After the close of another year, income taxes of course come to mind. While it’s clear we have to pay tax on our income, there are plenty of provisions in the tax code that require federal taxes to be paid on things you may not normally think of.
As you’re gathering your forms and preparing to submit your returns, consider the following checklist of surprises, groaners, and ironies.
It’s ironic but true – you have to pay income tax on benefits designed to help you when you have no income.
“While it is a shame that someone who is unemployed and most likely struggling financially must pay tax on unemployment benefits, there’s really no way around it,” says Samantha Fitzgerald, a tax lawyer in Plantation, Fla.
But one way to deal with this unfortunate scenario is to be sure to fill out a federal income tax withholding form when you apply for the benefits.
Typically, the spouse who pays the alimony gets to deduct it from his income, so that means the spouse who receives the spousal support must pay income tax on it. But tax lawyers say you can alter this arrangement in the support or divorce agreement.
Also, keep in mind another common aspect of divorce: “Child support works the other way,” observes Burton Haynes, a tax lawyer in Burke, Va. “It is not deductible to the payor spouse, and it is not taxable to the payee spouse.”
Another irony of the tax code is that if a creditor releases you from paying debt – on anything from your mortgage to a credit card – you must report the forgiven amount as “income” to the IRS.
“This has become a big problem due to the recession and the housing bust,” says Haynes. “It is deemed income because after the debt is gone you are better off, just as if you had earned real income.”
Exceptions exist, though, if you were insolvent both before and after the debt was cancelled; the debt was discharged in bankruptcy; or you were foreclosed on and meet certain requirements. “For any year you’ve had a foreclosure or a short sale or other cancellation of debt, hire a competent professional to prepare your return, and keep good records,” recommends Haynes.
Burton J. Haynes
You might not think of including non-cash prizes or gambling as income, but you must.
“The Nobel Prize is tax free, so sign up your kids for UC Berkeley or MIT!” says Haynes. But all kidding aside, “most prizes, and certainly gambling and lottery winnings, are taxable,” he says.
“Casinos and lottery agencies must file reports on winnings of $600 or more when the payout is 300 times the amount wagered,” Haynes says. “And the IRS will then look for that income on your return.” You should receive a 1099 form if you win any kind of serious money, adds Fitzgerald.
The good news is you can deduct losses up to the amount of your winnings. “But you must keep records to do this,” says Haynes. “And sadly most people don’t keep the records. In that case it looks like you’ve won when you’ve really lost, and when the IRS gets done you will have lost even more.
It’s also true that these are only taxable – but it depends on how much you brought in, and probably whether you are receiving income from other sources.
“If your income reaches a certain level, then up to 85 percent of your social security benefits could be subject to tax,” says Fitzgerald.
Fiscal Cliff Tax ‘Saves’
Finally, as part of the fiscal-cliff legislation passed by Congress at the end of 2012, several tax relief programs are still helpful for consumers.
“Two important provisions relate to the alternative minimum tax (AMT), and estate and gift taxes,” points out Alvin Lurie, an employee benefits lawyer in New York and Boston who once worked for the IRS.
“The AMT provision is very favorable to taxpayers in all brackets for having extended the so-called ‘patch’ for 2012 returns,” Lurie says. Without the now-perpetual patch, consumers in lower and lower tax brackets would have been exposed to the AMT.
And the estate tax changes are good for the great majority of estates in 2013, Lurie adds. The new law sets the top gift and estate tax rate at 40 percent, which is higher than the 35 percent rate of 2012, but lower than the 55 percent rate that the fiscal-cliff law saved you from.