INCOMEInterest and Dividends

Interest

Common sources of Taxable Interest:

checking and savings accounts, certificates of deposit (CDs)

savings certificates

U.S. government bonds

interest on insurance proceeds

loans that the taxpayer makes to others.

Interest

Ask the taxpayer to supply all Forms 1099-INT from institutions that pay interest.

If the taxpayer cashed in Series EE or Series I bonds, they should have a form 1099-INT from the bank.

Most taxpayers don’t report savings bond interest as it accrues every year.

They report the total interest when they cash the bonds.

If the taxpayer says they have been reporting the interest as it accrues each year, see Publication 17 under Interest Income for directions to report the current year interest.

IRA Interest

Interest on a Roth IRA is generally not taxable.

Interest on a traditional IRA is tax-deferred. Do not include that interest until the taxpayer makes withdrawals from the IRA.

The taxpayer will be issued Form 1099-R to report a distribution.

Non-Taxable Interest

Some examples:

state and local bonds

qualified Series EE and Series I savings bonds used to pay higher education expenses

interest earned on a traditional IRA Tax-deferred till they receive distributions

Although tax-exempt interest is not taxable, the taxpayer must report all tax-exempt interest on Form 1040 (line 8b)

Certain types of interest are exempt from federal income tax. However, they may be taxable by the state. Sometimes the reverse is true.

1099-INT

Box 1 of Form 1099-INT shows taxable interest income received from the payer. Add the taxable interest earned from all the taxpayer's Forms 1099-INT, and report the total on line 8a of Form 1040.

Box 3 shows taxable interest on U.S. Savings Bonds and Treasury obligations. Include the taxable portion with other amounts reported on line 8a of Form 1040.

1099-INT

Early Withdrawal Penalty

If a taxpayer withdrew funds from a time deposit before an account's maturity date and incurs an interest penalty, the penalty is shown in box 2 of Form 1099-INT.

The early withdrawal penalty is entered as an adjustment to income.

Some Forms 1099-INT have entries in box 4 indicating that federal income tax has been withheld from the interest paid. The amount shown in box 4 goes in the Payments section for Form 1040 and the amount shown in box 6 goes in the Credits section.

If any other boxes contain amounts, refer the taxpayer to a professional tax preparer.

Exercise

Mr. and Mrs. Wharton received $200 in interest from bonds issued by the State of Illinois. How should they report this on their 1040A?

a. On line 8a

b. On both lines 8a and 8b

c. On line 8b

d. They do not have to report it

Reporting Interest

Must complete Schedule B, if the taxpayer has the following:

Over $1,500 of taxable interest

Received, as a nominee, interest that actually belongs to someone else

Received interest from a seller-financed mortgage, and the buyer used the property as a home

Tax-exempt interest

A distribution from a foreign trust or foreign bank account

Educational savings bond exclusion

Exercise

Randy and Ann have three Forms 1099-INT:Epping National Bank, $62Epping Credit Union, $178Brenton Savings and Loan, $760How much interest income should they report on Schedule B (Form 1040A)?

a. None

b. $760

c. $240

d. $1,000

Dividends

Corporations make several types of distributions to their shareholders.

Although most dividends are paid in cash, others are paid in property, services, or additional shares of stock.

Most corporations use Form 1099-DIV to report distributions to shareholders.

Scope

The corporate distributions that VITA/TCE tax preparers may handle are:

Ordinary dividends

Capital gain distributions

Nontaxable dividends and distributions

Qualified Dividends

Qualified dividends are ordinary dividends that are eligible for a lower tax rate than other ordinary income.

They are shown in box 1b of Form 1099-DIV.

Taxpayers who have questions about why a dividend is "qualified" or "not qualified," should contact the company that issued the dividend.

Distributions

Ordinary dividends are corporate distributions paid in cash, as opposed to property, services, or stock shares. They come from a corporation's net earnings and profits.

Capital gain distributions come from mutual funds and real estate investment trusts (REITs). These distributions are treated as long-term capital gains, regardless of how long the taxpayer holds the shares.

Distributions associated with the sale of stock or mutual funds are detailed in the Advanced course.

1099-DIV

Ordinary dividends are shown in box 1. Add the box 1 amounts from all the Forms 1099-DIV the taxpayer receives.

If the taxpayer is married and the total for both spouses is:$1,500 or less, enter the total on line 9a of Form 1040

Over $1,500, complete Form 1040, Schedule B, Part II