The tax law is complex and difficult for even experts to negotiate. Just when you think you’ve followed all the rules and researched all the angles, a tax regulation blindsides you.
Here are five terrible tax surprises that you might encounter during tax season and how to deal with the consequences.
1. Unemployment benefits. Yes, it’s true. Under tax law, unemployment is considered wage income, and the IRS wants a cut of it. Now that you’re over the shock and anger, what can you do? When you apply for unemployment benefits, consider having federal income taxes withheld. T
2. Alimony received. You survived the divorce. Now you have the IRS to deal with if you’re getting alimony. Ending a marriage is never a happy event. But at least you got a good settlement, and those regular checks from your (insert your own description here) ex-spouse are completely warranted. They also are completely taxable. Alimony, separate maintenance payments and similar recompense from your former spouse are taxable to you in the year you receive them. Child support money, however, is not taxable. If your divorce decree calls for alimony and child support and specifies amounts for each, you only owe the IRS for the alimony payments.
3. Forgiven debt. ”Forgive but collect” is the IRS motto when it comes to canceled debt. Getting your credit card bill cut from $8,000 to $4,000 certainly helped your personal bottom line. But it also could be a boon to the U.S. Treasury. Why? The tax law generally considers the amount you get any creditor to write off as earned, and therefore taxable, income to you. Expect the accommodating debtholder to send you (and the IRS) a Form 1099-C or similar statement detailing your discharge of indebtedness as miscellaneous income. Not every debt settlement, however, has to pad Uncle Sam’s pocket. Under the Mortgage Debt Relief Act that became law in 2007, some homeowners who are granted forgiveness of mortgage debt won’t have to pay taxes on that amount. There are some restrictions. The forgiven debt amount is limited to up to $2 million, or $1 million for a married person filing a separate tax return. The tax relief only applies to mortgage debt discharged by a lender between 2007 and 2012. And the forgiven loan must have been taken out to buy or build a primary residence, not a second or vacation home.
4. Prize winnings Think you’re pretty lucky because you won $1,000 in a radio contest? Uncle Sam is even luckier. He’s due part of your winnings. Prize winnings are included in the long list of “other” income that tax law says is taxable. And it’s not just limited to cash awards. You have to pay taxes on the fair market value of any property you win. Be careful when reporting the amount of a noncash prize. In most cases, companies and groups that award prizes, cash and property, will send you a 1099 form declaring the value of what you won.
5. Some Social Security benefits.
You spent the last 40 years fattening the U.S. Treasury thanks to those dang Social Security taxes that came out of every paycheck. Now you’re retiring, and it’s time to get your tax money back, free and clear, right?
Well, maybe. Maybe not.
Generally, if Social Security benefits are your only income, your benefits are not taxable. But if you collect Social Security plus other income, as much as 85 percent of those government checks could be subject to tax.
To figure out just how much in taxes your Social Security might cost you, you’ll have to do some calculating using the work sheet found in your tax Form 1040 or 1040a. If you discover that you will owe taxes on some of your Social Security benefits, there are two ways to deal with them. You can make estimated tax payments on the government check amounts. Or you can have federal income tax withheld from your benefits by completing Form W-4V, Voluntary Withholding Request, and filing it with the Social Security Administration.