Small Business Taxes & Management

News On The Tax Front--The latest tax news.

IRS Gives Investors Benefit of Pending Technical Corrections on Qualified Dividends

Mutual Funds and Brokers Have 1099 Problems--Don't be surprised if you get one or more corrected 1099s.

In Brief:--Tax, business, and personal finance tips.

News On The Tax Front

Previously Reported In Daily Update

In Rev. Rul. 2004-37 (IRB 2004-11) the Service ruled that if an employee has issued a recourse note to his or her employer in satisfaction of the exercise price of an option to acquire the employer's stock and the employer and employee subsequently agree to reduce the stated principal amount of the note, the employee generally recognizes compensation income under Sec. 83 at the time of the reduction.

The IRS has issued proposed regulations (REG-166012-02) relating to the inclusion into income or deduction of a contingent nonperiodic payment provided for under a notional principal contract (NPC). This document also provides guidance relating to the character of payments made pursuant to an NPC. These regulations will affect taxpayers that enter into NPCs.

Think it's easy to get away with omitting assets on an estate tax return? After all, how's the IRS going to find them? In Estate of Emanuel Trompeter, et al. (T.C. Memo. 2004-27) the IRS asserted the coexecutors of the will failed to include some $4.5 million of assets in the estate's taxable estate. How the IRS find out about them? The unreported assets were based mainly on a creditor claim filed against the estate by the son of a former female acquaintance of the decedent. His claim alleged that he was entitled to a $1.4 million commission because, he alleged, the decedent had retained him to sell assets worth at least $14 million in return for a 10-percent commission. These assets, included the decedent's diamonds, jade and ivory collections, ancient Chinese artifacts, and handmade unique wool rug. The informant also had a finder's fee document, signed in the name of the decedent.

You may be able to recover court and administrative costs from the IRS if you're the prevailing party and you meet certain other conditions. In Florida Country Clubs, Inc., a Florida Corporation, Suncoast Country Clubs, Inc. (122 TC--, No. 3) the taxpayers received 30-day letters from the IRS. The taxpayers protested the deficiencies to the Appeals Office. After the taxpayers protested the proposed deficiencies with the Appeals Office, the parties settled without the IRS issuing either an Appeals Office notice of decision or a notice of deficiency. The Tax Court held that the IRS never took a position in the administrative proceeding as provided by Sec. 7430(c)(7)(B), because the taxpayers never received a notice of decision from the Appeals Office and the IRS never sent the taxpayers a notice of deficiency. Consequently, the taxpayers did not qualify as prevailing parties under Sec. 7430(c)(4).

The IRS has officially released the changes to the dividend rules that are expected to be enacted in the Tax Technical Corrections Act of 2003. The rules are contained in Announcement 2004-11 (IRB 2004-10). When enacted, the Technical Corrections Act would amend current law to allow partnerships, S corporations, and estates (including revocable trusts treated as part of an estate) with fiscal years beginning in 2002 to pass through dividends received in 2003 from domestic corporations and qualified foreign corporations as qualified dividends to their partners, shareholders, and beneficiaries (to the extent otherwise permitted by law). In addition, the legislation would amend the holding period rules for qualified dividends by changing the 120-day period to a 121-day period and the 180-day period to a 181-day period. Announcement 2004-11 contains specific instructions for fiscal-year partnerships, S corporations, and trusts for reporting such dividends.

The IRS has previously listed countries for which the eligibility requirements of Sec. 911(d)(1) of the Code (foreign earned income exclusion) are waived under Sec. 911(d)(4) because of adverse conditions in those countries on and after the date stated. This revenue procedure (Rev. Proc. 2004-17; IRB 2004-10) lists countries added to the list in 2003, for which the eligibility requirements of Sec. 911(d)(1) are waived.

In limited situations, taxpayers filing joint Federal income tax returns may be relieved from joint and several liability pursuant to Section 6015. Known as innocent spouse relief, the taxpayer must satisfy a number of requirements. In Gwendolyn A. Ewing (122 T.C. No. 2) the Tax Court held that the IRS abused it's discretion in denying the taxpayer innocent spouse relief. The Court noted the taxpayer did not significantly benefit from her husband's underpayment and lacked knowledge of the underpayment. The Court also noted that she and her husband kept their finances separate. Caution. The reasoning here is complicated and there was a dissenting opinion.

A taxpayer generally may not increase the basis in his or her S corporation stock in the amount of any guaranty on a loan by the corporation until the taxpayer makes an actual economic outlay (i. e., a payment) under the guaranty. Only amounts directly loaned to the corporation by the shareholder increases basis. In Gary and Janet Luiz (T.C. Memo. 2004-21) the taxpayers argued that amounts borrowed by the corporation but guaranteed by the shareholders should increase their basis. The taxpayers cited Selfe, but the Court noted it had previously disagreed with that decisions and noted the circumstances were not similar. The taxpayers also argued that Section 752 allows a basis increase for guaranteed debt. The Court noted that Sec. 752 applies to partnerships, not S corporations. The Court sided with the IRS in disallowing an increase in basis.

When you buy a business you're often purchasing a mix of assets, some are depreciable, some amortizable, some aren't depreciable or amortizable. Land itself is never depreciable, buildings may be depreciated over 39 years, equipment may be depreciated over various time periods such as 5 years for assets used in retail trade, goodwill and other intangible assets may be amortizable over 15 years. Allocating the purchase price is important for depreciation and amortization deductions. In Anotonio B. Secapure the taxpayer argued that when he bought a gas station he purchased only a non-depreciable right to use the oil company's name and that his basis in the property was equal to his original purchase price, $65,000 plus the $99,000 in improvements he made to the station. The Court found that the original purchase contract allocated only $5,000 of the $65,000 to goodwill, $21,525 to a leasehold right and the remainder to tools, equipment, and inventory. The Court found that his only remaining basis in the station at the time of sale was $5,000, the value of the goodwill which was nondepreciable at the time of purchase (1988). (The law changed several years later, but wouldn't alter the rules for prior purchases.) The other assets would have been sold, depreciated, or amortized by the time he sold the station. The taxpayer testified he purchased about $99,000 in improvements which should be added to his basis. The Court did not find the taxpayer's testimony credible. The Court noted he did not claim any depreciation related to improvements, offered no documentary evidence or corroboration that he had purchased the items, and his testimony lacked credibility because of discrepancies between his testimony and the purchase and sale documents. The lower basis allowed by the Tax Court resulted in a larger gain when he sold the station in 1995.

The Treasury Department and IRS issued a notice announcing their intention to propose regulations regarding the treatment of amounts that facilitate certain tax-free and taxable transactions and other restructurings, and that are required to be capitalized under Section 263. The notice requests comments regarding the appropriate treatment of certain transaction costs that are required to be capitalized, including whether such costs should be treated as giving rise to a new asset the basis of which is amortizable. "The proper treatment of amounts incurred to facilitate certain transactions has been the subject of disputes between taxpayers and the IRS in recent years," stated Acting Treasury Assistant Secretary for Tax Policy Greg Jenner. "This notice is the first step toward providing clear and administrable rules."

In Rev. Rul. 2004-21 (IRB 2004-10) the IRS ruled that a plan funded in whole or part with life insurance contracts failed to satisfy the requirements of Sec. 401(a)(4) of the Code prohibiting discrimination in favor of highly compensated employees where (1) the plan permits highly compensated employees, prior to distribution of retirement benefits, to purchase those life insurance contracts prior to distribution; and (2) any rights under the plan for non-highly compensated employees to purchase life insurance contracts from the plan prior to distribution of retirement benefits are not of inherently equal or greater value than the purchase rights of highly compensated employees.

In Nield Montgomery, et ux. (122 T.C. No. 1) the taxpayers filed their return owing some $196,000 in taxes which they did not remit with the return. The IRS accepted the return as filed and assessed the unpaid taxes. The taxpayers filed a request for a collection due process hearing (CDP). The taxpayers asserted they overstated the total tax on their original return and indicated that they intended to submit an amended return showing that they were due a refund for that year. The IRS issued the taxpayers a final notice of determination in which he determined that they were not entitled to challenge the amount of their tax liability in the administrative proceeding, citing Sec. 6330(c)(2)(B). The taxpayers filed with the Court a timely petition for review of the Service's determination. The Tax Court denied the Service's request for summary judgment, and allowed the taxpayers to challenge the existence or amount of the tax liability reported on their original tax return because the taxpayers had not received a notice of deficiency and had not otherwise had an opportunity to dispute the tax liability in question.

Before the IRS can proceed with collection on outstanding tax liabilities, a taxpayer is entitled to a collection due process (CDP) hearing. In Ariel J. Dorra (T.C. Memo. 2004-16) the taxpayer argued that the IRS failed to provide him with a CDP hearing. The IRS countered that the Appeals officer engaged in a telephonic conference with the taxpayer and his representative. The taxpayer's representative agreed that the administrative requisites had been followed or met by respondent. The Tax Court found that the taxpayer did, indeed, have a hearing and granted the IRS summary judgment.

The IRS has issued two notices concerning transactions intended to generate foreign tax credits for U.S. taxpayers. Notice 2004-19 describes the administrative and regulatory approaches the Treasury and IRS are using to address foreign tax credit transactions that create results inconsistent with the purpose of the foreign tax credit rules. Notice 2004-19 also discusses the legislation proposed in the President's FY 2005 Budget. The legislation would provide additional statutory rules disallowing foreign tax credits in appropriate circumstances and would grant Treasury regulatory authority to ensure that the mechanical foreign tax credit rules cannot be used to achieve results that do not reflect the economic effect of the transactions. Notice 2004-20 (IRB 2004-11) announced that the IRS is aware of a type of transaction, in which, pursuant to a prearranged plan, a domestic corporation purports to acquire stock in a foreign target corporation and make an election under Section 338 of the before selling all or substantially all of the target corporation's assets in a transaction that is subject to foreign income tax.

The IRS has announced the second quarterly update of the 2003-2004 Priority Guidance Plan. The Plan indicates the expected publication date of new regulations, revenue rulings, revenue procedures, notices, etc. The updated Priority Guidance Plan will be republished on the IRS web site on the Internet (www.irs.gov) under Tax Professionals, IRS Resources, Administrative Information and Resources, 2003-2004 Priority Guidance Plan. Copies can also be obtained by calling Treasury's Office of Public Affairs at (202) 622-2960.

In Rev. Rul. 2004-20 (IRB 2004-10) the IRS held that a plan that holds life insurance contracts and annuity contracts for the benefit of a participant that provides for benefits at normal retirement age in excess of the participant's benefits at normal retirement age under the terms of the plan cannot be a qualified Sec. 412(i) pension plan.

The IRS has released two new Publications and one Notice:

Pub. 919 How Do I Adjust My Tax Withholding
Pub. 4138 Earned Income Tax Credit: Information for the Tax Return Preparer
Notice 931 Deposit Requirements for Employment Taxes

Rev. Proc. 2004-16 (IRB 2004-10) is issued in connection with the issuance of proposed regulations under Sec. 402(a) of the regarding the valuation of life insurance contracts upon distribution from a qualified retirement plan and proposed regulations under Secs. 79 and 83 regarding the valuation of life insurance contracts under those Sections (REG-126967-03). The preamble to the proposed regulations states that it is not appropriate in some cases to use either the net surrender value of a distributed life insurance contract (i.e., the contract's cash value after reduction for any surrender charges) or the contract's reserves as the contract's fair market value upon distribution of an insurance contract from a qualified plan but the preamble provides limited guidance as to what value may be used instead. Similarly, the proposed regulations under Secs. 79 and 83 clarify that the amount includible in income under those Sections is based upon the fair market value of the insurance contract rather than its cash value but these proposed regulations do not provide any guidance as what constitutes fair market value.

The IRS has determined (Rev. Proc. 2004-14; IRB 2004-7) that it is consistent with the purposes of, and policies underlying, employee stock ownership plans (ESOPs) to enable an ESOP to direct certain rollovers of distributions of S corporation stock to an individual retirement plan (IRA) in accordance with a distributee's election without terminating the corporation's S election. Accordingly, if the requirements of this revenue procedure are satisfied, the Service will accept the position that a corporation's S election is not affected when an ESOP distributes stock of that corporation to a participant's IRA in a direct rollover.

The IRS has ruled (Rev. Rul. 2004-22; IRB 2004-10) that the Medicare entitlement of a covered employee is not a second qualifying event for a qualified beneficiary unless the Medicare entitlement would have resulted (if COBRA continuation coverage, including COBRA continuation coverage due to the first qualifying event, is disregarded) in a loss of coverage for the qualified beneficiary under the group health plan that is providing the COBRA continuation coverage.

The IRS has issued proposed amendments (REG-126967-03) to the regulations under Section 402(a) of the Code regarding the amount includible in a distributee's income when life insurance contracts are distributed by a qualified retirement plan and the treatment of property sold by a qualified retirement plan to a plan participant or beneficiary for less than fair market value.

. The IRS has issued guidance (IR-2004-21) to shut down abusive transactions involving specially designed life insurance policies in retirement plans, section "412(i) plans." The guidance designates certain arrangements as "listed transactions" for tax-shelter reporting purposes. A section 412(i) plan is a tax-qualified retirement plan that is funded entirely by a life insurance contract or an annuity. The employer claims tax deductions for contributions that are used by the plan to pay premiums on an insurance contract covering an employee. The plan may hold the contract until the employee dies, or it may distribute or sell the contract to the employee at a specific point, such as when the employee retires. "The guidance targets specific abuses occurring with section 412(i) plans," stated Assistant Secretary for Tax Policy Pam Olson. "There are many legitimate section 412(i) plans, but some push the envelope, claiming tax results for employees and employers that do not reflect the underlying economics of the arrangements." The guidance covers three specific issues. First, a set of new proposed regulations states that any life insurance contract transferred from an employer or a tax-qualified plan to an employee must be taxed at its full fair market value. Some firms have promoted an arrangement where an employer establishes a section 412(i) plan under which the contributions made to the plan, which are deducted by the employer, are used to purchase a specially designed life insurance contract. Generally, these special policies are made available only to highly compensated employees. The insurance contract is designed so that the cash surrender value is temporarily depressed, so that it is significantly below the premiums paid. The contract is distributed or sold to the employee for the amount of the current cash surrender value during the period the cash surrender value is depressed; however the contract is structured so that the cash surrender value increases significantly after it is transferred to the employee. Use of this springing cash value life insurance gives employers tax deductions for amounts far in excess of what the employee recognizes in income. These regulations, which will be effective for transfers made on or after today, will prevent taxpayers from using artificial devices to understate the value of the contract. A revenue procedure issued today along with the proposed regulations provides a temporary safe harbor for determining fair market value. Second, a new revenue ruling states that an employer cannot buy excessive life insurance (i.e., insurance contracts where the death benefits exceed the death benefits provided to the employee's beneficiaries under the terms of the plan, with the balance of the proceeds reverting to the plan as a return on investment) in order to claim large tax deductions. These arrangements generally will be listed transactions for tax-shelter reporting purposes. Third, another new revenue ruling states that a section 412(i) plan cannot use differences in life insurance contracts to discriminate in favor of highly paid employees.

IRS Commissioner Mark Everson has announced some planned changes at the IRS. Some two-thirds of the Service's enforcement efforts will be aimed at increasing compliance by corporations and high-income individuals. He also intends to attack military contractors who do not pay their taxes. Unpaid payroll taxes account for a major portion of the total. The IRS will also try to reduce the misuse of tax-exempt entities to avoid taxes. Commissioner Everson indicated that some 40% of credit counseling services is currently being audited.

IRS Gives Investors Benefit of Pending Technical Corrections on Qualified Dividends

The Treasury Department and the Internal Revenue Service have agreed (IR-2004-22) to make certain provisions of the Tax Technical Corrections Act of 2003 related to dividend income available to taxpayers in advance of its passage. These provisions will be of particular interest to certain mutual fund shareholders and other investors who are completing their 2003 tax returns.

The Chairmen and Ranking Members of both the House Ways and Means Committee and the Senate Finance Committee have advised the Treasury Department and the IRS that they plan to enact legislation to make the technical corrections in Section 2 of the Act effective for dividends received beginning January 1, 2003. To reduce the burden of requiring amended dividend statements to investors, who might then have to amend their tax returns, the Treasury Department and the IRS have agreed to let all taxpayers apply the technical corrections in Section 2 of the Act as if the legislation were already enacted.

Some mutual funds that received payments from partnerships have delayed issuing Forms 1099-DIV to shareholders while awaiting enactment of these corrections. The Act will allow partnerships, S corporations, estates and revocable trusts treated as part of an estate on a fiscal year that began in 2002 to pass through dividends received in 2003 to their partners, shareholders and beneficiaries as dividends qualifying for the lower tax rates, to the extent that the dividends are otherwise qualified.

The Act will also change the holding period test for qualified dividends. To qualify for the lower tax rates, the taxpayer must now hold the dividend-paying stock for at least 61 days during the 121-day period (instead of the current 120-day period) beginning 60 days before the ex-dividend date--the first date that the buyer will not be entitled to receive that dividend.

A stock bought on the last day before the ex-dividend date (the latest purchase date for collecting a dividend) can still meet the holding period test for that dividend, since there are 61 days left in the 121-day period. A stock sold on the ex-dividend date (the earliest selling date after entitlement to a dividend) can also meet the test, since that is the 61st day in the period. So if a taxpayer holds a stock for at least 61 continuous days, the holding period test will be met for any dividend received, unless the risk of loss was diminished.

A similar holding period exists for preferred stock dividends attributable to a period exceeding 366 days. This holding period is at least 91 days during a 181-day period beginning 90 days before the ex-dividend date.

Mutual funds, other regulated investment companies, and real estate investment trusts that pass through dividend income to their shareholders must meet the holding period test for the dividend-paying stocks that they hold in order for corresponding amounts that they pay out to be reported as qualified dividends on Form 1099-DIV. Investors must then meet the test relative to the shares that they hold directly, from which they received the qualified dividends that were reported to them.

The IRS expects to post revised versions of three publications and the instructions for various forms related to dividend reporting--for payors and investors--to its Web site at www.irs.gov later this month. The IRS will not reprint the already-printed versions of these materials to reflect the pending legislation. The affected materials are:

- Pub. 17, Your Federal Income Tax (For Individuals), chapter 9
- Pub. 553, Highlights of 2003 Tax Changes
- Pub. 564, Mutual Fund Distributions

- Forms 1040 and 1040A, U.S. Individual Income Tax Return, line 9b
- Form 1040NR, U.S. Nonresident Alien Income Tax Return, line 10b
- Form 1041, U.S. Income Tax Return for Estates and Trusts, line 2b
- Form 1065, U.S Return of Partnership Income, Schedules K and K-1, line 4b(1)
- Form 1065-B, U.S. Return of Income For Electing Large Partnerships, lines 2a through 2c in Part II
- Form 1099-DIV, Dividends and Distributions, line 1b, for issuers only (see also page DIV-1)
- Form 1120S, U.S. Income Tax Return for an S Corporation, Schedules K and K-1, line 4(b)(1)
- Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships, Schedules K and K-1, line 4b(1)

Mutual Funds and Brokers Have 1099 Problems

Even in the best of years 1099s from banks, brokers, mutual funds, etc. have their share of errors. Generally, the error rate is around 5%. Look for more errors this year. Mutual funds will have to track the holding period of stocks on which they received dividends. While it's not technically challenging, it is prone to error and the funds were under the January 31 deadline.

Brokerage firms, banks, and some other financial institutions who consolidate statements from mutual funds to put into customers' statements have even more of a problem. They can't send 1099s to customers until they get the information from the mutual fund.

The bottom line? Don't be The bottom line? Don't be too surprised if you get a second 1099 from your mutual fund, broker, etc. with corrections. In fact, this year you might want to hold off filing that return a little longer, even if you're done. You don't want to have to file an amended return.

A final point. Just because the mutual fund says the dividend is qualified in their hands doesn't mean it's qualified in your hands. The mutual fund is saying it held the stock the requisite period. You must have held the mutual fund the required period. Some mutual funds intend to send out special statements to holders that may not have passed the second test.

In Brief:

Previously Reported In Daily Update

Reservists and enlistees may get deferral of back taxes . . . Reservists called to active duty and enlistees in the armed forces may qualify for a deferral of taxes owed if they can show that their ability to pay taxes was affected by their military service. The Servicemembers Civil Relief Act provides this benefit. The act covers active duty members of the military services--Army, Navy, Air Force, Marine Corps and Coast Guard--and commissioned officers of the uniformed services--Public Health Service and the National Oceanic and Atmospheric Administration. Reservists must be placed on active duty to qualify. National Guard personnel not serving in a "federalized" status--that is, called to active duty specifically by the president of the United States--are not covered. The deferral applies to taxes that fall due before or during military service, and extends the payment deadline to six months (180 days) after the military service ends. No interest or penalty accrues during the deferral period. The deferral is not automatic. A taxpayer must apply for it. When applying, the taxpayer must show how the military service affected the taxpayer's ability to pay. A taxpayer must also have received a notice of tax due, or have an installment agreement with the IRS, before applying for the deferral. The deferral does not extend the deadline for filing any tax returns. However, taxpayers in the armed forces may get extra time to file under other provisions, such as being stationed overseas, in a combat zone or in a qualified hazardous duty area, or if they are serving in direct support of a combat zone. There is a long list of combat zones and duty areas that qualify.

Capital gain distributions in 2003 . . . Read your mutual fund or brokerage statement carefully. If you received capital gain distributions any post-May 5 distributions receive the lower tax rates applied to capital gains after that date and will be specifically identified. On Schedule D of your tax return you'll report your total capital gain distributions in column f, line 13. On the same line but in column g you'll report the post-May 5 distributions. Then follow the computations through. If you're using a computer program, it's even easier, just make sure you identify the amount of the post-May 5 distributions on the entry for capital gain distributions from that source.

HH bonds won't be issued after August 31, 2004 . . . That's the last date you can reinvest your HH/H bonds in new bonds and convert from EE/E bonds to HH/H bonds. HH bonds issued through August 2004 will continue to earn interest until they reach final maturity 20 years after issue. The Treasury will not waive the required 12 month holding period for EE bonds issued on or after February 1, 2003 before redemption or exchange is allowed.

Retirement savings credit . . . This is an easy one to miss on a personal return. While it may not apply to you, your children, relatives, or employees may be able to take advantage of it. It's a credit, up to $1,000, for contributions to IRAs (including a Roth), elective deferrals of compensation to plans of state or local governments and tax-exempt organizations and voluntary employee contributions to a qualified retirement plan. The credit percentage drops from a high of 50% for low income taxpayers (single taxpayers with adjusted gross income of $15,000 or less and married couples filing jointly with AGI of $30,000 or less) to 10% for those with AGI of $25,000 (single) or $50,000 (married, joint). For example, your daughter is single and has an AGI of $22,000. She makes a $3,000 contribution to an IRA. She can claim a credit of $300 (10% of $3,000). If her AGI had been $14,000 she could have claimed a credit of $1,000 (50% of $3,000 but no more than $1,000). In order to claim the credit you must be at least 18 on December 31, can't be claimed as a dependent on another's return, and can't have been a student. In addition, distributions from a qualified retirement plan during a test period may reduce or eliminate the credit. The credit won't be available for tax years after 2006.

Schedule D and loss carryovers . . . Because of the changes in tax rates for capital gains and dividends, Schedule D is even more complicated than in the past. But missing from the 2003 form is a place to record any unused capital losses that can be carried over to your 2004 return. If you do your return on a computer and use this year's files as the basis for next year's return, you shouldn't have a problem. (Even if you use a different software package, the program should recognize the carryforward.) But if you do your return by hand or have to re-enter the data, you'll have to be particularly careful. Put a big note in the your 2003 file with the amount of the carryover so you won't forget.

Schedule C and material participation . . . Schedule C of Form 1040 contains a question (G, just above Part I) asking whether or not you materially participated in the business in 2003? You've got to check either the yes or no box. For most sole proprietors, the question is an easy yes or no. If this is your sole source of income, the answer is probably yes, but check the definition of material participation on page C-2 of the instructions to Schedule C. If the business was managed by someone else and you participated 500 hours or less during the year, chances are you did not materially participate. But you may qualify under one of the other definitions so check the instructions. Time your spouse spent working in the business counts, even if its your business. This can be a tricky area and the consequences are significant. If you didn't materially participate and you have a loss, the loss will be one from a passive activity and you won't be able to deduct it currently.

Qualified dividends taxed at lower rate . . . Almost assuredly you know that many dividends received in 2003 (and later years through 2008) are taxed at lower rate--5% for taxpayers in the 10% and 15% brackets, 15% for those in higher brackets. But not all dividends qualify. Dividends on individual stocks (the $0.50 per share you receive on your Madison Inc. stock every quarter) generally qualify if you held the shares for 60 days each side of the ex-dividend date. But it's unlikely all the dividends from a mutual fund are qualified. Why? The fund may not have held the shares the required time, some of the income might be interest or pass-throughs from real estate investment trusts, etc. Your mutual fund statement will provide the details, just read it carefully. And don't forget that some of the dividends might really qualify as capital gain distributions (those belong on line 13 of Schedule D) or a nontaxable return of capital. If you use a tax program to prepare your return, just enter the data carefully, the program will do the work. If you're doing the return by hand, be careful to carry the qualified dividends to line 23 on the tax computation page of Schedule D.

Gain on tax-exempt bonds not tax exempt . . . The interest income on municipal bonds is generally tax exempt for federal purposes. (Whether or not it's taxable for state purposes depends on the rules in your state and who issued the bonds.) But any gain on the sale or redemption of the bonds is fully taxable. Likewise, any loss is deductible, the same as other short or long-term losses.

Co-ownership of savings bonds . . . If a U.S. savings bond is issued in the names of co-owners, such as you and your child or you and your spouse, interest on the bond is generally taxable to the co-owner who bought the bond. If you used your funds to buy the bond, you must pay the tax on the interest. That's true even if you let the other co-owner redeem the bond and keep all the proceeds. If that's the case, since the other co-owner will receive a Form 1099-INT at the time of redemption, the other co-owner must provide you with another From 1099-INT showing the amount of interest from the bond that is taxable to you. The co-owner who redeemed the bond is a nominee. If you and the other co-owner each contribute part of the bond's purchase price, the interest is generally taxable to each of you, in proportion to the amount each of you paid.

Bonds bought or sold between interest dates . . . If you buy a bond between interest payment dates, part of the purchase price represents interest accrued before the date of purchase. When that interest is paid to you, treat it as a return of your capital investment rather than interest income by reducing your basis in the bond. If you sell a bond between interest payment dates, part of the sales price represents interest accrued to the date of ale. You must report that part of the sales price as interest income for the year of sale.