Your mom may have told you that life isn’t fair, and no one claims that life is easy. Taxpayers in certain situations may agree with both of these sentiments.
The tax law is complex and difficult even for experts to negotiate. Just when you think you’ve followed all the rules and researched all the angles, a tax regulation blindsides you.
Here are five terrible tax surprises that you might encounter during tax season and how to deal with the consequences.
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Unemployment benefits are taxed
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Under tax law, unemployment is considered wage income, and the IRS wants a cut.
Now that you’re over the shock and anger, what can you do?
When you apply for unemployment benefits, consider having federal income taxes withheld. This process is similar to regular payroll withholding. In this case, you fill out Form W-4V, Voluntary Withholding Request, or a similar IRS-acceptable document that the paying agency has created. This way, taxes will be withheld at the rate of 10 percent of each unemployment payment.
If you can’t afford to surrender a chunk of each unemployment check to withholding, look into payingestimated taxes. This will help you avoid owing a large lump-sum tax bill when you file.
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The IRS wants a piece of alimony
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Ending a marriage is never a happy event. If you got a good settlement, those regular checks from your ex-spouse are taxable.
Alimony, separate maintenance payments and similar compensation from your former spouse are taxable to you in the year you receive them. Child support money, however, is not taxable. If your divorce decree calls for alimony and child support and specifies amounts for each, you owe the IRS only for the alimony payments.
To avoid a big bill in April, make your IRS payments on alimony and other untaxed income via estimated tax filings.
The one good tax surprise here is for the ex who’s paying spousal support. Those amounts are tax-deductible.
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Forgiven debt is taxable income
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Getting your credit card bill cut from $8,000 to $4,000 certainly helped your personal bottom line. It also could be a boon to the U.S. Treasury.
Why? Whenever you get a creditor to write off debt, the tax law generally considers the amount earned income. That means it’s taxable to you. Expect the accommodating debtholder to send you (and the IRS) a Form 1099-C or similar statement detailing your discharge of indebtedness as miscellaneous income.
Not every debt settlement, however, has to pad Uncle Sam’s pocket. Under the Mortgage Debt Relief Act that became law in 2007, some homeowners who were granted forgiveness of mortgage debt in 2016 won’t have to pay taxes on that amount.
There are some restrictions:
The forgiven debt amount is limited to up to $2 million, or
$1 million for a married person filing a separate tax return.
The forgiven loan must have been taken out to buy or build a primary residence, not a second home or vacation home.
This tax break is temporary and will end if Congress doesn’t retroactively extend mortgage debt relief beyond 2016.
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Prize winnings can bring a tax bill
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Think you’re pretty lucky because you won $1,000 in a contest?
Prize winnings are included in the long list of “other” income that tax law says is taxable. And it’s not just limited to cash awards. You have to pay taxes on the fair market value of any property you win.
Be careful when reporting the amount of a noncash prize. In most cases, companies and groups that award prizes, cash and property will send you a 1099 form declaring the value of what you won.
Note that gambling proceeds are taxable, too. But at least you get the chance to reduce the tax bite here by subtracting any betting losses from your winnings.
When you retire, some of your Social Security benefits may be taxed.
Generally, if Social Security benefits are your only income, your benefits are not taxable. But if you collect Social Security plus other income, as much as 85 percent of those government payments could be subject to tax.
To figure out just how much in taxes your Social Security might cost you, you’ll have to do some calculating using the worksheet found in your tax Form 1040 or 1040A. Or your tax software will automatically figure your tax liability for you.
If you discover that you will have to pay taxes on Social Security benefits, there are two ways to deal with them:
You can make estimated tax payments to cover what you owe.
You can have federal income tax withheld from your benefits by completing Form W-4V, Voluntary Withholding Request, and filing it with the Social Security Administration.