"Free Money?" Not From Taxes!

Terrible Tax Surprises

Kay Bell (yes, the coordinator of Carnival of Taxes and operator of Don't Mess with Taxes) reminds Yahoo! Finance and Bankrate readers that five sources of income which some might consider tax-exempt are at least in part gross income and subject to taxation. Included in Kay's list are unemployment insurance (which has been subject to tax since the late 1970s), alimony received (but NOT child support received), most forgiven debt (some exceptions including a mortgage debt deduction), prize winnings (pay particular care if you receive noncash prizes like a vacation or living room furniture; often these items are promotional items from advertisers and the full retail value of the item will be listed, even if you live in a low-cost area where you could buy the item for significantly less) and Social Security winnings (if you have significant income other than social security (and in this case, $50,000 of other income is significant) up to 85% of social security received is subject to tax).

Kay's article is a good reminder that what may popularly seem true and what actually IS true sometimes varies in tax law. Soapbox time: I have big problems with the 85% layer on Social Security taxation for two reasons: [1] it increases tax complexity, [2] since the recipient paid in at least 50% of his or her contribution to Social Security, it seems unfair to make receipts 85% taxable, ESPECIALLY at the relatively low level of modified AGI where the 85% provision kicks in ($44,000 MFJ, $34,000 other).