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Irs 1040ez Instructions

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Irs 1040ez Instructions

Irs 1040ez instructions Publication 538 - Main Content Table of Contents Accounting PeriodsCalendar Year Fiscal Year Short Tax Year Improper Tax Year Change in Tax Year Individuals Partnerships, S Corporations, and Personal Service Corporations (PSCs) Corporations (Other Than S Corporations and PSCs) Accounting MethodsSpecial methods. Irs 1040ez instructions Hybrid method. Irs 1040ez instructions Cash Method Accrual Method Inventories Change in Accounting Method How To Get Tax HelpLow Income Taxpayer Clinics (LITCs). Irs 1040ez instructions Accounting Periods You must use a tax year to figure your taxable income. Irs 1040ez instructions A tax year is an annual accounting period for keeping records and reporting income and expenses. Irs 1040ez instructions An annual accounting period does not include a short tax year (discussed later). Irs 1040ez instructions You can use the following tax years: A calendar year; or A fiscal year (including a 52-53-week tax year). Irs 1040ez instructions Unless you have a required tax year, you adopt a tax year by filing your first income tax return using that tax year. Irs 1040ez instructions A required tax year is a tax year required under the Internal Revenue Code or the Income Tax Regulations. Irs 1040ez instructions You cannot adopt a tax year by merely: Filing an application for an extension of time to file an income tax return; Filing an application for an employer identification number (Form SS-4); or Paying estimated taxes. Irs 1040ez instructions This section discusses: A calendar year. Irs 1040ez instructions A fiscal year (including a period of 52 or 53 weeks). Irs 1040ez instructions A short tax year. Irs 1040ez instructions An improper tax year. Irs 1040ez instructions A change in tax year. Irs 1040ez instructions Special situations that apply to individuals. Irs 1040ez instructions Restrictions that apply to the accounting period of a partnership, S corporation, or personal service corporation. Irs 1040ez instructions Special situations that apply to corporations. Irs 1040ez instructions Calendar Year A calendar year is 12 consecutive months beginning on January 1st and ending on December 31st. Irs 1040ez instructions If you adopt the calendar year, you must maintain your books and records and report your income and expenses from January 1st through December 31st of each year. Irs 1040ez instructions If you file your first tax return using the calendar tax year and you later begin business as a sole proprietor, become a partner in a partnership, or become a shareholder in an S corporation, you must continue to use the calendar year unless you obtain approval from the IRS to change it, or are otherwise allowed to change it without IRS approval. Irs 1040ez instructions See Change in Tax Year, later. Irs 1040ez instructions Generally, anyone can adopt the calendar year. Irs 1040ez instructions However, you must adopt the calendar year if: You keep no books or records; You have no annual accounting period; Your present tax year does not qualify as a fiscal year; or You are required to use a calendar year by a provision in the Internal Revenue Code or the Income Tax Regulations. Irs 1040ez instructions Fiscal Year A fiscal year is 12 consecutive months ending on the last day of any month except December 31st. Irs 1040ez instructions If you are allowed to adopt a fiscal year, you must consistently maintain your books and records and report your income and expenses using the time period adopted. Irs 1040ez instructions 52-53-Week Tax Year You can elect to use a 52-53-week tax year if you keep your books and records and report your income and expenses on that basis. Irs 1040ez instructions If you make this election, your 52-53-week tax year must always end on the same day of the week. Irs 1040ez instructions Your 52-53-week tax year must always end on: Whatever date this same day of the week last occurs in a calendar month, or Whatever date this same day of the week falls that is nearest to the last day of the calendar month. Irs 1040ez instructions For example, if you elect a tax year that always ends on the last Monday in March, your 2012 tax year will end on March 25, 2013. Irs 1040ez instructions Election. Irs 1040ez instructions   To make the election for the 52-53-week tax year, attach a statement with the following information to your tax return. Irs 1040ez instructions The month in which the new 52-53-week tax year ends. Irs 1040ez instructions The day of the week on which the tax year always ends. Irs 1040ez instructions The date the tax year ends. Irs 1040ez instructions It can be either of the following dates on which the chosen day: Last occurs in the month in (1), above, or Occurs nearest to the last day of the month in (1), above. Irs 1040ez instructions   When you figure depreciation or amortization, a 52-53-week tax year is generally considered a year of 12 calendar months. Irs 1040ez instructions   To determine an effective date (or apply provisions of any law) expressed in terms of tax years beginning, including, or ending on the first or last day of a specified calendar month, a 52-53-week tax year is considered to: Begin on the first day of the calendar month beginning nearest to the first day of the 52-53-week tax year, and End on the last day of the calendar month ending nearest to the last day of the 52-53-week tax year. Irs 1040ez instructions Example. Irs 1040ez instructions Assume a tax provision applies to tax years beginning on or after July 1, 2012, which happens to be a Sunday. Irs 1040ez instructions For this purpose, a 52-53-week tax year that begins on the last Tuesday of June, which falls on June 26, 2012, is treated as beginning on July 1, 2012. Irs 1040ez instructions Short Tax Year A short tax year is a tax year of less than 12 months. Irs 1040ez instructions A short period tax return may be required when you (as a taxable entity): Are not in existence for an entire tax year, or Change your accounting period. Irs 1040ez instructions Tax on a short period tax return is figured differently for each situation. Irs 1040ez instructions Not in Existence Entire Year Even if a taxable entity was not in existence for the entire year, a tax return is required for the time it was in existence. Irs 1040ez instructions Requirements for filing the return and figuring the tax are generally the same as the requirements for a return for a full tax year (12 months) ending on the last day of the short tax year. Irs 1040ez instructions Example 1. Irs 1040ez instructions XYZ Corporation was organized on July 1, 2012. Irs 1040ez instructions It elected the calendar year as its tax year. Irs 1040ez instructions Therefore, its first tax return was due March 15, 2013. Irs 1040ez instructions This short period return will cover the period from July 1, 2012, through December 31, 2012. Irs 1040ez instructions Example 2. Irs 1040ez instructions A calendar year corporation dissolved on July 23, 2012. Irs 1040ez instructions Its final return is due by October 15, 2012. Irs 1040ez instructions It will cover the short period from January 1, 2012, through July 23, 2012. Irs 1040ez instructions Death of individual. Irs 1040ez instructions   When an individual dies, a tax return must be filed for the decedent by the 15th day of the 4th month after the close of the individual's regular tax year. Irs 1040ez instructions The decedent's final return will be a short period tax return that begins on January 1st, and ends on the date of death. Irs 1040ez instructions In the case of a decedent who dies on December 31st, the last day of the regular tax year, a full calendar-year tax return is required. Irs 1040ez instructions Example. Irs 1040ez instructions   Agnes Green was a single, calendar year taxpayer. Irs 1040ez instructions She died on March 6, 2012. Irs 1040ez instructions Her final income tax return must be filed by April 15, 2013. Irs 1040ez instructions It will cover the short period from January 1, 2012, to March 6, 2012. Irs 1040ez instructions Figuring Tax for Short Year If the IRS approves a change in your tax year or you are required to change your tax year, you must figure the tax and file your return for the short tax period. Irs 1040ez instructions The short tax period begins on the first day after the close of your old tax year and ends on the day before the first day of your new tax year. Irs 1040ez instructions Figure tax for a short year under the general rule, explained below. Irs 1040ez instructions You may then be able to use a relief procedure, explained later, and claim a refund of part of the tax you paid. Irs 1040ez instructions General rule. Irs 1040ez instructions   Income tax for a short tax year must be annualized. Irs 1040ez instructions However, self-employment tax is figured on the actual self-employment income for the short period. Irs 1040ez instructions Individuals. Irs 1040ez instructions   An individual must figure income tax for the short tax year as follows. Irs 1040ez instructions Determine your adjusted gross income (AGI) for the short tax year and then subtract your actual itemized deductions for the short tax year. Irs 1040ez instructions You must itemize deductions when you file a short period tax return. Irs 1040ez instructions Multiply the dollar amount of your exemptions by the number of months in the short tax year and divide the result by 12. Irs 1040ez instructions Subtract the amount in (2) from the amount in (1). Irs 1040ez instructions The result is your modified taxable income. Irs 1040ez instructions Multiply the modified taxable income in (3) by 12, then divide the result by the number of months in the short tax year. Irs 1040ez instructions The result is your annualized income. Irs 1040ez instructions Figure the total tax on your annualized income using the appropriate tax rate schedule. Irs 1040ez instructions Multiply the total tax by the number of months in the short tax year and divide the result by 12. Irs 1040ez instructions The result is your tax for the short tax year. Irs 1040ez instructions Relief procedure. Irs 1040ez instructions   Individuals and corporations can use a relief procedure to figure the tax for the short tax year. Irs 1040ez instructions It may result in less tax. Irs 1040ez instructions Under this procedure, the tax is figured by two separate methods. Irs 1040ez instructions If the tax figured under both methods is less than the tax figured under the general rule, you can file a claim for a refund of part of the tax you paid. Irs 1040ez instructions For more information, see section 443(b)(2) of the Internal Revenue Code. Irs 1040ez instructions Alternative minimum tax. Irs 1040ez instructions   To figure the alternative minimum tax (AMT) due for a short tax year: Figure the annualized alternative minimum taxable income (AMTI) for the short tax period by completing the following steps. Irs 1040ez instructions Multiply the AMTI by 12. Irs 1040ez instructions Divide the result by the number of months in the short tax year. Irs 1040ez instructions Multiply the annualized AMTI by the appropriate rate of tax under section 55(b)(1) of the Internal Revenue Code. Irs 1040ez instructions The result is the annualized AMT. Irs 1040ez instructions Multiply the annualized AMT by the number of months in the short tax year and divide the result by 12. Irs 1040ez instructions   For information on the AMT for individuals, see the Instructions for Form 6251, Alternative Minimum Tax–Individuals. Irs 1040ez instructions For information on the AMT for corporations, see the Instructions to Form 4626, Alternative Minimum Tax–Corporations. Irs 1040ez instructions Tax withheld from wages. Irs 1040ez instructions   You can claim a credit against your income tax liability for federal income tax withheld from your wages. Irs 1040ez instructions Federal income tax is withheld on a calendar year basis. Irs 1040ez instructions The amount withheld in any calendar year is allowed as a credit for the tax year beginning in the calendar year. Irs 1040ez instructions Improper Tax Year Taxpayers that have adopted an improper tax year must change to a proper tax year. Irs 1040ez instructions For example, if a taxpayer began business on March 15 and adopted a tax year ending on March 14 (a period of exactly 12 months), this would be an improper tax year. Irs 1040ez instructions See Accounting Periods, earlier, for a description of permissible tax years. Irs 1040ez instructions To change to a proper tax year, you must do one of the following. Irs 1040ez instructions If you are requesting a change to a calendar tax year, file an amended income tax return based on a calendar tax year that corrects the most recently filed tax return that was filed on the basis of an improper tax year. Irs 1040ez instructions Attach a completed Form 1128 to the amended tax return. Irs 1040ez instructions Write “FILED UNDER REV. Irs 1040ez instructions PROC. Irs 1040ez instructions 85-15” at the top of Form 1128 and file the forms with the Internal Revenue Service Center where you filed your original return. Irs 1040ez instructions If you are requesting a change to a fiscal tax year, file Form 1128 in accordance with the form instructions to request IRS approval for the change. Irs 1040ez instructions Change in Tax Year Generally, you must file Form 1128 to request IRS approval to change your tax year. Irs 1040ez instructions See the Instructions for Form 1128 for exceptions. Irs 1040ez instructions If you qualify for an automatic approval request, a user fee is not required. Irs 1040ez instructions Individuals Generally, individuals must adopt the calendar year as their tax year. Irs 1040ez instructions An individual can adopt a fiscal year provided that the individual maintains his or her books and records on the basis of the adopted fiscal year. Irs 1040ez instructions Partnerships, S Corporations, and Personal Service Corporations (PSCs) Generally, partnerships, S corporations (including electing S corporations), and PSCs must use a required tax year. Irs 1040ez instructions A required tax year is a tax year that is required under the Internal Revenue Code and Income Tax Regulations. Irs 1040ez instructions The entity does not have to use the required tax year if it receives IRS approval to use another permitted tax year or makes an election under section 444 of the Internal Revenue Code (discussed later). Irs 1040ez instructions The following discussions provide the rules for partnerships, S corporations, and PSCs. Irs 1040ez instructions Partnership A partnership must conform its tax year to its partners' tax years unless any of the following apply. Irs 1040ez instructions The partnership makes an election under section 444 of the Internal Revenue Code to have a tax year other than a required tax year by filing Form 8716. Irs 1040ez instructions The partnership elects to use a 52-53-week tax year that ends with reference to either its required tax year or a tax year elected under section 444. Irs 1040ez instructions The partnership can establish a business purpose for a different tax year. Irs 1040ez instructions The rules for the required tax year for partnerships are as follows. Irs 1040ez instructions If one or more partners having the same tax year own a majority interest (more than 50%) in partnership profits and capital, the partnership must use the tax year of those partners. Irs 1040ez instructions If there is no majority interest tax year, the partnership must use the tax year of all its principal partners. Irs 1040ez instructions A principal partner is one who has a 5% or more interest in the profits or capital of the partnership. Irs 1040ez instructions If there is no majority interest tax year and the principal partners do not have the same tax year, the partnership generally must use a tax year that results in the least aggregate deferral of income to the partners. Irs 1040ez instructions If a partnership changes to a required tax year because of these rules, it can get automatic approval by filing Form 1128. Irs 1040ez instructions Least aggregate deferral of income. Irs 1040ez instructions   The tax year that results in the least aggregate deferral of income is determined as follows. Irs 1040ez instructions Figure the number of months of deferral for each partner using one partner's tax year. Irs 1040ez instructions Find the months of deferral by counting the months from the end of that tax year forward to the end of each other partner's tax year. Irs 1040ez instructions Multiply each partner's months of deferral figured in step (1) by that partner's share of interest in the partnership profits for the year used in step (1). Irs 1040ez instructions Add the amounts in step (2) to get the aggregate (total) deferral for the tax year used in step (1). Irs 1040ez instructions Repeat steps (1) through (3) for each partner's tax year that is different from the other partners' years. Irs 1040ez instructions   The partner's tax year that results in the lowest aggregate (total) number is the tax year that must be used by the partnership. Irs 1040ez instructions If the calculation results in more than one tax year qualifying as the tax year with the least aggregate deferral, the partnership can choose any one of those tax years as its tax year. Irs 1040ez instructions However, if one of the tax years that qualifies is the partnership's existing tax year, the partnership must retain that tax year. Irs 1040ez instructions Example. Irs 1040ez instructions A and B each have a 50% interest in partnership P, which uses a fiscal year ending June 30. Irs 1040ez instructions A uses the calendar year and B uses a fiscal year ending November 30. Irs 1040ez instructions P must change its tax year to a fiscal year ending November 30 because this results in the least aggregate deferral of income to the partners, as shown in the following table. Irs 1040ez instructions Year End 12/31: Year End Profits Interest Months of Deferral Interest × Deferral A 12/31 0. Irs 1040ez instructions 5 -0- -0- B 11/30 0. Irs 1040ez instructions 5 11 5. Irs 1040ez instructions 5 Total Deferral 5. Irs 1040ez instructions 5 Year End 11/30: Year End Profits Interest Months of Deferral Interest × Deferral A 12/31 0. Irs 1040ez instructions 5 1 0. Irs 1040ez instructions 5 B 11/30 0. Irs 1040ez instructions 5 -0- -0- Total Deferral 0. Irs 1040ez instructions 5 When determination is made. Irs 1040ez instructions   The determination of the tax year under the least aggregate deferral rules must generally be made at the beginning of the partnership's current tax year. Irs 1040ez instructions However, the IRS can require the partnership to use another day or period that will more accurately reflect the ownership of the partnership. Irs 1040ez instructions This could occur, for example, if a partnership interest was transferred for the purpose of qualifying for a particular tax year. Irs 1040ez instructions Short period return. Irs 1040ez instructions   When a partnership changes its tax year, a short period return must be filed. Irs 1040ez instructions The short period return covers the months between the end of the partnership's prior tax year and the beginning of its new tax year. Irs 1040ez instructions   If a partnership changes to the tax year resulting in the least aggregate deferral, it must file a Form 1128 with the short period return showing the computations used to determine that tax year. Irs 1040ez instructions The short period return must indicate at the top of page 1, “FILED UNDER SECTION 1. Irs 1040ez instructions 706-1. Irs 1040ez instructions ” More information. Irs 1040ez instructions   For more information about changing a partnership's tax year, and information about ruling requests, see the Instructions for Form 1128. Irs 1040ez instructions S Corporation All S corporations, regardless of when they became an S corporation, must use a permitted tax year. Irs 1040ez instructions A permitted tax year is any of the following. Irs 1040ez instructions The calendar year. Irs 1040ez instructions A tax year elected under section 444 of the Internal Revenue Code. Irs 1040ez instructions See Section 444 Election, below for details. Irs 1040ez instructions A 52-53-week tax year ending with reference to the calendar year or a tax year elected under section 444. Irs 1040ez instructions Any other tax year for which the corporation establishes a business purpose. Irs 1040ez instructions If an electing S corporation wishes to adopt a tax year other than a calendar year, it must request IRS approval using Form 2553, instead of filing Form 1128. Irs 1040ez instructions For information about changing an S corporation's tax year and information about ruling requests, see the Instructions for Form 1128. Irs 1040ez instructions Personal Service Corporation (PSC) A PSC must use a calendar tax year unless any of the following apply. Irs 1040ez instructions The corporation makes an election under section 444 of the Internal Revenue Code. Irs 1040ez instructions See Section 444 Election, below for details. Irs 1040ez instructions The corporation elects to use a 52-53-week tax year ending with reference to the calendar year or a tax year elected under section 444. Irs 1040ez instructions The corporation establishes a business purpose for a fiscal year. Irs 1040ez instructions See the Instructions for Form 1120 for general information about PSCs. Irs 1040ez instructions For information on adopting or changing tax years for PSCs and information about ruling requests, see the Instructions for Form 1128. Irs 1040ez instructions Section 444 Election A partnership, S corporation, electing S corporation, or PSC can elect under section 444 of the Internal Revenue Code to use a tax year other than its required tax year. Irs 1040ez instructions Certain restrictions apply to the election. Irs 1040ez instructions A partnership or an S corporation that makes a section 444 election must make certain required payments and a PSC must make certain distributions (discussed later). Irs 1040ez instructions The section 444 election does not apply to any partnership, S corporation, or PSC that establishes a business purpose for a different period, explained later. Irs 1040ez instructions A partnership, S corporation, or PSC can make a section 444 election if it meets all the following requirements. Irs 1040ez instructions It is not a member of a tiered structure (defined in section 1. Irs 1040ez instructions 444-2T of the regulations). Irs 1040ez instructions It has not previously had a section 444 election in effect. Irs 1040ez instructions It elects a year that meets the deferral period requirement. Irs 1040ez instructions Deferral period. Irs 1040ez instructions   The determination of the deferral period depends on whether the partnership, S corporation, or PSC is retaining its tax year or adopting or changing its tax year with a section 444 election. Irs 1040ez instructions Retaining tax year. Irs 1040ez instructions   Generally, a partnership, S corporation, or PSC can make a section 444 election to retain its tax year only if the deferral period of the new tax year is 3 months or less. Irs 1040ez instructions This deferral period is the number of months between the beginning of the retained year and the close of the first required tax year. Irs 1040ez instructions Adopting or changing tax year. Irs 1040ez instructions   If the partnership, S corporation, or PSC is adopting or changing to a tax year other than its required year, the deferral period is the number of months from the end of the new tax year to the end of the required tax year. Irs 1040ez instructions The IRS will allow a section 444 election only if the deferral period of the new tax year is less than the shorter of: Three months, or The deferral period of the tax year being changed. Irs 1040ez instructions This is the tax year immediately preceding the year for which the partnership, S corporation, or PSC wishes to make the section 444 election. Irs 1040ez instructions If the partnership, S corporation, or PSC's tax year is the same as its required tax year, the deferral period is zero. Irs 1040ez instructions Example 1. Irs 1040ez instructions BD Partnership uses a calendar year, which is also its required tax year. Irs 1040ez instructions BD cannot make a section 444 election because the deferral period is zero. Irs 1040ez instructions Example 2. Irs 1040ez instructions E, a newly formed partnership, began operations on December 1. Irs 1040ez instructions E is owned by calendar year partners. Irs 1040ez instructions E wants to make a section 444 election to adopt a September 30 tax year. Irs 1040ez instructions E's deferral period for the tax year beginning December 1 is 3 months, the number of months between September 30 and December 31. Irs 1040ez instructions Making the election. Irs 1040ez instructions   Make a section 444 election by filing Form 8716 with the Internal Revenue Service Center where the entity will file its tax return. Irs 1040ez instructions Form 8716 must be filed by the earlier of: The due date (not including extensions) of the income tax return for the tax year resulting from the section 444 election, or The 15th day of the 6th month of the tax year for which the election will be effective. Irs 1040ez instructions For this purpose, count the month in which the tax year begins, even if it begins after the first day of that month. Irs 1040ez instructions Note. Irs 1040ez instructions If the due date falls on a Saturday, Sunday, or legal holiday, file on the next business day. Irs 1040ez instructions   Attach a copy of Form 8716 to Form 1065, Form 1120S, or Form 1120 for the first tax year for which the election is made. Irs 1040ez instructions Example 1. Irs 1040ez instructions AB, a partnership, begins operations on September 13, 2012, and is qualified to make a section 444 election to use a September 30 tax year for its tax year beginning September 13, 2012. Irs 1040ez instructions AB must file Form 8716 by January 15, 2013, which is the due date of the partnership's tax return for the period from September 13, 2012, to September 30, 2012. Irs 1040ez instructions Example 2. Irs 1040ez instructions The facts are the same as in Example 1 except that AB begins operations on October 21, 2012. Irs 1040ez instructions AB must file Form 8716 by March 17, 2013. Irs 1040ez instructions Example 3. Irs 1040ez instructions B is a corporation that first becomes a PSC for its tax year beginning September 1, 2012. Irs 1040ez instructions B qualifies to make a section 444 election to use a September 30 tax year for its tax year beginning September 1, 2012. Irs 1040ez instructions B must file Form 8716 by December 17, 2012, the due date of the income tax return for the short period from September 1, 2012, to September 30, 2012. Irs 1040ez instructions Note. Irs 1040ez instructions The due dates in Examples 2 and 3 are adjusted because the dates fall on a Saturday, Sunday or legal holiday. Irs 1040ez instructions Extension of time for filing. Irs 1040ez instructions   There is an automatic extension of 12 months to make this election. Irs 1040ez instructions See the Form 8716 instructions for more information. Irs 1040ez instructions Terminating the election. Irs 1040ez instructions   The section 444 election remains in effect until it is terminated. Irs 1040ez instructions If the election is terminated, another section 444 election cannot be made for any tax year. Irs 1040ez instructions   The election ends when any of the following applies to the partnership, S corporation, or PSC. Irs 1040ez instructions The entity changes to its required tax year. Irs 1040ez instructions The entity liquidates. Irs 1040ez instructions The entity becomes a member of a tiered structure. Irs 1040ez instructions The IRS determines that the entity willfully failed to comply with the required payments or distributions. Irs 1040ez instructions   The election will also end if either of the following events occur. Irs 1040ez instructions An S corporation's S election is terminated. Irs 1040ez instructions However, if the S corporation immediately becomes a PSC, the PSC can continue the section 444 election of the S corporation. Irs 1040ez instructions A PSC ceases to be a PSC. Irs 1040ez instructions If the PSC elects to be an S corporation, the S corporation can continue the election of the PSC. Irs 1040ez instructions Required payment for partnership or S corporation. Irs 1040ez instructions   A partnership or an S corporation must make a required payment for any tax year: The section 444 election is in effect. Irs 1040ez instructions The required payment for that year (or any preceding tax year) is more than $500. Irs 1040ez instructions    This payment represents the value of the tax deferral the owners receive by using a tax year different from the required tax year. Irs 1040ez instructions   Form 8752, Required Payment or Refund Under Section 7519, must be filed each year the section 444 election is in effect, even if no payment is due. Irs 1040ez instructions If the required payment is more than $500 (or the required payment for any prior year was more than $500), the payment must be made when Form 8752 is filed. Irs 1040ez instructions If the required payment is $500 or less and no payment was required in a prior year, Form 8752 must be filed showing a zero amount. Irs 1040ez instructions Applicable election year. Irs 1040ez instructions   Any tax year a section 444 election is in effect, including the first year, is called an applicable election year. Irs 1040ez instructions Form 8752 must be filed and the required payment made (or zero amount reported) by May 15th of the calendar year following the calendar year in which the applicable election year begins. Irs 1040ez instructions Required distribution for PSC. Irs 1040ez instructions   A PSC with a section 444 election in effect must distribute certain amounts to employee-owners by December 31 of each applicable year. Irs 1040ez instructions If it fails to make these distributions, it may be required to defer certain deductions for amounts paid to owner-employees. Irs 1040ez instructions The amount deferred is treated as paid or incurred in the following tax year. Irs 1040ez instructions   For information on the minimum distribution, see the instructions for Part I of Schedule H (Form 1120), Section 280H Limitations for a Personal Service Corporation (PSC). Irs 1040ez instructions Back-up election. Irs 1040ez instructions   A partnership, S corporation, or PSC can file a back-up section 444 election if it requests (or plans to request) permission to use a business purpose tax year, discussed later. Irs 1040ez instructions If the request is denied, the back-up section 444 election must be activated (if the partnership, S corporation, or PSC otherwise qualifies). Irs 1040ez instructions Making back-up election. Irs 1040ez instructions   The general rules for making a section 444 election, as discussed earlier, apply. Irs 1040ez instructions When filing Form 8716, type or print “BACK-UP ELECTION” at the top of the form. Irs 1040ez instructions However, if Form 8716 is filed on or after the date Form 1128 (or Form 2553) is filed, type or print “FORM 1128 (or FORM 2553) BACK-UP ELECTION” at the top of Form 8716. Irs 1040ez instructions Activating election. Irs 1040ez instructions   A partnership or S corporation activates its back-up election by filing the return required and making the required payment with Form 8752. Irs 1040ez instructions The due date for filing Form 8752 and making the payment is the later of the following dates. Irs 1040ez instructions May 15 of the calendar year following the calendar year in which the applicable election year begins. Irs 1040ez instructions 60 days after the partnership or S corporation has been notified by the IRS that the business year request has been denied. Irs 1040ez instructions   A PSC activates its back-up election by filing Form 8716 with its original or amended income tax return for the tax year in which the election is first effective and printing on the top of the income tax return, “ACTIVATING BACK-UP ELECTION. Irs 1040ez instructions ” 52-53-Week Tax Year A partnership, S corporation, or PSC can use a tax year other than its required tax year if it elects a 52-53-week tax year (discussed earlier) that ends with reference to either its required tax year or a tax year elected under section 444 (discussed earlier). Irs 1040ez instructions A newly formed partnership, S corporation, or PSC can adopt a 52-53-week tax year ending with reference to either its required tax year or a tax year elected under section 444 without IRS approval. Irs 1040ez instructions However, if the entity wishes to change to a 52-53-week tax year or change from a 52-53-week tax year that references a particular month to a non-52-53-week tax year that ends on the last day of that month, it must request IRS approval by filing Form 1128. Irs 1040ez instructions Business Purpose Tax Year A partnership, S corporation, or PSC establishes the business purpose for a tax year by filing Form 1128. Irs 1040ez instructions See the Instructions for Form 1128 for details. Irs 1040ez instructions Corporations (Other Than S Corporations and PSCs) A new corporation establishes its tax year when it files its first tax return. Irs 1040ez instructions A newly reactivated corporation that has been inactive for a number of years is treated as a new taxpayer for the purpose of adopting a tax year. Irs 1040ez instructions An S corporation or a PSC must use the required tax year rules, discussed earlier, to establish a tax year. Irs 1040ez instructions Generally, a corporation that wants to change its tax year must obtain approval from the IRS under either the: (a) automatic approval procedures; or (b) ruling request procedures. Irs 1040ez instructions See the Instructions for Form 1128 for details. Irs 1040ez instructions Accounting Methods An accounting method is a set of rules used to determine when income and expenses are reported on your tax return. Irs 1040ez instructions Your accounting method includes not only your overall method of accounting, but also the accounting treatment you use for any material item. Irs 1040ez instructions You choose an accounting method when you file your first tax return. Irs 1040ez instructions If you later want to change your accounting method, you must get IRS approval. Irs 1040ez instructions See Change in Accounting Method, later. Irs 1040ez instructions No single accounting method is required of all taxpayers. Irs 1040ez instructions You must use a system that clearly reflects your income and expenses and you must maintain records that will enable you to file a correct return. Irs 1040ez instructions In addition to your permanent accounting books, you must keep any other records necessary to support the entries on your books and tax returns. Irs 1040ez instructions You must use the same accounting method from year to year. Irs 1040ez instructions An accounting method clearly reflects income only if all items of gross income and expenses are treated the same from year to year. Irs 1040ez instructions If you do not regularly use an accounting method that clearly reflects your income, your income will be refigured under the method that, in the opinion of the IRS, does clearly reflect income. Irs 1040ez instructions Methods you can use. Irs 1040ez instructions   In general, you can compute your taxable income under any of the following accounting methods. Irs 1040ez instructions Cash method. Irs 1040ez instructions Accrual method. Irs 1040ez instructions Special methods of accounting for certain items of income and expenses. Irs 1040ez instructions A hybrid method which combines elements of two or more of the above accounting methods. Irs 1040ez instructions The cash and accrual methods of accounting are explained later. Irs 1040ez instructions Special methods. Irs 1040ez instructions   This publication does not discuss special methods of accounting for certain items of income or expenses. Irs 1040ez instructions For information on reporting income using one of the long-term contract methods, see section 460 of the Internal Revenue Code and the related regulations. Irs 1040ez instructions The following publications also discuss special methods of reporting income or expenses. Irs 1040ez instructions Publication 225, Farmer's Tax Guide. Irs 1040ez instructions Publication 535, Business Expenses. Irs 1040ez instructions Publication 537, Installment Sales. Irs 1040ez instructions Publication 946, How To Depreciate Property. Irs 1040ez instructions Hybrid method. Irs 1040ez instructions   Generally, you can use any combination of cash, accrual, and special methods of accounting if the combination clearly reflects your income and you use it consistently. Irs 1040ez instructions However, the following restrictions apply. Irs 1040ez instructions If an inventory is necessary to account for your income, you must use an accrual method for purchases and sales. Irs 1040ez instructions See Exceptions under Inventories, later. Irs 1040ez instructions Generally, you can use the cash method for all other items of income and expenses. Irs 1040ez instructions See Inventories, later. Irs 1040ez instructions If you use the cash method for reporting your income, you must use the cash method for reporting your expenses. Irs 1040ez instructions If you use an accrual method for reporting your expenses, you must use an accrual method for figuring your income. Irs 1040ez instructions Any combination that includes the cash method is treated as the cash method for purposes of section 448 of the Internal Revenue Code. Irs 1040ez instructions Business and personal items. Irs 1040ez instructions   You can account for business and personal items using different accounting methods. Irs 1040ez instructions For example, you can determine your business income and expenses under an accrual method, even if you use the cash method to figure personal items. Irs 1040ez instructions Two or more businesses. Irs 1040ez instructions   If you operate two or more separate and distinct businesses, you can use a different accounting method for each business. Irs 1040ez instructions No business is separate and distinct, unless a complete and separate set of books and records is maintained for each business. Irs 1040ez instructions Note. Irs 1040ez instructions If you use different accounting methods to create or shift profits or losses between businesses (for example, through inventory adjustments, sales, purchases, or expenses) so that income is not clearly reflected, the businesses will not be considered separate and distinct. Irs 1040ez instructions Cash Method Most individuals and many small businesses use the cash method of accounting. Irs 1040ez instructions Generally, if you produce, purchase, or sell merchandise, you must keep an inventory and use an accrual method for sales and purchases of merchandise. Irs 1040ez instructions See Inventories, later, for exceptions to this rule. Irs 1040ez instructions Income Under the cash method, you include in your gross income all items of income you actually or constructively receive during the tax year. Irs 1040ez instructions If you receive property and services, you must include their fair market value (FMV) in income. Irs 1040ez instructions Constructive receipt. Irs 1040ez instructions   Income is constructively received when an amount is credited to your account or made available to you without restriction. Irs 1040ez instructions You need not have possession of it. Irs 1040ez instructions If you authorize someone to be your agent and receive income for you, you are considered to have received it when your agent receives it. Irs 1040ez instructions Income is not constructively received if your control of its receipt is subject to substantial restrictions or limitations. Irs 1040ez instructions Example. Irs 1040ez instructions You are a calendar year taxpayer. Irs 1040ez instructions Your bank credited, and made available, interest to your bank account in December 2012. Irs 1040ez instructions You did not withdraw it or enter it into your books until 2013. Irs 1040ez instructions You must include the amount in gross income for 2012, the year you constructively received it. Irs 1040ez instructions You cannot hold checks or postpone taking possession of similar property from one tax year to another to postpone paying tax on the income. Irs 1040ez instructions You must report the income in the year the property is received or made available to you without restriction. Irs 1040ez instructions Expenses Under the cash method, generally, you deduct expenses in the tax year in which you actually pay them. Irs 1040ez instructions This includes business expenses for which you contest liability. Irs 1040ez instructions However, you may not be able to deduct an expense paid in advance. Irs 1040ez instructions Instead, you may be required to capitalize certain costs, as explained later under Uniform Capitalization Rules. Irs 1040ez instructions Expense paid in advance. Irs 1040ez instructions   An expense you pay in advance is deductible only in the year to which it applies, unless the expense qualifies for the 12-month rule. Irs 1040ez instructions   Under the 12-month rule, a taxpayer is not required to capitalize amounts paid to create certain rights or benefits for the taxpayer that do not extend beyond the earlier of the following. Irs 1040ez instructions 12 months after the right or benefit begins, or The end of the tax year after the tax year in which payment is made. Irs 1040ez instructions   If you have not been applying the general rule (an expense paid in advance is deductible only in the year to which it applies) and/or the 12-month rule to the expenses you paid in advance, you must obtain approval from the IRS before using the general rule and/or the 12-month rule. Irs 1040ez instructions See Change in Accounting Method, later. Irs 1040ez instructions Example 1. Irs 1040ez instructions You are a calendar year taxpayer and pay $3,000 in 2012 for a business insurance policy that is effective for three years (36 months), beginning on July 1, 2012. Irs 1040ez instructions The general rule that an expense paid in advance is deductible only in the year to which it applies is applicable to this payment because the payment does not qualify for the 12-month rule. Irs 1040ez instructions Therefore, only $500 (6/36 x $3,000) is deductible in 2012, $1,000 (12/36 x $3,000) is deductible in 2013, $1,000 (12/36 x $3,000) is deductible in 2014, and the remaining $500 is deductible in 2015. Irs 1040ez instructions Example 2. Irs 1040ez instructions You are a calendar year taxpayer and pay $10,000 on July 1, 2012, for a business insurance policy that is effective for only one year beginning on July 1, 2012. Irs 1040ez instructions The 12-month rule applies. Irs 1040ez instructions Therefore, the full $10,000 is deductible in 2012. Irs 1040ez instructions Excluded Entities The following entities cannot use the cash method, including any combination of methods that includes the cash method. Irs 1040ez instructions (See Special rules for farming businesses, later. Irs 1040ez instructions ) A corporation (other than an S corporation) with average annual gross receipts exceeding $5 million. Irs 1040ez instructions See Gross receipts test, below. Irs 1040ez instructions A partnership with a corporation (other than an S corporation) as a partner, and with the partnership having average annual gross receipts exceeding $5 million. Irs 1040ez instructions See Gross receipts test, below. Irs 1040ez instructions A tax shelter. Irs 1040ez instructions Exceptions The following entities are not prohibited from using the cash method of accounting. Irs 1040ez instructions Any corporation or partnership, other than a tax shelter, that meets the gross receipts test for all tax years after 1985. Irs 1040ez instructions A qualified personal service corporation (PSC). Irs 1040ez instructions Gross receipts test. Irs 1040ez instructions   A corporation or partnership, other than a tax shelter, that meets the gross receipts test can generally use the cash method. Irs 1040ez instructions A corporation or a partnership meets the test if, for each prior tax year beginning after 1985, its average annual gross receipts are $5 million or less. Irs 1040ez instructions    An entity's average annual gross receipts for a prior tax year is determined by: Adding the gross receipts for that tax year and the 2 preceding tax years; and Dividing the total by 3. Irs 1040ez instructions See Gross receipts test for qualifying taxpayers, for more information. Irs 1040ez instructions Generally, a partnership applies the test at the partnership level. Irs 1040ez instructions Gross receipts for a short tax year are annualized. Irs 1040ez instructions Aggregation rules. Irs 1040ez instructions   Organizations that are members of an affiliated service group or a controlled group of corporations treated as a single employer for tax purposes are required to aggregate their gross receipts to determine whether the gross receipts test is met. Irs 1040ez instructions Change to accrual method. Irs 1040ez instructions   A corporation or partnership that fails to meet the gross receipts test for any tax year is prohibited from using the cash method and must change to an accrual method of accounting, effective for the tax year in which the entity fails to meet this test. Irs 1040ez instructions Special rules for farming businesses. Irs 1040ez instructions   Generally, a taxpayer engaged in the trade or business of farming is allowed to use the cash method for its farming business. Irs 1040ez instructions However, certain corporations (other than S corporations) and partnerships that have a partner that is a corporation must use an accrual method for their farming business. Irs 1040ez instructions For this purpose, farming does not include the operation of a nursery or sod farm or the raising or harvesting of trees (other than fruit and nut trees). Irs 1040ez instructions   There is an exception to the requirement to use an accrual method for corporations with gross receipts of $1 million or less for each prior tax year after 1975. Irs 1040ez instructions For family corporations engaged in farming, the exception applies if gross receipts were $25 million or less for each prior tax year after 1985. Irs 1040ez instructions See chapter 2 of Publication 225, Farmer's Tax Guide, for more information. Irs 1040ez instructions Qualified PSC. Irs 1040ez instructions   A PSC that meets the following function and ownership tests can use the cash method. Irs 1040ez instructions Function test. Irs 1040ez instructions   A corporation meets the function test if at least 95% of its activities are in the performance of services in the fields of health, veterinary services, law, engineering (including surveying and mapping), architecture, accounting, actuarial science, performing arts, or consulting. Irs 1040ez instructions Ownership test. Irs 1040ez instructions   A corporation meets the ownership test if at least 95% of its stock is owned, directly or indirectly, at all times during the year by one or more of the following. Irs 1040ez instructions Employees performing services for the corporation in a field qualifying under the function test. Irs 1040ez instructions Retired employees who had performed services in those fields. Irs 1040ez instructions The estate of an employee described in (1) or (2). Irs 1040ez instructions Any other person who acquired the stock by reason of the death of an employee referred to in (1) or (2), but only for the 2-year period beginning on the date of death. Irs 1040ez instructions   Indirect ownership is generally taken into account if the stock is owned indirectly through one or more partnerships, S corporations, or qualified PSCs. Irs 1040ez instructions Stock owned by one of these entities is considered owned by the entity's owners in proportion to their ownership interest in that entity. Irs 1040ez instructions Other forms of indirect stock ownership, such as stock owned by family members, are generally not considered when determining if the ownership test is met. Irs 1040ez instructions   For purposes of the ownership test, a person is not considered an employee of a corporation unless that person performs more than minimal services for the corporation. Irs 1040ez instructions Change to accrual method. Irs 1040ez instructions   A corporation that fails to meet the function test for any tax year; or fails to meet the ownership test at any time during any tax year must change to an accrual method of accounting, effective for the year in which the corporation fails to meet either test. Irs 1040ez instructions A corporation that fails to meet the function test or the ownership test is not treated as a qualified PSC for any part of that tax year. Irs 1040ez instructions Accrual Method Under the accrual method of accounting, generally you report income in the year it is earned and deduct or capitalize expenses in the year incurred. Irs 1040ez instructions The purpose of an accrual method of accounting is to match income and expenses in the correct year. Irs 1040ez instructions Income Generally, you include an amount in gross income for the tax year in which all events that fix your right to receive the income have occurred and you can determine the amount with reasonable accuracy. Irs 1040ez instructions Under this rule, you report an amount in your gross income on the earliest of the following dates. Irs 1040ez instructions When you receive payment. Irs 1040ez instructions When the income amount is due to you. Irs 1040ez instructions When you earn the income. Irs 1040ez instructions When title has passed. Irs 1040ez instructions Estimated income. Irs 1040ez instructions   If you include a reasonably estimated amount in gross income and later determine the exact amount is different, take the difference into account in the tax year you make that determination. Irs 1040ez instructions Change in payment schedule. Irs 1040ez instructions   If you perform services for a basic rate specified in a contract, you must accrue the income at the basic rate, even if you agree to receive payments at a reduced rate. Irs 1040ez instructions Continue this procedure until you complete the services, then account for the difference. Irs 1040ez instructions Advance Payment for Services Generally, you report an advance payment for services to be performed in a later tax year as income in the year you receive the payment. Irs 1040ez instructions However, if you receive an advance payment for services you agree to perform by the end of the next tax year, you can elect to postpone including the advance payment in income until the next tax year. Irs 1040ez instructions However, you cannot postpone including any payment beyond that tax year. Irs 1040ez instructions Service agreement. Irs 1040ez instructions   You can postpone reporting income from an advance payment you receive for a service agreement on property you sell, lease, build, install, or construct. Irs 1040ez instructions This includes an agreement providing for incidental replacement of parts or materials. Irs 1040ez instructions However, this applies only if you offer the property without a service agreement in the normal course of business. Irs 1040ez instructions Postponement not allowed. Irs 1040ez instructions   Generally, one cannot postpone including an advance payment in income for services if either of the following applies. Irs 1040ez instructions You are to perform any part of the service after the end of the tax year immediately following the year you receive the advance payment. Irs 1040ez instructions You are to perform any part of the service at any unspecified future date that may be after the end of the tax year immediately following the year you receive the advance payment. Irs 1040ez instructions Examples. Irs 1040ez instructions   In each of the following examples, assume the tax year is a calendar year and that the accrual method of accounting is used. Irs 1040ez instructions Example 1. Irs 1040ez instructions You manufacture, sell, and service computers. Irs 1040ez instructions You received payment in 2012 for a one-year contingent service contract on a computer you sold. Irs 1040ez instructions You can postpone including in income the part of the payment you did not earn in 2012 if, in the normal course of your business, you offer computers for sale without a contingent service contract. Irs 1040ez instructions Example 2. Irs 1040ez instructions You are in the television repair business. Irs 1040ez instructions You received payments in 2012 for one-year contracts under which you agree to repair or replace certain parts that fail to function properly in television sets manufactured and sold by unrelated parties. Irs 1040ez instructions You include the payments in gross income as you earn them. Irs 1040ez instructions Example 3. Irs 1040ez instructions You own a dance studio. Irs 1040ez instructions On October 1, 2012, you receive payment for a one-year contract for 48 one-hour lessons beginning on that date. Irs 1040ez instructions You give eight lessons in 2012. Irs 1040ez instructions Under this method of including advance payments, you must include one-sixth (8/48) of the payment in income for 2012, and five-sixths (40/48) of the payment in 2013, even if you do not give all the lessons by the end of 2013. Irs 1040ez instructions Example 4. Irs 1040ez instructions Assume the same facts as in Example 3, except the payment is for a two-year contract for 96 lessons. Irs 1040ez instructions You must include the entire payment in income in 2012 since part of the services may be performed after the following year. Irs 1040ez instructions Guarantee or warranty. Irs 1040ez instructions   Generally, you cannot postpone reporting income you receive under a guarantee or warranty contract. Irs 1040ez instructions Prepaid rent. Irs 1040ez instructions   You cannot postpone reporting income from prepaid rent. Irs 1040ez instructions Prepaid rent does not include payment for the use of a room or other space when significant service is also provided for the occupant. Irs 1040ez instructions You provide significant service when you supply space in a hotel, boarding house, tourist home, motor court, motel, or apartment house that furnishes hotel services. Irs 1040ez instructions Books and records. Irs 1040ez instructions   Any advance payment you include in gross receipts on your tax return for the year you receive payment must not be less than the payment you include in income for financial reports under the method of accounting used for those reports. Irs 1040ez instructions Financial reports include reports to shareholders, partners, beneficiaries, and other proprietors for credit purposes and consolidated financial statements. Irs 1040ez instructions IRS approval. Irs 1040ez instructions   You must file Form 3115 to obtain IRS approval to change your method of accounting for advance payment for services. Irs 1040ez instructions Advance Payment for Sales Special rules apply to including income from advance payments on agreements for future sales or other dispositions of goods held primarily for sale to customers in the ordinary course of your trade or business. Irs 1040ez instructions However, the rules do not apply to a payment (or part of a payment) for services that are not an integral part of the main activities covered under the agreement. Irs 1040ez instructions An agreement includes a gift certificate that can be redeemed for goods. Irs 1040ez instructions Amounts due and payable are considered received. Irs 1040ez instructions How to report payments. Irs 1040ez instructions   Generally, include an advance payment in income in the year in which you receive it. Irs 1040ez instructions However, you can use the alternative method, discussed next. Irs 1040ez instructions Alternative method of reporting. Irs 1040ez instructions   Under the alternative method, generally include an advance payment in income in the earlier tax year in which you: Include advance payments in gross receipts under the method of accounting you use for tax purposes, or Include any part of advance payments in income for financial reports under the method of accounting used for those reports. Irs 1040ez instructions Financial reports include reports to shareholders, partners, beneficiaries, and other proprietors for credit purposes and consolidated financial statements. Irs 1040ez instructions Example 1. Irs 1040ez instructions You are a retailer. Irs 1040ez instructions You use an accrual method of accounting and account for the sale of goods when you ship the goods. Irs 1040ez instructions You use this method for both tax and financial reporting purposes. Irs 1040ez instructions You can include advance payments in gross receipts for tax purposes in either: (a) the tax year in which you receive the payments; or (b) the tax year in which you ship the goods. Irs 1040ez instructions However, see Exception for inventory goods, later. Irs 1040ez instructions Example 2. Irs 1040ez instructions You are a calendar year taxpayer. Irs 1040ez instructions You manufacture household furniture and use an accrual method of accounting. Irs 1040ez instructions Under this method, you accrue income for your financial reports when you ship the furniture. Irs 1040ez instructions For tax purposes, you do not accrue income until the furniture has been delivered and accepted. Irs 1040ez instructions In 2012, you received an advance payment of $8,000 for an order of furniture to be manufactured for a total price of $20,000. Irs 1040ez instructions You shipped the furniture to the customer in December 2012, but it was not delivered and accepted until January 2013. Irs 1040ez instructions For tax purposes, you include the $8,000 advance payment in gross income for 2012; and include the remaining $12,000 of the contract price in gross income for 2013. Irs 1040ez instructions Information schedule. Irs 1040ez instructions   If you use the alternative method of reporting advance payments, you must attach a statement with the following information to your tax return each year. Irs 1040ez instructions Total advance payments received in the current tax year. Irs 1040ez instructions Total advance payments received in earlier tax years and not included in income before the current tax year. Irs 1040ez instructions Total payments received in earlier tax years included in income for the current tax year. Irs 1040ez instructions Exception for inventory goods. Irs 1040ez instructions   If you have an agreement to sell goods properly included in inventory, you can postpone including the advance payment in income until the end of the second tax year following the year you receive an advance payment if, on the last day of the tax year, you meet the following requirements. Irs 1040ez instructions You account for the advance payment under the alternative method (discussed earlier). Irs 1040ez instructions You have received a substantial advance payment on the agreement (discussed next). Irs 1040ez instructions You have enough substantially similar goods on hand, or available through your normal source of supply, to satisfy the agreement. Irs 1040ez instructions These rules also apply to an agreement, such as a gift certificate, that can be satisfied with goods that cannot be identified in the tax year you receive an advance payment. Irs 1040ez instructions   If you meet these conditions, all advance payments you receive by the end of the second tax year, including payments received in prior years but not reported, must be included in income by the second tax year following the tax year of receipt of substantial advance payments. Irs 1040ez instructions You must also deduct in that second year all actual or estimated costs for the goods required to satisfy the agreement. Irs 1040ez instructions If you estimated the cost, you must take into account any difference between the estimate and the actual cost when the goods are delivered. Irs 1040ez instructions Note. Irs 1040ez instructions You must report any advance payments you receive after the second year in the year received. Irs 1040ez instructions No further deferral is allowed. Irs 1040ez instructions Substantial advance payments. Irs 1040ez instructions   Under an agreement for a future sale, you have substantial advance payments if, by the end of the tax year, the total advance payments received during that year and preceding tax years are equal to or more than the total costs reasonably estimated to be includible in inventory because of the agreement. Irs 1040ez instructions Example. Irs 1040ez instructions You are a calendar year, accrual method taxpayer who accounts for advance payments under the alternative method. Irs 1040ez instructions In 2008, you entered into a contract for the sale of goods properly includible in your inventory. Irs 1040ez instructions The total contract price is $50,000 and you estimate that your total inventoriable costs for the goods will be $25,000. Irs 1040ez instructions You receive the following advance payments under the contract. Irs 1040ez instructions 2009 $17,500 2010 10,000 2011 7,500 2012 5,000 2013 5,000 2014 5,000 Total contract price $50,000   Your customer asked you to deliver the goods in 2015. Irs 1040ez instructions In your 2010 closing inventory, you had on hand enough of the type of goods specified in the contract to satisfy the contract. Irs 1040ez instructions Since the advance payments you had received by the end of 2010 were more than the costs you estimated, the payments are substantial advance payments. Irs 1040ez instructions   For 2012, include in income all payments you received by the end of 2012, the second tax year following the tax year in which you received substantial advance payments. Irs 1040ez instructions You must include $40,000 in sales for 2012 (the total amounts received from 2009 through 2012) and include in inventory the cost of the goods (or similar goods) on hand. Irs 1040ez instructions If no such goods are on hand, then estimate the cost necessary to satisfy the contract. Irs 1040ez instructions   No further deferral is allowed. Irs 1040ez instructions You must include in gross income the advance payment you receive each remaining year of the contract. Irs 1040ez instructions Take into account the difference between any estimated cost of goods sold and the actual cost when you deliver the goods in 2015. Irs 1040ez instructions IRS approval. Irs 1040ez instructions   You must file Form 3115 to obtain IRS approval to change your method of accounting for advance payments for sales. Irs 1040ez instructions Expenses Under an accrual method of accounting, you generally deduct or capitalize a business expense when both the following apply. Irs 1040ez instructions The all-events test has been met. Irs 1040ez instructions The test is met when: All events have occurred that fix the fact of liability, and The liability can be determined with reasonable accuracy. Irs 1040ez instructions Economic performance has occurred. Irs 1040ez instructions Economic Performance Generally, you cannot deduct or capitalize a business expense until economic performance occurs. Irs 1040ez instructions If your expense is for property or services provided to you, or for your use of property, economic performance occurs as the property or services are provided or the property is used. Irs 1040ez instructions If your expense is for property or services you provide to others, economic performance occurs as you provide the property or services. Irs 1040ez instructions Example. Irs 1040ez instructions You are a calendar year taxpayer. Irs 1040ez instructions You buy office supplies in December 2012. Irs 1040ez instructions You receive the supplies and the bill in December, but you pay the bill in January 2013. Irs 1040ez instructions You can deduct the expense in 2012 because all events have occurred to fix the liability, the amount of the liability can be determined, and economic performance occurred in 2012. Irs 1040ez instructions Your office supplies may qualify as a recurring item, discussed later. Irs 1040ez instructions If so, you can deduct them in 2012, even if the supplies are not delivered until 2013 (when economic performance occurs). Irs 1040ez instructions Workers' compensation and tort liability. Irs 1040ez instructions   If you are required to make payments under workers' compensation laws or in satisfaction of any tort liability, economic performance occurs as you make the payments. Irs 1040ez instructions If you are required to make payments to a special designated settlement fund established by court order for a tort liability, economic performance occurs as you make the payments. Irs 1040ez instructions Taxes. Irs 1040ez instructions   Economic performance generally occurs as estimated income tax, property taxes, employment taxes, etc. Irs 1040ez instructions are paid. Irs 1040ez instructions However, you can elect to treat taxes as a recurring item, discussed later. Irs 1040ez instructions You can also elect to ratably accrue real estate taxes. Irs 1040ez instructions See chapter 5 of Publication 535 for information about real estate taxes. Irs 1040ez instructions Other liabilities. Irs 1040ez instructions   Other liabilities for which economic performance occurs as you make payments include liabilities for breach of contract (to the extent of incidental, consequential, and liquidated damages), violation of law, rebates and refunds, awards, prizes, jackpots, insurance, and warranty and service contracts. Irs 1040ez instructions Interest. Irs 1040ez instructions   Economic performance occurs with the passage of time (as the borrower uses, and the lender forgoes use of, the lender's money) rather than as payments are made. Irs 1040ez instructions Compensation for services. Irs 1040ez instructions   Generally, economic performance occurs as an employee renders service to the employer. Irs 1040ez instructions However, deductions for compensation or other benefits paid to an employee in a year subsequent to economic performance are subject to the rules governing deferred compensation, deferred benefits, and funded welfare benefit plans. Irs 1040ez instructions For information on employee benefit programs, see Publication 15-B, Employer's Tax Guide to Fringe Benefits. Irs 1040ez instructions Vacation pay. Irs 1040ez instructions   You can take a current deduction for vacation pay earned by your employees if you pay it during the year or, if the amount is vested, within 2½ months after the end of the year. Irs 1040ez instructions If you pay it later than this, you must deduct it in the year actually paid. Irs 1040ez instructions An amount is vested if your right to it cannot be nullified or cancelled. Irs 1040ez instructions Exception for recurring items. Irs 1040ez instructions   An exception to the economic performance rule allows certain recurring items to be treated as incurred during the tax year even though economic performance has not occurred. Irs 1040ez instructions The exception applies if all the following requirements are met. Irs 1040ez instructions The all-events test, discussed earlier, is met. Irs 1040ez instructions Economic performance occurs by the earlier of the following dates. Irs 1040ez instructions 8½ months after the close of the year. Irs 1040ez instructions The date you file a timely return (including extensions) for the year. Irs 1040ez instructions The item is recurring in nature and you consistently treat similar items as incurred in the tax year in which the all-events test is met. Irs 1040ez instructions Either: The item is not material, or Accruing the item in the year in which the all-events test is met results in a better match against income than accruing the item in the year of economic performance. Irs 1040ez instructions This exception does not apply to workers' compensation or tort liabilities. Irs 1040ez instructions Amended return. Irs 1040ez instructions   You may be able to file an amended return and treat a liability as incurred under the recurring item exception. Irs 1040ez instructions You can do so if economic performance for the liability occurs after you file your tax return for the year, but within 8½ months after the close of the tax year. Irs 1040ez instructions Recurrence and consistency. Irs 1040ez instructions   To determine whether an item is recurring and consistently reported, consider the frequency with which the item and similar items are incurred (or expected to be incurred) and how you report these items for tax purposes. Irs 1040ez instructions A new expense or an expense not incurred every year can be treated as recurring if it is reasonable to expect that it will be incurred regularly in the future. Irs 1040ez instructions Materiality. Irs 1040ez instructions   Factors to consider in determining the materiality of a recurring item include the size of the item (both in absolute terms and in relation to your income and other expenses) and the treatment of the item on your financial statements. Irs 1040ez instructions   An item considered material for financial statement purposes is also considered material for tax purposes. Irs 1040ez instructions However, in certain situations an immaterial item for financial accounting purposes is treated as material for purposes of economic performance. Irs 1040ez instructions Matching expenses with income. Irs 1040ez instructions   Costs directly associated with the revenue of a period are properly allocable to that period. Irs 1040ez instructions To determine whether the accrual of an expense in a particular year results in a better match with the income to which it relates, generally accepted accounting principles (GAAP; visit www. Irs 1040ez instructions fasab. Irs 1040ez instructions gov/accepted. Irs 1040ez instructions html) are an important factor. Irs 1040ez instructions   For example, if you report sales income in the year of sale, but you do not ship the goods until the following year, the shipping costs are more properly matched to income in the year of sale than the year the goods are shipped. Irs 1040ez instructions Expenses that cannot be practically associated with income of a particular period, such as advertising costs, should be assigned to the period the costs are incurred. Irs 1040ez instructions However, the matching requirement is considered met for certain types of expenses. Irs 1040ez instructions These expenses include taxes, payments under insurance, warranty, and service contracts, rebates, refunds, awards, prizes, and jackpots. Irs 1040ez instructions Expenses Paid in Advance An expense you pay in advance is deductible only in the year to which it applies, unless the expense qualifies for the 12-month rule. Irs 1040ez instructions Under the 12-month rule, a taxpayer is not required to capitalize amounts paid to create certain rights or benefits for the taxpayer that do not extend beyond the earlier of the following. Irs 1040ez instructions 12 months after the right or benefit begins, or The end of the tax year after the tax year in which payment is made. Irs 1040ez instructions If you have not been applying the general rule (an expense paid in advance is deductible only in the year to which it applies) and/or the 12-month rule to the expenses you paid in advance, you must get IRS approval before using the general rule and/or the 12-month rule. Irs 1040ez instructions See Change in Accounting Method, later, for information on how to get IRS approval. Irs 1040ez instructions See Expense paid in advance under Cash Method, earlier, for examples illustrating the application of the general and 12-month rules. Irs 1040ez instructions Related Persons Business expenses and interest owed to a related person who uses the cash method of accounting are not deductible until you make the payment and the corresponding amount is includible in the related person's gross income. Irs 1040ez instructions Determine the relationship for this rule as of the end of the tax year for which the expense or interest would otherwise be deductible. Irs 1040ez instructions See section 267 of the Internal Revenue Code and Publication 542, Corporations, for the definition of related person. Irs 1040ez instructions Inventories An inventory is necessary to clearly show income when the production, purchase, or sale of merchandise is an income-producing factor. Irs 1040ez instructions If you must account for an inventory in your business, you must use an accrual method of accounting for your purchases and sales. Irs 1040ez instructions However, see Exceptions, next. Irs 1040ez instructions See also Accrual Method, earlier. Irs 1040ez instructions To figure taxable income, you must value your inventory at the beginning and end of each tax year. Irs 1040ez instructions To determine the value, you need a method for identifying the items in your inventory and a method for valuing these items. Irs 1040ez instructions See Identifying Cost and Valuing Inventory, later. Irs 1040ez instructions The rules for valuing inventory are not the same for all businesses. Irs 1040ez instructions The method you use must conform to generally accepted accounting principles for similar businesses and must clearly reflect income. Irs 1040ez instructions Your inventory practices must be consistent from year to year. Irs 1040ez instructions The rules discussed here apply only if they do not conflict with the uniform capitalization rules of section 263A and the mark-to-market rules of section 475. Irs 1040ez instructions Exceptions The following taxpayers can use the cash method of accounting even if they produce, purchase, or sell merchandise. Irs 1040ez instructions These taxpayers can also account for inventoriable items as materials and supplies that are not incidental (discussed later). Irs 1040ez instructions A qualifying taxpayer under Revenue Procedure 2001-10 on page 272 of Internal Revenue Bulletin 2001-2, available at www. Irs 1040ez instructions irs. Irs 1040ez instructions gov/pub/irs-irbs/irb01–02. Irs 1040ez instructions pdf. Irs 1040ez instructions A qualifying small business taxpayer under Revenue Procedure 2002-28, on page 815 of Internal Revenue Bulletin 2002-18, available at www. Irs 1040ez instructions irs. Irs 1040ez instructions gov/pub/irs-irbs/irb02–18. Irs 1040ez instructions pdf. Irs 1040ez instructions In addition to the information provided in this publication, you should see the revenue procedures referenced in the list, above, and the instructions for Form 3115 for information you will need to adopt or change to these accounting methods (see Changing methods, later). Irs 1040ez instructions Qualifying taxpayer. Irs 1040ez instructions   You are a qualifying taxpayer under Revenue Procedure 2001-10 only if: You satisfy the gross receipts test for each prior tax year ending on or after December 17, 1998 (see Gross receipts test for qualifying taxpayers, next). Irs 1040ez instructions Your average annual gross receipts for each test year (explained in Step 1, listed next) must be $1 million or less. Irs 1040ez instructions You are not a tax shelter as defined under section 448(d)(3) of the Internal Revenue Code. Irs 1040ez instructions Gross receipts test for qualifying taxpayers. Irs 1040ez instructions   To determine if you meet the gross receipts test for qualifying taxpayers, use the following steps: Step 1. Irs 1040ez instructions List each of the test years. Irs 1040ez instructions For qualifying taxpayers under Revenue Procedure 2001-10, the test years are each prior tax year ending on or after December 17, 1998. Irs 1040ez instructions Step 2. Irs 1040ez instructions Determine your average annual gross receipts for each test year listed in Step 1. Irs 1040ez instructions Your average annual gross receipts for a tax year is determined by adding the gross receipts for that tax year and the 2 preceding tax years and dividing the total by 3. Irs 1040ez instructions Step 3. Irs 1040ez instructions You meet the gross receipts test for qualifying taxpayers if your average annual gross receipts for each test year listed in Step 1 is $1 million or less. Irs 1040ez instructions Qualifying small business taxpayer. Irs 1040ez instructions   You are a qualifying small business taxpayer under Revenue Procedure 2002-28 only if: You satisfy the gross receipts test for each prior tax year ending on or after December 31, 2000 (see Gross receipts test for qualifying small business taxpayers, next). Irs 1040ez instructions Your average annual gross receipts for each test year (explained in Step 1, listed next) must be $10 million or less. Irs 1040ez instructions You are not prohibited from using the cash method under section 448 of the Internal Revenue Code. Irs 1040ez instructions Your principle business activity is an eligible business. Irs 1040ez instructions See Eligible business, later. Irs 1040ez instructions You have not changed (or have not been required to change) from the cash method because you became ineligible to use the cash method under Revenue Procedure 2002-28. Irs 1040ez instructions Note. Irs 1040ez instructions Revenue Procedure 2002-28 does not apply to a farming business of a qualifying small business taxpayer. Irs 1040ez instructions A taxpayer engaged in the trade or business of farming generally is allowed to use the cash method for any farming business. Irs 1040ez instructions See Special rules for farming businesses under Cash Method, earlier. Irs 1040ez instructions Gross receipts test for qualifying small business taxpayers. Irs 1040ez instructions   To determine if you meet the gross receipts test for qualifying small business taxpayers, use the following steps: Step 1. Irs 1040ez instructions List each of the test years. Irs 1040ez instructions For qualifying small business taxpayers under Revenue Procedure 2002-28, the test years are each prior tax year ending on or after December 31, 2000. Irs 1040ez instructions Step 2. Irs 1040ez instructions Determine your average annual gross receipts for each test year listed in Step 1. Irs 1040ez instructions Your average annual gross receipts for a tax year is determined by adding the gross receipts for that tax year and the 2 preceding tax years and dividing the total by 3. Irs 1040ez instructions Step 3. Irs 1040ez instructions You meet the gross receipts test for qualifying small business taxpayers if your average annual gross receipts for each test year listed in Step 1 is $10 million or less. Irs 1040ez instructions Eligible business. Irs 1040ez instructions   An eligible business is any business for which a qualified small business taxpayer can use the cash method and choose to not keep an inventory. Irs 1040ez instructions You have an eligible business if you meet any of the following requirements. Irs 1040ez instructions Your principal business activity is described in a North American Industry Classification System (NAICS) code other than any of the following NAICS subsector codes: NAICS codes 211 and 212 (mining activities). Irs 1040ez instructions NAICS codes 31-33 (manufacturing). Irs 1040ez instructions NAICS code 42 (wholesale trade). Irs 1040ez instructions NAICS codes 44-45 (retail trade). Irs 1040ez instructions NAICS codes 5111 and 5122 (information industries). Irs 1040ez instructions Your principal business activity is the provision of services, including the provision of property incident to those services. Irs 1040ez instructions Your principal business activity is the fabrication or modification of tangible personal property upon demand in accordance with customer design or specifications. Irs 1040ez instructions   Information about the NAICS codes can be found at http://www. Irs 1040ez instructions census. Irs 1040ez instructions gov/naics or in the instructions for your federal income tax return. Irs 1040ez instructions Gross receipts. Irs 1040ez instructions   In general, gross receipts must include all receipts from all your trades or businesses that must be recognized under the method of accounting you used for that tax year for federal income tax purposes. Irs 1040ez instructions See the definit
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The Irs 1040ez Instructions

Irs 1040ez instructions 9. Irs 1040ez instructions   Depletion Table of Contents Introduction Topics - This chapter discusses: Who Can Claim Depletion? Mineral PropertyCost Depletion Percentage Depletion Oil and Gas Wells Mines and Geothermal Deposits Lessor's Gross Income TimberTimber units. Irs 1040ez instructions Depletion unit. Irs 1040ez instructions Introduction Depletion is the using up of natural resources by mining, drilling, quarrying stone, or cutting timber. Irs 1040ez instructions The depletion deduction allows an owner or operator to account for the reduction of a product's reserves. Irs 1040ez instructions There are two ways of figuring depletion: cost depletion and percentage depletion. Irs 1040ez instructions For mineral property, you generally must use the method that gives you the larger deduction. Irs 1040ez instructions For standing timber, you must use cost depletion. Irs 1040ez instructions Topics - This chapter discusses: Who can claim depletion Mineral property Timber Who Can Claim Depletion? If you have an economic interest in mineral property or standing timber, you can take a deduction for depletion. Irs 1040ez instructions More than one person can have an economic interest in the same mineral deposit or timber. Irs 1040ez instructions In the case of leased property, the depletion deduction is divided between the lessor and the lessee. Irs 1040ez instructions You have an economic interest if both the following apply. Irs 1040ez instructions You have acquired by investment any interest in mineral deposits or standing timber. Irs 1040ez instructions You have a legal right to income from the extraction of the mineral or cutting of the timber to which you must look for a return of your capital investment. Irs 1040ez instructions A contractual relationship that allows you an economic or monetary advantage from products of the mineral deposit or standing timber is not, in itself, an economic interest. Irs 1040ez instructions A production payment carved out of, or retained on the sale of, mineral property is not an economic interest. Irs 1040ez instructions Individuals, corporations, estates, and trusts who claim depletion deductions may be liable for alternative minimum tax. Irs 1040ez instructions Basis adjustment for depletion. Irs 1040ez instructions   You must reduce the basis of your property by the depletion allowed or allowable, whichever is greater. Irs 1040ez instructions Mineral Property Mineral property includes oil and gas wells, mines, and other natural deposits (including geothermal deposits). Irs 1040ez instructions For this purpose, the term “property” means each separate interest you own in each mineral deposit in each separate tract or parcel of land. Irs 1040ez instructions You can treat two or more separate interests as one property or as separate properties. Irs 1040ez instructions See section 614 of the Internal Revenue Code and the related regulations for rules on how to treat separate mineral interests. Irs 1040ez instructions There are two ways of figuring depletion on mineral property. Irs 1040ez instructions Cost depletion. Irs 1040ez instructions Percentage depletion. Irs 1040ez instructions Generally, you must use the method that gives you the larger deduction. Irs 1040ez instructions However, unless you are an independent producer or royalty owner, you generally cannot use percentage depletion for oil and gas wells. Irs 1040ez instructions See Oil and Gas Wells , later. Irs 1040ez instructions Cost Depletion To figure cost depletion you must first determine the following. Irs 1040ez instructions The property's basis for depletion. Irs 1040ez instructions The total recoverable units of mineral in the property's natural deposit. Irs 1040ez instructions The number of units of mineral sold during the tax year. Irs 1040ez instructions Basis for depletion. Irs 1040ez instructions   To figure the property's basis for depletion, subtract all the following from the property's adjusted basis. Irs 1040ez instructions Amounts recoverable through: Depreciation deductions, Deferred expenses (including deferred exploration and development costs), and Deductions other than depletion. Irs 1040ez instructions The residual value of land and improvements at the end of operations. Irs 1040ez instructions The cost or value of land acquired for purposes other than mineral production. Irs 1040ez instructions Adjusted basis. Irs 1040ez instructions   The adjusted basis of your property is your original cost or other basis, plus certain additions and improvements, and minus certain deductions such as depletion allowed or allowable and casualty losses. Irs 1040ez instructions Your adjusted basis can never be less than zero. Irs 1040ez instructions See Publication 551, Basis of Assets, for more information on adjusted basis. Irs 1040ez instructions Total recoverable units. Irs 1040ez instructions   The total recoverable units is the sum of the following. Irs 1040ez instructions The number of units of mineral remaining at the end of the year (including units recovered but not sold). Irs 1040ez instructions The number of units of mineral sold during the tax year (determined under your method of accounting, as explained next). Irs 1040ez instructions   You must estimate or determine recoverable units (tons, pounds, ounces, barrels, thousands of cubic feet, or other measure) of mineral products using the current industry method and the most accurate and reliable information you can obtain. Irs 1040ez instructions You must include ores and minerals that are developed, in sight, blocked out, or assured. Irs 1040ez instructions You must also include probable or prospective ores or minerals that are believed to exist based on good evidence. Irs 1040ez instructions But see Elective safe harbor for owners of oil and gas property , later. Irs 1040ez instructions Number of units sold. Irs 1040ez instructions   You determine the number of units sold during the tax year based on your method of accounting. Irs 1040ez instructions Use the following table to make this determination. Irs 1040ez instructions    IF you  use . Irs 1040ez instructions . Irs 1040ez instructions . Irs 1040ez instructions THEN the units sold during the year are . Irs 1040ez instructions . Irs 1040ez instructions . Irs 1040ez instructions The cash method of accounting The units sold for which you receive payment during the tax year (regardless of the year of sale). Irs 1040ez instructions An accrual method of accounting The units sold based on your inventories and method of accounting for inventory. Irs 1040ez instructions   The number of units sold during the tax year does not include any for which depletion deductions were allowed or allowable in earlier years. Irs 1040ez instructions Figuring the cost depletion deduction. Irs 1040ez instructions   Once you have figured your property's basis for depletion, the total recoverable units, and the number of units sold during the tax year, you can figure your cost depletion deduction by taking the following steps. Irs 1040ez instructions Step Action Result 1 Divide your property's basis for depletion by total recoverable units. Irs 1040ez instructions Rate per unit. Irs 1040ez instructions 2 Multiply the rate per unit by units sold during the tax year. Irs 1040ez instructions Cost depletion deduction. Irs 1040ez instructions You must keep accounts for the depletion of each property and adjust these accounts each year for units sold and depletion claimed. Irs 1040ez instructions Elective safe harbor for owners of oil and gas property. Irs 1040ez instructions   Instead of using the method described earlier to determine the total recoverable units, you can use an elective safe harbor. Irs 1040ez instructions If you choose the elective safe harbor, the total recoverable units equal 105% of a property's proven reserves (both developed and undeveloped). Irs 1040ez instructions For details, see Revenue Procedure 2004-19 on page 563 of Internal Revenue Bulletin 2004-10, available at www. Irs 1040ez instructions irs. Irs 1040ez instructions gov/pub/irs-irbs/irb04-10. Irs 1040ez instructions pdf. Irs 1040ez instructions   To make the election, attach a statement to your timely filed (including extensions) original return for the first tax year for which the safe harbor is elected. Irs 1040ez instructions The statement must indicate that you are electing the safe harbor provided by Revenue Procedure 2004-19. Irs 1040ez instructions The election, if made, is effective for the tax year in which it is made and all later years. Irs 1040ez instructions It cannot be revoked for the tax year in which it is elected, but may be revoked in a later year. Irs 1040ez instructions Once revoked, it cannot be re-elected for the next 5 years. Irs 1040ez instructions Percentage Depletion To figure percentage depletion, you multiply a certain percentage, specified for each mineral, by your gross income from the property during the tax year. Irs 1040ez instructions The rates to be used and other rules for oil and gas wells are discussed later under Independent Producers and Royalty Owners and under Natural Gas Wells . Irs 1040ez instructions Rates and other rules for percentage depletion of other specific minerals are found later in Mines and Geothermal Deposits . Irs 1040ez instructions Gross income. Irs 1040ez instructions   When figuring percentage depletion, subtract from your gross income from the property the following amounts. Irs 1040ez instructions Any rents or royalties you paid or incurred for the property. Irs 1040ez instructions The part of any bonus you paid for a lease on the property allocable to the product sold (or that otherwise gives rise to gross income) for the tax year. Irs 1040ez instructions A bonus payment includes amounts you paid as a lessee to satisfy a production payment retained by the lessor. Irs 1040ez instructions   Use the following fraction to figure the part of the bonus you must subtract. Irs 1040ez instructions No. Irs 1040ez instructions of units sold in the tax year Recoverable units from the property × Bonus Payments For oil and gas wells and geothermal deposits, more information about the definition of gross income from the property is under Oil and Gas Wells , later. Irs 1040ez instructions For other property, more information about the definition of gross income from the property is under Mines and Geothermal Deposits , later. Irs 1040ez instructions Taxable income limit. Irs 1040ez instructions   The percentage depletion deduction generally cannot be more than 50% (100% for oil and gas property) of your taxable income from the property figured without the depletion deduction and the domestic production activities deduction. Irs 1040ez instructions   Taxable income from the property means gross income from the property minus all allowable deductions (except any deduction for depletion or domestic production activities) attributable to mining processes, including mining transportation. Irs 1040ez instructions These deductible items include, but are not limited to, the following. Irs 1040ez instructions Operating expenses. Irs 1040ez instructions Certain selling expenses. Irs 1040ez instructions Administrative and financial overhead. Irs 1040ez instructions Depreciation. Irs 1040ez instructions Intangible drilling and development costs. Irs 1040ez instructions Exploration and development expenditures. Irs 1040ez instructions Deductible taxes (see chapter 5), but not taxes that you capitalize or take as a credit. Irs 1040ez instructions Losses sustained. Irs 1040ez instructions   The following rules apply when figuring your taxable income from the property for purposes of the taxable income limit. Irs 1040ez instructions Do not deduct any net operating loss deduction from the gross income from the property. Irs 1040ez instructions Corporations do not deduct charitable contributions from the gross income from the property. Irs 1040ez instructions If, during the year, you dispose of an item of section 1245 property that was used in connection with mineral property, reduce any allowable deduction for mining expenses by the part of any gain you must report as ordinary income that is allocable to the mineral property. Irs 1040ez instructions See section 1. Irs 1040ez instructions 613-5(b)(1) of the regulations for information on how to figure the ordinary gain allocable to the property. Irs 1040ez instructions Oil and Gas Wells You cannot claim percentage depletion for an oil or gas well unless at least one of the following applies. Irs 1040ez instructions You are either an independent producer or a royalty owner. Irs 1040ez instructions The well produces natural gas that is either sold under a fixed contract or produced from geopressured brine. Irs 1040ez instructions If you are an independent producer or royalty owner, see Independent Producers and Royalty Owners , next. Irs 1040ez instructions For information on the depletion deduction for wells that produce natural gas that is either sold under a fixed contract or produced from geopressured brine, see Natural Gas Wells , later. Irs 1040ez instructions Independent Producers and Royalty Owners If you are an independent producer or royalty owner, you figure percentage depletion using a rate of 15% of the gross income from the property based on your average daily production of domestic crude oil or domestic natural gas up to your depletable oil or natural gas quantity. Irs 1040ez instructions However, certain refiners, as explained next, and certain retailers and transferees of proven oil and gas properties, as explained next, cannot claim percentage depletion. Irs 1040ez instructions For information on figuring the deduction, see Figuring percentage depletion , later. Irs 1040ez instructions Refiners who cannot claim percentage depletion. Irs 1040ez instructions   You cannot claim percentage depletion if you or a related person refine crude oil and you and the related person refined more than 75,000 barrels on any day during the tax year based on average (rather than actual) daily refinery runs for the tax year. Irs 1040ez instructions The average daily refinery run is computed by dividing total refinery runs for the tax year by the total number of days in the tax year. Irs 1040ez instructions Related person. Irs 1040ez instructions   You and another person are related persons if either of you holds a significant ownership interest in the other person or if a third person holds a significant ownership interest in both of you. Irs 1040ez instructions For example, a corporation, partnership, estate, or trust and anyone who holds a significant ownership interest in it are related persons. Irs 1040ez instructions A partnership and a trust are related persons if one person holds a significant ownership interest in each of them. Irs 1040ez instructions For purposes of the related person rules, significant ownership interest means direct or indirect ownership of 5% or more in any one of the following. Irs 1040ez instructions The value of the outstanding stock of a corporation. Irs 1040ez instructions The interest in the profits or capital of a partnership. Irs 1040ez instructions The beneficial interests in an estate or trust. Irs 1040ez instructions Any interest owned by or for a corporation, partnership, trust, or estate is considered to be owned directly both by itself and proportionately by its shareholders, partners, or beneficiaries. Irs 1040ez instructions Retailers who cannot claim percentage depletion. Irs 1040ez instructions   You cannot claim percentage depletion if both the following apply. Irs 1040ez instructions You sell oil or natural gas or their by-products directly or through a related person in any of the following situations. Irs 1040ez instructions Through a retail outlet operated by you or a related person. Irs 1040ez instructions To any person who is required under an agreement with you or a related person to use a trademark, trade name, or service mark or name owned by you or a related person in marketing or distributing oil, natural gas, or their by-products. Irs 1040ez instructions To any person given authority under an agreement with you or a related person to occupy any retail outlet owned, leased, or controlled by you or a related person. Irs 1040ez instructions The combined gross receipts from sales (not counting resales) of oil, natural gas, or their by-products by all retail outlets taken into account in (1) are more than $5 million for the tax year. Irs 1040ez instructions   For the purpose of determining if this rule applies, do not count the following. Irs 1040ez instructions Bulk sales (sales in very large quantities) of oil or natural gas to commercial or industrial users. Irs 1040ez instructions Bulk sales of aviation fuels to the Department of Defense. Irs 1040ez instructions Sales of oil or natural gas or their by-products outside the United States if none of your domestic production or that of a related person is exported during the tax year or the prior tax year. Irs 1040ez instructions Related person. Irs 1040ez instructions   To determine if you and another person are related persons, see Related person under Refiners who cannot claim percentage depletion, earlier. Irs 1040ez instructions Sales through a related person. Irs 1040ez instructions   You are considered to be selling through a related person if any sale by the related person produces gross income from which you may benefit because of your direct or indirect ownership interest in the person. Irs 1040ez instructions   You are not considered to be selling through a related person who is a retailer if all the following apply. Irs 1040ez instructions You do not have a significant ownership interest in the retailer. Irs 1040ez instructions You sell your production to persons who are not related to either you or the retailer. Irs 1040ez instructions The retailer does not buy oil or natural gas from your customers or persons related to your customers. Irs 1040ez instructions There are no arrangements for the retailer to acquire oil or natural gas you produced for resale or made available for purchase by the retailer. Irs 1040ez instructions Neither you nor the retailer knows of or controls the final disposition of the oil or natural gas you sold or the original source of the petroleum products the retailer acquired for resale. Irs 1040ez instructions Transferees who cannot claim percentage depletion. Irs 1040ez instructions   You cannot claim percentage depletion if you received your interest in a proven oil or gas property by transfer after 1974 and before October 12, 1990. Irs 1040ez instructions For a definition of the term “transfer,” see section 1. Irs 1040ez instructions 613A-7(n) of the regulations. Irs 1040ez instructions For a definition of the term “interest in proven oil or gas property,” see section 1. Irs 1040ez instructions 613A-7(p) of the regulations. Irs 1040ez instructions Figuring percentage depletion. Irs 1040ez instructions   Generally, as an independent producer or royalty owner, you figure your percentage depletion by computing your average daily production of domestic oil or gas and comparing it to your depletable oil or gas quantity. Irs 1040ez instructions If your average daily production does not exceed your depletable oil or gas quantity, you figure your percentage depletion by multiplying the gross income from the oil or gas property (defined later) by 15%. Irs 1040ez instructions If your average daily production of domestic oil or gas exceeds your depletable oil or gas quantity, you must make an allocation as explained later under Average daily production. Irs 1040ez instructions   In addition, there is a limit on the percentage depletion deduction. Irs 1040ez instructions See Taxable income limit , later. Irs 1040ez instructions Average daily production. Irs 1040ez instructions   Figure your average daily production by dividing your total domestic production of oil or gas for the tax year by the number of days in your tax year. Irs 1040ez instructions Partial interest. Irs 1040ez instructions   If you have a partial interest in the production from a property, figure your share of the production by multiplying total production from the property by your percentage of interest in the revenues from the property. Irs 1040ez instructions   You have a partial interest in the production from a property if you have a net profits interest in the property. Irs 1040ez instructions To figure the share of production for your net profits interest, you must first determine your percentage participation (as measured by the net profits) in the gross revenue from the property. Irs 1040ez instructions To figure this percentage, you divide the income you receive for your net profits interest by the gross revenue from the property. Irs 1040ez instructions Then multiply the total production from the property by your percentage participation to figure your share of the production. Irs 1040ez instructions Example. Irs 1040ez instructions Javier Robles owns oil property in which Pablo Olmos owns a 20% net profits interest. Irs 1040ez instructions During the year, the property produced 10,000 barrels of oil, which Javier sold for $200,000. Irs 1040ez instructions Javier had expenses of $90,000 attributable to the property. Irs 1040ez instructions The property generated a net profit of $110,000 ($200,000 − $90,000). Irs 1040ez instructions Pablo received income of $22,000 ($110,000 × . Irs 1040ez instructions 20) for his net profits interest. Irs 1040ez instructions Pablo determined his percentage participation to be 11% by dividing $22,000 (the income he received) by $200,000 (the gross revenue from the property). Irs 1040ez instructions Pablo determined his share of the oil production to be 1,100 barrels (10,000 barrels × 11%). Irs 1040ez instructions Depletable oil or natural gas quantity. Irs 1040ez instructions   Generally, your depletable oil quantity is 1,000 barrels. Irs 1040ez instructions Your depletable natural gas quantity is 6,000 cubic feet multiplied by the number of barrels of your depletable oil quantity that you choose to apply. Irs 1040ez instructions If you claim depletion on both oil and natural gas, you must reduce your depletable oil quantity (1,000 barrels) by the number of barrels you use to figure your depletable natural gas quantity. Irs 1040ez instructions Example. Irs 1040ez instructions You have both oil and natural gas production. Irs 1040ez instructions To figure your depletable natural gas quantity, you choose to apply 360 barrels of your 1000-barrel depletable oil quantity. Irs 1040ez instructions Your depletable natural gas quantity is 2. Irs 1040ez instructions 16 million cubic feet of gas (360 × 6000). Irs 1040ez instructions You must reduce your depletable oil quantity to 640 barrels (1000 − 360). Irs 1040ez instructions If you have production from marginal wells, see section 613A(c)(6) of the Internal Revenue Code to figure your depletable oil or natural gas quantity. Irs 1040ez instructions Also, see Notice 2012-50, available at www. Irs 1040ez instructions irs. Irs 1040ez instructions gov/irb/2012–31_IRB/index. Irs 1040ez instructions html. Irs 1040ez instructions Business entities and family members. Irs 1040ez instructions   You must allocate the depletable oil or gas quantity among the following related persons in proportion to each entity's or family member's production of domestic oil or gas for the year. Irs 1040ez instructions Corporations, trusts, and estates if 50% or more of the beneficial interest is owned by the same or related persons (considering only persons that own at least 5% of the beneficial interest). Irs 1040ez instructions You and your spouse and minor children. Irs 1040ez instructions A related person is anyone mentioned in the related persons discussion under Nondeductible loss in chapter 2 of Publication 544, except that for purposes of this allocation, item (1) in that discussion includes only an individual, his or her spouse, and minor children. Irs 1040ez instructions Controlled group of corporations. Irs 1040ez instructions   Members of the same controlled group of corporations are treated as one taxpayer when figuring the depletable oil or natural gas quantity. Irs 1040ez instructions They share the depletable quantity. Irs 1040ez instructions A controlled group of corporations is defined in section 1563(a) of the Internal Revenue Code, except that, for this purpose, the stock ownership requirement in that definition is “more than 50%” rather than “at least 80%. Irs 1040ez instructions ” Gross income from the property. Irs 1040ez instructions   For purposes of percentage depletion, gross income from the property (in the case of oil and gas wells) is the amount you receive from the sale of the oil or gas in the immediate vicinity of the well. Irs 1040ez instructions If you do not sell the oil or gas on the property, but manufacture or convert it into a refined product before sale or transport it before sale, the gross income from the property is the representative market or field price (RMFP) of the oil or gas, before conversion or transportation. Irs 1040ez instructions   If you sold gas after you removed it from the premises for a price that is lower than the RMFP, determine gross income from the property for percentage depletion purposes without regard to the RMFP. Irs 1040ez instructions   Gross income from the property does not include lease bonuses, advance royalties, or other amounts payable without regard to production from the property. Irs 1040ez instructions Average daily production exceeds depletable quantities. Irs 1040ez instructions   If your average daily production for the year is more than your depletable oil or natural gas quantity, figure your allowance for depletion for each domestic oil or natural gas property as follows. Irs 1040ez instructions Figure your average daily production of oil or natural gas for the year. Irs 1040ez instructions Figure your depletable oil or natural gas quantity for the year. Irs 1040ez instructions Figure depletion for all oil or natural gas produced from the property using a percentage depletion rate of 15%. Irs 1040ez instructions Multiply the result figured in (3) by a fraction, the numerator of which is the result figured in (2) and the denominator of which is the result figured in (1). Irs 1040ez instructions This is your depletion allowance for that property for the year. Irs 1040ez instructions Taxable income limit. Irs 1040ez instructions   If you are an independent producer or royalty owner of oil and gas, your deduction for percentage depletion is limited to the smaller of the following. Irs 1040ez instructions 100% of your taxable income from the property figured without the deduction for depletion and the deduction for domestic production activities under section 199 of the Internal Revenue Code. Irs 1040ez instructions For a definition of taxable income from the property, see Taxable income limit , earlier, under Mineral Property. Irs 1040ez instructions 65% of your taxable income from all sources, figured without the depletion allowance, the deduction for domestic production activities, any net operating loss carryback, and any capital loss carryback. Irs 1040ez instructions You can carry over to the following year any amount you cannot deduct because of the 65%-of-taxable-income limit. Irs 1040ez instructions Add it to your depletion allowance (before applying any limits) for the following year. Irs 1040ez instructions Partnerships and S Corporations Generally, each partner or S corporation shareholder, and not the partnership or S corporation, figures the depletion allowance separately. Irs 1040ez instructions (However, see Electing large partnerships must figure depletion allowance , later. Irs 1040ez instructions ) Each partner or shareholder must decide whether to use cost or percentage depletion. Irs 1040ez instructions If a partner or shareholder uses percentage depletion, he or she must apply the 65%-of-taxable-income limit using his or her taxable income from all sources. Irs 1040ez instructions Partner's or shareholder's adjusted basis. Irs 1040ez instructions   The partnership or S corporation must allocate to each partner or shareholder his or her share of the adjusted basis of each oil or gas property held by the partnership or S corporation. Irs 1040ez instructions The partnership or S corporation makes the allocation as of the date it acquires the oil or gas property. Irs 1040ez instructions   Each partner's share of the adjusted basis of the oil or gas property generally is figured according to that partner's interest in partnership capital. Irs 1040ez instructions However, in some cases, it is figured according to the partner's interest in partnership income. Irs 1040ez instructions   The partnership or S corporation adjusts the partner's or shareholder's share of the adjusted basis of the oil and gas property for any capital expenditures made for the property and for any change in partnership or S corporation interests. Irs 1040ez instructions Recordkeeping. Irs 1040ez instructions Each partner or shareholder must separately keep records of his or her share of the adjusted basis in each oil and gas property of the partnership or S corporation. Irs 1040ez instructions The partner or shareholder must reduce his or her adjusted basis by the depletion allowed or allowable on the property each year. Irs 1040ez instructions The partner or shareholder must use that reduced adjusted basis to figure cost depletion or his or her gain or loss if the partnership or S corporation disposes of the property. Irs 1040ez instructions Reporting the deduction. Irs 1040ez instructions   Information that you, as a partner or shareholder, use to figure your depletion deduction on oil and gas properties is reported by the partnership or S corporation on Schedule K-1 (Form 1065) or on Schedule K-1 (Form 1120S). Irs 1040ez instructions Deduct oil and gas depletion for your partnership or S corporation interest on Schedule E (Form 1040). Irs 1040ez instructions The depletion deducted on Schedule E is included in figuring income or loss from rental real estate or royalty properties. Irs 1040ez instructions The instructions for Schedule E explain where to report this income or loss and whether you need to file either of the following forms. Irs 1040ez instructions Form 6198, At-Risk Limitations. Irs 1040ez instructions Form 8582, Passive Activity Loss Limitations. Irs 1040ez instructions Electing large partnerships must figure depletion allowance. Irs 1040ez instructions   An electing large partnership, rather than each partner, generally must figure the depletion allowance. Irs 1040ez instructions The partnership figures the depletion allowance without taking into account the 65-percent-of-taxable-income limit and the depletable oil or natural gas quantity. Irs 1040ez instructions Also, the adjusted basis of a partner's interest in the partnership is not affected by the depletion allowance. Irs 1040ez instructions   An electing large partnership is one that meets both the following requirements. Irs 1040ez instructions The partnership had 100 or more partners in the preceding year. Irs 1040ez instructions The partnership chooses to be an electing large partnership. Irs 1040ez instructions Disqualified persons. Irs 1040ez instructions   An electing large partnership does not figure the depletion allowance of its partners that are disqualified persons. Irs 1040ez instructions Disqualified persons must figure it themselves, as explained earlier. Irs 1040ez instructions   All the following are disqualified persons. Irs 1040ez instructions Refiners who cannot claim percentage depletion (discussed under Independent Producers and Royalty Owners , earlier). Irs 1040ez instructions Retailers who cannot claim percentage depletion (discussed under Independent Producers and Royalty Owners , earlier). Irs 1040ez instructions Any partner whose average daily production of domestic crude oil and natural gas is more than 500 barrels during the tax year in which the partnership tax year ends. Irs 1040ez instructions Average daily production is discussed earlier. Irs 1040ez instructions Natural Gas Wells You can use percentage depletion for a well that produces natural gas that is either Sold under a fixed contract, or Produced from geopressured brine. Irs 1040ez instructions Natural gas sold under a fixed contract. Irs 1040ez instructions   Natural gas sold under a fixed contract qualifies for a percentage depletion rate of 22%. Irs 1040ez instructions This is domestic natural gas sold by the producer under a contract that does not provide for a price increase to reflect any increase in the seller's tax liability because of the repeal of percentage depletion for gas. Irs 1040ez instructions The contract must have been in effect from February 1, 1975, until the date of sale of the gas. Irs 1040ez instructions Price increases after February 1, 1975, are presumed to take the increase in tax liability into account unless demonstrated otherwise by clear and convincing evidence. Irs 1040ez instructions Natural gas from geopressured brine. Irs 1040ez instructions   Qualified natural gas from geopressured brine is eligible for a percentage depletion rate of 10%. Irs 1040ez instructions This is natural gas that is both the following. Irs 1040ez instructions Produced from a well you began to drill after September 1978 and before 1984. Irs 1040ez instructions Determined in accordance with section 503 of the Natural Gas Policy Act of 1978 to be produced from geopressured brine. Irs 1040ez instructions Mines and Geothermal Deposits Certain mines, wells, and other natural deposits, including geothermal deposits, qualify for percentage depletion. Irs 1040ez instructions Mines and other natural deposits. Irs 1040ez instructions   For a natural deposit, the percentage of your gross income from the property that you can deduct as depletion depends on the type of deposit. Irs 1040ez instructions   The following is a list of the percentage depletion rates for the more common minerals. Irs 1040ez instructions DEPOSITS RATE Sulphur, uranium, and, if from deposits in the United States, asbestos, lead ore, zinc ore, nickel ore, and mica 22% Gold, silver, copper, iron ore, and certain oil shale, if from deposits in the United States 15% Borax, granite, limestone, marble, mollusk shells, potash, slate, soapstone, and carbon dioxide produced from a well 14% Coal, lignite, and sodium chloride 10% Clay and shale used or sold for use in making sewer pipe or bricks or used or sold for use as sintered or burned lightweight aggregates 7½% Clay used or sold for use in making drainage and roofing tile, flower pots, and kindred products, and gravel, sand, and stone (other than stone used or sold for use by a mine owner or operator as dimension or ornamental stone) 5%   You can find a complete list of minerals and their percentage depletion rates in section 613(b) of the Internal Revenue Code. Irs 1040ez instructions Corporate deduction for iron ore and coal. Irs 1040ez instructions   The percentage depletion deduction of a corporation for iron ore and coal (including lignite) is reduced by 20% of: The percentage depletion deduction for the tax year (figured without this reduction), minus The adjusted basis of the property at the close of the tax year (figured without the depletion deduction for the tax year). Irs 1040ez instructions Gross income from the property. Irs 1040ez instructions   For property other than a geothermal deposit or an oil or gas well, gross income from the property means the gross income from mining. Irs 1040ez instructions Mining includes all the following. Irs 1040ez instructions Extracting ores or minerals from the ground. Irs 1040ez instructions Applying certain treatment processes described later. Irs 1040ez instructions Transporting ores or minerals (generally, not more than 50 miles) from the point of extraction to the plants or mills in which the treatment processes are applied. Irs 1040ez instructions Excise tax. Irs 1040ez instructions   Gross income from mining includes the separately stated excise tax received by a mine operator from the sale of coal to compensate the operator for the excise tax the mine operator must pay to finance black lung benefits. Irs 1040ez instructions Extraction. Irs 1040ez instructions   Extracting ores or minerals from the ground includes extraction by mine owners or operators of ores or minerals from the waste or residue of prior mining. Irs 1040ez instructions This does not apply to extraction from waste or residue of prior mining by the purchaser of the waste or residue or the purchaser of the rights to extract ores or minerals from the waste or residue. Irs 1040ez instructions Treatment processes. Irs 1040ez instructions   The processes included as mining depend on the ore or mineral mined. Irs 1040ez instructions To qualify as mining, the treatment processes must be applied by the mine owner or operator. Irs 1040ez instructions For a listing of treatment processes considered as mining, see section 613(c)(4) of the Internal Revenue Code and the related regulations. Irs 1040ez instructions Transportation of more than 50 miles. Irs 1040ez instructions   If the IRS finds that the ore or mineral must be transported more than 50 miles to plants or mills to be treated because of physical and other requirements, the additional authorized transportation is considered mining and included in the computation of gross income from mining. Irs 1040ez instructions    If you wish to include transportation of more than 50 miles in the computation of gross income from mining, request an advance ruling from the IRS. Irs 1040ez instructions Include in the request the facts about the physical and other requirements that prevented the construction and operation of the plant within 50 miles of the point of extraction. Irs 1040ez instructions For more information about requesting an advance ruling, see Revenue Procedure 2013-1, available at www. Irs 1040ez instructions irs. Irs 1040ez instructions gov/irb/2013-01_IRB/ar11. Irs 1040ez instructions html. Irs 1040ez instructions Disposal of coal or iron ore. Irs 1040ez instructions   You cannot take a depletion deduction for coal (including lignite) or iron ore mined in the United States if both the following apply. Irs 1040ez instructions You disposed of it after holding it for more than 1 year. Irs 1040ez instructions You disposed of it under a contract under which you retain an economic interest in the coal or iron ore. Irs 1040ez instructions Treat any gain on the disposition as a capital gain. Irs 1040ez instructions Disposal to related person. Irs 1040ez instructions   This rule does not apply if you dispose of the coal or iron ore to one of the following persons. Irs 1040ez instructions A related person (as listed in chapter 2 of Publication 544). Irs 1040ez instructions A person owned or controlled by the same interests that own or control you. Irs 1040ez instructions Geothermal deposits. Irs 1040ez instructions   Geothermal deposits located in the United States or its possessions qualify for a percentage depletion rate of 15%. Irs 1040ez instructions A geothermal deposit is a geothermal reservoir of natural heat stored in rocks or in a watery liquid or vapor. Irs 1040ez instructions For percentage depletion purposes, a geothermal deposit is not considered a gas well. Irs 1040ez instructions   Figure gross income from the property for a geothermal steam well in the same way as for oil and gas wells. Irs 1040ez instructions See Gross income from the property , earlier, under Oil and Gas Wells. Irs 1040ez instructions Percentage depletion on a geothermal deposit cannot be more than 50% of your taxable income from the property. Irs 1040ez instructions Lessor's Gross Income In the case of leased property, the depletion deduction is divided between the lessor and the lessee. Irs 1040ez instructions A lessor's gross income from the property that qualifies for percentage depletion usually is the total of the royalties received from the lease. Irs 1040ez instructions Bonuses and advanced royalties. Irs 1040ez instructions   Bonuses and advanced royalties are payments a lessee makes before production to a lessor for the grant of rights in a lease or for minerals, gas, or oil to be extracted from leased property. Irs 1040ez instructions If you are the lessor, your income from bonuses and advanced royalties received is subject to an allowance for depletion, as explained in the next two paragraphs. Irs 1040ez instructions Figuring cost depletion. Irs 1040ez instructions   To figure cost depletion on a bonus, multiply your adjusted basis in the property by a fraction, the numerator of which is the bonus and the denominator of which is the total bonus and royalties expected to be received. Irs 1040ez instructions To figure cost depletion on advanced royalties, use the computation explained earlier under Cost Depletion , treating the number of units for which the advanced royalty is received as the number of units sold. Irs 1040ez instructions Figuring percentage depletion. Irs 1040ez instructions   In the case of mines, wells, and other natural deposits other than gas, oil, or geothermal property, you may use the percentage rates discussed earlier under Mines and Geothermal Deposits . Irs 1040ez instructions Any bonus or advanced royalty payments are generally part of the gross income from the property to which the rates are applied in making the calculation. Irs 1040ez instructions However, for oil, gas, or geothermal property, gross income does not include lease bonuses, advanced royalties, or other amounts payable without regard to production from the property. Irs 1040ez instructions Ending the lease. Irs 1040ez instructions   If you receive a bonus on a lease that ends or is abandoned before you derive any income from mineral extraction, include in income the depletion deduction you took. Irs 1040ez instructions Do this for the year the lease ends or is abandoned. Irs 1040ez instructions Also increase your adjusted basis in the property to restore the depletion deduction you previously subtracted. Irs 1040ez instructions   For advanced royalties, include in income the depletion claimed on minerals for which the advanced royalties were paid if the minerals were not produced before the lease ended. Irs 1040ez instructions Include this amount in income for the year the lease ends. Irs 1040ez instructions Increase your adjusted basis in the property by the amount you include in income. Irs 1040ez instructions Delay rentals. Irs 1040ez instructions   These are payments for deferring development of the property. Irs 1040ez instructions Since delay rentals are ordinary rent, they are ordinary income that is not subject to depletion. Irs 1040ez instructions These rentals can be avoided by either abandoning the lease, beginning development operations, or obtaining production. Irs 1040ez instructions Timber You can figure timber depletion only by the cost method. Irs 1040ez instructions Percentage depletion does not apply to timber. Irs 1040ez instructions Base your depletion on your cost or other basis in the timber. Irs 1040ez instructions Your cost does not include the cost of land or any amounts recoverable through depreciation. Irs 1040ez instructions Depletion takes place when you cut standing timber. Irs 1040ez instructions You can figure your depletion deduction when the quantity of cut timber is first accurately measured in the process of exploitation. Irs 1040ez instructions Figuring cost depletion. Irs 1040ez instructions   To figure your cost depletion allowance, you multiply the number of timber units cut by your depletion unit. Irs 1040ez instructions Timber units. Irs 1040ez instructions   When you acquire timber property, you must make an estimate of the quantity of marketable timber that exists on the property. Irs 1040ez instructions You measure the timber using board feet, log scale, cords, or other units. Irs 1040ez instructions If you later determine that you have more or less units of timber, you must adjust the original estimate. Irs 1040ez instructions   The term “timber property” means your economic interest in standing timber in each tract or block representing a separate timber account. Irs 1040ez instructions Depletion unit. Irs 1040ez instructions   You figure your depletion unit each year by taking the following steps. Irs 1040ez instructions Determine your cost or adjusted basis of the timber on hand at the beginning of the year. Irs 1040ez instructions Adjusted basis is defined under Cost Depletion in the discussion on Mineral Property. Irs 1040ez instructions Add to the amount determined in (1) the cost of any timber units acquired during the year and any additions to capital. Irs 1040ez instructions Figure the number of timber units to take into account by adding the number of timber units acquired during the year to the number of timber units on hand in the account at the beginning of the year and then adding (or subtracting) any correction to the estimate of the number of timber units remaining in the account. Irs 1040ez instructions Divide the result of (2) by the result of (3). Irs 1040ez instructions This is your depletion unit. Irs 1040ez instructions Example. Irs 1040ez instructions You bought a timber tract for $160,000 and the land was worth as much as the timber. Irs 1040ez instructions Your basis for the timber is $80,000. Irs 1040ez instructions Based on an estimated one million board feet (1,000 MBF) of standing timber, you figure your depletion unit to be $80 per MBF ($80,000 ÷ 1,000). Irs 1040ez instructions If you cut 500 MBF of timber, your depletion allowance would be $40,000 (500 MBF × $80). Irs 1040ez instructions When to claim depletion. Irs 1040ez instructions   Claim your depletion allowance as a deduction in the year of sale or other disposition of the products cut from the timber, unless you choose to treat the cutting of timber as a sale or exchange (explained below). Irs 1040ez instructions Include allowable depletion for timber products not sold during the tax year the timber is cut as a cost item in the closing inventory of timber products for the year. Irs 1040ez instructions The inventory is your basis for determining gain or loss in the tax year you sell the timber products. Irs 1040ez instructions Example. Irs 1040ez instructions The facts are the same as in the previous example except that you sold only half of the timber products in the cutting year. Irs 1040ez instructions You would deduct $20,000 of the $40,000 depletion that year. Irs 1040ez instructions You would add the remaining $20,000 depletion to your closing inventory of timber products. Irs 1040ez instructions Electing to treat the cutting of timber as a sale or exchange. Irs 1040ez instructions   You can elect, under certain circumstances, to treat the cutting of timber held for more than 1 year as a sale or exchange. Irs 1040ez instructions You must make the election on your income tax return for the tax year to which it applies. Irs 1040ez instructions If you make this election, subtract the adjusted basis for depletion from the fair market value of the timber on the first day of the tax year in which you cut it to figure the gain or loss on the cutting. Irs 1040ez instructions You generally report the gain as long-term capital gain. Irs 1040ez instructions The fair market value then becomes your basis for figuring your ordinary gain or loss on the sale or other disposition of the products cut from the timber. Irs 1040ez instructions For more information, see Timber in chapter 2 of Publication 544, Sales and Other Dispositions of Assets. Irs 1040ez instructions   You may revoke an election to treat the cutting of timber as a sale or exchange without IRS's consent. Irs 1040ez instructions The prior election (and revocation) is disregarded for purposes of making a subsequent election. Irs 1040ez instructions See Form T (Timber), Forest Activities Schedule, for more information. Irs 1040ez instructions Form T. Irs 1040ez instructions   Complete and attach Form T (Timber) to your income tax return if you claim a deduction for timber depletion, choose to treat the cutting of timber as a sale or exchange, or make an outright sale of timber. Irs 1040ez instructions Prev  Up  Next   Home   More Online Publications