Unusual Income Can Complicate Taxes

BOSTON (TheStreet) -- IRS agents must be big fans of Oprah Winfrey. Over the years, the talk show queen has certainly done her part to push her fans into their arms.

Every time the soon-to-be-moving-on host surprises her studio audience with a new car or trip to Australia, the taxman at the Treasury Department gets his due.

Oprah giveth -- cars, trips to Australia and televisions -- and the taxman taketh away. After an early fumble on this front, though, the beloved talk show host made she sure waved goodbye to her own tax money instead of putting the obligation on her fans.

For most, tallying up income each tax season is relatively straightforward -- collecting W-2s and 1099s, itemizing assets and subtracting deductions. Windfalls from out-of-the-ordinary sources such as Oprah's largess, game-show prizes and even criminal activity can complicate how federal and state tax collectors eyeball your cash flow.

An annual tradition for Oprah's audiences has been her annual "Favorite Things" episodes, where a throng of audience members, so excited they're nearly speaking in tongues, collect a variety of (likely donated) luxury items, electronics and big-ticket items. Digital cameras, large-screen TVs, Blu-ray players and even cars have been given out en masse.

Back in 2004, Oprah became embroiled in what has been dubbed "Cargate" after giving away a minifleet of brand-new Pontiacs. Thrilled as audience members may have been at the time, the roughly $7,000 in gift taxes they were soon hit with must have been a hardship and unhappy surprise.

Oprah has changed her game plan, basically adjusting her prize packages so she and her company absorb the tax hit. Otherwise, a recent trip to Australia with about 300 fans would have cost them plenty.

"Most of these shows have now made a practice of grossing up the money and holding the taxpayer revenue-neutral on those gifts," says Mark Steber, chief tax officer for Jackson Hewitt Tax Service ( JTX). "There is actually an IRS equation on how to treat that so you don't get into, 'Well, I'm going to give you $10,000, but here's $15,000, and now it's $15,000, so I'll have to give you $17,000, and so on.' The equation is very specific on how you do it and what you fold into it. You can get more elaborate with the Social Security, Medicare and state elements, but the IRS has the federal element pretty much tied down in terms of how you compute that."

Oprah's employees have been in the same bind as her studio guests. This month, Oprah's media company gave all staffers a $10,000 bonus and Apple ( AAPL) iPads in monogrammed leather cases. Alas, gifts from employers need to be counted as income and are subject to income and FICA taxes -- a hit that could detract upward of a third of the perk package's value.

Giveaways such as game show and lottery prizes are never as profitable as they seem once taxes are determined at the state and federal level. And even a moderate windfall could boost the lucky into a higher tax bracket.

Game show prizes have an added headache. Let's say you win a car. At some point, the producers will send you a 1099 form to document the value of the prize. These calculations are almost always based, however, on the manufacturer's suggested retail price, a figure that may not accurately reflect what that model is being sold and bought for. Your choices: Suck it up and pay the extra or go through an appeal process to adjust the value.

"It is as much art as science," Steber says. "It is art because there is an interpretation of what the value is. There certainly is some argument there you see from time to time"

A cautionary tale for game show contestants comes from reality star Richard Hatch, the first Survivor million-dollar winner, back in 2005.

Hatch was convicted of failing to report the prize and other show-related winnings on his federal income tax returns. He would later be sentenced to 51 months in prison.

Crime does pay (taxes)
Even the underworld is expected to pay taxes on their ill-gotten gain. There are federal and state penalties for failing to report income from gambling (legal or otherwise), fraud and drug deals.

Form 1040, Line 21, and Schedule A, Line 28, of federal tax return forms are used to account for any unique gains or losses that might otherwise not be itemized elsewhere. Were you the architect of a billion-dollar Ponzi scheme? Embezzled hundreds a month from accounts receivable? Well, the IRS expects you to 'fess up to the added income (and if you choose not to, don't forget that it was tax evasion charges that brought down Al Capone).

Drug dealers are required to itemize profits from their illicit enterprise for federal income statements. Many states also require a levy in various ways.

The rationale for drug taxes dates back to 1937, where a federal crackdown on marijuana led Congress to pass an act requiring that dealers had to pay a tax that, in turn, netted them a stamp to be affixed to all sales. Failure to do so meant property and assets could be seized as part of tax collection efforts.

Over the years, though the feds abandoned the strategy, about two dozen states have deployed a similar tactic.

If they didn't have the tax stamps for their drugs, state agents seized their property and cleaned out their bank accounts until the state got whatever amount was supposedly owed.

Does anyone in this line of "work" actually play by the tax rules? Surprisingly, they do.

Tennessee's so-called "crack tax" was struck down by the state's Supreme Court in 2009 and refunds ordered for many who paid it. The legal snag was that drug dealers didn't fall within existing classifications for merchants (something the state legislature has since fixed and legal challenges in other states have been similarly resolved).

Before the decision, Tennessee had assessed a levy of $50 per gram of cocaine and $3.50 per gram of marijuana. Over the years, dealers have coughed up more than $10 million. By late last year, following the court decision, the state's Department of Revenue had refunded $3.7 million to 161 people, with payments to 2,772 others either delayed or disputed.

A big break
That song you plunked out on a piano back in college finally caught the ear of an up-and-coming singer who wants to include it on her next album. Rather than selling it as a one-shot deal, you may want to strike an arrangement in which it is bundled with other songs.

The Tax Reconciliation Act of 2005 included a piece of legislation called the "Songwriters Capital Gains Tax Equity Act" envisioned by the Nashville Songwriters Association International to benefit American songwriters who sell a song catalog. Previously, when songwriters sold a "catalog" they paid ordinary income taxes and self-employment taxes that could amount to more than 40% of their income from the sale.

The tax change makes them eligible for a flat 15% capital gains rate if they sell the royalty stream on a group of songs.

Give and take
A happy birthday may not lead to a happy tax day.

If an person gets a gift in excess of $13,000 (or $26,000, if the gift is shared between joint filers), they are on the hook for a tax bill. They can either pay taxes on the amount above this limit or apply it against their lifetime gift tax exemption -- $5 million as of this year. Also as of this year, the tax on gifts ranges from 18% on applicable gifts below $10,000 to 35% on gifts of $5.5 million.

"As a single filer, if you gave your niece a car valued at $20,000 last year, you need to decide if you want to pay taxes on the $7,000 in excess of the allowable gift tax or have that amount applied to your lifetime gift tax exemption," says Mark Luscombe, principal federal tax analyst, for CCH Group, a Wolters Kluwer business and provider of tax information and services. "Your niece owes no taxes on receiving the gift. However, if she sells it a few years from now, she owes taxes on any gain on the sale amount."

Slick move
If you got compensation after the BP oil spill in the Gulf of Mexico, you may need to pay taxes on it.

Payments received from BP ( BP), the Gulf Coast Claim Fund or the Vessels of Opportunity Program for lost business income, wages or profits are taxable, and either a 1099 or a W-2 form will be issued.

A Congressional effort to exempt this compensation failed last year.

The taxman giveth
Sometimes an unexpected windfall can come courtesy of the IRS itself.

Steber says that earlier this month, since he is chief compliance officer, a flagged return was sent to his attention. The problem: The return seemed far too high.

The filers were a retired couple who had recently adopted their four grandchildren. The father had abandoned them and the mother was dealing with her own issues in rehab.

"It seemed like a pretty simple return," Steber says. "But in the new tax changes that happened last year, there were some very favorable adoption rules put in place. By adopting a "family unit," the grandparents were classified as a "special-needs adoption," a designation that comes with a $13,00 credit per child. They also qualified for the Earned Income Credit and other child-related deductions.

"They ended up getting a refund of about $62,000 when they had very low to moderate income," Steber says. "They almost had a heart attack. That was about four times their total income for the year, all refundable, all valid and coming to those good people."

-- Written by Joe Mont in Boston.

>To contact the writer of this article, click here: Joe Mont.

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