Skipping These Taxable Income Sources Could Get You Audited

Posted in Tax , Tax Returns • March 1, 2014

what is taxable incomeAccording to the Tax Policy Center, 77 percent of U.S. households faced a tax increase as a result of a budget deal passed last year. This increase means the temptation to treat certain items as non-taxable income on a tax return is higher than ever before.

For some, the problem is ignorance; many taxpayers are unsure about what is taxable income. However, not claiming all taxable income could land you in trouble with the IRS — not the best of situations from a financial or legal standpoint.

What Is Taxable Income?

Some ask whether or not they have social security taxable income, while others ask the common question, “Is disability income taxable?” Others might be in the situation to wonder is child support taxable income. For the majority of people receiving these benefits, the answer to the questions of if they are considered taxable income is no — but consulting a tax professional is the best move to be sure when determining taxable income.

However, other items are often overlooked, whether in the interest of saving money or otherwise. Here are some sources of taxable income to keep in mind when filing your 2013 tax return.

Contract Work

As a contractor, you are self-employed. With this comes both a standard income tax and a self-employment tax. The self-employed tax is a Social Security and Medicare tax that is assessed on contractors and other self-employed individuals.

Note that you’ll claim income generated from contract work whether you do so as your primary occupation or a side business, provided that you have a net income of at least $400 or meet one of the other Form 1040 filing requirements. You’ll also have to pay quarterly taxes.

Related: Self Employed? Here’s Your Guide to Filing Taxes This Year

Gambling Winnings

According to the IRS, gambling winnings are fully taxable income. These include winnings from bingo, casinos, dog races, horse races, poker tournaments, raffles and more. Also included are cash prizes such as lottery winnings.

One that would be easy to overlook is a non-cash prize. If you win a prize such as a car or vacation, you must report the fair market value of it on your taxes.

Note that you may deduct gambling losses, but only enough to offset your winnings. So, if you hit the Atlantic City casinos and win $500 and lose $700 next time around, you could cancel out your winnings and pay no taxes on them. However, the remaining $200 will be treated as money spent and is still taxable.

Gifts

Gifts that you give to someone else could be taxable. The good news it that you can give up to $13,000 worth of gifts to an unlimited amount of recipients tax-free. That’s $13,000 per person, so you could, for instance, buy each of your four grandchildren a $13,000 car without giving a “gift” to Uncle Sam.

Additionally, certain gifts are considered non-taxable income altogether. These include:

  • Tuition expenses
  • Medical expenses
  • Gifts to your spouse
  • Gifts to political organizations

Note that gifts to charities are tax-deductible.

Related: 2014 Calendar of Important Personal Finance Dates

Inheritances

If you inherit an estate that is worth $5 million or more, it will be taxed. To pay this inheritance tax, you’ll need to complete Form 706. This is a 31-page form that, at first glance, might make you reconsider accepting the estate to begin with — but if you have to file this form in the first place, the wealth you’ve obtained should offset the hassle!

Note that you must file Form 706 within nine months of the decedent’s death.

Mutual Fund Gains

The sale of mutual funds could be taxable, depending on whether or not you incurred a gain. When determining taxable income on a mutual fund sale, you’ll need to figure out the basis (how much you paid) for the shares you sold. Unfortunately, there are plenty of what-ifs and potential snags when attempting this calculation.

There are two methods of determining basis: Cost basis and average basis. As an example, let’s go with the “easier” route of cost basis.

Within the cost basis approach, there are two options: Specific share identification and first in, first out (FIFO). Specific share identification involves identifying the specific shares you sold, which can be cumbersome if you have made multiple purchases at various times. The FIFO method is a bit less complicated, so let’s go with that.

For example, suppose you made the following purchases into your mutual fund account in 2012:

  • March 3: $5,000 purchase of 200 shares at $25 a share
  • May 5: $6,000 purchase of 300 shares at $20 a share
  • August 9: $3,000 purchase of 100 shares at $30 a share

Then, in 2013, you sold 350 shares at $27 a share for a total of $9,450. Did you incur a gain?

To figure this out under the FIFO method, you’d calculate the total purchase price of the first 350 shares you purchased. We know you paid $5,000 for the first 200 shares, so now we have 150 shares left to calculate. Take half (150 shares) of the second purchase, multiply by the share price of $20 and we arrive at $3,000.

So, the basis is as follows:

  • $5,000 + $3,000 = $8,000

Now, to figure out your gain, the calculation is as follows:

  • $9,450 – $8,000 = $1,450

So, you’d have to pay taxes on the $1,450 gain on your mutual fund sale.

Determining Taxable Income

It’s easy to overlook the mentioned items, but doing so is a risky move and could get you in hot water for tax fraud. Remember to pay taxes on contract work, gambling winnings, gifts, inheritances and mutual fund gains.

If you feel overwhelmed with these or any other items on your tax return, seek the assistance of a tax professional. Then, after the filing deadline, you won’t have to cross your fingers every time you open your mailbox!

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