Kinds of Income You must report on your tax return all income you receive from yourbusiness unless it is excluded by law. In most cases, your businessincome will be in the form of cash, checks, and credit card charges.But business income can be in other forms, such as property orservices. These and other types of income are explained next. Caution: If you are a U.S. citizen who has business income from sourcesoutside the United States (foreign income), you must report thatincome on your tax return unless it is exempt from tax under U.S. law.If you live outside the United States, you may be able to exclude partor all of your foreign-source business income. For details, seePublication 54,Tax Guide for U.S. Citizens and Resident AliensAbroad. Property or Services (Barter) Bartering is an exchange of property or services. You must includein your gross receipts, at the time received, the fair market value ofproperty or services you receive in bartering. If you exchangeservices with another person and you both have agreed ahead of time onthe value of the services, that value will be accepted as the fairmarket value unless the value can be shown to be otherwise. Example 1.You are a self-employed lawyer. You perform legal services for aclient, a small corporation. In payment for your services, you receiveshares of stock in the corporation. You must include the fair marketvalue of the shares in income. Example 2.You are an artist and create a work of art to compensate yourlandlord for the rent-free use of your apartment. You must include thefair rental value of the apartment in your gross receipts. Yourlandlord must include the fair market value of the work of art in hisor her rental income. Example 3.You are a self-employed accountant. Both you and a house painterare members of a barter club, an organization that each year gives itsmembers a directory of members and the services each member provides.Members get in touch with other members directly and bargain for thevalue of the services to be performed. In return for accounting services you provided for the housepainter's business, the house painter painted your home. You mustinclude in gross receipts the fair market value of the services youreceived from the house painter. The house painter must include thefair market value of your accounting services in his or her grossreceipts. Example 4.You are a member of a barter club that uses credit units to creditor debit members' accounts for goods or services provided or received.As soon as units are credited to your account, you can use them to buygoods or services or sell or transfer the units to other members. You must include the value of credit units you received in yourgross receipts for the tax year in which the units are credited toyour account. The dollar value of units received for services by an employee ofthe club, who can use the units in the same manner as other members,must be included in the employee's gross income for the tax year inwhich received. It is wages subject to social security and Medicaretaxes (FICA), federal unemployment taxes (FUTA), and income taxwithholding. See Publication 15,Circular E, Employer's TaxGuide. Example 5.You operate a plumbing business and use the cash method ofaccounting. You join a barter club and agree to provide plumbingservices to any member for a specified number of hours. Each memberhas access to a directory that lists the members of the club and theservices available. Members contact each other directly and request services to beperformed. You are not required to provide services unless requestedby another member, but you can use as many of the offered services asyou wish without paying a fee. You must include the fair market value of any services you receivefrom club members in your gross receipts when you receive them even ifyou have not provided any services to club members. Information returns.If you are involved in a bartering transaction, you may have tofile either of the following forms. Form 1099-B, Proceeds From Broker andBarter Exchange Transactions. Form 1099-MISC, MiscellaneousIncome. For information about these forms, see the Instructionsfor Forms 1099, 1098, 5498, and W-2G. Real Estate Rents If you are a real estate dealer who receives income from rentingreal property or an owner of a hotel, motel, etc., who providesservices (maid services, etc.) for guests, report the rental incomeand expenses on Schedule C or C-EZ. If you are not a real estatedealer or the kind of owner described in the preceding sentence,report the rental income and expenses on Schedule E, instead of onSchedule C or C-EZ. Prepaid rent.Advance payments received under a lease that does not put anyrestriction on their use or enjoyment are income in the year youreceive them. This is true no matter what accounting method or periodyou use. Lease bonus.A bonus that you receive from a lessee for granting a lease is anaddition to the rent. Include it in your gross receipts in the year itis received. Lease cancellation payments.Report payments that you receive from your lessee for canceling alease in gross receipts in the year received. Payments to third parties.If your lessee makes payments to someone else under an agreement topay your debts or obligations, include the payments in your grossreceipts when the lessee makes the payments. A common example of thiskind of income is a lessee's payment of your property taxes on leasedreal property. Settlement payments.Payments you receive in settlement of a lessee's obligation torestore the leased property to its original condition are income inthe amount that the payments exceed the adjusted basis of theleasehold improvements destroyed, damaged, removed, or disconnected bythe lessee. Personal Property Rents If you are in the business of renting personal property (equipment,vehicles, formal wear, etc.), include the rental amount you get inyour gross receipts on Schedule C or C-EZ. Prepaid rent andother payments described in the preceding Real Estate Rentsdiscussion can also be received for renting personal property.If you receive any of those payments, include them in your grossreceipts as explained in that discussion. Interest and Dividend Income Interest and dividends may be considered business income. Interest.Interest received on notes receivable that you have accepted in theordinary course of business is business income. Interest received onloans is business income if you are in the business of lending money. Uncollectible loans.If a loan payable to you becomes uncollectible during the tax yearand you use an accrual method of accounting, you must include in grossincome interest accrued up to the time the loan became uncollectible.If the accrued interest later becomes uncollectible, you may be ableto take a bad debt deduction. See chapter 14 in Publication 535,Business Expenses. Unstated interest.If little or no interest is charged on an installment sale, a partof each payment may be treated as unstated interest. See UnstatedInterest and Original Issue Discount in Publication 537,Installment Sales. Dividends.Generally, dividends are business income to dealers in securities.For most sole proprietors and statutory employees, however, dividendsare nonbusiness income. If you hold stock as a personalinvestment separately from your business activity, the dividends fromthe stock are nonbusiness income. If you receive dividends from business insurance premiums youdeducted in an earlier year, you must report all or part of thedividend as business income on your return. To find out how much youhave to report, see Recovery of items previously deducted,later. Canceled Debt The following explains the general rule for including canceled debtin income and the exceptions to the general rule. General Rule Generally, if a debt you owe is canceled or forgiven, other than asa gift or bequest, you must include the canceled amount in your grossincome for tax purposes. A debt includes any indebtedness for whichyou are liable or which attaches to property you hold. Example.You got a mortgage loan on your home several years ago at arelatively low rate of interest. This year, in return for your payingoff the loan early, the lending institution cancels part of theremaining principal. You must include the amount canceled in grossincome. Exceptions The following discussion covers some exceptions to the general rulefor canceled debt. Deductible debt.You do not realize income from debt cancellation to the extent thatpayment of the debt would have led to a deduction. Example.You own a business and get accounting services on credit. Later,you have trouble paying your business debts, but you are not bankruptor insolvent. Your accountant forgives part of the amount you owe forthe accounting services. How you treat the cancellation of debtdepends on your method of accounting. Cash method - You do not include the debt cancellationin income because payment for the services would have been deductibleas a business expense. An accrual method - You include the debt cancellationin income. Under an accrual method of accounting, you deduct theexpense when you incur the liability, not when you pay thedebt. For information on the cash and accrual methods of accounting, seechapter 2. Price reduced after purchase.If you owe a debt to the seller for property you bought, and theseller reduces the amount you owe, generally you do not have incomefrom the reduction. Unless you are in bankruptcy or are insolvent,treat the reduction as a purchase price adjustment and reduce yourbasis in the property. Excluded Debt Do not include in gross income a debt canceled in the followingsituations. However, you may be required to file Form 982. For moreinformation, see Form 982, Reduction of Tax Attributes Due toDischarge of Indebtedness. The cancellation takes place in a bankruptcy case undertitle 11 of the United States Code (relating to bankruptcy). SeePublication 908, Bankruptcy Tax Guide. The cancellation takes place when you are insolvent. You canexclude the canceled debt up to the amount by which you are insolvent.See Publication 908. The canceled debt is a qualified farm debt that is canceledby a qualified person. See chapter 4 in Publication 225,Farmer'sTax Guide. The canceled debt is qualified real property business debt.This situation is explained next. If a debt cancellation is excluded from income because it takesplace in a bankruptcy case, items (2), (3), and (4) do not apply. Ifit takes place when you are insolvent, items (3) and (4) do not applyto the extent you are insolvent. Qualified real property business debt.You can choose to exclude (up to certain limits) the cancellationof qualified real property business debt. If you make the choice, youmust reduce the basis of your depreciable real property bythe amount excluded. Make this reduction at the beginning of your taxyear following the tax year in which the cancellation occurs. However,if you dispose of the property before that time, you must reduce itsbasis immediately before the disposition. Cancellation of qualified real property business debt.Qualified real property business debt is debt (other than qualifiedfarm debt) that meets all the following conditions. It was incurred or assumed in connection with real propertyused in a trade or business. It was secured by such real property. It was incurred or assumed at either of the followingtimes. Before January 1, 1993. After December 31, 1992, if incurred or assumed to acquire,construct, or substantially improve the real property. It is debt to which you choose to apply these rules. Qualified real property business debt includes refinancing of debtdescribed in (3) above, but only to the extent it does not exceed thedebt being refinanced. You cannot exclude more than either of the following amounts. The excess (if any) of: The outstanding principal of qualified real propertybusiness debt (immediately before the cancellation), over The fair market value (immediately before the cancellation)of the business real property that is security for the debt, reducedby the outstanding principal amount of any other qualified realproperty business debt secured by this property immediately before thecancellation. The total adjusted bases of depreciable real property heldby you immediately before the cancellation. These adjusted bases aredetermined after any basis reduction due to a cancellation inbankruptcy, insolvency, or of qualified farm debt. Do not take intoaccount depreciable real property acquired in contemplation of thecancellation. Choice.To make this choice, complete Form 982 and attach it to your incometax return for the tax year in which the cancellation occurs. You mustfile your return by the due date (including the extensions). If youtimely filed your return for the year without making the choice, youcan still make the choice by filing an amended return within sixmonths of the due date of the return (excluding extensions). AttachForm 982 to the amended return and write "Filed pursuant to section301.9100-2" at the top of the form. File the amended returnat the same address you filed the original return. Other Income The following discussion explains how to treat other types ofbusiness income you may receive. Restricted property.Restricted property is property that has certain restrictions thataffect its value. If you receive restricted stock or other propertyfor services performed, the fair market value of the property inexcess of your cost is included in your income on Schedule C orC-EZ when the restriction is lifted. However, you can choose tobe taxed in the year you receive the property. For more information onincluding restricted property in income, see Publication 525,Taxable and Nontaxable Income. Gains and losses.Do not report on Schedule C or C-EZ a gain or loss from thedisposition of property that is neither stock in trade nor heldprimarily for sale to customers. Instead, you must report these gainsand losses on other forms. For more information, see chapter 3. Promissory notes.Report promissory notes and other evidences of debt issued to youin a sale or exchange of property that is stock in trade or heldprimarily for sale to customers on Schedule C or C-EZ. Ingeneral, you report them at their stated principal amount (minus anyunstated interest) when you receive them. Lost income payments.If you reduce or stop your business activities, report on ScheduleC or C-EZ any payment you receive for the lost income of yourbusiness from insurance or other sources. Report it on Schedule C orC-EZ even if your business is inactive when you receive thepayment. Damages.You must include in gross income compensation you receive duringthe tax year as a result of any of the following injuries that areconnected with your business. Patent infringement. Breach of contract or fiduciary duty. Antitrust injury. Economic injury.You may be entitled to a deduction against the income if itcompensates you for actual economic injury. Your deduction is thesmaller of the following amounts. The amount you receive or accrue for damages in the tax yearreduced by the amount you pay or incur in the tax year to recover thatamount. Your loss from the injury that you have not yetdeducted. Punitive damages.You must also include punitive damages in income. Kickbacks.If you receive any kickbacks, include them in your income onSchedule C or C-EZ. However, do not include them if you properlytreat them as a reduction of a related expense item, cost of goodssold, or a capital expenditure. Recovery of items previously deducted.If you recover a bad debt or any other item deducted in a previousyear, include the recovery in income on Schedule C or C-EZ.However, if all or part of the deduction in earlier years did notreduce your tax, you do not have to include all of the recovery.Exclude the part that did not reduce your tax. If you exclude part ofthe recovery from income, you must include with your return acomputation showing how you figured the exclusion. Example.Joe Smith, a sole proprietor, had gross income of $8,000, a baddebt deduction of $300, and other allowable deductions of $7,700. Healso had personal exemptions of $5,500. He would not pay income taxeven if he did not deduct the bad debt. Therefore, he will not have toreport as income any part of the $300 he may recover in any futureyear. Exception for depreciation.This rule does not apply to depreciation. You recover depreciationusing the rules explained next. Recapture of depreciation.In the following situations, you have to recapture the depreciationdeduction. This means that you include in income part or all of thedepreciation you deducted in previous years. Business use of listed property that falls to 50% or less.If your business use of listed property (explained in chapter 8under Depreciation) falls to 50% or less in a tax yearafter the tax year you placed the property in service, you may have torecapture part of the depreciation deduction. You do this by includingin income on Schedule C part of the depreciation you deducted inprevious years. Use Part IV of Form 4797, Sales of BusinessProperty, to figure the amount to include on Schedule C. SeeApplying the Predominant Use Test in chapter 4 ofPublication 946,How To Depreciate Property. That chapter explains how to determine whether property is used more than 50% inyour business. Property not predominantly used in business.If you take a section 179 deduction (explained in chapter 8underDepreciation) for an asset and before the end of theasset's recovery period it is not used predominantly in business, youmust recapture part of the section 179 deduction. You do this byincluding in income on Schedule C part of the deduction you took. UsePart IV of Form 4797, Sales of Business Property, to figurethe amount to include on Schedule C. See chapter 2 in Publication 946to find out when you recapture the deduction. Sale or exchange of depreciable property.If you sell or exchange depreciable property at a gain, you mayhave to report as income all or part of the gain due to depreciation.You figure the income due to depreciation recapture in Part III ofForm 4797. For more information, see chapter 4 in Publication 544,Sales and Other Dispositions of Assets.