Think you got what it takes to make a sound Federal budget? Ladies and gentlemen get your calculators ready – it’s time to play Budget Hero!
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I generally don’t recommend using credit cards because it’s too easy to get into trouble with over spending. But I also know that most people do use them and how you use your credit card can have a profound effect on your business bottom line. If you are a sole proprietor of a small business, here’s what you need to know about credit card spending.
It’s up to you to make wise choices about how and if you use your credit card for business. Knowing the rules can help you make better decisions.
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This post is about your gambling and how it affects your income tax return.
Here in Missouri, we’ve got casinos so I get to see a fair number of W-2Gs; that’s the form you get when you win at a gambling event. Not everybody receives a W-2G for their winnings; you need to win over a certain amount before one is issued. The limits go like this:
When you get your W-2G, you report your gambling winnings on the other income line of your 1040 tax return. (Line 21)
If you have gambling losses, you may claim a deduction for your losses up to the amount of your winnings on your Schedule A itemized deductions page. (Line 28)
That’s all pretty easy, but there’s some picky stuff you’re going to want to know. First, you need to keep records of your losses if you want to deduct them. Now many casinos track that for you, but for the IRS you really should keep a log. If your gambling is more in the form of horse racing or lottery tickets, keeping cancelled tickets supports your loss claim.
Also, although you can deduct your losses up to the amount of your winnings on your Schedule A—if you don’t already itemize, this might not help you much or even not at all. For example: let’s say you’re single and win $5,000 at a slot machine. You don’t already itemize. Your standard deduction is $5,800—in this case, you might not get any value from itemizing your gambling deduction. This deduction is much more valuable for people who already have other things to write off like mortgage interest.
Another issue for gamblers, even if you can deduct all of your gambling winnings on the Schedule A, is that the gambling income will increase your “Adjusted Gross Income” (AGI). Now before I lose you with tax jargon, let me explain why that’s important. The AGI number is figured before you subtract the Schedule A deductions. The AGI number is used to figure a lot of other tax deductions and credits.
If you normally have a low AGI and you qualify for things like the Earned Income Tax Credit or the Child Tax Credit, and you win big at gambling, even though you can deduct all of those winnings, the gambling makes your AGI number bigger. A big AGI can make your tax credits smaller or even eliminate them completely. I’ve seen families lose their entire EIC refund because they have gambling winnings that they had to report.
On the flip side, let’s say you’re a high income earner and you’ve got a big gambling win. When your AGI goes up and it can trigger the Alternative Minimum Tax. Once again, even though you’ve written off your gambling winnings completely, you can still get socked with more tax. I’ve had that happen to clients as well.
Now you might be thinking—well gee, I just won’t report my gambling winnings at all. Sorry, but that’s not an option. W-2Gs are reported to the IRS. If you don’t report your gambling winnings, you will get a letter.
I didn’t mean to sound like a complete party pooper. Let’s face it, if you win big that’s pretty cool! But if you do win big, it makes sense to do a little tax planning. You want to enjoy the fact that you won and not have to suffer for it months later.
Editor: And remember, what happens in Vegas, stays in Vegas!
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Good question. I bet you’re looking for a yes or no answer though and it’s not quite that easy.
Everybody talks about the “death tax” but for most people, there’s no such thing. Generally, if you inherit money, you do not pay tax on it. There are a couple of states that tax inheritances, but the federal government does not.
But… (You were waiting for the ‘but’ weren’t you?) While you won’t be taxed on the inheritance itself, you can be taxed on the income of a deceased person’s estate. The easiest way to explain this is with an example.
Let’s say your Uncle Bob dies and leaves you $10,000 in his will. Cool. You get $10,000 cash, and that’s it. There’s no inheritance tax. He just left you a dollar amount; nothing to it but cash.
But what if instead of just leaving you cash, your Uncle Bob left you half of his estate? Suppose he leaves half of everything he owns to you and the other half to your sister. Let’s say he has $50,000 cash in the bank.
It might take some time for the estate to settle and for you and your sister to get what’s coming to you. During the time after your uncle’s death and before you settled the estate, the estate (that is, the stuff your uncle used to own) made some money. Interest was paid on the bank account. While you won’t pay tax on the $25,000 cash you get, you will pay tax on the interest that the cash earned while it was part of the estate. It will be “passed through” to you as the beneficiary.
That’s the part that’s really confusing to most people. You read the IRS books that say inherited money isn’t taxable—it isn’t. But the income that money earns while it’s sitting in the estate is.
The taxable income will be reported on a document called a K1. If you’ve never seen one before, it’s a little intimidating. But if you’re doing your own taxes, you just input the numbers from the K1 into the boxes in the software and you’re going to be okay.
So, if the $50,000 in the bank earned $1,000 in interest and you’re supposed to get half of the estate, then you’ll pay tax on $500 (your share of the interest earned) and you’ll get $25,500. (Half of the $50,000 plus half of the interest earned.)
Now, realize that I’ve really simplified this. Usually there’s more than just a bank account. There will be stocks, a house, maybe even a business. But the idea is basically the same: you pay tax on the income that the estate earns, but you don’t pay tax on the value of the actual stuff in the estate. (If we’re looking at estates that are worth over $5 million dollars, referred to as the $5 million estate-tax exemption—that’s another story, but that’s not what I’m talking about today.)
The Jan Tax Plan
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After two weeks of political conventions I thought I’d know a whole lot more about the tax plans for the Republicans and Democrats. Oh, I’ve heard some high minded ideal stuff—but not much in the way of nuts and bolts. If you’d like to do a comparison, you can check out the Tax Foundation’s website to see how they compare and how they compare to the Simpson Bowles plan too: http://taxfoundation.org/article/romney-obama-simpson-bowles-how-do-tax-reform-plans-stack
But since Romney and Obama didn’t give me what I wanted to hear, I decided to make up my own tax plan. To be honest, it’s more of a reflection of problems that I see with tax returns that I actually work on but these are the top changes that I would make if I were in charge.
1. Earned Income Tax Credit: First I’d reduce EIC payouts by 10% per year until it’s reduced by 30%. In order to claim EIC for a child, you’d be required to produce the child’s report card with passing grade. Why the cuts and why the extra requirements? First, the EIC credit is so high right now that it encourages fraud. Currently, the IRS estimates that between $12 to $14 billion dollars of EIC fraud occur every year. If the payout wasn’t so high, the temptation for fraud wouldn’t be so great.
The extra requirements would help ensure that the kids in our communities get a better education. Everybody gives lip service to more education, and parental involvement is key to kids succeeding in school. Well, if your kid is required to pass school in order to get the Earned Income Tax Credit, I think we’d have a whole lot of parental involvement. No report card, no money.
If the child is too young to attend school, a current immunization record would be required. It’s proof that the child is getting proper medical treatment.
One more thing on EIC—if a person is caught fraudulently claiming a child on his/her tax return, the penalty, besides paying back the tax, should be never being able to claim EIC again. Ever! I work with a lot of the EIC fraud victims, I think they’d really like that rule.
2. Self-employment income: If you receive 1099 MISCs and the total amount is less than $4,000—you should have the option to elect to count that as “hobby” income instead of automatically being taxed as self employment. Currently, if you receive a 1099 MISC, it’s counted as self employment and taxed an extra 13.3% on top of your regular taxes. For someone like me, that’s fine. I own my business, I write of my expenses—it’s the way it works. For many people, they have no clue they’re considered self employed. The small amount of income is a hobby or not a real business. $4,000 to me seems to be the break point between hobbyists and business owners.
I say, that if you elect to claim the income as “not self employment” then you can’t write off expenses. If you elect to claim that you’re in a business, you can’t go back later and call it a hobby in later years. That keeps people from jumping back and forth.
3. The Alternative Minimum Tax: This one is my pet peeve. The AMT adjustment was set in 1969 and hasn’t been adjusted. Right now, Congress basically votes for a “patch” every year. Why they wait until December to do it is beyond me. I say that we should adjust the AMT threshold for inflation and automatically adjust it every year to correspond to the rate of inflation. Normal people can’t plan their taxes without knowing about AMT. The fact that this has been going on for so long is ridiculous.
I could probably go on and on but these are my top three. What would you change if you could fix the tax code?
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This is one of those questions I hear all the time: Why do I have to pay tax on my cancelled debt? It’s not income so why am I being hit with income tax?
Here’s the situation—you’ve rung up some credit card bills and then you couldn’t afford to pay them off. You make a deal with the credit card company (or more likely a debt collector) and you agree to pay half of it and they cancel the rest of the debt. Sounds like a pretty sweet deal doesn’t it?
At least it sounds like a sweet deal until tax time. What happens then is that you get a statement called a 1099C form which shows that your debt was cancelled and it becomes taxable income to you. Not so sweet.
But why does it count as income? This one’s easier to explain with an example. Let’s say you charged $20,000 worth of stuff. Let’s say you bought shoes, clothes, a big screen TV and some furniture all on credit. Or maybe you charged medical bills and food. It doesn’t matter what you did to acquire the debt. The results are the same. Then let’s say you lost your job and couldn’t pay for it. The credit card company charges interest on the amounts not paid and the bill goes up to $23,000. You’re in over your head so you get some help from a credit card counselor. With a loan from your parents you settle the bill for $13,000. Now you’re free and clear of the debt.
But tax time comes and you get a 1099C stating that you have income of $10,000 which is the amount of your credit card debt that the credit card company forgave.
It’s counted as income, because unlike your parents, the credit card company didn’t make it a gift. For the credit card company, if they write off your debt, it’s a business expense, and that makes it a deductible business expense to them. If they were to just give you a gift, that’s not a deductible business expense.
You might be thinking that it’s not fair—but in reality, it’s not only fair, but it’s absolutely necessary. You see, the credit card company has to report what you charged as income. Let’s take that TV as an example. You charge $1,000 for the TV and the credit card company is required to pay $1,000 to the store. They record the $1,000 as income to the credit card company and then they expense the $1,000 they paid to the store—they haven’t gotten the $1000 from you yet, but since you’re going to pay it, they report the income. It’s called accrual basis accounting.
But now you’re not going to pay them. They’re already out the $1,000 they paid to the store for your TV and now they’re not going to get the money that they’ve already had to pay their income tax on. So when they get to the point that they’re going to cancel your debt—well they have to issue you the 1099C to prove they cancelled the debt and claim their tax deduction.
But why do they add the interest into it? Once again, they already counted the interest that you should have been paying on that debt as income.
Remember, it takes money to pay for things you want and need. We pay for those things with our income. Usually we think of income as wages, but if we buy stuff and then don’t pay for it, that’s also a kind of income to us as well.
For more information on cancellation of debt, see my blog post titled How to Report Debt Forgiveness (1099C) on Your Tax Return.
In my last post I wrote about why debt forgiveness counts as income, but I didn’t explain how to report it on your tax return. And it’s important that you do report it, or you’ll be getting a nice little letter from the IRS asking you why you didn’t.
First and foremost, if you received a 1099C for cancellation of debt on mortgage interest, you should be reading a different post. See: http://robergtaxsolutions.com/2011/11/what-you-need-to-know-if-your-mortgage-debt-is-forgiven/ What I’m talking about here is cancellation of credit card debt. It doesn’t get treated in exactly the same way as mortgage interest.
Generally, if you receive a 1099C statement, I think you should see a tax professional—and make sure it’s someone who’s worked on debt cancellation issues before. Not everybody does that. I once had a client who had called around and I was the 5th person he called before he found someone with debt cancellation experience. He had started at one of those big box tax places and was told that he owed the IRS $14,000. That’s when he started thinking he wanted a second opinion. When I did the return, he actually had a refund.
To be fair, his case was unusual and he managed to catch all the breaks in the tax code—but if he didn’t have someone who knew the tax code and where the breaks were—well then he would have been paying $14,000 in income taxes that he didn’t really owe.
So how do you report income from cancellation of debt? Basically, it goes on line 21 of your tax return, in the other income category. It gets taxed just like anything else that goes on that line—at your regular income tax rate. That’s what happened with the $14,000 fellow—his preparer put his 1099C income on line 21. While that’s the correct way to report 1099C income, she had neglected to look for exceptions to see if some (or all) of it might not be taxable.
The two most common exceptions to having your 1099C income being taxed are bankruptcy and insolvency. In bankruptcy, you’ve actually filed for bankruptcy and your case is either under the jurisdiction of the court and the court has granted a discharge of indebtedness—or is under a plan approved by the court. Bottom line—you’ve got the legal paperwork to back up your claim that you should be exempt from tax on your cancelled debt.
With insolvency—it means that your liabilities exceeded the fair market value of your assets immediately before the discharge. Okay, in English. Let’s say you owed $10,000 on a credit card—that’s a liability. Your assets included a car, some clothes, a TV, a little cash in the bank that the value of all that totaled $7,000. Since your liabilities (the $10,000) are more than your assets (the $7,000) you are insolvent by $3,000. So if the credit card company discharged $5,000 of your debt, you would be able to exclude $3,000 from tax but you’d still pay tax on the $2,000 that you weren’t insolvent on.
To report an exclusion of cancelled debt from taxes, you’ll need to use Form 982. Here’s a link to that: http://www.irs.gov/pub/irs-pdf/f982.pdf
If you think you might qualify for the insolvency exclusion, you’ll want to fill out the worksheet located in publication 4681, it’s on page 6. http://www.irs.gov/pub/irs-pdf/p4681.pdf
Now to be perfectly honest, I’ve really oversimplified this for the sake of brevity. Many people will have cancelled debt and won’t qualify for any tax forgiveness. Also, it’s important that you don’t file for tax exclusions if you don’t qualify for them (it’s a type of fraud—you don’t want to go there.) And it’s quite possible that you can do everything right with the 982 form and you’ll still get a letter from the IRS asking you to confirm something. (That actually happens quite often so don’t be surprised—it’s pretty normal.)
There are two really important issues you need to learn from this blog post:
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It’s back to college time and lots of students have employment on or off campus. Here’s a rundown of what is and what isn’t taxable to students.
Scholarships and fellowships: If you are a degree candidate, you can exclude from your income scholarship money used for tuition and fees, or for classroom books, fees, supplies or equipment. If you use your scholarship for room and board, that’s taxable. If you are not a degree candidate, then all of your scholarship or fellowship is taxable. For example: let’s say you received a scholarship for $40,000. Your tuition is $32,000 and your room and board is $8,000. $8,000 of your scholarship would be taxable. (Of course, saving your receipts for your books and fees would reduce your taxable portion.)
Most students who receive scholarships are not going to be taxed on them, but every year I come across at least one student who received a free ride and wound up having some taxable income from it. It’s just something you need to be aware of.
Fulbright students and researchers: these follow the same rules as scholarships and fellowships.
Fulbright grant for lecturing or teaching: this is a little different, it counts as a payment for service and that’s taxable. You need to know the difference once you’ve got a Fulbright.
Pell Grants, Supplemental Educational Opportunity Grants, and State Grants: these are not taxable as long as they are used for tuition. I’ve seen cases where students get these grants and don’t go to school and go to school and use the money for something else instead. (Okay, true story, one got a breast enhancement and went to work for Hooters.) If you do that, the money will be taxed. Your Pell Grant is for tuition!
Reduced tuition for school employees and their children: this is not taxable to undergraduate students, but taxable to graduate students. There is an exception for the graduate students though, if they perform teaching or research activities, then the reduced tuition is tax exempt.
Contest prizes: If you win a prize but you don’t use it for education, then it’s taxable. If it’s used for tuition and fees, then it’s not.
ROTC: the subsistence allowance that you get paid in advanced training is not taxable, but the active duty pay you get is something like the summer advanced camp and is taxable.
Work study jobs count as wages and you should be getting a W2 for that work just like you would any other job. That’s taxable income.
Self-employment: this is really tricky because companies often hire college students for jobs but they’re not employees, they’re contract labor. In a case like that you have to pay self employment tax. Right now, that’s 13.3% of your income over and above and other income tax you might have to pay. I see lots of students get burned at tax time because they didn’t know about that little rule. It’s often called a 1099 job. It’s okay to have a 1099 job, but just know there are extra taxes involved. If you’re thinking about taking a contract labor job, check this site out for more information: http://robergtaxsolutions.com/2010/09/employee-or-contract-labor/
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There’s an email going around saying that President Obama’s finance team wants to tax direct deposited Social Security checks at 1% and that’s why everyone will be required to direct deposit their check starting in 2013. The bottom line with this is—it’s a bunch of horse hockey. (I like to keep my blog at a G rating.)
Let’s start with some background on the issue. It’s actually a recirculation of an old email from 2010 when the bill was originally introduced by a congressman named Chaka Fattah of Pennsylvania. He originally proposed this legislation with the name “Debt Free America Act” which was his plan to eliminate the national debt. (Back then the national debt was around $10 trillion as compared with today’s almost $16 trillion.) Here’s a link to his post about the bill which is dated April 15, 2010: http://fattah.house.gov/latest-news/fattah-my-bill-erases-the-national-debt-and-abolishes-april-15-as-personal-income-tax-day/
There are two really important things to know about this bill:
1. This is not an Obama Administration bill. It wasn’t a Bush bill either. Now, I’m making a guess but I think I’m pretty safe in saying that Romney would never support this bill either.
2. The bill already died a quiet death in committee. There was never even a floor vote. Nobody supported this bill except for Mr. Fattah.
So why am I writing a blog in 2012 about a phony email that started in 2010? Because the email is still going around! I just got it last week. And when somebody sends me an email about taxes I check it out.
So what else do I know about this bill? Well, Mr. Fattah re-proposed his bill in March of 2011 as HR1125. Once again, it went to committee the same day and nothing has happened since. There are no cosponsors to this bill. Not Tom Harkin, not Peter Defazio, not Nancy Pelosi; nobody.
If you still want more information, check out the Snopes.com article debunking it: http://www.snopes.com/politics/taxes/debtfree.asp
So folks, your Social Security checks are safe. If you get this in your email box, just delete it because it’s not true.
Photo by Jan Roberg.
People often ask me if their Social Security income is taxable. No, sorry, I just lied. When I finish preparing a tax return for someone on Social Security I’ll often hear, “What do you mean my Social Security is taxable? ” People who say that are usually angry when they say it too. But, for many people, Social Security is taxable.
So how do you tell if your Social Security is going to be taxed? Here’s the quick and dirty way to figure it out. First, take half of all of the Social Security income you get and add that to all of the other income you get. If you’re single and the amount is over $25,000 you’ll start getting hit with tax. If you’re married filing jointly—then you’ll start getting hit at $32,000. If you’re married-filing separately and don’t live apart—then it’s all taxable.
So this can totally mess up your tax rates. For example—let’s say you ‘re currently in the 15% tax bracket and you haven’t crossed into “Taxable Social Security Land” yet, but you’re right on the border. You want to take a really nice vacation and it’s going to cost you $10,000. How much money do you need to take out of your IRA to go on vacation and pay the income tax?
Well, you know you need 15% more for the tax so let’s say you take out $12,000.
$12,000 X 15% = 1800
That means that you’ll have $10,200 for your vacation, right? (12,000 IRA – 1,800 income tax = 10,200 vacation money)
Looks good, except it’s wrong. See, if you’re on that border, then half of the $12,000 is going to go into the taxable Social Security pile. So instead of paying 15% on $12,000 you’re paying 15% on $18,000; that’s another $900 in taxes. ($18,000 X 15% = $2,700 and $2,700 – $1,800 = $900)
Now you don’t have enough money to pay for your vacation. You’ll need to be taking more out of your IRA and then even more of your Social Security will be taxed.
Because taking that distribution makes your Social Security Taxable—your real tax rate is 22.5% instead of 15%.
$2,700 tax divided by $12,000 distribution = 22.5% tax rate
For lots of people, there really isn’t much you can do. If your income is high enough, you’re stuck with your Social Security being taxed and there’s no way out. But for some folks—you can plan ahead to avoid this bumped up tax—or at least try to reduce it. You’ve got to know about the tax though if you’re going to plan ahead for it. If you want help figuring out if your Social Security is taxable, give us a call.