10 Overlooked Forms of Taxable Income

Posted 4/14/2009 1:37:08 PM

Everyday our law firm receives calls from thousands of American taxpayers that owe the IRS. Over the years, we have heard every possible explanation as to why someone ended up in debt to the IRS. Most of the time, it is due to an unfortunate series of circumstances that has left a taxpayer simply unable to pay.

But sometimes, a person gets in debt to the IRS because they just do not understand the complex US Tax Code. And who can blame them? Taxes are complicated and trying to read through convoluted IRS explanations of the rules is daunting. Many taxpayers are not aware of their basic obligations to pay taxes on the income they earn, or even what kinds of income are taxable. When a taxpayer fails to report all their income, the IRS has the authority to make changes to tax returns, either through an audit or a Substitute for Return. This can leave taxpayers owing thousands of dollars in unpaid taxes, and untold amounts of interest and penalties.

Read on to see the most common forms of taxable income our clients overlook in preparing their taxes.

1. Social Security Income

Social Security benefits may be non-taxable, or partially taxable. It depends on your total income from other sources. If your sole source of income during the tax year was Social Security, your benefits are probably not taxable. But, if you have other forms of income, including tax-exempt income, it could make your Social Security benefits taxable. If you add half the amount of your Social Security Benefits to all other forms of income, and the total exceeds a “base” amount, then a portion of your benefits will be taxable. In 2008, the base amount is $25,000 if single, married filing single, or head of household, and $32,000 if married filing jointly.

2. Unemployment Compensation

People are always surprised that unemployment compensation is taxable income. This includes any amounts you received under federal or state unemployment compensation laws, state unemployment insurance paid by a state (or District of Columbia) from the Federal Unemployment Trust Fund. If you received unemployment compensation during the year, you should receive IRS Form 1099-G, showing the amount you were paid, and if any taxes were already withheld. If your unemployment benefit payments were made from a private, non-union fund to which you voluntarily contribute are only taxable if you received more money than you put into the fund.

Please note that as a result of passing the American Recovery and Reinvestment Act (ARRA), starting in 2009, the first $2,400 earned in unemployment compensation is excludable as taxable income.

3. Gambling Winnings

Gambling winnings are fully taxable and must be reported on your tax return. Gambling winnings include any winnings from lotteries, raffles, horse races, or casinos. Both cash winnings and the fair market value of prizes such as cars and trips are counted as taxable income. If you win a prize in a lucky number drawing, television or radio quiz program, beauty contest, or other event, you must also include it in your income. A payer (such as the casino or track, etc.) is required to issue you an IRS Form W-2G if you receive certain gambling winnings or if your gambling winnings are subject to Federal income tax withholding. All gambling winnings must be reported no matter if any portion is subject to withholding or not.

Please note that you may deduct gambling losses only if you itemize deductions. You may claim your gambling losses as a miscellaneous deduction, however, the amount of losses you deduct may not be more than the amount of gambling income you have reported on your return.

4. Bonuses

Bonuses or awards from your employer based on work performance are included as taxable income. Money, gift cards, property, or prizes such as a vacation trip all count as “bonuses”. If the award you receive is a good or service, then you need to include the fair market value in your income. Even holiday bonuses count if your employer gives you cash, a gift certificate, or a similar item that you easily can exchange for cash.

Please note that if you receive personal property (e.g. something other than cash, gift card, or its equivalent) as an award for length of service exceeding five years, the fair market value of the award is less than $1,600, and the award is presented as part of a meaningful presentation, it can generally be excluded as income.

5. Punitive Damages

If you were awarded damages for actual monetary losses (due to property damage or medical care for injuries) the funds are generally not taxable. However, if any damages were awarded beyond compensating you for monetary losses, like punitive damages, (usually to punish or make an example of a defendant based on outrageous conduct), interest, emotional distress, injury to reputation etc these are all taxable income.

Please note that if you receive compensatory damages and took a medical expense deduction on your tax return for expenses related to the underlying injury of your lawsuit or settlement, then the compensatory damages are taxable and should also be reported on your tax return.

6. Reimbursed Business Expenses

Reimbursed business expenses may be considered taxable income, depending upon whether your employer meets the requirements for an Accountable Plan. To be considered an Accountable Plan, your employer’s reimbursement or allowance arrangement must meet all of the following rules:

1. Employee paid or incurred expenses that are deductible while performing services as an employee.

2. Employee adequately accounts for these expenses to employer within a reasonable time period.

3. Employee returns any excess reimbursement or allowance within a reasonable time period.

If your employer’s reimbursement arrangement does not meet all three requirements, the reimbursements you receive for business expenses should be shown on your W-2, and the payments should be reported as income. You can get this income back by itemizing your deductions and completing IRS Form 2106 with your return.

7. Cancelled Debt

If you had a debt cancelled or forgiven, you may have to include the amount of canceled debt as income. This depends on the specific circumstances by which your debt was cancelled, and the nature of the property associated with the debt. Some canceled debt qualifies for an exception to gross income, or the canceled debt may result in gross income, but the income might be excluded. If a federal government agency or an applicable financial entity cancels or forgives a debt of $600 or more, you should receive an IRS Form 1099-C, Cancellation of Debt, showing amounts and other information relating to the cancellation.

Please note if you exclude canceled debt from income under one of the exceptions (including the cancellation of debt in regards to your personal residence) you must file an IRS Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness to report the exclusion and the corresponding reduction of certain tax attributes.

8. Severance Pay

Any type of severance pay or payment on the cancellation of your employment contract is taxable income. This includes a lump-sum payment for accrued vacation or leave time, or back pay awards as the result of a judgment or settlement. If you choose a reduced severance payment in exchanged for your former employer paying for an outplacement service or employment agency, you must include the unreduced severance pay as income.

9. Alimony

Alimony payments received from your spouse or former spouse are taxable to you in the year received. If you receive alimony income, you are not eligible to file an IRS Form 1040EZ or IRS Form 1040A. Do not include child support payments as alimony. If your divorce decree or separation agreement calls for both alimony and child support payments and specifies amounts for each, only the alimony is taxable.

Please note that the person making the payment may claim a deduction in the year paid. To facilitate the deduction, you must give the person who paid the alimony your social security number.

10. Hobby Income

You must report income from an activity from which you do not expect to make a profit, (i.e. hobbies). An activity is presumed carried on for profit if it produced income in at least 3 of the last 5 tax years, including the current year. Activities involving the breeding, training, showing, or racing of horses are presumed carried on for profit if they produced a profit in at least 2 of the last 7 tax years, including the current year.

Please note that deductions for expenses related to the activity are limited. They cannot total more than the income you report and can be taken only if you itemize deductions.