Chapter by Chapter
What’s New for 2012 xxv
Key Tax Numbers for 2012 xxviii
Looking Ahead to 2013 xxxi
FILING BASICS 1
Do You Have to File a 2012 Tax Return? 3
Filing Tests for Dependents: 2012 Returns 4
Where to File 5
Filing Deadlines (on or before) 6
Choosing Which Tax Form to File 8
Filing Status 9
1.1 Which Filing Status Should You Use? 10
1.2 Tax Rates Based on Filing Status 10
1.3 Filing Separately Instead of Jointly 11
1.4 Filing a Joint Return 13
1.5 Nonresident Alien Spouse 14
1.6 Community Property Rules 14
1.7 Innocent Spouse Rules 16
1.8 Separate Liability Election for Former Spouses 16
1.9 Equitable Relief 20
1.10 Death of Your Spouse in 2012 21
1.11 Qualifying Widow(er) Status If Your Spouse Died in 2011 or 2010 22
1.12 Qualifying as Head of Household 22
1.13 Filing for Your Child 24
1.14 Return for Deceased 25
1.15 Return for an Incompetent Person 26
1.16 How a Nonresident Alien Is Taxed 27
1.17 How a Resident Alien Is Taxed 27
1.18 Who Is a Resident Alien? 27
1.19 When an Alien Leaves the United States 30
1.20 Expatriation Tax 30
REPORTING YOUR INCOME 31
Wages, Salary, and Other Compensation 33
2.1 Salary and Wage Income 36
2.2 Constructive Receipt of Year-End Paychecks 37
2.3 Pay Received in Property Is Taxed 37
2.4 Commissions Taxable When Credited 38
2.5 Unemployment Benefits 38
2.6 Strike Pay Benefits and Penalties 39
2.7 Nonqualifi ed Deferred Compensation 39
2.8 Did You Return Wages Received in a Prior Year? 41
2.9 Waiver of Executor’s and Trustee’s Commissions 41
2.10 Life Insurance Benefits 41
2.11 Educational Benefits for Employees’ Children 42
2.12 Sick Pay Is Taxable 43
2.13 Workers’ Compensation Is Tax Free 43
2.14 Disability Pensions 44
2.15 Stock Appreciation Rights (SARs) 45
2.16 Stock Options 45
2.17 Restricted Stock 48
Fringe Benefits 50
3.1 Tax-Free Health and Accident Coverage Under Employer Plans 52
3.2 Health Savings Accounts (HSAs) and Archer MSAs 53
3.3 Reimbursements and Other Tax-Free Payments From Employer Health and Accident Plans 55
3.4 Group-Term Life Insurance Premiums 57
3.5 Dependent Care Assistance 59
3.6 Adoption Benefi ts 59
3.7 Education Assistance Plans 60
3.8 Company Cars, Parking, and Transit Passes 60
3.9 Working Condition Fringe Benefi ts 62
3.10 De Minimis Fringe Benefi ts 63
3.11 Employer-Provided Retirement Advice 64
3.12 Employee Achievement Awards 64
3.13 Employer-Furnished Meals or Lodging 64
3.14 Minister’s Rental or Housing Allowance 67
3.15 Cafeteria Plans Provide Choice of Benefits 68
3.16 Flexible Spending Arrangements 69
3.17 Company Services Provided at No Additional Cost 70
3.18 Discounts on Company Products or Services 71
Dividend and Interest Income 72
4.1 Reporting Dividends and Mutual-Fund Distributions 73
4.2 Qualifi ed Corporate Dividends Taxed at Favorable Capital Gain Rates 74
4.3 Dividends From a Partnership, S Corporation, Estate, or Trust 75
4.4 Real Estate Investment Trust (REIT) Dividends 75
4.5 Taxable Dividends of Earnings and Profits 76
4.6 Stock Dividends on Common Stock 76
4.7 Dividends Paid in Property 76
4.8 Taxable Stock Dividends 77
4.9 Who Reports the Dividends 77
4.10 Year Dividends Are Reported 78
4.11 Distribution Not Out of Earnings: Return of Capital 78
4.12 Reporting Interest on Your Tax Return 79
4.13 Interest on Frozen Accounts Not Taxed 80
4.14 Interest Income on Debts Owed to You 80
4.15 Reporting Interest on Bonds Bought or Sold 81
4.16 Forfeiture of Interest on Premature Withdrawals 82
4.17 Amortization of Bond Premium 82
4.18 Discount on Bonds 83
4.19 Reporting Original Issue Discount on Your Return 84
4.20 Reporting Income on Market Discount Bonds 85
4.21 Discount on Short-Term Obligations 86
4.22 Stripped Coupon Bonds and Stock 87
4.23 Sale or Retirement of Bonds and Notes 88
4.24 State and City Interest Generally Tax Exempt 88
4.25 Taxable State and City Interest 89
4.26 Tax-Exempt Bonds Bought at a Discount 89
4.27 Treasury Bills, Notes, and Bonds 90
4.28 Interest on United States Savings Bonds 91
4.29 Deferring United States Savings Bond Interest 92
4.30 Minimum Interest Rules 93
4.31 Interest-Free or Below-Market-Interest Loans 93
4.32 Minimum Interest on Seller-Financed Sales 95
Reporting Property Sales 97
5.1 General Tax Rules for Property Sales 98
5.2 How Property Sales Are Classified and Taxed 98
5.3 Capital Gains Rates and Holding Periods 99
5.4 Capital Losses and Carryovers 102
5.5 Capital Losses of Married Couples 103
5.6 Losses May Be Disallowed on Sales to Related Persons 103
5.7 Deferring or Excluding Gain on Small Business Stock Investment 105
5.8 Sample Entries of Capital Asset Sales on Form 8949 and on Schedule D 106
5.9 Counting the Months in Your Holding Period 113
5.10 Holding Period for Securities 113
5.11 Holding Period for Real Estate 114
5.12 Holding Period: Gifts, Inheritances, and Other Property 114
5.13 Calculating Gain or Loss 115
5.14 Amount Realized Is the Total Selling Price 116
5.15 Finding Your Cost 116
5.16 Unadjusted Basis of Your Property 116
5.17 Basis of Property You Inherited or Received as a Gift 118
5.18 Joint Tenancy Basis Rules for Surviving Tenants 120
5.19 Allocating Cost Among Several Assets 122
5.20 How To Find Adjusted Basis 123
5.21 Tax Advantage of Installment Sales 124
5.22 Figuring the Taxable Part of Installment Payments 125
5.23 Electing Not To Report on the Installment Method 128
5.24 Restriction on Installment Sales to Relatives 128
5.25 Contingent Payment Sales 129
5.26 Using Escrow and Other Security Arrangements 130
5.27 Minimum Interest on Deferred Payment Sales 131
5.28 Dispositions of Installment Notes 131
5.29 Repossession of Personal Property Sold on Installment 132
5.30 Boot in Like-Kind Exchange Payable in Installments 133
5.31 “Interest” Tax on Sales Over $150,000 Plus $5 Million Debt 134
5.32 Worthless Securities 134
5.33 Tax Consequences of Bad Debts 135
5.34 Four Rules To Prove a Bad Debt Deduction 137
5.35 Family Bad Debts 137
Tax-Free Exchanges of Property 139
6.1 Trades of Like-Kind Property 140
6.2 Personal Property Held for Business or Investment 141
6.3 Receipt of Cash and Other Property—“Boot” 142
6.4 Time Limits and Security Arrangements for Deferred Exchanges 144
6.5 Qualifi ed Exchange Accommodation Arrangements (QEAAs) for Reverse Exchanges 147
6.6 Exchanges Between Related Parties 147
6.7 Property Transfers Between Spouses and Ex-Spouses 148
6.8 Tax-Free Exchanges of Stock in Same Corporation 150
6.9 Joint Ownership Interests 151
6.10 Setting up Closely Held Corporations 151
6.11 Exchanges of Coins and Bullion 151
6.12 Tax-Free Exchanges of Insurance Policies 152
Retirement and Annuity Income 154
7.1 Retirement Distributions on Form 1099-R 156
7.2 Lump-Sum Distributions 158
7.3 Lump-Sum Options If You Were Born Before January 2, 1936 159
7.4 Averaging on Form 4972 159
7.5 Capital Gain Treatment for Pre-1974 Participation 161
7.6 Lump-Sum Payments Received by Beneficiary 161
7.7 Tax-Free Rollovers From Qualified Plans 162
7.8 Direct Rollover or Personal Rollover 163
7.9 Rollover of Proceeds From Sale of Property 166
7.10 Distribution of Employer Stock or Other Securities 166
7.11 Survivor Annuity for Spouse 167
7.12 Court Distributions to Former Spouse Under a QDRO 168
7.13 When Retirement Benefi ts Must Begin 169
7.14 Payouts to Benefi ciaries 169
7.15 Penalty for Distributions Before Age 59½ 170
7.16 Restrictions on Loans From Company Plans 172
7.17 Tax Benefi ts of 401(k) Plans 173
7.18 Limit on Salary-Reduction Deferrals 174
7.19 Withdrawals From 401(k) Plans Restricted 175
7.20 Designated Roth Contributions to 401(k) Plans 176
7.21 Annuities for Employees of Tax-Exempts and Schools (403(b) Plans) 176
7.22 Government and Exempt Organization Deferred Pay Plans 178
7.23 Figuring the Taxable Part of Your Annuity 178
7.24 Life Expectancy Tables 183
7.25 When You Convert Your Endowment Policy 184
7.26 Reporting Employee Annuities 184
7.27 Simplifi ed Method for Calculating Taxable Employee Annuity 185
7.28 Employee’s Cost in Annuity 187
7.29 Withdrawals From Employer’s Qualified Retirement Plan Before Annuity Starting Date 187
IRAs 188
8.1 Starting a Traditional IRA 189
8.2 Traditional IRA Contributions Must Be Based on Earnings 190
8.3 Contributions to a Traditional IRA If You Are Married 191
8.4 IRA Deduction Restrictions for Active Participants in Employer Plan 193
8.5 Active Participation in Employer Plan 196
8.6 Nondeductible Contributions to Traditional IRAs 197
8.7 Penalty for Excess Contributions to Traditional IRAs 198
8.8 Taxable Distributions From Traditional IRAs 198
8.9 Partially Tax-Free Traditional IRA Distributions Allocable to Nondeductible Contributions 200
8.10 Tax-Free Rollovers and Direct Transfers to Traditional IRAs 202
8.11 Transfer of Traditional IRA to Spouse at Divorce 204
8.12 Penalty for Traditional IRA Withdrawals Before Age 59½ 204
8.13 Mandatory Distributions From a Traditional IRA After Age 70½ 208
8.14 Inherited Traditional IRAs 211
8.15 SEP Basics 217
8.16 Salary-Reduction SEP Set Up Before 1997 217
8.17 Who Is Eligible for a SIMPLE IRA? 217
8.18 SIMPLE IRA Contributions and Distributions 218
8.19 Roth IRA Advantages 219
8.20 Annual Contributions to a Roth IRA 220
8.21 Converting a Traditional IRA to a Roth IRA 221
8.22 Recharacterizations and Reconversions 222
8.23 Distributions From a Roth IRA 224
8.24 Distributions to Roth IRA Beneficiaries 226
Income From Real Estate Rentals and Royalties 228
9.1 Reporting Rental Real Estate Income and Expenses 229
9.2 Checklist of Rental Deductions 229
9.3 Distinguishing Between a Repair and an Improvement 231
9.4 Reporting Rents From a Multi-Unit Residence 232
9.5 Depreciation on Converting a Home to Rental Property 233
9.6 Renting a Residence to a Relative 234
9.7 Personal Use and Rental of a Residence During the Year 235
9.8 Counting Personal-Use Days and Rental Days for a Residence 236
9.9 Allocating Expenses of a Residence to Rental Days 237
9.10 Rentals Lacking Profi t Motive 239
9.11 Reporting Royalty Income 240
9.12 Production Costs of Books and Creative Properties 241
9.13 Deducting the Cost of Patents or Copyrights 241
9.14 Intangible Drilling Costs 242
9.15 Depletion Deduction 242
9.16 Oil and Gas Percentage Depletion 243
Loss Restrictions: Passive Activities and At-Risk Limits 245
10.1 Rental Activities 246
10.2 Rental Real Estate Loss Allowance of up to $25,000 248
10.3 Real Estate Professionals 251
10.4 Participation May Avoid Passive Loss Restrictions 253
10.5 Classifying Business Activities as One or Several 253
10.6 Material Participation Tests for Business 255
10.7 Tax Credits of Passive Activities Limited 257
10.8 Determining Passive or Nonpassive Income and Loss 257
10.9 Passive Income Recharacterized as Nonpassive Income 259
10.10 Working Interests in Oil and Gas Wells 262
10.11 Partners and Members of LLCs and LLPs 262
10.12 Form 8582 263
10.13 Suspended Losses Allowed on Disposition of Your Interest 264
10.14 Suspended Tax Credits 265
10.15 Personal Service and Closely Held Corporations 266
10.16 Sales of Property and of Passive Activity Interests 267
10.17 At-Risk Limits 268
10.18 What Is At Risk? 269
10.19 Amounts Not At Risk 270
10.20 At-Risk Investment in Several Activities 271
10.21 Carryover of Disallowed Losses 272
10.22 Recapture of Losses Where At Risk Is Less Th an Zero 272
Other Income 273
11.1 Prizes and Awards 274
11.2 Lottery and Sweepstake Winnings 274
11.3 Gambling Winnings and Losses 274
11.4 Gifts and Inheritances 276
11.5 Refunds of State and Local Income Tax Deductions 276
11.6 Other Recovered Deductions 279
11.7 How Legal Damages Are Taxed 280
11.8 Cancellation of Debts You Owe 282
11.9 Schedule K-1 286
11.10 How Partners Report Partnership Profit and Loss 287
11.11 When a Partner Reports Income or Loss 288
11.12 Partnership Loss Limitations 288
11.13 Unifi ed Tax Audits of Partnerships 288
11.14 Stockholder Reporting of S Corporation Income and Loss 289
11.15 How Benefi ciaries Report Estate or Trust Income 290
11.16 Reporting Income in Respect of a Decedent (IRD) 290
11.17 Deduction for Estate Tax Attributable to IRD 290
11.18 How Life Insurance Proceeds Are Taxed to a Beneficiary 291
11.19 A Policy With a Family Income Rider 292
11.20 Selling or Surrendering Life Insurance Policy 292
11.21 Jury Duty Fees 293
11.22 Foster Care Payments 293
CLAIMING DEDUCTIONS 295
Deductions Allowed in Figuring Adjusted Gross Income 297
12.1 Figuring Adjusted Gross Income (AGI) 298
12.2 Claiming Deductions From Gross Income 298
12.3 What Moving Costs Are Deductible? 301
12.4 The Distance Test 302
12.5 The 39-Week Test for Employees 303
12.6 The 78-Week Test for the Self-Employed and Partners 304
12.7 Claiming Deductible Moving Expenses 304
12.8 Reimbursements of Moving Expenses 305
Claiming the Standard Deduction or Itemized Deductions 306
13.1 Claiming the Standard Deduction 308
13.2 Husbands and Wives Filing Separate Returns 309
13.3 Standard Deduction If 65 or Older or Blind 310
13.4 Standard Deduction for Dependents 311
13.5 Prepaying or Postponing Itemized Expenses 312
13.6 No Phaseout of Itemized Deductions 312
Charitable Contribution Deductions 313
14.1 Deductible Contributions 314
14.2 Nondeductible Contributions 315
14.3 Contributions That Provide You With Benefits 316
14.4 Unreimbursed Expenses of Volunteer Workers 318
14.5 Support of a Student in Your Home 319
14.6 What Kind of Property Are You Donating? 319
14.7 Cars, Clothing, and Other Property Valued Below Cost 323
14.8 Bargain Sales of Appreciated Property 324
14.9 Art Objects 325
14.10 Interests in Real Estate 327
14.11 Life Insurance 328
14.12 Business Inventory 329
14.13 Donations Th rough Trusts 329
14.14 Records Needed To Substantiate Your Contributions 329
14.15 Form 8283 and Written Appraisal Requirements for Property Donations 331
14.16 Penalty for Substantial Overvaluation of Property 333
14.17 Ceiling on Charitable Contributions 333
14.18 Carryover for Excess Donations 335
14.19 Election To Reduce Fair Market Value by Appreciation 336
Itemized Deduction for Interest Expenses 337
15.1 Home Mortgage Interest 338
15.2 Home Acquisition Loans 339
15.3 Home Equity Loans 341
15.4 Home Construction Loans 341
15.5 Home Improvement Loans 343
15.6 Mortgage Insurance Premiums and Other Payment Rules 343
15.7 Interest on Refi nanced Loans 344
15.8 “Points” 345
15.9 Cooperative and Condominium Apartments 347
15.10 Investment Interest Limitations 347
15.11 Debts To Carry Tax-Exempt Obligations 349
15.12 Earmarking Use of Loan Proceeds For Investment or Business 349
15.13 Year To Claim an Interest Deduction 351
15.14 Prepaid Interest 351
Deductions for Taxes 353
16.1 Deductible Taxes 354
16.2 Nondeductible Taxes 355
16.3 State and Local Income Taxes or General Sales Taxes 355
16.4 Deducting Real Estate Taxes 356
16.5 Assessments 357
16.6 Tenants’ Payment of Taxes 357
16.7 Allocating Taxes When You Sell or Buy Realty 357
16.8 Automobile License Fees 359
16.9 Taxes Deductible as Business Expenses 359
16.10 Foreign Taxes 359
Medical and Dental Expense Deductions 360
17.1 Medical Expenses Must Exceed AGI Threshold 361
17.2 Allowable Medical Care Costs 361
17.3 Nondeductible Medical Expenses 365
17.4 Reimbursements Reduce Deductible Expenses 365
17.5 Premiums of Medical Care Policies 367
17.6 Expenses of Your Spouse 368
17.7 Expenses of Your Dependents 369
17.8 Decedent’s Medical Expenses 370
17.9 Travel Costs May Be Medical Deductions 370
17.10 Schooling for the Mentally or Physically Disabled 372
17.11 Nursing Homes 373
17.12 Nurses’ Wages 373
17.13 Home Improvements as Medical Expenses 374
17.14 Costs Deductible as Business Expenses 375
17.15 Long-Term Care Premiums and Services 376
17.16 Life Insurance Used by Chronically ill or Terminally ill Persons 377
Casualty and Theft Losses and Involuntary Conversions 378
18.1 Sudden Event Test for Casualty Losses 379
18.2 When To Deduct a Casualty Loss 381
18.3 Disaster Losses 382
18.4 Who May Deduct a Casualty Loss 384
18.5 Bank Deposit Losses 385
18.6 Damage to Trees and Shrubs 386
18.7 Deducting Damage to Your Car 387
18.8 Proving a Casualty Loss 387
18.9 Th eft Losses 388
18.10 Proving a Theft Loss 389
18.11 Nondeductible Casualty and Theft Losses 389
18.12 Floors for Personal-Use Property Losses 390
18.13 Figuring Your Loss on Form 4684 391
18.14 Personal and Business Use of Property 393
18.15 Repairs May Be a “Measure of Loss” 394
18.16 Insurance Reimbursements 394
18.17 Excess Living Costs Paid by Insurance Are Not Taxable 394
18.18 Do Your Casualty or Th eft Losses Exceed Your Income? 396
18.19 Defer Gain by Replacing Property 396
18.20 Involuntary Conversions Qualifying for Tax Deferral 396
18.21 How To Elect To Defer Tax 397
18.22 Time Period for Buying Replacement Property 397
18.23 Types of Qualifying Replacement Property 399
18.24 Cost of Replacement Property Determines Postponed Gain 400
18.25 Special Assessments and Severance Damages 400
18.26 Reporting Gains From Casualties 401
Deducting Job Costs and Other Miscellaneous Expenses 402
19.1 2% AGI Floor Reduces Most Miscellaneous Expenses 403
19.2 Eff ect of 2% AGI Floor on Deductions 404
19.3 Checklist of Job Expenses Subject to the 2% AGI Floor 404
19.4 Job Expenses Not Subject to the 2% AGI Floor 405
19.5 Dues and Subscriptions 405
19.6 Uniforms and Work Clothes 406
19.7 Expenses of Looking for a New Job 407
19.8 Local Transportation Costs 408
19.9 Unusual Job Expenses 408
19.10 Computers Bought for Work 409
19.11 Cell Phones, Calculators, Copiers and Fax Machines 410
19.12 Small Tools 410
19.13 Employee Home Office Deductions 410
19.14 Telephone Costs 411
19.15 Checklist of Deductible Investment Expenses 411
19.16 Costs of Tax Return Preparation and Audits 413
19.17 Deducting Legal Costs 414
19.18 Contingent Fees Paid Out of Taxable Awards 415
Travel and Entertainment Expense Deductions 416
20.1 Deduction Guide for Travel and Transportation Expenses 417
20.2 Commuting Expenses 417
20.3 Overnight-Sleep Test Limits Deduction of Meal Costs 418
20.4 IRS Meal Allowance 420
20.5 Business Trip Deductions 421
20.6 Local Lodging Costs 422
20.7 When Are You Away From Home? 422
20.8 Fixing a Tax Home If You Work in Different Locations 423
20.9 Tax Home of Married Couple Working in Different Cities 424
20.10 Deducting Living Costs on Temporary Assignment 424
20.11 Business-Vacation Trips Within the United States 426
20.12 Business-Vacation Trips Outside the United States 426
20.13 Deducting Expenses of Business Conventions 428
20.14 Travel Expenses of a Spouse or Dependents 429
20.15 Restrictions on Foreign Conventions and Cruises 429
20.16 50% Deduction Limit 430
20.17 Th e Restrictive Tests for Meals and Entertainment 430
20.18 Directly Related Dining and Entertainment 430
20.19 Goodwill Entertainment 431
20.20 Home Entertaining 431
20.21 Your Personal Share of Entertainment Costs 431
20.22 Entertainment Costs of Spouses 432
20.23 Entertainment Facilities and Club Dues 432
20.24 Restrictive Test Exception for Reimbursements 432
20.25 50% Cost Limitation on Meals and Entertainment 432
20.26 Business Gift Deductions Are Limited 434
20.27 Record-Keeping Requirements 435
20.28 Proving Travel and Entertainment Expenses 435
20.29 Reporting T&E Expenses If You Are Self-Employed 436
20.30 Employee Reporting of Unreimbursed T&E Expenses 437
20.31 Tax Treatment of Reimbursements 437
20.32 What Is an Accountable Plan? 438
20.33 Per Diem Travel Allowance Under Accountable Plans 439
20.34 Automobile Mileage Allowance 440
20.35 Reimbursements Under Non-Accountable Plans 441
Personal Exemptions 442
21.1 How Many Exemptions May You Claim? 443
21.2 Your Spouse as an Exemption 444
21.3 Qualifying Children 444
21.4 Qualifying Relatives 446
21.5 Meeting the Support Test for a Qualifying Relative 448
21.6 Multiple Support Agreements 451
21.7 Special Rule for Divorced or Separated Parents 452
21.8 The Dependent Must Meet a Citizen or Resident Test 453
21.9 The Dependent Does Not File a Joint Return 453
21.10 Spouses’ Names and Social Security Numbers on Joint Return 453
21.11 Reporting Social Security Numbers of Dependents 454
21.12 Personal Exemptions Not Subject to Phaseout for 2012 454
PERSONAL TAX COMPUTATIONS 455
Figuring Your Regular Income Tax Liability 457
22.1 Taxable Income and Regular Income Tax Liability 458
22.2 Using the Tax Table 458
22.3 Tax Computation Worksheet 459
22.4 Tax Calculation If You Have Net Capital Gain or Qualified Dividends 459
22.5 Foreign Earned Income Tax Worksheet 459
22.6 Income Averaging for Farmers and Fishermen 459
22.7 Tax Credits 460
Alternative Minimum Tax (AMT) 461
23.1 Computing Alternative Minimum Tax on Form 6251 462
23.2 Adjustments and Preferences for AMT 464
23.3 Tax Credits Allowed Against AMT 467
23.4 AMT Tax Credit From Regular Tax 467
23.5 Avoiding AMT 468
Computing the “Kiddie Tax” on Your Child’s Investment Income 469
24.1 Filing Your Child’s Return 470
24.2 Children Subject to “Kiddie Tax” for 2012 471
24.3 Computing “Kiddie Tax” on Child’s Return 472
24.4 Parent’s Election To Report Child’s Dividends and Interest 473
Personal Tax Credits Reduce Your Tax Liability 475
25.1 Overview of Personal Tax Credits 476
25.2 Child Tax Credit for Children Under Age 17 476
25.3 Figuring the Child Tax Credit 477
25.4 Qualifying for Child and Dependent Care Credit 478
25.5 Limits on the Dependent Care Credit 478
25.6 Earned Income Test for Dependent Care Credit 480
25.7 Credit Allowed for Care of Qualifying Persons 480
25.8 Expenses Qualifying for the Dependent Care Credit 481
25.9 Dependent Care Credit Rules for Separated Couples 482
25.10 Qualifying Tests for EIC 482
25.11 Income Tests for Earned Income Credit (EIC) 484
25.12 Look up EIC in Government Tables 485
25.13 Qualifying for the Adoption Credit 485
25.14 Claiming the Adoption Credit on Form 8839 485
25.15 Eligibility for the Saver’s Credit 487
25.16 Figuring the Saver’s Credit 487
25.17 Health Coverage Credit 488
25.18 Mortgage Interest Credit 488
25.19 Residential Energy Credits 488
25.20 Credits for Fuel Cell Vehicles and Plug-in Electric Vehicles 489
25.21 Repayment of the First-Time Homebuyer Credit 490
Tax Withholdings 491
26.1 Withholdings Should Cover Estimated Tax 492
26.2 Income Taxes Withheld on Wages 492
26.3 Low Earners May Be Exempt From Withholding 493
26.4 Are You Withholding the Right Amount? 493
26.5 Voluntary Withholding on Government Payments 494
26.6 When Tips Are Subject to Withholding 494
26.7 Withholding on Gambling Winnings 495
26.8 FICA Withholdings 495
26.9 Withholding on Retirement Distributions 496
26.10 Backup Withholding 497
Estimated Tax Payments 498
27.1 Do You Owe an Estimated Tax Penalty for 2012? 499
27.2 Planning Estimated Tax Payments for 2013 500
27.3 Dates for Paying Estimated Tax Installments for 2013 501
27.4 Estimates by Husband and Wife 502
27.5 Adjusting Your Payments During the Year 502
TAX PLANNING 505
Tax Planning Overview 507
28.1 Tax-Saving Opportunities 508
28.2 When To Defer Income and Accelerate Deductions 509
28.3 Watch for Tax Law Changes 510
28.4 Additional Medicare Taxes Take Effect in 2013 510
Tax Savings for Residence Sales 511
29.1 Avoiding Tax on Sale of Principal Residence 512
29.2 Meeting the Ownership and Use Tests 513
29.3 Home Sales by Married Persons 516
29.4 Reduced Maximum Exclusion 517
29.5 Figuring Gain or Loss 520
29.6 Figuring Adjusted Basis 521
29.7 Personal and Business Use of a Home 521
29.8 No Loss Allowed on Personal Residence 522
29.9 Loss on Residence Converted to Rental Property 524
29.10 Loss on Residence Acquired by Gift or Inheritance 525
Tax Rules for Investors in Securities 526
30.1 Planning Year-End Securities Transactions 527
30.2 Earmarking Stock Lots 527
30.3 Sale of Stock Dividends 528
30.4 Stock Rights 528
30.5 Short Sales of Stock 529
30.6 Wash Sales 531
30.7 Convertible Stocks and Bonds 533
30.8 Constructive Sales of Appreciated Financial Positions 533
30.9 Straddle Losses 534
30.10 Capital Gain Restricted on Conversion Transactions 537
30.11 Puts and Calls and Index Options 537
30.12 Investing in Tax-Exempts 538
30.13 Ordinary Loss for Small Business Stock (Section 1244) 539
30.14 Series EE Bonds 539
30.15 I Bonds 541
30.16 Trader, Dealer, or Investor? 541
30.17 Mark-to-Market Election for Traders 542
Tax Savings for Investors in Real Estate 544
31.1 Real Estate Ventures 545
31.2 Sales of Subdivided Land—Dealer or Investor? 546
31.3 Exchanging Real Estate Without Tax 547
31.4 Timing Your Real Property Sales 548
31.5 Cancellation of a Lease 548
31.6 Sale of an Option 549
31.7 Granting of an Easement 549
31.8 Special Tax Credits for Real Estate Investments 550
31.9 Foreclosures, Repossessions, Short Sales, and Voluntary Conveyances to Creditors 551
31.10 Restructuring Mortgage Debt 552
31.11 Abandonments 553
31.12 Seller’s Repossession After Buyer’s Default on Mortgage 554
31.13 Foreclosure on Mortgages Other Th an Purchase Money 555
31.14 Foreclosure Sale to Th ird Party 556
31.15 Transferring Mortgaged Realty 556
Tax Rules for Investors in Mutual Funds 557
32.1 Timing of Your Investment Can Affect Your Taxes 558
32.2 Reinvestment Plans 558
32.3 Mutual-Fund Distributions Reported on Form 1099-DIV 558
32.4 Tax-Exempt Bond Funds 559
32.5 Fund Expenses 559
32.6 Tax Credits From Mutual Funds 559
32.7 How To Report Mutual Fund Distributions 561
32.8 Redemptions and Exchanges of Fund Shares 561
32.9 Basis of Redeemed Shares 561
32.10 Comparison of Basis Methods 563
Educational Tax Benefi ts 565
33.1 Scholarships and Grants 566
33.2 Tuition Reductions for College Employees 566
33.3 How Fulbright Awards Are Taxed 566
33.4 United States Savings Bond Tuition Plans 566
33.5 Contributing to a Qualified Tuition Program (Section 529 Plan) 568
33.6 Distributions From Qualified Tuition Programs (Section 529 Plans) 568
33.7 Education Tax Credits 570
33.8 American Opportunity Credit 571
33.9 Lifetime Learning Credit 572
33.10 Contributing to a Coverdell Education Savings Account (ESA) 573
33.11 Distributions From Coverdell ESAs 574
33.12 Tuition and Fees Deduction 576
33.13 Student Loan Interest Deduction 577
33.14 Types of Deductible Work-Related Costs 578
33.15 Work-Related Tests for Education Costs 579
33.16 Local Transportation and Travel Away From Home To Take Courses 581
Special Tax Rules for Senior Citizens 583
34.1 Senior Citizens Get Certain Filing Breaks 584
34.2 Social Security Benefi ts Subject to Tax 584
34.3 Computing Taxable Social Security Benefits 586
34.4 Election for Lump-Sum Social Security Benefit Payment 586
34.5 Retiring on Social Security Benefits 587
34.6 How Tax on Social Security Reduces Your Earnings 587
34.7 Claiming the Credit for the Elderly and Disabled 588
34.8 Base Amount for the Elderly or Disabled Credit 589
34.9 Reduction of the Base Amount and Liability Limitation for the Credit 589
34.10 Tax Effects of Moving to a Continuing Care Facility 590
34.11 Medicare Part B and Part D Premiums for 2013 591
Members of the Armed Forces 592
35.1 Taxable Armed Forces Pay and Benefits 593
35.2 Tax-Free Armed Forces Benefits 593
35.3 Deductions for Armed Forces Personnel 595
35.4 Tax-Free Pay for Service in Combat Zone 595
35.5 Tax Deadlines Extended for Combat Zone or Contingency Operation Service 597
35.6 Tax Forgiveness for Combat Zone or Terrorist or Military Action Deaths 597
35.7 Extension To Pay Your Tax When Entering the Service 598
35.8 Tax Information for Reservists 598
How To Treat Foreign Earned Income 600
36.1 Claiming the Foreign Earned Income Exclusion 601
36.2 What Is Foreign Earned Income? 601
36.3 Qualifying for the Foreign Earned Income Exclusion 603
36.4 How To Treat Housing Costs 604
36.5 Meeting the Foreign Residence or Physical Presence Test 605
36.6 Claiming Deductions 606
36.7 Exclusion Not Established When Your Return Is Due 607
36.8 Tax-Free Meals and Lodging for Workers in Camps 608
36.9 Virgin Islands, Samoa, Guam, and Northern Marianas 608
36.10 Earnings in Puerto Rico 608
36.11 Tax Treaties With Foreign Countries 608
36.12 Exchange Rates and Blocked Currency 608
36.13 Foreign Tax Credit 609
Planning Alimony and Marital Settlements 611
37.1 Planning Alimony Agreements 612
37.2 Decree or Agreement Required 612
37.3 Cash Payments Required 614
37.4 Payments Must Stop at Death 614
37.5 Child Support Payments Are Not Alimony 615
37.6 No Minimum Payment Period for Alimony 616
37.7 3rd Year Recapture If Alimony Drops by More Than $15,000 616
37.8 Legal Fees of Marital Settlements 617
Household Employment Taxes (“Nanny Tax”) 618
38.1 Who Is a Household Employee? 619
38.2 Social Security and Medicare (FICA) Taxes for Household Employees 619
38.3 Filing Schedule H To Report Household Employment Taxes 620
38.4 Federal Unemployment Taxes (FUTA) for Household Employees 622
Gift and Estate Tax Planning Basics 623
39.1 Gifts of Appreciated Property 624
39.2 Gift Tax Basics 624
39.3 Filing a Gift Tax Return 625
39.4 Gift Tax Credit 625
39.5 Custodial Accounts for Minors 625
39.6 Trusts in Family Planning 626
39.7 What is the Estate Tax? 627
39.8 Take Inventory and Estimate the Value of Your Potential Estate 627
39.9 Estate Tax for 2012 628
39.10 Planning for a Potential Estate Tax 629
BUSINESS TAX PLANNING 631
Income or Loss From Your Business or Profession 633
40.1 Forms of Doing Business 634
40.2 Reporting Self-Employed Income 634
40.3 Accounting Methods for Reporting Business Income 636
40.4 Tax Reporting Year for Self-Employed 638
40.5 Reporting Certain Payments and Receipts to the IRS 638
40.6 Filing Schedule C 639
40.7 Deductions for Professionals 643
40.8 Nondeductible Expense Items 644
40.9 How Authors and Artists May Write Off Expenses 645
40.10 Deducting Expenses of a Sideline Business or Hobby 645
40.11 Deducting Expenses of Looking for a New Business 646
40.12 Home Offi ce Deduction 647
40.13 What Home Offi ce Expenses Are Deductible? 650
40.14 Allocating Expenses to Business Use 650
40.15 Business Income May Limit Home Office Deductions 651
40.16 Home Office for Sideline Business 652
40.17 Depreciation of Office in Cooperative Apartment 653
40.18 Net Operating Losses (NOLs) 654
40.19 Your Net Operating Loss 654
40.20 How To Report a Net Operating Loss 655
40.21 How To Carry Back Your Net Operating Loss 656
40.22 Election To Carry Forward Losses 656
40.23 Overview of the Domestic Production Activities Deduction 656
40.24 Qualified Production Activities 656
40.25 Figuring the Deduction 657
40.26 Business Credits 657
40.27 Filing Schedule F 658
40.28 Farming Expenses 659
Retirement and Medical Plans for Self-Employed 660
41.1 Overview of Retirement and Medical Plans 661
41.2 Choosing a Keogh Plan 661
41.3 Choosing a SEP 662
41.4 Deductible Keogh or SEP Contributions 662
41.5 How To Claim the Keogh or SEP Deduction 665
41.6 How To Qualify a Keogh Plan or SEP Plan 665
41.7 Annual Keogh Plan Return 665
41.8 How Keogh Plan Distributions Are Taxed 666
41.9 SIMPLE IRA Plans 666
41.10 Health Savings Account (HSA) Basics 666
41.11 Limits on Deductible HSA Contributions 667
41.12 Distributions From HSAs 667
41.13 Archer MSAs 668
41.14 Small Business Health Tax Credit 669
Claiming Depreciation Deductions 670
42.1 What Property May Be Depreciated? 671
42.2 Claiming Depreciation on Your Tax Return 672
42.3 First-Year Expensing Deduction 672
42.4 MACRS Recovery Periods 674
42.5 MACRS Rates 675
42.6 Half-Year Convention for MACRS 677
42.7 Last Quarter Placements—Mid-Quarter Convention 677
42.8 150% Rate Election 678
42.9 Straight-Line Depreciation 678
42.10 Computers and Other Listed Property 680
42.11 Assets in Service Before 1987 681
42.12 MACRS for Real Estate Placed in Service After 1986 681
42.13 Demolishing a Building 683
42.14 Leasehold Improvements 683
42.15 Depreciating Real Estate Placed in Service After 1980 and Before 1987 683
42.16 When MACRS Is Not Allowed 684
42.17 Amortizing Goodwill and Other Intangibles (Section 197) 684
42.18 Deducting the Cost of Computer Software 686
42.19 Amortizing Song Rights 686
42.20 Bonus Depreciation 686
Deducting Car and Truck Expenses 688
43.1 Standard Mileage Rate 689
43.2 Expense Allocations 691
43.3 Depreciation Restrictions on Cars, Trucks, and Vans 691
43.4 Annual Ceilings on Depreciation 692
43.5 MACRS Rates for Cars, Trucks, and Vans 693
43.6 Straight-Line Method 697
43.7 Depreciation for Year Vehicle Is Disposed Of 698
43.8 Depreciation After Recovery Period Ends 699
43.9 Trade-in of Business Vehicle 699
43.10 Recapture of Deductions on Business Car, Truck, or Van 700
43.11 Keeping Records of Business Use 701
43.12 Leased Business Vehicles: Deductions and Income 701
Sales of Business Property 702
44.1 Depreciation Recaptured as Ordinary Income on Sale of Personal Property 703
44.2 Depreciation Recaptured as Ordinary Income on Sale of Real Estate 703
44.3 Recapture of First-Year Expensing 704
44.4 Gifts and Inheritances of Depreciable Property 704
44.5 Involuntary Conversions and Tax-Free Exchanges 705
44.6 Installment Sale of Depreciable Property 705
44.7 Sale of a Proprietorship 705
44.8 Property Used in a Business (Section 1231 Assets) 705
44.9 Sale of Property Used for Business and Personal Purposes 706
44.10 Should You Trade in Business Equipment? 707
44.11 Corporate Liquidation 707
Figuring Self-Employment Tax 708
45.1 What Is Self-Employment Income? 709
45.2 Partners Pay Self-Employment Tax 710
45.3 Schedule SE 711
45.4 How Wages Aff ect Self-Employment Tax 712
45.5 Optional Method If 2012 Was a Low-Income or Loss Year 713
45.6 Self-Employment Tax Rules for Certain Positions 714
FILING YOUR RETURN AND WHAT HAPPENS AFTER YOU FILE 717
Filing Your Return 719
46.1 Keeping Tax Records 720
46.2 Getting Ready To File Your Return 720
46.3 Applying for an Extension 721
46.4 Getting Your Refund 722
46.5 Paying Taxes Due 723
46.6 Electronic Filing 724
46.7 Notify the IRS of Address Changes 724
46.8 Interest on Tax Underpayments 724
46.9 Tax Penalties for Late Filing and Late Payment 725
Filing Refund Claims, and Amended Returns 731
47.1 Filing An Amended Return 732
47.2 When To File a Refund Claim 732
47.3 Stating the Reasons for Refund Claim 733
47.4 Quick Refund Claims 733
47.5 Interest Paid on Refund Claims 733
47.6 Refunds Withheld To Cover Debts 734
47.7 Amended Returns Showing Additional Tax 734
47.8 Penalty for Filing Excessive Refund Claim 734
If the IRS Examines Your Return 735
48.1 Odds of Being Audited 736
48.2 When the IRS Can Assess Additional Taxes 737
48.3 Audit Overview 738
48.4 Preparing for the Audit 738
48.5 Handling the Audit 739
48.6 Tax Penalties for Inaccurate Returns 739
48.7 Penalties for Not Reporting Foreign Financial Accounts 741
48.8 Agreeing to the Audit Changes 742
48.9 Disputing the Audit Changes 743
48.10 Off er in Compromise 744
48.11 Recovering Costs of a Tax Dispute 744
48.12 Suing the IRS for Unauthorized Collection 745