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As many are still recovering from the Great Recession, the idea of having income (or even excess income) subject to tax is the last thing people want to think about.<\/p>\n
Generally, tax law defines income as \u201cundeniable accessions to wealth\u201d within an individual\u2019s control. Obvious items of income are: wages, salary, rents, profits, royalties, dividends, annuities, and interest, as all these items clearly increase one\u2019s wealth. But with the quirkiness of the tax law, there are a few instances where losses become income, and lawful income is exempt from taxation.<\/p>\n
Types of Income That Are Not Taxed<\/strong><\/p>\n Through legislation, Congress creates certain exemptions from Federal taxation. In particular, life insurance proceeds, disability benefits, personal injury settlements, and child support payments are all excluded from Federal income tax<\/a>.<\/p>\n In addition, certain amounts of income are excluded for subsistence living. For example, if a single filer is under age 65 and has annual gross income less than $10,000, they are not subject to Federal income tax, nor are they required to file a Federal income tax return. The IRS defines gross income<\/em> as \u201call income you receive in the form of money, goods, property, and services that is not exempt from tax.\u201d See IRS Publication 501<\/a> (Tables 1-3) for more information about filing requirements.<\/p>\n READ: 5 Tips for People Who Owe Taxes<\/a><\/p>\n Another area of great mystery in the income tax world is the treatment of gifts. If someone gives an individual money or property (while receiving nothing, or less than full value, in return), it is not considered income to the receiver. In general, the recipient is not responsible for reporting or paying tax on the gift. However, the giver is required to report and pay a gift tax<\/em> if their gift exceeds the annual exclusion of $14,000 (for 2013-2014). This annual exclusion applies to each recipient. For example, you are allowed to give each of your children up to $14,000 per year without incurring the Federal gift tax.<\/p>\n If you receive gifts from a foreign corporation or partnership, the U.S. Treasury requires you to report any gifts over $15,358. While foreigners are not subject to the gift tax, the recipient of the gift must report it if the gift exceeds the threshold amount. IRS Form 709<\/a> is used to report items that are subject to the Federal gift tax.<\/p>\n When Forgiven Debt Becomes Taxable Income<\/strong><\/p>\n Of course, there are times when Congress makes a rule that seems counterintuitive \u2014 none more bizarre than the taxation of \u201ccancellation of indebtedness income,\u201d which actually turns \u2018forgiven debt\u2019 into taxable income.\u00a0 For example, individuals who negotiate a reduction of the principle balance on their credit card are responsible for paying tax on the amount saved. You are only exempt from this taxation if you qualify as being insolvent or bankrupt. Typically, a bank will issue a Form 1099-C (Cancellation of Debt)<\/a> that will state the amount of the debt forgiven which will need to be included on an individual\u2019s income tax return.<\/p>\n When forgiven debt arises from the sale of a principal residence, it gets a bit trickier. Whether or not the loss on the mortgage will be included as income depends upon the type of mortgage you have. A non-recourse mortgage<\/em> is when a bank provides a loan that\u2019s secured only by the land and physical structure. Simply put, an individual with a non-recourse mortgage can turn the property over to the bank and have no tax consequences, even if the home is later resold for less than the original mortgage note.<\/p>\n READ: Top 10 Tax Tips If You Sell Your Home This Year<\/a><\/p>\n However, the other type of mortgage that\u2019s more common is a recourse mortgage<\/em>. In addition to being secured by the land and structure, a recourse mortgage also requires a personal guarantee. This personal guarantee gives the bank the option to pursue the homeowner if the property is sold below the mortgage balance. If the bank forgives this debt by declining to pursue the homeowner, the forgiven debt is considered taxable income to the individual. In 2007, Congress did grant a tax holiday for qualifying homeowners who had forgiven debt, but it expired at the end of 2013. So unless a homeowner with recourse debt is bankrupt or insolvent, their cancelled debt will be taxed at ordinary rates.<\/p>\n Conclusion<\/strong><\/p>\n As you can see, the definition of \u2018taxable income<\/a>\u2019 can get very complicated, given the number of exceptions to the rule. Whenever you encounter an unusual or atypical financial situation, you should always look out for the tax consequences.<\/p>\n