Wednesday, March 5, 2008

Taxable Income & Gifts: Am I Screwed? PART ONE

So, you've received a gift from a relative of a sizable sum. And it's tax time. What do these things mean? Headache and worry. Do I report? Is it taxable?

Let's get into what is and is not taxable first.

The basic distinction that makes something taxable or not taxable is whether or not it can be included as income...

Some common examples of items that are not included in your income are:

  • Adoption Expense Reimbursements for qualifying expenses
  • Child support payments
  • Gifts, bequests and inheritances
  • Workers’ compensation benefits
  • Meals and Lodging for the convenience of your employer
  • Compensatory Damages awarded for physical injury or physical sickness
  • Welfare Benefits
  • Cash Rebates from a dealer or manufacturer
  • Tax Exempt Interest from municipal bonds and tax exempt bond mutual funds. Although this interest is usually not taxed it must be reported on line 8b of Form 1040 or 1040A.

Examples of items that may or may not be included in your income are:

  • Life Insurance. If you surrender a life insurance policy for cash, you must include in income any proceeds that are more than the cost of the life insurance policy. Life insurance proceeds paid to you because of the death of the insured person are not taxable unless the policy was turned over to you for a price.
  • Scholarship or Fellowship Grant. If you are a candidate for a degree, you can exclude amounts you receive as a qualified scholarship or fellowship. Amounts used for room and board do not qualify.

All other items, unless specifically excluded by law, must be included in your income. This income may be in a form other than cash. For example:

  • Bartering. Bartering is an exchange of property or services. The fair market value of goods and services exchanged is fully taxable and must be included on Form 1040 in the income of both parties.
  • Gambling winnings- this includes lottery winnings.
  • Prizes – if you win a prize in a contest.
So, basically, if it CAN be income, it SHOULD be taxed. See this IRS publication for a more specific explanation.

Now, this seems pretty clear cut. Gifts and inheritance are NOT taxable. But the IRS is a sneaky thing and there are nuances to this rule. See PART TWO for more.

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