Terrible Tax Surprises to Avoid

Understanding the tax laws is not an easy task even for the experts. Thus, tax surprises are not uncommon even when a person thinks that he or she followed all the applicable tax laws relevant for his or her income. However, early knowledge regarding potentially terrible tax surprises could help a person deal effectively with its consequences and prevent being taxed unduly in the future.

‘Unemployment benefits have been taxed’

Just when a person thinks being unemployed safeguards him or her from income tax, the law proves the person wrong. The reason being, the Internal Revenue Service (IRS) considers unemployment benefits taxable income. Thus, the tax exemption received by the unemployed person at the time of receiving the benefits is actually a tax withholding which should be paid later, or with each pay cheque. However, it is possible for a person to pay an estimated tax of 10 percent with each unemployment benefit in order to avoid having to pay a large lump sum following full receipt of unemployment benefits, or during the tax season. At the same time, entire unemployment benefit is not taxable in most instances, as the IRS calculates the amount received in excess to their designated benefit level, in order to calculate the tax deductions.

IRS going after ‘Alimony’

Receiving alimony following a divorce case is also considered an income and therefore is taxable. However, the child support money received in addition to alimony shall not be taxed according to law.  Thus, tax consultants advocate paying the due taxes for alimony and other untaxed income through an estimated tax filing through the IRS before receiving a large tax bill.

‘Cancelled debt has been considered an income’

If a person receives a debt reduction, as in the case of a cut in his or her credit card bill, the tax office considers this reduced amount as an income. However, certain mortgage debt reliefs do not fall into this category and therefore is not considered taxable. Even in such instances, the mortgage debt relief would be subjected to a maximum, and the IRS would consider the time period on which the debt relief was given as well as the purpose for which the mortgage has been obtained for considering tax relief.

‘Part of lottery winnings gone to IRS’

Being lucky enough to win a lottery does not mean a person is lucky enough to receive untaxed income. Even the lottery winnings, whether it is cash or property, is considered an income and therefore is taxable. Same criteria apply for prizes of any sort as well as for the gambling proceeds.

‘Social security benefits have been reduced by taxes’

Usually, when a person retires, if social security is his or her only declared income, tax deductions would not be made. However, if the person receives additional income in excess of a stipulated income level, there can be a significant tax deduction from social security benefits. As with many other surprise taxes, the person can choose to pay these taxes as estimated tax payments or request to withhold the tax using relevant forms.

According to the IRS, taxpayers can make use of the worksheet in publication 919 to calculate their proper tax withholding. This can avoid unnecessary surprises when it comes to paying the dues as well as close scrutiny from the part of the IRS in instances where there is a suspected underreporting.