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Pop Quiz! Taxable or Not Taxable?

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There are a number of areas in the tax code that cause confusion as to the taxability of money received. Some of these items may surprise you.

Unemployment compensation. Unemployment compensation is typically required to be reported as taxable income. Because of the pandemic, millions of taxpayers could now be facing a tax surprise with their unemployment income. There are historic cases where federal and state taxing authorities are authorized to exempt unemployment income from taxation, so this is an area worth watching for possible future legislation.

Free services. Receiving free services is almost always taxable as ordinary income under IRS barter regulations. You should report the fair market value of services received as income on your tax return. If you exchange services, you can deduct allowable business expenses against the value of the services provided. So if you are trading goods or services, now is the time to be tracking this information.

Illegal activities. Even income received from illegal activities is taxable income and must be reported. The IRS even states that stolen items should be reported at the fair market value on the date the thief stole the item.

Jury duty pay. This is taxable as ordinary income. Yes, even doing your civic duty can be a taxable event.

Legal settlements. A general rule of thumb with legal settlements is to consider what the settlement replaces. If the settlement replaces a taxable item, like lost wages, the settlement often creates taxable income. This area is complex and often requires a detailed review.

Some life insurance proceeds. Life insurance proceeds paid to you because of the death of an insured are generally not taxable. There are, however, a number of exceptions to this general rule. For example, you could have taxable income if you receive benefits in installments above the value of the life insurance policy at time of death.

Prizes. Most prizes received should be reported as ordinary income using the fair market value of the item received. This area has been a major surprise to contestants on game shows, along with celebrities who have received large gifts at events like the Academy Awards. The taxable prizes category would also include travel or trips awarded through an employer as an incentive.

Alimony. Alimony is taxable to the person who receives it and deductible to the person who pays it for divorce decrees prior to 2019. For all divorces finalized after 2018, alimony is neither deductible by the person who paid it nor deemed additional income by the person receiving it. Be aware of these new rules if you are considering a change to old divorce decrees. Make sure you have proper documentation as part of a divorce decree to support your tax position.

Child support. Child support is not taxable to the person who receives it on behalf of the dependent. It is also not deductible for the person who pays it.

Some of these areas can be complicated, so please call to discuss if any of these situations apply to you.

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Andrea L. Blackwelder, CFP®, ChFC, CDFA® and Joseph D. Clemens, CFP®, EA are the founders and partners of Wisdom Wealth Strategies. Their shared passion is simple: to bring financial empowerment, understanding, and peace-of mind to people who wish to improve their financial future, build wealth for their families, and achieve financial independence. Click here to find out more about how you can work with the Denver Financial Advisors at Wisdom Wealth Strategies.

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