You always try to be on top of your taxes, you have all the receipts, the forms, statements and miscellaneous other papers and you try to be as thorough as possible. Surprises can be nice, but the wrong surprises from Uncle Sam at tax time can be terrible.
Unfortunately, tax law is complicated and with the ongoing creation and cessation of different tax regulations, acts and policies, even an expert will get tripped up in the process. Knowing what and whatnot to declare and where to declare it then becomes taxing on you.
Explained below are 5 terrible tax surprises, which you could run into while completing your taxes and how to avoid them so you’re not hit with a big bill come April.
1. Unemployment Benefits
The first of the 5 terrible tax surprises applies if you are currently financially supported by the federal government, you must understand this, your unemployment benefits are considered a taxable income and you will owe a portion to the U.S. Treasury.
You have two options to consider in this situation;
- The first option is to choose to withhold federal income taxes by completing Form W-4V, Voluntary Withholding Request, or a similar document, provided by the benefit agency and accepted by the IRS. Hereafter, the required portion of your benefits will be withheld each pay period, much like a standard payroll system.
- The second option is to make payment on estimated taxes. Rather than surrendering a portion of your benefit at each pay period, you can choose to pay your tax each quarter based a calculated approximation of what you expect to earn for the year using Form 1040-ES, Estimated Tax for Individuals. Make sure you recalculate your estimate each quarter though, as both overestimating and underestimating your earnings can incur penalties.
Going through a divorce is never a happy occasion nor is it easy, but once it’s done, it’s done and you can get on with the rest of your life with a little help from your ex via alimony payments. The future never looked better, however, that regular payment you receive from your ex is considered a taxable wage and the U.S. Treasury will require its cut. This is number two on our list of 5 terrible tax surprises.
Your best option here is to go the estimated taxes route outlined previously. Make sure to consider all alimony, maintenance remuneration and similar payments received as well as any other untaxed funds received all on the one form; otherwise you could find yourself under examination by one of Uncle Sam’s auditors.
Other notes to consider regarding alimony;
- Money received for child support is not tax applicable.
- If you are the payer of the alimony, the maintenance amount is tax deductible.
3. Forgiven Or Cancelled Debt
Woo-hoo, you’re debt was cut by $5,000, or maybe you’re really lucky and the debt has been forgiven or cancelled. Financially things are looking up again, until you still have to pay the U.S. Treasury on the previously owing amount – welcome the third of the 5 terrible tax surprises. When you borrow money you have an obligation to repay the lender and therefore do not have to declare the loan amount in your earnings. However, if you are granted forgiveness or the debt is cancelled, the previously outstanding amount is now classed as income to yourself.
For every rule there is an exception. If you took out a loan between 2007 and 2014 to buy, build or improve your primary residence and then later have your outstanding mortgage debt forgiven or cancelled, you may not have to declare the amount as taxable income according to the Mortgage Forgiveness Debt Relief Act of 2007. However, you are restricted by a limit of $2 million, unless you are a married person filing separately, in which case the limit is $1 million.
At this time it is not known if the Mortgage Debt Relief Act will continue and so for now we have to assume that from 2015 any forgiven or cancelled debt will have to be declared as taxable income.
4. Prize And Awards
We’re almost at the end of this 5 terrible tax surprises list so hang in there for the penultimate way you didn’t know you’d have to pay tax on. If you’ve recently exclaimed “Bingo!”, “I won”, or “I’m here to claim my prize”, you may think you’ve come into some easy money. It goes straight in your pocket, or maybe even into your garage, right? Wrong! Any winnings, whether cash, property or otherwise, have a value and that increased value to you is treated as income. Therefore, all prizes and awards must be declared as “other income” on your Form 1040. This includes winnings from gambling; however, you are able to subtract your losses from your total winnings to reduce the total tax owed.
Pay especially close attention when reporting prizes other than cash as underreporting could have you in trouble with Uncle Sam. Most businesses or groups prizing non-cash goods will provide you with a Form 1099-MISC, Miscellaneous Income, which states what the item is worth at the time of award. Suddenly that year’s supply of pet food doesn’t seem like such a great saving.
5. Social Security Benefits
You’ve spent the better part of your life at work, in a job, building a career, making a living, earning your paycheck, a paycheck less Social Security taxes of course. But now you’re retired and ready to live off those taxes you’ve been passing onto Uncle Sam to hold for some 40 years. Unfortunately it’s not always that simple and this brings us to the final of the 5 terrible tax surprises.
If your Social Security benefits are your only source of payment then the full amount is non-taxable. That’s the simple part! However, it gets more complicated if you also receive some other source of income along with government support. In this case, the amount of your Social Security benefit subject to tax will vary depending on your individual situation, but it can be as high as 85%.
You can calculate the amount owed using the worksheet in tax Form 1040 or 1040A. Once you know how much you owe you can choose to use Form 1040-ES and pay estimated taxes quarterly or withhold your federal income tax by filing Form W-4V with the Social Security Administration.