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Help amending tax return 4. Help amending tax return   Interest Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Allocation of InterestOrder of funds spent. Help amending tax return Payments from checking accounts. Help amending tax return Amounts paid within 30 days. Help amending tax return Optional method for determining date of reallocation. Help amending tax return Interest on a segregated account. Help amending tax return How to report. Help amending tax return Interest You Can DeductStatement. Help amending tax return Expenses paid to obtain a mortgage. Help amending tax return Prepayment penalty. Help amending tax return De minimis OID. Help amending tax return Constant-yield method. Help amending tax return Loan or mortgage ends. Help amending tax return Interest You Cannot DeductPenalties. Help amending tax return Who is a key person? Exceptions for pre-June 1997 contracts. Help amending tax return Interest allocated to unborrowed policy cash value. Help amending tax return Capitalization of Interest When To Deduct InterestPrepaid interest. Help amending tax return Discounted loan. Help amending tax return Refunds of interest. Help amending tax return Prepaid interest. Help amending tax return Discounted loan. Help amending tax return Tax deficiency. Help amending tax return Related person. Help amending tax return Below-Market LoansLimit on forgone interest for gift loans of $100,000 or less. Help amending tax return Introduction This chapter discusses the tax treatment of business interest expense. Help amending tax return Business interest expense is an amount charged for the use of money you borrowed for business activities. Help amending tax return Topics - This chapter discusses: Allocation of interest Interest you can deduct Interest you cannot deduct Capitalization of interest When to deduct interest Below-market loans Useful Items - You may want to see: Publication 537 Installment Sales 550 Investment Income and Expenses 936 Home Mortgage Interest Deduction Form (and Instructions) Sch A (Form 1040) Itemized Deductions Sch E (Form 1040) Supplemental Income and Loss Sch K-1 (Form 1065) Partner's Share of Income, Deductions, Credits, etc. Help amending tax return Sch K-1 (Form 1120S) Shareholder's Share of Income, Deductions, Credits, etc. Help amending tax return 1098 Mortgage Interest Statement 3115 Application for Change in Accounting Method 4952 Investment Interest Expense Deduction 8582 Passive Activity Loss Limitations See chapter 12 for information about getting publications and forms. Help amending tax return Allocation of Interest The rules for deducting interest vary, depending on whether the loan proceeds are used for business, personal, or investment activities. Help amending tax return If you use the proceeds of a loan for more than one type of expense, you must allocate the interest based on the use of the loan's proceeds. Help amending tax return Allocate your interest expense to the following categories. Help amending tax return Nonpassive trade or business activity interest Passive trade or business activity interest Investment interest Portfolio interest Personal interest In general, you allocate interest on a loan the same way you allocate the loan proceeds. Help amending tax return You allocate loan proceeds by tracing disbursements to specific uses. Help amending tax return The easiest way to trace disbursements to specific uses is to keep the proceeds of a particular loan separate from any other funds. Help amending tax return Secured loan. Help amending tax return   The allocation of loan proceeds and the related interest is not generally affected by the use of property that secures the loan. Help amending tax return Example. Help amending tax return You secure a loan with property used in your business. Help amending tax return You use the loan proceeds to buy an automobile for personal use. Help amending tax return You must allocate interest expense on the loan to personal use (purchase of the automobile) even though the loan is secured by business property. Help amending tax return    If the property that secures the loan is your home, you generally do not allocate the loan proceeds or the related interest. Help amending tax return The interest is usually deductible as qualified home mortgage interest, regardless of how the loan proceeds are used. Help amending tax return For more information, see Publication 936. Help amending tax return Allocation period. Help amending tax return   The period for which a loan is allocated to a particular use begins on the date the proceeds are used and ends on the earlier of the following dates. Help amending tax return The date the loan is repaid. Help amending tax return The date the loan is reallocated to another use. Help amending tax return Proceeds not disbursed to borrower. Help amending tax return   Even if the lender disburses the loan proceeds to a third party, the allocation of the loan is still based on your use of the funds. Help amending tax return This applies whether you pay for property, services, or anything else by incurring a loan, or you take property subject to a debt. Help amending tax return Proceeds deposited in borrower's account. Help amending tax return   Treat loan proceeds deposited in an account as property held for investment. Help amending tax return It does not matter whether the account pays interest. Help amending tax return Any interest you pay on the loan is investment interest expense. Help amending tax return If you withdraw the proceeds of the loan, you must reallocate the loan based on the use of the funds. Help amending tax return Example. Help amending tax return Celina, a calendar-year taxpayer, borrows $100,000 on January 4 and immediately uses the proceeds to open a checking account. Help amending tax return No other amounts are deposited in the account during the year and no part of the loan principal is repaid during the year. Help amending tax return On April 2, Celina uses $20,000 from the checking account for a passive activity expenditure. Help amending tax return On September 4, Celina uses an additional $40,000 from the account for personal purposes. Help amending tax return Under the interest allocation rules, the entire $100,000 loan is treated as property held for investment for the period from January 4 through April 1. Help amending tax return From April 2 through September 3, Celina must treat $20,000 of the loan as used in the passive activity and $80,000 of the loan as property held for investment. Help amending tax return From September 4 through December 31, she must treat $40,000 of the loan as used for personal purposes, $20,000 as used in the passive activity, and $40,000 as property held for investment. Help amending tax return Order of funds spent. Help amending tax return   Generally, you treat loan proceeds deposited in an account as used (spent) before either of the following amounts. Help amending tax return Any unborrowed amounts held in the same account. Help amending tax return Any amounts deposited after these loan proceeds. Help amending tax return Example. Help amending tax return On January 9, Olena opened a checking account, depositing $500 of the proceeds of Loan A and $1,000 of unborrowed funds. Help amending tax return The following table shows the transactions in her account during the tax year. Help amending tax return Date Transaction January 9 $500 proceeds of Loan A and $1,000 unborrowed funds deposited January 14 $500 proceeds of Loan B  deposited February 19 $800 used for personal purposes February 27 $700 used for passive activity June 19 $1,000 proceeds of Loan C  deposited November 20 $800 used for an investment December 18 $600 used for personal purposes Olena treats the $800 used for personal purposes as made from the $500 proceeds of Loan A and $300 of the proceeds of Loan B. Help amending tax return She treats the $700 used for a passive activity as made from the remaining $200 proceeds of Loan B and $500 of unborrowed funds. Help amending tax return She treats the $800 used for an investment as made entirely from the proceeds of Loan C. Help amending tax return She treats the $600 used for personal purposes as made from the remaining $200 proceeds of Loan C and $400 of unborrowed funds. Help amending tax return For the periods during which loan proceeds are held in the account, Olena treats them as property held for investment. Help amending tax return Payments from checking accounts. Help amending tax return   Generally, you treat a payment from a checking or similar account as made at the time the check is written if you mail or deliver it to the payee within a reasonable period after you write it. Help amending tax return You can treat checks written on the same day as written in any order. Help amending tax return Amounts paid within 30 days. Help amending tax return   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. Help amending tax return This applies to any payment made within 30 days before or after the proceeds are received in cash or deposited in your account. Help amending tax return   If the loan proceeds are deposited in an account, you can apply this rule even if the rules stated earlier under Order of funds spent would otherwise require you to treat the proceeds as used for other purposes. Help amending tax return If you apply this rule to any payments, disregard those payments (and the proceeds from which they are made) when applying the rules stated under Order of funds spent. Help amending tax return   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. Help amending tax return Example. Help amending tax return Giovanni gets a loan of $1,000 on August 4 and receives the proceeds in cash. Help amending tax return Giovanni deposits $1,500 in an account on August 18 and on August 28 writes a check on the account for a passive activity expense. Help amending tax return Also, Giovanni deposits his paycheck, deposits other loan proceeds, and pays his bills during the same period. Help amending tax return Regardless of these other transactions, Giovanni can treat $1,000 of the deposit he made on August 18 as being paid on August 4 from the loan proceeds. Help amending tax return In addition, Giovanni can treat the passive activity expense he paid on August 28 as made from the $1,000 loan proceeds treated as deposited in the account. Help amending tax return Optional method for determining date of reallocation. Help amending tax return   You can use the following method to determine the date loan proceeds are reallocated to another use. Help amending tax return You can treat all payments from loan proceeds in the account during any month as taking place on the later of the following dates. Help amending tax return The first day of that month. Help amending tax return The date the loan proceeds are deposited in the account. Help amending tax return However, you can use this optional method only if you treat all payments from the account during the same calendar month in the same way. Help amending tax return Interest on a segregated account. Help amending tax return   If you have an account that contains only loan proceeds and interest earned on the account, you can treat any payment from that account as being made first from the interest. Help amending tax return When the interest earned is used up, any remaining payments are from loan proceeds. Help amending tax return Example. Help amending tax return You borrowed $20,000 and used the proceeds of this loan to open a new savings account. Help amending tax return When the account had earned interest of $867, you withdrew $20,000 for personal purposes. Help amending tax return You can treat the withdrawal as coming first from the interest earned on the account, $867, and then from the loan proceeds, $19,133 ($20,000 − $867). Help amending tax return All the interest charged on the loan from the time it was deposited in the account until the time of the withdrawal is investment interest expense. Help amending tax return The interest charged on the part of the proceeds used for personal purposes ($19,133) from the time you withdrew it until you either repay it or reallocate it to another use is personal interest expense. Help amending tax return The interest charged on the loan proceeds you left in the account ($867) continues to be investment interest expense until you either repay it or reallocate it to another use. Help amending tax return Loan repayment. Help amending tax return   When you repay any part of a loan allocated to more than one use, treat it as being repaid in the following order. Help amending tax return Personal use. Help amending tax return Investments and passive activities (other than those included in (3)). Help amending tax return Passive activities in connection with a rental real estate activity in which you actively participate. Help amending tax return Former passive activities. Help amending tax return Trade or business use and expenses for certain low-income housing projects. Help amending tax return Line of credit (continuous borrowings). Help amending tax return   The following rules apply if you have a line of credit or similar arrangement. Help amending tax return Treat all borrowed funds on which interest accrues at the same fixed or variable rate as a single loan. Help amending tax return Treat borrowed funds or parts of borrowed funds on which interest accrues at different fixed or variable rates as different loans. Help amending tax return Treat these loans as repaid in the order shown on the loan agreement. Help amending tax return Loan refinancing. Help amending tax return   Allocate the replacement loan to the same uses to which the repaid loan was allocated. Help amending tax return Make the allocation only to the extent you use the proceeds of the new loan to repay any part of the original loan. Help amending tax return Debt-financed distribution. Help amending tax return   A debt-financed distribution occurs when a partnership or S corporation borrows funds and allocates those funds to distributions made to partners or shareholders. Help amending tax return The manner in which you report the interest expense associated with the distributed debt proceeds depends on your use of those proceeds. Help amending tax return How to report. Help amending tax return   If the proceeds were used in a nonpassive trade or business activity, report the interest on Schedule E (Form 1040), line 28; enter “interest expense” and the name of the partnership or S corporation in column (a) and the amount in column (h). Help amending tax return If the proceeds were used in a passive activity, follow the Instructions for Form 8582, Passive Activity Loss Limitations, to determine the amount of interest expense that can be reported on Schedule E (Form 1040), line 28; enter “interest expense” and the name of the partnership in column (a) and the amount in column (f). Help amending tax return If the proceeds were used in an investment activity, enter the interest on Form 4952. Help amending tax return If the proceeds are used for personal purposes, the interest is generally not deductible. Help amending tax return Interest You Can Deduct You can generally deduct as a business expense all interest you pay or accrue during the tax year on debts related to your trade or business. Help amending tax return Interest relates to your trade or business if you use the proceeds of the loan for a trade or business expense. Help amending tax return It does not matter what type of property secures the loan. Help amending tax return You can deduct interest on a debt only if you meet all the following requirements. Help amending tax return You are legally liable for that debt. Help amending tax return Both you and the lender intend that the debt be repaid. Help amending tax return You and the lender have a true debtor-creditor relationship. Help amending tax return Partial liability. Help amending tax return   If you are liable for part of a business debt, you can deduct only your share of the total interest paid or accrued. Help amending tax return Example. Help amending tax return You and your brother borrow money. Help amending tax return You are liable for 50% of the note. Help amending tax return You use your half of the loan in your business, and you make one-half of the loan payments. Help amending tax return You can deduct your half of the total interest payments as a business deduction. Help amending tax return Mortgage. Help amending tax return   Generally, mortgage interest paid or accrued on real estate you own legally or equitably is deductible. Help amending tax return However, rather than deducting the interest currently, you may have to add it to the cost basis of the property as explained later under Capitalization of Interest. Help amending tax return Statement. Help amending tax return   If you paid $600 or more of mortgage interest (including certain points) during the year on any one mortgage, you generally will receive a Form 1098 or a similar statement. Help amending tax return You will receive the statement if you pay interest to a person (including a financial institution or a cooperative housing corporation) in the course of that person's trade or business. Help amending tax return A governmental unit is a person for purposes of furnishing the statement. Help amending tax return   If you receive a refund of interest you overpaid in an earlier year, this amount will be reported in box 3 of Form 1098. Help amending tax return You cannot deduct this amount. Help amending tax return For information on how to report this refund, see Refunds of interest, later in this chapter. Help amending tax return Expenses paid to obtain a mortgage. Help amending tax return   Certain expenses you pay to obtain a mortgage cannot be deducted as interest. Help amending tax return These expenses, which include mortgage commissions, abstract fees, and recording fees, are capital expenses. Help amending tax return If the property mortgaged is business or income-producing property, you can amortize the costs over the life of the mortgage. Help amending tax return Prepayment penalty. Help amending tax return   If you pay off your mortgage early and pay the lender a penalty for doing this, you can deduct the penalty as interest. Help amending tax return Interest on employment tax deficiency. Help amending tax return   Interest charged on employment taxes assessed on your business is deductible. Help amending tax return Original issue discount (OID). Help amending tax return   OID is a form of interest. Help amending tax return A loan (mortgage or other debt) generally has OID when its proceeds are less than its principal amount. Help amending tax return The OID is the difference between the stated redemption price at maturity and the issue price of the loan. Help amending tax return   A loan's stated redemption price at maturity is the sum of all amounts (principal and interest) payable on it other than qualified stated interest. Help amending tax return Qualified stated interest is stated interest that is unconditionally payable in cash or property (other than another loan of the issuer) at least annually over the term of the loan at a single fixed rate. Help amending tax return You generally deduct OID over the term of the loan. Help amending tax return Figure the amount to deduct each year using the constant-yield method, unless the OID on the loan is de minimis. Help amending tax return De minimis OID. Help amending tax return   The OID is de minimis if it is less than one-fourth of 1% (. Help amending tax return 0025) of the stated redemption price of the loan at maturity multiplied by the number of full years from the date of original issue to maturity (the term of the loan). Help amending tax return   If the OID is de minimis, you can choose one of the following ways to figure the amount you can deduct each year. Help amending tax return On a constant-yield basis over the term of the loan. Help amending tax return On a straight-line basis over the term of the loan. Help amending tax return In proportion to stated interest payments. Help amending tax return In its entirety at maturity of the loan. Help amending tax return You make this choice by deducting the OID in a manner consistent with the method chosen on your timely filed tax return for the tax year in which the loan is issued. Help amending tax return Example. Help amending tax return On January 1, 2013, you took out a $100,000 discounted loan and received $98,500 in proceeds. Help amending tax return The loan will mature on January 1, 2023 (a 10-year term), and the $100,000 principal is payable on that date. Help amending tax return Interest of $10,000 is payable on January 1 of each year, beginning January 1, 2014. Help amending tax return The $1,500 OID on the loan is de minimis because it is less than $2,500 ($100,000 × . Help amending tax return 0025 × 10). Help amending tax return You choose to deduct the OID on a straight-line basis over the term of the loan. Help amending tax return Beginning in 2013, you can deduct $150 each year for 10 years. Help amending tax return Constant-yield method. Help amending tax return   If the OID is not de minimis, you must use the constant-yield method to figure how much you can deduct each year. Help amending tax return You figure your deduction for the first year using the following steps. Help amending tax return Determine the issue price of the loan. Help amending tax return Generally, this equals the proceeds of the loan. Help amending tax return If you paid points on the loan (as discussed later), the issue price generally is the difference between the proceeds and the points. Help amending tax return Multiply the result in (1) by the yield to maturity. Help amending tax return Subtract any qualified stated interest payments from the result in (2). Help amending tax return This is the OID you can deduct in the first year. Help amending tax return   To figure your deduction in any subsequent year, follow the above steps, except determine the adjusted issue price in step (1). Help amending tax return To get the adjusted issue price, add to the issue price any OID previously deducted. Help amending tax return Then follow steps (2) and (3) above. Help amending tax return   The yield to maturity is generally shown in the literature you receive from your lender. Help amending tax return If you do not have this information, consult your lender or tax advisor. Help amending tax return In general, the yield to maturity is the discount rate that, when used in computing the present value of all principal and interest payments, produces an amount equal to the principal amount of the loan. Help amending tax return Example. Help amending tax return The facts are the same as in the previous example, except that you deduct the OID on a constant yield basis over the term of the loan. Help amending tax return The yield to maturity on your loan is 10. Help amending tax return 2467%, compounded annually. Help amending tax return For 2013, you can deduct $93 [($98,500 × . Help amending tax return 102467) − $10,000]. Help amending tax return For 2014, you can deduct $103 [($98,593 × . Help amending tax return 102467) − $10,000]. Help amending tax return Loan or mortgage ends. Help amending tax return   If your loan or mortgage ends, you may be able to deduct any remaining OID in the tax year in which the loan or mortgage ends. Help amending tax return A loan or mortgage may end due to a refinancing, prepayment, foreclosure, or similar event. Help amending tax return If you refinance with the original lender, you generally cannot deduct the remaining OID in the year in which the refinancing occurs, but you may be able to deduct it over the term of the new mortgage or loan. Help amending tax return See Interest paid with funds borrowed from original lender under Interest You Cannot Deduct, later. Help amending tax return Points. Help amending tax return   The term “points” is used to describe certain charges paid, or treated as paid, by a borrower to obtain a loan or a mortgage. Help amending tax return These charges are also called loan origination fees, maximum loan charges, discount points, or premium charges. Help amending tax return If any of these charges (points) are solely for the use of money, they are interest. Help amending tax return   Because points are prepaid interest, you generally cannot deduct the full amount in the year paid. Help amending tax return However, you can choose to fully deduct points in the year paid if you meet certain tests. Help amending tax return For exceptions to the general rule, see Publication 936. Help amending tax return The points reduce the issue price of the loan and result in original issue discount (OID), deductible as explained in the preceding discussion. Help amending tax return Partial payments on a nontax debt. Help amending tax return   If you make partial payments on a debt (other than a debt owed the IRS), the payments are applied, in general, first to interest and any remainder to principal. Help amending tax return You can deduct only the interest. Help amending tax return This rule does not apply when it can be inferred that the borrower and lender understood that a different allocation of the payments would be made. Help amending tax return Installment purchase. Help amending tax return   If you make an installment purchase of business property, the contract between you and the seller generally provides for the payment of interest. Help amending tax return If no interest or a low rate of interest is charged under the contract, a portion of the stated principal amount payable under the contract may be recharacterized as interest (unstated interest). Help amending tax return The amount recharacterized as interest reduces your basis in the property and increases your interest expense. Help amending tax return For more information on installment sales and unstated interest, see Publication 537. Help amending tax return Interest You Cannot Deduct Certain interest payments cannot be deducted. Help amending tax return In addition, certain other expenses that may seem to be interest but are not, cannot be deducted as interest. Help amending tax return You cannot currently deduct interest that must be capitalized, and you generally cannot deduct personal interest. Help amending tax return Interest paid with funds borrowed from original lender. Help amending tax return   If you use the cash method of accounting, you cannot deduct interest you pay with funds borrowed from the original lender through a second loan, an advance, or any other arrangement similar to a loan. Help amending tax return You can deduct the interest expense once you start making payments on the new loan. Help amending tax return   When you make a payment on the new loan, you first apply the payment to interest and then to the principal. Help amending tax return All amounts you apply to the interest on the first loan are deductible, along with any interest you pay on the second loan, subject to any limits that apply. Help amending tax return Capitalized interest. Help amending tax return   You cannot currently deduct interest you are required to capitalize under the uniform capitalization rules. Help amending tax return See Capitalization of Interest, later. Help amending tax return In addition, if you buy property and pay interest owed by the seller (for example, by assuming the debt and any interest accrued on the property), you cannot deduct the interest. Help amending tax return Add this interest to the basis of the property. Help amending tax return Commitment fees or standby charges. Help amending tax return   Fees you incur to have business funds available on a standby basis, but not for the actual use of the funds, are not deductible as interest payments. Help amending tax return You may be able to deduct them as business expenses. Help amending tax return   If the funds are for inventory or certain property used in your business, the fees are indirect costs and you generally must capitalize them under the uniform capitalization rules. Help amending tax return See Capitalization of Interest, later. Help amending tax return Interest on income tax. Help amending tax return   Interest charged on income tax assessed on your individual income tax return is not a business deduction even though the tax due is related to income from your trade or business. Help amending tax return Treat this interest as a business deduction only in figuring a net operating loss deduction. Help amending tax return Penalties. Help amending tax return   Penalties on underpaid deficiencies and underpaid estimated tax are not interest. Help amending tax return You cannot deduct them. Help amending tax return Generally, you cannot deduct any fines or penalties. Help amending tax return Interest on loans with respect to life insurance policies. Help amending tax return   You generally cannot deduct interest on a debt incurred with respect to any life insurance, annuity, or endowment contract that covers any individual unless that individual is a key person. Help amending tax return   If the policy or contract covers a key person, you can deduct the interest on up to $50,000 of debt for that person. Help amending tax return However, the deduction for any month cannot be more than the interest figured using Moody's Composite Yield on Seasoned Corporate Bonds (formerly known as Moody's Corporate Bond Yield Average-Monthly Average Corporates) (Moody's rate) for that month. Help amending tax return Who is a key person?   A key person is an officer or 20% owner. Help amending tax return However, the number of individuals you can treat as key persons is limited to the greater of the following. Help amending tax return Five individuals. Help amending tax return The lesser of 5% of the total officers and employees of the company or 20 individuals. Help amending tax return Exceptions for pre-June 1997 contracts. Help amending tax return   You can generally deduct the interest if the contract was issued before June 9, 1997, and the covered individual is someone other than an employee, officer, or someone financially interested in your business. Help amending tax return If the contract was purchased before June 21, 1986, you can generally deduct the interest no matter who is covered by the contract. Help amending tax return Interest allocated to unborrowed policy cash value. Help amending tax return   Corporations and partnerships generally cannot deduct any interest expense allocable to unborrowed cash values of life insurance, annuity, or endowment contracts. Help amending tax return This rule applies to contracts issued after June 8, 1997, that cover someone other than an officer, director, employee, or 20% owner. Help amending tax return For more information, see section 264(f) of the Internal Revenue Code. Help amending tax return Capitalization of Interest Under the uniform capitalization rules, you generally must capitalize interest on debt equal to your expenditures to produce real property or certain tangible personal property. Help amending tax return The property must be produced by you for use in your trade or business or for sale to customers. Help amending tax return You cannot capitalize interest related to property that you acquire in any other manner. Help amending tax return Interest you paid or incurred during the production period must be capitalized if the property produced is designated property. Help amending tax return Designated property is any of the following. Help amending tax return Real property. Help amending tax return Tangible personal property with a class life of 20 years or more. Help amending tax return Tangible personal property with an estimated production period of more than 2 years. Help amending tax return Tangible personal property with an estimated production period of more than 1 year if the estimated cost of production is more than $1 million. Help amending tax return Property you produce. Help amending tax return   You produce property if you construct, build, install, manufacture, develop, improve, create, raise, or grow it. Help amending tax return Treat property produced for you under a contract as produced by you up to the amount you pay or incur for the property. Help amending tax return Carrying charges. Help amending tax return   Carrying charges include taxes you pay to carry or develop real estate or to carry, transport, or install personal property. Help amending tax return You can choose to capitalize carrying charges not subject to the uniform capitalization rules if they are otherwise deductible. Help amending tax return For more information, see chapter 7. Help amending tax return Capitalized interest. Help amending tax return   Treat capitalized interest as a cost of the property produced. Help amending tax return You recover your interest when you sell or use the property. Help amending tax return If the property is inventory, recover capitalized interest through cost of goods sold. Help amending tax return If the property is used in your trade or business, recover capitalized interest through an adjustment to basis, depreciation, amortization, or other method. Help amending tax return Partnerships and S corporations. Help amending tax return   The interest capitalization rules are applied first at the partnership or S corporation level. Help amending tax return The rules are then applied at the partners' or shareholders' level to the extent the partnership or S corporation has insufficient debt to support the production or construction costs. Help amending tax return   If you are a partner or a shareholder, you may have to capitalize interest you incur during the tax year for the production costs of the partnership or S corporation. Help amending tax return You may also have to capitalize interest incurred by the partnership or S corporation for your own production costs. Help amending tax return To properly capitalize interest under these rules, you must be given the required information in an attachment to the Schedule K-1 you receive from the partnership or S corporation. Help amending tax return Additional information. Help amending tax return   The procedures for applying the uniform capitalization rules are beyond the scope of this publication. Help amending tax return For more information, see sections 1. Help amending tax return 263A-8 through 1. Help amending tax return 263A-15 of the regulations and Notice 88-99. Help amending tax return Notice 88-99 is in Cumulative Bulletin 1988-2. Help amending tax return When To Deduct Interest If the uniform capitalization rules, discussed under Capitalization of Interest, earlier, do not apply to you, deduct interest as follows. Help amending tax return Cash method. Help amending tax return   Under the cash method, you can generally deduct only the interest you actually paid during the tax year. Help amending tax return You cannot deduct a promissory note you gave as payment because it is a promise to pay and not an actual payment. Help amending tax return Prepaid interest. Help amending tax return   You generally cannot deduct any interest paid before the year it is due. Help amending tax return Interest paid in advance can be deducted only in the tax year in which it is due. Help amending tax return Discounted loan. Help amending tax return   If interest or a discount is subtracted from your loan proceeds, it is not a payment of interest and you cannot deduct it when you get the loan. Help amending tax return For more information, see Original issue discount (OID) under Interest You Can Deduct, earlier. Help amending tax return Refunds of interest. Help amending tax return   If you pay interest and then receive a refund in the same tax year of any part of the interest, reduce your interest deduction by the refund. Help amending tax return If you receive the refund in a later tax year, include the refund in your income to the extent the deduction for the interest reduced your tax. Help amending tax return Accrual method. Help amending tax return   Under an accrual method, you can deduct only interest that has accrued during the tax year. Help amending tax return Prepaid interest. Help amending tax return   See Prepaid interest, earlier. Help amending tax return Discounted loan. Help amending tax return   See Discounted loan, earlier. Help amending tax return Tax deficiency. Help amending tax return   If you contest a federal income tax deficiency, interest does not accrue until the tax year the final determination of liability is made. Help amending tax return If you do not contest the deficiency, then the interest accrues in the year the tax was asserted and agreed to by you. Help amending tax return   However, if you contest but pay the proposed tax deficiency and interest, and you do not designate the payment as a cash bond, then the interest is deductible in the year paid. Help amending tax return Related person. Help amending tax return   If you use an accrual method, you cannot deduct interest owed to a related person who uses the cash method until payment is made and the interest is includible in the gross income of that person. Help amending tax return The relationship is determined as of the end of the tax year for which the interest would otherwise be deductible. Help amending tax return See section 267 of the Internal Revenue Code for more information. Help amending tax return Below-Market Loans If you receive a below-market gift or demand loan and use the proceeds in your trade or business, you may be able to deduct the forgone interest. Help amending tax return See Treatment of gift and demand loans, later, in this discussion. Help amending tax return A below-market loan is a loan on which no interest is charged or on which interest is charged at a rate below the applicable federal rate. Help amending tax return A gift or demand loan that is a below-market loan generally is considered an arm's-length transaction in which you, the borrower, are considered as having received both the following. Help amending tax return A loan in exchange for a note that requires the payment of interest at the applicable federal rate. Help amending tax return An additional payment in an amount equal to the forgone interest. Help amending tax return The additional payment is treated as a gift, dividend, contribution to capital, payment of compensation, or other payment, depending on the substance of the transaction. Help amending tax return Forgone interest. Help amending tax return   For any period, forgone interest is The interest that would be payable for that period if interest accrued on the loan at the applicable federal rate and was payable annually on December 31, minus Any interest actually payable on the loan for the period. Help amending tax return Applicable federal rates are published by the IRS each month in the Internal Revenue Bulletin. Help amending tax return Internal Revenue Bulletins are available on the IRS web site at www. Help amending tax return irs. Help amending tax return gov/irb. Help amending tax return You can also contact an IRS office to get these rates. Help amending tax return Loans subject to the rules. Help amending tax return   The rules for below-market loans apply to the following. Help amending tax return Gift loans (below-market loans where the forgone interest is in the nature of a gift). Help amending tax return Compensation-related loans (below-market loans between an employer and an employee or between an independent contractor and a person for whom the contractor provides services). Help amending tax return Corporation-shareholder loans. Help amending tax return Tax avoidance loans (below-market loans where the avoidance of federal tax is one of the main purposes of the interest arrangement). Help amending tax return Loans to qualified continuing care facilities under a continuing care contract (made after October 11, 1985). Help amending tax return   Except as noted in (5) above, these rules apply to demand loans (loans payable in full at any time upon the lender's demand) outstanding after June 6, 1984, and to term loans (loans that are not demand loans) made after that date. Help amending tax return Treatment of gift and demand loans. Help amending tax return   If you receive a below-market gift loan or demand loan, you are treated as receiving an additional payment (as a gift, dividend, etc. Help amending tax return ) equal to the forgone interest on the loan. Help amending tax return You are then treated as transferring this amount back to the lender as interest. Help amending tax return These transfers are considered to occur annually, generally on December 31. Help amending tax return If you use the loan proceeds in your trade or business, you can deduct the forgone interest each year as a business interest expense. Help amending tax return The lender must report it as interest income. Help amending tax return Limit on forgone interest for gift loans of $100,000 or less. Help amending tax return   For gift loans between individuals, forgone interest treated as transferred back to the lender is limited to the borrower's net investment income for the year. Help amending tax return This limit applies if the outstanding loans between the lender and borrower total $100,000 or less. Help amending tax return If the borrower's net investment income is $1,000 or less, it is treated as zero. Help amending tax return This limit does not apply to a loan if the avoidance of any federal tax is one of the main purposes of the interest arrangement. Help amending tax return Treatment of term loans. Help amending tax return   If you receive a below-market term loan other than a gift or demand loan, you are treated as receiving an additional cash payment (as a dividend, etc. Help amending tax return ) on the date the loan is made. Help amending tax return This payment is equal to the loan amount minus the present value, at the applicable federal rate, of all payments due under the loan. Help amending tax return The same amount is treated as original issue discount on the loan. Help amending tax return See Original issue discount (OID) under Interest You Can Deduct, earlier. Help amending tax return Exceptions for loans of $10,000 or less. Help amending tax return   The rules for below-market loans do not apply to any day on which the total outstanding loans between the borrower and lender is $10,000 or less. Help amending tax return This exception applies only to the following. Help amending tax return Gift loans between individuals if the loan is not directly used to buy or carry income-producing assets. Help amending tax return Compensation-related loans or corporation-shareholder loans if the avoidance of any federal tax is not a principal purpose of the interest arrangement. Help amending tax return This exception does not apply to a term loan described in (2) above that was previously subject to the below-market loan rules. Help amending tax return Those rules will continue to apply even if the outstanding balance is reduced to $10,000 or less. Help amending tax return Exceptions for loans without significant tax effect. Help amending tax return   The following loans are specifically exempted from the rules for below-market loans because their interest arrangements do not have a significant effect on the federal tax liability of the borrower or the lender. Help amending tax return Loans made available by lenders to the general public on the same terms and conditions that are consistent with the lender's customary business practices. Help amending tax return Loans subsidized by a federal, state, or municipal government that are made available under a program of general application to the public. Help amending tax return Certain employee-relocation loans. Help amending tax return Certain loans to or from a foreign person, unless the interest income would be effectively connected with the conduct of a U. Help amending tax return S. Help amending tax return trade or business and not exempt from U. Help amending tax return S. Help amending tax return tax under an income tax treaty. Help amending tax return Any other loan if the taxpayer can show that the interest arrangement has no significant effect on the federal tax liability of the lender or the borrower. Help amending tax return Whether an interest arrangement has a significant effect on the federal tax liability of the lender or the borrower will be determined by all the facts and circumstances. Help amending tax return Consider all the following factors. Help amending tax return Whether items of income and deduction generated by the loan offset each other. Help amending tax return The amount of the items. Help amending tax return The cost of complying with the below-market loan provisions if they were to apply. Help amending tax return Any reasons, other than taxes, for structuring the transaction as a below-market loan. Help amending tax return Exception for loans to qualified continuing care facilities. Help amending tax return   The below-market interest rules do not apply to a loan owed by a qualified continuing care facility under a continuing care contract if the lender or lender's spouse is age 62 or older by the end of the calendar year. Help amending tax return A qualified continuing care facility is one or more facilities (excluding nursing homes) meeting the requirements listed below. Help amending tax return Designed to provide services under continuing care contracts (defined below). Help amending tax return Includes an independent living unit, and either an assisted living or nursing facility, or both. Help amending tax return Substantially all of the independent living unit residents are covered by continuing care contracts. Help amending tax return A continuing care contract is a written contract between an individual and a qualified continuing care facility that includes all of the following conditions. Help amending tax return The individual or individual's spouse must be entitled to use the facility for the rest of their life or lives. Help amending tax return The individual or individual's spouse will be provided with housing, as appropriate for the health of the individual or individual's spouse in an: independent living unit (which has additional available facilities outside the unit for the provision of meals and other personal care), and assisted living or nursing facility available in the continuing care facility. Help amending tax return The individual or individual's spouse will be provided with assisted living or nursing care available in the continuing care facility, as required for the health of the individual or the individual's spouse. Help amending tax return For more information, see section 7872(h) of the Internal Revenue Code. Help amending tax return Sale or exchange of property. Help amending tax return   Different rules generally apply to a loan connected with the sale or exchange of property. Help amending tax return If the loan does not provide adequate stated interest, part of the principal payment may be considered interest. Help amending tax return However, there are exceptions that may require you to apply the below-market interest rate rules to these loans. Help amending tax return See Unstated Interest and Original Issue Discount (OID) in Publication 537. Help amending tax return More information. Help amending tax return   For more information on below-market loans, see section 7872 of the Internal Revenue Code and section 1. Help amending tax return 7872-5 of the regulations. Help amending tax return Prev  Up  Next   Home   More Online Publications
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Help amending tax return 4. Help amending tax return   Retirement Savings Contributions Credit (Saver's Credit) Table of Contents What's New Introduction Full-time student. Help amending tax return Adjusted gross income. Help amending tax return Distributions received by spouse. Help amending tax return Testing period. Help amending tax return What's New Modified AGI limit for retirement savings contributions credit increased. Help amending tax return  For 2013, you may be able to claim the retirement savings contributions credit if your modified AGI is not more than: $59,000 if your filing status is married filing jointly, $44,250 if your filing status is head of household, or $29,500 if your filing status is single, married filing separately, or qualifying widow(er). Help amending tax return Introduction You may be able to take a tax credit if you make eligible contributions (defined later) to a qualified retirement plan, an eligible deferred compensation plan, or an individual retirement arrangement (IRA). Help amending tax return You may be able to take a credit of up to $1,000 (up to $2,000 if filing jointly). Help amending tax return This credit could reduce the federal income tax you pay dollar for dollar. Help amending tax return    Can you claim the credit?   If you make eligible contributions to a qualified retirement plan, an eligible deferred compensation plan, or an IRA, you can claim the credit if all of the following apply. Help amending tax return You were born before January 2, 1996. Help amending tax return You are not a full-time student (explained next). Help amending tax return No one else, such as your parent(s), claims an exemption for you on their tax return. Help amending tax return Your adjusted gross income (defined below) is not more than: $59,000 if your filing status is married filing jointly, $44,250 if your filing status is head of household, or $29,500 if your filing status is single, married filing separately, or qualifying widow(er). Help amending tax return Full-time student. Help amending tax return   You are a full-time student if, during some part of each of 5 calendar months (not necessarily consecutive) during the calendar year, you are either: A full-time student at a school that has a regular teaching staff, course of study, and regularly enrolled body of students in attendance, or A student taking a full-time, on-farm training course given by either a school that has a regular teaching staff, course of study, and regularly enrolled body of students in attendance, or a state, county, or local government. Help amending tax return You are a full-time student if you are enrolled for the number of hours or courses the school considers to be full time. Help amending tax return Adjusted gross income. Help amending tax return   This is generally the amount on line 38 of your 2013 Form 1040; line 22 of your 2013 Form 1040A; or line 37 of your 2013 Form 1040NR. Help amending tax return However, you must add to that amount any exclusion or deduction claimed for the year for: Foreign earned income, Foreign housing costs, Income for bona fide residents of American Samoa, and Income from Puerto Rico. Help amending tax return Eligible contributions. Help amending tax return   These include: Contributions to a traditional or Roth IRA, Salary reduction contributions (elective deferrals, including amounts designated as after-tax Roth contributions) to: A 401(k) plan (including a SIMPLE 401(k)), A section 403(b) annuity, An eligible deferred compensation plan of a state or local government (a governmental 457 plan), A SIMPLE IRA plan, or A salary reduction SEP, and Contributions to a section 501(c)(18) plan. Help amending tax return They also include voluntary after-tax employee contributions to a tax-qualified retirement plan or section 403(b) annuity. Help amending tax return For purposes of the credit, an employee contribution will be voluntary as long as it is not required as a condition of employment. Help amending tax return Reducing eligible contributions. Help amending tax return   Reduce your eligible contributions (but not below zero) by the total distributions you received during the testing period (defined later) from any IRA, plan, or annuity included above under Eligible contributions. Help amending tax return Also reduce your eligible contributions by any distribution from a Roth IRA that is not rolled over, even if the distribution is not taxable. Help amending tax return   Do not reduce your eligible contributions by any of the following. Help amending tax return The portion of any distribution which is not includible in income because it is a trustee-to-trustee transfer or a rollover distribution. Help amending tax return Distributions that are taxable as the result of an in-plan rollover to your designated Roth account. Help amending tax return Any distribution that is a return of a contribution to an IRA (including a Roth IRA) made during the year for which you claim the credit if: The distribution is made before the due date (including extensions) of your tax return for that year, You do not take a deduction for the contribution, and The distribution includes any income attributable to the contribution. Help amending tax return Loans from a qualified employer plan treated as a distribution. Help amending tax return Distributions of excess contributions or deferrals (and income attributable to excess contributions and deferrals). Help amending tax return Distributions of dividends paid on stock held by an employee stock ownership plan under section 404(k). Help amending tax return Distributions from an eligible retirement plan that are converted or rolled over to a Roth IRA. Help amending tax return Distributions from a military retirement plan. Help amending tax return Distributions from an inherited IRA by a nonspousal beneficiary. Help amending tax return Distributions received by spouse. Help amending tax return   Any distributions your spouse receives are treated as received by you if you file a joint return with your spouse both for the year of the distribution and for the year for which you claim the credit. Help amending tax return Testing period. Help amending tax return   The testing period consists of the year for which you claim the credit, the period after the end of that year and before the due date (including extensions) for filing your return for that year, and the 2 tax years before that year. Help amending tax return Example. Help amending tax return You and your spouse filed joint returns in 2011 and 2012, and plan to do so in 2013 and 2014. Help amending tax return You received a taxable distribution from a qualified plan in 2011 and a taxable distribution from an eligible deferred compensation plan in 2012. Help amending tax return Your spouse received taxable distributions from a Roth IRA in 2013 and tax-free distributions from a Roth IRA in 2014 before April 15. Help amending tax return You made eligible contributions to an IRA in 2013 and you otherwise qualify for this credit. Help amending tax return You must reduce the amount of your qualifying contributions in 2013 by the total of the distributions you received in 2011, 2012, 2013, and 2014. Help amending tax return Maximum eligible contributions. Help amending tax return   After your contributions are reduced, the maximum annual contribution on which you can base the credit is $2,000 per person. Help amending tax return Effect on other credits. Help amending tax return   The amount of this credit will not change the amount of your refundable tax credits. Help amending tax return A refundable tax credit, such as the earned income credit or the refundable amount of your child tax credit, is an amount that you would receive as a refund even if you did not otherwise owe any taxes. Help amending tax return Maximum credit. Help amending tax return   This is a nonrefundable credit. Help amending tax return The amount of the credit in any year cannot be more than the amount of tax that you would otherwise pay (not counting any refundable credits) in any year. Help amending tax return If your tax liability is reduced to zero because of other nonrefundable credits, such as the credit for child and dependent care expenses, then you will not be entitled to this credit. Help amending tax return How to figure and report the credit. Help amending tax return   The amount of the credit you can get is based on the contributions you make and your credit rate. Help amending tax return Your credit rate can be as low as 10% or as high as 50%. Help amending tax return Your credit rate depends on your income and your filing status. Help amending tax return See Form 8880 to determine your credit rate. Help amending tax return   The maximum contribution taken into account is $2,000 per person. Help amending tax return On a joint return, up to $2,000 is taken into account for each spouse. Help amending tax return   Figure the credit on Form 8880. Help amending tax return Report the credit on line 50 of your Form 1040; line 32 of your Form 1040A; or line 47 of your Form 1040NR and attach Form 8880 to your return. Help amending tax return Prev  Up  Next   Home   More Online Publications