6 Times You May Be Surprised By Unexpected Taxes
January 10, 2023
by Jerry Zeigler
Usually, we know what income gets taxed based on our experience. But sometimes, we just don’t think about it. With our busy lives, most of us aren’t thinking about taxes all the time. So SaverLife is here to help!
Here are some situations when you may have taxable income that may surprise you when you file your taxes. Note: This discussion is focused on federal income taxes. State income taxes may or may not follow what the federal government does for these situations.
1) Sign-on bonuses with banks and other institutions
We are usually talking about money or physical items here. If you get points for a credit card, the IRS views points as discounts and not as income. If a bank gives you a sign-on bonus in money form, it is taxable whether the bank sends you a tax document (usually a 1099-INT in this case) or not
But what if they give you a toaster? The IRS provides guidance there. If the deposit to the account is less than $5,000 and the value of the toaster is more than $10, the value of the toaster is taxable. If the account deposit is $5,000 or more and the value of the toaster is $20 or more, the toaster is subject to taxation. This rule generally applies to all non-cash incentives.
2) Canceled debt
Sometimes canceled debt is taxable, and you will often receive a Form 1099-C reporting the canceled debt. The lender is required to provide the 1099-C for canceled debt of $600 or more, unless they know one of the exceptions applies.
One exception, under current tax law, is that debt canceled due to federal student loan forgiveness programs is not taxable (a few states will tax this canceled debt). The most common way to avoid taxation of canceled debt is if you are insolvent. The concept of insolvency, more exceptions, and more details regarding canceled debt and taxes can be found here.
3) 401K loan or loan from another employer-sponsored qualified retirement plan
Often you’re permitted to take out loans from employer-sponsored retirement plans like 401Ks. I don’t view this option as the best first choice for a source of funds, but it can be the best option available at times. Normally you make the payments, and there is no tax impact.
Taxes may come into play if you leave the employer. If you leave the employer, you have up to 60 days to repay the loan in full. Otherwise, it is considered to be a withdrawal. If you aren’t eligible to make a qualified withdrawal, this can mean both taxes and a 10% penalty will be owed. There aren’t any exceptions for the taxes, but there are some exceptions for the penalty, which can be found here.
Besides paying the loan back, taxes and penalties can be avoided by putting the equivalent of the outstanding loan amount into an IRA or qualified retirement plan by the due date of the tax return filing (including extensions) for the tax year the loan is considered a distribution.
4) Selling your stuff
If you make a profit selling personal items and goods, then it is taxable. Yes, even your old jeans, but you only make a profit if you sell it for more than you paid for it.
You should consider whether or not you can prove how much you paid for the items. Some of us keep receipts for big-ticket items, but most of us don’t keep records of all purchases. If you can’t prove how much you paid for an item, generally, the sale price will be considered to be the profit.
You may have heard that for tax year 2022, digital platforms and other entities that process payments and money transactions have additional reporting requirements in reference to the 1099-K form. However, the IRS has chosen to delay these requirements until next tax season. Learn more about the 1099-K changes here.
5) Short-term disability
You might think this should be a simple one. Maybe it should be simple, but it isn’t. Generally speaking, the following are true:
- If you paid for your short-term disability coverage, then when you receive payments, the payments are NOT taxable.
- If your employer pays for your short-term disability coverage, the payments you receive are taxable.
- If you receive state-sponsored plan disability payments, they are taxable, except that it can be a “maybe” if you have made payments into the plan. If you have made payments, you can avoid taxation up to the sum equal to your total payments.
Payments from some insurance products may or may not be taxable.
Clear as mud? It can be confusing and complicated, so it’s best to tread carefully. To learn more about whether your disability income is taxable, a good starting point is Publication 525, Taxable and Nontaxable income.
6) Social Security
For Social Security payments, there are NO taxes on Social Security IF your annual income is below these base amounts listed by your filing status (using a calculation which only counts half of your Social Security):
- $25,000 if you’re single, head of household, or qualifying widow(er),
- $25,000 if you’re married filing separately and lived apart from your spouse for the entire year,
- $32,000 if you’re married filing jointly,
- $0 if you’re married filing separately and lived with your spouse at any time during the tax year.
If you’re filing single, your Social Security income is $20,000, and if your pension income is $10,000 for the year, then: ($20,000/2) + $10,000 = $20,000. This is less than $25,000. Therefore, none of the Social Security income is taxable.
If single (or head of household, or qualifying widow(er), etc.) and half your Social Security payments plus your other income is between $25,000 and $32,000, up to 50% of your Social Security is taxable. If the total is greater than $32,000, up to 85% of your Social Security is taxable.
If filing jointly and your total is between $32,000 and $44,000, up to 50% of your Social Security is taxable. If the total is greater than $44,000, up to 85% of your social security is taxable.
The IRS provides an Interactive Tax Assistant to help you determine if your Social Security payments are taxable.
No one likes tax surprises. One method to help you avoid tax surprises is to use the IRS starting position, which is that any worldwide income is taxable until it is proven that the income is not taxable. This can be a good approach for taxpayers who are trying to sort out which income is taxable and which is not. A good starting point to determine which income is taxable is IRS Publication 525, Taxable and Nontaxable income.