Avoid the Gambling Winnings Tax Surprise

With the increased popularity of lotteries and casinos, more unsuspecting winners are experiencing a lucky payday only to end up with a huge tax head-ache when filing their income taxes. Here is what you need to know:

Look for the warning signs

You are required to report as income any winnings you receive including, but not limited to:

• slot machines • bingo • pull tabs • horse/dog racing
• game shows • raffles • lottery • gambling (e.g. cards, roulette)

The winnings could be in cash, but also includes the fair market value of prizes such as a car, boat or vacation package. When you win the payer is required to give you a Form W-2G. Receipt of this form should be your clear signal that you have a taxable event.

How the tax math works

Unlike a business, gambling winnings are reported on one part of your tax return while any offsetting gambling losses are reported as a miscellaneous itemized deduction. In plain English, this means:

  • Your income is increased by the amounts listed on W-2Gs and any other winnings you had during the year.
  • If you do not itemize, you cannot deduct any gambling losses during the year.
  • If you do itemize, you must be able to substantiate any gambling losses with an accurate diary, receipts, tickets, statements and other records.
  • You may never deduct more in losses than winnings.

Some tips

  • Merchandise. If you win a non-cash item, make sure you agree with the market value attributed to the item won. Often the item is overstated by the game organizer as a promotional technique. Ask to see a copy of the invoice that the organizer actually paid for the item. Consider printing out a dated copy of an advertisement of a similar item that is offered for less money.
  • Losses. Losses do not need to match winnings for time and date. You may play bingo all year long at a locally hosted charitable bingo hall, but only win the big payout once during the year. You can offset all your losses against this one win, as long as you have accurate records.
  • Casino assistance. When you win at a casino ask them for help. They often can help you understand and record your costs/losses. Consider joining the casino’s player’s club. With it they will send you a winning/loss statement at the end of each year.
  • Tax withholdings. Consider withholding some of your winnings to pay for your federal and state tax obligation. This will help reduce the sting on tax day. Also consider submitting quarterly estimated tax payments.
  • Professionals. If you consider yourself a professional gambler, business tax rules apply. But make sure this consideration is a defensible position in the eyes of the IRS. The IRS often challenges professional gamblers that attempt to take more in expense than they earn in winnings.
  • Reselling merchandise. A special caution if you win an item and then resell it. Using a new car as an example, say you don’t need the car so you sell it for $25,000. You could find your W-2G has a market value of $30,000. In this case you would have $30,000 in taxable income, but only received $25,000. Your personal loss is not a tax deductible item.
  • Is there good news? Yes, gambling losses cannot be reduced at the federal level if you are subject to the Alternative Minimum Tax (AMT) or if you are subject to the reinstated itemized deduction phase-out.

Five Big Tax Mistakes Don’t let them happen to you

Every year taxpayers are hit with tax surprises that could be avoided if they just knew the rules. Here are five big ones that are easy to avoid with some simple planning.

Mistake #1. Withholding too little. This results in a tax surprise when filing your income tax. Don’t be too hard on yourself if this happens to you. Social Security withholdings have changed each year and new tax laws in 2013 make it very difficult to withhold the proper amount from each paycheck.

The plan: Check your withholdings after filing each year’s taxes. Make adjustments as necessary by filing a new W-4 with your employer.

Mistake #2. Inadvertently withdrawing funds from retirement plans. Amounts taken out of pre-tax retirement plans like 401(k)s and IRA’s can create taxable income. The most common inadvertent withdrawal occurs when you roll over funds from one retirement plan to another. If done incorrectly all the rollover could be deemed taxable income.

The plan: Do not touch your retirement accounts if at all possible (Exception: when you reach age 70 ½ you may be subject to Required Minimum Distribution rules). If you do withdraw funds, ensure you have the proper withholdings taken out at time of withdrawal. Direct rollovers into your new plan are always a better alternative than receiving the withdrawal from the plan administrator and then conducting the transfer yourself.

Mistake #3. Not taking advantage of tax-deferred retirement programs. There are numerous opportunities to shelter income from tax through tax preferred retirement programs.

The plan: Review your retirement savings options and plan to contribute as much as possible to your plans. Pay special attention to plans that include an employee match component. This attention can reduce your taxable income each year.

Mistake #4. Direct deposit mix-ups. You may now have tax refunds directly deposited in up to three bank accounts. The problem: what if one of the account numbers is entered incorrectly? Unfortunately, unlike replacing a lost check, the IRS does not have a good means of correcting this type of error. There have been instances where taxpayers have lost their refund when this occurs.

The plan: Many taxpayers do not feel comfortable giving the IRS direct access to their bank account. If you are in this camp, the digital deposit problem is solved. If you use direct deposit, avoid depositing your refund into more than one account. Ideally have a second person double check the account number on your tax form prior to submitting the return.

Mistake #5. Not keeping correct documentation. You know you drove the miles, donated the items to charity, had the medical expense, and paid the daycare. How can the IRS be disallowing your valid deductions? Remember without correct documentation the IRS is quick to disallow them.

The plan: Set up good recordkeeping habits at the beginning of each year. Create both a digital and paper folder separated by income and expense type. Keep a mileage log and properly document your charitable contributions.

Business Capital Expending Good or bad decision?

As a reminder, businesses may accelerate the expensing of qualified capital purchases. This can be done within two special provisions in the tax code.

Section 179

The American Taxpayer Relief Act of 2012 extends the annual $500,000 amount of qualified assets that may be expensed (instead of depreciated) for 2013. This benefit can be maximized as long as total assets purchased by your firm does not exceed $2 million. Qualified purchases can be new or used equipment and qualified software placed in service during the year.

Bonus Depreciation

The recent tax law also extends an additional first-year bonus depreciation of 50% of the cost of qualified property. To qualify the property must be purchased and placed in service after 1/31/2012 and before 1/1/2014. For property to qualify it must be “original use” property. This typically means new property. Not interested in accelerating your depreciation expense? Then you may choose to opt out of this provision for each category (class) of property you place in service.

What should you do?

So is taking advantage of these provisions good for your business? Not always.

Remember if you use these special asset “expensing” provisions, depreciation expense taken this year is given up in future years. This is especially important to plan for if your company is organized as a “flow through” entity like an S-Corporation as more income could be exposed to higher marginal tax brackets in a number of future years. How many future years? It depends on the recovery period of the asset, but the additional tax exposure could be from two to six years!

More importantly, if you think Congress will increase tax rates to help balance the budget, your future income may be exposed to a higher tax rate than your current income.

If you have some predictability in your business, it probably makes sense to forecast your projected pre-tax earnings with and without the accelerated depreciation to ensure you are making the right tax decision over the long-term.

IRS Notices with Interest Calculation Error IRS to send out special mailings

Noted here is a copy of a recent interest error calculation announcement made by the IRS. If you recently received a form CP2000 from the IRS please be aware an adjusted, higher interest amount may be owed.

The IRS alerted taxpayers and tax professionals about an interest calculation error on certain notices mailed the weeks of July 1 and July 8.

The IRS discovered errors in the CP2000 notices during a two-week period this July. The notices contained an incorrect calculation on the interest owed on proposed taxes from under reported income. The interest figures were lower than they should be. The IRS has corrected the issue for future mailings.

Later this month, the IRS will be sending a special mailing to the recipients of the notices. Taxpayers should follow the directions on the letter, and they will be encouraged to either call a special toll-free number or write to the IRS to receive the corrected interest amount.

A CP2000 notice shows proposed changes to income tax returns based on a comparison of the income, payments, credits and deductions reported on a tax return with information reported by employers, banks, businesses and other payers. The CP2000 also reflects any corrections made to an original tax return during processing.

Source: IRS.gov

Should you Reduce Your Charitable Giving?

New itemized deduction phase-out causing concern

In 2013 federal tax legislation reintroduces the phase-out of itemized deductions for certain taxpayers. Because of this, many who are subject to itemized deduction phase-outs wonder if the benefit of charitable giving is reduced. Here is what you need to know.

Most taxpayers are not impacted. The phase-out of itemized deductions for 2013 is based on Adjusted Gross Income (AGI) in excess of $250,000 for single filers, $300,000 for joint filers ($150,000 for married filing single), and $275,000 for head of household. So if your income is below these amounts your itemized deductions will not be reduced because of the new phase-out rules.
Alternative Minimum Tax (AMT) does not impact charitable giving. If you have been subject to the AMT in the past, please note that charitable giving generally does not impact this alternative tax calculation. Other things like state taxes and property taxes are a couple of items that do impact this alternative tax calculation.
The phase-out calculation is based on income not deductions. This means that unless you are in a low or no tax state your charitable deductions will probably not be impacted by the deduction phase-out. Why? The itemized deduction phase-out amount is based upon your income. Say, for example, the phase-out calculation will reduce your itemized deductions by $8,000. Income required to produce this phase-out amount will also generate state taxes in most states in excess of this amount. Therefore the phase-out reduction will almost always be absorbed by your state income taxes.
Are there cases when the phase-out will eat up a lot of your charitable giving? Yes, especially in no or low tax states. Because of this risk it is a good idea to review the phase-out impact on your situation as soon as possible. Otherwise, you might be foregoing an opportunity to reduce your tax liability this year with planned charitable giving.