Greg Rosica, CPA, CFP, a partner with the accounting firm Ernst & Young who specializes in private client services and tax consulting, New York City. EY.com
Buried treasure…generous gifts from your employer…and that iPad you got as a gift for opening a bank account—they all have something in common. The IRS defines them as income and expects you to pay federal tax on their cash value.
Americans underreport an estimated $68 billion in personal income annually, sometimes intentionally but often because they don’t realize it counts as taxable income. Many establishments such as casinos aren’t even required to notify the IRS that you have received income unless the income tops a certain threshold. But in some cases, failing to report taxable income can trigger an audit and/or result in civil penalties ranging from “failure to file” penalties (up to $135 if you are more than 60 days late) to “failure to pay” penalties (0.5% of the amount of unpaid tax per month).
Surprising things that are taxable…
Many financial institutions offer incentives for opening new accounts, ranging from cash and electronic gadgets to frequent-flier miles. These generally are considered taxable income unless you must spend a certain amount on a credit card or debit card within a limited time period. Important: Frequent-flier miles and cash back that you receive when you use a credit or debit card are not taxable because they are rebates.
When someone negotiates a settlement with a credit card issuer to pay less than the full amount owed, the IRS treats the forgiven debt as income. So if you owe, say, a balance of $25,000 and the issuer settles for $18,500, the $6,500 difference counts as taxable income.
Exceptions: Credit card debt discharged in a Chapter 11 bankruptcy does not count as income. And in cases of insolvency, you may not have to pay tax on all or possibly any of your forgiven credit card debt. Just before any of the debt is forgiven, if your total debt exceeds your total assets (excluding assets that creditors can’t seize, such as 401(k) accounts), you are insolvent by that excess amount. You subtract the insolvency amount from the forgiven debt to get the amount of taxable income. So if your total debt exceeds your assets by $5,000 and your credit card issuer forgives $6,500, you report $1,500 of the forgiven debt as income.
Whether you rob a bank or win an illegal football betting pool at the office, the IRS expects you to pay tax on any ill-gotten gains, although few lawbreakers choose to do so. Although the IRS technically must keep the contents of your tax returns confidential, there are enough legal loopholes that law-enforcement agencies are likely to find out if you are including ill-gotten gains as part of your income. For instance, if the IRS audits you, it is allowed to reveal certain information to law-enforcement authorities that it gathers from outside sources, such as witnesses to your illegal activities.
There’s a better way to gain from illegal profits—report other people who are tax evaders. The IRS Whistleblower Office paid out more than $50 million in awards in 2014 to tipsters—they typically get 15% to 30% of the amount the government eventually collects. And yes, any money you get as a whistleblower is regarded as taxable income on your own return. More information: IRS.gov/uac/Whistleblower-Office-At-a-Glance.
Generally, you aren’t required to pay tax on gifts you receive from family and friends no matter how much they’re worth. But most sizable gifts from your boss or company are regarded as taxable compensation subject to federal and state income tax withholding as well as FICA taxes. This includes everything from golf clubs to the use of a company-owned apartment for a vacation.
Two exceptions: “De minimis” fringe benefits—gifts of minimal value, which some employers define as $75 or less but which the IRS has not defined—generally are not taxable. That includes, for example, a holiday gift basket, group meals and picnics, and local transportation after hours if it is required because of security concerns. Cash and gift cards generally are not included under the de minimis rule—they typically are taxable—but gifts awarded to employees to recognize their achievements for “length of service” are not taxable if you have been with the company for at least five years and the value of the award is $1,600 or less.
The IRS expects you to report all “gambling” winnings, no matter how small, whether they come from church bingo games, raffles, sweepstakes, lotteries, casinos or online sports fantasy betting sites. If you win more than a certain amount, ranging from $1,200 (bingo and slot machines) to $5,000 (poker tournaments and lotteries), the gambling establishment typically withholds a 25% flat tax and must notify the IRS…and then you adjust that for your tax bracket when you file tax forms. The good news: If you itemize, gambling losses are deductible up to the amount of winnings you report as income. You must be able to prove your losses through documentation such as receipts, tickets, payment slips and/or a gambling diary with specific dates, the type of gambling, and the names and addresses of the establishments and the names of other people accompanying you at the establishments.
Services such as Airbnb.com that enable you to rent out available rooms in your house or apartment to travelers have allowed hundreds of thousands of home owners to earn extra income. The IRS considers any short-term rental income taxable if you rent out space for 15 or more days a year. Be aware that additional taxes imposed by your local and state government also may apply. Example: Chicago, Philadelphia, San Diego and San Francisco are among cities that impose a “transient occupancy” or hotel tax on every short-term rental stay.
You can reduce the taxes you owe on rental income by taking related deductions. In addition to a portion of your own rent or mortgage payments, utilities and insurance expenses, you can deduct items such as the cost of sheets and linens that you designate for the exclusive use of your guests…toiletries for guests…and cleaning fees. Helpful: Get more strategies at websites of the major online lodging services, LearnAirbnb.com and Community.HomeAway.com.
“Treasure Trove” is a fanciful term used by the IRS to categorize any lost or abandoned cash and/or valuables that you find. Precedent for taxing treasure troves dates back to a famous 1964 case in which an Ohio couple bought a used piano for $15 and found $4,467 in cash inside while cleaning it. Recent cases involve fans who have caught historic home run baseballs in stadiums. The balls are taxable based on “fair market value.”