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Irs free efile Publication 596 - Introductory Material Table of Contents Future Developments What is the EIC? Can I Claim the EIC? Do I Need This Publication? Do I Have To Have A Child To Qualify For The EIC? How Do I Figure the Amount of EIC? How Can I Quickly Locate Specific information? Is There Help Online? What's New for 2013 Reminders Future Developments For the latest information about developments related to Publication 596, such as legislation enacted after it was published, go to www. Irs free efile irs. Irs free efile gov/pub596. Irs free efile What is the EIC? The earned income credit (EIC) is a tax credit for certain people who work and have earned income under $51,567. Irs free efile A tax credit usually means more money in your pocket. Irs free efile It reduces the amount of tax you owe. Irs free efile The EIC may also give you a refund. Irs free efile Can I Claim the EIC? To claim the EIC, you must meet certain rules. Irs free efile These rules are summarized in Table 1. Irs free efile Table 1. Irs free efile Earned Income Credit in a Nutshell First, you must meet all the rules in this column. Irs free efile Second, you must meet all the rules in one of these columns, whichever applies. Irs free efile Third, you must meet the rule in this column. Irs free efile Chapter 1. Irs free efile  Rules for Everyone Chapter 2. Irs free efile  Rules If You Have a Qualifying Child Chapter 3. Irs free efile  Rules If You Do Not Have a Qualifying Child Chapter 4. Irs free efile  Figuring and Claiming the EIC 1. Irs free efile Your adjusted gross income (AGI) must be less than:  • $46,227 ($51,567 for married filing jointly) if you have three or more qualifying children,  • $43,038 ($48,378 for married filing jointly) if you have two qualifying children,  • $37,870 ($43,210 for married filing jointly) if you have one qualifying child, or   • $14,340 ($19,680 for married filing jointly) if you do not have a qualifying child. Irs free efile 2. Irs free efile You must have a valid social security number. Irs free efile   3. Irs free efile Your filing status cannot be Married filing separately. Irs free efile   4. Irs free efile You must be a U. Irs free efile S. Irs free efile citizen or resident alien all year. Irs free efile   5. Irs free efile You cannot file Form 2555 or Form 2555-EZ (relating to foreign earned income). Irs free efile   6. Irs free efile Your investment income must be $3,300 or less. Irs free efile    7. Irs free efile You must have earned income. Irs free efile 8. Irs free efile Your child must meet the relationship, age, residency, and joint return tests. Irs free efile   9. Irs free efile Your qualifying child cannot be used by more than one person to claim the EIC. Irs free efile   10. Irs free efile You cannot be a qualifying child of another person. Irs free efile 11. Irs free efile You must be at least age 25 but under age 65. Irs free efile    12. Irs free efile You cannot be the dependent of another person. Irs free efile   13. Irs free efile You cannot be a qualifying child of another person. Irs free efile   14. Irs free efile You must have lived in the United States more than half of the year. Irs free efile 15. Irs free efile Your earned income must be less than:  • $46,227 ($51,567 for married filing jointly) if you have three or more qualifying children,  • $43,038 ($48,378 for married filing jointly) if you have two qualifying children,  • $37,870 ($43,210 for married filing jointly) if you have one qualifying child, or  • $14,340 ($19,680 for married filing jointly) if you do not have a qualifying child. Irs free efile Do I Need This Publication? Certain people who file Form 1040 must use Worksheet 1 in this publication, instead of Step 2 in their Form 1040 instructions, when they are checking whether they can take the EIC. Irs free efile You are one of those people if any of the following statements are true for 2013. Irs free efile You are filing Schedule E (Form 1040). Irs free efile You are reporting income from the rental of personal property not used in a trade or business. Irs free efile You are reporting income on Form 1040, line 21, from Form 8814 (relating to election to report child's interest and dividends). Irs free efile You are reporting an amount on Form 1040, line 13, that includes an amount from Form 4797. Irs free efile If none of the statements above apply to you, your tax form instructions have all the information you need to find out if you can claim the EIC and to figure the amount of your EIC. Irs free efile You do not need this publication. Irs free efile But you can read it to find out whether you can take the EIC and to learn more about the EIC. Irs free efile Do I Have To Have A Child To Qualify For The EIC? No, you can qualify for the EIC without a qualifying child if you are at least age 25 but under age 65 and your earned income is less than $14,340 ($19,680 if married filing jointly). Irs free efile See chapter 3. Irs free efile How Do I Figure the Amount of EIC? If you can claim the EIC, you can either have the IRS figure the amount of your credit, or you can figure it yourself. Irs free efile To figure it yourself, you can complete a worksheet in the instructions for the form you file. Irs free efile To find out how to have the IRS figure it for you, see chapter 4. Irs free efile How Can I Quickly Locate Specific information? You can use the index to look up specific information. Irs free efile In most cases, index entries will point you to headings, tables, or a worksheet. Irs free efile Is There Help Online? Yes. Irs free efile You can use the EITC Assistant at www. Irs free efile irs. Irs free efile gov/eitc to find out if you may be eligible for the credit. Irs free efile The EITC Assistant is available in English and Spanish. Irs free efile What's New for 2013 Earned income amount is more. Irs free efile The maximum amount of income you can earn and still get the credit has increased. Irs free efile You may be able to take the credit if: You have three or more qualifying children and you earned less than $46,227 ($51,567 if married filing jointly), You have two qualifying children and you earned less than $43,038 ($48,378 if married filing jointly), You have one qualifying child and you earned less than $37,870 ($43,210 if married filing jointly), or You do not have a qualifying child and you earned less than $14,340 ($19,680 if married filing jointly). Irs free efile Your adjusted gross income also must be less than the amount in the above list that applies to you. Irs free efile For details, see Rules 1 and 15. Irs free efile Investment income amount is more. Irs free efile The maximum amount of investment income you can have and still get the credit has increased to $3,300. Irs free efile See Rule 6—Your Investment Income Must Be $3,300 or Less . Irs free efile Reminders Increased EIC on certain joint returns. Irs free efile . Irs free efile  A married person filing a joint return may get more EIC than someone with the same income but a different filing status. Irs free efile As a result, the EIC table has different columns for married persons filing jointly than for everyone else. Irs free efile When you look up your EIC in the EIC Table, be sure to use the correct column for your filing status and the number of children you have. Irs free efile Earned income credit has no effect on certain welfare benefits. Irs free efile  Any refund you receive because of the EIC cannot be counted as income when determining whether you or anyone else is eligible for benefits or assistance, or how much you or anyone else can receive, under any federal program or under any state or local program financed in whole or in part with federal funds. Irs free efile These programs include the following. Irs free efile Temporary Assistance for Needy Families (TANF). Irs free efile Medicaid. Irs free efile Supplemental security income (SSI). Irs free efile Supplemental Nutrition Assistance Program (food stamps). Irs free efile Low-income housing. Irs free efile In addition, when determining eligibility, the refund cannot be counted as a resource for at least 12 months after you receive it. Irs free efile Check with your local benefit coordinator to find out if your refund will affect your benefits. Irs free efile Do not overlook your state credit. Irs free efile  If you can claim the EIC on your federal income tax return, you may be able to take a similar credit on your state or local income tax return. Irs free efile For a list of states that offer a state EIC, go to www. Irs free efile irs. Irs free efile gov/eitc. Irs free efile EIC questioned by IRS. Irs free efile  The IRS may ask you to provide documents to prove you are entitled to claim the EIC. Irs free efile We will tell you what documents to send us. Irs free efile These may include: birth certificates, school records, etc. Irs free efile The process of establishing your eligibility will delay your refund. Irs free efile Spanish version of Publication 596. Irs free efile  You can order Publicación 596SP, Crédito por Ingreso del Trabajo, from the IRS. Irs free efile It is a Spanish translation of Publication 596. Irs free efile See How To Get Tax Help to find out how to order this and other IRS forms and publications. Irs free efile Photographs of missing children. Irs free efile  The Internal Revenue Service is a proud partner with the National Center for Missing and Exploited Children. Irs free efile Photographs of missing children selected by the Center may appear in this publication on pages that would otherwise be blank. Irs free efile You can help bring these children home by looking at the photographs and calling 1-800-THE-LOST (1-800-843-5678) if you recognize a child. Irs free efile Comments and suggestions. Irs free efile  We welcome your comments about this publication and your suggestions for future editions. Irs free efile You can write to us at the following address:  Internal Revenue Service Individual Forms and Publications Branch 1111 Constitution Ave. Irs free efile NW, IR-6526 Washington, DC 20224 We respond to many letters by telephone. Irs free efile Therefore, it would be helpful if you would include your daytime phone number, including the area code, in your correspondence. Irs free efile You can send your comments from www. Irs free efile irs. Irs free efile gov/formspubs/. Irs free efile Click on “More Information” and then on “Comment on Tax Forms and Publications. Irs free efile ” Although we cannot respond individually to each comment received, we do appreciate your feedback and will consider your comments as we revise our tax products. Irs free efile Ordering forms and publications. Irs free efile  Visit www. Irs free efile irs. Irs free efile gov/formspubs/ to download forms and publications, call 1-800-TAX-FORM (1-800-829-3676), or write to the address below and receive a response within 10 days after your request is received. Irs free efile  Internal Revenue Service 1201 N. Irs free efile Mitsubishi Motorway Bloomington, IL 61705-6613 Tax questions. Irs free efile  If you have a tax question, check the information available on IRS. Irs free efile gov or call 1-800-829-1040. Irs free efile We cannot answer tax questions sent to either of the above addresses. Irs free efile Prev  Up  Next   Home   More Online Publications
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Understanding Your CP01A Notice

This notice tells you about the Identity Protection Personal Identification Number (IP PIN) we sent you.


What you need to do

  • Forms 1040, 1040A, 1040EZ and 1040 PR/SS
    Be sure to enter your IP PIN in the correct place when you file your 2013 federal tax return:
    • Electronic Returns (Caution: see new joint filing rules below)
      • Your tax software or practitioner will tell you when and where to enter the IP PIN.
      • If you can’t find where to enter your IP PIN, search within your software on Identity Protection PIN or IP PIN or contact the software provider’s help desk. Due to software variations, the IRS doesn't know the location of the IP PIN within each package.
    • Paper Returns
      • Enter your IP PIN in the gray box marked “Identity Protection PIN” to the right of “Spouse’s signature and occupation”.
  • Amended Returns, Extensions and Installment Agreements
    An IP PIN is not required to file:
    • Form 1040X, Amended U.S. Individual Income Tax Return ,
    • Form 4868, Application for Automatic Extension of Time To File U.S. Individual Income Tax Return, or
    • Form 433-D, Installment Agreement

If you are filing a joint return

  • Electronic Returns
    • Each taxpayer who receives an IP PIN must enter it on their tax return when filing as the primary (first SSN on the tax form) or secondary taxpayer.
      • If only one taxpayer receives an IP PIN, you must enter it with the taxpayer’s SSN to whom it belongs.
      • If both taxpayers receive an IP PIN, both taxpayers must enter the IP PIN that goes with their SSN.
  • Paper Returns
    • Only the primary taxpayer should enter their IP PIN on the tax return. The secondary taxpayer must not enter their IP PIN even if they received one
    • Note: The secondary taxpayer’s IP PIN still provides protection by preventing the fraudulent use of your SSN as the primary or secondary SSN on an e-filed return or as the primary SSN on a paper return

Important things to remember about your IP PIN

  • Store this letter with your tax records
  • A new IP PIN is assigned to you each year
  • The latest IP PIN assigned to you is your IP PIN of record and you should destroy all prior IP PINs securely
  • Do not reveal your IP PIN to anyone other than your tax preparer. Reveal it only when you are ready to sign and submit your federal income tax return
  • Use your IP PIN on your 2013 federal income tax return
    • Electronic Returns: We will reject your return if you fail to use your IP PIN.
    • Paper Returns: A significant delay processing your return and any refund you may be due will occur if you fail to use the primary taxpayer’s IP PIN.
  • Your IP PIN is not used on your state income tax return

Use on prior year returns

You must use your latest IP PIN on any delinquent 2012 or 2011 Forms 1040. 1040A, 1040EZ or 1040PR/SS returns you may file in calendar year 2014.


If you misplaced your IP PIN

Visit the Lost or Misplaced IP PINs page for instructions on how to recover your original IP PIN or request a replacement.


Answers to Common Questions

We have complete answers to questions you might have about the IP PIN process on our Frequently Asked Questions about the IP PIN page.

Page Last Reviewed or Updated: 19-Feb-2014

How to get help

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

The Irs Free Efile

Irs free efile 3. Irs free efile   Investment Expenses Table of Contents Topics - This chapter discusses: Useful Items - You may want to see: Limits on DeductionsPassive activity. Irs free efile Other income (nonpassive income). Irs free efile Expenses. Irs free efile Additional information. Irs free efile Interest ExpensesInvestment Interest Limit on Deduction Bond Premium AmortizationSpecial rules to determine amounts payable on a bond. Irs free efile Basis. Irs free efile How To Figure Amortization Choosing To Amortize How To Report Amortization Expenses of Producing IncomeFees to buy or sell. Irs free efile Including mutual fund or REMIC expenses in income. Irs free efile Nondeductible ExpensesUsed as collateral. Irs free efile Short-sale expenses. Irs free efile Expenses for both tax-exempt and taxable income. Irs free efile State income taxes. Irs free efile Nondeductible amount. Irs free efile Basis adjustment. Irs free efile How To Report Investment Expenses When To Report Investment Expenses Topics - This chapter discusses: Limits on Deductions , Interest Expenses , Bond Premium Amortization , Expenses of Producing Income , Nondeductible Expenses , How To Report Investment Expenses , and When To Report Investment Expenses . Irs free efile Useful Items - You may want to see: Publication 535 Business Expenses 925 Passive Activity and At-Risk Rules 929 Tax Rules for Children and Dependents Form (and Instructions) Schedule A (Form 1040) Itemized Deductions 4952 Investment Interest Expense Deduction See chapter 5, How To Get Tax Help , for information about getting these publications and forms. Irs free efile Limits on Deductions Your deductions for investment expenses may be limited by: The at-risk rules, The passive activity loss limits, The limit on investment interest, or The 2% limit on certain miscellaneous itemized deductions. Irs free efile The at-risk rules and passive activity rules are explained briefly in this section. Irs free efile The limit on investment interest is explained later in this chapter under Interest Expenses . Irs free efile The 2% limit is explained later in this chapter under Expenses of Producing Income . Irs free efile At-risk rules. Irs free efile   Special at-risk rules apply to most income-producing activities. Irs free efile These rules limit the amount of loss you can deduct to the amount you risk losing in the activity. Irs free efile Generally, this is the cash and the adjusted basis of property you contribute to the activity. Irs free efile It also includes money you borrow for use in the activity if you are personally liable for repayment or if you use property not used in the activity as security for the loan. Irs free efile For more information, see Publication 925. Irs free efile Passive activity losses and credits. Irs free efile   The amount of losses and tax credits you can claim from passive activities is limited. Irs free efile Generally, you are allowed to deduct passive activity losses only up to the amount of your passive activity income. Irs free efile Also, you can use credits from passive activities only against tax on the income from passive activities. Irs free efile There are exceptions for certain activities, such as rental real estate activities. Irs free efile Passive activity. Irs free efile   A passive activity generally is any activity involving the conduct of any trade or business in which you do not materially participate and any rental activity. Irs free efile However, if you are involved in renting real estate, the activity is not a passive activity if both of the following are true. Irs free efile More than one-half of the personal services you perform during the year in all trades or businesses are performed in real property trades or businesses in which you materially participate. Irs free efile You perform more than 750 hours of services during the year in real property trades or businesses in which you materially participate. Irs free efile  The term “trade or business” generally means any activity that involves the conduct of a trade or business, is conducted in anticipation of starting a trade or business, or involves certain research or experimental expenditures. Irs free efile However, it does not include rental activities or certain activities treated as incidental to holding property for investment. Irs free efile   You are considered to materially participate in an activity if you are involved on a regular, continuous, and substantial basis in the operations of the activity. Irs free efile Other income (nonpassive income). Irs free efile    Generally, you can use losses from passive activities only to offset income from passive activities. Irs free efile You cannot use passive activity losses to offset your other income, such as your wages or your portfolio income. Irs free efile Portfolio income includes gross income from interest, dividends, annuities, or royalties that is not derived in the ordinary course of a trade or business. Irs free efile It also includes gains or losses (not derived in the ordinary course of a trade or business) from the sale or trade of property (other than an interest in a passive activity) producing portfolio income or held for investment. Irs free efile This includes capital gain distributions from mutual funds (and other regulated investment companies) and real estate investment trusts. Irs free efile   You cannot use passive activity losses to offset Alaska Permanent Fund dividends. Irs free efile Expenses. Irs free efile   Do not include in the computation of your passive activity income or loss: Expenses (other than interest) that are clearly and directly allocable to your portfolio income, or Interest expense properly allocable to portfolio income. Irs free efile However, this interest and other expenses may be subject to other limits. Irs free efile These limits are explained in the rest of this chapter. Irs free efile Additional information. Irs free efile   For more information about determining and reporting income and losses from passive activities, see Publication 925. Irs free efile Interest Expenses This section discusses interest expenses you may be able to deduct as an investor. Irs free efile For information on business interest, see chapter 4 of Publication 535. Irs free efile You cannot deduct personal interest expenses other than qualified home mortgage interest, as explained in Publication 936, Home Mortgage Interest Deduction, and interest on certain student loans, as explained in Publication 970. Irs free efile Investment Interest If you borrow money to buy property you hold for investment, the interest you pay is investment interest. Irs free efile You can deduct investment interest subject to the limit discussed later. Irs free efile However, you cannot deduct interest you incurred to produce tax-exempt income. Irs free efile See Tax-exempt income under Nondeductible Expenses, later. Irs free efile You also cannot deduct interest expenses on straddles discussed under Interest expense and carrying charges on straddles , later. Irs free efile Investment interest does not include any qualified home mortgage interest or any interest taken into account in computing income or loss from a passive activity. Irs free efile Investment property. Irs free efile   Property held for investment includes property that produces interest, dividends, annuities, or royalties not derived in the ordinary course of a trade or business. Irs free efile It also includes property that produces gain or loss (not derived in the ordinary course of a trade or business) from the sale or trade of property producing these types of income or held for investment (other than an interest in a passive activity). Irs free efile Investment property also includes an interest in a trade or business activity in which you did not materially participate (other than a passive activity). Irs free efile Partners, shareholders, and beneficiaries. Irs free efile   To determine your investment interest, combine your share of investment interest from a partnership, S corporation, estate, or trust with your other investment interest. Irs free efile Allocation of Interest Expense If you borrow money for business or personal purposes as well as for investment, you must allocate the debt among those purposes. Irs free efile Only the interest expense on the part of the debt used for investment purposes is treated as investment interest. Irs free efile The allocation is not affected by the use of property that secures the debt. Irs free efile Example 1. Irs free efile You borrow $10,000 and use $8,000 to buy stock. Irs free efile You use the other $2,000 to buy items for your home. Irs free efile Since 80% of the debt is used for, and allocated to, investment purposes, 80% of the interest on that debt is investment interest. Irs free efile The other 20% is nondeductible personal interest. Irs free efile Debt proceeds received in cash. Irs free efile   If you receive debt proceeds in cash, the proceeds are generally not treated as investment property. Irs free efile Debt proceeds deposited in account. Irs free efile   If you deposit debt proceeds in an account, that deposit is treated as investment property, regardless of whether the account bears interest. Irs free efile But, if you withdraw the funds and use them for another purpose, you must reallocate the debt to determine the amount considered to be for investment purposes. Irs free efile Example 2. Irs free efile Assume in Example 1 that you borrowed the money on March 1 and immediately bought the stock for $8,000. Irs free efile You did not buy the household items until June 1. Irs free efile You had deposited the $2,000 in the bank. Irs free efile You had no other transactions on the bank account until June. Irs free efile You did not sell the stock, and you made no principal payments on the debt. Irs free efile You paid interest from another account. Irs free efile The $8,000 is treated as being used for an investment purpose. Irs free efile The $2,000 is treated as being used for an investment purpose for the 3-month period. Irs free efile Your total interest expense for 3 months on this debt is investment interest. Irs free efile In June, when you spend the $2,000 for household items, you must begin to allocate 80% of the debt and the interest expense to investment purposes and 20% to personal purposes. Irs free efile Amounts paid within 30 days. Irs free efile   If you receive loan proceeds in cash or if the loan proceeds are deposited in an account, you can treat any payment (up to the amount of the proceeds) made from any account you own, or from cash, as made from those proceeds. Irs free efile This applies to any payment made within 30 days before or after the proceeds are received in cash or deposited in your account. Irs free efile   If you received the loan proceeds in cash, you can treat the payment as made on the date you received the cash instead of the date you actually made the payment. Irs free efile Payments on debt may require new allocation. Irs free efile   As you repay a debt used for more than one purpose, you must reallocate the balance. Irs free efile You must first reduce the amount allocated to personal purposes by the repayment. Irs free efile You then reallocate the rest of the debt to find what part is for investment purposes. Irs free efile Example 3. Irs free efile If, in Example 2 , you repay $500 on November 1, the entire repayment is applied against the amount allocated to personal purposes. Irs free efile The debt balance is now allocated as $8,000 for investment purposes and $1,500 for personal purposes. Irs free efile Until the next reallocation is necessary, 84% ($8,000 ÷ $9,500) of the debt and the interest expense is allocated to investment. Irs free efile Pass-through entities. Irs free efile   If you use borrowed funds to buy an interest in a partnership or S corporation, then the interest on those funds must be allocated based on the assets of the entity. Irs free efile If you contribute to the capital of the entity, you can make the allocation using any reasonable method. Irs free efile Additional allocation rules. Irs free efile   For more information about allocating interest expense, see chapter 4 of Publication 535. Irs free efile When To Deduct Investment Interest If you use the cash method of accounting, you must pay the interest before you can deduct it. Irs free efile If you use an accrual method of accounting, you can deduct interest over the period it accrues, regardless of when you pay it. Irs free efile For an exception, see Unpaid expenses owed to related party under When To Report Investment Expenses, later in this chapter. Irs free efile Example. Irs free efile You borrowed $1,000 on August 26, 2013, payable in 90 days at 12% interest. Irs free efile On November 26, 2013, you paid this with a new note for $1,030, due on February 26, 2014. Irs free efile If you use the cash method of accounting, you cannot deduct any part of the $30 interest on your return for 2013 because you did not actually pay it. Irs free efile If you use an accrual method, you may be able to deduct a portion of the interest on the loans through December 31, 2013, on your return for 2013. Irs free efile Interest paid in advance. Irs free efile   Generally, if you pay interest in advance for a period that goes beyond the end of the tax year, you must spread the interest over the tax years to which it belongs under the OID rules discussed in chapter 1. Irs free efile You can deduct in each year only the interest for that year. Irs free efile Interest on margin accounts. Irs free efile   If you are a cash method taxpayer, you can deduct interest on margin accounts to buy taxable securities as investment interest in the year you paid it. Irs free efile You are considered to have paid interest on these accounts only when you actually pay the broker or when payment becomes available to the broker through your account. Irs free efile Payment may become available to the broker through your account when the broker collects dividends or interest for your account, or sells securities held for you or received from you. Irs free efile   You cannot deduct any interest on money borrowed for personal reasons. Irs free efile Limit on interest deduction for market discount bonds. Irs free efile   The amount you can deduct for interest expense you paid or accrued during the year to buy or carry a market discount bond may be limited. Irs free efile This limit does not apply if you accrue the market discount and include it in your income currently. Irs free efile   Under this limit, the interest is deductible only to the extent it is more than: The total interest and OID includible in gross income for the bond for the year, plus The market discount for the number of days you held the bond during the year. Irs free efile Figure the amount in (2) above using the rules for figuring accrued market discount in chapter 1 under Market Discount Bonds . Irs free efile Interest not deducted due to limit. Irs free efile   In the year you dispose of the bond, you can deduct any interest expense you were not allowed to deduct in earlier years because of the limit. Irs free efile Choosing to deduct disallowed interest expense before the year of disposition. Irs free efile   You can choose to deduct disallowed interest expense in any year before the year you dispose of the bond, up to your net interest income from the bond during the year. Irs free efile The rest of the disallowed interest expense remains deductible in the year you dispose of the bond. Irs free efile Net interest income. Irs free efile   This is the interest income (including OID) from the bond that you include in income for the year, minus the interest expense paid or accrued during the year to purchase or carry the bond. Irs free efile Limit on interest deduction for short-term obligations. Irs free efile   If the current income inclusion rules discussed in chapter 1 under Discount on Short-Term Obligations do not apply to you, the amount you can deduct for interest expense you paid or accrued during the year to buy or carry a short-term obligation is limited. Irs free efile   The interest is deductible only to the extent it is more than: The amount of acquisition discount or OID on the obligation for the tax year, plus The amount of any interest payable on the obligation for the year that is not included in income because of your accounting method (other than interest taken into account in determining the amount of acquisition discount or OID). Irs free efile The method of determining acquisition discount and OID for short-term obligations is discussed in chapter 1 under Discount on Short-Term Obligations . Irs free efile Interest not deducted due to limit. Irs free efile   In the year you dispose of the obligation, or, if you choose, in another year in which you have net interest income from the obligation, you can deduct any interest expense you were not allowed to deduct for an earlier year because of the limit. Irs free efile Follow the same rules provided in the earlier discussion under Limit on interest deduction for market discount bonds , earlier. Irs free efile Limit on Deduction Generally, your deduction for investment interest expense is limited to your net investment income. Irs free efile You can carry over the amount of investment interest you could not deduct because of this limit to the next tax year. Irs free efile The interest carried over is treated as investment interest paid or accrued in that next year. Irs free efile You can carry over disallowed investment interest to the next tax year even if it is more than your taxable income in the year the interest was paid or accrued. Irs free efile Net Investment Income Determine the amount of your net investment income by subtracting your investment expenses (other than interest expense) from your investment income. Irs free efile Investment income. Irs free efile   This generally includes your gross income from property held for investment (such as interest, dividends, annuities, and royalties). Irs free efile Investment income does not include Alaska Permanent Fund dividends. Irs free efile It also does not include qualified dividends or net capital gain unless you choose to include them. Irs free efile Choosing to include qualified dividends. Irs free efile   Investment income generally does not include qualified dividends, discussed in chapter 1. Irs free efile However, you can choose to include all or part of your qualified dividends in investment income. Irs free efile   You make this choice by completing Form 4952, line 4g, according to its instructions. Irs free efile   If you choose to include any of your qualified dividends in investment income, you must reduce your qualified dividends that are eligible for the lower capital gains tax rates by the same amount. Irs free efile Choosing to include net capital gain. Irs free efile    Investment income generally does not include net capital gain from disposing of investment property (including capital gain distributions from mutual funds). Irs free efile However, you can choose to include all or part of your net capital gain in investment income. Irs free efile   You make this choice by completing Form 4952, line 4g, according to its instructions. Irs free efile   If you choose to include any of your net capital gain in investment income, you must reduce your net capital gain that is eligible for the lower capital gains tax rates by the same amount. Irs free efile   For more information about the capital gains rates, see Capital Gain Tax Rates in chapter 4. Irs free efile    Before making either choice, consider the overall effect on your tax liability. Irs free efile Compare your tax if you make one or both of these choices with your tax if you do not. Irs free efile Investment income of child reported on parent's return. Irs free efile   Investment income includes the part of your child's interest and dividend income you choose to report on your return. Irs free efile If the child does not have qualified dividends, Alaska Permanent Fund dividends, or capital gain distributions, this is the amount on line 6 of Form 8814. Irs free efile Include it on line 4a of Form 4952. Irs free efile Example. Irs free efile Your 8-year-old son has interest income of $2,200, which you choose to report on your own return. Irs free efile You enter $2,200 on Form 8814, lines 1a and 4, and $200 on lines 6 and 12 and complete Part II. Irs free efile Also enter $200 on Form 1040, line 21. Irs free efile Your investment income includes this $200. Irs free efile Child's qualified dividends. Irs free efile   If part of the amount you report is your child's qualified dividends, that part (which is reported on Form 1040, line 9b) generally does not count as investment income. Irs free efile However, you can choose to include all or part of it in investment income, as explained under Choosing to include qualified dividends , earlier. Irs free efile   Your investment income also includes the amount on Form 8814, line 12 (or, if applicable, the reduced amount figured next under Child's Alaska Permanent Fund dividends). Irs free efile Child's Alaska Permanent Fund dividends. Irs free efile   If part of the amount you report is your child's Alaska Permanent Fund dividends, that part does not count as investment income. Irs free efile To figure the amount of your child's income that you can consider your investment income, start with the amount on Form 8814, line 6. Irs free efile Multiply that amount by a percentage that is equal to the Alaska Permanent Fund dividends divided by the total amount on Form 8814, line 4. Irs free efile Subtract the result from the amount on Form 8814, line 12. Irs free efile Example. Irs free efile Your 10-year-old child has taxable interest income of $4,000 and Alaska Permanent Fund dividends of $2,000. Irs free efile You choose to report this on your return. Irs free efile You enter $4,000 on Form 8814, line 1a, $2,000 on line 2a, and $6,000 on line 4. Irs free efile You then enter $4,000 on Form 8814, lines 6 and 12, and Form 1040, line 21. Irs free efile You figure the amount of your child's income that you can consider your investment income as follows: $4,000 − ($4,000 × ($2,000 ÷ $6,000)) = $2,667 You include the result, $2,667, on Form 4952, line 4a. Irs free efile Child's capital gain distributions. Irs free efile   If part of the amount you report is your child's capital gain distributions, that part (which is reported on Schedule D (Form 1040), line 13, or Form 1040, line 13) generally does not count as investment income. Irs free efile However, you can choose to include all or part of it in investment income, as explained in Choosing to include net capital gain , earlier. Irs free efile   Your investment income also includes the amount on Form 8814, line 12 (or, if applicable, the reduced amount figured under Child's Alaska Permanent Fund dividends , earlier). Irs free efile Investment expenses. Irs free efile   Investment expenses are your allowed deductions (other than interest expense) directly connected with the production of investment income. Irs free efile Investment expenses that are included as a miscellaneous itemized deduction on Schedule A (Form 1040) are allowable deductions after applying the 2% limit that applies to miscellaneous itemized deductions. Irs free efile Use the smaller of: The investment expenses included on Schedule A (Form 1040), line 23, or The amount on Schedule A (Form 1040), line 27. Irs free efile See Expenses of Producing Income , later, for a discussion of the 2% limit. Irs free efile Losses from passive activities. Irs free efile   Income or expenses that you used in computing income or loss from a passive activity are not included in determining your investment income or investment expenses (including investment interest expense). Irs free efile See Publication 925 for information about passive activities. Irs free efile Example. Irs free efile Ted is a partner in a partnership that operates a business. Irs free efile However, he does not materially participate in the partnership's business. Irs free efile Ted's interest in the partnership is considered a passive activity. Irs free efile Ted's investment income from interest and dividends (other than qualified dividends) is $10,000. Irs free efile His investment expenses (other than interest) are $3,200 after taking into account the 2% limit on miscellaneous itemized deductions. Irs free efile His investment interest expense is $8,000. Irs free efile Ted also has income from the partnership of $2,000. Irs free efile Ted figures his net investment income and the limit on his investment interest expense deduction in the following way: Total investment income $10,000 Minus: Investment expenses (other than interest) 3,200 Net investment income $6,800 Deductible investment interest expense for the year $6,800 The $2,000 of income from the passive activity is not used in determining Ted's net investment income. Irs free efile His investment interest deduction for the year is limited to $6,800, the amount of his net investment income. Irs free efile Form 4952 Use Form 4952 to figure your deduction for investment interest. Irs free efile See Form 4952 for more information. Irs free efile Exception to use of Form 4952. Irs free efile   You do not have to complete Form 4952 or attach it to your return if you meet all of the following tests. Irs free efile Your investment interest expense is not more than your investment income from interest and ordinary dividends minus any qualified dividends. Irs free efile You do not have any other deductible investment expenses. Irs free efile You have no carryover of investment interest expense from 2012. Irs free efile   If you meet all of these tests, you can deduct all of your investment interest. Irs free efile    Bond Premium Amortization If you pay a premium to buy a bond, the premium is part of your basis in the bond. Irs free efile If the bond yields taxable interest, you can choose to amortize the premium. Irs free efile This generally means that each year, over the life of the bond, you use a part of the premium to reduce the amount of interest includible in your income. Irs free efile If you make this choice, you must reduce your basis in the bond by the amortization for the year. Irs free efile If the bond yields tax-exempt interest, you must amortize the premium. Irs free efile This amortized amount is not deductible in determining taxable income. Irs free efile However, each year you must reduce your basis in the bond (and tax-exempt interest otherwise reportable on Form 1040, line 8b) by the amortization for the year. Irs free efile Bond premium. Irs free efile   Bond premium is the amount by which your basis in the bond right after you get it is more than the total of all amounts payable on the bond after you get it (other than payments of qualified stated interest). Irs free efile For example, a bond with a maturity value of $1,000 generally would have a $50 premium if you buy it for $1,050. Irs free efile Special rules to determine amounts payable on a bond. Irs free efile   For special rules that apply to determine the amounts payable on a variable rate bond, an inflation-indexed debt instrument, a bond that provides for certain alternative payment schedules (for example, a bond callable prior to the stated maturity date of the bond), or a bond that provides for remote or incidental contingencies, see Regulations section 1. Irs free efile 171-3. Irs free efile Basis. Irs free efile   In general, your basis for figuring bond premium amortization is the same as your basis for figuring any loss on the sale of the bond. Irs free efile However, you may need to use a different basis for: Convertible bonds, Bonds you got in a trade, and Bonds whose basis has to be determined using the basis of the person who transferred the bond to you. Irs free efile See Regulations section 1. Irs free efile 171-1(e). Irs free efile Dealers. Irs free efile   A dealer in taxable bonds (or anyone who holds them mainly for sale to customers in the ordinary course of a trade or business or who would properly include bonds in inventory at the close of the tax year) cannot claim a deduction for amortizable bond premium. Irs free efile   See section 75 of the Internal Revenue Code for the treatment of bond premium by a dealer in tax-exempt bonds. Irs free efile How To Figure Amortization For bonds issued after September 27, 1985, you must amortize bond premium using a constant yield method on the basis of the bond's yield to maturity, determined by using the bond's basis and compounding at the close of each accrual period. Irs free efile Constant yield method. Irs free efile   Figure the bond premium amortization for each accrual period as follows. Irs free efile Step 1: Determine your yield. Irs free efile   Your yield is the discount rate that, when used in figuring the present value of all remaining payments to be made on the bond (including payments of qualified stated interest), produces an amount equal to your basis in the bond. Irs free efile Figure the yield as of the date you got the bond. Irs free efile It must be constant over the term of the bond and must be figured to at least two decimal places when expressed as a percentage. Irs free efile   If you do not know the yield, consult your broker or tax advisor. Irs free efile Databases available to them are likely to show the yield at the date of purchase. Irs free efile Step 2: Determine the accrual periods. Irs free efile   You can choose the accrual periods to use. Irs free efile They may be of any length and may vary in length over the term of the bond, but each accrual period can be no longer than 1 year and each scheduled payment of principal or interest must occur either on the first or the final day of an accrual period. Irs free efile The computation is simplest if accrual periods are the same as the intervals between interest payment dates. Irs free efile Step 3: Determine the bond premium for the accrual period. Irs free efile   To do this, multiply your adjusted acquisition price at the beginning of the accrual period by your yield. Irs free efile Then subtract the result from the qualified stated interest for the period. Irs free efile   Your adjusted acquisition price at the beginning of the first accrual period is the same as your basis. Irs free efile After that, it is your basis decreased by the amount of bond premium amortized for earlier periods and the amount of any payment previously made on the bond other than a payment of qualified stated interest. Irs free efile Example. Irs free efile On February 1, 2012, you bought a taxable bond for $110,000. Irs free efile The bond has a stated principal amount of $100,000, payable at maturity on February 1, 2019, making your premium $10,000 ($110,000 − $100,000). Irs free efile The bond pays qualified stated interest of $10,000 on February 1 of each year. Irs free efile Your yield is 8. Irs free efile 07439% compounded annually. Irs free efile You choose to use annual accrual periods ending on February 1 of each year. Irs free efile To find your bond premium amortization for the accrual period ending on February 1, 2013, you multiply the adjusted acquisition price at the beginning of the period ($110,000) by your yield. Irs free efile When you subtract the result ($8,881. Irs free efile 83) from the qualified stated interest for the period ($10,000), you find that your bond premium amortization for the period is $1,118. Irs free efile 17. Irs free efile Special rules to figure amortization. Irs free efile   For special rules to figure the bond premium amortization on a variable rate bond, an inflation-indexed debt instrument, a bond that provides for certain alternative payment schedules (for example, a bond callable prior to the stated maturity date of the bond), or a bond that provides for remote or incidental contingencies, see Regulations section 1. Irs free efile 171-3. Irs free efile Bonds Issued Before September 28, 1985 For these bonds, you can amortize bond premium using any reasonable method. Irs free efile Reasonable methods include: The straight-line method, and The Revenue Ruling 82-10 method. Irs free efile Straight-line method. Irs free efile   Under this method, the amount of your bond premium amortization is the same each month. Irs free efile Divide the number of months you held the bond during the year by the number of months from the beginning of the tax year (or, if later, the date of acquisition) to the date of maturity or earlier call date. Irs free efile Then multiply the result by the bond premium (reduced by any bond premium amortization claimed in earlier years). Irs free efile This gives you your bond premium amortization for the year. Irs free efile Revenue Ruling 82-10 method. Irs free efile   Under this method, the amount of your bond premium amortization increases each month over the life of the bond. Irs free efile This method is explained in Revenue Ruling 82-10, 1982-1 C. Irs free efile B. Irs free efile 46. Irs free efile Choosing To Amortize You choose to amortize the premium on taxable bonds by reporting the amortization for the year on your income tax return for the first tax year you want the choice to apply. Irs free efile You should attach a statement to your return that you are making this choice under section 171. Irs free efile See How To Report Amortization, next. Irs free efile This choice is binding for the year you make it and for later tax years. Irs free efile It applies to all taxable bonds you own in the year you make the choice and also to those you acquire in later years. Irs free efile You can change your decision to amortize bond premium only with the written approval of the IRS. Irs free efile To request approval, use Form 3115. Irs free efile For more information on requesting approval, see section 5 of the Appendix to Revenue Procedure 2011-14 in Internal Revenue Bulletin 2011-4. Irs free efile You can find Revenue Procedure 2011-14 at www. Irs free efile irs. Irs free efile gov/irb/2011-04_IRB/ar08. Irs free efile html. Irs free efile How To Report Amortization Subtract the bond premium amortization from your interest income from these bonds. Irs free efile Report the bond's interest on Schedule B (Form 1040A or 1040), line 1. Irs free efile Under your last entry on line 1, put a subtotal of all interest listed on line 1. Irs free efile Below this subtotal, print “ABP Adjustment,” and the total interest you received. Irs free efile Subtract this amount from the subtotal, and enter the result on line 2. Irs free efile Bond premium amortization more than interest. Irs free efile   If the amount of your bond premium amortization for an accrual period is more than the qualified stated interest for the period, you can deduct the difference as a miscellaneous itemized deduction on Schedule A (Form 1040), line 28. Irs free efile    But your deduction is limited to the amount by which your total interest inclusions on the bond in prior accrual periods is more than your total bond premium deductions on the bond in prior periods. Irs free efile Any amount you cannot deduct because of this limit can be carried forward to the next accrual period. Irs free efile Pre-1998 election to amortize bond premium. Irs free efile   Generally, if you first elected to amortize bond premium before 1998, the above treatment of the premium does not apply to bonds you acquired before 1988. Irs free efile Bonds acquired before October 23, 1986. Irs free efile   The amortization of the premium on these bonds is a miscellaneous itemized deduction not subject to the 2%-of-adjusted-gross-income limit. Irs free efile Bonds acquired after October 22, 1986, but before 1988. Irs free efile    The amortization of the premium on these bonds is investment interest expense subject to the investment interest limit, unless you choose to treat it as an offset to interest income on the bond. Irs free efile Expenses of Producing Income You deduct investment expenses (other than interest expenses) as miscellaneous itemized deductions on Schedule A (Form 1040). Irs free efile To be deductible, these expenses must be ordinary and necessary expenses paid or incurred: To produce or collect income, or To manage property held for producing income. Irs free efile The expenses must be directly related to the income or income-producing property, and the income must be taxable to you. Irs free efile The deduction for most income-producing expenses is subject to a 2% limit that also applies to certain other miscellaneous itemized deductions. Irs free efile The amount deductible is limited to the total of these miscellaneous deductions that is more than 2% of your adjusted gross income. Irs free efile For information on how to report expenses of producing income, see How To Report Investment Expenses , later. Irs free efile Attorney or accounting fees. Irs free efile   You can deduct attorney or accounting fees that are necessary to produce or collect taxable income. Irs free efile However, in some cases, attorney or accounting fees are part of the basis of property. Irs free efile See Basis of Investment Property in chapter 4. Irs free efile Automatic investment service and dividend reinvestment plans. Irs free efile   A bank may offer its checking account customers an automatic investment service so that, for a charge, each customer can choose to invest a part of the checking account each month in common stock. Irs free efile Or a bank that is a dividend disbursing agent for a number of publicly-owned corporations may set up an automatic dividend reinvestment service. Irs free efile Through that service, cash dividends are reinvested in more shares of stock after the bank deducts a service charge. Irs free efile   A corporation in which you own stock also may have a dividend reinvestment plan. Irs free efile This plan lets you choose to use your dividends to buy more shares of stock in the corporation instead of receiving the dividends in cash. Irs free efile   You can deduct the monthly service charge you pay to a bank to participate in an automatic investment service. Irs free efile If you participate in a dividend reinvestment plan, you can deduct any service charge subtracted from your cash dividends before the dividends are used to buy more shares of stock. Irs free efile Deduct the charges in the year you pay them. Irs free efile Clerical help and office rent. Irs free efile   You can deduct office expenses, such as rent and clerical help, you incurred in connection with your investments and collecting the taxable income on your investments. Irs free efile Cost of replacing missing securities. Irs free efile   To replace your taxable securities that are mislaid, lost, stolen, or destroyed, you may have to post an indemnity bond. Irs free efile You can deduct the premium you pay to buy the indemnity bond and the related incidental expenses. Irs free efile   You may, however, get a refund of part of the bond premium if the missing securities are recovered within a specified time. Irs free efile Under certain types of insurance policies, you can recover some of the expenses. Irs free efile   If you receive the refund in the tax year you pay the amounts, you can deduct only the difference between the expenses paid and the amount refunded. Irs free efile If the refund is made in a later tax year, you must include the refund in income in the year you received it, but only to the extent that the expenses decreased your tax in the year you deducted them. Irs free efile Fees to collect income. Irs free efile   You can deduct fees you pay to a broker, bank, trustee, or similar agent to collect investment income, such as your taxable bond or mortgage interest, or your dividends on shares of stock. Irs free efile Fees to buy or sell. Irs free efile   You cannot deduct a fee you pay to a broker to acquire investment property, such as stocks or bonds. Irs free efile You must add the fee to the cost of the property. Irs free efile See Basis of Investment Property in chapter 4. Irs free efile    You cannot deduct any broker's fees, commissions, or option premiums you pay (or that were netted out) in connection with the sale of investment property. Irs free efile They can be used only to figure gain or loss from the sale. Irs free efile See Reporting Capital Gains and Losses , in chapter 4, for more information about the treatment of these sale expenses. Irs free efile Investment counsel and advice. Irs free efile   You can deduct fees you pay for counsel and advice about investments that produce taxable income. Irs free efile This includes amounts you pay for investment advisory services. Irs free efile Safe deposit box rent. Irs free efile   You can deduct rent you pay for a safe deposit box if you use the box to store taxable income-producing stocks, bonds, or other investment-related papers and documents. Irs free efile If you also use the box to store tax-exempt securities or personal items, you can deduct only part of the rent. Irs free efile See Tax-exempt income under Nondeductible Expenses, later, to figure what part you can deduct. Irs free efile State and local transfer taxes. Irs free efile   You cannot deduct the state and local transfer taxes you pay when you buy or sell securities. Irs free efile If you pay these transfer taxes when you buy securities, you must treat them as part of the cost of the property. Irs free efile If you pay these transfer taxes when you sell securities, you must treat them as a reduction in the amount realized. Irs free efile Trustee's commissions for revocable trust. Irs free efile   If you set up a revocable trust and have its income distributed to you, you can deduct the commission you pay the trustee for managing the trust to the extent it is to produce or collect taxable income or to manage property. Irs free efile However, you cannot deduct any part of the commission used for producing or collecting tax-exempt income or for managing property that produces tax-exempt income. Irs free efile   If you are a cash-basis taxpayer and pay the commissions for several years in advance, you must deduct a part of the commission each year. Irs free efile You cannot deduct the entire amount in the year you pay it. Irs free efile Investment expenses from pass-through entities. Irs free efile   If you hold an interest in a partnership, S corporation, real estate mortgage investment conduit (REMIC), or a nonpublicly offered mutual fund, you can deduct your share of that entity's investment expenses. Irs free efile A partnership or S corporation will show your share of these expenses on your Schedule K-1 (Form 1065) or Schedule K-1 (Form 1120S). Irs free efile A nonpublicly offered mutual fund will indicate your share of these expenses in box 5 of Form 1099-DIV (or substitute statement). Irs free efile Publicly-offered mutual funds are discussed later. Irs free efile   If you hold an interest in a REMIC, any expenses relating to your residual interest investment will be shown on Schedule Q (Form 1066), line 3b. Irs free efile Any expenses relating to your regular interest investment will appear in box 5 of Form 1099-INT (or substitute statement) or box 9 of Form 1099-OID (or substitute statement). Irs free efile   Report your share of these investment expenses on Schedule A (Form 1040), subject to the 2% limit, in the same manner as your other investment expenses. Irs free efile Including mutual fund or REMIC expenses in income. Irs free efile   Your share of the investment expenses of a REMIC or a nonpublicly offered mutual fund, as described above, are considered to be indirect deductions through that pass-through entity. Irs free efile You must include in your gross income an amount equal to the expenses allocated to you, whether or not you are able to claim a deduction for those expenses. Irs free efile If you are a shareholder in a nonpublicly offered mutual fund, you must include on your return the full amount of ordinary dividends or other distributions of stock, as shown in box 1a of Form 1099-DIV (or substitute statement). Irs free efile If you are a residual interest holder in a REMIC, you must report as ordinary income on Schedule E (Form 1040) the total amounts shown on Schedule Q (Form 1066), lines 1b and 3b. Irs free efile If you are a REMIC regular interest holder, you must include the amount of any expense allocation you received on Form 1040, line 8a. Irs free efile Publicly-offered mutual funds. Irs free efile   Most mutual funds are publicly offered. Irs free efile These mutual funds, generally, are traded on an established securities exchange. Irs free efile These funds do not pass investment expenses through to you. Irs free efile Instead, the dividend income they report to you in box 1a of Form 1099-DIV (or substitute statement) is already reduced by your share of investment expenses. Irs free efile As a result, you cannot deduct the expenses on your return. Irs free efile   Include the amount from box 1a of Form 1099-DIV (or substitute statement) in your income. Irs free efile    A publicly offered mutual fund is one that: Is continuously offered pursuant to a public offering, Is regularly traded on an established securities market, and Is held by or for no fewer than 500 persons at any time during the year. Irs free efile Contact your mutual fund if you are not sure whether it is publicly offered. Irs free efile Nondeductible Expenses Some expenses that you incur as an investor are not deductible. Irs free efile Stockholders' meetings. Irs free efile   You cannot deduct transportation and other expenses you pay to attend stockholders' meetings of companies in which you have no interest other than owning stock. Irs free efile This is true even if your purpose in attending is to get information that would be useful in making further investments. Irs free efile Investment-related seminar. Irs free efile   You cannot deduct expenses for attending a convention, seminar, or similar meeting for investment purposes. Irs free efile Single-premium life insurance, endowment, and annuity contracts. Irs free efile   You cannot deduct interest on money you borrow to buy or carry a single-premium life insurance, endowment, or annuity contract. Irs free efile Used as collateral. Irs free efile   If you use a single premium annuity contract as collateral to obtain or continue a mortgage loan, you cannot deduct any interest on the loan that is collateralized by the annuity contract. Irs free efile Figure the amount of interest expense disallowed by multiplying the current interest rate on the mortgage loan by the lesser of the amount of the annuity contract used as collateral or the amount of the loan. Irs free efile Borrowing on insurance. Irs free efile   Generally, you cannot deduct interest on money you borrow to buy or carry a life insurance, endowment, or annuity contract if you plan to systematically borrow part or all of the increases in the cash value of the contract. Irs free efile This rule applies to the interest on the total amount borrowed to buy or carry the contract, not just the interest on the borrowed increases in the cash value. Irs free efile Tax-exempt income. Irs free efile   You cannot deduct expenses you incur to produce tax-exempt income. Irs free efile Nor can you deduct interest on money you borrow to buy tax-exempt securities or shares in a mutual fund or other regulated investment company that distributes only exempt-interest dividends. Irs free efile Short-sale expenses. Irs free efile   The rule disallowing a deduction for interest expenses on tax-exempt securities applies to amounts you pay in connection with personal property used in a short sale or amounts paid by others for the use of any collateral in connection with the short sale. Irs free efile However, it does not apply to the expenses you incur if you deposit cash as collateral for the property used in the short sale and the cash does not earn a material return during the period of the sale. Irs free efile Short sales are discussed in Short Sales in chapter 4. Irs free efile Expenses for both tax-exempt and taxable income. Irs free efile   You may have expenses that are for both tax-exempt and taxable income. Irs free efile If you cannot specifically identify what part of the expenses is for each type of income, you can divide the expenses, using reasonable proportions based on facts and circumstances. Irs free efile You must attach a statement to your return showing how you divided the expenses and stating that each deduction claimed is not based on tax-exempt income. Irs free efile   One accepted method for dividing expenses is to do it in the same proportion that each type of income is to the total income. Irs free efile If the expenses relate in part to capital gains and losses, include the gains, but not the losses, in figuring this proportion. Irs free efile To find the part of the expenses that is for the tax-exempt income, divide your tax-exempt income by the total income and multiply your expenses by the result. Irs free efile Example. Irs free efile You received $6,000 interest; $4,800 was tax-exempt and $1,200 was taxable. Irs free efile In earning this income, you had $500 of expenses. Irs free efile You cannot specifically identify the amount of each expense item that is for each income item, so you must divide your expenses. Irs free efile 80% ($4,800 tax-exempt interest divided by $6,000 total interest) of your expenses is for the tax-exempt income. Irs free efile You cannot deduct $400 (80% of $500) of the expenses. Irs free efile You can deduct $100 (the rest of the expenses) because they are for the taxable interest. Irs free efile State income taxes. Irs free efile   If you itemize your deductions, you can deduct, as taxes, state income taxes on interest income that is exempt from federal income tax. Irs free efile But you cannot deduct, as either taxes or investment expenses, state income taxes on other exempt income. Irs free efile Interest expense and carrying charges on straddles. Irs free efile   You cannot deduct interest and carrying charges allocable to personal property that is part of a straddle. Irs free efile The nondeductible interest and carrying charges are added to the basis of the straddle property. Irs free efile However, this treatment does not apply if: All the offsetting positions making up the straddle either consist of one or more qualified covered call options and the optioned stock, or consist of section 1256 contracts (and the straddle is not part of a larger straddle); or The straddle is a hedging transaction. Irs free efile  For information about straddles, including definitions of the terms used in this discussion, see Straddles in chapter 4. Irs free efile   Interest includes any amount you pay or incur in connection with personal property used in a short sale. Irs free efile However, you must first apply the rules discussed in Payments in lieu of dividends under Short Sales in chapter 4. Irs free efile   To determine the interest on market discount bonds and short-term obligations that are part of a straddle, you must first apply the rules discussed under Limit on interest deduction for market discount bonds and Limit on interest deduction for short-term obligations (both under Interest Expenses, earlier). Irs free efile Nondeductible amount. Irs free efile   Figure the nondeductible interest and carrying charges on straddle property as follows. Irs free efile Add: Interest on indebtedness incurred or continued to buy or carry the personal property, and All other amounts (including charges to insure, store, or transport the personal property) paid or incurred to carry the personal property. Irs free efile Subtract from the amount in (1): Interest (including OID) includible in gross income for the year on the personal property, Any income from the personal property treated as ordinary income on the disposition of short-term government obligations or as ordinary income under the market discount and short-term bond provisions — see Discount on Debt Instruments in chapter 1, The dividends includible in gross income for the year from the personal property, and Any payment on a loan of the personal property for use in a short sale that is includible in gross income. Irs free efile Basis adjustment. Irs free efile   Add the nondeductible amount to the basis of your straddle property. Irs free efile How To Report Investment Expenses To deduct your investment expenses, you must itemize deductions on Schedule A (Form 1040). Irs free efile Enter your deductible investment interest expense on Schedule A (Form1040), line 14. Irs free efile Include any deductible short sale expenses. Irs free efile (See Short Sales in chapter 4 for information on these expenses. Irs free efile ) Also attach a completed Form 4952 if you used that form to figure your investment interest expense. Irs free efile Enter the total amount of your other investment expenses (other than interest expenses) on Schedule A (Form 1040), line 23. Irs free efile List the type and amount of each expense on the dotted lines next to line 23. Irs free efile (If necessary, you can show the required information on an attached statement. Irs free efile ) For information on how to report amortizable bond premium, see Bond Premium Amortization , earlier in this chapter. Irs free efile When To Report Investment Expenses If you use the cash method to report income and expenses, you generally deduct your expenses, except for certain prepaid interest, in the year you pay them. Irs free efile If you use an accrual method, you generally deduct your expenses when you incur a liability for them, rather than when you pay them. Irs free efile Also see When To Deduct Investment Interest , earlier in this chapter. Irs free efile Unpaid expenses owed to related party. Irs free efile   If you use an accrual method, you cannot deduct interest and other expenses owed to a related cash-basis person until payment is made and the amount is includible in the gross income of that person. Irs free efile The relationship, for purposes of this rule, is determined as of the end of the tax year for which the interest or expense would otherwise be deductible. Irs free efile If a deduction is denied under this rule, this rule will continue to apply even if your relationship with the person ceases to exist before the amount is includible in the gross income of that person. Irs free efile   This rule generally applies to those relationships listed in chapter 4 under Related Party Transactions . Irs free efile It also applies to accruals by partnerships to partners, partners to partnerships, shareholders to S corporations, and S corporations to shareholders. Irs free efile   The postponement of deductions for unpaid expenses and interest under the related party rule does not apply to OID, regardless of when payment is made. Irs free efile This rule also does not apply to loans with below-market interest rates or to certain payments for the use of property and services when the lender or recipient has to include payments periodically in income, even if a payment has not been made. Irs free efile Prev  Up  Next   Home   More Online Publications