Other Income
All income in the form of money, property, and services must be included on a tax return unless specifically excluded. In Chapters 12 and 18 of Publication 17 chapters, with some elaboration in this section, many different kinds of income are presented. On Form 1040, these items would be reported on the “Other Income” line (use of the 1040A is not an option when reporting other income).
Alimony payments are taxable income to the person receiving the payments and deductible by the individual making the payments. The term “alimony,” for income tax purposes, includes separate maintenance payments or similar periodic payments made to a spouse or former spouse. Payments must meet certain requirements to be considered alimony. These requirements depend on whether the divorce or separation agreement was executed before 1985 or after 1984.
For divorce agreements executed after 1984, alimony and property settlements are subject to a different set of rules. The definition of alimony, sometimes referred to as family support, is more certain under these new provisions. Deductible alimony payments are no longer required to be in settlement of an obligation under local law, nor must they be periodic.
Disguised child support payments may not be treated as alimony. Payments contingent on the status of a child (e.g., age or marital status of the child) are not considered alimony.
Example
Under a divorce agreement, Mike agrees to pay his former spouse, Meg, $1,500 per month. The payments meet all the tests for classification as alimony, but they will be reduced to $500 per month when their child, in Meg’s custody, becomes 18 years of age. In this situation, $1,000 of each payment must be treated as nondeductible child support and cannot be considered alimony.
Child support payments are not deductible by the taxpayer making them, nor are they income to the recipient. However, they may be an important factor in determining which spouse is entitled to claim the dependency exemption for the child (see Chapter 2, The Federal Income Tax Return). Child support payments must be up to date before any amount paid may be treated as alimony. That is, if a taxpayer is obligated to pay both child support and alimony, he or she must first meet the child support obligation before obtaining a deduction for alimony payments. Payments for child support include payments designated as such in the divorce settlement agreement, plus any alimony payments that are contingent upon the status of a child.
Example
Leo is required under a divorce decree to pay $300 alimony and $450 child support per month. Since the decree separately states that $450 is child support, only $300 per month is deductible by Leo and counts as income to his ex-wife.
Gifts and inheritances are excluded from income. The income received from the property after the transfer is taxable. Normally, the gift tax or estate tax is paid by the donor or the decedent’s estate; such property is therefore usually tax free to the person receiving the gift or inheritance.
Example
In January of the current year Kathy inherits shares of Buchanan Corporation stock worth $19,000. After receiving the stock, she receives $938 in dividends during the current year. Her gross income from the inheritance in the current year would be $938. The $19,000 fair market value of the stock is excluded from gross income.
A problem that may arise concerning a giftgiftA voluntary transfer of property without adequate consideration. is the definition of what constitutes a gift. The courts define a gift as a voluntary transfer of property without adequate consideration. Gifts made in a business setting are suspect since they may be disguised payments for goods or services. The courts are likely to rule that gifts in a business setting are taxable income, even if there was no obligation to make the payment. Also, if the recipient provides services for the gift, it will be presumed to be income for the services performed.
Example
Sarah provides her friend and CEO of Jefferson Medical, Karen, with a list of names of potential buyers of medical equipment. Karen “gives” Sarah an all expense paid trip to Cabo, Mexico. There was no contract or requirement on Karen to provide anything to Sarah. The fair market value of the trip would be income to Sarah because of the business nature of the exchange.
Prizes and awards are taxable income to the recipient. Winnings from television or radio shows, door prizes, lotteries, and other contest winnings are income to taxpayers. In addition, all other awards are generally taxable, even if they are awards given for accomplishments and with no action on the part of the taxpayer. If the prize or award is received in property instead of cash, the fair market value of the property is included in the taxpayer’s income. Taxpayers may refuse a prize and exclude its value from income.
An exception is provided for certain employee achievement awards in the form of tangible personal property, such as a gold watch. If the award is made in recognition of length of service or safety achievement, the value of the property may be excluded from income. Generally, the maximum amount excludable is $400. However, if the award is a “qualified plan award” (employers can get their plans qualified), the maximum exclusion is increased to $1,600.
Example
Sandi enters a drawing and wins a new HDTV with an MSRP (manufacturer’s suggested retail price) of $4,325. The fair market value of the prize should be included in Sandi’s gross income. If Sandi advertised the HDTV and then accepted $3,900 from a complete stranger, she would include in income the $3,900 less any cost for advertising.
Scholarships are usually excludable. A scholarshipscholarshipAmount paid or awarded to, or for the benefit of, a student to aid the student in the pursuit of his or her studies. is an amount paid or awarded to, or for the benefit of, a student to aid the student in the pursuit of his or her studies. Scholarships granted to degree candidates are taxable income, with the exception of amounts spent for tuition, fees, books, and course-required supplies and equipment. Therefore, scholarship amounts received for such items as room and board are taxable to the recipient.
Example
Lisbeth receives a $3,000 scholarship to study psychology at Sacramento State. Her expenses for tuition, fees, and books amount to $1,900 during the fall semester; therefore, she would have taxable income of $1,100 ($3,000 − 1,900) from the scholarship.
Payments received by students for part-time employment are taxable as compensation. For example, students in work-study programs must include their compensation in gross income.
Unemployment compensation payments are fully taxable.
Example
Tony was unemployed for several months during the year and received unemployment compensation of $4,000. The entire $4,000 is included in Tony’s taxable income for the year.
Go to Publication 17 and read Chapter 12: Other Income. Go to Publication 17 and read Chapter 18: Alimony.
Problems
Under a divorce agreement, Brie is required to pay her ex-husband, Carl, $900 a month until their son is 18 years of age. At that time, the required payments are reduced to $300 per month.
How much of each $900 payment may be deducted as alimony by Brie? $__________
How much of each $900 payment must be included in Carl’s taxable income? $__________
Under the terms of a property settlement, Deanna transferred property worth $350,000 to her ex-husband, Hans. The property has a tax basis to Deanna of $200,000. What amount does Hans report as income? $__________
In each of the following independent cases, how much should be reported as income?
Brienna won a $5,000 Spirit of America award. $__________
Christel won a new motorcycle with a Manufacturer’s Suggested Retail Price of $9,750. She sold it through a newspaper ad for $8,000. $__________
Deb received a $2,500 room and board scholarship to attend UC-Davis. $__________
Klaus was unemployed for a few months during the year. He received $3,100 in unemployment compensation payments. How much of the unemployment compensation payments must be included in gross income? $__________
