Tax season begins in just a few months, which means there's precious little time left to prevent unwelcome tax surprises next April. For many people, the blow comes when they find out they have to report income they thought wasn't taxable — and then have to come up with money to pay taxes on it.
Here are four kinds of income that people routinely think they don't have to report, tax pros say, plus tips on how to do things, such as spreading out estimated tax payments, to avoid the related sticker shock when they file returns.
The surprise: A lender settles or forgives all or part of your loan or credit card balance, and in return you get a bigger-than-expected tax bill.
Why it happens: Generally, in the eyes of the IRS, getting debt forgiveness is the same as receiving cash. Typically, the lender will send you — and the IRS — a Form 1099-C, which reports how much of your debt was forgiven and thus what you might need to report as income, says Rick Norris, a certified public accountant in Los Angeles.
How to avoid sticker shock: Know the rules before you agree to any settlement or forgiveness. In some cases, the IRS doesn't make you report forgiven debt as income. Bankruptcy, certain types of student loans and the mortgage on your main home are examples of potential exceptions, but there are others.
The surprise: You collect unemployment from the state to help put food on the table after a layoff, but then the IRS takes a bite of its own.
Why it happens: Government unemployment benefits are taxable income. You'll get a Form 1099-G from the payer that shows how much you received. A copy goes to the IRS, too.
How to avoid sticker shock: Make quarterly estimated tax payments or have the payer withhold taxes on your unemployment checks. "This way you're not going to get killed at the end of the year. That helps a lot," Norris says.
Proceeds from a fundraising website
The surprise: You start an online campaign to raise money for someone. The IRS then sends you a thank-you note of its own.
Why it happens: If the online campaign account is in your name and it receives $20,000 or more from at least 200 transactions, the campaign platform's payment processor may send you and the IRS a Form 1099-K showing what was collected. That could be reportable income depending on what the money is for, says Marianela Collado, a CPA at Tobias Financial Advisors in Plantation, Florida.
How to avoid sticker shock: "Try to direct those funds to be issued to the intended beneficiary so you're not the one getting the 1099-K," she says. Ask the campaign platform how to do it.
Disability insurance benefits
The surprise: You get hurt, and then the payments from your disability insurance policy end up hurting your wallet.
Why it happens: Disability insurance benefits can be treated as income depending on how you paid for the policy. "Normally it's not taxable (income) if you pay the disability premiums with after-tax dollars," Collado says. But if you paid for the policy with pretax dollars — as many people do if their employers offer disability insurance — you could end up owing taxes on the benefits if you make a claim.
How to avoid sticker shock: Have the insurance company withhold taxes on your payments, or make estimated tax payments yourself. Also, look carefully at the paperwork if you're signing up for disability insurance at work, and think about whether you're paying the premiums with after-tax dollars. "Otherwise, the disability benefits become taxable," Collado says. Instead, you could make estimated tax payments yourself. Or you could purchase the policy on your own.