your principal place of business for deducting expenses for its use if you meet the following requirements. Freestatetaxreturn You use it exclusively and regularly for administrative or management activities of your business. Freestatetaxreturn You have no other fixed location where you conduct substantial administrative or management activities of your business. Freestatetaxreturn   Alternatively, if you use your home exclusively and regularly for your business, but your home office does not qualify as your principal place of business based on the previous rules, you determine your principal place of business based on the following factors. Freestatetaxreturn The relative importance of the activities performed at each location. Freestatetaxreturn If the relative importance factor does not determine your principal place of business, you can also consider the time spent at each location. Freestatetaxreturn   If, after considering your business locations, your home cannot be identified as your principal place of business, you cannot deduct home office expenses. Freestatetaxreturn However, for other ways to qualify to deduct home office expenses, see Publication 587. Freestatetaxreturn Deduction limit. Freestatetaxreturn   If your gross income from the business use of your home equals or exceeds your total business expenses (including depreciation), you can deduct all your business expenses related to the use of your home. Freestatetaxreturn If your gross income from the business use is less than your total business expenses, your deduction for certain expenses for the business use of your home is limited. Freestatetaxreturn   Your deduction of otherwise nondeductible expenses, such as insurance, utilities, and depreciation (with depreciation taken last), allocable to the business is limited to the gross income from the business use of your home minus the sum of the following. Freestatetaxreturn The business part of expenses you could deduct even if you did not use your home for business (such as mortgage interest, real estate taxes, and casualty and theft losses that are allowable as itemized deductions on Schedule A (Form 1040)). Freestatetaxreturn The business expenses that relate to the business activity in the home (for example, business phone, supplies, and depreciation on equipment), but not to the use of the home itself. Freestatetaxreturn Do not include in (2) above your deduction for one-half of your self-employment tax. Freestatetaxreturn   Use Form 8829, Expenses for Business Use of Your Home, to figure your deduction. Freestatetaxreturn New simplified method. Freestatetaxreturn    The IRS now provides a simplified method to determine your expenses for business use of your home. Freestatetaxreturn The simplified method is an alternative to calculating and substantiating actual expenses. Freestatetaxreturn In most cases, you will figure your deduction by multiplying $5 by the area of your home used for a qualified business use. Freestatetaxreturn The area you use to figure your deduction is limited to 300 square feet. Freestatetaxreturn For more information, see the Instructions for Schedule C. Freestatetaxreturn More information. Freestatetaxreturn   For more information on deducting expenses for the business use of your home, see Publication 587. Freestatetaxreturn Other Expenses You Can Deduct You may also be able to deduct the following expenses. Freestatetaxreturn See Publication 535 to find out whether you can deduct them. Freestatetaxreturn Advertising. Freestatetaxreturn Bank fees. Freestatetaxreturn Donations to business organizations. Freestatetaxreturn Education expenses. Freestatetaxreturn Energy efficient commercial buildings deduction expenses. Freestatetaxreturn Impairment-related expenses. Freestatetaxreturn Interview expense allowances. Freestatetaxreturn Licenses and regulatory fees. Freestatetaxreturn Moving machinery. Freestatetaxreturn Outplacement services. Freestatetaxreturn Penalties and fines you pay for late performance or nonperformance of a contract. Freestatetaxreturn Repairs that keep your property in a normal efficient operating condition. Freestatetaxreturn Repayments of income. Freestatetaxreturn Subscriptions to trade or professional publications. Freestatetaxreturn Supplies and materials. Freestatetaxreturn Utilities. Freestatetaxreturn Expenses You Cannot Deduct You usually cannot deduct the following as business expenses. Freestatetaxreturn For more information, see Publication 535. Freestatetaxreturn Bribes and kickbacks. Freestatetaxreturn Charitable contributions. Freestatetaxreturn Demolition expenses or losses. Freestatetaxreturn Dues to business, social, athletic, luncheon, sporting, airline, and hotel clubs. Freestatetaxreturn Lobbying expenses. Freestatetaxreturn Penalties and fines you pay to a governmental agency or instrumentality because you broke the law. Freestatetaxreturn Personal, living, and family expenses. Freestatetaxreturn Political contributions. Freestatetaxreturn Repairs that add to the value of your property or significantly increase its life. 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