Twitter recently lit up with a post reminding taxpayers to report income from illegal activities. Some users couldn’t believe it was real. But the statement, which is not new, is in Publication of SRI 17, which notes that “income from illegal activities, such as money from trafficking illegal drugs, must be included in your income…”
You will find the same language in IRS Publication 525.
Authority for reporting is in the tax code Section 61, which clarifies that “gross income means all income from whatever source”, unless otherwise excluded. That’s a pretty high bar and the starting point for our entire tax system.
And while it seems a little odd to require taxpayers to report income from a crime, it’s a law that has been upheld by the courts. In United States vs. Sullivan, the United States Supreme Court has ruled that fear of self-incrimination is no excuse for not reporting, with Justice Holmes writing: “We see no reason to doubt the interpretation of the law, nor any reason why the fact that a business is illegal should exempt from paying the taxes it would have to pay if they were lawful.
Sullivan was to prove crucial a few years later, when, in 1931, Al Capone was sentenced to prison for tax evasion. Capone, who made millions from bootleg liquor, gambling halls and other crimes of the time, reportedly boasted, “The government can’t levy legal taxes on illegal money .
What is taxable?
Not sure what else you need to report? Here are four more surprising sources of taxable income for federal tax purposes.
Found money. If you find and keep property that is not yours and has been lost or abandoned, sometimes called “treasure”, the property is taxable to you. It is taxable at fair market value the first year you establish ownership. .
The rule has been in the books for decades. Rev. Rul. 61, 1953-1, Cum. Bull. 17 confirmed that “the treasure finder receives taxable income, for federal income tax purposes, to the extent of its value in U.S. currency, for the tax year in which it is reduced to an undisputed possession”. The guidelines were formally tested in court in 1969 in Cesarini v USA— today, found money is generally considered ordinary income.
Unemployment benefits. All states provide benefits to eligible unemployed workers. Benefits paid under these plans are generally considered compensation for federal income tax purposes. This makes sense – unemployment benefits are seen as a replacement for taxable wages.
Unemployment compensation is reported to taxpayers on Form 1099-G. If this form sounds familiar, Form 1099-G is used to report many types of government payments, including state tax refunds.
It was the case only for the tax year 2020, people with an adjusted gross income of less than $150,000 could exclude up to $10,200 in unemployment benefits from gross income. However, under current law, there is no exclusion, which means that unemployment benefit received in 2021 and 2022 is taxable.
Canceled debt. Getting rid of a debt by having it written off seems like a big win, but if your debt is canceled for less than the amount you owe, the amount of the canceled debt may be taxable. This means that you must report the canceled debt as income, unless an exclusion applies. The most common exclusions include bankruptcy, insolvency, and qualifying principal residence debt.
If your debt is paid for less than you owe — and that amount is $600 or more — you may receive Form 1099-C. This usually happens when the creditor determines that you can’t or won’t pay what you owe. Examples include when you enter into an agreement with a credit card company to pay a reduced amount to close the account, or following a seizure or repossession. The difference between what you owe and what you pay is considered income, again assuming you don’t qualify for an exclusion.
Even if you qualify for an exclusion, you may still receive Form 1099-C because the creditor may not know your situation. However, if the creditor has reason to know that canceling the debt would not be taxable, for example due to bankruptcy, Form 1099-C should not be issued.
Lottery winnings. Lottery winnings are treated as gambling winnings, which means that for federal purposes they are taxed as ordinary income. This is true whether you receive your payment as a lump sum or as an annuity. This is also the case if you win a non-monetary prize, such as a car or a house.
Winnings are usually reported on Form W-2G and are subject to 24% withholding if the amount is over $5,000. If you owe more tax, you’ll pay the difference at tax time, and if you owe less, any excess will be refunded to you.
What is not taxable?
So it turns out that a lot of things are taxable. But all is not dark and catastrophic. Remember when I said income is taxable unless otherwise excluded? These exclusions do exist. Here are five examples of money that could end up in your pocket that isn’t taxable.
Gifts and estates. Property you receive as a gift or inheritance is generally not included in your taxable income. However, keep in mind that the tax features of the gift or inheritance will generally remain in place. So if your dad gives you $100 worth of stock as a gift, the $100 isn’t taxable to you for federal purposes, but any dividends he generates — or gains on the sale — would be taxable. Some exceptions may apply – the SECURE Act, for example, changed the way pension assets can be taxed after death.
Alimony. Child support is completely tax neutral, meaning there are no deductions to make the payment and it is not taxable to the recipient.
Sale of your house. You can exclude the gain from the sale of your home — up to $250,000 for single taxpayers and $500,000 for married taxpayers — as long as you qualify. To be eligible, the house must be your primary residence and you must have owned and lived in the house for two of the five years prior to the sale.
Life insurance. Life insurance proceeds paid after the death of the insured are generally not taxable. However, as with gifts and inheritances, all tax features associated with the proceeds remain in place, meaning, for example, interest income received as a result of life insurance proceeds may be taxable.
Short term rental income. If you rent your personal residence less than 15 days per year, you do not need to report the rental income for federal income tax purposes. You also cannot deduct the corresponding rental expenses.
Remember that this is a quick overview of what is taxable and what is not. The tax code is made up of over a million words…and that’s before adding regulations and case law. There is plenty of room for exceptions, exemptions and nuances. If you have any questions, it’s always a good idea to check with a tax professional.
This is a weekly column from Kelly Phillips Erb, the Taxgirl. Erb offers commentary on the latest tax news, tax law and tax policy. Look for Erb’s column each week in Bloomberg Tax and follow her on Twitter at @taxgirl.