Skipping These 5 Taxable Income Sources Could Get You Audited

Skipping These 5 Taxable Income Sources Could Get You Audited

The average combined federal tax rate for someone who made $50,000 to $75,000 in 2015 is 15.2 percent, according to The Tax Foundation, a non-profit, non-partisan tax research organization. Understanding what the IRS defines as taxable sources of income is critical to making sure you are filing an accurate return. You could potentially be subject to costly or legal consequences for any discrepancies between your tax return and the income documents the IRS receives disclosing money paid to you.

Related: How to Protect Your Tax Refund From Being Stolen

What Is Taxable Income?

For the majority of people, disability, Social Security, and child support benefits are not taxable ― but consulting a tax professional is the best move to be sure you have identified all of your sources of taxable income.

Many taxpayers often overlook sources of income they should report either out of ignorance that it is a taxable income type or out of forgetfulness, such as failing to report income from a small freelance project completed long before the tax filing deadline. Here are five sources of taxable income to keep in mind when filing your tax return.

1. Contract Work

As a contractor, you are self-employed, which means you are subject to 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 have to make quarterly payments.

Related: How to File Taxes When You’re Self-Employed

2. Gambling Winnings

Gambling winnings are fully taxable income, according to the IRS. 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 of the easiest winnings to overlook for taxes, however, 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 casino, 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.

3. Gifts

Gifts that you give to someone else could be taxable. The good news is that you can give up to $14,000 as a gift to an unlimited number of recipients tax-free. So you could, for instance, give your children or grandchildren $14,000 each without owing anything to Uncle Sam.

Additionally, certain gifts are not taxable. These include:

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

Note that gifts to charities are tax-deductible.

Keep Reading: 3 Tips for Filing Taxes Last-Minute

4. An Inheritance

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 form is a few dozen pages long ― but if you have to file this form, the money you obtain from the inheritance could be worth the hassle. Be aware that you must file Form 706 within nine months of inheriting the estate.

5. Mutual Fund Gains

The sale of mutual funds could be taxable, depending on whether 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.

You or your financial advisor can calculate your cost basis using a few different methods, such as:

  • Average cost
  • First in, first out (FIFO)
  • Specific identification

How to Calculate Cost Basis for Mutual Fund Sales

FIFO is the default method used by the IRS for stock and mutual fund sales, according to Charles Scwab. Essentially, the calculation is based on the assumption that the first items purchased (first in) are the first sold (first out). For example, suppose you made the following purchases for your mutual fund account:

  • March 2010: 200 shares at $25 a share = $5,000
  • May 2012: 300 shares at $20 a share = $6,000
  • August 2015: 100 shares at $30 a share = $3,000

Then, within the last year, you sold 350 shares at $27 a share for a total sale price of $9,450.

Using the above purchases and sale example, here is a breakdown of how to use the FIFO method according to Morningstar, an independent investment research and investment management firm:

1. Calculate your cost basis.

First calculate the total purchase price of the first 350 shares you purchased. You paid $5,000 for the first 200 shares. You need to calculate how much you paid for the next 150 shares to total 350 shares: 150 shares of the second purchase price, $20, totals $3,000. Add these two totals together to get your cost basis.

(200 ?– $25) + (150 ?– $20)

$5,000 + $3,000 = $8,000, which is your cost basis

2. Calculate your taxable gain. A positive result indicates a taxable gain; a negative number would indicate a tax loss.

Your taxable gain is the total sale price minus your cost basis. You sold 350 shares at $27, totaling $9,450. Subtract that from your cost basis to get your taxable gain.

(350 ?– $27) – $8,000

$9,450 – $8,000 = $1,450 taxable gain

You would have to pay taxes on the $1,450 gain from your mutual fund sale if you use the FIFO calculation method.

Consult your financial advisor to determine which cost-basis calculation you should use to get the greatest tax advantage. Some calculation methods can result in higher taxable gains than others.

How to Calculate Taxable Income

It’s easy to overlook some types of taxable income, but doing so could get you in hot water for tax fraud, whether it was intentional or not. If you are confused about whether to report something on your taxes or if you feel overwhelmed when looking at tax forms, consider consulting a tax professional.

Some online sources can help you calculate your taxable income; however, talking to a tax advisor might be the best way to make sure you’re including all of your different types of taxable income in your calculation. Additionally, this person can help you correctly report taxable gains or claim tax losses and deductions on applicable tax forms.

If you typically file your tax return electronically but you experienced something unusual in the last year, such as receiving an inheritance or working on a contract basis for the first time, you could benefit from talking to a tax professional before filing electronically to make sure you don’t make any mistakes in your calculations.

Keep Reading: IRS Lists the ‘Dirty Dozen’ Tax Scams You Need to Avoid

Stephanie Barbaran contributed to the reporting for this article.

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  • George

    The IRS will look for any opening to audit you, don’t give it to them!

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